The U.S. Department of Commerce took a huge step in the right direction last Friday when it approved the export of a small quantity of crude oil by American oil producers. The move, while limited, foreshadows the inevitable reversal of a 40-year ban on crude oil exports, a move long overdue but eminently sensible given the dramatic increase in American production and the shifting geopolitical landscape.
Technically, the deal will allow American oil companies to swap different grades of crude with Mexico in order to facilitate more efficient refining. But it adumbrates a major reversal in an archaic policy prohibiting U.S. exports to all but a handful of close allies, and opens the door for Congressional action lifting the ban, perhaps as early as next year. The move would significantly reduce market inefficiencies, create jobs, and likely result in lower gas prices at the pump for most Americans.
You have to be over 50 to remember the first Arab oil embargo, when Saudi Arabia withheld supplies from the US in reprisal for support of Israel during the 1973 Arab-Israeli war. In an economically flawed but politically popular series of actions, Congress and Presidents Nixon and Ford collaborated on legislation that eventually choked off virtually all crude oil exports from the United States. Coincident with the advent and ascension of OPEC was the sharp decline in U.S. crude oil production, solidifying popular support for the export ban. American domestic production peaked in 1979, after which time a relentless decline in domestic output continued through 2006. Analysts almost universally foresaw progressively disruptive energy crises in the future.
Well, not so fast. Thanks to a unique confluence of ingenuity, capital and private property rights only possible in America, we are now awash in oil and gas, and will soon eclipse our previous 1979 record production levels. Storage tanks are filled to overflowing, while the pace of technological advance compounds the global supply glut. Meanwhile, millions of barrels of surplus American crude remain stranded on U.S. soil thanks in part to the obsolete proscription of exports into global markets.
Most of the newly abundant oil gushing from American wells is the relatively low-sulphur grade known as light sweet crude. Unfortunately, the legacy of four decades of importation of sour crude from the Middle East has left our refinery infrastructure tooled to process heavy, high-sulphur grades. Hence the supply glut and consequent price discount of $15 per barrel for North Dakota oil and $7 for West Texas crude versus the global market price. All of this during a year during which the number of drilling rigs in service plunged by more than half.
The move by the Commerce Department signals progress in recruiting the powerful equilibrating dynamism of market forces. Mexico's state-run oil company PEMEX applied for a permit to swap up to 100,000 barrels per day of heavy Mexican crude for the light sweet US variety in order to better utilize its refining infrastructure. Commerce acceded to the PEMEX request after 8 months (practically light speed in Washington), sending an encouraging signal to proponents of exports.
More progress is coming. The Senate Energy committee approved a bill in July to lift the export ban, and the House of Representatives is due to vote on a similar resolution in September. A final draft could reach the President's desk by early 2016.
The prohibition of exports was never economically justified despite the political support for such a restriction. But given the nimiety of American oil supply and the waning expansion in global demand, the ban is a relic whose days are seemingly numbered.
Christopher A. Hopkins, CFA, is portfolio manager and vice president of Barnett & Co. in Chattanooga.