95th Congress COMMITTEE PRINT IC~M''E 2d Session RI JNT 953-G3
WHY ENERGY PRICES SHOULD BE
PREPARED FOR T.HE USE OF THE
SUBCOMMITTEE ON ENERGY AND POWER,
INTERSTATE AND FOREIGN COMMERCE
UNITED STATES HOUSE OF REPRESENTATIVES
U.S. GOVERNMENT PRINTING OFFICE 34-930 WASHINGTON :1978
COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE
HARLEY O. STAGGERS, West Virginia, Chairman
JOHN E. MOSS, California SAMUEL L. DEVINE, Ohio
JOHN D. DINGELL, Michigan JAMES T. BROYHILL, North Carolina
PAUL G. ROGERS, Florida TIM LEE CARTER, Kentucky
LIONEL VAN DEERLIN, California CLARENCE J. BROWN, Ohio
FRED B. ROONEY, Pennsylvania JOE SKUBITZ, Kansas
JOHN M. MURPHY, New York JAMES M. COLLINS, Texas
DAVID E. SATTERFIELD III, Virginia LOUIS FREY, JR., Florida
BOB ECKHARDT, Texas NORMAN F. LENT, New York
RICHARDSON PREYER, North Carolina EDWARD R. MADIGAN, Illinois
CHARLES J. CARNEY, Ohio CARLOS J. MOORHEAD, California
JAMES H. SCHEUER, New York MATTHEW J. RINALDO, New Jersey
RICHARD L. OTTINGER, New York W. HENSON MOORE, Louisiana
HENRY A. WAXMAN, California DAVE STOCKMAN, Michigan
ROBERT (BOB) KRUEGER, Texas MARC L. MARKS, Pennsylvania
TIMOTHY E. WIRTH, Colorado PHILIP R. SHARP, Indiana JAMES J. FLORIO, New Jersey ANTHONY TOBY MOFFETT, Connecticut JIM SANTINI, Nevada ANDREW MA G UIRE, New Jersey MARTY RUSSO, Illinois EDWARD J. MARKEY, Massachusetts THOMAS A. LUKEN, Ohio DOUG WALGREN, Pennsylvania BOB GAMMAGE, Texas ALBERT GORE, JR., Tennessee BARBARA A. MIKULSKI, Maryland
W. E. WILLIAMSON, Chief Clerk and Staff Director KENNETH J. PAINTER, First Assistant Clerk ELEANOR A. DINKINS, Assistant Clerk SWILLIAM L. BURNS, Printing Editor Professional Staff
( W ELIZABETH A1RISON ROSs DAVID AiN
JEFFREY H. A&ARZ CHRISTOPHER E. DUNNE
SBRIAN R. Mo e WILLIAM M. KITZMILLER
KAREN NE SO MARK J. RAABE
THOMAS M. RYAN
ELE- E. BERRY, Minority Counsel
COMMITTEE ON ENERGY AND POWER JOHN D. DINGELL, Michigan, Chairman RICHARD L. OTTINGER, New York CLARENCE J. BROWN, Ohio
ROBERT (BOB) KRUEGER, Texas CARLOS J. MOORHEAD, California
PHILIP RIt. SHARP, Indiana JAMES M. COLLINS, Texas
ANTHONY TO B Y MOFFETT, Connecticut W. HIIENSON MOORE, Louisiana
BOB GAMMAGE, Texas DAVE STOCKMAN, Michigan
JOHIIN M.. MURPIIY, New York EDWARD R. MADIGAN, Illinois
DAVID E. SATTERFIELD III, Virginia SAMUEL L. DEVINE, Ohio (ex offlclo)
TIMOTHY E. WIRTII, Colorado ANDREW MAGUIRE, New Jersey MARTY RUSSO, Illinois EDWARD J. MA RKEY, Massachusetts DO UG WALG (REN, Pennsylvania ALBERT GORE, Ja., Tennessee IIARItLEY O. STAGGERS, West Virginia (ex officio)
FRANK M. POTTER, Jr., Staff Director ani Cousel
LETTER OF TRANSMITTAL
HOUSE OF ]REPRESENTATIVES, SUBCOMMITTEE ON ENERGY AND POWER,
COMMITTEE ON INTERSTATE AND FOREIGN COMM ERCE,
Washington, D.C., October 1S, 1078.
Hon. HARLEY 0. STAGGERS,
Chairman, Committee on Interstate and Foreign Commerce, U.S. House of Representatives, Rayburn House Office Building, Washington, D. C.
DEAR MR. CHAIRMAN: Professor Kenneth E. F. Watt, who has served as a consultant to this committee in the past, has produced a provocative paper entitled "Why Energy Prices Should Be Deregulated", a copy of which is enclosed.
Dr. Watt's central thesis is that high energy prices act to the advantage of the lower income segments of society. The correctness of this conclusion is not immediately apparent, and the thesis itself is the subject of considerable debate. I will say frankly that I find aspects of this troubling but, at the same time, I believe that the issue is one which we must address directly.
It is in this light that I recommend Dr. Watt's paper be reprinted as a committee print and given wide distribution. It is my intention to convene hearings of the Subcommittee on Energy and Power at a later date to examine the questions Dr. Watt discusses in his paper. Publication of this paper should assist in our efforts.
SinceelyJOHN D. DINGELL, Chairman. Enclosure.
