How to Get a Breakthrough in Ukraine
The Case Against Incrementalism
Consider the plight of some distinguished oil expert, a modern-day Rip Van Winkle who had been lulled in the summer of 1978 into a long nap by the then widespread predictions for the 1980s-ample oil supplies at constant or even declining real prices. By the beginning of 1980 he would have awakened to a thoroughly disorienting situation. He would have thought that the year was 2000, for 20 years of anticipated change had been telescoped into one. From $12-13 per barrel in late 1978, oil prices had risen to the $30-35 range, a level that many 1978 predictions had not anticipated until the year 2000. And political threats to the world's oil supply that had been discussed as potentially serious five to ten years in the future had become visibly critical in 1979 alone. It was a fateful 18 months.
In absolute terms the new price increases are greater than those that accompanied the first oil shock in 1973-74; they pose even more serious challenges to the energy and economic policies of all the industrialized nations, but especially to the United States. Strains among these nations focused increasingly on the United States, and the record during the year was not one of good coordination or management. The international energy system seemed to be slipping out of any rational control. American overdependence on imported oil poses not only a host of old problems in graver form but at least one new one, the problem of "hostile oil"-potentially decisive proportions of Middle East oil under the actual or prospective control of governments that are politically antagonistic to the United States. Also, the present outlook forces us to consider how, in the 1980s, we can maintain economic growth with zero energy growth.
Moreover, the fact that time has been telescoped means that the difficulty of meeting the challenge is much greater than would have been the case had its gravity become apparent after the first shock. Responses that might have been sufficient between 1974 and 1979 no longer suffice; today the United States and all the world's importers of oil are caught in an acute and lasting energy emergency. What happened? How was time so accelerated? How did the oil-consuming countries react and what are the needs of U.S. energy policy in the future?
Let us start by reviewing the story of the oil price increases and their proximate causes, including the sorry record of international cooperation, or rather the lack of it. Then, with the focus on the United States, we examine what the record of the year showed in terms of progress toward reducing America's dependence on imported oil and developing a coherent national energy program. Finally we look candidly at the enormous range of actions still needed, and the apparent obstacles to putting these into effect.
The years 1974-78 were a kind of Indian summer for world oil, a period of apparent calm and stability. The price of oil in nominal dollars had gradually crept up, from $10.46 a barrel (Arab light) on January 1, 1975, to $13.34 on January 1, 1979. After correcting for inflation, however, this rise in nominal dollar prices actually represented a decline in real terms of four percent. And in stronger currencies, the drop in real terms was greater-18 percent in the Deutschemark. World production in 1978 had approximated the all-time high of 60 million barrels per day reached in 1977, 13 percent over the pre-embargo year of 1972.
But the prevalent self-congratulations on the process of adjustment were premature. Beneath the apparent calm the crisis was creeping, for the international energy system that had emerged after 1973 was profoundly unstable. Even if the oil-consuming countries had been doing all they should have been doing-as they were not-the system depended on decisions by a small group of nations who were the leaders of the Organization of Petroleum Exporting Countries. And even before the fall of 1978 these nations were starting to reconsider the policies that had made the temporary equilibrium possible.
Specifically, many OPEC members were asking whether rapid economic development programs would damage their long-term economic and social prospects. Some estimates indicated that up to half of the $400 billion spent by OPEC countries between 1974 and 1978 had been wasted. Immediate social and political consequences of rapid development were already evident: inflation, unsound urbanization, an excessive building boom, a large influx of foreigners, an adverse impact on agriculture and traditional industries and often a lopsided distribution of wealth. These problems, in turn, led to a weakening of established social and political values, accompanied by disappointment and resentment.1
Such experiences pushed OPEC nations to reevaluate their development plans and hence their need for revenue. The difficulties encountered in establishing a self-sustaining non-oil-based economy encouraged the stretching of oil reserves by producing less. Of course, there was another alternative-continue high production levels, but invest the revenues in the West. This option, however, was made less attractive by the difficulty of earning a real return on the investment, especially in the face of accelerating inflation. Oil in the ground seemed to offer a sounder return than money in the bank or money invested in rapid development. Especially concerned were the younger members of the ruling cliques, who, looking 30 years ahead, did not want to inherit oil fields pumped dry, bank accounts ravaged by inflation, industrial facilities not competitive in world markets, and societies so churned up that their own political positions would be much eroded.
This sentiment was certainly beginning to appear in Saudi Arabia. Western hopes that Saudi Arabia would expand its production capacity to 14 million barrels per day (mb/d) by the early 1980s and up to 20 mb/d later in the decade were evaporating. For Saudi Arabia made increasingly clear that it was unwilling to take such steps. The major reasons were a concern about the disruptive effects of rapid development and a fear of straining capacity and injuring longer term production prospects. In addition, the Saudis indicated that they had two other goals-to pressure the United States and other Western countries to conserve energy and to push the United States to support an Arab-Israeli settlement satisfactory to Riyadh.
But the net social and political consequence of rapid development was becoming most evident in another OPEC country, the one that had, in its own way, pushed the hardest for rapid modernization. This was OPEC's second largest producer-Iran.
The revolution in Iran-which was really both a revolution by moderates and the Left and a counterrevolution by traditionalists in response to the Shah's modernization policies-had been a long time in the making. This is not the place to analyze all of its causes, or to recite the sequence of climactic events that ran from the major riots of September 1978 to the departure of the Shah in January 1979 and the advent of Ayatollah Khomeini and a new Islamic Republic shortly thereafter. But one of its major effects was to demonstrate dramatically the political risks that went with maximum oil production and forced-draft industrialization. The Iranian revolution provided a vivid lesson in the dangers of rapid development to rulers of other oil-producing nations. It undermined stability in the rest of the region. And within a couple of months, the cut-off of Iranian oil began to have a dramatic effect on the world oil market, an impact that continued through 1979 even after production was resumed at reduced levels.
Until the very end of 1978, the developments in Iran and other OPEC countries were not accorded much attention in the United States, which had become the largest importer of OPEC oil. In addition to the Indian summer in the international oil market, price controls at home had shielded Americans from the reality of their situation. The constructive and sensible Carter energy program of April 1977 was introduced as the "moral equivalent of war." But it did not capture the imagination of public or experts. At almost the same time as the President's speech, the Central Intelligence Agency released a prescient and pessimistic study of the world oil market.2 Critics immediately dismissed it as merely a tactical political document. Unfortunately, the critics carried the day. There was lots of oil in the world, they said, and oil producers would produce it rapidly to maximize profits. The Shah was a reliable regional policeman, and the Saudi regime as stable as the Rock of Gibraltar.
The complacency took on a momentum of its own. In an influential article in 1978, for example, Congressman David Stockman dismissed the argument for a national energy policy as "reminiscent of Chicken Little's defective logic."3 He described the CIA's April 1977 forecast as "ludicrous." With considerable assurance he announced, "The global economic conditions necessary for another major unilateral price action by OPEC are not likely to re-emerge for more than a decade-if ever." Writing at the end of 1978, one energy analyst announced that by 1983 "the world production of oil should be causing one of the greatest oil gluts that we have seen" and dismissed the oil crisis as "largely a media event."4
All of these analyses shared a common thread-they looked at the oil market in narrow, abstract economic terms. They assumed an underlying stability and exaggerated production potentials, portraying the producing countries as simple profit-maximizing firms.
Amid such optimism, it was not surprising that the President's energy plan was sidetracked. Its central feature, a crude oil equalization tax that would have brought the cost of domestic oil to world market prices over a period of years, was killed by the Senate at an early stage. And most of the President's other proposals lost their way in a long and exhausting debate over the long-standing issue of natural gas prices, on which producing and consuming areas of the country were totally at odds.
Thus, the energy legislation that finally passed the Congress in October 1978 was at best a small fraction of a true energy program. There was one important breakthrough-the ending of the disruptive distinction between interstate and intrastate natural gas markets, with built-in steps toward price decontrol of natural gas. And there were modest provisions seeking to stimulate coal production and to further the incentives to energy conservation and early development of solar energy technology and sources. But the main source of difficulty-oil-remained subject to a complicated and unwieldy system of price controls that did little to encourage reduced oil consumption; energy users simply did not have to face up to the real values of various energy sources.
