Family Feud: Lifting the Oil Export Ban

Larry Summers has called for an end to the crude oil export ban in the US. This is pretty much a no-brainer for even a pedestrian economist, let alone one of Summers’s intelligence, not to say one as intelligent as Summers thinks he is.

No-brainer or not, eliminating the ban (which isn’t a total ban, in any event) will have only modest effects. This is because although crude cannot be exported freely, refined products can be. Lifting the ban will mainly entail a substitution of crude exports for product exports, which will result in modest impacts on final product prices.

Here’s a crude outline of how opening up exports will play out (pun intended).

  1. The price of crude in the US will rise, and the price in Europe (notably Brent) will fall, until the price differential is approximately equal to transport costs of a buck or two, in contrast to the current differential of approximately $6.50. This isn’t immaterial, but it’s not a huge change either, given current prices in the $90s.
  2. The amount of crude refined in the US will decline, and the amount of crude refined overseas will rise. Refining margins in Europe will rise and those in the US will fall. The differentials in product prices will remain about the same, because products will be exported after the ban is lifted just as they are now, though export volumes will decline. Prices will differ by transportation costs post-lifting, just as they do now.
  3. The effect on product prices in the US (e.g., the price of gasoline) is a priori impossible to sign, because there are offsetting effects. US refiner input prices will rise, but margins will fall. The net price effect of higher costs and lower margins can’t be determined a priori.
  4. One factor will definitely lead to lower product prices. Post-free trade in crude, there will be a better match between crude slates and refineries. US refineries are more complex, and optimized to process heavier crudes from Mexico and Venezuela. Most are not optimized to process the large quantities of very light crudes that are flowing from Eagle Ford and the Bakken. In contrast, European refineries are better able to process lighter crudes. This better match of refineries to crude will reduce costs and increase productivity, which tends to reduce product prices.
  5. The main factor that will determine whether product prices rise or fall will be the effect of the lifting of the ban on the total output of crude: if more crude is produced, more products will be produced, and prices will decline. The lifting of the ban will reduce Brent prices, which will reduce North Sea output (and Nigerian output too). The lifting of the ban will increase US prices, which will cause US output to rise. The net effect on total crude output depends on the relative elasticities of supply. If, for instance, Brent supply is very elastic and US supply is very inelastic, total crude output could well fall, which would tend to increase gasoline and distillate prices in the US. If the elasticities are reversed, total supply would likely rise leading to lower product prices.
  6. If I had to guess, I would say that given that the product price changes will be negative but small, and hard to detect in the normal fluctuations of prices. The combined price effect shared between the US and non-US markets for light crudes is relatively small (on the order of 5 percent of price) and the offsetting effect on foreign and domestic output leaves a net effect on output (and hence prices) that will be relatively small.
  7. Tom Friedman supports lifting the ban, which makes me think twice. Friedman also says that lifting the ban will cause crude prices to drop by $25/bbl and thereby crush Putin and Iran and ISIS, thereby saving Ukraine and the MIddle East. Tom Friedman is an idiot. Pay no attention.

There will be one major effect, which Summers alludes to, and which I have emphasized when I teach about the export restriction in my Energy Policy course for EMBAs: the main effect of the change in policy will be to redistribute rents within the domestic oil industry. It will reduce the profitability of US refiners, especially some independents who are feasting on the abundant supply of light crude. It will increase the profitability of domestic crude producers.

In other words, contrary to a lot of the rhetoric, this isn’t about “big oil” vs. main street. It’s about Downstream Medium Oil vs. Upstream  Medium Oil. The big integrated majors basically see money shifted from one pocket to the other: since the lifting of the ban will increase total surplus in the energy market, the integrated majors will benefit, but the benefit will be smallish. The independent refiners will be losers, and pure upstream companies will be winners.

This is, in other words, a sort of family feud. A battle between different branches of the US energy sector family. But as any cop called to the scene of a domestic dispute will tell you, these can be pretty intense.

In sum, ending the ban would make the pizza slightly bigger, but you won’t notice it much at the pump, if you notice it at all. The main effect would be to change the size of the slices. But since conflicts over how the pizza is divided drive politics, the export ban will generate  political battles of an intensity out of proportion to its modest effects  on overall wealth and welfare.

About Craig Pirrong 230 Articles

Affiliation: University of Houston

Dr Pirrong is Professor of Finance, and Energy Markets Director for the Global Energy Management Institute at the Bauer College of Business of the University of Houston. He was previously Watson Family Professor of Commodity and Financial Risk Management at Oklahoma State University, and a faculty member at the University of Michigan, the University of Chicago, and Washington University.

Professor Pirrong's research focuses on the organization of financial exchanges, derivatives clearing, competition between exchanges, commodity markets, derivatives market manipulation, the relation between market fundamentals and commodity price dynamics, and the implications of this relation for the pricing of commodity derivatives. He has published 30 articles in professional publications, is the author of three books, and has consulted widely, primarily on commodity and market manipulation-related issues.

He holds a Ph.D. in business economics from the University of Chicago.

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