Full text of Oil Imports and Energy Security : Hearings Before the Ad Hoc Committee on the Domestic and International Monetary Effect of Energy and Other Natural Resource Pricing of the Committee on Banking and Currency, House of Representatives, Ninety-Third Congress, Second Session, August 9 and 12, 1974
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OIL IMPORTS AND ENERGY SECURITY HEARINGS BEFORE T H E A D HOC COMMITTEE ON T H E DOMESTIC I N T E R N A T I O N A L M O N E T A R Y EFFECT OF A N D OTHER N A T U R A L RESOURCE AND ENERGY PRICING OF T H E COMMITTEE ON BANKING AND CURRENCY HOUSE OE REPRESENTATIVES NINETY-THIRD SECOND CONGRESS SESSION AUGUST 9 AND 12, 1974 P r i n t e d f o r t h e use of the C o m m i t t e e on B a n k i n g a n d C u r r e n c y U.S. GOVERNMENT PRINTING OFFICE 38-387 WASHINGTON : 1974 C O M M I T T E E ON B A N K I N G A N D C U R R E N C Y W R I G H T P A T M A N , Texas, Chairman W I L L I A M A . B A R R E T T , Pennsylvania L E O N O R K . (MRS. J O H N B.) S U L L I V A N , Missouri H E N R Y S. REUSS, Wisconsin T H O M A S L. A S H L E Y , Ohio W I L L I A M S. M O O R H E A D , Pennsylvania R O B E R T G. S T E P H E N S , JR., Georgia F E R N A N D J. ST G E R M A I N , Rhode Island H E N R Y B. G O N Z A L E Z , Texas J O S E P H G. M I N I S H , New Jersey R I C H A R D T . H A N N A , California T O M S. G E T T Y S , South Carolina F R A N K A N N U N Z I O , Illinois T H O M A S M. R E E S , California JAMES M. H A N L E Y , New York F R A N K J. B R A S C O , New York E D W A R D I . K O C H , New York W I L L I A M R . C O T T E R , Connecticut P A R R E N J. M I T C H E L L , Maryland W A L T E R E . F A U N T R O Y , District of Columbia A N D R E W Y O U N G , Georgia J O H N J O S E P H M O A K L E Y , Massachusetts F O R T N E Y H . ( P E T E ) S T A R K , California L I N D Y ( M R S . H A L E ) B O G G S , Louisiana W I L L I A M B. W I D N A L L , New Jersey A L B E R T W. J O H N S O N , Pennsylvania J. W I L L I A M S T A N T O N , Ohio B E N B. B L A C K B U R N , Georgia G A R R Y B R O W N , Michigan L A W R E N C E G. W I L L I A M S , Pennsylvania C H A L M E R S P. W Y L I E , Ohio M A R G A R E T M. H E C K L E R , Massachusetts P H I L I P M. C R A N E , Illinois J O H N H . R O U S S E L O T , California S T E W A R T B. M c K I N N E Y , Connecticut B I L L F R E N Z E L , Minnesota A N G E L O D . R O N C A L L O , New York J O H N B. C O N L A N , Arizona C L A I R W. B U R G E N E R , California M A T T H E W J. R I N A L D O , New Jersey PAUL NELSON, Clerk and Staff Director CURTIS A . PRINS, Chief Investigator BENET D . GELLMAN, Counsel JOSEPH C. LEWIS, Professional Staff Member DAVIS COUCH, Counsel ORMAN S. FINK, Minority Staff Director A D H O C C O M M I T T E E ON T H E D O M E S T I C A N D I N T E R N A T I O N A L M O N E T A R Y OF E N E R G Y A N D O T H E R N A T U R A L R E S O U R C E P R I C I N G EFFECT T H O M A S M . R E E S , California, Chairman J O S E P H J. M I N I S H , New Jersey JAMES M . H A N L E Y , New York F R A N K J. B R A S C O , New York E D W A R D I . K O C H , New York W I L L I A M R . C O T T E R , Connecticut A N D R E W Y O U N G , Georgia F O R T N E Y H. (PETE) STARK, California J. W I L L I A M S T A N T O N , Ohio G A R R Y B R O W N , Michigan C H A L M E R S P. W Y L I E , Ohio M A R G A R E T M. H E C K L E R , Massachusetts S T E W A R T B. M c K I N N E Y , Connecticut B I L L F R E N Z E L , Minnesota A N G E L O D . R O N C A L L O , New York <n) CONTENTS STATEMENTS Pag* D r . M i l t o n Russell, D r . Douglas R . Bohi, a n d N a n c y M c C a r t h y , cons u l t i n g economists, Southern Illinois U n i v e r s i t y , Garbondale (ill) OIL IMPORTS AND ENERGY SECURITY F R I D A Y , AUGUST 9, 1974 HOUSE OF R E P R E S E N T A T I V E S , A D DOMESTIC AND HOC INTERNATIONAL COMMITTEE ON MONETARY EFFECT THE OF E N E R G Y A N D O T H E R N A T U R A L R E S O U R C E P R I C I N G OF T H E COMMITTEE ON B A N K I N G AND CURRENCY, Washington, D.C. The committee met, pursuant to notice, at 10:15 a.m., i n room 2222, Rayburn House Office B u i l d i n g , H o n . Thomas Rees [chairman] presiding. Present: Representatives Rees, Hanley, Stanton, Frenzel, and Roncallo. Also present: D r . Douglas R. Bohi, D r . M i l t o n Russell, and Nancy McCarthy Snyder, consulting economists. M r . R E E S . I w i l l call this meeting to order. The purpose of this meeti n g is to have a staff presentation of p a r t I I of the ad hoc committee's study on the p r i c i n g of energy and other natural resources. P a r t I of the study, which was given to the members of the committee several weeks ago, dealt w i t h how we got to where we are i n our energy situation. Part I I of the study is an approach to what m i g h t happen i n the future, and the f o r m a l t i t l e is " O i l Imports and Energy Secur i t y : Future Prospects." Much of this study relates to Project Independence projections of what we can produce i n this country by 1985, what the cost w i l l be, what the various options of the O P E C countries might be. The economists who have been w r i t i n g part I and part I I are f r o m Southern I l l i n o i s University, Carbondale: D r . Douglas R. Bohi, D r . M i l t o n Russell, and Nancy McCarthy Snyder. I w i l l now t u r n the meeting over to them to give us an outline of part I I . STATEMENTS OP DR. MILTON RUSSELL, DR. DOUGLAS R. BOHI, AND NANCY MCCARTHY SNYDER, CONSULTING ECONOMISTS, SOUTHERN ILLINOIS UNIVERSITY, CARBONDALE Ms. S N Y D E R . P a r t I of the study was devoted to analysis of the current energy situation. B y p u t t i n g the energy shortage i n economic perspective, we hope to provide a basis for predicting future supply and demand levels, and to establish criteria on which energy security policy should be based. The course that the U n i t e d States w i l l ultimately follow w i t h respect to energy w i l l have a significant impact on the entire international system. W e conclude i n part I that the crisis of 1973-74 was a problem of adjusting to higher energy prices without advanced warning. I t was not a problem of exhausting the w o r l d resource base. The s h i f t i n the (l) 2 international petroleum market f r o m a cartel of international o i l companies to a cartel o f oil-producing countries has had a market effect on the security o f U.S. energy supplies. Domestic energy output has been affected by the degree of competit i o n i n the domestic energy industry. A number of factors contributed simultaneously t o the energy shortage of 1973-74. I n addition to i m p o r t quotas, price controls and State p r o r a t i o n i n g policies, the regul a t i o n of n a t u r a l gas prices increased demand and reduced supply. Productive capacity i n the coal industry had been declining over a long period and the development of nuclear electric generating capaci t y was delayed. E n v i r o n m e n t a l constraints increased the demand f o r energy at the same t i m e t h a t they reduced the use of some forms of energy. Combined w i t h these factors was the fact t h a t the rate of g r o w t h of energy demand, accelerated by worldwide economic boom, increased faster t h a n expected. I n general, the energy crunch was the result of a series of policies t h a t prevented smooth operation of market forces and s t i m u l a t i n g domestic output and restricting domestic demand i n an orderly way. A s a result ox the shortages and the g r o w i n g power of the O P E C cartel, i m p o r t e d petroleum prices rose drastically between 1971 and 1974, f r o m less t h a n $3 per barrel to more t h a n $12 per barrel. T h e conclusion of this review of the situation is t h a t our basic problem f o r the f u t u r e w i l l be one of uncertainty, not only w i t h respect t o the supply of energy, b u t w i t h respect to the price at w h i c h t h a t supply w i l l be available t o us. P a r t I I of our study deals w i t h the problems and issues involved i n achieving and m a i n t a i n i n g secure energy supplies i n the coming years. A s our dependence on imports grows, our v u l n e r a b i l i t y to another embargo increases. Such an event w o u l d require large supply and demand adjustments i n this country. Chapter 6 focuses on these adjustments. W e conclude t h a t the energy consumers w i l l have to bear the m a j o r burden of any shortage f o r a period of approximately 2 years or more. I t w i l l take at least that l o n g f o r the domestic energy industry to increase supply significantly, assuming the m a x i m u m cooperation f r o m a l l sectors of the economy. T h e costs o f adjustment are h i g h , and i t w i l l be difficult to mobilize the resources necessary to meet the requirements of the domestic indust r y i n an emergency. W e must therefore take some action to protect ourselves against the uncertainties of energy supply and price t h a t confront us. T h e options available t o us are many. W e can protect ourselves f r o m shortrun interruptions. Acceptance of a p l a n of this nature w o u l d hinge upon the threat of embargo, w h i c h i n t u r n depends on the international situation. W e must therefore pay careful attention to O P E C behavior. A n o t h e r option f o r us is to isolate ourselves completely f r o m the international situation by becoming self-sufficient. A l t e r n a t i v e l y we could devise domestic policies t h a t m a i n t a i n l o n g r u n energy security i n an open economy. A n y policy decision must be based on some expectation of f u t u r e magnitudes of energy supply, demand, and price. Discussion of the security risks i m p l i e d by dependence on foreign energy, analysis of the policy options t o reduce these risks, and estimations of f u t u r e U.S. energy supply-demand balance are the next subjects. 3 D r . B O H I . The next chapter i n p a r t I I , chapter 7 , is concerned w i t h an estimate of lower bound price of imported oil. W e have already talked about this i n p a r t 1 and was shifted f r o m p a r t 1 t h a t was concerned w i t h history, to p a r t I I , which is hypothesis, g i v i n g a cleaner break between the two. Let me briefly cover some of the things we talked about i n this chapter. The point of reference here is to suppose the cartel collapses, perhaps due to the weight of excess capacity, and w o r l d prices f e l l : H o w f a r would they f a l l ? W h a t is the lower l i m i t ? I n this chapter we estimate that the lower l i m i t is $3 per barrel, landed U.S. east coast. Y o u may ask w h y is that important. W e l l , i t gives a view of the lower bound extreme that domestic industry may be faced w i t h i n the future, and may show why they are somewhat reluctant to make investments i n very h i g h l y capital intensive areas, w i t h the h i g h average cost of production, which simply could not compete w i t h these prices. Certainly, the lower extreme must be taken into consideration f o r any future policy decisions about Project Independence and self-sufficiency. I t is not a forecast of what w i i l happen, but simply an extreme of what may happen. Incidentally, i t need not actually happen to have its discouraging effect upon investment. Just the prospect that i t could happen is sufficient. The estimate is based upon production costs i n the Persian G u l f and delivery costs to the U n i t e d States, because we believe that that area w i l l be the price-determining area f o r w o r l d prices. The most uncertain element about the price is, of course, the amount of royalty that w i l l be required to induce host countries to part w i t h their oil rather than leave i t i n the ground. Our m i n i m u m here is a dollar a barrel, largely based on past experience. Chapter 8 is concerned w i t h estimates of future oil imports. W e developed i n this chapter a range of estimates of i m p o r t demand based on a range of supply and demand projections i n the U n i t e d States. They range f r o m a set of optimistic supply and demand conditions to relatively pessimistic supply and demand conditions. I f you take these extreme conditions as equally likely, the best point estimate of the outcome f o r 1985 is simply the midpoint. Our estimate is 7.6 m i l l i o n barrels a day, w h i c h amounts to 35 percent of future consumption, or not much different t h a n i t is r i g h t now. I f you take the approach t h a t energy policy must be geared to the pessimistic outcome, which we believe i t should, then you have to take into consideration the upper extreme. I n our subsequent discussion of policy alternatives we start w i t h the m i d p o i n t estimate, then go up to the upper extreme of 15 m i l l i o n barrels a day, or about 55 percent of U.S. o i l consumption. These estimates are based largely on the National Petroleum Council's projections t h a t were published i n 1972, but they have been modified by some current events, namely the increases i n crude o i l prices. W e assume also i n these projections that natural gas prices w i l l be deregulated. Essentially the forecast assumes that the current price of crude oil of around $8 a barrel w i l l persist indefinitely. Given that price assumption, what is the likely availability of all energy, especially crude o i l and the demand for energy. The supply and demand estimates, ranging f r o m the pessimistic to the optimistic, are balanced assuming 4 t h a t a l l energy supplies t h a t could be available w i l l be used, except perhaps coal and nuclear power. The projections assume t h a t up to 74 percent of electrical generation w i l l be satisfied by coal and nuclear power. B u t even assuming that, there w i l l s t i l l be an excess a v a i l a b i l i t y of potential coal and nuclear power. So not a l l potential supplies w i l l be used. T h e gap t h a t results between the supply and demand estimates implies t h a t we must i m p o r t the gap or that domestic prices must rise. The rest o f this chapter supposes t h a t imports do i n fact satisfy the s h o r t f a l l i n domestic energy supply. T h e range o f estimates already given, the 7.6 to 14.8 m i l l i o n barrels—are broken down by l i k e l y sources of imports. The m i d p o i n t estimate, as I pointed out before, is about the same as current experience. So we simply expect that the same pattern of imports would exist i n 1985, too. The increase over today's experience we would expect to come f r o m the Persian G u l f countries and Nigeria. I n short, the estimated volume of A r a b imports i n t h a t m i d p o i n t estimate comes to nearly 2 m i l l i o n barrels a day, which is a b i t more t h a n current estimates, and that amounts to slightly over 8 percent of U.S. consumption i n 1985. A s f o r the upper estimate, the difference between this m i d p o i n t estimate and the 15 m i l l i o n barrels a day upper estimate is largely expected to come f r o m A r a b sources. Consequently, i n the upper case A r a b imports rise to 7.9 m i l l i o n barrels a day, or nearly 30 percent of U.S. consumption. T h a t pretty much covers the h i g h l i g h t s i n this chapter. Chapter 9, then, goes on to discuss the nature of the security risks i m p l i e d by these projections, specifically, the necessary increases i n domestic prices that would be required to reduce i m p o r t demand. The m a i n risk, of course, is the price and quantity uncertainty t h a t is implied by these imports. W e discount the balance-of-payments risk to the U n i t e d States, because i f the A r a b w o r l d and the rest of the petroleum exporting countries are induced at a l l to supply the w o r l d o i l requirements, the excess foreign exchange earnings t h a t they are l i k e l y to accrue are undoubtedly going to flow to the U n i t e d States i n large part, so that the U n i t e d States may be expected to be a net recipient of petrodollars. Nevertheless, i n order f o r the o i l e x p o r t i n g countries to have these incentives requires that the U