Digitized by the Internet Archive in 2013
W Hy ENERGY PRICES SHOULD BEDEREGULATED
(Kenneth E. F. Watt)'
Given constant increases in the real cost of producing petroleum and natural gas in the United States, it is clearly an injustice to domestic energy producers for the government to impose an arbitrary ceiling on the prices they can receive. The conventional political justification for this price regulation is that without it, there would be a deleterious impact on a large number of political constituencies, including labor, consumers, the poor and the middle classes. The standard aro ument offered is that since energy is an input to the manufacture of a wide array of goods, any increase in the price of energy would ultimately be reflected in an increase in the retail prices of all those goods. Consequently, the consumer price index would rise, consumer purchasing power would drop, and there would be a decline in the standard of living for Americans.
This argument is based on an extremely simplistic view of the workings of the U.S. economy. Hereinafter it will be demonstrated that the conventional political rationale for low energy prices is simply false; in fact there are six different arguments as to why cheap energy penalizes the very constituencies it is supposed to protect.
The conventional argument overlooks the various types of adjustments to cheap energy that occur in the U.S. economy and in the linkage of the U.S. economy to other economies through the international trade and international monetary systems. Figure I illustrates some of the causal pathways that will be discussed, and serves as a backdrop and introduction to the first three arguments for higher energy. prices. This flow chart by itself is clearly only a complex hypothesis as to how part of the system responds to energy prices; however, data can be found which demonstrate the existence of all the postulated causal pathways in this chart. Low U.S. ener gy prices discourage domestic energy production (causal pathway 1) but encourage consumption (2). These two phenomena jointly produce a shortfall in the U.S. enercr production relative to demand (3, 4) which in turn stimulates energy importation (5). However, as energy importation increases, this stimulates the export of other comm ditties, particularly wheat, corn, soybeans, textiles, wood and raw metal, in order to balance U.S. trade with other countries (6). But the extent to which U.S. commodity exports can be increased depends on both the U.S. stocks of commodities available for export (13) and the stocks of commodities in other countries (9). Many factors determine the size of these variables, in turn, but important system determinants are
I Kenneth Watt is a professor of zoology, and of environmental studies, and research systems analyst in the Institute of Ecology, at the University of California, Davis; of course, all positions expressed in this article are his alone.
crop-goowing weather in other countries (8) and in the United States
(10), the acreage of crops planted in the United States (11), and technology inputs to U.S. agriculture (12). Years when crop-growing weather is favorable, on average, outside the United States, world demand for U.S. crops will not be great enough for us to balance up our international trade (14). Thus, when U.S. energy prices are low, but also foreign demand for our crops is low, the U.S. trade deficit will be large (7). This causes U.S. money to accumulate in foreign banks at a rate in excess of the rate of demand for it (20), and the dollar drops in value relative to other currencies (21). This in turn increases the prices of foreign goods in the United States, and that has two bad effects: the U.S. inflation rate is increased (25) but also, sales of foreign goods in the United States weaken (27).
This ultimately leads to a decrease in the rate of growth in foreign
economies (28), which still further decreases their purchases of U.S. manufactured goods (29) which are already at a competitive disadvantage because of the high cost of our labor, and the unsuitability of some of our products for foreign market (e.g., large, energy-inefficient cars). This, in turn, slows down the rate of growth in the U.S. economy (30). But if U.S. energy prices are low, so that in some years our agricultural commodity exports are very large, but in other years good crop-growing weather elsewhere decreases foreign demand for our crops, this leads to a massive overhang of U.S. commodity stocks over domestic demand (17). This drops the price of commodities (19), farmers' earnings are lower than their costs (23) and there is a depression in the farm sector which spills out to the rest of the economy if it persists (22). However, if crop-growing weather in other countries is bad, there is a tremendous drawdown in U.S. commodity stocks because of massive exports (17), the domestic commodities prices rise
(19) and this can trip an inflation (24).
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the U.S. economy operaTting throug-hout the international trade and monetary
This chart brings out two most curious consequences of low energy prices in the United States. They always s have ain inflationary offec t. If our crop exports are large, inflation is affected by inc-reased food costs (24). If crop exports are small, the inflationary impact comes from increased prices of foreign goods in the United Stalfes (25). These are only two of the inflationary impacts of cheap U.S. energy prices. Others are found in other flow charts. Jay Forrester of M_\.I.*T. has pointed out that complex systems often behave in a "counterintuitive" f ashion because it is difficult f or the human mind to visualize the ultimate consequences of long chain causal pathways.
The other curious phenomenon revealed by this flow chart is that cheap U.S. energy -prices render the economy remarkably sensitive to a number of phenomena produced by crop-growing weather in maj or prospective consumers of U.S. food, particularly. Russia and China. This is particularly significant, because crop-growing weather in some other countries, and hence, crop production is much more volatile from year to year than in the United States. Thus, by keeping energy prices low in the United States, we create the surprising situation in which short-term fluctuations in the economy are made extraordinarily sensitive to a powerful and violently fluctuating destabilizing f orce: crop growing weather in countries with unstable crop growing weather. Much of the surprising behavior of the U.S. economy since we began importing vast quantities of crude oil is traceable to this situation.
With this flowchart as a backdrop, we now consider six arguments against low energy prices, using illustrative data from standard U.S. Government statistical sources.
