Almost exactly five years after the first oil shock, the second began. The parts of the puzzle are arranged quite differently this time around, but the two central pieces are the same. The upheaval in Iran has meant an interruption of supply and a loss to world production already as great as that from the 1973 embargo; the tight world oil market which had been predicted, just last fall, only for the mid-1980s or beyond is already upon us. And, as a direct result, the OPEC countries-which in December 1978 had already announced a substantial price rise during 1979-are further increasing prices.

It is, of course, too soon to say whether this second shock will be as great an earthquake as that of 1973-74. But it has certainly dramatized anew how great is the insecurity that results from the United States depending to the present degree on the Middle Eastern producers. It also reminds us again how it is the "accidents," which cannot be put into an economist's equation, that reshape the market.

Within the United States, this second shock should bring to an end what had become an increasingly powerful tendency to pronounce the energy crisis a thing of the past, to discount the possibility of a second shock and instead to project scenarios depicting a glut of oil on the world market. In particular, it spotlights the steady rise in American oil imports, from 25 percent of consumption in 1971 to the current level of about nine million barrels per day (mb/d)-almost half of U.S. oil consumption. Here is the key contradiction of U.S. energy policy-that while the declared goal has been to hold steady or decrease oil imports, they have kept rising. This increase has been watched with dismay by other Western nations, who see this growth accentuating trends that pose fundamental threats to their well-being. Their stands and actions on other issues, such as nuclear weapons proliferation and the dollar, are directly related to their perception of America's inability to control imports.

This second oil shock, combined with the depreciation of the dollar, has again made clear the urgent need to move away from heavy reliance on foreign oil. But general perception of the danger hardly means any consensus about how to do this. Intense emotions and suspicions abound on the energy issue-not surprisingly, since very large stakes and a great deal of money are involved.

But the intensity of the debate goes beyond self-interest. Powerful romanticisms compete. On one side are those who have a vision of the national life decentralized in many spheres through the mechanism of the energy crisis, to the point where it becomes a post-industrial pastoral society. Even more powerful has been another kind of romanticism, what might be called an industrial romanticism, a belief that conventional production by itself can be a savior, that it is possible to return to an era of ever-increasing production rates. As a member of the Texas Railroad Commission has put it, "This country did not conserve its way to greatness. It produced itself to greatness."

Both kinds of romanticism becloud a comprehension of the alternatives to imported oil. What is required is a pragmatic investigation of the potentials of the various alternatives-an analysis based in the real world of political and institutional constraints in contemporary America, not within the disembodied world of econometric models and technological forecasts that ignore the realities of American society.

Such a pragmatic undertaking, which looks at each energy source from the bottom up, leads to conclusions that run quite contrary to the credo of the industrial romantics. That is, the conventional sources-domestic oil and natural gas, coal and nuclear power-do not hold out an alternative to increased imports of oil. This is not to say that the United States must remain beholden to enormous oil imports, for genuine alternatives do exist-conservation efforts and, over time, solar energy sources. Contrary to the romanticism of the post-industrial pastoralists, the wide diffusion of these efforts and sources will, while making possible a transition from imported oil, hardly revolutionize our social order. Yet, given a fair chance, they are the alternative to a dependence whose dangers have now been forcefully communicated once again.

II

Let us start by examining briefly just how politically precarious the supply of foreign oil is, and the economic and other costs of growing dependence.

If oil were distributed evenly throughout the world, the problems would be much less. But two facts summarize the world oil picture as it is the Organization of Petroleum Exporting Countries dominates the international petroleum market; and Saudi Arabia dominates OPEC. Neither of these is likely to change at any time in the foreseeable future.

True, producing areas outside of OPEC will be important exporters. The combined North Sea production of Britain and Norway, which was about 1.5 million barrels per day at the end of 1978, might rise to four mb/d during the 1980s. Beyond that, Mexico and possibly the People's Republic of China represent, at least over the next decade, the only likely sources of significant new supplies for the world oil market outside of OPEC. But the current euphoria about Mexico is not justified, for Mexican leaders have made clear that exports will be limited to the pace required by domestic development rather than by the size of its oil reserves or the pressure of foreign demand. Moreover, Mexico's proven reserves are only a small fraction of the heady numbers recently tossed about. We believe that Mexican oil exports are unlikely to be higher than 2.5 mb/d in 1985-less than four percent of expected world demand. And by that time the oil exports of China will not exceed one or two mb/d. These amounts are hardly large enough to challenge Saudi Arabia's dominance.1

Saudi Arabia is favored by a unique conjunction of huge reserves, extraordinary ease of exploitation, and a population so tiny (four to six million people) that domestic revenue needs at current prices have no practical effect on the level of oil production. Saudi Arabia is the largest producer in OPEC with 30 percent of total production and 34 percent of total reserves. Thus it carries the brunt of adjustment within OPEC, at various times closing the valve to keep prices from falling, and opening the valve to keep prices from rising. During the first stages of the current Iranian crisis, it opened the valve all the way, thus preventing panic from gripping the international petroleum market.

How stable is the country on which the world has become so dependent? Too little is known about internal relations in Saudi Arabia to make any solid predictions. What is obvious, however, is that a pre-modern social structure, based upon kinship, has been catapulted into the modern age. No one, not even members of the royal family, can guess how successfully the present system will adjust to the new world-or for how long. No one who has assimilated the lessons of Iran can confidently assess what the corrosive effects of instant wealth will be, and how suddenly they will bubble to the surface. And Saudi Arabia is surrounded by rivals and enemies-Iran, not only unstable but with a rising influence of Shi'a Islam, antithetic to the Sunni Islam of Saudi Arabia; South Yemen, with a Marxist government aided by Cuban and Soviet military elements; Iraq, with a Soviet military presence. Thus, at the very least, the United States and the other Western countries are depending on a regime in a highly unstable environment to provide the leading part of their imported oil and to stabilize the world oil market.

Even if a regime closely tied to the West stays in power, it is an open question how much oil Saudi Arabia will choose to make available in the future. The high production rates frequently mentioned-such as 15-20 mb/d in the late 1980s-seem increasingly improbable. The disappointing progress and prospects of the economic development programs so far of individual OPEC nations, including Saudi Arabia, raise serious questions about the economic viability of such activities. Cutbacks in their pace are almost inevitable, and sooner or later there may be a wave of disenchantment, frustration, and resentment that will create widespread turmoil in producing countries, as it has in Iran.2

In any event, the prospect of steadily higher oil prices is now a virtual certainty. At the end of 1978, OPEC oil cost an average of $14.50 a barrel delivered to U.S. refineries. The increases projected under the December 1978 OPEC decision would themselves mean a price of over $16 per delivered barrel by the end of 1979. But in fact, depending in part on the speed at which Iranian production is returned to service, subsequent increases already under way seem likely to bring the average delivered price to $18-$20 per barrel by the end of the year. In short, during 1979 alone, higher prices may cause the present nine mb/d of U.S. imports to cost $10 billion per year more than in 1978, a direct charge to the U.S. balance of payments just at the time when it is under acute pressure and when improvement had been hoped for.

If one looks into the future, and assumes a level of U.S. oil imports rising gradually to 14 mb/d by the late 1980s, the price picture becomes so uncertain as to be very hard to quantify. However, in the area of direct costs alone, two conclusions seem clear. First, any increase in U.S. oil imports will tend to be accompanied by an increase in the import levels of the other major industrialized countries. For reasons that are in part political, in part psychological, and in part economic, U.S. oil import levels directly affect the imports of the other industrialized nations, as a recent study by the Organization for Economic Cooperation and Development (OECD) has indicated.

And, second, with oil demand thus increasing, the pressures on the producing countries would be bound to mean price increases substantially above what would otherwise take place. If one assumes that on existing long-term trends, prices would "normally" increase only at rates keeping pace with inflation, then a rudimentary guess would be that the "abnormal" real price increases related to a 14 mb/d U.S. oil import level would exceed these rates by perhaps 30-40 percent by the late 1980s.3

The result, applied to a U.S. import level rising from nine mb/ d to 14 mb/d by the late 1980s, would produce additional U.S. costs of some $60 billion yearly (in 1978 dollars) in the late 1980s-the equivalent of $30-$35 a barrel for each of the extra five mb/d of imports.

