Another Blue Ribbon Energy Report Falls Flat

Yesterday saw the publication of yet another blue ribbon style report on energy policy, this one called Recommendations to the Nation on Reducing U.S. Oil Dependence, from the Energy Security Leadership Council.  The press went wild.  Color me unimpressed.

The authors of the report are convinced that America’s reliance on foreign oil is a dangerous thing.  But why?  Panicky narratives abound, but none of them are particularly well informed.

Consider the widespread concern about the prospect of being cut off from supply.  Relying on foreign producers for oil means that we might find ourselves without physical access to petroleum if those foreign producers were to decide to shut us out.  But that worry is only plausible if you fail to understand and fully appreciate the fungible nature of the global oil market.  As MIT oil economist M.A. Adelman once wrote:

Rarely has a word [“access”] been so compact of error and confusion. Nobody has ever been denied access to oil: anyone willing to pay the current price could have more than he wanted. One may assume what he likes about future demand, supply, and market control, and conclude that the future price will be high or low, but that price will clear the market in the future as in the past. The worry about “access” assumes something queer indeed: that all of the producing countries will join in refusing to sell to some particular buyer—for what strange motive is never discussed … it takes only one other country, with a desire for gain, to cure this irrationality. 

The 1973 oil embargo proves the point.  As Adelman notes,  

The “embargo” of 1973–4 was a sham. Diversion was not even necessary, it was simply a swap of customers and suppliers between Arab and non-Arab sources… .  The good news is that the United States cannot be embargoed, leaving other countries undisturbed. 

In short, the only way for producers to keep their oil out of America is to impose a military blockade of U.S. ports.  Market agents – not agents of the producer states – decide where oil goes when it enters the market.  As long as someone is willing to buy oil from a producing state and then sell it to the United States, no shut off is possible absent military force.

OK, so physical access isn’t the problem – our vulnerability to producer-induced price spikes is the real worry.  Or is it? 

Recent macroeconomic studies suggest that the economy is nowhere near as vulnerable to oil-induced recessions as once thought.  How else to explain the world’s gangbuster economic performance in the teeth of the present price spike?

Nor is it reasonable to fear that producers might shut down drilling platforms in an act of global economic spite.  Producers need oil revenues more than consumers need the oil.  Even vitriolic anti-American regimes such as revolutionary Iran, Iraq under Saddam Hussein, and Libya prior to our recent rapprochement, have shown no interest in committing the economic and political suicide entailed in shutting down the only significant source of revenue they have.

Supply disruptions can and do happen, but they have historically tended to be modest and temporary.  Over the past 50 years, we’ve had 12 supply crises with an average of a 5.4 percent reduction in global oil supply for each event, and none of those supply disruptions lasted for more than 9 months.

Question #1 – don’t market agents have every incentive to insure against such events?  That, after all, is what futures contracts, oil inventories, and energy efficient technologies are for.  To argue that government must act to hedge against such possibilities is to argue that governmental actors are better risk managers than market actors.  And that is a fairly dubious proposition.

Question #2 – what sense does it make to say goodbye to an energy source that is cheap most of the time but expensive some of the time (oil) and hello to an energy source that is expensive all of the time but presumably more price stable (biofuels)?  If any individual company or consumer wants to go that route, then fine.  But why should the government dictate energy choices for every single person and corporate entity in the United States?  Are market actors so incapable of making intelligent decisions about what to buy that the feds have to step in?  And if so, why not have the feds grab the reins in other sectors of the economy?  

The final worry is that our dependence on foreign oil requires military expenditures and foreign policy contortions to keep producers safe and friendly.  But this is nonsense.  If the U.S. didn’t pay to secure oil production and tanker traffic abroad, producers would do so as long as the marginal costs associated with security expenditures were less than the marginal benefits associated with oil production – as they certainly are.  The U.S. military “oil mission” is really a welfare program in disguise.  And friendly relationships have nothing to do with it.  As noted above, without oil revenues, producing states could not pay their troops, fund their secret police, build luxurious palaces, or even feed their people (read: keep riots from breaking out).  Whether they like us or not, they have to produce, and as long as they produce, we will have oil to buy as long as we are willing to pay the market clearing price.

All of this is well known and completely uncontroversial to oil economists of the Left, Right, and Center.  But it’s a complete revelation to foreign policy mavens and military professionals, who simply do not understand a single thing about the oil market.  Unfortunately, too many people in Washington listen to the latter but not the former.

And yes, it simply kills me to see that Cato board member Fred Smith (CEO of Federal Express) is one of the two co-chairmen of the group that issued this report.