U.S. condensate sale, easing of crude oil export ban & What It means for Alaska: Cracks in the Door

 "Since we cannot change reality, let us change the eyes which see reality." 
Nikos Kazantzakis

"Progress is impossible without change, and those who cannot change their minds cannot change anything." 
George Bernard Shaw

During the first week of November, 2014, even as plummeting oil prices were roiling the global economy, global oil markets witnessed a minor revolution. On November 4^th, 2014, the Anglo-Australian resources giant BHP Billiton announced a US$50 million deal to sell 650,000 barrels of Texan lightly-processed, ultra-light oil, known as condensate, to the Swiss trading firm Vitol SA. By stitching up the sale, BHP Billiton is poised to become the first commercial entity to sell U.S. domestically-produced oil overseas without the express permission of the federal government. The sale constitutes the foremost crack in the four decade-long ban that has governed U.S. crude oil export policy, with minor exceptions. In time, the BHP Billiton sale is expected to be the first of many such deals as voluminous North American oil and natural gas production seeks new markets and higher prices abroad. A U.S. policy of banning crude oil exports that was built to cope during an age of energy scarcity is giving way, gradually, in this era of growing abundance.

The origins of the U.S. crude oil export ban date back to the mid-1970s. To alleviate fears of shortages and spiraling inflation in the wake of the Middle East Oil Crisis as well as to channel then-newly-flowing Alaskan North Slope oil to the U.S. West Coast rather than to Japan, the U.S. Congress enacted the Energy Policy and Conservation Act in 1975. The law directed the president to issue regulations that would prohibit the export of domestically-produced crude oil overseas. Limited waiver authority “consistent with the national interest and the purposes” of the law was appended to the Act and, to date, seven exceptions to the ban including exports from Alaska’s Cook Inlet to Canada have been permitted.

In important respects, the Energy Policy and Conservation Act bears some interesting parallels with the earlier Natural Gas Act of 1938. This pre-World War II Act required the U.S. Department of Energy (DOE) to make an affirmative determination that all permits issued to export natural gas from the U.S. were consistent with the American “public interest.” As a practical matter, this “public interest” determination has since been applicable to those countries with which the U.S. does not have a free trade agreement (FTA) – in effect, to most countries given that the U.S. has very few such FTAs in force. As such, both the Energy Policy Act and the Natural Gas Act provide discretionary, non-automatic licensing authority to federal government agencies to determine the scope of U.S.-originating, cross-border energy flows. Determinations in favor have been few and far between – in effect, heaping a layer of distortion on an already-distorted international energy market. Equally, both laws, by way of their interpretation today, are tantamount to being deemed as ‘export restraints’, which would place the U.S.’ compliance with its international trade obligations in questionable territory.

As per the 1994 General Agreement on Tariffs and Trade (GATT) rules to which the U.S. is a signatory, a country may enjoy a limited exception to the otherwise generalized prohibition on export restraints if such prohibitions or restrictions are: temporary, related to essential products that are in short supply, applied in conjunction with other conservationist objectives, or made with an express national security objective in mind. In an era of energy insecurity and national peril, discretionary, non-automatic licensing authority for crude oil and natural gas exports may have comported with the above criteria. In an age of production abundance, this case is much harder to make. Between 2005 and 2013, U.S. production of natural gas increased by 33 per cent from 18 to 24 trillion cubic feet per year – with the production of shale gas increasing from 0.75 to 8.5 trillion cubic feet. Over the same period, U.S. production of liquid fuels too increased by 52 per cent, with the contribution of ultra-light/tight oil increasing from 0.29 million barrels per day to 3.48 million barrels per day. The U.S. is expected to soon overtake Russia (gets circa 50% of its state revenues from oil exports) and Saudi Arabia as the world’s top oil producer, as per International Energy Agency (IEA) projections. Crude oil and natural gas are no longer in short supply and their export overseas does not impair U.S. national security. The ban on their export in fact stands today on questionable legal ground.  

The proximate driver of the relaxation of the crude oil export ban - and thereby BHP Billiton’s recent condensate sale to Vitol SA, can be traced back to this prodigious discovery and extraction of tight oil. In mid-June 2014, the Bureau of Industry and Security (BIS), a little-known office within the U.S. Commerce Department tasked with administering the Energy Policy Act of 1975 issued a reinterpretation of the Act. It ruled that with minimal processing of crude oil to a low-density variety, called condensate (to ensure its stability and safe transport), the crude would henceforth officially be classified as having undergone transformation into a petroleum product - and hence liable for export without the need for a license. Refined oil products have long been exported license-free from the U.S.; the Energy Policy Act ban was limited to crude only. Further, at the time of this relaxation, government officials let it be known that such ‘self classification’ of transformation to a petroleum product, and export thereafter, would quietly be encouraged henceforth without having new rulings to be issued.