Broadly speaking, a gradual increase in prices, on the scale suggested, would result in relatively low indirect economic losses-perhaps only a fraction of the $60-billion estimated annual increase in direct outflows. But a rapid increase in oil prices could create indirect economic losses considerably greater than those of the direct outflows and lasting for a number of years-as happened after 1973-74.4

Finally, to these direct and indirect costs must be added serious social and political risks. The impact on inflation could make the problem almost unmanageable without draconian measures. And, as has often been pointed out, continued high U.S. oil imports are an important contribution to political tensions within the Western community. As a recent headline in The Economist put it: "Will American Oil Greed Doom the World?" The other industrial nations, who are also our allies in political and security matters, are far more dependent than we on imported oil; as the price of oil is bid up by what appears to them to be the pressure of continuing high American imports, the tensions within the Western alliance could become almost impossible to handle-and at the very least would make concerted action on other fronts far more difficult to obtain.

And, finally, as U.S. imports increase, U.S. foreign policy is bound to become more subject to the influence of the oil-exporting countries, with possible disastrous effects on our relationships with key friends and allies.

The general nature of these effects should need no further underlining. We have seen each of them in operation in the aftermath of 1973-74. Today and in future years their impact would be at least as serious as it has been in the last five years.

In short, having just enacted the first installment of an energy policy, the United States now confronts the need for a much more significant effort. Where can the energy sources be found to stop the growth of oil imports, and what should be the stress in that new energy program?

Let us start by summarizing briefly the present U.S. energy balance and the "conventional" forecast for the state of that balance in the late 1980s, and then examine, one by one, the realistic likelihood of increases in major present energy sources.

III

Table I, below, shows the 1977 energy balance of the United States in terms of oil equivalents along with a "conventional program" for the late 1980s derived from recent projections by the U.S. Department of Energy. The latter is, of course, only an approximation, involving a whole series of underlying assumptions concerning the overall economic growth rate as well as the feasible rates of production of different energy sources. For imported oil, the "conventional program" shows estimated levels of 14 mb/d, the figure we have just been using in the preceding section. Obviously, this could vary in a range of, say, 12-16 mb/d-but the figure of 14 mb/d gives a good picture of where we are headed under existing policies.

TABLE I

U.S. ENERGY SUPPLY

ACTUAL 1977 AND CONVENTIONAL PROGRAM FOR LATE 1980s

(in millions of barrels daily of oil equivalent)

Actual Conventional Program

1977 Late 1980s

Domestic (excluding U.S. Exports)

Oil 10 10

Natural Gas 9 9

Coal 7 12

Nuclear 1 3

Subtotal, "traditional" 27 34

Solar, including hydro 1 2

TOTAL DOMESTIC 28 36

Imports

Oil 9 14

Gas * 1

Subtotal 9 15

TOTAL 37 51

Extra Conservation - 3

GRAND TOTAL 37 54

* slightly less than 0.5 mbd.

The most obvious way to change this picture would be to turn back the clock to the early 1960s, when the United States produced 80 percent of the petroleum it consumed-in other words, to reduce the need for foreign oil by increasing the production of domestic oil. Is this possible?

As shown in Table I, domestic oil production is the largest domestic source of energy, now accounting for 10 mb/d and predicted to hold at about this level. (For this purpose, "oil" includes natural gas in liquid form.)

In the arguments and debates of the last six years, three different domestic oil "solutions" can be identified. The oil companies urge the first two-stimulation of conventional production through deregulation of oil prices and speedy granting of offshore oil licenses; and incentives to produce more oil by unconventional means, such as enhanced recovery and the extraction of shale oil. Opponents of the oil industry offer the third solution-breaking up the big companies.

The elimination of price controls, it is said, would help in two ways: first, controlled prices have substantially constrained oil exploration, and second, price controls have been created and administered in a way that generates great uncertainty. The latter is certainly true. The whole jerry-built structure-"old" oil, "new new" oil, "stripper" oil, altogether some 17 categories in recent legislation-has fostered a confusing and expensive bureaucratic monster.

It is, of course, impossible to determine the extent to which either price controls or the way they are administered have held back exploration or production. By any measure, the rewards for finding new oil have increased substantially since 1973-even the regulated price of newly found oil has more than tripled compared with an approximate doubling of drilling costs. And the number of total wells drilled increased by 69 percent between 1973 and 1977. Yet the quantity of new reserves added has been less each year than in 1973 and has fallen far short of annual production.5 In the aggregate, U.S. proven reserves of oil have fallen from 35.5 billion barrels in 1973 to 28.5 billion barrels at the end of 1978, the lowest level since 1952.

It is now widely accepted that in the late 1980s, even with higher real prices, only about five million barrels a day-instead of the current 10 mb/d-are likely to come from reserves that were known to exist in 1978, including Alaska, through the use of conventional recovery methods. And on the basis of experience with the accelerated exploration since 1973, a reasonable judgment is that no more than four mb/d of oil can be expected from new fields found between now and then.6

Indeed, this may be a high estimate: the prospects for finding a big field onshore or offshore in the Gulf of Mexico are quite small because these territories have already been intensively searched. (It must be recalled that over two million wells have been drilled in the United States-four times as many as in all the rest of the non-communist world combined.) New territories, especially the outer Continental Shelf and Alaskan North Slope, are the main hopes for finding a big field. But so far drilling off the East Coast has been disappointing. Most basically, even without the kind of environmental constraints that delayed Alaskan development, finding and developing a major new field in inhospitable areas can take the better part of a decade.

What about new sources from unconventional means? A large quantity of oil-more than half-is left behind in conventional recovery methods. For years, oil companies have been developing increasingly sophisticated methods for extracting a portion of this oil, and not surprisingly, the 1973-74 OPEC price hikes boosted interest in the effort. (The new methods for enhanced recovery ordinarily involve the injection of a chemical compound or heat into an oil field.) Unfortunately, years are needed to determine the effectiveness of any given method for any single field. Hence, enhanced recovery is still more promise than reality. The best current estimates, both in government and in the industry, indicate that an additional one million barrels daily is the most that can be expected in the late 1980s through enhanced recovery methods.7

Another potential unconventional source is oil-bearing shale rock. In Colorado, in the early part of the twentieth century, vast shale-oil deposits were discovered. These reserves still dwarf known reserves in conventional oil fields, but the problem has always been to get the oil out. As the price of oil has risen, so has the estimated cost of producing oil from shale. The best current estimate puts this cost in the range of $16-$28 per barrel.8

Even if existing shale processes were to prove profitable, with or without a government subsidy, their capital and time requirements are great: a production level of 100,000 barrels a day would require over a billion dollars and a decade for development. Furthermore, under present technology, water requirements are potentially very large, which would generate opposition from farmers and ranchers. Nor are environmentalists happy about a process that breaks some shale rock into fine particles that float into the sky-while the shale rock that remains expands to a volume greater than it previously occupied, which necessitates filling in some canyons. The so-called in situ process, in which most of the rock is burned underground, involves less environmental damage, but has not been fully tested. One must conclude that shale oil still is unlikely to make any contribution to the national energy supply by the late 1980s and very little by the year 2000.

Taking into account both known and newly found oil fields as well as enhanced recovery, our best judgment is that total U.S. oil output in the late 1980s will approximate 10 mb/d, about the same as current production. But even this is quite speculative and perhaps on the optimistic side. To maintain that production level would require the finding of almost four billion barrels annually; but there has been only one year in the last 30 in which more than three billion barrels of reserves have been found.9

As for the third proposal, breaking up the companies, such divestiture ("dismemberment," as the companies call it), could take one of two forms. One would be a horizontal break-up, in which oil companies were required to sell off non-oil activities such as coal. No one argues that horizontal divestiture would increase oil supply, and the available evidence suggests that it would be harmful to the coal industry by depriving it of needed capital, technology, and management. The other is vertical divestiture, which typically would involve breaking up each of the largest dozen or so oil firms into three separate companies-the first restricted to oil exploration and production; the second, to pipelines; and the third, to refining and marketing.

Would vertical divestiture increase the supply of domestically produced oil? This question has traditionally been argued in economic terms, seeking to measure the trade-off between increased competition and decreased efficiency. Numerous studies have been conducted on vertical divestiture. A careful review of them leads us to the conclusion that economic analyses do not yet enable one to determine whether breaking up the companies would result in any meaningful changes in either competition or efficiency. What is clear is that there is no evidence that divestiture would lead to greater domestic supplies of oil.10 The consequences to the consumer might be on the order of a tank of gasoline a year, but whether a tank richer or a tank poorer cannot be determined.

Thus, we are left with the conclusion that there is no domestic oil solution to the problem of increasing U.S. oil imports-no way that production from American oil wells can narrow the gap of nine million barrels daily between what the United States produces and what it consumes. In fact, higher oil prices will be required to maintain production at current levels.

