Policy on Oil: A Continuing U.S. Dilemma

Risky though the embargo of Iraq and Kuwait is for Western economies, some say the military confrontation might stand as a mere dress rehearsal for a true oil crisis that could be far harder to defuse.

The real oil crunch draws closer every day that the world’s reliance on oil from the unstable Middle East grows, these oil watchers say--a dependence that has reversed course and climbed dramatically in the last five years.

A steep fall in oil prices that began in late 1985 has made oil more attractive to use but less rewarding to produce, with the result that demand is up and production outside the Organization of Petroleum Exporting Countries is flat. Thus, the daily appetite for OPEC oil has surged by nearly 50% since then, to 23 million barrels.

In this country, domestic oil output has tumbled to a 29-year low, and imports of crude have jumped to 50% of consumption--most of it from OPEC nations--surpassing the previous high of 45% that prevailed at the time of the 1979 oil shock. Already the world’s oil nations are producing about 90% of the oil they can, the highest percentage since 1973. And the only nations whose oil output can be significantly expanded are members of the fractious OPEC cartel, whose hand is thus growing stronger by the day.

These conditions are widely seen as a recipe for rising oil prices and all the ills that can result.

“This one is military,” says analyst Daniel Dreyfus of the Gas Research Institute and former staff director of the Senate Energy Committee, referring to the crisis caused by Iraqi President Saddam Hussein. “The next one will be economic. It won’t take an invasion.”

The invasion has already renewed the familiar debate over U.S. energy policy, which critics consider to be almost non-existent.

Various segments of the energy industry have proposed a floor on oil prices, greater access to public land for drilling, dollar incentives to capture more oil from old fields, a new generation of nuclear reactors, subsidizing oil exploration in foreign countries friendly to the United States, more federal funds for energy research and getting clean-coal technology to market.

Consumer and environmental groups want stiffer auto gas-guzzler taxes and a gas-sipper rebate, higher gasoline taxes, tougher efficiency standards for motor vehicles, appliances and buildings, a “carbon user’s fee,” protection of public lands from drilling and research funds and subsidies for solar, wind and other renewable forms of energy.

“We have to look at the whole litany,” says Philip Verleger Jr. at the International Institute for Economics in Washington. “We have to move in lots of directions.”

But unless oil prices continue to climb, skeptics doubt that this latest incident will trigger any lasting effort to cut usage, find more crude or wean the nation from oil toward other fuels--all of which carry a price tag. History suggests that the public isn’t willing to pay the price until a crisis is upon it and the damage is done.

Says Dreyfus, “If somebody assassinated Saddam (Hussein) tomorrow and his troops staggered back to Baghdad, in two weeks you wouldn’t even know it had happened other than a few people making speeches, the same speeches they’ve been making for 10 years.”

Nor is there unanimity that anything dramatic needs to be done. Advocates of the free-market approach that has stood for U.S. energy policy over the past decade say that--given the reality of the Middle East’s oil riches--it has served the nation well.

“I frankly think the policy was right. It has avoided pain and cost for the consumer,” says Fereidun Fesharaki, once an oil adviser to the Shah of Iran who heads energy research at the U.S. government-funded East-West Center in Honolulu. “We have to accept (the need for OPEC oil) and try to do things to make sure their economies and ours have mutual interests.”

This predicted oil crunch down the road reflects the same geologic dilemma that has helped to drive U.S. foreign policy since vast amounts of oil were discovered in Saudi Arabia in the 1930s, just in time to fuel the world’s burgeoning fleet of cars, trucks and planes.

The Middle East holds about 70% of all known, economically recoverable crude oil, not counting the old East Bloc nations. The fields are not only the world’s biggest but also the most prolific, the oil is the highest quality and the cost of producing it is the cheapest.

That imbalance has steadily worsened as the United States, the world’s biggest user of oil, depleted its own once-plentiful reserves. The nation’s reliance on imported oil has since become one of the facts of life that define America’s place in the world.

This dependence has changed complexion from time to time, as oil strikes in Mexico, China, Canada, Venezuela and other regions outside the Middle East bolstered the big Alaska discovery of 1968 to help ease the U.S. vulnerability to the political uncertainties of the Arab world.

