From the May 26, 2008 Weekly Standard
May 19, 2008
by Irwin Stelzer
Students of energy policy despair, and at times believe that Dante's inscription on the entrance to hell should be emblazoned on the entrances to the Capitol and the White House, "Abandon hope all ye who enter here."
Our president has just gone to Saudi Arabia to grovel before the royal family in the hope of persuading the kingdom to open its taps just a bit to bring soaring oil prices down. The caribou lobby in the Senate has voted down a bill that would have opened a small portion of Alaska's untapped oil fields to exploration and development. (Hillary Clinton and Barack Obama voted to continue the restriction, and John McCain would have joined them had he not been out of town reveling in the applause for his speech promising to lead the fight on global warming.) And the farm and ethanol lobbies are prepared to crush the groups calling for an end to the food-for-fuel mandate that requires motorists to use nine billion gallons of ethanol (auto fuel made from corn) this year.
A good part of the energy policy muddle stems from a tendency to ask the wrong questions. Ask the wrong questions, and you get the wrong answers. The question now being asked by Hillary Clinton, John McCain, and other politicians whose notion of the long run extends only for the six months until the November election is, "How can we lower gasoline prices?" Their answer: Reduce the approximately 18 cent-per-gallon federal tax on gasoline during the summer driving season. The reasons that is exactly the wrong policy are too many to list. One is that oil producers, or oil companies, or service station operators would raise prices by an equivalent amount. Hillary Clinton, in her new populist incarnation, might dismiss this as the ranting of pointy-headed economists, but it is nevertheless true. But give the pandering pols the benefit of the doubt, and assume that prices would go down. The right question would have been, "Is it good policy to lower gasoline prices?" The right answer is "no."
Higher prices seem to be persuading Americans to use less gasoline, witness the increased use of mass transit reported in many cities around the country. Lower gasoline prices would encourage Americans to drive more, use more of the cheaper gasoline, emit more pollutants, and increase the demand for crude oil. So regimes hostile to the United States would sell us still more oil. Venezuela's Hugo Chávez, whose government owns some 8,000 Citgo gasoline stations in America, must be astonished to learn that leading American politicians are eager to increase his revenues so that he can step up his propaganda campaign against America. And the Saudi financiers of jihadists and of the Wahabbi mullahs who fuel anti-Americanism would be pleased to have a few extra hundred million. So would Vladimir Putin. Better that, figure our politicians, than to take the political risk of increasing taxes on gasoline, reducing demand, and getting to the consumers' wallets before OPEC and its allies do.
The wrong question--how do we lower prices?--also led Congress last week to pass legislation ordering the president to stop buying oil for the Strategic Petroleum Reserve. The reserve now contains 701.3 million barrels, a record. Bush wants to fill it to its capacity of 727 million barrels this year, and eventually double the capacity. Stop buying oil, critics, including John McCain, tell President Bush, and demand pressures will ease. Better still, start selling off some of the strategic reserve, and increase supplies of crude oil. The notion that the government can outsmart the market by buying low and selling high is, to put it mildly, questionable. As is the assumption that it is smart enough to distinguish a shock, which might justify use of the reserve, from a trend, which should be allowed to play itself out so that the economy can readjust to the new prices. Besides, oil companies are likely to increase their own inventories when the government stops stockpiling, stepping up purchases of imported crude oil in order to do so. Net effect of all of this on demand and supply: nil. Net effect on our ability to withstand a supply cut-off: substantial.
Next wrong question, and one being asked not only in America, but in most other countries: "How can we replace crude oil with renewable sources of energy?" Answer: Subsidize construction of wind turbines, solar panels, nuclear plants, and the production of corn. But neither wind turbines nor solar energy, on the cheeriest of assumptions, can make a significant dent in the demand for crude oil and its products. As for nuclear, few of these costly plants--and cost estimates seem to be doubling every few months--will be built unless overt or covert subsidies are offered to private-sector players, licensing proceedings and construction times are shortened, and politicians are willing to override Senate Majority Leader Harry Reid to allow the opening of the Yucca Mountain nuclear waste depository.
Which leaves corn. Congress has mandated that farmers be paid huge subsidies to grow corn to be converted into ethanol, a gasoline substitute, while quite inconsistently maintaining a tariff wall to deny motorists access to cheaper imported ethanol. The answer produced by the wrong question has serious negative consequences. For one thing, the negative environmental impact of these biofuels seems to outweigh their positive effect. Among other things, production requires the use of huge amounts of fertilizers, causing run-off that pollutes streams and rivers; farmers around the world cut down environmentally friendly forests to increase planting of oil-substitutes; and acreage previously devoted to growing food is converted to growing fuel. That has contributed to the massive increases in food prices that are afflicting not only Americans but, with greater ferocity, the world's poor. In essence, rich countries are trying to fill their gasoline tanks at the expense of empty stomachs in Africa, Central America, and parts of Asia.
