The economic impact of oil import reductions


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The economic impact of oil import reductions
Series Title:
Serial - Senate, Committee on Energy and Natural Resources ; no. 95-158
Physical Description:
viii, 31 p. : ill. ; 24 cm.
United States -- Congress. -- Senate. -- Committee on Energy and Natural Resources
Black, Robert, 1948-
U.S. Govt. Print. Off.
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Energy policy -- United States   ( lcsh )
Petroleum industry and trade -- United States   ( lcsh )
federal government publication   ( marcgt )
bibliography   ( marcgt )
non-fiction   ( marcgt )


Includes bibliographical references.
Statement of Responsibility:
prepared at the request of Henry M. Jackson, chairman, Committee on Energy and Natural Resources, United States Senate.
General Note:
CIS Microfiche Accession Numbers: CIS 78 S312-26
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At head of title: 95th Congress, 2d session. Committee print.
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"Written by Robert F. Black."
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Dec. 1978.
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Reuse of record except for individual research requires license from LexisNexis Academic & Library Solutions.

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University of Florida
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All applicable rights reserved by the source institution and holding location.
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Full Text

2d Session I



'0 JAN 17 1979 "






Publication No. 95-158 DECEMBER 1978

Printed for the use of the Committee on
Energy and Natural Resources


For sale by the Superintendent of Documents, U.S. Government Printing Office Washington. D.C. 20402 Stock Number 052-070-04777-1


HENRY M. JACKSON, Washington, Chairman FRANK CHURCH, Idaho CLIFFORD P. HANSEN, Wyoming
DALE BUMPERS, Arkansas LOWELL P. WEICKE R, JR., Connecticut
JOHN A. DURKIN, New Hampshire PAUL LAXALT, Nevada
HOWARD M. METZENBAUM, Ohio SPARK M. MATSUNAGA, Hawaii WENDELL R. ANDERSON, Minnesota JOHN MELCHER, Montana GREENVILLE GARSIDE, Staff Director and Counsel DANIEL A. DREYFUS, Deputy Staff Director jor Legislation D. MICHAEL HARVEY, Chief Counsel W. 0. CRAFT, Jr., Minority Counsel

To Members of the Senate Committee on Energy and Natural Resources:
Earlier this year, the committee asked the Congressional Budget Office to analyze the possible economic impacts of future interruptions of oil imports, accompanied by oil price increases. This report, prepared in response to that request, makes clear that such interruptions and price increases would have a significant impact on the U.S. economy.
The report underscores the significance of an effective strategic reserve, and the importance of an equitable allocation system to minimize the disruptions caused by oil import shortfalls and price increases. Specifically, it concludes that a 500 million barrel reserve could avert an additional $20 billion loss in real GNP in 1982 if a reduction in imports of 3 million b/d occurred in that year.
By assessing the economic costs of supply interruptions and price increases, this report will be helpful to Congress in evaluating the strategic reserve and other programs designed to minimize these costs. The report does not purport to deal with the longer-term political and economic consequences of U.S. dependence on foreign oil. The recent cartel price increases and the current situation in Iran have once again reminded us that oiir growing reliance on oil imports is politically unwise and economically unsound. As a ,Nation, we will ig4nore these new warnings at our peril.
The committee is grateful to the Congressional Budget Office for its cooperation in the preparation of this report.

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The threat of another foreign oil production limitation and price increase has been a major concern of U.S. energy policy since the 1973-74 oil crisis. This report, prepared at the request of the Senate Energy and Natural Resources Committee, examines both the impact on the economy of another supply interruption and the effectiveness of a series of policy options, such as the strategic petroleum reserve and oil allocation regulations, for minimizing that impact.
"The Economic Impact of Oil Import Reductions" was written by Robert F. Black of the Congressional Budget Office's Natural Resources and Commerce Division, under the general direction of Raymond C. Scheppach and Richard D. Morgenstern. Special thanks go to Bill Finan and George Schink of Wharton Econometric Forecasting Associates for providing technical assistance for this project. Marion F. Houstoun edited the manuscript, which was typed for publication by Misi Lenci. In accordance with CBO's mandate to provide objective and nonpartisan analysis, this paper contains no recommendations.
ALICE M. RIVLIN, Director.
December 1978.


Memorandum of the (ill)
Chapter 1. 5
Chapter II. Framework for analyzing a future oil production limitation and
price increase ---------------------------------------- 7
Recent changes in U. S. oil imports and energy policy 7
The analytic 7
Duration and magnitude of an oil production limitation-------- 8 World oil prices during an oil production limitation ------------ 9
Strategic petroleum reserve -------------------------------- 9
Allocation regulations- 10
Price controls on 10
Chapter III. Macroeconomic effects and policy implications------------ 13
Macroeconomic 13
Effects during the 13
Effects after the 14
Impact of SPR and petroleum allocation regulations--------------- 15
Effectiveness of petroleum allocation regulations --------------- 16
Description of the Wharton annual energy 21
Input-output analysis of a foreign oil production cutback ----------- 21
Development of assumptions regarding oil import reduction levels ------- 29
Forecast of future U.S. oil 29
OAPEC share of U.S. 29
Financial condition of OAPEC 30
Oil import reduction 30
Table 1. Summary of analytic framework for a hypothetical yearlong oil
production limitation and price increase in 1982 8
Table 2. Impact of a yearlong oil production limitation in 1982 on GNP, unemployment, and inflation during the supply interruption ----------- 14
Table 3. Impact of a yearlong oil production limitation in 1982 on real
GNP, unemployment, and inflation in 1985 ------------------------- 14
Table 4. Impact of strategic petroleum reserve (SPR) on real GNP during a
3 and 4 MMBD oil supply interruption in 15
Table 5. Impact of strategic petroleum reserve on unemployment during a
3 and 4 MMBD oil supply interruption in 1982 ---------------------- 16
Table 6. Impact of an 8-percent petroleum shortfall in 1982 on major sectors of the economy during the supply interruption ---------------- 17


Table A-i. Simple input-output accounting example ----------------------21
Table A-2. Simple input-output accounting example with expanded final
,demand------------------------------- 22
Table A-3. Simple input-output table in coefficient fom---------22
Table B-i. OAPEC share of U.S. oil imports ------------------------- 29
Table B-2. Financial condition of OAPEC countries, 1973 and 1977 --------30 Table B-3. Derivation of 3 M.MBD c,9se ----------------------------- 30
Table B-4. Derivation of 4 M\MBD cae---------------31

Figure A-i. Basic input-output structure ---------------------------- 22
Figure A-2. Direction of solution of input-output relationships ------------23
Figure A-3. Direction of solution of price relationships---.----------------24
Figure A-4. Income and price effects--------------------------------- 24

The Arab oil production limitation andl quadrupling of oil prices, which occurred from October 1973 to March 19 74, significantly affected the American economy. In the aftermath, real GNP and income decreased by several percent and, by 1975, unemployment increased by almost 2 percent. Perhaps even more significantly, the rate of inflation accelerated, causing major~ adjustment problems during the next several years. These aggregate effects dto not, however, tell the whole story: certain industries, firms, andl indi vi duals experienced considerable hardship during this 5-month crisis, which is difficult to measure in terms of economic loss.
The severity of that oil supply interruption provided a major impetus for legislation designed t~o mitigate the impact of another oil production limitation and price increase. In fact, reducing the dependence of the U.S. economy on foreizrn oil imports is a major objective of most recently proposed energy legislation. Although it is extremely difficult to determine the probability of the occurrence of another oil production limitation, in developino- future energy oice it is important to assess the likely impact of another supply interruption on the economy. This is particularly true at the present time, because both the level and source of U.S. oil imports, as well as Federal policies designed to mitig--ate an oil supply interruption, have changed markedly since 1973.
Since the 1973-74 crisis, U.S. imports of crude oil and products have increased sharply, from 6.2 million barrels a (lay in 1973 (36 percent of total U.S. Oil consumption) to 8.6 million barrels a day in 1977 (47 percent of total U.S. oil consumption). Not only have total oil imports increased, but U.S. dependence on the countries that imposed the previous supply limitation-the Organization of Ar'ab Petroleum Exporting Countries (OAPEC)-has increased dramatically, from 8 t~o 21 percent of total domestic oil consumption between 1973 and 1977.
Government policy has also changed significantly since 1973. A strategic petroleum reserve (SPIR), aimed at offsetting the likely output losses associated with a cutback, is now being filled; the Department of Energy (DOE) estimates it will contain 500 million barrels by 1980. New regulations allocating oil in the event of another production cutback are also currently being considered by DOE. In addition, the fact that the President no longer has clear-cut authority to invoke mandatory economywide price controls-as he (lid in 1973-74--could also affect the severity of another foreign oil supply interruption.
This report analyzes the macroeconomic effects of alternative levels of OAPEC oil export restrictions and the effectiveness of the U.S. strategic petroleum reserve in mitigating those effects. Four cases are considered. Each case assumes that a yearlong oil supply interruption occurs in 1982, with oil import prices remaining constant in real