But those were minor discoveries--Alaska’s biggest field has already begun its natural decline--compared to the oil riches of Saudi Arabia, Kuwait, Iraq, Iran and other Middle East members of OPEC, whose oil politics twice rocked the Western economies in the 1970s.

The oil jolts of 1973 and 1979 reduced actual supplies by a relatively minor amount, making them a particularly dramatic illustration of America’s need for other people’s crude.

The six-month Arab oil embargo that began in October, 1973, removed an average of less than 3% of the oil production from world markets while the Iranian revolution in 1978-79 represented an average cutback of about 4%. By comparison, today’s blockade of Iraq and Kuwait is apparently costing up to 4.5 million barrels of crude per day--roughly 8% of world production including the old East Bloc.

The first energy shock bumped crude oil prices from $4 to $12 a barrel, the second from $13 to $37. The dramatic events helped bring down the presidency of Jimmy Carter, tore up the landscape with double-digit inflation and soaring interest rates and triggered a deep worldwide recession that fundamentally changed the industrialized economies.

But the energy shocks also generated a dramatic response, starting with fuel economy standards for cars and extending to changes in the personal habits of Americans. The government imposed conservation programs and subsidized new industries to develop alternative forms of energy. While the oil industry got rich from the high prices, it used some of the money to find more oil.

Conservation, fuel substitutions and the recession itself caused oil consumption to plummet, while supplies surged. The need for imported oil was reversed, undercutting the OPEC cartel. Prices began to slide in late 1981 and inflation oozed out of the economy, giving way to the Reagan-era prosperity that has continued into 1990.

But an outright price collapse at the end of 1985 unleashed forces that have undone much of the progress on energy efficiency and slowly narrowed the gap between the world’s need for oil and ability to supply it, setting the stage for the panicky run-up in oil and gasoline prices that greeted the invasion of Kuwait.

As 1986 unfolded, the price for a 42-gallon barrel of oil nose-dived from $30 to as low as $9 a barrel, sowing the seeds for greater consumption of oil while putting a damper on oil production and exploration. The low prices and a free-market philosophy led the U.S. government to relax automotive fuel economy standards, raise speed limits and dismantle non-nuclear energy research and subsidy programs.

Meanwhile, thousands of U.S. oil wells were closed as unprofitable, and industry exploration efforts tumbled. The remaining exploration outlays were redirected toward the most promising overseas areas where there is often less environmental opposition of the type that has kept oil producers out of the Alaska National Wildlife Refuge and some offshore California regions.

The resulting big jump in imported oil entering the United States doesn’t worry everybody.

The Japanese and West German economies have thrived despite their almost total reliance on imported oil. Free-market economists say Americans should sit back and enjoy the imported crude because it is cheaper to produce than our own, and thus save whatever reserves lie under Alaska and off the California shore to use when foreign sources finally dry up. Meanwhile, the decontrol of prices since the oil shocks of the 1970s will tend to self-correct the swings in oil markets, driving down demand and boosting supplies when prices surge.

But many argue there is no free market in oil as long as OPEC is in operation, withholding oil from the market to prop up prices, and as long as other governments--including Japan--are in the business of subsidizing oil exploration and development.

“If the U.S. treated oil as a national security issue and supported oil production in some way, U.S. production would be a lot higher than it is and imports would be lower,” says Joseph Story, a Washington consultant to oil-producing nations who has long experience in the Middle East.

The 50% oil-import benchmark has been suggested by politicians such as Sen. Lloyd Bentsen (D-Tex.) as a ceiling for the United States on the grounds of national security--an argument bolstered by such incidents as the Iraqi invasion of Kuwait.

Such initiatives have attracted little support in recent years. But the invasion of Kuwait, after the resurgence of the environment as a major issue in the United States, could foster debate once again on longer-term energy solutions.

Under President Bush, a former oilman who also considers himself an environmentalist, congressional aides see a slight shift away from a Reagan energy policy described as one of benign neglect. The Bush Administration restored the maximum fuel economy standards for cars, for example, after the requirements had been relaxed annually for several years.

