Why the Price of Foreign Oil Still Influences How Much You Pay for Gas

Scott Barbour/Getty Images

Scott Barbour/Getty Images

Americans have been enjoying the spoils of cheaper gas prices lately. After nearly four years of near record-high prices, the average price of gas has dropped below $3 per gallon, freeing up disposable income for millions. According to Gallup, self-reported daily spending averaged $89 in October, up from $87 in September and $88 a year ago. For the 14-day period ending November 23, daily spending averaged $93.

A boom in domestic energy production has been the main catalyst behind lower gas prices in the U.S. Over the past few years, the nation has climbed the ladder of energy producers and currently ranks second only to Saudi Arabia in terms of overall oil production, according to the U.S. Energy Information Administration (EIA). This has led to a national conversation about the export of crude oil, which has historically been restricted. However, given that there has been a supply boom, it’s not clear that the existing restrictions make economic sense. Export restrictions have been in place since the 1970s, many being put in place in response to the 1973 Arab oil embargo.

But overly strict regulations are a competitive disadvantage and the need for energy security is diminishing. “Total U.S. crude production will be 9.6 million barrels per day by 2019 — up from 7.7 million in 2013. Nearly all of this growth is expected to come from tight oil production. This anticipated growth is resulting in calls to lift or otherwise ease U.S. crude oil export restrictions,” says a Congressional Research Service report released earlier this year.

“The rise in U.S. production has decreased the need for imports, improving the U.S. trade balance, and leaving more oil and spare production capacity on the world market. … Some oil producing countries that viewed the United States as a market destination, may now view it as a competitor.”

This ramp up in domestic U.S. production is generally assumed to be the reason for the decline in gas prices. But, while production is definitely part of the equation, a study conducted by the EIA shows that international forces can have a huge impact on domestic prices. What the study found was that an international benchmark for oil prices known as North Sea Brent is actually more important than the popular domestic benchmark, West Texas Intermediate (WTI), in determining prices. Also, the EIA says that reducing regulations on crude oil exports wouldn’t necessarily drop oil prices domestically, and that it would depend more so on international crude prices. Since oil is a globally traded commodity, prices are more correlated across the world than other goods.

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Source: EIA

Because the price of gas at your local gas station largely depends on the amount of supply being created not just in America but abroad, that means that a surplus of oil into the international market — if it were allowed by relaxing the rules — could result in cheaper prices. “A change in current limitations on crude oil exports could have implications for both domestic and international crude oil prices,” the EIA says. “Such a relaxation could raise the prices of domestically produced oil. If higher prices for domestic crude were to spur additional U.S. production than might otherwise occur, the increase to global crude oil supply could reduce the global price of crude.”

The EIA says that gasoline prices in America largely depend on four main factors: The price of crude oil, refining costs/profit margins, retail/distribution costs, and taxes. The taxation, distribution and retail sales of oil products, like what you would buy at a gas station, are generally stable prices, as opposed to the ultimate price of crude, and the costs associated with producing it.

So, why is it so important at this point in time to look at the differences between the two pricing benchmarks? Well, in previous years, there really hasn’t been much of a reason to take it into consideration. But several years ago, production in both Canada and the United States led to discrepancies in the two benchmarks, which had typically traded at roughly equal levels. When the domestic indicator (the WTI) began to come down, it wasn’t reflected in real-world gasoline prices. This is because, as the EIA explains, U.S. gas prices are more closely tied to the Brent than previously thought.

Again, this may not sound like much in terms of news to the standard American, but it could have some interesting implications on the markets and inside the political system. Bear in mind, the recently elected Congress will be controlled by Republicans, who are much more likely to pass legislation, or attempt to tear down regulations that currently bind the energy industry. That could include approving the construction of the Keystone Pipeline and weakening the Environmental Protection Agency, among other things.

But what could really be important down the road is whether or not the Republican Congress will be willing to remove the existing crude oil export rules. Seeing as how there is a surplus, and a slowing of production could lead to lost jobs, politicians will likely want to give producers incentives to keep producing. Not only that, but there will be plenty of reason for American energy producers to want to keep production rates high, especially if there is a whiff of confidence that trade barriers will fall. The reason being that many developing nations in South America and especially in Asia are starting to get hooked on oil, and there are plenty of potential new car buyers in those markets which will require fuel.

Naturally, there are inherent dangers to opening up the floodgates for oil exports (like potential shortages, resulting in higher prices), but there will be plenty of support for removing regulatory barriers. “U.S. crude exports are self-limiting: If the supply gains expected do not materialize, the market will induce producers to keep the oil at home rather than to send it abroad,” writes Blake Clayton, an adjunct fellow for energy at the Council on Foreign Relations. “Though the companies that benefit from today’s export restrictions might oppose any change in the status quo, the broader gains available to the United States from allowing crude exports make it the far better choice.”

The EIA, however, doesn’t share Clayton’s confidence. “While EIA’s new report provides directional insights regarding the implications for U.S. gasoline prices of a possible relaxation of current limitations on crude oil exports, it does not address the extent of any actual change in domestic production or the domestic or international price of crude oil that might follow from a decision to relax or eliminate those limitations,” the EIA says.

For now, Americans can enjoy the spoils of a domestic energy production surplus, but if Congress decides to remove some regulations, a lot of that oil may be headed overseas. Is that a good thing for the American consumer? It could be, insofar as that more supply on the global scale should help bring international prices down as well.

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