Must-know: Why the U.S. could hit a light crude oil refining wall
While U.S. oil imports have been falling over the last few years, tanker companies such as Frontline Ltd. (FRO) and Nordic American Tanker Ltd. (NAT) could benefit from a brighter outlook on U.S. oil imports in 2014. U.S. oil production is definitely surging, but refining capacity could be hitting a wall.
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The LLS and Brent price differential
Louisiana Light Sweet crude (or LLS) is a coastal-based benchmark that has tracked closely with imported crude price—the international benchmark, Brent crude. Until recently, LLS has traded mostly at a premium because U.S. crude is of slightly higher quality than Brent or the international average and it’s closer to domestic refiners.
LLS is trading at a discount to Brent
But this relationship started to collapse in August, when LLS started to trade lower than Brent. This change reflects a buildup of supply at the U.S. coast and suggests refiners can’t take as much supply as they want. If this were driven by a temporary shutdown of a major refiners of high-quality domestic oil, the discount of LLS price to Brent would likely narrow to zero over time. On January 17, the spread stood at $4.47 a barrel. While it has narrowed further despite narrowing from $15.83 per barrel in October and our last reported $7.70 per barrel for December 23, the consistent discount suggests that U.S. refineries may have hit capacity to refine U.S. domestic oil.
Citigroup’s head of commodities research, Ed Morse, recently noted that the current volatility seen in the Brent-to-WTI and Brent-to-LLS crude oil spreads is a sign that U.S. refining capacity for light sweet crude is being reached. Although he noted there’s growing investment in capacity to refine further light sweet crude of approximately 700,000 barrels a day, that could take time.
On January 21, 2014, the IEA (International Energy Agency) also cautioned that U.S. oil output growth could hit a wall because of insufficient infrastructure capacity to take oil away and refine it.
Interpretation and thoughts
If U.S. refiners are running out of capacity to refine domestic oil, then additional U.S. demand for crude (including exports) would support crude oil imports. This could help crude tankers like Frontline Ltd. (FRO), Nordic American Tanker Ltd. (NAT), Tsakos Energy Navigation Ltd. (TNP), and Teekay Tankers Ltd. (TNK). The Guggenheim Shipping ETF (SEA) could also benefit until significantly more refining capacity is added.