U.S. Crude Oil’s Eastern Promise

One of the hottest topics at the recent oil industry gathering – IP Week in London – was the growing influence of U.S. crude oil on the Asian markets. Until very recently, that would have seemed like a fantasy discussion.  Before the repeal of U.S. crude oil export restrictions in December 2015, it had been 40 years since U.S. crude oil had left north America.

What a difference a year makes.  The oil industry responded immediately to the new opportunity and shipments of U.S. crude oil have quickly found their way to the booming Asian demand centers of Singapore, China, Japan, South Korea and Thailand.

The U.S. sent virtually no crude oil to Asia in 2015, but that figure leapt to 50,000 barrels per day between January and November of 2016 – the latest period for which official figures are available from the Energy Information Administration (EIA). Exports have continued to grow strongly so far in 2017 and this trend is likely to continue.

Shale Investment 2.0

The recent rally in the crude oil price is driving renewed investment in the U.S. shale oil sector, which is expected to deliver increased production. Forecasts from the EIA estimate U.S. production at 5.7 million barrels per day by the end of 2017, a rate well above the first shale boom from 2011-2014.  Some of this output will have to find a home overseas and the growing Asian economies are its most likely destination.

 

 

Asian Hedging in WTI

Strong Asian demand for U.S. crude oil is also generating strong demand from Asian consumers to use West Texas Intermediate (WTI) crude oil futures as a risk management tool.  During the Asian working day, around 80 million barrels of WTI are currently being traded.  This has made WTI the most liquid major energy derivative that is traded in Asian hours.

Before the lifting of the export ban, activity in Asian hours typically accounted for 2-3 percent of overall WTI traded volumes.  This has changed dramatically amid growing interest from Asian customers in managing the price risk related to U.S. crude oil imports.  Increased interest from commercial oil companies in Asia has also encouraged greater participation from the region’s financial investors.  In recent months, Asian time zone activity has soared and now accounts for as much as 14 percent of overall volumes of WTI.

WTI has always been the key price-discovery mechanism for the oil markets ever since its launch in 1988.  But back then, no one could have imagined just how global the benchmark could become.  The speed with which U.S. oil producers have built up an Asian market for their oil since the repeal of the export ban has caught virtually everyone by surprise.

Increasing efficiency in producing shale oil means that U.S. production is very competitively priced relative to oil from high-cost areas like the North Sea.  U.S. exports are already beginning to remake the world’s energy trading map by providing competition for West African and Asian sweet crude that typically price against the North Sea Brent benchmark.

Asian refiners are increasingly looking at the full range of U.S. grades.  Even more dense and viscous U.S. crudes such as Mars, which is produced in the Gulf of Mexico, have found favor with Chinese refiners, despite the huge distances involved.  This is in part because OPEC has reduced the overall supply of these heavier crudes, even though demand from Asia keeps growing.

This combination of factors provides both a pull and a push for U.S. oil exports to Asia and activity in this new trading route is likely to increase.  The soaring liquidity in WTI crude oil futures during the Asian working day enables participants on both sides of the market to manage their price risk appropriately and we can expect physical supply and derivative activity to grow together in tandem.

is Managing Director of Energy Research and Product Development at CME Group. He is based in London.

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