Argument 1: The impact of cheap energy on the purchasing power of the poor and the middle classes. Elementary common sense tells us that if the price of energy is kept artificially low by the Government, this will encourage Americans to use it, but also discourage domestic producers from producing it. Thus, low domestic energy prices simply result in a discrepancy between production and consumption, which gradually increases as the purchasing power of Americans increases relative to the retail price of energ-y. This shortfall is met by gradually increasing petroleum imports. But a country is like a family: on balance, over time, it must sell goods and services at roughly the rate at wNhich it buys goods and services. Therefore, as the United States has increased its imports of petroleum, it has had to increase its exports of other items to raise the money needed to pay for the oil. The reason for the economic and political problems related to petroleum pricing- is that few Americans inside or outside Government grasp the full implications of the massive export required to pay for the imported oil.
Table 1 reveals the impact that increasing crude oil imports have had on the U.S. balance of trade with other countries, and shows how various categories of U.S. exports to other countries have increased to *compensate for this increasing importation from O.P.E.C. countries. The table brings out two key facts. First, the increase in the cost of oil imports from 1970 to 1976 has been very great: about $28.3 billion dollars. The other fact is less well known. Most people, thinking of the United States as a major manufacturing nation, would expect this increase in imports of crude oil to be paid for largely by increase in exports of manufactured products. This assumption is based on a lack of awareness of the intensity of the competition the United States now faces in world markets from West Germany,
Japan, and other manufacturing nations. Thus, we see in the table that only about $9 billion of the increased fuel costs could be covered by an increase in exports of all manufactured goods and chemicals. In fact, over $10 billion of the increase in fuel import costs was paid for by an increase in U.S. exports of just a few raw commodities, particularly wheat, corn and soybeans. But there has also been a great increase in net exports of a wide variety of other raw commodities from the United States: Textiles, wood and metal ores and scrap. Too little attention has been given to the consequences for the U.S. economy of all these massive, and gradually rising exports. In fact, as figure 2 shows, the consequences are remarkably p evasive throughout the economy. They include food prices, land prices, and effects on city densities and the relative economic attractiveness of various types of transportation systems.
It is interesting to track the impact of massive crude oil imports through the economic system so as to reveal the way in which these affect the standard of living of the typical American family. Using nothing but routinely-published Government statistics, we do this in table 2. As the real price of drilling for U.S. crude oil (price corrected for inflation) increased, it became increasingly uneconomic, in the face of Government price regulation, to supply the U.S. market with domestic crude oil. Consequently, the U.S. oil market was increasingly supplied with foreign, as opposed to domestic crude oil. Consequently, the U.S. oil market was increasingly supplied with foreign, as opposed to domestic crude oil (third column). One of the means used o pay for this was wheat exports, which accordingly rose (fourth column) *in : ears when other countries had major crop production shortfalls. This meant that in the years following 1972, great increases in crude oil resulted in a drawdoixrn of U.S. domestic stocks of commodities, as illustrated by the wheat stocks statistics in column five. This was because between 44 and 73 percent of the wheat being grown each year in the United States was being exported to pay for imported crude oil. Consequently, years when there was a particularly heavy export of wheat, as between 1972 and 1975, there was a great increase in the price of wheat. Thus, from 1972 to 1974, the Firice, of wheat per bushel increased by 2.32 times. This, in turn, transated into a higher U.S. food cost for the typical family (last column).
Where food had only taken 39 percent of the average family spendable earnings in 1972, it took 47 percent in 1974. In short, "cheap energy" is an illusion. By keeping the cost of domestic crude oil down, the Government simply plays the cruelest type of political hoax on the electorate. Energy becomes more costly than it would have been if the price had been deregulated, but the family pays for energy everywhere except at the pump island. The same phenomenon as revealed for food costs in this table is found for housing and clothing.
TABLE I.-RELATIVE ROLES OF MANUFACTURED PRODUCTS AND RAW MATERIALS IN MAINTAINING THE U.S,
TRADE BALANCE IN THE FACE OF MASSIVE INCREASES IN CRUDE OIL IMPORTS
[All amounts in billions of dollars
Increase (+) or
Value of- decrease (-)
in net U.S.
1970 U.S. 1970 U.S. 1976 U.S. 1976 U.S. trade balance
Item exports imports exports imports 1970 to 1979
Mineral fuels and related materials ------ 1.595 3.075 4.226 33.996 -28.291
Machinery and transportation equipment- 17.882 11.172 49.510 29.824 12.976
Other manufactured goods ------------- 7.636 13.285 17.777 30.179 -6.753
Chemicals ---------------------------- 3.826 1.450 9.958 4.772 2.810
Subtotal, manufactured goods and
chemicals ---------------------------------------------------------------------------- 9.033
Wheat and flour ----------------------- 1.112 -------------- 4.041 -------------- 2.929
Corn --------------------------------- .824 -------------- 5.223 -------------- 4.399
Soybeans ---------------------------- 1.216 -------------- 3.315 -------------- 2.099
Textiles ------------------------------ .543 .202 1.426 .249 .836
Subtotal, renewable resources ------------------------------------------------------------ 10.263
Note: Data from tables 1478 and 1479, Statistical Abstracts of the United States for 1977
FIGURE 2.-Flow chart illustrating the systemic effects of massive raw commodities exports on the U.S. economy. In the chart, wheat is used as a surrogate variable to represent the kinds of effects introduced by increasing exports of a wide range of commodities, including corn, soybeans, rice, wood products and textiles. This type of chart not only can be used to explain the causal pathways in the system; it can also be used as the basis for building computer models to mimic the consequences of low energy prices on the economy. This chart illustrates only one of a variety of classes of effects of low energy prices; other parts of the model mimic the effects on unemployment and crime rates, pollution, investment, taxation and economic growth rates, etc.
