•

Twenty-five years ago I was beginning my career as an analyst in the policy office of the Federal Energy Administration. My office did the staff work for the interagency Energy Resources Council, which set Administration energy policy in those days. It was a heady time when energy policy was the central question of the day. Most people believed that how the country responded to the key energy issues would have important consequences for later generations.

You won't be surprised to hear that what I thought was going to happen 25 years ago never happened. The idea that the real price of oil in early 1999 could possibly be less than it had been in 1974 remains difficult to imagine, and is not something I would have even thought possible at the time. The reason why it seemed impossible was not that oil was running out – I knew there was plenty in the rest of the world – but I didn’t believe the US would ever allow its dependence on imports to grow unchecked. I supposed in those days that basic strategic thinking by what I took to be a very powerful military-industrial complex would rule out the possibility of complete reliance on imports. If nothing else, I supposed that market forces would operate to keep imports down if the cartel controlled supply.

Why didn’t this happen? The real answer is simple: we took the easy way out during a period when oil producing nations were unable to get their act together. In my early experience as an energy analyst, this was illustrated by a 1975 letter on energy policy sent by the then president of Ford Motor Company to President Ford. That letter filtered its way down, and it fell to one of my friends to draft a reply. In essence, the president of Ford wanted to know, what’s the point of all this Project Independence stuff? Independence would require major changes and wasn’t possible anyway. It would be expensive and difficult, and it would certainly hurt the Ford Motor Company. Given that the oil reserves of the Middle East are plentiful, why don’t we just rely on the free market to bring it to us? No doubt a response was prepared on the merits of the administration’s policy positions, but the point is, Congress and the American political system chose the Ford Motor Corporation approach rather than the Nixon / Ford / Carter government-centered approach to energy policy.

Granted, the easy-way-out philosophy bought a quarter century more cheap oil and the attendant economic benefits, but was it worth it when we look at the next quarter century? We postponed doing something serious about petroleum dependence and global warming, two pressing problems that are intertwined and complex, that grow more threatening with each passing year, and that require a policy response that will be unpopular and more expensive than it should have been. The problems didn’t go away; we just put off having to face them. The proper response to Ford Motor then, and to those who blocked all attempts to at least point our policy in the right direction since, is that there really are national security issues at the heart of the both questions, and we cannot allow other countries to set critical parameters that will govern our future.

Those 25 years are gone, there’s no longer a possibility of independence from petroleum imports -- there may never have been, even in the early 70s -- but our dependence can be managed much better than at present. The possible outcomes of a Sec. 232 proceeding – including either quantitative petroleum import restrictions or oil import duties -- are an important first step. I urge the Department of Commerce to affirmatively find that the current levels of crude oil imports has an adverse impact on national security, and to take immediate steps to limit the consequences of reliance on petroleum imports.

Impact of Foreign Competition on the Economic Health of the Domestic Petroleum Industry

Figure 1 shows the companies that imported large amounts of crude in 1998 and how much they brought in. The list accounts for about 88% of crude imports.

• In 1974 the Seven Sisters, all but two US-based, owned and controlled almost all of the oil moving in world trade. Today, the surviving companies no longer own equity in the oil they import and have themselves dwindled in number, in part because of the truly competitive nature of the business. The US majors are remarkably efficient and for the most part are managed superbly. And yet they haven’t done very well as a group. The losers who were assimilated, or are in the process of being assimilated, include Gulf, Amoco, and Mobil. Recent market reports suggest that Texaco may soon join these ranks.

