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4/11/86 114

A SIX-POINT STRATEGY FOR ENJOYING LOW

O IL PRICES WHILE ENHANCING U.S. ENERGY SECURITY

Most Americans probably only dimly recall what life was like

before OPEC's extortionist oil prices. Now at last, the U.S. is

e xperiencing relief as the OPEC oil cartel crumbles. Consumers are

enjoying the plunging prices at the gas pump and business is welcoming

a reduction in one of its basic costs. So dramatic and pervasive are

the benefits of the oil price fall that forecasters are raising their

e stimates of economic growth for 1986 by as much as 1.5 percentage

points.

Regrettably, of course, every silver lining has a cloud. Low oil

p rices help the national economy in the aggregate, but-inflict severe

pain on U.S. oil producing regions. Experts caution that a

c ontinuation of current prices, now about $14 per barrel, for an

extended period could threaten the nation's energy industry and energy

s ecurity. Exploration for new U.S. oil supplies has ground to a

halt. In addition, imports from Saudi Arabia have climbed from 27,000

b arrels per day in September 1985 to 664,000 barrels in January 1986.

Aggressive Saudi Arabian price cutting could wipe out permanently a

s ignificant proportion of domestic U.S. oil production capability if

low Saudi prices force American drillers to abandon their so-called

" stripper" wells (those producing less than 10 barrels per day) and

other high-cost wells. This could leave the U.S. increasingly

d ependent on OPEC. But while U.S. domestic sources of oil must be

preserved, many proposed "solutions" would undermine the benefits from

l ow oil prices, and do little to help the U.S. domestic energy

industry.

Calls for an oil import tax are one example of grievously flawed

p olicy. A tax would shatter Ronald Reagan's pledge not to raise taxes

and would send a shock wave through the economy, slowing growth. And

w ith the production costs lower than those in the U.S., OPEC producers

could absorb an import fee and still undersell U.S. producers.

Yet actions could be taken to enhance U.S. energy security by

r emoving federal barriers preventing the U.S. energy industry from

responding to the new era of lower and fluctuating world prices.

A mong them:

1) Waive regulations that lead to early abandonment of marginal

w ells. State and federal regulations now require a producer who

ceases production for more than 60 days to relinquish his lease to the

w ell and "reclaim" the well. This forces the owner to plug the well

with concrete, often making it very uneconomic to restart the well,

s ince a now hole must be drilled, should oil prices start to climb.

Texas and Oklahoma already have modified some of their rules. Other

s tates and the federal government should follow suit. This would

allow marginal producers to halt production only as long as the price

o f oil remains below their production costs, without having to abandon

their wells. This would give the U.S. a reserve of wells that could

b e reactivated if world conditions change.

2) Abolish the Windfall Profits Tax on oil. At current prices,

at any rate, the U.S. Treasury will collect no revenue from this tax.

E ven so, producers bear an enormous cost for the paperwork required by

the tax law--as much as $1 per barrel for a small producer.

3) Restore the depletion allowance to its pre-1969 level. It is

a mong the most important capital formation tools the oil industry ever

had and would spur new drilling.

4) Eliminate the minimum tax on so-called intangible drilling

c osts. This would provide more incentives for domestic exploration.

5) Decontrol natural gas prices. This would improve the revenue

available to producers from oil well by-products, giving an additional

e ncouragement to drill for oil.

6) Lift the restriction on purchases of domestic oil for the

Strategic Petroleum Reserve. Allowing domestic producers to bid on SPR

p urchases would help to enhance their cash flow.

Collapsing world oil prices do carry the risk that the U.S. could

again become vulnerable to the OPEC cartel. These dangers cannot be

a verted by oil import taxes or jawboning the sheiks to raise their

prices. To confront the danger effectively, the White House and

C ongress should take steps to encourage exploration and forestall the

premature abandonment of marginal wells. So doing would allow the

A merican consumer to enjoy the benefits of low energy prices without

flirting with either renewed dependency on the Middle East or sending

t he economies of oil producing states into a permanent tailspin.

Milton R. Copulos

Senior Policy Analyst

For further information:

Monetary Perwective (Drexel Burnham Lambert, Inc.), February 24, 1986.

"Repeal of Windfall Profits Tax on Oil Urged by Baker," The Wall Street Journal, April 7, 1986.

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