IV

The 20 trillion cubic feet (tcf) of natural gas that Americans consumed in 1978-the equivalent of nine million barrels per day of oil-accounted for about one-quarter of the energy used by the country. Unlike oil, natural gas has remained for the most part a domestically produced fuel, with only five percent imported. But in recent years, in spite of dramatically higher prices for new gas and increased exploration and development, the rate of discovery of additional natural gas reserves within the United States has been only at the rate of approximately ten tcf-although within the last year producers have offered increased quantities of gas to the interstate market, creating an impression of plenty. Proven reserves of gas, which began to decline in 1967 and in the next decade dropped by 30 percent, were estimated in 1978 to sustain only ten years of consumption at the consumption rate of 20 tcf per year.11

Prices are perhaps even more central to the natural gas controversy than they are to the oil controversy: the most contentious part of the framing of the 1978 National Energy Act was the battle over natural gas pricing. At base, it was a controversy over whether pricing should be according to cost of production or value to consumer, a contest among regions of the country, and a debate over how to distribute the $400 billion that OPEC price increases added to the value of domestic U.S. gas reserves since late 1973.12 No one could wish to replay the battle, and we mention it only as it relates to the vexing question whether natural gas offers a realistic alternative to growing imports of foreign oil.

The pricing issue naturally leads into the baffling question of supply: How much gas do we have and at what price? Economists typically estimate the supply that would be forthcoming at various price levels. Geologists, on the other hand, typically ignore price and relate supply to the size of recoverable reserves. Within both groups of experts, there is deep disagreement.

Some economists believe that supply is not very responsive to price; others state the opposite. In 1976, for example, the General Accounting Office declared that no additional reserves would be discovered at prices above $1.75 per thousand cubic feet (mcf). At the same time, a task force within the Energy Research and Development Administration estimated that a rise in the price of natural gas from $1.75 to $2.50 per mcf would increase U.S. recoverable reserves by 20 percent. The differences among geological estimates as to the size of prospective gas reserves are at least as large. Estimates of undiscovered recoverable natural gas resources by the U.S. Geological Survey range from 322 to 655 tcf, which if added to already proven reserves would produce a total gas supply in the range of 525 to 850 tcf.13

The Natural Gas Policy Act of 1978, of course, was intended to "resolve" the problem of price. The compromise ends the separation between the free market for intrastate gas and the regulated market for interstate gas. Newly found gas sold in the intrastate market is temporarily brought under the umbrella of interstate regulation. But, at the same time, the ceiling price of all newly found gas, in both interstate and intrastate markets, will be allowed to rise and eventually be deregulated completely.

In general, the compromise as passed could have three possible outcomes. First, the prospect of higher prices might stimulate exploration and lead to the discovery of new reservoirs that would support consumption significantly in excess of the current 20 tcf per year. In that case, new electric generating plants might even be permitted to use natural gas. This seems, on the available evidence, to be the least likely outcome, but it is possible. Second, and only slightly more likely, is that higher prices could fail to stimulate more than the current 10 tcf of new discoveries per year.

The third and most likely outcome is that annual discoveries will range between 10 tcf and 25 tcf per year. Within that range, a figure closer to 10 tcf means further restrictions on the industrial use of gas as boiler fuel and as feedstock, plus stern enforcement of mandates to convert existing gas-fired industrial and electric utility boilers to coal. A figure closer to the upper end of the range, 25 tcf, means little change in present use patterns.

The outcome is, of course, uncertain. But we would emphasize that the nation would be unwise to plan on the upper levels. Indeed, a recent study by the Congressional Research Service concluded that even with gradual deregulation of natural gas and a drawdown of gas reserves below the normal reserve-to-production ratio, "maintaining a production level through the middle 1980s close to the current rate of output will be very difficult." And recent Shell and Exxon projections show natural gas production in 1990 at about two-thirds of present levels.14

Gas proponents point to other possible ways to supplement supplies, notably synthetic gas (SNG) from coal. Although several oil companies and gas pipeline firms have announced that they would construct commercial plants for this purpose, as yet none have been built. Inflation, high and uncertain operating and construction costs, and environmental concerns have contributed to the delayed construction.

True, additional imports of gas are possible, with the preferred transportation method being pipelines. Since the early 1970s, such imports from Canada have been providing about five percent of the total natural gas used in the United States, but they are unlikely to exceed that level. As yet the United States has imported only meager amounts of Mexican gas. Negotiations for much greater amounts broke down in 1977 over the price, but have been resumed after the Carter visit in February. Although the Mexicans have announced plans to use all their gas internally, many observers expect the United States eventually to import up to one tcf yearly, still only about five percent of current natural gas consumption in the United States.15

Of course, natural gas can also be imported from more distant points, in the form of liquefied natural gas. A small project began operation in 1974 and two larger ones in 1978, all based on Algerian gas, bringing U.S. LNG import capacity to the equivalent of about 0.4 tcf of natural gas-two percent of U.S. gas consumption. An additional ten projects for LNG importation were being planned and if all of these projects were to come to fruition, LNG imports in 1990 would still only constitute 12 percent of the current consumption of natural gas. In December 1978, the Department of Energy denied applications for two large LNG import projects, signaling the Carter Administration's present reluctance to see LNG imports increase beyond their current modest levels. New LNG projects face controversy, a result of three severe obstacles-cost, sharp disagreement in the scientific community about safety, and dependence on OPEC sources.16

The uncertainties surrounding feasible levels of natural gas production in the next 8-10 years are greater than in the case of oil. While higher levels are conceivable, we believe that it would be very unwise to plan that natural gas production will exceed the present level, the equivalent of nine mb/d of oil. Indeed it will be a challenge to find enough new reserves to maintain production at current levels.

V

While domestic oil and natural gas are constrained by geology, the other two conventional domestic sources-coal and nuclear power-are constrained by political issues. The political conflict has been about the side effects involved in providing and using these energy sources, that is, the externalities, or costs, indirectly borne by the members of society at large rather than paid for directly in cash by the consumers of the energy.

Coal is today the most important of the two, providing 18 percent of U.S. energy, or the equivalent of seven mb/d of oil. And the Carter Administration's National Energy Plan calls for an increase in coal supply between 1976 and 1985 that would provide the equivalent of an added 6.5 mb/d of oil. As we are frequently reminded, coal is America's most abundant fossil fuel, comprising, by some estimates, 90 percent of total energy reserves in the United States. Reasonable estimates about recoverable reserves vary widely-from 150 to 440 billion tons. Even reserves at the lowest estimates, however, could assure ample supplies for at least a century at high consumption rates.17

Great hopes were expressed after the oil embargo for domestic coal as an alternative to imported oil. Moreover, the financial, managerial and technological capabilities of the coal industry have been significantly strengthened by the entrance of oil firms, natural resource firms and other large companies. But the experience of the last five years makes it appear very doubtful whether significantly higher production and consumption levels can be achieved at least in the next decade.18 For external costs, in the forms of environmental and health problems, are rung up at every step in coal's journey from the mine along the railroad to the boiler where it is burned-in particular acid drainage from mines, the disruption of life in Western communities by enormous trains hauling coal, and when it is burned, the release of sulphur dioxide and a host of other pollutants. Perhaps most serious of all, in the long run, may be the (unknown) consequences for future generations of increasing the temperature of the atmosphere by producing carbon dioxide.

Some of these problems can be dealt with, for example, through the installation of scrubbers by utilities (to remove sulphur dioxide), the building of overpasses over railroad tracks, and the return of strip-mined land to its original contour and condition. But inevitably there has been controversy over costs, their allocation, and regulatory requirements. The problems are not trivial, and their clear resolution is not yet politically in sight.

But even if these problems were resolved, coal would still confront deep-seated problems of what might be called a "systemic" nature. There has been a continuous decline in productivity since 1969, variously attributed to mine safety regulations and to social conditions and labor strife in the eastern coal fields, where most of the nation's coal now comes from. And the full development of Western coal would require a massive new program to expand rail facilities.

Thus, a circular chain of uncertainty exists. Environmental issues, government end-use policy, and prospective electricity demand make utilities reluctant to shift to coal, which delays openings of new mines and new transportation, which in turn makes utilities wonder whether the coal would be available if they were to shift to it. There is so much uncertainty on all points that development is moving much more slowly than was anticipated two years ago.

But what about gasification or liquefaction? These are certainly the long-term routes for coal to go, but the costs are quite high. As already noted, technology heretofore not widely used promises an additional source of domestic gas-synthetic gas (SNG), manufactured from coal. Pilot plants, established in the 1960s to prove technical and economic feasibility of the process, showed it to be uneconomical at then-current natural gas prices; the best current guess would suggest costs at least at the equivalent of $20-$30 per barrel of oil. And the cost of producing oil from coal is $30 or more a barrel. Despite frequent assertions of optimism, neither gasification nor liquefaction-the latter important because of the security need to have a supply of domestic liquids during crises and interruptions-seems likely to make an important contribution until the next century.19

The United States has the coal. But its very abundance has misled people, for the existence of huge reserves does not mean that the United States will automatically be in a position to reverse the long decline in coal's share of U.S. energy. Most likely, there will be a slow growth in production and consumption, but hardly of the kind to provide an alternative to the pressing problem of imported oil.

