The Incidence of an Oil Glut: Who Benefits from Cheap Crude Oil in the Midwest?

The primary beneficiaries of depressed Midwest crude oil prices have been Midwest refiners rather than Midwest consumers.

Beginning in 2011, increases in crude oil production from North Dakota's shale resource and Canada's tar sands created a transportation bottleneck as the pipelines capable of carrying oil from the Midwest to the Gulf Coast reached full capacity. This constraint caused the benchmark Midwest crude oil price to fall substantially below the "world" oil price on the Gulf Coast, despite the fact that these two prices have been very close to one another historically.

In The Incidence of an Oil Glut: Who Benefits from Cheap Crude Oil in the Midwest? (NBER Working Paper No. 18127), authors Severin Borenstein and Ryan Kellogg show that this relative price change has not passed through to markets for refined products: Midwest wholesale prices for gasoline and diesel have not fallen relative to those along the Gulf Coast. The authors explain that the marginal gallon of gasoline (and diesel) in the Midwest is being imported from the Gulf Coast, where it is refined using relatively expensive crude oil. In other words, while trade in crude oil between the Midwest and Gulf Coast is capacity constrained, trade in refined products is not. In fact, the Midwest is actually importing rather than exporting gasoline and diesel.

The authors' results imply that the primary beneficiaries of depressed Midwest crude oil prices have been Midwest refiners rather than Midwest consumers (Midwest and Canadian crude oil producers are, of course, bearing the costs). The authors emphasize that this outcome does not imply that Midwest refiners are exerting market power. Instead, they are operating at or near their production capacity while benefitting from the fact that the marginal refined product suppliers from refineries on the Gulf Coast are producing from more expensive crude oil.

The substantial rents accruing to Midwest refiners, and to holders of the limited Midwest crude oil export capacity, strongly suggest that the present situation is not a long-run equilibrium. In fact, several investment projects have already been announced or are underway that would increase Midwest crude oil export capacity, including construction of the southern segment of the controversial Keystone XL pipeline (the northern segment would expand capacity from the Canadian tar sands to the Midwest). These projects will relieve the Midwest crude oil export bottleneck as they come on-line, bringing the Midwest oil price closer to, if not ultimately back into equality with, the Gulf Coast price. This re-equilibration will primarily increase the Midwest crude oil price rather than decrease the Gulf Coast price because the Gulf Coast is tied to the very large world oil market, of which the Midwest is only a small part.

Because expanding Midwest crude oil export capacity will have only a minimal impact on Gulf Coast and world oil prices, U.S. consumers outside the Midwest will not experience a decline in gasoline prices. As for Midwest consumers, the authors' results imply that capacity expansions that increase the Midwest crude oil price will not increase the Midwest gasoline price.

--Lester Picker