Time to end federal interference with free trade in crude oil

The current ban on exports of U.S. crude oil was enacted as part of the 1975 Energy Policy and Conservation Act, and was justified on the basis of two fallacies. First: That the 1973 Arab OPEC oil “embargo” was the cause of higher oil prices and the gasoline lines and other market disruptions experienced in the early 1970s. Second: That a ban on exports of crude oil would insulate the U.S. economy from the effects of international supply disruptions.

{mosads}The central analytic principle to bear in mind is straightforward: Abstracting from such minor factors as transport costs, there can be only one price for oil in the world market, because a higher price in one region would attract sellers, reducing the price there so as to equalize it with that everywhere else.

And that is why the 1973 embargo, directed at the U.S., the Netherlands and some other allies of Israel, had no effect at all. Since there can be only one price in the world oil market, that attempt to impose a higher price on certain nations did not succeed; market forces resulted in the reallocation of oil so that prices were equal everywhere. The U.S. faced the same higher prices as everyone else.

The actual source of the price increase was not the embargo; it was for the most part the production cutback by Arab OPEC. A far less important factor was the weakening of the dollar related to the collapse of the Bretton Woods exchange rate system, and the (sensible) decision by the Nixon administration to stop exchanging gold for dollars, that is, to end the fixed exchange-rate system by closing the gold window.

Similarly, the gasoline lines and market disruptions were the result of the price and allocation controls imposed upon the domestic market for crude oil and refined products. Notice that there was no embargo in 1979; but there was a production cutback in the Persian Gulf as a result of the overthrow of the shah of Iran, there was a newly invigorated system of price and allocation controls, and there were once again gasoline lines and market chaos.

This straightforward analysis means that the “insulation” rationale for the export ban similarly is fundamentally flawed: As long as the U.S. participates in the world market for crude oil, the volume of such imports or exports will adjust so that U.S. and international prices are equalized, controlling for transport costs.

Accordingly, the first central point to bear in mind is straightforward: The intellectual and policy justifications for the export ban were bankrupt when it was enacted, and remain so today.

With respect to the domestic price of crude oil, note that the current price difference between domestic (West Texas Intermediate) and foreign (Brent) crudes is about $5 per barrel. A repeal of the export ban would increase domestic prices modestly, by an amount of around $2 to $3 per barrel. This would be a straightforward supply-and-demand effect reducing the difference between the spot prices for crudes produced domestically and overseas, a difference that is likely to have been made artificially larger by the export ban.

There is the further matter that an increase in crude exports would have the effect of strengthening the dollar, an impact the magnitude of which is very difficult to estimate among all the many factors influencing the dollar exchange rate. But however difficult to measure, this effect is real, and it would put some downward pressure on the dollar prices of crude oil internationally, thus offsetting to some degree the supply/demand effect just noted. And that stronger dollar would increase aggregate wealth in the U.S., which in principle would take the form of a reduction in the overall price of the U.S. basket of goods and services, an effect that again is difficult to measure in isolation, but that would offset in the aggregate the increase in the domestic price of crude oil.

One might assume that an increase in the domestic price of crude would yield a rise in the prices of such refined products as gasoline and diesel fuel. Counterintuitively, that is not correct. Because refined products are not included in the export ban, and thus are traded freely in the international market, it is difficult to see how a repeal of the export ban on crude oil could increase product prices. Instead, ending the export ban on crude actually would put downward pressure on product prices, for two reasons.

First: The increase in the international supply of crude oil created by increased U.S. exports would reduce both crude and product prices overseas. Accordingly, product prices in the U.S. would decline because, again, products are traded more-or-less freely in the world market, creating the one-price outcome described above.

Second: Both internationally and domestically, the export ban has distorted the allocation of various types of crude oil among refineries, which are designed in various ways to refine particular crude oil types more efficiently than others. An end to the export ban would improve the alignment of refinery and crude oil characteristics, particularly in the U.S., thus reducing the cost of refining crude oil generally, and therefore of producing refined products. (This would be one of the hidden benefits of the Keystone XL pipeline.)

Two final observations are worthy of attention. First: The reduction in international crude prices would have the salutary effect of reducing foreign exchange earnings by several unsavory regimes, the Iranian and Russian ones in particular. That impact might be modest, but every bit helps, particularly in terms of increasing energy security in Europe by increasing the Russian need to sell natural gas there.

Second: The defense of free trade is a crucial component of the larger defense of capitalism and freedom, with important implications for such other specific issues as the prospects for the export of liquefied natural gas. The export ban on crude oil was from the very beginning a deeply perverse policy implemented in a futile attempt to mitigate the perverse effects of other government policies. Ending the ban would be an important component of a larger reform agenda for this Congress.

Zycher is the John G. Searle scholar at the American Enterprise Institute.