All told, our best judgment is that it is unlikely that coal production will increase between 1976 and 1985 by an amount greater than the oil equivalent of three million barrels daily, rather than the 6.5 million barrels daily shown in the Administration's National Energy Plan. By the late 1980s, we estimate that coal could be providing four mb/d more than at present, as compared to the additional five mb/d projected in the "conventional program" shown in Table I.20 It may be argued that these are "static" estimates-that a really concerted national effort would achieve at least the Administration's target. However, if one examines only the extent of investment required in all stages of the system-mines, railroads, and power plants-one is driven to conclude that a dramatic increase in coal in this time frame is unlikely. And the nature of the adjustments required in our society is great indeed under any circumstances.

VI

The common response of all industrial nations in the immediate aftermath of the embargo was to renew a commitment to nuclear power. President Nixon's Project Independence, in late 1974, projected that up to 40 percent of America's electricity could be generated by atomic power by the late 1980s.

Projections of nuclear energy in terms of what was technically possible were one thing. But the reality-involving questions of safety, escalating costs, and issues of weapons proliferation-transformed nuclear decision-making from a narrow technological matter into a major political question. Delay after delay resulted from endless litigation, hearings, and vociferous demonstrations. The result has been a continuing stalemate.21

True, nuclear power, with an existing capacity of 50 gigawatts (GW), is now generating about 12 percent of the nation's electricity-supplying, in the total energy picture, the equivalent of 1.25 mb/d of oil. And another 145 GW is either in the advanced planning stage, on order, or under construction. If all of these plants are built on or near schedule, the United States would have a total of about 195 GW of operating nuclear capacity by the early 1990s, which would be generating perhaps a quarter or more of the nation's electricity.

But even this modest growth-only one-half of what had been officially projected less than five years ago-can by no means be considered a sure thing. The argument over nuclear power involves a set of external costs even more controversial than coal's. Advocates of nuclear power, who maintain that further nuclear development is essential to the well-being of the nation, have lost ground in a widening debate. Doubts raised concerning safety have delayed completion and forced added safety precautions, both of which contributed to a rapid and still-unchecked rise in costs that led to a second major controversy: Does it cost more, the same, or less to generate electricity from nuclear power than from coal? The question is difficult enough to answer when only the direct costs carried by the utility are considered. It is virtually impossible to answer when an effort is made to measure the relative external costs of coal and nuclear.

This change over a decade has had a profound effect on the key decision-makers-the utility executives who decide whether to order or not order. Some highly publicized episodes, such as Seabrook in New Hampshire and the recent orders placed by Commonwealth Edison, might leave the impression that utilities are fully committed. On the contrary, less than half a dozen reactors were purchased in the years 1975-79, compared to 34 in 1973 alone.22 And many that were ordered before 1974, some even partially built, have been canceled or deferred to such an extent that cancellations have been exceeding new orders.

Today, the issue of spent fuel disposal looms as an even greater obstacle than questions of reactor safety or environmental impact. In the 1960s and early 1970s, government and industry planners assumed that the spent fuel would be reprocessed, to recover still-usable fissionable material from useless and dangerous waste materials, as soon as enough reactors were in operation to support the large-scale facilities for economical reprocessing. Both the government and the nuclear industry postponed important technical decisions about the treatment and disposal of the waste materials pending the start of large-scale reprocessing.

But in response to concerns about nuclear proliferation, the Ford and Carter Administrations placed a moratorium on the development of reprocessing and the breeder reactor. This moratorium highlighted an acute operating problem.

The spent fuel has been piling up in storage areas that consist of specially designed pools of water at nuclear power plant sites, many of which will be filled by 1985, and several by 1983. As these plants exhaust storage capacity, their owners will be forced either to transfer spent fuel to other locations or to build and license additional storage capacity-or to shut the plants down altogether.23

One expedient would be to transport spent fuel to one or more "Away from Reactor" pools (AFR), which could be comparatively cheap to build and could safely store spent fuel for many years. A dozen or so such facilities, each about the size of an average industrial warehouse, would accommodate all the spent fuel that is likely to be produced for the rest of the century. But AFRs pose a considerable "not in my backyard" political problem. By early 1978 at least seven state legislatures had imposed various prohibitions on the construction or expansion of local nuclear waste storage facilities or on transport of radioactive waste into the state, and there were many indications that others would follow suit.

In this political environment, and in order to find a more long-lasting solution, U.S. government officials turned their attention in 1978 to waste isolation pilot plants (WIPPs), an idea conceived some years earlier as part of a government program for ultimate disposal of radioactive wastes. But here too there is serious uncertainty. The U.S. approach has envisaged that such ultimate disposal would use salt caverns several hundred meters beneath the earth's surface, but an interagency review committee, set up by President Carter, has recently found that such underground salt formations are by no means unanimously accepted by the scientific community as the best method for disposing of nuclear wastes-indeed, there is a substantial body of opinion that holds that they are not even very desirable.24

Obviously, a waste disposal procedure is necessary, if for no other reason than to handle waste already generated (most of it actually from past weapons-directed production). But it will be most difficult to find a method that will be generally acceptable to concerned parties, including a significant number of nuclear critics. Unless government and industry leaders start to work now with nuclear critics, existing plants will begin to run out of spent-fuel storage within four years. The federal government will then face a very difficult choice: shutting down the plants or riding roughshod over the nuclear critics. And without a consensus on waste policy, including the certainty of a satisfactory method for ultimate waste disposal, there can be no end to the nuclear power stalemate.

In the face of these difficulties, the best that can be hoped during the next dozen years is that nuclear energy may add a million and a half barrels a day of oil equivalent to the million and a quarter barrels a day it provides now. Such a production level would require the continued operation of all existing nuclear capacity, plus the completion and operation of all new capacity currently under construction or on order.

That, we stress, is a very bullish scenario. Indeed, we regard the nuclear outlook as very uncertain, and believe that the energy generated by nuclear power could actually undergo an absolute decline within ten years.

This pessimistic conclusion for the late 1980s does not mean for a moment that the United States should not increase its effort both to remove present technical obstacles to the expansion of existing light-water reactor use and to develop better forms of nuclear energy production. Answers may be found to the weapons proliferation risks of current breeder reactor designs, and in the span of 15-25 years fusion power may have proved itself at least experimentally. But for the balance of this century it would clearly be unwise to rely on nuclear energy to make any substantial contribution to the problem of reducing dependence on imported oil.

VII

Except for those who believe in an electrified world using fusion power, there is general agreement that eventually a transition will have to be made from oil, gas, coal and uranium to what is called solar energy. The term "solar" covers many diverse sources, their common thread being that they are all renewable, depend ultimately on the sun, and, in the case of burnable materials, have come into existence on the earth "recently," in the last century or so (in contrast to fossil fuels).

At the present time, all forms of solar energy account for only one million barrels per day of oil equivalent in the U.S. energy balance-and this only if one includes hydroelectric power under this heading.25 And in the conventional forecast for the late 1980s, this amount is predicted only to double, to a two mb/d level.

Especially under the Carter Administration, the amounts allocated by the government to solar energy research and development have increased substantially, as have the attention and effort by private companies. But the policy direction of the government's research effort is open to serious question, and private solar industry remains in the difficult first phase that characterizes the initial diffusion of innovation.

Far too much of the present research program is directed at "big solar"-expensive high-technology projects that mimic the space and nuclear programs. There are two prominent examples. One is the "power tower" which would use acres of mirrors to focus light in order to heat water to boiling; it accounts for a fifth of the government's entire solar research and development budget. The other is the orbiting satellite, which would beam the sun's energy back to earth, and whose supporters have attempted to obtain large-scale funding.

While the various forms of big solar differ in many ways among themselves, they have certain important features in common: they fit in well with the traditional mode of federal budgeting for technological development; they are highly uncertain as to their practicality; they are likely to be very expensive, with current cost estimates highly speculative; and they may well encounter severe environmental problems. Unfortunately, federal solar policy favors these programs at the expense of "small solar"-the decentralized forms of renewable energy that can deliver a sizable contribution in this century.

Of these the foremost are those related to space and hot water heating, and the consumption of "biomass"-organic matter, primarily from plants-for all forms of burning.

In terms of quantitative contribution, solar space and hot water heating can make its greatest impact, in the next decade at least, through the so-called active systems, which involve mechanical moving parts. The most common form today is the solar panel designed to catch and concentrate the sun's rays, to heat air, water, or some other medium flowing through pipes, and to convey the heat, with the aid of fans or pumps, to where it is needed.

