David R. Henderson  

Obama vs. Wall Street Journal on Global Oil Markets

Markets describe reality; mode... W. Lee Hansen on University of...

Both Obama and the WSJ are wrong: The WSJ is more wrong.

Here's an excerpt from the Wall Street Journal's Review and Outlook (unsigned) editorial, "Obama on Oil Markets: Supply and demand seem to be elusive concepts," on President Obama's statement about the Keystone pipeline and its impact on U.S. gasoline prices:

Mr. Obama's market analysis is more remarkable and worth quoting at length: "So there's no--I won't say 'no'--there is very little impact, nominal impact, on U.S. gas prices--what the average American consumer cares about--by having this pipeline come through. And sometimes the way this gets sold is, let's get this oil and it's going to come here. And the implication is, is that's going to lower gas prices here in the United States. It's not. There's a global oil market. It's very good for Canadian oil companies and it's good for the Canadian oil industry, but it's not going to be a huge benefit to U.S. consumers. It's not even going to be a nominal benefit to U.S. consumers."

Let's break that down. The oil market is global, but somehow adding to the global supply of oil via the pipeline is not going to affect the global price for oil, so it won't affect American gasoline prices. That doesn't seem to pass the basic supply-demand test.

But it also overlooks that refiners on the Gulf Coast can handle Canada's heavy crude, which means more lighter crude from the Bakken and Eagle Ford Shales would be available to export onto the global oil market. If global supplies increase, all other things being equal, the global oil price would fall for everyone--including American consumers.

Obama contradicts himself here. He goes from "there is very little impact, nominal impact" to "it's not even going to be a nominal benefit."

The Wall Street Journal editors are making a good point but they go too far. It's absolutely correct that adding to the world oil supply will, ceteris paribus, reduce gasoline prices in the United States. So they're right on that. But they seem to suggest that not allowing x barrels of oil to flow through the United States will make the amount supplied at a given price x barrels fewer. This is false. If Canadian producers don't get to use the least-cost means of transportation, as the Keystone Pipeline appears to be, they will use the next least-cost means, which might be a pipeline to the West Coast and tankers to China. That will also increase the world oil supply. Will it do so as much as if the oil went through the Keystone Pipeline? No. With higher transport costs, the Canadian producers will produce marginally less. With marginally less world oil supply, world oil prices will be slightly higher than otherwise and gasoline prices will be slightly higher than otherwise. So Obama's first statement quoted by the WSJ was actually correct, but then he blew it.

Of course, the WSJ editors might have had my point above in mind when they wrote their op/ed, but they certainly did not communicate that to their audience. They seemed to prefer the "gotcha" over good economic analysis.

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COMMENTS (19 to date)
Alan Reynolds writes:

Quite right. But if Obama really believes the pipeline will not increase production from Canadian tar sands then he cannot oppose the pipeline by claiming it would increase global carbon omissions. With the supposedly same amount of oil transported by pipeline rather than by rail and truck, carbon omissions would be lower with the Keystone pipeline than without it.

Don Boudreaux writes:


I take the Journal simply to be saying that Obama is mistaken when he argues the following: because the actual units of oil that would be shipped through the pipeline won't themselves be consumed in the U.S., the addition of such oil to the world supply of oil won't affect the prices of gasoline and other oil-based products in America. That's certainly how I read Obama's statement, and it is indeed mistaken. Your point is correct that Keystone isn't the only means of transporting that oil, and so even without Keystone (most of) that oil would eventually become part of the global supply of oil (and, thus, put downward pressure on the price of oil).

And it's an important point to recognize, I grant. But Obama's argument (made by other people in addition to him) struck me as being that physical stocks of oil not retailed and consumed here will have no effect on prices here because it is oil that is not retailed and consumed here.

For the WSJ to point out that the price of oil (and gasoline at the pump) in the U.S. is determined largely on the global market does not strike me as a "gotcha."

It might have been appropriate for the WSJ to then go further and explain the point that you make. But the editorial-writer's goal in that essay was to expose Obama's economic ignorance - which is important to do. Unless you really believe that Obama had in mind the point that you make - a fact that would require him then to admit (a la Alan Reynolds's comment) that blocking Keystone really won't do much, if anything, to "help" the environment - I believe that the WSJ is not wrong in the point it is making.

Don Boudreaux writes:


P.S. In the WSJ essay just before the part you quote, Obama is quoted as saying "At issue in Keystone is not American oil" - implying (or, at least, strongly suggesting) that Obama believes that if the physical units of oil destined to run through Keystone were oil extracted in the United States, then the prices that Americans would pay for gasoline and other oil-based products would likely, and not insignificantly, be reduced by Keystone. But because the oil would be Canadian, then (Obama seems to argue) Americans won't benefit from the Keystone pipeline.

