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The End of Energy—A Commentary by Michael J. Graetz

The following commentary was published in The World Financial Review in October 2011.

The End of Energy
By Michael J. Graetz

“Americans have been living an energy delusion for forty years. Until we face the facts about price, our energy incompetence will continue—and along with it the unraveling of our environment, security, and independence.”

Four decades of U.S. energy policy failures

One may deny that the United States is engaged in military operations today in Iraq and Libya, but not in Syria, only because of oil, but no one should believe that oil is irrelevant to our foreign policy or military choices. Before the 1970s, U.S. oil was plentiful and cheap. The job of U.S. energy regulators—primarily state agencies, such as the Oklahoma Commerce Commission and the Texas Railroad Commission—had been mostly to manage abundance. In effect, they limited output so as not to exceed domestic consumption. In 1969 the Shah of Iran offered to sell the U.S. a million barrels a day for a decade at $1 a barrel, but, in a decision we would soon regret, U.S. policy makers brushed his offer aside with hardly any discussion. The most conspicuous U.S. policy involving oil was an import quota, adopted in the 1950s by Dwight Eisenhower, which kept foreign oil out of the country and raised oil prices high enough to satisfy the oil producers but not so high as to make consumers fret. So we used up our own oil when it was cheap and plentiful rather than buying Middle East and Venezuelan oil when it was even cheaper. We are still paying for that mistake today. Beginning in the 1970s, we have had to import most of the oil we use, much of it from the Middle East.

“We used up our own oil when it was cheap and plentiful rather than buying Middle East and Venezuelan oil when it was even cheaper. We are still paying for that mistake.”

This spring, following a major energy policy speech by President Obama along with the White House’s simultaneous release of his new “Blueprint for a Secure Energy Future,” many newspapers, ran a cartoon by Jeff Stahler depicting the eight presidents from Richard Nixon to Barack Obama each supplying one word of the refrain: “We must reduce our dependency on Mideast oil.” Nearly a year earlier, following President Obama’s first Oval Office address to the nation, setting forth his energy policy goals nearly two months after the explosion of BP’s Deepwater Horizon drilling rig in the Gulf of Mexico, Jon Stewart of Comedy Central’s The Daily Show played clips from the same eight presidents: all promising to end our dependence on oil, all offering other energy alternatives, and all setting deadlines for reaching their goals 1. The problem, of course, is that four decades of U.S. energy policy failures are not funny.

The geopolitics of oil

Ironically, our problems started with Maommar al-Qaddafi. Before he came along, OPEC had been an ineffectual and unimportant oil cartel. But in 1969 the 27-year-old Qaddafi led a military coup that overthrew Libya’s ineffectual King Idris. Soon thereafter he expelled all American and British troops from their large Libyan airbases. Then—when Libya was then supplying about 30 percent of Europe’s oil imports—Qaddafi demanded substantial increases in the price of Libya’s oil. Executives of the major oil companies, badly underestimating both Qaddafi’s determination and his political skill, essentially ignored him. So Qaddafi went after one of the smaller independent companies, Occidental Petroleum, cutting its production by more than one-third and demanding a substantial price hike. Unlike the majors, with sources of oil spread throughout the Middle East and elsewhere, Occidental depended entirely on Libyan oil to supply its European refineries. Qaddafi knew that. After Exxon refused to make up Occidental’s shortfall by selling it the oil it needed at cost, Occidental capitulated to Qaddafi’s price demands. This gave the majority of profits to Libya, ending the historical 50-50 profit split between the oil companies and the oil-producing nations that had prevailed since the 1950s. It also unmistakably and irrevocably shifted power over Middle East oil away from the large oil companies to the oil-producing nations.

