Energy Overview
Jude Wanniski
July 23, 1979


Executive Summary:The Carter energy plan, to tax $140 to $200 billion out of the domestic energy industry to finance a crash, government synthetic-fuel program, stands as the most serious threat to the U.S. economy.  Adoption would approach the seriousness of the 1929 Crash on dollar-denominated financial assets, although the decline would be masked by inflation.  As in the 1929 adoption of the Smoot-Hawley Tariff, Big Business and Big Labor support this autarkic measure.  As in 1929, the U.S. Senate is the best hope to block the move.

The President clearly does not understand the nature of the global energy problem, which results from government impediments to exploration -- in the United States, but more especially in the Third World.  Even a small change in foreign and domestic policy toward exploration incentives would end the global energy problem and reveal the colossal inefficiencies of synfuels, which is why the private capital markets will not finance synfuel projects.

Energy Overview

The most astonishing thing about President Carter's 10 days at Camp David, struggling to find a solution to the nation's energy problems, is that he moved farther away from understanding the nature of the problem.  Like the fanatic who doubles his speed when he loses sight of his goal, the President concluded that only massive intervention by the federal government could solve the problem when it is precisely the energy and economic policies of the government that have created the problem. 

The discouraging outcome of Camp David seems less astonishing when we consider that for all his talk of having consulted a broad cross-section of American society during these deliberations Mr. Carter did not meet with a producer of any kind.  Not an oil producer.  Not even a farmer.  He met with Democratic politicians, labor leaders, environmentalists, preachers, favorite corporate managers, obsolete Keynesian economists, stars of the news media, selected bankers, and state and local bureaucrats.  The only energy "expert" consulted was Atlantic Richfield's Thornton Bradshaw, popular in the White House these days for having endorsed the "windfall profits tax" that ARCO no doubt imagines will finance the conversion of its vast coal holdings into synthetic oil and gas.

If there were a serious chance the President could find the support in the country and in the Congress to implement his program, there would be serious cause for alarm.  Taxing $140 billion out of the private sector (to use the President's figure) to finance a synthetic-fuel, solar energy program in the next decade would so decrease the efficiency of the stumbling U.S. economy that the stock market would have to sharply discount the value of the U.S. capital stock; the ensuing recession cum inflation would further insure Jimmy Carter's departure from the White House. The program is not likely to get anywhere in Congress, despite the early, perfunctory applause from Democratic congressional leaders, for the simple, basic reason that the President has no mandate to sustain it.  Neither in his 1976 election nor in the 1978 congressional elections were the voters asked to consider and ratify such a grandiose government energy scheme.  Indeed, in the 1976 Presidential election, President Carter was identified with government decontrol of energy and private-sector solutions. President Ford, although he did not beat the drums for it, was still identified with Vice President Rockefeller's $100 billion program of subsidies for energy alternatives.  The 1978 congressional elections provided sharp gains for free-market candidates over government interventionists, especially in the Senate.

The Senate is where the President's energy program will unravel.  In its instant analysis of the Carter energy speeches, the national press pointed out that Congress was "already ahead" of the President in legislating a mammoth synthetic-fuel program as well as the "windfall tax" revenues to finance it.  But beneath the surface movement, the whole idea of an emergency energy scheme had been running out of gas.  President Carter knew this, which is the chief reason he conceived of the Camp David theatrics.

There was an extraordinary vote on synthetic fuels on June 26 in the House of Representatives/ a vote that created an artificial sense of vast support for synfuels.  In 1975 and 1976, conservative free-marketeers and liberal environmentalists had combined to thwart the Rockefeller synfuel scheme in the House.  But on June 26, with Washington, D.C., at the peak of the gasoline crunch that had rippled across the nation and had members of Congress in a panicky mood, House Democratic leaders whipped up an amendment to the Defense Production Act of 1950 that set as a goal the procurement of 2 million barrels a day of synfuel by 1990.  Without hearings, with almost no debate, and with pleas by the leadership to strike this blow for energy independence prior to the Fourth of July, the House approved the amendment by 368-to-25.  Even Rep. Richard Ottinger of New York, who had led the environmental assaults against the Rockefeller scheme, was swept up by the emotions of the hour and voted for the amendment.

