America’s energy security faces a strange paradox. On the one hand, we are the only leading industrial nation that prohibits crude oil exports. On the other, foreign tankers regularly line up at the dock in Galveston, Texas, to take on what is not supposed to leave the country, namely, crude oil—almost half a million barrels to South Korea alone last September and October.
The paradox is explained by the fact that this exported oil is ultra-light condensate from natural gas extraction, which the Commerce Department has decided is not crude oil as defined under the law Congress passed back in 1975 to ban oil exports. That technical loophole has allowed U.S. producers to export so much condensate that we are now shipping more oil than we did in the record year of 1957—more than 400,000 barrels a day, much of it condensate. “I expect the United States will be exporting close to 300,000 barrels a day of processed condensate by the end of 2015”, says energy analyst Andrew Lipow, president of the consulting firm that bears his name. That’s still just a fraction of the oil exported by Saudi Arabia, or even Venezuela. But it could become a flood if Congress acts to lift the 1975 ban altogether.
The explosive growth of available condensate reflects the key new factor in America’s energy equation, namely the widely discussed shale revolution. Since 2008 America has been producing record amounts of shale natural gas in addition to shale oil—more oil, in fact, than the current market can absorb. The result is that we are now almost literally awash in oil that we can’t ship abroad because of a law built around erroneous 1970s-era assumptions about “peak oil”, which kindled expectations of looming oil shortages and dwindling supply.
For these reasons most experts, and a growing number of politicians, agree that the paradox of America’s current oil exports is passing into the realm of absurdity. But the question of whether to lift the ban or preserve it has set off a major debate on Capitol Hill pitting free marketers against those who fear that ending the ban will drain away our hard-won national energy independence.
Unfortunately, the debate tends to get stuck on conflicting economic priorities when the real issue should be strategy, and when the real question should be not whether to lift the 1975 oil export ban, but how. Other oil-exporting countries use the commodity to further their national interests, and there is no reason the United States should not do the same. Without violating free-market principles, we can turn our energy superpower status into strategic advantage to help friends and gain leverage over enemies, and thus to restore American leadership around the globe.
Two years after the economic trauma caused in part by the Arab oil embargo of 1973–74, Congress passed the Energy Policy and Conservation Act, or EPCA. It directed President Gerald Ford “to promulgate a rule prohibiting the export of crude oil” produced in the United States. At the time it seemed a sensible if somewhat drastic response to a massive rise in the price of oil and to a domestic oil industry that was nearly overwhelmed by growing demand (this was before completion of the Alaska Pipeline). It also conformed to historical precedent: Congress and the Ford Administration knew that the Eisenhower Administration had decided in 1957 that it was cheaper and strategically wiser to buy what was then very inexpensive oil abroad and keep domestic oil in the ground as a strategic asset. In 1975, the United States believed it had to keep every drop of oil it pumped—especially when U.S. oil production was tumbling below ten million barrels a day, with no end to the fall-off in sight. Indeed, even with the Alaska Prudhoe Bay fields, domestic oil production dropped to just over five million bpd by 2000, a fourth of daily domestic consumption.
Then the shale revolution happened, otherwise known as hydraulic fracturing, or fracking. Between 2007 and 2012 fracking sparked an 18-fold increase in U.S. production of high-quality crude oil known as light tight oil, or LTO. U.S. crude oil production is now headed back to ten million barrels a day, even as domestic demand first declined and then flat-lined. The result is more oil than we can refine at home, as producers struggle to find ways to get around the 1975 export ban through regulatory waivers like the one for condensate.
Light tight oil (LTO) is a lighter crude, meaning that it is less viscous and “sweeter”, which in petrospeak means it contains less sulfur, making it easier and less expensive to refine. It’s a product much in demand among refineries in Asia and Europe. Meanwhile, refineries in this country are largely designed for handling the heavier crude that comes from Mexico, Canada, and South America. America’s heavy crude refiners can process LTO but only with a significant loss of efficiency, which means they demand a considerable discount from producers. The point here is that LTO is an oil virtually made for export rather than for domestic U.S. consumption.