The effort to get even this much had been an exhausting one. Energy Secretary James Schlesinger compared this first major legislative effort to Mao's Long March. There was a general weariness with the energy issue, especially in view of growing doubts about the existence of the threat. And the meager result after 18 months of heated debate struck foreigners both in producing countries and in other oil-consuming countries as a discouraging indication that the United States was simply not capable, in terms of public attitudes and perhaps of institutions as well, of coming to grips solidly with the dimensions of the energy problem.
The strike by Iranian oil-field workers that stopped exports in November 1978 did not last long, but another strike in mid-December once again shut down oil exports, removing 5.2 million barrels a day from the world market. By this time virtually all of the foreign oil technicians were gone, making the resumption of full production impossible.
With Iran shut down, other countries increased production, the most important being Saudi Arabia, which went up to 10.4 mb/d for December prior to settling at 9.5 mb/d-still one million barrels higher than its earlier self-imposed ceiling. Thus, the world was still producing at near-record levels, but world consumption had increased substantially. The industrialized nations as a group used 2.9 mb/d more in January 1979 than in January 1978-a 7.4 percent increase. When everything was added up, there appeared to be a shortfall of 1.5 to 2 million barrels a day.
The OPEC countries had agreed at their meeting in December 1978 to a 14.5 percent increase in the price of oil, to be phased in through 1979. But the worldwide shortage quickly caused the international market to split into three channels, each with different prices. The lowest priced oil was that from Saudi Arabia, sold under contract-mostly to the four U.S. parents of Aramco-at the official OPEC price of $13.34 for Arab light that had been set at the December 1978 OPEC meeting. But by early March, most other OPEC countries moved to a higher price level, with increases of $1.00 or so above the official OPEC price (after correcting for quality and location). The highest priced sales were in the spot market-typically ranging $5 or so a barrel above the contract prices in early 1979. To complicate matters further, oil producers sometimes coupled contract sales with spot sales, insisting that buyers had to take some oil at spot oil prices in order to hold onto contract oil. A key question for Western consumers was whether OPEC would soon seek to capture the spot prices in its official prices.
Yet, in the face of these trends, the consuming countries were unable to coordinate their purchasing policies or to reduce competitive bidding in the spot market. The obvious framework for collaborative action by the consumers was the International Energy Agency (IEA), which had been formed in 1974 to coordinate energy policies of the industrial nations and had come to play an important, if largely unseen, role as a multilateral means of communication. While its initial efforts had centered on the creation of machinery to allocate oil in an emergency situation, its focus had shifted somewhat, from dealing with "another 1973" to preparing for energy problems in the 1980s and 1990s.
As the impact of the Iranian crisis became evident, certain countries, such as Sweden, expressed interest in invoking the IEA's emergency system, which was supposed to be triggered when one or more nations reached a seven percent shortfall. But most of the IEA countries, as well as the Secretariat, believed that the situation could be better managed without triggering the allocation machinery, which had been designed for a major sudden interruption, not a creeping price crisis. Instead, the IEA governing board, at the ministerial level, decided in March to commit the member nations voluntarily to reduce consumption by five percent below projected demand, the most, many felt, that the domestic politics of the various IEA members would allow. In addition, they assumed that Iranian production would be coming back, as indeed it already was by early March.
But the resumed Iranian exports were only about half as much as during the Shah's regime, and even this reduced level was not secure. The five percent commitment was not enough-nor taken seriously enough-to have much influence on the critical OPEC oil ministers' meeting in Geneva on March 26 and 27. A number of OPEC countries, eager to capture the entire spot surge in OPEC's official price, called for price increases of 25 percent or more. Saudi Arabia resisted, threatening to continue to maintain its excess production of a million barrels a day if the other countries insisted on such increases.
In the compromise that emerged, the 14.5 percent phased price increase, agreed to in December 1978, was instituted immediately, rather than over the course of the year. (That meant an official 9.5 percent increase over the December level, as the first 5 percent increase had already occurred in January.) More significant, however, each producer could "add to its price market premiums which they deem justifiable in the light of their own circumstances." The communiqué at the end of the meeting had spoken of "the large gaps that currently exist between prices prevailing in the open market and the OPEC official selling prices." Now the producers were free to capture as much of that difference in their official prices as they could-or wanted to. OPEC's new pricing system was, as Saudi Oil Minister Yamani put it, "a free-for-all."5 Indeed, OPEC market discipline was collapsing, but not in a downward movement of prices, as had been frequently predicted, but upward. What had happened at Geneva was an official acknowledgement of a breakdown in OPEC's ability to set prices. Saudi Arabia, now feeling much more lonely in the Persian Gulf, no longer had either the will or the ability (in terms of capacity) to control price.
Saudi production was only the front-line barrier against ever-increasing prices. Potentially much more formidable-if only it could be achieved-was significant demand restraint, especially in the world's most important oil consumer, the United States. On April 5, President Carter sought again to focus the attention of the American people on the energy problem. Now, more than before, he pointed to the central problem-America's overdependence on imported oil. "Our national strength is dangerously dependent on a thin line of oil tankers stretching halfway around the earth, originating in the Middle East and around the Persian Gulf, one of the most unstable regions in the world."6 Taking a decisive step, he announced that he would initiate a phased decontrol of domestic oil prices, so that they would reach world levels by September 1981. At the same time, he urged a "windfall" tax on decontrolled oil, which would be used to finance conservation and alternative energy sources. But the actual measures to restrain immediate demand were relatively weak.
Meanwhile, the effects of the Iranian shutdown were still working their way through the system. Moreover, when Iran returned as an oil exporter, some of the other OPEC nations reduced output. For example, for the second quarter, Saudi Arabia returned to its self-imposed ceiling of 8.5 million barrels per day. Thus, the world market remained tight.
In early spring, gasoline lines began to develop in California and soon spread to other parts of the nation, including the self-proclaimed "oil capital of the world," Houston. The spectacle of the gasoline lines caused furious recriminations. Some blamed the oil companies for deliberately withholding supplies to drive up prices. Others charged the Department of Energy with mismanagement of available supplies and with deliberate collusion with the oil companies to drive up prices (to meet the Department of Energy's goal of conservation)-or both. Especially troublesome was the fact that world oil production (for the first six months) was up almost six percent over the year-earlier period and U.S. imports of crude oil were up even more-about nine percent. Confusion was rampant.
Any explanation of the 1979 gasoline crisis must be offered with a dose of modesty, but a close examination indicates that the oil companies were not withholding supplies-indeed the shortage was real. First, the fact that imports of crude oil had risen from levels of a year earlier was not representative of total supplies. Imports of refined products had fallen; thus, total imports of crude and products had risen only marginally. Furthermore, year-earlier import levels had been unusually low because the domestic refiners had been trying to work off excessive inventories built up in late 1977 in anticipation of an OPEC price rise. Also, domestic oil production was slightly lower in 1979 than 1978. Finally, and most important, domestic demand for oil-especially gasoline-had continued to rise. These factors combined to make U.S. imports and oil availability lower than needed to meet the increased demand. The net result was in the first quarter a draw-down of inventories, and then, in the second and third quarters, gasoline lines.
There were many reasons why the shortage had a particularly serious effect on the availability of gasoline. These included: increased use of unleaded gasoline, causing a reduction in gasoline yield at refineries; a lower proportion of lighter crudes available to refineries, thereby lowering gasoline yields; and government requirements aimed at producing ample supplies of heating oil to preclude shortages in this vital area. All these factors amplified an overall oil shortage of 2-4 percent into a nationwide gasoline shortage of about 12 percent.
The federal allocation system then operated to magnify further the impact of the shortages. Regular consumers received only what was left after the farmers, the military, the police and other local services got all the gasoline they wanted. And a regional allocation system based on the previous year's consumption failed to keep pace with shifting levels of demand.
By midsummer a reduction in gasoline demand-due partly to higher prices, partly to fear of shortages, and partly to such measures as "odd-even"-and a slight increase in supplies had caused the lines to evaporate. But in the meantime, as the shortages, like some unseen plague, hit various parts of the country, panic and hysteria on the part of the public and their elected representatives became the order of the day.