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TABLE 2.-IMPACT OF GOVERNMENT ENERGY PRICE REGULATION ON THE PURCHASING POWER OF THE TYPICAL FAMILY
per foot to Average weekly
drill for oil Value of imported Wheat exports U.S. stocks of food cost as a
and gas in the petroleum pro- from United States wheat, June I percentage of United States ducts (billions of (millions of (millions of average spendable Year (1972 dollars) dollars) bushels) bushels) weekly earnings
1965 ------------- 18.09 2.09 852 921 43
1970 ------------- 20.61 2.76 741 982 41
1972 ------------- 20.76 4.30 1,135 983 39
1973 ------------- 21.27 7.61 1,217 597 45
1974 ------------- 24.85 24.29 1,019 340 47
1975 ------------- 29.06 24.81 1,173 435 46
1976 ------------------------------- 31.79 950 664 43
However, while the trend in food, clothing and housing is for these budget items to take a progressively larger percentage of average spendable weekly earnings, that trend is obscured by deviations about the trend produced by variations in crop-growing weather in countries that are prospective customers for U.S. commodities. Thus, it will be noted that the percentage of spendable earnings taken by food declined from 1974 to 1975, and again to 1976.
Table 3 gives more understanding as to why there should be fluctuations about a gradually rising trend line in the last column of table -2. Table 3 shows how we can project a trajectory for the most likely foreign demand for U.S. wheat each year, on the basis of historical data. Differences between actual demand, and this projected trajectory of likely demand account for year-to-year fluctuations in the price of food. Table 3 shows how, in turn, these fluctuations can be traced back to fluctuations in food production in other countries, which in turn are largely the product of fluctuations in crop-gro-wing weather. The second column gives the trend in world population, exclusive of the United States of America. The third column computes a. likely trend in world per capita demand for wheat, exclusive of the Unite4 States, on the assumption that that trend is a, simple linear function of gross world product each year. The fourth column gives -world per capita likely what production, on the assumption that that trend is a simple linear function of year number.
The fifth column gives a likely trend in foreign demand for U.S. wheat, computed from world population multiplied by the difference between per capita wheat demand and production (from the previous two columns). The sixth column gives actual U.S. wheat exports. The difference between actual wheat exports, and the trend in likely foreign demand for U.S. wheat is in the seventh column. Prior to 1972, this difference was large, because prior to the great increase in U.S. imports of O.P.E.C. crude oil, it was not necessary for the United States to export vast quantities of agricultural commodities to balance up its international trade, and further, there was lan insufficient market for U.S. wheat amongst nations able to pay for it. This market was created with the Nixon understandings with Moscow and Pekimz. After 1971, discrepancies between actual wheat exports and likely exports can be accounted for on the basis of fluctuations in the wheat harvests in world major wheat-growmig countries, particularly the Soviet Union. Thus, the big surg 'in actual exports relative to likely expected exports in 1973 is attributable to a shortfall in Russian wheat production in 1972 (see table 6).
TABLE 3.--COMPUTATION OF LIKELY TREND IN FOREIGN DEMAND FOR U.Si WHEAT, AND DIFFERENCE BETWEEN THIS TREND AND ACTUAL U.Si WHEAT EXPORTS
In millions of bushels
Non-U.S. Per capita non- Actual U.S.
world U.S. world wheat Foreign Actual U.S. wheat exports population demand produc- demand for wheat less foreign Year (millions) tion (bushels) U.S. wheat exports demand
1967 ---------------------------- 3,225 3.25 2.99 839 761 -78
1968 ---------------------------- 3,286 3.31 3.03 920 544 -376
1969 ---------------------------- 3 362 3.37 3.06 1,042 606 -436
1970 ---------------------------- 3: 430 3.41 3.09 1,098 741 -357
1971 ---------------------------- 3 502 3.44 3.13 1,085 610 -475
1972 ---------------------------- 3: 576 3.49 3.16 1 180 1,135 -45
1973 ---------------------------- 3 648 3.49 3.19 1:094 1,217 123
1974 ---------------------------- 3: 720 3.54 3.23 1,153 1 019 -134
1975 ---------------------------- 3,795 3.58 3.27 1,176 1 173 -3
1976 ---------------------------- 3,871 3.61 3.30 1,200 : 950 -250
1977 ---------------------------- 3,948 3.65 3.33 1,263 1,145 -118
At the beginning of this discussion, it was asserted that common sense indicates that low energy prices would encourage energy use, but discourage energy production. What does the evidence say? First, with respect to the effect of energy price on use within the United States, energ-y prices have never increased enough to have any discernable impact on use. As table 4 indicates, retail gasoline prices are actually lower now, relative to average spendable weekly earnings, than they were in 1965. To discover the likely impact of any significant enercr tny
price increases on U.S. energy use, we have to turn to comp native international data. However, to expose the effect of energy prices on use per capita, it is not adequate to simply use the price: we must use the price corrected for the ability to pay that price. Thus, in figure 3, a plot of crasoline use per capita as a function of price, there is only a
-;lio bt relationship (the fitted line is based on the data for all countries). However, when the price of gasoline is expressed as a proportion of GNP per capita as in figure 4, a very striking dependence of use on
V rice is revealed. These two graphs reveal an important point about
S. energy policy: it is meaningless to increase energy prices by a factor of two, in the name of conservation, over a sequence of years in which average spendable earnings are increasing by a factor of three. This would actually increase the use of gasoline. There will be no real enero, conservation in the United States until energy prices are allowed to increase at a faster rate than wages. Figure 4 also indicates
bow low U.S. energy prices are relative to those in other countries, including Sweden, which has a GNP per capita hi ,Yher than in the United States. Clearly, the argument that higher energy prices would be inimical to economic growth needs examination.