The potential for active solar heating is vast because it is well suited to most new residential and commercial buildings and to about one-third of the nation's 55 million existing dwellings. It had formerly been thought that it would take decades for passive solar heating-designing buildings to take advantage of the environment-to make a major impact, because of the slowness with which the building stock turns over. But recent evidence indicates that passive solar heating can also be effectively retrofitted onto existing structures, on a substantial scale and in a much shorter time.

In 1975, one could still have only speculated about the possibilities for a solar heating industry. Today it is a vibrant, growing industry. Sales, including installation, increased tenfold in three years, from $25 million in 1975 to $260 million in 1977. The development of the industry and the market potential permit one to be increasingly optimistic about solar energy.26

But yet, in absolute terms, the industry remains small and fragmented. The key problem is to help the diffusion of innovation occur at a more rapid rate, and this requires mechanisms to help overcome a series of economic and institutional obstacles.

The most important is the question of payback, how fast a building owner will recover his investment. Research seems to indicate that about a five-year payback is required. Currently, solar heating has about a 12-year payback. But, of course, that is measured against other energy sources that are sold to consumers at prices heavily subsidized (by price controls) and some of which bear heavy externalities of the sort we have noted earlier.

Other major obstacles include building codes, financing, "the right to sunlight," quality control, distribution, and the relationship to utilities. That last is a most important consideration. Some proponents of solar power are making a serious error in trying to keep utilities out of solar energy, instead of encouraging them to enter the business of "delivering" solar energy by taking the responsibility for installing and financing (perhaps owning) solar units. Wide diffusion of solar heating will have a major impact on the utilities, and if they feel threatened and so oppose it, then large-scale implementation of solar could be delayed for a long time.

The other major near-term renewable source is biomass-organic matter from plants and animals. Biomass can be burned, or it can be converted into a gas or liquid fuel. Biomass means, for instance, that municipal solid waste can be converted from a major disposal problem into a significant energy source, rivaling the present contribution of nuclear power. But the main source of biomass energy in the near term will probably be wood, forest wastes and other plant products. That potential can be augmented through the development of fast-growing energy crops. The equivalent of three mb/d of oil might be obtained from burning forest wastes and wood without relying on sophisticated forest management techniques and new tree species, but such a high level will take many years, perhaps several decades.27

Rapid expansion of the use of solar energy requires, at this stage, major additional support from government, along lines to be discussed in a later section of this article. If such support were forthcoming, we believe that it would be reasonable to project by the late 1980s a supply from solar sources equivalent to four mb/ d of oil, roughly twice the current Department of Energy forecast.

This projection does not assume any dramatic technological breakthroughs becoming available on a production basis during this time frame. The most obvious such possibility has to do with photovoltaics, that is, small cells of silicon that convert sunlight directly into electricity. We omit photovoltaics not because we are skeptical, for we are not, but rather to underline the potential of existing technologies that do not require a major breakthrough. Photovoltaics may well be on the edge of such a breakthrough. They are made through the same processes used to manufacture semiconductors and integrated circuits. The early photovoltaic cells used to power orbiting satellites worked satisfactorily, but were also extraordinarily expensive. Although costs have since dropped to less than one-half of one percent of initial levels, a major refinement of cells is still required to make photovoltaics competitive with commercial fuels. This is a reasonable prospect, however, very much in line with what happened to semiconductors. And that, obviously, could radically transform the energy supply picture in the United States.28

VIII

To sum up our argument to this point, the prospect for major increases in domestic energy supplies from the four conventional sources-oil, gas, coal and nuclear energy-is bleak. Today, domestic production from these four sources accounts for the equivalent of 27 million barrels of oil per day. Over a period of ten years or so, that 27 mb/d could perhaps be stretched to 32 mb/d, and supplemented by an additional four mb/d from solar-related sources. But during that period, according to the current forecasts of the Department of Energy, consumption requirements could rise, as we saw in Table I, to the equivalent of 51 mb/d of oil by the late 1980s, even on the Department's assumption that by then we shall have achieved a saving, through conservation measures additional to those in use in early 1978, estimated at the equivalent of three mb/d of oil. The need for imported oil would still be 14 mb/d, a level we believe to be untenable for the economic and political reasons outlined in Section II above.

Today, Americans are conservation-conscious to a degree that would have been unthinkable a decade ago. A great many Americans are aware that the United States now uses much more energy per capita and per unit of GNP than other advanced industrial countries that enjoy as high an average standard of living.29 And considerable progress has been made on a few fronts: the increased gasoline mileage of new automobile production-now slated to rise to an average of 27.5 miles per gallon by 1985-may in itself be saving two mb/d by the late 1980s, as compared to what consumption levels would be if the gasoline mileage of new cars had stayed at pre-1974 levels.30 But since automobiles will continue to be central to American life, there is a need for post-1985 performance standards that will allow automakers to find flexible ways to reach a higher goal of perhaps 50 miles per gallon.

But it is also true that on many major fronts we have hardly begun to practice serious conservation. In American industry, the range for further energy savings remains very broad-from better housekeeping to recovery of waste heat and materials, to major technological innovation. Altogether, according to one recent study, it may be possible to reduce industrial energy use in economically justifiable ways by more than a third through familiar conservation methods, without any breakthrough.31

One of the major methods is cogeneration, the combined production of heat and power. Today there are two independent energy delivery systems in the United States. One is composed of utilities, in which electricity is centrally produced, and steam is released as waste into the air or lakes and rivers. In the second system, companies generate their own steam for heating and industrial processes. Almost half of all energy consumed by industry is used to produce steam. Cogeneration integrates these two systems at industrial sites, using only about half as much energy as is needed to produce the steam and electricity separately. There is nothing fancy about the technology. It is quite common in Europe and used to be in the United States. Today, however, major institutional barriers stand in its way-such as how electricity generated by an industrial firm can be incorporated into the regulated utility system.

For, while there are notable examples of effective energy saving in U.S. industry, the overall record could be improved considerably. One of the most thorough independent analyses has come to the conclusion that five out of the eight most energy-intensive industries actually increased their energy use per unit of output since the embargo.32

There are many reasons for the relatively slow pace of energy saving. One is the confusion over energy prices and uncertainty about whether there is an energy problem. Many firms have discovered that energy prices do not affect market share or profit margin because they can be passed on to consumers. The regulatory system impedes cogeneration. Many executives are confused by the twists and turns of government policy. One of the principal obstacles, it now appears, is the high rate of return that many firms demand for conservation investments-30 percent after taxes-or in some cases twice that required for strategic investments. The rather small tax credits in the National Energy Act are insufficient to overcome this critical obstacle, which is probably retarding industrial energy conservation more than anything else. A more stimulative policy that encourages investment could be very effective.

The same kind of broad potential exists in the building sector. Almost 40 percent of American energy consumption goes for space heating, hot water, air conditioning, and lighting in homes, commercial structures, and factories. Prior to 1973, energy consumption had been a subject increasingly neglected in buildings: in New York City, for instance, the sealed, glass office buildings put up in the late 1960s used twice as much energy per square foot as those put up in the late 1940s. Since 1973, "energy-conscious design" has begun to work its way into the repertoire of architects and construction companies. For instance, whereas office buildings of the early 1970s might have used 400,000 BTUS per square foot, new buildings are going up that use 55,000 to 65,000 BTUS per square foot.33 But, even with the push of new standards, the effects of energy-conscious design will take a decade or more to be felt, as the building stock turns over very slowly.

The real opportunity in the building sector is "retrofit"-changes in equipment and structure that "button up" buildings, that is, improve thermal and lighting efficiency. The possibilities are considerable. IBM, for instance, which set out in 1973 to reduce energy consumption by ten percent in 34 major locations around the country, was surprised to discover that it actually cut its energy consumption by 39 percent by 1977. "Nothing very technical or profound" was required.34

Real-world experience proves that major savings are also possible in the residential sector. Studies across the country indicate that 25 to 50 percent reductions in energy use in the American housing stock are possible with relatively simple efforts.35 And a five-year study of a New Jersey town by researchers from Princeton University showed that a 67 percent reduction in annual energy consumption for space heating in residences was possible with a relatively simple package. "With patience, groups of small and tiny fixes can be put together into large assemblies that overall can produce impressive results," they concluded. "It does not appear to be impossible, in fact, that under present technology and economic conditions, space heat in houses could be a minor rather than a major consumer of fuel."36

All this suggests a major realm of possibility. Retrofit is occurring in the United States, but at a much slower rate than is possible or desirable. The main reason is the lack of stimulative government programs. Until 1978, the United States had no major national retrofit programs, despite the fact that the United States has one of the most inefficient housing stocks. The problem is that the American building stock is highly decentralized. Homeowners are very poorly informed, have only limited access to capital, and do not know whom to trust. Strong positive incentives are needed. The National Energy Act contains minor inducements, but the required level of encouragement has been missing.

