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The Other Big Energy Export News

by Michael Levi
June 27, 2014

The energy world has been abuzz this week with news that the Department of Commerce will allow exports of minimally processed condensate. This has been heralded as a “step towards a rational oil policy” and a shift that “could change the world’s energy balance”. In particular, many are speculating that this is a step toward complete elimination of the ban on crude oil exports.

Meanwhile, far more quietly, BP and CNOOC announced a twenty billion dollar deal (last week) to trade liquefied natural gas (LNG). That agreement, I’d hazard, is at least as important as the U.S. move.

But first the oil export news. The ban on U.S. oil exports matters: it could ultimately push down U.S. oil prices substantially and deter (otherwise) economically attractive production as a result. It’s also liable to be an irritant in U.S. trade relations with other countries, particularly because U.S. policy may be unacceptable under the WTO.

This week’s news, though, says relatively little about whether the ban will be lifted. The Department of Commerce appears to have approved exports of condensate – essentially ultra-light oil – if the condensate has been processed through a distillation tower. Many politically informed market observers have long expected that the administration will ultimately allow condensate exports without any processing at all. There has never seemed to be much administration enthusiasm for the oil export ban on policy grounds; this isn’t like the gas export ban, where there are legitimate questions about impacts on consumers and on some manufacturers that stirred up internal debate.

My sense is that the big question has long been political: does the administration (and potentially Congress) believe that the political price of actually lifting the oil export ban is worth paying? In that context, any low profile move that effectively relaxes the ban or confirms a loose interpretation of it – including the announcement this week – should look attractive to policymakers. Most important, this week’s move says little about the political appetite for a big move on the ban – and hence provides little insight into what its ultimate fate will be. If there’s one interesting wrinkle, it may be the timing – the administration’s willingness to do this now, rather than after the elections, implies some willingness to take political risk. On the other hand, given the amount of confusion surrounding the decision, it’s probably unwise to infer too much finely-tuned strategy behind the move. Heck, I wouldn’t be surprised if a Department of Commerce bureaucrat made this decision without any meaningful White House involvement.

Meanwhile interesting things are happening in Asia with the BP/CNOOC announcement. News reports indicate that “BP will likely source much of the LNG [that it will sell to China] from its U.S. export plant at Freeport, Texas”. This follows little-noticed news last year that BG (not BP) would sell CNOOC natural gas priced according to a formula based in part on U.S. (i.e. Henry Hub) prices – an arrangement that, at a minimum, only makes sense financially for BG given its stake in U.S. LNG exports. In this case, one can’t find any public speculation about links to actual physical U.S. volumes (as opposed to U.S. prices). But when I was in China last month, I was stunned to hear an industry insider describe the deal straightforwardly as China buying U.S. natural gas.

Why is this important? No Chinese company has applied directly to export U.S. LNG or has even done a direct contract with an operator of a U.S. LNG export facility. Part of this is a desire to avoid regulatory headaches. But some analysts (myself included) have suspected that Chinese companies aren’t particularly eager to depend on U.S. natural gas supplies. These two deals now make something of a pattern, and suggest that China (or at least some Chinese companies) may be more comfortable depending on the United States than might plausibly have been the case. At a time where distrust between the two countries is high, this matters.

It’s important, of course, not to infer too much. If I could look at the BP and BG contracts I’d immediately focus on one thing: What are the sellers’ obligations if U.S. supplies are physically interrupted by the U.S. government? One possibility is that BP and BG would be off the hook for delivering the contracted gas, and the Chinese buyers would be sent scrambling for alternatives. If that’s the case, then the Chinese companies really are depending on the continued flow of gas from the United States to Asia, and on U.S. policymakers’ decisions. The other possibility, though, is that the contracts put the burden on BP and BG: in this case, faced with an interruption of U.S. supplies, the companies would be required to make up the shortfall using gas sourced from elsewhere. If this is the case, then CNOOC isn’t really becoming meaningfully dependent on the United States (and on U.S. policy) – they’re just getting a nice financial deal.

I tend to think that these sorts of political developments in the shape of gas trade will ultimately be more important than ones in oil. Oil markets are already highly flexible; while bad U.S. decisions could erode that at the margin, it’s going to be tough to really reverse the decades-long trend in that direction. Gas markets, in contrast, remain much more rigid, balkanized, and political. Developments that change this over the next decade or so therefore have the potential to do considerably more.

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