In such circumstances, the Administration made an important turnaround on policy. In the winter, mindful that aggressive buying would drive up the price of OPEC oil, the Administration had specifically asked U.S. oil companies to proceed gingerly on the world market. In late May, it reversed itself and encouraged the companies to bid actively for oil for the United States. Fearful of shortages of home heating oil, especially in the Northeast, it also offered a subsidy of $5 per barrel for imports of middle distillates (home heating oil and diesel fuel). The switch gave rise to a bizarre situation in which Energy Secretary James Schlesinger was forced to express happiness that U.S. oil imports had jumped upward in May!
Now two "games" were being played on the world market. One was "leapfrog," the oil producers vying with each other in raising prices. The other was "scramble," a rougher competition among consumers. Such competition had mounted ever since the fall of 1978. But the American subsidy, as a dramatic official action, highlighted the problem and was immediately denounced by the European Community as "a step in the wrong direction."7 Spot prices for middle distillates rose several dollars a barrel on the news of the American entitlement.
As oil prices continued to increase in May and June, these intra-Western tensions became more acute. Underlying them was a critical difference in perceptions. The official American view was that the heart of the problem was OPEC-essentially a matter of supply. To the Europeans, the essence of the problem was OPEC and the United States-a matter of supply and demand. The intensity and logic of this European conviction are hardly yet appreciated in the United States, but it was-and is-a very major factor. The Europeans had noted that between 1973 and 1978, U.S. oil consumption had risen by 1.5 million barrels per day, whereas that of the other industrialized nations had fallen by a like amount. In their view, the potential of conservation had barely been touched in the United States; and America's price controls in such circumstances were inexplicable. The scale of U.S. consumption and imports-America's "sheer weight," as Chancellor Schmidt put it-was such as to cancel out whatever any of the other countries might do. This, in turn, made them feel, to varying degrees, helpless or angry or both. As one European energy minister observed at this time, "The middle-size European countries will be desperate if the United States does not handle its energy problem in a more reasonable way."8
The most outspoken critics were the French. "The average price of oil has gone up more than one-third since last December," French Foreign Minister Jean François-Poncet told an OECD meeting in mid-June. "We are not scientists meeting dispassionately to discuss a laboratory experiment involving interesting catastrophes. We are political leaders, and as I see it, politics starts by a refusal to leave things to chance. . . . The problem now facing us was predicted by experts for the middle of the 1980s based on political and contingent factors. It is here already, earlier than expected, due to political events that everyone is aware of and because the world's leading industrialized country has not been able to control its oil imports, in spite of efforts made by that country's leaders."9 Just in case the point was not clear, President Valéry Giscard d'Estaing was quite blunt just before the Tokyo economic summit. When an interviewer remarked that, "The Americans have not yet succeeded in reducing consumption," the French President interrupted: "They haven't started."10
By mid-June, on the eve of the Tokyo economic summit, oil prices had increased by about 60 percent since the beginning of December. The average price was between $18 and $20; spot market prices, almost $40 a barrel. The tension between the Americans and the French was obvious.
At the same moment that the Western heads of state were meeting, the OPEC oil ministers again convened in Geneva. Their discussions were bitter. The Saudis still sought to play a moderating role, but they were less keen to go out on a limb for the West in the continuing absence of significant demand restraint-particularly by the United States. Finally, on June 20, the Saudis agreed to raise the floor price of their marker crude from $14.55 to $18. Premiums-some based on quality and location and some based on what the market would bear-brought the official price of other OPEC crudes as high as $23.50.
The news of the new OPEC jump reached the Western heads of state in the middle of their deliberations. The Western leaders immediately deplored the decision. But what came out of their summit was hardly sufficient to slow the immediate game of leapfrog. The principle of individual limits on imports was adopted, and the United States specifically agreed to limit imports in 1979, 1980 and 1985 at or below the 1977 level of 8.5 mb/d. Similarly, the European community as a whole was committed to keep its annual imports through 1985 at or below the 1978 level of 10 mb/d, with each of the individual countries not exceeding its 1978 level. In the case of Japan, taking account of its lack of domestic energy resources and need for economic growth, the commitment was that imports would rise from the current 5.4 mb/d level to no higher than 6.9 mb/d by 1985.
These commitments were the first of their kind ever taken by the major consuming countries. They may have great importance in the long run, especially as a precedent. But their immediate impact was slight, and world demand for oil continued strong through the summer and fall. Oil was needed not only to replenish inventories drawn down early in the year but also to build inventories to a high level as insurance against another Iranian shutdown or trouble elsewhere. Although oil production continued at a high rate-with Saudi Arabia's returning to 9.5 mb/d-the supply/demand balance remained tight enough to keep the spot market strong.
The market was already far from stable when yet another event underscored how crisis-prone the international energy system is. On October 22, the Shah was admitted to the United States for medical treatment, and on November 4 a group of "students" seized the American Embassy in Tehran, taking about 60 Americans hostage. In the wave of action and reaction that followed, President Carter instituted an embargo against Iranian oil imports into the United States on November 12. The Iranians responded by prohibiting oil sales to U.S. companies.
Without demand restraint, the U.S. action amounted to little more than a shuffling around of barrels on the world market-in fact, it helped move prices upward by pushing more buyers into the spot market, where some cargos now went for as high as $45 per barrel.
And, at about the same time, in response to an Iranian threat to withdraw funds from the United States, the Carter Administration acted to freeze Iranian assets held by U.S. banks both at home and abroad. Although Washington tried to make clear that this action was dictated only by extraordinary circumstances that were unlikely to be repeated, it was bound to trigger further doubts among OPEC nations about their dollar investments.
Thus, by the time the OPEC nations met for the third time in 1979, at Caracas on December 17, the oil market was in almost total confusion. On December 13, in an effort to preempt the price hawks, Saudi Arabia raised its benchmark price by 33 percent-from $18 to $24 a barrel. This new price approximated other OPEC official prices. The Saudis hoped to isolate the hawks, who wanted an official price of $30 or more. The preemption was not effective; Libyan leaders, angered by the Saudi action, immediately raised their price to $30 a barrel.
The stated aim of the Caracas meeting was to recreate a unified pricing system. It was not clear, however, that the producers all actually wanted a unified price, for its absence permitted a continuing rapid leapfrog, whereas a unified price, if observed, would be a ceiling, not a floor. After three rancorous days, the Caracas meeting broke up without an agreement. Once again, as at Geneva in March, the final "decision" was not to decide, but rather to let the market decide. And the direction of the market was plainly still upward. By the end of the year, Iran had made a deal for contract oil with Japan at $30 a barrel, and Libya had pegged its oil at $34.72 a barrel. Non-OPEC countries followed suit: Mexico for example, set its price at $32.
Within one year, official OPEC prices about doubled; including spot transactions, average world oil prices substantially more than doubled. The increases exceed in absolute terms those brought by the first oil shock of 1973-74. The experience of the second oil shock demonstrates how unstable the market has become. A minor loss of total supply-of about five percent-transformed the market. Caracas also underlined what had already become evident at the OPEC meeting in Geneva in March-the breakdown in OPEC's price-setting function. Its effective role in the slack years of 1974-78 had been to keep a floor under prices. Now, in a strong seller's market, it was not able to maintain a ceiling. In effect, power within OPEC has tilted in favor of price hawks little concerned about the effects of oil prices on the world economy. Saudi Arabia remains potentially the overwhelming oil producer in terms of reserves and production. But it will need substantial investments to increase capacity sufficiently to keep prices steady. Concerned about domestic unrest and feeling more isolated since the Shah's fall, its leaders are less willing to challenge directly other OPEC countries, especially in the face of the failure of the consuming nations to mount demand restraint policies.
