April 2015

Exports: Last Demand Standing

April 1, 2015

Market Alert
Exports: Last Demand Standing

Key Takeaways
Inventory builds are implying the US is
oversupplied by 800 Mb/d
Traditional sources of demand in years past
(displacing imports, higher refinery runs) have
largely run their course
The massive oversupply situation at current
production levels provides a sobering narrative on
the prospects for further growth in US production
Unrestricted exports of crude provide the last
significant source of demand

Premise
The US crude oil market has finally hit the proverbial wall that Bentek Energy has long predicted
would arise as a result of persistent supply growth. Traditional demand sources are struggling to
absorb this growing supply, made evident by crude inventories that are surging higher at
unprecedented rates. Domestic production, however, remains captive in the US due to
antiquated policies that limit the exports of domestically-produced crude. Growing US supply
has led to depressed prices, signaling to the market that the US is surpassing demand needs at
todays production level of 9.4 MMb/d. Exports to the globe, therefore, are the last significant
demand source for US crude. Unchanged, the current US crude export policy signals the end of
growth in North Americas shale crude revolution.

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The Wall: How We Got Here

The US refining complex has absorbed incremental US production by sourcing domestic crude over
waterborne imports and operating at higher utilization rates than previous years. However, demand
markets have reached the point at which they can no longer absorb this growing production and
domestic storage is filling to record levels.

US production grows
After peaking at roughly 10 MMb/d in 1970, and averaging around 9 MMb/d in the 1970s and early
1980s, US production declined by about 2% year-over-year for the next two decades, spurring
worries of peak oil. With the proliferation of hydraulic fracturing and horizontal drilling, however,
worries of peak oil were shelved, and exploitable crude reserves in the US grew exponentially. In
2008, US production averaged just 5 MMb/d. Since then, production has grown substantially,
averaging 8.7 MMb/d in 2014. In 2014 alone, production grew by 17% over 2013 volumes, flooding
the market with an incremental 1.3 MMb/d.
In the wake of collapsing crude prices during the second half of 2014, US producers have
announced substantial cuts to planned capital expenditures and drilling programs, but few intend to
cut production. In fact, many producers still intend to grow production year-over-year, citing falling
service and drilling costs, with reductions ranging from 10% to 50%, and falling tax rates linked to
crude prices. Producers also intend to target their most productive acreage where they have realized
considerable efficiencies, resulting in reduced drilling times and high initial production (IP) rates.
Additionally, contractual obligations and hedging programs will allow some producers to meet near
term production targets despite the low price environment.

US supply displaces comparable waterborne imports

A large portion of US production has historically been light-sweet crude, a low-density, low-sulfur
grade considered to be of high quality because it typically requires less complex infrastructure and is
easier to refine than high-density, high-sulfur grades. As US light-sweet crude production declined
through the end of the century, US refineries anticipated any future supply would be of a heavier,
sourer quality and adjusted much of its infrastructure accordingly by installing complex units capable
of refining more viscous crudes into refined products. Domestic refineries also became increasingly
reliant on waterborne imports. Waterborne crude imports into the US (imports from countries other
than Canada), averaged 8.2 MMb/d in 2008, of which 1.9 MMb/d was of light-sweet quality similar to
that produced in the US today, and 6.3 MMb/d of which was heavier and sourer than the majority of
US production. In 2014, however, total US waterborne imports averaged just 4.45 MMb/d, of which
only 198 Mb/d was of light-sweet quality.

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The remaining 4.45 MMb/d of imports is too heavy and sour for US refineries to easily displace with
domestic production. Refineries configured to refine heavier, sourer crude will likely continue to find
it economic to source feedstock from the foreign sources where heavy, sour crude supply is
abundant, as configuration modifications are capital-intensive and time-consuming. In order to
incentivize substantial investment in reconfiguration once again, refiners would have to expect the
economics of running light-sweet crude not only to exceed those of running heavier crudes, but also
to exceed them by enough to justify further capital deployment.
With only 160 Mb/d of light-sweet imports remaining as of December 2014, US production has
displaced nearly all comparable waterborne imports.

US refineries increase utilization rates

In addition to sourcing domestic crude over waterborne imports, refineries in the US are operating at
higher utilization rates in an attempt to absorb incremental production. Since 2010, refinery utilization
has grown from an average of 86.3% to 90.4% in 2014. Required maintenances throughout the year
hinder the ability of refineries to maintain consistently higher utilization rates. In addition, several
refinery expansion projects and new builds increased total US refining capacity by 286 Mb/d from
2010 to 2014. As such, US refineries have, in total, processed 1.12 MMb/d more crude in 2014
versus 2010.

