Economic Evidence Is Tipping The Scales In The Debate Over Oil Exports

Ike Brannon Ike Brannon is president of Capital Policy Analytics, a consulting firm in Washington, D.C.
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The North American countries may not have any tariff barriers between them but we are far from having a fully integrated North American economy. That’s a pity, because there are major gains to be had from doing so — and nowhere as much as in the energy sector of the economy.

What’s changed since the ink became dry on NAFTA is that the U.S. and Canada have become major energy producers. In 2009 the U.S. produced just 5 million barrels of oil a day and Canada 3.3 million barrels. Today, the two countries are at 7.5 million and 4.3 million — a cumulative increase of 42 percent in just 5 years.

What’s more, there’s reason to believe that Mexico may soon experience a similar boom. Over the last two decades the Mexican energy sector – which was a major oil exporter just a few decades ago — has atrophied, thanks to antiquated laws that gave the government a monopoly over oil production. But earlier this year the government opened the sector to private investment, and a raft of foreign investment and market discipline is poised to enter the market.

But the North American economies are not taking full advantage of these gains in energy production, and one major reason is that U.S. law currently prohibits the export of oil. The ostensible reason for the export ban is to keep domestic gasoline prices down and help insulate U.S. consumers from the price impact of broader global events that might impact prices. Another argument for the ban is that lower oil prices in the U.S. helps U.S. companies that operate in global markets stay more competitive by having lower energy costs than their foreign-based competitors, thereby giving us a cost advantage over them.

The only problem is the export ban does not work as promised. The consensus among energy economists is that allowing oil exports would actually reduce gas prices by two to twelve cents a gallon. Currently, domestic gasoline prices tend to track closely with the price of Brent Crude oil, a type of trading classification for oil that acts as the major benchmark for price purchases of oil worldwide. As more U.S. supply is inserted into the global market, the price of Brent Crude lowers, which in turn will lower domestic gasoline prices.

What’s more, the fact that we allow refined oil products such as gasoline to be exported negates the supposed gains from the export ban. If gas prices are sharply higher in the rest of the world, savvy energy producers merely send gasoline rather than oil to the other markets. The only beneficiaries of the ban are the owners of refineries, who can buy oil more cheaply as a result and then export gasoline into pricier foreign markets.

Besides lowering gasoline prices, removing the ban on oil exports would pave the way for a more tightly integrated North American energy market, as well as a more integrated global market.

The gains from ending the ban would be immense. The energy consulting firm NERA suggests it could add as much as one percentage point to economic growth. Economist and former Treasury Secretary Larry Summers opined that it could be even more.

If we were to see a lifting of the export ban, the greatest beneficiaries would be the two countries where it would be cheapest for us to export oil – Canada and Mexico. While we remain a net importer, there are still myriad gains to be had from U.S. shipping oil across the border. For instance, it can be cost-effective to ship certain blends of oil to be refined in a Mexican plant with excess capacity. And the U.S. won’t be a net importer of oil for too much longer, if production trends in North Dakota and Texas continue.

While NAFTA went a long way towards improving trade ties and the free flow of goods and services between the countries, no one would dare suggest that our respective energy markets function in remotely the same way.

But they should. We would see tremendous economic gains from a tighter integration of the country’s energy markets as well. No one – least of all U.S. consumers – benefits from a fragmented American energy market. The inability of U.S. producers to export oil – one of the principal reasons for this fragmentation – results in higher gasoline prices in the U.S.

What’s more, prohibiting oil exports protects us from precisely nothing. Domestic energy prices will spike in response to supply shocks that happen elsewhere in the world whether or not we are exporting oil. The best way to mitigate such potential price vagaries is to be a full-fledged participant in the global oil market, and the first step towards this would be to allow oil exports and concomitantly embrace a wholly integrated North American energy market.

Ike Brannon is a Senior Fellow at the George W. Bush Institute and President of Capital Policy Analytics, a consulting firm based in Washington, DC.

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Ike Brannon