Project Independence

Oil. Particularly qualified were the report's rather central conclusions on the effects world oil prices would have on U.S. energy demand and supply. It was assumed that world oil prices would be the transcendent influence on U.S. energy consumption because of their impact on domestic prices for all fuels and energy. On the other hand, the link between U.S. prices and U.S. energy consumption and production —the so-called elasticities of demand and supply—was acknowledged as one of the principal factual-analytical uncertainties.
World price-supply-demand relationships had also to be considered. If world oil prices were to be maintained at roughly the equivalent of $11 per barrel, delivered to U.S. shores, it would be at the expense of any significant increase in market for OPEC-country production. Even if the price were to fall to as little as $7 per barrel, world demand would not support the anticipated doubling of OPEC production by 1985 that some have predicted.

The prices of $7 and $11 per barrel were used as the illustrative assumptions for predicting the range of supply-demand eventualities. At $7 per barrel for petroleum, in the "base case," the analysts calculated a probable rate of increase in U.S. energy consumption, between 1972 and 1985, of 3.2 percent per year. At $11, the predicted growth rate was 2.7 percent. These compare with average rates of about 2.5 percent for the past fifty years, 4 percent in the past twenty-five years, and something over 4.5 percent in the five years ending in 1972. One may infer that the rate of increase in U.S. energy consumption is determined by a lot more than its relative cheapness.

On the supply side, it takes no elasticity calculations to predict that within the next several years, price will have very little to do with the outcome. Given the time needed to step up the rate of drilling and the capacity for transportation and refining, there is small hope of significant increases in domestic oil and gas output in a short-term period. Expansion in coal mining is hampered by delays in deciding what to do about environmental problems, by hesitation to invest large sums in new capacity in a context of long-range price uncertainty, and by the same kinds of machinery and labor-supply problems as affect petroleum output.

Over the longer term, which the FEA dates from 1978 to 1985, prices and price elasticities are assumed to be not only important, but largely controlling. The analysts find supply responses rather more striking than demand responses. Specifically, they calculate only a mild (5 percent) rise in U.S. oil production at the $7 price, but a nearly 50 percent rise at $11, mostly as the result of the more widespread use of secondary and tertiary recovery. Admittedly, however, these calculations are subject to great uncertainty: primary petroleum output depends upon the continued discovery of new reserves, and, while price affects the rate of drilling, there is little assurance that any projected amount of discovery will actually accompany any particular rate of drilling. This is particularly so since most of the new reserves will have to come from "frontier" regions, like new parts of the Outer Continental Shelf, that have as yet been little investigated.

Natural Gas. The reliability of elasticity calculations has a particularly immediate policy relevance in the case of natural gas. The price of interstate gas is regulated by the Federal Power Commission, but the Administration has been urging deregulation for years, arguing that this would both decrease demand and increase supply. The Project Independence report in effect projects that if gas is not deregulated, production will decline, by 1985, by some 30 percent; if it is deregulated, output will rise by at least 10 percent.

Since there is scant factual evidence to support such calculations, especially insofar as expected new producing areas are concerned, one may wonder how free the conclusions may be from pro- or antiregulation bias. Even accepting the projected supply response, one may still wonder how far deregulation should be carried. The report indicates a base-case price of at least 80 cents per thousand cubic feet for newly discovered gas as the required incentive to elicit the 10-percent increase in output. The Federal Power Commission has already taken some giant steps toward this price level by raising the ceiling price of "new" gas (gas from wells producing since January 1, 1973) to 42 cents in June 1974 (from a previous actual average of 27 cents for new interstate contracts) and to 50 cents in early December. If all new gas, as presently defined, were permitted to go to the 80-cent level, it would mean more than a doubling of the average wellhead price for "new" and "old" gas combined, or an increase of at least $5 billion in the annual cost to consumers. Even a staged regulatory increase, in which the price of currently identified new gas remained at 50 cents, with higher prices being allowed for gas which was new after some later cutoff date, would come close to doubling the wellhead average. Complete deregulation, however, would imply prices well above 80 cents for all gas not already under contract, since the only constraint would be the competitive price of other fuels. Yet such higher prices, costing consumers many additional billions of dollars, would, according to the Project Independence report, bring forth little additional output, owing to the physical limits on potentially exploitable resources and the inapplicability of secondary and tertiary recovery techniques, such as exist in the case of oil. It should be noted, on the other hand, that this finding of almost total price inelasticity of supply above 80 cents per thousand cubic feet is one that needs to be looked into very carefully, since its implications are too critical to warrant acceptance on the basis solely of the task force's heavily premised analysis.

Other Sources. The report predicts coal production in the base case of 1.0 to 1.1 billion tons per year by 1985 (it is about 600 million now), although greater output was said to be possible if policy changes were made. Effective nuclear generating capacity was forecast as lower than had previously been estimated, because of schedule deferments, construction delays, and operating problems. Synthetic oil and gas from coal or oil shale were considered to be of only marginal potential by 1985 under any oil price assumptions. Other energy resources, such as solar and geothermal, were considered to have even less potential through 1985, although they would become important some time thereafter.

To achieve even this kind of an energy future would require federal actions not yet taken. The most important of these are: modifying the Clean Air Act to permit more widespread use of high-sulfur coals than the present statute allows, assisting the electric power industry to finance itself, and solving the problems that have slowed down the growth in nuclear generating capacity.

