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March 28, 1 980

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SynfuelSubsidy?
Early this month, House-Senate conferees
approved legislation which would create an
independent, Federally-owned corporationthe Synthetic Fuels Corporation -to foster
the commercial production of synthetic fuels
(synfuels) within the United States.These
synfuels would include any liquid, gaseous
or solid fuels produced from nonconventiona I materials-such as coal; shale, tar
sands and biomass (vegetable matter) -for
use as substitutes for petroleum and natural
gas. Prospects appear favorable for passage
of the legislation.
Under a two-stage program, the legislation
is designed to give private industry the
capability to produce synthetic fuels, by
1 995, at a rate of 1.5 million barrels of oil
equivalent per day. The Corporation would
receive spending authority of $20 billion
immediately upon passage of the legislation,
to foster the development of different
technologies among a diverse group of
industrial firms. Four years later, it would
receive an additional $68 billion in spending
authority, to encourage commercialization
of the most promising technologies. Both
phases would be subject to the Congressionalappropriation process.
The Corporation could provide industrial
firms with several types of incentives, listed
in order of priority: purchase agreements and
price guarantees, loan guarantees, and direct
loans. As a last resort, it also could enter into
joint government-private ventures as
a minority shareholder. The Administration
originally proposed that the program be
funded from the "windfall profits taxI/-that
is, from the extra revenues earned by oi I
companies under the program of gradual
price decontrol-but
those funds now
appear to be earmarked for other purposes.

Arguments for subsidies
Supporters of the synfuel legislation base their
case largely on grounds of national security.

They recognize that domestic production of
synthetic fuels is not commercially feasible at
current world oil prices. But they maintain
that synthetic fuels are essential to reduce the
nation's heavy dependence on foreign oil,
and that government assistance to private industry is necessary to accelerate the commercialization process. The social benefits to be
derived from reduced oil imports-namely,
greater security of energy supply and a lower
world oil price than might otherwise prevailthus justify government intervention.
Most policymakers agree that the United
States needs to reduce its heavy dependence
on foreign oil. In 1979, the nation imported
8.1 million barrels of oil per day, equivalent
to 42 percent of its total petroleum requirements. Th is degree of foreign dependencewhich could rise further-exposes the United
Statesto a high risk of serious supply interruption and economic dislocation, either
because of a cutoff of imports or further OPEC
price hikes.

Replacing the price system
Critics question, however, whether government subsidies are required to achieve the
goal of increased energy security. Further,
they question whether synthetic fuels provide
the least-cost alternative for achieving a given
reduction in imports.
In a free market, commercial production
of synfuels would begin when the world price
of oil had risen to the point where their
production was economically justified. One
major criticism of the proposed program
centers around the difficulty of determining
the relative efficiency of various alternatives,
once the allocation process is transferred
from the price system to government. For
example, Congress has no way of knowing
whether the magnitude of the proposed
synfuel subsidy would be adequate enough,
(or more than adequate) to close the gap
between the cost of synfuel technologies and
the world price of oil.

Butthe legislation could lock the government
into a costly subsidy program, when more
cost-effective means are available of reaching the desired 1.5 million bid reduction in
imported oil.

If the differentials between their cost and the
world price widen over time, $88 billion in
subsidies may prove insufficient to bring forth
significant synfuel production by 1 995. In
that case, more billions of tax dollars might
have to be sunk into synfuel technologies to
bring them to commercial production. On
the other hand, if certain technologies were
to become commercially feasible through the
market process, there wou Id have been no
need for government assistance in the first
place. The synfuel program thus may be seen·
as a means of transfering the risk with regard
to the uncertain outlook for world oil prices
from the private to the public sector.

Alternative approach?
Critics of the synfuel program tend to
disapprove of any kind of government
interference in the nation's energy markets.
But they argue that if the government is to
intervene at all to reduce imports or enhance
energy security, there are more cost-effective
means than synfuel subsidies for reaching
the desired 1.5 million bid reduction in
imported oil. they point out that conservation is by far the most cost-effective way to
"produce" energy, and therefore should
have the top priority for government fi nancial
assistance. Aside from higher domestic
petroleum prices, they favor, for example,
programs to promote the installation of
insulation in buildings, the development
of solar hot-water and space-heating systems,
and the production of more energy-efficient
consumer goods and industrial technologies.
Development of a strateg.icpetroleum reserve
also would be a cost-effective method of
enhancing energy security.
In their view, rising oil imports result partly
from existing government regulations. For
years Federal price controls have held the
average price for domestically-produced
crude oi I and natural gas below world market
levels. This policy serves both to stimulate
domestic consumption and to reduce
domestic production of these fuels. In the
case of crude oil, the entitlement program
actually subsidizes foreign imports, by
requiring refiners with access to lower-cost
domestic crude to pay refiners using highercost imported oil an amount sufficient to
equalize the effective acquisition cost of all
available oil.
Critics claim that the most efficient means
of reducing oil imports would involve an
immediate decontrol of prices of domesticallyproduced crude oil and natural gas, rather
2

than the present pol icy of gradual decontrol
coupled with a windfall-profits tax. By providing increased price incentives, immediate
decontrol would both stimulate domestic
production and reduce consumption of conventional fuels.