The delight of the synfuel forces lasted only two days.  On June 28, the "windfall profits tax" legislation came to the House floor from the Ways and Means Committee.  It is this permanent excise tax on the domestic production of conventional petroleum that the President envisions raising $140 billion for his energy scheme, somehow selling the idea that this would be a tax on oil, not people.  Given the public's angry identification of the gasoline crunch with the petroleum industry, the Ways and Means tax seemed like a juggernaut, and the anti-tax forces made no direct attempt to kill it.  Instead, they put their energies behind a weakening substitute drafted by Democrats Jones of Oklahoma, Santini of Nevada and Republicans Moore of Louisiana and Brown of Ohio, the "Jones-Moore" substitute.  The measure did not seem all that "weakening" on the surface.  The Ways and Means bill would have taxed real, as opposed to nominally inflated, increases in the world price of crude oil by 70 percent.  The substitute cut this to 60 percent.  But there were two important provisos. Instead of a permanent tax, it would be temporary, ending in 1990.  More importantly, in its second year, it would annually permit a 2 ½ percent real increase in the world oil price before the tax would bite.  Only if the real price of oil rose at a greater rate in the 1980s would the tax yield any revenues on newly discovered oil.  Proponents of the measure were eminently aware that the world price of oil in dollars has risen largely in nominal terms since 1974, with OPEC price hikes merely offsetting inflationary U.S. monetary policy.  As Laffer has pointed out, in the four years ending in December 1978, the real price of OPEC oil fell by 20 percent.  Unless the real price would balloon in the 1980s, an event that would imply Global Depression, domestic producers would have this 2 ½ percent cushion to stay ahead of the tax collector and the revenue bonanza the President contemplates would wither.

The strategy behind Jones-Moore went further, though.  If there is to be a tax bill in this session of the 96th Congress, it will be drafted in the conference committee of the Senate and House sometime this fall, or perhaps even later.  There is no way Chairman Russell Long of the Senate Finance Committee relishes the idea of taxing $140-to-$200 billion out of the domestic energy industry in the 1980s to finance a government Synfuel Scheme.  And unlike the Ways and Means Committee, which has been stacked with liberals since the departure of Wilbur Mills, Senate Finance is laden with Democrats who are in harmony with Long's thinking.  But even if Long could work his magic in the Senate in hobbling the Synfuel-tax scheme, he would have to compromise with the House in conference, and he did not want to have to compromise with the Ways and Means version of the tax.  If Jones-Moore could get a respectable showing, Long could at least argue in conference that the sentiment in the House was not as punitive as the Ways and Means version implied.  He will have more to work with than that, for Jones-Moore was accepted by the House by the decisive vote of 236-to-183.  The Jones-Moore strategists toasted each other in a champagne celebration the evening of June 28.  The House Democratic leadership, particularly Ways and Means Chairman Al Ullman, had been whipped.  These events signaled to the President an inevitable path of defeat unless he could conjure up something dramatic that would give him a grip on the Senate.  Camp David followed.

