Ultimate Piece of U.S. Shale Oil Puzzle in Place

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By Gary Bourgeault

oil

Although the U.S. government finally gave U.S. oil producer’s approval to export oil about a year ago, the lack of suitable port infrastructure has kept the U.S. industry from having much effect on the global markets.  This is going to change soon, as companies such as BP (NYSE:BP) are working on ways to streamline the process of shipping oil to the Asian market in particular.

Before getting into that, I want to mention one thing that isn’t talked about much or thought about in regard to the U.S. shale industry, and that is how it has disrupted the oil market to this point in time.

The disruption has been the decline in oil imports because of the supply coming from domestic producers, or those operating in the domestic market.  The consequence of that has been the rearranging of oil markets, as those losing market share in the U.S. went after alternative markets – primarily in Asia.

That’s not to say oil demand in the U.S. isn’t growing, only that shale producers are supplying a lot of it.

At times during the last year, Saudi Arabia, in particular, had to lower its price of imports to the U.S. in order to maintain or grow its share.  The recent agreement to cut oil confirms it isn’t able to compete at that level; not because it can’t produce oil at a lower price than U.S. producers, but because it operates under different conditions, meaning it has domestic obligations its U.S. competitors don’t have.

Things are about to get worse for global competitors of U.S. shale producers, as they’re not only supplying more of the energy needs of the U.S. but are ready to display their full potential as they start to compete in the global markets, targeting Asia as well.

Export growth will make the U.S. the global oil leader

As Saudi Arabia and Russia stand at this time, there isn’t a lot of potentials to add a lot more barrels to what they’re already producing.  For a period of time, they may be able to kick it up a notch, but it would be short-lived.

Longer term Russia, at least within its own territory, probably has the most potential for growth.  Its decision on what to develop will determine how much more it can supply the market with over time.  By that I mean whether or not it continues to pursue Arctic locations, or it tries to develop some of its shale resources.  Russia is close to the U.S. in the amount of known recoverable shale reserves, with about 75 billion barrels.  The numbers are fluid because more recoverable oil continues to be found in the U.S.

To me, it’s not as important for the U.S. to be the global leader in the supply, than it is to be the swing producer, which it already is.  What the U.S. does is now far more important than what OPEC or Russia do.  If they do in fact really cut production, the U.S. shale producers can easily, quickly and profitably increase output and take market share from them.

In the recent past most of that has come from supply the domestic U.S. market, but with companies like BP looking to add another revenue stream to its fold finding more efficient ways to deliver U.S. oil to Asia, it’s only a matter of time before the U.S. starts hammering its competitors at the export level.

Ongoing improvements in efficiencies and productivity will make them harder to compete against, especially when they focus on market-driven issues, rather than the issues nationalized or partially nationalized companies face.

While it’s off the primary focus of this article, over time this will be good for the oil market, as it’ll force nationalized companies to become more market driven, as already evidenced by Saudi Aramco going public in the near future.

For U.S. shale producers, what’s important to understand is it’s now entering into the phase I think their competitors have been dreading, which is to start competing at the global level.

In that regard, a Trump presidency could lead to infrastructure improvements at the port level, which would make U.S. oil the global powerhouse it has the potential to become.  In that regard, it’ll be the global supply leader and the swing producer.

U.S. Shale shipping challenges BP is working on solving

It needs to be understood from the beginning of talking about U.S. shale exports and shipping, it has nothing to do with OPEC and Russia supposedly making production cuts.  This has been part of the strategy of U.S. shale producers since they were given the go-ahead to export oil.

I mention that because most of the media reports I’ve been reading suggest that’s a key trigger and catalyst, when in reality it’s irrelevant to the shale industry, as far as it being an impetus behind their export strategy.

The key challenges that must be resolved are the how best to ship U.S. oil in light of port limitations, the long distance to Asian ports, and the costs associated with delivering oil to that growing market.

This isn’t insurmountable issues by any means, and with the U.S. poised to become the global supply leader over the next several years, it will be a very lucrative business for those being able to most efficiently ship oil from the U.S. to Asia.  BP is aggressively pursuing that business.

According to a source cited by Reuters, here is the challenge BP faces: “Keeping regional price differentials, different tanker rates, and the forward price curve in mind while considering the delivery needs and schedules of your counterparties is not something many oil trading firms can do.”

“BP is one of perhaps half a dozen firms capable of doing so.  Aiding the current U.S. export market is low-cost tanker rates and current oil deliveries being less expensive because of “a price/time curve,” which makes North American oil deliveries profitable.

Working on streamlining the shipping process, BP did a recent run where it delivered just under 3 million barrels of oil to the Asian market.  It may not sound like a lot, but the cargo was valued at about $150 million.  It took BP about four months to deliver the oil.

What could help make it even more profitable would be if some U.S. ports were improved so they could handle larger ships.

U.S. ports as they are now

There are a couple of things involved with shale oil shipping that challenges the shippers. One of them can be changed, and the other will remain the same.

First, we’ll look at the Panama Canal, which isn’t big enough for the larger tankers.  There is nothing that can, or probably will be done, to address that need.  So we’ll see the biggest tankers having to take a longer route to deliver oil.  I don’t see that changing anytime soon.

In the case of U.S. ports, since they aren’t able to handle the larger tankers either, it forces the splitting of oil cargoes in order to be able to access the oil at the ports, which are then delivered to larger tankers for delivery.

This is an area that should be able to be improved.  As shale producers boost production going forward, it will put pressure on the ports to be revamped to be able to handle larger tankers.  If that doesn’t happen, it means extra steps and costs in the shipping and delivery process.

Another interesting aspect of shipping U.S. shale oil is because it targets the Asian markets, it has to not only load and unload oil from smaller to larger tankers but also have to split the deliveries in order to meet different market demands in the region.

The complexity of this in the case of BP has allowed it to take the lead in shipping U.S. shale, which if it is able to defend and grow it, could be a surprising revenue stream for years into the future.  I don’t think the market has priced this into the share price of BP yet.

Conclusion

There are a lot of pieces to the U.S. shale puzzle, and at the export level, it’s the final piece to the overall sector, which when put in place, will bring the U.S. oil sector to a market leadership role.

Since it’s already the swing producer in the world, it won’t generate more influence, as it’s already at the top of its game there, even though a lot of old school analysts, pundits and investors still haven’t figured this out.

What exports will do is reveal the U.S. shale industry as the future supply leader of oil, which will expose OPEC as the weak and former power it has in reality already become.  It will also bring a lot of investors significant profits as revenue for individual U.S. shale companies soars, and with costs shrinking and oil demand, over time, eventually catching up with the oversupply, earnings will climb with it.

For that reason, I’m bearish on U.S. shale in the near term but very bullish on it for the long term.  It’s the same to me concerning the overall oil sector as a whole.  I don’t care about the volatility of the market, I just continuing adding shares over time to my specific oil holdings, as they’re going to do very well in the years ahead.

As for BP, I see this as an excellent opportunity to take a complex problem with a lot of future upsides and create a significant new revenue stream that will last for years.  Only a few companies can do what it is now doing, and it’s already created a gap between its few competitors.

With shale exports about to take off, even though it’ll be incrementally in the short term, it will be a powerful force in the oil market in the years ahead, and low-cost shale producers with a lot of reserves will make many shareholders happy.

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Reference: Seeking Alpha, Reuters

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