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Limitations on Natural Gas Exports and the Brownsville U-Turn

Thursday, September 12, 2013

A bit of history demonstrates the folly of recent calls to limit natural gas exports.

Oh what a tangled web we weave when first we practice to obtain favors from the federal government. That is the large, unexplored reality lurking between the lines of a recent article in the New York Times on the infighting between the firms and industries in support of expanded natural gas exports as determined by market forces (free trade) and those in favor of limitations, most prominently America’s Energy Advantage (AEA), an industry group that favors free trade for its own members’ products but protectionism for natural gas, one of the central inputs produced by others.

Ask not what the federal government can do for AEA. Ask instead how an export limit would be implemented. AEA calls for limits below the export levels that market forces would yield, or as its website puts it, a careful consideration of the economic consequences of “unfettered” natural gas exports.

Let us oblige them. Limits on gas exports would yield lower gas prices in the United States than overseas (and thus lower production costs and a competitive advantage for AEA’s membership). Higher international prices mean that the right to export gas would be valuable in both pecuniary and political terms: the federal government would have to determine not only the “right” export level but also who would be given the valuable export rights. In short, it is the feds that would pick the winners. As that noted political philosopher and former Illinois governor Rod Blagojevich once said, “… it's @#$%*&! golden. I'm not just giving it up for @#$%*&! nothing."

It is far more likely that the export rights would be allocated on the basis of political criteria.

And rest assured: neither will the federal government. Yes, on the one hand, the feds in principle could simply auction the rights to export natural gas, which would generate some cold cash to bestow on various spending interests. On the other hand, doing so would highlight the economic costs of the export limitations, and thus put the proponents in the uncomfortable position of having to justify them. It is far more likely that the export rights would be allocated on the basis of political criteria, as a bit of history demonstrates.

The Past As Prologue

From 1959 through 1973, an import quota program limited the amount of crude oil and refined products that could be imported into the United States. (This was justified on dubious national security grounds.) That program was the mirror image of the proposed export limit on natural gas: the import quotas had the effect of raising domestic prices for crude oil and refined products above international prices by roughly $5 per barrel (in year 2012 dollars). Accordingly, the right to import a barrel was worth about $5, and the allowed volume of imports was approximately 400-800 million barrels per year over the period. If we assume 600 million imported barrels annually, that is about $3 billion per year that the feds were able to bestow upon those offering something of political value in return. (We ignore here the larger economic costs of the program in terms of inefficient resource use.)

So how did the federal government allocate the import rights? That was the subject of a classic 1971 paper by Professor Kenneth W. Dam, the upshot of which is that the rights were allocated on the basis of criteria that had relationships to “national security” decidedly weak or nonexistent, and that became more complex, more tenuous, and more dubious over time. A few examples should suffice:

• Since new importers somehow had to be accommodated — the refining and other relevant industries could not be closed to new firms — the overall quota meant that the existing importers, who had made investments driven by their allowed import levels, would have to import less. Unsurprisingly, this was viewed by the existing importers as unfair. In the end, the existing importers were given an extra “historical quota” designed to be phased out. The link between these considerations and “national security” was left to the imagination.

• The allocation of import rights was based in part on historical imports, but firms competing within an industry often had very different importation histories due to a host of geographic and other factors. This led to (largely incorrect) claims that import quotas based upon historical imports would create competitive disadvantages for those who had imported relatively little in the past. The solution was to allow those using above-average amounts of imported oil to do so, but to limit the economic benefits of this “cheap” imported oil by forcing compensation for those using below-average amounts of imported oil, in the form of higher-priced domestic oil given in trade. But even this compromise was compromised: in order to preserve political support for the quota program, no company was to receive an allocation less than 80 percent of its allocation under an earlier “voluntary” import quota program. National security? What’s that?

• A sliding scale was used to allocate import rights among refiners: small refiners received higher allocations as a proportion of their production than larger ones. This complication was wholly political — “independent” refiners mounted an effective publicity campaign positioning themselves as Davids doing battle with the large, integrated Goliaths — but was implemented also as a means of offsetting the inconsistencies created by the quotas based upon historical imports. Again, this had nothing to do with the national security rationale for the program, and no one pretended that it did.

