Lifting the US Oil Export Ban

Last week, the US House of Representatives passed a bill to lift the US ban on exporting oil. The bill must also pass the US Senate and, of course, gain the approval of President Obama. In a letter to Congress, the White House expressed its opposition to the bill, but fell short of ruling it out if some sort of deal could be reached. So, for the first time in some 40 years, there is the real potential for the United States to re-enter the oil export market.

Why lift the oil export ban now?

Just looking at the US field production of crude oil tells a dramatic story. After years of persistent declines, the United States has experienced a dramatic reversal thanks largely to the oil shale revolution. As illustrated in the following graph, US oil production reached its modern nadir in 2008, with average monthly production of about 152 million barrels per month. Since then, US oil production has rocketed upwards. As of July 2015 (the most recent date for which data is available), US production was 290 million barrels for the month — an increase of over 90% in just seven years.

So, as the United States becomes self sufficient in oil, it will swing from a massive net importer to a (potentially) massive exporter. With this in mind, we asked our esteemed CFA Institute Financial NewsBrief readers, “Do you think the United States potentially lifting its oil-export ban will have a meaningful impact on future oil prices?” Of the 588 respondents, roughly 50% said yes, 42% said no, and 8% were undecided.

Do you think the United States potentially lifting its oil-export ban will have a meaningful impact on future oil prices?

On the supply side of the equation, the United States has emerged as a major factor in global oil markets as domestic demand for foreign oil has declined. But on the demand side, world GDP growth has slowed dramatically. Before the financial crisis, developed markets had grown at a decent pace and emerging markets — led by China — at rapid clips. Now fast forward seven years and we see Europe and Japan teetering on the edge of recession, the US dollar rising, China struggling, and other emerging markets fading fast. Global oil demand is weakening. So, strong emerging supply is meeting weakening demand.

Oil, like other commodities, is priced on the marginal cost. According to industry experts, shale oil is more costly than conventional oil but cheaper than deepwater and tar sands oil. So, in the 2000–2008 period, when global oil demand was soaring, the supply was slowly shifting away from lower cost conventional oil sources to higher-priced deep-water and tar sands sources. As the marginal cost of production shifted, oil prices went with it. They had to — otherwise the industry would not have produced the high-cost oil.

As productivity has exploded in the shale oil sector, however, the marginal cost of oil production has come down. Analysts initially estimated the marginal cost of oil from the shale deposits in Texas and North Dakota at $70 per barrel, but improvements in efficiency have lowered the break-even prices to as low $50, and they could be as cheap as $30 in some areas.

Hence, oil prices have receded materially from their all-time highs. As illustrated in the following graph, after reaching a peak of $147 per barrel in 2008, oil prices are now hovering in the mid $40s. What could possibly explain all this price volatility ?

Oil is priced in part on the marginal cost of production (for the industry as a whole) and in part on more extreme changes in supply and demand. Perhaps 90% of the time, oil is priced through marginal cost. Likewise, perhaps 10% of the time, it is priced from extreme events impacting supply or demand. So, barring any shocks to the system, oil prices should work toward finding a level commensurate with the marginal cost of shale. So long as shale continues to be the marginal cost driver, then it will continue to drive oil prices.

Find the cost of US shale production and you will find the level for oil prices.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.