It will soon be clear that Camp David did not succeed and in a way may have worked against the President.  He did, after all, heighten public discussion about the energy issue to a level above the clogged service stations.  And tempted to be bold, he placed that incredible price tag of $140 billion on his program.  The major oil companies who see themselves as  recipients of this largesse, either in peddling their coal to Uncle Sam -- like ARCO and Exxon -- or in getting government contracts to build synfuel plants, have applauded the program.  So has George Meany of the AFL-CIO, who sees all that work for the building trades at cost-plus.  We can also expect the National Association of Manufacturers to do the same calculations, especially those companies which believe they are in a good position to bite into the apple. But that $140 billion will rattle around in the head of the electorate as the play unfolds on Capitol Hill.  And the environmentalists have been roused again with the vision of dozens of synfuel plants pouring fumes into the atmosphere.  Senator Proxmire calls the Synfuel Scheme the "SST of the Eighties," and can be counted upon to lead the charge against it in the Senate.  Senator Gravel of Alaska, a liberal Democrat on Senate Finance, is alarmed at the implications of the windfall tax on his state's petroleum industry and vows to filibuster against it.  Senator Ribicoff, Connecticut Democrat and member of Senate Finance, who is retiring next year, has been steadily becoming more outspoken against the idea of taxing domestic production.  The mood of the committee at the moment is to exempt the taxation of newly discovered oil altogether, to exempt stripper oil, and to exempt small producers — up to 1,000 barrels per day, perhaps.  With luck, the tax can still be beaten altogether.

This scenario does not take into account the grim determination and resourcefulness of the forces behind this mammoth tax and spending scheme.  The parallels with 1929 are almost eerie.  Fifty years ago exactly a Great Engineer was in the White House as the Smoot-Hawley Tariff Act was making its way through the legislative mill.  The same autarkic forces that were behind the industrial independence of the Fortress America are now behind the Carter plan of energy independence. Big Business and Big Labor backed Smoot-Hawley, which would shut out foreign imports with a massive tax.  Now, the President would hold crude imports to 1977 levels with a quota, imposing the tax internally, and Big Business and Big Labor eye the pork barrel.  At this point in the summer of 1929, it still seemed as if the internationalists would win.  October of 1929 is when it became clear that they had lost, thus causing the great Crash of 1929. 

Should the present Great Engineer win a similar victory for autarky in 1979, the difference would be in a less palpably dramatic stock market crash.  In 1929, the United States still held to a monetary standard, so all declines of value were real, there being no inflation. Now, with no monetary standard to keep U.S. monetary authorities in check, inflation masks the decline in stock values.  Crashes take place quietly.  In the last 18 months, relative to gold, the value of dollar-denominated financial assets has crashed by 50 percent.  The OPEC price increase of 50 percent this spring did not lead the price of gold, but trailed it.  The price of oil in dollars is not set by OPEC, but by the U.S. monetary authority.  As Laffer has also pointed out, the Swiss monetary authority sets the price of oil in terms of Swiss francs, and between December 1973 and December 1978, the world price of oil in Swiss francs fell more than 40 percent, to 20.6 S.Fr. per barrel from 34 S.Fr. per barrel.  We did not hear the Swiss complaining that the OPEC cartel had conspired to lower the price of their oil.

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"Oil is found in abundance only if a great many people are looking for it at once in all sorts of unlikely places."
— Ruth Sheldon Knowles, in The Greatest Gamblers

The chief reason why there is an energy crisis in the world is not that insufficient numbers of people are looking for oil and gas in the United States, although the policies of the federal government certainly discourage domestic oil and gas exploration.  The chief reason is that insufficient numbers of people are looking for oil and gas outside the United States, because the policies of foreign governments discourage domestic oil and gas exploration by many people searching in all sorts of unlikely places.  This fact, which could change tomorrow or a year from now or five years from now, discourages the capital markets from financing the development of synthetic fuels, for an unanticipated change in foreign policies toward domestic oil exploration could instantly bankrupt all private synfuel schemes with a flood of inexpensive, conventional oil and gas.

Liquid petroleum that comes out of a man-made hole in the ground under its own pressure constitutes only 1 percent of all the petroleum in the earth's crust.  The rest is "heavy," the shales and tar sands that must be extracted at great expense. If you took all the liquid petroleum produced from all the wells drilled on earth since the first, at Titusville, Pa., in 1859, and poured it into one lake of oil it would not seem so much.  
If the lake were, say, the surface acreage of the city of Chicago, roughly 227 square miles, the 330 billion barrels the earth has yielded so far would fill the lake to a depth of only 300 feet.  The estimated global petroleum that could be recovered at current price and technology would fill the lake to a depth of 2,000 feet.

