Blog Post

Projected Reductions in Drilling Activity Do Not Undermine the Argument for Lifting the Crude Oil Export Ban

Apr 28, 2015 | Charles Mason

In early 2014, the case for lifting the crude oil export ban, which has been in place since the 1970s, started to gain traction—and with good reason. Doing away with the ban would result in lower US gasoline prices and greater US tight oil production. But the momentum stalled out as the price of crude oil dropped dramatically over the past several months. Indeed, Russell Gold recently reported in the Wall Street Journal that drilling of new wells in two key production basins—the Bakken and Eagle Ford plays—was set to decline. On one hand, this observation for the immediate term would seem to suggest that the case for lifting the oil export ban has become much less pressing. On the other hand, in its recently released 2015 Annual Energy Outlook, the US Energy Information Administration (EIA) predicted higher levels of domestic production of crude oil over the next several years, with a steadily falling share of crude oil consumed in the United States attributable to imports, down to 17 percent by 2040. This apparent conflict between the two projections seems to raise doubt about the urgency of lifting the export ban. But does it?

In my view, the case for lifting the ban remains strong, irrespective of the future path of new drilling. The recent trend toward ever-larger inflows of tight light oil into US refineries is apparently continuing apace. Consider the recent historical paths of oil production in North Dakota and Texas, two key locations of light tight oil. As shown in Figure 1, production in the United States has increased dramatically over the past five years, continuing into the last several months. By contrast, imports from the three major trading partners in the western hemisphere—Canada, Mexico, and Venezuela—have increased at a much slower rate.

Figure 1. US Tight Oil Production vs. Western Hemisphere Imports
Figure 1. US Tight Oil Production vs. Western Hemisphere Imports
Source: Graph created using data compiled from the US Energy Information Administration.
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As my coauthors Steve Brown, Alan Krupnick, Jan Mares, and I pointed out in an RFF issue brief last year, this light oil is a mismatch to refinery configurations in the Midwest and Gulf Coast areas, forcing sellers of light oil to accept dramatic price discounts. These discounts are unlikely to be arbitraged away until this oil can be exported. And to the extent that light tight oil sources must bear a discount, the incentive to extract these prolific deposits is reduced, ultimately to the detriment of US consumers and producers. Indeed, the likely gains from exploiting tight deposits could well run into the billions of dollars—monthly. (More on that in this related RFF discussion paper.) However, added production would likely be encouraged by action taken to relieve the pressure on producers to sell tight oil at prices below those that would be commanded on a global market.

But would relaxing the export ban force gasoline prices up? As my coauthors and I (along with a number of others) have pointed out, relaxing the ban is likely to lead to lower, not higher, gasoline prices. With increased supplies, relative to the situation where the export ban remains in place, there will be more oil on global markets. In turn, this will lead to lower crude prices, which will lead to falling refining costs, globally and in the United States. And a reduction in costs for all refiners will lead to a reduction in gasoline prices.

One might wonder whether the increase in the prices paid to tight oil producers would run opposite to this effect. Surprisingly, here the answer is no: the lower prices paid for Bakken oil mainly benefits Midwestern refiners. As a result, changes in costs borne by these refiners are what economists call infra-marginal: they do not impact the cost of the last unit of gasoline sold, and hence they do not impact the market price of gasoline. Clear evidence to this point is borne out by data on US crack spreads—essentially, the difference between the cost of a barrel of oil and the revenues received from the gasoline produced from that oil.

Figure 2. Midwestern and Gulf Coast Crack Spreads
Figure 2. Midwestern and Gulf Coast Crack Spreads
Source: Graph created using data compiled from the US Energy Information Administration.
For more information, please contact the author.

Crack spreads received by Midwestern refiners have been substantially greater than other US refiners for many months (see Figure 2). In other words, the steep discounts these refiners have received for their crude oil inputs are not being passed on to gasoline consumers. This is exactly the sort of phenomenon one would expect if output prices (i.e., gasoline prices) arise from a national, or even global, market, while seller costs are based on regional input markets.

In the end, the case for lifting the export ban remains as persuasive as ever: the main effect of the ban is to force sellers of light tight oil from the Bakken, Eagle Ford, and Permian basins to sell their oil at prices below the level that would be commanded on global markets. This discount benefits Midwestern refiners, but not US gasoline consumers. Lifting the ban would lead to increased tight oil production and lower gasoline prices.