During 1979, moreover, high spot prices may have changed the character of the oil market in basic and lasting ways. Increasingly through the year the producing countries shifted oil away from contract customers in order to make spot sales. (In one day, for example, the Abu Dhabi National Oil Company cut Gulf Oil from 150,000 barrels per day down to only 20,000.) By late 1979, OPEC nations as a whole were selling about 25 percent of their oil exports at higher than the official contract prices. If Saudi Arabia is excluded, the average rises to 40 percent. The shift to the spot market further eroded the position of the major oil companies, which have reduced and even eliminated their sales of crude to independent refiners which had been regular customers, for the majors now need all the crude they can obtain for their own systems. The disruption of the established and reliable supply channels that had been represented by contract sales also inherently served to help push prices upward. For it forced more buyers (i.e., independent refiners, major companies and middlemen) into the spot bidding match. All this meant that the producing nations were successfully intruding more and more into the marketing of oil.
The dominating question at the beginning of 1980 is the same as a year earlier-when and where the price spiral will stop. Inventories are very high, which could have a dampening effect. But anxieties are also very high, which drives price up. Moreover, the OPEC countries seem increasingly keen to prove the axiom that reduced production assures higher prices and higher income. At least four OPEC countries have announced production cutbacks for 1980. Such cutbacks would blunt the impact of high inventories.
Even if recession and conservation combine to cause a leveling off or even a drop in effective real oil prices during 1980 and 1981, the world oil supply system will still face a fundamental problem: the declining availability of reliable supply. The trend among OPEC producers to restrict production and so stretch out their reserves is only one aspect of the problem. Another is the increasing importance of "hostile oil." Along with other Western nations, the United States has become increasingly dependent on nations that, to one degree or another, regard the West as an enemy and show little compunction in subordinating oil supply to other considerations. Thirty percent of the oil in the world market in 1978 came from four countries-Iran, Iraq, Libya, Algeria-that are now decidedly antagonistic to the United States.
Moreover, the possibility of unrest exists in every single oil-producing country in the Middle East-including the most important of all, Saudi Arabia. Until recently, one comforting assumption wound through most energy outlooks-"at least Saudi Arabia is stable." But this is no longer at all certain. Indeed, the seizure in November of the Grand Mosque in Mecca by perhaps 700 militants may well prove, in retrospect, to have been the single most important development relevant to energy in 1979. For it seemed to say-and this, no doubt, was an intention of the perpetrators-that the great stabilizer of the world oil market is itself not stable. That such a conspiracy could go undetected is deeply disturbing. Very little is known about the event; the fact that so much about Saudi internal politics is shrouded in obscurity is hardly a source of comfort or confidence as one analyzes energy prospects for the 1980s.
Finally, a larger threat hangs over the entire Middle East, especially the Persian Gulf-of bold Soviet interventions and an increasingly prominent Soviet presence. By supplying arms and advisers and using mercenaries provided by its client states, the U.S.S.R. has gained a strong foothold in the Horn of Africa and in the southern part of the Arabian peninsula. And it has now carried out a massive and brazen invasion of Afghanistan. The pro-Soviet Tudeh Party holds a strong position among Iranian oil-field workers. There is still a Soviet presence in Iraq, although Soviet-Iraqi relations are volatile.
The consequences of continuing Soviet success would be of overwhelming strategic importance-perhaps leading to Russian domination of the world's oil line. Such an eventuality would compound many times over the problem of hostile oil. The U.S.S.R.'s invasion of Afghanistan suggests that it may eventually be prepared to challenge some of the most vital Western interests, and that would prove to be a very dangerous and unpredictable engagement. This situation, superimposed on national and regional instabilities, certainly provides a further major reason for immediate concern about the security of oil supplies.
Perhaps Egyptian President Anwar Sadat was too quick when he said, on the last day of 1979, that the "battle of energy" had already begun. But the rise in regional instability and the increasingly active Soviet role surely add up to an enormous threat to the continued availability of the oil on which the United States and the West depend for their economic health.
There are limits to what the United States and other Western countries can do about this unstable international energy system. However, there is one overwhelmingly important measure that the United States can take-use less imported oil. This would be the single most important step taking the pressure off the oil market, and so helping cap the dizzy price spiral. It would slow the hemorrhage of funds going overseas to pay for oil, and make those dollars available for investment in the United States. Reducing our imports is essential if we are to alleviate the rising energy-related tension in American relations with other Western countries, especially as we now seek their cooperation in dealing with the crises in Afghanistan and Iran. And a reduction in U.S. oil imports would strengthen the hands of the OPEC moderates, who are concerned about the effect of oil prices on the world market, and who, up to now, have been left in a highly exposed position by the failure of the United States to get much beyond words in its commitment to use less imported oil.
What progress are we making, in terms first of those domestic conventional sources of energy that are the most obvious alternatives to imported oil? The record in 1979 is not, alas, encouraging.
Of the four conventional sources of domestic energy-oil, gas, nuclear power and coal-domestic oil is the only one that could substitute for imported oil in all end-uses. Unfortunately, domestic oil production in 1979 dropped slightly from 1978 levels, remaining about 10 million barrels per day. (Figures on "oil production" include about 17 percent natural gas liquids.) This drop represented a return to the long-term production downtrend that had started in 1970 and had been interrupted briefly by the upward blip of Alaskan oil in 1978. Alaskan oil production, which now accounts for about 14 percent of domestic output and 8 percent of domestic consumption of oil, is expected to rise slightly during 1980-from 1.35 million barrels daily to a permanent peak of 1.5 million barrels daily.
Overall, the outlook for domestic oil became even more bleak during 1979. Even though drilling activity remained quite high-about the same as 1978 and some 80 percent over 1973-proven reserves of domestic oil continued their long-term decline. New additions during the year equaled only a little over one-third of the oil produced. And, whereas earlier in the year there had been some hope of reversing the decline and holding domestic oil output level through 1990, by the year's end these hopes were rapidly evaporating. Even with price decontrol, the CIA now estimates that U.S. oil output in 1982 will fall to 9.2 mb/d, the Congressional Budget Office has estimated a 7.8 mb/d level in 1985, and within the industry Exxon has projected as little as 7 million barrels per day in 1990.11
For domestic natural gas-a fuel that can substitute for imported oil in almost every use except transportation-1979 was the first year under a new regime. The Natural Gas Policy Act of 1978 allowed higher prices and moved to correct a major regulatory irregularity-the distinction between interstate and intrastate natural gas markets.
It is too soon for anything more than a preliminary analysis of the effects of this act, but one immediate effect was the creation of a temporary surplus of natural gas commonly called the "gas bubble." The reason for the bubble was that natural gas supplies held for the intrastate market were released to the interstate market in response to anticipated price increases. Another factor helping to create the bubble had been a shift away from natural gas use in the industrial and utility markets, especially in response to gas shortages during the winters of 1976-77 and 1977-78. Furthermore, in response to the higher prices (up 42 percent between July 1978 and July 1979) and even higher prices anticipated in the future, exploration and drilling increased: 13 percent more gas wells were completed during the first nine months of 1979 than during the year-earlier period.
Most industry observers thought that the twin effects of the gas bubble and increased well completions would prove to be quite powerful. In fact, these effects failed to stop the long-term decline in domestic gas production, which was the oil equivalent of 9 mb/d in 1979 (a shade down from 1978). Reserves, in the meantime, continued to decline; less than one half as much gas was added to reserves as was used.12 And by the end of the year, the gas bubble, originally expected to last two to five years, had all but evaporated.
Of course, optimists pointed to some positive signs: the increase in the number of successful gas wells and the continued increase in output of natural gas from "tight sands," once considered an exotic source. There also remains the hope of eventual large-scale production from other exotic sources, such as geopressured brine and sedimentary rock with low porosity (Devonian shale and coal). And a breakthrough was made in the negotiations to bring Mexican natural gas to U.S. markets, albeit with initial volumes representing less than two percent of U.S. consumption.
Unfortunately, the possibility that U.S. production of natural gas may increase-a highly uncertain event-has caused some to question the need for natural gas from Alaska. But it would be highly improvident for the United States to count on any substantial increased availability of natural gas. On the contrary, it makes considerable sense to move expeditiously to bring natural gas from Alaska to the U.S. market, especially since there is almost no practical limit on the amount of natural gas that can be used to replace imported oil.