That’s one reason why Senator Lisa Murkowski of Alaska has recently introduced a bill, S.1312, that lifts the ban on crude oil and which has found no less than eleven co-sponsors, including six committee chairmen. Not surprisingly, the American Petroleum Institute has been strongly supportive, predicting that an expanded export market would generate another half million barrels of oil a day to meet global demand and directly and indirectly create as many as 300,000 jobs.
Proponents of lifting the ban have included President Obama’s own Secretary of Energy Ernest Moniz, his former Director of National Economic Council Lawrence Summers, and his former Undersecretary of Defense for Policy Michèle Flournoy. Still, resistance has been fierce, thanks to the efforts of an unusual coalition of environmentalists, oil refiners, and protectionist-minded nationalists who worry that lifting the ban will both drive up gas prices and dissipate our shale energy edge.
“As oil producers head overseas to fetch higher prices than they [can] get at home”, says Tyler Slocum, director of Public Citizen’s Energy Program, “domestic supplies will dry up, and the cost will rise.” This argument seems compelling from a strict supply-demand perspective, but it ignores the fact that the oil market is integrated globally. Sending crude outside the United States will therefore add to global supply and push global prices downward. A host of studies, including by both the Houston-based energy research firm IHS Cambridge Associates and by NERA Economic Consulting for the Brookings Institution, suggest that U.S. oil exports will not raise gasoline prices but lower them.
More specifically, NERA estimates that even if the U.S. producers exported as much as two million barrels a day—roughly one quarter of current production—the price plunge might be as much as $5–7 per barrel in the first year, with further price declines following over the next decade. The report concludes that the price drop at the pump would be in the 8-12 cents per gallon zone, even if the decline in supply of LTO for domestic production means a growing convergence of West Texas Intermediate and Brent crude prices.
This touches on the heart of the resistance from refiners. Because domestic refiners don’t relish their product, LTO producers have had to sell at a discount, sometimes as much as $28 below world prices. Ending the ban means ending the discount—which is in effect a non-market subsidy provided by the 1975 law—that allows refiners to buy LTO cheaply and sell it as gasoline on the world market. (Unlike crude oil, there are no restrictions on exporting gasoline.) This is such a lucrative market distortion that even during the third quarter of 2014, when oil prices were steadily tumbling, refiners still enjoyed a considerable premium based on the price differentiated between the crude oil they bought from U.S. producers and the refined products they sold, including abroad. The NERA experts conclude that the net effect of exports will be to introduce “greater efficiency in the refining system due to the increased ability of U.S. refineries to utilize the types of crude oil for which their design is optimized”—that is, the heavier crudes from U.S. producers and from Canada and other countries.
The third and final argument against lifting the 1975 ban is a macroeconomic one, namely, that the energy abundance the shale revolution has produced will dissipate if our surplus is shipped abroad. Related to this argument is the fear that, if oil prices retain their historic volatility, the American consumer could be caught in a vise if prices spike while U.S. producers are exporting too much of the shale supply. On the other hand, a steep drop in prices will induce a cutback in new shale exploration and production, undercutting our abundance at its very source. To support their claim, oil-export critics point to the impact of the recent drop in the price of oil on new shale investment, especially by smaller and mid-size producers.
This pessimistic scenario overlooks the fact that shale extraction technology has enabled producers to adopt a much more flexible response to price changes than conventional producers, enabling them to reduce production quickly when prices fall and resume with similar speed when prices rise again. The overall impact has been to provide a new stability to global oil prices, even as other technologies are allowing more efficient production from existing wells. Indeed, oil analyst Rusty Braziel has recently reasoned that even at $35 a barrel, increased drilling efficiency, falling production costs, and heavier reliance on the most productive oil areas will mean sustained production for a large proportion of U.S. shale producers. “I just don’t see a way that the brakes are going to be slammed on”, adds David Knapp of Energy Intelligence.