Following Qaddafi’s lead, Abu Dhabi, Iran, Iraq, Kuwait, Qatar, and Saudi Arabia soon also sought higher prices for their oil. But the price increases didn’t satisfy Qaddafi or the other nations of the Organization of Petroleum Exporting Countries for long. The OPEC nations all began demanding “equity participation” in the oil companies. This was a turning point as the oil-producing countries established control over the oil in their lands. Soon thereafter, the Arab embargo of October 1973 made it unmistakable that control over Middle East oil production had shifted away from U.S. and European oil companies — which for decades had controlled both the level of output and prices — to the nations in whose lands the oil was located.

The structural factors that had made OPEC ineffective for the first decade of its existence had irreversibly changed. In March 1971, Texas oil producers announced that they had reached peak oil production and that their output would begin to decline. By 1973, the United States was consuming 6.3 million barrels of oil per day more than it produced; Japan was consuming 5 million more barrels than it produced; and Europe was consuming 13.1 million more than it produced. The Middle East countries were exporting more than 20 million barrels every day. Middle Eastern petroleum reserves were estimated to exceed 316 billion barrels, while those in every other region of the world were estimated to have fallen to less than 50 billion. The Middle East governments were now in control. The oil companies’ new role would be primarily as their technicians, sales agents, and managers.

Richard Nixon, the first of the eight presidents to confront our nation’s new dependence on foreign oil, thought he had a solution. Nixon turned to our Cold War allies Saudi Arabia and Iran for support, in spite of their autocratic governments. Washington provided both countries with military aid and encouraged their economic interdependence with the United States, hoping that in exchange they would serve as the Middle East’s “two pillars” of anti-Soviet stability and free-flowing oil. Needless to say, that plan failed miserably.

The Iranian “pillar” collapsed a few years later in an anti-American Islamic revolution. And even though Saudi Arabia and the other Arab states of the Persian Gulf have nominally remained U.S. allies, they, not we, hold the key strings in the relationship. The United States continues to support and aid these regimes despite their authoritarianism. If the sheiks of the Persian Gulf decide to put down popular unrest with the same fervor Libya has, the hands of U.S. foreign policy almost certainly will be tied.

“Our domestic energy policies have failed us largely because we have failed to put a true price on the fuels we consume.”

Inadequate responses to the “Addiction to Oil”

The problem, however, is not only that the United States has had the wrong foreign policy. The problem also lies in the failures of U.S. domestic policies. For 40 years, we have had no effective response to what all eight presidents have called our “addiction to oil.” Notwithstanding all the new laws that Congress has enacted since the oil embargo of 1973, we have still not solved our nation’s energy problems.

Four decades after energy policy first took center stage in our nation’s political discourse, the fundamental difficulties that brought energy onto the policy forefront remain unresolved. The United States has 4 percent of the world’s population, but consumes a quarter of the world’s oil. In 1970, we imported less than half a billion barrels of oil; by 1980, our imports had increased to nearly 2 billion. Now, we import about 3.5 billion barrels annually. Much comes from Canada and Mexico, but we still depend on OPEC oil to keep our vehicles moving. We import 13 million barrels of oil every day, 5 million from OPEC countries.

Our domestic energy policies have failed us largely because we have refused to put a true price on the fuels we consume. In 1973 about 17 percent of our nation’s electricity was generated from oil; now just over one percent is. The good news is that producing electric power is now essentially a domestic enterprise. The bad news is that electricity accounts for about 40 percent of U.S. carbon dioxide emissions, and given the risks from climate change and other pollutants, our heavy reliance on dirty coal-fired electricity has become just another problem to solve.

“The problem is not only that the United States has had the wrong foreign policy. The problem also lies in the failures of U.S. domestic policies. For 40 years, we have had no effective response to what all eight presidents have called our “addiction to oil.”

Our presidents have all sought a technological “silver bullet” to solve our problems. Richard Nixon, for example, was certain the nuclear “breeder reactor” was the solution to our nation’s energy problems; Jimmy Carter placed his bets on fueling our cars with “synfuels” made from coal. Both cost billions, and both came to naught.

