Under the budget deal passed by Congress and signed into law by President Obama in December, the decades-old ban on exporting US crude oil has been lifted. Producers long argued that removal of the ban would eliminate market distortions, increasing domestic prices and stimulating further exploration and production in the US. Some US refiners, on the other hand, argued that lifting the ban would increase crude costs and that the higher costs would be passed on to consumers. Opportune has investigated the economics of lifting the ban and offers the following analysis of its effects.
Why the Ban?
The US ban on crude oil exports finds its roots in the first oil price shock of the early 1970s. At that time, economic factors combined to result in a quadrupling of the price of crude oil worldwide and shortages of supply in the US. US crude oil consumption had outpaced domestic production beginning before 1950 as shown in Figure 1. By 1970, a domestic oil price control system, which stifled some production, and increasing consumption had created a significant dependence on imported crude oil. Changes in economic policies also set the stage for a dramatic increase in the world market price of crude oil.
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In October 1973, Egypt, Syria, and Arab nation members of the Organization of Petroleum Exporting Countries (OPEC) declared an embargo on supplying crude oil to the US and other nations acting in support of Israel during the Yom Kippur War. The embargo involved not only a ban on crude oil exports to the targeted nations, but also cuts to production to achieve increases in worldwide price of crude oil. The effects were rapidly felt in the US. Shortages developed and refined products were rationed through a voluntary system. Consumers were forced to wait in long lines to get gasoline. By the time the embargo ended in March 1974, worldwide crude oil prices had increased from about $3.00 per barrel to nearly $12.00.
The US Congress responded to the first oil price shock by enacting the Energy Policy and Conservation Act of 1975. The intent of the law was to decrease the US dependency on foreign oil and to reduce the potential impact of any future supply disruptions. The act focused on establishing security of supply and reducing domestic consumption. The act created (1) the Strategic Petroleum Reserve, (2) the Corporate Average Fuel Economy standard for light vehicles, (3) the Energy Conservation Program for Consumer Products, and (4) banned the export of crude oil from the US. The ban on exported crude oil was administered by the US Commerce which was able to grant certain exceptions, principally associated with Alaskan production and exports to Canada and Mexico. Once oil was processed, it could be exported without restriction, so there were no impediments to exporting refined products. The ban would remain in place for the next 40 years.
Current Market Dynamics to Lift the Ban
Since the mid-2000s, US crude oil production has rapidly increased as a consequence of technological improvements in drilling and production of oil, principally directional drilling and fracking. This rapid increase in US production, combined with decreasing consumption of oil, has had a profound impact on crude oil and refined product markets in the US. Crude oil imports have declined significantly over the same period as shown in Figure 2.
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This decline occurred because of the increase in new US production. Since the new oil produced in the US could not be exported, it had to be processed in US oil refineries. Refiners needed to find additional outlets for their products. Once domestic consumption was satisfied, refiners turned to export markets. In fact, the US refined product market switched from a net importer of refined products to a net exporter in 2010 as shown in Figure 3.
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As these market changes played out, producers in the US began to recognize that their traditional crude oil markets were becoming disrupted. Producers had to discount the price of their oil in order to sell it and traditional markets were being supplied from new production areas. This situation was acutely demonstrated at the oil market in Cushing, Oklahoma. Cushing traditionally supplied crude oil via pipeline to refineries in the Midwest. As the trade patterns changed, less oil moved north and Cushing became oversupplied, eventually creating the need to move crude oil from Cushing south to refineries on the Gulf Coast.
The price of West Texas Intermediate (WTI), the US benchmark crude which is set in Cushing, became discounted to the price of Brent, a commonly-used benchmark for the world price of oil.
Prior to 2010, WTI traditionally sold at parity or even at a premium to Brent. In 2011 and 2012 as Cushing became oversupplied, the discount to Brent became quite large, in the range of $16 to $18 per barrel, reflecting the increased costs of transporting the oil to an alternative market. Since that time, additional investment in pipeline capacity to transport the oil to the Gulf Coast has reduced the discount significantly, but WTI remained discounted compared to Brent for much of 2015 as shown in Figure 4.
This persistent discount may be viewed as a measure of the incentive needed to place the crude into US refineries, which in turn reflects any additional transportation cost plus an incentive to refine the crude into products for export. Lifting the ban on crude oil removes the need to discount the oil to provide an incentive to make export products. Once equilibrated after the ban is lifted, and if no logistical constraints existed, then the WTI price would be expected to sell at parity to Brent as it did before 2010. Additionally, US net refined product exports would be expected to decline.
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The recent collapse in the price of oil has created market behavior that likely masks the actual impact of lifting the oil export ban. For instance, the price differential between WTI and Brent narrowed significantly before the legislation lifting the ban was passed. While this could have been the market anticipating the ban being lifted, it likely reflects the extreme oversupply situation and the willingness of strapped producers to sell at almost any price just to hang on until better days.
