Testing the waters: US condensates exports take off
August 2015 | Tim Fitzgibbon, Cherry Ding
Growing supplies of US condensate, largely from unconventional oil and gas plays, have resulted in a supply glut and deeply discounted prices. Evolving US export regulations have recently provided reprieve, allowing exports of minimally processed condensate to export markets, largely in Asia and Europe to feed the petrochemicals industries. As supplies continue to grow, there will be varying implications across the supply chain. Producers will have a greater opportunity to play further down the supply chain once price relationships stabilize. Growing volumes and net-back prices to the international market should still make many downstream investments to process condensates attractive. On the demand side, uncertainty lies around whether US exports will be sufficient to meet Asian splitter demand; this will impact both global naphtha crack spreads and Asian splitter economics.
Growth in unconventional oil and gas supply has led to a significant glut of extra light crude oil or condensate. US LTO production grew from only 130 kbd in 2005 to 3.7 MMbd in 2014. Regions like west and south Texas in the Eagle Ford and Permian shale regions have become awash in ultra-light crudes such as condensate (traditionally crude with API of greater than 55).
The limited marketability of condensate has led to heavy discounting against higher quality crudes. Posted prices for Eagle Ford condensate fell dramatically from 2011-2013 as condensate flooded the market. Discounts of various grades of Eagle Ford condensate to LLS during this period were as high as $25-30/bbl.
The price discount has since incentivized midstream companies and oil and gas producers to find ways to market this condensate at higher prices. US refiners, particularly in the US Gulf Coast, have invested heavily over the last two decades in capacity to process medium- to heavy-crude slates. In order to accommodate greater quantities of LTO, refiners have to either debottleneck distillation capacity or add new distillation for LTO. Over time, as LTO displaces medium and heavier crudes, refiners will have less feedstock for their high value conversion units (FCC, hydrocracking, and coking), as these are found primarily in heavier crudes.
Producers have also looked for opportunities to move barrels into the international market but have been limited by restrictions on exports of crude oil at the federal level. This has put pressure on regulators to clarify and relax the restrictions.
US crude oil exports have been effectively banned since 1975 under the Energy Policy and Conservation Act (EPCA). Under this act, exports are only allowed if an export permit is provided by the Department of Commerce. The conditions for receiving a permit have been quite narrow, resulting in an effective ban on exports. The few exceptions include exports to Canada for consumption within the country, exports of heavy Californian crude up to a certain amount, and re-exports of foreign imported crude. Under these rules, lease condensate has been classified as a crude oil and banned from export, while petroleum products are freely exportable. For several decades, this blanket export ban was able to go largely unexamined until most recently when US light tight oil (LTO) production took off.
In June 2014, the US Department of Commerce’s Bureau of Industry and Security (BIS) issued private rulings authorizing the export of lease condensate processed through a stabilization unit. Since then, exports have grown as condensate producers have sought to realize international prices for condensate. However, exports still account for a small share of total condensate production. Whether or not the US begins to export greater volumes of processed condensate will depend primarily on still evolving export regulations.
Last year’s rulings provided the first significant change to oil export regulations since the development of Alaska North Slope crude in the 1980s. Enterprise and Pioneer were the first to present cases to the BIS for the export of stabilized condensate, which they argued is a type of refined product (and allowable for export). Prior to these rulings, simple distillation through a splitter or topper was assumed by the industry to be the minimum refining process required to meet standards for US export. This is because the BIS Short Supply Controls define crude oil as “a mixture of hydrocarbons…which has not been processed through a crude oil distillation tower.” Compared to splitters and toppers, stabilizers are simpler in that their primary function is to remove lighter, more volatile hydrocarbons (typically C1 to C4) from the condensate produced on gas leases. The fact that BIS ruled in favor of the export implies that Enterprise and Pioneer’s processed condensate has been run through some type of distillation column, though the exact processing parameters are unknown.
In January 2015, the Bureau of Industry and Security attempted to clarify what it considers sufficient processing on its website. The guidance re-emphasized that distillation was the key to classification of lease condensate as a refined product, though it did not provide specifics on the required output product content and gravity. With this gradual evolution of export rules, there has been significant activity by producers to find ways to move barrels into the international market.
