DrillingInfo’s Take On ‘Vendemonium’

DrillingInfo’s Take On ‘Vendemonium’

As a large crude producer, and the third largest source of US imports (as of April EIA data), Venezuela plays an important role in the global and US crude markets. This week, the impact of continued unrest in Venezuela on crude markets and prices has ramped up and the market is watching several key events closely.

The Issue:

Venezuelan citizens head to the polls on Sunday to elect a constituent assembly who will redraft the constitution.  There are several key issues with this vote that the market is tracking:

  • This election is sponsored by President Maduro and designed to increase his power and control by working around the Opposition-controlled congress.
  • On July 16th, the opposition organized an election. The result was 7.6 million people that voted NOT to redraft the constitution.
  • The opposition (against President Maduro) is calling for its supporters to stay home and opt out of the vote because they never agreed to redraft the constitution in the first place, and the opposition has no representation among the candidates that are running.
  • There is no minimum turnout required for the vote to be legitimate. At this point, the outcome of Sunday’s vote is essentially pre-determined and will increase President Maduro’s powers if it goes forward.
  • The US has recently entered the discussion with President Trump promising to inflict “economic pain” if the election goes ahead as planned. Trump’s administration imposed sanctions on 13 senior Venezuelan officials on Wednesday but also stressed that the action was only a precursor to additional sanctions that will be implemented should the vote go forward.  Additional sanctions would likely limit US imports of Venezuelan crude.
  • This week there have been several meetings behind closed doors to negotiate. Both parties, and several third parties have been included in these negotiations and each has different goals.  The opposition is pushing to stop the redraft of the constitution, and the current administration is promising future elections for President and state-level government positions in exchange for an end to protests.  The next Presidential election is scheduled for Dec 18th, and the state Government’s election is scheduled for Dec 17th.
  • In addition to the two recognized parties (the Opposition and President Maduro’s Administration), there are other independents actively participating in the protests. The main independent group is largely made up of young people and students and is called “The Resistance.”  Because of these independents, even a successful negotiation between the two main parties this week may not be enough to stop the protests.


Key US Data Points to Consider:

The US imported 811 MBbl/d from Venezuela in April (latest EIA data). This makes Venezuela the 3rd largest source of US imports behind 1. Canada and 2. Saudi Arabia. Of the 812 MBbl/d imported in April, 795 MBbl/d came into PADD 3 and 16 MBbl/d came into PADD 1.   In addition to the crude imported from Venezuela, the US is linked to Venezuela by the roughly 100 MBbl/d of light crude exports that leave the US and land at Curacao for blending with heavy Venezuelan barrels.  It is not clear what impact any US sanctions would have on these light barrels.
In April, the following refiners imported Venezuelan crude:

  • Citgo: 218 MBbl/d to their refineries in Lake Charles, LA & Corpus Christi, TX
  • Valero: 200 MBbl/d to their refineries in Port Arthur, TX (on behalf of Premcor) & Corpus Christi, TX & Saint Charles, LA
  • Chevron: 103 MBbl/d to the Pascagoula, MS refinery
  • P66: 101 MBbl/d to the Sweeny, TX refinery
  • Paulsboro: 97 MBbl/d to their refineries in Chalmette, LA (on behalf of Chalmette) & Delaware City, DE
  • Marathon: 36 MBbl/d to the Garyville, LA refinery
  • Motiva: 34 MBbl/d to the Port Arthur, TX refinery
  • Houston Refining: 19 MBbl/d to the Houston, TX refinery


What Does This Mean for the US:

DrillingInfo believes that if Venezuela crude is sanctioned, there would be a temporary short-term disturbance to some refinery operations in the US that would result in higher WTI prices due to scheduling issues for any waterborne crudes that are already en route.  However, within a couple of months after the sanctions are implemented, the Venezuelan crude would find its way to other markets (likely at a discount), essentially reshuffling what comes to the US.  WTI would normalize to lower price levels based on global fundamentals again, and Venezuela would be forced to offer additional discounts to land crude abroad. US refiners have the ability to import other heavy crudes, so the winners would definitely be Canadian and Mexican crude grades and Middle East heavies during that disturbance period.

