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    Untitled Document

    The future of exports

    US oil boom fuels debate over decades old ban on exporting domestic crude

    Steven Farkas, Manatt, Phelps & Phillips LLP

    The future of exports

    The decades old ban on exporting domestic crude oil is under review by the Obama administration in light of radical changes in domestic oil production brought about by fracking and other advanced drilling technologies. The recent increase in domestic production has created a potential supply glut, benefiting some segments of the oil industry while limiting the possible upside for oil producers. Proponents of lifting the ban on crude exports argue that such a reversal will benefit domestic consumers and will ensure that producers continue to maximize production from new domestic shale deposits, while those opposed to lifting the ban argue that keeping the export prohibition in place is the only way to protect US consumers from international oil pricing that in the past has led to domestic upheaval.

    The US ban on crude exports originated almost four decades ago when Congress passed the Energy Policy and Conservation Act (EPCA) of 1975, designed to minimize the impacts of future oil embargos by oil producing nations. Lawmakers believed that national security would be enhanced by limiting the foreign exports of crude oil and natural gas. The law grants the President authority to establish rules prohibiting the export of crude oil and natural gas, but also gives the President authority to grant exemptions to the ban under certain circumstances. Subsequent legislation, including the Mineral Leasing Act, the Naval Petroleum Reserve Production Act, the Outer Continental Shelf Lands Act and the Export Administration Act of 1979 (among others), provided further restrictions and exemptions to the ban.

    Those arguing in favor of lifting the ban believe that in light of the recent boom in domestic oil production, prohibiting the export of crude oil will actually harm long term national security, defeating the original purpose of the ban. If oil producers cannot sell crude on the international market at higher international prices, the recent boom in oil production might come to a premature end driven by artificial uneconomic conditions resulting from an oversupplied domestic crude market.

    Opponents of the export ban argue that existing US refineries are unable to handle the new supply of lighter grade crude oil coming from Montana and the Dakotas, resulting in a glut and a lower domestic price for this crude. As noted by one of the authors of a new report by IHS Energy, a report sponsored by major oil and oilfield service companies, the existing ban on crude exports is threatening to create "gridlock" in the industry because existing coastal refineries are configured to process heavier sour crude imported from Mexico, Venezuela, and other locations, and do not have the capacity to process the ever increasing supply of lighter crude coming from new domestic production. The existing oversupply of crude results in a discounted price for West Texas Intermediate crude or Louisiana Sweet crude relative to the internationally traded Brent crude. The discounted domestic crude price benefits purchasers of crude, like independent refiners and some manufacturers, but can put financial pressures on US oil producers, making future development projects infeasible. The IHS report concludes that lifting the export ban would result in an increase in domestic crude production from the 8.2 million barrels per day currently produced to 11.2 million barrels per day by 2022 and would boost global oil supplies resulting in lower global oil prices that will translate into lower gasoline prices in the US (estimated to be an 8 cent per gallon decrease in the price of gasoline and other transportation fuels).

    Those in favor of keeping the ban in place, including refiners, manufacturers, and consumer advocacy groups, do not believe that decreased domestic product prices will result from increases in international crude supply. Over the four decades that the ban has been in place, supply has been only one of many factors that established the price of international crude. Growing demand for fossil fuels in rapidly developing countries could quickly consume any extra crude added to supply by the US, resulting in tight demand and no drop in international crude pricing. Those opposed to lifting the ban maintain that removing this prohibition will only benefit oil producers and will increase domestic crude oil prices.

    Some of the most strident opponents to a change in US policy are independent refiners. Major independent refiners such as Valero, as well as numerous small independent refining companies, have publicly opposed lifting the ban, believing that domestic crude price increases will harm refining margins. The policy battle between independent refiners and oil producers appears to be less about equalizing world crude oil prices than it is about which sector of the energy industry should benefit from exports. Some opponents of the ban argue that as long as export prohibitions remain in place only finished products can be exported, which benefits independent refiners that buy domestic crude at discounted prices and then export finished products to the global market at a premium. If the ban is lifted, a portion of the export premium now paid to independent refiners will instead go to oil producers. A reduction in the export of finished products, combined with a possible increase in the cost of crude oil, will further shrink refining margins, putting the long term survivability of many small refining companies at risk. According to the Energy Information Administration, exports of gasoline, diesel and other petroleum products reached a record 4.3 billion barrels a day last December, more than twice the 2.1 million barrels daily average last year. In addition, the average daily export of petroleum products reached 3.5 million barrels a day in 2013, double the export numbers from five years ago.

