By Irina Mironova, Michael Roh
(This article was originally written for Russia Direct)
In late February, the U.S. started exporting oil and gas to Europe, 40 years after the oil embargo imposed by Congress. In this period of cheap oil and high unpredictability on the energy market, renewed oil and gas exports from the U.S. may have serious consequences on the European energy market and could be an additional burden for Russia.
In December 2015, the U.S. Congress ruled to allow exports of oil and natural gas. It was a 65-33 vote in the Senate and a 316-113 vote in the House of Representatives. Republicans and Democrats have actually passed a bipartisan deal, with the export ban lifted, while also providing tax incentives for wind and solar power (it includes a five-year extension on tax breaks to encourage renewable energy development).
This will certainly alter the balance between fossil and non-fossil sources in the U.S. economy, but that’s another story. What is more relevant are the changes that led to lifting the crude oil export ban: Whether this would mean actual increase of the U.S. fossil fuel exports (including further developments in exports of natural gas) and what will be the implications of this move on international oil and gas markets.
Background: History of the bans on exports of natural gas and oil
The key documents on the U.S. export limits include the Mineral Leasing Act of 1920, the Natural Gas Act of 1938, the Energy Policy and Conservation Act of 1975 and Export Administration Act of 1979.
The Mineral Leasing Act of 1920 changed the approach to the use of lands and subsoil resources in the U.S. from ‘open-access’ to the system of leasing with permission of the government. It is an important background document, although its provisions were not actually touched, but they provide a framework for upstream activities in the U.S. in both oil and natural gas.
Meanwhile, the Natural Gas Act of 1938 rules that “No person shall export any natural gas from the United States to a foreign country or import any natural gas from a foreign country without first having secured an order of the Commission authorizing it to do so.”
“The Commission shall have the exclusive authority to approve or deny an application for the siting, construction, expansion, or operation of an LNG terminal,” the document reads. The ultimate rationale for this document was to prevent monopolistic behavior in the U.S. natural gas industry, as most of its provisions still control company behavior today. Some of the provisions have been amended by later legislation (e.g. overall deregulation of prices inside the U.S.), but the export provision remained in place.
The oil export ban has its roots in the oil shocks of the 1970-ies. After the U.S. supported Israel during the 1973 Arab-Israeli War, the Arab members of the Organization of the Petroleum Exporting Countries (OPEC) imposed an oil embargo against the U.S., which revealed the vulnerability of the American economy. This vulnerability increased dependence on oil imports from the Middle East, especially obvious in the times of instability in the region and when the region expressed a certain level of hostility toward the U.S.
What followed was an attempt by the U.S. to develop new partnerships with different Middle Eastern suppliers to address the problem by diversifying oil imports, improving energy efficiency and decreasing the dependence on oil. That’s why the U.S. was interested in increasing interest toward domestic oil production, paying more attention to creating strategic reserves or inventories and imposing a ban on exports.
This led to the adoption of the Energy Policy and Conservation Act of 1975, which regulated domestic energy supplies in cases of severe interruptions. The act proposed creating “the storage of substantial quantities of petroleum products,” which were expected “to diminish the vulnerability of the United States to the effects of a severe energy supply interruption, and provide limited protection from the short-term, consequences of interruptions in supplies of petroleum products.”
The need to limit exports was a result of the growth of oil prices, which skyrocketed throughout the 1970s. Firstly, the oil embargo of 1973 and later the Iranian revolution caused the oil price to increase. What did this mean for U.S. oil producers? It was, in fact, profitable for them to supply the international markets, using supplies from fields in the U.S. Such a tactic could lead to the shortage of resources. So in an effort to avoid this situation, Washington introduced the export ban.
Figure 1. Oil prices in 1970-1980 (Arabian Light posted at Ras Tanura) Source: BP
The Export Administration Act of 1979 was relevant in this regard. It introduced licenses for export activities.
“Excessive dependence of the United States, it allies, or countries sharing common strategic objectives with the United States, on energy and other critical resources from potential adversaries can be harmful to the mutual and individual security of all those countries,” the documents reads.
It also points out that the U.S. can impose oil export controls in cases when the restriction of the export of goods is necessary “to protect the domestic economy from the excessive drain of scarce materials and to reduce the serious inflationary impact of foreign demand.”
This brief analysis demonstrates that exports ban from the US is product of time and should be understood in the context relevant to the time.
How does the situation differ today?
The first and the most important change is the increase in production of both oil and natural gas by the U.S. over the past seven-eight years.
According to data form BP, the U.S. remains the word’s third largest oil producer since 1985, but today it has been catching up with the leaders – Saudi Arabia and Russia – very quickly. However, there is no growing potential of exports in the U.S. due to high consumption levels. The U.S. is still a net-importer of oil.
Figure 2. Top-5 world’s oil producers Source: BP
As for natural gas production, the U.S. surpassed Russia in 2009. Other large producers, such as Iran, China, Saudi Arabia, were far behind the U.S. and Russia as of 2014. The consumption level is still bigger, but the gap between production and consumption of natural gas is less than in the case of oil.
Figure 3. Some of the key world’s gas producers Source: BP
Figure 4. Production and consumption of natural gas in the US Source: BP
Lifting the ban: Benefits to the U.S.
