THE BLOG
02/07/2013 10:06 am ET Updated Apr 09, 2013

Obstacles in the Path to a U.S. Oil Boom

A boom in North American oil production is under way, thanks in part to technological advances that are unlocking millions of barrels of oil that were previously inaccessible. But as these new supplies are extracted, they are facing logistical and policy hurdles above ground. Resolving these challenges is of paramount importance if we are to benefit from this vast resource.

Advances in hydraulic fracturing and horizontal drilling are allowing the U.S. oil industry to recover millions of barrels of so-called light, tight oil from shale formations across the middle of the country. U.S. crude oil production has increased by 1.3 million barrels per day (mb/d) in the past two years, and the U.S. Energy Information Administration forecasts that the U.S. will produce a further 1.4 mb/d by the end of 2014.

But it is no secret that once the oil is extracted from wells in the country's midsection, it often faces a long and complicated journey to refineries, many of which are located on the coasts. Transportation bottlenecks are one of the main reasons U.S. crude trades at a discount to international benchmarks. It is now well-known that landlocked West Texas Intermediate (WTI) crude has been trading at a deep discount to other benchmarks such as Brent since production volumes started ramping up two years ago.

What is perhaps less well-known is that internal North American grades fetch even lower prices, trading at a deep discount to WTI itself. Ironically, American end-users do not benefit from this production windfall since U.S. retail product prices are still heavily influenced by international markets.

If this disconnect in prices were to continue, it could threaten the economic viability of these new supplies, potentially stopping the boom in its tracks.

Fortunately, new pipeline and rail capacity is set to open in 2013 that will allow more crude from the Plains states to move to refining hubs to the east and west and along the Gulf Coast. While these are welcome improvements, they will not bring the marketing problems to an end. That is because U.S. crude exports are subject to stiff restrictions, and America's refiners can only absorb so much of the new supplies.

The sale of U.S. crude overseas is governed by the Export Administration Act of 1979, which allows the president to prohibit or curtail the export of commodities -- namely crude -- deemed to be in "short supply." Exceptions do exist, but for the most part U.S. producers are hopelessly constrained in their capacity to export domestic crude to countries other than Canada and Mexico.

U.S. businesses have adapted by exporting refined products -- which are not restricted under U.S. law -- instead of crude. The U.S. refining industry has in effect become a conduit for crude oil exports, allowing rising U.S. crude production to be exported in product form. In just seven years, the U.S. has tripled the amount of products it exports, transforming itself from the world's top product importer to second-largest product exporter, surpassed only by Russia.

Effective as U.S. refiners may have been in mopping up the additional supply and sending it overseas, they have limited capacity to absorb additional barrels of high quality light, low sulphur oil. Much of their capacity is geared to processing cheap, low quality dense, high sulphur grades and maximizing their yield of high-value-added products such as gasoline and diesel.

They have limited appetite for the premium lighter grades from the Eagle Ford and Bakken shale formations. Moreover, U.S. refining capacity is set to grow by less than 300,000 b/d through 2017.

This will not be the first time in the history of the oil industry that changes in technology and market conditions expose a misalignment between resources and regulations. While much of the anxiety about energy resources in recent years has focused on "peak oil" or other aspects of resource scarcity, in fact some of the bigger challenges facing the energy industry lurk not below ground, but above.

Some may see this as a choice between keeping American oil within U.S. borders for reasons of economic security and allowing the U.S. to generate billions of dollars in new export revenues. But market realities suggest a far simpler decision ahead: either U.S. crude is shipped abroad, or it stays in the ground.

While new pipeline links, supplemented with increasingly efficient railroad links, will give producers short-term relief from depressed prices, new export outlets will ultimately be necessary to leverage the full potential and reap the benefits of the new American oil revolution.

Washington will need to address this misalignment, lest the great American oil boom goes bust.

Maria van der Hoeven is executive director of the International Energy Agency.

This article was originally published on 7 February, 2013, in the Financial Times. It is based on analysis that first appeared in the January 2013 issue of the IEA's Oil Market Report, a monthly publication that provides a snapshot of the international oil market and projections for oil supply and demand 12-18 months ahead. To subscribe to the report, please click here.