• Home heating oil was a particularly sensitive topic in the northeast, and the import restrictions had the effect of raising prices. Under the quota program, only historical allowances were allowed for finished products, which prevented new competitors from importing home heating oil. The loud resulting political criticism led to an entirely ad hoc solution: the creation of the Oil Import Appeals Board, which exercised executive authority to give out increasing allocations of import rights over time in response to pressures from innumerable constituencies.

• As concerns about air pollution grew in the 1960s, allocations increasingly were used to subsidize the production of fuels generating fewer emissions of such effluents as sulfur dioxide. This process was extended to several electric utilities — consumers rather than producers of fuels — so as to encourage power generation with improved pollution outcomes. Again, “national security” as the objective of the quota program was diminished ever more.

• The petrochemical producers were given their own allocations, ostensibly because petroleum inputs are a heavy part of their costs, but that condition applies to many industries and no explanation or national security rationale was given as to why the petrochemical producers received this special treatment.

• Special treatment in terms of allocations was implemented for Puerto Rico, the Virgin Islands, and various foreign trade zones, but these arrangements were largely ad hoc; at one point, the secretary of the interior made a decision to award some import rights to one firm rather than another on the grounds that particular reefs and beaches had to be protected, a rationale not easy to reconcile within a “national security” framework. The winner also had pledged to pay $.50 per barrel into a conservation fund.

There is the related point that because the quota program had never been authorized by Congress, the federal executive agencies had enormous latitude and powerful incentives to involve themselves in the administration of the program so as to engender benefits for their respective constituencies. Federal bureaus, in short, are interest groups. The obvious differences in interests between the federal departments meant that the program constantly evolved as economic and political conditions changed, thus increasing uncertainty and incentives to engage in lobbying in all its various forms.

What this history tells us is that the rent-seeking behavior displayed by AEA is only the beginning of the story in the context of the proposed limits on exports of natural gas: once government has goodies to bestow, the rent-seeking never ends.

AEA and its members argue that they are doing the economy a favor, and actually may believe that they are doing themselves one as well. They are wrong on both counts.

Ignore the blatant inconsistency on the part of AEA and its intended use of government for narrow ends, about which my colleague Mark Perry has written extensively; examples can be found here, here, and here. Ignore the reality that government rarely grants favors for free; even in terms of its own interests, it is far from clear that AEA’s members would end up better off with limits on gas exports after the entire political game is played out in all its glory. Ignore the fact that both ganders and geese are subject to being drowned in sauce, as others will be driven by this campaign to seek favors that will not yield benefits for the AEA membership’s bottom lines; why not impose export controls or heightened regulatory constraints on their products, many of which are important inputs for others? The possibilities are endless. And ignore the amusing fact that AEA is happy to quote from a recent “study” from the Center for American Progress, an institution not renowned for the high priority that it places on the defense of limited government, free markets, strong economic growth, and “jobs.”

The comedy highlight of the Oil Import Quota Program, ironically, was the result of the “national security” rationale: imports from Canada were not plausibly “insecure,” and so a complex “overland” exemption from the quota restrictions was implemented. That made officials in Mexico, and their allies at the State Department, unhappy because most Mexican oil at the time arrived by ocean tanker. An exemption for Mexican oil would have been problematic because it would have increased pressures for an exemption for oil from Venezuela as well.

And so a solution was found: the Brownsville U-Turn, an arrangement under which Mexican oil was shipped by ocean tanker to Brownsville, Texas, pumped into trucks that then drove into Mexico, made a U-turn, and then returned into the United States, thus qualifying the Mexican oil for the “overland” exemption.

Such are the small joys of life in a world in which private interests seek favors from government. The ensuing effects, whether intended or not, metastasize; and thus does big government become bigger still. AEA and its members argue that they are doing the economy a favor, and actually may believe that they are doing themselves one as well. They are wrong on both counts.

Benjamin Zycher is a visiting scholar at the American Enterprise Institute.

FURTHER READING: Zycher also writes “A Fascinating Report from the Government Accountability Office” and “The President’s Broken Window Fallacy: Carbon Policies and Jobs.” Kenneth P. Green contributes “Depending on Energy, Not Energy Independent” and argues “The Impossibility of Rapid Energy Transitions.” Mark J. Perry explains the effects of the “Keystone Battle” on the oil market, and discusses the shale gas boom in “Who’d A-Thunk It? Rent-Seeking Presented as a Noble Quest.”

Image by Dianna Ingram / Bergman Group

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