Incremental Supply/Demand versus 2010

5000
4000
3000

Mb/d

2000
1000
0
-1000
-2000
-3000
-4000
-5000
2011

2012

2013

Production

Refinery Runs

Heavy

Intermediate

Light Sour

Light Sweet

Exports

Adjustment

2014

Source: EIA

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Looking forward, a risk to maintaining high refinery utilization rates exists due to the changing
landscape of the refineries that still operate in the US. Though total US refining capacity has grown,
since 1985, sixty refineries have been decommissioned in the US. That has changed the refining
landscape to rely on high utilization rates on the operations of fewer refineries. Therefore, the total
utilization rate can be significantly affected by an accident, unplanned maintenance, or a labor
dispute at any remaining refinery.

Storage inventories nearing tank tops

Crude barrels that cannot be absorbed into the US refining market, or displace waterborne imports,
must accumulate in US storage complexes. Typically, crude inventories draw down at the end of the
year when refineries maximize utilization. However, this trend reversed at the end of last year. In
December 2014, refineries were operating at 94% utilization, yet crude inventories continued to grow
throughout the end of the year and into 2015.

US Crude Stocks (excl. SPR)

500
480
460

MM bbls

440
420
400
380
360
340
320
300
Jan

Feb

Mar

Apr

5 Year Min-Max Range

May

Jun

Jul

Avg. 2010-2014

Aug

2013

Sep

Oct

2014

Nov

Dec

2015

Source: EIA

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After eleven weeks of aggressive stock builds at an average of 7.7 MMbbls per week to begin 2015,
commercial stocks reached 467 MMbbls as of March 20th, the highest recorded inventory since
1930, exceeding the five-year March average by over 100 MMbbls. If builds persist at this
aggressive rate, total US inventories (which includes line fill, lease tanks, and oil in transit from
Alaska) will exceed 500 MMbbls as soon as the last week of April. Though inventories typically build
when refineries enter into maintenance season in the first quarter, the five-year average injection
rate has been only 2.1 MMbbls per week through the third week of March, far below the
aforementioned 2015 average injection rate. The discrepancy between the historical average
injection rate, and the injection rate thus far in 2015, implies that the domestic market is oversupplied
by around 800 Mb/d ((7.6 MM - 2.1 MM)/7 days per week = 800 Mb/d).

Weekly Inventory Builds

12,000
10,000

M bbls

8,000
6,000
4,000
2,000
0
(2,000)

5 Year Average

2015

Source: EIA

Overall, persistent storage builds clearly indicate that, though refineries have absorbed much more
supply, the US refinery market is approaching the limits of its ability to absorb incremental, domestic
production.

Exports, the only remaining outlet for US production

In the wake of the Arab oil embargo of the 1970s, and consequent fears of supply shortages, the US
government imposed restrictions on the ability of producers to export domestically-produced crude.
Until only recently, the US has relied heavily upon foreign oil in order to fuel the economy. Global
supply disruptions and political conflicts have often sent global prices sky-rocketing, leading the
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American public to largely dismiss the idea of crude exports. Additionally, the fact that the US still
imports foreign oil begs the question as to why domestic crude should be exported.
As mentioned, nearly all waterborne imports into the US are of a heavier, sourer quality than US
production. Due to the refinery configuration in the US, as well as feed slate preferences, the
demand for heavy-sour crude is expected to either remain relatively stable going forward, or even
grow as refiners take incremental heavies for blending with lighter grades. Additionally, raw crude oil
has little value until it is refined into consumer products, such as gasoline, diesel, and jet fuel. US
refineries are legally able to export those products, and the US has actually become a net exporter
of refined products, with total net exports having averaged 1.9 MMb/d in 2014. By contrast, the US
was a net importer of refined products as recently as 2010, to the tune of around 270 Mb/d.
However, the general publics lack of understanding regarding the chemical composition of crude oil
and the downstream economics of the commodity hinders the paradigm shift in American sentiment
required to lift export restrictions.
As refineries reach their capacity to absorb incremental US crude production, and storage levels are
approaching working capacity, the next several months will demonstrate the damaging short-term
and long-term effects sustained export restrictions will have on domestic crude prices, the US oil
exploration and production (E&P) industry, and the US economy as a whole.

