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The Impact of Oil Exports Is Being Greatly Exaggerated

by Michael Levi
September 8, 2014

Oil prices: Brent Louisiana Light Sweet Spread Bloomberg

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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.

The chart at the top of this page 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 report sponsored 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.

Post a Comment 7 Comments

  • Posted by David B. Benson

    Only diminishing demand, most unlikely to occur.

  • Posted by Thaomas

    Freedman may be wrong about the effect on international prices, but it is still a good Idea. It would allow Alaska oil to be shipped to Asia and save transportation cost.

  • Posted by Max Planck

    Oh, demand in the U.S., at least, IS plummeting. Thanks to fuel efficiency standards, and all the energy efficient measures we’ve taken in homebuilding, appliances, and just about everything that consumes energy, consumption has been dropping since 2008, and continues to trend down.

  • Posted by sk

    Tom Thumb’s comments and those of other pundits only show how poorly they understand markets, while at the same time they sing its hymns.

    Oil is a commodity. That means oil prices are set by the global supply and demand equilibrium. If the US could produce more economically, it would, today. We might not export it but we could definitely import less. That would increase the global supply and reduce the global prices. That in turn make some US extraction uneconomical and so on.

    This piece is an excellent take down of the pompous old f#rt Tom. But I am also sure it will not teach him anthing. Poor we will continue to be innundated with his foolish drivel.

  • Posted by Mr Truth

    Tom Friedman doesn’t just not understand energy, he doesn’t understand economics, foreign policy, health care, etc, etc.

  • Posted by abarrelfull

    SK

    I believe you are in error.

    The whole crux of the problem is that the US refineries need heavy crude and the growing domestic production is light. So there will come a point where an export ban is a really significant barrier to further oil production growth.

  • Posted by Jack William

    Solar energy may be used in a water stabilisation pond to treat waste water without chemicals or electricity. A further environmental advantage is that algae grow in such ponds and consume carbon dioxide in photosynthesis, although algae may produce toxic chemicals that make the water unusable

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