Should the U.S. Allow Oil Exports?

The great American shale revolution is driving a vigorous revival in America’s natural gas and crude oil output. The recent production growth has pushed oil and gas prices lower than anticipated just a few years ago. The revolution’s success has turned upside down all our beliefs and assumptions about America’s energy future. Not only have American energy planners, company executives and government policymakers been forced to reassess their outlooks, but the knock-on effects are cascading across the globe, altering geopolitical thinking and trading patterns. Do you wonder what they’re thinking in Riyadh and the Kremlin now? I do. 

From a peak of 10 million barrels a day at the end of 1970, U.S. oil output steadily declined with the exception of a few years in the early 1980s when Alaska’s Prudhoe Bay field came on stream. It bottomed at about five million barrels a day in 2006. Today, U.S. oil production is 8.1 million barrels a day. Forecasts call for output to climb by nearly 18 percent to 9.6 million barrels a day in 2019 before peaking.  

Meanwhile, consumption is declining and, as a result, imports are falling too. The last time America was oil-self-sufficient, the nation imported 1-1.5 million barrels a day. In 2006, when domestic oil production stopped falling, America was bringing in 10.7 million barrels a day. Today, imports are down 25 percent, and if domestic production forecasts prove correct, there will be even less foreign oil in our future. 

A New World Order 

Around the world, people only now are beginning to comprehend how pervasive the global energy market changes will be due to America’s shale revolution. For example, the decades-old restriction on exporting domestic crude oil, enacted in response to America’s first oil crisis in the early 1970s, is now perceived as bad for the economy. For the past five years, U.S. hydrocarbon output growth has been associated with more jobs, greater tax revenues and higher economic activity, at least in certain parts of the country. Today, that economic growth is at risk due to the oil export restriction.   

Not that long ago America anticipated being increasingly dependent on imported oil for its fuel, and the quality of that supply was deteriorating. Increasingly, the oil was more viscous and contained more metals and sulfur. In response, the industry reconfigured its refineries to maximize gasoline and heating oil output from this lower quality oil. The shale revolution is producing primarily lighter, sweeter and less metallic oil, which is rapidly creating a mismatch with our refineries.   

For the American oil industry, the debate over exporting shale oil is an important economic question. The surge in production has depressed domestic oil prices due to logistical challenges in moving the increased output to the nation’s refineries. Recently, the industry reversed some pipeline flows between the Gulf Coast and Mid-Continent regions and added additional capacity. Those steps have reduced the Mid-Continent supply glut that was depressing prices. With the glut at its peak in 2011, the price discount for domestic oil was $36 a barrel. Today, the spread between domestic and international oil prices is only $15.  

If U.S. oil producers could send some of their shale oil abroad, they would earn 15 percent more than by keeping it here, which would help their bottom lines. Furthermore, exporting oil would encourage producers to step up drilling since higher prices would more than offset increased drilling and completion expenses. More drilling would employ more workers, boost economic activity, and hike local and federal revenues. The loser, however, would be the American consumer – drivers and those who heat their homes with oil, who would be paying higher prices.    

In the early years of this century, conventional wisdom held that the U.S. would be a significant importer of crude oil and refined products due to falling domestic production and rising consumption. Since World War II, the U.S. has had an insatiable appetite for oil. Until domestic oil production peaked in 1970, the U.S. barely imported any oil, and then only for logistical reasons. Some imported oil came from our neighbors – Canada and Mexico – while other volumes came from integrated oil companies’ overseas operations. Post-peak oil production, the U.S. was perceived as a sponge – ready, willing and able to soak up all the volumes exporters pumped.   

Impact on Maritime 

During the 1960s and 1970s, to satisfy U.S. and Western European oil consumption, the global tanker industry embarked on a significant expansion. Tanker volumes from the Middle East were growing and shipping distances lengthened due to the closure of the Suez Canal at the time of the Six-Day War in 1967, causing a dramatic increase in tonnage requirements. The Yom Kippur War in 1973, the re-opening of the Suez Canal in 1975, the Iranian Revolution in 1979 and the early 1980s’ global recession all contributed to a chaotic period for shipping. It wasn’t until the end of the 1980s that the tanker industry returned to sustained profitability, just in time for the global economic upswing of the 1990s.   