n i t e d States actively engage i n p r o m o t i n g investment opportunities i n the U n i t e d States and also facilitate the necessary i n t i t u t i o n a l requirements f o r recycling international capital. The balance-of-payments risk is a rather manageable risk relative t o the quantity risk and the price risk. The quantity risk could be handled by increased storage or increased shut-in capacity that could be used i n an emergency. T h i s is the subject of chapter 10. T h a t alternative does not guard very well against price and quantity uncertainty. So we consider the options of direct i m p o r t controls, subsidies, consumption taxes, and various other policies. T h e direct controls are largely the subject of chapter 12; the subsidies and taxes are the subject of chapter 13. The rest of chapter 9 considers an estimated price i m p o r t relationship. The idea here is, given the assumed price of $8 a barrel, and the range of i m p o r t projections that I talked about, and assuming 5 that there is some elasticity of supply—that is, that as price rises, domestic producers are inclined to reduce the rate of output—and there is also some price elasticity of demand—that means that as the price goes up consumption is discouraged—then a relationship between the price and the amount of imports we w i l l require i n 1985 results. Given a number of assumptions about these elasticities, we estimate that complete self-sufficiency i n the U n i t e d States could be achieved at prices ranging between $10 a barrel and $13 a barrel, depending upon whether you take the optimistic or pessimistic demand and supp l y conditions. These i m p l y , of course, that self-sufficiency could be achieved i n the U n i t e d States i f the domestic price rises approximately to current w o r l d price, and i f everybody expects i t to remain there indefinitely. Whether or not i t w i l l is a big question. W e have already talked about the lower bound price. I n chapter 11 M r . Russell w i l l be t a l k i n g about what we m i g h t expect to happen w i t h respect to the cartel, and therefore what the range of cartel prices m i g h t be. I f we assume that w o r l d prices are not expected to remain as they are—and we do not expect them to remain there—how could we achieve self-sufficiency—that is, how could you achieve these prices ? Y o u could by i m p o r t controls, of course, either impose a tariff, which raises the domestic price, or a quota which creates a scarcity that forces the price up. I n fact, the estimates that I just gave, the price estimates, would be precisely those that would be required by a tariff or a quota t h a t would eliminate all imports. Another alternative to achieve complete self-sufficiency would be to give a subsidy to domestic producers, leaving the $8 a barrel price unchanged f o r consumers. The idea then would be to leave the domestic price alone, but encourage sufficient additional domestic production to satisfy a l l wants. The price may have to rise to as h i g h as $18 a barrel i n order to induce t h a t much more output, and that implies a subsidy of nearly $10 a barrel. On the other hand, you could leave the incentive to domestic production at about $8 a barrel and discourage consumption by imposing a consumption tax. T h a t tax may require a price—including the tax— of up to $171 a barrel, or a per barrel tax of up to $9. Given those p r e m i l i n a r y estimates of what may be required, chapter 10 talks about the option of meeting the security risks of these i m p o r t projections w i t h increased emergency storage or shut-in capacity. Ms. S N Y D E R . A s our dependence on imports grows, the threat of an embargo grows. B u t the many political and social differences among the O P E C nations make i t h i g h l y unlikely that the organization as a whole could find a common target or a common cause f o r undert a k i n g an embargo. The possibility that a subgroup of O P E C would be w i l l i n g to i n t e r r u p t supplies to the U n i t e d States is much more likely. The only subgroup of O P E C that w i l l probably be able to do this is the Arabs. O n l y they have a sufficient share of the w o r l d market, lack of necessity to export to the U n i t e d States, and the likely political incentive to undertake an embargo. Even though the threat is real, the likelihood of enforcing an embargo effectively is very small. The development of excess capacity throughout the w o r l d and the commercial maintenance of increased inventories w i l l reduce the impact 37-387—74 2 6 of any f u t u r e embargo. O n the other hand, our g r o w i n g dependence on A r a b energy and the expanding role of A r a b producers i n s h i p p i n g and refining w i l l increase the risk of a supply interruption. Protection against the risks of an embargo could be accomplished b y m a i n t a i n i n g some standby supplies of oil. One way to m a i n t a i n these standby supplies would be by storage. The annual cost of storing a barrel of o i l i n an above-ground steel t a n k would be between $2.04 and $2.29 a barrel, depending upon the price at which the oil is purchased. M r . R E E S . T h a t is per year? M s . SNYDER. Y e s . A n alternative means of m a i n t a i n i n g energy supplies w o u l d be to shut i n productive capacity. The cost of m a i n t a i n i n g excess capacity is the amount required t o induce the producer to h o l d his o i l i n the ground rather than to produce it. T h a t is, the interest that w o u l d be earned on the value of the oil held i n the ground. The annual cost of shutting i n 1.8 m i l l i o n barrels per day capacity—that is, the m i d p o i n t estimate we made i n chapter 8 f o r A r a b imports—at a $10 price and a 12-percent interest rate w o u l d be $788 million. A policy of protect i o n by means of standby capacity has the advantage of not being restricted to a particular time period. Even i f t h a t amount of shut-in capacity is maintained, i t w i l l take a certain amount of leacltime to b r i n g i t up to the productive state. Therefore, an optimal policy of protection against shortrun interruptions w o u l d be some combination of storage and shut-in capacity. The main advantage of a policy t h a t deals specifically w i t h emergencies rather than to seek continuous self-sufficiency is t h a t i t allows us to take advantage of insecure energy imports at the same time t h a t i t allows us to conserve our domestic resource base. The disadvantage is that i t provides l i t t l e protection against violent price fluctuations and the uncertainties associated w i t h them. D r . R U S S E L L . I want to go on and talk, then, about w h a t we m i g h t expect f r o m the O P E C countries, and i n effect what the price fluctuations m i g h t be and what expectation there m i g h t be i n terms of shortr u n interruptions such as we have had before. Policies to deal w i t h the uncertainties exist. The real question is, what are those uncertainties and how much do we need to pay i n order to deal w i t h uncertainties. W e want to examine the issue, then, of what the oil exporting countries are l i k e l y to do i n the future. We want to report on some of the more interesting results of our study, not only because they are interesting i n and of themselves, but because no one else has before suggested, I submit, this rationale of how the O P E C decisions m i g h t well be made i n the future. T h a t is what we want to come to now. The o i l exporting nations, I t h i n k we must agree, now control the w o r l d market. The i m p o r t a n t matter f o r the i m p o r t i n g countries is how this newly won power w i l l be used. W e accept that political and historical factors play a great role i n oil exporting country decisions. B u t the outside constraints on those decisions are created by economic forces and these are the ones that are our concern. W h a t we set out to do here is to predict a set of o i l e x p o r t i n g country prices under longrun conditions, i g n o r i n g inflation. Now, O P E C has signaled its intent to operate as a cartel to increase revenues. B u t intent is a long way f r o m reality. 7 As we a l l know, O P E C , i f i t is to succeed i n holding up prices, must hold down output. Y e t no efficient means of operating a cartel are available to O P E C because i t is made up of sovereign nations. I t has no enforcement power. B u t what the cartel can do is to establish a target price which i n t u r n determines w o r l d demand and then allocate production quotas i n such a wvay as to make a l l producers better off than they would be under competition, and consequently make them w i l l i n g to go along. Then i f some member countries decide they do not want to go along because they are not getting quite as large a share of the w o r l d market as they t h i n k they should, quotas can be renegotiated w i t h i n the O P E C cartel. T o follow this strategy, though, the cartel must choose a price. I t has to find that target price. B u t that is not an easy process nor an obvious one, because different countries, because of economic conditions, w i l l want different prices, and no one can say what is the correct price; i t is very difficult to b r i n g agreement among sovereign nations when they do not, cannot, find some external reference as to what the correct price is. I t is our view t h a t a price exists t h a t O P E C w i l l l i k e l y choose, and that is the price based on the self-sufficiency price i n the U n i t e d States—that $10 price t h a t D o u g mentioned a moment ago. A selfsufficiency price has, to the negotiators of O P E C , an external reality. Each country knows what that price is or can estimate i t using the N P C data or other data t h a t has been established. Each country also knows that at a price above the U.S. self-sufficiency price i t w i l l not be able to sell into the U.S. market i n the long run, and also knows that the U n i t e d States w i l l become an exporter of energy and energy technology i f i t tries to push the price above self-sufficiency price i n the U n i t e d States. They also recognize that there is no reason to charge a price lower than the self-sufficiency price i n the U n i t e d States because the lower price would simply lower their revenues. Now, the question is, what is the price that the countries w i l l receive i f they do indeed choose this self-sufficiency U.S. price as their focal price, the price they are going to t r y to establish their cartel around ? W e l l , the f.o.b. price to the exporting countries on the basis of a $10 c.i.f. price i n the U n i t e d States ranges f r o m a h i g h of $10.28 i n A l g e r i a to a low of about $7 i n K u w a i t These are the prices we predict t h a t these countries w i l l receive i f the cartel holds i n the long run. On this view, the longrun cartel price is somewhat lower t h a n current prices; t h a t is, we predict t h a t w o r l d oil prices should trend d o w n w a r d i n the intermediate term, then perhaps rise a little, to settle at a level no higher than $10 a barrel c.i.f. to the U n i t e d States. The question then is, w i l l that longrun price stay continuously at $10 ? A s D o u g has suggested earlier, i f we knew i t w o u l d stay continuously at $10, we would not have any security problem, but we would have h i g h prices, because at that price we w o u l d have selfsufficiency. O u r view is t h a t i t w i l l not stay at t h a t $10 price because of, again, the fact that these countries are sovereign nations. The cartel price can only be maintained i f each country is satisfied w i t h its share of total sales. B u t f r o m time to time some w i l l not be. They w i l l want to sell more to take advantage of a cartel price f a r above their cost, and as some 8 countries place a b i t more o i l on the market here and a b i t more o i l on the market there i n order t o get a l i t t l e b i t more t h a n their quota, what w i l l happen is t h a t prices w i l l decline, and then there w i l l be short-term price conflicts among the O P E C countries. I t is our thesis that these prices do have a lower l i m i t ; t h a t is, t h a t there is a lower bound below w h i c h these prices w i l l not f a l l . A f t e r a period of price softness, we find t h a t some countries w i l l decide that they would prefer to leave their o i l i n the ground rather than to sell i t at a price that they consider too low. The issue, then, is what is the price at w h i c h these countries would choose to leave their o i l i n the ground ? W e argue that i t is the present value of the future revenue t h a t could be received f r o m a barrel of o i l i f i t were produced later rather than immediately. I n other words, the value of the o i l i n the g r o u n d w i l l determine the lower bound below w h i c h these countries w i l l not choose to sell additional oil. T h i s value w i l l differ f r o m country to country depending on the country's discount rate and depending on its f.o.b. price. A c c o r d i n g to our calculations, I t h i n k i t is interesting to note t h a t the reservation price f o r o i l f r o m different countries as i t is imported into the U n i t e d States ranges f r o m a h i g h of about $7.90 f o r Qatar, about $7.30 f o r Saudi A r a b i a , to a low of $2.29 f o r Indonesia. These are the prices they would be w i l l i n g to sell the o i l f o r rather than leave i t i n the ground, or alternately, these are the prices below w h i c h they w i l l not sell o i l under any circumstances. A g a i n , price is c.i.f. the U n i t e d States. Therefore, we would suggest that intracartel jockeying f o r greater sales, even though i t w i l l create price instability i n the w o r l d , cannot drive the price below about $7.50 imported into the U n i t e d States so long as the member countries, and especially Saudi A r a b i a , expect the cartel to be revived and the prices ultimately to rise back up to their target price of $10. The cartel price w i l l fluctuate, we argue, as delivered i n the U n i t e d States, f r o m about $10 to $7.50 a barrel, depending on supply and demand conditions. Our analysis also identified the countries that i n the long r u n w i l l be the price cutters and the countries i n the long r u n which w i l l be those that w i l l support the price of oil. The price cutters i n the l o n g r u n include Indonesia, I r a n , and Nigeria. The producers on the A r a b i a n peninsula, on the other hand, w i l l be the ones to resist price declines because their longrun interests are i n higher prices, whereas the countries I mentioned earlier have more of the need f o r current funds. These results f r o m our study, l o o k i n g to the long run, are obviously different than the current statements of the different spokesmen f o r these countries. B u t I t h i n k we can explain the differences, and I w i l l be happy to elaborate on t h a t later i f you like. I n the discussion thus f a r our analysis was based on the assumption that all of the exporting countries w i l l expect the cartel to remain strong. There is a contrary view, of course, often expressed, t h a t the cartel w i l l not i n fact survive, t h a t i t w i l l decline i n a spate of competitive price cutting. W e conclude f r o m our analysis t h a t the cartel w i l l l i k e l y remain secure, that i t is unlikely to f a l l , i f the threat comes f r o m economic 9 forces. O f course, they can make mistakes on economic forces and have misconceptions about each other's positions and jockeying can degenerate into a price war. B u t we t h i n k t h a t h i g h l y unlikely. O n the other hand, the O P E C cartel can also f a l l because of internal conflicts, because of massive shifts i n w o r l d supply and demand, because of intracartel difficulties between, f o r example, the Arabs and other nations. I n these latter circumstances disruptions are not predictable, and