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August 15, 2014

Oil Export Ban is Bad Economics

August 15, 2014
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The sharp increase in U.S. crude oil production over the last few years has opened a discussion on whether the long-standing ban on exports should be rescinded. The issue is complex because many conservative supporters of the market economy nonetheless are wary of allowing free trade in this particular commodity. Nonetheless, the logic of free markets works here as in other arenas: Arbitrary government restrictions on trade make Americans poorer. Ironically, in this particular case the ban on crude oil exports might actually make gasoline prices higher for Americans.

The General Case for Free Trade

Robert Bradley (the founder of IER) has already provided a comprehensive post detailing the history of the U.S. ban on crude oil exports, and he explains why eliminating the ban would promote economic efficiency. In the present post I’ll elaborate on his arguments since some of them at first seem counterintuitive.

Normally, when people want the government to limit trade their desire is to restrict imports. The idea is that it “destroys jobs” domestically when cheap foreign imports flood the home market. At the same time, people often support government subsidies (such as those provided by the Ex-Im Bank) to promote exports, again thinking that this “creates jobs” at home by producing goods to ship to foreigners.

Yet things are oddly flipped when it comes to the discussion of the crude export ban. For some reason, the focus isn’t on all of the jobs that will be created in the oil sector if American producers are allowed to sell to a world market. Instead, people worry that shipping crude oil abroad won’t leave enough here for Americans. In other words, the focus shifts from producers to consumers.

Yet this single-minded focus on consumers when it comes to crude exports is just as wrong as the (more typical) focus on producers when it comes to other commodities. In general, government interference with international trade makes Americans poorer on net. If the government restricts, say, the import of Japanese cars, then that helps Detroit autoworkers, but it hurts American car buyers even more. In other words, government restrictions on imports tend to hurt American consumers more than they help American producers.

And when it comes to the export of American crude oil, government restrictions can help domestic purchasers of crude oil, but they hurt American crude producers even more. In other words, government restrictions on exports tend to hurt American sellers more than they help American buyers of crude. (Also keep in mind, the “buyers of crude oil” aren’t the average folks driving cars. The “buyers of crude oil” are refiners.)

In my textbook introduction to free-market principles, I devote an entire chapter (Lesson 19) to the case for free trade. Yet for our purposes here, we can rely on a reductio ad absurdum approach: To see why the logic behind the crude oil export ban makes little sense, change commodities. For example, should the U.S. government make it illegal for American farmers to ship wheat out of the country? After all, don’t we want to make bread as affordable as possible for American households? Or what about banning the export of pharmaceuticals? Don’t we want to keep drug prices as low as possible in the United States? How about jet airplanes or heavy equipment—should American producers of these items be prohibited from selling them in foreign markets?

Hopefully the reader can see that this logic leads to disaster. In the limit, if the U.S. government banned all exports, then the U.S. dollar would collapse against other currencies, making it very expensive for Americans to import goods from other countries. Ultimately a country pays for its imports through its exports, and so a total ban on exports would make imports impossible too, except to the extent that foreigners wanted to acquire actual dollars as assets.

Less dramatically, the ban on U.S. crude oil exports makes it harder for Americans to acquire goods that can be more efficiently produced in other countries. The artificial interference with trade diverts production into inefficient lines, with the U.S. not producing as much crude oil as it should, and other countries not producing enough electronic goods or textiles (say) for shipment to America.

The fact that oil (unlike wheat or heavy equipment) is a finite natural resource doesn’t change the logic of the free-trade case. It is wrong to think that a barrel of oil sent abroad somehow “only helps foreigners” while a barrel of oil processed domestically “helps Americans.” On the contrary, both outcomes “help Americans” so long as they are the result of voluntary market decisions. A barrel of oil shipped abroad for $100 (say) allows Americans to import $100 worth of goods from other countries. Nobody thinks the individual owner of an oil well makes his family poorer when he lets the oil leave the property, and by the same token the people in the United States don’t become poorer by trading some of their oil to foreigners in exchange for items that the foreigners have to offer.

The Crude Oil Export Ban Might Actually Make U.S. Gasoline More Expensive

In the previous section, we laid out the general case for free trade: the ban on crude exports hurts producers more than it helps consumers. This might have led some readers to think, “Okay, so the crude export ban does indeed keep prices low at the pump, but at the expense of the big oil companies. Well who cares? That’s a tradeoff I’m willing to make.”

Ah, but not so fast. What I wrote is that the ban on crude exports helps the consumers of crude oil. American motorists don’t actually buy crude oil, however: No, they buy gasoline, which is a product made from crude oil. It’s not actually American motorists who are directly helped by the ban on crude exports, but rather American refiners. They are the ones who directly buy crude oil, and so they’re the ones who benefit if the ban on exports forces domestic oil production to go into their hands, without having to compete with an entire world market of refiners bidding on that American oil.