This sector analysis demonstrates the wide flexibility possible for energy use in the United States. Its extent was underlined in the recent report of a panel on energy futures assembled by the National Academy of Science, which looked at four different plausible and carefully constructed scenarios for future energy demand in the United States. The results were extraordinary-that in the year 2010 "very similar conditions of habitat, transportation, and other amenities could be provided" in the United States using twice the energy consumed today, or alternatively using almost 20 percent less than used today. And this is with continuing economic and population growth. The fundamental conclusion is "that there is much more flexibility toward reducing energy demand than has been assumed in the past."37

How much, then, might a really intensive conservation effort reduce the predicted level of energy demand in the United States, by the late 1980s, of roughly 51 million barrels per day in oil equivalent? Our best guess is that if the government, Congress as well as the executive branch, were to approve and get behind realistic programs of subsidies and incentives, the result could be savings on the order of eight million barrels per day of oil equivalent, which would be five mb/d more than the results of increased conservation now forecast by the Department of Energy (Table I), reducing total energy consumption to 46 mb/d of oil equivalent.

We are confident that such further savings in energy consumption in the United States can be achieved without affecting predicted levels of economic growth. Indeed, mounting evidence strongly suggests that energy conservation is itself a form of productive investment, yielding much more rapid and substantial real changes in the energy balance of the nation than almost any given investment in energy production. Furthermore, it can actually stimulate employment, innovation and solidly based economic growth.38

But "conservation energy" is not so simple to recover as it might seem. Unfortunately, it is a diffuse source, and it has no clear constituency in the way that oil, gas, coal and nuclear do. Public policy must be its champion, and many different strategies will be needed. If we had decades, then the market alone, working through gradual rises in prices, would be sufficient. But the decades are not there. For conservation to make the kind of contribution it should in the relevant time span, there must be found an adroit mixture of signals-of price, regulation, incentives and information. Only in that way can conservation actions become as economically attractive to individual decision-makers as they are to the society at large.

The American system is particularly responsive to incentives, and that is where public policy has been particularly loath to intrude. Up to now, the failure of public policy has been its inability to assess the true prices and true risks of conventional alternatives, and its consequent inability to measure against them the costs of incentives that will promote conservation.

IX

Table II, opposite, shows the results of the balanced program we believe should be pursued to meet U.S. energy needs in the late 1980s without increasing the amount of oil we import. This is not an "either-or" program. On the contrary, it presupposes every reasonable effort to increase domestic supplies of conventional fuels, including:

1. The leasing of offshore oil and gas properties, under strict environmental regulations, and in a manner to promote rapid development.

2. Decontrol of newly found oil and gas, and of oil obtained by using enhanced recovery methods to produce oil left behind after normal recovery methods have been used.

3. Government assistance for technologies that could provide new supplies-such as coal gasification and liquefaction, and extraction of shale oil.

4. A major attempt by the government to find an acceptable method to dispose of spent fuel from nuclear reactors.

Unless measures such as these are pursued, there might be very little, if any, increase above the 27 million barrels a day of oil equivalent from the four traditional sources. Indeed, there could be an absolute decline, potentially making the United States far more dependent on imported oil than current forecasts indicate. But whether the four domestic sources increase somewhat, remain constant or decline, the broad choice before the United States is the same-increased dependence on imported oil, or a transition

TABLE II

U.S. ENERGY SUPPLY

BALANCED PROGRAM FOR LATE 1980s

(in millions of barrels daily of oil equivalent)

Actual Conventional Program Balanced Program

1977 Late 1980s Late 1980s

Domestic (excluding U.S. Exports)

Oil 10 10 10

Natural Gas 9 9 9

Coal 7 12 11

Nuclear 1 3 2

Subtotal, "traditional" 27 34 32

Solar, including hydro 1 2 4

TOTAL DOMESTIC 28 36 36

Imports

Oil 9 14 9

Gas * 1 1

Subtotal 9 15 10

TOTAL 37 51 46

Extra Conservation - 3 8

GRAND TOTAL 37 54 54

SOURCE: Authors' estimates for the Balanced Program. The other two columns are from Table I and are included for purposes of comparison.

to a more balanced energy system in which conservation and solar energy play large roles.

The attentive reader may, at this point, be bothered by what seems a paradox of our argument. On the one hand, we say that conservation and solar energy are the most effective alternatives to imported oil. Yet, on the other, the thrust of our argument is to point out that they suffer from the least momentum and the weakest advocacy. Do not the very difficulties faced by conservation and solar, some may say, undercut our argument?

The answer lies in clarifying the handicaps under which conservation and solar energy labor. To begin with, they run against the force of habit, the familiar patterns of energy production that have been associated with the great period of postwar economic growth. Second, conservation and solar do not now have a fair chance in the market to compete with imported oil and other traditional sources. The subsidies caused by price controls that encourage consumers to use oil, gas and electricity run into tens of billions of dollars yearly.39 Moreover, many of the conventional sources carry potentially great external costs that are not reflected in prices. Indeed, these costs tend to be seriously underestimated. Studies, for instance, often equate the health costs of pollution with lost wages plus medical expenses. Presumably, in such a formulation, it "costs" society very little for a non-working wife to contract lung cancer from air pollution if she dies quickly, so that large medical bills are avoided.40

Third, conservation and solar lack the constituency of the conventional sources. A solar constituency is beginning to develop, but it is still quite small, and is often disregarded as a fringe element. Conservation has virtually no constituency. As the former assistant Federal Energy Administrator for conservation observed: "The oil companies and utilities are busy talking up how much they need to produce. But no one's out there wholesaling conservation by the ton and barrel."41

Fourth, conventional energy sources generally depend upon centralized production by highly competent firms. In the past, it has proved much easier to generate electricity in a central power plant, and then distribute it over wires to the population. Large firms will continue to play an important role in energy production. But conservation and solar energy involve much more decision-making and action at the point of end-use of energy. They involve a move away from a producer-dominated system to a more balanced one, in which consumers play an important, rather than passive, role as well. But that, in turn, means that energy decision-making becomes highly decentralized, involving millions and millions of actors, often poorly informed, without easy access to capital or to the requisite skills, and for whom energy is only one of a myriad of concerns, rather than the central organizational focus. To reach these actors, indeed, represents a problem, but the California experience with financial incentives for solar installations indicates that it is possible. What is needed are government policies that reflect an adroit blend of pricing, incentives, regulations, and information.42

An ever-more-regulated system is not the answer to the problems posed by energy. But if the market is to resolve the problems, its distortions must be corrected so that all energy sources, including conservation and solar, will be able to compete on an equal footing. Without a transition to a more balanced energy program, the market system itself in the years ahead will inevitably become increasingly constrained by regulation and disruption. Although both incentives and sanctions have a role to play in the process of equilibration, the emphasis should be placed on incentives. The carrot makes for better politics and more acceptable change than does the stick.

The last point is crucial, because a politically acceptable program that can make a significant contribution to a solution of the energy problem is better than one that might theoretically solve it altogether but which has no chance of being adopted.

We do not claim to know the exact appropriate level of subsidy for conservation and solar energy. The fact that the true costs of imported oil are potentially at least three times its current U.S. market price suggests an offsetting subsidy of two-thirds of the cost of implementing conservation and solar energy. We do not, however, recommend this large a subsidy, for we acknowledge readily that our calculations are only crude approximations. Furthermore, for the most part we would think somewhat lower subsidies would probably be sufficient to encourage a substantial increase in investment in conservation and solar energy. We suggest, as rough guides, conservation subsidies of 40 to 50 percent and solar subsidies up to 60 percent, with the higher solar subsidies being justified because of the need-and value to society-of encouraging the diffusion of technology not widely used.

Are we not talking about a great deal of money? How to pay for this kind of program, especially at a time when budget-cutting has become a preoccupation in Washington? Most oil and gas executives realize that a windfall tax on part of the profits that result from deregulation of old oil is inevitable. We would propose that the windfall tax be specifically assigned to financing-primarily by tax credits, but also by grants and loans-conservation and solar energy, which are the two most promising alternatives to oil. And, as the windfall tax might be self-extinguishing as we move to a free market for domestic oil and gas, so these credits might be self-extinguishing over a period of ten years-an important feature because it has often proved difficult in the past to stop programs once launched. Our proposal would thus respond to two of the most urgent problems in U.S. energy policy-the stimulation of conservation and solar energy, and the need to gradually free all oil prices, not just those of new oil.43

As it is today, the system of price regulation of oil is highly irrational. And, if our analysis about the impact of larger rather than smaller oil imports is correct, then an irrational American pricing system could be one of the main causes of much higher oil prices in the years ahead, with all that will do to the Western economies. It makes no sense for the United States to be as integrated as it is into the world oil market-as by far the largest consumer of OPEC oil-and yet have a pricing system that is insulated from the market.