consequently we cannot take a position on whether the cartel w i l l decline f o r these essentially political reasons. B u t note that i f the cartel falls f o r any of these reasons, the result could be a competitive price of as low as $3 a barrel, $3 c.i.f. the U.S. point of entry. This is an unlikely, but a possible result. The uncertainty of price creates the problems f o r American producers. W h a t we want to look at now is, how do we deal w i t h this uncertainty for American producers and for American consumers i n a most efficient way ? T h a t is the subject of the last two chapters of the study. D r . B O H I . Chapter 12 returns to the subject of i m p o r t controls and brings together some of these estimates that you have been hearing here. Recall that i n chapter 8 we said that i f the price remains indefinitely at about $8 a barrel that imports are expected to be f r o m a m i d p o i n t of nearly 8 m i l l i o n barrels a day to up to 15 m i l l i o n barrels a day. Chapter 9, on the other hand, suggests that the U n i t e d States could achieve self-sufficiency i n the long r u n after all of the necessary adjustments had taken place at a price between $10 and $13 a barrel. I n order to achieve that higher price, $10 to $13, depends upon conditions i n the w o r l d o i l market. T h a t is to say, you do not have to do anything i f the w o r l d o i l price is that high. Y o u could just let the domestic price rise up to t h a t level. On the other hand, i f the w o r l d price falls below that level, then the U n i t e d States has to engage i n some policy to protect domestic producers. Incidentally, before I forget i t , we do provide estimates of i m p o r t levels at other prices and not just the extreme of self-sufficiency. A s I said before i n the beginning and D r . Russell has repeated, there is the possibility of $3 a barrel i f competition returns to the w o r l d oil market, and he just concluded that i t is likely that a m i n i m u m price under cartel conditions would be $7.50 a barrel. So the $3 a barrel and the $7.50 a barrel price provide us w i t h two reference points, the possible w o r l d prices t h a t must be guarded against under two extreme w o r l d market conditions, the condition of competition and of an effective cartel. The difference between those t w o alternative w o r l d prices and what the U.S. price is what would have to be achieved by either a subsidy or an i m p o r t control or some other f o r m of tax. T h a t difference between those t w o prices, the domestic price and the w o r l d price, is the basis f o r the protective effect to domestic industry and also the opp o r t u n i t y cost to American consumers. I f the i m p o r t price were $7.50, the lower bound cartel price, and the U n i t e d States engaged i n an i m p o r t control policy to eliminate a l l imports, we estimate t h a t U.S. consumers would have to pay approximately $34 b i l l i o n a year more for petroleum prod nets than they would i f imports were allowed uncontrolled. O n the other hand, i f the w o r l d price f e l l as low as $3 a barrel, U.S. consumers would 10 be faced w i t h p a y i n g up to $66 b i l l i o n more per year f o r petroleum products. These figures obviously reflect a very heavy burden f o r the U.S. consumers i f we engage i n a self-sufficiency policy. These costs apply whether tariffs or quotas are used. The difference between tariffs and quotas concerns uncertainty about prices and quant i t y , administrative flexibility, and i n other respects. The quota achieved the price, as I said, by restricting quantity, i n the extreme case to zero, and then f o r c i n g the domestic price to rise i n order to clear the market. The t a r i f f would raise the price directly and allow the market to squeeze out imports indirectly. A major distinction between quotas and tariffs is the certainties and uncertainties that they generate. Quotas maintain absolute certainty w i t h respect to the amount of imports, of course, but a great deal of uncertainty about the domestic price that must be achieved i n order t o clear the market. T a r i f f s establish that price w i t h relative certainty. B u t the amount o f imports t h a t w i l l be allowed are relatively uncertain. Quotas tend t o insulate the domestic market f r o m changes i n demand and supply nocditions, while tariffs, on the other hand, tend to t r a n s m i t those changes t h r o u g h prices. Quotas are inherently discriminatory unless they are auctioned— but we have never auctioned t h e m — w i t h the licenses usually issued by some subjective, often political, criteria. T a r i f f s on the other hand operate t h r o u g h the market system, so that anybody who wants to i m p o r t f r o m any source may do so. B o t h controls may be designed to discriminate according to source. B u t we do not expect such an effort to be very successful f o r the same reason that w^e do not expect a selective embargo by exporting countries to be very successful either. Quotas are more flexible to administer because they do not require legislative approval, while tariffs do, and this greater flexibility is advantageous i f changes i n market conditions w a r r a n t changes i n i m p o r t restrictions. However, there is much to be said f o r m a i n t a i n i n g public debate, even at the expense of flexibility. The difference between the price of imports and the domestic price created by the control is the scarcity value of imports that accrues either to the Government i n the f o r m of t a x revenues—if tariffs are used—but to importers or exporters i f a quota is used. Given that we expect the O P E C cartel to continue, we w o u l d expect that that scarcity value of imports would accrue to the o i l exporting countries, not to the o i l i m p o r t i n g companies. I n short, the inflexibilities imposed on the market by the quota system—and we talked a great deal about those inflexibilities i n p a r t I , i n chapter 3 we believe t h a t this is a compelling reason to prefer a t a r i f f over a quota, i f i n fact any i m p o r t controls are going to be used at all. W e w o u l d probably recommend w i t h some reluctance a t a r i f f on a standby basis to eliminate the downside risk to domestic industry. W e w o u l d recommend something slightly below the lower bound i f the cartel exists. T h a t would be something around $7 a barrel, that is, a t a r i f f that would maintain the i m p o r t price of foreign oil at approximately $7 a barrel. Now, the next chapter considers these other policy alternatives, the subsidies and the taxes. D r . R U S S E L L . I want to t a l k about things that are a l i t t l e b i t more common, or perhaps have a l i t t l e more direct appeal as f a r as the public 11 is concerned, as ways of dealing w i t h our energy security problem. W e have looked at some of these policies before, but let us look at them more directly now. The direct actions that Government could take m i g h t include such things as subsidies to increase outputs, a hodgepodge of particular policy changes—most of which would be desirable whether we have a problem of energy security or not—and, finally, rriuch-neglected programs to reduce energy demand. F i r s t let us t a l k about subsidies. Subsidies i n general are against the public interest. They distort the decisions made by producers and consumers and, as f a i r l y widely recognized, they iead to inefficiencies. They can be justified only i f they increase efficiency or b r i n g about a desired change i n the distribution of income i n some efficient way. W h i l e subsidies i n general are not recommended, i f a subsidy is to be granted, i n our paper we suggest that i t should be based on capacity and not on output. Now, Government risk-absorption is a k i n d of subsidy, a special f o r m of subsidy which m i g h t have much more desirable effects. Government can absorb risks by producing energy on its own or i t can absorb risks of producers by guaranteeing prices for private production. Those are two kinds of subsidies which could be used. U n f o r t u nately, very sound arguments against each of these alternatives exist and we certainly would not recommend either of them. Government absorption of some of the technological risks, on the other hand, is h i g h l y desirable on many grounds and probably should be expanded. Government subsidies for research and development, w i t h proper guarantees to insure free and easy access to information by all parties, can reduce the total resource cost of new energy supplies. Such Government support would promote competition by loweri n g entry barriers and by increasing the number of participants i n the energy industries. A "switch i n the allocation of R. & D . is also called for. More funds should go to intermediate-term projects. Government support should be continued through the prototype stages and not end w i t h just basic research. Government support of, for example, demonstration plants f u l l scale may well be wise as an absorption of risks. Expanded Government activity i n developing data underlying petroleum explorat i o n and i n developing coal and oil shale conversion technologies are also analyzed i n chapter 13. M o v i n g away f r o m subsidies, several other policies could also be adopted to increase energy security. A m o n g these are alterations i n the way the public lands are opened f o r exploitation. W i t h reference to Federal land leasing, especially OCS—the Outer Continental Shelf—diverse methods of bidding, especially through the use of royalty shares which puts Government into j o i n t ventures w i t h oil firms, could well produce major benefits. Competition would be enhanced and productive capacity increased. The deregulation of the field price of natural gas would increase the supply of energy and the supply of both gas and oil, and restrict gas consumption i n i n f e r i o r uses. The s h i f t i n the focus of environmental regulations away f r o m fuels and toward emissions and their effect on ambient air quality would lead to more efficient use of energy. O f particular interest to this committee, policies which improve the functioning of international markets and which facilitate foreign 12 investment i n the U n i t e d States w o u l d be especially h e l p f u l i n includi n g o i l exporters to continue supplying the U.S. market. F u r t h e r investment i n the U.S. energy supply can be made relatively more attractive by eliminating subsidies t o export of energy equipment and by abolishing tax incentives to foreign energy production. W e t u r n now to the last policy that we analyzed, the controversial matter of restricting energy demand. I t can be done. The question is, A t what cost i n terms of human welfare? One policy w o u l d be to improve consumer i n f o r m a t i o n regarding the relative efficiencies of d i f ferent pieces of equipment. Another would be research on more efficient energy consumption. A n d few, I t h i n k , would disagree w i t h either of these policies o f Government. Beyond here, though, lie instruments to reduce particular kinds of energy consumption and to reduce energy consumption i n general, Now, a selective restriction of energy use means substituting Government edict f o r private decisionmaking, which probably leads to inefficiencies. Clearly though, whether the benefits are w o r t h these costs is a political matter and not subject to economic analysis. O n the other hand, a general tax on petroleum and other insecure energy sources would be consistent w i t h the general welfare, so long as the revenues covered no more than the real cost of energy consumption, including the cost of security and the cost of environmental damage. There is certainly a role to play here f o r restricting demand i n the interest of energy security. W e l l , to summarize, what we have done i n parts I and I I of this study is to set the stage f o r the w o r k which is to follow, dealing specifically w i t h the effects of these changes i n our energy situation on the international financial community. I f there is one conclusion we could draw, i t is t h a t w i t h appropriate leadership and decisionmaking, the U n i t e d States can come out of this situation secure, w i t h o u t being impoverished. F o r other nations of the w o r l d the picture is considerably more gloomy. W e are now ready to answer any questions or expand on any of these elements or make any i n f o r m a l remarks that you m i g h t choose to request. M r . R E E S . T h a n k you very much. I appreciate your presentation. Y o u are assuming that we can have complete seLfsufficiency i n this country i f the energy price were h i g h enough ? D r . B O H I . T h a t is r i g h t . M r . R E E S . B u t that probably the best policy would be to not have selfsufficiency, but have sufficient storage backup so that you could take advantage of lower prices of imports ? D r . B O H I . Basically that is r i g h t . The question of selfsufficiency is, at what price? I t is not a matter that we are r u n n i n g out of resources. W e are r u n n i n g out of resources that are relatively cheap to produce. M r . S T A N T O N . Just f o l l o w i n g that—and I appreciate a l l the economic factors that play i n determining selfsufficiency—could you recommend to us what you w o u l d recommend as the level of selfsufficiency t h a t we should establish ? D r . R U S S E L L . W e could t a l k about t h a t today i f you like. W e were scheduled to deal w i t h the recommendations specifically on Monday. M r . S T A N T O N . I w i l l wait u n t i l Monday. 