Energy Production
Committee
Understanding the Petroleum Industry
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- Last year, Asia-Pacific’s net imports averaged well over 12 million
B/D, only modestly less than its gross imports because its large supply deficit leaves
little room for exports. Its import dependency rose to over 60%.
- Asia-Pacific’s imports are not just the highest but have also been
the fastest growing in the world: up 140% in a decade. This is the direct result of Asia
being the main driver of growth in world oil demand while oil production in all its six
top producing countries was hampered by various combinations of overly restrictive
contract terms, national oil company monopolies and a bias toward natural gas.
- As a result, Asia-Pacific has acted like a magnet on world oil trade,
pulling it eastward. Consequently, the region’s dependence on Middle East oil has
soared. Almost 90% of all its imports, and over half of all the oil it consumes, now comes
from this region, which has long been regarded as unstable. However, supply security is
taking a back seat to short-term economics, and no special steps are being taken to
mitigate the situation.
- This pull eastward has led to the emergence of a new trade flow: West
African crude to Asia. This primarily reflects Asia’s increasing thirst for West
Africa’s specialty: distillate-rich, high quality crudes, as governments across the
region tighten product quality specifications faster than local refiners can invest to
meet them. It also reflects the intermittent surplus that arises now in the Atlantic
Basin, due to the surge in production there in the last decade plus the determination of
Middle East producers to maintain a significant Western Hemisphere presence.
- (Back to
Trade and Import Chapter) (Back to Top)
- U.S. dependency on Middle East crudes in general, and on Saudi Arabian
crudes in particular, was expected to continue to rise in the 1990’s, just as it had
in the second half of the 1980’s. Instead, although total imports jumped by 2.7
million B/D, crude imports from the region declined.
- Politics are partly to blame. The unilateral U.S. embargo on Iranian
crude and the UN embargo on Iraq have limited refiners’ choices. However, the key
factor is the new paradigm adopted globally by the Upstream sector that has led to strong
production growth outside of the Middle East, and especially in the Western Hemisphere
(see World Supply). Production has risen fast enough in Canada, Mexico and much of South
America to allow their oil exports to soar; and their logical target is the neighbor that
is also the world’s leading oil importer: the U.S.
- Venezuela, and to a lesser degree Mexico, have also worked to make this
target market as large and as profitable as possible for their heavy, high sulfur crudes.
They have invested, via joint ventures at a number of U.S. coastal refineries, in new
refinery upgrading units, like cokers or asphalt plants. These turn their poor quality
crudes into the feedstock of choice at these sites, significantly reducing the large
discount they otherwise incur. This strategy has substantially raised the volume of crude
that Venezuela and Mexico can place most profitably in the U.S.
- Thus, Western Hemisphere suppliers grabbed over 90% of this decade’s
increase in U.S. crude oil imports, pushing their share of total imports up to 53% by
1997. The Atlantic Basin share dropped to 22% and the Middle East’s to 20%.
- Much of this incremental, Western Hemisphere crude takes less than a week
to reach the U.S. It has gained market from medium-haul, Atlantic Basin crudes, such as
West African and North Sea, that take 2-3 weeks, and from long-haul, Middle East crudes,
that take a month and a half. The resultant sharp reduction in average voyage times for
U.S. crude imports has encouraged refiners to reduce their inventories. (see Inventory
section).
- (Back to Trade and
Import Chapter) (Back
to Top)
- Unlike imports, exports are biased toward products, because most crude
exports have been banned most of the time. The only non-trivial crude export flow has been
of Alaskan North Slope (ANS). Destinations were originally limited to the Virgin Islands
and Puerto Rico but, with ANS exports liberalized in mid-1996, the flow quickly switched
to Asia. The Asian crisis plus declining production has caused this trade to slump in
1998, but total crude exports have risen because of a doubling, to 65 thousand B/D, of
exports of mid-continent crude to Canada.
