TCS Daily

Oil Econ 101

By Arnold Kling - January 20, 2003 12:00 AM

My instinct is to oppose any policy initiative that is touted to fight child pornography or the drug menace. It's not that I'm in favor of child porn or drug abuse. However, I am conditioned by experience to expect proposals supposedly aimed at those problems to turn out to be ineffectual while threatening damage to the Internet and/or the Constitution.

But the worst refuge of scoundrels, in my opinion, is the line that "we need to reduce our dependence on foreign oil in order to fight terrorism." When I hear that, my baloney-sandwich detector really starts vibrating. I am ready to reject whatever is on offer, whether it be oil drilling in Alaska, regulations on SUV's, or some new synthetic fuels program.

Oil Is Oil

I teach economics in high school. Here is a good question for an introductory course:

If the United States currently satisfies 10 percent of its demand for oil with imports from Saudi Arabia, by what percentage must the U.S. reduce its consumption in order to be 100 percent independent of Saudi oil?

If you answer "10 percent," you get an F. If we reduce oil consumption by 10 percent, then we will not cut 100 percent of our imports from Saudi Arabia. We cannot arrange to consume only American oil and no Saudi oil. Oil is oil. If we reduce demand by 10 percent, we probably will reduce our demand for Saudi oil by 10 percent, not by 100 percent.

(Actually, oil is not exactly the same everywhere. Saudi oil is somewhat cheaper to extract and refine than other oil. What this means is that if we reduce our demand for oil, the impact is likely to be felt somewhat more on other oil, and somewhat less on Saudi oil. Lowering our demand by 10 percent might not lower Saudi oil exports much at all. But we can leave that aside for now. Just keep in mind that oil is oil.)

But what if we passed a law against importing Saudi oil? In that case, the Saudis would export their oil to us via Venezuela. They might not physically use this channel, but if the Venezuelans sell more oil to the U.S. and the Saudis sell more to other customers no longer served by Venezuelans, it has the same effect.

I have received emails suggesting that I should switch brands of gasoline to a company that supposedly does not use Saudi oil. But if we all did that, then the brand that we switched to would run out of non-Saudi oil and have to start using Saudi oil.

The correct answer to the question of how much the United States would have to reduced oil consumption in order to drive our demand for Saudi oil to zero is 100 percent. Only if we stop using oil altogether can we be sure that we are not contributing to the demand for Saudi oil. Oil is oil, so that any demand for oil creates demand for Saudi oil

Once we recognize that oil is oil, it should be apparent how futile it is to try to reduce Saudi oil revenues by cutting back on our demand. True, if we reduce demand, then total world demand falls, and oil prices and revenues fall, but unless we take truly Draconian steps the effects are likely to be small.

How to Reduce Oil Consumption

I personally do not care much for SUV's, but the way I express my dislike for them is the same way that I express my dislike for cable television. I don't purchase those products. (One could argue that the fact that other people buy SUV's causes me some harm. For that matter, one could make the same argument about cable television. However, those effects are small, below what I would regard as the threshold that might justify regulation.)

As an economist, even if you told me that the policy objective is to reduce oil consumption, I would not opt for regulating the fuel economy of SUV's as my first choice. I would prefer a large gasoline tax (preferable phased in to give people time to adjust). This would give people a clear incentive to conserve, while allowing them to find the most efficient means to do so.

In contrast, regulating fuel economy of SUV's is inefficient. Old SUV's would be exempt from regulation, and they would tend to stay in the market longer. And new fuel-efficient SUV's would cost less per mile to drive at the margin, leading to more miles driven, which would cancel out some or all of the effect on gasoline consumption.

Of course, this still begs the question of why we should be reducing oil consumption below the natural level incented by the cost of oil in the market. One can argue that lower oil consumption would lead to lower pollution, but if fighting pollution is the objective then it is more efficient to tax or regulate pollution than to regulate fuel economy. From a pollution-fighting standpoint, it would be better to have a low-pollution car that gets 15 miles to the gallon than a high-pollution car that gets 40 miles to the gallon.

Just Take the Oil

The issue that leads people to suggest that we need to "reduce our dependence on foreign oil" is the apparent role of Saudi Arabia in funding terrorism. Someone who I love dearly but is a bit naive once said to me, "We've got a powerful army. The Saudis don't have bupkis. We should just take the oil!"

She is naive, because she is not sensitive to the issue of imperialism and world public opinion. To wage a war for oil would be to offend the sensibilities of large numbers of decent, well-educated people.

However, if Saudi funding for terrorism is the crux of the issue, then we have little choice but to confront the Saudis directly. The indirect approach of reducing oil demand is meaningless. Only a worldwide boycott of Saudi oil would effectively cut off their oil revenues. Yet such a boycott would be difficult to orchestrate and would itself be tantamount to war.

The problem with sponsoring terrorism is not that oil revenues are the source of funds. The problem with sponsoring terrorism is that it is grossly immoral. People introduce the connection with oil revenues as a red herring. As we have seen, trying to make a connection between fighting terrorism and regulating SUV's or drilling for Alaskan oil is a violation of Oil Econ 101. At best, it is a way to dodge the challenge posed by apparent Saudi support for terror. At worst, it is an attempt to advance another agenda using terrorism as an excuse.

The real issue is the alleged Saudi funding of terror. No matter how much demand we withdraw from the oil market, the Saudis will have revenue and we have to be concerned with how they use it.

If cutting off funding is critical to winning the war on terror, then we must press the Saudis on that point. We should tell them that we respect their rights as a sovereign nation, but they owe it to the community of nations to not fund terrorists. If that approach does not work, then it is a waste of time to wring our hands over our "dependence on foreign oil." The only fallback position is the one suggested by my wife: just take the oil.


Why don't we take the oil?
The whole world seems to accuse of us of doing this even though we are not. Why do I know we are not? Oil prices would be down if we were.

Maybe the incremental extra effort needed to simply steal the oil would be justified?


We don't even need to steal oil from the middle east... out of the top 5 providers of oil to us, only Saudi Arabia is from that region. We'd be better off developing our own local drilling and refining.

Big Mike
CEO of Santa Ana Bail Bonds

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