The Molecule Laws: History and Future of the Crude Export Ban

  • photo courtesy of Terence Wright http://www.flickr.com/photos/london-commodity-markets/8200278608/
    Jan 2, 2014

    In 2011, the Energy and National Security Program at CSIS began to examine the consequences of new, surging hydrocarbon production on a wide array of the upstream, midstream, and downstream infrastructure throughout North America. Last month, we held a conference on the policy implications of the changing oil and gas landscape in North America. The keynote presenter, Rusty Braziel of RBN Energy, clearly outlined the myriad changes taking place in the market and highlighted a number of resulting infrastructure consequences. Braziel’s focus, however, was the complicated legal structure governing oil and gas exports, which he dubbed the “molecule laws”—his point being that the United States permits or restricts exports of hydrocarbons primarily based on their chemical composition, but also on several other less-than-straightforward factors. Braziel argued that these “molecule laws” could lead to inefficient investment decisions and affect the level of future oil production from the newly emerging plays and should be reviewed. Since then, other market analysts, companies, and even Secretary of Energy Ernest Moniz have publicly commented on the need to reconsider our export regulations.

    The law and administrative rules—cobbled together over decades and enshrined in a disparate set of statutory laws—have effectively made the question of whether a particular hydrocarbon can be exported dependent on the shape of its molecules, how those molecules were processed, where they were produced, to whom they are being exported, and (in some cases) the temperature at which those molecules were processed. Braziel described the “molecule laws” as follows:
     

    • Molecule Law #1 (governing natural gas): Methane (natural gas) molecules can be exported. Permits for liquefied natural gas (LNG) terminals are granted on a project-by-project basis, and the process differs, so far, based on destination. All LNG export projects undergo an environmental and safety review process (pipeline exports to Mexico and Canada go through a separate process). In addition, the Department of Energy grants export authorizations unless the export is found to be inconsistent with the public interest. For countries with whom the United States has a free trade agreement that decision has been set by law, and the requests are automatically and swiftly approved.
    • Molecule Law #2 (governing natural gas liquids [NGLs]): There are five NGLs (propane, ethane, normal butane, isobutane, and natural gasoline). NGL molecules can be exported to any nonsanctioned country, regardless of the needs of the U.S. market.
    • Molecule Law #3 (governing crude oil): Crude oil molecules (technically, the mix of hydrocarbon molecules that comprise crude) can be exported to Canada (as long as they stay in Canada or if the product is exported back to the United States), if they come from Alaska, or if they come from certain heavy oil fields in California (up to 25,000 barrels per day). Otherwise they must remain in the United States to be refined.
    • Molecule Law #4 (governing gasoline, diesel, and other petroleum products): There are no restrictions on motor gasoline, diesel, and other petroleum products molecules; they can be exported to any nonsanctioned country, regardless of the needs of the U.S. market.
    • Molecule Law #5 (governing condensates/plant condensate [natural gasoline]): Condensate comes straight off of a wellhead (like crude oil) and is lightly processed, while plant condensate results from the processing of natural gas in a natural gas processing plant. Chemically, lease condensate and plant condensate (natural gasoline) are essentially the same thing. In fact, a given molecule of this material can end up either as natural gasoline or plant condensate depending on whether the weather is hot or cold at the time of production (in hot weather, more pentane molecules end up in natural gasoline, while in colder weather more pentane ends up as field condensate). However, the laws governing them are different. Field-derived lease condensate can only be exported to Canada (even though it is the chemical equivalent of natural gasoline), while as noted above natural gasoline is treated as an NGL and can be exported to any nonsanction country, regardless of the needs of the U.S. market.

    Of course, there is no evidence in the legislative history that Congress was concerned about chemistry, and the ban on exports of some hydrocarbons and not others is not framed in terms of molecules (it is typically framed as refined products versus crude oil, with natural gas and NGLs as outliers to some degree). But Braziel’s point is that the laws governing exports have resulted in a confused policy.

