"Normalcy" returned to the energy picture in 1976. On the surface it appeared nothing much happened. There were no supply shortages except for natural gas—and that shortage is becoming normal. There were no substantial price changes. Consumption rose, as did oil imports. There were no discontinuous changes in energy supply or demand. The Organization of Petroleum Exporting Countries (OPEC) remained intact, though the price increases of December were less than expected and also demonstrated disagreement among the members. Unfortunately, there was also little progress in solving any of the nation's energy problems. Facing them in 1977 will be no easier than in 1976, though the increase in the urgency to do so may lead to greater results.
Major problems. Four major problems continue to confront the United States.
- Supply is insecure because our rising absolute and relative dependence on foreign oil has not been offset by measures that would reduce that dependence or make it less threatening. Effective action has not followed rhetoric.
- Energy is produced and used inefficiently, in part because the price signals given producers and consumers distort reality. Domestic oil, for example, is produced at three price levels depending on its classification, with the price of uncontrolled "stripper" oil (and imported oil) approaching three times that of "old" oil, and "upper tier" oil falling somewhere in the middle. Price controls thus make it unprofitable to produce some "old" oil because its regulated price is below its cost of production, while they encourage production of oil from other reservoirs where cost is substantially higher. Or again, controls lead to more resources being spent to buy a barrel of oil from abroad than would be used to find and produce it here. Because of these policies the society gives up more resources than it needs to in providing the oil it subsidizes consumers to use! On the consumption side, to pick one example, lucky consumers of regulated natural gas can obtain it for a low price. Others who buy unregulated gas pay a higher price, while still others—a growing number—face an infinite price for gas because they cannot obtain any all. As a consequence, the nation receives less value than it could from the dwindling natural gas supply.
- The United States is also consuming too much energy. The true cost of energy—including diminished environmental quality and lessened geopolitical flexibility—is what the society has to give up to consume it. Oil provides the incremental energy, and imports provide the incremental oil, thus setting the social cost of energy. Oil, because of price controls, is priced at only two-thirds to three-fourths of this true cost. Natural gas is underpriced to an even greater extent; between them, they supplied about 74 percent of total energy in 1976. Other energy sources are used primarily for electricity generation, and, for different reasons, electricity is underpriced to consumers as well. Thus consumers are presented individually with a choice between "bargain" energy and other goods priced at full cost—and naturally choose to consume "too much" energy—more than they would if its price were equal to the value of the resources, including the environment, the nation gives up to get and use it.
- The long-term problem is to provide energy supplies for the future. Nonrenewable and exhaustible fuels supply most of our needs now, but they will be increasingly expensive to obtain and use until, around some distant corner, they will be replaced. The questions are when, and with what, and at what cost.
The answer to the "when" question depends upon the rate of use and the rate at which new reserves can be discovered and recovery from known reserves increased. Research has a major role to play—in finding ways to get more benefit from the resources we consume (conservation), in improving environmentally acceptable access to the resource base itself, and in developing substitutes which will allow the more scarce fuels to be dedicated to their most valuable uses. Price policy has another role—in assuring that we do not consume the resource base wastefully and that we find it worth while to ex-tract a maximum amount of value from known reserves.
The "what" and "cost" questions are largely matters of research, partly to ascertain which of the possibilities are environmentally acceptable. They also have a price dimension, because research and commercialization are affected by the target of the expected price for energy sources.
The larger context. The slow start toward addressing these problems is both discouraging and frustrating. But impatience must be tempered by recognition of the total economic, social, and political context in which they arise.
For example, the rate of increase in domestic energy prices since 1973 is too low from an energy-efficiency-environmental standpoint. However, the social and political instability precipitated by a more rapid increase could have been substantial. Again, while energy price controls are a woefully inappropriate and perhaps even counter-productive means of affecting income distribution, difficulties and lags in adjusting to more rapid increases might have led to serious harm for some groups. Energy goals have been sacrificed to attain other ends, because energy policy is part of total national and international policy, not the other way around.
Response to the new energy reality cannot wait forever, however, as the nation was reminded by the OPEC decisions in December.
Implications of the OPEC decisions. The world economy had not yet recovered from the 1973-1974 OPEC price increases when the latest increases were announced, but observers should be reassured that at least the first six months of 1977 will not see a further substantial deterioration of the system induced by an increase in oil prices. At the December meetings, Saudi Arabia and the United Arab Emirates announced that they would increase prices by 5 percent. The other OPEC member states agreed upon a 10 percent rise, but these higher levels are unlikely to be realized. World oil stocks at year-end were at record highs in anticipation of a yet higher price increase. Demand for OPEC oil is likely to fall during early 1977 as these precautionary inventories are reduced and as consumption continues to adjust to higher prices. This decline in sales will be shared among oil producers.