13 D r . R U S S E L L . W e m i g h t point out on this self sufficiency b i t that i t is always easy enough to get self sufficiency. A l l you have to do is consume less. B u t that comes at, again, a very, very h i g h price, as we suggested, something like $17 a barrel. M r . R E E S . S O you figure probably the cheapest f o r m of storage is to have shut-in capacity like E l k H i l l s % D r . B O H I . T h a t is what our estimates seem to say. M r . R E E S . W e l l , that m i g h t be a good idea. F o r example, they are t a l k i n g about d r i l l i n g the Outer Continental Shelf and now they are t a l k i n g about d r i l l i n g outside of Los Angeles, and there is a great deal of opposition. B u t i t m i g h t be a policy that i n areas where there m i g h t be an adverse environmental impact, you m i g h t d r i l l the field, improve i t and then cap i t , and use that as a shut-in capacity f o r protection against boycotts. D r . B O H I . T h a t is true. I understand that i n some cases, such as the Santa Barbara Channel, i t is the d r i l l i n g that is the risk and not the production. D r . R U S S E L L . The production itself is usually not environmentally hazardous. I say "usually". I t is the accidents that can take place i n the process of d r i l l i n g i n some areas which are environmentally hazardous. A n d so, I do not know that not producing would be that much less hazardous. B u t there certainly is a good argument f o r maintaining standby capacity. M r . F R E N Z E L . Y O U hardly discussed the allocation of exports by the O P E C countries or by the O P E C cartel. I guess you discussed some of the political factors. W h a t happens when a new government, perhaps erratic or unstable, coming into control of one of the countries on which we are now quite reliant—for instance, Venezuela or Nigeria—those two r u n about neck and neck as our major suppliers D r . B O I I I . A n d Canada. M r . F R E N Z E L . W h a t happens i n that instance ? D r . R U S S E L L . A r e you suggesting what happens i f M r . F R E N Z E L . There is either a unilateral embargo or an enormous price fluctuation. D r . R U S S E L L . W e l l , this is essentially the problem. T h a t always that possibility exists, and the question is, W h a t is the price of the insurance we are w i l l i n g to pay i n order to avoid the uncertainties that m i g h t be created by the k i n d of change that you are suggesting? M r . F R E N Z E L . O K . W h a t is the probability, then, of the other O P E C countries adjusting their production to fill that hole ? T h i s is unilateral action. D r . R U S S E L L . W e have some history behind us, though the w o r l d has changed so much since that time that I do not know i f we can rely upon it. Certainly at the time of the I r a n i a n convulsion i n the early fifties when I r a n nationalized their oil industry, the other countries and the o i l companies had no hesitation i n t a k i n g over Iran's markets. M r . F R E N Z E L . H O W about d u r i n g the embargo ? D i d not Venezuela increase its production and d i d not the other A f r i c a n countries increase their production ? D r . R U S S E L L . W e l l , the A f r i c a n countries that were not A r a b countries certainly did. B u t we were i n a peculiarly bad position at the time of the last embargo because pretty well worldwide the industry 38-387—74 3 14 was operating close to capacity. I t was not a question of whether I r a n , f o r example, wanted to increase its output. I t was a question o f whether I r a n was able to increase its output, and every indication was that they a l l increased their output as much as they could, b u t they simply could not do enough. M r . F R E N Z E L . O K . I s t h a t the condition under w h i c h we are l i k e l y to labor f o r the intermediate term, t h a t everybody is going to be nearly at capacity anyway and that they cannot pick up slack i n the case of disruption of one of the major suppliers ? D r . B O H I . N O . I would t h i n k we expect some excess capacity t o develop i n the future, not only on the production side, but also i n terms of inventories here and i n other countries, and a corresponding increase i n refinery capacity. I t has been a serious problem f o r the U n i t e d States. I t h i n k i t is more of a refinery capacity problem than a crude oil problem. W e would expect these kinds of adjustments to be made because of two changes: One is the fact that O P E C is something altogether new i n the w o r l d today that we never had before, and t h a t creates a great deal of uncertainty f o r the companies and they have got to make adjustments to guard against the risk. Also, the U n i t e d States is i m p o r t i n g a greater proportion of its o i l consumption now than i t ever had i n the past. I t was largely self-sufficient before 1970. So we can expect inventory adjustments on the basis too. D r . R U S S E L L . I would just note r i g h t now t h a t r i g h t now there is apparently about a 2- or 3-million-barrel-a-day surplus capacity. So i f we have an i n t e r r u p t i o n problem r i g h t now, i t could be picked up. M r . S T A N T O N . T O v e r i f y your results, we had lunch w i t h Secretary Simon yesterday, and several of the points you d i d make, especially on the surplus availability today—2 m i l l i o n barrels—your price range, f r o m $7 to $10 dollars, would come down, coincided w i t h his. D r . R U S S E L L . O f course, we do not know whose estimates those are. M r . S T X \ N T O N . H e made another significant fact, t h a t the American attitude, probably t h i n k i n g of these A r a b countries—some people t h i n k of them as Palestinian guerrillas. I n reality these are the shrewdest, sharpest, most educated, capable businessmen that you probably r u n into anywhere i n the world. D r . B O H I . O f t e n educated i n the U n i t e d States. M r . R E E S . W e educate them at H a r v a r d Business School. D r . R U S S E L L . This is one of the reasons that I would submit that our estimates of O P E C behavior are not likely to be too f a r wrong, because they are calculated on the basis of m a x i m i z i n g behavior on the p a r t of those countries; how can they themselves be made better off. Now, of course, we cannot include i n that the political factors, the internal factors, the convulsions government ally that we talked about before. M r . S T A N T O N . H e said another thing. I n considering their a b i l i t y to cut back, they reach a point whereby their own use of natural gas becomes a factor. W o u l d you agree w i t h that ? Dr. RUSSELL. What ? M r . S T A N T O N . T h a t their use, their tremednous g r o w t h and their need f o r natural gas becomes a factor i n how f a r they can cut back ? D r . R U S S E L L . T h a t is certainly true of some of the countries. B u t most of them have surplus gas. I w i l l give you one interesting example, though, and that is K u w a i t . K u w a i t operates its total u t i l i t y structure on the basis of natural gas, which is produced concurrently w i t h oil. 15 I f K u w a i t does not produce o i l f o r 10 or 12 days, the lights go out i n K u w a i t because they cannot produce the gas without producing the oil. Consequently, there is a l i m i t to how far down K u w a i t , f o r example, can reduce production. M r . R E E S . On the two buzzes, i t is the rule on the m i l i t a r y construction bill. W h a t I t h i n k we m i g h t do is vote. I w i l l be back. I would like to ask some more questions. B u t I suspect that d u r i n g the 15 minutes that we are not here that other members i n the audience might wish to ask some questions. So we w i l l just k i n d of throw i t open informally. [Whereupon, at 11:15 a.m., the committee was recessed, to reconvene at 10 a.m. on Monday, August 12,1974.] OIL IMPORTS AND ENERGY SECURITY M O N D A Y , AUGUST 12, 1974 HOUSE OF R E P R E S E N T A T I V E S , DOMESTIC ENERGY AND AND THE AD HOC INTERNATIONAL OTHER NATURAL COMMITTEE COMMITTEE ON THE MONETARY EFFECT OF RESOURCE PRICING OF ON B A N K I N G AND CURRENCY, Washington, D.C. The committee met, pursuant to notice, at 10:15 a.m., i n room 2222, Rayburn House Office B u i l d i n g , Hon. Thomas M . Rees [chairman], presiding. Present: Representatives Rees, Stanton, and Frenzel. Also present: D r . Douglas R. Bohi, D r . M i l t o n Russell, and Nancy McCarthy Snyder, consulting economists. M r . R E E S . I t h i n k we might start. This is the A d Hoc Committee on the P r i c i n g of Energy and Other Natural Resources; and what we are doing is hearing the summary and recommendations of our petroleum task force on parts I and I I of the study. I do want to make i t perfectly clear—that these are the first two parts of. I believe, a six-part study; and that we w i l l be continuing into the area of other natural resources, such as copper and bauxite, uranium, et cetera, and we w i l l also be doing an extensive study on the international and domestic monetary problems of this arbitrary pricing. A n d . Ave w i l l also be looking at the effect of petroleum p r i c i n g on lesser developed economies throughout the world. Parts I and I I have been contracted out to a group f r o m Southern I l l i n o i s University, D r . Russell, D r . Bohi. and Ms. Snyder; and parts I and I I are their work, and the recommendations are their recommendations. These are not necessarily the recommendations of the committee; we won't come up wTith any specific recommendations, I suspect, u n t i l all of the studies are over and we have had a chance to vote on each recommendation. So, I would like to now t u r n the meeting over to the panel. STATEMENTS OT DR. MILTON RUSSELL, DR. DOUGLAS R. BOHI, AND NANCY MCCARTHY SNYDER, CONSULTING ECONOMISTS, SOUTHERN ILLINOIS UNIVERSITY, CARBONDALE—Resumed D r . R U S S E L L . Thank you, M r . Chairman. W h a t we have done i n our study is look at the problems of international oil and the p r i c i n g of international oil. and the problem of energy security for the U n i t e d States. The general conclusion we have arrived at is that a positive policy for energy security is required i n the U n i t e d States, but i t certainly need not include, and should not include, total self-sufficiency, or a large measure of self-sufficiency, i n energy. (17) 18 I do want to point out that this is an abstract and analytical study, i t is not designed to promote legislation, nor is i t designed on a programmatic basis, and therefore some modifications m i g h t need to be made i n terms of implementation. O u r recommendations follow f r o m the general goal of increasing the welfare of the Nation, which implies increasing efficiency i n the use o f resources. Now, this obviously involves a value judgment, and t h a t value judgment i n addition involves a couple of constraints t h a t ought to be made clear. F i r s t of all, we have argued that we should avoid any irreversible damage, including damage to the a b i l i t y of the U n i t e d States to engage i n foreign policy free of pressures f r o m o i l exporting countries; irreversible damage to the environment; irreversible damage i n terms of premature resource exhaustion i n the U n i t e d States. The second constraint we placed on this study was t h a t even though energy prices are going to necessarily increase compared to what we have known i n the past, there should be no reduction i n the level of l i f e of the poorest of our citizens. So, there is t h a t much, but no more, redistribution indicated as f a r as the study is concerned. The recommendations that we are presenting today are to be taken as a package. T h a t is to say, we suggest a number of things which, taken together, would improve the energy security of the U n i t e d States; any one of which, taken out and enacted i n d i v i d u a l l y , m i g h t not improve the welfare of the U n i t e d States. So, they should be considered as a package rather than as i n d i v i d u a l components f r o m w h i c h one could pick and choose. W e have organized our recommendations under five general goals which we m i g h t mention before we t u r n to those recommendations. The first of those goals would be to increase the efficiency of the domestic energy i n d u s t r y ; the second goal would be to decrease reliance on foreign energy sources; the t h i r d would be to improve the climate of international trade; f o u r t h , to protect against shortrun supply interruptions of the embargo sort; and finally, to enact measures to protect the poorest of the citizens of the U n i t e d States. Now, that's a general overview, M r . Chairman, of the way i n which we approached the study and the nature of the recommendations. W e can proceed as you wish, either to go t h r o u g h the recommendations one by one, or to answer questions about the recommendations t h a t are listed; there are 20 i n number, and some of them m i g h t be of more interest, or less interest, than others. M r . REES. I t h i n k that probably the best way to proceed w o u l d be to go through the recommendations. I suspect you can do t h a t i n about 10 or 15 minutes; and then we can ask questions on the recommendations. D r . R U S S E L L . W o u l d you want to do the first set of recommendations ? D r . B O H I . A l l right. The first goal is to improve the efficiency of the market. Here the idea w a s — I suppose what we were t r y i n g to get at most, given some of the history of Government interference i n the market i n other ways, as w e l l as i n the energy industry—is to improve the confidence and efficiency of the market directly, rather than to impose other ad hoc measures which take account of existing inefficiencies. 19 So, our preference here i n this goal is t o promote the efficiency of t h e market, or to improve the market itself, rather than to t r y and patchi t up, to patch up the shortcomings w i t h a series of ad hoc policies. A s a result, most of these recommendations may look rather indirect i n achieving that goal, but I t h i n k they do come to t h a t point. The first is to l i m i t vertical integration i n the petroleum firms. We see this as a major source of potential problems i n terms of limiting: competition i n this industry, and perhaps l i m i t i n g , most seriously, competition and v i t a l i t y i n the crude o i l production stage itself. The second recommendation is to l i m i t the horizontal integration of petroleum firms i n t o other sectors, such as coal, nuclear power, and so on, of which they are doing quite a b i t r i g h t now. Competition among products, which is just as important as competition among firms w i t h i n a given industry i n order to maintain that competitive edge. I t is believed this is a serious source of a potential price problem i n the future. The t h i r d recommendation is to alter Federal leasing policies i n a number of ways. I n general these are to encourage more participation i n crude oil production. I t is being l i m i t e d r i g h t now by the fact that crude oil producing firms have to come up w i t h rather sizable bonuses i n order to get into exploration of a given field. The capital requirements f o r exporation i n the new major petroleum provinces of the w o r l d are also l i m i t i n g them. These capital requirements plus risk are l i m i t i n g not only the newcomers i n the industry, but also the smaller firms. A s part of the package, i f i n fact we do increase by the various measures competition i n industry, we see no reason at all why there should be price controls i n the industry f o r crude oil or natural gas. Usually the justification f o r those controls is based upon a lack of confidence i n the market itself, and given that we seek to improve that confidence, there is no reason at a l l to impose these other controls. The sixth recommendation is repeal of the Connallv H o t O i l A c t that is probably something that is not too operative r i g h t now anyway, i f I can borrow a term f r o m somebody else. T h a t particular act lent credence and v a l i d i t y to State market demand prorationing control, which we t h i n k should be eliminated as well. A n d finally, to eliminate preferences to U.S. shipping, which I t h i n k is pretty much embodied i n the Jones Act. M r . R E E S . W e l l , those are pretty good recommendations, they are well balanced, enraging to both labor and management, and that is a compliment to your approach. [Laughter.] D r . R U S S E L L . W e l l , the second basic goal that we have is to reduce the reliance on foreign energy sources, to narrow the i m p o r t gap that those of you who were w i t h us on F r i d a y heard us discuss at t h a t time. A number of policies can narrow that import gap, both i n the present and i n the future, without significantly decreasing the efficiency w i t h which resources are allocated i n this country; and those are the recommendations that we make. The eighth recommendation is to provide extensive geological data on Federal land, both offshore and onshore to the extent practical both f r o m private and f r o m public sources, i n order to increase, again, the ability of potential energy producers to get into the market. 20 T h i s would involve a large expansion i n Government expenditures t o w a r d geological surveys and elsewhere, and that expansion should be, according to this recommendation, funded by an o i l consumption tax that we t a l k more about a l i t t l e later. The next recommendation i n terms of n a r r o w i n g this i m p o r t gap w o u l d be to broaden and deepen government support of research and development energy technology. I n the past we have allocated our R. & D . basically t o w a r d nuclear, basically t o w a r d the l o n g run, basically t o w a r d basic research rather than operational research. I t is certainly our view that we need to improve and increase the amount of R. & D., and we ought to do i t toward the t r a d i t i o n a l fuels rather t h a n t o w a r d the more exotic fuels. The exotic fuels, and the work we are doing now, and the expenditures we are making now are those to get us f r o m the year 2000 f o r w a r d ; the problem we face r i g h t now is getting to the year 2000, and so, reallocation of R. & I).