A Different Kind of Oil Pollution

To include the mighty American oil industry among the disadvantaged in our society may seem to call for a quantum flight of the imagination, but an oilman puts the case that the press and the politicians widely misunderstand and/or misrepresent the industry’s motives and problems.

As we have grown more aware of the vulnerability of our environment, the concept of “pollution” has been extended by analogy to include not only obtrusive noises, but also aesthetic “pollution” of natural beauty. Generally, and often quite rightly, the petroleum industry has found itself on the defensive, having to solve problems that previously were not considered problems at all.

The change in our society’s standards—the extension of the concept of pollution—has naturally been led by the intellectuals and the politicians; but “environmental protection” has become an accepted part of the petroleum industry. It is time, therefore, for the intellectuals and the politicians to help us clean up the intellectual and political environment in which the petroleum industry must operate. In other words, those who have set standards for others should also set standards for themselves, not by censorship, but by a sense of responsibility.

Just as smog is more than an aesthetic problem, the pollution of the economic atmosphere involves far more than the sensibilities of oilmen. First, there is a prolonged political uncertainty which, added to the already high economic risks, makes long-term planning by the major companies for such essentials as refineries and deepwater ports even more difficult. What is a serious inconvenience for the major companies may prove to be fatal to the surviving 10,000 independent wildcatters whose numbers have already been reduced be more than half during the last twenty years.

Second, a corrosive distrust and suspicion of everyone’s motives afflicts all of our institutions, not just the petroleum industry. Indeed, in the examples that follow, the subject is really not petroleum economics, but a general malaise that extends far beyond the controversy over one industry. Here are some examples of the “pollution of reality.”

1. The Industry as Adversary

Recently a number of oilmen have discovered that in private conversations many politicians from nonproducing states will agree with them, and then say, “but my constituents won’t buy it.” It has become advantageous to run against the oil industry and dangerous to try to explain its economic problems and requirements. Obviously, such a situation tends to feed upon itself. If legislation is passed that makes the national situation worse, the tendency will be to blame the industry again—and enact still more punitive legislation.

This situation is not unique to oil, but is a fundamental problem of democracy, making it all the more curious that no one is seeking to overcome the problem. On the contrary, the tendency is to reward those who aggravate the condition, as witness our next example.

2. “Obscene Profits”

If Senator Henry M. Jackson were not considered by some to be a “leading contender for the Democratic nomination.” the “most effective senator,” and one of the Senate’s “experts” on energy, it might be best to ignore his repeated use of the term “obscene” to describe the profits of the major oil companies. And it might seem to be in the interest of the independent oil producers to put as much distance as possible between themselves and these “obscene” giant companies. But pollution is indeed everyone’s battle, so let it be recognized that this excess of rhetoric is as corrosive to our social fabric as any sulfuric exhausts which bring tears to the eyes. Frankly, we cannot escape the suspicion that had the erstwhile hawk Senator Jackson, in his televised hearings, been questioning the patriotism of alleged leftists rather than oil company executives, the specter of “McCarthyism” resurrected would have been raised by every fastidious civil libertarian.

In the present atmosphere it would seem that a politician, or any self-appointed “guardian of the public interest.” can say anything about the oil industry without arousing skepticism or offending the traditional American sense of fair play. For instance, two United States senators charged that during the oil embargo tankers were waiting offshore for higher prices and that one thousand offshore wells were closed down to reduce the domestic supply. Actually, the federal government had information that these charges were baseless, but the senators did not bother to check in advance, nor did they bother to correct their misstatements after they were demonstrated to be false.

This is not just a matter of abstract truth. Some members of Congress seem determined to punish the profitability of the major companies, and in their ignorance of the industry thev have fostered proposals which would fall most heavily on the small independents—hurting the majors, yes, but at the same time leaving them a virtual monopoly in exploration for oil.

