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A public policy blog from AEI
Even a world-famous statesman can have a bad day, and for former Secretary of State George P. Shultz, the most recent was August 12, when his essay on the evils of foreign oil “dependence” was published. Apart from an initial discussion of the wondrous efficiency with which the Nixon Administration Cabinet Task Force on Oil Import Control implemented its public comment process, Mr. Shultz’ central arguments are:
• A limitation of oil imports from the Middle East to about 10% of US consumption would reduce the adverse effects of a severe oil supply disruption.
• Pre-crisis “investments” in emergency supplies would reduce the need for “rationing” during a supply disruption.
• The oil embargo imposed by Arab OPEC in October 1973 had important adverse effects on the US not felt by such nations as the UK and France that “pull[ed] away from” US policies toward Israel.
Each of those arguments is exceptionally weak. Because there can be only one price in the world oil market (apart from the minor effects of differential transport costs and other such small factors), an oil supply disruption, whatever its magnitude, has the same effect on all oil-consuming economies regardless of the level of their “dependence.” That is: a change in the world market price of oil, resulting from a supply disruption or any other cause, has price effects that are identical (except for such second-order parameters as exchange rates) for nations importing all or none of their oil. If economies importing disproportionately large proportions of their consumption were to experience larger price increases than other economies, the market would reallocate supplies until prices were equalized; that is a central implication of the profit motive. Therefore, the degree of import “dependence” is irrelevant.
Pre-crisis stockpiling of crude oil and/or refined products, and perhaps substitute fuels, might mitigate the price effects of a supply disruption, but unless we are prepared to limit exports — a policy the implementation of which would be far more complex and politicized than commonly assumed — such policies would reduce prices worldwide rather than in the US alone. More generally, Mr. Shultz’s essay does not delve into two crucial issues: why private sector investment in emergency supplies might be insufficient, and what effect government stockpiling might have on private stockpiling. With respect to the first, it is reasonable to hypothesize that private preparation is inefficiently small because of the prospect that price controls would be imposed in the event of an important supply disruption and increase in world market prices, thus weakening private investment incentives. Moreover, the corporation income tax is likely to induce the private sector to discount the future profitability of current investments too heavily, thus again reducing incentives for private preparations.
In terms of the effect of government stockpiling on incentives for private stockpiling: the more oil that the government stores, the smaller the future price effects of a supply disruption, under the assumption that the government actually would use its stockpile during a disruption, whether directly or indirectly. That is a topic for another day. But in a simple world, an increase in government preparation is very likely to be offset at least in part by a decline in private preparation, so that Mr. Shultz’s casual assumption that “pre-crisis investments… [would] increase domestic emergency supplies” is far less obvious than a first glance might suggest.
The 1973 Arab OPEC embargo was directed at the US and at the Netherlands. The embargo by itself, for the reasons discussed above, had no effect: both nations faced the same increase in the world market price of oil confronting all other oil-consuming nations. The price increase was caused not by the embargo, but instead by the production cut implemented by Arab OPEC generally, and by Saudi Arabia in particular. Finally, the gasoline lines and other market chaos observed in the US were the result of the price and allocation controls imposed by the Nixon administration. Note that in 1979 in the wake of the overthrow of the Shah of Iran, there was no embargo; but there was a reduction in international supplies, there were price and allocation controls in the US, and again there was market chaos, courtesy this time of the Carter administration.
There is just something about oil imports or “dependence” that has a deeply corrosive effect on clear thinking, a commodity all too rare in policy discussions generally, and in the Beltway in particular.
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