295 October 6, 1983 CENTRAL AMERICA GROWING ROLE IN US. ENERGY SECURITY INTRODUCTION The tenth anniversary of the Arab oil embargo finds the public as complacent as it was in September 19

73. Yet today's sanguine public attitude overlooks a potentially greater threat to U.S energy security than that of a decade ago. While policy makers focus on oil supplies from the Middle East, they ignore the f unda- mental shift in the source of U.S. oil imports. For the first ~arter of 1983, only 29.5 percent of U.S. oil imports came from the Organization of Petroleum Exporting Countries (OPEC)--and a mere 8.9 percent of imports from the Arab members of OPEC-d o wn from 70.3 percent in 1977 to indicate that the energy security problem is solved, quite the opposite is true. shifted to the Western Hemisphere and the Caribbean Basin have risen the share of U.S. imports of crude oil and refined products from Latin Am e rica and the Caribbean increased from 16.6 to 37.8 percent between 1977 and- 1983.l When Venezuela is included, the total jumps to 45.3 percent. Imports from Mexico, in particular, have assumed great importance, rising from 2 percent of the total in 1977 t o 20 percent now. By April 1983, 6.6 percent of total U.S oil demand was met by Mexican crude While America's reduced dependence on OPEC imports may seem America's energy vulnerability merely has As imports from OPEC have decreased, those from Latin Ameri c a Excluding OPEC member Venezuela In short, the U.S. has merely shifted its dependence on the Middle East to reliance on Latin America. As..yet, there have been Estimate. based on "gross imports" figure and therefore includes some oil producsd in the U.S. or Middle East, but refined in the Caribbean. 2 I no overt moves against Latin American oil producers. But the threat is real. Mexico's gigantic Reforma oil field, the largest in the Western Hemisphere, lies off the coast of Yucatan Peninsula, a haven for rebel forces hostile to the government of Guatemala itself a possible major producer. Moreover, operations by Nicaragua's Sandinistas could eventually endanger Panama, through which 44 percent of all Alaskan crude oil is shipped. Even with- out direct att a cks on the oil producers, guerrilla activity could disrupt the flow of oil from the region The major danger involves the region's future potential. Central and South America hold among the most promising of the world's undeveloped oil resources. Since 197 7 , Latin America's proved oil reserves have increased an astounding 187 percent; some geologists.be1ieve its oil riches could rival the Middle East's. oil offshore, and Guatemala is believed to have as many as 20 billion barrels off its coast. Venezuela, E c uador, Peru, Argentina, Colombia, and Brazil are all known or believed to have significant oil deposits be more damaging than the cut-offs of 1973 or 1977. therefore that the United States has a vital interest in the continued stability of Latin America a nd the Caribbean Basin.

What should be done to preserve the region's stability? First, the U.S. should provide the economic and military assis- tance needed to support friendly governments in the region. Second, U.S. firms should be encouraged to assist La tin American nations develop their' petroleum resources, perhaps by providing "political risk" insurance similar to that 'offered through the Overseas Private Investment Corporation (OPIC). Third, the U.S. should expand efforts to reduce imports by elimin ating economic restraints on domestic oil production, decontrolling natural gas prices and expanding federal leasing programs.

By promoting stability in Latin America and the Caribbean Basin, while stimulating increased domestic oil production, the U.S. wo uld reduce its energy vulnerability. in a manner which would enhance the economic and political sta bility of its Latin American neighbors Mexico alone may contain up to 500 billion barrels of An interruption of U.S. oil supplies from just Mexico .would I t is clear It would be doing so BACKGROUND Not until 1947 did the U.S. rely constantly on foreign crude oil to meet a significant portion of its requirements. year the figure was a scant 8 percent of total domestic needs 99.6 percent of imports came from L a tin America. As late as 1970 72.7 percent came from the Western Hemisphere-although Canada had replaced Latin America as the principal Western Hemisphere sup- plier. Of the oil imports from the Eastern Hemisphere, less than half came from the Middle East I n that 3 Just three years before the Arab oil embargo, there was little sign of an energy security problem. sources, and the largest single foreign source of crude oil was America's stable and friendly neighbor. what they seem. From virtually the moment t h e U.S. became a consistent oil importer a series of events changed fundamentally the structure of the world oil market Imports came from diverse Yet things are not always THE EARLY FEDERAL ROLE Between 1947 and 1958, the share of U.S. oil needs met by imp o rts.rose from 8 percent to 18.6 percent. More important, an ever greater proportion of that oil came from unstable Middle East countries. President Dwight Eisenhower imposed import quotas on crude oil to brake this import rise and spur further domestic pr oduction.