3. “Excess” and “Windfall” Profits

While our objections to terms such as “obscene profits" and to abusive treatment of oil company executives are based on noneconomic factors that affect all Americans, it must be acknowledged that oilmen have a specific self-interest in the concepts of so-called excess or windfall profits. Nonetheless, we believe that general economic ignorance about the capitalist system, not just ignorance about one industry, underlies these concepts. If Americans decide to abandon capitalism, the decision should not be taken on the basis of such manifest ignorance. Specifically, while the profits of the oil industry rose sharply, principally as the result of inventory markups, the percentage increases were generally reported without noting that return on investment in the industry has been depressed for at least ten years. Moreover, the earnings of the petroleum industry still are not in excess of its capital requirements, which some estimates put as high as one and one-half trillion dollars over the next ten years.

There are only three ways for an industry to accumulate Capital: internally, by current profits; through outside investment made in hope of future profits; or by force through taxation. If an industry is “excessively profitable,” capital will flow in to produce more of the “excessively” profitable product; and, in time, a surplus of the product will result in lower prices, with profits falling to or even below the average.

While “excess" and “windfall” sound more precise economically than “obscene,” no definition of the terms has been generally agreed upon. Is it not strange that words with no precise definition in a quantifiable subject like economics can be bantered about for years without anyone having asked, What does that mean?

4.Increasing Production

It should be noted that higher prices will not result in immediate increases in supplies. The February 17 issue of Time quotes Senator Jackson as complaining, “Just look at the record: production has gone down steadily.” This is precisely the kind of misleading presentation of an isolated fact that endangers far more than the oil industry. If domestic production had soared when prices rose, it would have demonstrated that the shortage was artificial, or contrived.

The New England and Middle Atlantic stales continue to resist the development of potentially rich reserves off their own shores, citing both environmental and economic reasons. But one asks in vain if they have considered the environmental and economic damage done by their dependence on tanker-carried foreign oil. On the heavily developed Texas and Louisiana coasts, conditions may not be pristine, but there are both fish offshore and jobs onshore. The leaders of the Northeast are shirking their responsibility to their region and country: they should adopt a more farsighted policy.

5. Subsidizing OPEC

The price of “old” oil (production from pre-embargo wells except high-cost, low-production “stripper” wells) is frozen at $5.25 per barrel. This lowers the average cost of all oil, increasing the demand for the product which must then be imported from the Organization of Petroleum Exporting Countries. It is an ironic consequence of economic ignorance that many politicians who claim to be friends of Israel increase the relative strength of the Arabs by causing the domestic oil industry in effect to subsidize OPEC. Of course, perpetuating our dependence on imported oil also reduces our ability to pursue an independent policy, and not only in the Mideast.

6. Resource Allocation and Income Redistribution

Here is another area in which intellectuals and politicians ought to help clarify, not confuse, the issue. The question of pricing needs to be separated from the matter of income redistribution. When the cost of anything goes up, the burden almost always falls most heavily on the poor. This is a part of the economic definition of poverty and it is not “heartless” to recognize it as a fact. It may be desirable to redistribute income, but we should ask ourselves if we want to do so by the very inefficient and counterproductive means of subsidizing energy consumption, by either rationing, allocation, or price regulation.

7. Deregulation of Natural Gas Prices

Federal Power Commission regulation has kept the price of natural gas below market for more than twenty years. The result has been to encourage the wasteful use of natural gas and to discourage exploration for a clean fuel that is also an important source of fertilizer. Moreover, the controlled wellhead price was, and is, far below replacement costs. (Gas wells are often very deep.) Consequently, there are growing shortages which cannot be quickly overcome by imports.

Deregulation would not mean suddenly soaring utility bills in the North. Much of current production is under long-term contract, and roughly 80 percent of the cost paid bv the northern consumer goes for pipelines and utility transmissions.

Politicians from the consuming states still seem to see only the short-run political costs of deregulation. Perhaps the charade of “stepby-step” deregulation will deceive the people and spare their representatives and senators some embarrassment. But is this the function of regulation, to disguise the consequences of folly? Perhaps it often is.

