Congress is on the verge of passing a major budget deal that includes some of the largest changes to energy policy in some years. Tucked into the budget bill is a repeal on the ban on crude oil exports from the United States, a highly sought after goal on behalf of the oil and gas industry.
In exchange for lifting the export ban, Republicans agreed to extend tax credits for wind and solar for five years.
Just as the oil export ban is about to be lifted, the spread between WTI and Brent has narrowed to its lowest level in years. No doubt part of the reason that the differential has all but vanished is that the intentions of Congress were telegraphed to oil markets over the past few weeks, so the markets have already taken the move into account to a certain degree.
But there are underlying reasons to explain the shrinking spread between Brent and WTI. First let’s look at why the enormous differential opened up in the first place.
U.S. oil production surged from 5.3 MMbpd in early 2010 to a peak of 9.6 MMbpd in April 2015. The rapid rise in output, coupled with the ban on exports, trapped some oil within the borders of the United States. That edged out a lot of imports. Domestic refiners turned much of that crude into gasoline, diesel, jet fuel and other refined products, but refiners also had trouble keeping up with the rapidly rising production.
Too much oil within U.S. borders forced WTI to begin trading at a rather large discount relative to the Brent benchmark, which tends to reflect international conditions.
At times, the spread was very large, hitting a peak of nearly $30 per barrel in September 2011. Between 2011 and 2013, the spread was consistently in double digits, often between $10 and $25 per barrel. However, since early 2014, the spread began to narrow. A large part of that was because of greater pipeline capacity that relieved localized bottlenecks within the United States.
But another reason that the differential between WTI and Brent shrank over the past two years is because the Obama administration has already greenlighted a small volume of crude oil exports. In 2014, the Commerce Department gave the approval for exports of ultralight forms of oil known as condensate. Companies that put their light oil through a minimum level of processing could essentially begin exporting. With the stroke of a pen, some of the excess supply began seeping out through U.S. borders.
In August 2015, the Commerce Department also approved oil swaps with Mexico, allowing light sweet U.S. oil to reach Mexico, in exchange for Mexican heavy crude. The deal suited both sides, and marked another hole in the oil export ban. The 40-year-old export ban has been dealt a death by a thousand cuts by the Obama administration.
Furthermore, with the collapse of crude oil prices since 2014, U.S. oil production growth has ground to a halt and even reversed. As of September, U.S. output is down from the April peak by at least 300,000 bpd, and likely much more than that in recent months. At the same time, OPEC has increased output significantly since 2014. Saudi Arabia added about 500,000 bpd over the past year, and Iraq has added about 1 MMbpd.
In short, the glut of U.S. oil supplies has eased, both because of a fall in production and because some oil is beginning to be exported. Globally, however, the supply overhang has only grown worse.
That brings us to where we are today, with the Brent/WTI spread shrinking to less than $1 per barrel. That may not be a large enough price difference to justify large-scale oil exports. By some estimates, WTI needs to trade at least $4 below Brent in order for exports to make sense.
“We don’t believe at current spreads there is any impact, as exports would not be profitable,” Amrita Sen, chief oil economist at Energy Aspects Ltd, told Bloomberg.
The conditions could change at some point in the future, but for now, with such a small difference between WTI and Brent, lifting the crude oil export ban may not be such a big deal.