Our proposal would respond to another need, a political need, if the nation is ever to resolve its energy difficulties. It would help to bridge the gap between contending parties in the bitter American energy debate. The various interest groups-oil and gas producers, advocates of conservation and solar, even environmentalists and consumerists-are secret allies, though, to understate the matter, not all by any means would recognize this truth. Oil and gas producers are convinced that they need higher prices in order to maintain production. Advocates of conservation and solar energy should recognize that they need higher prices to make their programs more attractive. Consumerists need somewhat higher prices now to help protect the public against the awesomely high prices that could eventuate if the United States does end up importing 14 million barrels a day of oil. It is not merely rhetoric, but absolute necessity, to find some ways to make this alliance clear to the various participants. Our proposal reconciles their interests.

Moreover, we wish to stress the need for greater understanding among normally warring parties. For instance, public interest groups must understand the substantial and complex difficulties faced by utilities as they try to adapt to the new energy era. Utilities should be partners in the promotion of conservation and solar energy. The exclusion of utilities from the conservation business in the 1978 National Energy Act was, in this connection, not some minor mistake, but a major blunder, creating a very significant and totally unnecessary barrier to the exploitation of conservation possibilities.

X

In sum, the government must lead, for the only thing that is going to happen "automatically" in the years immediately ahead is an ever greater stream of imported oil. But government leadership does not mean government management. Rather, it means correcting market defects in a way to create more jobs and more business opportunities for both large established companies and small new firms with a stake in conservation and solar energy.

The balanced program we suggest seems politically more workable than other proposals. Of course, there is an important variation that some would offer as at least theoretically possible. That would be to take our principle of the "fair chance" and also apply it to conventional domestic resources by giving financial incentives to producers of domestic energy: oil, gas, coal, and nuclear power. But we have serious doubts that this program would be politically acceptable.44 For some time, the government has not even allowed finders of new oil and gas to obtain world prices. To obtain a large premium over world prices would seem completely impossible, at least for many years to come. It must be recognized that many people question whether even world prices, much less a financial incentive in addition to world prices, would be justified by the incremental domestic energy forthcoming. This is especially the case, given the lack of success in keeping U.S. oil and gas reserves from declining even after the dramatic price jumps that have occurred since 1973, and given the environmental costs and resultant political barriers associated with coal and nuclear power. Furthermore, analyses-albeit of a preliminary nature-suggest that even without considering external costs, conservation and solar energy are cheaper for at least an additional ten mb/d of oil equivalent than are conventional energy sources.45

There are many who do not wish to face this reality. They would still say that if the financial incentives proposed here for conservation and solar energy were also given to producers of conventional sources, then the pay-off would be as good or even better. We would reply that substantial effort has already gone into conventional production. Conservation and solar energy are, on the other hand, largely untested possibilities, and yet the effort required to exploit them seems doable and economic, and also less socially disruptive than trying to force too much from conventional sources.

The matter can be expressed thusly: our conventional energy production-oil, gas, coal, and nuclear-may be thought of as an already well-explored producing region. We favor continuing and augmenting production in that terrain. No reader should mistake our commitment there. But, in terms of allocating resources and effort for further major increments of energy, the evidence strongly indicates that the nation would be better served by concentrating its exploratory and development "drilling" in the highly promising but still largely untested acreage of conservation and solar energy.

What we propose here would represent the beginning of a realistic transition for the United States away from ever-growing and ever more dangerous dependence on foreign oil. No other nation has so great an impact on the entire international energy system. It is time for the United States to come to terms with the realities of the energy problem, not with romanticism, but in a pragmatic and reasonable way-and not out of altruism, but for the most pressing reasons of self-interest.

Footnotes

3 These estimates, with sources and underlying assumptions, including elasticities, are discussed at length in Chapter 2 of our Energy Future Report.

5 The conclusion on drilling costs holds for both wells and footage. Footage drilled also increased substantially. Recent additions to reserves have been far below those added annually for at least two decades before 1973. U.S. proven reserves and production of oil both peaked in 1970, when reserves of crude oil reached 39.0 billion barrels (with the addition of Prudhoe Bay). See the most recent annual report of the Energy Information Administration, Annual Report to Congress Vol III-1977, Washington: GPO, May 1978 (cited hereafter as Annual Report); Monthly Energy Review, January 1979; American Petroleum Institute statistics; and Oil and Gas Journal, December 25, 1978, p. 103.

6 For examples to support this and the next paragraph, see discussions in Energy: An Uncertain Future, cited in footnote 1 above, especially the chart on p. 239.

8 The $16-$28 represents estimates from 1977 and early 1978 adjusted by us for inflation to early 1979. Dr. Armand Hammer of Occidental Petroleum has stated that his company, which is developing an in situ process, would earn a 15 percent return on Occidental's investment based on the U.S. price paid for OPEC oil in early 1978 ($14.50 per barrel, or about $16 in early 1979 dollars). Some other companies think that Dr. Hammer's estimates of required price are too low-Cities Service and Continental Oil, for example. The latter estimates Occidental's costs at $16-$26 a barrel. See Business Week, January 30, 1978, p. 55. A recent Rand study indicates required prices of $23 to $29 per barrel for surface retorting. Edward W. Merrow, Constraints on the Commercialization of Shale Oil (Santa Monica, CA.: Rand, September 1978), p. vii. For earlier estimates of the production costs of shale oil, see Federal Energy Administration, Project Independence, Potential Future Role of Oil Shale: Prospects and Constraints, Washington: GPO, 1974.

10 This is our conclusion after an extensive study of available literature, which is quite large. For samples of work tending to support divestiture, see Paul Davidson's and Walter Measday's chapter in David J. Teece, ed., R&D in Energy, Stanford: Institute for Energy Studies, 1977. For work tending not to support divestiture, see other chapters in Teece's book plus Edward J. Mitchell, ed., Vertical Integration and Vertical Divestiture in the Oil Industry, Washington: American Enterprise Institute, 1976.

11 This section on natural gas is based primarily on the work of I. C. Bupp and Frank Schuller in our Energy Future Report; data on reserves, production, exploration and development are from the sources cited above in footnote 5.

12 This estimate is based on economic values of natural gas at world energy prices rather than the value with prices controlled by law or long-term contracts. U.S. proven reserves of natural gas were the equivalent of 44 billion barrels of crude oil at the end of 1973, and the OPEC price rises of 1973-74 increased world oil prices, in round numbers, by about $10 a barrel (in 1978 dollars). Our estimate of $400 billion has not been corrected by discounting future cash flows to obtain present value, nor does it consider enlargement of reserves. Similarly, the value of oil reserves also increased by about $400 billion.

13 See Energy Research and Development Administration, Market Oriented Program Planning Study-I, Washington: GPO, 1976. Early 1979 prices for new gas approximated $2.00/mcf. In 1974, two MIT economists, Paul W. MacAvoy and Robert S. Pindyck, constructed an econometric model that predicted that if the government stopped controlling the wellhead price of interstate gas, domestic discoveries would climb to 33 tcf per year by 1980 at a price of $1.00/mcf (At the time of their estimate, the national average of controlled prices for new discoveries was $0.54/mcf.) MacAvoy and Pindyck, Price Controls and the Natural Gas Shortage, Washington: American Enterprise Institute, 1975, p. 57. This estimate now seems implausible. For the limitations of energy models generally, see the Appendix to our Energy Future Report.

The estimates of 332 to 655 tcf are from Energy: An Uncertain Future, cited in footnote 1 above, p. 59. Earlier estimates by the U.S. Geological Survey and the CIA also showed a very wide range. A summary of 1975 estimates appears in the U.S. Geological Survey Circular, 725, 1975. U.S. Central Intelligence Agency, The International Energy Situation: Outlook to 1985, Washington, April 1977.

16 The most authoritative study that we have seen is U.S. Congress, Office of Technology Assessment, Transportation of Liquefied Natural Gas, Washington: GPO, 1977. Our account of the LNG situation draws heavily on this source. Also see Edward K. Fariday, LNG Review: 1977, Energy Economics Research Limited, 1978.

17 This section on coal is based primarily on Mel Horwitch's work in our Energy Future Report. For information on reserves, see U.S. Federal Energy Administration, Fuel Task Force Report on Coal: Project Independence, Washington: GPO, November 1974; 1977 Keystone Coal Industry Manual, New York: McGraw Hill, 1977.