86-379,--78--2 (1)


terms before that year, at which point they increase by 20 percent. The petroleum allocation regulations now being considered by the Department of Energy and price controls on oil-related products are also assumed to be in effect.' Within the framework of those common assumptions, the report examines the impact of oil import reductions of 3 or 4 million barrels a day (mmbd) and an SPR of 250 or 500 million barrels, representing an 8, 11, 13, and 16 percent net reduction, respectively, in the total amount of oil available for U.S. consumption.

An oil production limitation and price increase of the duration and size assu med above would have a significant, but not a devastating, impact on the U.S. economy. The policy options available to the Federal Government could, however, offset some of those effects. The strategic petroleum reserve would help mitigate output losses and a system of petroleum allocation regulations would hell) insure the production of vital national goods and services; thus, both of these policy options 'would diminish the adverse impact of a foreign oil production limitation and price increase on the U.S. economy.
Output and employment effects.-As with most economic shocks, the impact of another oil production limitation and accompanying price increase would be greatest during the year in which it occurred. Nevertheless, the level of GNP and employment would also be affected during the next several years. With a 500-million-barrel SPR, the imposition of a yearlong 3-mmbd oil cutback (which would represent approximately an 8-percent reduction in domestic oil consumption, or about half the reduction experienced. during the 5-month interruption in 1973-74) would reduce real output in the United States by 2.9 percent and increase the unemployment rate by 1 percentage point above the levels forecast for 1982. An oil restriction of this nature would also reduce real output over the next several years; for example, in 1985, real output would still be 0.7 percent below, and unemployment would be 0.5 percent above, the base case.
If the oil import restriction were increased, so that the net impact was roughly equivalent to the 16-percent shortfall in oil supply experienced (luring the 1973-74 interruption-that is, in the case of a 4-mmbd oil reduction and a 250-million-barrel SPR-output would be reduced by 9.8 percent and the unemployment rate would be 3.2 percent above the base case level in 1982. By 1985, output and employment would still be .8 and 1 percent, respectively, below that projected without an oil cutback. In short, a larger oil supply reduction (a 16-percent shortfall) has a proportionately greater effect on GNP than a smaller reduction (an 8-percent shortfall), because of the limits that conservation and fuel switching have on mitigating output losses.
Price ffects.-Although all the cases considered in this analysis assume that allocation regulations andi price controls on petroleum products would be in effect, the 20-percent price increase on nonOAPEC crude oil and the oil supply shortfall cause significant inIDespite the current lack of authority for mandatory price controls, this analysis assumes they would be in effect in the event of an oil supply interruption because an oil price increase, when coupled with shortages in sectors of the economy that use petroleum, would cause serious short-run problems.


creases in the general price level. For example, a 3-mmbd reduction and a 500-million-barrel SPR would increase general Drices in 1982 by 1.3 percent; a 4-mmbd reduction and, a 250-million barrel SPR would increase prices by 4.3 percent. Similarly, in 1985, prices would still be .7 and .1 percent, respectively, above that expected without an oil cutback.
Strategic petroleum reserve.-A strategic petroleum reserve would offset some of the economic disruptions caused by an oil supply reduction and price increase. In particular, with a 3-mmbd oil reduction, an SPR level of 500 million-as opposed to 250 mill ion-barrels would avert an additional $20 billion loss in real GNP in 1982. That would represent a net real output savings of about $80 per barrel of reserve, and there would be additional output loss protection during the next several years. In the case of a 4-mmbd interruption, each barrel in storage above 250 million would avert $172 in real GNP loss in 1982, with some additional offsets during the next several years. Those savings in output, losses would also be translated into the saving of 430,000 and 960,000 jobs, respectively. The SPR would also provide a limited amount of price inflation protection. Nevertheless, in making actual decisions about the rate at which the strategic petroleum reserve should be filled, these potential benefits must be balanced against its total cost and the probability of another oil supply interruption.
Allocation regulations.- Regulations that would allocate petroleum products across industries during a petroleum shortfall do ,Appear to provide some protection to sectors of the economy deemed vital to the national interest in the Emergency Petroleum Allocation Act of 1973. In general terms, this means that agriculture, utilities, health services, and other industries would suffer proportionally less employment and output loss than durable and nondurable goods, construction, and wholesale/retail trade.
The data provided in this paper on the output, employment and inflationary effects of alternative oil supply shortfalls are meant to provide only estimates of the short-run vulnerability of the U.S. economy to the current level of foreign oil dependence. These estimates, when coupled with implementation costs and an assessment of the probability and size of another oil supply interruption and price increase, should be helpful to the Congress as it decides the rate at which the strategic petroleum reserve should be filled. More importantly, however, it provides background information on some of the potential risks associated with the current high level of oil consumption by the United States and, particularly, its *increasing dependence on foreign oil. The other major risks, which are not considered in this analysis, are the possibility of a long-term. world oil shortage, a continuing devaluation of the dollar, and the extent to which U.S. national security and international relations are jeopardized by this oil dependency. These and other risks will be assessed by the Congress as it debates additional proposed energy legislation during the next session. The potential economic effects of another oil supply curtailment and price increase, as addressed in this paper, represent one aspect of that debate.

Reducing the vulnerability of the U.S. economy to another oil production limitation and price increase is a major objective of most recently proposed energy legislation. What would be the impact on the economy of another worldwide production limitation, stemming" from either a political event or from a foreign oil production bottleneck? What policies are available for mitigating its macroeconomic effects on the United States?
In order to understand the dynamics of any future oil production limitation, it is useful to review the 1973-74 crisis. The Arab oil supply interruption, which occurred from October 1973 to March 1974,
resulted in approximately a 15-percent reduction in the amount of petroleum available to the U.S. economy.1 This reduction in petroleum supplies and the subsequent quadrupling of oil prices affected all sectors of the economy. The oil reduction led to the allocation of existing supplies of such petroleum products as gasoline and home heating oil to consumers, which led to shortages in some sectors of the economy. These shortages, in turn, caused consumer prices to rise in many sectors of the economy. Higher energy prices raised the cost of almost every commodity and service consumed. Furthermore, Price hikes led to, an increase in wage levels, which further aggravated inflationary pressures.
Real growth and unemployment were also adversely affected by the oil supply interruption. In many industries, the reduced supply of petroleum forced factories to decrease their hours of operation or, in some cases, to close down. This situation was especially pronounced in the automobile industry, where falling demand for cars caused auto manufacturers to cut back production and lay off large numbers of workers. Finally, because consumers could not easily reduce their use of gasoline or home heating oil when the price increased, higher petroleum prices forced consumers to spend more of their income on energy. As a consequence, less income was available for other roods and services, so the demand for other products dropped, and real output and employment fell.
Although it is extremely difficult to quantify the impact of the 197374 crisis on the U.S. economy, a number of studies, using a varietv of approaches, have attempted to assess the economic impact of that oil production limitation and price increase.2 The most recent analysis of
I Randall G. Holcombe, "A Model Estimate of the Economic Impact on an Interrupl ion in the United States Petroleum Imports" (final report for the Federal Energy Adniiiisration, April 1976).
2 See for example, Federal Energy Administration, "Project Indepencence Reporl" (1974), and Federal Energy Administration, "Report to Congress on the Economic Impact of Energy Aclions" (1976).