TABLE 4.-INCREASE IN GASOLINE PRICES, RELATIVE TO THE INCREASE IN AVERAGE SPENDABLE WEEKLY EARNINGS
worker in private
Retail price index, nonagricultural Price of gasoline
regular and pre- industry with
Year mium gasoline 1 3 dependents 2 Average earnings
1960., 92.5 73.0 1.27
94.9 86.3 1.10
1970 ------------------------------------------------- 105.6 104.6 1.01
1971 ------------------------------------------------- 106.3 112.4 .95
1972 ------------------ ------------------------------ 107.6 121.1 .89
1973 ------------------------------------------------- 118.1 127.4 .93
1974 ------------------------------------------------- 159.9 134.4 1.19
170.8 145.9 1.17
1976 ------------------------------------------------- 177.9 156.5 1.14
1977 ----------------------- ------------------------- 189.2 182.7 1.04
I From table 784, Statistical Abstracts of the United States for 1977a :From table 666, Statistical Abstracts of the United States for 1977
GASOLINE 1.0 1
CSweden PER CAPITA
3 ,Austria *
METRIC TONS, .. 0 Italy
IN 1970 ..
4 Thailand '-3
1 10 100
PRICE OF 100 LITRES OF GASOLINE IN U.S. DOLLARS, IN 1970
FIGURE 3.-The relation between gasoline price and use per capita: cross-sectiona analysis across countries. Based on statistics published by the Internationa Road Federation.
GASOLINE 1.0 U.S.A.
PER CAPITA 5
IN 4 0 Sweden
METRIC TONS, 3 Austria
IN 1970 2 0 Italy
5 0 Thailand
7 Zaire 0 0 Malawi
001 .01 .1 1.0
PRICE OF 100 LITRES OF GASOLINE AS A PROPORTION OF GROSS NATIONAL PRODUCT PER CAPITA, 1970
FIGUR, 4.-The relation between energy price and use per capita, when price is
corrected for ability to pay for gasoline.
Now what of the argument that low energy prices discourage production? First, we consider traditional sources of energy. In tabL 5 we see that while there has been a large increase in the price per barrel of crude oil at the well (column 2), this increase has been no more than that justified by the increase in cost per foot to drill for oil (column 3). Thus the ratio of price to cost is essentially the same in 1975 as it was in 1960. In other words, there is no more profit to drill for oil in the United States now than there was in 1960. So we simply do not know what would happen to the rate of oil production in the United States if the price of crude oil were to rise faster than drilling cost: No one has yet done the experiment to find out. However, table 5 does not reveal the complete story of the situation in which oil producers find themselves. Oil exploration and production will increasingly shift from onshore to offshore. While onshore costs of drilling for oil only increased by 2.03 times from 1960 to 1975, offshore costs increased by 2.58 times. In other words, the oil (and gas) industries will be forced to move to offshore sites as onshore sites are deleted, but the offshore exploration is far more capital intensive. Hig er profitability for oil and fa producing companies can be regarded as an obscene and gross Iy inequitable redistribution of the capital in the United States;
but given the likely future of the industry, a far more reasonable interpretation is that the industry needs to be more profitable in order to raise the capital that will be necessary to funi the enormously expensive program of energy exploration and development that is oil the way.
TABLE 5.-INCREASE IN THE AVERAGE PRICE OF A BARREL OF CRUDE OIL, RELATIVE TO THE AVERAGE COST PER FOOT TO DRILL FOR OIL
Average price of
Average price per a barrel of crude
barrel of crude Average cost per oil relative to
Year oil at the well foot to drill for oil cost to drill I ft
1960 ------------------------------------------------- 2.88 13.01 0.22
1965 ------------------------------------------------- 2.86 13.44 .21
1970 ------------------------------------------------- 3.18 18.84 .17
1972 ------------------------------------------------- 3.39 20.76 .16
1973 ------------------------------------------------- 3.89 22.50 .17
1974 ------------------------------------------------- 6.74 28.93 .23
1975 ------------------------------------------------- 7.67 36.99 .21
But there is another reason for raising energy prices. There is much talk about the need to develop new energy technologies, such as solar and wind power. However, these developments will be inhibited unless energy prices rise to a level at which they will be sufficiently attractive to risk capital. As long as energy prices are kept down by regulation, new energy technologies will be an uncertain investment.
Argument 2: The impact of cheap energy on U.S. economic stability. Many people will have noticed that within the last few years, the U.S. economy has developed an alarming tendency towards large, and unexpected economic fluctuations. In 1974, agricultural commodities prices were unusually high, and there was a tendency to inflation radiating outwards from the commodities sectors of the economy. But by 1977, there had been a great drop in the value of agricultural commodities. Farmers were going bankrupt, because they could not sell enough of their commodities, or get high enough prices to allow them to pay for their inputs. But also, there was a deterioration of the U.S. trade balance, the United States could not sell enough to pay for imported crude oil, U.S. dollars were piling up, unwanted, in many other countries, and the value of the dollar was dropping fast relative to a number of other currencies, particularly Japanese Yen, Swiss Francs, and German Marks. How did this come about?