Coal was the one domestic energy source for which the Carter Administration projected substantial growth-a doubling of production between 1977 and 1985. And coal production (for the first eight months of 1979) was up 26 percent over the year-earlier strike-ridden period and 10 percent over the more normal period of two years ago. Coal consumption also was up substantially, running 11.5 percent over the prior year.
Unfortunately, there is a limited range of uses for which the direct burning of coal can substitute for oil (or natural gas). These are primarily the utilities market and part of the industrial market. During 1979, oil usage in the utilities market dropped from 1.5 mb/d to 1.3 mb/d. Coal's share of the utilities market rose from 44 to 47 percent, whereas oil's dropped from 17 percent to 14 percent.13
Although some further substitution of coal to reduce oil use is possible, it will be slow because of the limited number of boilers that can be directly converted to coal. Many will require outright replacement with new facilities, which would place even heavier capital burdens on already capital-burdened utilities. Because regulations outlaw oil and gas for new plants, because hydroelectric potential is limited, and because solar-electric is decades away from large-volume output, coal's chief competitor in the new plant market is nuclear power; and in this race, coal has pulled far ahead.
Yet there has continued to be disappointment within the coal industry itself. The industrial market for coal actually declined, so the overall projected growth for coal did not materialize. About 12 percent of the coal industry's productive capacity stood idle, stockpiles grew, and spot prices of coal dropped. Marginal firms went out of business and thousands of miners were idle.
One of the main reasons for the disappointment was confusion over federal regulations and policy. Here there was some clarification, with revised rules on the "best available technology" provisions of the Clean Air Act providing more flexibility in dealing with sulfur levels in the coal. The clarification should help clear the way for utilities to proceed with the construction of new coal-fired plants. In sum, the use of coal is increasing, but more slowly than industry expectations, and as much, if not more, as an alternative for nuclear power than as a substitute for oil.
The Iranian interruption focused renewed attention on expediting the development of nuclear power as an alternative to imported oil. Much the same had happened after the 1973 embargo, although in early 1979 the enthusiasm was much more muted.
In 1973-74, the government of the United States, like those of most other Western nations, had strongly endorsed rapid development of atomic energy as a major response to the first oil shock. But disappointment quickly set in. The regulatory wrangle over safety helped cause lead times for plants to stretch as long as 14 years, thereby driving up costs and prolonging an old debate over the economics of nuclear power. In the meantime, fear of weapons proliferation caused a halt in developing plutonium-processing facilities. The problem of what to do with the spent fuel from nuclear plants remained unsolved, and California, for instance, banned new nuclear power plants until a satisfactory solution to disposal of the waste had been developed. Orders for new nuclear power plants dwindled, and projections for future installed capacity were continually lowered in the United States, as well as in Western Europe. There have been virtually no new orders for nuclear reactors in the United States since 1975.
In early March 1979, as the full effects of the Iranian interruption were being felt, the Nuclear Regulatory Commission ordered five operating reactors to be temporarily shut down because of worry that they had been poorly designed to withstand earthquake stress. There was considerable criticism of the NRC for taking this step just when oil supplies were so tight.
In President Carter's speech of early April, his first major statement on the second oil shock, one of his major proposals was to be the cutting of regulatory delays, so that the lead time for a new nuclear plant might be cut to seven years. He never made the proposal. In the early morning hours of March 28, 1979, a breakdown occurred in the cooling system of a reactor at Three Mile Island power station near Harrisburg, Pennsylvania. It resulted in the spilling of radioactive water and the development of a hydrogen bubble within the containment vessel.
For two weeks, the accident at Three Mile Island dominated headlines and provided dramatic evidence for those who questioned nuclear safety. It undercut any move to accelerate atomic development and reduce challenges on safety. It had a similar effect in Western Europe, and, for the first time, questioning about nuclear safety was even permitted in the Soviet Union. In the United States, the not-in-my-backyard syndrome on nuclear waste became more pronounced, as governors in various states, including the former head of the Atomic Energy Commission, temporarily closed down waste disposal sites. Meanwhile, the nation's nuclear waste management effort is in disarray.
On October 30, 1979, the presidential commission to investigate Three Mile Island, headed by John Kemeny, issued its report. It described the effects of the accident on physical health as "negligible" and reckoned that the probability of the accident having turned into a catastrophe was slight-although allowing that others might disagree. On balance, however, the report did little to help the prospects for nuclear power. It called for a "fundamental change" in the way that atomic energy is administered, arguing that the potential for human error is much greater than had been thought and questioning whether electric utilities "have the necessary technical expertise and managerial capabilities for administering such a dangerous high-technology plant."14
The Kemeny Commission backed off from calling for a formal moratorium. But a practical moratorium seemed to be firmly in place by the end of 1979. In November, the Nuclear Regulatory Commission put a freeze on issuing operating permits for all new nuclear plants. And it is quite likely that some of the 90 or so in various stages of planning and construction, with tens of billions of dollars invested, will never operate. Furthermore, it is possible that some of the 70 or so plants on line will be shut down, either because new regulations might affect some located near population centers or because some might run out of storage for disposing of nuclear waste pending an overall solution to the waste problem.
All this points to a far more limited role for nuclear power under any conceivable scenario than might have been imagined in recent years. It is an open question whether nuclear power in 1990 will be providing any more energy than it provided in 1978. To generate this amount of electricity by oil would have required 1.4 mb/d. In fact, however, the linking of nuclear power to oil dependence is somewhat misleading, because nuclear power-except in the short run for certain geographical areas-is primarily an alternative to coal, not oil. And if one assumes that the resolution of the "best available technology" question allows the construction of new coal-fired plants, then the debate over expanding nuclear power in the United States is largely irrelevant to the oil-import problem. But even as an alternative to coal, nuclear's future is increasingly uncertain.
The largest potential contributor to a reduction in dependence on imported oil is increased energy efficiency: that is, productive conservation. Progress in this "source" is difficult to chronicle, though it is clear that some gains have been made. But it is equally clear that this progress, while laudable, is quite inadequate when measured against the problem and the opportunity.
American industry certainly has discovered the importance of conservation. In many parts of industry, a new profession of "energy manager" is growing in status and importance. Savings by some companies have been substantial, and, as might be expected, the heavy energy users have been among the leaders. For example, U.S. oil refiners are saving an estimated 135,000 barrels per day of oil equivalent-almost three times the projected output of the largest shale oil plant expected to be operating in 1990. As one oil company executive observed, "Although it does cost the oil industry money to realize energy savings, it is much less than the capital cost of an alternate energy scheme, whatever it might be. In addition, the lead time to produce the savings involved is a matter of months rather than years." One of the three largest industrial energy users in the country-Union Carbide-has discovered the considerable flexibility that exists in energy usage; its corporate energy manager reported that whereas in 1974 the company had expected a 3.8 percent compounded growth in energy use through 1990, its actual use had declined year by year since 1974.15
Some companies that are not heavy energy users have also made substantial, even spectacular, progress. Gillette, for instance, reduced its energy usage per unit of output by 48 percent between 1973 and 1979. But some large companies and many small and medium-sized companies have not yet begun serious conservation programs. Still, industry saved more energy during the 1973-78 period than the other two end-use sectors-residential and commercial, and transportation. Estimates in these latter sectors are necessarily more difficult than for industry, but a recent CIA report estimates that between 1973 and 1978 there was a one percent increase in per capita energy usage in the residential and commercial sector, and a four percent increase in per capita energy usage in the transportation sector.16
Examination of the 1979 results shows the difficulties of reaching firm conclusions about progress in conservation. For the first eight months of the year, energy consumption was up only one percent compared with the similar 1978 period. In contrast, GNP, after correcting for inflation, rose 2.7 percent, resulting in a ratio of increased energy usage to increased GNP of .37 percent, a figure considerably below similar ratios of 0.60 to 0.93 that have existed in recent years.17 Indeed, at the International Energy Agency's ministerial meeting in December 1979, the U.S. government presented these results as "very encouraging" and as one of America's "very positive contributions to reducing demand pressures in the world oil market."18
But U.S. per capita use of energy remains far higher than in other industrialized countries that enjoy a similar standard of living, and a closer examination reveals how unsure one is that real progress is being made. In the first eight months of 1979 substantial consumption increases in the residential and commercial and industrial sectors were partially offset by a drop in gasoline consumption.19 But part of these savings were due to the possibly temporary phenomenon of gasoline lines and fears of shortages. Self-congratulations on America's conservation performance in general, or on gasoline savings in particular, are premature.
