578 A pril 29, 1987 AMERICA'S LOOMING ENERGY CRISIS THE CAUSES INTRODUCTION As world ener prices have fallen, the United States has been increasing its imports of foreign oil and re Y ucing its efforts to discover new domestic supplies. This could be bad oll pr o duction fel P from nearly 9.2 million barrels per day (mbd) to just under 8.3 mbd, a resulting from the world price co lapse reaches 1.1 mbd 27,000 b/d in September 1985, to 664,000 1 /d in January 1986, a 24-fold increase. l!y news for Americans. Accordi n g to the report of the Reagan Administration's high-level task force on energy and national security re1eased)ast month, America is once again falling into a perilous dependence on imported oil. Overall U.S. oil imports rose from 5,067,000 barrels per day (b/d) in 1985 to 6,061,000 b/d in 1986, an increase of 994,000 b(d, or nearly 20 ercent. And between February 1986 and Februaxy 1987, U.S. domestic decline of nearly 10 percent. Moreover, when natural gas hquids (used as a component of most refiied petrol e um products are taken into account, the loss of U.S. oil production The threat to U.S. energy security arises not just from the volume of imports, but from the source. During the last year, oil imports from Organization of Petroleum Exporting Countries (O PEC) members, and particularly from Saudi Arabia, have skyrocketed.

Meanwhile imports from more secure sources outside OPEC's sphere, such as Canada and Britain, have plunged. In fact, U.S. oil im orts from Saudi Arabia rose from a low oint of Janu7! the U . rose by 51.2 percent in 1986, while non-OPEC oil exports to the U.S. declined by an almost identical percentage 1987, Saudi exports to the U.S. stood at 873,000 b/d. Overall, OPEC exports to This is the fvst in a series of studies analyzing national sec urity aspects of United States energy supplies. Future papers will identi

regulatory obstacles to energy development, ways to increase oil' and gas output, and development of nonpetroleum energy sources 1. EnerevSecu ritv: A Rewrt to the President of the United States. DOE/S-0057 (Washington, D.C.: U.S.

Department of Energy, March 1987).

Crippling U.S. Ability. What is precipitated this trend is that it is reserve base If steps are not America's dan erous de exploration. evidence that t fi is could s indicator of the leve lp of oil exploration takin place in the U.S. The average count has The number of o erating rotary drilling rigs is generally accepted as the most reliable fallen alarmingl from 3,970, at its 1981 pe to just 964 rigs in 1986, a leve l that is 17 percent below ti at of 1973, the year of the OPEC embargo. Indeed, the reduction in operating rigs that occurred in reaction to the world oil price collapse was so peat that by June 1986, when the rig count hit its low point of 686, it was bel o w any time since World War II. And even thou h it did recover to a small degree--largely thanks to investors trying to beat the intro f uction of the new tax code--it still remains at pre-embargo levels Economic and Political Threats. Since it is necessar y to continually re lace oil that is used with new discoveries, the drop in domestic exploration assures that trl e decline in U.S oil production will continue. This in turn means that the level of imports required to operate the domestic economy will incr ease. Ameiica's vulnerability to economic and political threats from OPEC thus will become steadily greater U.S. oil imports during the first months of 1987 still exceeded those of 19

73. Further the sharp decline in Alaskan oil expected to begin early in 1988, coupled with the drop in domestic production resulting from the lack of drilling in the lower 48 states, virtual1 guarantees that America's import dependence will rise to more than 50 percent by 1 B 90 and could be as great as 70 percent by 19

95. Even more disturbing, two-thirds of these new imports are likely to come from unstable nations located in the Middle East, once again opening the door to the possibility of politically motivated oil interruption wreaking havoc with the U.S. economy.

The ra pid collapse of the domestic oil industry means that further delay in action ;by Washington could make it impossible to avoid a security catastrophe. Oil exploration requires a uni ue combination of equipment, skilled manpower, and entrepreneurial spirit.

However, the evastation of America's oil-producin regions is resulting in the rapid dismantling of the infrastructure of oil exploration n 1986 alone, more than 150,000 oil workers lost their jobs; hundreds of firms once engaged in exploration went out of business.