Summer 2015
Spring refinery maintenance season is typically completed by the end of April, and refineries once
again ramp up utilization in anticipation of summer demand for gasoline and other refined products.
The higher utilization by refineries leads them to source supply from storage, drawing down
inventories that were built up during maintenance. Stocks fall, on average, about 1.15 MMbbls per
week throughout the summer (May-August), but at currently elevated inventory levels, stocks must
draw at much faster rates this year in order to return inventories to more manageable levels before
the end of summer, when refineries begin fall maintenance.
Since 2010, stock levels have drawn down to around 360 MMbbls by the last week of August;
however, since 2010 capacity has been added in the form of both tank and pipeline infrastructure
expansions. For this reason, Bentek will use 400 MMbbls as a reasonable level for stocks to draw
down to by the end of August. While this would still imply a persistently oversupplied environment, a
draw down to this level would provide some breathing room for the export discussion to continue.
With this predicament in mind, the following section lays out an aggressive demand scenario for the
summer of 2015 to paint a picture of the magnitude of adjustments the market needs to make in
order to return storage levels to relative normalcy before the fall refinery maintenance season
begins. Production levels will be held constant at todays production rate to stress the severity of the
current situation.

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Further import displacement

As mentioned, US production has already displaced nearly all crude imports of comparable quality.
Light-sweet waterborne imports into the US averaged just 230 Mb/d last summer. Theoretically, US
refiners can consume an additional 230 Mb/d of domestic crude this summer and forego all lightsweet waterborne imports. However, these remaining imports of light-sweet crude were
predominantly supplied to East and West Coast refineries, which have essentially no pipeline
connectivity to domestic supply. Therefore, the WTI-Brent differential will have to remain wide to
incentivize refineries on the East and West Coast to absorb rail and/or barge transportation costs
from US production areas rather than import foreign barrels.
As US production began aggressively displacing waterborne imports of light-sweet crude, imports of
light-sour and intermediate grade crudes remained relatively stable through the end of 2013. During
2014, however, imports of these grades fell by 47%. Though light-sweet US barrels are not direct
replacements for these grades, the decrease in the imports of these mid-range barrels during 2014,
coupled with increasing imports of heavy-sour grades, signifies US refiners were blending heavy and
light barrels in an effort to displace mid-range waterborne imports. It is important to note, however,
that blending a heavy barrel with a light one does not necessarily produce the same refined product
mix that refining a true intermediate barrel does. An economic blend depends largely upon the
appetite of each individual refinery and, therefore, it is unlikely that US production can entirely
displace light-sour and intermediate imports.
Summing up, some waterborne heavy-sour grades will be displaced by incremental production from
Canada entering the US, domestic production will displace all light-sweet imports, and, to an extent,
further blending of heavy and light grades will displace mid-range waterborne grades. For the
purposes of this analysis, we will assume that total waterborne imports can fall to just 3.8 MMb/d this
summer, a 715 Mb/d decrease from last summer.

Refineries run even harder, allowed exports double

Refineries operated at a 90.9% and 92.2% utilization rate in the summers of 2013 and 2014,
respectively, suggesting an increase of 1.3%. We will suppose in our aggressive demand scenario
that refineries are able to increase utilization at the same rate into 2015, operating at 93.5%
utilization throughout this summer. Additionally, two new refineries configured to consume US lightsweet crude, Dakota Prairies 20 Mb/d refinery in North Dakota and Kinder Morgans 100 Mb/d
condensate splitter in Houston, will add another 112 Mb/d of incremental demand, assuming this
additional capacity will operate at a 93.5% utilization as well. All told, this scenario analysis will
assume refineries will generate 245 Mb/d of incremental demand.
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Allowable crude exports under current regulations, though relatively small, could see substantial
increases summer-over-summer. Exceptions to US crude export restrictions include crude exported
to Canada, production from Alaskas Cook Inlet, and stabilized condensate (ultra-light crude lightly
refined at a condensate stabilizer). US crude exports averaged 370 Mb/d last summer. In this
aggressive demand scenario, we suppose that exports will double over last summers levels to 740
Mb/d.
Assuming the US can, in fact, displace 715 Mb/d of waterborne imports, US refineries can absorb an
incremental 245 Mb/d, and allowable exports can double summer-over-summer, stocks would draw
by approximately 497 Mb/d, or 3.5 MMbbls per week, throughout the summer. US inventories would
end the summer with 442 MMbbls in storage, still 84 MMbbls above the average August inventory
levels.

May - August
Supply

Demand
Balance

Production

Waterborne
Imports

Canadian
Imports

Storage
Withdrawal

Adjustment

Refinery
Runs

Exports

2013

7,366

5,406

2,460

252

326

15,743

107

-40

2014

8,673

4,516

2,811

284

271

16,188

370

-2

2015

9,400

3,800

3,100

497

375

16,432

740

Source: EIA, Bentek

* All values are in Mb/d
** The 'Adjustment' value is an EIA fill number used to balance the reported crude oil supply and demand numbers
*** An 'Adjustment' value of 375 Mb/d was used as a representation of what the implied adjustment has been in 2015

The End of the US Energy Renaissance?