Far from threatening the shale oil bonanza, exporting would likely prevent an overflow of domestic oil. One alternative to selling at a discount to U.S. refiners has been to stockpile supply. Indeed, by the end of 2015 there is a real danger that LTO may be a glut on the market, which means plunging profits for even for the most efficient producers who, along with relevant banks and other investors, will increasingly come to see the shale oil business as a money loser. Wall Street Journal columnist Holman W. Jenkins Jr. has even predicted that a failure to permit oil exports will cripple the shale boom altogether. Taken together with falling global prices over the past year, the discount domestic producers are still forced to take from American refiners will discourage more exploration and production. “With the global oil price 50 percent lower than it was a year ago”, Jenkins notes, “the difference between the depressed world price and the even more depressed domestic price inevitably is the margin of ruin for some producers.”
In short, the American gusher may come to an end if no action is taken on the 1975 ban.The September 2014 NERA report argues lifting the ban would actually serve as a boost to production by removing a regulatory barrier that has artificially suppressed the price of both LTO and condensate and as a result minimized their production. “With the crude oil export ban lifted all crude oil produced in the U.S. would compete freely in the global market”, the report concludes, “and receive value commensurate with the global price of crude oil”, thus improving the prospects for new investment and higher levels of future crude oil production.
The case for lifting the ban therefore seems strong, and the arguments against it either highly special-interest motivated or simply wrong. The remaining question for policy, then, is how to lift it.
As with most policy debates in Washington, politicians are torn between the compelling intellectual arguments for a policy change and fears of the political consequences if they take action and something goes wrong. Lifting the ban outright could expose them to blame if prices at the pump rise for a totally unrelated reason. They could also be left exposed to charges that lifting the ban is motivated by Big Oil profits. Politicians, especially Republican ones, are understandably skittish. But on the other hand, there’s the simple fact that not lifting the ban harms the nation’s interests and energy security, sapping precisely the comparative energy advantage that many supporters of the ban say they want to protect.
Fortunately, in this case there may be a way for Congress to have its oil and, well, sell it, too. Proponents of lifting the ban are right that we need a new direction in export policy. But that new direction doesn’t have to mean opening the tap up for every willing buyer, including China. Lifting the ban represents not just an economic opportunity but a strategic one as well.
From a petro-diplomatic standpoint, the best starting point is to think about oil exports as a form of international trade in a critical strategic commodity. Just as the U.S. government is careful about allowing U.S. producers to sell other strategic assets, from computers to military hardware, it doesn’t have to allow oil to be sold to everyone who wants to buy it. Instead, as with our high-tech fighter jets, it makes more sense to sell oil to our import-dependent friends and allies. A deliberate policy of American petro-diplomacy would employ a series of negotiated bilateral trade deals with selected countries to direct oil exports to those we want to support at the expense of those we don’t.
Such an approach will, of course, make true believers in free trade swoon. Yet as energy experts from Daniel Yergin to T. Boone Pickens will tell you, the global oil market isn’t a true free market anyway and hasn’t been for decades. Ever since the first Arab oil embargo in 1973–74, oil-exporting countries have manipulated their production to maximize revenues and advance their national interests. Meeting global demand has been a necessary byproduct of pursuing those goals, not an altruistic favor to the world. It is now time for the United States to use its new oil bonanza as a “smart power” asset in the same way, in order to gain strategic advantage while creating jobs and new sources of tax revenue at the same time.
Fortunately, there are mechanisms within the 1975 law to do this without abolishing the ban altogether. One route, for example, would be for Congress to ask the President to authorize the Commerce Department’s Bureau of Industry and Security to exempt LTO from the statute along with condensate, thus opening the way for allies like Japan and Germany to apply for import licenses.
