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Continental Resources, Inc. (CLR), EOG Resources Inc (EOG), Valero Energy Corporation (VLO): Will Oil Prices in America Hit a Wall?

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There’s no doubt about it, the US energy market is pretty unique. Not only do we have a one of a kind natural gas market that gives us a competitive advantage for chemical manufacturing and LNG exports, but we also have a robust pipeline infrastructure that is getting better every day. Both of these elements have contributed to the boom in American oil and gas production, but there also one unique element of the US oil market that could slow it down: our inability to export crude oil. We are still a long ways off from being completely oil independent, so how could a ban on exports constrict the market? Let’s take a look at why a 30 year old rule could hold back our boom in oil.

The Other Blend Wall

At first glance, it would seem a bit odd that we would need to start exporting crude oil. Even though we have turned around production in the US thanks to shale oil and increased activity in the Gulf, the US still imports about 9 million barrels per day. What is important to note, though, is the type of oil we produce and the type of oil we import.

Source: US Energy Information Administration

Much of the oil that we are finding today in shale plays is considered very light, sweet oil and we’re growing our production of this particular type of oil very fast. Continental Resources, Inc. (NYSE:CLR) recently announced that it is shooting for a production rate of 200,000 barrels per day by the end of 2014, which is 47% higher than the company’s current production. They aren’t the only ones, either. EOG Resources Inc (NYSE:EOG) expects a 35% increase in production from shale oil this year alone, and has plans to drill 500 wells in the Eagle Ford and Bakken formations next year. According to a recent report from Deutsche Bank, the US is expected to increase production of light, sweet oil by about 700,000 barrels per day within the next 12 months.

Source: EOG Resources Investor Presentation

This is in some senses good for the US, because these types of oil generally command the highest price point, and producing domestically does give a small discount based on today’s prices. But, for refineries to run at optimum capacity, they need heavier, more sour oils as well.

This is where the situation gets sticky.

At this rate, we would produce more light, sweet oil than US refiners can handle. Also, since the US cannot legally export crude oil with some minor exceptions regarding crude originating from Alaska and oil destined for Canada, then any production that is greater than refinery capacity would essentially have no place to go. Based on the report from Deutsche Bank, this effect could result in the the spread between domestic and foreign prices growing and US crude prices dropping to $75-$80 a barrel.

Oil Prices….Not Gas Prices

This should be good news, right? The basic laws of supply and demand mean that gas prices will drop because supply is in abundance. There are two reasons why this isn’t the case: 1) Our supply of gasoline is still limited by how much can be refined, and 2) There are no rules against exporting petroleum products. This means that excess supply of gasoline can be deflected to foreign markets, where refiners can command a higher price point. This past quarter, both Valero Energy Corporation (NYSE:VLO) and Phillips 66 (NYSE:PSX) combined to export 420,000 barrels per day of gasoline and diesel. Furthermore, the two companies have plans to increase export capacity to about 500,000 for each company. With such a large release valve for domestic gasoline supplies, refiners like Valero Energy Corporation (NYSE:VLO) and Phillips 66 (NYSE:PSX) will have a much stronger control of domestic gasoline prices.

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