So what are the right questions? First, have any of the programs now in place proved counterproductive? Yes, several have costs that exceed their benefits. Best example: the attempt to grow our way out of the energy problem. Admit that we have erred, and wind down the subsidies that are denuding forests and contributing to food shortages without significantly adding to fuel supplies. That's what a coalition of environmentalists, livestock producers, and consumer groups last week called on Congress to do. They are unlikely to overcome the powerful farmer-ethanol lobby.
Second, are there cost-effective ways of increasing the supply of conventional crude oil? Probably. Studies that showed that the environmental cost of drilling in Alaska's Arctic National Wildlife Reserve and offshore Florida and California exceeded any benefit from new discoveries are now out of date. The benefits were estimated when oil prices were less than half current levels. So the benefits of stepped up exploration have multiplied with the price and value of oil. Meanwhile, the industry claims to have learned a great deal about reducing the environmental impact of such stepped-up drilling. If new studies bear out these impressions, and suggest that the environmental and other costs of drilling are now exceeded by their benefits, restrictions on domestic drilling should be relaxed. But that is not in the cards--all three of the presidential wannabes are pledged to keep Alaska closed to drilling, no matter what the balance of costs and benefits.
Final sensible question, Can anything be done to increase supplies of oil from the world's important suppliers? Answer: Yes, if there is the will to act. The Mexican government depends heavily on remittances sent to poor Mexican families from the millions of its citizens working, legally and illegally, in the United States; the Saudi regime depends on the U.S. military umbrella for its survival; and the Saudi-led OPEC cartel, which has held production constant for eight months in the face of a 54 percent increase in prices, exists only because successive administrations have prevented the antitrust authorities from attempting to break it up. Hillary Clinton is on to something when she calls for antitrust action against this cartel, which would not be the first time the Justice Department has moved against a price-fixing conspiracy by foreign firms. Antitrust lawyers tell me that the immunity of sovereign governments from antitrust prosecution does not extend to their commercial activities.
Bush knows this. He knows that nothing frightens the Saudi regime more than the threat of the furling of the U.S. umbrella, which as Karen Elliott House put it in the Wall Street Journal, "has provided the Saudis with a security blanket that puts this desert kingdom off limits to regional predators" and prevented Iran and Syria from turning Saudi Arabia into another Lebanon. He knows that the Saudis have about two million barrels per day of shut-in, excess capacity. And he knows how vulnerable the Saudi-led OPEC cartel is to antitrust action. Perhaps he worries that if he deploys any of these weapons the Saudis will dump some part of their dollar pile on the market, driving down the value of our currency, and increasing inflationary pressures and interest rates in America. They might, but only if they are willing to drive down the value of the billions of dollars remaining in their vaults, and damage the value of their U.S. investments. Would the president of the United States or the king of Saudi Arabia be the first to blink in a stare down? We will never know, since the administration prefers the role of supplicant to that of tough bargainer.
Nor is there any indication that we are prepared to harden our line with Mexico. No one has suggested that Mexico's continued refusal to allow American capital to flow into its oil industry might be considered when NAFTA is reviewed. Is it unreasonable to suggest that free trade in goods and services, and the virtually unhindered movement of labor across the border, must be accompanied by the free flow of capital across borders? Yes, we benefit from NAFTA, and its abrogation would impose costs on us. But so does Mexico's ban on U.S. participation in its oil industry.
A serious American administration would explain to the Saudis and their OPEC allies, and to the Mexicans, that continuation of their present policies would not be without cost to them. Continued defense of the Saudi regime, a staying of the hand of the antitrust authorities, and continued absence of restrictions on remittances to Mexico will, they should be told, depend at least in part on their willingness to allow Western firms to develop new reserves and to wring more oil from existing fields, and to relax cartel restrictions on current output.
Unfortunately, the right questions are precisely the sorts of questions that politicians abhor. Asking them produces politically difficult answers--higher not lower taxes on gasoline to encourage new technologies and discourage consumption, the opening of now-closed areas to exploration and development, the end of massive subsidies to farmers to grow corn-for-fuel.
Wrong questions and the inevitably wrong policy answers might be one reason Goldman Sachs is talking about a "super spike" that would take oil prices to $200 per barrel. Remember: These are the guys who were laughed at when they predicted that the price of oil would hit $100. Dante might have been referring to what happens to good ideas on energy policy when they are sent to the halls of Congress or the White House, when he wrote, "Through me you pass into the city of woe .??.??. into eternal pain."
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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