Oil: A Solution

The world crisis is now past its peak. The initial quadrupling of the price of crude oil after the Arabs cut output was a temporary response that has been working its own cure. Higher prices induced consumers to economize and other producers to step up output. It takes time to adjust, so these reactions will snowball. In order to keep prices up, the Arabs would have to curtail their output to zero; they would not for long keep the world price of crude at $10 a barrel. Well before that point the cartel would collapse.

—Professor Milton Friedman, 1974

President Carter has the authority to decontrol the prices of crude oil and gasoline immediately. That action would have immediate effects. Just about every professional economist, even including outgoing Secretary of Energy James Schlesinger, agrees that decontrolling the price of gasoline at retail and eliminating government allocation of gasoline would end gasoline lines immediately and make gasoline rationing unnecessary. Decontrolling the prices of crude oil and natural gas would not have an immediate effect, but it would stimulate production within months.

—same, 1979

The energy crisis—in fact, the oil problem, for that is the energy source that has been subject to all recent change—is, in its basic lineaments, not terribly complex. The complexity, that which comes from ordinary, uncomplicated, understandable dim-mindedness apart, is largely the contribution of those who do not wish to face reality. Evasion, even a measure of obfuscation, protects deeply held belief from what exists. And there is an even more severe conflict between ideology and obvious practical action. So yet more evasive dialectic is required. Finally and more reasonably, there is, in the longer run, the uncertainty that is inevitable when policy involves technical innovation that is theoretically plausible but wholly unconsummated.

In the short run there are only two possible solutions to the oil shortage. The first is to rely on the market to bring the demand for oil down to where it equals supply. The second is to intervene directly to bring about this result—to set aside the market, at least in part, and to resort instead to some form of planning. There is a third line of action, though not a solution, and it is one to which, in fact, the recent energy czars have resorted. This is to have enough half-hearted planning of the wrong kind so that one gets the worst of both worlds. One notices here the use of the word czar. This is in accordance with a bipartisan convention of some years’ standing in Washington which holds that the word czar has a more democratic connotation than planner.

I speak of making supply and demand equal by reducing the demand. When a shortage is exigent, it is demand that must, with narrow exceptions, be adjusted. One of the first rules for anyone who wishes to respond sensibly to the energy shortage is to ignore, if possible without ostentatious contempt, the pompous ass who avers that “we must always place our emphasis on producing more.” If shortage is here and now, it’s because no more can be had. Supply responds, at best, only after a little time.

What is called sound market doctrine holds that supply for a producible item such as oil, given a little time, will always respond to higher prices. Any effort seriously to limit supply and enhance prices will, it is held, be destroyed by the pressure to sell more at the higher price. And also by the enthusiastic response of producers who are not part of the control effort.

OPEC, in this regard, has been inconveniently resistant to free-market doctrine. That is because the Saudis, now also the Iranians and potentially, one judges, the Libyans, are not compelled by their need for revenue to keep their oil output at the maximum. Since oil is an exhaustible resource and their need for more current revenue is not that great, they realize that they can leave the oil in the ground for a possibly better future return. Such a thought is devastating for free-market doctrine, but it nonetheless occurs.

Past cartel efforts for other commodities, if carried very far, brought a sharp reduction in sales. Wanting to sell as much as before, cartel participants then began to shade their prices and to suspect others of doing so. So the cartel effort on frequent occasion did collapse. OPEC, comprising countries willing to absorb a reduction (and facing an inelastic and steadily increasing demand for oil), has thus defeated the free-market predictions. And it is not possible for the good free enterprise scholar to be more than annoyed. The OPEC countries have only been using their strong market position to maximize profits. That is precisely what the textbooks urge; it is what those with a gift for innovative language say the system is all about.