  Figure 1. Venezuela Imports to US


On the product side, we expect lower distillate exports from the US in the short-term until cargoes are re-routed and US refiners replace their heavy feedstock supplies.

For US refiners, the obvious loser is the PDVSA backed Citgo, but Valero, Chevron, and P66 would also be negatively impacted. Valero and P66, in particular, have units (Cokers) built around the processing of Venezuelan crudes. They could run a lower utilization on the cokers, but their light ends processing capacities may limit this ability.

Where Else Can Venezuelan Crude Land:

The key reason Venezuela sends significant volumes of crude to the US is because of the complexity of US refineries and our ability to handle very heavy sour crudes.  Refining heavy sours requires coking and desulfurization units.   There are select refineries in all major refining centers globally that have coking and desulfurization units (example: Reliance Jamnagar Refinery) but no single region is a direct substitute for the overall US refining fleet complexity.   We expect that additional discounts to the already-discounted Venezuelan prices will be necessary to land these barrels outside the US.


If sanctions are implemented in the US that prohibit the import of Venezuelan crude, expect WTI prices to increase in the short-term as a global reshuffling of crude shipments unfolds.  Specific US refiners will be impacted more than others, and pressure on Venezuelan crude prices is likely.

Use DI International keep up with E&P trends in Venezuela and other producing countries.

How Will a Border Adjustment Tax Impact the US Oil & Gas Industry?

How Will a Border Adjustment Tax Impact the US Oil & Gas Industry?

Yesterday Goldman Sachs’ Damien Courvalin looked at the effects a Border Adjustment Tax might have on the domestic oil and gas industry. We expand on that analysis and look at impacts to not only the upstream industry but also to how it might play out for refiners who are challenged by shrinking supplies of low gravity crude that is their primary feedstock.

A border adjustment tax (BAT) in general means a tax applied to imports. It’s important to note that nothing is set in stone, but early discussions of the potential BAT being proposed by the GOP in their “A Better Way” plan would tax goods made abroad but sold in the US while exports would not be taxed. A 20% tax is the general rate proposed at this stage. For our discussion here about the impact on the US oil and gas industry, we will focus on how the proposed BAT would impact US oil and gas producers, refiners, and consumers.

For frame of reference, the charts below illustrate US crude imports broken out by origin (Canada, OPEC, Other) and by PADD.

Figure 1 – Imports by Origin (Source: EIA)

Figure 2 – Imports by PADD (Source: EIA)

Key Facts To Keep In Mind (these will come up again in the discussion below)

  • Global refined products trade with Brent today.
  • The US exports 3 MMBbl/d of finished petroleum products today (Figure 5 shows finished petroleum products in addition to crude oil and NGL exports) and commodities move/flow in the direction of higher prices. The mix of these exports is skewed towards heavy-end products like distillates and fuel oil. To maintain the current level of exports going forward, the refined products we export will need to be priced at a level that covers transport and incentivizes that movement.
  • US refineries are better suited to handle heavy and mid-range barrels. The growth of US unconventional production, which tends to be light, has pushed out nearly all light barrel imports. The remaining imported crude barrels are heavy and mid-range. There are no other major refining centers globally that are well suited to take these barrels.
  • US crude is growing again, but it is all light barrels. The US is better suited to take heavy and mid-range barrels than the light domestic barrel production that is growing today.
  • There are certain areas of the country (PADD 1 and PADD 5) that are not well connected to the US crude pipeline transportation network, and are instead heavily reliant on imported crude. PADD 1 and PADD 5 are also large demand areas and this demand pull is a large driver of refinery utilization rates.
  • The BAT would not happen in a vacuum. There are other global market trends unfolding that will impact the impact of the BAT in the medium-term. Specifically, there is a disconnect between the type of crude that is growing globally (light barrels), and the expected demand growth products (distillates that are primarily produced from mid or heavy barrels).
    • Drilling activity around the world has fallen dramatically in the past 1.5 years.
    • Global CAPEX tied to heavy and mid-range barrels is down dramatically
    • Demand growth expectations are expected to be skewed towards distillate products.