Germany during World War II, and are being
produced today in South Africa. The capital
expend itu res requ i red for the development of
an entire synfuel industry would be huge. The
capital outlays required for individual commercial projects, although high -ranging
from $1.0 to $1.5 billion for a small 50,000
b/d size plant -are dwarfed however by the
costs of other privately-financed energy
projects such as the $9-billion Alaska oil
pipeline. The private energy industry thus
appears capable of bringing synfuel technologies into production, and perhaps at
considerably lesscostthan would be incurred
by the Synthetic Fuels Corporation.
Yvonne levy

Immediate decontrol, however, would not
speed up the commercial ization of synthetic
'fuels, because the cost of most such fuels
wou Id stiII be much higher than the
$28/barrel average contract price of OPEC
oil, with which synthetic fuels would have to
compete. According to Department of Energy
estimates, such costs would range from $32
for shale oil (surface retorting) to $38 for
either coal liquids and fuels produced from
biomass, in 1979 dollars per barrel of
crude-oil equivalent.
A synfuel-subsidization program would aim
to encourage the commercialization of those
fuels at an earlier date than might be economically justified, by requiring taxpayers to
finance the difference between synfuel production costs and the world oil price. Synfuel
production under such circumstances would
represent an inefficient use of society's scarce
resources, and thus would require justification on national security or other grounds.
Critics see Iittle merit to the argument that
there are special risks associated with the
commercialization of synfuel technologies
that make government intervention a
necessity to bring them to production. The
technological and market risks ascribed as
"special" -advanced technology, large
capital requirements, long lead times,
uncertain market prices-actually are
characteristic of all emerging technologies
which are not yet economic at current prices
for competitive products. Thus, those
obstacles would disappear in the present case
as world oil prices continue rising.
The technical feasibility of synfuels has long
been proven. Shale oil was first produced in
Britain in the 1850's. Gaseous and liquid
hydrocarbons were produced from coal in
3

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B AN KI NG DATA-TWE LF TH FEDERAL
RESERVE
DISTRICT
(Dollar amounts in millions)

SelectedAssetsand Liabilities
large Commercial 8anks
Loans (gross, adjusted) and investments*
Loans (gross, adjusted) - total #
Commercial and industrial
Real estate
Loans to individuals
Securities loans
U.s. Treasury securities*
Othersecurities*
Demand deposits - total #
Demand deposits - adjusted
Savings deposits - total
Time deposits - total #
Individuals, part. & corp.
(Large negotiable CD's)

Weekly Averages
of Daily Figures

Amount
Outstanding
3/12/80
138,612
116,463
33,639
44,982
24,496
1,290
6,736
15,413
43,994
32,015
27,611
60,372
51,756
21,414
Weekended
3/1 2/80

Change from
year ago
Dollar
Percent

Change
from
3/5/80

+
+
+
+
-

+
+
-

+
+
+
+

+
+
+
+
+

231
193
74
165
25
165
31
7
663
484
266
526
559
85

-

+
+
+
-

+
+
+

Weekended
3/5/80

16,812
17,106
4,565
8,834
3,573
210
1,040
746
3,652
2,354
2,121
9,826
10,704
3,290

+
+
+
+
+
-

+
+
+
+
+
+

13.8
17.2
15.7
24.4
17.1
14.0
13.4
5.1
9.1
7.9
7.1
19.4
26.1
18.2

Comparable
year-ago periOd

Member 8ank ReservePosition
Excess Reserves (+ )/Deficiency ( - )
Borrowings
Net free reserves (+ )/Net borrowed( -)

11
182
171

-

65
250
185

55
27
29

Federal Funds**

* Excludes trading account securities.
# Includes items not shown separately.
** The revised series on Federal Funds and Repurchase Agreement Borrowings (FR 2415) is available on
request from the Statistical and Data Services Department of the Federal Reserve Bank of San Francisco.

Editorial comments may be addressed the editor (William Burke) or to the author .... Freecopiesof this
to
and other FederalReservepublications can beobtained by calling or writing the Public Information Section,
FederalReserveBank of SanFrancisco,P;O. Box 7702, SanFrancisco94120. phone (415) 544-2184.

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