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Commentary: Oil: A Modest Proposal For The U.S.


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Commentary: Oil: A Modest Proposal for the U.S.

The U.S. needs a policy--one flexible enough for the future

Americans haven't heard the words oil and election so entwined since President Jimmy Carter ran for reelection--and lost--back in 1980. With oil prices near their highest level in a decade, sticker shock at the gas pump, rising fears of oil-induced global stagflation, OPEC leaders parading across our TV screens, and the worries of Northeasterners over how they'll heat their homes this winter, energy policy is once again near the top of the national agenda. While Americans prefer oil to go unseen, unsmelled, and unnoticed, these days it's impossible to ignore. What people want to know is: How can we get out of this mess--and make sure it doesn't happen again?

A good national policy on oil should keep oil affordable while encouraging conservation. It should also protect the environment and reduce U.S. dependence on OPEC--all without breaking the budget or imposing undue costs on other parts of society.EAGER TO PLEASE. In the Presidential campaign, Vice-President Al Gore has been touting tax incentives for conservation, while Governor George W. Bush emphasizes increasing supply, in part by promoting more drilling in the U.S. Both are fine ideas as far as they go. But let's start with a politically incorrect thought that you probably won't hear from either of the eager-to-please candidates: The best cure for high oil prices is...high oil prices. Over time, a high price will suppress demand and call forth new supply, causing prices to fall. It happened in the 1970s, and it's sure to happen again.

That said, government does have an important role to play, stepping in where the market fails. Understandably, many people aren't reassured to hear that the futures market is predicting the price of oil will slowly decline over the coming year, to $29 a barrel, from nearly $32 today. Or that traders are expecting heating oil to be lower than today's wholesale level of 94.8 cents a gallon by next February. People are feeling pain now--and they remain worried that prices will go even higher.

Consequently, the first order of business is to insulate the most vulnerable people from the shock of costly oil. President Clinton did the right thing in September by releasing $400 million in federal funds from the Low Income Home Energy Assistance Program--a program that has bipartisan support. Congress should replenish the fund, which has just $150 million left in it, as more aid may be needed this winter.

At the same time, it's important to keep the current price jump in perspective. Except for certain particularly hard-hit groups such as truck drivers, most people can absorb the run-up. Oil now accounts for just 2.7% of personal expenditures, down from 6% in 1980. And it's still cheaper in inflation-adjusted terms than it was for the average of any decade except the 1990s. All of which helps explain why the economy remains healthy. Even Goldman, Sachs & Co.'s chief international economist, Gavyn Davies, a relative pessimist, predicts "a moderate slowdown in growth, but not...a global recession."

In that light, many recent calls to action seem ill-conceived. President Clinton acted too hastily in promising to release 30 million barrels of oil from the Strategic Petroleum Reserve. Although the release quickly helped send oil down from its high of $37.80 a barrel to a little under $32, it's too small to make a long-term impact on the world price--and could give OPEC an excuse to cut back its own output increases. Likewise, Governor Bush and his running mate, Richard B. Cheney, are too quick to cry "crisis" in calling for drilling for oil in the pristine Arctic National Wildlife Refuge.

Nor do Vice-President Gore's promises to stand up to "Big Oil" as President make sense. It's not clear what that means, and moreover, there's no evidence that the big shareholder-owned oil companies have driven up the price of oil. Why? They can't. The 13 biggest companies provide only about 17% of the world supply of crude, and they don't decide production jointly.

That's not to say Big Oil is blameless. What they're guilty of is excessive caution. Even with oil over $30 a barrel, many of the majors are refusing to develop projects unless they would be profitable with oil at $14 to $16 a barrel. As a result, production of the 10 biggest companies fell 4% in the first half of 2000 from a year earlier. Exxon Mobil Corp.--the behemoth formed by a merger last November--cut its combined exploration and production budget by 30% in the first half. Oil companies need to remember that they serve the public, not just their risk-averse shareholders. If they don't step up drilling, Congress and trustbusters are going to start wondering whether size has dulled their zest for competition.GREATER CONCENTRATION. The place to worry about lack of competition is in refining and marketing. The immediate cause of the heating oil crisis is not undersupply of crude; it's the lack of refining capacity to combat inventory shortages. And while the share of refining capacity held by the 23 biggest companies has fallen from 77% in 1981, to 56% today, that trend masks greater concentration of ownership in particular regions--Tosco on the East Coast, for instance, and BP Amoco in the Midwest. The Federal Trade Commission should vet future merger plans to prevent any company from gaining a stranglehold on a region's refining and marketing. "One of the public-policy challenges is how to deal with a situation where prices are spiking because supplies are constrained," says William J. Baer, an FTC antitrust chief under Clinton.

As for the long term, a national oil policy is pretty simple: it should make oil as cheap as possible--while finding creative ways to deal with the negative effects of heavy consumption.TOUGHEN EMISSION STANDARDS. Cheap oil is good for the same reason that cheap wheat is good. It lowers the cost of living. And oil companies are developing cost-reducing technologies without any government prodding. If there's a role for government, it's more on how to deal with the downside of cheap oil. Once people are hooked on it, as has happened over the last two years, OPEC has more leverage to raise prices and wreak havoc. What's more, overconsumption worsens air pollution and global warming.

Economists favor heavy taxes on fuel, but that's a political no-no. The most palatable way to deal with the ill effects of cheap oil is to combat them directly: Cut air pollution by toughening emission standards. And Congress ought to do something about the most egregious example of wasteful consumption around: the poor gas mileage of many sport-utility vehicles. Considering that the corporate average fuel economy (CAFE) standards have been stuck at 27.5 miles per gallon for passenger vehicles and 20.7 mpg for light trucks and SUVs since 1995, Congress should allow the Transportation Dept. to raise the standards for both categories. And the exemption for the heaviest SUVs--which don't have to meet any mileage standards at all--should be eliminated.

To mitigate OPEC dependency, the government should encourage more oil production outside of OPEC while simultaneously encouraging conservation. In fact, the Bush campaign is right to reopen the issue of drilling for oil in the U.S. under tight environmental safeguards. While highly sensitive areas such as the Arctic refuge should be kept out of reach, there are other areas, possibly including off the coasts of California and Florida, where more drilling could safely be done.

What else? The U.S. desperately needs more refining capacity. The big profits that refiners are earning now, after years of drought, should encourage growing players to step up investing. It would help if the Environmental Protection Agency made it easier to add refining capacity. Another problem is that refiners are currently forced to produce more than 50 blends of gasoline, including regional variations. This causes local price spikes because refiners with extra oil can't ship it to hard-up areas with different requirements. Government standardization of blends would ease this bottleneck.

No matter what oil policy a country has, oil prices will fluctuate. And OPEC's not going away. But there's still plenty that can be done. Witness Japan, where an intense focus on conservation has softened OPEC's blow. The U.S. will carve its own path, of course. The point is, hard times can produce creative solutions. Time to get started.By Peter Coy; Coy Is Associate Economics Editor.Return to top


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