The Economics and Politics of the United States Oil Industry, 1920-1990: Profits, Populism, and Petroleum.

The Economics and Politics of the United States Oil Industry, 1920-1990: Profits, Populism, and Petroleum by STEVE ISSER (New York: Garland Publishing, 1996), 472 pages. ISBN 0-8153-2307-7.

If one were to imagine an archaeologist from the future finding a time capsule with descriptions of the array of institutions, markets, and policies governing today's oil industry, but without any historical, economic or political context from which each emerged, he or she would undoubtedly be quite puzzled by a strange assortment of items. The Strategic Petroleum Reserve, OPEC, the IEA, the Department of Energy, the API, the IPAA, the foreign tax credit, the depletion allowance, IDC's--all are current artifacts of a rich history of institutions and policies affecting the industry. If curiosity led him or her to delve into the history of these artifacts, an even more curious layer of institutional artifacts would be discovered--the Windfall Profits Tax, price controls, the entitlements program, FERC, oil import quotas, prorationing, conservation, the "rule of capture," unitization, the Federal Oil Conservation Board, and "Hot oil," to name a few. Upon such a find, the observer would hope to be able to piece together a history of how all of these artifacts came to be created. If a bit more ambitious, he or she might hope to discover how these artifacts were intended to facilitate adaptation to the market environment of the twentieth century. If even more ambitious, he or she might attempt to examine the degree to which each artifact succeeded or failed to facilitate such adaptation. In this search process, a discovery of this book by Steve Isser would initially appear to be a valuable find, particularly for the first of these tasks. For the more ambitious explorer hoping to advance to the second or third task, the book would be less helpful.

In the first three chapters, Isser has assembled a detailed history of the development of the U.S. policies affecting the oil industry over the period 1920 to 1990. In the first Chapter, he describes the evolution of the system of domestic and international control that emerged between the World Wars. This system consisted of coordinated controls on foreign production by the Seven Sisters, with the support of the U.S. government, and a domestic system of production controls implemented by the states and coordinated by the Federal government. Chapter 2 then turns to the post-World War II period, when growing U.S. imports of foreign oil, principally from the Middle East, increasingly threatened high cost domestic producers and led to eventual implementation of a system of import controls by the late 50s, first voluntary, later mandatory. Chapter 3 traces the events leading to the abandonment of import controls in the early 70s, followed by the shock of the Arab embargo and a sequence of highly incoherent U.S. policies responding to that crisis, beginning with price controls on domestic production, an entitlements program to allocate underpriced domestic crude to refiners in an attempt to insulate domestic consumers from the ongoing volatility in world crude oil prices. He tracks the erosion of political support for these controls, eventually leading to their demise, beginning in the Carter administration and completed under Reagan. He describes the buildup of the Strategic Petroleum Reserve, the weakening of world oil prices, culminating in the 1986 price collapse, and the failed attempt at new import controls as dependence on foreign oil increased afterwards.

Generally, these first three chapters are meticulously assembled, and stand alone as a useful historical reference document. However, these chapters do suffer from two shortcomings whose significance becomes increasingly apparent later in the book. First, the coverage is less than even, with by far the greatest attention and detail dedicated to the pre-1973 years, when arguably the most important historical changes have been in the years since that time. Second, the perspective adopted is almost entirely dominated by domestic concerns, when arguably the central theme of energy policy over the second half of the century has been that of adaptation to a world of growing energy interdependence. There is far too little attention in the discussion devoted to changes in the international market occurring over this time period, and the manner in which those changes drove U.S. policy. This lack of attention is apparent by the end of Chapter 3, when the author summarizes policies in the years since 1970 as follows:

"After 20 years of attempts at formulating an energy policy that would

reduce the nation's dependence on foreign oil, the best that six

presidents and Congress could accomplish was to raise gasoline prices

by 9.3 cents a gallon, establish CAFE standards ... and a few

inconsequential tax incentives and research programs. The one fact

which stood out after two decades was that energy taxes were a third

rail of electoral politics. The combination of the Gulf War, Global

Warming and never ending deficits were insufficient to provide the

political will to increase energy taxes."

