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Coping with oil-supply disruptions
0360-5442183 53.m- .a, Pergamon Res Ltb
Elqy Vd. 8. No. F-9. p$. 621629.15733 Printed in Gma! Brik.
COPING WITH OIL-SUPPLY DISRUPTIONS WILLIAM P. SCHLARB ARC0 Petroleum Products Co., 515 South Flower Street, Los Angeles, CA 90071.U.S.A. (Received 15 Sepfember 1982) Abstract-A general lack of understanding by the public and the media has characterized the U.S. response to the oil-supply disruptions of the 1970s. Controls hampered the adjustment to the changed energy environment following the 1973-74embargo. Spurred by decontrol, the higher price of oil has stimulated conservation, intensive search for new oil and gas, and allocation of existing oil to the changed pattern of most-valued uses. In future disruptions. the government should establish a credible public information program, strive to facilitate the competitive functioning of the marketplace, and intrude into the market only with programs that automatically end in 2-6 months.
I. PUBLIC
INFORMATION
IS CRITICAL
Many of our difficulties in handling past oil disruptions can be blamed on the public’s lack of understanding of what was going on. I mean that, superficially, it was simple to connect the politics of the 1973 embargo to the oil cutoff by the Arabian members of OPEC. But the embargo masked the more critical underlying forces that were working to restructure world petroleum markets. Our historic arrangements for access to foreign oil, the Persian Gulf supply, in particular, were being undone. Embargo or not, the international oil price structure of the 1950s and 1960s was being unhinged. Regrettably, the embargo politics and chaotic scenes at service stations held a great deal more appeal for media broadcasts than the unappealing facts of international oil economics. For whatever reason, the more important aspects of what was happening were not conveyed to the public. The embargo and the Iranian revolution also obviously presented irresistible moments for political opportunism. Instead of trying to allay public fear and panic, we saw some of our Washington leaders appearing on television to accuse the oil industry of conspiracy and rip-off. Through innuendo, the public was led to believe that key governmental agencies were kept ignorant of the substantive issues discussed in the Tehran and Tripoli conferences more than a year before the embargo. On the contrary, the U.S. State Department was fully aware of the demands by Saudi Arabia and other key Arab oil producers to alter completely their concession arrangements with the major international companies. It was, in fact, James Akins, U.S. Ambassador to Saudi Arabia in 1973-76, who provided clear evidence on several occasions that the State Department was privy to every step of the negotiations between the oil companies and the producing countries. The Justice Department was also close at hand during the Tehran-Tripoli meetings. These key agencies were fully aware that the producing countries were negotiating direct control of their oil production and that their demands would have potentially dramatic implications for world oil prices. But the critical nature of these negotiations was not conveyed in simple, credible terms to the public at large. American consumers were left to learn that an era of stable energy price and supply had suddenly ended when the embargo was imposed and the political turmoil of the Middle East was enmeshed with the economics of oil. Confused and dismayed, a panicky public turned with outrage on oil companies. The federal government reacted, in turn, with the imposition of an enormously complex set of price and allocation controls. 2. CONTROLS CONFOUNDED
THE MARKETPLACE
ADJUSTMENT
manage the disruptive impacts of a four-month shortage of minor extent in 1973-74, a network of unintelligible controls was created. The controls grew more complex and pervasive and were still in place when the second disruption came with the Iranian revolution. The result was predictable: serious market dislocation and needless costs and inconvenience borne by consumers. Worse yet, both industry and consumers were denied the signals of the marketplace to guide their responses to the new realities of world oil markets. To
627
628
W1LLl.W P. .kHL.lRB
