Another paper, “Exports: Last Demand Standing,” has claimed the U.S. crude market has reached its “proverbial wall” and only crude exports can save the industry. There frequently is a grain of truth in such studies, but the market is broader and more complex than this report implies. The grain of truth is that there is too much supply relative to demand, NOT claims that domestic refiners have maxed out their ability to use domestic crude oil. In fact, the problem is not just in the U.S. This is a world problem.
As world oversupply has grown, a contango market developed. A contango market is simply one in which prices in future months are higher than today’s spot markets. Even international Brent crude futures are in contango. What crude producer would want to sell their crude $5 less today than they can get in October as long as they have a place to store their oil? In fact, even if crude exports were allowed, we would have expected large stock builds in the U.S. As RBN pointed out, Cushing, OK is the largest commercial storage area in the Midwest, which is where much of the very light tight oil being produced is gathered, and since it is the delivery point for the WTI futures contract, it is well suited for traders to profit from contango storage trades. It is no surprise that inventories here built much more than elsewhere, even when pipeline space was available to move these volumes to the coast.
The report is misinterpreting today’s contango situation for the longer-term “refinery saturation” problem. It ignores the fact that while inventories have continued to build to record levels in 2015, prices have not fallen further, and in fact the gap between WTI and Brent narrowed recently. (Louisiana Light Sweet crude stays in parity with Brent.) The WTI spot price averaged about $47/barrel in January, and was actually up to about $50/barrel in the first week of April as inventories climbed.
The U.S. built much storage in Cushing to accommodate growing production, but after new pipelines opened, many of those tanks were drained until the recent contango market evolved. Much of the current inventory build is likely crude that has been committed to future use and is not available for spot sales. As a result, it is not weighing on the market as heavily as one might expect from inventory levels alone. This cannot continue forever, and market forces will come into play at some point to end the contango storage builds. But this is not the refinery saturation problem.
The recent report also postulates U.S. refiners’ use of domestic crude oil based on qualitative arguments and an assumption of refinery inflexibility that have been shown not to be correct. AFPM’s recent survey of U.S. refiners illustrates that this year, a subset of the industry representing 61% percent of U.S. refining capacity plans to increase its use of U.S. light tight oil by over 420 thousand barrels per day (KB/D) from 2014. This same subset is planning another 310 KB/D increase in 2016. In other words, this sample set of refiners will increase their ability to process light, tight crude oil by over 730 KB/D through 2016. The Energy Information Administration’s (EIA) April forecast is projecting increases in total lower 48 production of only 440 KB/D through 2016 . Furthermore, these same refiners will be reducing imports not just of light sweet crude oil as discussed in the report, but also of medium crude oil to accommodate the increasing U.S. production. Refiners have made and continue to make investments to use growing U.S. volumes.
With storage availability in the U.S. there has been no need for many U.S. producers to sell at today’s low prices, and at the same time, refiners have been able to buy crude oil – both domestic and imports at today’s low prices. Drawing down world inventories (including U.S.) will not happen quickly, even though signs of stronger demand should help. The “proverbial wall” in this case is a world demand wall. U.S. refiners are able to process substantially more volumes of U.S. light tight oil, and exports are not the salvation for U.S. producers in this specific situation.