Energy Developments

THE DOMESTIC ENERGY story of 1978 was one of adjustment and small changes. Most energy prices were down relative to the prices of other goods and services—natural gas being the exception. Energy supply rose, but by the year's end demand had risen more, leading to rising oil imports. Energy legislation was passed, though important policy issues remained unresolved.

The news from abroad was more dramatic and worrisome—troubles in Iran and the large price hike by the Organization of Petroleum Exporting Countries (OPEC). The threat to world production caused by the strikes in Iran, coupled with the lack of significant progress in implementing the Strategic Petroleum Reserve (SPR), reawakened fears of economic turmoil because of energy developments.

The Carter administration had committed itself to storing 1 billion barrels of oil by 1985, and to having 250 million barrels in reserve by the end of 1978. By the end of December, however, only about 70 million barrels were in permanent storage, and none of that was available for use in an emergency. The 250-million-barrel target is now expected to be reached during 1980—and the price tag for reaching it has about doubled. By December there was growing concern about the management and design of the SPR, and questions were being raised as to whether it was desirable to implement the full reserve, given its escalating cost at a time of tightening budgetary constraints.

Energy prices. Energy price news was dominated by the continued OPEC price freeze. Adjusting for inflation, imported oil declined in cost at the refinery gate during the year, while the refinery acquisition cost of domestic crude oil stayed about the same. The domestic price would have fallen had there not been a shift in the mix away from "lower-tier" oil (controlled at the lowest price) toward higher-priced "upper-tier," stripper, and Alaskan oil. Within each class, the price of oil at the wellhead was lower at the end of the year than at its beginning. For lower-tier oil, in real terms the price was about $1 per barrel less than it averaged in 1974; for upper-tier oil, it was over $2 per barrel less than it averaged in 1975. On the average, natural gas prices in the field markets rose during the year, but less rapidly than before, and coal prices remained about the same.

At the consumer level, energy prices rose less than did other prices. Adjusting for inflation, natural gas prices to residential consumers were slightly higher in November 1978 than in November 1977, but prices fell for electricity, gasoline, and home-heating oil. In terms of their effect on the Consumer Price Index (CPI), energy prices lowered the November-over-November inflation rate since they rose 7.0 percent, while the CPI without energy rose 9.2 percent.

Energy supply. Three developments in petroleum and natural gas supply made headlines during 1978. The most important of these occurred in Mexico, where huge discoveries came to public attention. The only comparable reserves are in the Middle East. Mexico's deposits may rival or exceed even those of Saudi Arabia. Unfortunately, the U.S. government's rejection of the terms of a proposed sale of Mexican natural gas rekindled the anti-American feelings that accompanied foreign exploitation of Mexican oil reserves before their nationalization in 1938. A major task for U.S. policy during 1979 will be to establish a setting in which the fossil fuel resources of Mexico may be developed to the mutual benefit of that country and of energy importers.

To the north, new gas discoveries in Canada offered the opportunity for expanded exports. Among others under consideration is a plan whereby these exports are to be coordinated with prospective gas supplies from Alaska's North Slope. A prebuilt section of a transportation system to move that gas could carry Canadian reserves until the rest of the pipeline is completed.

On the domestic side, drilling began in the Baltimore Canyon off the East Coast, and operation of the Alyeska pipeline, bringing oil from the Alaska North Slope, reached capacity. Early results from the Baltimore Canyon exploration are inconclusive. Some possible commercial deposits have been located, but outcomes were disappointing in some locations that had been considered promising. Several years will be required before a clear picture of the prospects emerges. Capacity operation of the Alaska North Slope pipeline displaces 1.2 million barrels a day (or 15 percent) of 1978 oil imports.
Other domestic drilling continued to increase; the average number of rigs active during the year was 13 percent above that for 1977. Well completions were up about 3 percent. As compared with the embargo year 1973, gas well completions more than doubled, while the increase in oil wells was a more modest 80 percent.

Despite the increase in well completions, production levels sagged except for the Alaska North Slope. Gas production for the twelve months beginning November 1977 was down 2 percent from the previous twelve months and 13 percent below the peak output of 1973. Oil production excluding the North Slope fell slightly as compared to 1977. And even the Alaska production did not offset the decline registered since the peak oil production year of 1970: output was about 3.2 billion barrels as compared with 3.5 billion barrels then. Coal output was down 5 percent from 1977, partly because of mining and railroad strikes and from lack of demand due to declining export demand.

Energy demand. Stimulated by the continued economic recovery, energy demand rose about 2 percent during 1978. High gasoline consumption was the surprise of the year; good driving weather in the fall and higher than expected sales of new automobiles contribute to sporadic tightness in the supply of unleaded gasoline that was exacerbated by controls inhibiting price flexibility.

Generally, though, the increase in energy demand trailed growth in the economy. All the evidence is not yet in, and a few years is too short a period to judge, but it seems that conservation practices, higher energy prices, and the automobile mileage standard have combined to lower the ratio of energy to gross domestic product (GDP). The number of Btus consumed per dollar (constant dollars of GDP) stood at 60.8 thousand in 1973 and 57.6 thousand in 1977, and at about 56.3 thousand for the first three-quarters of 1978.