David R. Henderson writes:

@Alan Reynolds and Don Boudreaux,
First, I’m honored that two of my favorite economists, the first of whom, Alan, gave me some important mentoring about writing for the public back in the 1970s, are commenting on my post.
Second, to substance.
The point Alan makes is absolutely right. Obama can’t have it both ways. And not only that, but to the extent the oil would be transported by rail, the carbon emissions would be much greater.
I think Don’s point would be correct had Obama not suggested that there would be a slight nominal impact on U.S. gasoline prices. I don’t know how he could have said that if he, or his advisors, hadn’t had my (and Alan’s and Don’s) idea in mind. Of course, as I pointed out, he didn’t stick to that for long.

michael pettengill writes:

Lowering Canada's cost for exporting oil is done by killing jobs, and if the Canadian oil is shipping by train through the US, either to US east coast ports or to Gulf coast refineries, the jobs killed by the pipeline will be American jobs.

Almost all the costs of shipping oil by rail is going into labor cost. While railroads are charging premium prices due to scarce supply, the railroads are using the profits to invest in infrastructure in the US. Note, I'm using profit as an economist, so this is not ROIC, but the premium above labor cost plus ROIC.

The high cost of oil forced shippers to explore alternatives to trucks, plus the drought and then flood in the central US made barge an unreliable alternative. Thus railroads were pressed to provide better service, which required significant capital investment. But the oil boom surge gave the rail industry a supercharge for the capitalist, funding a lot of investment in physical assets that will reap returns for decades.

So, the lack of the Keystone has diverted Canadian oil profits into the coffers of US capitalist railroads to fund significant investment of mostly US labor into capital assets that will generate returns for decades.

The higher the labor costs, the greater the GDP - production capacity sits idle if no one can buy the production.

Kevin Erdmann writes:

Michael, you're on to something, but you're too timid. Why stop at railroads? Mule carts achieve most of your goals far more effectively.

NZ writes:


The Harrison Act's centennial came and went last Wednesday, December 17th, without a whisper about it anywhere on the internet. Not in the news, not on any political blogs or websites I could find on Google, not even on sites dedicated to drug war topics. (A search for "Harrison Act centennial" pulls up only two results: some guy's blog entry from 2011 listing anniversaries in the drug war, and one of my own comments on this blog in August of this year.)

That didn't surprise me too much, but it was kind of surprising there was no mention of the centennial here either, since the history of drug prohibition isn't completely alien to you EconLoggers. Or maybe it is?

Anyway, I've stopped using the internet for ingesting or broadcasting my political opinions, so as part of that I don't come around here anymore and I probably won't be back. I just wanted to check in and see if that topic had been covered. A bit disappointed that it hasn't, but hey, I guess the drugs issue just isn't that important to people--sorta like 100 years ago all over again.

Well, Merry Christmas!

Jon writes:

Gulf coast refineries are tuned for heavy crude. The efficiency of producing high value products depends on having the designed-for input mix.

Much of this heavy, sour crude used to come from Venezuela. The new US domestic production is mostly lighter--thus why it is important to lift the export ban, we need to ship the light crude out to Europe where the refineries can take it. But is also important to get more heavy crude down to the Gulf Coast.

1) It will help US refineries to have the right input mix
2) If the Gulf Coast can fill its need for heavy crude from the Canada, we can squeeze Venezuela's prices a bit harder.

Major mistake to think of oil as having single price. Grade, source, destination every tuple commands its own price. This is one reason gasoline is not the same price everywhere. It isn't just taxes!


Peter H writes:

Prof. Boudreaux,

The more charitable reading of Obama's focus on the source of the oil being Canada is that there won't be increased US economic activity from extraction of the oil. When I watched the presser live, that was the impression of the point that I got - especially considering the question was a generic one about the whole range of benefits the KXL pipeline might bring, not specific to lower gas prices.

andujar cedeno writes:

President Obama and the Democrats said that their $900 billion dollar in 2009 saved the country from a 2nd Great Depression. A significant proportion of that stimulus was spent on projects of dubious economic value, the Turtle Tunnel, shoody weatherproofing, and various green energy boondoggles.

The President and others call for an infrastructure bank that would also stimulate the economy.

We also have the multiplier argument claiming that a dollar spent by the Federal Government magically multiplies in its effect on the economy.

So building the Keystone Pipeline with federal borrowing, printing, tax dollars, etc. has massive demand side benefits that the President and his CEA continually advocate.

How can liberal Democrats, Keynesians, or whatever label you want to put on this line of economic thought oppose the Keystone Pipeline as a public works project regardless of its impact on the oil market?

The intellectual inconsistency of the left is glaring on this aspect of the pipeline.