Near-Term Impact to WTI/Brent Spread

The BAT effectively makes imported crude barrels less competitive than those produced in the US. It would effectively cost 20% more to import a barrel than it does today so refiners would be incentivized to use a US barrel or the price of imported barrels would need to drop to cover the new tax. For example, if Brent were $50, the imported cost of the barrel would be $60 ($50+20% tax). Today, Brent (the international benchmark for crude prices) trades at a $2.46/Bbl premium to WTI (West Texas Intermediate, the US benchmark crude price). The BAT would result in a fundamental change in the Brent to WTI spread, with WTI trading at a premium. The logical question is whether Brent falls, WTI rises, or both. Assuming overall demand growth trends continue, the equilibrium supply/demand doesn’t change, so the answer is both (Brent falls and WTI rises). The chart below illustrates the Brent-WTI Spread today (white) versus the spread three weeks ago (red). The market has responded to the possibility of the BAT implementation; however, the full impact has not been priced in yet since likelihood of the BAT is unknown at this time.

Figure 3 – WTI – Brent Differential Today vs. 3 Weeks Ago (Source: MarketView by DI)

Near-Term Impact to US Producers

The impact to US oil and gas producers that produce a WTI quality barrel or heavier barrel would be positive overall. They would receive a higher price for their production because their production would be advantaged at US refineries. This dynamic is very similar to that observed by ethanol producers (or corn growers) in the US when the renewable energy standards were implemented.

The impact to producers of light or condensate production is less clear. In the near-term, the producers of light crude would likely enjoy a similar uplift to that observed by producers of mid or heavy barrels. Light barrels in general produce more gasoline and light products while heavy barrels generally produce more distillate and heavy products. As mentioned in the key facts section above, there is shaping up to be a disconnect globally between the quality of growing crude production and the demand growth of specific refined products on the demand side. Demand for distillates is expected to lead demand growth going forward, but crude production growth of mid and heavy range barrels necessary to make those products is at risk given severely depressed CAPEX and drilling levels abroad.

Figure 4 – Production Forecast by Crude Quality @ $50/Bbl WTI & $3.50/MMBtu HH (Source: DI ProdCast)

The impact to US oil and gas producers that produce a WTI quality barrel or heavier barrel would be positive overall. They would receive a higher price for their production because their production would be advantaged at US refineries. This dynamic is very similar to that observed by ethanol producers (or corn growers) in the US when the renewable energy standards were implemented.

Near-Term Impact to US Refiners

To understand the impact to refiners, we analyzed demand for refined products, crude exports, and imports by PADD. While we’ve seen opinions in the market on both sides (positive and negative for US refiners), we are of the opinion that margins will largely stay unchanged and refiners will neither win nor lose. The key thing here is that US refinery utilization rates in general hover over 90% (at a level higher than other regions globally) not just because WTI trades at a discount to Brent. The key drivers of US refining competiveness are high US demand for refined products, and US refiners’ ability to take heavy barrels and turn them into refined products the world demands because of the way they are tooled and the complexity of their operations. The US exports approximately 5 MMBbld/d petroleum products today of which is 3 MMBbl/d of refined products (crude oil and NGLs make up the balance). The specific mix of those exports is illustrated below:

Figure 5 – Exports by Product (Source: EIA)

The majority of our product exports come from heavy barrels. We take heavy barrels because our refineries are well-suited to do so, and we export the refined products. This 3 MMBbl/d of exported refined product volume is demanded abroad and there are no other global refining centers well-suited to take this crude and refine it if we don’t. You also have to consider that 3 MMBbl/d of US heavy imports come from Canada, and those barrels are effectively captive to the US today because existing infrastructure is not set up to export those barrels.