—as well as enlarging R, & D . — t o w a r d the shorter t e r m and immediate needs seems h i g h l y desirable at this time. W e w o u l d like i n recommendation 10 to encourage f u r t h e r use o f coal f o r electric generation, which implies several actions. I t implies changing the Clean A i r A c t to permit the use of h i g h sulfur coal when emissions can be controlled, where air quality itself w i l l not suffer. U n f o r t u n a t e l y we have i n the past l i m i t e d ourselves, or not l i m i t e d , but tended to l i m i t ourselves to concern about i n p u t rather than output. Rather than concerning ourselves w i t h how much sulfur goes into the fuel we ought to be concerning ourselves about what happens to the quality of the air around the places where the fuel is being used. Cert a i n l y i n terms of increasing the production of coal, and the use of coal,, one of the major goals is to eliminate the uncertainty i n its use, both i n terms of consumption and i n terms of the problem the mine operators are having now i n not knowing exactly what they can expect i n the future i n terms of environmental controls. W e f u r t h e r would suggest that to narrow this i m p o r t gap we need to provide more certainty f o r domestic o i l producers and domestic energy producers generally; and to do that we suggest a standby t a r i f f — n o t an operative t a r i f f , but a standby t a r i f f — t h a t would, on present expectations, h o l d the price of o i l above the $7 a barrel G I F i n the U n i t e d States. Now, at present of course, imported o i l is considerably higher t h a n that. I m p o r t e d oil, as we discussed earlier, could f a l l to a much lower level than that. W e feel that a $7 a barrel standby t a r i f f — t h a t is not a t a r i f f of $7 a barrel, but a standby t a r i f f which would hold the price of oil imports at $7 a barrel—is appropriate. W e would, as the next recommendation, eliminate the tax provisions that encourage exploration and development of foreign energy sources. W e are at present financing to a degree through export credit and t a x provisions of one sort or another the exploration f o r foreign o i l w h i c h t i l t s oil producers toward foreign sources of energy. W e suggest that that balance ought to be t i l t e d back t o w a r d producing energy i n the U n i t e d States. The next recommendation would have to do w i t h e l i m i n a t i n g discriminatory tax provisions f a v o r i n g income received f r o m production 21 of energy. This would include such things as the percentage depletion allowance; i t w o u l d also include some of the other tax credits t h a t are now existing f o r the production of energy, not only f o r the production of oil, but also f o r the production of coal. Now, this would have the effect of increasing the cost of producing energy, and consequently i t m i g h t have the effect of reducing the production of energy. I t would also increase the price of energy. B u t , i t would also tend to dampen its consumption, and i t would also tend to b r i n g about a more efficient allocation of resources as consistent w i t h the goals we suggested earlier. We do feel that f o r a number of reasons the consumers i n the country do not have appropriate i n f o r m a t i o n to make wise decisions about energy consumption. The builders of homes have no real incentive to insuiate them p r o p e r l y ; the producers of various other capital equipment have no real incentive to make them energy efficient because consumers do not know enough to know what the long-term cost of b u i l t - i n energy waste is going to be. Consequently we would argue f o r legislation establishing perhaps m i n i m u m standards of thermal efficiency, or at least standards of disclosure to prospective consumers, on energy consuming capital assets. A n d the final goal i n this area—I mean the final recommendation— would be to impose a tax on the consumption of insecure energy, namely on the consumption of oil and natural gas to the extent i t is imported natural gas and to use the revenues f r o m that consumption tax to pay the costs of the Government programs that w i l l be required to provide the energy security that we need. The rationale here is f a i r l y straightforward. I t is the energy consumer of the Nation who w i l l benefit f r o m energy security, and i t therefore should be the energy consumers, i n proportion to that energy they consume, who should pay the costs of energy security. A n d consequently we would suggest a tax on the consumption of o i l to cover the cost of extra R. & D., to cover the cost of some of the other recommendations that we are making to narrow this import gap. A n d that is the set of recommendations consistent w i t h the goal of reducing the reliance on foreign energy. Ms. S N Y D E R . The t h i r d goal is to protect ourselves against shortterm supply interruption. This protection can be handled w i t h o u t maintaining a policy of self-sufficiency by maintaining some storage and shut-in capacity. I n keeping w i t h this goal we recommend storage capacity be increased to an amount to cover 60 days of our insecure energy imports. Specifically, under our projections for 1975, that would be about 1 m i l l i o n barrels a day f r o m A r a b sources. The cost of maintaining the storage should be paid for by the importer, and the price to be passed on to the consumer. A f t e r this we would recommend establishing some shut-in capacity, immediately 1 m i l l i o n barrels a day. The capacity should be reviewed annually and be changed i n accordance w i t h the amount of imports t h a t are judged insecure. Petroleum reserves are extremely useful i n this area, and great care should be taken t h a t the f u l l cost of the shut-in capacity should be borne by the consumers of energy, and not by the public as a whole. Also, offshore placement would be very appropriate f o r this type of shut-in capacity. 22 Dr. B O H I . Goal 4 is essentially designed to increase interdependence among consuming and producing nations alike. R i g h t now the incentive f o r trade tends to be more one way i n favor of the consumer, and not so much i n favor of the producer. So, the idea here is to increase the incentive to the producing countries i n order to induce them to exp l o i t their o i l reserves. One way, and i t seems to me a very i m p o r t a n t way, would be to encourage their investment i n the U n i t e d States; to actively encourage i t , and to use the f u l l credibility of the U.S. Government i n order to reduce the perceived risk to oil-producing countries that are making that k i n d of investment. Past customs are such that they tend to abbor that type of investment, and I t h i n k t h a t has now to be offset i n some fashion. Also i n keeping w i t h this, some mechanism has to be achieved, and this is going to require active Government support by a l l of the oilconsuming countries, to facilitate the recycling of o i l dollars. W e have heard i n this room not too long ago of the magnitude of the dollars involved and of the risks that private institutions just can't handle. T h i s recycling has got to involve active participation of governments; and that essentially means, most i m p o r t a n t l y , the U n i t e d States. The idea is, to repeat i t again, i f the oil producers become dependent upon the oil consumers i n terms of incentives f o r trade, i n a sense the blackmail goes both ways between buyers and sellers, as i t often does i n other markets. To reduce the leverage of oil as a political and economic weapon perhaps m i g h t be the best way to achieve security i n the long run. D r . R U S S E L L . The last goal that we suggested doesn't f o l l o w directly f r o m the study, but does follow f r o m our view of the world. W h a t we are describing here is a considerable future increase i n energy costs i n the U n i t e d States, to the American consumer; and of course the American consumer has already suffered quite an extensive increase i n energy cost. T h a t is as i t should be, i n the sense t h a t the real cost of energy, including the costs of security and the cost of resources, are i n fact rising. T h a t does mean that we need to reassess, however, the levels of protection f o r income—not protection for energy consumption—but protection f o r income of the citizens of the country. A n d so, we w o u l d submit that the adoption of any program of this sort should take into account, f o r instance, changes i n social security payments; changes i n other transfer payments; changes i n perhaps some of the tax laws. I t should take into account the impact increased energy costs is going to have on the level of l i v i n g of the very lowest income group. Energy security is not going to come cheap; i t certainly is going to come f r o m the consumer paying the price for it. The question really is whether we wish to have part of this burden f a l l on the very poorest of our citizens, and we would argue that probably i t should not. A n d that is the set of recommendations that we made available. M r . R E E S . W e l l , thank you very much. I do want to compliment each of you on part I and p a r t I I and your recommendations, I t h i n k t h a t i t is a l l very valuable work. I k n ow i t w i l l not only be of help to this ad hoc committee, but to the Congress i n general and w i l l help the administration and industry. I have been concerned about Federal leasing policy i n that most of the bids are bonus bids. So, at a time when we are t r y i n g to find 23 enough money to develop resources, whether they be shale or offshore oil, that those companies b i d d i n g have to put their money out f r o n t , and t h a t money goes to the Federal Government and is not used i n the development of those fields. I have also been concerned about the problem of vertical integration i n that there is a tendency for the largest companies to get larger, and the independents to get smaller, or go out of business. A n d I t h i n k this is obvious i n the present situation where independents have to buy expensive foreign oil to compete against some of the large integrated firms t h a t have a low-cost domestic base. I was wondering about the possibility of a leasing policy where you m i x up your bid, whether you make i t a bonus royalty bid, or you have the Government come i n w i t h a larger percentage of the takeout, instead of one-sixth maybe 25 percent, and then the Government going to auction on their takeout. This is done i n California f o r the one-sixth i n the field; it's also done by K u w a i t and w i l l be done by Saudi A r a b i a i n terms of their takeout oil. They could also cap some of the wells so that we do develop a strategic reserve. I was just wondering i f a policy of that type—do you t h i n k i t could open up the market so that you would develop independent refineries, pipelines, independent retail distribution outlets? D r . R U S S E L L . I t h i n k what you are suggesting is quite consistent w i t h our policy. As you suggest, r i g h t now most of the bidding— although the Department of I n t e r i o r has announced i t is going to do some experimenting w i t h other types of b i d d i n g i n the fall—most of the bidding is done w i t h bonus bidding, which does mean that i t is cash outlay at first. I f we have diverse kinds of policies, that would certainly open up the market to smaller firms who would not have to provide the capital r i g h t at first; and i t would provide the Federal Government w i t h its royalty share which i t could sell any way i t wanted to. The problem here, though—one of the problems—is i n terms of transportation, because i n order to get that oil to the market, there has to be access to transportation facilities as well. I is not clear i n the law whether all oil pipelines have to be common carriers, and consequently this would reinforce the argument f o r disintegration of the industry between crude o i l production and refining, and other aspects. I would m o d i f y your suggestion i n one respect, however. T h a t is, I t h i n k that the shut-in capacity argument is quite desirable over and beyond the bonus b i d d i n g argument. I wouldn't tie the two together. I n fact, I suggest that shut-in capacity could easily stand on its own as a desirable policy. M r . R E E S . W e l l , it's easier to shut i n petroleum. I mean, i t would be difficult to spend a quarter of a billion dollars on a shale plant, and just close i t down. So, probably we should shut i n petroleum supplies, and concentrate on gasification of coal rather than shale. D r . R U S S E L L . The cost of that shut-in is not that expensive, either, as i t turns out. Just i n "back-of-an-envelope" calculations—and these calculations are not i n the study which, as I suggested earlier, moves more t o w a r d policy i n the abstract, rather than detail—the outside costs, and that is the upper-bound cost, of shutting i n a m i l l i o n barrels a day would be about 7 cents a barrel on petroleum consumption i n 24 the U n i t e d States. N o w , t h a t is not the capital costs, you understand; i t would cost $3 or $4 b i l l i o n to p u t i t i n place i n the first place. B u t , the annual costs of shutting i n a m i l l i o n barrels a day w o u l d require a tax on a l l consumption of about 7 cents a barrel to cover t h a t cont i n u i n g cost. M r . REES* T h a t is i n comparison to what cost f o r above-ground storage ? D r . R U S S E L L . W e l l , it's very difficult, maybe the rest of you can help. . . . I t ' s very difficult to compare directly shut-in capacity to above-ground or salt dome storage because shut-in capacity w i l l be available f o r the indefinite future, you don't use i t up i n 60 days, or 90 days. I t ' s available there u n t i l you finally get ready to pump the last of the oil. I n storage, on the other hand, you are t a l k i n g about capacity f o r 60day consumption, or 90-day consumption, or something of that sort. So, it's difficult to compare the costs of the two. I would suggest, to add to i t , an appropriate energy security policy would be a combination of shut-in capacity and enough storage to get us over a short-term embargo. M r . S T A N T O N . W e don't w o r r y too much about salt domes. M r . R E E S . They know more about i t than I do. M r . S T A N T O N . I ' m intrigued about that. W e have i n m y home town, on the shore of Lake Erie, some of the largest mines. They have about 100 miles i n our county and out into Lake Erie. I was i n the mine about 8 or 10 years ago. I t looks like a c i t y ; there are streets named after New Y o r k C i t y ; Broadway, and so f o r t h . I t is a most i n t r i g u i n g place, large removal equipment goes down never to come out. B u t , it's a fantastic storage f a c i l i t y , really unbelievable. D r . R U S S E L L . I t turns out to be a very cheap way of storage, i n salt domes. Most of i t , i n our study we assumed, is going to be used f o r storage commercially, and it's not going to be available f o r emergency storage, as you suggested before. B u t , the salt domes do not necessitate mining, they pump water down there and take i t out as brine and you have a hole. Y o u fill i t w i t h o i l and pump water i n i t to push the o i l out and you have a larger hole than you had before. M r . S T A N T O N . They say it's a l i t t l e over a hundred miles. Ms. S N Y D E R . The capacity is about 6 5 0 m i l l i o n barrels of storage i n salt domes; and about 200 m i l l i o n barrels of natural gas liquids are being stored i n salt domes, r i g h t now. I n the f u t u r e t h a t amount should increase. B u t , i t costs about $1 a barrel to store o i l f o r a year i n a salt dome. M r . S T A N T O N . I n lands closer by—they are t a k i n g out salt brine and m o v i n g i n natural gas. I n larger areas they are doing t h a t now. M r . R E E S . O n your tax policy you w o u l d do away w i t h , or substant i a l l y reduce the foreign tax credits on petroleum, and I take i t , you w o u l d remove or reduce the depletion allowance as well. W h a t about the d r i l l i n g costs? D r . B O H I . The intangibles? M r . R E E S . The intangibles, yes. Ms. S N Y D E R . Yes; we w o u l d recommend t h a t the t a x policies t h a t provide special treatment of the industry disrupt the market to the extent t h a t the price of energy does not reflect the cost of producing the energy. T o allow the expensing of intangibles and d r y holes maint a i n s a reduced price, you know, and has an influence on the price. 