Energy 2020: Out of America

The Rapid Rise of the United States as a Global Energy Superpower

When it comes to crude oil and other hydrocarbons, the U.S. is bursting at the seams. This situation is unlikely to stop even if prevailing prices for oil fall significantly – Citi anticipates that even if West Texas Intermediate (WTI) prices fell below $75 for a while, production growth would continue at relatively high levels for years to come.

While the debate in the United States intensifies over whether the country should export crude oil, facts on the ground are mushrooming significantly faster than policymakers in Washington recognize or global markets are ready to realize.

As of today, every barrel of locally produced petroleum product and crude oil – as well as the as-yet-to-be-defined category of condensate — that can get out of the country is in fact getting out. Too much attention has perhaps been placed on whether to lift the ‘ban’ on crude oil exports. There really is only a limited legal ban effectively impacting only oil produced in federal waters or transported through a federally mandated pipeline; elsewhere there is a minefield of obstacles but also a fairly permissive regulatory framework that already applies to Canada, is likely to be applied within a year to Mexico, and soon thereafter to some free trade agreement partners, even without legislation to lift the ban.

The U.S. has very rapidly become a powerhouse as an exporter of finished petroleum products, natural gas liquids, “other oils” including ethanol, and – yes – even crude oil – with total gross exports expected to reach a combined 5-million barrels per day (m b/d) or more by the end of this year, up a stunning 4-m b/d since 2005. Mid-year 2014 combined hydrocarbon exports of 4.5-m b/d already pushed total oil exports to the top of the list of US exports by category, far surpassing all agricultural products, capital goods and even aircraft as the largest sector of U.S. export trade. Meanwhile, US crude oil exports, largely to Canada, are 500% above what they were a year before, and are heading for around 500,000 barrels per day (500-k b/d) by year end.

Citi fully expects that allowable exports of crude oil and condensates – a special category of light crude oil – will exceed 1-m b/d gross by early 2015 if not before. Exports to Eastern Canada are marching toward a half a million barrels a day, and we expect renewed exports from Alaska to grow to a higher, steadier state of above 100-k b/d, for exports to Mexico to begin to materialize at least under an exchange program and to grow possibly to well over 200-k b/d, for allowable exports of processed condensate to reach 200-k b/d or more before long, and for re-exports of Canadian crude oil entering the U.S. by both pipeline and rail to reach a similar level. Already the U.S. exports more crude oil than OPEC member Ecuador, but that still opens the question of “net” exports.

The U.S. has reduced its net oil imports by a stunning 8.7-m b/d over a very short period of time – that’s more than the total production of all countries in the world other than the U.S., Russia and Saudi Arabia and also greater than the combined exports of Saudi Arabia and Nigeria. Eight years ago, in August 2006, the U.S. imported, net, a little over 13.4-m b/d of crude and products; recently the net import number has fallen to 4.7-m b/d at the end of 1H 2014.

Citi expects that the oil import gap will be totally closed well before the end of the decade, possibly by 2019 if not by 2018, at which time the US should become a net exporter of crude oil and petroleum products combined. Meanwhile other exports are closing the total “hydrocarbon” import gap rapidly. Obstacles to crude oil exports have given rise to phenomenal growth in petroleum product exports.

Since 2010, the U.S. moved from being the largest gross and net product importer (of gasoline, diesel, jet fuel and liquefied petroleum gas’ (LPGs) like propane) to the largest gross exporter and the second-largest net exporter next to Russia, which ended last year exporting 3.2-m b/d of products. By the end of 2016, the U.S. could jump ahead of Russia as the largest supplier – net – of petroleum products in the world; by 2020, Citi estimates U.S. net product exports could lie somewhere between 4.7- and 5.6-m b/d, somewhere between 1.3- and 2.2-m b/d higher than Russia at that time.

When it comes to LPGs like propane, butane and ethane, the U.S. already overtook Saudi Arabia as the largest exporter more than a year ago. Within three or four years the U.S. is likely to add more than 1-m b/d to these exports and alone should be exporting more LPGs than the entire Middle East, today’s base load supplier of these feed stocks to Asia and the rest of the world.

