Geopolitics of Oil and Inflation

William Alan Reinsch

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Both the U.S. government and the G7 are considering policies to simultaneously address high oil prices and inflation as well as Russia’s control over energy markets. However, the proposed U.S. crude oil export ban would do little reduce inflation, and instead could have the opposite effect of actually increasing U.S. gasoline prices. The effects of the G7 price cap, alternatively, would depend on a few key actors, namely Russia, China, and India. Ultimately, prices levels may eventually decrease not due to government intervention but rather because of growing fears of an economic downturn.

Q1: Would stopping U.S. crude oil exports help reduce inflation?

A1: Curbing or banning U.S. crude oil exports would not help reduce inflation and could further increase it. The price of gasoline and diesel in the United States is based on global energy markets, not just the U.S. domestic market. The United States exports on average about 3 million barrels per day of crude oil, meaning if these exports were cut, there would be a decrease in supply in the global markets which would cause the price of oil to increase. Some industry experts have acknowledged that West Texas Intermediate (WTI) prices—the key U.S. crude oil benchmark—may fall if exports are banned. However, petroleum product prices in the United States reflect global prices. If crude exports from the United States fall and global supply diminishes, product prices may well rise as a result.

A ban on crude oil exports also ignores the differences between types of crude oil. The United States largely exports light, sweet crude oil, while Gulf Coast refiners are optimized to process heavier crudes with higher sulfur content. Furthermore, U.S. refineries are already operating near full capacity , so an increase in U.S. crude oil supply may not help. Additionally, even if there were a ban on U.S. crude oil exports, currently no such ban would be in effect for refined oil products. An export ban on refined products would add to the global scarcity of refined products and would likely drive up prices of U.S. gasoline and diesel products.

Banning crude oil exports would also increase the U.S. trade deficit. A ban on crude oil exports would remove an export outlet for upstream producers and could lead them to shut in production. The decrease in U.S. crude oil production would thus cause a decrease in U.S. net exports of crude oil and petroleum products, increasing the U.S. trade deficit. Decreased production of U.S. crude oil would also likely make the United States more dependent on foreign oil in the long term as a need to recover lost U.S. production. Increased dependence on foreign oil could be offset, however, if renewable energy replaced the decrease in domestic crude oil production.

Q2: Would a ban on oil exports hurt the European Union?

A2: Lower oil supplies would drive up global prices, simultaneously hurting net importers like the European Union, and benefiting Russia, where revenue from oil and gas made up 45 percent of its federal budget in 2021.

As Europe begins to institute a partial embargo on Russian crude oil and petroleum products, access to U.S. oil will become even more critical for Europe. In the months since the invasion of Ukraine, U.S. exports have reached their highest ever since the ban on U.S. crude oil exports was lifted. The United States is projected to have sent 1.4 million barrels of oil a day to Europe during the second quarter of 2022, a 30 percent increase from last year, with Europe now accounting for roughly 42 percent of all U.S. crude oil exports. Meanwhile, the supply of oil from the North Sea is expected to decline, placing further importance on U.S. exports.

Representative Ro Khanna (D-CA), a proponent of enacting the export ban, has suggested that Europe could be exempted. However, as exports to Europe constitute such a large percentage of total U.S. exports, a European exemption would significantly reduce any intended effect of the ban. Furthermore, key U.S. allies such as Canada, South Korea, the United Kingdom, and Taiwan are major importers of U.S. crude oil as well, and they would still be negatively affected by an export ban. These regions have already seen their imports decrease as Europe consumes more U.S. crude oil.

Q3: How would the proposed G7 oil price cap affect global oil markets?

A3: The effect of the proposed G7 oil price cap on global markets depends largely on three key countries: Russia, China, and India. The potential effect on oil markets is predicated largely on how Russia would respond to such a cap. The price cap would likely be set between the discounted price of Urals blend and Russia’s marginal cost of exploration, which is estimated at $40 per barrel. The idea is to set the price cap high enough to incentivize continued production and exports but low enough to reduce Russian revenue. If the price cap were successfully implemented, global oil prices would likely fall and inflation would likely decrease. However, Russia may refuse to sell at the capped price level in an effort to exert its leverage and drive up prices.

Outside of Russia, China and India’s reaction to a price cap will also determine its effect. China and India are two of the largest importers of crude oil in the world and have increased consumption of Russian oil since the invasion, benefiting from the steep discount. If India and China don’t agree to the proposed price cap, then it would likely stop the proposal in its track. The G7 has reportedly had positive discussions with both China and India regarding the price cap, pitching it as a way for the two countries to buy Russian gas at an even steeper discount.

The implementation of a price cap and effective establishment of an oil buyer’s cartel could change global oil markets in the long run, as it would create a counterweight to the oil supplying cartel of OPEC. An accelerating renewable energy transition would also increase the viability of an oligopsony by reducing global demand for fossil fuels.

Q4: Would an oil export ban comply with WTO rules?

A4: It is likely that an export ban would not comply with WTO rules. The organization does not regulate how much of a resource a country produces. Instead, regulations only come into effect once the resource has been extracted and can be exported. When the United States first allowed crude oil exports in 2015, much of the debate leading up to the decision to remove the ban centered around the legality of the ban in the first place. The Obama administration worried about potential South Korean and NATO challenges to the ban. In 2014, one of the lawyers that represented the United States at the creation of the WTO claimed that the arguments for the ban, based on national security and the need to prevent a domestic oil shortage, could not be successfully defended. In 2013, when the United States was considering a similar export ban on liquefied natural gas (LNG), a former WTO appellate judge stated it was certain such export restrictions would be in violation of the WTO if challenged by another member.

However, Senator Ed Markey (D-MA), a proponent of keeping the ban in place, at the time argued that it was consistent with U.S. commitments under the WTO. Senator Markey argued that exceptions outlined in Articles XX and XXI of the GATT allowed for the United States to curb crude oil exports as a matter of domestic security. Senator Markey also highlighted the inclusion of several OPEC nations in the WTO, even though they restrict domestic oil production in order to manipulate prices, as further proof that a crude oil export ban is in keeping with WTO commitments. Thus, if the United States were to impose such a ban on U.S. crude oil exports, it would likely be litigated at the WTO with an uncertain outcome.

Q5: How do recession fears affect the proposed oil policies?

A5: Growing fears of a recession could decrease the price of oil enough to make either an export ban or price cap moot. Recessions historically cause the price of oil to decrease, as quickly falling demand brings lower prices. In July 2008, for example, crude oil reached $145 per barrel, but by December 2008, it had fallen to $35 per barrel. Estimates suggest that during a recession a decline in demand of 10 percent can cause the price of crude oil to decrease between $35 to $50 per barrel. The Brent Crude oil benchmark has already decreased by over $20 per barrel over the last month as recession fears intensified. If this continues, oil prices could fall enough to make a price cap ineffective and unnecessary. Similarly, a ban on U.S. crude oil exports could be unnecessary if the price of oil were already low. Instead, such a ban could harm U.S. production at a time when the United States would be trying to encourage growth.