Removing the barriers for exports could translate to more efficiency for the U.S. oil economy: A large amount of U.S. light crude oil is unfit for U.S. refiners, and the transportation is expensive. The U.S. does not have sufficient domestic buyers, so the producers end up leaving the oil in the ground, or pumping it at low prices. Crude oil exports have rapidly gained steam from nearly nothing in 2007 to 100,000 barrels per day in March 2013 (to Canada).
Figure 5. Production and consumption of oil in the US Source: BP
Although U.S. crude from Texas is similar to oil produced in Norway or Nigeria, those countries are closer to the European and Asian markets, so buyers will likely choose European or Asian crude when considering transportation costs. However, the Panama Canal will be expanded in the next few years, allowing larger ships to pass, and thus, crude from Texas can travel to Asian refiners. Ken Medlock, senior director at Rice University’s Center for Energy Studies, says that this will be very attractive if crude bounces back to $40 or 50 per barrel.
Skip York, vice president of integrated energy at Wood Mackenzie, says that U.S. refiners are equipped to handle heavy crude, and that the light, sweet crude is better for other refiners in the world.
“U.S. crude oil producers earn higher realizations selling to US refineries rather than paying to ship that same crude oil to an international market,” he argues in Forbes.
Some refiners in the U.S. will likely shut down, as they have enjoyed an advantageous position through the former laws restricting crude exports. But transporting oil from other parts of the country to the Gulf, to then export is not economically sound yet. Therefore, exports will not immediately take off.
Overall, experts believe that lifting the ban is highly beneficial to the U.S. economy, allowing the market to run freely. And free and fair trade is a principle the U.S. should promote.
Though the attention has been focused on crude oil, natural gas was not directly mentioned in the December 2015 document. The bill itself only mentions natural gas once, referring to the Alaska Natural Gas Transportation Act being amended. However, in the summary, it states, “[The] American Crude Oil Export Equality Act amends the Energy Policy and Conservation Act to repeal the authority of the President to restrict exports of: coal, petroleum products, natural gas, or petrochemical feedstocks; and materials or equipment which he determines necessary for either exploration, production, refining, or transportation of energy supplies, or for construction or maintenance of energy facilities within the United States.”
New Europe says, “Defying a White House veto threat, the Republican-controlled House on Thursday approved a sweeping bill to boost U.S. energy production, lift a four-decade ban on crude oil exports and modernize the aging electric grid. The first major energy legislation in nearly a decade, the bill would also speed natural gas exports and hasten approval of natural gas pipelines across public lands.”
Overall, easier conditions for oil and gas exports means that the U.S. has an opportunity to strengthen its position worldwide, including in Latin America, Asia and Europe. The United States has already been exporting 500,000 barrels a day since October.
When it comes to oil, the U.S. exports will likely take a few years to start impacting the market. Until then, shipments to Europe and elsewhere will be more like “test shipments.”
However, when the exports do take off, they will have major implications for Russia.
Russia is a major player in both the oil and gas markets, both of which have experienced a range of difficulties in the past couple of years. These challenges include a stagnant economy, the introduction of the sanctions regime, as well as falling profits resulting from low energy prices.
The exports of oil and oil products from the U.S. will increase competition in global markets. In Europe, the U.S. has the potential to push out Russia and Saudi Arabia, players who are already competing. Russian and Saudi competition in markets for refined products is not only happening in Europe, but in the Asian market as well.
In natural gas markets, besides increased competition exacerbating the effects of oversupply, there could be serious implications for the organization of trade, particularly in the Asia Pacific. The majority of natural gas in the Asia Pacific region is sold under long-term contracts. Indexation to oil price and regulated pricing are the main price setting mechanisms used in the Asia Pacific gas market.
With the start of LNG exports from North America, it becomes possible to use hub-based pricing in the Asia Pacific. The parties investing in liquefaction terminals want to sign long-term contracts for using liquefaction capacity, the so-called tolling agreements. In this case, gas is purchased in the wholesale market (and not at the wellhead). There are also no limits in relation to the end point of LNG sales: buyers can route tankers according to their priorities in relation to the region and the final sales price. Therefore, the price at the largest American Henry Hub can be translated to the Asia Pacific region by adding liquefaction, transportation and regasification costs.
The main motivation for Asian importers to sign contracts in the North American market is the hope of reducing the end prices, since the given formula provides a price level lower than average gas prices in the Asia Pacific region in 2011-2014; or the possibility of arbitrage profits from the supplies to the premium Asia Pacific market.
There is no guarantee that the price generated in this way will be lower than the price linked to the price of oil. Consequently, in the long term such agreements may not lead to lower LNG import prices or to high earnings hoped for by the Asian parties signing these contracts.
One major consequence for Russia is that realizing its ‘pivot to the East’, it has to take into consideration alternative supplies as well as possibly much lower price levels than those expected during a period of high oil prices.
Finally, with exports of crude oil and natural gas, we could possibly witness more trading formats (i.e. exchange-based trade, when oil and natural gas are seen as traded commodities). Whilst this is the case in international oil markets, natural gas is still far from becoming a traded commodity. Russia might find itself in a position when redirecting from the European market, where it underwent a long process of dealing with the introduction of hub-based natural gas trade compelling Russia to adjust the conditions of its long-term contracts to the new reality. In the Asia Pacific, it may have to follow the same course.