The controls were based on frozen supplier-purchaser contracts related to an arbitrarily_ chosen reference period. The fundamental premise of the controls was that somehow we would return to the energy world of the 1950s and 1960s as soon as the political event causing the disruption ended. Given the total rearrangement of our terms of access to foreign oil supplies, a return to business-as-usual was out of the question. As one administration after another chose to leave the controls in place, market dislocations inevitably grew more severe. It was no surprise that pent-up forces in energy markets let loose with a bang when the controls were lifted in January 1981. While controls were hampering domestic markets, critical changes were taking place outside the United States. Both the use and search for petroleum were beginning to respond dramatically to the higher prices. Decontrol has accelerated the pace of similar changes in the U.S. market and we are beginning to witness surprising impacts of conservation and oil substitution. Currently, both here and abroad, exploration and production activity have moved to unprecedented levels. 3.ALTEREDCONSUMPTIONPATTERNS The high price of oil is the most important motivator in conservation. Substituting for oil is a complex mixture of price response and consumer fear of future supply cut-off. Substitution obviously makes sense if a cheaper and more secure domestic alternative exists. But substitution for oil has an interesting double-barreled impact. The oil displaced as industrial furnace and boiler fuel can be refined into higher-valued gasoline, diesel, and jet fuel for transportation. To illustrate the significance of displacing oil as boiler fuel, consider, for example, that around 1978-79 in Japan and Europe, less than one-fourth of the oil consumed went to transportation. In fact, in 1978-79 something like 18 million barrels per day of oil were being burned world-wide as industrial fuel, where, to a large extent, coal and nuclear power could be substituted. Investments are being made by refiners to upgrade their plants in the U.S. and abroad in order to obtain higher yields of transportation fuels. Since 1978-79, industrialized regions of the world have cut heavy fuel-oil use more than 30%. I might add that potential future substitution of natural gas for distillate heating oils would further reduce crude oil demand. 4GLOBALOILRESOURCES High oil prices, as we all know, have triggered an unprecedented level of world-wide exploration and production. In 1981, preliminary figures indicate that irrell over 80,000 wells were drilled in the search for new oil and gas production. The greater part of the accelerated drilling was done in the United States where the decontrol of domestic crude prices provided the greatest incentive. Much of the increased drilling is going on in known oil regions. However, it’s important to note that high prices are also pushing exploratory activity into frontier regions in all parts of the globe. Little more than a decade ago we were told that the end of conventional oil was in sight. Authorities declared that by the end of this century we’d be,scraping the bottom of the barrel. The perception of imminent run-out is gradually changing. There is now talk that the higher prices may lead to a doubling over present world reserves. It’s also interesting to note that the predictions of run-out were based on relatively little knowledge. At this time only a handful of wells have penetrated to depths of 30,OOOftor slightly beyond. Geographically, not more than one-fourth of. the earth’s surface has been explored to an appreciable extent. Even here in the continental United States, the most intensively explored region of the globe, new petroleum provinces such as the Western and Eastern Overthrust Belt are yielding important new finds. The higher prices are spurring plans to drill to depths of 40,000-50,000 ft, drilling activity could climb to as many as 100,000 wells annually, and offshore exploration is expected to increase. The intense search for new oil and gas fields is going on throughout the world. The increased exploration doesn’t guarantee that regions as prolific as the Persian Gulf will be discovered. But it does mean the time horizon of conventional oil will be pushed further into the future than was predicted during the 1970s. As a result, U.S. reliance on foreign suppliers is
Coping with oil-supply disruptions
629
