June 28, 2007 2:47PM

Heritage — Out of Energy

To many people, the Cato Institute and the Heritage Foundation are closely related ideological siblings. This causes me no end of frustration. There are plenty of rather significant differences between us — health care, immigration, foreign policy, the War in Iraq, etc. — but even in areas where you would think we might agree, we often don't. Like energy.

For instance, according to Heritage, the Ur-commandment for the federal energy policy is as follows:

Lawmakers should implement a long-term energy plan that balances supply and demand, ensures reliable and affordable supplies of energy for the future, and provides responsible stewardship of the nation's resources.

To me, that smells of Soviet 5/10-year economic planning. If you really think a bunch of vote-maximizing politicians with no particular expertise in energy markets can competently execute those tasks, then God bless you. Me? I'd rather leave those tasks to the market, thank you very much.

Still, views over there are not monolithic. Ben Lieberman and I generally see eye-to-eye, but Ariel Cohen might as well be titled "Senior Research Fellow for Anti-Taylor Studies." See, for instance, his worries about energy security and his support for turning Justice Department antitrust lawyers loose on OPEC.

The tension between the Lieberman and Cohen is palpable. Cohen, for instance, was generally happy with President Bush's 2007 State of the Union address, which called for America to break its "addiction to oil." Lieberman, on the other hand, was not. And some outside voices given a platform at Heritage muddy the waters further. For instance, Daniel Fine appears willing to entertain federal subsidies for oil shale development, and no one over there — to my knowledge — has said a discouraging word about Republican efforts to launch "Synfuels, Part Deux."

So it was with some interest that I read a new missive out of Heritage from Stuart Butler and Kim Holmes — Heritage's vice presidents for domestic and foreign policy studies respectively — on the 12 principles that should guide federal energy policy. When the bosses step in to lay down some guidelines in a policy arena where tension has previously existed, one should pay attention.

And what do they have to say? Not much that I would say. Let's go through their principles one by one.

1. Avoid costly environmental regulatory man­dates that will achieve little environmental gain.

No problem here, but the idea that environmental regulations are constraining investment in America's energy infrastructure is greatly overblown, as we'll see when we get to their nearly-identical Principle #5.

2. Rely on the private sector's research and development capabilities.

Fine, but Butler & Holmes support generalized rather than specific tax subsidies for energy R&D, which they imply here but make more explicit when they get to Principle #7. Given where energy prices are today, I don't think investors need any encouragement from the taxpayer to engage in these undertakings. Profit incentives established by endogenous price signals should suffice.

3. Urge government agencies to learn from the private sector.

Yeah, that will happen. The reason government agencies rarely behave like private businesses is because their incentives are different. Public actors gain utility by maximizing political capital. Market actors gain utility by maximizing profits.

That aside, Butler & Holmes seem to be saying that the Pentagon and other federal agencies should be willing to pay more for fuel efficiency than they do at present. Maybe, but fuel efficiency costs money, and unless we know the gains associated with those expenditures versus the gains associated with alternative expenditures, we can't confidently offer advice.

4. Make all sources of energy within U.S. bor­ders accessible.

I'm not so sure. If policymakers could allocate scarce resources among competing user groups in an efficient manner without price signals to guide them, then the Soviet Union would probably still be around. We don't really know whether ANWR, for instance, is more valuably employed as an oil platform or as a wildnerness preserve because we have only limited information about the public's willingness to pay for either. Now, I suspect that, it these things were left to the market, that there would be more energy development on federal lands, but I don't know that. It would be best to privatize the lands at issue and let market actors sort this out.

Regardless, Butler & Holmes argue that "Failure to make full use of these domestic energy resources exacer­bates the security and cost problems caused by geopolitical events and makes America more vulnerable to supply disruptions and price increases." This is nonsense. Supply disruptions anywhere in the world increase the price of crude oil everywhere in the world to more-or-less the same degree, so increasing domestic production does nothing to insulate our economy from malicious producers or random disruption events abroad.

Nor would increasing domestic production reduce revenue to producers very much given that there are not enough untapped reserves in the United States to affect world crude oil prices in any substantial manner.

Nor is increasing domestic production a hedge against the threat of embargo for the simple reason that embargoes can't work absent a deep-sea navy to enforce them. All that happened in 1973, for instance, was instead of buying our oil from Arab members of OPEC, we bought our oil from people who bought their oil from Arab members of OPEC and shifted to non-OPEC producers, displacing their customers who then bought from Arab members of OPEC.

5. Remove artificial constraints on the domes­tic energy infrastructure, including unneces­sarily severe environmental regulations.

While it would be convenient for anti-government types like me to argue that "Red tape has restrained the expansion of refineries, construction of new pipelines and electricity transmission lines, and construction of new power plants," that's not entirely true. Refineries are not being built because (i) it's cheaper to expand capacity at existing refineries, and (ii) because it's a hotly competitive industry with little return on investment capital compared to the returns available to the industry elsewhere. Transmission lines aren't getting built for a whole host of reasons, and "red tape" is only a relatively minor contributor to the problem.

The proposition that "Several key domestic energy sources, particularly coal and nuclear power, can fulfill their potential and thus help to achieve energy security only if costly regula­tions and procedural requirements are revised or eliminated" likewise misdiagnoses the problems. Nuclear power plants aren't built because they are simply too expensive, and even the industry's own trade association thinks the regulatory problems identified by Butler & Holmes are relatively nonexistent (something I learned when sitting on a panel with Richard Myers, Vice President at the Nuclear Energy Institute, at a conference sponsored by the Manhattan Institute earlier this year).