the 1973-74 oil crisis, undertaken by Data Resources Inc., concluded the following:
-The oil price increase added nearly 1.8 percentage points to the
U.S. inflation rate in 1974 and 1975; Z
-By 1975, the energy crisis had raised the unemployment rate
by 1.7 percentage points; and
-Real GNP was reduced by 3 percent in 1974.1
A number of Government policies were pursued in response to this oil production limitation and price increase. In the first place, Phase IV price controls and a voluntary petroleum allocation program were in effect even before the production cutback. On November 1, 1973, the Nixon administration implemented a mandatory allocation program for middle distillates. During that same month, the Congress enacted the Emergency Petroleum Allocation Act (EPAA), which required p romulgation of mandatory petroleum allocation regulations. The Phase IV price controls and the mandatory petroleum allocation regu'lations formed the heart of the Government response to the crisis. The regulations, which gave priority to food, defense, emergency services, and fuel production, covered all petroleum products and directed their allocation from refining to end-use, with the exception of gasoline, which was allocated at the wholesale level. Finally, in December 1973, the Federal Energy Office was created to deal with the energy crisis caused by the production cutbacks.
An oil supply interruption and resulting price increase in the early 1980's could likewise reduce real growth and cause substantial inflation. The severity of such a crisis would, however, be affected not only by the duration and magnitude of a foreign oil supply interruption, but also by the policies pursued by the U.S. Government. Notwithstanding the common belief on the part of the American public that another foreign oil supply interruption and price increase would be disastrous to the American economy, a number of Federal policies, such as the strategic petroluem reserve, oil allocation regulations, and price controls on oil-related products, could help minimize the short-run economic problems that are likely to result from a foreign oil supply interruption.
The objectives of this background paper are thus twofold. On the one hand, it attempts to determine the impact of a new oil production limitation and price increase on the U.S. economy in general and on Iparticiar --e ctors of it. On the other hand, however, the analysis also attempts 10 assess the effectiveness of several policy options available to the Federal Government for minimizing the economic effects that are likely to be associated with a supply interruption. Thus, this analysis provides background information for the Congress on some of the
posibe issoa continuingc U.S. dependence on foreign oil. A longterm world oil shortage, a continuing devaluation of the dollar, and the constraints on U.S. foreign policy generated by that oil dependency are other major risks which, while not analyzed in this paper, are also associated with the current high level of oil consumption by the United States and its increasing dependence on oil imports.
3 Data Resourees ic., U.S. Long-term Review, "11980 Oil Ernbargo Study" (fail 1977), p. 2.


In the years since the 1973 crisis, significant changes, which could alter the effect of another Arab oil production limitation and price increase, have taken place in the level and source of oil imports and in Government policy.
The volume of U.S. oil imports has significantly increased since 1973. In 1973, refined and crude imports totaled about 6.2 million barrels a day, which represented 36 percent of total U.S. oil consumption; by 1977, U.S. imports amounted to 8.6 million barrels a day, or 47 percent of U.S. oil consumption. Moreover, the countries responsible for the 1973 oil supply interruption now provide a much larger share of U.S. petroleum imports than they did at that time. In January through September 1973, the Organization of Arab Petroleum Exporting Countries (OAPEC)'-the world's major oil producersprovided the United States with 23.6 percent of its total oil imports, which constituted 8.4 percent of domestic oil demand. But, by September 1977, OAPEC's share of U.S. oil imports had risen to 42 percent, or 20.5 percent of domestic demand.' This shift in supply reflects a U.S. demand for light, low-sulfuLr, crude oils, which provide a higher volume of gasoline and fuel oil from distillation than does heavy crude oil.'
Government policy has also changed since the 1973-74 crisis. Clearly, one of the most significant changes was the decision to build strategic petroleum reserve (SPR), aimed specifically at minimizing the output losses associated with a production limitation. Petroleum allocation regulations have also been developed and tested. But, unlike the 1973-74 period and despite the fact that, without a modified form of price controls on oil-related products, the economy would face a number of serious short-run problems in the event of another oil supply interruption, the President today has no clear-cut authority to invoke mandatory economywide price controls.4

In order to analyze the macroeconomic impact of future oil supply interruptions and assess the effectiveness of the strategic petroleum reserve, a framework was developed incorporating data regarding the
1The GAPEC nations involved in the supply interruption were Algeria, Egypt, Kuwait, Libya, Qatar, Saudi Arabia, Syria, and the United Arab Emirates.
2 "OPEC Share of U.S. Petroleum Imports Still Increasing," Oil and Glas Journal, vol. 76 (May 15, 1978), p. 49.
3 Data Resources Inc., "1980 Oil Embargo Study," p. 2.
4 Another change in Government policy, which is not specifically examined in this analysis, is the development of the International Energy Agency.


1973-74 experience, the changing oil import position of the United States, and energy policy changes that have occurred since 1973. Table 1 specifies the key variables central to the analysis of any future oil production limitation and price increase. All of these assumptions were then integrated into the Wharton annual energy model, which was utilized to carry out the analysis. (Details concerning the Wharton annual energy model can be found in Appendix A.)
Four particular cases are examined within this framework. In all of the cases, oil import, prices are assumed to remain constant in real terms before a yearlong oil supply interruption in 1982, when oil import prices are assumed to increase by 20 percent. The analysis also assumes that price controls on oil-related products and oil allocation regulations would be in effect and would be identical in all four cases. Within the framework of those common assumptions, the macroeconomic effects of a yearlong .3 -mill ion-barrels-a-d ay (mmbd) oil product-Ion cutback are analyzed on the assumption of a strategic petroleum reserve level of 500 million barrels (case 1, a resulting petroleum shortfall of 8 percent) and on the assumption of an SPIR level of 250 million barrels (case 2, an 11 1-percent, shortfall). The effects of a 4-mmbd production cutback with an S'!'PR level of 500 million
barrels (case 3, a 13-percent shortfall), and with an SPR of 250 million barrels (case 4, a 16-percent shortfall) are similarly analyzed. Each of the key variables affecting the magnitude of a future oil supply interruption are discussed in subsequent sections of this chapter.
Key variables Case 1 Case 2 Case 3 Case 4
Amount of oil supply reduction (millions of barrels a day). 1 3 1 3 2 4 24 Percent increase in oil prices------------------------- 20 20 20 20
Strategic petroleum reserve level (millions of barrels)--- 500 250 500 250 Allocation regulations-------------------------------- (1) (1) (3) (3)
Price controls------------------------------------- (3) (3) (3) (3)
Resulting petroleum shortfall (percent) 4-------------------- . .8 11 13 16
1 Represents 7 percent of total U.S. energy consumption in 1982. 2 Represents 10 percent of total U.S. energy consumption in 1982.
3 In place and identical in all 4 cases.
4 Represents the amount of petroleum lost to the U.S. economy in 1982 after accounting for SPR.
Duration and Magnitude of an Oil Production Limitation
Both the duration and the magnitude of an oil production limitation will affect, the severity of another oil crisis. Although the 1973-74 Arab oil production limitation and price increase lasted for only about, 5 months, in order to determine the maximum effects of an oil supply interruption on the economy, this analysis assumes it will last 1 year.
In order to provide a range of results and to test their sensitivity, two further assumptions about the reduction in oil supplies were made. The first case assumes that the United States would face -an oil import reduction of .0 million barrels a day, representing approximately 7 percent of total U.S. energy constimption in 1982. T1he second case assumes oil impoirts would be reduced by 4 million barrels a day, or about 10 percent of total energy consumption. Although a number of events cotild cause oil reductions of that mfagnitiile (for example, a fire in the I ersitn Cult), this analysis i3ssuimes a situation analogous to the 197;3-74 supply interrutption, wh-len the major OAPEC nations


