America's Secret Weapon: Liberalizing U.S. Oil Exports?
What would allowing U.S. crude oil exports do to the global price of oil? Tom Friedman, in a column Sunday, reflects popular conventional wisdom when he says they’d do a lot:
“The necessary impactful thing that America should do at home now is for the president and Congress to lift our self-imposed ban on U.S. oil exports, which would significantly dent the global high price of crude oil…. If the price of oil plummets to just $75 to $85 a barrel from $100 by lifting the ban… we inevitably weaken Putin and ISIS….”
He’s wrong. Here’s why.
This chart (click here) shows market expectations for Brent and Light Louisiana Sweet (LLS) oil prices. You should think of Brent as a “world” oil price and LLS as a “U.S.” oil price. The market expects Brent prices to be in the neighborhood of a hundred dollars a barrel for quite some time. It also expects LLS prices to be below Brent prices indefinitely. (The discount varies between about six and nine dollars over time.) Part of this – perhaps around three dollars – reflects the cost of transporting oil from the U.S. Gulf Coast (where LLS is priced) to northern Europe (where Brent is priced). A bit reflects the fact that LLS is higher quality than Brent. The rest of it reflects logistical and legal constraints on the ability to export oil from the United States.
Now imagine that those constraints were removed. Friedman says that oil prices could plummet by $15 to $25 dollars. Suppose for a moment that he’s correct. The Brent price would drop to $75 to $85 a barrel. The LLS price would remain a few dollars below that (mostly reflecting transportation costs) at, say, $72 to $82. Now take another look at the chart above: This would mean that U.S. oil prices would drop by between $7 and $22. The most obvious result of this would be to depress U.S. oil production relative to what it otherwise would have been.
But now stop for a moment: We are predicting a world in which oil production is lower and oil prices have also dropped. This makes zero sense: less oil production results in higher prices – not lower ones. Friedman’s claim about oil exports and oil prices quickly leads to a logical impossibility. The only possible conclusion is that Friedman is wrong.
That this is the correct conclusion can be seen by looking at what allowing oil exports would actually do to the global price of oil. As a basic rule, when you connect two markets where a commodity is selling at different prices, the common price that results is somewhere between the two. So further liberalization of oil exports should reduce Brent prices by at most a few dollars a barrel; anything more and Brent (plus transportation costs) would suddenly become cheaper than LLS. In actual practice the impact is likely to be considerably smaller, with most of the adjustment coming from higher U.S. oil prices rather than lower world ones.
There is an important caveat worth throwing in here: forward curves often are bad predictors of the future. It may well be that traders are underestimating how much constraints on U.S. oil exports will drive down LLS prices. But no one has identified plausible ways that the export ban could sustain a whopping $15 to $25 wedge between U.S. and world oil prices. Besides, even if it could, the impact of the ban would need to be entirely on U.S. prices (keeping them depressed), while the impact of lifting it would need to be entirely on world prices (reducing them to U.S. levels). That’s implausible.
Indeed if you look at estimates in a couple recent studies sponsored by the oil industry – which presumably would want to talk up the great benefits of removing the ban – you’ll see smaller numbers than Friedman’s. An ICF study sponsored by the American Petroleum Institute (API) pegs the impact on Brent oil prices at $0.05 to $1.05. An IHS reportsponsored by a group of oil companies claims a larger wedge – but even that stays below about $5 (see page IV-17 of the report for the relevant chart). (The IHS study also finds world oil prices never dropping below $95 even with free trade.) Indeed one prominent study (from a team at Resources for the Future) envisions an increase in world oil prices if oil exports are liberalized, as a more efficient refining complex boosts demand for crude oil.
I don’t know which of these figures is correct. But the one figure we can be confident is incorrect is the one that Friedman puts forward in his op-ed. Liberalizing U.S. oil exports would be a good thing to do for both economic and geopolitical reasons. But it is not a massive weapon that could fundamentally change U.S. prospects in the world – not by a longshot.
Image: Wikicommons/Creative Commons License 2.0