There is oil production outside OPEC and by far the largest amount is in the United States. But here again the free market effect has been distressingly perverse. Prices for newly discovered oil, this being rather obviously the oil that is affected by pecuniary return, have, thanks to OPEC, been at superbly rewarding levels. But, Alaska apart, US production has, year by year, been going down. That is again a reflection, in various and sometimes indirect ways, of the fact that oil is an exhaustible resource and that the US supply is being exhausted. So there has been no response from US fields to break down the OPEC price. Thus for those who deal rationally with the market, as distinct from those for whom it is a matter of faith or those who accept automatically the liturgical observances of the oil companies about incentives, there is only one recourse. That is to hope that, with high enough prices, demand can be brought down to or below the currently available supply. Only thus can there be a brake on further price increases and reduced dependence on the cartel.

This is possible. But for the effect to be appreciable, we now know, the price increase must be very stiff. There are no special factors such as OPEC or domestic resource exhaustion operating on the demand side to resist the response to price as there are on the supply side. But there is, instead, our enormous social and political accommodation to high oil use—to automobiles, to the residential pattern that these have made possible, to the associated commuting, to the decline in the energy-efficient railroad plant, to the over-the-road haulage that the interstate highway system has brought about, and, a most important matter, to oil furnaces and oil heat. This accommodation of life to oil is what makes the energy crisis a crisis and its discussion a national preoccupation. And, most significantly, it makes demand inelastic with respect to price.

Nonetheless, if the price rises enough, purchases will fall. Those who urge this remedy have only to ignore the differences in income of the people who buy gasoline and heating oil and the fact that the poor as well as the rich have accommodated their lives and their manner of making a living to the use of gasoline and oil furnaces and stoves. And also that the poor family does not have the freedom for substitution that money gives to the more affluent.

For the free market purist, the poor do not count. Professor Milton Friedman, the acknowledged leader of the free market convocation, is not a thoughtfully hard-hearted man. The use of high prices to deny gasoline and heat to the low-income family is, for him as for his communicants, a technical matter devoid of moral content. Nothing distinguishes such action from the tax revolt of the affluent against welfare, schools, parks, public recreation facilities, libraries, and the police, all of which are also far more important in the lives of the poor than for those who can afford privately earned or purchased substitutes.

But for others, including some who must run for public office, the differential-income effect of the free enterprise solution has moral or anyhow political content. Not everyone yet views the revolt of the rich against the poor with complete equanimity. And the oil companies pose a special problem. They are the grateful recipients of the revenues from the high prices; the market solution means, in effect, that income is recycled from the public at large, including those most pressed by the higher prices, to the Seven Sisters and the equally blessed independents. So vast has been the income so recycled in recent months that it has led to a problem unparalleled in the history of literature. The oil companies are no longer able to buy talent capable of justifying with even minimal plausibility the increases in their profits.¹

During World War II in Washington, we often observed that the great corporate executives working for the War Production Board, when faced with the certainty that the market for some scarce commodity would no longer serve, would regularly propose just enough intervention to make everything worse. And while not yielding anything in their suspicion of government bureaucracy, they would surround themselves with a very sizable organization similarly dedicated to maximum inaction.

No one can doubt that Mr. James Schlesinger, like his predecessors, was in this tradition. His market principles, rivaled only by those of Mr. William Simon, were and remain impeccable. Wherever possible, he adhered to these principles. Price differentials or tax incentives were the essence of the encouragement to use coal, conserve heat, install solar panels, and, of course, to encourage oil and gas exploration. Few market theologians, however devout, react adversely to incentives, whatever their source.

Mr. Schlesinger was partly a casualty of the free market. Incentives failed him. More specifically, he was ruined by the inelasticity of supply, demand, and substitution. Neither supply nor demand responded as he had hoped, and none should doubt that his former teachers have a contingent liability. Some one of us should have told him about this possibility during his years at Harvard. He was also, in fairness, the victim of a Congress that was not as willing to punish the poor with high prices as the pure doctrine required. That is why price controls were kept on previously discovered oil and on to retail. But most of all he was ruined by the kind of half-hearted planning to which I earlier adverted, which has the effect of making everything worse.