The catalyst of the BIS’ regulatory relaxation was a U.S. Energy Information Administration (EIA) report of late-May 2014 which found that the U.S. light crude oil market was at risk of saturation given the inherently limited domestic capacity to refine such light oil. Should the crude oil export ban not be relaxed, fresh investments in domestic hydraulic fracturing and horizontal drilling infrastructure would itself have been in jeopardy. Indeed at this time, existing U.S. refineries in the Midwest and along the Gulf Coast, which are configured to process heaver (imported) crude from Mexico, Venezuela and Canada, continue to typically demand that light oil producers sell their product at a discount - sometimes running as high as double-digit percentage points. At this discounted price, which has been further exacerbated by the recent plunge in international prices, new wells are uneconomical to drill and the hydraulic fracturing revolution liable to be stopped in its tracks until further light crude refining capacity is domestically brought on-stream. As per the EIA report, facilitating foreign market entry, and market prices, for U.S. light oil will enable U.S. light oil producers to generate healthier cash flows – in turn, facilitating a virtuous cycle of reinvestment in U.S. domestic shale oil production. The Commerce Department’s June 2014 ruling was a timely and appropriate response to the predicament laid out in the EIA report.

The ruling is also likely to be greeted warmly by Asian consumers across the Pacific, given their economies’ inexorable need for energy as well as their desire to diversify sources of supply beyond Middle East producers. As per International Energy Agency (IEA) forecasts, Asia’s demand for oil imports is expected to rise from 12 to 27 million barrels per day between 2012 and 2035. At this time of writing, Enterprise Product Partners LP., a Houston-based pipeline and oil storage operator and Pioneer Natural Resources Company, a Dallas-based oil producer, have also received special permission from the U.S. government to export such minimally processed oil. Enterprise Partners already has two term contracts with Japanese traders Mitsui and Mitsubishi for condensate supply and reportedly is looking to make further sales of condensate from South Texas’ Eagle Ford shale formation to Asia in 2015.

Going forward, as the U.S. gradually displaces Saudi Arabia and Russia later this decade to become the world’s foremost oil producer, it stands to eminent reason that the four decades-old crude export ban be lifted in stages too.  Protectionist arguments which claim that U.S. oil must be confined within U.S. borders to hold prices down and assist the nation’s manufacturing sector recovery are fundamentally misguided. The fungible nature of international oil markets, unlike that for natural gas which require dedicated pipeline or liquefaction infrastructure, means that the greatest penalty for failure will instead be borne by U.S. shale oil producers at the hands of their domestic refining counterparts. Equally, energy intensive sectors – primarily chemicals, primary metals, paper and print – constitute a small share of U.S. manufacturing, and a bare fraction of U.S. GDP. U.S. ‘reindustrialization’ will not be manufactured on the back of cheap energy; rather that will be a function of technological breakthroughs like 3D printing and additive manufacturing which are already transforming the way modern-day manufacturing is conducted.

Hydraulic fracturing in the United States has redrawn geo-political maps and fundamentally altered oil markets. The United States was and still remains the world's largest consumer of oil. In 2005, the US had to import 60% of its supplies; today it imports only 30% .  As fracking increases domestic production, the USA will switch from being a net importer to a net exporter of oil and that will change the world's political alliances forever.  Let us give a less known but classic example of how the geopolitical sands are shifting. A few years back, Greenland was imagining independence from Denmark and riches from an oil bonanza as the price of crude approached $150 a barrel (the U.S. Geological Survey estimates 50 billion barrels of oil and gas beneath Greenland’s waters) and had, accordingly, licenses were awarded to oil companies such as BP, Conoco Philips, Shell, and others. Today, due to a drop in oil prices all those hopes have been dashed. Crude oil from the shale fields of North Dakota is a major factor in the surge in U.S. domestic oil production. This surplus has led to a debate over whether it is time to lift U.S. restrictions on oil exports.Proponents of lifting the export ban include giant oil companies such as ExxonMobil and Chevron. The crucial breakeven points have been trending lower and lower in recent years due to technological advances that have made oil producers dramatically more efficient. Despite tumbling prices the OPEC cartel surprised everyone by deciding to keep pumping oil at current levels. One motivation appears to be to put financial pressure on the higher-cost producers in the U.S., Canada, and Brazil. We feel, like in every aspect of life, that the strong players will remain while the weak ones will disappear.

Lifting the ban on the export of domestically-produced crude will allow the North American shale oil revolution to continue apace, generating jobs, profits and tax revenues while enabling the U.S. to remain in compliance with its international trade, as well as, global stakeholder obligations. As Alaska has an abundance of oil and gas, and especially as the state’s operating budget depends inordinately on oil revenues, this state of play on U.S. law/ regulation has titanic financial implications for Alaska. The U.S. Congress has its work cut out for itself as the global energy landscape gets reshaped.