Even this amount may seem worrisome, until we add in a number of important facts.  In 120 years, about 3,200,000 oil wells have been drilled into the planet's crust.  Of this number, 2,400,000 were drilled in the continental 48 states of the U.S. and most of these in the "oil patch."  The rest of the world has been relatively unexplored, most especially the recent colonial nations that now constitute the bulk of the Third World.

Density of Petroleum Drilling
(As of end of 1975)

                                     Country or Regions                            Wells/Sq. Mi.                            Exploration Wells/Sq. Mi.

                                                   USA                                                  0.98                                                       0.20
                                                 USSR                                                 0.15                                                       0.029
                                                Canada                                               0.053                                                     0.011
                                       Western Europe                                        0.019                                                     0.0094
                                                 Japan                                                 0.021                                                     0.0039
                               Australia & New Zealand                                0.0016                                                   0.0032
                             South and Southeast Asia                               0.0067                                                   0.0031
                                         Latin America                                          0.0021                                                    0.0029
                                            China, P.R.                                            0.010                                                      0.0022
                                            Middle East                                           0.0083                                                    0.0017
                                                Africa                                                  0.0031                                                    0.0014

Source: Bernardo Grossling, U.S. Geological Survey, Reston, VA. The Future Supply of Nature-Made Petroleum and Gas, Technical Reports, Pentagon Press, New York, 1977.

Of the 645,500 exploratory wells drilled on earth to the end of 1975, 616,000 or 95.4 percent were drilled in the developed world. Africa, Latin America, South and Southeast Asia and China have barely been scratched. The United States accounts for 482,000 of the exploration wells, 74.7 percent of the total, and 34.9 percent of the oil in that imaginary Chicago lake of oil. The reason is not simply that the U.S. has had the skilled manpower, technology, capital and market, but that it has had a government conducive to exploration, a stable government that has protected the property rights of its private landowners.  And the landowners have possessed the mineral rights to oil discovered on their property. 

The indigenous exploration industry could develop here because individual explorers could lease the mineral rights from private landowners and drill, with the sure knowledge that he and the landowner would possess any oil discovered, and that high risk would be matched with high reward.  Americans collectively benefited by having the oil for their use.  In addition, the U.S. government did not hoard land in the name of the collective interest, but sold the majority of western lands at $1.25 an acre in order to encourage settlement.  Where this pattern was not followed, there has been scant exploration.  The U.S. government, for example, "owns" more than 90 percent of Nevada's 100,000 square miles, and Nevada has been relatively untouched by oil exploration. Alaska, too, has been relatively untouched by oil exploration, and increasingly the environmentalists, with the eager assistance of President Carter, are keeping it this way, by closing off public lands to mineral exploration of any kind.  The North Slope field, the second largest field discovered in the U.S. (next to East Texas), covers an area of only 400 square miles in a state of 566,000 square miles.

In most of the Third World, even where there are relatively stable governments, the conditions that brought forth multiple exploration of the United States are not present.  Governments either keep title to most of the land or to the mineral rights of privately-owned land.  Or, the progressive taxation of individual incomes is so confiscatory that should a native landowner possess mineral rights, he could not find native capital and labor willing to explore the land, for the government would confiscate the rewards through taxation.  Governments will lease lands to the major international oil companies to explore, but in most cases the companies will look only in those places where there is the greatest probability of finding oil, where seismology can at least hint at probable finds.  Most oil cannot be tracked by seismology, for like the East Texas field, it is trapped in complex geology and will yield only to myriad explorers taking long shots.  One rule of thumb among the international oil companies in going into unstable Third World countries is that you must try to recapture all costs in the first tanker of oil that leaves the country, on the historically reasonable assumption that the remainder will be nationalized or confiscated via taxation.