If the Government keeps the price of energy down, thus stimulating massive oil imports, this means that the hE Wlth of the U.S. economy becomes sensitive to two other factors. First, we must be able to produce enough goods for export to pay for the imported oil. But second, other countries must have the demand for enough of our exports for us to raise the cost of the crude oil bill from O.P.E.C. But in turn, the demand of other countries for our agricultural produce depends upon the ability of prospective customers for our food to produce that food themselves. This in turn, is dependent on their crop-growing weather. But particularly *in some of the communist block countries which may import massive q aantities of our food in certain years, their cropgrowing v eather is extraordinarily volatile, because their principal crop growing regions are in the center of massive land masses remote from the moderating effects of oceanic currents and wind systems.
Table 6 indicates just how variable crop production is in various countries. Notice, first, that the absolute amounts of food grown in other countries are very large relative to the total amount of food the United States can grow. Thus, the largest Soviet wheat crop was 89 percent higher than the largest U.S. wheat crop. But further, the crop production shortfalls in other countries can be very large relative to the largest crops the United States has ever produced. Thus, the decrease in the Soviet wheat crop from 1973 to 1975 was equal to 75 percent of the largest wheat crop the United States has ever produced. This means that if the United States, on average every year, must produce enough of a crop surplus to pay for imported crude oil, some years we will have produced way too much, and other years we will have produced way too little. Either of these eventualities throws :)gigantic perturbation into the U.S. economy.
TABLE 6,-VARIABILITY IN PRODUCTION OF SOME OF MAJOR WORLD CROPS [All figures in millions of metric tons]
U.S.S.R. Mainland China India United States
Year Wheat Corn Wheat Rice Corn Wheat Rice Wheat Corn
1975 --------------------------- 66.2 7.3 41.0 116.3 33.1 24.1 74.2 58.1 147.3
1974 --------------------------- 83.9 12.1 37.0 115.2 31.1 21.8 59.4 48.9 118.1
1973--------------------------- 109.8 13.4 36.0 112.0 30.4 24.7 66.1 46.4 143.4
1972 --------------------------- 86.0 9.8 34.5 101.0 23.5 26.4 58.0 42.0 141.1
1971 --------------------------- 98.7 9.5 32.0 104.0 -------- 23.3 64.0 44.6 140.8
1970 --------------------------- 99.5 10.3 -------- 100.0 -------- 20.1 63.7 37.5 104.4
1969 --------------------------- 79.9 13.2 27.0 91.0--------- 18.7 60.7 39.7 116.3
1968 --------------------------- 93.4 8.6 25.7 92.0--------- 16.5 59.7 42.8 111.2
1967 --------------------------- 77.3 9.1 25.7 88.0-----11.5 47.7 41.5 119.9
Difference in production between most and least productive year----------------- 43.6 6.1 15.3 28.3 9.6 14.9 26.5 20.6 42.9
Table 7 suggests some of the kinds of perturbations that can be introduced into the U.S. economy by various combinations of cropgrowing weather conditions throughout the world. Clearly, by keeping energy prices 1low and thus st imulat ing~ massive energy importation and massive food export, Congress makes the U.S. economy very sensitivec to violent short-term economic fluctuations t riggered by crop-growing weather in other countries, particularly Russia.
Of course, these violent economic fluctuations produce some utterly unexj )Cct ed consequences. MLany U.S. corporations have recently been bed evilled with foreign exchange curr-ency translation losses. These losses occur when a~ company sells a product in the U.S. imported from elsewhere, but then has to pay the producer when the U.S. currency has dropped in value relative to the currency in which final payment is made. In effect, the U.S. corporation is trapped into selling cheap anl buying deair, due to circumstances completely beyond its control. These circumstances are changes in the rate at which the U.S. dollar is dropping in value relative to other currencies, produced by changes in the rate at which we are exporting commodities to pay for imported crudle oil; the ultimate causes are changes in the amount of crop shortfall produced in other countries in response to changes in their- cr-op-growing weather. Of course, this crop-pgrowingr weatlier can be neither p~redlicted nor- managedl. Thus1 by keeping energy prices downN( ()JU2T-sS and the Whi1te House are turning~ the mnnagrement of U.S.
enterprises into a vast game of chance. Thiis is true for' anf enormious diversity of activities, includliflg Exxon, the farm sect or, the importI ('I of European sporting goods, or of German stained gPlass.
TABLE 7.-IMPACT OF WEATHER ON ECONOMIC SCENARIOS FOR THE UNITED STATES
Crop-growing Tendency to
Crop-growing weather in Value of U.S. depression Approyimate
weather in countries U.S. domestic U.S. corn- dollar relative radiating out- probaulity
United importing U.S. crop commodity modity price to other ward from of tPu; States U.S. crops exports stocks inflation currencies agriculture scenario
Good -------Good --------High ------Very high--Little -------Dropping--High --------0.55.
Good -------Bad --------Very high --- Very low- ---Serious------Stabilizing--- None -----0.36.
Bad --------Good --------Very low --- Low --------Serious,--- Dropping____Moderate ___0.01.
Bad -------- Bad --------- Low------- Extremely low-. Very serious-- Stabilizing----. Moderate-----.. 0.08.
Conclusion: Congress, by keeping energy prices so low as to encourage massive importation of crude oil, makes the U.S. economy very sensitive to violent economic fluctuations between inflation and depression.