imposed a production cutback. phits, the analysis assumes that the remaining OPEC countries as well as such other exporting countries as Mexico and Canada would not participate in the production cutback.
These two assumptions regarding the probable level of a future oil import reduction were developed, first, by surveying various forecasts of future U.S. oil imports, in order to obtain a reasonable range of possible oil imports for the early 1980's. The historical relationship between U.S. oil imports and OAPEC countries was then examined. Finally, the international reserve position of the key OAPEC nations was reviewed to determine their ability to limit oil production without suffering financial difficulties. These factors were then integrated together to obtain the oil impoi-t reduction levels used in the analysis. (See Appendix B for details on how these oil import reduction levels were developed.)
World Oil Prices During an. Oil Production Limnitation
Assessing future world oil prices during a supply interruption is quite difficult, clue to the wide range of political and economic factors that could affect, the price of oil. Although world oil supply and demand conditions (luring the 197:3-74 crisis enabled OAPEC countries to increase the price of oil significantly, if an oil production limitation occurred in the early 1. 980's current political factors and world oil market conditions make it less likely that world oil prices would skyrocket, as they did in 197.'). Several other factors may also constrain the price of oil during another supply interruption. A marked increase in the price of oil would no doubt make many synthetic fuels, which are currently above the world price of oil, economically feasible. In the long run, this development, would clearly be disadvantageous to OAPEC; thus, it might, constrain the amount of the oil price increase. On the political side of the equation, a significant, increase in the price of oil could be more detrimental to Thiird World countries than to the United States. Although the United States could afford to pay for a dramatic increase in oil prices, many Third World countries could not. As a consequence, OAPEC may not want to absorb the political costs of a. dramatic increase in prices.
Nevertheless, this analysis does assume that non-OAPEC oil exporters would marginally increase oil prices, to take advantage of the oil production limitation instituted by OAPEC. Thus, this analysis assumes that world oil prices would remain constant, in real terms before a supply interruption in the early 1980's, as they had before the 1973-74 cutback. At the point of the supply interruption, however, oil prices would increase by 20 percent and remain at that level.5 Strategic Petrolemun, Reserve
The 1973-74 Arab oil production cutback and the increasing dependence of the American economy on imported oil led Congress, in the Energy Policy and Conservation Act of December 1975 (EPCA), to mandate the development of a strategic petroleum. reserve. In order to expedite development of the SPR, the EPCA legislation provided for an early storage reserve (ESR), wh-ich was to be at least, 150 million barrels.
EPCA also mandated that the Federal Energy Administration submit a st rateg(i c petroleum reserve plan, detailing proposals for
6Alternative oil price assumiptionis were made to test the sensitivity of the Whartoin model. Only wheii oil prices doubled did the results of the analysis change significantly. For example, a 40-pereent increase in oil prices, as opposed to the 20-percent increase used in the analysis, had only a inarginal effect on the results,


designing, constructing, -An filling the reserve. In February 1977. an SPR plan was submitted to the Congress: it became effective in April of 1977. This plan superseded the ESR plan, but retained the goal of storing 150 million barrels of oil by December 1978.
Concomitantly with the national energy plan, an amendment to SPR was submitted to the Congress on May 29, 1977. This accelerated plan called for the storage of 250 million barrels by December 1978 and of a total of 500 million barrels by December 1980. The administration has also recently requested and received approval for an additional 500 million barrels, which will bring the total crude in storage to 1 billion barrels-the maximum amount authorized in EPCA-by 1985.6 About 35 million barrels are in the ground now, according to the latest DOE data.
The SPR is clearly one of the major policy options available to mitigate the effects of an oil supply interruption on the economy. Two SPR levels are assumed in the analytic framework. In the first case, 500 million barrels are assumed to be in storage; in the second case, only 250 million barrels are assumed to be stored. Both cases, however, assume that the oil in the reserve is depleted after 1 year. Allocation Regdulations
During the 1973-74 oil production cutback, the Energency Petroleum Allocation Act of 197 (EPAA) led to the develo pinent of a system of petroleum allocation regulations, which represented a major part of the Federal Government's response to the supply interruption. In essence, the allocation system distributed petroleum products to particular sectors, with priority goin' to sectors that protected public health, safety, and welfare amnd mintrinel national defensee, mineral lprOduction, and agricultural operations.
Since the 1973-74 forein oil supply interruption, the Federal Energy Administration and, later, DOE have engaged in a careful review of the policies pursued during the 1973 oil production cutback. To that end, DOE has funded a number of studies to evaluate the existing priority classification system, znd the agency will probably issue a new set of reulat ions within the next year. A priority classification system developed by Resource Plamin Associates (RPA) of Cambrid(ge, Mass., was ut il ized( in all lour iol the cases, analyzed in this report ."
Price Controls on 01
In terms of macroeconomic policy for dealingg -wit the 1973-74
energy (sis, the"' Nixon administration utilized Phase IV price confrols, which were in effect when the criis occurred. Phase IV was introduced M inid-Jul of 1973. Except for liftingo the freeze in the agricultural sector of the economy, Phase IV reula Co s allowed most firms to pass through the increased ,osts only on. a (doll r--dolr, rather than On a percentage, I)asis. Furt ermiore, onlyv cert in cost increases alter the last quarter of 1972 were Ipermitted.
6 Since 1he supply interrul) io is assumI t t ake CC in y ei 2 1' i 2'> (,1lv 5O0 million barrels are (,stiinated 10 be in place at I ha I ime. Thefull I !),'I on barrels is n,)I i l y to the in s orace in ii the mid-1980's. ,A ot her .o1iponeli I of the sysla ndin lc I a frooze iTn Snnr l *r- Ir r ic" ois I l r, mired alloc SliollS eyoIlI (I Ctrlde tO hi, s I i a (, le produ "lloa' i( 10 e() h ". il er o 1) : ribI or of producl ion. Thi l1ea' ion also had a Snue set-aside iroi.ram and a ile. Ol Iu'1 i pr0r l
3 For more dtail on this eiassiiain al,)roaoh, see rsource llan Assw V4: s, "A ise i PrioriI y (Classifioation S vstm for Allorat i lnu Pe rollt'" ( () c a ml)er 1977).


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11 c 0 1711, i) I C_ I III-vesti'l ielll 01, 1 ehlt'ons bet futlll e 1) ri I ial
li ivjor tliat ivoilld -mil zit Mcrei-tsiI-Io- pro(llictivitv ai)(l restn 111111(). price increases. TUl'L_" 0rrlOre7 1) r 1C a1101 lv,._ s P_ an 111011"t r-v wel-e ustlal1v (!econtrolle,1 at t'he szo-ne time. AiAlwr't-- fol pl1( ln l pi it
controls ended in late 'A' pn 119714-, wlell di 1 e Economic Stabilizatioll
4- -AT
Act, expire(l.1 To y, Pj-asi(lent 1- ,),s no c1leZ-11--clit "IlithoriL to
ITIVOke I)ViCC' 8h NV"_),),e coll.!, is ill-,ler e_ 1Lst*P,.(, Wals!" tion, sm, s ille cJ on Wage an(l Pr,
Dol'ense J'ro(,juct-*o-1i '_ct 01* tiffOU0, I the Cell I I ice,
Price controls are (Illite yet tilev (.1 T.e One of tLe 111 a j o I
enc-v such as a fore*(m o'l
policy 01)[101"'S In a nation-,! eniei ()- I I
production 1'1101ta! loll an(! pl icO i 11 (* 4, e e. A illodifie(t form of price controls Vjas (1,17-clioped for t'his -inaivss. Tbe analvsIS
'Issumes tht,t tllar e col t '6 IV 0 U pei niit prices to increase enough to compensate f or *Pcr(1,_-,,S"d "OPOC, tctlol-) ce ts of 1)etroleurrn-related pro(]ucts op. a do'T,,l --fo-,--do1lar Similarl-N-1 forehrn oil import pill c e
incre, ses wov. P
11 Iso be 41o, IT to ttlrotigh the economy.
Wliat arp an(.1 (Lvant -res of t1lis particular f orm
of price colltt ols? Oile of the rna:or for utilizin0' Drice controls
-tiv to the petroleum allocation,
in the analytic fr L, 11-le v: o-k relief s direc .r(_,gvlAions. Bv(_ ause Co_Ll(1) -rcss inarld'ated (1evelopment of a system foll i-t7ttioning oil to ey sectors of tle e-oll roi-nv in order to prevent m dlicels from mal,--ing excess profits, sonle poten-tial benefits of these
11 U L I Oil F 1-1 IT lolls VNOlild cle.-i'l-, 1),, ile(-rate(l withotit a sy-stem
0 011oc- Z tll- t '77'Z
of price contrcl,- on oil. Price coritrols were ako assumed to be in effect lwc(, Use the 1 f-11) lil-ovent a tn-insfer of inconle aNva v froTn consume-s
to prodwI(_1l'S, wii-deli- is likcIA- to occ ,ir In a petre101MY, sfiortfall. In thiS instance ""Ire controls alleviate scl-1-1-10 of the disruptive effects of an "I ilicoill -Iiorf run, plice
immediate redistr"mt i o o i e. Finidly in the ,I L,
controls on 11,-av ivate of Inflation
,.Ithotiolj the emp"ir -d ev-(1,_-r_ce oil C.Iiz point- is not clear cut.
But price controls also lia-ve a, ntirn'be'L OL SIMOUS limitations. The temporary short-r,in c,.:-),ins from controls mav lead to, a hicrher rate of infiatioD vin the long ,--uin tl, Pv supp'ress the rate of inflation.
to 11117 jero
Price controls mily also lead D JIS market inefficiencies an(I
ineyllties, whicli. Avoiild not Occur it mp.I-ket- were free to operate.
roveo-ver, in order for conti-ohl-) to work efTectivelv, -nionetarv an(l fiscal policy tim,,;t, 11)e closely coc i (llilatetl. C21early thi'l-I did not, happen diunno flie 1 10, T 3-74 ,is the Federal Reserve clid not
increase t.1he mo'ne V StIpply. C controls are also very (11iffictilt to a(]ininister a,-n(l require a, large- bini-eaucracy. Am-1, finally, in impleinenting ,,.,ny 1orm of prke controls, it. is vel-y (lifflictilt. to developp ,I fair set of standar(-1s: one that can be ivtullly Capplied In slleclfic 111S.Lances as well as in a, broad ratio-e of' cziscs. Bee'ause of thest, negative factors regarding T Zl 7
11 price controls, Vie results t)reseilted in the next chapter are niiinmul-a estiniatcs of t1ic inwz,(,t oil the
econoTay of an oil supply interruption an(I price increase.
9 171-tisdiscu-:s', uon prit-econtrolsis alien directly Lom (7ongressiol"al BUJgA OV-Ice, I'll Policies inthe United Sta,,os: Historical Reviewand Somelssues "(_' IayI977).

