The Fuse

Citi Analyst: No Market Rationale for U.S. Crude Exports

by Matt Piotrowski | October 06, 2015

There’s no market rationale for U.S. producers to export crude oil, now that the Atlantic basin is glutted with supply and the differential between U.S. benchmark West Texas Intermediate (WTI) and European marker Brent has narrowed. In fact, more oil sent into the Atlantic market would further weaken prices, for both Brent and WTI, undermining the purpose behind lobbying for a lifting of the ban on exports, said Seth Kleinman, the Global Head of Energy Strategy at Citi Group, on Tuesday at the 2015 Winter Energy Outlook Conference in Washington, DC.

Those seeking repeal of the export ban “should be careful what they wish for,” given that volumes shipped from the U.S. would “just kick more into the Atlantic basin” and hurt prices.

Those seeking repeal of the export ban “should be careful what they wish for,” given that volumes shipped from the U.S. would “just kick more into the Atlantic basin” and hurt prices. “Exports get you nothing,” Kleinman said. He added that on a free-trade ideological basis, the ban should be lifted, but market dynamics have shifted dramatically since the debate over nixing the 40-year-old law began several years ago.

Brent’s massive premium to WTI throughout 2011-14 drove the debate over crude exports, but now the spread has narrowed to about $3 and has held steady for some time. High stock levels at Cushing, Oklahoma, the delivery point for WTI, were the main reason for the blowout between the benchmarks, but new pipelines have connected the hub to major refining centers, keeping crude there from being “land-locked,” or less accessible. Against this backdrop, the sharp divergence between the two markers may be a thing of the past.

The House of Representatives is set to vote on nixing the ban this month, and it’s expected to pass. But it won’t likely become law: There are a lot of hurdles in the Senate and President Barack Obama would veto a bill allowing the liberalization of U.S. crude exports.

Shale caps oil prices on the upside

Although shale oil production in the U.S. is hurting from the lower oil price, albeit not as badly as originally expected, output can return at a faster pace than it was turned off. If the market tightens and prices rise, shale can essentially ramp back up and meet any shortfalls, putting a cap on prices in the $60-$80 range.

If the market tightens and prices rise, shale can essentially ramp back up and meet any shortfalls, putting a cap on prices.

The market is “basically rangebound,” said Kleinman, adding that “you can’t get properly bullish on oil” given current market fundamentals and the ability of shale to rebound when prices recover.

The rebalancing effort is taking longer than expected for three key reasons. First, non-OPEC supply has not been materially affected by lower prices. Russia recently boasted record volumes in the post-Soviet era, Petrobras will increase output despite being enveloped in a scandal, and North Sea producers plan to see an increase this year. In the U.S., limited access to capital may drive out smaller, weaker producers, but won’t take a material amount of volumes offline and “solve the overhang.”

The Energy Information Administration (EIA), in its latest Short-Term Energy Outlook, released Tuesday, estimates that total U.S. crude oil production declined by .12 mbd in September compared with the previous month. The government agency sees output decreasing through mid-2016 before it starts growing again toward the end of the year.

Second, demand growth so far has not been strong enough to tighten the global market as lower prices do not necessarily stimulate demand. Oil exporters have been “massive drivers” of oil demand growth over the past 10-15 years, but lower revenues have dented their GDP growth. This, in turn, has weakened oil demand growth in certain markets.

Too much oil is “being jammed into an extremely congested market” in Asia.

Third, major producers are all fighting for outlets for their crude only in the Asia-Pacific region, and it will get tougher next year when more Iranian volumes hit the market once sanctions are lifted. Kleinman noted that OPEC output will keep growing, and despite talk of Russia cutting output to help shore up prices, it won’t. Saudi Arabia could reevalute its strategy in order to support prices to help with its fiscal shortfalls, but he sees that as the wrong approach. If the Saudis pull back, they would weaken their position in Asia while also stimulating supply in North America. Too much oil is “being jammed into an extremely congested market” in Asia, Kleinman said.

Geopolitical risk, still a threat to oil markets

If the situation shifts on the supply side, the danger of a price spike from geopolitical risk reemerges as the global oil market has very limited spare capacity.

While physical fundamentals are no doubt weak right now and will take some time to tighten, geopolitical risk provides a bullish undercurrent for oil prices. There are a host of menacing threats, particularly in the Middle East, where producers such as Syria, Yemen, Iraq and Libya are all under stress. Russia, meanwhile, is being antagonistic with its bombing campaign in Syria and is also dealing with fallout in its own economy from Western sanctions and low oil prices.

Geopolitical dangers are not impacting the oil price now because of the massive supply overhang and high inventory levels. If the situation shifts on the supply side, the danger of a price spike from geopolitical risk reemerges as the global oil market has very limited spare capacity, which is all concentrated in Saudi Arabia and makes up only 2 percent of global demand.

With low spare capacity part of the new market paradigm, Kleinman says the oil industry should now look at commercial inventories and strategic stockpiles as a security buffer when geopolitical tensions are high. Stocks provide a “new alternative” to what OPEC carried in spare capacity, Kleinman said, arguing that downsizing the U.S. Strategic Petroleum Reserve (SPR), an idea now being floated in Congress, is not a constructive plan.