David Henderson Author Profile Page writes:

Dear NZ,
I’m sorry you won’t be back. I found some of your comments helpful.
I do think, though, that it is unreasonable on your part to assume that people who oppose the drug war should know the exact date of the Harrison Act. I don’t remember the exact date in October 2011 that Congress passed the USA PATRIOT Act. But I don’t need to remember that date to know that I opposed almost everything in it.
I also think that it’s reasonable to conclude, simply because someone doesn’t call attention to the centennial of a bad law, that that person’s opposition to the law is suspect. I think World War I was one of the biggest travesties of the 20th century and that it set up future travesties. But I didn’t post about it on the centennial of that war.
To take another example, I think that no one doubts my co-blogger Bryan Caplan’s opposition to immigration restrictions. He has been outspoken about them many times. So I think it would be silly to fault him if, for example, he did not call attention to various round-number anniversaries of various bad laws.

ThomasH writes:

Obama is spot on to criticize the idea that Keystone will benefit the US consumer by reducing gasoline prices. Keystone benefits the US through royalty payments to landowners and profits to the investors. And that's enough. The additional oil that would be consumed because the US allowed a slightly lower cost transport route cannot at at any reasonable estimate of the damage done by CO2 accumulation in the atmosphere be enough to offset the benefits to the pipeline owners and royalty receivers.

Consumer price effects are politically salient, but not all of interest in evaluating the question.

If the policy issue under discussion is whether or not the federal government should grant the Keystone XL pipeline a permit, all the costs and benefits are relevant and not only possible lower prices for consumers.

Stephen Dawson writes:

Prof Henderson, I think you might be misunderstanding the second WSJ para that you're quoting. They seem to be saying that the oil involved is not completely fungible. That by allowing the 'heavier' Canadian crude to get to US refineries which are capable of dealing with it, and instead exporting lighter US crude (this apparently can be more readily refined by overseas facilities), greater efficiencies can be achieved. At least, if their underlying technical points are correct, there would be a delay in oil supply increases if there was insufficient overseas capacity for type of oil that Keystone would carry.

David R. Henderson writes:

@Stephen Dawson,
You--and the WSJ--are making a good point. There would be greater efficiencies. But I’m not misunderstanding it. I’m saying that that heavy oil, if it doesn’t go to New Orleans, will go somewhere. It will be part of world supply either way. Of course, there won’t be quite as much, due to higher transport costs, which is what I said above.

Karl Salemangi writes:

I read the article from a similar perspective to Don. The exported product from Canada will probably not impact consumption in the US both w.r.t production or consumption. But will be good for Canada... even better if price stabilizes a little highe, feels a little surreal

Glenn writes:

Given the higher transportation costs associated with the outside options, and the rapidly rising marginal costs-per-barrel, all else equal total global supply is lower under the current regime than under a Keystone regime (Canadian producers are operating deliberately and voluntarily below potential output due to distribution chain constraints binding).

Nothing in the WSJ article was factually correct, as far as I can see. Nowhere does WSJ claim that x barrels of flow-through on Keystone is foregone without Keystone. They simply say world oil supply will increase with Keystone versus without. Further, the gains to global welfare are not simply captured by the marginally increased supply. All product moved through the pipeline, even that not marginally added to world supply, is more efficiently delivered and therefore delivers real welfare gains. This post is, as far as I can tell, textbook straw man.

Obama is even more wrong than you give him credit for. He claims the share of gains not captured by US consumers in the form of lower gas prices would instead go to Canadian oil producers, a clever appeal to economic nationalism to undermine the policy. But this is false. Since the pipeline must flow across the United States, this country could - and would - extract a significant share of the surplus. In fact, the US could extract the gain until the Canadian firm was just indifferent between tankers to China and pipeline to Texas - or ALL of the marginal gains from the pipeline.

NZ writes:

See, this is why I can't be trusted with an internet connection. I just HAD to check back...

Anyway, David, I apologize. Everything you said about my being unreasonable was correct.

Reading my earlier comment, I guess I must have been venting frustration at the missed golden opportunity to touch on the drugs issue, since centennials are significant and the issue itself remains central to questions of national and foreign policy. Most people think the war on drugs started with Nixon and is ending with marijuana decriminalization, after all.

I am indeed troubled by the repeating pattern of apathy being exploited by political elites to advance malicious causes, but I was wrong to use your lack of knowledge about one trivial date as local evidence of that apathy.

I hope you'll continue to write about the drugs issue in the future.

Daublin writes:

To spell out the issue a little more carefully, reducing the transportation costs for any oil sold will reduce the price of *that* oil. Since oil is a global market, this will reduce the price for everyone.

To put it a different way, transportation costs can be viewed as a tax on oil sales. It raises the price that buyers see, and it lowers the effective price that sellers see. It's Pigou in reverse: reduce the tax, and the price will look better from both the buyer's and seller's side.

Anyway, I agree it is sad to see the president saying economically stupid stuff, and then for supposed watchdogs to say additional stupid stuff on top of it. Depressing stuff. I am glad so many econ profs are blogging nowadays, and doubly glad for the ones that point out errors no matter who makes them.

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