Oil imports. Oil imports averaged 8.1 million barrels per day in 1978, down from the 8.7 million average in 1977, but one-third higher than in 1973. The decline in imports recorded in 1978 came despite an increase in energy consumption and the continued downward trend in oil output in the lower-48 states.

Comparing 1978 with 1977, Alaska contributed 750 thousand barrels per day to lowering imports. Other influences were a reduction in oil inventories (200 thousand barrels per day) and an increase in hydroelectric production due to more rain in the West (100 thousand barrels per day). These are once-and-for-all changes, and their influence was waning by the end of the year. The trend of increased dependence on foreign oil returned in late 1978 when import levels for the last quarter were 8 percent higher than in 1977.

Energy legislation of 1978. The most important political event of 1978 affecting energy was passage of the omnibus energy legislation which had been in the works since April 1977. Fully satisfying no one, this statute at least provided a framework for making decisions on a wide array of matters.

A pricing philosophy of gradual de-control was accepted for natural gas (though the interim regulations are frighteningly complex and cumbersome). A restrained set of incentives was put in place for energy conservation, for conversion away from oil and gas, and for use of solar and other non-conventional energy sources. The principle of incremental pricing for most utility services was also enunciated.

The unresolved issues. The energy legislation passed in 1978 did little to settle the controversy over petroleum pricing, nor did it address concerns about nuclear power that have restrained its development without satisfying its critics. Further dramatized by the disruptions in Iran and the OPEC price increase, it now appears that these issues will be prominent in policy discussions during 1979.

• In the long run, decontrol of petroleum prices would foster national security and international stability by reducing oil imports. It would also lead to a more efficient use of energy and other resources, and this enhances the productivity of the economy. But de-control would simultaneously add to the inflation rate at a time when even small increases may have debilitating effects on domestic economic growth and international monetary stability.

Decontrol poses a second dilemma because its efficiency and security benefits are achieved through actions which alter income and wealth distributions by class, by region, and by economic sector. Such changes are always divisive, but they seem especially so in the case of energy.

The OPEC price increase in December 1978 makes each dilemma more cruel. The imported oil price not only feeds directly into domestic price levels, but it also affects the uncontrolled price of domestic energy. Hence the inflationary and income-distribution effects of decontrol are more serious than they would have been had the OPEC price hikes been lower.

The domestic conflicts over decontrol are sharpened by the decline of the dollar. The president has now pledged to stabilize the dollar against other world currencies. The U.S. inflation and the growing level of oil imports are two of the factors that are eroding confidence in the dollar. Unfortunately, petroleum price decontrol to lessen oil imports would increase inflation; the dollar suffers either way.

Energy policy is further complicated by other commitments. At the Bonn Summit in July the president promised that domestic petroleum prices would be raised to world levels by the end of 1980, primarily to restrain oil imports. But the price-and-wage guidelines announced by the president will be harder to sustain to the extent that domestic energy prices rise. As in the case of support for the dollar, these conflicting commitments cannot be resolved as a product of petroleum pricing policy alone; but, paradoxically, it is in petroleum pricing that the administration itself has the greatest freedom of action.

Price controls can be maintained, leading to some sacrifice of oil import restraint in exchange for added price level stability and less income redistribution. Alternately, decontrol is possible.

Gasoline price decontrol can be implemented subject to reversal by either house of Congress. Crude oil prices can be raised immediately. (The prices now allowed by regulation are below those authorized in the statute.) And the president gains complete discretion over crude oil prices in June 1979.

Further, the president has some authority to impose direct controls or fees on oil imports, raising domestic prices above world levels.

The important petroleum pricing decisions for 1979 will be in the hands of the president rather than Congress. The political travail that energy issues brought during 1978 may be reignited as choices are made which affect such sensitive issues as inflation, the value of the dollar, energy security, the balance of payments, and the distribution of income and wealth.

• The other major unfinished energy policy business relates to the future of nuclear power. Three matters seem to dominate the debate: (1) avoidance of proliferation of nuclear weapons states; (2) prevention of diversion of nuclear materials to terrorist and subnational groups; and (3) safe disposal of nuclear wastes. Little was achieved during 1978 toward resolution of these concerns.

In the discussions in the International Nuclear Fuel Cycle Evaluation (INFCE), the United States appears to have failed to convince other industrial countries that nuclear fuel recycling and the breeder reactor must be delayed until adequate safeguards against proliferation and diversion are achieved. Indeed, several such projects are going forward. On the other hand, broad consensus has been secured among the nuclear supplier countries that uranium enrichment and plutonium separation technology and facilities should be restricted to as few additional countries as possible.

Some progress appears possible on strengthened safeguards against terrorist diversions and on international arrangements for improving the reliability of uranium supplies and enrichment services. The difficult search continues for technological means to reduce the proliferation hazards of plutonium use and for institutional means to reduce the motivation, as well as the opportunity, for acquiring atomic weapons materials.

Domestically, those opposed to plans for disposal of radioactive wastes have not been convinced that future safety is assured, and new doubts about the long-term suitability of some proposed techniques have been raised. Meanwhile, siting controversies continue; costs have escalated, and fears of nuclear accidents have not disappeared.

The long-term effect of policy indecision and cost uncertainty is becoming truly serious. The U.S. power plant manufacturing and fabrication industry is more or less stuck on dead center; it is neither able to proceed with confidence that there will be a nuclear future, nor to begin the difficult process of winding down the enterprise.