6. Ensure that any effort to reduce reliance on foreign oil is grounded in policies that are best for the economy.

I could write a book on the absurdity of the popular campaign against "foreign oil," but rather than turn this blog post into said book, let me simply propose the following: The case for importing oil is the same as the case for importing anything else. If it's cheaper to get oil from a foreign producer than from a domestic producer, then economic health is improved by buying from the former source rather than the latter. The case for free trade applies to oil just as much as it applies to steel, tennis shoes, or television sets. There is no "BTU exception" to Adam Smith's observations on this matter.

Anyway, Butler & Holmes want to have the feds lead us in a campaign to diversify America's energy supplies. Poppycock. If diversification makes sense as a hedge against supply disruption, then why won't market actors efficiently diversify of their own accord? Until I hear a reasonable answer to that question, we can deposit this idea into the wastebasket labeled "ideas that make sense for one minute until you think about them for two."

7. Manage risks to critical energy infrastruc­ture as a responsibility shared jointly by the government and the private sector.

Why should the taxpayer expend funds to protect private property? Don't property owners have every incentive to optimally invest to protect assets worth millions and in some cases billions of dollars? What exact market failure leads us to think that they don't?

Unfortunately, Butler & Holmes don't get into that. Instead they simply assert that "Government can best understand threats and take steps to reduce them, while businesses can best assess their own vulnerabilities and address them effectively." Question #1: what makes them think that government assesses risk better than market actors? Question #2: what makes them think that government knows better than private asset owners about how to efficiently address whatever risks are identified?

8. Establish effective risk communications for energy issues.

I'm all for educating the public about energy issues and energy risks, but I'm not convinced that vote-maximizing politicians with no expertise in energy markets are in any position to constructively engage in that activity. Nor am I convinced that Joe Public trusts government enough to take anything it says on these matters at face value. And he's right.

9. Develop foreign policies that thwart the capacity of coercive regimes to employ energy supplies as an economic weapon.

The oil weapon is the foreign policy equivalent of UFOs — often reported to exist but never produced for public inspection. Can producers purposefully and signficantly cut way back on production and consequently harm consumers? Sure, in theory. Have they ever done so? No. Why? Because it would blow their economies to smithereens. Simply put, producers need the money derived from oil revenues more than consumers need the oil from the same.

Regardless, the ability of producers to inflict damage on consumers in this manner is entirely related to how dependent consumers are on oil ... from whatever source. There is no foreign policy in the world that can change that fact.

10. Sustain access to the global marketplace.

Sure, count me in. But when Butler & Holmes go on to say that, "To accomplish this, the United States should retain the capability to use all of the instruments of national power — including military, diplomatic, law enforcement, intelligence, economic, and informational power — in any theater where U.S. interests could be at risk," I get off the policy train. I simply do not think the U.S. should be threatening war if a country is not producing as much oil as we might like or is adopting anti-market policies that we disapprove of. In short, I say "no blood for oil."

11. Discourage restrictive international regimes.

Sure, but how? As noted above, Heritage's Ariel Cohen thinks we should prosecute OPEC as a criminal conspiracy in violation of U.S. antitrust law. I think that's nuts. Short of that, how can we "discourage these practices" — as Butler & Holmes put it? Beats me.

How about a policy of providing no favors whatsoever to cartel members? That is, no military assistance, no foreign aid, and no bilateral actions that provide any benefit to those countries whatsoever? That might make some sense, but then we'd have to get out of Iraq (why are we defending a regime that's a member of said criminal conspiracy?), tell Saudi Arabia that, as far as al Qaeda is concerned, they are on their own, and inform Kuwait that we regret having lifted a finger to defend that country against fellow-conspirator Saddam Hussein and won't do that again were Iran, say, to come a-knocking. That would be fine with me, but I doubt that it would be fine with Butler & Holmes.

12. Recognize that not all trading partners are equal.

On the surface, what's to argue with here? Of course Canada (our number one source of imported oil) is not the same as Venezuela (our fourth largest supplier of imported oil). But Butler & Holmes is smuggling in a more ambitious argument. To wit, America (presumably when possible) should trade with producers that share our political values and not with those who don't.

Decisions about where America gets its oil are not, however, made by some bureaucrat in the Department of Energy. They are made by thousands of private actors in energy markets. So a policy of discouraging imports from countries a, b, and c while encouraging imports from countries x, y, and z by neccessity means regulating a vast swath of the market previously unmolested by government.

What would be gained by this? Nothing much. As noted above, America's vulnerability to supply disruptions abroad is dictated by how much oil it uses, not where its oil comes from. Producer revenues are dictated by global supply and demand curves that establish price, not by the identity of the parties lining up for its oil. All that would result from the intervention suggested by Butler & Holmes is slightly higher domestic oil prices. That's because buying from a distant "good actor" (say, Norway) rather than a much closer "bad actor" (say, Venezuela) means paying higher transportation prices.

Butler & Holmes conclude with this: "Americans clearly understand that freedom, opportunity, and their very quality of life suffer when abundant, affordable energy supplies are threatened."

Americans may think that, but that doesn't make it so.

Even with the highest inflation-adjusted gasoline prices in recorded history and plenty of threats in the air menacing supplies abroad, Americans spend less on automotive fuel as a percentage of their take-home pay than they have during most of modern history and the economy continues to hum along nicely. Even a worse-case scenario, like the loss of Saudi Arabia to the world market (13% of global supply), would likely have no more impact than the loss of Iran to the world market (10% of global supply) had in the late 1970s (which is particularly the case given that much of the damage from the 1978 price explosion was due to the oil price controls in place at that time, not a rise in oil prices per se). America survived the latter event and would certainly survive the hypothetical equivalent today without losing its "freedom, opportunity, or quality of life."

It would be nice to have more allies on the Right. Unfortunately, I find that the Sierra Club is more willing to entertain free market energy policies than is the venerable Heritage Foundation. And that's sad.