In this aggressive demand scenario, US inventories are only expected to draw down to 442 MMbbls
by August 2015, 84 MMbbls above the five-year average. For inventories to reach 400 MMbbls,
stocks would have to fall by 830 Mb/d, or 5.8 MMbbls per week. Therefore, in order to reach
normal storage levels by the end of August, the US would have to export over 1.08 MMb/d, an
additional 335 Mb/d beyond that of the aggressive demand scenario laid out above.
US producers have already indicated they intend to export self-classified stabilized condensate
without formal approval from the Bureau of Industry and Security (BIS) and Eastern Canadian
refineries intend to continue to source increased volumes of US light-sweet crude. An additional 370
Mb/d of exports year-over-year, though aggressive, is not unreasonable under current export
restrictions. To meet the 1.08 MMb/d of required exports to balance the market, however, the US
government must formally change their policy to allow raw crude oil exports.
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If export policy remains unchanged, barring significantly higher refinery runs and/or feedstock
switching, the challenges of which have been discussed in some detail already, the alternative is that
production would have to drop to 9.07 MMb/d for inventories to draw down to normal levels by the
end of August. That is an over 300 Mb/d drop from current production levels. To realize that kind of
drop in production would require drilling to slow down well beyond what it already has, and
potentially shut in existing production if the market needs to see that kind of response occur by this
summer.

Exports a needed option, but not a panacea

Taking a look at the global picture, while the general consensus is that the global market will be
nearly balanced by the latter half of 2015, several factors could rapidly change this picture. One
such factor that the market has been cautiously following is whether a deal is struck between the US
and Iran over Irans nuclear program. If a deal does happen this summer, the restrictions that are
currently limiting Irans ability to export crude to international counterparties will be lifted, and a
potential 1.0 MMb/d of incremental crude will flood the global markets. Another country where the
landscape could rapidly change is Libya. Internal fighting in the country has caused large volatility in
the amount of production that is available for export. If the parts of the country where production and
shipping take place were to stabilize, incremental production could rapidly return to the market as
well. The recent events surrounding the conflict between Saudi Arabia and rebel groups in Yemen
are a stark reminder of the immediate impact this kind of turmoil can have on oil prices.
These factors, among other uncertainties and potential global supply risks, will ultimately decide
whether Brent prices come under pressure, or can begin to appreciate once more. A global supply
shock is likely to widen the spread between Brent and WTI. While a wide differential between WTI
and Brent exists, theoretically, arbitrage would open for US exports of crude to international refining
centers. However, if global supply is able to ramp up at more aggressive rates than is currently
expected, US exports would be fighting for space in an already oversupplied global market. In this
situation, Brent prices would come under additional pressure, and the WTI/Brent spread would likely
narrow. In a narrow WTI/Brent spread environment, US production will struggle to compete into
international refining centers, even if exports were not restricted.

A sobering outlook
Without unrestricted exports, the US E&P industry will suffer. To balance the market, US producers
will have to reduce costs further, resulting in additional capital fleeing the energy market, and a loss
of wages and employment in the industry. The cost reduction will trickle down through the supply
chain to other industries that rely on E&P for a portion of their profits, including, but not limited to,
service companies, steel tube and pipe manufacturers, trucking companies, and local businesses
patronized by oil field workers. The oil and gas industry was hailed as the driver of economic and job

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growth in the US in the wake of the Great Recession of 2009. Any slowdown in this sector is
therefore concerning as it has played a significant role in the economic recovery to date.
Benteks production projection models indicate that, absent a lack of demand, US production could
continue to soar in the years ahead. However, incremental domestic demand for US production
growth is waning and the market is largely signaling the end to the boom in US production without a
new source of demand. Unrestricted crude exports on the back of US policy change are the most
immediate solution to finding that demand. While there is no guarantee that the global market would
be able to absorb incremental production growth from the US, the optionality of exports would
provide the much-needed relief valve to provide an outlet for future US crude production growth.

CONTRIBUTORS & ACKNOWLEDGEMENTS

Tony Starkey, Manager, Energy Analysis

tstarkey@bentekenergy.com

Jenna Delaney, Energy Analyst

jdelaney@bentekenergy.com

Nicole Leonard, Project Consultant

nleonard@bentekenergy.com

David Xu, Energy Analyst

dxu@bentekenergy.com

For more information online:

www.bentekenergy.com

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