Living Economics

Oil Glut
Supply gluts do not always result in low prices to consumers if supply and demand conditions are not allowed to freely interact.

As a globally traded commodity, one would expect similar grades of oil to command similar prices if the market is free of artificial constraints. At the end of 2008, however, a barrel of Brent (from the North Sea) sold for $9.46 higher than the similarly graded Louisiana Light Sweet. In prior years, Brent normally sold for a couple of dollars less. (WSJ)

Such a drastic price reversal came about for several reasons. First, horizontal drilling and hydraulic fracking have drastically increased the oil output from North Dakota and Texas. Daily oil output increased from about 6.5 million barrels a day in 2012 to about 8 million barrels a day in 2013 (a 23% increase) (BW). This supply increase would not have led to such a dramatic price decrease if the oil could be sold freely in the world market.

But US oil could not be freely exported because of a US law. Only refined oil products such as gasoline, jet fuels and other oil-derived products are allowed to be exported. And there are not enough refining capacity along the Gulf Coast to handle the sudden surge in domestic oil output. Even so, surging export of refined oil products has helped to reduce the need to lower domestic gasoline prices.

Oil stored in the Gulf Coast could of course be shipped to refineries on the East Coast. But the shipping cost is artificially inflated because of a 93-years old US law, the Jones Act. The Act requires that maritime shipments between US ports can only be carried by US-made and US-flagged ships. There are just 32 tankers and 42 barges eligible under the Jones Act to transport oil between the Gulf Coast and the East Coast. This Act makes it three times as expensive to ship a barrel of oil from the Gulf Coast to the East Coast than from the Gulf Coast to Canada ($6 vs $2) (BW).

New US oil tankers will not be ready for at least a couple of years because of limited US ship-building capacity. And US-built tankers will be five times as expensive as oil tankers built in Asia. (BW).

With higher oil supply and restricted demand due to artificially imposed constraints, the fall in domestic oil prices is to be expected.

Because of artificial barriers, the benefits of increased domestic oil output are unevenly distributed. Instead of US oil producers getting higher prices and US oil-products consumers paying lower prices, US oil refiners, US ship owners, US ship-builders, US labor unions and US defense contractors have siphoned off most of the benefits. It is a wonder that the US Congress ever allowed WalMart to break through all these protective hurdles to bring us the Everyday Low Prices from countries with low labor costs.

References:
  • Business Week. 12/16/2013. "Lot of oil, not enough ships."
  • Economist. 12/14/2013. "Spreading disarray."
  • WSJ. 12/6/2013. "U.S. oil prices fall sharply as glut forms on Gulf Coast."
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