This chapter summarizes the results obtained from the analysis of
the four oil production limitation an(d prince increase cases considered by this report. Each case is compared with a "base case" economic forecast of the 1978-85 economy.1 The first section of this chapter briefly reviews their short- and long-run effects on real output, unemployment, and inflation. The second section examines the effectiveness of the oil allocation regulations and(l the strategic petroleum reserve in mitigating those mac-roconomic effects.
Before presenting the specific res ults of the analysis, however,
several points that help to keepl) them in perspective should be noted.
All of the cases analyzed in this 1pap)er assume a yearlong oil supply interruption, in sharp contrast to the 1973-74 crisis, which lasted less than 6 months.2 These cases also assume a 20-percent increase in the real world price of oil as opposed to the 1973-74 quadrupling of oil prices. Further, the cases consi(lderpc(l assume that the composition of final demand is essentially dleterminedl through the oil allocation
regulations and that price controls on oil are in effect throughout the time period under consideration.
Effects Dutring the Iterruplit,
As expected, larger )etroletm short falls lead( to larger output losses,
greater unemployment, and more rapi(lly rising prices. As table 2 shows, the 4-year-long oil productionn limitation cases examined in this report have wide-rangin effects on real GNP. For example, in case
1, the smallest petroleum short fall, real GNP losses relative to the
base case would be 2.9 1)pe'cent. At the other extreme, the largest oil production limitation, case 4, woul(l result in a 9.8-percent decrease in real GNP. The impact of the oil limitation on unemployment closely parallels that of real GNP. In case 1, the unemployment rate would increase by 1 percent over 1ihle base case ; in case 4. ii would increase by 3.2 percent.
The impact of the supply interruptions on prices in the short run is similar to their impact on real GN and unemployment. For instance,
in case 1, the inflation rate woull increase 1 .:3 pIercent over the base case; in case 4, it would increase by 4.: percent. These price increases would also affect GNP. higher )prices reduce both real income and the real wealth of households, thereby causing' households to reduce
purchases of goods an(l services, which slows real economic growth.'
A base case projection is useful for 1neasuring I lhe relative output loads associated with specific supply interruptions. The forecast used in this analysis assumes a growth rate of about 3.6 percent and an inflation rate of slightly more than 6 percent between 1978 and 1985. The unemployment rate is projected to decline to just over 5 percent by 1982 and 4.6 percent by 1985.
2 In the 1973-74 oil crisis, about 15 percent of the U.S. pctroleuim supply was cut off, resulting in a 3-percent reduction in output. See chapter I of this paper for more details.
3 Uncertainty as to how conservation mineasures, fuel switching, thi drawdown of the SPR, and the level and drawdown of oil pipeline inventories would mitigate the eect of the production limitation makes it extremely difficult to estimate the precise impact of a briefer supply interruption; hence, the results of the analysis are presented in annual terms. Nevertheless, for an oil production limitation of less than a year, the impact on real output (as well as prices and unemployment) is assumed to be linearly related to the annual results. For example, case 1 would result in a 822.5 billion loss to the economy in a 6-month supply interruption, as compared with a 845 billion loss during a yearlong cutback.
4 The price controls applied in this analysis permit price increases sufficient to compensate for increased costs of production, which would lead to severe, bottlenecks and inefficiencies in the costs of producing all goods and services in the economy. These inefftciecies would obviously be greater at higher levels of oil shortfall, which, in turn, would lead to mor~ rapid increases in prices. A fuller discussion of the interaction between prices and GNP can be found in a number of ('BO publications. See for example. "President Carter's Energy Proposal" (1977), chapter II, and "Recovery How Fast and How Far" (1975), chapter 5.


[In percent]

Change in Change in rate
Resulting real GNP3 unem- in 1982 Change in
Level of oil reduction and of strategic petroleum (billions Change ployment with oil inflation petroleum reserve shortfall2 of dollars) in GNP rate limitation rate

Case 1, 3,000,000 bbl/d oil reduction,
500, 000 bbl SPR- ------------------ 8 -45 -2.9 +1.0 6.1 1.3
Case 2, 3,000,000 bbl/d oil reduction,
250,000 bbl SPR ------------------ 11 -G5 -4.1 +1.4 6.5 -- 1.8
Case 3, 4,000,000 bbl/d oil reduction,
500,000 bbl SPR- ----------------- 13 -112 -7.1 +2.3 7.4 +3.0
Case 4, 4,000,000 bbl/d oil reduction,
250, 000 bbl SPR ------------------- 1 -155 -9.8 3.2 8.3 +4.3

I As compared with the baseline economic forecast.
2 Represents the amount of petroleum lost to the economy during the interruption, after accounting for SPR.
3 GNP is in 1972 dollars.

Effects After the Interruption
In the 3-year period following the oil production limitation, the economy would rebound substantially, with real output increasing,
unemployment declining, and price increa",,ses subsiding. But all of these key macroeconomic indicators are still at variance with the bilse case
forecast for 1985: Real GNP would be below the forecast, level and the unemployment and inflation rates would be higher.
More specifically, as Table 3 illustrates, real output by 1985 would
remain .72 to .82 percent below the base case forecast. Similarly, the
unemployment rate in 198 would continue to remain above the 1x-se
case forecast (by .5 to 1 percent) in all four of the cases examined.
Price increases in each case would also remain above the baseline forecast in 1985, but the smallest oil production limitation would have
a slightly lower rate of inflation. The slightly lower rates of inflation for the larger supply interruptions is the result of their higher rates of unemployment, which ten( to suppress ")rice "creases.

[In percent]

Change in Change in rate
Resulting real GNP3 unem- in 1985 Change in
Level of oil reduction and of strategic petroleum (billions Change ployment with oil inflation petroleum reserve shortfall 2 of dollars) in GNP rate limitation rate

Case 1, 3,000,000 bbl/d oil reduction,
500,000 bbl SPR- ------------------ 8 -12.6 -0.72 +0. 5 5.1 +0.68
Case 2, 3,000,000 bbl!d oil reduction,
250,000 bb SPR-- ......11 -12.8 -.73 +.G 5.2 +. 55
Case 3, 4,000,000 bbli/d oil reduction,
500,000 bbl SPR ------------------ 13 -13.7 -.78 +.8 5.4 -1-. 32
Case 4, 4,000,000 bbl/d oil reduction,
250,000 bbl SPR ------------------ 16 -14.2 -.82 +1.0 5.6 +.13

1 As compared with the baseline economic forecast.
2 Represents the amount of petroleum lost to the econojoy during the interruption, after accounting foi SPR.
3 GNP is in 1972 dollars.


