July 2015, Vol. 242, No. 7
Editor's Notebook
A Call for Crude Oil Exports and Pipelines
The U.S. shale revolution has created jobs, improved the balance of trade, spurred billions of dollars of foreign and domestic investment, reduced carbon emissions and lowered oil and gas prices. From the shale gas fields in Williamsport to the refineries around Philadelphia, new energy technologies have had a profound local impact. This revolution could do even more if the U.S. allowed crude oil exports and expanded its pipeline system.
There has been a ban on crude exports since the 1973 Yom Kippur War, though domestic refiners are free to export gasoline and other petroleum products. Lifting this ban would amplify the benefits of the energy revolution at little cost. However, removing the ban is not enough. The nation desperately needs more pipelines to efficiently, safely, and cheaply move its bonanza in shale oil to coastal refineries and ports. Here’s why:
For the lifting of the ban to have appreciable economic benefits, U.S. crude oil production would have to increase. But costs and logistics make such an increase difficult. Production depends on two factors: extraction costs and the prices producers receive. Lifting the ban would have no bearing on extraction costs, which are determined by technological change, financial conditions and other factors such as contracts negotiated by drillers, servicers and suppliers.
It would be natural to assume that, if the export ban is lifted, U.S. producers could sell their oil overseas, prices would rise, and they could afford to extract more expensive oil. Here’s the problem: Few pipelines have been built to accommodate the shale oil being pumped in Texas and especially North Dakota, so crude is transported by rail, which is inherently more expensive.
For example, it costs between $6-15 per barrel to get oil from the Bakken shale formation in North Dakota to Philadelphia area refineries; it would cost only $3-5 with a pipeline. Those high rail costs won’t go away just because producers would be allowed to export their crude rather than sell it to U.S. refineries. Here’s the bottom line: As long as refineries offer prices to shale oil producers similar to what they can get in the international market, lifting the export ban would not affect U.S. production. However, lowering transportation costs would get drillers a higher price for their oil and enable them to drill more.
Regardless of whether the ban is lifted, refineries will be able to offer shale oil producers prices comparable to overseas markets for a couple more years. Meanwhile, refineries will continue to replace imports with domestically produced crude, eventually nearing the limits of the amount of light, sweet oil they can refine.
As that limit approaches, refineries will require a progressively larger discount for domestic crude relative to imports until all imports are replaced. Only then would lifting the export ban provide macroeconomic benefits through higher U.S. crude production. So lifting the ban by itself would have minimal effect in the short term. To truly make the economy stronger and more efficient, the nation would need more pipelines.
Today there are no pipeline links between the midcontinent and the East and West Coast refining hubs. In theory, the drillers who would benefit most from new pipelines would fund their construction. But the drillers at the forefront of innovation have borrowed against the value of their wells, land, and equipment to fund more drilling, and the decline in oil prices has minimized the value of these assets. For the most part, they lack the financial wherewithal to build these needed pipelines.
When markets are unable or unwilling to serve the national interest, government must step in. It has done so many times in connection with the nation’s energy and transportation infrastructure, providing loan guarantees for nuclear power, awarding tax credits for oil drilling, and building the interstate highway system. The federal government should do so again so that oil can be piped from the center of the continent to refineries on the coasts.
Government support could be modeled on the national infrastructure bank that President Obama has proposed throughout his presidency. Washington would partner with private investors to provide cheap long-term financing, loan guarantees, or a small amount of equity. The government would also accelerate the approval process, minimizing investor uncertainty.
Moody’s Analytics has been calling for the government to facilitate pipeline construction in the United States since 2012. With so many jobs on the line, it is better late than never.
Chris Lafakis is a senior economist at Moody’s Analytics in West Chester, PA.
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