- Product exports have moved upward in steps that reflect the removal of
both real and assumed barriers. Until the early 1980’s, restrictive regulations
choked off exports of almost everything except petroleum coke. As these regulations were
removed, product exports quickly tripled, to over 600 thousand B/D, but then stagnated,
thanks to apathy and political caution.
- Then, Asia’s desperate need for products after Iraq’s
destruction of Kuwait’s refining capacity in 1990 provoked U.S. refiners and
marketers into developing expertise in exporting products to Asia both profitably and at
low risk. As the surge in exports provoked no political backlash, they started to use this
new expertise to routinely include a wide spectrum of overseas markets in their list of
options for maximizing their net sales revenue. Product exports rose to a new, almost 50%
higher, plateau of around 900 thousand B/D.
- Distillate fuel oil exports were such a significant part of this growth
that, between 1991 and 1995, they approximately matched imports, making the U.S., at least
theoretically, self-sufficient in distillates. Strong diesel demand growth has
subsequently pushed the U.S. back into being net deficit on distillate.
- (Back to Trade and
Import Chapter) (Back
to Top)
- Since 1975, U.S. product imports have fluctuated by less than 600
thousand B/D. Yet this stability is only skin deep.
- Residual fuel oil has changed from being the most important product
imported to almost an afterthought. As utilities and industrial users have switched to
other fuels, imports have dropped from a 1973 peak of 1.8 million B/D, and a 60% share of
the total, to under 200 thousand B/D in 1997, and a 10% share. At the same time, products
that need to be reprocessed or blended have been gaining in importance, reflecting the
increased complexity of the U.S. refining system (higher proportion of refinery upgrading
to distillation capacity) and the rapid growth of specialty products like RFG. Gasoline
blendstocks, oxygenates and unfinished oils accounted for 1/3 of all product imports in
1997.
- Capital investment in refining has slowed because there is a lull in the
environmentally-driven mandates that triggered so much of the activity earlier in the
decade and rates of return have been inadequate to stimulate commercial projects. With
effective utilization rates close to 100%, domestic refiners are unlikely to be able to
keep pace with the expected growth in consumption over the next 5 years. The U.S. need for
product imports can be expected to grow.
- Price in an importing region, like the East Coast, is the price of the
marginal supply in its home market plus transportation (plus import tariffs etc.). As
imports grow, the marginal supply will tend to come from further away. Consequently,
product prices in the U.S. East Coast should rise relative to world prices over the next
few years.
- (Back
to Trade and Import Chapter) (Back to Top)
- As countries adopt specialty products like RFG, oxygenated gasoline and
low sulfur diesel, it becomes much harder to resolve supply problems through imports and
exports. There are fewer potential offshore suppliers of the finished product, and fewer
blendstocks that can be used. In other words, there are fewer resupply options.
- Compared to when product specifications were more standardized, it is
necessary to go further afield to find the same volume of product. That means that the
price of the imports delivered into the U.S. will be higher, even if there is no scarcity
premium attached, and that they will take longer to get there to resolve the supply
problem. Prices become more volatile, and the risk of stock-outs is higher. In other
words, specialty products lower supply security.
- U.S. refiners have been trying to ease this problem by importing a
product referred to as GTAB, gasoline treated as blendstock. This is a finished grade
where it is produced, primarily Europe, but needs to be reprocessed to meet RFG
specifications. Through their willingness to do this, U.S. refiners have at least
partially reversed the shrinkage in the import pool for U.S. gasoline brought on by the
move to specialty grades.
- Market fragmentation also makes it harder for both the importer and the
supplier to protect themselves from price risk. Chances are there will be important
quality differences between the product in question and the product on which the futures
contract is based. That means that the price differential in the market between the two
grades will be variable, creating what is known as basis risk. If this basis risk is
large, the number of potential suppliers of imports to the U.S. could shrink even further.
- Back to Trade and
Import Chapter
- See also, Specialty
Products and Market Fragmentation, from the Demand Side
- See also, Specialty
Products and Market Fragmentation, from the Refining Side
- See also, Specialty
Products and Market Fragmentation, from the Inventory Side
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