25 M r . R E E S . So, you would merely depreciate your assets like any other business depreciates the assets, and deductions f o r d r y holes would be deducted as any other business expense is deducted. D r . R U S S E L L . O r capitalized. I n intangible d r i l l i n g costs, the tax break comes f r o m expensing rather than capitalizing i t , t a k i n g i t over the l i f e of the asset. So, you have the interest saving involved f r o m the early capital due to tax deduction involved. A n d the foreign o i l credit is beginning to get much less important as time goes on. M r . R E E S . Takeovers? D r . R U S S E L L . Because of the takeovers. M r . R E E S . W e l l , then you take away i n terms of taxes, but then you eliminate all price ceilings, both on natural gas and on oil. Dr. RUSSELL. Right. M r . R E E S . N O W , on natural gas you were t a l k i n g about a 70-cent M C F cost on F r i d a y ? D r . B O H I . No, we were t a l k i n g about something less than the L N G ; other t h a n that, it's relatively insensitive to the unregulated price of natural gas. W e expect i t to be something less than $1.25; we don't have any specific projection or estimate of what the unregulated price is, although we do refer to other studies that do put i t around 85 cents, or less sometimes. M r . R E E S . S O , i f the intrastate price is at the present time $1, or $1.10, are the prices artifically h i g h because they are looking for a constant source ? D r . R U S S E L L . I suggest that those h i g h delivery prices have been created by a long period of regulation of the natural gas industry, created by the energy crunch of this last year, and created by the failure of nuclear power to come on. A n d so, what we have had is a surge of demand i n the natural gas field, which, because of the long lead time involved i n changing capital equipment f o r gas consumption, and because of the long lead times involved i n increasing energy production and natural gas production, created a short-term blip, i f you w i l l , i n the price of natural gas. The long-range equilibrium, as I suggested earlier—according to other studies, we haven't done any study on that—comes closer to 85 cents an M C F . M r . R E E S . N O W , i f you had an unregulated price f o r all oil you feel there wouldn't be any more necessity of Federal allocation? D r . B O H I . That's r i g h t , then the market would do the allocating, rather than specific Federal officials. D r . R U S S E L L . I t would certainly remove also the problems of particular producers and particular consumers and particular places; i t would remove the problems of the independent refiners, f o r example, having inordinately h i g h prices f o r their input, as compared to the majors. A n d , i t would prevent the problem on the east coast where they are having to depend to a much larger extent on imported and more expensive oil. M r . F R E N Z E L . W h y would that relieve the problems of the independents ? D r . R U S S E L L . Deregulation ? M r . FRENZEL. Yes. D r . R U S S E L L . Because they would have an even shot at whatever oil existed. A t the present time the majors, because they have a larger 26 proportion of regulated o i l available to them, have lower refinery costs t h a n the independents. Consequently they are able to carry t h a t price through to the gas station pump, or o i l pump, or home heating, and are able to hold a lower price than the independents can hold. M r . F R E N Z E L . H O W is that going to change ? D r . R U S S E L L . Because the independents w i l l be able to purchase the o i l just as the majors are going to purchase the oil. M r . F R E N Z E L . Where are they going to purchase i t ? D r . R U S S E L L . They w i l l be purchasing that on the open market. M r . F R E N Z E L . H O W are they going to move i t , how are they going to refine i t ? D r . R U S S E L L . W e l l , I thought your question had to do w i t h the independent refiners because they have been squeezed because they have a disproportionate M r . F R E N Z E L . I am t a l k i n g about the independent refiners. I come f r o m the State of Minnesota, where our independent refiners are relyi n g on Canadian crude oil. D r . R U S S E L L . Right. M r . F R E N Z E L . I n any k i n d of a situation that I can envision they are going to stay reliant on Canadian crude; they are always going to be. A s f a r as we can see ahead, they are going to be delivering a higherpriced product than the majors. Standard of Indiana, a major marketer out of Chicago, or out of the Southwest, or out of storage or refining capacity on the G u l f Coast, has got to come i n at a lower price; you are not going to change that at all. M r . R E E S . Sure we w i l l , a l l the o i l then gets to a national price and stablizes at $8 a barrel. M r . F R E N Z E L . I t doesn't i f Canada s t i l l gets D r . B O H I . The national price w i l l also have to stabilize i n accordance w i t h the w o r l d price. M r . F R E N Z E L . T h a t is not going to happen. I f Canada is p a y i n g Persian G u l f prices on the east coast, they are going to leave their premium tax on, and we are going to have to pay it. D r . B O H I . B u t then the U.S. price w i l l rise up to the w o r l d price as well. M r . F R E N Z E L . W e l l , i t won't according to you because it's too high. D r . R U S S E L L . I t w i l l i n the short run. I n the long r u n the w o r l d price w i l l tend to fall. B u t , oil does flow, and i t moves f r o m market to market, and the price would equilibrate over time. Now, what you w o u l d have would be M r . F R E N Z E L . I n the meantime I w i l l have four broke refineries. D r . B O H I . They won't be discriminated against. D r . R U S S E L L . W e wall have increases i n price of production f o r users i n the U n i t e d States, but the smaller independent refiners w i l l no longer be discriminated against, as D r . B o h i suggested. Now, perhaps the goal of having everybody pay a higher price is not necessarily a desirable role for the consumer, but at least the small refiners are not going to be put i n the same squeeze as before. M r . R E E S . M r . Frenzel, i f they freeze the prices as of a certain date, so that i n Los Angeles—and I mentioned this F r i d a y — y o u have f o u r stations at f o u r corners, they are a l l major stations, and they a l l have a different posted price. W e have a law i n the city, we have to have a b i g posted price, so people can see what they are paying, and there w i l l 27 be as much as 6 cents a gallon difference i f they are frozen as of one date. A n d each price really reflects the combination of how much is imported and how much domestic crude is i n their refinery m i x . M r . F R E N Z E L . W e l l , I agree t h a t those problems exist, but I guess I don't t h i n k that simply l e t t i n g the Allocation A c t solve the problem D r . B O H I . A S an i n d i v i d u a l policy, I agree w i t h you. W h a t we are looking at is a package of things, taken together, rather separately. D r . R U S S E L L . A l o n g w i t h that package, we are including the whole disintegration of the major o i l firms to give not only your small independent refiners an even shot at the market, but the different majors an even shot as well. M r . S T A N T O N . A n d you are saying your presentation is a package, and to adopt some w i t h o u t the others would create more problems. D r . R U S S E L L . That's r i g h t . Not necessarily w i l l create more problems, but m i g h t create more problems. I n a sense we got into the situation that we have today because of a series of ad hoc, piecemeal, shortrun kinds of policies where people are looking only at a small piece of the elephant. T o get out of the situation we want to get out of we are not going to be able to do so, again, by adopting a series of piecemeal ad hoc programs; we w i l l end up, i f not w i t h the elephant, the camel, i f we continue this k i n d of approach. M r . S T A N T O N . Leave i t up to Congress ? [Laughter.] D r . B O H I . O n the contrary, they are the only ones t h a t can set the t h i n g straight, now. M r . F R E N Z E L . Our track record would not indicate that. D r . R U S S E L L . I m i g h t suggest, though, there is a good reason f o r your track record, and that is, u n t i l the present there has not been—and by the present I mean the last 6 months—there has not been a national focus on this package of issues. Consequently Congress has had the issues brought to its attention on a piecemeal basis, dealing w i t h one special problem, or one special interest, at a time. A t present, though, you do have a national focus, and consequently perhaps a better chance of avoiding some of these problems you describe. M r . F R E N Z E L . B u t , the Congressional Record says that we legislate results. So, we w i l l pass a b i l l that says everybody w i l l have lots of cheap gasoline; the l i t t l e businessman w i l l make lots of profit, and all the b i g guys w i l l be skinned r i g h t down to the bone. That's what our law w i l l say. M r . S T A N T O N . Backing up a l i t t l e bit to F r i d a y on the subject we are on r i g h t now, I wanted to c l a r i f y i n my own mind—you made i t clear f r o m your observation on the balance of payment problems of the U n i t e d States, we should not be as alarmed as we thought we m i ^ h t be. Y o u didn't—or, I missed your thoughts and observations on other countries, could you elaborate on that ? D r . B O H I . I suppose that i t should be pointed out that leaving out other countries is another n a r r o w i n g of our focus here. W e intended here only to concentrate on U.S. problems, and as a result the recommendations and conclusions are strictly w i t h respect to the U n i t e d States; and the comments about the balance of payment are f r o m the same narrow view. 28 O n the contrary, the rest of the w o r l d is i n a terrible position us fas as the balance of payments are concerned. Our conclusions refer only to countries like the U n i t e d States, which have some capacity to produce, and who at the same time are going to be l i k e l y recipients of a b u l k of the recycled P E T R O dollars—the rest w i l l suffer. H o w ever, i n order to sort of keep the circle going there has to be some reason f o r the oil-producing countries to continue the ^ recycling; they've got to have an incentive to produce, otherwise, they just simply gradually cut back production, and that of course eliminates the balance-of-payment problem. Then you have the "where is the o i l " problem. S i m i l a r l y , i n order f o r the lesser developed countries and some of the other developed consuming countries to continue their purchases, the foreign exchange has got to be recycled back to them. F i n d i n g the mechanism f o r doing that is going to be very difficult. A s I see i t , it's got to involve central banks p a r t i c i p a t i n g i n some cooperative effort. So, I guess we tend to pass i t off f o r the U n i t e d States as a manageable, but not necessarily—let me just say as a manageable problem; but it's manageable i f we assume the w o r l d w i l l cooperate, M r . S T A N T O N . D i d you read the Rockefeller article i n U . S . News & W o r l d Report? D r . B O H I . I S that the one based on the W i l l i a m s b u r g speech ? M r . S T A N T O N . T h a t the answer lies i n a w o r l d bank system. D r . R U S S E L L . I m i g h t just note that while our focus was on the U n i t e d States, and our recommendations are on the U n i t e d States, I don't see any of the recommendations here inconsistent w i t h the wellbeing of the other oil consumers i n the world. I n fact, one of the arguments we make strongly is that i f the U n i t e d States is not prepared to accept investments of the P E T R O dollars, for example investment i n U.S. equities, then the rest of the w o r l d w i l l be considerably worse off. So, we are not n a r r o w i n g our focus and abandoning the rest of the world. M r . R E E S . This is getting into parts of our study that w i l l be f o r t h coming i n the next few months, but on the p r i m a r y recycling, the basic problem is that the P E T R O dollars are recycled, obviously they are recycled back to the strongest currency, the strongest economy. ' D r . BOHI. Yes, sir. M r . R E E S . A n d so, i f money is recycled into the U.S. economy, basically we w i l l be t a k i n g away f r o m the I n d i a n economy, or whatever i t w i l l be. A n d there is a problem of investing i n other countries because i f you pick up too much of their economy, foreign money picks up too much of i t , then they w i l l be i n a situation where they w i l l be taken over; that happened to us i n Chile and Peru. One way m i g h t be to have some of the mutual f u n d operation worki n g t h r o u g h the International Monetary F u n d , where you w o u l d take your P E T R O dollars and invest i n the mutual fund, and then the m u t u a l f u n d would be a whole basis of various investments i n both r i c h countries and poor countries; but at least you w i l l have some system of allocation because the investments would be International Monetary F u n d equity investments, or debt investments, and i t would be very h a r d for one country to take over an International Monetary 29 F u n d interest i n a local concern. A n d then we could then get around this problem of whether a country is socialistic, or capitalistic, or whatever i t m i g h t be; and then you can guarantee a return on the investment of at least what the E U R O dollar interest rate m i g h t be. I n this way, I t h i n k , you could p u t clean money into lesser developed economies without the problem of exploitation. D r . B O H I . The U n i t e d States has always n a t u r a l l y acted as a financial intermediary to the world. Even i f the money came i n on a private basis, as i t has i n the past, i t is likely to flow back to the rest of the w o r l d i n various ways. D r . R U S S E L L . W e shouldn't forget, though, that there is, underneath a l l the monetary and financial activities, a real asset flow going on. The reality is that the oil-exporting countries of the w o r l d are getting claims on more of the world's goodies than they had i n the past. A n d so there is a real transfer of resources, whether those be current resources i n terms of goods exported to the oil-exporting countries, or claims on future resources when they purchase capital assets. So, there are real problems here, over and above the monetary problems; and it's the real problems the w o r l d should be focusing on, rather than the process by which the flow takes place. M r . R E E S . Getting back to goal 1, we are t a l k i n g about vertical and horizontal integration. W h a t would be the effect i n vertical integrat i o n i f you broke up the producers f r o m the refineries, f r o m the pipelines, f r o m the distributors? D r . B O H I . We would have a lot of mad o i l executives, I guess. The idea there, is, of course, to l i m i t market control. I suppose that would be the first effect: to force what are now integrated refineries, producers, and distributors to become competitors, so that the o i l they pass on f r o m one stage to the other