18 For recent general assessments, see National Electric Reliability Council, 8th Annual Review, August 1978; Federal Energy Regulatory Commission, Status of Coal Supply Contracts; General Accounting Office, U.S. Coal Development-Promises, Uncertainties, EM-77-43, September 22, 1977; Balaji Chakravarthy, "Adapting to Change in the Coal Industry: A Managerial Perspective," Doctor of Business Administration dissertation, Harvard Business School, 1978; Congressional Research Service, Natural Energy Transportation: Issues and Problems, Vol. 3, March 1978.

19 Roger Detman (C. F. Braun and Co.), "Preliminary Economic Comparison of Six Processes for Pipeline Gas from Coal," Presentation to the Eighth Synthetic Pipeline Gas Symposium, Chicago, Illinois, October 18-20, 1976; William F. Henderson, Jr., "Prospects for the Commercialization of High BTU Coal Gasification," R02294, Santa Monica (Ca.): Rand Corporation, 1978; Earl T. Hayes, "Energy Resources Available to the United States, 1985 to 2000," Science, January 19, 1979, p. 238; and Chemical Week, November 8, 1978, p. 36.

20 As shown in Table I, recent estimates by the Department of Energy indicate substantially lower coal production than President Carter's goal. Many observers do not share our outlook. A series of models analyzed in 1978 by the Energy Modeling Forum at Stanford University generally supported the conclusion that President Carter's goal of doubling annual coal production from 685 million tons in 1977 to 1.2 billion tons by 1985 could be met. (U.S. consumption is slightly lower because of exports.) The models, however, specifically did not consider some of the factors that we think will prove to be the critical barriers, including, in the language of the report, "uncertainties about such issues as air pollution controls, coal mine reclamation, other mining regulations (including leasing and permit policy for Western coal), pricing regulations . . . the availability of the capital, labor, materials, equipment, land, and water resources needed . . . [and] declines in underground mining productivity." Energy Modeling Forum, Coal in Transition: 1980-2000, Stanford University, July 1978, EMF Report 2, Vol. 1, p. v.

21 This section is based primarily on the work of I. C. Bupp in our Energy Future Report. Also, see I. C. Bupp and J. C. Derian, Light Water: How the Nuclear Dream Dissolved, New York: Basic Books, 1978.

22 Alvin M. Weinberg, "Energy Policy and Energy Projections: The Case of a Nuclear Moratorium," Address to the Atomic Industrial Forum Conference on United States Energy Policy, Washington, D.C., January 1977; and industry trade journals.

23 For further detail on this and succeeding paragraphs, see Alan Jakimo and Irvin C. Bupp, "Nuclear Waste Disposal: Not in My Backyard," Technology Review, March/April 1978. We have also used unpublished data from the Office of Nuclear Policy, Department of Energy.

24 Executive Office of the President, Office of Science and Technology, "Isolation of Radioactive Wastes in Geological Repositories: Status of Scientific and Technological Knowledge," a working paper prepared for the Interagency Review Group on Nuclear Waste Management, July 3, 1978. See also U.S. Department of Energy, Directorate of Energy Research, "Report of Task Force for Review of Nuclear Waste Management," DOE/ER-0004/D, February 1978; and Executive Office of the President, Office of Science and Technology Policy, "Report of the Subgroup on Alternative Technology Strategies," Interagency Review Group on Nuclear Waste Management, August 7, 1978. See also: Office of Science and Technology Policy, "Alternative Technology Strategies for the Isolation of Nuclear Wastes: Report of Subgroup One," September 8, 1978.

25 This section is based primarily on work by M. A. Maidique in our Energy Future Report. The one mb/d estimate of oil equivalent excludes some wood burning, because of inadequate data. For general background on active systems, see Bruce Anderson, Solar Energy: Fundamentals in Building Design, New York: McGraw Hill, 1977, Parts III, IV, V. For details, see Solar Energy, Domestic Policy Review, Domestic Policy Review Integration Group, Washington, D.C., August 25, 1978. See also Fred S. Dubin, "Solar Energy Design for Existing Buildings," ASHRAE Journal, November 1975.

26 Market estimates are from Sheldon H. Butt, President, Solar Energy Industries Association (SEIA), Keynote Address, SEIA Convention, Phoenix, Arizona, February 1978; Federal Energy Administration, Solar Collector Manufacturing Activity Report, July through December 1975, March 1976. We have also drawn on interviews with solar suppliers and installers, and with government officials.

27 Alan N. Poole and Robert H. Williams, "Flower Power," Bulletin of Atomic Scientists, May 1976; John R. Benemann, Biofuels: A Survey, Special Report (EN-746-SR), Palo Alto (Ca.): Electric Power Research Institute, June 1978. On wood pellets, see Allen C. Hammond, "Photosynthetic Solar Energy: Rediscovery Biomass Fuels," Science, August 19, 1977.

28 See Bruce Chalmers, "The Photovoltaic Generation of Electricity," Scientific American, November 1976; John C. C. Fan, "Solar Cells: Plugging Into the Sun," Technology Review, August-September 1978.

29 See Joel Darmstadter, Joy Dunkerley and Jack Alterman, How Industrial Societies Use Energy, Baltimore: Johns Hopkins Press, 1977.

30 See U.S. Federal Task Force, Motor Vehicle Goals Beyond 1980, Washington: Energy Resources Council, 1976; Richard John, Philip Coonley, Robert Ricci and Bruce Rubinger "Mandated Fuel Economy Standards as a Strategy for Improving Motor Vehicles Fuel Economy," paper presented at the Symposium on Technology, Government, and the Future of the Automobile Industry, Harvard Business School, October 19, 1978.

31 G. N. Hatsopoulos, E. P. Gyftopolous, R. W. Sant, and R. F. Widmer, "Capital Investment to Save Energy," Harvard Business Review, March-April 1978.

34 Ibid. The IBM experience is described in its 1977 Annual Report, p. 33.

39 In addition, some analysts estimate that conventional domestic energy sources have already received subsidies greater than $120 billion, and that producers are continuing to receive subsidies. Battelle Memorial Institute, An Analysis of Federal Incentives Used to Stimulate Energy Production, Springfield (Va.): National Technical Information Service, March 1978.

40 Some studies have attempted to overcome this error by giving all housewives the value of a domestic servant or using time-motion studies to price housewives' services as though person-hours from the labor force were purchased as a replacement. Psychic values, pain, and suffering are omitted. See Barbara S. Cooper and Dorothy P. Rice, "The Cost of Illness Revisited," Social Security Administration, DHEW Publication No. (55A) 76-11703, reprinted from the Social Security Bulletin, February 1976, U.S. Department of Health, Education, and Welfare.

41 Remarks by Roger Sant to the Conference Board, Federal Energy Administration release, September 30, 1975.

42 The enactment in California of a tax credit of 55 percent for solar installations caused a boom in the solar industry in that state, as discussed in our Energy Future Report.

43 In our Energy Future Report, although we call for considerably larger financial incentives than those contained in the National Energy Act of 1978 (providing for tax credits of up to 15 percent for conservation, with a $300 limit, and 15-30 percent for solar installation, with a $2200 limit), the taxes collected by the government from the windfall would sustain the general range of tax credits (or other incentives) likely to be given for conservation and solar energy under our recommendations. Note that the rationalization of gas prices, so that consumers paid market value, would also require the deregulation of old gas, which would presumably also be accompanied by some kind of windfall tax on the profits.

44 A variation of this alternative would call for a tariff sufficiently large on imported oil to allow all domestic energy prices to rise substantially above world levels and to raise the price of electricity to a level equivalent to replacement costs. We do not believe that this is a politically viable alternative.

45 For conservation, see Roger Sant, "A Preliminary Assessment of the Potential to Adjust Capital Stock to Higher Energy Using Efficiencies," (mimeographed) presented to the Annual National Meeting of the American Association for the Advancement of Science, Washington, D.C., February 14, 1978; and for conservation and solar energy, see Chapters 6 and 7, respectively, in our Energy Future Report.

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  • Robert Stobaugh and Daniel Yergin are co-editors of Energy Future: Report of the Energy Project at the Harvard Business School (to be published in 1979 by Random House) with I. C. Bupp, Mel Horwitch, Sergio Koreisha, M. A. Maidique, and Frank Schuller. Professor of Business Administration at the Business School, Robert Stobaugh is director of the Project. Daniel Yergin is a Lecturer at the Kennedy School at Harvard and directs the International Energy Seminar at the Center for International Affairs. This article reflects the main conclusions of the Energy Future Report, and is based on the six-year research program that lies behind that study.
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