This summary presumes that a policy of reducing dependence by 1990 is equally desirable as it was (if it was) in 1970. In fact, one key insight in the policy literature examining that period has been the distinction between dependence and vulnerability, and the recognition that policies suited to reducing vulnerability may have no particular relationship to dependence on foreign oil.

Before building on this flawed premise, however, Isser treats the reader to a review in Chapter 4 of the role economists have played in the energy policy process. This review is comprehensive, and depending on one's perspective, either entertaining, humbling, or downright humiliating. In any case (with the possible exception of the last few pages of the Chapter, to which we will return later) the review is a highlight of the study, presenting a concise overview of much of the literature that contemporary energy economists would regard as the core of their field. Isser begins with exhaustible resource theory of Gray and Hotelling, the extensions and generalizations of Herfindahl and Gordon, and the simplistic misapplication of these models motivated by the Limits to Growth resource exhaustion scares in the 70s. The theme of simplistic misapplication was not entirely new in the resource economics field, as the Malthusian-Ricardian premise of inevitably increasing scarcity had given rise to the Conservation Movement, empirically challenged by Barnett and Morse in 1963. Apart from exhaustibility, the common pool problem gave rise to externalities in oil and gas production, but strong dissension among economists and within industry whether mandatory unitization was required as a remedy. Perhaps the most serious market failure attributed to oil markets, however, was that of the competitiveness or lack thereof in the world petroleum industry. Frankel had argued in 1946 that large scale integration was the natural outcome of the extreme economies of scale in the oil industry, and consequently that attempts to improve competitiveness by divestiture were likely to be counterproductive. Adelman and others argued by the early 60s that oil was not a natural monopoly, that the cartelization of world supply had unraveled since World War II, and that price would continue to fall, which it did through most of the 60s. Since 1973, however, successful re-cartelization of the market by OPEC in an attempt to sustain the effects of an embargo caused even more divergence in the guidance offered by economists.

There were several factors at the root of this divergence. First, there was no clearly accepted theory of oligopoly behavior clearly suited to characterizing OPEC behavior, making prediction hazardous. Nonetheless, after 1973 there was a flood of models incorporating oligopoly theory and exhaustibility. Few were empirically verified, and the forecasts were wildly different for that reason alone Moreover, given the fact that the new cartel activity followed on the heels of an embargo, and a costly supply shock, there was a clear mingling of issues of national security costs and macroeconomic costs with cartel behavior, making for a wide range of estimates of a "security premium" attached to incremental barrels of oil consumption, and widely divergent policy prescriptions. These diverse policy prescriptions combined with a long history of inaccurate empirical predictions, arguably might have limited the influence of economists in the policy process. Perhaps they did, but as Isser points out, the qualitative insights provided by economists throughout the period were quite influential in the policy process. It is here, unfortunately, that he ends the Chapter, with a seriously deficient summary of these qualitative insights that reinforces the shortcomings of the previous Chapters. He states that:

"Economists proved themselves lousy prophets of detailed economic

behavior, ... [but] have been relatively consistent and accurate in many

of their qualitative observations. The need for an oil stockpile, to

alleviate the ill effects of dependence on imports, has been a consistent

theme ... Most economists also agreed that higher prices were the most

effective method of inducing conservation."

True enough. But this was a small subset of the qualitative insights drawn from economic analyses during the period. Generally, the period since the early 70s was an awkward period in the U.S. relationship to the world market. The initial problem was perceived as dependence, which had led to high prices and massive redistribution of wealth both domestically and internationally. The policy remedies initially proposed were attempts to reverse these effects, with a complicated domestic price control and allocation scheme designed to insulate the domestic market by defeating the effects of international market changes. Economic analysis played a key role in exposing the fundamental flaws in this failed paradigm, which since the late 70s has been progressively replaced by a systematic reliance on markets to adapt to inevitable increases in oil import dependence. In such a new paradigm, prices are not the problem, but rather the key signal for allocation of resources. When high, they will induce conservation, new supply, and reduced dependence, precisely what was called for during the 70s, but systematically defeated by misguided policies. But when low, they will reduce conservation, trim high cost supplies, and increase dependence. This was the key lesson of the 70s--that despite the shortcomings of oil markets (concentration, cartelization, externalities, redistribution effects), the guidance provided by the market mechanism is more reliable than government controls (however well meaning) in managing interdependence with the external world.