Paradoxically, it was also during the Eisenhower years that the erosion of incentives for.domestic producers began--the full impact of which would not be felt for nearly two decades. This took the form of a Supreme Court-decision extending the Fe deral Power Commission's (FPC) authority to set prices, including the wellhead or field price, for natural gas. Since many independent oil companies--responsible for some 90 percent of exploratory wells--retained the rights to any natural gas they discove r ed, the decision profoundly affected the industry. This was aggra- vated after 1960 when the FPC adopted an "area wide rates" policy under which all gas wells in a given region were limited to one price, regardless of their costs Thereafter, the number of new field wildcat wells began to decline.

The foreign royalty tax credit was also a factor in making the U.S. vulnerable. Imposed soon after the Second World War, the tax allowed firms to deduct foreign taxes from their federal income taxes to avoid doubl e taxation. royalties as a cost of doing business, deductible from the firm's taxable income, this change allowed a dollar for dollar reduction in federal taxes payable explore.overseas the threat posed by these developments. Despite the growth of imports , most energy planners felt confident that even if an ex- porting nation attempted to use its oil as a form of blackmail, it would be countered easily. When the Iranian government at- tempted to nationalize foreign oil holdings in 1951-1953, for instance, t he large international oil companies boycotted Iranian crude. This was successful at forestalling the Iranian move largely because the U.S. had some 2 million barrels per day of spare production capacity to offset the loss of Iranian crude Instead of trea t ing This was a tremendous incentive to Most industry and government officials remained oblivious to The most important reason for the complacency, however, was that world oil production was outstripping world demand, creating 4 I' I a buyer's market. In r eal terms, the price of a barrel of oil declined between 1950 and 1970, and in nominal terms it rose by just 67 cents.

This seemingly rosy picture masked the danger signals. some sounded the alarm, few listened. One critical development noted by experts wa s the steady decline of investment in explora- tion. Disincentives at home, combined with incentives to move overseas, were having their effect, and U.S. proved reserves began to taper after 1969 importance of the Persian Gulf, which by then had displaced the United States as the world's most productive oil province While Most disturbing was the rapidly increasing THE GROWING IMPORTANCE OF MIDDLE EASTERN RESERVES Few industry analysts were prepared for the Saudi Arabian oil bonanza, discovered in 1948 fiel d was capable of producing an astounding 5,000 barrels per day, without artificial stimulation. This meant that Saudi pro- duction costs were so low--about 10 cents per barrel--that even after transportation and shipping it was still cheaper than oil from a ny other reservoir then known The average well in the new i Iran, Iraq, Kuwait, and the United Arab Emirates also saw By 1974, half of the top ten oil producing major discoveries. nations were located in the Persian Gulf, accounting for 44.5 percent of th e Free World's oil production, and 35.8 percent of total world oil production. By 1977, the U.S. share of world oil production fell to 13.7 percent of the total--down from 61.4 per- cent in 1947.

By the late 1960s, then, the stage was set f0r'U.S. dependen cy I on oil imports to reach a critical level. needed The government provided it Only a catalyst was SECOND PHASE OF FEDERAL INTERVENTION Although earlier federal intervention discouraged domestic exploration, actions between 1969 and 1973 virtually guara n teed a rapid decline in domestic oil exploration and increasing imports. The first blow came in 1969 when Congress reduced the depletion allowance for oil production and imposed a minimum tax on so-called preference items. These moves cut oil exploration i nvestment by one-third, just when firms were finding it necessary to search for oil in remote and very expensive areas such as Alaska and deep offshore waters Congress was not the only culprit. In 1971, responding to pressures to do something" about infla t ion, President Richard Nixon slapped wage and price controls on a wide range of com- modities, including crude oil and refined petroleum products These controls were a heavy blow to oil exploration, because.it These actions fostered a dependence on oil im p orts unimagined I just a decade earlier. Between 1970 and 1977, imports rose from 23.3 percent of total U.S. oil consumption to 47.7 percent a security point of view, the share of imports from the Eastern Hemisphere grew from 27.3 percent of the total to 8 6.4 percent during that period--despite the well-known instability of the Middle East From THE PROLIFERATION OF OIL PROVINCES Yet another major shift in world oil power was underway The first indication came in 1968 with the discovery of the giant Prudhoe Bay oilfield in Alaska, at that time the largest single oilfield ever discovered in North America Two years later, Phillips Petroleum announced the discovery of a gigantic oilfield in the frozen waters off the coast of Norway. Initial estimates put its si ze at 40 billion barrels-later revised to at least 50 billion barrels. into a major oil exporter.