Significant losses in real output could be averted through the strategic petroleum reserve. Table 4 vividly illustrates the benefits of the SPR.
Comparison of a 250- and 500-million-barrel SPR in a 3-mmbd production cutback indicates that the additional 250 million barrels in the ground would save $20 billion in real output ($65 minus $45 billion). In this case, there is a net 1.2-percent savings in real GNP from the base case. Thus, on the margin, $80 in output loss is averted per SPR barrel in the ground during a 3-mmbd supply interruption with a 500-million SPR.5
In the 4-mmbd oil supply interruption, the total output loss averted by an additional 250-million barrel SPR is even more striking. As Table 4 indicates, about $43 billion in real output loss-more than twice the SPR savings in the 3-mmbd supply interruption-would be averted, representing a net 2.7-percent savings in real GNP relative to the base case forecast. A 500-million barrel SPR with a 4-mmbd oil production cutback would save $172 per barrel in real GNP, as compared with $80 in the 3-mmbd case. In short, although the SPR is effective in preventing output losses under the conditions assumed for this analysis in both supply interruption cases, it is clearly more effective in averting output at higher levels of oil shortfall.
3,000,000 bbl per day 4,000,000 bbl per day
Change in real Changein real
GNP 2(in bil- Percent change GNP 2 (in bil- Percent change Level of SPR lions of dollars) in GNP lions of dollars) in GNP
250,000,000 barrels ..... ....------------------------------- -65 -4. 1 -155 -9.8
500,000,000 barrels .... ... ..-------------------------------. -45 -2.9 -112 -7.1
t As compared with the baseline economic forecast.
2 GNP in 1972 dollars.

Another perspective on the impact of the SPR can be gained from Table 5, which shows the (effect of the reserve on the unemployment rate. In tho 3-ninhd Sipply interruption, the additional 250 million barrels of the reserve would re(lduce the unemployment rate from 6.5 to 6.1 percent. By taking about four-tenths of 1 percent off the unemployment rate in 1982, about 430,000 workers could be kept from unemployment.
in the 4-minbd case, the 500-millon SPR would reduce the unemployment rate by 0.9 percent (3.2 minus 2.3 percent), which is slightly wore than twice the 3-mnmbd case. This implies that an SPR of 500 million barrels would keep approximately 960,000 workers empiloved. It should be noted, however, that even with a reserve of 500 million barrels, an annual unemployment rate of 8.3 percent in 1982 would be very high for the postwar era.
5 The marginal benefit per barrel is determined by dividing the additional benefit of $20 billion in the 3mnibd case by the additional 250 million barrels asociated with a 500-million-barrel reserve. The same procedure was carried out in the 4-nmnbd case ($43 Idillion, or $155 minus $112 billion, divided by 250 million barrels).


These results indicate that Ilie strategic petroleum reserve is an effective policy option for mitigating the output losses that are likely to occur during an oil production cutback. Several key points concerning its effectiveness can be summarized(l. First, the reserve appears to be more useful in reducing output losses at higher levels of oil shortfall. Second, the marginal benefit-in terms of output loss averted-of increasing the reserve from 250 to 500 million barrels in both the 3- and 4-mmbd supply interruption is significant.
[In percent
3,000,000 bbl per day 4,000,000 bb! per day
Change Change
in unemploy- Unemployment in unemploy- Unemployment Level of SPR ment rate rate in 1982 meant rate I rate in 1982
250,000,000 barrels........ --------------------. +1.4 6.5 +3.2 8.3
500,000,000 barrels .......-------- +1.0 6.1 +2.3 7.4
1 As compared with the baseline economic forecast of 5.1 percent unemployment.

Despite those benefits, it is important to note that final assessment of the effectiveness of this policy option must be balanced against both its cost (the 500-million SPR will cost around $8 billion) and the probability of the occurrence of another oil production limitation and price increase. The actual value of the strategic petroleum reserve to the Federal Government can be estimated only by doing a form of
risk analysis. Mforeovem, the prombability of another oil production limitation cannot be determined.
Efectiven ess of Petroleum Allocation Regulations
Several observations about the petroleum allocation regulations can be made as a result of the analysis of the impact of the various oil production limitation and price increase cases on key sectors of the economy. Of prime importance from a policy perspective is the finding that the higher priority sectors generally lose proportionately less output than the lower priority sectors. The relative advantage of the high priority sectors, however, depends on the magnitude of the oil limitation facing the economy. In ad(lition, certain sectors of the economy, such as finance, insurance, and real estate, sustain the smallest output loss on a percentage basis because these sectors consume very little p)etroleum; hence, they are relatively insensitive to supply reduction
In the smallest petroleulin shortfall, relatively minor changes in output take place in the sectors that constitute the higher priority industries, as compared'( with those constituting the lower priority industries (see Table 6). For example, communications, utilities, agriculture, and mining experience small ottlut re(duct.ions, while durables, nondurables, and the wholesale aml retail trade undergo significantly larger output losses. This result holds for all of the cases, at both high and low levels of oil shortfall, because durabless, nondurables, and the
6 Several point s should he noted in interpret ing t he data in this; section. First, the relative sector effects are essentially determined by the criteria selected(l by R PA for the allocation regulations, which are consistent with EPAA of 1973. Second, the impact of alter native petroleumai allocation regulation plans on total GNP and on the distribulion of (AN I' has not tben reviewed.


wholesale/re tail sectors continue to absorb the largest output losses while vital sectors undergo proportionately less output loss.
The data also indicate that at higher levels of oil shortfall-around 15 percent-significant changes in both output loss and rates of decline occur in most sectors. This finding indicates that at some intermediate level of supply interruption, further oil reductions cannot be absorbed as efficiently as smaller reductions. This, of course, varies by sector.
Thus through the allocation regulations, sectors of the economN;
defined by Congress in the Emergency Petroleum Allocation Act of 1973 as vital to the national interest generally (10 not suffer outp~t losses as large as those in other sectors. More specifically, such vital sectors as agriculture, mining, utilities, and communications suffer proportionately less out put loss than durable and nondurable roods, contract construction, and wholesale and retail sales. Allocation re~2'ulations of this kind thus help make the composition of final demand during a foreign oil supply interruption compatible with the national interest, as defined by the Congress.
Rank Sector Output loss I
1 Financial, insurance, real esae--------------------1.17
2 Utilities---------------------------------------------------------------------- 1,45
3 Communications--------------------------------------------------------------- 1.72
4 Mining------------------------------------------------------------------------ 2.24
5 Agriculture ------------------------------------------------------------------- 2. 55
6 Services---------------------------------2.59
7 Construction ------------------------------------------------------------------ 2.91
8 Tasotto------------------------------3.1'6
9 Wholesale retaiI --------------------------------------------------------------- 3.92
10 Nondurables------------------------------------------------------------------ 4.30
11 Durables---------------------------------6.34
IAs compared with the baseline economic forecast

In sum, although this analyIsis indicates that another oil limitation and price increase would significantly affect the American economy, both the strategic petroleum reserve, which would reduce output losses, and a system of petroleum allocation regulations, which would help iisure the production of vital national goods and services, would help minimize the resulting out put loss and inflation.