Another way, proposed earlier by Senators Lisa Murkowski (R-AK), John McCain (R-AZ), and others, would urge the President to make exemptions “based on the purpose of export, class of seller or purchaser, country of destination, or any other reasonable classification or basis” as provided in the 1975 law. This would allow American companies to submit export applications to the Commerce Department for consideration “on a case by case basis”, in accordance with Part 754 of the Export Administration Regulations covering commodities considered in short supply—which American crude oil clearly is not.
The boldest way for Congress to act, however, would be to reinvigorate the Export Administration Act (EAA) of 1977, which expired in August 2001. Presidents Bush and Obama have since renewed it annually by executive order, yet it is rarely used. That act gave the President control over exports for national security purposes, and gave him authority to establish export licenses for certain items—for example, crude oil. Such licensing, of course, would not come free. A revived EAA would authorize the President and his Commerce Department to negotiate bilateral oil export treaties in which a foreign country would receive a certain guaranteed supply of American oil—for example, 300,000 barrels per day at the global market price for three years—in exchange for trade concessions at its end.
The impact of such an approach on America’s trade balance could be considerable. It’s worth noting that the shale revolution has meant that petroleum imports counted for less than 20 percent of the U.S. trade deficit last year—half the amount just five years ago. But we’re still running a hefty trade deficit. Last year U.S. exports rose 2.9 percent from 2013, to $2.345 trillion, but imports rose 3.4 percent, and are rising still. Indeed, this past March we achieved the highest trade deficit in seven years. Oil export deals won’t make that large number disappear, but it could substantially whittle away at the deficits we have with individual countries, including some of our closest allies.
Which countries would make suitable candidates for such bilateral oil trade deals? One is certainly Japan. It’s the third largest petroleum consumer in the world, and the second biggest net importer. It’s also the fourth-largest supplier of goods to the United States, from cars and machinery to electronics and medical instruments, worth a total of $73 billion in 2013. Today Japan is almost entirely dependent on imported oil, 83 percent of it from the Middle East, and a third of that from Saudi Arabia. U.S. light crude would be welcome to Japanese refiners, and also allow them to reduce dependence on an increasingly volatile Middle East.
Indeed, Japan is one of the Asian countries that has already lined up at the condensate window (another is South Korea). In October 2014 almost 300,000 barrels worth of condensate were shipped to Japan’s Cosmo Oil Company, while Houston-based Enterprise held term contracts with Japanese traders Mitsui & Co. and Mitsubishi Corporation to supply condensate through the end of 2014. Japan is also looking for alternatives to its dependence on Middle Eastern oil. Barring a breakthrough on the American market, it’s been turning in desperation to Russia and buying East Siberian oil on the spot market to the tune of 300,000 barrels per day. A bilateral trade deal with the United States could all but erase Japan’s need for Russian oil, delivering a sharp rebuff to Vladimir Putin’s growing energy-supply extortion racket in Asia.
Another candidate is India. Its crude oil bill came to $144 billion in 2013, the single biggest of India’s import costs. Indeed, 75 percent of its oil needs are imported, almost all from Gulf states, including Iran. Just as Japan wants to reduce its dependence on Saudi oil, India is keen to reduce its dependence on Iranian oil. A U.S. trade deal could go a long way toward doing that, while having an important impact on the U.S. trade deficit with India, now at about $20 billion per year. A putative deal of 300,000 barrels per day at $50 per barrel would lop off one-quarter of that deficit—not to mention other trade benefits the United States could negotiate as part of the final deal.
Then there is Australia, perhaps the most acute case of an oil-poor ally. Once an oil producer, Australia now imports 91 percent of its petroleum needs—up from 60 percent in 2000. A recent government study concluded that, if that vital flow of oil were interrupted, the country’s transportation system would run dry in just three weeks. Australia’s main sources of imported oil are Vietnam, Malaysia, and Indonesia. A 300,000 barrel-per-day deal with the United States would provide much-needed relief on the supply side and also breathe new life into Australia’s stumbling refining industry (in 2014 almost one third of the countries’ refineries were set to close).