On rationing to consumers, Mr. Schlesinger, as late as this summer, was emphatic. He said he did not think it in the American tradition. It is now the acknowledged right and privilege of any cabinet or elected official to identify the American tradition, and it is perhaps not surprising that Congress, being so reminded of the American tradition, denied him even standby authority. But rationing supplies to gasoline dealers—businessmen—was and remains a different case. In times of shortage, the consumer can go without, but it is not in the American tradition that a businessman be denied supplies to sell. So, as an inheritance from his predecessors, Mr. Schlesinger administered a complex design for rationing gasoline to service stations. And since there was no way of adjusting this to changing patterns of use, it was admirably arranged, with any shortage, to be regionally inequitable and erratic. Thus the effect of half-hearted planning. It can be laid down as a general rule that any allocation of a short supply to retailers makes a bad mess worse. Among other sources of anger and confusion, it gives the retailer the power of deciding who gets what amount.

If an insufficient supply is to be distributed equitably, i.e., without resort to high prices alone, one must take firm control of the ultimate sale. Anything short of this will, if for something important such as oil, cause a crisis of the American spirit.

Effective consumer rationing being forsworn, the Department of Energy presided, in effect, over the worst conceivable form of rationing—gasoline to the person willing to wait the longest time (with an idling motor) at an open gas station. The confusion at the pumps brought the sacking of Mr. Schlesinger, his second such experience in a cabinet job in successive administrations of two different parties, which is unquestionably a record. His position, one is happy to note, is not as bad as this sounds. The architect of any real disaster in modern public administration achieves the notoriety that all but invariably assures more remunerative employment. It was so even for Richard Nixon. It is our compassionate system of upward failure. The uncertainty whether one could get gasoline brought a temporary reduction in demand. This and some noblesse by the Saudis have resulted now in a certain calm. There is no assurance that the calm will last. And our oil imports remain far too high for international or our own stability. If the country and also those managing energy are to be safe in the future, there must be a simple, effective system for rationing gasoline to consumers. This, no one should suppose, is agreeable in itself; it is only better than rationing by lines at the pump, taking it away from the poor by higher prices, taking it away from home heating where the consequence could be truly disagreeable, or importing too much. In the short run it is gasoline, or rather motor fuel, that must, in the main, be made to yield.

The required procedure is not all that difficult. Gasoline prices at the pump should be raised by taxes to a penalty level. One thinks of five dollars or more a gallon, although even this is not astonishing by European standards. Then each family should be given stamps, similar to food stamps, allowing a basic purchase for household and pleasure driving at present prices or, for the government wishes to be nice in a perfectly reasonable way, at a level somewhat below. Cars certifiably in use for car pools and business purposes would be given a larger allocation of stamps.

The stamps would be sent in from the service station to the wholesaler along with the money to pay the taxes on the high-priced gallonage. The stamps would be good for a year, and people would be urged to hold any surplus against emergencies. Expiration would be at the end of the year when there is the least danger of a burst of driving to use them up. The organization to issue the stamps and check against claims would not be slight. People would be required to man extra windows at the post offices and the regional offices of D.O.E. Nothing, alas, can be done without people.

Under this system those of modest income are protected; those in real trouble (and the rich) can always get more gasoline by paying the price. The shrinkage of gasoline demand, which can be achieved either by reducing the basic allocation or raising the penalty price, should be sufficient to ensure oil for home heating as well as to reduce the pressure of overseas demand. As Mr. Carter has now, in effect, proposed, users of small amounts of home heating oil should also be helped out with stamps.

Such a design for managing gasoline (and therewith oil) demand at minimum sacrifice will not sit well with the Jacobins of the great conservative revolution. More big government. But the more astute of the revolutionaries must be noticing by now that their revolt is in deep trouble—that it is encountering a powerful counterrevolution in its own ranks. At no time in recent history have we had so many demands for more government and more government regulation, and all from the affluent. Thus the demand after Three Mile Island that nuclear energy, however safe, be made safer—by government action. And after the crash of the DC-10 that air safety regulation be closely reviewed and greatly tightened. And with the fall of Chrysler that the United States government, following those of Britain, France, and Italy, get deeply involved in the automobile business. And that, as the price of SALT II, there be more arms spending.