Madagascar, off the Southeast coast of Africa, is almost the size of Texas, and lies in one of the world's largest sedimentary basins where oil is likeliest to be found.  Prior to 1975 the French controlled the island and there was no exploration, possibly because the French believed that if oil was discovered they would be pitched out.  Since 1975, the government has been wary of the international oil companies, and vice versa, with the upshot that only 83 wells have been drilled on the island.

The point is that enormous amounts of conventional oil is sitting out there waiting to be discovered, and will be once governments around the world — including the U.S. government — are prepared to match the high risks of exploration with commensurate rewards.  And here, President Carter wants to tax between $140 and $200 billion out of the domestic industry in the next decade, at the same time he is shutting off more and more government lands to exploration, in order to finance synfuel projects that can, at best, produce a dribble of oil with high costs to the environment. 

This is done in the name of energy independence, to free us from OPEC's alleged ability to set prices.  Yet as Rep. David Stockman of Michigan has pointed out, even if by some miracle the government can produce 2 ½  million barrels a day of synfuel by 1990 it will still not be able to control the world price to any degree.  This is because the synfuel supply will go into the world's base supplies of oil, and a country can only influence the world price if it can control the marginal supply.  If, in other words, the U.S. were willing to shut down the synfuel plants when the world oil price got too low and crank it up again when the price got too high, it could influence the world price as the Texas Railroad Commission used to do, by regulating the output of the Texas oilfields. "Just one million barrels per day of reserve synfuels capacity would cost nearly $100 million per week to maintain idle, even at today's optimistic estimates of capital costs," says Stockman the leading expert on domestic and global energy economics in the Congress.  The same effect can be accomplished by a storage program "for substantially less that $1 per barrel in annualized storage and net interest costs."

The chief case against energy alternatives, including solar energy, is not that they will not free the U.S. from OPEC's pricing — since OPEC's pricing is only a function of U.S. monetary policy anyway.  The chief reason is that the global and domestic potential for nature-made petroleum and gas is so enormous that synfuels will be uneconomic well into the next century and perhaps beyond.  It is not a question, as Exxon's Clifford Garvin intimates, of having the government provide early start-up capital for synfuels (Exxon owns 9 billion tons of coal it would like to unload to Uncle Sam's synfuel plants, which Exxon would also like to build under contract.)  If, in the 1980s, the U.S. were to only slightly increase the rewards for domestic exploration, or if a feeble attempt were made by Third World governments to do likewise, the relative price of oil in the world would resume its historic decline.  The U.S. would then either be forced to scrap the uneconomic synfuel system or drain the rest of the economy through taxation for an interminable period in order to keep them operating.

In microcosm, the problem is precisely the same as that of the proposed natural-gas pipeline from Alaska to the Midwest, which President Carter accuses the Alaska oil companies of dragging their feet on.  At the most optimistic estimates, the pipeline would cost $10 billion, and the gas delivered in Chicago would cost $3.50 per thousand cubic feet (mcf).  The pipeline can't be built because no investor can count on anyone buying $3.50 gas five or 10 years from now.  Should a supply-oriented President and Congress be elected in 1980, and government controls lifted from the production and pricing of natural gas at much less than $3 per mcf, by the Department of Energy's own study of 1977, the so-called MOPPS study that was suppressed by the Carter administration. 