Description of the Wharton Annual Energy Model

Input-output analysis offers one of the most effective techniques for studying the relation between the size of a petroleum shortfall and aggregate economic activity because it allows the direct as well as the indirect effects of the shortfall on output to be captured.
Applying conventional input-output analysis alone to the study of a supply interruption does, however, have some disadvantages. First, conventional inputoutput analysis assumes fixed technologies and prices; no substitution among inputs is allowed. Second, although it permits the determination of industrial deliveries to final demand, it does not determine the distribution of these deliveries by GNP component-that is, consumption, investment, public expenditures, and net exports. Third, it does not recognize inherent output restrictions, which exist in such industries as oil and gas.
These problems can be resolved by combining conventional input-output analysis with a framework which permits input substitution, distributes industrial deliveries to final demand across the GNP components, and restrains oil and gas output. The Wharton Annual Model (Energy Version), which combines inputoutput analysis with a miacroecono-iietric model, eliminates many of the shortcomings of conventional input-output analysis.
In studying the impact of petroleum import shortfalls, the Wharton Annual Energy \,odel is "solved backwards." Restrictions on industrial output, as determined by the Resource Planning Associates (RPA) allocation regulations, restrain the gross output of the model's 63 industrial sectors. The input-output table is then used to determine the feasible set of deliveries to final demand.' By comparing the "feasible" set of deliveries to final demands with the set required by the existing final demand composition, necessary allocation adjustments to final demand are determined. The purpose of those adjustments is to eliminate excess demand for the output of each industrial sector. This procedure is repeated until the final demands are consistent with the constrained output.
The presence of excess demand in the system is an obvious source of inflation during an oil production cutback. The model is structured to allow these inflationary surges to either be passed through to the general price level and wages or, alternatively, to be suppressed. The latter option posits the existence of price restraints to prevent primary prices from adjusting because of excess demand.

Consider an input-output model of a fictitious three-industry economy consisting of agr-iculture, steel, and oil (see Table A-i). Each column provides a list of the inputs needed for the production of an industrial good. For example, for each $100 of oil output, $25 of input is required from the steel industry, and $65 in labor and capital inputs. Each row gives the distribution of an industry's output. Again, for the oil industry, $35 are delivered to the agricultural industry, $50 to steel, $10 to oil, and $15 to final demand. For each industry, the row/column sum equals the total gross value of output for that sector.

[In dollars]

Industrial deliveries to
Agriculture Steel Oil final demand Gross output

Agriculture--------------------------- 50 0 0 100 150
Steel -------------------------------- 25 100 25 50 200
Oil---------------------------------- 25 50 10 15 100
Value added-------------------------- 50 50 65 165 ------Gross output--------------------- 150 200 100---------------- 450

Note: GNP==Z' value added=Z industrial deliveries to final demand=165. I The appropriate starting point is the final demand distribution that would exist in the absence of a Pro duct ion cutback.


Intermediate inputs Final demand
ConsumpAgriculture Steel oil tion Net exports Other Gross output
Agriculture-------------- 50 0 0 80 10 10 150
Steel------------------- 25 100 25 0 50 0 200,
Oil-------------------- 25 50 10 10 5 0 100
Value added------------- 50 50 65---------- -6 ------i------G NP components----------------------------------------- 90 65----10Gross output------------- 150 200 100 ------------------ 450
Note: GNP=Z; value added=2Z GNP components=165. Now, consider the same example, except the single final demand category is broken down into three categories: consumption, net exports, other final demands (see Table A-2). Both the summation of the value added and the summation of the GNP components yield GNP.
If the intermediate sector column recipes are divided by the gross output of the sector, the proportions for $1 of gross output are obtained (see Table A-3). Similarly, if each component of final demand is divided by its column total, the industrial distribution of $1 of each category of final expenditure is obtained.
Agriculture Steel Oil Consumption Net exports Other
Agriculture-------------- 0.33 0 0 0.89 0.15 1.00
Steel------------------- .17 .50 .25---- -------------Oil--------------------- .17 .25 .10 .11 .08 ------Value added---------------.33 .25 .65
GNP copnns---------------------1.00 1.00 1.00
Gross output------------- 1.00 1.00 1.00 -------------------Finally, the basic form shown in Table A-3 can be redefined. Figure A-1 shows the basic structural elements of the single table. In solving the Wharton annual model, a vector of GNP components is first determined (the G vector). The H matrix (or bridge matrix) translates the final demands by GNP component into final demands by the industrial sector (the F vector). The technology matrix (or A matrix) then translates the F vector into gross output by industry (the X vector). Value added is determined by fractioning the gross output into intermediate and primary inputs.

Figure A-i.Basic Input-Output Structure
Deliveries to Consumption Net
Agric. Steel Oil Final Demand Other Exports


Steel A F H


Added V




Figure A-2.

Direction of Solution of Input-Output Relatiohships




Figure A-2 shows the direction of solving the input-output relation-translating final demands into industry output requirements. The difficulty with solving the model using this standard procedure to study the impact of an oil production cutback is that restrictions will be applied to industrial outputs. This means that rather than using the composition of final demand to determine the composition of industrial output, to some degree, industrial outputs are predetermined by the RPA petroleum allocation regulations. Defining XE to be the vector of constrained gross outputs induced by the oil production cutback, Figure A-2 must then be solved "backwards." Thus, a new set of final demands must be derived, given XE.2 Although the industrial deliveries to final demand can be determined in a rather straightforward manner, given the technology, a difficulty in implementing this step arises because no unique relation exists between the industrial deliveries vector, F, and the vector of GNP components, G.
There are several ways to circumvent the indeterminacy problem of directly translating the industrial deliveries vector into the final demand components. One way, used in several earlier studies of oil production cutbacks, is to reduce final demand through some ad hoe procedure until the output constraints are satisfied. An alternative methodology, however, was developed for this study. The basis for the methodology can be summarized by examining Figure A-3, which shows the direction of price conversion in the model. Pi-ices are built up from both unit labor and capital costs, which in turn determine gross output prices. The gross output prices are then used to determine the implicit final demand deflators. The direction of price conversion in the model parallels the direction of the oil production cutback solution-from the output side, back to final demand.

I XE Is derived by utilizing the RPA allocation scheme


Figure A-3.

Direction of Solution of Price Relationships

h P:
A e' K0s c
a e

Primary Prices

ImlctFinal Demand
__________ __________Del lators
Unit Labor Costs
and Unit Capital Costs Before describing how new excess demand is translated into price adjustments, it is Useful to discuss first how the constraints on industrial output affect the level and composition of final demand. The adjustment of final demand can be broken down into an income effect and a price effect.
The income-price effects are summarized in Figure A-4. If we are dealing with just two goods, A and B, let U0U0 represent the pre-oil production cutback indifference curve. Line Y.Y0 is the pre-oil production cutback budget line; the slope of the budget line is determined by the relative prices for A and B. Now assume that income is reduced in the oil production cutback to YEYE. A reduced level of consumption of goods, A and B results.3 The relative prices of A and B can then be adjusted to eliminate excess demand for industrial deliveries to final demand. Figure A.
Income and Price Effects

Before Oil Production Cutback After Oil Production Cutback
Good A Good A

CA cA0

c1 U


y0 cB co
Good B Good B
3 This assumes that neither good is Inferior.


Price adjustment due to excess demand can be treated in two ways. The methodology can best be explained by writing out the basic relationship for determining gross output prices:
Gross output price sector j equals value added deflator sector j plus material input prices.
P WPp I .i-- PVA ;+ .aij* PWPIi

This relation states that the weighted sum of the primary input price for an industrial sector plus the material input prices yields the gross output price for a sector. This relation is modified in the production cutback period to account for excess demand for the sector's output. The revised specification reads:

PWPI4=i *PVA;+7 2aij*P[VPIi+j
Where the additional term, Aj, is determined by the relation:

"--k Fi F]

That is, ccj represents the adjustment to prices due to the reduction in deliveries to final demand. The term, ej, is an elasticity-the fraction of the percentage shortfall in deliveries that is passed into gross output prices. By assumption, the ej was set to 0.5.
Alternatively, the Aj term can be suppressed. The argument is that price controls permit price increases only sufficient to compensate for increased costs of production. But a mechanism is required to adjust the allocation of final demand. The methodological approach is to bypass the model's normal price channels and transmit the allocational information to final demands by way of "shadow prices"; that is, although the aggregate price level is not affected, relative prices are. The final demands are adjusted by the relation:

FD*=FD,*(P embargo )

where FDj*, is the final demand for category j after adjustment for changes in relative prices due to the production cutback. This ccj term is an elasticity paraneter. These terms are assumed for each component of final demand.
This discussion has greatly simplified the price-income effects, but the main thrust of the argument is that the proposed methodology systematically solves for a feasible final demand set. The RPA allocation plan determines XE, the constrained set of gross outputs. Given XE, a vector of industrial deliveries to final demand, FE, can be determined. Using an initial estimate for final demand, G, a corresponding required deliveries vector, F, can be obtained. By comparing the two vectors-FE and F-on a sector-by-sector basis, an excess demand vector is derived. This is used to revise the gross output prices for each industrial sector. In turn, the revised gross output prices adjust final demand prices. For each final demand category, then, a revised estimate is obtained by comparing the constrained and unconstrained final demand prices. This methodology permits either the pass-through of excess demand inflationary shocks or the suppression of those shocks by some form of price controls.

