Crude is rallying on this final day of January, as hopes and projections of OPEC production cuts return to the fore once more. Before we charge into a new month tomorrow, amid weekly inventory data to boot, hark, here are five things to consider in oil markets today.
1) The implications of a Border Adjustment Tax (BAT) – aka an import tax – on U.S. crude would not only impact import flows, but exports and domestic production as well.
If crude was homogenous, then there could be direct substitution: U.S. domestic production, suddenly at a 20 percent advantage given an import tax, could replace crude imports. But it is not quite that simple; crude comes in many different grades (we tracking nearly 400 of ’em). There are three main grades: light, medium and heavy. This is where the challenge arises.
U.S. shale plays produce higher quality, light crude. This is juxtapositioned with the U.S. Gulf coast, the refinery hub where nearly half of U.S. refinery capacity is. It has some of the most sophisticated refineries in the world, which are configured towards refining lower quality, heavier crude. They are not configured to refine light crude.
2) In addition to Canadian land-based flows of over 3 million barrels per day, the U.S. imports nearly 1.7mn bpd of waterborne heavy crude, the vast majority of which (1.45mn bpd) goes to U.S. Gulf refiners. The remaining volume finds its way to East and West coast refiners. There are two leading suppliers of this heavy crude, Mexico and Venezuela, who account for three-quarters of these flows.
Given that U.S. domestic light crude cannot replace these heavy imports, they will continue to be imported by U.S. Gulf Coast refiners, just at a 20 percent higher price. The refiners will then pass on this cost to the consumer in the form of higher refined product prices – aka…higher prices at the pump.
3) ‘What about light crude imports?’, I hear you say. That’s a good question. The U.S. imports nearly 1.5mn bpd of light crude, despite U.S. shale plays producing nearly 5mn bpd of the stuff. This is simply because of logistics.
It is cheaper for U.S. East Coast refiners to import light crude from the likes of Nigeria, Algeria and Norway, than to ship Bakken crude by rail from North Dakota. The West Coast has limited access to crude by rail, pulling in predominantly Saudi grades of Arab light and Arab Extra Light instead.
Hence, our ClipperData show
(hark, below) that both East and West Coasts imported well over 400,000 bpd of light crude last year, while the Gulf Coast imported nearly 600,000 bpd. Gulf Coast refiners have already maxed out their receipts of domestic crude, although an immediate 20 percent discount to domestic crude (via a 20 percent premium to foreign light grades) will likely inspire a renewed appetite.
4) We here at the good ship ClipperData (aharrrgh, me hearties!) put the below chart together to highlight certain scenarios based on varying degrees of OPEC compliance for our recent ClipperView events (as well as the mighty Abudi Zein’s Argus webinar yesterday). We can riff off this to highlight the impact of an import tax also.
We presented three scenarios:
- If OPEC / NOPEC show full compliance of production cuts, then prices could rise to as high as $65/bbl. If this were to happen, we believe that domestic production would rise to over 9.6mn bpd by year-end
- If OPEC / NOPEC show partial compliance to the tune of ~950,000 bpd (with Core OPEC participating fully, Oman too, Iraq cutting in part, and Mexico dropping naturally), then we believe a price of ~$53 seems reasonable. At this price level, we project domestic production to rise to 9.2mn bpd by year-end
- If the deal unravels, chaos reigns, and everyone returns to putting their pedal to the metal in terms of production, then prices could drop to $39, leading domestic production to finish the year at 8.8mn bpd
Applying a similar logic to a potential import tax, should we see demand for U.S. crude rise, we should see prices rise, and in response…higher production. Should we see WTI move to a material premium versus Brent – bid fare thee well to U.S. crude exports…because they’ll be toast.
5) Now for something completely different. Let’s switch gears as we finish up with an observation about the supermajor Shell. After its whopping $54 billion purchase of BG group, it is in the process of trying to pare some of its net debt, which has risen to $78 billion as at the end of Q3 2016.
After already making asset sales in every quarter of last year, it has just sold oil fields in the North Sea and Thailand for $4.7 billion. More sales are to come: it is targeting $30 billion in total divestitures to defend both its credit rating and its dividend.