TCS Daily

The Independence Chimera

By Robert Krol - April 22, 2005 12:00 AM

There appears to be one issue on which both Republicans and Democrats agree -- the high price of oil and the vulnerability of Middle-East supplies to terrorist attacks calls for a national effort to reduce oil imports. Concern over our dependence on foreign oil was expressed in the Bush Administration's 2001 National Energy Policy report. John Kerry talked about the need to reduce oil imports during last year's presidential campaign. More recently, a bipartisan group of former national-security officials urged President Bush to accelerate the adoption of energy policies designed to reduce U.S. consumption of foreign oil.

The proponents of this popular view (which seems to include just about everyone) appear to believe that by reducing oil imports we will be able to avoid the harmful effects of oil-price swings, prevent energy shortages, and reduce our military presence in the Middle East. Unfortunately, reducing oil imports will not free us from these concerns.

Even if the United States produced enough oil to meet its own needs, a major supply disruption in Saudi Arabia or elsewhere would cause U.S. prices to rise. The price of U.S. oil moves in tandem with prices abroad.

This is because today's oil markets are highly integrated. Oil is sold wherever it can fetch the highest price. When oil is in short supply in one region, prices rise, attracting oil from other parts of the world. As a result, oil prices equalize around the globe (adjusting for differences in quality and transportation costs). Energy "independence" cannot change this fact.

The experience of the United Kingdom illustrates the mythical benefits of energy independence. By the late 1970s, the development of North Sea oil made the United Kingdom energy-independent. Yet the United Kingdom was not spared when the revolution in Iran and the Iraq-Iran War caused dramatic increases in oil prices around the world. With the oil price spike, the energy-independent U.K. suffered a major recession along with oil-importing countries such as the United States and Japan. Even though the U.K. was able to satisfy all its energy needs from domestic sources, it was unable to avoid the higher unemployment and slower growth that accompany higher oil prices.

In order for the United States to become truly energy independent, it would have to cut itself off from the rest of the world's energy trade. Trade in oil, and its substitutes, including natural gas, would have to grind to a halt. Of course, such an energy policy, while accomplishing the stated goal of energy independence, would be prohibitively expensive.

The cost of gasoline, other fuels, and home heating oil would rise dramatically. The economy would stumble precipitously. We'd be energy independent, but with a much lower standard of living.

Currently, a little over 60 percent of our oil consumption is imported, with about 20 percent coming from the Persian-Gulf region. The concern is that, if we continue our use of foreign oil, at some point, we will be faced with a repeat of the shortages and gas lines of the 1970s. However, without federally imposed price controls, there would have been no lines.

Today, without price controls, gasoline prices adjust quickly, keeping markets in balance, avoiding shortages. Higher energy prices are unpleasant, but for most, it beats waiting in line for hours to purchase gasoline. And high prices encourage efforts to conserve--they make investment in fuel efficient technology and production capacity attractive.

It's certainly the case that a significant reason for the U.S. strategic interest in the Middle East is related to the area's substantial oil reserves. However, reducing oil imports will not eliminate our strategic interest in the region. The global threat of terrorism, American interests in establishing democratic regimes, and our alliance with Israel will keep U.S. policy focused on the region for some time to come.

An important danger with the call for energy independence is that it can lead to greater government involvement in energy markets. Whether it's subsidizing uneconomic alternative fuels, or schemes to promote conservation, government planning rarely identifies efficient alternatives. As soon as funds are set aside, industry lobbyists will begin the effort to influence spending and program decisions.

The view that reducing our dependence on foreign oil would benefit the United States remains the consensus view of policymakers and politicians in this country. Sadly, this misdirected view ignores the realities of global-oil markets.

Efforts to reduce oil imports will not protect from us from the higher prices associated with supply disruptions, prevent shortages, or reduce our presence in the Middle East.

Robert Krol is a professor in the Department of Economics at California State University, Northridge. Previously, he worked as an international energy economist in banking.



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