Dec 18, 2015 | 10:10 GMT

9 mins read

Why the U.S. Decision to Allow Oil Exports Won't Change Much

The Wilmington refinery in Los Angeles, Calif.
Forecast Highlights

  • The United States' decision to lift its ban on oil exports will have little impact on its energy security or export volumes.
  • Most U.S. output will continue to feed North American demand, though small volumes may shift to Latin American or European consumers.
  • The tax credits to renewable energies given in exchange for lifting the ban will give solar and wind producers a much-needed boost in their competition with cheaper fossil fuels. 

The U.S. Congress is taking steps to remove a long-standing ban that, until about five years ago, was largely irrelevant because of falling oil production. On Dec. 15, Republicans and Democrats agreed to a 2016 budget deal that will lift the U.S. ban on crude oil exports in exchange for tax incentives on investments in renewable energy.

Washington's prohibition on exporting domestically produced crude is a holdover from the 1973 Arab oil embargo against the West, which prompted the United States to look for ways to reduce its dependence on oil imports. However, between December 1975, when the ban was enacted, and about 2008, U.S. production never rose high enough to merit significant exports beyond North America, rendering the ban pointless. (Exports to Canada are exempt from the ban.)

But since 2008, the situation has changed. Rising oil production in the United States and Canada not only reversed both countries' declining outputs but also boosted their combined total to its highest level in history. This has given rise to speculation that the United States could achieve its long-time goal of energy independence. 

Energy Independence: An Impossible Goal

Every U.S. administration since the 1973 oil embargo has touted the concept of energy independence as a way for the country to become less dependent on foreign oil suppliers — some of which are politically unstable or unfriendly to the United States — and more insulated from shocks to the global market. But it is an unattainable goal, even if the United States were to produce enough oil to meet its domestic needs.

The United States stands at the center of the global economy. Its economic prospects are intimately linked to those of the world, giving it every incentive to ensure that the markets for globally traded commodities such as oil remain stable. The effects of significant upheavals in such markets would ripple throughout economic and financial systems worldwide, including those of the United States.

Add to this the fact that, although the United States has forbidden the export of crude oil, it never banned the sale of refined oil products such as gasoline or diesel. As a result, the price of U.S. refined products tracks closely with those refined internationally. If the oil market were disrupted in some way, U.S. consumers would feel the effects regardless of whether the United States imported oil.

Each of these factors means that, with or without the ban on crude exports, the United States cannot fully isolate itself from fluctuations in the global oil market.

Meanwhile, even with the export ban in place, the United States continues to rely on foreign oil. For example, U.S. imports from the Persian Gulf totaled nearly 1.9 million barrels per day in 2014 — an amount higher than that seen between 1980 and 1998, despite lower production levels at the time. That said, the ban's removal could raise the country's imports somewhat. For each barrel of U.S. oil that leaves the country, U.S. consumers will demand a barrel of oil to replace it. Nevertheless, the United States' interest in and dependence on countries that are important to the global market will remain largely unchanged.

With or without the ban on crude exports, the United States cannot fully isolate itself from fluctuations in the global oil market.

Minor Changes in Oil Trade

Despite climbing output levels, the United States and Canada are still far from achieving self-sufficiency in oil production. Together, they consumed 21.4 million bpd in 2014 but produced only 15.9 million bpd. But perhaps of greater concern is the type of oil being produced, rather than the quantity.

In the past few years, the bulk of the output added in the United States has been light, sweet crude from tight oil and shale formations like those seen in Texas and North Dakota. However, U.S. refineries in the Midwest and along the Gulf Coast have invested significant funds into building up their capacities to process heavier, sourer grades of crude from the Gulf of Mexico, Venezuela and Canada into lighter, more valuable products such as gasoline. This has given them an advantage over refineries elsewhere that are capable of processing only lighter grades of crude — an advantage that would mean little if they were to process the United States' new, light volumes. Additionally, some of these refineries' capacities to handle light crude itself are limited.

