Crude oil exports and the price of gasoline

Government policies virtually without exception create economic distortions, so that policy reform can yield results highly counterintuitive. That is the case with the emerging effort to end the current U.S. ban on the export of crude oil, enacted as part of the 1975 Energy Policy and Conservation Act. The ban was justified as a tool with which to insulate the U.S. economy from the effects of international supply disruptions and to reduce the prices of such refined products as gasoline.

{mosads}Both of those justifications were and remain fallacious. In the absence of policy distortions, domestic prices (net of international transport costs) must equal international prices. If domestic prices were lower, foreign suppliers would shift sales to other economies, reducing the overall supply of crude oil or refined products to the U.S. market until domestic and international prices were equalized. The most obvious policy distortions in this context would be import limitations (quotas), which would raise domestic crude prices artificially, as they did from 1959 through 1973; and export limitations, which have the opposite effect.

Just as the past limitations on imports increased domestic crude prices above international prices, so does the current export ban suppress domestic prices below international levels. 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 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 has been increased artificially by the export ban.

One might assume that an end to the export ban, by increasing the domestic price of crude oil, would yield a rise in the prices of such refined products as gasoline and diesel fuel. Counterintuitively, that is not correct, because ending the export ban would remove an important market distortion. The crucial factor to bear in mind is the fact that refined products are not included in the export ban; they are traded freely in the international market. That means that the domestic and international prices of gasoline must be equalized by market competition, abstracting from transport costs and taxes and the like.

Accordingly, ending the export ban on crude oil cannot increase product prices; if it did, foreign refiners would sell more gasoline in the U.S. market, thus driving prices down until U.S. and international prices were equalized.

Moreover, 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.

Many do assume that ending the export ban on crude oil would increase the U.S. price of crude and thus necessarily domestic product prices as well, because the refiner cost of crude oil is a major component of the cost of producing products. That analysis fails to understand that the current export ban distorts the market in such a way as to reduce domestic crude prices while increasing domestic product prices, by reducing the international supply of (U.S.) crude oil and by increasing refining costs. Perhaps counterintuitively, ending the export ban on crude oil would have the opposite effect: U.S. crude prices would rise (modestly) while gasoline and other product prices would be driven down by the falling price of product prices in the international market and reductions in U.S. refining costs.

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 crude oil supply/demand effect just noted. And that stronger dollar would reduce the overall price of the U.S. basket of goods and services, thus increasing aggregate wealth in the U.S., again an effect difficult to measure in isolation, but that is real.

Some prominent members of the Beltway policy community simply do not understand the implications of the distortionary effect of government policies. The relationship between the export ban on crude oil and the attendant effects on gasoline prices is a newly prominent example of that phenomenon. An end to the export ban would end the distortionary impacts, yielding benefits for the energy sector, for consumers, and for the economy as a whole. After four decades, Congress should do away with this perverse policy.

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