Figure 6 – Imports by Origin (Source: EIA)

It is our opinion that product prices will rise sufficiently to maintain existing margins and incentivize US refiners to continue operating at 90%+ utilization. US refiner margins will neither increase nor decrease.

It also must be noted that different market dynamics are at play depending on the US PADD in question. The map below illustrates refining capacity by PADD. One comment we’ve seen several times in the past couple weeks is PADD 1 refiners will lose because they are heavily reliant on foreign crude imports and their margins will be crushed if the BAT is implemented. We do not agree.


As illustrated below PADD 1 is a high demand area that relies on a combination of products from other PADDs (PADD 3 mainly), product imports from abroad, and crude imports to PADD 1 refineries to meet demand in the region.

Figure 8 – PADD 1 Demand & PADD 3 Supply to PADD 1 (Source: EIA)

This effectively makes PADD 1 a demand-pull region and product prices will do whatever they need to do to incentivize refineries to run or product imports to increase sufficiently to meet demand. Either way you look at it, refined product prices will likely need to increase to meet demand (and cover the new BAT). A similar dynamic is at play in PADD 5.

One logical question is why PADD 1 and PADD 5 could not simply take more US crude instead of imports? The answer lies in examination of the crude pipeline transport grid. Both PADD 1 and PADD 5 are effectively ‘islands’ within the US in terms of infrastructure connectivity. Neither is well connected to the main production supply areas as illustrated in the map below (there are also no planned infrastructure expansions underway to increase connectivity).


The next logical question is whether other PADDs could supply additional products to PADD 1? The answer to that is illustrated below. The existing product pipelines that move volume from PADD 3 to PADD 1 are nearly fully utilized. Similar to the crude infrastructure piece, the refined product pipeline system is not able to increase significantly to move more product to PADD 1.
Another logical question is what the impact will be to product prices in other PADDs (3,2,4)? It is our opinion that those product prices will also rise because they will need to compete with higher prices abroad and in PADD 1 and PADD 5. Given the option, a refiner will opt to sell their product at the highest price available and if the price locally does not compete, the products will move out in the direction of the highest price.

Everything we’ve discussed points to higher product prices in general and the loser will be the consumer.

Near-Term Implications For US Production Growth

A border adjustment tax will push prices higher for WTI. Two production scenarios were considered using DI ProdCast. One that is meant to forecast production without the border adjustment tax ($50/Bbl WTI & $3.50/MMBtu HH). The other is meant to forecast production with the border adjustment tax ($60/Bbl WTI & $3.50/MMBtu HH). For simplicity sake, this analysis assumes that WTI will rise and Brent will stay flat (despite the reality that WTI will likely rise at the same time Brent falls) so that we can quantify the impact of higher WTI prices on US production. The difference between $50 WTI and $60 WTI prices is approximately 1.0 MMBbl/d more production by the end of 2020 as illustrated below in the chart. Higher WTI prices would support more drilling, primarily in US unconventional plays.

Figure 10 – Production Forecast with BAT ($60/Bbl WTI) and w/out BAT ($50/Bbl WTI) (Source: DI ProdCast)

When you look at the quality of US production under these two different price scenarios in the two figures below, you can see that the 1 MMBbl/d of incremental supply is primarily in the ultra-light crude and condensate API gravity range (42-50 and 50+ API).