Although the U.S. government has in place a (partial) ban on crude oil exports,[i] there is no similar restriction on the export of petroleum products, in particular gasoline. Therefore, it is theoretically possible that the government ban on crude exports paradoxically makes gasoline more expensive for American motorists.

This result is very counterintuitive, so let me walk through the logic. First, realize that if there are no restrictions on the import or export of gasoline, then the U.S. price of gasoline is the same as the world price. (We’re obviously simplifying by talking about “the” U.S. price of gasoline, just to make the logic clear. There is also the added complication of higher taxes on gasoline in Europe.).At the same time, the ban on U.S. crude exports (if it has any effect at all) means that the U.S. crude price is lower than the world price. U.S. producers of crude would like to be able to sell abroad at the higher world price, but this is illegal, so they must be content to sell within the United States at the lower U.S. price.

Now, the U.S. government suddenly lifts the ban on crude exports: what happens? The immediate response is that U.S. oil producers begin shipping crude abroad, to fetch the higher world price. In the new equilibrium, the price that American refiners must pay for crude has risen, because now they are effectively competing with crude buyers all over the world.

But even though the price of crude oil within the borders of the United States has risen, does this mean the price of gasoline has risen as well? Probably not. Consider that because American oil producers can now sell at a higher price, they will “move up their supply curve” and produce more barrels of crude per day than they otherwise would have done, had the export ban remained in effect. Total world crude output rises, in fact, because the slight decrease in rest-of-the-world crude output is more than offset by the jump in U.S. production.

In the new equilibrium, with more total crude oil being produced on Earth each day, it stands to reason that refiners across the globe will end up producing more total gallons of gasoline each day. Since the U.S. government’s policy shift wouldn’t have directly affected any motorist’s demand for gasoline, the increased quantity brought to market can only be sold at a lower price per gallon at the pump. The free-flow of gasoline across borders ensures that the price of gas in the U.S. is always the world price, meaning that a lower world price for gasoline translates into lower prices at the pump for Americans, too.

Other researchers have estimated the potential size of this effect. For example, a Resources for the Future study estimated that removing the export ban would lead to a 2 to 5 cents per gallon reduction in gasoline prices for Americans. (Note that the RFF study more realistically modeled the refinery sector, and allowed for the possibility that world crude prices could go up or down—but either way, the increased efficiency in refining and greater total crude production would lead to lower gas prices.) Similarly, an IHS study estimated that removing the export ban would reduce American pump prices an average of 8 cents per gallon from 2016 to 2030.

Flipping the Argument to Understand the Result

Thus we’ve argued that eliminating the ban on crude oil exports would actually reduce pump prices for Americans. In case the reader is still doubting this counterintuitive result, try going the other way: Starting from a position of free trade in crude oil and petroleum products, would a ban on U.S. crude exports cause the price of gas for Americans to fall?

If we think about it just for a moment, we see that this would be unlikely to occur, without some contrived mechanism. Once the ban on crude exports is implemented, even though American refiners can now enjoy cheaper crude, they can still export their products; that means any tendency for pump prices to fall in the U.S. would be shared by motorists across Earth.

This is the subtlety of the situation that most casual observers miss. They erroneously think that by “keeping oil here at home,” this will also “keep the gasoline here at home.” Yet that’s not the case. Because refiners currently have the ability to sell their product to the highest bidder, the ban on U.S. crude exports lowers world oil output, thereby pushing up world crude prices and world gasoline prices, and thus paradoxically pushing up U.S. gasoline prices.

Conclusion

Thus the case for maintaining the ban on U.S. crude exports completely falls apart. In general, government interference with trade flows—either imports or exports—makes its citizens poorer on net; the gains to one group are more than offset by the losses to the rest of the country.

Yet when it comes to the actual ban on crude exports, the situation is even more perverse: Because relatively free trade in petroleum products is allowed, the crude oil ban introduces artificial bottlenecks in the refining sector that paradoxically drive up the world (and hence U.S.) price of gasoline. Indeed, an IHS study estimates that eliminating the ban on crude exports would reduce pump prices for American motorists by an average of 8 cents per gallon through 2030.

Free trade and free markets enhance freedom of choice for all Americans, and the benefits flow accordingly. If the government places arbitrary restrictions on the flow of resources, that makes Americans poorer on net. Ironically, the very people supposedly helped by the export ban—American motorists—are among those hurt by it.

 

[i] The ban is only partial because there are exceptions. As this Brookings analysis explains: “One major issue is the vagueness of the export ban; it is not a total prohibition. Exports of crude oil to Canada are allowed as long as the oil is used there, as are exports of Alaskan oil using the Trans-Alaskan pipeline and small amounts of specific heavy Californian crude oil. Moreover, companies may request an exemption, which [the government] may grant if the exports are deemed in ‘the national interest.’”

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