Finally, there’s Great Britain. This is ironic, since its North Sea oil discoveries in the 1970s produced the Brent crude that still gives the name to the light sweet oil that dominates world financial markets. Yet those North Sea reserves are on the wane. Production there has dropped to less than one million barrels per day; Britain now imports almost half its fossil fuels from abroad, including crude oil. Like other EU countries, Britain is increasingly dependent on oil from Libya, where a chaotic political situation regularly threatens to cut off supply. A generous and reliable stream of crude oil from U.S. producers, which is similar to Libya’s light crude, could breathe new stability to Britain’s economic fortunes and those of other EU countries as well.
Interestingly, the national security case for U.S. energy exports to the European Union has already been made and accepted—with regard to liquefied natural gas. The political battle over gas exports is virtually over, with the Obama Administration all but conceding defeat after initial opposition due to pressure from environmental groups. Creating a liquefied natural gas export infrastructure will take years, however—perhaps as much as a decade. Oil exports to the EU could begin tomorrow morning were the political will—and the right political strategy—in place.
A series of bilateral oil trade agreements would mark a new kind of diplomacy for the United States: petro-diplomacy. It would leverage our current energy advantage in not one but three ways.
The first and most obvious would be using oil exports to enhance the energy security of long-standing allies like Japan and Britain, as well as relatively new ones like India or, to choose another likely candidate, Poland. At the same time, it sends a powerful signal to the rest of the world that the days of the American oil embargo, as the Financial Times once dubbed it, are over.
The second is that it would turn oil into a commodity that enhances our terms of trade with other industrialized countries that want and need petroleum to sustain economic growth, and would do it without literally opening the floodgates. It could even turn the status of Most Favored Oil Export Nation into something worth trading in exchange for concessions on other traded commodities. South Korea, for example, currently buys considerable quantities of condensate but refuses to import American automobiles. A formal bilateral agreement could adjust that trade picture, while showing sustained “soft power” support for an important ally.
The third advantage of the petro-diplomacy approach is less obvious but just as crucial. America’s reserves of shale oil are limited. Shale wells exhibit much steeper decline rates than conventional wells, which implies that the boom could fizzle out much sooner than optimistic forecasters believe. Even with a best-case scenario of discovering additional reserves through enhanced technology, there may be only a twenty-year window for American LTO production to have a decisive effect on global prices and supply.
This means that an outright lifting of the ban could quickly dissipate our current shale advantage, whereas a carefully modulated petro-diplomacy strategy would husband and exploit it. Of course, some will object that this approach borders on neo-mercantilism, thus overthrowing a sacrosanct principle of American diplomacy, namely promotion of free trade. Yet the sober truth is that the vast majority of bilateral “free trade agreements” are anything but; most contain loopholes for certain favored industries and products that remain protected by tariffs, import quotas, or other mechanisms. A real free-trade agreement need be only one page long; but there are no such agreements. Right now the United States has very little leverage for advancing freer trade on a bilateral basis. Oil trade deals with countries like South Korea or India could become among the most valuable levers we have.
Some critics will still insist that such bilateral deals will undermine efforts to negotiate comprehensive free trade agreements such as those with the European Union (the Transatlantic Trade and Investment Partnership, or TTIP) or with Asia (the Trans-Pacific Trade Treaty, or TPTT). This is simply untrue. On the contrary, these bilateral oil trade agreements could serve as important curtain raisers for comprehensive agreements already in the works, by lowering tariffs and trade barriers (the goal of every free trade agreement) to a commodity like oil now, rather than waiting until a multilateral deal is done.
As Senators Murkowski, McCain, and Bob Corker (R-TN) pointed out in Foreign Policy back in April, “For more than forty years, U.S. laws have tightly restricted crude oil exports”, yet “the United States is producing more energy today than at any point in its history.” America has a commodity the rest of the world wants to buy, so why not let that happen in a way that will benefit our allies as well as ourselves?