• The United States is a particularly mature oil province, meaning that the easy-to-find, cheap-to-produce reserves are gone. The domestic oil production industry is hurt, and hurt badly, when import prices hit historically low levels, since domestic producers can no longer compete effectively. Domestic production cost is not only markedly higher here than abroad, the average US well produces little more than about 13 barrels a day, meaning that it is economically marginal and particularly sensitive to the effect of downward prices swings. The US industry badly needs price stability and predictability to keep production from dropping even faster.
• In recent months we’ve watched Mr. Ali Ibrahim Naimi, the Saudi oil minister, ratchet prices up and down as he seeks to enforce OPEC production discipline. Our small producers and stripper well owners have paid heavily during the period of low prices. Now that Mr. Naimi has had considerable success, we wait to see if the economy can adjust to an 75% increase in short-term oil prices during an era of hard money.  For some time the real issue has been can the Saudis keep the price at a level to satisfy the other OPEC members without encouraging the development of the Caspian region by American firms.  Oil import restrictions would help stabilize prices at a level high enough to permit real investment in the required infrastructure.
• The administration should not be under any illusions that action under Sec. 232 will produce a revival in the domestic industry. Assuming domestic prices rise in response to a Trade Expansion Act remedy, the ensuing higher prices will produce a flurry of activity in all of the indicia of industry responsiveness – more wells will be drilled, more seismic line miles will be logged, employment will go up – but there is no reason to expect that a sustained increase in domestic crude oil production will result. The decline in US production will continue without regard to any likely Sec. 232 action. While one could argue about rates of decline under various policy regimes, the restrictions would have to be major indeed to produce any noticeable, sustained increase in domestic production.

Quantity, Quality and Availability of Imports

Many Americans might suppose that 20 years of freedom from oil regulations would have produced a surge in domestic oil reserves, as the Reagan and Bush administrations promised. The surge never developed and today reserves are far below where they were. While there have been a few years when additions to reserves at least matched draw down for production, there haven’t been nearly enough such years to prevent proved reserves from falling very significantly. The international situation does show expansion in proved reserves, but the increase to world reserves was much greater between 1975 and 1991 than in the last seven years. The data are summarized in Figure 2.

• While there is some question whether international reserves will peak in 10 years or in 25 years, there is reason to doubt it will be much longer than that. After that time, all industrial countries will be competing for remaining supplies worldwide. In addition, the newly industrialized countries, particularly the most populous, will also be attempting to secure adequate supplies to provide the types of transportation services we take for granted. In many instances, the new market entrant will have added far more value than his or her US counterpart, and will be seeking to run a motorbike capable of hundreds of miles per gallon instead of a second SUV capable of 15 mpg.
• There has been no repeat of the politically motivated embargo of 1974. But we learned in 1980 and again in 1990 how closely our economic fate remains linked to events in the Middle East. We seem destined to learn the same lesson for events in Central Asia, where the planned pipelines transit a thousand miles of geopolitical territory one could politely describe as being difficult to defend. Crude oil is both absolutely essential to our economy, and marginal developments abroad can have both direct and indirect macroeconomic consequences.
• A major difference between the situation today and that prevailing when oil imports hit their earlier peaks in 1980 is the relative effect on the merchandise trade balance. Because real oil prices have been so low, the US has been able to run consistent deficits on current account without letting the imbalance get out of hand. And yet the recent run-ups in world crude prices have caused the deficit to grow considerably. So while the dollar outflows haven’t be a problem in recent years, there is no reason to think that they won’t become a problem if oil prices continue to rise.

General Failure of Energy Conservation Policy

Most people assume that 25 years of talking about the importance of energy conservation has had the desired effect. It hasn’t. Per capita energy consumption in 1997 was as high as at any time in the past. All the conservation practiced when prices were high has disappeared, despite more stringent standards for the construction of homes, cars, furnaces, and hot water heaters. Significantly higher petroleum prices are the only market force that will produce a conservation response.

• The situation is even worse with petroleum consumption. The only usage declines have followed periods of sharply higher prices, lagged by two years. Overall petroleum consumption has grown rapidly since 1984. See Figure 3.