During 1979, solar energy consolidated its position as a serious energy alternative. The Administration produced a domestic policy review on solar energy in March that included a high scenario in which solar would be supplying between 25 and 33 percent of the nation's energy by the year 2000. At a ceremony in June dedicating the White House solar panels, President Carter adopted a 20-percent solar goal for 2000, which set an important framework for all energy policy.
The total contribution of solar energy in its broadest sense-covering all renewable energy sources-is still relatively small in the American energy balance. It is officially estimated as the energy equivalent of about two million barrels per day of oil, a little over half of which is from large-scale hydroelectric installations (mostly of long standing), most of the rest being wood and waste used by industry, especially the forest products industry. The contribution of other forms of solar energy is small but growing.
Especially important is a trend toward so-called passive solar design-energy-conscious design. The California Energy Commission has set a goal to have passive solar systems included in ten percent of all new buildings constructed in 1980. California has also been a leader in encouraging active solar systems. The number of people taking advantage of the state's 55 percent solar tax credit increased from 15,000 in 1977 to 25,000 in 1979. But the barriers are still seen as substantial. In an attempt to speed the spread of solar energy, several California cities are planning "solar utilities."
During the year, biomass fuels received wide attention. There was the beginning of a controversial boom in gasohol, which was given an unexpected boost in January 1980 by the restriction of grain exports to the Soviet Union. The use of wood as a fuel increased substantially, especially in New England. On the high-technology front, a number of firms and researchers claimed important advances in reducing the cost of photovoltaics.
Although there are now limited federal tax incentives for solar installations, even greater incentives-along the lines of the California subsidy-will be required to foster the number of solar installations needed to provide a healthy foundation for an important contribution later in this decade.
In sum, the record in 1979 indicated that the outlook for the expansion of conventional energy sources was, if anything, less promising than the Carter Administration's own forecasts, while the progress achieved in conservation and the development of solar energy was at most limited. Unless a great deal more can be achieved, the President's Tokyo pledge that future American oil imports will never exceed the 8.5 mb/d of 1977 can only be achieved in future years at serious cost to economic growth.
Yet the American policy response to these clear realities continued to be inadequate during 1979. Certainly it fell far short of the urgency of the problem, and many of the most prominent "solutions" put forward failed to take into account the telescoping of time-offering some limited relief many years hence, whereas the immediate issue is how to get through the early 1980s with a well-functioning economy. As we have already noted, the staged deregulation of natural gas prices, enacted in October 1978, was a significant step forward, as was President Carter's decision of April 1979 to allow price controls on oil to expire in September 1981. But the significance of these steps was generally lost in the rowdy domestic debate that erupted in the wake of the gasoline crisis and the sharp increase in real oil prices.
For the most part, this debate did not clarify the issues, but rather obfuscated them. Indeed, in many ways the debate was characterized primarily by its irrelevance, and, as such, constituted one of the fundamental obstacles to dealing with the problem. A series of blinders have obscured reality and continue to impede America's ability to confront its energy problem.
The first blinder has been simple ignorance. Although U.S. oil imports increased from 3.4 mb/d (24 percent of consumption) in 1970 to 8.2 mb/d (almost 50 percent of consumption) in 1978, there has been an extraordinary lag in appreciating this change. Opinion polls as late as September 1979 showed that 45 percent of the American people were unaware that the United States imported any oil!
This simple ignorance, in turn, has contributed heavily to the search for a domestic villain on whom to blame the problem. The adversary character of the American political system, the never-ending welter of charge and countercharge, the regulatory confusion, the cacophony of contradictory expert opinions-all these reinforced the tendency to go on an energy witch-hunt. Producer-oriented groups argue that the villain is the government, environmentalists or both. Thus, economist Milton Friedman has written that there is an energy crisis "for one reason and one reason only. Because government has decreed that there be one."20
While that belief is quite intensely held in certain circles, much more pervasive is the belief that the "oil companies" are the villain. More than half the people in a poll in October asserted that the oil companies had fabricated the energy shortage, and one-quarter thought that the government should take over the companies and run them.21 Here too is an example of time lag-the belief that the oil companies are as powerful in 1980 as they were in 1960, when in fact one of the causes of the problem is the waning power of the oil companies in the face of the growing assertiveness of the OPEC producers. In the early 1970s, the oil companies lost control abroad over ownership of reserves and production rates, and the ability to set prices. The past year has witnessed a remarkable further deterioration of their control over international marketing channels, and the discipline of competition alone precludes any significant manipulation of supplies. Even if the profit margins of major oil companies were excessive (which they do not now appear to be by comparison with other industries), the share of increased retail prices represented by oil company profits remains an insignificant proportion alongside the gains realized by the producing countries. Yet the fact that the oil companies have shown major increases in their profits remains an inescapable and major factor.
Indeed, the amount of money involved is itself a major obstacle. In early 1973 the value of domestic U.S. oil and gas reserves was $200 billion at then current world oil prices. On January 1, 1980, the value of those reserves (even allowing for depletion) had increased, at OPEC prices, to more than two trillion dollars-a ten-fold increase. How this increase in value should be divided among consumers, producers and the government has been at the core of the political struggle over price decontrol and the windfall tax.
For years the issue of price decontrol has been hotly debated, and the failure to achieve a national consensus has been perhaps the greatest single barrier to a rational energy policy. Decontrol is likely to be one of the most inflammatory issues in the 1980 presidential election, and the movement toward rational pricing could be interrupted. As we have traveled through the country speaking to many different groups, we have found the issue of price to be one of the most emotional and least understood aspects of the energy issue.
This issue is so important that the terms of the debate must be clarified. The vexing issue of price controls on oil (and gas) is usually argued in terms of equity versus efficiency. Keeping price controls on oil is said to be more equitable than decontrol because the poor suffer unduly from higher prices (i.e., relatively more than the well-to-do), while the rewards are given to one set of the well-to-do (i.e., stockholders).
On the other side of the debate, letting prices rise to whatever level the market sets is said to be more efficient because the higher prices encourage greater efficiency in energy usage and greater oil output. But many of those who favor decontrol believe in equitable treatment just as strongly as those who support price controls. Their prescription is to achieve a more efficient economy and then split up the extra income in an equitable way, thereby increasing everyone's income, including the poor's. Thus, they would let the price system allocate supplies and then tax the well-to-do and give to the poor. In other words, controlling prices is a "shotgun effect," a very inefficient way to help the poor. In fact, given overall consumption levels, price controls actually provide more of a subsidy to the rich than the poor. In absolute terms, the rich use more energy than the poor, and in relative terms use almost as much. There are more direct ways to aid the poor, such as grants for home insulation or fuel purchases.22
Finally, as the last 18 months should have demonstrated, the net result of price controls almost surely is higher oil prices than would have been the case if controls had not existed. Low prices encourage consumers to use more oil than they otherwise would do. This increased consumption, in turn, makes the world oil market tighter than it otherwise would be. A tighter world oil market, even without a major accident, results in higher oil prices; and, when accompanied by an accident such as Iran, can result in disastrously higher oil prices. And higher prices for imported oil, especially if they occur suddenly, result in even further loss of GNP because of the deflation of domestic economic activity due to large flows of money out of the United States, and the difficulty of stimulating the economy during periods of high inflation partially induced by higher oil prices. Dollars that might be invested in the United States instead go overseas to oil producers, who do not return all the dollars to the United States.
Thus our own view is clear. We believe that the system of price controls on domestic natural gas and domestic oil has done all American consumers a great disservice. It has been a policy of penny wisdom and pound foolishness. Those who have argued for continued price controls, or who will in the course of the 1980 campaign advocate the reimposition of controls, essentially assume that America is self-sufficient-an island unto itself. This is a dangerous delusion for a country that imports almost half of its oil and is the largest buyer of OPEC oil.