Argument 3: The impact of cheap U.S. energy on the world econom.In years when the United States cannot export enouiwh food to pay for imported crude oil, U.S. dollars accumulate in other countries because they cannot buy enough from us to use up all the dollars we have spent buying the crude oil. (This is an oversimplification of the situation, but in essence it is correct. Complications occur, as when Saudi Arabia sells unwanted U.S. dollars for gold, and the dollars are used, ultimately to purchase U.S. wheat). When these dollars accumulate, their value drops relative to the value of other currencies. This, in turn measn that a Volkswagon, Toyota, Sony, Rolls Royce jet engine or A.300B airbus costs more in the United States. Thlat, in turn means that all other factors remaining constant, we would be less likely to buy the foreign product. That is serious, because many foreign economies are more dependent on export markets than the United States, because their national populations are not larg-e enough to give them significant and competitive economies of scale in manufacturing. Thus, enough of a drop in U.S. purchases of German, Japanese and other products could lead to significant slowdowns in their economies, and ultimately, a significant slowdown in the world ecomomy, including the U.S. economy. In short, cheap energy in the United States has implications which go f ar beyond the internal dynamics of our own economy. We cannot, on the one hand, expect Germany and Japan to keep the world from sliding into a, new recesinyet on the other hand adopt an energypie oiyvhc
makes it impossible for them to sell enough to us to prevent that from happening. Our failure to grasp this is the root cause of a lot of the criticisms of our economic management so frequently expressed by foreign business and Government leaders and reported in the Wall Street Journal and elsewhere.
Argument 4: The impact ofc heap U.S. energy on resource substitution. When Congress continually votes to keel) energy prices low, but to allow the minimum wage to rise, they are simply voting for a substitution of the cheap energy for expensive labor. In turn, this means they are voting for all the other phenomena, that accompany that substitution: high rates of unemployment and crime, high costs for unemployment insurance and police protection, high costs of operating Government, an inefficient economy and a low rate of economic growth. None of this is theory: Each step in the implied
-arguments can be demonstrated by statistical analysis of available ,data. Thus, in making comparisons between countries, we find that
hiLyh crime rates accompany cheap energy.
"'Argument 5: Cheap energy and the survival of the United States. Normally, as the real cost of roducing petroleum increased, this would be converted into a signaY to the marketplace, in the form of higher retail prices. That signal, in turn, would have several effects, besides conservation. One effect would be to intensify the search for existing energy sources (oil, gas, coal). Another effect would be to stimulate research and development for new energy sources and technologies- However, by keeping energy prices artificially low, Congress and the White House prevent such a message from beg flashed to
the marketplace. That, in turn means, that when the nited States begins to run short of conventional sources of cheap energy, there will be a mad scramble to develop and find energy sources for which the search should now be underway. But can we make up the lost time under crisis conditions? This, in turn raises the question as to how long it takes to get new energy technology in lace. In fact, as Z-) les 1
figure 5 shows, it has taken a very long time indeeN to get new technologies in place. The times it took before coal, oil and gas supplied .30 percent of U.S. energy consumption were 72, 78 and 69 years, respectively. So the times were not only remarkably lop they were remarkably similar. The reason is that the rate at whil a national population of energy -a berating plants of a particular type can be built up is limited, ty a thermodynamic constraint. If the population builds too rapidly, too hig a proportion of the entire population has just been constructed or is under construction. In that case, there would be no net energy or money output from the entire national population of plants. Thus, a problem wiih a national policy of keeping energy prices down is that we might get caught in a "systems trap" in 10 or 20 years: We might get trapped into trying to build new energy generating systems so rapidly that there was no net energy ou From the construction process at all. To illustrate, w te
gross energy output from the entire national population of nuclear plants grows at 24 percent or more, there is no net energy output at all. To 1977, that gross energy grew at 38 percent: one reason why Project Independence became Project Dependence.
ENERGY CONSUMPTION BY CATEGORY
AS A PERCENTAGE OF TOTAL U.S. ENERGY CONSUMPTION
O78 YEARS ,20 5 6 EASI
20 ~ 56 YEARS
40 69 YEARS >
20 ....... --44 YEARS
1800 1820 1840 1860 1880 1900 1920 1940 1960 1980
FIGURE 5.-The time it took to have each of coal, oil and gas supply 10, and 30
percent of national energy consumption.
LOW-DENSITY METROPOLITAN AREA
INCREASE IN PRICE OF ENERGY
PER YEAR -._.......... MAXIMUM
AVERAGE COST OF LIVING AREA
METROPOLITAN AREA (SQ. MILES)
INCREASE IN PRICE OF ENERGY
DOLLARS AVERAGE INCOME
AVERAGE COST OF LIVING MAXIMUM
METROPOLITAN AREA (SQ. MILES)
Fim(;ii 6-,a.-A theory of the relation between average income, average cost of living, city density and city area. Note that these relations determine the area of a city which is et )fonicall viable; also note that this maximum viable economic area shrinks in response to increasing energy prices.