The biggest surprise was in the waters off Mexicols Yucatan Peninsula, the so-called Cantarell field. Oil also was found onshore in the "Reforma" field. Although Mexico in the 1920s and 1930s had been a major oil exporter, by the end of the 1960s it was b elieved that Mexican oil resources were nearing exhaustion barrels per day in 1951 to zero in 19

66. Cantarell changed this dramatically. By 1977, Mexican oil exports to the U.S. were 177,000 barrels per day and rising. million barrels per day, constitutin g the largest single component of U.S. oil imports. While official estimates of Mexican'reserves are 250 billion barrels of oil and gas equivalent, some geologists estimate the potential at nearer to 500 billion barrels of oil, and more than 1,400 trillio n cubic feet of natural gas. the official estimates prove more accurate, Mexican reserves still would be enormous The North Sea discovery turned Great Britain 8 Mexican exports to the U.S. had fallen from around 38,000 Today, they are close to one Even if M exico is not the only major Latin American source of oil for the U.S. Of the top dozen nations exporting oil to the U.S seven are in the Western Hemisphere: Canada and six Latin American and Caribbean states. Only five of the top dozen are OPEC members. S a udi Arabia, once the largest exporter of crude oil to the U.S now ranks tenth, just ahead of Trinidad and Tobago and Puerto Rico 6 The remarkable speed with which the locus of U.S. oil imports shifted took many energy planners by surprise for the change, a nd many still fail to recognize its full impli cations an interruption of oil supplies from the Middle East. Granted such an eventuality would have severe consequences in Europe and the Far East, but the loss of oil from the Middle East would not be very i mportant to the U.S., while an interruption of supplies from Mexico alone could have far more serious consequences than either the 1973 Arab oil embargo or the 1979 Iranian boycott Few were prepared As a result, most energy planning continues to focus on PREVENTING ANOTHER CRISIS To prevent another oil crisis in this new context, the U.S must address two broad issues 1) import independence, and 2) security of import sources.

Reducing Import Dependence Decontrol of Natural Gas. Although the U.S. has made gr eat strides in reducing its import dependence, thanks to President Reagan's decontrol of oil prices, more must be done. The most important next step is decontrol of natural gas prices. It is estimated that as much as one-third of U.S. proven gas reserves may never be utilized because producers are denied a sufficient return under current federal rules.

Gas controls adversely affect oil imports in two ways since natural gas is a ready alternative to oil in a number of uses, the failure to fully utilize U.S. gas resources means oil must be used instead association with.crude oil often necessary to extract the other. Although gas can be re injected into a reservoir to store it, if the controlled price does not warrant transportation and sale, re-injection is w asteful and eventually daniages the formation, limiting the amount of the deposit that can be produced. By making natural gas uneconomic controls reduce the attractiveness of the whole field. The best example of this is the Prudhoe Bay oil field where as m uch as one-third of the gas is used up in powering the re-injection process production must be restored. This.would be achieved in part by abolishing the so-called windfall profits tax the gross revenues of oil producers to a maximum of $22 per barrel 1.f the U.S. is serious about reducing its import dependence, this artificial revenue ceiling must be eliminated to encourage more exploration by Dr. H. A. Merklein, of Texas A&M University, indicates that if the windfall profits tax were eliminated, the U.S. could become oil self-sufficient within five years. Even if this is overly optimistic, there is little doubt that domestic oil production would be greatly enhanced by the move First A second link is that much gas is found in To produce one of these fuels, it is Restoring Production Incentives. Incentives to domestic oil The tax limits A computer model of the oil and gas market developed 7 Leasing. A third action to enhance domestic oil production would be an expansion of the Administration's policy of leas i ng promising areas of federal lands for oil exploration. Many of the most promising exploration areas are controlled by the federal government. And denying access now, when exploration could take place in an orderly fashion, might result in panic explorat ion during some future crisis, with scant regard for the environment.

Depletion Allowance. The federal government could also restore the percentage depletion allowances to pre-1969 levels.