really is bid f o r i n the open market just as the independents have to b i d for it. The transfer price, then, would not be controlled by the same firms, but rather would result f r o m the b i d d i n g process. D r . R U S S E L L . I f I could comment on that. One of the things that is most striking, perhaps, looking at the o i l industry is that for the producer producing crude oil or producing natural gas, the precondition, or potential, f o r competition exists. Now, these preconditions or potentials f o r competition over the years have been hampered first by the state p r o r a t i o n i n g p r o g r a m ; second, by the oil i m p o r t controls; and then finally, and perhaps even to a lesser extent than by the first two, by the integration of major firms. Now, eliminating vertical integration would be the last step, i f you w i l l , i n p r o v i d i n g competitive entry into that industry. State pror a t i o n i n g no longer is restricting output, nor is there any i m p o r t control. So, here we would have, I t h i n k , a viable competitive industry that w o u l d make i t possible to eliminate a lot of the other constraints placed on i t . M r . R E E S . E l i m i n a t i n g vertical integration, would you eliminate vertical integration across the broad ? D r . R U S S E L L . There are a number of arguments along those lines. I understand that the chief executive of Ashland O i l last week was suggesting that refining and marketing should be kept together, but t h a t you should separate out transportation and production of crude oil. Ashland, of course, is a large refiner and marketer, and does very 30 l i t t l e producing, w h i c h has perhaps some implications i n terms of his recommendation. Clearly, I t h i n k , t h a t the most i m p o r t a n t division is between product i o n and the rest of i t — I don't know i f either of you w o u l d agree. D r . B O H I . I t is hard, though, i n the sense t h a t competition downstream is important f o r competition i n the production stage itself. So, it's not easy to separate out these stages. D r . R U S S E L L . I would argue, though, t h a t the major cause of our energy crunch i n 1973-74 was because we were short of refinery capacity. A n d the reason we were sort of refinery capacity was t h a t independent refiners and other refiners recognized that they d i d not have a handle on domestic crude—they couldn't get the domestic crude they needed; the i m p o r t controls prevented them f r o m b r i n g i n g i n f o r e i g n o i l ; and consequently we had no grass roots refining capacity b u i l t i n this country f o r years upon years, upon years. A n d that i f we would have had an open market for crude we may w e l l have had a lot more independent refiners available—which is not to say there is not an enormous capital barrier to entry, i t certainly does exist. M r . R E E S . O n the horizontal integration, there are f a i r l y obvious reasons w h y the major o i l producers should not go into nuclear, coal, and other areas of energy. H o w f a r would you l i m i t the horizontal integration ? F o r example on shale, converting shale to petroleum, you wouldn't want to break t h a t step, would you? Nuclear energy of course would be something else, or coal, gasification of coal; some are direct connections, and others aren't. D r . B O H I . Some of the problems would be eliminated i n t u r n here. I f we i n fact don't have any vertical integration, when you get to the horizontal integration you wouldn't have the problem of h a v i n g o i l refineries linked up w i t h o i l shale production. I t would presumably be independent. B u t as f a r as, specifically, how f a r you go i n any of these recommendations, how you implement them, that is another class of problems we have barely even begun to scratch the surface on. Each one of these problems would require a great deal of study. D r . R U S S E L L . I would like to make one comment on that, I am not nearly as concerned about o i l companies and o i l shale as I am o i l companies and coal, p a r t l y , practically, because I don't see o i l shale as being that important f o r a considerable period of time. Now, coal is important, and i t is i m p o r t a n t shortrun as well. So, o i l shale f o r a generation is going to be a m i n i m a l contributor to American energy security, and i t doesn't make that much difference. M r . S T A N T O N . On that relationship, to carry i t f u r t h e r , you d i d state we should reallocate and expand upward, develop energy away f r o m nuclear energy. W e have an electrical company at home—they have made the p o i n t t h a t nuclear fuel w i l l make a significant contribution i n the future. D o you disagree w i t h them ? D r . R U S S E L L . I certainly wouldn't disagree that nuclear is going to be quite i m p o r t a n t i n the future. I would argue that we have perhaps spent too much money on nuclear i n the past, that the billions t h a t have been poured into nuclear technology were probably 10 or 15 years 31 ahead of their time, and they would have been much better spent f o r developing means of using coal, because i t is s t i l l true, even at the very h i g h prices f o r fossil fuel today, that the k i l o w a t t hours coming out of nuclear plants are more expensive than they are f r o m a fossil fuel plant. One of the reasons—perhaps not a reason—but one explanation of the electric power industry's interest i n nuclear is clearly t h i s : they are able to control the capital investment. Nuclear has much higher capital costs, and much lower operating costs. They throw the whole capital cost i n directly. The company itself is independent f r o m purchasing f r o m the outside. I would also t h i n k they would choose the nuclear route given the regulatory structure they have. Thus far we would have to say i n fairness that nuclear—well, I can't vouch for i t , I haven't looked at i t myself—but the quip is there was more energy consumed i n b u i l d i n g nuclear plants than nuclear plants have produced. Now, as I say, I can't vouch for that fact, but I wouldn't find i t unbelievable. M r . S T A N T O N . Has there any study been made, or are there statistics available of the price of gasoline at the pump i n relationship to the rate of consumption ? D r . R U S S E L L . D O you want to t a l k about that ? D r . B O H I . Yes, there have been a number of studies: none of them are completely satisfying. I n the past we haven't had many changes i n price i n order to l i n k up w i t h changes i n the rate of consumption. A n d also, that relationship between price and quantity consumed assumes everything else staying constant, like population and income, and a l l of t h a t ; and of course none of that holds s t i l l for us. Nevertheless, there have been quite a number of studies, and they a l l tend to come pretty much to the same conclusion. F i r s t of all, they are broken down into two time frames. One would be a shortrun response: how much is a given percentage increase i n price today likely to yield i n percentage reduction i n consumption w i t h i n a few weeks, or a few months? The conclusions there are that the relationship is about —.1 to —.2 or —.3; that is to say, a 1-percent increase i n the price yeilds, .1- to .3-percent reduction i n quantity demanded. Whereas the longer term reduction necessarily would be larger because the consumers have the ability to adjust to higher prices by altering the way they consume energy i n many more ways than they would i n the short run. A n d studies there place the elasticity between — A and —.7; that is, a 1-percent price increase leads to a A to .7 reduction i n the quantity demanded. I t h i n k certainly that was the estimate that went into, f o r example, the Cabinet Task Force where they were studying i m p o r t control. The Chase Manhattan B a n k has just published those kinds of numbers not too long ago. I can supply you w i t h the references i f you want to go into some detail. The elasticity we used is the midpoint between those, —.5. D r . R U S S E L L . I m i g h t note that the demand, the elasticity of demand, f o r oil products other than gasoline is more elastic. So that our midpoint takes into acount—the —.5 takes into account—demand for fuel o i l and other petroleum products. I believe gasoline is the least elastic. D r . B O H I . T h a t probably is the major part. 32 D r . R U S S E L L . I m i g h t just note t h a t we have seen f a i r l y obvious evidence of demand elasticity i n the U n i t e d States i n the last 6 months when consumption of gasoline has dropped, even though there has been an increase i n population, an increase i n the number of automobiles, and the automobile m i x has not shifted significantly. I t ' s not because there are more smaller cars t h a t we are actually consuming less gasoline than before. Now, again, that data is muddied by the recession going on. M r . R E E S . A r e there any more questions ? I was wondering, there m i g h t be some members of the audience t h a t m i g h t wish to ask some questions, and some of them m i g h t be more expert than we are i n posing questions. So, I m i g h t ask, i f anyone w o u l d like to ask questions, i f you do, please give your name and affiliation so we know who you are. A n y questions? M r . S C U K A . M y name is Scuka, congressional research, L i b r a r y of Congress. There were quite a few points made on F r i d a y , and you dispelled many today. I have one item I would like to start w i t h and t h a t is M r . R E E S . Speak up a l i t t l e louder. M r . S C U K A . When you were discussing price F r i d a y , under many conditions, or many possibilities, were you r e f e r r i n g to a current price i n terms of open operations and domestic prices, when you were speaki n g about 1980 and 1985, or were you r e f e r r i n g to some other price ? D r . R U S S E L L . A r e you asking the question of whether we use constant dollars or current dollars ? M r . S C U K A . R i g h t , constant dollars. D r . R U S S E L L . W e were dealing always i n constant dollars, i n 1 9 7 3 dollars. D r . B O H I . Yes, 1 9 7 3 dollars. D r . R U S S E L L . S O , t h a t doesn't take into account any inflation t a k i n g place f r o m 1973 f o r w a r d . M r . S C U K A . I am sure t h a t i n t h a t context Secretary Simon meant constant dollars, too, when he mentioned $7. O n the project of independence, after hearing you today, I am convinced t h a t you are not i n any way supporting i t because you f o u n d i t economically unrealistic w i t h i n the time framework. I wish somebody had suggested the project semi-independent at the time. Y o u have mentioned t w o other m a j o r considerations, one a quota, reimposition of a quota, should conditions evolve where the domestic U.S. price should be protected; and the other one, the alternative, to go t o a t a r i f f system. D o I take i t that you are not i n favor of reimposition o f the quota ? D r . B O H I . That's correct. M r . S C U K A . The cost of t h a t has been adequately confirmed i n historical terms, and I don't t h i n k we should reenter that. O n the t a r i f f side today you mentioned, should the differential i n the U.S. w o r l d price become such that a t a r i f f was required, you would opt f o r that. I s t h a t correct ? D r . B O H I . That's r i g h t , on a standby basis, we indicated t h a t i f the downside risk of domestic producers has to be removed, perhaps the easiest way to do t h a t would be w i t h some k i n d of a standby t a r i f f . W e 33 d i d suggest a level t h a t we don't t h i n k is likely to be realistically achieved i n the foreseeable future. A n d the $7 we don't t h i n k w i l l be the landed price of imported oil, at least as we see it. So, i t is an imaginary t h i n g but i t eliminates the risks, the perceived risks, of domestic producers, of price going below that. I t would be perceivable to have a price of $3. M r . S C U K A . W o u l d you foresee that as a temporary measure, or something t h a t once set i n would likely perpetuate itself? D r . B O H I . O f course i f it's never ever used, except f o r a psychological effect, i t doesn't matter. M r . S C T J K A . R i g h t , there is no argument on that. I n terms of having a weapon at your disposal, it's already a credit to the system; but, i f i t were to be used on the international level, any t a r i f f i n direct proportion to the level would create side economic problems i n terms of our own total industry competitiveness i n the w o r l d market. D r . B O H I . That's true. M r . S C U K A . A n d that, institutionalized, could become a greater danger that we m i g h t face. D r . B O H I . That's t r u e ; and a proportionally greater danger i n the quota. T h a t is why i t is not recommended at all. M r . S C U K A . T h a n k you, I ' l l pass on, perhaps somebody else has some questions. M r . R E E S . W e l l , you w i l l get away w i t h a quota probably easier than you w i l l get away w i t h a t a r i f f , I mean, w i t h a t a r i f f you r u n into G A T T . D r . B O H I . The quota is i n G A T T , too, quotas and tariffs. A l l of these treaties also have the subclauses on national security. So, given that a t a r i f f falls into that category as well, there is no real problem i n terms of the treaty itself. M r . R E E S . W e have had an o i l quota for years. D r . B O H I . Yes, on national security grounds, and that is why there was no G A T T problem. M r . R E E S . I n the context of Project Independence, isn't that a public relations gimmick more than anything else? I mean, it's obvious we have to increase our domestic sources to protect us against the insecur i t y of shutoffs, or a r b i t r a r y price increases. So, do you t h i n k at any time the administration was t h i n k i n g of absolute security? D r . R U S S E L L . I certainly wouldn't want to second-guess the administration, what its goals were. M r . R E E S . I t ' s k i n d of h a r d to second-guess—well, I won't go any further. D r . R U S S E L L . B u t , certainly i n terms of the costs versus the benefits, i t w^ould appear to us that self-sufficiency is one of those things that i t is better to t a l k about than to create. W h e n you recognize what the resource cost is i n the U n i t e d States i n the long r u n — m a r g i n a l barrels are approaching $10 a barrel i f we get enough output to reach selfsufficiency—self-sufficiency • requires an enormous real resource cost when i t m i g h t be possible instead to pick up cheaper imported o i l d u r i n g periods when the O P E C o i l price falls. O f course there is the other point, too. T h a t is, i f we do opt for actual self-sufficiency, and we do tie ourselves to $10 o i l i n the U n i t e d States, i t is going to place the U n i t e d States i n a severe competitive disadvantage i n the event that the O P E C cartel i n fact falls, and the 34 other o i l consumers of the w o r l d get o i l at a resource cost of $3, $4, or $5. T h a t would be especially p a i n f u l f o r our energy intensive export industries. M r . R E E S . Then the cost of production, what we are t a l k i n g about, i t is too h i g h i n shale and gasification of coal, i t is very h i g h and very difficult to b r i n g them into production, and then to stop that product i o n ; i t is relatively labor-intensive, too. D r . R U S S E L L . That's r i g h t . The political problems of closing down a shale p l a n t would be. A n d then attempts to reinstitute i t sometime i n the future would be intolerable. Y o u just can't p u t 2,000 people to w o r k out there i n Colorado and suddenly t u r n them o f f ; and t u r n them back on again. M r . R E E S . S O , probably i n any policy there w i l l come a time when you want to l i m i t your expensive research development so i t doesn't p u t you i n an inflexible position i n terms of i m p o r t i n