In addition: all 20 of the steel plants specializing in producing drilling pipe for oil wells closed their doors in 19

86. And countless other firms in the oil well service industry either closed or severely curtailed their operations as well f 8 Complacency Cost $2 Trillion. Yet the average American still thinks in terms of oil gluts" and chea gasoline. Moreover, industries such as transportation, steel, and individuals and businesses tend to focus on the short-term benefits of cheaper oil ri s e to a sense of complacency about oil imports. This attitude is eerily similar to t at which existed before the 1973 embargo. Since that ear, the United States paid out more petrochemicals K ave benefited enormously from lower energy costs. Understandably , both Fng than one-half trillion dollars for im orted oil, two- x irds of which went to OPEC nations.

When the full cost of all of the resu P ting inflation, unemployment, and slower growth are 2taken into account, complacency in the earl 1970s cost the U.S. as much as $2 trillion.

Similar complacency in the late 1980s coul cr be even more costly.

What is least understood about the threat implicit in oil import de endency is that the factors are in large degree a roduct of federal pohcies 4 ashington set the fit embargo and made it P ar more severe by undercutting the domestic oil and controlling prices, ensuring a needless detenoration of America's energy security in the comng decade.

America's enerw security is eroding. Unless Congress and the Administ ration wde up to the full dimensions of the looming oil crisis, and recognize that re lations and laws have shockwave far more damaging than that of 1973 THE TIGHTENING FEDERAL NOOSE Complacency continues to pervade Washington. Lawmakers ignore how rapid1 exacerbated the crisis, Americans are destined to experience a PO P itical and economic U.S. oil import problems can be traced to 1969, when Washington began erecting the regulatory obstacles and im osing punitive taxes on the domestic oil industy that le d the nation's current oil import ilemma. The most si nificant actions were the im osition of tough environmental regulations by Congress an the reduction of the oil dep etion allowance from 27.5 percent to 22 percent. These seemingly small steps signaled a pattern of policy which had severe implications during the 1970s Land Use Restrictions d P B Among the most dama g environmental re lations imposed since 1969 have been restrictions on the way fe cr era1 lands can be use cr for oil exploration. The feder a l restrictions are so severe t x at no ermanent structures or roads can be built. Even government controls activities on some 775 million acres of public land, or roughly one-third the total land area of the U.S. The activities allowed on a tract of feder a l land is determined by the catego into which is placed. If a tract is designated "wilderness the firefighting is normally prohibiteb The use of restrictive classifications such as wilderness are intended to preserve unique and sensitive ecosystems for po s terity. Increasingly in the 1970s, however, such classifications became a tool of environmental activists bent on preventin mineral Management Policy Act to lock up tens of millions of acres from mineral e loration of the Interior's Bureau of Land Managem e nt is studying for potential inclusion as Yuilderness" areas. While the review is taking place, these 'blderness study areas" are treated as though they are wilderness and closed to mineral exploration development. One favorite tactic was to take advantag e of Section 603 o B the Federal Land This section requires that Congress review all tracts of federal land that the "g epartment closed to exploration tens of millions of promising acres f or potential oil and gas Overuse of both the "wilderness" and ''wi l derness stud 'I designation during the 1970s has discoveries. Many other environmental restrictions inhibit oll exploration. Example: in Alaska, some 80 million acres were set aside in 1971 for possible classification as national parks, wildlife refuges, a nd other restricted categories by the Secretary of the Interior under the provisions of the Alaska Native Claims Settlement Act. Example: Congress has I -3restricted sharply the ability of com anies to explore the offshore areas of the U.S most promising t racts to exploration Restrictions on Capital Formation P Althou it is expected that as muc K as 60 percent of future oil and as discoveries will be made o f! shore, successive congressional moratoria on drilling have oreclosed many of the Other congressio n al actions erode the U.S. otential for energy security by undermining the ability of domestic firms to attract capital. 8 il and gas exploration is a high-risk such as manu P acturing, oil production does not result in the accumulation of a stock of explo r atory well is unsuccessful, there remains little or no asset base to s ap vage in order to re lace depleted assets. Acknowle B ging this fact, Con ess in 1918 enacted the "de letion investment. On average, only one "wildcat" well in five succeeds in disco v ering a new economic reserve. Even so-called "development wells those drilled in existin fields) are successful onl about 80 percent of the time. In addition, unlike other forms o B business capital equipment, structures, or other assets. To the contrary. The main capital of an oil producer is the oil deposit itself, which over time will be consumed or "de leted So if an recoup a portion of the investment remain. Thus, to stay in business, a roducer must continually make new discoveries to all)owance' for t he oil industry. It was intended to pe orm the same function for oi producers that depreciation did for manufacturers Capital Formation. In 1969, Congress reduced the percentage depletion permitted to oil companies. Then in 1974, a law eliminated depletio n for all but a small number of independent oil producers. So doing, lawmakers took away one of the oil industry's most important capital formation tools. Since exploratov wells or "rank wildcats" were so ris financed either through limited artnershi s amo n rivate investors or through was also reduced Even in the case of a successful well, once the oil is produced, no significant assets lf P wells could not be financed through traditional means such as bank loans, availab Y e to other industries. Instead, m o st wildcats were savings from compan income ut with t K e loss o BX t e depletion allowance, oil exploration became I ar less attractive to private investors, and internal cash flow Price controls im osed by Richard Nixon in 1971, and extended by Gerald F o rd in 1975 normal operation of the oil market. They virtually assured that shortages eventually would develop merely compounde B the problem. These controls erected an enormous barrier to the particularly damaeing because the oil indust has been character i ze B by "boom and bust times o 7 perceived shortage, for instance, when oil Boom and Bust. These tax disadvantages and price controls have roven to be cycles throughout its histo prices rose, the were discovere this oint, new investors would enter the ict u re, purchasing at a discount the leases on pro B ucing properties discovered during e "boom and proceed to develop and produce the oil reserves would inspire a flurxy of investment. As new oil sources would collapse prices or force them down sharply. At t i!

