| | | Friday, March 20, 2015 | Issue #2503 | |
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A Simple Fix to End Oil Volatility David Fessler, Energy and Infrastructure Strategist, The Oxford Club
 On Wednesday, crude oil's slow death spiral was interrupted by Janet Yellen.
The dollar dropped when the Federal Reserve said it would take a gradual path toward raising U.S. interest rates. Since oil is priced in dollars, any significant fall in the dollar's value causes oil to rise.
West Texas Intermediate (WTI) closed the day at $45.16 per barrel, up 3.91%. The rise in Brent was even more dramatic, jumping 6.05% to close the day at $56.75.
Oil volatility is on fire right now. Just look at the chart below. It shows the price of oil in dollars per barrel (blue line) versus the Chicago Board of Options Exchange's (CBOE) Crude Oil Volatility Index (green line).
The two lines are nearly a mirror image of one another. Why the volatility? Because right now, oil prices are making wild swings up and down.
Geopolitical events, the value of the dollar, and supply and demand are all affecting the value of WTI. My friend John Hofmeister, former president of Shell Oil, predicted this during a discussion we had a few months ago (you can listen to our chat here).
When will volatility subside? When oil prices rise. And oil prices won't rise until the supply-demand imbalance changes.
This spring, between March and May, we should see U.S. refineries ramp up demand by at least 1 million barrels per day. This happens every year following the late winter-early spring maintenance shutdown most refineries undergo.
But what we really need to end volatility is the ability to export American crude oil. In fact, the price difference between WTI and Brent would likely disappear.
WTI might even fetch a higher price on the world markets than Brent does. Why? Because it's a higher-quality crude than most of what comes out of the Middle East.
Why Can't We Just Use the Oil We Produce Here?
The problem is most American crude refineries aren't designed to process straight WTI crude. They were back in the 1960-1970 era. But then our crude production slowed.
The U.S. decided to increase our imports of the heavier, more difficult to refine Brent. As a result, refiners had to spend billions of dollars modifying their facilities to process the imported oil.
Now America finds itself between a rock and a hard place. Using fracking and horizontal drilling, we are once again awash in light, sweet WTI crude oil. Unfortunately, we can't refine anywhere close to the amount we can produce.
The easiest solution would be to export it. But that's another issue.
As you may recall, we got into a bit of a spat with Saudi Arabia in the 1970s. It declared an oil embargo against the United States.
Here in the U.S., prices at the pump shot up overnight. Two- and three-hour gas lines at fill-up stations were the norm. (I know, because I was old enough to drive back then.)
The dispute over prices was eventually resolved and Saudi Arabia lifted the embargo. However, in the interest of our national security, Congress passed a law banning the export of U.S. crude.
Fast-forward to present day... the embargo doesn't make sense any more. Yet we continue to abide by it.
So, here we are with all this wonderful, light, sweet crude that we are unable to turn into finished products... and we can't even export it.
This isn't the only concern, though...
Are U.S. Oil Reserves About Ready to Burst?
By some estimates, our largest storage facility in Cushing, Oklahoma, could be completely full by mid-April.
The storage tanks there hold 85 million barrels of crude oil. New tanks are being built all the time. Yet analysts believe we are quickly running out of places to put the crude.
You see, right now the U.S. is importing and producing about 1.1 million more barrels of crude than it is using every day. The concern is that we will run out of storage before supply and demand equalize, which could send oil prices down to the $20 per barrel range.
But that's simply not going to happen. Because Cushing isn't the only crude storage facility in the United States. Here are the locations and capacities of the remaining four of the top five U.S. crude storage facilities:
- The Louisiana Offshore Oil Port (LOOP) has a capacity of 67 million barrels.
- The Houston Fuel Oil Terminal has a capacity of 36 million barrels.
- The Sunoco Logistics Nederland Terminal near Port Arthur, Texas, can hold 30 million barrels.
- The St. James Strategic Petroleum Reserve Terminal can also hold 30 million barrels.
Here's another thought: With oil prices so cheap, why not top off the U.S. Strategic Petroleum Reserve (SPR)? Its total capacity is 727 million barrels. And as you can see from the chart below, it has about 30 million barrels of capacity left.
In addition to the above-mentioned storage facilities, there are literally hundreds of other smaller facilities located around the U.S. And with oil prices so cheap, the cost of transportation becomes less of an issue for customers.
Where's All the Excess Oil Coming From?
You might be thinking if we stopped importing so much oil from Saudi Arabia, we wouldn't have such low prices. Think again. Saudi Arabia isn't the biggest problem when it comes to crude imports. It's Canada... by a long shot.
We import four times as much crude oil from Canada per day as we do from Saudi Arabia. Look at the chart below, courtesy of the Energy Information Administration.
It's interesting to note that as Canadian imports have steadily risen, imports from Saudi Arabia, Venezuela, Iraq, Kuwait and Columbia have steadily fallen.
So, should we blame our dilemma on Canada, our friendly northern neighbor and largest trading partner? If you read my Keystone Pipeline piece a few weeks back, then you know I think that would be a huge mistake.
The solution isn't to punish Canada for sending us thick oil (our refineries can easily process that oil). It's to remove the crude export embargo.
If we lift the embargo, WTI prices would flip-flop with Brent. This would have a positive effect on the U.S. balance of trade. Our exports would increase by billions of dollars per year.
Of course, none of this can happen without agreement between the president and Congress - a change in sentiment that I'm not expecting anytime soon.
Even if it is for our common good.
What do you think? Agree or disagree? Let me hear your thoughts on this very important issue.
Good investing,
Dave Fessler
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