Will Oil Prices in America Hit a Wall?

There's no doubt about it, the US energy market is pretty unique. Not only do we have a one of a kind natural gas market that gives us a competitive advantage for chemical manufacturing and LNG exports, but we also have a robust pipeline infrastructure that is getting better every day. Both of these elements have contributed to the boom in American oil and gas production, but there also one unique element of the US oil market that could slow it down: our inability to export crude oil. We are still a long ways off from being completely oil independent, so how could a ban on exports constrict the market? Let's take a look at why a 30 year old rule could hold back our boom in oil.

The Other Blend Wall
At first glance, it would seem a bit odd that we would need to start exporting crude oil. Even though we have turned around production in the US thanks to shale oil and increased activity in the Gulf, the US still imports about 9 million barrels per day. What is important to note, though, is the type of oil we produce and the type of oil we import.

Source: US Energy Information Administration

Much of the oil that we are finding today in shale plays is considered very light, sweet oil and we're growing our production of this particular type of oil very fast. Continental Resources recently announced that it is shooting for a production rate of 200,000 barrels per day by the end of 2014, which is 47% higher than the company's current production. They aren't the only ones, either. EOG Resources expects a 35% increase in production from shale oil this year alone, and has plans to drill 500 wells in the Eagle Ford and Bakken formations next year. According to a recent report from Deutsche Bank, the US is expected to increase production of light, sweet oil by about 700,000 barrels per day within the next 12 months.

Source: EOG Resources Investor Presentation

This is in some senses good for the US, because these types of oil generally command the highest price point, and producing domestically does give a small discount based on today's prices. But, for refineries to run at optimum capacity, they need heavier, more sour oils as well.

This is where the situation gets sticky.

At this rate, we would produce more light, sweet oil than US refiners can handle. Also, since the US cannot legally export crude oil with some minor exceptions regarding crude originating from Alaska and oil destined for Canada, then any production that is greater than refinery capacity would essentially have no place to go. Based on the report from Deutsche Bank, this effect could result in the the spread between domestic and foreign prices growing and US crude prices dropping to $75-$80 a barrel.

Oil Prices....Not Gas Prices
This should be good news, right? The basic laws of supply and demand mean that gas prices will drop because supply is in abundance. There are two reasons why this isn't the case: 1) Our supply of gasoline is still limited by how much can be refined, and 2) There are no rules against exporting petroleum products. This means that excess supply of gasoline can be deflected to foreign markets, where refiners can command a higher price point. This past quarter, both Valero and Phillips 66 combined to export 420,000 barrels per day of gasoline and diesel. Furthermore, the two companies have plans to increase export capacity to about 500,000 for each company. With such a large release valve for domestic gasoline supplies, refiners like Valero and Phillips 66 will have a much stronger control of domestic gasoline prices.

The Ripple Effect
Provided there is no action from Congress to repeal the oil export laws, then this emerging trend could have a deep impact across several sectors of the oil industry. As you can imagine, refiners would be elated to be given the keys to the gateway of American oil, because it could potentially lead to those magnificent crack spreads they enjoyed back in 2012. At the same time, domestic oil producers could find themselves in a situation very similar to what we saw in 2012 when the price of natural gas slumped because supply was outpacing demand. If Deutsche Bank's prediction were to come true, then domestic producers could see realized oil prices drop by 20-30%. This could put the brakes on US shale drilling very fast.

America's oil industry has fundamentally changed over the past few years, and the way that we think, regulate, and invest in it needs to change as well. It may seem counter intuitive to allow crude oil exports from the US, but in doing so we can maximize the value of our domestic resources. Since we have the ability to export gasoline but not crude, we're not going to see a major price change at the pump if we keep the ban in place. As investors, we should keep a sharp eye on domestic production and what Washington decides to do with the oil export ban because it will have a profound impact on the prospects for companies across the energy value chain.

Keep Up to Date
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The article Will Oil Prices in America Hit a Wall? originally appeared on Fool.com.

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