Decontrol, of course, has led inevitably to another bitter money battle-this time over the windfall tax, that is, over whether the extra money paid by the consumers would go to the producers or to the government. As with pricing, the debate in Congress broke largely along geographic lines. It was not until the end of the year that the Senate and House conferees finally agreed on an overall figure to be captured by the tax-$227 billion over a ten-year period. (Unfortunately, the tax will probably include profits from the sale of newly found oil, which we believe to be a major mistake.)
As of mid-January 1980, Congress has not decided finally what to do with the proceeds of this windfall tax. A substantial amount will go to cushion the impact on poorer groups of decontrolled prices. The rest should be used to finance alternatives to imported oil that deserve funding but which would not be funded unless there were a tax. In other words, this can be a mechanism for putting the money into energy activities that are undercapitalized and which are unlikely to be financed directly or indirectly by money flowing exclusively back to the producers. Given the balance among the various energy sources, the bulk of the proceeds should be used to finance the two major promising but underfinanced alternatives to imported oil-conservation and renewable energy sources. As we shall shortly see, that is not likely to happen.
Although we stress the importance of decontrolling prices, it would be a mistake to regard it as a miracle solution. Indeed, the drive to find a miracle solution-be it nuclear power, cheap gas, price decontrol, Mexican oil, Athabascan tar sands-has been yet another blinder. It is always possible that a deus ex machina will arrive just in time. However, it is, to say the least, not prudent to base energy policy on faith, and all the miracles proffered to date have been far too circumscribed to play that role. While some of the technical fixes will make significant contributions, they will do so only at the end of very long lead times-10 or 15 years-and only then in limited amounts. Emphasis on them diverts attention from the immediate problem and responses that can have much greater impact in much shorter times. Yet appeals for another Manhattan Project or another man-in-space program seem almost to be a constitutionally mandated requirement for presidential energy speeches and programs. That certainly is what happened in 1979. In this case, the miracle was synthetic fuels.
The full political impact of the gasoline crisis hit while President Carter was in Tokyo for the economic summit. In a memorandum later disclosed, one of his closest advisers, Stuart Eizenstat, warned that "We have a worsening short-term domestic energy crisis. Congress is growing more nervous each day over the energy problem. . . . Nothing else has so frustrated, confused, angered the American people-or so targeted their distress at you personally." It was in the mood of near-panic reflected in that memorandum that, on his return from Tokyo in July, President Carter retired to Camp David where he conferred with about 100 prominent leaders and reviewed his energy options.
The plan with which the President finally emerged was built around a crash program for synthetic fuels-primarily liquids and gas from coal and from shale. The program's roots lay in a campaign mounted in Washington in the spring. Particularly influential was a memo circulated by three prominent Washington figures, Paul Ignatius, Eugene Zuckert and Lloyd Cutler. Citing the experience with synthetic rubber, aluminum and other materials during World War II and the Korean War, the three argued that (1) the United States could produce five million barrels a day of synthetic fuel-more than a quarter of current U.S. oil consumption-within five to ten years; (2) that the technologies in question were "proven," and; (3) that the capital cost would be $20 billion to $40 billion for each million barrels a day. The three advocates added that the program "would give us all the psychological lift of 'doing something' instead of just doing without."23
That last proposition was of obvious interest to a beleaguered Administration that had been bitterly attacked for emphasizing "doing without"-conservation-two years earlier in the first Carter energy program. Although a crisis atmosphere did exist in mid-1979, the Administration had little taste for going the 1977 route again. This was especially so since the House of Representatives, frightened by the political effect of the gas lines, had just rushed to approve a synthetic fuels bill.
So, on July 15, the President unveiled an $88-billion proposal for a crash synthetic fuels program-to be financed mostly out of the windfall tax proceeds. The proposal launched a vigorous debate. Even some who had been strong advocates of an accelerated synthetic fuels program now argued that such a massive program was unmanageable in anything like the President's time frame. Each of these proposed plants would be as large or larger than the largest industrial plant project ever built at one time in the United States. Together, they would constitute a huge undertaking that would strain skills and infrastructure to a great, but unknown, degree. Nor was it correct to say that the technology was "proven." There was neither enough experience nor knowledge to scale up rapidly from pilot plants to a host of full-sized plants.
The cost estimates of the program were also highly uncertain. As late as 1974, the best estimate of the production costs for oil from a synthetic fuel plant was (in 1979 dollars) about $10 a barrel. By 1979, those estimates were in the $30-$40-plus range. By the end of 1979, estimates of individual plant costs had risen from $2 billion to as high as $4 billion, and of course, until a commercially sized plant has been completed, these cost estimates remain highly speculative. What does seem certain is that a crash program would create tremendous inflationary pressures, as it bid away available workers and materials from other activities. (Even with relatively familiar technology, for instance, North Sea oil drilling costs tripled between 1973 and 1978.) Fiscal conservatives worried about shielding such a large undertaking from market forces. Others worried about the diversion of attention and resources from the immediate problems of the 1980s to partial solutions that might become available in the 1990s.
Certainly, the logic of an accelerated synfuels effort was compelling. The President rightly insisted that the United States should develop this capability. But a manageable program would be less ambitious, structured to proceed step by step from pilot plants to demonstration units, scaling up on the basis of experience. In that spirit, the Congress, in effect, took the President's program as a rough first draft, reworked it, and finally, in November, came up with an alternative: $20 billion of the windfall tax proceeds were allocated for synthetic fuel development, with the program and further funding to be reviewed after three years.
While the debate on synthetic fuels at least reduced the President's initial proposal very greatly, unfortunately the amount of time devoted to this subject necessarily diverted attention and funds away from the more fundamental and continuing issue of energy conservation. In this area 1979 was a sad record of missed opportunity.
For during 1979 the Congress began to take conservation seriously for the first time. In the late summer and early fall, a number of measures were introduced in Congress that would have put conservation on an economic par with conventional sources. These bills were stimulated by the perception of the crisis and, more directly, by the Administration's synthetic fuel program. Many Congressmen felt that conservation deserved at least the same degree of financial support as synthetic fuels, especially since, by the President's own program, a barrel of conservation energy cost only about a tenth in federal funds of what a barrel of synthetic fuels cost.24 Moreover, the conservation would be available almost immediately to help the United States get through the 1980s, whereas the synthetic fuels would not be available until the 1990s.
Yet the Administration for the most part either opposed or gave only weak, distracted support to the conservation initiative. This puzzled many, for both the President and his new Secretary of Energy, Charles Duncan (who had replaced James Schlesinger in July), had spoken strongly in favor of conservation. But the constituency for conservation in the Administration was not strong, while the momentum of the political commitment to synthetic fuels was very powerful. The imagery of synthetic fuels-boldness, another man-in-space program-was considered more attractive than that of conservation.
In effect, the Administration recognized that a trade-off between synthetic fuels and conservation did exist for proceeds of the windfall tax and voted for synthetic fuels. True, at the end of the year, some conservation measures were pending, but of a rather modest nature. In terms of scale, existing federal conservation programs involved an expenditure in 1979 of $1.5 billion. To put these numbers into perspective, America's bill for imported oil was running in early 1980 at the rate of $80 billion per year.
Clearly, priorities are askew. Yet there is reason to believe that more meaningful programs may be forthcoming. For in 1979 there occurred a significant shift in thinking about energy. A growing consensus was beginning to emerge that America's most important "energy source" for the 1980s would be conservation energy. For the first time, a public-opinion poll showed that a majority of Americans (65 percent) feel that current U.S. energy consumption, if not curtailed, will lead to "severe cutbacks in our lifestyle." They were optimistic about how much energy could be saved.25
Where, then, does the United States now stand in developing a coherent energy program, and what still needs to be done? Our conclusion is that, if the 1978 legislation brought the country one quarter of the way toward such a program, the results achieved during 1979 have moved us at most to the halfway point. The decontrolling of oil prices, provided it stands, is an essential element in such a program, and even the imperfect allocation of the windfall tax proceeds at least contains some gains.
Yet the prospects for achieving a substantial reduction in American oil imports remain uncertain, and, as we have argued at length, the economic and political consequences of continued major U.S. dependence on imported oil can only become progressively more serious. Almost all the potential developments now point in a negative direction. Another shutdown in Iranian production, political instability in Saudi Arabia, a refusal to sell to the Western allies by Libya-any one of these could repeat the experience of 1979 that followed the Iranian revolution.