And overshadowing all, there has been the raucous demand, much of it from people near Jesse Helms, that Jimmy Carter get the government going on the production of synthetic fuels. Not even Mobil seems prepared to argue that private enterprise can do this job; its most recent advertisements have been confined to urging that “energy options,” nearly all calling for more pollution, have not been discussed. In the weeks ahead the Seven Sisters, or most of them, will be engaged in fighting legislation, backed by both Jimmy Carter and Edward Kennedy, that bans the use of oil profits by the big oil companies for acquiring large enterprises (such as Montgomery Ward) which have nothing to do with the production of oil. So much for the case for greater incentives to produce more oil.

The common feature of all of the substitutes for oil, increased use of ordinary coal possibly apart, is that time will be required to get them and that economic judgment must yield to scientific and engineering knowledge and the resultant determination of feasibility, cost, and environmental effect. In the case of one source, atomic energy, there are the further imponderables of reactor safety and waste disposal and the circumstance that even if these were shown to be utterly safe or were solved, millions would no longer believe it.

For anyone getting into these longer-run considerations, by far the best text currently available is the recent report of the Energy Project at the Harvard Business School (Energy Future, edited by Robert Stobaugh and Daniel Yergin). It is competently researched, technically sophisticated, and, by academic standards, lucidly written. In these last weeks it has been praised, and deservedly, as a model of what university research and monograph writing on a major question of policy should be.

Its solutions are also admirably resistant to business and corporate clichés and should give everyone a better view of business schools in this regard. Against the mindless assertion that the only American solution is to produce more, the authors conclude that the practical solution is to conserve energy, use a lot less—as only one example, by better insulation and architecture.

A very large number of cautiously intelligent people must have wondered if there isn’t an element of romance in the enthusiasm for solar energy. Solar energy attracts people with an indifferent commitment to personal hygiene and a strong commitment to organic foods. But Stobaugh and Yergin conclude that, in its varied direct and indirect manifestations, solar energy is, by a fair margin, the best practical prospect, better than the coal that lies massively behind the Carter synthetic fuels proposals.² And they have no time for the market theomorphists: “….the reader should not be deceived.Nothing will happen automatically…. It is disheartening to compare the role of public policy in the United States with that of other Western countries, especially when one remembers that the United States is the dominant energy consumer on the world scene.”

On one or two points the authors do seem casual, even negligent. Thus the rehabilitation of the railroads (and their reorganization into a single coherent system) surely deserves more consideration than they accord it. We are the only major industrial country without such a system, and railroads, compared with other means of moving goods, are energy-efficient. As I do not worship the market, I also do not exclude the possibility of bad planning. Our extreme plunge away from the railroads to the interstate highway system was an example.

Fifteen years ago I served on a commission established by Secretary Udall to study and set policy on the oil shale reserves. These deposits, nearly all on public land, stretch endlessly over Colorado and into Utah and Wyoming, and have a nearly limitless amount of oil-equivalent combined with the rock. Where the mahogany ledge is deepest and richest, an astonishingly small area can have a year’s supply of oil, could it be recovered. Years ago this wealth sufficiently impressed the government that a big stretch of the formation was set aside as a naval oil reserve. Benjamin Cohen, Joseph Fisher, now a congress-man from northern Virginia, and I led in urging that all the shale lands be held against future need, which presumably is now.

Stobaugh and Yergin are cursory on this resource. Although water supply and environmental considerations may be inhibiting, it is not my impression that they are as serious as sometimes suggested. And while present methods of recovery require a large earth-moving operation, this would involve a relatively limited acreage of no great topographical interest which, except from an airplane, is rarely seen. The authors should have given this huge resource more attention.

But they have done a lot. The lesson from their pages, as from the devastation of James Schlesinger and of the predictions and policies of Milton Friedman and his disciples, is all the same. Over the years, if imperfectly, socialists have had to learn that faith is not enough. Things have to work. Frequently the best course is to rely pragmatically on the market. Now in this first year of the great windy free enterprise revival the lesson for conservatives is equally clear. Faith in the universal efficiency and beneficence of the market, however devout, is also not enough. Here, too, ideology is not a substitute for thought.