Then there’s natural gas. At the start of this decade, the U.S. was a net importer of natural gas. By the end of the decade, exports by ship of Liquefied natural gas (LNG) should rival those of Qatar, the largest such exporter today, and pipeline exports to Mexico and Canada could be of the same magnitude, pitting the U.S. against Russia as the number one or two natural gas-exporting country in the world.

Since the start of the ramp-up of Canadian and then later U.S. production there has been a lag in infrastructure to get new production to domestic markets and get both product and crude oil to foreign markets. An enormous build-out of rail transportation for crude has resulted, bringing crude to pipelines, to refineries and to ports both within the United States and from Canada to the United States. Combined volumes have grown dramatically since 2010, rising from less than 50-k b/d to nearly 1-m b/d at the end of 2013. Despite the fact that pipeline transportation is far more efficient than transportation by rail, barge and truck, adequate investments are not being made in pipeline infrastructure and the rail system in particular is becoming congested and, after some major accidents, the subject of debates on improving rail safety.

The lag in pipeline infrastructure is part of a big chicken-and-egg problem. Most of the rail transportation comes from the Bakken where some 70% of production is shipped by rail, mostly to the East and West Coasts. Refiners on the U.S. Gulf Coast do not need light sweet crude and indeed have a superabundance of it locally in the Eagle Ford and Permian Basin in Texas. But refiners on the two coasts are fearful that if they commit to use pipelines to transport the crude oil they need, they could end up in an unfavorable position economically if the U.S. were to ease restrictions of exports. Similarly, companies and investors are unwilling to commit to build new refinery capacity lest the U.S. government lift the export restrictions, impacting their feedstock costs.

Export capacity is constrained both because of congestion in the U.S. Gulf of Mexico harbors and because of lack of investment, which itself is being held back because of uncertainty related to U.S. export restrictions. So, even if export restrictions were to be relaxed significantly, it could take years to get the infrastructure in place.

In the end, there remains an inevitable day of reckoning when U.S. crude production cannot escape its North American confines, pushing down U.S. crude oil prices and endangering production, without widely liberalized exports. That day may be coming sooner than people expect, perhaps before the end of 2015. Meanwhile outcomes for production and export levels make a big difference – to the trade balance and to energy-intensive industries like fertilizers, petrochemicals and processed metals. This report explores some of the implications of these big differences.

The U.S. government will inevitably need to respond to growing pressures to export crude oil. But the debates in Washington on whether to lift the various bans on exports of crude oil and condensate are misplaced. We do not anticipate a set of big debates in Congress or in the Administration to settle overnight issues related to changing the legislation on exports. By law, exports of crude oil produced in federal waters or from federal lands are banned, with some notable exceptions like exports from Alaska, from heavy oil in California and to Canada. It is unlikely that either of these laws will be changed any time soon. Other exports are placed on the Export Administration’s short supply control list and in addition to crude oil, there are only two other commodities that are restricted from exports: unprocessed Western red cedar and horses exported by sea (but not by truck, train or airplane).

What is most likely to occur is the unfolding of a piecemeal, ad hoc set of decisions facilitating exports incrementally, with the sum of the increments reaching very high levels. There is unlikely to be a sudden change in the restrictive framework that limits crude oil exports from the United States. But progressive change is highly likely. The special conditions which now allow a significant volume of exports to Canada are undoubtedly being extended to Mexico. Both Canada and Mexico are Free Trade Agreement (FTA) partners of the United States and other FTA partners, including especially Chile, Israel, Singapore and the Republic of Korea are likely to petition for similar status. And eventually, restrictions on condensate exports, already reduced by recent decisions to allow processed condensate for export, are likely to be further eliminated with the development of a clear definition of what constitutes condensates. And meanwhile, exports from Alaska are likely to continue to grow in volume. The re-export of imported crude oil from Canada is also expected to grow significantly, soon to 200-k b/d and later to perhaps twice that level.

All of these details matter because they are shaping the emergence of North America as an energy superpower that is poised to usher in disruptive changes to global oil markets, trade, and investment. How this process unfolds is sure to create new winners and losers even as it remakes the global energy landscape.