Figure 11 – Production Forecast by Crude Quality @ $50/Bbl WTI & $3.50/MMBtu HH (Source: DI ProdCast)

Figure 12 – Production Forecast by Crude Quality @ $60/Bbl WTI & $3.50/MMBtu HH (Source: DI ProdCast)

The logical question here is which of the follow scenarios play out:

  • Brent prices stay flat, WTI prices rise – global demand absorbs incremental supply of light barrels from the US (above what demand would be if the BAT wasn’t imposed).
  • Brent prices fall, WTI prices stay flat – mid range non-US production loses market share due to lower prices, overall global crude production is lower than it would be without the BAT, demand drops accordingly (otherwise crude prices would need to come up to meet more demand).
  • Brent prices fall AND WTI prices rise – US gains market share and produces more than it would otherwise, non-US production loses market share due to lower prices (which would lead to lower capital spending). The change in global crude quality in favor of light US barrels puts pressure on light crude prices, heavy and mid-range barrels gain relative strength.

It is our opinion that the third scenario is likely to play out if the BAT were implemented.

Near-Term Overall Winners and Losers

US Oil and Gas Producers – Winner

US Light-Heavy Quality Spread – Loser (Spread blows out more than it would otherwise.)

US Refiners – Indifferent

US Consumers – Loser

Canadian Producers – Loser

Post-2018 Implications

Up to this point, our analysis has primarily covered the immediate impacts if the BAT were implemented. There are other global market trends unfolding that will affect the impact of the BAT in the medium-term. Specifically, there is a disconnect between the type of crude that is growing globally (light barrels), and the expected demand growth products (distillates that are primarily produced from mid or heavy barrels). This dynamic promises to impact the value of specific qualities of crude dramatically. A relative ‘glut’ of light barrels will push prices of these barrels down. There are many US unconventional producers that will see lower prices for their crude based on the light quality (think back to 2014 when Gulf Coast condensate was trading $10-15 back from WTI).

At the same time light barrels are facing pressure, there will be a shortage of heavy barrels and the relative price of these barrels will improve as a result. In all likelihood, the BAT would result in a short-term boost for US producers but will do little to combat long-term market dynamics. On the refining side, the value of refined products will continue to drive refining demand for specific qualities of crude and margins will largely stay intact.

Things To Watch Out For

  • Most recent commentary from the administration has presented the possibility that the 20% tax might apply only to goods sourced from countries we have a trade deficit with. The majority of crude imports into the US today come from countries we have a trade deficit with.
  • Press Secretary Spice mentioned that the 20% tax was one of several options on the table. And the 20% tax itself “could be a multitude of things. Instead of 20 percent, it could be 18, it could be 5.”
  • The strength of the dollar will dictate the net impact of any Border Adjustment Tax. If the value of the dollar goes up, some (or all) of the impact of the BAT are mitigated.
  • Would the tax plan also include an exemption for American companies from paying taxes on exported crude and/or refined products? This would incentivize exports and/or result in higher US refined product prices.
  • Would Canadian barrels that flow through the US and are then exported through the Gulf Coast be subject to the BAT (Keystone XL implications)? Would proposed Canadian export pipelines like Energy East gain support?
  • What import taxes would be implemented by the countries that could be takers of US exported crude barrels as a response to the US BAT?
  • What import taxes would be implemented by the countries that take US exported refined products as a response to the US BAT?
  • The US imported 5.94 Bcf/d of natural gas on average in 2016 from Canada. The BAT would impact natural gas, not just crude, and make that production less competitive (basis would widen). In the medium term, pressure on Canadian natural gas prices would pressure supply competitiveness and this important source of marginal US supply would decline. The result would likely be higher overall US natural gas prices to mitigate these declines in Canada or incentivize additional US production.
  • What import taxes would be implemented by the countries that will take US exported petchem products (the US is expanding our petrochemical cracking capacity dramatically in the coming years; the utilization of this infrastructure may be at risk if barriers to global trade increase)?
  • The sulfur spec changes that will impact bunker fuel in the coming years will create an ‘edge’ for refineries all around the world that are sophisticated enough the achieve the lower spec (generally speaking a coking unit will be necessary). Adding infrastructure to refineries so that they are better able to handle sulfur and heavy-ends will create more competition for US refineries that are already well suited to do this.

Thoughts? Comment below.