Last week RBN co-hosted the “Surviving the Flood” conference with Turner, Mason & Company in Houston. The major theme of the conference was the expected timing and likely impact of a “Day of Reckoning” for the US oil market that could come any time between 2015 and 2020 depending on critical factors influencing market dynamics. If and when the big day arrives, and if export rules don’t change and refinery hardware is not upgraded, Gulf Coast light Louisiana sweet (LLS) crude could be trading at a discount of $15-$20/Bbl to international light sweet benchmark Brent. Today we discuss the day of reckoning and its critical influencers.
Day of Reckoning
John Auers, Executive VP at Turner, Mason & Company (TMC), coined the phrase that became a recurring theme during the conference last week. He talked about a Day of Reckoning (DOR) defined as the time when the US runs out of refinery processing capacity to handle domestic crude and condensate production. What does that mean? Well US crude production is increasing rapidly as a result of the shale revolution. After growing by 70 percent since 2008 to reach about 8.5 MMb/d in July 2014 (of which about 1.2 MMb/d RBN estimates is condensate) both RBN and TMC expect US total production to get to about 12 MMb/d by the end of 2019 (of which RBN thinks about 1.8 MMb/d will be condensate). When you compare that with US crude refinery throughput of about 15.3 MMb/d in 2013, you might think that the DOR is still a ways off. But as we have explained in previous posts, US refiners are not able to process as much light crude and condensate as the shale revolution is producing because many refineries are geared toward processing heavy crude (see Charge of the Light Brigade). So if refineries cannot process all the light shale crude then at some point new production will outrun refining capacity. For most oil producing countries, such a development would not be a problem because excess production is simply exported. Here in the US however, regulations dating back to the 1970’s restrict the export of crude oil except to Canada and under a few specialized circumstances (see I Fought The Law). The bottom line – with rising production, refineries geared towards heavy crude processing and a ban on exports it looks like we are headed for a DOR.
Many of the conference presentations and much of the debate in the panel sessions concerned the factors that influence when the DOR will be upon us and what can be done by the petroleum industry to delay the date. There is also consensus between RBN and TMC about the impact of the DOR on the US crude oil market. Both companies believe that once production exceeds processing capacity, market pricing will become volatile and the resultant stranded crude or condensate that can’t find a home will weigh on prices. If export rules allow the export of processed condensate but otherwise don’t change, and if refinery hardware is not upgraded, RBN expects that sometime not too long after the DOR, LLS prices could be trading at a discount to Brent of $15-$20/Bbl – just the same way West Texas Intermediate traded at a big discount to Brent when it was stranded at Cushing, OK by a lack of pipeline capacity during 2011 and 2012 (see It’s Been Three Long Years). That big price dislocation is certainly not a desirable outcome for oil producers.
In the rest of this blog we lay out the factors that were highlighted at the conference as having a big influence on when the DOR will arrive as follows:
Production Increases: The speed at which crude production increases will be a big influence on the DOR. Right now we see no sign of an end to booming crude and condensate production. In fact Rusty emphasized the current boom in Permian basin production based on favorable economic return estimates that make even moderate length-lateral horizontal wells in the prolific Wolfcamp shale strata of the Midland Basin a 63 percent return on investment (ROI) based on publically available drilling and completion costs. See details of these calculations in Stacked Deck: Why Producers like Their Odds in the Permian. Permian production is up 300 Mb/d so far this year (2014) and is expected to increase at least a further 560 Mb/d to reach 2.3 MMb/d in 2019. And according to those economic estimates, Permian/Wolfcamp producers would still make a 30 percent ROI if crude prices fell to $60/Bbl. We do not see production declining in any of the other shale plays either. In the circumstances, the chances of new crude production slowing down enough to put off the DOR by a few years seem slender.
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