Vulnerability. The Federal Energy administration sees no quick solution to the problem of import vulnerability. For the longer term, the report sees an inverse relationship between the degree of vulnerability and the level of oil prices: the higher the price, the lower the vulnerability. The logic is that at lower world prices we would, unless impeded by tariffs or quotas, import more and increase domestic production less. Specifically, the report estimates that we would import five times as much oil at a price of $7 per barrel as at $11 per barrel. In the event of a sudden cutoff, the damage to the economy would be some $200 billion, over a year's time, at the higher import level, and $40 billion at the lower. Establishment of a 1-billion-barrel oil stockpile program would not reverse this relationship, but would reduce the one-year damage at the $7 price to less than $40 billion, and at the $11 price to zero—a true bargain, since ten years of storage, as an example, would cost only some $6 billion.

The paradoxical conclusion that we are somehow better off at the higher price of oil is not negated by the balance-of-payments effects, as the report calculates them. In the base case, we would import some 3 million barrels per day at the higher price, in contrast with some 12 million at the lower, effecting a net balance-of-payments saving of around $51 million per day or $18.5 billion annually. Since it would cost only $4 billion extra at the higher price to accumulate a 1-billion-barrel stockpile, even this does not change its apparent advantage.

What is left out of the foregoing picture, of course, is the higher real cost (that is, higher than $7) of producing domestically the extra 9 million barrels per day that, at $7 compared with $11, we would have found it advantageous to import. This real cost is expressed in part in the projection that $11 oil, compared with $7 oil, would reduce the U.S. economic growth rate from 3.7 percent per year to 3.2 percent. Eleven dollar oil would also have a disproportionate impact on the poor, because their energy costs are a larger percentage of their total income than are those for the more well-to-do. Because the East Coast is by far the largest consumer of imported oil, the adverse economic effects of high energy prices would be greater for this area than for others.

Options and Conclusions. If, to ameliorate this situation, the option chosen is to accelerate domestic supply, the principal means available are (1) expanded leasing of the outer continental shelves, including the Atlantic and other new areas; (2) tapping the Naval petroleum reserves, and (3) accelerating oil shale development. The report observes that accelerating nuclear power does not reduce oil imports (nuclear energy replaces coal) and that accelerating the production of synthetic fuels may not be cost-effective because it would require bypassing necessary research.

Pursuit of the "energy conservation and demand management" option (option 2 above) would reduce demand growth to 2.0 percent per year between 1972 and 1985. Achieving this goal would require the adoption of new standards for products and buildings, or else the institution of incentives or subsidies. Examples are standards for more efficient automobiles, incentives to reduce the number of miles driven, and improved thermal efficiency in new or existing structures. Since the objective is to reduce oil imports, and not merely to lower total energy consumption, demand management could be an effective complement to generalized conservation. Coal could be mandated to replace oil or gas in firing both existing and new industrial and utility boilers. According to the report, electrification could be encouraged for domestic and commercial heating, thus permitting the replacement of directly consumed oil and gas by utility-consumed coal and nuclear fuel. However, the shift to coal, under this option, would maximize environmental stress.

Finally, the reduction of vulnerability to interruption of imports could be achieved by means other than or additional to the stockpiling already mentioned. Among these are standby rationing and the pursuit of international energy cooperation (the "International Energy Program"). Rationing is considered to be easily implemented and relatively easy to administer. Maintaining a 1-billion-barrel stockpile for ten years would cost $6.3 billion, FEA calculates, in contrast to an avoidance of damages, from a one-year cutoff, of at least $30-$40 billion. In summation, the report states the following principal conclusions:

1. Oil at $11 per barrel makes for energy self-sufficiency, but we would be economically better off with $7 oil, if we could get it, and a lesser degree of self-sufficiency.
2. It is possible to achieve maximum self-sufficiency in either circumstance through various combinations of the available options: ". . . we can pick from those that make the most economic, environmental and regional sense."
3. Accelerating domestic supply has the drawbacks that: "It will adversely affect environmentally clean areas. It requires massive regional development in areas which may not benefit from or need increased supply. It is a gamble on as yet unproved reserves of oil and gas. It may well be constrained by key materials and equipment shortages."
4. "While cost effective, there are several important ramifications to a storage program: It will take a few years to implement and our vulnerability will be greatest during that period. It requires more imports now, which will act to sustain cartel prices. We could suffer major capital losses—$4 billion for each I billion barrels stored if the world oil price drops from $11 to $7."
5. Actions to increase domestic self-sufficiency would significantly affect world oil prices and could make even a $7-per-barrel price hard for OPEC to maintain; a lower price, in turn, would make it harder to attain self-sufficiency.
6. Any U.S. policy "must be designed to resolve uncertainties and minimize the risk of not anticipating world oil prices correctly." It may be necessary "to avoid or defer major investments or actions, if they involve significant costs of being wrong, until world uncertainty is reduced." Yet "a flexible and dynamic approach must be balanced against the need for a stable long-term policy which encourages domestic energy investment."

As noted at the outset, this group of conclusions is hardly a set of recommendations, unless one regards as a recommendation the implication that a mix of remedies ought to be used, with caution. Even this scant degree of conclusiveness, moreover, suffers from at least minor inconsistencies with the supporting task force reports and—more importantly—from the admitted uncertainties of the database and analytical underpinnings. In particular, there are substantial uncertainties as to the elasticity coefficients in the critical demand and supply equations.

Peer review of the Project Independence analysis will not be quickly consummated. The published final task force reports occupy some 2 feet of shelf space. They were obviously too hurriedly put into final form for care to be taken in providing a pathway through the analytical logic. Moreover, most of the quantitative underpinning, of the sort that serious outside analysts will want to examine, is, if anywhere, in supporting files rather than in the public prints. Perhaps the major use will be to serve as a tool for gauging the effect of whatever policies are selected in the months and years to follow. Moreover, the very inconclusiveness serves to remind those who expect ready-made solutions, and thus avoidance of hard choices, that even this kind of large-scale, computer-oriented exercise leaves major decisions to government and those who elect it.