B A classic case of this was the career of "Dad Joiner, the le Texas wildcatter who in 1930 discovered the huge East Texas field. When prices after his discovery, he 4sold his leases to H.L. Hunt for just $50,000, creating the basis of the multibillion dollar Hunt fortune.

When price controls were imposed and extended, the normal pattern of investment in exploration durin times of high prices was interrupted. Thus in 1979, when forei n oil federal re lations and taxes meant that domestic producers were receivin only an forei oil suppliers, at the expense of its domestic producers. Even when controls were imposed in 1979 on domestic producers Assure Future Supplies. Through 1984, windfall profit tax collections exceeded $72 billio n . Given the oil industry's history of reinvesting profits in the search for new reserves much of this money would have expanded America's proved reserve base to assure continuin future supplies If even half the amount had been available for such investmen t would now be at least two-thirds larger, sharply reducing the threat from imports Constraints on Natural Gas suppliers were ab f e to charge Americans an average of $20.19 for a barrel of CN d e oil average o r $12.64 for their oil. The differential cons t ituted a huge windf af for America's lifte cr in 1981, the situation remained inequitable because of the Windfall Profits Tax given the nding costs for oil that prevailed in the 197Os, the domestic proved reserve base Washington-inspired roadblocks also h a ve retarded development of gas reserves as an alternative energy source. Until quite recent1 most natural gas was discovered accidentally" b companies looking for oil us any reduction in oil exploration also discovered, a host of federal rules, ranging fr o m the price controls first imposed in 1954 to use restrictions imposed under the Carter Administration, often keeps the gas from coming to the market reduces natur d gas discoveries. To make matters worse, even when a gas reserve is Limitations on the dev e lopment and use of domestic natural gas supplies are particularly dama 'ng to the nation's energy security because natural as is the one fuel large amounts domestically use significant amounts of methanol produced from natural gas in automobiles. And with only minor modifications to the fuel system, conventional automobiles can also be converted to Compressed Natural Gas. Since 97.4 ercent of all vehicles in the U.S oil consumption in this area is enormous. Yet restrictions as a result of the uel Use Act o n the ability of indusq to use natural gas as widely as would otherwise be the case and Environmental Proternon Agency limitations on the methanol content of motor fuels continue to keep natural gas from reaching its full potential The U.S. currently consu mes around 16 trillion cubic feet (Td) of natural gas annually.