In Congress, narrow regional interests have taken precedence over national needs. Our legislators have routinely provided large subsidies and tax breaks to favored constituents and contributors. The heavily subsidized ethanol industry has no doubt been the most costly of these pork-barrel programs. The most scandalous involved ‘black liquor,” a concoction made from wood pulp, which increased, rather than reduced, petroleum use, while bestowing about $8 billion of government largesse on the paper industry. In 2008, congressional “earmarks” for specific institutions, projects, or locations took up one-half of the total R&D budget for biomass, one-third for wind, and more than one-quarter for hydrogen projects—an absurd way to try to develop and commercialize new energy technologies.

Sherlock Holmes famously instructed us to be alert to a dog that fails to bark. In the large kennel of policies that the United States has deployed to address energy policy, one dog fails to bark, the same dog that never barks. In the thousands of pages of energy legislation and regulations enacted since energy policy came to the fore in the 1970s, Congress has never demanded that Americans pay a price that reflects the true price of the energy they consume. For nearly a decade following the oil embargo of 1973, Congress refused even to allow the price of gas at the pump to rise enough to reflect the worldwide market price of oil. And now, not one of our political leaders urges requiring gasoline prices to include, for example, the costs of keeping oil moving safely from the Persian Gulf into our gas tanks, or insists that our electricity prices reflect the costs of coal pollution or of nuclear power safety.

The problem, of course, is that reflecting these kinds of costs in the price of energy would require taxing energy consumption, rather than subsidizing its production. As our nation’s massive public debt reminds us, it is far easier for our government to spend than to tax. And during the same decade that energy policy came to the fore, antitax rhetoric and political promises became the linchpin holding the Republican coalition together. Past efforts to tax energy consumption are not encouraging: Jimmy Carter failed in his effort to tax gasoline; Bill Clinton’s BTU energy tax plan suffered a resounding defeat. So we should not be surprised that no American politician is now proposing that we tax what we want to reduce — petroleum use and electricity consumption from fossil fuels — and use the revenues to reduce taxes on things we want to increase, such as wages or jobs.

Despite all the costs our nation has paid in lives and treasure to keep oil moving here from the Middle East, our political leaders remain afraid to ask the American public to do anything tough. Despite all his bold talk of policy initiatives, President Obama hasn’t even asked Americans to drive less or more slowly, to turn down our thermostats, or even to turn off the lights when we leave a room.

Many of the “incentives” the president promised, if not most, will, unfortunately, take the shape of tax breaks, despite nearly half a century of compelling evidence—from ethanol, wind power, hybrid vehicles, and energy-saving home improvements, to name just a few—that they are wasteful and inadequate to the task.

And “command and control” regulations have also been overly expensive and frequently ineffective. But, given the failure in 2009 of climate change legislation in Congress, President Obama fails to say anything about the well-known cost savings advantages of cap-and-trade regulatory regimes. In the midst of the recent political food fight over the debt ceiling, President Obama announced the largest increase in automobile fuel efficiency standards since they were first enacted more than 35 years ago. He said that the Environmental Protection Agency will issue new regulations requiring automobile manufacturers to double their cars’ average fuel consumption from the current 27.5 miles per gallon to 54.5 mpg by 2025.

“The fuel efficiency standards (known as CAFE) may rank among our nation’s most successful energy policies, but it is a long way from the best we might have had.”

The fuel efficiency standards (known as CAFE) were enacted in 1975. Then-president Gerald Ford, who had long served in Congress as the representative of Grand Rapids, Michigan, a city about 160 miles from Detroit and itself home to an automobile manufacturer early in the twentieth century, had no enthusiasm for mandatory rules of any sort. And the automobile industry and its powerful unions had another key ally in Congress: Michigan Congressman John Dingell, who then chaired the key House subcommittee. So the mileage requirements enacted in 1975 did little more than ratify changes already under way in the auto industry, and the penalties for failing to meet them were trivial. Writing at the time, political journalist Elizabeth Drew of The New Yorker described the new standards as “in effect, a product of the Ford Motor Company.”