g cheaper energy. D r . R U S S E L L . That's r i g h t . I n terms of the next 1 0 years you really have to face the fact t h a t we are, i n essence, a fossil f u e l enonomy, and i n essence we are going to i m p o r t a very large p r o p o r t i o n of our energy, almost under any circumstances. The question then is, how do we do i t i n such a way as to minimize security risks, and to minimize the total resource costs to the U n i t e d States. One way of doing t h a t ; and to avoid at least the political problem, is to enhance storage and develop as r a p i d l y as possible the shut-in capacity of the U n i t e d States. T h a t shut-in capacity w o u l d make ourselves secure f r o m that political embargo. M r . R E E S . Have you made any specific recommendations on how much shut-in capacity we should have ? D r . B O H I . W e l l , i t should be linked to the volume of i m p o r t . M r . R E E S . W h a t w o u l d be the percentage i n terms of barrels per day imported now, about 8 m i l l i o n barrels a day ? D r . B O H I . A l i t t l e over six. D r . R U S S E L L . W e argued f o r about 1 m i l l i o n barrels a day shut-in capacity at the current rate of imports. M r . R E E S . W h a t do we have now, one i n Alaska, and E l k H i l l s . Ms. S N Y D E R . E l k H i l l s r i g h t now can produce i n 6 0 days about 1 6 0 , 0 0 0 barrels a d a y ; and it's estimated t h a t w i t h about $ 3 0 0 m i l l i o n investment, t h a t i t could produce 3 5 0 , 0 0 0 barrels a day. M r . R E E S . F o r how long, how extensive is t h a t ? Ms. S N Y D E R . The estimate, I t h i n k , is f o r 5 years they could maint a i n t h a t very h i g h o u t p u t ; but there are doubts about that. The total estimated reserve, I t h i n k , is about 1.4 b i l l i o n barrels. D r . R U S S E L L . A n d the N o r t h Slope of Alaska stuff is really not accessible because not only does i t have to be drilled, we have to have the pipeline, the transportation facilities, and then the receiving facilities on the west coast. So, i n a generational sense, that w i l l be years away. M r . R E E S . S O , we probably need another 6 0 percent increase i n shuti n capacity. D r . R U S S E L L . A t a minimum. I would suggest i t come f r o m Government purchases of private fields t h a t are already existing and ready to use, as well as Government development of the Outer Continental Shelf, or Government development of other either public lands or private lands. 35 M r . R E E S . N O W , you suggest that the Government could pay a private developer a fee f o r keeping shut-in capacity. D r . R U S S E L L . T h a t would likely t u r n out to be the most economical way of p r o v i d i n g the reserves that are necessary. M r . R E E S . T h a t would be a market interest on the amount t h a t m i g h t be d r i l l e d that year? D r . R U S S E L L . T h a t m i g h t be produced that year. M r . R E E S . Produced. D r . B O H I . There is a regular organized market r i g h t now i n selling what you may have found, to somebody who is equipped to produce or refine it. The Government simply enters that market and buys the reserves that have already been, i f not drilled, at least sized up as to capacity. D r . R U S S E L L . O f course, there would be continuing costs involved i n maintaining the pipelines, and maintaining the wells i n shape. Some geological structures would be satisfactory f o r holding and others would not. Some have tendency f o r well bores to sand up while others flow f a i r l y easily, and so f o r t h . So, i t couldn't be just any reserve ; some of them you have to continue to use. M r . R E E S . Fine. A r e there any other questions, J i m ? M r . S I V O N . Yes, I have a couple questions. W h e n M r . W i n g e r was here f r o m Chase, he said by 1985 we should be 85 percent self-sufficient. Now, give me your analysis. I t h i n k you disagree. Can you give me any specific percentage of self-sufficiency by 1985? D r . B O H I . W e l l , given the price assumptions we made, and so on, our best guess would be, i f there were no interference, around 35 percent of consumption, which is approximately what i t is now. D r . R U S S E L L . Imports. D r . B O H I . T h a t would be imports. M r . SIVOJN". That's g i v i n g your market analysis. B u t , do you t h i n k we should D r . B O H I . There's a good question. W e really d i d n ' t face the matter i n terms of what do we recommend as a desired level of self-sufficiency. W e d i d n ' t i n fact t h i n k we were capable of g i v i n g any better answer on that than anybody else. The best we can do is say how much different levels of self-sufficiency might cost, given different methods of achieving them. A n d certainly we concluded that complete self-sufficiency was too costly, given the use of import control, or subsidy approaches. B u t , as f a r as, "how f a r do you back down f r o m t h a t ? " "what do we guess ?"—it may be any way down to 35 percent. M r . S I V O N . The other question I had dealt w i t h consumption tax, a l i t t l e more specificity there. W h o would administer the tax, and what tax level are we t a l k i n g about? D r . R U S S E L L . Probably the easiest t h i n g to do would be a tax that would move into the price at the refinery. A g a i n , we didn't attempt to design an actual tax. You m i g h t be interested to know what rate of tax we were t a l k i n g about to meet these goals. T o meet the goals of 1 m i l l i o n barrels a day shut-in capacity, to provide $2.5 b i l l i o n a year extra R, & D. f o r energy research, and to provide $1.2 b i l l i o n f o r those low-income 36 problems that we described before, would require something like 67 cents a barrel tax. Now, we are talking about 1.5 cents a gallon tax, which is a relatively small tax when you look at the current highway taxes, and other taxes on gasoline. Of course that tax would be proportionately much greater on other fuel. I n terms of the costs of providing 60-day storage of insecure oil, that is Arab oil, it would cost about 40 cents a barrel on that which is imported—not over all 17 million barrels—but on that imported and provided for storage. So, these are not—when you are talking about Project Independence kinds of figures—these are really not that exorbitant a cost. Mr. SrvoN. Thank you. Mr. W H I T E . I ' m Tom White, on Congressman Hanley's staff. I don't know i f you have done this on purpose, or not, but you ignored completely solar energy; is that because the technology costs are too extreme. I f this is the case, would you then for 10 or 15 years go through gasification of shale, and then to nuclear energy, and then to solar energy? Ms. S N Y D E R . I think we ignored it in the time frame, we are considering up through 1985, and we don't anticipate that solar energy will make a significant contribution to energy before that time. Dr. B O H I . Also remember that in order to use it beyond 1 9 8 5 some new technology has to be developed that Ave don't know anything about. We preferred not to make any guesses of that sort. Mr. S C U K A . T W O more points I would like to offer. One, have you considered the formation of a national corporation for the specific task of managing either the shut-in possibly, or the actual storage, so that you remove that from private hands; payments, fees, instructions, or regulations have notoriously been ignored, distorted, or just simply not been followed. The Government owns, the Government has absolute right to the offshore areas, has i t not; and onshore we have Federal lands, or public lands where the Government can intervene and has administrative authority over, without precluding the continuation of the oil industry to remain in private hands. The constitution of a public oil corporation, national oil corporation would give a working, functional organization where by starting with a lease, which would exclude bonuses, but wTould include royalties dues, royalty production dues; the corporation could elect not to produce a certain amount of royalty oil, not to l i f t i t in any given period of time ; and that would be part of the national reserve, the producible national reserve, administered by the Government. I t would eliminate fees; it would eliminate cost accounting, although we could still, i f we wanted to, establish a certain cost pattern to the operation. But, it's just something that should be considered, and should be considered because the same situation, i t is now under review, and i t has been presented as a law in the Canadian Parliament; I expect it to be functional before the spring of next year. Obviously i t is the embryonic stage, but i t w i l l have the same consideration, will have among the operations of the private corporations a government arm that w i l l be interested, itself, only in having secured delivery in case of emergency. 37 Dr. RUSSELL. I can comment on that. First of all, we did not think i t was our mission to try and describe processes by which the goals could be achieved; and so we did not attempt to develop the institution of a Federal corporation. Now, I can make some general comments, first of all with reference to storage. The important elements with reference to storage are that stored oil be capable of moving immediately into the same channels of distribution so as to take the place of that oil which is interrupted. The feasible way of doing that is to have the importers themselves handle the storage, and pass that storage cost on to the consumers; and therefore you wouldn't have the problem of the storage being at point A, when the refinery is at point B. Mr. S C U K A . My scheme would not have that problem. My scheme would be entirely consistent with the fact that you do develop a field, but once the field is developed you must provide pipelines to move i t ; and, say, 10 percent, or 5 percent, or 15 percent of the production that the Government would choose not to produce would have accessible all the downstream movement that's necessary to put it immediately into utilization. Mr. REES. We have been considering that in the A d Hoc Committee in terms of Federal leasing policy on the Inter-Continental Shelf where the Federal Government takes more than their one-sixth, takes whatever they think is necessary, or whatever the geological formation would justify; and then becomes more or less a joint venture between the Federal Government and the private company. I ran that out to a couple of companies. They weren't "the majors," but they were multi-million-dollar companies—in the legislature when they have oil fights we say it's the millionaires versus the billionaires— but these were substantial national companies. They thought that a joint venture both in shale and in the Inter-Continental Shelf wouldn't be a bad situation. I thought the reaction would be totally negative, but it was not. Mr. S C U K A . They were accepting it in principle ? Mr. REES. They were accepting the principle. We do that in California, not for storage; but we can take our oil and auction it off. We do that to keep the independents busy. Unfortunately we have some problems in the Federal Energy Administration, they won't let us auction off our oil in the market because they say the price will be higher than the old oil price at an auction, and we are now in the midst of fighting that. But, the way I envision i t is somewhat the way you envision it. I don't know i f a formal corporation has to be put together. I'm always afraid of forming something like this because just having a Federal corporation gets people nervous because they think a Federal corporation would be actively competing with private enterprise. Mr. S C U K A . I ' m not minimizing the political problems. Mr. REES. I ' m not minimizing political problems, but I ' m dealing with realities. But, I think without even forming a Federal corporation, in fact without even passing a law, that the Federal Government today could take more than one-sixth in interest and could store that, or could put i t out to bid. I don't think there is anything in the statute today that would prevent that. 38 Mr. S O U K A . The way they can come up with a leasing regulation, they can come up with some other regulation consistent with the authority that they now have. Mr. REES. W i t h the authority they now have they can go into a policy like that without any action by any legislative branch. Dr. RUSSELL. Let me suggest one problem with that policy, a problem perhaps in the abstract, but one I think very serious. That is that the tendency would be for those resources to be transferred without bonuses, which would imply that part of the cost of that oil offshore would come out of public domain, domain owned by the taxpayers of the country. The tendency would be, then, to transfer it finally to the consumers at a price consistent with getting the resource free in the first place. I think one of our problems has been the underpricing of energy in the past for reasons such as this, and our tax laws. And that you would end up with far too much consumption of energy; energy security would not be charged to those who benefit from it—to consumers. So, the public domain ought to be kept public; and the funds from public domain should be transferred into general funds and not cover the cost of energy security. Mr. S C U K A . My scheme does not have that problem, perhaps you did not understand clearly the position. I f the Department of Interior, or the White House, for that matter, takes the position that you not accept a bonus, but you tie the results of exploration into the future production accruing to the Government, at a given level, as Mr. Rees suggested, at a reasonable given level, that is a money transfer which could be handled as bonuses are handled now, or in some other fashion. That would be a real asset to retain by the public domain, and channeled into, whether emergency supplies, or to play a part in the shut-in costs, or whatever else. But that is an administrative problem, it's an administrative problem concerned with any other tax problem. I have one other point which I would like to offer as part of my own study over the past several years, referring to the price of oil, the current price of oil, denominating dollars, yen, or whatever else. I t seems to me, i f you look at the world situation, the world price situation, the world commodities, including gold, you will find that last fall and this past winter it reached a natural equilibrium between the gold price and the petroleum price. It's almost at the point of indifference, what we call economic indifference. I n support of ijiy theory, I have information from the BIS, from other sources, banking sources in Europe and here, as well as from those who actively participated, the Middle Eastern banking activities, that the Arabs have not been buying any substantial amounts of gold since last summer. Before there was a concept, or at least an accepted concept that gold on the free market was purchased by the French, by France in general; by Middle Eastern oil sheiks; and of course a large quantity goes into the sub-Indian continent. But I was rather surprised to hear transactions in the gold market, legal market, there was not any active participation by the Arabs now that they have excess of money. So they are either considering producing oil in order to have a direct investment at some point or other; or they will opt to retain the oil in the ground, rather than just exchange it for gold and then keep it. That's just a theory. Mr. REES. Any comments ? 39 Dr. R U S S E L L . Not from me. D r . BOHI. NO. Mr. REES. Congressman Crane is our gold expert in this committee. Are there any other questions ? I f not, I want to thank you very much for an excellent study, and we really do appreciate your contribution to the work being done by the ad hoc committee. The meeting is adjourned. [Whereupon, at 11:50 a.m., the meeting of the ad hoc committee was adjourned, subject to the call of the Chair.] o