The domestic reserve base of so-called conventional natural gas could easily sustain an additional 2 Tcf of annual consumption for 50 ears. If gas from so-called unconventional or more K which is complete P y interchan eable with oil in most applications, an it is available in currently are powered with petroleum based fuels tK e potential for natural as to reduce If ecent advances in motor fuel additives make it possible to b sources such as tight sands or coal seams is inc r uded, supplies could easily last two centuries The drop in domestic oil drilling could lead to a natural gas shortage within a few years.

Like oil reserves, natural gas reserves must be replaced continually as they are co nsumed 5IMPLICATIONS FOR NATIONAL DEFENSE At the end of World War I, Britain's Lord Curzon stated The Allies floated to v ctory on a sea of oil." He could as easily have qualified his statement to say "American" oi hnnmice in hnth the Grct Qnrl CnnnnA Wnr l rl Warr thn T 1 C nrndrlnrl mnrn than QCI nnrnnnt of the petroleum for the war effort. In World War II especially, oil was critical to AIlied JUClClGJJ. VUG UL L11G lllU3L IIILGLWIVG NUGU GLIVl L3 UUllllg L11G WQ1 WQ3 Q1111GU QL UCll Ulg Germany access to the strategically critical Romanian oil fields at Ploesti. In modrn conflicts, oil likely will play an even more important role I Mnct nnntnmnnraur militaur ctratnninc Fnr nnnnmsnlnar nnnR;ntc awn hncnrl nn nn AvAuub UAALWAAA~UA cuy AIUUCQIJ JU urbewi LUI uuuuucliclai ~UIUII~CD Q~G UQJGU uii ail assumption that forces will be highly maneuverable and rely heavily on airpower. Indeed 68 percent of America's military consumption of petroleum products even in peacetime oes to jet fuel. In just a limited confli c t--on the order, say, of Vietnam--military needs for direct fuel use would rise by more than 1 mbd. Increased oil use by industry to support the war effort would increase by even more than that amount. America's growng dependence on oil im orts raises an a larming specter: if a conflict were combined with an Limited War. Given current trends in drilling and the impending decline of Alaskan production U.S. domestic production by 1990 easily could fall to between 6.5 mbd and 7 mbd. By then, domestic consumpti o n, according to the Department of Energy, could be between 15.8 mbd and 11.2 mbd. Two-thirds of the required im orts likely would come oil deliveries from the Gulf could range rough1 between 5.9 mbd and 7.5 mbd. At the around 3 mbd for direct military and civilian use. In the case of full mobilization, the increased requirement could be 6 mbd embargo of foreign oi f supplies, the U.S. might be unable to field an army--literally from the Persian Gulf This means that the potential loss of supp Y y from an in t erruption of same time, the total national requirement in a r imited war could be expected to rise by itself short by Etf etween .9 rnbd and 13.5 mbd. Even with the full use of the Strategc Middle East oil has been a factor in B oreign policy was demonstr a ted dramatically by the If an oil im ort disru tion thus coincided with a military conflict, the U.S. could find Petroleum Reserve and a drastic curtailment of nonessential oil consumption, the interruption could make the mobilization and effective operat ion of U.S. armed forces nearly impossible.

I constrains the Administration's abili to exercise its foreign pohcy. The extent to which b.S. arms tomIran. In virtually every case, including those of Secretary of State George Shultz, former National Security Advisor Robert McFarlane, and former CIA Director William Casey, the witnesses testified that a major reason for initiating the arms initiative was concern over the future of the oil reserves of the Persian Gulf. Even Ronald Reagan cited oil as a concern I Policy Constraints. Even in peacetime, the evolving U.S. import dependence severely arade of Reagan Administration witnesses called by Congress to testify on the shipment of The sale of Airborne Warning and Control System (AWACS) aircraft to Saudi Arabi a in 1984, was also justified to congressional opponents in large part on the basis of protecting American oil supplies. In addition, the U.S. has made an enormous investment in establishing forward bases near the Persian Gulf, and in creating a Rapid Depl oyment 6Force capable of protectin military forces in the region. Mounting imports from Arab WINDOW OF VULNERABILITY OPEC suggests that U.S. P oreign policy will face even greater constraints in the future.