    The legal architecture governing hydrocarbon exports was put in place during a long period of actual then perceived energy shortage in the United States, stemming primarily from the shock of the oil embargo in the early 1970s but also from the twin facts of U.S. domestic production decline and increased consumption. The anchor of U.S. crude export policy is the Energy Policy and Conservation Act (EPCA) of 1975, passed in reaction to the oil embargo of 1973. (Natural gas exports are also governed by EPCA, but the licensing process is administered by the Department of Energy based on less restrictive guidelines set forth in the Natural Gas Act of 1938). That law directs the president to establish a rule prohibiting the export of crude oil (and natural gas) produced in the United States, with the authority to grant exemptions based on the purpose of export, the class of seller or purchaser, country of destination, or other reasonable classification. In short, the law establishes a general policy of crude oil export prohibition, with exports being made under certain exceptions. Other statutes also govern the export of crude, restricting or allowing crude exports based on production location. These include the Mineral Leasing Act, Export Administration Act of 1979, the Exports of Alaskan North Slope Oil Title (technically part of the Mineral Leasing Act), the Outer Continental Shelf Lands (OCS) Act, and the Naval Petroleum Reserves Production Act. These statutes were all enacted at a time when the prevailing mindset accepted exports as detrimental to national security (a mindset that still prevails in some quarters today).

    All of these laws are administered by the Department of Commerce, which has issued guidelines for licenses of crude exports. Currently, the Department of Commerce issues licenses in the following situations:

    • Crude from Alaska’s North Slope that travels through the Trans-Alaska Pipeline System (TAPS) (this is the only exception provided by statute);
    • Heavy crude oil (American Petroleum Institute [API] gravity of 20° or less) from certain fields in California, up to 25,000 barrels/day (enacted in the early 1990s after a long intergovernmental review process approved by the president);
    • Crude to Canada for consumption or use therein;
    • Crude from Alaska’s Cook Inlet;
    • Crude that is of foreign origin that has not been mixed with U.S. oil (i.e., reexports that the Department of Commerce can determine are not of U.S. origin);
    • Some instances of swaps with Mexico and/or Canada;
    • Crude exported in connection with refining or exchange of oil in the Strategic Petroleum Reserve.

    For the last 35 or so years since the blanket ban on crude oil was enacted, these rules didn’t have a significant impact on domestic production or prices because U.S. consumption far outstripped production. But as hydrocarbon production accelerates at a breakneck clip—U.S. oil production is at the highest level in 25 years, and the United States has added the equivalent of an Iraq to world oil markets in the past 5 years alone—the United States finds itself in a position of abundance in terms of natural gas liquids, natural gas, and crude oil (of some grades). With respect to oil, the United States is awash with light, sweet crude oil—more than U.S. refineries can efficiently or profitably process.* Just a few years ago, the United States was a net importer of propane (one of the NGLs). Now more than one-third of U.S. propane is exported. When it comes to gas, even increased demand from the power sector, industrial use, and pipeline exports to Mexico can’t vacuum up all U.S. production—exports will also be necessary to help balance supply and demand. In short, we have shifted from a position of hydrocarbon shortage to one of surplus—and policy has yet to catch up.

    The reality of abundance leads to the important question of whether and how the laws should change. Are hydrocarbon export restrictions still serving the public interest as they were intended to when enacted under very different circumstances?

    Some commentators and producers have already publicly stated that they believe it is necessary to lift the ban on crude exports. Proponents of unrestricted trade give multiple reasons to justify lifting the ban. The most politically savvy claim that unhindered trade flows will reduce gasoline prices (this is undoubtedly a possibility, but not a certain one). Citibank recently argued in a research note that U.S. gasoline prices would fall by up to 12 cents per gallon because U.S. exports would drive the price of Brent crude, a global benchmark, down (the global price of gasoline tracks to Brent, and gasoline—because it is refined—is an exportable commodity under U.S. law). But the overarching reason why producers—and many consumers—favor freer trade is that the ban distorts the energy market and leads to inefficiencies. For example, as Braziel pointed out, inconsistencies in export policy will create artificial arbitrage opportunities that will be exploited by some market participants. Others have argued that the export ban risks jeopardizing production by artificially lowering prices in the United States. Lower prices will reduce the investment in new wells and reduce the growth or actual level of future production and discourage investment in the oil and gas sector, sacrificing jobs, economic growth, and government revenue. Opponents of a ban also argue that prohibiting crude exports amounts to a violation of our international trade obligations under the World Trade Organization and makes the United States—a longtime, vocal proponent of free trade—look like a hypocrite. Condemning other countries’ export restrictions while simultaneously banning exports of our own “strategic” commodity does not help broader U.S. trade policy.

