The U.S. government has just approved a crude oil swap agreement between the United States and Mexico, in the latest dent in the longstanding ban on exports of American crude oil. The approval from the Department of Commerce allows U.S. producers to send about one hundred thousand barrels per day of light crude to Mexico’s state-run Pemex in exchange for the same volumes of heavy grades for U.S. refiners.
Given that the swap has been approved under existing law, which bans the export of crude from the U.S. under most conditions, it does not fundamentally alter the dynamics of the U.S. or global oil markets.
Given that the swap has been approved under existing law, which bans the export of crude from the U.S. under most conditions, it does not fundamentally alter the dynamics of the U.S. or global oil markets. Nor does it radically shift the debate over crude oil exports. The approval does, however, provide an outlet (albeit a small one) for beleaguered U.S. producers who are swimming in a glut of light, sweet crude as a result of rapid growth in shale output over the past five years. The exchange, which will last for a year and begin at the end of this month, was not a surprise and is another example of the Obama administration making a concession to the oil industry without having to actually change current laws or permanently lift the export ban. Late last year, the Bureau of Industry and Security (BIS), the wing of the Commerce Department that approves licenses for exports, said lease condensate that has been processed through a crude oil distillation tower is considered a petroleum product and can therefore be shipped overseas, helping alleviate the domestic glut of the ultra-light form of crude oil.
“Approving the swap agreement, along with allowing condensates to be exported, does signal that the BIS will be flexible in keeping the market moving,” said John Auers with downstream consultancy Turner, Mason & Co.
Given that U.S. producers are coming under pressure now that U.S. benchmark West Texas Intermediate is approaching the $40 per barrel level, down about $50 year-on-year, the Obama administration’s flexibility with allowing more crude exports under the current law is less controversial.
“Lower oil prices and stagnating or declining production made this decision easier,” said Auers.
The U.S. market is now glutted with commercial inventories some 86 million barrels, or almost 25 percent, above last year’s levels. Total crude oil output has declined modestly since the beginning of June, but is still around 9.4 mbd, up a robust .9 mbd annually.
Exports to Canada, and now Mexico
Canada is currently the only major export outlet for U.S. crude producers. Exports to Canada are allowed under existing laws, and, based on the Energy Information Administration’s (EIA) latest numbers, about .5 mbd is shipped to the U.S.’ northern neighbor, up from under .1 mbd as recently as 2012. With the massive oversupply in the U.S. and domestic grades trading well below international benchmark Brent, producers are pushing harder than ever to end the ban on crude exports so they can capture higher prices. A vote to liberalize U.S. crude exports recently passed the Senate energy committee and will eventually move to the floor. It is unlikely to pass in an election year, and even if it did, President Obama would likely veto the bill. Given voters’ sensitivity to fluctuations in gasoline prices, Congress and the President are likely to remain cautious on lifting the ban, which was put in place in the 1970s in the aftermath of the Arab Oil Embargo. U.S. refiners have come out against ending the ban as they benefit from lower feedstock costs and the ability to sell refined products on the global market. Against this backdrop, flexibility on the part of the BIS for swaps with Mexico is the easiest and least controversial path. Reuters reported that the BIS denied requests for swaps with Asian and European countries.
With the massive oversupply in the U.S. and domestic grades trading well below international benchmark Brent, producers are pushing harder than ever to end the ban on crude exports so they can capture higher prices.
The BIS has allowed the exports to Canada and the swaps with Mexico under language in the Energy Policy Conservation Act of 1975 that provided flexibility when dealing with countries with historical trade ties such as Canada and Mexico. Oil issues were left out of the North American Free Trade Agreement (NAFTA) that was put in place in 1994 because they were too politically sensitive.
The swap deal with Mexico can provide some relief for producers in the short run, even though the exchange is for a relatively small amount. Pemex asked for the waiver because it needs light crude for its aging refineries, and Mexico produces mostly heavy grades. “Pemex requested imports of lighter U.S. oil to mix with its own heavy crudes in order to boost production of premium, higher-value refined products, including gasoline and diesel, at its refineries,” said Lisa Viscidi, Director of the Energy, Climate Change and Extractive Industries at the Washington-based Inter-American Dialogue. “The swap will allow Pemex to move away from producing lower-value ‘bottom of the barrel’ products like fuel oil.”
Mexico currently imports roughly .64 mbd of refined products from the U.S., but the swap for light, sweet crude might lessen the country’s reliance on these imports. Pemex’s refineries are currently under-utilized, but the plants at Salamanca, Tula, and Salina Cruz, which have a combined capacity of .83 mbd, can boost runs with the imports of lighter crude.
U.S. Gulf Coast refiners, on the other hand, are configured to run heavier grades, such as those Mexico produces. These refineries underwent costly upgrades in the 2000s, prior the domestic production boom, to enable them to process heavy-sour crudes which typically sell for a significant discount on the global market. Mexico currently ships .74 mbd to the U.S., based on the latest data from the EIA. It’s still the third largest supplier to the U.S. (behind Canada and Saudi Arabia), although it occasionally lags Venezuela. Mexico’s volumes are down by a massive 1.1 mbd since their peak in early 2006, thanks to production declines of aging fields and poor management from the state. Nonetheless, U.S. refiners are keen on running heavy Mexican Maya, which trades at a discount to WTI.
Pemex will likely ask for future swaps once the current agreement expires given the country’s close proximity to U.S. shale fields and its “desire to further integrate itself with the North American energy market.”
Viscidi said that Pemex will likely ask for future swaps once the current agreement expires given the country’s close proximity to U.S. shale fields and its “desire to further integrate itself with the North American energy market.” Mexico seeks to foster an energy relationship with the U.S. similar to the one Washington has with Canada, particularly since the U.S.’ neighbor to the north imports a substantial amount of U.S. crude. Like U.S. producers, Pemex would benefit from a complete lifting of the ban on U.S. exporting crude so it could take in more oil produced in shale fields and prompt Mexico to invest more in its refineries and run at higher rates.