“They’re talking a better game on conservation and efficiency, but they haven’t actually done much yet,” says Jack Riggs, staff director for the House subcommittee on energy and power.

Bush has ordered the Energy Department to propose options by next year for a “national energy strategy” that would attempt to make sense out of various contradictory federal policies.

But the Bush Administration made the familiar free-market argument in resisting demands that the nation tap its 590-million-barrel strategic petroleum reserve (SPR) to defuse last week’s run-up in oil prices--a position that has been roundly criticized by the energy community.

“It says a lot about energy policy,” says Verleger, who argues that merely declaring an intent to use the reserve would have undercut the sharp run-up in gasoline prices. “The petroleum reserve is the only significant element of our energy policy, and the Administration didn’t use it.”

For all the appeal of such renewable forms of energy as solar and wind power, which are now being used to make electricity in Southern California, the nation would have to cut into cars and trucks to make major inroads in oil consumption. More than 60% of the oil consumed by the United States now goes for transportation. Despite fuel-economy gains to date, cars and trucks alone use up the equivalent of the entire output of the nation’s oil fields.

One of the few things everybody agrees about is the virtue of natural gas, which is plentiful and burns more cleanly than oil. It has been described as a bridge fuel between the oil age and whatever comes after oil. But only a major role for natural gas to fuel cars--which is now being attempted on an experimental basis--would make a big dent in oil exploration.

Meanwhile, the use of oil to make electricity has been making a comeback because it has become so cheap, undermining progress made by nuclear, hydroelectric, natural gas, wind, solar and other cleaner and more plentiful sources.

Just how much enthusiasm the nation could muster for another round of investments in alternative energy is open to question. A rash of such ventures subsidized by the federal government in the early 1980s later collapsed when they either didn’t work or couldn’t compete with traditional fuels. It remains to be seen whether many would take the plunge again unless oil prices climb much higher than they have so far.

The biggest such undertaking was Unocal Corp.’s oil-shale project in Parachute Creek, Colo., which has relied on federal price supports that guarantee a whopping $45 for every barrel of oil that the company manages to squeeze out of rocks. It has cost Unocal nearly $1 billion and the taxpayers up to $400 million.

Just as a continuation of this week’s higher oil prices would tend to make the economy use less oil, it should encourage oil companies to explore for more oil. Today’s leaner oil industry can find oil more cheaply and be profitable at lower prices than it could before the mid-1980s price collapse.

The dramatic changes in the Soviet Union have raised hopes that an influx of Western oil technology could sharply boost oil production there. But Fesharaki, recently returned from the Soviet oil fields, says it will be decades before declining production there can be reversed. Experts blame poor drilling practices, deteriorating equipment, improper maintenance and antiquated technology for the bleak outlook.

Geologists say that even the best luck in turning up new oil reserves in Alaska, offshore California, the Far East, the Soviet Union and other promising areas would not change the overwhelming dominance of the Middle East. The region’s control of an estimated 70% of the 808 billion barrels of oil left in the world doesn’t even include unexplored areas such as the world’s only known “mega-province,” in geologists’ parlance. That alone is thought to exceed 700 billion barrels--almost half of it Iraq’s.

Already, the only significant oil nations not producing oil flat-out are members of OPEC. Historically, the higher their share of world markets, the greater their power over prices. And except for Venezuela and Nigeria, the only ones that can readily boost output are in the Persian Gulf.

“This is a long-term problem,” says G. Henry Schuler, a former Middle East oilman now at the Center for Strategic and International Studies in Washington. “It is not something you can meet with the Strategic Petroleum Reserve or with surge capacity in Venezuela. The problem is over-reliance on the Middle East.”

How Americans Use Oil Oil accounts for 42% of all U.S. energy needs. Foreign oil imports have increased 14.9% since the Arab oil embargo of 1973 and now represent 50% of U.S. oil consumption. 1973: Transportation: 53% Industrial: 25.9% Heating and Cooking: 12.9% Electrical Power: 8.9% 1990: Transportation: 63% Industrial: 24% Heating and Cooking: 7.8% Electrical Power: 4.9%