During the mid-1980s, the fuel economy standards actually did come to have some bite when oil prices tumbled downward. But an exception for light trucks—supposedly to help farmers—soon became a loophole large enough to drive a Hummer through and permitted gas-guzzling SUVs to capture more than a quarter of our nation’s automobile sales by the turn of the century. In addition, because the mileage requirements turn on the average fuel economy of each manufacturer’s fleet, they favored Japanese manufacturers of small cars, who easily met them and, then in response to Americans’ taste for larger cars, began to sell larger less fuel-efficient brands, such as the Lexus and Infiniti. Despite its weaknesses, however, many experts now regard CAFE as the most effective conservation measure adopted in response to the OPEC oil embargo and price increases of the 1970s –faint praise indeed. CAFE may rank among our nation’s most successful energy policies, but it is a long way from the best we might have had.

Unlike a gasoline tax, the CAFE standards create no incentive for people to reduce how much they drive. Economists have estimated that a gasoline tax of just 25 cents a gallon could have saved as much oil as the fuel efficiency standards at one-third of their costs to the economy. Alternatively, allowing automobile manufacturers to trade gas mileage allowances would also allow us to achieve our overall fuel economy goals at much lower costs to our economy. A cap-and-trade type fuel efficiency regime would permit those automobile manufacturers who are most efficient at increasing gas mileage to sell excess credits to firms that find increasing the mileage of their vehicles more costly. This would bring down substantially the total costs to auto manufacturers of complying with the mileage standards. Given the serious economic challenges that automobile companies now face, lowering the costs of complying with CAFE should be a national priority.

“Either a cap and trade regime or a gas tax would eliminate more gasoline consumption at a fraction of CAFE’s costs. But no one is urging us to move in either of those directions.”

But President Obama is handcuffed. He is worried about the risks from climate change and anxious to reduce our dependence on imported oil, but, unfortunately, persuading Congress to enact policies to reduce the regulatory costs of CAFE is not an option. Pledges signed by virtually all Republican members of Congress take gasoline taxes off the table. And, despite its conservative Republican pedigree and its notable success in reducing emissions from electric power plants that cause acid rain, “cap and trade,” has now become an epithet in the American political process, no matter how cost effective and limited in scope. It is so poorly understood by the public that political opportunities for mischaracterization and demagoguery are ubiquitous. So our dysfunctional politics keep us mired in an inefficient regulatory structure enacted more than 35 years ago. And unnecessary costs to our fragile economy multiply. Either a cap and trade regime or a gas tax would eliminate more gasoline consumption at a fraction of CAFE’s costs. But no one is urging us to move in either of those directions.

“We may hope that the current turmoil in the Middle East, along with the recent nuclear power troubles in Japan, will galvanize our nation into action.”

Lessons from history?

Despite all the laws Congress has enacted since 1973, our policies have always been inadequate. In 2010, when energy legislation most recently cratered, we learned once again the potent political barriers to any effective action. We may hope that the current turmoil in the Middle East, along with the recent nuclear power troubles in Japan, will galvanize our nation into action. Our history, however, offers little cause for optimism: knowing our past failures is not enough to prevent us from repeating them. 

Michael J. Graetz is the Isidor and Seville Sulzbacher Professor of Law and the Columbia Alumni Professor of Tax Law at Columbia Law School. Before coming to Columbia in 2009, he was the Justus S. Hotchkiss Professor of Law at Yale University, where he had taught since 1983. His specialties include taxation, tax policy, health law and policy, and income security law and policy. In addition to Yale and Columbia, Mr. Graetz has taught at Virginia, the University of Southern California, and the California Institute of Technology; he also served in the U.S. Treasury in Washington, D.C. in the early 1990s.

His most recent book is The End of Energy: The Unmaking of America’s Environment, Security and Independence, published in spring 2011 by MIT Press. His books on taxation include 100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States, (Yale University Press, 2008) and Death by A Thousand Cuts: The Fight over Taxing Inherited Wealth (Princeton University Press, 2005).