Bakken Achievements Meet Infrastructure Constraints

The Obama administration’s recent decision to reject the Keystone XL Pipeline has another set of unintended consequences with particular importance to U.S. independent producers. The pipeline’s construction would have been a significant boon to the regional infrastructure needed to loosen the growing crude oil bottleneck in the Midwest, caused, in part by the surge in Bakken crude oil production led by America’s independent producers.

Bakken Benefits

In North Dakota, crude oil production has more than quadrupled since 2007. Based on current trends (see graph below), North Dakota will probably surpass California as the number three U.S. producer within the next few months, overtaking Alaska not long after. One benefit of this surge in supply is that, because crude oil from the Bakken tends to be light and sweet, it is easier to refine and easier to convert into the lighter products (gasoline, diesel, jet fuel) that are in high demand both at home and globally.

 

The economic benefits are enormous. Unemployment in North Dakota stood at 3.3 percent in December, the lowest rate in the entire country. Home foreclosures are also among the lowest in the nation. The state government’s tax revenues from oil and gas production have risen from a little over $100 million in fiscal 2005 to $1 billion for fiscal 2011. In addition, over the past three years, lease revenues and royalties have added over $800 million to state revenues and close to half a billion dollars to federal revenues.

Growing Pains

In light of this rapid growth, the logistical landscape has shifted markedly. Traditionally, imported and American crude moved north from the Gulf Coast to the Midwest’s refineries, which can currently handle about 3.5 million barrels per day. Now, with increasing crude from North Dakota and Canada, Midwest refineries’ demand for crude from the Gulf Coast has greatly diminished, and the net movement northwards between the two regions has dwindled to not much more than 500,000 barrels per day.

Now, more crude runs in the other direction, and with these challenges of moving Midcontinent crude out of the region, crude oil prices there have become sharply discounted compared with elsewhere. One symptom of this imbalance can be seen in the price spread between Brent, an international crude, and West Texas Intermediate (WTI), a Midcontinent crude stream. This differential, which was often a negative $2 to $3 per barrel in the early 2000s, flipped in 2010 with the most recent differentials in the $15-20 range as the imbalance has returned due to takeaway limitations.

Regional Markets Reflect Bottlenecks

An even more telling symptom for Bakken producers, in particular, is the recent shift in the differential between Bakken crude priced at Clearbrook, Minnesota and WTI priced at Cushing, Oklahoma. The Bakken quotes earlier had been tracking roughly with WTI — already at a sizeable discount to Gulf Coast and world crudes. But in February, with the regional supply imbalance persisting and in-place capacity to deliver crude oil outside the region apparently topping out, it has developed a sharp discount even relative to WTI — on the order of over $20 per barrel as of early February.


These regional imbalances have led to various efforts to adapt and reconfigure the distribution system, ranging from a planned reversal and expansion of the Seaway Pipeline between Cushing, Oklahoma and the Gulf Coast, to increased barging of crude oil down the Mississippi River. The Seaway reversal is already underway and reportedly could be shipping 150,000 barrels per day before mid-year, with further expansion planned. Among other possible projects, TransCanada says it is considering building U.S.-only segments of the Keystone XL pipeline. There has been a revival of rail transportation to fill in some of these gaps. As is shown in the accompanying graph, shipments of Bakken crude by rail now exceed 125,000 barrels per day and account for some 23 percent of total shipments.

East Coast refiners have been at an even greater logistical disadvantage with respect to these burgeoning American supplies. Getting Midwest crude to Eastern refineries is costly and problematic, and as a result East Coast refineries have largely continued to rely on more expensive, Brent-priced, imported crude. The result has been the closure of some East Coast refineries, others being put up for sale, and some companies exiting the refining business altogether.

Infrastructure Essential to Success

Overcoming underground geologic and engineering challenges have turned U.S. shale plays into technological energy success stories. Unfortunately, above-ground challenges remain. Because energy infrastructure has, for decades, lagged behind the expansion of energy production, the full benefits remain yet to be realized. U.S. policymakers must realize that the oil and natural gas industry relies on working energy infrastructure to connect the production, refining, and consumers. With those solid links in place, America’s independent producers can continue to do what they do best – explore, develop, and deliver the energy our economy needs now and in the years to come.

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