Streetwise Professor

It is common to speak of “oil” as a homogeneous commodity, but it is anything but.  Oil produced from different fields differs on myriad dimensions, including most notably sulphur content and density.  Some oil is light and “sweet” (i.e., has little sulphur).  Some oil is heavy and sour. What’s more, refineries are configured to process particular kinds of oil.  A refinery equipped to process very heavy Venezuelan crude is not suited for processing something light and sweet, like WTI.  Much domestic oil production was in light and sweet varieties like WTI, and many foreign crudes are heavier and sour, so with the decline in US output refineries upgraded to refine the heavier imports.

So when you read stories about the fracking-driven oil boom in the US, you have to keep in mind that it’s not just the amount of oil that’s being produced–which is truly remarkable–but the type.  The oil gushing from the Bakken, Eagle Ford, and the Permian is very light, and sweet.  It has displaced imports of of lighter crudes, like those from Nigeria, but capacity best configured to refine it–especially on the Gulf Coast–is running pretty much full out.  So even though the US is still a net importer of oil, most of that is heavy and sour crude, and we have a surplus of light sweet.

Price signals tell the tale.  Light sweet crudes on the Gulf (like Louisiana Light Sweet) are selling at a substantial discount to lighter foreign crudes, notablyBrent.  These price signals are screaming “export light sweet oil”, but with limited exceptions, under laws passed in the 1970s, such exports are banned.

Those laws never made much sense, but they were never much of an issue as US production continued its inexorable decline until the mid-00s.  But the stunning reversal in this trend now means that the law is a seriously binding constraint. Just as of last week, moves are afoot to relax the restrictions on exports.

Economically, this is a no brainer.  The price gap between domestic and foreign light crudes means that there is a gain from trade to be realized.  But exploiting that gain from trade will not make everyone better off. It will tend to cause the price of crude to increase in the US.  It will also cause the price of refined products to decline overseas, as the cheaper American crude is run through foreign (notably European) refineries.  This would bad news for US refiners, especially those oriented to processing lighter crudes.  These refiners are making money hand over fist (especially compared to their lackluster historical financial performance) refining the new Texas and Dakota production, and exporting large amounts of refined products (notably gasoline), primarily to Europe.  Relaxing the export ban would shrink their margins, by raising the crude price and reducing prices of refined products in foreign markets (as they increase their output using US oil.)

So this promises to be a rough and tumble political fight, as the upstream and downstream segments of the US oil industry slug it out.  No doubt this fight will be heavy on the demagogy, if the early salvo from New Jersey Senator Robert Menendez, who claims that ending the export ban would be a win for “big oil” and would hurt American consumers, is any indication.  The foregoing analysis makes it plain that “big oil” is not a single entity with a single interest, but has factions (refiners, producers) whose interests are at odds.  This is mainly a battle between these factions.  Insofar as US consumers are concerned, Menendez’s claim is unpersuasive.  The marginal barrel of products is being exported, and the price of that barrel is being driven by prices in export markets.  Exporting US crude should reduce foreign prices, and lead to lower exports of products, which should actually put downward pressure on the prices of refined products in the US.

No, this isn’t about helping US consumers.  This is basically a battle over the margins of US refiners, especially the independents.  I have no idea how the politics are going to play out.  Some sort of compromise, no doubt, rather than an outright repeal of the export ban.

I note that Russia uses various means to attempt to reduce exports of crude oil, in order to bolster domestic refining.  Let’s not follow their example.

So what’s the moral of the story?  Perhaps that it is possible to have too much of a good thing, especially if you can’t trade it to someone who values it more.