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).
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
Family feud indeed, but if the end result is a reduction of economic rents (removal of export ban) then we shall have a more efficient mid-stream marketplace – the slightly bigger pizza reference. Those small efficiency gains can produce a much different price impact at the pump than a simple linear econometric analysis. Not only will US refiners see their crack spreads drop $5-10/barrel, but their output volumes will drop precipitously, possibly facing bankruptcy (as many in Europe already are). Refineries will run for long time with negative margins- just to keep them open, since the EPA will never allow a new one. Worldwide we are awash in mogas.
Comment by scott — September 11, 2014 @ 3:07 am
Saudis cut price- target could be $75?
Posted by WARREN MOSLER on September 10th, 2014
I missed this when it first came out a few days ago.
This could be serious, as the plan could be to cut price low enough to put the higher priced producers out of business, which they can easily do. This includes all the shale and tar sands producers, for example.
And once that happens, with $trillions(?) of lost investments, it will be that much more difficult to raise capital to restart that production after the Saudis subsequently raise prices to the $150 level?
This article on the price cuts misses the above point entirely:
Saudi Arabia cuts October crude prices
By By Anjli Raval, Oil and Gas Correspondent
Sept 5 (FT) — Saudi Arabia cut October selling prices this week to customers in Asia, Europe and the US, in a sign that Opec’s largest producer is unlikely to curb production even amid an excess of crude oil supply.
The state-owned oil company Aramco reduced prices for its main oil export grade – Arab Light – to Asia by $1.70 a barrel in October from September, to a discount of 5 cents a barrel to the Oman-Dubai benchmark.
Prices to the Mediterranean fell by 95 cents a barrel, to a discount of $3.20 against the Brent benchmark. The same grade going to the US and northwest Europe declined by 40 and 70 cents respectively to the Argus Sour Crude Index and Brent benchmarks.
All four regions saw prices reach levels last seen in November 2010. Heavier grades also posted decreases.
“While the cuts were widely expected, the magnitude took a few in the market by surprise,” said Amrita Sen, at London-based consultancy Energy Aspects.
“For the Saudis, market share has really become an issue over the last year, so this is a signal that they are not just going to cut production because they have done so in the last few years,” she added.
Saudi Arabia has lost significant market share – particularly in Asia and the Mediterranean – to Iraq and Iran, both of which have been heavily discounting their crude. It is also increasingly competing with Kuwait and the UAE.
Although some analysts have said the lowering of prices for the US has been in response to growing shale oil production, others believe it is rather to do with low cost Opec producers seeking to expand their footing in the region.
“The overall reductions indicate they [Saudi Arabia] see a slack market and weak refining margins, meaning they have to discount more – particularly in Asia – to ensure their crude is taken,” said Gareth Lewis-Davies at BNP Paribas.
ICE October Brent, which hit $115 a barrel in mid-June, fell close to the $100 a barrel mark this week amid an oil glut.
Geopolitical tensions, from Libya to Iraq, have failed to disrupt production meaningfully. Moreover, excess supplies in the Atlantic Basin and North Sea, amid weak European demand, have only compounded the effect of North American production increases.
Market participants believe Saudi Arabia will cut production, influence prices and balance the market in times of oversupply, particularly since signalling its preferred price range of about $100 a barrel.
Production stands at close to 10m barrels a day, with 7m-8m b/d allocated for export.
As yet unhindered global production, combined with Saudi Arabia’s reluctance to cut output, bar seasonal fluctuations, could mean the price of oil falls further.
However, Abhishek Deshpande, analyst at Natixis, said the country was too reliant on oil revenues not to step in. “A greater number of exports at lower and lower prices doesn’t make sense.”
Even so, Mr Lewis-Davies added that when Saudi Arabia had sought to cut production in the past, regaining market share without disturbing the price had been problematic. There are also questions as to how much of the Gulf nation will be willing to lower output, especially if other Opec members do not follow suit.
Comment by Peter M Todebush — September 11, 2014 @ 6:59 am
@Peter-This would be a predatory pricing strategy, and those seldom work. Existing wells will continue to produce, and even if few new wells are drilled while the Saudis are keeping down the price, once they try to raise price again the drilling will re-start. This would be all pain, no gain for the Saudis.
I also wonder if they have the excess capacity to drive down price substantially. This isn’t 86, when they were operating at 33 percent capacity and could flood the world market.