• Another particularly significant trend concerns natural gas. Despite the common perception that the US has all of the gas it could ever need, and the fact that we have been producing more natural gas, we have basically been importing a large proportion of our marginal supplies from Canada. EIA’s assessment of the future of this trend also presents reasons for concern (Figure 4). While Canada is a particularly loyal friend of the United States, it should not be forgotten that the National Energy Board took steps to restrict gas exports to the US in the mid-1970s, and caused the gas that did cross the border into the northern tier to be sold for more than $4/Mcf. We must expect Canada to protect her own economic interest. Again, there’s no reason to think controls are imminent, but the situation deserves careful attention.
• To the extent that either quantitative restrictions or large import duties are imposed on oil, demand for gas will increase proportionately. According to recent studies, the US is already going to fire nearly all planned additions to electricity production by using natural gas for the foreseeable future, which is a major reason why the projected growth in consumption is so great. If oil duties are increased, consideration will have to be given to ways to prevent natural gas demand, and hence gas imports, from getting out of hand. Stricter due diligence standards for institutions providing long-term finance for gas-fired electricity production is one possible measure.
• Figure 5 presents the Energy Information Administration’s view of what’s going to happen to oil production. One can’t help but wonder what could make it possible for the US to produce so much future natural gas (Figure 4) and not so much future oil (Figure 5). I suspect that EIA may be a little optimistic about future domestic gas production.
• By the same token, no one should be confused about the magnitude of the salutary effect that either oil import duties or quantitative restrictions will have. At best, they will slightly reduce oil imports from the expected reference case shown in Figure 6 to the high oil case. While the amount of the effect would vary with the size of the duty or quantitative restriction, it would have to be very large to have even a relatively modest impact for nearly a decade. This doesn’t mean that the idea should be abandoned, but proponents of the idea should be realistic about how long it will take to bring the situation back to manageable proportions.

Global Warming

Just as the government has had no policy toward oil imports, it has no serious policy toward global warming. Global warming has less pressing national security implications than oil imports, but the long-term implications of neutrality toward greenhouse gas emissions could produce climatic changes that disrupt key national security variables.

• Only two policy initiatives in recent years are even worth mentioning. The Clinton Administration began its tenure with what started out as a carbon tax. Unfortunately, it soon became a general energy tax when, for illogical political reasons, electricity produced by nuclear energy was included in the tax, while the usual ineffective technologies favored by the democratic left were subsidized. Shortly thereafter, it died the usual death Congress reserves for energy tax legislation.
• The second initiative, the Kyoto Treaty, at first appears to be a serious attempt to do something. But consider: In 1990 according to EIA, total fuel combustion greenhouse gas emissions were 1,346 million metric tons. By 1997, this total had risen to 1,480 million metric tons. EIA now projects that energy-related carbon emissions will reach 1,790 million metric tons in 2010, conspicuously way beyond the promised 1990 level. This farce will have grown to 1,975 million metric tons in 2020.
• Unfortunately, the Administration failed to really understand how very costly it would be to actually hold down the use of carbon-based fuels to 1990 levels. However, Congress understood, and continues to ignore Kyoto. The Administration itself has yet to understand that the most promising technology for reducing greenhouse gases, by an order of magnitude, is an emphasis on nuclear electrification using the most recent innovations in safe reactor design and allowing the current generation of reactors to be re-licensed in the post-2005 timeframe. It is important to understand that while Sec. 232 restrictions on oil imports may have a minor impact on CO₂ emissions, it will not have anything like the effect that a coordinated strategy emphasizing nuclear power would have. 

Conclusion

The question of whether national security has been harmed by crude oil imports has been investigated by the Secretary of Commerce again and again. The answer has been made in the affirmative again and again. The situation today is every bit as threatening as at any time in the past, even more so. And yet Sec. 232 has yet to be used to provide an effective remedy. Sometimes administrations fooled themselves into thinking that their energy policies were working; at other times overt politics intervened to prevent remediation.

It is time to use the statute as Congress intended and protect our nation from even greater danger by directly managing our dependence on oil imports. Sec. 232 restrictions will not be enough to solve the underlying problems, but they are a necessary first step. However, this step should only be taken if the Administration is willing to accept the consequences of this extraordinary remedy, many of which are harmful, and shows it has the political will to withstand the storm of criticism that action under Sec. 232 will inevitably produce.

Policy Pete