8. The Environment and the Oil Depletion Allowance

The environmental question is too complex for consideration here, but it is worth noting that the independent oil producers account for more than 85 percent of the onshore drilling. Virtually all the offshore drilling is done by the majors. But have we found many “environmentalists" who oppose offshore drilling also lobbying for the retention of the depletion allowance which is vital to the people who drill onshore? The question is rhetorical. We know that for ideological reasons, the same people are often “pro-environment" and “anti-depletion.”There is an additional irony in the fact that “cleaning up” the environment has increased the capital requirements of the oil industry. Conversely, as the net profits of the oil industry rise, the industry can pay for more environmental protection.

But, of course, the depletion allowance has become the very symbol of tax “loopholes"; so much so that many people seem to have forgotten that “depletion” does not refer to taxes per se, but to a limited and exhaustible commodity. A hundred and one minerals have some sort of depletion allowance, and forty-two carry the same 22 percent rate that has applied to oil and gas, but we hear little discussion of these. Equity aside, the real economic justification for the depletion allowance is to provide an incentive for taking the high risk involved in searching for oil and gas. People take the high risk of drilling for oil because, to put it bluntly, there is a chance of a high return. But if the tax laws make a high return impossible, there will be no high risk taken, nor should there be, because it would be a profligate waste of resources.

The Role of Government

During the 1950s and 1960s the domestic industry also sought to limit the importation of “cheap foreign crude" through import quotas which roughly stabilized the price of oil but gradually allowed imports to rise to almost 40 percent of consumption at present.

The domestic oil industry based its arguments on the proposition that the United States should not become dependent upon “cheap foreign crude”—for it would soon cease to be cheap. Recent events have, of course, borne this out; and yet even today, many intelligent individuals say that we should not have “wasted" our domestic reserves when we could have used all that “cheap foreign crude.” This is not an academic point about who was right, but holds clear implications for future policy decisions. The objective of the domestic industry was to maintain a domestic capacity to find oil—and, by the way, a domestic distribution network. Had we relied totally upon that “cheap foreign crude.” we would have more oil in the ground today, but little prospect of getting it out—and no way to deliver it. Even with this limited protection the domestic industry was declining into a state of gradual liquidation, with exploration falling yearly. Production peaked in 1970.

This is not to imply that we should never have imported any foreign crude, or should seek total self-sufficiency in the near future, but simply that the value of secure domestic resources cannot be measured by the world market prices of petroleum which may be in temporary oversupply. The paradox is that the security of this source of cheap crude depends upon our not being dependent on it. Perhaps it is not surprising that the public is confused.

A related misconception, common among many intelligent people, is that there is an inherent contradiction between conservation and development. Conservation, however, means not nonuse, but efficient use; therefore, a relatively high price would encourage both conservation and development.

What we have tried to do here is not to give an economics lesson, but to show that it is possible—all too possible—to let ideology lead us into economic absurdity, wherein we oppose the only means to our objectives. Income redistribution is good politics, but long-term planning is not. Politicians talk of Operation Independence and then propose heavy new taxes on the only people who can deliver that “independence.”Supporters of Israel cause the domestic oil industry to subsidize OPEC. Environmentalists strive to weaken the major source of onshore oil and clean natural gas. Profit rates of the oil and gas industry are called “excessive" without regard for the industry’s “excessive” capital requirements.

Unfortunately this state of affairs is not unique to the “energy question.” In the current cacophony, no one can get a hearing because no one can be heard. No issues are effectively joined because, as Canadian Prime Minister Trudeau once observed, the principal function of politics would seem to be “entertainment,” rather than a search for policy. Since the Senate became a mass launching pad for the White House, its enfeebled value as a debating forum has totally expired. “Hearings” have become more like “show trials,” in which the principal function of “expert opinion” is to help candidates avoid contact with possibly unpopular truth. The really effective Washington “vested interests” are those intertwined lobbies and government agencies that thrive on institutionalizing rather than on solving problems.

The average citizen will no doubt have difficulty believing that it is not “exposure” the oil and gas industry fears, but the danger that it will get no real hearing at all. Consider, then, the implications for the average citizen. If a major segment of our economy cannot be heard, what chance has a little man—or one with an even less popular cause? □