Testing the export waters
The US exported an average of 40 kbd of processed condensate from July 2014 to April 2015. The export destinations outside North America are primarily Asia and Europe, where the condensate is destined for either direct blending with other crudes or run through a splitter to feed petrochemical plants. Japanese refiner Cosmo Oil, for example, purchased 300,000 bbl for its Yokkaichi refinery in October 2014, reportedly to blend with other crudes. SK Innovation purchased 400,000 bbl which was destined for either its 110 kbd splitter in the company’s new petrochemical complex in Incheon or for blending with heavy crude at the company’s 860 kbd Ulsan refinery, according to a company official.
In Asia, the recent build-out of splitters, which require condensate as an input, coupled with a relatively flat supply, has led to concerns about future condensate availability, with condensate prices climbing steadily against Brent in the past few years. The current 700-800 kbd of condensate splitter capacity in Asia Pacific has been primarily supplied by Australia, Indonesia, and the Middle East. However, splitter expansion in Iran and Qatar is likely to reduce exports of condensate from the region into Asia. Currently, Iran and Qatar have 500 kbd of planned splitter capacity expected before the end of this decade. These developments could provide a strong demand for US condensate volumes in Asia.
Assuming US condensate export regulations remain unchanged and companies continue to apply for BIS classification or export based on self-classification, we see US condensate exports increasing by about 1000 kbd, from 2014 to 2020, driven by continued growth in US LTO supply.
The supply volume depends on the definition of condensate, which is still widely debated in the market. Traditional condensates have an API gravity ranging from 50 to 60 or higher (for reference, Brent is a 38-API crude). Recent light tight oil production in the US is creating a glut of light crudes in the 36-44 API range, as well as some “ultra-light” crudes in the 45-55 API range, mostly from the Eagle Ford and Permian. In Energy Insights’ reference case North America onshore oil production forecast, most of the growth in the medium term is expected to come from light tight oils with gravities in the 36-49 API range. Light crudes and gas lease production that falls within our condensate definition of 45 to 50+ API is expected to reach 2.4 Mbd by 2020, up from 1.4 Mbd in 2014.
On the demand side, the domestic market is limited to processing through crude splitters and topping units. We see 330 kbd of splitting and 270 kbd of topping capacity coming online by 2018, assuming the units are all built. Many of these projects were planned prior to the BIS ruling in anticipation of refining condensate in products which were in compliance with US export laws. Given the changing regulatory environment, some of this capacity may be at risk.
Two major uncertainties could impact the availability of US condensate for export markets: competition from Latin American buyers and inland transportation constraints for US condensate producers in the mid-continent. There is uncertainty around how much of the condensate could be exported to Latin America as a potential diluent for the region’s heavy crude oil grades, as the region is competing with Asia for the condensate. On the US side, it’s possible that much of the condensate produced in the mid-continent and other inland regions will not be exported, since the transportation cost for trucking condensate as a separate product to the US Gulf Coast may be prohibitive.
Implications across the supply chain
Producer prices and economics – For producers, the future should provide more attractive and stable price relationships as well as a more diverse range of end markets and end users to market to. This will provide an opportunity for producers willing to play further down the supply chain and intermediaries willing to step in to match volumes with end-use customers.
USGC downstream investments – Growing volumes and net-back prices to the international market should still make many downstream investments to process condensates, either neat or together with other refinery feedstocks, attractive. However, there will not be a large margin for error, so project developers will need to get all the pieces right, aligning project design (processing and transportation) perfectly with feedstock sourcing (location, quality, and pricing) and product placement.
Asian splitters – If splitters consume much of the additional condensate supply, tightness in the market is likely to continue in spite of the new US exports, possibly leading to relatively narrow naphtha crack spreads. However, if the additional condensate volumes exceed splitter capacity – forcing the marginal condensate barrel into refineries – the price of condensate could decline significantly, boosting Asian splitter economics.
About the authors
Tim Fitzgibbon is a senior expert for McKinsey's oil and gas practice and Cherry Ding is a market analyst with Energy Insights, both in McKinsey’s Houston office