Those nations which stick to a 10 percent price increase will lose sales unless, unexpectedly, Saudi Arabia chooses to do indirectly what it refused to do directly: support the higher price (for others only!) by holding its own output low enough that consumers are forced to buy all that other countries want to sell at the higher price. If the Saudis are willing to increase production, most high-priced suppliers will probably try to maintain revenues by discounting prices, perhaps through the subterfuge of large adjustments in the value of quality differentials between Saudi Arabian crude and other oil.
Such ad hoc adjustments would increase the pressure within OPEC to formalize these differentials; this may prove to be the most significant effect of the two-tier base price increase. The freedom to make unilateral changes in differentials now provides the safety valve which prevents the joint decisions of the cartel from conflicting directly with the aims of member states. If differentials are standardized and enforced, OPEC may be driven toward prorating world demand among its members to avoid open price cutting. Thus far OPEC has avoided this potentially disruptive task.
The role of Saudi Arabia in OPEC will become stronger if, as expected, world oil prices in fact rise no more than about 5 percent. If the world economic recovery regains speed, sustainable oil demand may press on previous output levels by mid-to-late 1977. In these circumstances, Saudi Arabia's position when OPEC meets at midyear to consider further price adjustments may be even more critical than it was in December 1976, a fact with impor-tant international implications.
The 1976 experience. Energy consumption in the United States, which had declined in both 1974 and 1975, rose between 2 and 3 percent in 1976, but still remained below 1973 levels. It appears that the increase in energy consumption has been trailing the increase in GNP by more than would be expected for a recovery year, lending support to the view that the higher energy prices of the past few years are check-ing the growth of consumption.
Despite the February 1976 rollback of domestic oil prices, the composite relative price of energy to consumers remained about the same during 1976. Natural gas prices increased substan-tially, but changes in other energy prices were not widely different from those in the remainder of the economy.
Domestic energy production fell slightly from 1975 as higher output of coal, hydropower, and nuclear power did not match the declines in oil and natural gas. The rate of decline in the production of oil and natural gas leveled off, however, as the higher investment over the past few years began to have an effect. The coal industry had excess capacity through much of the year. The production of nuclear and hydropower was constrained by capacity alone; the cost of electricity from each, as currently calculated, was below the cost from alternatives. In the case of nuclear power, the increase in maximum-rated dependable capacity was off-set somewhat by declines in actual operating rates.
Investment in energy production continued high, especially in oil and gas. By the end of 1976 the number of drilling rigs in operation reached a level last experienced in 1962 (but on average still only 60 percent of 1955). Well completions for the year were expected to reach a twelve-year high. The only area where investment was low was in electric generation where excess capacity held back activity. No new nuclear power plants were ordered.
Oil imports reached an all-time high. Imports from Canada were restricted by the Canadian government; imports from Arab countries continued to rise, which has lifted them to 250 percent of their preembargo levels. Saudi Arabia, with about 25 percent of the total, is now the largest supplier of crude oil to the United States.
What to expect in 1977. Energy prices will probably increase relative to other prices, but by the end of 1977 energy will still be underpriced—that is, still below its long-run incremental cost. Thus energy production and use will continue to be responding to price signals muted by other policy considerations.
Domestic oil production will respond both to the investment of the past few years and to such developments as increased output from Elk Hills, California. Alaskan North Slope oil will also begin to flow during 1977. Thus, by the end of 1977 domestic oil production may show its first year-to-year increase since 1970.
Demand for coal will probably set another record; the additional capacity of the past few years means that production can keep pace unless the 1977 contract negotiations lead to an unexpectedly long work stoppage. Without such a stoppage, there is also likely to be adequate capacity to accommodate tightened strip mine laws without large transitory price effects.
Meanwhile, domestic energy consumption will also rise, as higher use caused by the economic recovery will overshadow the residual effects of higher energy prices on energy use per dollar of GNP. Oil consumption will probably rise relative to other energy sources because of problems in producing additional natural gas and in using coal (as distinct from producing it).
Oil import levels for 1977 will be affected by these and other developments. They may decline initially as firms work off excess inventories, but over the year, the consumption of it will probably rise more than will domestic oil production, and consequently oil imports will continue to increase.
While supply uncertainties remain, the concerns expressed about a world crude oil shortage are unlikely to be realized. Adequate capacity appears to exist to meet demands at current prices.
The thrust of the Carter administration's energy policy is not yet clear. The promised energy reorganization is unlikely in itself to lead to substantive shifts in policy or to progress in meeting the problems identified above. Moreover, the diversion of effort to reorganization might even weaken the ability to achieve policy reform. Indeed, the record in energy has been that decisions follow crises, and there are no imminent "forcing events" which will require basic policy reassessments.
In other words, like 1976, 1977 appears to be headed for energy "normalcy." That sounds reassuring until one remembers the underlying energy problems that refuse to go away on their own.
A version of this article appeared in print in the January–March 1977 issue of Resources magazine.
