US Pumps Up Oil Output to Highest Level in 20 Years

Ty Wright | Bloomberg | Getty Images

Derrick in Knox County, Ohio on January 5, 2013.

U.S. oil production topped seven million barrels per day for the first time since March, 1993 and is nearly 20 percent above the amount produced at this time last year.

The latest weekly data from the Energy Information Administration Wednesday again highlights how the growing role of the U.S. as a major energy producer is changing the dynamic of the energy market. As domestic production rose, U.S. imports fell in the week ended Jan. 4 to 7.9 million barrels per day, 10 percent below the four-week average and nearly 16 percent below the level imported in the same period last year.

U.S. oil production continues to accelerate at a surprising rate, and the government this week predicted in its short term energy outlook that the U.S. industry could pump 14 percent more oil this year alone. The use of non conventional drilling techniques in places like North Dakota and Texas has created an explosion in U.S. production to the point where the U.S. is expected to surpass Saudi Arabia in crude production by 2020, according to International Energy Agency statistics.

At the same time, the industry is developing more pipeline capacity to carry landlocked U.S. crude from storage in Cushing, Okla. to the Gulf Coast refining areas. That should continue to drive the trend, create more refined product for the U.S. and export markets, and bring down some oil prices in the next several years, according to the EIA.

In the next few days, a significant pipeline expansion is coming on line as the Seaway pipeline adds 250,000 barrels a day in capacity from Cushing to its current 150,000 barrels. In anticipation, the market has compressed the spread between U.S.-produced West Texas Intermediate and the international bench mark Brent crude, to about $18, the narrowest level since September.

"There's high hopes for what this Seaway pipeline will do for the WTI market, and that spread. There's a lot of expectations around that right now," said John Kilduff of Again Capital.

(Watch Now: Seaway & Keystone Help Oil Prices?)

The energy market has been trading these macro trends, and on Wednesday, both WTI and Brent were trading lower. WTI was just above $93 per barrel. EIA oil and refined product inventory data showed an increase in crude inventories of 1.31 million barrels for the week. Gasoline stocks, however, showed a surprisingly steep increase to 7.4 million barrels. Refineries were running at 89.1 percent.

The EIA short-term outlook, released Tuesday, included raised expectations for 2013 and its first forecast for 2014.

It said U.S. oil production, already at a 15-year high, is now expected to rise to 7.3 million barrels per day in 2013. That's 300,000 more than its December forecast, and 900,000 barrels per day more than what was produced in 2012. It also expects 2014 production to increase to 7.9 million barrels, the highest since 1988. That is up from a low of 5 million barrels in 2008.

The result could be lower prices. The EIA forecasts Brent could fall to $105 next year, and to $99 in 2014, from its 2012 average of $112. It expects WTI to trade an average $89.54 in 2013, and $91 in 2014. The spread between WTI, trading at about $93 Tuesday, and Brent, trading at $111.82 Tuesday, should continue to narrow to $16 in 2013, and to $8 in 2014.

"We were having trouble getting oil to market because of that bottleneck in Cushing, and that's one of the things that the pipeline is supposed to help," said Gene McGillian, analyst with Tradition Energy. McGillian said the oil market also has its eye on Washington, and trading has been more volatile as a result.

"The idea that the spending cuts and the debt ceiling weren't dealt with keeps the market focused on economic issues," he said.

Andrew Lipow, president of Lipow Oil Associates, said Seaway is the first of several pipelines that will change the flow of oil. "By the end of the first quarter, we expect pipelines form Magellan LP and Sunoco Logistics to be on line," said Lipow. "By the end of 2013, we should have the Keystone XL Southern leg in service from Cushing to the Gulf Coast.

(Read More: US Energy Agency Adopts Brent, Drops US Crude)

The flood of new oil coming to the Gulf Coast could compete with Louisiana Light Crude, used in refining, and priced closer to Brent, said Kilduff.

"The question is whether the impact of all this crude coming into the Gulf Coast, is it going to be enough to top over demand for Brent? Will it be a tipping point?" said Kilduff. "The way these numbers keep going up and up, it seems like it could." Kilduff said that would depend on how the impact of the Midwest crude filters through to the east coast, since the east coast refineries have run on oil based on Brent prices.

"The question is whether WTI rises to the Brent price, or Brent falls down toward the WTI price," said Kilduff. "Right now, it appears the WTI is rising toward the Brent. The focus now is on what this pipeline is going to do to drain the bottleneck in Cushing." Brent has historically traded below WTI, but in the last several years it's been at a premium because of Middle East tensions, declining production in the North Sea, production disruptions in Africa and mostly the bottleneck in Cushing.

Kilduff added that the Saudis have also increased supplies to their jointly owned Motiva refinery in Texas, and that supply will also hit the Gulf Coast market.

"My expectation is that the Brent spread will get to $10," said Lipow. "My expectation is that we will export a record amount of petroleum product in 2013 because petroleum product demand in the U.S. is relatively stagnant and we are going to process more crude as refiners in the Gulf Coast have raw material and operating cost advantages." The U.S. became a net exporter of refined products in 2011 for the first time since 1949.

Lipow said the U.S. refineries are running at historically high levels for this time of year, and he thinks pump prices, could fall to a low this year of $3.10 per gallon. According to AAA, the national average is $3.30 per gallon for unleaded regular gasoline, up slightly from $3.29 a week ago, but down from $3.47 a month ago. His expectation is that the year high will be $3.70.