also likely to continue much longer than most experts had predicted just 2-3 years ago. There is a certain irony in this. Should the generally more optimistic assessment of oil in the 1980s be confirmed, we cannot avoid a number of risks and uncertainties as part of the price for continued dependence on oil imports. 5. COPING
WITH THE NEXT DISRUPTION
In closing, I suggest that there are several steps we ought to consider in the event of another oil shock, and there are some lessons of the 1973-81 period of federal controls that we can call upon to avoid the imposition of regulations. This is especially important since controls, once begun, inevitably grow more and more complex and pervasive as efforts are made to satisfy special-interest clamoring for favored treatment. We should take the following steps: First, a credible public information program must be established. Fullest possible support by the media is critical in helping to allay public concern. This, of course, requires an effective government information program. As I pointed out earlier, there has always been a strong connection between oil and U.S. foreign policy, and that connection is likely to become stronger in the future. That doesn’t suggest that more and more data should be collected from industry. Rather, it means that the public should be given a proper understanding of the political facts and how these are likely to influence oil supplies from foreign producers-for example, a key OPEC member like Saudi Arabia. The concept of an oil hot-line or situation report at the federal level should be explored. Such an effort can be designed with minimal intrusion. With an effective information program, the second important action by government is to facilitate the functioning of the marketplace. In other words, the government should use the market as a tool to allocate available supplies, stepping in only to fill gaps as the marketplace adjusts to the disruption. Third, direct governmental intrusion, when required in the national security interest, should be as flexible as possible. In all events, the government should avoid programs which lock in place pre-disruption relationships on the premise that we’ll somehow return to business-asusual when the disruption ends. The past events surely demonstrate that we will never return to international oil markets as they once were. Even if the Middle East war in 1973had not triggered the embargo, oil prices would have continued rising through the 1970s because of the changed relationships between the key producing countries and the oil companies. Flexibility means the maximum reliance on the marketplace so that fuel users and suppliers can adjust as quickly as possible to the new situation. Past experiences have shown that circumstances during and following a disruption have virtually no resemblance to some arbitrarily-chosen base-period entitlements. Freezing commercial relationships does not ameliorate the effects of an embargo. It does compound market dislocations by preserving inefficient operations. The added cost and inconvenience is ultimately heaped on consumers. Finally, whatever steps are taken to intervene directly in the marketplace, the government’s program should not have an automatic trigger. The implementation should be based on an assessment of the disruption situation through an expert advisory group. Once set in motion, the government’s program should have an automatic sunset provision. The dynamics of the market, whether controlled or not, are such that the life span of any program should not be more than 3-6 months.
EGY Vol. 8 No. F-9-E
Elqy Vd. 8. No. F-9. p$. 621629.15733 Printed in Gma! Brik.
COPING WITH OIL-SUPPLY DISRUPTIONS WILLIAM P. SCHLARB ARC0 Petroleum Products Co., 515 South Flower Street, Los Angeles, CA 90071.U.S.A. (Received 15 Sepfember 1982) Abstract-A general lack of understanding by the public and the media has characterized the U.S. response to the oil-supply disruptions of the 1970s. Controls hampered the adjustment to the changed energy environment following the 1973-74embargo. Spurred by decontrol, the higher price of oil has stimulated conservation, intensive search for new oil and gas, and allocation of existing oil to the changed pattern of most-valued uses. In future disruptions. the government should establish a credible public information program, strive to facilitate the competitive functioning of the marketplace, and intrude into the market only with programs that automatically end in 2-6 months.