This would help the oil industry to generate much-needed capital b y improving the tax treatment of reserves, and so would act as a strong incentive to increase exploration THE NEED FOR A STABLE IMPORT BASE Reducing the need for imports by increased domestic produc tion and market-driven conservation is half the answer t o the oil security problem. The other half lies in preserving reliable overseas sources. This requires a new and broader view of U.S policy towards overseas oil suppliers fail to note a host of other factors, such as political stability social conditions o r the military environment. All of these bear directly on the security of oil supplies from a nation Mere economic analyses The Nature of the Threat: Short and Lonq Term Problems Nowhere is this broad view more necessary than in the case of oil imports fro m Latin America and the Caribbean Basin, where as never before, non-economic factors are critical to the security of the region's oil supplies.

The most immediate threat to U.S. energy security in the region comes from the growing influence of Marxist grou ps. Al though there have been no direct military moves against oil producers, the chances of such action remain considerable. For example, bases in southern portions of the Yucatan Peninsula operated by forces opposing the government of Guatemala could re a dily be used to mount military operations against Mexico's huge Reforma oilfield in Central America succeed in consolidating their rule over the isthmus, allowing them to turn their attention northward economies to undernine the legitimacy of governments t hey seek to overthrow of Mexico makes them highly vulnerable to terrorism. One very promising deposit already has been abandoned due to attacks by guerrilla bands This is particularly likely if the insurgents Marxist insurgents traditionally have sought t o disrupt local Oil production would be an ideal target in the case The remote location of some of Mexico's major oilfields The Panama Canal is another potential target. About 44 per cent of Alaskan crude oil passes through the canal on its way to 8 U.S. r efineries on the Gulf and East coasts. Should access be restricted, Alaskan oil would have to be shipped around South America, adding greatly to its final cost.

Another threat is the potential use of Cuba or Grenada as a base from which submarines could ha rass shipping the Caribbean.2 During the Second World War, for example, fewer than a dozen German submarines operating in the Caribbean during 1942 sank an estimated 3.5 percent of all allied tankers. And these submarines had no base of operations in the region.

Although the Reagan Administration has made some moves to counter the threat posed by insurgents in Central America, more must be done if U.S. oil supplies are to be protected. Governments in the region have indicated that they need equipment and t raining, not combat troops. By providing such aid now, the U.S. will avoid even higher military expenditures in the future to maintain oil security.

The military threat is but one part of the problem. A more basic set of issues involves economic, politica l and social con sequences of oil wealth in the region. Here, the need for U.S. involvement is longer-term, but the result of a carefully crafted program could be lasting political and social stability throughout the region.

Technical and Economic Assista nce A lesson of the 1979 Iranian revolution is that sudden oil riches can become destabilizing in developing countries. ments can find themselves caught in a political trap between the rising expectations of their citizens, and the need to invest revenues in long-term development projects. And all too often new projects draw large segments of the rural population to the central cities, leading to social, economic and political dis- ruption Govern With proper technical assistance, however, it is possible to use new oil to foster development while preserving the social and political structure. In Latin America, such assistance would have to be relatively sophisticated, as most of the nations in that region are well developed compared with the Middle East. sti l l are areas in which the U.S. could provide critical assistance ranging from oil exploration and development help to enhanced agricultural production techniques. would depend,on the individual country's requirements. For example, Mexico and Venezuela hard l y need assistance in oil development, but Guatemala may. Providing "custom-made1' technical support in this way would go a long way toward improving relations between But there The proper form of assistance See Edward Lynch MOSCOW Eyes the Caribbean Herit age Foundation Backgrounder No.' 284, August 17, 1983 9 two halves of the Western Hemisphere, and thereby improve U.S oil security.

CONCLUSION Perhaps the most important step that the U.S. can take to The meet the new threat to energy security is to recogn ize the profound changes that have occurred. Latin America and the Caribbean Basin now constitute a resource base rivalling the Middle East proximity of the region to the U.S. greatly reduces the strategic problems associated with its defense, but makes a strong U.S. com mitment to defend it all the more necessary. The U.S. thus quickly I must take the steps to counteract insurgencies in the area, to avoid a far greater military commitment in the future.

I Simultaneously, the U.S. should enhance its domestic energy production so that the absolute level of oil imports is reduced.

The U.S. should also provide the technical assistance necessary to help its southern neighbors to use their newfound oil revenues in a way that enhances politica l, economic, and social stability rather than disrupting it could help transform a region now posing a threat to its oil security into a strong and dependable economic partner By acting in this manner, the U.S Milton R. Copulos Policy Analyst I