Because of the precipitous decline in oil and nat ural gas exploration that began in 1986 the U.S. cannot avoid a period of increased vulnerability to import disruptions. In 1986 the number of active American drilling ri fell to the lowest levels in four decades. And one-third that of 1981 the rate of oi l and natural gas wells comp r eted in 1987 is proceeding at a rate roughly Since there is a three to five year lead time from the point at which an onshore well is drilled and the time oil comes into production, the worst conse uences of the past 15 reduc ed and even reversed it was in 1981-4f incentives for drilling are put in place and if federal obstacles to the oil market removed months colla se of oil and gas drillmg will not emerge full unti 9 19

90. While these short-term e E ects of the lack of dril ling are unavoidable, Xe phase of deep decline can be If the worst consequences of import dependence are to be avoided, Congress and the Administration must take decisive action now to avoid the incipient ener removing the market uncertainties that govern m ent action has fostered ent of uncertainty, based on the oil industrys bitter experience of previous government action, in many ways stands as the preeminent barrier to private investors, and has been great1 exacerbated by actions on the part of the Reaga n Administration. These actions inc r ude Administration tax planners twice since 1983 have raised the specter of repealing some of the remaining oil industry tax incentives. And while the 1986 tax reform package wisely left the provisions untouched, the p o ssibility that they might be repealed had a chilling effect on investment in oil and gas development The Rea an Environmental Protection Aeency has been actively considering classifying as in ti ustrial wastes what are called drilling muds--substances use d to lubricate impose an estimated $30 illion in cleanup costs on the oil drilling in d ustry congressional actions as the special tax on oil to help pay for tg e Superfund the shafts of an oil drillin bit and to plaster the sides of the hole bein drilled. This would The Reagan Administration often has not effectively o posed such unwise W The Administration and Congress have dragged their feet on natural gas decontrol.

Indeed, the Addstrations only truly significant success in regard to oil and gas policy was to speed up the decontrol of oil prices imtiated by President Carter.

The release of the Department of Energy report of the task force on energy and national security is an encouraging sign that the Reagan White House is beginnin to take the matter of energy dependency senously. Yet it remains unclear whether the dite House is willing to pursue an aggressive policy to secure Americas energy future.

Losing Oil Reserves. To do so, it must break out of its short-term mindset. It is true that inflation moderated in part because of lower energy prices in 19

86. It is also true that 7man domestic industries benefited from those lower costs. However, it is equally tee that the S. lost at least one-half billion barrels of proved reserves as a come uence of ea rly abandonments of so-called stripper wells that became uneconomic, lost 3 ,O00 jobs in oil exploration and related industries, and that im orts rose to 38 percent of domestic oil 34.5 percent import levels of 1973 costs will far excee !r any short-term benefits now being realized CONCLUSION d 6 needs during the third uarter of 1986 (stock B rawdowns moderated the import rise in the fourth quarter) and sett 3 ed at around 36 percent by early 19

87. These levels exceed the Inevitably this will ve rise to h igher future prices. I f history is any gui BY e, these onglterm Thus the short-term gains of low prices are leadin to a long-term de enden I America once again has wandered into ener complacency. It is a com lacency that could be shattered at any moment b y a new Ara 7 embargo. Only concerte B and imrqediate America has plenty of energy at its disposal--in the form of domestic oi P resources and proposed new ones. Rather than workin for a secure energy I ture, the federal imported oil are looming B arge on the horizon. The only question is whether the Congress action by the President can avoid the worst consequences of such an im ort disruption alternatives to oil.

The development of these resources is constrained by past olicies and threatened by government still is workin against one. %he warning signs of a renewed dependency on and the Administration will recognize them in time.

Milton R. Copulos Senior Policy Analyst 8 I