I. PUBLIC
INFORMATION
IS CRITICAL
Many of our difficulties in handling past oil disruptions can be blamed on the public’s lack of understanding of what was going on. I mean that, superficially, it was simple to connect the politics of the 1973 embargo to the oil cutoff by the Arabian members of OPEC. But the embargo masked the more critical underlying forces that were working to restructure world petroleum markets. Our historic arrangements for access to foreign oil, the Persian Gulf supply, in particular, were being undone. Embargo or not, the international oil price structure of the 1950s and 1960s was being unhinged. Regrettably, the embargo politics and chaotic scenes at service stations held a great deal more appeal for media broadcasts than the unappealing facts of international oil economics. For whatever reason, the more important aspects of what was happening were not conveyed to the public. The embargo and the Iranian revolution also obviously presented irresistible moments for political opportunism. Instead of trying to allay public fear and panic, we saw some of our Washington leaders appearing on television to accuse the oil industry of conspiracy and rip-off. Through innuendo, the public was led to believe that key governmental agencies were kept ignorant of the substantive issues discussed in the Tehran and Tripoli conferences more than a year before the embargo. On the contrary, the U.S. State Department was fully aware of the demands by Saudi Arabia and other key Arab oil producers to alter completely their concession arrangements with the major international companies. It was, in fact, James Akins, U.S. Ambassador to Saudi Arabia in 1973-76, who provided clear evidence on several occasions that the State Department was privy to every step of the negotiations between the oil companies and the producing countries. The Justice Department was also close at hand during the Tehran-Tripoli meetings. These key agencies were fully aware that the producing countries were negotiating direct control of their oil production and that their demands would have potentially dramatic implications for world oil prices. But the critical nature of these negotiations was not conveyed in simple, credible terms to the public at large. American consumers were left to learn that an era of stable energy price and supply had suddenly ended when the embargo was imposed and the political turmoil of the Middle East was enmeshed with the economics of oil. Confused and dismayed, a panicky public turned with outrage on oil companies. The federal government reacted, in turn, with the imposition of an enormously complex set of price and allocation controls. 2. CONTROLS CONFOUNDED
THE MARKETPLACE
ADJUSTMENT
manage the disruptive impacts of a four-month shortage of minor extent in 1973-74, a network of unintelligible controls was created. The controls grew more complex and pervasive and were still in place when the second disruption came with the Iranian revolution. The result was predictable: serious market dislocation and needless costs and inconvenience borne by consumers. Worse yet, both industry and consumers were denied the signals of the marketplace to guide their responses to the new realities of world oil markets. To
627
628
W1LLl.W P. .kHL.lRB
The controls were based on frozen supplier-purchaser contracts related to an arbitrarily_ chosen reference period. The fundamental premise of the controls was that somehow we would return to the energy world of the 1950s and 1960s as soon as the political event causing the disruption ended. Given the total rearrangement of our terms of access to foreign oil supplies, a return to business-as-usual was out of the question. As one administration after another chose to leave the controls in place, market dislocations inevitably grew more severe. It was no surprise that pent-up forces in energy markets let loose with a bang when the controls were lifted in January 1981. While controls were hampering domestic markets, critical changes were taking place outside the United States. Both the use and search for petroleum were beginning to respond dramatically to the higher prices. Decontrol has accelerated the pace of similar changes in the U.S. market and we are beginning to witness surprising impacts of conservation and oil substitution. Currently, both here and abroad, exploration and production activity have moved to unprecedented levels. 3.ALTEREDCONSUMPTIONPATTERNS The high price of oil is the most important motivator in conservation. Substituting for oil is a complex mixture of price response and consumer fear of future supply cut-off. Substitution obviously makes sense if a cheaper and more secure domestic alternative exists. But substitution for oil has an interesting double-barreled impact. The oil displaced as industrial furnace and boiler fuel can be refined into higher-valued gasoline, diesel, and jet fuel for transportation. To illustrate the significance of displacing oil as boiler fuel, consider, for example, that around 1978-79 in Japan and Europe, less than one-fourth of the oil consumed went to transportation. In fact, in 1978-79 something like 18 million barrels per day of oil were being burned world-wide as industrial fuel, where, to a large extent, coal and nuclear power could be substituted. Investments are being made by refiners to upgrade their plants in the U.S. and abroad in order to obtain higher yields of transportation fuels. Since 1978-79, industrialized regions of the world have cut heavy fuel-oil use more than 30%. I might add that potential future substitution of natural gas for distillate heating oils would further reduce crude oil demand. 