HIGH-DENSITY( METROPOLITAN. AREA
INCREASE IN PRICE OF ENERGY
AVERAGE INCOME AVERAGE COST
PER PERSON FLVN
METROPOLITAN AREA (SQ. MILES)
INCREASE IN PRICE OF ENERGY
7 AVERAGE COST DLASAVERAGE INCOME- OF LIVING
PER PERSON *
METROPOLITAN AREA (SQ. MILES) FIGURE 6a
AVERAGE 58I OVER 1000 PEOPLE
5.8 -PER SQUARE MILE PER CAPITA INCOME
(THOUSANDS OF DOLLARS) 300-1000 PEOPLE PER SQUARE MILE 10 3 100299 PEOPLE
/ PER SQUARE MILE
5.0 ,4 10,,3
7 UNDER 100 PEOPLE
7 PER SQUARE MILE
0 2 4 6 8 10 12 14
LAND AREA OF STANDARD METROPOLITAN STATISTICAL AREA
(SMSA) IN THOUSANDS OF SQUARE MILES
FIGURE 7.-Test of the notion that average incomes are related to city densities
and areas, using Bureau of the Census data. Numbers above the lines indicate
the number of metropolitan areas averaged to make each point in each line.
SUMPTION 100-1000 PEOPLE
PER 270 PER SQUARE MILE
OVER 1000 PEOPLE
220 /PER SQUARE MILE
0 1 2 3 4 5 6 7 8
LAND AREA OF STANDARD METROPOLITAN STATISTICAL AREA
(SMSA) IN THOUSANDS OF SQUARE MILES
FIGURE 8.-Test of the notion that average living cost is affected by city densityand area, using data from the Census of Retail Trade. The lines are drawn, through points obtained by averaging data from a great many metropolitan
Argument 6: Cheap energy and the spatial design of American society. Cheap gasoline is encouraging American cities to develop a pattern of urban sprawl which builds a tremendous hidden transportation overhead cost into all activities. But further, a great deal of the Nation's capital is being invested in a physical plant which will be difficult to maintain when the price of gasoline begins rising rapidly in response to worldwide increases in the cost of obtaining energy, an inevitable development once all cheap O.P.E.C. crude oil is depleted, in the late 1980's or eaxly 1990's. Figure 6 presents a graphical theory showing how, in either high or low density cities, average cost of' living rises with increased city area, whereas average incomes drop at very Ngh city areas. Also, incomes rise as a function of city density, for any given urban area. The maximum possible size that a city can be is determined by the area at which the income and cost of living lines cross. For cities of all densities, this maximum possible area must drop when gasoline price increases drive up the cost of living. Clearly, un-less gasoline prices are allowed to rise faster than the average wage-
very shortly, the U.S. cities are going to get locked into a pattern of continuing sprawl that will be a terrible financial burden for everyone, once the inevitable future gasoline price increases do occur. Putting it differently, our cities are being encouraged to evolve in response to energy prices which are not an accurate reflection of the state of the world, but an artificial reflection created by interference in the free marketplace by Congress and the White House.
Figures 7 and 8, based on analysis of data from the Bureau of Census, census of population and of retail trade in gasoline, show that the theory graphed in figure 6 does in fact describe the situation. In short, the federal government is now in the ironical position of encouracring U.S. cities to evolve rapidly in the fashion of dinosaurs, which became extinct because.they had adapted to an environment which did not last. Further, this inappropriate spatial design already is having a large, but veiled impact on the U.S. economy. The hidden transportation overhead on all transportation of crowds and passengers affects our ability to compete in the international marketplace for manufactured ooods with the other developed countries. This phenomenon is revealed when we conduct cross-sectional statistical analyses to discover the factors that determine the rate of growth of various economies. When we do this we discover that population densitv shows tip as a beneficial factor in promoting economic growth. What this actually reflects is not a beneficial impact of high population density, but rather of hidden transportation efficiency and lowered transportation systems overhead when a society has a spatial design which promotes energy efficiency in passenger and goods movement. This efficiency is associated with short average distances for passenger and goods trips, both within and between cities. Particularly as transportation energy costs rise, the United States will only be able to compete with other nations manufacturing goods competitive with ours if our transportation energy efficiency is increased. One way to do this is to make our cities more compact. Otherwise, this Nation will have stumbled into a "systems trap" by failing to look ahead to the implications for the spatial design of society of higher future energy prices.
There is a simple solution to all six of these problems. The United States currently has an overall policy of making low energy price a basic national policy, then allowing policy in every other policy area to follow from that. Thus, national agricultural policy, foreign p licy, our strategies of international agricultural development, military policy and all other policies are determined by our commitment to cheap energy, no matter bow much mischief results. Thus, for example, instead of shippincr wheat, corn, soybeans and rice to other countries so we can raise the money we need to pay for imported crude oil, it would make far more sense for many other countries, particularly in the tropics, to shift from the growing of cash crops for exl)ort to us to growing wheat, corn, rice and soybeans. We would not have to export commodities to them if energy prices were high enough so that we could be self-sufficient in energy. Further, if countries were all more independent in agriculture, thus eliminating a lot of unnecessary agricultural shipments across the oceans, the whole world would be more energy-efficient. It would seem to be worthwhile to become energy-efficient now, voluntarily, through
wise planning, rather than waiting a few-N decades and1 having efficient use of energy forced on us, with some trauma, as worIlwidle depletion forces higher prices.
It would make far more sense to have national agricultural p~olic'-y be the basic policy from which all other policies flowed. In thatca, we would determine a reasonable price to farmers for their produ(I(ce, and a reasonable price for consumers to pay for food, and let national energy policy be determined by the free play of market forces, (given national agricultural policy. The problem with present policy is that it has produced economic distortions simultaneously in farming, coal, oil and gas industries. This is, on the face of it, a remarkable state of affairs. Surely we can do much better.
UNIVERSITY OF FLORIDA 3 1262 09il9 2590