Mr. Carter now proposes to chip in $1.5 billion to such a pipeline project, but even that will not do the trick.  As Stockman has also pointed out, through 1974 "97 percent of the non-North American natural gas resource base had yet to be disturbed by a production-well bore.  Nor was this potential resource negligible in dimension.  The remaining natural-gas resource base outside of North America may total 1.4 trillion barrels equivalent, a quantity of energy equal to four times all of the crude oil that has ever been produced."  Because the domestic price of natural gas has been held down by government control for 25 years, almost all domestic exploration has aimed at finding crude oil, not gas, which implies that a freeing of the natural gas price would produce serious exploration in the continental U.S., and this cleanest of fuels would be produced in such quantity that it would not only displace nuclear and coal as serious competitors, but also reduce demand for imported crude.  The Alaska pipeline could only be built if the government promises to buy $3.50 (or $4 or $5) gas that it transmits, when there are plentiful supplies at $2.25 (as MOPPS indicated), paying the difference out of general revenues. The only alternative would be to force the Midwest customers to pay the tab through regulated utility rates, but Midwestern commercial and farming interests would become marginally uncompetitive with areas not so bound, with explosive political implications.

How astonishing that President Carter would wrestle with the energy issue for three years, and 10 days at Camp David, and understand none of this.  Worse, he does not seem to have any concept of the dimensions of the problem, the plan or the economics.  During the 10 days at Camp David, The New York Times editorials and news columns, as well as those of The Wall Street Journal, warned of the enormous costs of synfuel and the limited payout, even under the most optimistic scenarios.  With great luck, the scheme may yield 1 million barrels a day by 1990, these newspapers reported after consulting the leading experts in the field.  Yet decontrol of crude prices, without a windfall tax on domestic production, would yield an additional 2 million barrels per day by 1985, according to testimony before the Senate Finance Committee by the Independent Petroleum Association of America.  The calculations, based on historic relationships between price, exploration and finding rates, have not been challenged by the Department of Energy.

The Carter plan thus stands as the greatest threat to the economy, at the present moment, an opinion shared in the gold market as witnessed by the run-up to more than $300 in its price. The inflation thus implied will continue to melt dollar-denominated financial assets, and if the worst elements of the plan are enacted by Congress, even nominal values will decline on the stock markets.  As in 1929, the Senate is the nation's best hope.

It will not be easy for the Senate to resist.  Democrats and Republicans who have been held down by tightening budgets for several years now view the excise tax on domestic production as a windfall for themselves, to hand out in big batches. Here is just a smattering of how it works, from Bruce Bartlett, a Senate staff member, writing in the August 6 issue of Inquiry:

.....Senator Henry Jackson has come up with his own energy bill that would, among other things, authorize $5 billion to build fifteen synfuel plants.  In  order to spread the wealth around and attract co-sponsors Jackson made a point of specifying the following projects:
-$500 million for the Solvent Refined Coal 1 project in Kentucky (supported by Senators Wendell Ford and Walter Huddleston);
-$700 million for the SRC II project in West Virginia (supported by Senator Robert Byrd);
-More than $1 billion for high- and low-BTU coal gasification projects in Ohio and Louisana (supported by Senators Howard Metzenbaum and Bennett Johnston);
-Geothermal plants now tentatively set for Idaho, California, and New Mexico locations (supported by Senators Frank Church, Alan Cranston, and Pete Domenici);
-$300 million, in loan guarantees for an urban and industrial waste conversion plant (supported by Senator Bill Bradley of New Jersey); and
-$250 million for a new fuel-cell demonstration program pushed by United Technologies Corporation of Connecticut (supported by Senator Lowell Weicker).

Big Business and Big Labor can only see the first-order effects of such largesse, which benefit them as individual entities.  They cannot see the colossal drain on the economy as a whole, which will drag down the standard of living for all Americans, themselves included, as the Tariff did in the 1930s.

We can only hope that unlike 1929, the Senate will hold against these narrow interests. As Stockman put it, in his important essay in the Fall of 1978 Public Interest:

"The decision to eschew an economic policy of trading on the world market for the 90 percent of the non-U.S. oil and gas resource base that remains to be developed in favor of a cramped, inward-looking policy of autarky may prove to be the most costly national error of the last half of the twentieth century — if it is not soon reversed."

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