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Oil production: A Slippery Issue

The world is awash in oil, and Congress has decided to do something about it. With the Saudis pumping like crazy, the Iranians returning to the market, and U.S. production near record highs, oil prices are the lowest in more than a decade, and gasoline prices are back to their Great Recession lows. In the midst of all this, Congress ended the ban on exporting oil.

A worker on a rig near Midland, Texas, where shale oil extraction caused a boom. This boom spurred Saudi Arabia to maximize production, threatening to drive U.S. producers out of business.
A worker on a rig near Midland, Texas, where shale oil extraction caused a boom. This boom spurred Saudi Arabia to maximize production, threatening to drive U.S. producers out of business.Read moreBrittany Sowacke/Bloomberg

The world is awash in oil, and Congress has decided to do something about it.

With the Saudis pumping like crazy, the Iranians returning to the market, and U.S. production near record highs, oil prices are the lowest in more than a decade, and gasoline prices are back to their Great Recession lows. In the midst of all this, Congress ended the ban on exporting oil.

Though the decision may not make much of a difference right now, when the oil markets return to normal there could be some real impacts, and they might not all be positive.

First, some history. The oil-export ban was one of a number of defensive measures instituted after the 1973 Arab oil embargo created shortages and long gasoline lines. The belief was that retaining our oil would limit our dependence on foreign suppliers.

Needless to say, those actions failed to keep prices from rising, but they did have a mitigating impact on the cost of domestic oil.

So, will ending the embargo cause prices to be higher or lower in the United States? Economic theory provides the answers.

Think about it this way: Imagine a totally isolated country that has lots of oil, but no place to sell it. Prices would be low in this "excess supply" nation. Next, imagine a second totally isolated country where the oil supply is limited. Prices would be high in that nation.

What happens, then, if the isolation ends? The nation with the extra oil would ship it to the country with the shortage. The added supply would lower prices in the high-cost nation. However, as supply leaves the low-cost country, prices would rise. It's simple economics.

Who benefits and loses from the decision to allow U.S. energy companies to ship oil out of the country? It depends on whether you are a producer or consumer of oil.

The oil producers will export oil only if they can get higher prices outside the U.S. If they cannot, nothing changes. Because they likely will be able to get higher prices around the world, their earnings will rise, so oil producers are the primary beneficiaries of this change.

If their earnings increase, oil companies might expand, increasing investment, employment, and growth. Additionally, rising oil exports could positively impact economic activity, but only if those exports are not replaced by additional foreign oil imports. Remember, the U.S. still gets about 25 percent of its oil from imports, though that is the lowest share in 30 years.

As for the losers, that's anyone who uses oil. Refiners will have to pay more for their major input: oil. Companies in industries such as chemicals and pharmaceuticals that use petroleum-based products in their production process could see higher prices than they would have if the embargo hadn't been lifted.

That is true, too, for businesses that depend on oil for heating and production. And, of course, gasoline prices would be higher, so consumers are hurt.

Why was the ban lifted? When you are awash in oil, as we are right now, it's hard to argue that the ban makes sense. But that argument requires one major leap of faith: that there will be a long-term excess supply of oil. Unfortunately, that is not likely to be the case.

And we should expect that oil prices will rise again. The Saudis decided to meet the threat of growing U.S. shale-oil production by pumping full out, driving prices down and U.S. producers out of business. Because their production costs are less than $5 a barrel, the Saudis can withstand low prices a lot longer than the U.S. shale-oil companies that have costs that run to $50 - or even $75 - a barrel.

Ultimately, someone has to blink, and the Saudis believe it will be U.S. producers. Once that occurs, supply will drop and prices will rise.

Meanwhile, U.S. firms will still be able to ship oil out of the country. Less oil here and more oil there can only mean that U.S. prices will have to rise to world levels.

jnaroff@phillynews.com