For tankers, the early 2000s’ boom was driven by the Western World’s economic growth and an explosion in Chinese oil demand. Tanker freight rates jumped and newbuilding programs ensued. The heady days of 2005-2008 for tanker owners came to a crashing halt when the global financial crisis erupted in the summer of 2008. The resulting recession curbed economic activity and crushed oil demand, sending tankers into layup. Tankers under construction in 2008 and 2009 were delivered and often entered service as they were more efficient than the existing fleet. Older, less-efficient tankers were culled from fleets and either sold, converted to alternative uses, or sent to breakup yards.   

After five years of slow-paced global growth and reduced oil consumption, prospects of a new source of oil flows to be transported by ship will be welcomed, although it means further industry adjustments. For example, Europe used to supply gasoline to the U.S., but now that flow has been reversed. The result is 15 European refineries have shut down in the last five years. Nigeria used to send 12 supertankers of light oil to the U.S. a month; now it only sends three.   

The policy debate over allowing the export of America’s shale oil began late last year and only because it was becoming apparent that increased shale oil output was depressing domestic crude oil prices, creating distortions in refinery operations and potentially disrupting the U.S. economic recovery. The sustainability of shale oil production has quickly turned a temporary problem into a permanent one. An economy where oil production growth is strangled by a decades-old government restriction enacted during an era of oil shortages and spiking prices is deemed unacceptable. The problem is the winners and the losers in this debate.   

Winners & Losers 

Pitting 310 million Americans against a few hundred energy CEOs doesn’t seem like a fair fight, let alone one the petroleum industry can win. But it is evident there are many prisms through which this battle can be viewed. One prism is the prospect of reduced economic activity due to slowing employment growth from higher energy costs and reduced drilling. Hiking gasoline and heating oil prices by allowing shale oil exports that erase the domestic price discount is another. Exporting shale oil helps improve the U.S. balance of trade position, another positive, but tankers don’t employ many workers, and most will be foreigners. Allowing oil exports would help international tanker owner profits, but probably to the detriment of those of domestic tanker and barge operators.   

The shale oil export debate highlights the challenge of moving our growing domestic oil supplies around the country to maximize their utility. Since the major shale oil producing basins are in regions with few pipelines, the petroleum industry has increasingly turned to rail and barge for shipping the output. The industry is also moving greater volumes along the Gulf Coast and to East Coast ports.   

Those companies owning U.S.-flagged vessels that transport oil from Gulf Coast ports to ports along the East Coast could be losers if the oil export ban is lifted. In late December, the cost to ship a barrel of oil from Houston to New York City was between $5 and $6. At the same time, to move that barrel of oil from Houston to Eastern Canada cost only $2. How can a similar barrel travel hundreds of miles farther at less than half the cost?  

Thank Wesley Livsey Jones, the first popularly-elected senator from Washington State and the author of the Merchant Marine Act of 1920, also known as the Jones Act. The law, which has been revised a number of times in its 94-year history, is designed to insure a vibrant U.S. maritime industry by requiring goods moved between U.S. ports to be transported in U.S.-built, -flagged and -crewed vessels. The law’s benefits were substantiated by two government studies last year. Jones’s primary intent with the law was to preserve the Alaska trade for the ports of Washington. We doubt he realized the Act’s impact on future U.S. shipping costs and domestic oil prices.   

Today, there are just 32 tankers and 42 barges eligible under the Jones Act to move fuel along the U.S. Gulf and East coasts. The fleet hasn’t grown much in recent years and, with the increase in petroleum output needing to be moved around the country, freight rates have exploded. There are some new Jones Act-eligible vessels under construction, but they will not be ready for a while. Limited shipping capacity explains why it costs so much to move fuel between Houston and New York City. It also explains why moving oil by rail is a popular alternative.  

The oil export debate will likely come down to whose economic argument is more powerful. We are confident someone in the marine industry will be happy with the outcome. We are just not sure who that will be.