    "The policy battle between independent
    "The policy battle between independent
    refiners and oil producers appears to be
    less about equalizing world crude oil prices
    than it is about which sector of the energy
    industry should benefit from exports."

    While the debate over lifting the export ban continues, the US oil industry has created an investment boom in unsophisticated oil refineries along the Gulf of Mexico as one way around current US policy. These unsophisticated refineries, sometimes referred to as condensate splitters, turn the lighter ends of crude oil into exportable products, such as naphtha, which are not subject to the ban. Splitters process crude that would otherwise create a domestic glut, but also allow oil companies to increase sales of petroleum products into the premium international market. Besides a splitter currently running at Port Arthur Texas, eight companies have announced plans to build new splitters for a total investment of over one billion dollars. Valero is also building topping units at its Texas refineries to serve the same purpose. Kinder Morgan is building a $360 million, 100,000 barrel a day splitter that BP will use when opened in November. Some industry experts estimate that by constructing splitters, US refineries can process an additional 800,000 barrels of crude per day, alleviating some of the potential domestic glut of crude oil.

    John Podesta, one of the Obama administration's senior advisors, recently stated that an active review of the strains caused by the US shale oil boom is underway with the ban on crude exports being one of the topics under review. This statement was seen by some as a softening of the administration's position on upholding the ban and members of Congress representing oil producing states continue to increase pressure on the administration to lift the ban as soon as possible. Although it is too early to tell what if any changes to the export ban will be recommended by the administration, recent investment decisions by the oil industry suggest that insiders believe the ban's prohibitions will be relaxed sometime in the future. For example, the splitter refineries under construction in the Gulf would be unnecessary if the crude oil ban were to be lifted. It has been reported that one company planning to construct a splitter refinery in Corpus Christi, Texas, in partnership with a major integrated oil company has halved the size of its proposed facility and has slowed the project down based on the belief that the ban will be lifted sooner than later. Shipping operators also believe that the ban will be lifted soon and the tanker industry has embarked on a construction boom. Orders for new, very large crude carriers have gone from three in 2011 to 47 in 2013. Ship operators have already ordered 18 of these tankers in the first quarter of 2014.

    Restrictions on the sale of natural gas are administered by the Department of Energy and are less restrictive than the rules governing the crude oil ban which are administered by the Department of Commerce. As a result of these less restrictive rules, the Obama administration and natural gas producers have agreed to modify the ban in a piecemeal fashion. Instead of lifting the ban on natural gas exports, the Department of Energy has conditionally approved, on an application basis, the construction of six separate terminal facilities allowing for the shipment of natural gas beyond the continental US, with additional applications pending.

    Earlier this year, proponents of lifting the crude oil ban argued that Russia's energy stranglehold over Europe could be lessened if restrictions on the export of oil and natural gas were lifted. As the crisis in Ukraine faded from the headlines, justifications for lifting the ban were based on the simple economic theory that increased international crude supply will lead to decreased prices in domestic gasoline and other petroleum products. This simple analysis ignores international political factors that continue to influence crude supply and price. What is universally agreed upon is that the recent US oil boom from shale production has created a surplus of light crude that cannot be refined by existing US refining capacity. A piecemeal approach to lifting the ban, like that used for lifting the ban on natural gas exports, will lessen any immediate impacts of the policy change, and will allow regulators to evaluate how exports of domestic crude impact national security and domestic crude and product prices.

    About the author

    Steven Farkas is of counsel in the Los Angeles office of law firm Manatt, Phelps & Phillips LLP. With nearly 25 years of experience working in-house for petroleum companies, he has handled the full array of issues that confront the heavily regulated industry. Farkas has advised on numerous asset sales and acquisitions, environmental compliance matters, investigations and enforcement actions.

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