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Return to Sender - Backhaul Economics Encourage U.S. Crude Shipments on VLCCs to Asia

In February 2016, two months or so after the U.S. lifted its crude oil export ban, prices hit their lowest point in the current down-cycle that began in the summer of 2014. The ongoing price collapse had contributed to the favorable political winds in Washington, DC that resulted in lifting the ban. But what was favorable in the political realm posed severe commercial difficulties: U.S. producers were stuck with trying to sell into an international market awash in crude. Facing adversity, though, U.S. exporters have been getting creative, with the latest strategy involving backhauls of U.S. crudes on the same ships delivering foreign crude to U.S. ports. In today's blog, ClipperData's Abudi Zein looks at the market conditions that make such crude flows economically rational. 

Back in December 2015, the U.S. crude oil export ban was lifted to a warm welcome from producers and free market enthusiasts. Lifting the ban fulfilled the wishes of many in the oil industry who argued that unfettered markets were the most efficient.  But there were a couple of unintended consequences.  First, with the U.S still importing millions of barrels of crude per day, for every barrel exported a replacement barrel would have to be imported.  And second, for exports to make sense, the price for crude oil in the U.S. would have to be cheaper than the price of competing grades in global markets.  In other words, domestic grades would have to be cheap enough to justify putting that oil on ships, paying the cost of moving those ships a considerable distance, and arriving at their destination at a final, delivered cost below that of competitors that traditionally served those markets.

Partly as a consequence of lifting the export ban, exporters found pricing differentials were moving against them just as they were getting ready to start selling abroad.  Now that U.S. Gulf Coast crude could be exported to higher value markets, it helped bump the price up slightly, even though volumes actually exported didn’t increase substantially.  That is, just the act of releasing domestic grades from the confinement of the U.S. market brought their prices more into line with the international market.  The Brent – West Texas Intermediate (WTI) differential - a measure of the competitiveness of U.S. grades with West African and North Sea crudes - flipped from a premium in favor of Brent to a discount of Brent to WTI.  For example, the March Brent contract in late November 2015 was $1.74/bbl more expensive than the same month contract for WTI. By mid-January, that same contract was 64 cents/bbl cheaper than WTI.  (Today the differential is back, with Brent being the higher price barrel, but more on that later.)

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