    While the historical legacy and the economic theory against the crude export ban are clear, likely next steps for U.S. policy remain murky. As the energy market responds to ever-growing U.S. hydrocarbon production, policymakers are racing to keep up. As Secretary Moniz recently acknowledged, the crude export ban needs to be reexamined, stating “There are lots of issues in the energy space that deserve some new analysis and examination in the context of what is now an energy world that is no longer like the 1970s.” On the other side of the issue, Senators Edward Markey (D-MA) and Robert Menendez (D-NJ) have both issued their own letters urging the administration to resist appeals to lift the crude export ban. The senators argue that oil continues to be a strategic asset that, despite the current atmosphere of abundance, export restrictions are a vital part of our national interest and justifiable under WTO regulations.

    Given the competing viewpoints on the subject and the increasing reality of production—the Energy Information Administration (EIA) recently estimated that crude oil production would reach 9.5 mmb/d by 2016—will the crude export laws evolve to take this new energy reality into account? It is not yet clear that the politics of the situation allow for such an immediate shift to a more export permissible environment.

    Several paths forward are possible:

    1. Status quo—The molecule laws remain in place. The permitting of natural gas facilities continues at its current pace and crude exports to Canada expand until its refineries are absorbing all the U.S. crude that they can profitably process. In the near term, U.S. crude prices will likely stay depressed and refined product exports—already at historic highs—are likely to continue.

    2. Administrative changes—The administration could change the criteria for approving export licenses. EPCA and the other laws related to crude exports give the president implementation discretion. For example, the OCS Act states that if the president makes a finding that exports of crude from the OCS will not increase reliance on imported oil and gas, are in the national interest, and are in accordance with the Export Administration Act of 1969, then he may approve them (in which case Congress has 60 days to pass a joint resolution disagreeing with the president’s finding). Mechanically, given the president’s authority, guidelines or criteria for exports could be established, taking into account things like crude availability, quality, and characteristics, refinery configurations and utilization, infrastructure, and crack spreads.

    3. Congressional action—Possible congressional action ranges from partial, selective repeals of some of the molecule laws—perhaps allowing unrestricted exports of U.S. crude produced on the Outer Continental Shelf, or revising the Mineral Leasing Act—to full repeal of the relevant section of the EPCA. While advocates have pushed for full repeal (and of course Congress could authorize it), other congressional action is possible, including new laws directing the Department of Commerce to loosen its criteria for export licenses (but keeping in place the broad restrictions) or authorizing exports of a certain type of crude up to a certain amount.

    Market participants and political actors are making real-time and not necessarily coordinated decisions on the most plausible pathways forward. Some of these decisions, especially on the refining and marketing side, will have an impact on whether and how pressing an issue this becomes for the actual crude license issuers at the Department of Commerce. The next stage of analysis for public- and private-sector analysts alike is to examine the range of possible market outcomes if no changes are made and consider what specific circumstances might warrant a break from the status quo.

    * When looking at the actual data, claims that the United States has more supply than demand appear confusing. After all, U.S. production has hit about 8 million barrels per day, while U.S. liquids consumption is close to 18 million barrels per day (some of which is consumed in the form of biofuels, natural gas liquids, etc.), and there is still a crude shortage. So why are exports necessary? It is an issue of crude oil quality rather than quantity. Many U.S. refineries are configured to process crude oil that is heavy, while U.S. production is mostly light. Light sweet crude and condensate imports are expected to reach zero by 2016, according to projections by Braziel’s group. Over the next few years, he projects that the United States will have an oversupply of 500–600 thousand barrels per day of light sweet crude, continuing until either refineries make configuration changes (which are expensive) or they are able to obtain a way to export those crudes.

    Sarah Ladislaw is a senior fellow and codirector of the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Michelle Melton is a research associate with the CSIS Energy and National Security Program.

    Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

    © 2014 by the Center for Strategic and International Studies. All rights reserved.

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