U.S. must avert impending oil crisis, or pay the price

0 Comments | Insight on the News, May 1, 1995 | by Donald Paul Hodel, | Milton Copulos

America is sleepwalking into a disaster. Within the next two years, we will experience another oil shock. There still may be a chance to avert the crisis, but Congress, the administration, the media and the oil industry itself refuse to recognize the warning signs. It is the average American, however, who will pay for their indifference.

The source of the threat is the growing unrest and instability of Saudi Arabia and its potential to explode into civil strife. Should this happen, Saudi Arabia's 8 million barrels per day of oil exports will be interrupted for months, or even years. Representing roughly 13 percent of world oil production and 26 percent of world reserves, the loss of Saudi output would be nearly three times as great as the two previous oil-supply disruptions. The shock wave it would send through the global economy would be of unprecedented proportions.

How did this situation develop? Simply, despite a 42 percent drop in national income, the Saudi royal family has not curbed its profligate spending habits. As a result, the country is left with too little money to run the economy. The manifestations of this fact are all too clear on the streets of Riyadh where, for the first time, there is a visible homeless population. Unemployment is rampant, and at least one international risk insurer has canceled open-ended lines of credit for Saudis because they are not paying their bills. An even more ominous indication of the kingdom's precarious stability is the liquidation of in-country assets by wealthy Saudis who are not members of the royal family, further exacerbating the kingdom's financial crisis. Accompanying the economic turmoil is an unprecedented level of rebellious talk in the streets.

The volatility of the situation is greatly amplified by the illness of aging King Fahd. Since ascending the throne, King Fahd has maintained a delicate balance among the desert kingdom's competing nations, keeping their historic enmities in check. When the king passes away, no prospective successor will easily duplicate this feat.

Even worse is the fact that Fahd's likely heir, Crown Prince Abdullah, is a Muslim Fundamentalist with openly anti-American sentiments. Therefore, even in the absence of a civil war, the kingdom's vast oil production and reserves will fall under the control of a regime certain to be antagonistic to the West.

What do we do about the situation?

First, we should dispatch a highlevel, credible emissary (former President Bush, for example) to the kingdom to counsel Fahd about the dangers of the royal family's spending and urge a more prudent employment of his nation's oil revenues. There still might be enough time to forestall a civil revolt if such a program were instituted immediately, and in earnest. Unfortunately, it is unlikely that the current administration would take this course.

Second, we should take the longneeded steps that would serve to reduce America's import dependence. Congress must move to restore the vitality of the domestic oil industry. For nearly three decades, the financial well-being of the domestic oil industry has been steadily undermined by federal actions ranging from price controls to the Windfall Profits Tax to overly restrictive leasing policies on federal lands.

Since 1985, these domestic problems have been compounded by the predatory pricing policy the Saudis instituted to expand their market stare at the expense of higher-cost producers (such as the United States). The move brought on a collapse of world oil prices and of domestic oil and gas exploration, discouraged conservation, and made alternative energy sources uneconomic.

Congress should, at a minimum, restore the full depletion allowance for all new wells, eliminate the tax on so called intangible drilling costs and ease restrictions on leasing federal lands for oil exploration. Given the low prices prevailing on world markets, however, even these incentives may generate only modest amounts of new investment. Therefore, Congress also should consider imposing a floor price for oil through a variable fee on petroleum imports to prevent predatory pricing from destroying America's entire domestic energy industry.

Congress also should assure that no obstacles exist to the use of alternatives to oil. In the past, restrictions on such fuels as natural gas prevented them from achieving their fun potential as alternatives to imported oil.

A final measure is to make clear that a disruption there will be met with an immediate sale of oil from the Strategic Petroleum Reserve. This action will help quell market fears, curb speculation and give time to the market to adjust.

One thing Congress must avoid at all costs: the imposition of controls. The temptation for Congress to impose price and allocation controls will be enormous once the oil shock hits. Members will be bombarded with demands to "do something." Yet, our experience with controls from 1973 to 1981 makes their pernicious nature clear. Rather than helping to alleviate shortages and keep prices down, their actual effect was exactly the opposite. Oil prices actually rose by 750 percent during the dozen years the controls were in effect and declined by almost two-thirds after they were lifted.