Most of the North American refineries that are better suited to make use of the United States' new production are situated on the Atlantic Coast or in Mexico. But pipeline infrastructure connecting the Midwest and Gulf Coast to either is nearly nonexistent, in part because until recently, U.S. exports to Mexico had been banned. (Earlier this year, the United States approved the export of 75,000 bpd to its southern neighbor.) Without pipelines, U.S. producers have had to rely on more costly modes of transport, such as shipping or rail, to send their light crude to Atlantic and Mexican refineries.

Because the ban on exports prevented U.S. producers from sending their oil abroad, these factors have decoupled regional oil prices in the United States from global prices. For example, in September 2011, the gap between West Texas Intermediate and Brent, the respective benchmark prices for U.S. and European light, sweet crude, widened to nearly $30 because of transportation constraints. It is possible that as U.S. and global prices moved further apart and refiners ran into physical constraints in processing light crude, U.S. producers' growth may have been inhibited.

Now, amid oil prices that have dropped from over $100 per barrel in June 2014 to around $35-$40 per barrel today, U.S. output is declining and producers are reeling from the financial impact. Policymakers are concerned with the health of these companies, and their decision to remove the ban will enable producers to price their oil more closely to the going international rate. Still, this will not substantially raise the revenue U.S. companies receive per barrel; the gap between U.S. domestic and global prices has narrowed to between $1 and $2 per barrel. So, despite the small bump in income, corporations that have invested in the costly production of U.S. shale will continue to face significant financial constraints. A further drop in U.S. production levels is therefore inevitable, at least until global oil prices recover.

Despite the limited impact that lifting the ban will have, allowing U.S. producers to export oil could lead to a minor redistribution of worldwide oil trade. The United States still has a glut of light, sweet crude in the Midwest and Gulf Coast regions. Since shipping or transporting oil via rail to Atlantic refineries may be less efficient and costlier for certain U.S. producers in Texas, Louisiana, New Mexico and Oklahoma than shipping it to Latin America or Europe, small amounts of U.S. oil may start to go to refineries in Venezuela, Mexico and Europe that are configured to process light crude. In turn, U.S. refineries on the Atlantic Coast may revive their imports of light crude from traditional providers in Nigeria and Algeria, where shipping costs are not inflated by the cabotage laws that drive up the expense of shipping between U.S. ports.

However, these changes will be relatively small in the grand scheme of things. At least initially, the removal of the ban will lead to only minor increases in U.S. exports as most U.S. production continues to feed North America's robust appetite for oil. Meanwhile, oil from the Midwest will still have trouble getting to coastal markets since pipeline options in the region are limited. With rail as the only viable alternative to piping, Midwestern oil will likely continue to head to destinations in North America, such as eastern Canada.

Looking Beyond the Oil Sector

While the removal of the export ban itself will have a relatively limited geopolitical impact, the green energy tax incentives that it was traded for are more notable. In return for allowing oil exports, U.S. President Barack Obama secured a five-year extension of tax credits for solar and wind power producers, as well as a 30 percent tax credit on investment in new solar and wind products. Additionally, companies attempting to earn these credits will be required only to start construction on projects, rather than complete them, during the fiscal year.

Combating climate change and promoting the use of renewable energy have been a focal point of Obama's agenda for the past two years. In addition to the latest tax credit deal, Obama aggressively campaigned for the climate agreement struck at the recent summit in Paris. He also blocked the construction of the Keystone XL pipeline project in response to emissions concerns raised by the refining of oil sands, and he promoted the Environmental Protection Agency's Clean Power Plan.

The budget deal's extension of tax credits may pave the way for further gains to be made. For example, before the deal, the United States was at risk of seeing its growth in solar power generation fall over the next five years. With tax perks renewed, that may not be the case. In the long term, the power market appears to be leaning toward more sustainable and environmentally friendly sources of power generation anyway, but the tax credits will give renewable energies a boost in the short term as they compete with cheaper fossil fuels such as coal, natural gas and oil.

Finally, by removing the ban on oil exports, the United States will also eliminate one of the obstacles in the way of a possible free trade agreement with the European Union. The bloc, whose members view energy security and their current dependence on Russian natural gas as a critical issue, has long pushed for the inclusion of energy in any potential trade deal with the United States. While other hurdles remain, lifting the ban on U.S. oil exports will alleviate those concerns.

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