David R. Henderson  

Larry Summers on Oil Exports, Part I

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I believe that the question of whether the United States should have a substantially more permissive policy with respect to the export of crude oil and with respect to the export of natural gas is easy. The answer is affirmative. The merits are as clear as the merits with respect to any significant public policy issue that I have ever encountered and it is an important test of the efficacy and functioning of our democracy whether within the next nine months we will get to that correct solution.
This is from the transcript of a talk given by Larry Summers at the Brookings Institution this week. It's Larry's case for allowing exports of oil and natural gas. I agree with his case and I agree with most of his reasoning. He does it well and succinctly.

I'll highlight a few of the best parts and a couple of places in which he got it wrong or exaggerated. Remember that this is a transcript and so don't pick on Larry or the transcriber. I've seen my own transcripts and I'm never as good as I thought I was--I get words wrong, etc.

His nice statement about how we got export controls. They were a consequence of price controls on oil:

Now, if you were one country in the free world and you wish to control the price of a quantity [DRH: I'm sure he said, or meant, commodity] you have no choice but to associate that control with an export ban because if you don't everything you produce will be exported. So we put this in place, this export regime, in place for a good reason. That good reason was that we had price controls. Price controls might or might not have been a good idea. I doubt they were a good idea but it's not relevant for the purpose of this argument. What is relevant is that those price controls were eliminated 34 years ago.

As I said, this is a nice statement, but it does have one mistake in it. Price controls were not eliminated 34 years ago. They were eliminated 33 years ago. 34 years ago, a law was passed, that President Carter signed, in which price controls would be phased out and gone by late 1981. That was the good part of the bill. The bad part was that the bill also included a so-called "windfall profits tax" on oil. It was not a tax on profits at all. It was a progressive excise tax on oil, taking a percent of the difference between the old price-controlled price and the price the oil actually sold for, with the percent increasing the bigger the gap. The bill allowed the president the discretion to end the price controls earlier. When Reagan came in in January 1981, one of his first orders of business was to consider whether to get rid of the price controls. He did so in early February.

Larry knows all that. I think his 34 was deliberate. I don't think he was just rounding up. I think, although I could be wrong, that he is just unwilling to give credit to Reagan.

His explanation of why the export restriction on oil has been, until recently, largely a non-binding constraint:

Now, for most of those 34 years, did this ban matter? No. We were a large-scale importer of all kinds of crude oil. It would have been goofy for us to have exported the oil. The ship would have come to our port, and then the ship would've left our port. It wouldn't have made any sense. So, this restriction was like the PGA Tour passing a restriction that said that Larry Summers was ineligible to play. It didn't really matter given the realities of the situation. The feared outcome would not materialize even in the absence of the restriction. So, we have, for the first time, a situation today that we have not had in at least two generations, namely that the market is sending signals that it is desirable on free market grounds to export U.S. oil.

His really nice statement on why export controls are in principle a bad idea and how U.S. presidents have, at least in principle, opposed them:
United States and every President of the United States since the Second World War has professed our allegiance to the concept of free trade. The part of the concept of free trade that gets the most discussion is, of course, the avoidance of the restriction of imports. But the logic of free trade applies equally in opposition to the restriction of exports, and in particular, condemned on free trade grounds is the idea that exports should be restricted so as to give a competitive advantage to domestic producers. This is not just some hypothetical economic theory stuff. On dozens if not hundreds of occasions the United States at the World Bank and at the IMF has voted in favor of programs that included conditionality where the conditionality stopped export controls with respect to raw materials that were motivated by helping domestic producers.

He then gives a nice concrete example.

He then explains why, apparently counterintuitively, allowing exports of oil would make U.S. gasoline cheaper:

What would happen if you allowed oil to be exported? If you allowed oil to be exported people would ship it from West Texas to Brent or to someplace that would otherwise receive it from Brent. They would make a profit. There would be a larger supply of Brent oil. The same demand and a larger supply means a lower price and so in fact the price of gasoline would be lower.

By the way, Bob Murphy, who writes often for Econlib, had earlier given the same analysis.

His argument that bad environmental consequences of oil use are not a good reason to restrict oil exports:

Here there's both a theoretical and an empirical response. The theoretical response, which doesn't go quite as far back as Adam Smith but almost in economics, is the principle that you should always use the most targeted policy instrument possible. So if you are concerned that fracking does damage to the ground water then you should regulate fracking appropriately and having regulated fracking appropriately you should then let the market operate.

There is no environmental argument for a policy that distinguishes between oil produced in the United States for domestic consumption and oil produced in the United States for foreign consumption.

This post is getting overly long and so I'll continue later today or tomorrow with highlights.

HT to Tyler Cowen.

COMMENTS (8 to date)
JohnE writes:

The argument that the price of US gasoline would lower when oil restrictions are lifted is certainly wrong. If the world price for oil is higher than the US price, then when export restrictions are lifted, the US price will increase to the world price.

Maybe Larry Summers was referring to the world price for gas decreasing, which would happen due to the increase in the amount supplied by the US. But the drop in the world price could not go below the old US price as this would then imply no increase in US production, and therefore no drop in the world price. Hence, if the world price drops due to the increase in US production, it will still be higher than the old US price.

David R. Henderson writes:

@John E,
Read the Robert Murphy article I linked to. He goes into the argument in greater detail.

JohnE writes:


I did look at that too. However his analysis left me scratching my head a bit. Assuming that that no oil refiner has market power, then the refiners' demand for crude oil should essentially be the same as the consumers' demand for gas, and the refiners supply curve for gas should be essentially the same as the crude oil supply curve. Another way to think about it is that the market for crude oil and the market for gas should be essentially the same market. Except, as Robert Murphy points out, that crude oil can't be exported but gas can be. In that case, the export restrictions have absolutely no bite, and lifting them would have no impact whatsoever on the price of gas in the US.

It is certainly possible that the refiners have some market power, but Robert Murphy's argument doesn't invoke that, so I'm not sure how he is getting to his conclusion that US gas prices could go down. His argument doesn't seem to recognize that the US refiners' demand for crude oil would reflect the world demand for refined oil.

ThomasH writes:

Larry Summers is a great guy and all, but really, is there an economist in the last 25 years who has argued for a petroleum export ban?

Don Boudreaux writes:

David: Great post, as always. Here, though, is one tiny correction. Reagan signed the Executive Order to deregulate the prices of oil and gas not in February 1981 but in January 1981 - January 28th, to be precise. It was the first Executive Order (#12287) signed by Reagan.

David R. Henderson writes:

@Don Boudreaux,
Thanks. Even better than I remembered.

Peter Johnson writes:

Hi all,

What do you think about charlie munger's point? (let's save the oil for when the rest of the world runs out)

Flocccina writes:

@Peter Johnson

1. If the owners of petroleum rights think that oil will be much more valuable in the future they can not drill but wait. They might even sell futures to provide for current income while they wait.
2. We will most likely be richer in the future.
3. We may not need it so much in the future. Someone might for example figure out a way to make a cheaper good battery.

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