During the forthcoming recession of 1980 and perhaps 1981, we may be misled by an easing of oil prices (in real terms) from the peaks eventually reached at the end of the current runup. But we should not again let cries of "oil glut" lull us into the complacency that prevailed in 1978. The United States simply cannot rely on any prospect of substantially increased overall output from conventional energy sources.26 Only coal can be counted on for additional supply over the next decade. And it is possible that the increase in coal production will be offset by a decrease in the total combined output from domestic oil, gas, and nuclear-even with all the help the government can give these sources, as it should. And synthetic fuels can only begin to make a very modest contribution by 1990. With a major increase in oil imports appearing unlikely, the United States, therefore, might well be facing zero energy growth during the 1980s.
The heart of the problem is still the most rapid possible development of renewable energy sources, and above all a vast improvement in energy efficiency. The telescoping of the energy emergency in 1979 has greatly increased the urgency of early action. As things stood in 1978, and given the decision now made to decontrol oil prices, we might have hoped to continue with "business as usual" on energy conservation, allowing higher prices to work through the economy and gradually cause us to increase energy efficiency.
In current circumstances, however, such a course will not be adequate. The gap between energy resources and energy demand would be closed by "unproductive conservation"-the shutting down of factories, higher unemployment, higher inflation, offices too warm in the summer for efficient work, colder houses, a choice for some between food and fuel. In other words, we would experience economic recessions interspersed with periods of slow economic growth, both accompanied by inflation and monetary dislocations.
Far more desirable is the alternative of accelerated energy efficiency. Our whole industrial system is like a vehicle built to operate on $3 oil, puffing along with an inefficient engine and with a body leaking vast amounts of energy. Each drop wasted drives higher the price of future oil purchases, which in turn makes it easier for OPEC to cut production and raise prices even more. Now that we have $30 oil, correcting this situation is the nation's first order of business.
Can this be done? We think it can, with substantial investments in conservation measures encouraged by federal financial incentives-40 to 60 percent of the investment and long-term financing-and the removal of institutional barriers. The result will not only be a higher GNP but much less inflation than if we send these dollars abroad to pay for oil at ever-increasing prices.
Such large incentives-at least as large as those provided to synthetic fuels-are justified.27 They would be an important signal. Capital is not necessarily easily available for energy-saving investment, either for the homeowner or the firm. Would-be investors in energy conservation should be helped, in order to bridge the gap between the interest of the society at large and that of the individual consumer.
Indeed, it is time to set a meaningful national goal for conservation. At the very least, our aim should be zero energy growth for the 1980s-not just because our supplies might be limited to that, but because meeting this goal through productive conservation is the best way to promote positive economic growth. Conventional economic analysis relying on historical relationships would dismiss this notion as fanciful. Our reply is that such conventional analysis is increasingly and distressingly distant from reality. Practical experience is proving that the flexibility is considerable. AT&T is hardly a fanciful dreamer. On the basis of its own experience, the company has set an internal goal of negative energy growth-to use less energy in 1984 than in 1973-even though business is projected to double. In this case, what is good for AT&T is also good for the United States.
The United States could be at a dramatic turning point. Perhaps the Ayatollah Khomeini and the "students" who took Americans hostage have now succeeded in achieving what three Presidents have been unable to do-dramatize the danger of overdependence and so change the course of U.S. energy policy.
But the fact that energy will certainly be one of the major issues in the 1980 campaign is not necessarily fortunate. For short-term political advantage and emotional appeals can further obscure the problem, polarize the nation, and divert attention from the central challenge. The prospects for rational, informed discussion at this critical time, when we are still caught up in the second shock, do not look good. For the debate so far has not been of a particularly distinguished nature. Perhaps the unfolding campaign will force the various candidates to get beyond slogans-to explain how they think nuclear power or synthetic fuels or continued price controls will help us to meet the immediate energy problem in the 1980s, when there is considerable evidence to the contrary-and to explain what they see as the role of conservation and how to implement it. We certainly hope so.
Whatever may happen in 1980, what all Americans must recognize is that the events in the international oil market that erupted at the end of 1978 turned the energy future into the energy present. An already serious energy problem has now become an energy emergency, an emergency that will persist throughout the entire 1980s.
2 U.S. Central Intelligence Agency, The International Energy Situation, the Outlook to 1985, Washington, April 1977.
5 The New York Times, March 28, 1979, p. 1.
6 Speech of April 5, 1979.
7 European Community News, Number 10-1979, June 30, 1979.
8 Personal communication.
9 Statement by Jean François-Poncet before a ministerial meeting of the OECD, June 13, 1979.
10 Newsweek, July 3, 1979, p. 30. While the criticism by the French had merit, their case was undercut by their continuing refusal to join the International Energy Agency, which would have provided them with a much more constructive and less abrasive forum in which to influence thinking on U.S. energy policy.
11 The reserve estimates are by Oil and Gas Journal, December 31, 1979 and December 25, 1978. Estimates that will be issued in 1980 by the American Petroleum Institute and the American Gas Association are expected also to show a decline in reserves although they might indicate a different portion of oil (or gas) replaced. U.S. Central Intelligency Agency, The World Oil Market in the Years Ahead, Washington, August 1979 (also contains Exxon's projections), and U.S. Congressional Budget Office, Decontrol of Domestic Oil Prices: An Overview, Washington, May 1979, and Effect of June 26 OPEC Price Increase on the Decontrol of Domestic Crude Oil (unpublished), July 1979.
12 Oil and Gas Journal, ibid.
13 Most of the "substitution" of coal for oil represented a general increase in the amount of electricity generated by coal and a decrease in that generated by oil, rather than a direct substitution of coal for oil in a given boiler. Also, part of the drop in oil was due to direct substitution of natural gas under a policy of expediency adopted in early 1979. The natural gas share of the utility market increased from 14 to 15 percent. Nuclear's declined from 12.5 to 11.3 percent.
14 Kemeny Commission, The President's Commission on the Accident at Three Mile Island, The Need for Change: The Legacy of Three Mile Island, Washington, 1979.
15 R. S. Wishart, "Energy R & D Priorities and Decentralized Electricity and Cogeneration Options," Paper at Aspen Institute Seminar, July 1979.
16 CIA, The World Oil Market in the Years Ahead, cited in footnote 11. The increase in per capita usage in transportation reflected primarily increased driving; measured in terms of miles per gallon, automobiles actually improved their efficiency by six percent.
17 Robert Stobaugh and Daniel Yergin, Energy Future: Report of the Energy Project at the Harvard Business School, New York: Random House, 1979, p. 303. In only one of five recent years has the ratio been below 0.60.
18 Department of Energy Fact Sheet, U.S. Energy Policy Development, IEA Ministerial Meeting, December 10, 1979.
19 There was a 2.9 percent increase in residential and commercial use and a 1.8 percent increase in industrial, versus a 3.0 percent decrease in transportation.
20 Newsweek, June 4, 1979, p. 70.
21 The New York Times, November 6, 1979.
22 See Kenneth J. Arrow and Joseph P. Kalt, Petroleum Price Regulation: Should We Decontrol?, Washington: American Enterprise Institute, 1979. Also, Hans H. Landsberg, Energy: The Next Twenty Years, Cambridge, Mass.: Ballinger, 1979, chapter 5; and Thomas C. Schelling, Thinking Through the Energy Problem. New York: Committee for Economic Development, 1979. Schelling is the originator of the phrase "shotgun effect."
23 The Washington Post, June 10, 1979.
24 The New York Times, June 16, 1979, p. A10.
25 The poll data are by Cambridge Reports, October 1979, for the Alliance to Save Energy. For a succinct summary of the new consensus on energy conservation, see the forthcoming The Dynamics of Energy Efficiency, a report on a symposium held at Dumbarton Oaks in October 1979 under the joint sponsorship of the Alliance to Save Energy and Harvard University, to be published in Washington in February 1980.
27 For a fuller discussion of the rationale for subsidizing conservation and solar energy, see Energy Future, op. cit.