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Macro Macchiato: Covid, China and the Future for US Oil Exports


As US shale producers struggle with a slump in demand related to the pandemic and a glut of crude oil in the global market, US national crude oil production has fallen to around 10.5 million barrels per day (Mn bpd). Future production is also endangered as the ratio of mature wells to new finds grows as oil prices remain low. The number of active wells is down considerably year on year according to data from Baker Hughes which showed 830 a year ago, a nadir of 254 in the middle of September and slight growth to 287 on 26 October.

US oil refiners are also facing difficulties. Data from the Energy Intelligence Administration, part of the US Department of Energy, shows that refineries across the US are operating at around 70 per cent of capacity, a level that is unsustainable even in the short term. As one oil analyst put it, some refineries are only a bad fortnight away from closure.

Already in the last two quarters around three per cent of US refining capacity has gone permanently offline. Refineries that are distant from pipelines and ports, that have a low Nelson Complexity Index, or are suited mostly to only one or a few grades of crude, are most at risk of closure or adaptation to storage. Others that can be adapted are being considered for conversion into biodiesel production or the manufacture of ammonia or hydrogen.

As California leads the way but around one dozen other US states follow with clean-air and other regulations that encourage car owners to consider hybrid and pure electric vehicles, demand for gasoline and diesel in the US may be peaking. Even through the Trump administration has relaxed corporate average fuel economy standards, a future administration could tighten them again. The US may be the world’s biggest petroleum products consumer today, as it has been for the last hundred years, but demand growth may stall in the future if consumer preference can be balanced with sustainability policies.

The question arises, what might in the future happen to US oil production and exports, particularly the US-China oil trade, if less oil is being refined domestically? Recent events may provide a guide.

According to more data from the EIA, between February and May 2020 there was a 3 Mn bpd or a 24 per cent fall in US oil production, coinciding with the strictest Covid-19 lockdowns. During the same 90 day period, US crude oil exports fell by 0.8 Mn bpd or around 21 per cent. Since then they have been steadily recovering.

According to news published by the China General Administration of Customs, US exports of crude oil to China reached a record in September of 3.9 million tonnes (around 0.95 Mn bpd) as Chinese refiners reacted to low prices and the phase one trade deal between the two super-economies. Even as the number of active US rigs was bottoming out, the US was exporting increasing quantities of crude oil to its biggest strategic competitor.

It’s worth noting that China's oil imports ran at record levels in Q2 and Q3 this year as refiners took advantage of low prices, just as they did in 2014-15 when China was building up its Strategic Petroleum Reserve. This time however commercial inventories have been growing. On every day during the five months to September, China’s oil imports have been over 11 Mn barrels, peaking at nearly 13 Mn bpd in June. Total imports for the first nine months were 416 Mn Tonnes (around 11 Mn bpd), up over 12 per cent year on year. Estimates for the proportion of imports going into storage vary, but a range of 1 to 2 Mn bpd seems reasonable.

Will this American trend of exporting crude for which there is no domestic demand continue? A number of unpredictable factors are in play, but, from an oil tanker owner's perspective, it’s still worth asking the question as the tonne miles from Louisiana to Shanghai are double those from Ras Tanura to Shanghai.

On the demand side, China has been a happy buyer of US crude oil regardless of the political relationship between Beijing and Washington. This is unlikely to change whoever wins the US presidential election. Chinese buyers focus on price and grade. For as long as they are allowed to import oil from the US, they will, if US oil meets their criteria.

But right now, independent ‘teapot’ refineries in China are said to be bumping up against their oil import quotas for the year, in which case a reduction in the overall amount of oil imports to China may become evident in Q4. Assuming China’s refiners remain committed to their contracted cargoes, the tanker freight market in the last two months of this year may depend on where China's refineries who can still import spot cargoes source those spot cargoes.

China’s preference for spot cargoes of lighter, sweeter crudes has already impacted the tanker markets in the last month as Brazilian crude oil exports to China rose to 4.5 Mn T (around 1.1 Mn bpd) for September, up from 3.0 Mn T a year earlier, making Brazil China’s third biggest supplier for the period (After Saudi Arabia and Russia) and making China the buyer for 70 per cent of Brazil’s exports.

OPEC’s total seaborne exports meanwhile continue to head south, falling below 17 Mn bpd in October after around 18.2 Mn bpd for September, well below the five year average of around 24 Mn bpd.

On the supply side, US oil investment is down this year as investors, faced with over USD 40 billion of restructuring in the oil exploration and production sector, are definitely in ‘risk-off’ mode when it comes to hydrocarbons. WTI crude makes up a large share of the export volumes while domestic offshore crude (which tends to be heavier and less sweet) is more often consumed by domestic refiners. The massive fall in the well count and the rising proportion of mature wells may reduce the amount of WTI available for export in future years if new wells don't come on stream.

That's a real possibility as US oil market analysts have flagged the end of the ‘grow at any cost’ business model for shale and now reckon on a period of consolidation and defensive M&A postures as producers seek access to capital. That is a different scenario from 2016 when oil prices last decimated the ranks of shale producers. In that year, capital was available to support a recovery in production. Now its absence portends a slower recovery to a lower peak.

In 2021, US WTI production and exports will continue to be influenced not only by economics but by politics. A Trump second term will mean ‘open all taps’ if the economics allow. A Biden victory may make little difference for next year. Mr Biden has after all said he will continue to license fracking operations. But longer-term, a Biden administration will signal greater support for renewables over further hydrocarbon exploration and production. And both sides of the House are now hawks on the US-China relationship, which could do more than any economic factor to decouple trade between the two nations.

All in all, it looks like US – China oil exports are not going to be booming any time soon. In fact their recent 0.9 Mn bpd peak may be unassailable for some time given constraints on both demand from China and the supply of WTI crude oil grades in the US. To that one can add competition from other light, sweet oil from the likes of Brazil. Tanker owners hoping for demand growth led by US-China oil trade may be disappointed. But then again, the cargoes from Brazil are a silver lining to this particular cloud.

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