Effects of Lifting the Ban
So what are the effects of lifting the crude oil export ban? Not surprisingly, it depends on your position in the oil supply chain. For some, it will be beneficial. For others, it will be detrimental. For all, it will be some time before the real effects are clear.
For producers, lifting the export ban is beneficial. It will help domestic markets achieve prices for US crude oil that are at parity with the world market. However, in the short term, there are logistical constraints, including pipeline capacity and availability of export marine terminals, that will have to be optimized before producers can fully benefit from exporting oil. It is likely to take some time for opportunities to completely open up for exporting US crude oil. Even so, cargos of Eagle Ford crude oil have already been exported from the Gulf Coast bound for Europe.
The price difference between WTI and Brent decreased to under $1 per barrel in December 2015 and has since been at a small premium during January. While this decrease may partly be a result of lifting the export ban, the current glut of crude oil worldwide has also played a role. The differential between WTI and Brent narrowed as the underlying price of oil declined. This narrowing reflected the oversupply in the world market relative to the US and the general eroding of the world price of oil. For example, this past summer, some East Coast refiners increased the importation of cargoes of distressed oil from West Africa, displacing crude oil supplied by rail from the Bakken. Ironically, WTI’s recent premium to Brent has created interest in placing North Sea crudes into East Coast refineries as well, rather than providing an incentive to export US crude oil.
In the long run, prices will recover and, without the export ban, US producers will receive a higher price for their oil than they would have with the ban in place. It is probable that WTI will, after remaining logistical constraints have been removed, sell at a parity to Brent. However, given the current low crude oil price, US producers will not see the improvement any time soon. There is simply too much crude oil available in the world market at distressed prices to open up big opportunities to export US crude oil.
For US refiners/processors, lifting the ban is negative. With the ban in place, US crude prices were slightly depressed relative to the world market. Since there were no limitations on the import/ export of refined products under the ban, US product prices were already at world market parity, so refiners experienced a higher margin with the ban in place. Now, refiners will lose the benefit of lower US crude oil prices. Since refined product prices are already set in the world market, refiners will find it difficult to pass any increased feedstock cost on to consumers and may expect to see a decline in refining margin over the long run. Of course, the current low crude oil price environment attenuates this margin decline in the short term.
To help refiners offset any prospective decline in refining margins, the Congressional deal included a tax break for refiners. The tax break allows independent refiners to exclude 75 percent of oil-transportation costs (pipeline tariffs, rail cost, marine tanker freight, etc.) from their pre-tax net income when calculating an existing domestic manufacturing deduction. This provision is set to expire on December 31, 2021. Since the provision applies to non-major integrated oil companies, many refiners will not be able to qualify. Consequently, the overall impact of this provision on margins will be small.
Whether lifting the ban helps or hurts consumers is more difficult to say. With the ban in place, the US refiners make more refined products, the excess of which have to be exported. Exporting excess products means the wholesale price for refined products in the US is at export parity, which decreases the domestic price relative to the world market. With the ban removed, crude will get exported instead of being refined. The US will make fewer refined products, moving the wholesale price in the direction of import parity and increasing the price compared to when the ban was in place. Thus, the US domestic wholesale price would be expected to be marginally higher without the ban, compared to the price when the ban was in place.
The magnitude of this effect is likely to be small. As long as refiners continue to generate enough refined products that the US is a net exporter, the prices of refined products will remain fairly constant. It is likely that consumers will never notice the effect of lifting the crude oil ban in the price they pay at the pump, particularly given the recent decreases in product prices resulting from the decline in crude oil prices worldwide.
Lifting the US crude oil export ban creates both winners and losers in the US. While it will take some time for markets to equilibrate as logistics are optimized for exporting crude oil, US producers can expect to realize higher prices for the oil they sell, eventually achieving parity with the world market. Since the import/export of refined products in the US has always been unrestricted, refined product prices in the US are at parity with the world market, which limits the ability of refiners to pass on increasing crude oil costs to consumers. Consequently, refiners will see a decrease in refining margin as their feedstock price rises. Consumers may expect a marginal increase in price from decreased refined product availability as less crude oil is refined in the US and more is exported. Given the current low crude oil price environment, however, consumers are unlikely to observe much immediate change in pump prices associated with lifting of the export ban.
The true effects of lifting the ban will not be felt until the crude oil price recovers. The recent collapse in the price of crude oil tends to minimize the specific pricing effects of lifting the ban. As the underlying price of crude oil rises, the pricing effects of lifting the ban will become more pronounced. However, it will be difficult to separate the effect of lifting the ban from rising crude oil prices generally. Policy makers were fortunate to have this period of low oil prices during which to lift the ban because the specific effects are attenuated in the low price environment.