4GLOBALOILRESOURCES High oil prices, as we all know, have triggered an unprecedented level of world-wide exploration and production. In 1981, preliminary figures indicate that irrell over 80,000 wells were drilled in the search for new oil and gas production. The greater part of the accelerated drilling was done in the United States where the decontrol of domestic crude prices provided the greatest incentive. Much of the increased drilling is going on in known oil regions. However, it’s important to note that high prices are also pushing exploratory activity into frontier regions in all parts of the globe. Little more than a decade ago we were told that the end of conventional oil was in sight. Authorities declared that by the end of this century we’d be,scraping the bottom of the barrel. The perception of imminent run-out is gradually changing. There is now talk that the higher prices may lead to a doubling over present world reserves. It’s also interesting to note that the predictions of run-out were based on relatively little knowledge. At this time only a handful of wells have penetrated to depths of 30,OOOftor slightly beyond. Geographically, not more than one-fourth of. the earth’s surface has been explored to an appreciable extent. Even here in the continental United States, the most intensively explored region of the globe, new petroleum provinces such as the Western and Eastern Overthrust Belt are yielding important new finds. The higher prices are spurring plans to drill to depths of 40,000-50,000 ft, drilling activity could climb to as many as 100,000 wells annually, and offshore exploration is expected to increase. The intense search for new oil and gas fields is going on throughout the world. The increased exploration doesn’t guarantee that regions as prolific as the Persian Gulf will be discovered. But it does mean the time horizon of conventional oil will be pushed further into the future than was predicted during the 1970s. As a result, U.S. reliance on foreign suppliers is
Coping with oil-supply disruptions
629
also likely to continue much longer than most experts had predicted just 2-3 years ago. There is a certain irony in this. Should the generally more optimistic assessment of oil in the 1980s be confirmed, we cannot avoid a number of risks and uncertainties as part of the price for continued dependence on oil imports. 5. COPING
WITH THE NEXT DISRUPTION
In closing, I suggest that there are several steps we ought to consider in the event of another oil shock, and there are some lessons of the 1973-81 period of federal controls that we can call upon to avoid the imposition of regulations. This is especially important since controls, once begun, inevitably grow more and more complex and pervasive as efforts are made to satisfy special-interest clamoring for favored treatment. We should take the following steps: First, a credible public information program must be established. Fullest possible support by the media is critical in helping to allay public concern. This, of course, requires an effective government information program. As I pointed out earlier, there has always been a strong connection between oil and U.S. foreign policy, and that connection is likely to become stronger in the future. That doesn’t suggest that more and more data should be collected from industry. Rather, it means that the public should be given a proper understanding of the political facts and how these are likely to influence oil supplies from foreign producers-for example, a key OPEC member like Saudi Arabia. The concept of an oil hot-line or situation report at the federal level should be explored. Such an effort can be designed with minimal intrusion. With an effective information program, the second important action by government is to facilitate the functioning of the marketplace. In other words, the government should use the market as a tool to allocate available supplies, stepping in only to fill gaps as the marketplace adjusts to the disruption. Third, direct governmental intrusion, when required in the national security interest, should be as flexible as possible. In all events, the government should avoid programs which lock in place pre-disruption relationships on the premise that we’ll somehow return to business-asusual when the disruption ends. The past events surely demonstrate that we will never return to international oil markets as they once were. Even if the Middle East war in 1973had not triggered the embargo, oil prices would have continued rising through the 1970s because of the changed relationships between the key producing countries and the oil companies. Flexibility means the maximum reliance on the marketplace so that fuel users and suppliers can adjust as quickly as possible to the new situation. Past experiences have shown that circumstances during and following a disruption have virtually no resemblance to some arbitrarily-chosen base-period entitlements. Freezing commercial relationships does not ameliorate the effects of an embargo. It does compound market dislocations by preserving inefficient operations. The added cost and inconvenience is ultimately heaped on consumers. Finally, whatever steps are taken to intervene directly in the marketplace, the government’s program should not have an automatic trigger. The implementation should be based on an assessment of the disruption situation through an expert advisory group. Once set in motion, the government’s program should have an automatic sunset provision. The dynamics of the market, whether controlled or not, are such that the life span of any program should not be more than 3-6 months.
EGY Vol. 8 No. F-9-E