Development of Assumptions Regarding Oil Import
Reduction Levels

The four scenarios analyzed in this report assume yearlong oil import reductions of 3 or 4 million barrels a day, with the OAPEC nations again instituting a production cutback. These oil import reduction levels were developed by assessing forecasts of future U.S. oil imports, the GAPEC share of U.S. oil imports, and the international reserve position of the key OAPEC countries. These factors, each one of which is discussed below, were then combined to develop plausible assumptions concerning the level of a future oil import cutback.

In developing the assumptions regarding future oil import levels, six recent studies of U.S. energy supply and dlemand, employing a wide range of methodologies and assumptions, were reviewed.'
Despite differences in method of analysis, all conclude that U.S. oil imports in the early 1980's will range between 9 and 11 million barrels a day. Hence, while each of the studies is subject to a great deal of uncertainty, together, they provide a reasonable range of future oil imports, which effectively bounds the import range for the United States in the carly 1980's.

As Table B-i illustrates, GAPEC's share of total U.S. oil imports has increased substantially since the 1973-74 oil production cutback.
[In thousands of barrels a day]

imports as a
percent of
Total U.S. QAPEC total
Year oil imports imports i mports

1973------------------------------------------------------- 6,256 1,377 22
197----------------------------------6,112 1,106 18
197-------------------------------- 6,056 1,790:0
1976 ------------------------------------------------------- 7,313 2,773 38
197----------------------------------8,696 3,693 42

Source: U.S. Department of Energy, Monthly Energy Review (July 1978).

GAPEC imports decreased from 1973 to 1974, primarily because of the oil production cutback, but its share of total U.S. oil imports has grown since 1974. In 1977, GAPEC totaled 42 percent of all U.S. oil imports. Within GAPEC, the major suppliers of oil impots to the United States are Saudi Arabia (42 percent), Libya (23 percent), Algeria (16 percent), and the United Aral) Emirates (12 percent). Kuwait, Iraq, Qatar, and several other smaller countries combine for about 7 percent of all OAPEC imports to the United States.

I These studies included: U.S. Department of Energy, "Projections of Energy Supply and Demand and Their Impacts" (1978); Petroleum industry Research Foundation, "Outlook for World Oil Into The 21st Century" (1978); Congressional Research Service, "Project Interdependence: U.S. and WVorld Energy Outlook Through 1990" (1977); Organization for Economic Cooperation and Development, "World Energy Outlook-" (1977). Central Intelligence Agency, ".Major Developed Countries: Changing Trade Flows and Increasing Vulnerability in 1982" (1977); and Irving Trust Co., "International Oil Revisited: Could The Experts Be Wrong?" (1977).
1 29)


This analysis assumes that the GAPEC share of total U.S. oil imports in 1982 would range between 35 and 43 percent. That range both captures our most recent historical experience and takes into account a variety of likely future developments affecting GAPEC's future share of U.S. oil imports.

A yearlong oil production cutback could clearly have an adverse financial impact on a number of GAPE C nations, which could conceivably limit the participation of particular countries. To assess the ability of the major GAPEC countries to sustain a yearlong production cutback, their international reserves and the ratio of reserves to imports were reviewed on a country-by-country basis.
The financial condition of all OAPEC countries appears to have improved since 1973 (see Table B-2). Further, these reserve estimates reflect only public holdings and do not include the private reserves of individual Arab monarchs or families.2 Nevertheless, assessment of this increase in reserves should be balanced by the fact that, since 1973, almost all of these countries have begun large-scale development projects, which require substantial capital.
TABLE 8-2.-FINANCIAL CONDITION OF QAPEC COUNTRIES, 1973 AND 1977 [In millions of U.S. dollars]

Ratio of reserves to
Financial reserves Imports imports
Country 1973 1977, 1973 1977 1973 1977

Saudi Arabia ---------------------- 3,877 27,784 1,840 2,935 2.11 9.46
United Arab Eiae---------92 1,798 744 989 .12 1.82
Libya --------------------------- 2,127 3,087 1,838 1,061 1.16 2.91
Alera---------------1,143 2,193 2,129 1,148 .54 1.91
Kuwait ---------------------------- 501 1: 831 910 953 .55 2.01
Iraq ---------------------------- 1,553 5,070 817 490 1.90 10.35
Qatar ----------------------------- 76 2 137 176 2251 .43 254

l ist quarter of 1977i,
2 4th quarter of 1976.
Source: International Monetary Fund, International Financial Statistics (April 1978).

Table B-2 suggests that (luring a lengthy production cutback some GAPEC countries (such as Qatar, Libya, or Algeria, which together currently account for 40 per-cent of OAPEC oil imports to the United States) might have some financial difficulties. Thus, in view of the likelihood that these countries and some smaller GAPEC countries might have to limit their participation in the production cutback because of their need for foreign exchange, the analytical framework developed in this paper reduced the magnitude of the Arab oil production cutback.
As the preceding analysis has indicated, a range of factors could affect the size of the Arab oil production cutback. This section considers those factors and concludes that two conservative yet plausible import reduction levels are 3 and 4 million barrels a day.
Three-million-barrel-a-day-case.-A 3-mmbd oil production cutback, which represents a "best case" for this analysis-that is, the lowest level of U.S. oil imports-can be developed in a number of ways. Table B-3 illustrates two of the ways in which the 3-m-tmbd estimate can be derived.

Level of U.S. imports OAPEC share of U.S. imports QAPEC financial limitation Total QAPEC cutback
(million barrels per day) (in percent) (in percent) (million barrels per day)

9 35 5 3
9 40 15 3

2 In addition, it is likely that almost all of t lie Arab States involved in the production cutback could expect to obtain needed capital by borrowing fromi either international banking institutions or from richer OAPEC countries, such as Saudi Arabia.


The 9-mmbd level of U.S. imports was used in both of these cases. The OAPEC share of U.S. oil imports was, however, varied: in one case, GAPEC is assumed to contribute 35 percent; in the other case, 40 percent. Thus, for example, multiplying the 9 mmbd by the 35 percent GAPEC import factor yields imports of 3.15 mmbd. But the analysis also assumes that a combination of smaller OAPEC countries, headed by Qatar, would be forced to limit its participation by 5 percent) which would reduce the oil production cutback to about 3 mmbd. Similarly, for the other 3-mmbd case, one of the large GAPEC countries, such as Algeria or Libya, is assumed to limit its participation, causing a further (15 percent) reduction in the production cutback.'
Although a number of alternative assumptions can be made with respect to the key factors affecting the magnitude of the oil production cutback, the 3-mmbd figure, which can be derived in a number of ways, is a reasonable "best case" estimate.
Four-million-barrel-a-day case.-The 4-mmbd case, which represents a "worst case "-the highest level of U.S. oil imports-was developed in the same fashion as the 3-mmbd case (see Table B-4).


Level of U.S. imports QAPEC share of U.S. imports QAPEC financial limitation Total QAPEC cutback (million barrels per day) (in percent) (in percent) (million barrels per day)

11 38 5 4
11 43 15 4

The major difference in this case is that both a higher level of U.S. oil imports (11 mmbd) and a higher range of the GAPEC share of U.S. imports (38-43 percent) are assumed. However, the same factors used to capture the reduction in particular OAPEC countries participating in the cutback because of financial strain were used again. Obviously, all of these factors could be combined in a variety of ways and the same result could be achieved. The intent of the analysis, however, is to provide a reasonable "worst case" oil import reduction level in order to effectively bound the magnitude of the oil supply reductions.
3For all of these cases, the United States is assumed a priori to meet its commitment to the International Energy Agency.

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