EconoMonitor

Offshoring is a More Dubious Policy, When the Question is Oil Drilling

President Bush yesterday removed a long-standing executive moratorium on off-shore oil drilling (NYT, 7/15/2008, p.A13), a move also supported by presidential candidate John McCain.

The Democrats responded:

(1) that this was an election-year stunt,

(2) that the move would be too small to make a difference

(3) that it would bring no downward pressure on oil prices at the crucial short-term horizon, and

(4) that it would not ultimately help move the country in the direction of energy security. The Democrats have the right answer, but are giving the wrong reasons.

No doubt they are right that it is a political stunt. A Congressional ban on offshore drilling has been in effect since 1981, so the President’s action is moot. But making a political point in this way is in itself fair game. The Republicans are trying to blame high oil prices on the Democrats. Similarly, the Democrats’ response could well be the right one from the viewpoint of political gamesmanship.

But I should try to stick to economics in my blog, rather than politics. Let’s drill down on what makes sense for policy.

On grounds of good economic policy the Democrats’ chosen arguments are beside the point. It is true that all the oil in all the offshore sites adds up to “a few months of national consumption.” It would not amount to much as a percentage of world reserves, which is the relevant metric for determining the effect on price. But if one believed there was no cost to more domestic oil drilling, then one should conclude that every little bit helps. Basic economic theory tells us to judge proposals by the ratio of benefits to costs, not by the absolute magnitude of the benefits.

Regarding point (3), both parties are responding (unsurprisingly) to the American public’s great sensitivity to short-term prices for gasoline (in the summer) and home heating oil (in the winter). No doubt high prices are causing a lot of hardship. (And even if it takes five years to develop new oil reserves, the knowledge that the oil was coming should put a bit of downward pressure on prices today.) But market prices are high today for a reason. What is the market failure that would call for government intervention in the oil market?

The most obvious market failures are the externalities that characterize air pollution and emission of greenhouse gases. These of course are reasons for higher prices, not lower. I am struck every time I see an article on politicians’ commitment to action on global climate change sitting side-by-side in the newspaper with an article on their opposition to oil price increases.

I realize that higher energy taxes are politically out of the question at this point. But I could imagine legislation that would automatically raise energy taxes if and when oil prices fall, thereby putting a floor at recent levels and providing industry with the clear incentive to undertake the long-term investment in energy-saving equipment and technology that we badly need. Rebate the proceeds by fixing the AMT, or removing the payroll tax on low-income Americans, one answer to the income distribution point. In any case McCain’s proposal for a gas tax holiday is a spectacularly bad idea.

The other obvious market failure is national security, and here we come to argument number (4), and the central point of my post. While Americans need to recognize that achieving complete energy security is an impossible goal, it should indeed by a national goal to reduce our dependence on imported oil. We could thereby reduce our need to fight messy wars in the Mideast and to coddle unpalatable autocrats worldwide. But, in the first place, conservation is the largest and most sustainable component of such a strategy. In the second place, as high as world energy prices are now by historical standards, this is not the worst-case geopolitical crisis that we should be seeking to protect our economy against. That worst-case scenario is a prolonged loss of world access to Gulf oil stemming from some combination of military conflict with Iran, anti-Western popular uprisings in the region, terrorism, and/or nuclear or radiological weapons.

Once the long-term goal of “energy security” policy is properly seen to be amelioration of the economic effects of such a disaster, the Republican policy of “drain America first” is seen to be precisely the wrong response. We don’t want to maximize current domestic production. Rather we want to leave the oil underground (or underwater) for decades, until we really need it, until we are so desperate that the economic benefits really do outweigh the costs. (The costs are chiefly environmental, of course. But the Republicans have often been keen on giving oil companies access to nationally owned reserves at prices that are even below market costs. Same as hard-rock mining for miners, subsidized water for farmers, and grazing rights on federal lands for ranchers. But the hypocrisy of anti-Washington self-reliance rhetoric in the Western states is another story.)

Thus the Democrats have it precisely backwards. The problem with Republican proposals to re-open domestic oil drilling is not that we desperately need the oil right now, whereas new oil discoveries would not come on line for 5 years or more. Rather it is that we might truly desperately need the oil in 20 or 30 years, and so don’t want to use it up over the next decade.


Originally published at Jeff Frankel’s Weblog and reproduced here with the author’s permission.

7 Responses to “Offshoring is a More Dubious Policy, When the Question is Oil Drilling”

GuestJuly 17th, 2008 at 9:30 pm

very good points. any chance that Prez Obama will introduce a carbon tax? Would you support that?

AnonymousJuly 17th, 2008 at 9:33 pm

What about a cap & trade system for emissions? Is this the right approach to the negative externalities of fossil fuel use? Prof: your view?

GuestJuly 19th, 2008 at 3:12 am

Some comments:1. Exactly why does the existence of a "Congressional ban on offshore drilling has been in effect since 1981" make "the President’s action is moot"? From what standard dictionaries give for the definition of "moot," your claim does not necessarily follow.2. You join the chorus singing that we Americans need to "reduce our dependence on imported oil." While it’s true that plenty of countries with hideous regimes are major oil producers, I was wondering: are you terribly concerned about the oil which Canada exports to the US?

Marcus AnonymousJuly 19th, 2008 at 3:42 pm

JF,Good post, but one inconsistency and one major omission: the real environmental risks.If you’re really worried about “..we might truly desperately need the oil in 20 or 30 years, and so don’t want to use it up over the next decade,” then the time to start is now. The Democrats’ chief complaint is that this isn’t a quick, short-term fix because it won’t have any impact for at least 10 years and it won’t have a major impact for 20 or 30 years. The lead times on ultra-deep drilling projects are really staggering. If we have a crisis in 20 or 30 years it won’t do us any good to start then. It’s not a reserve unless it can be quickly accessed. You’d at least have to put the facilities in place (and pay to keep them idol) or pay to produce and store. Besides, oil is transitional. The only issues are “when we are going to have to move past the oil age”, “in what manner”, and “whether the transition is orderly or not.” Will electric vehicles be the dominant automotive design in 25 years or 50 years? Will that be because electric vehicles are better and cheaper or because oil peaked in 2019? Or will we just use synthetic liquid fuels? I don’t know. But if we desperately need more oil at some point, it’s likely to be between tomorrow and 2050. So now is a good time to start opening the OCS. You did not mention the feared environmental impacts. Opponents of the drilling implied that any oil spill would be some environmental mega-disaster, another Chernobyl. Yes, the Exxon Valdez and Santa Barbara oil spill were awful, but not infinitely awful. Those coasts are recovering. There is no 30-mile dead zone around them. After all the oil tankers that were sunk in WWII, people did not have to wait until 1975 to go swimming again. Those who pay attention to such things know that in 2004 Hurricane Ivan did astonishing and totally unanticipated damage to the offshore infrastructure by setting off massive underwater mudslides. However, for whatever reason (probably extremely robust design) there were no significant offshore oil spills.There was an interesting and informative article on Bloomberg recently about oil production in Beverly Hills. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a5fyvudrWEoo#(Not a new plot twist to the Beverly Hillbillies). There are 97 producing oil wells in Beverly Hills: a bunch by a high-end mall and one by the High School. It’s just not true that oil wells all cause massive and unavoidable environmental damage. We should be aware of the risks. We should require that the oil companies control and minimize the risks and internalize the costs. But when we set policy we should not exaggerate the risks. They are not infinite. Risks need to be properly described and weighed against the economic benefits of more oil. Unfortunately, oil prices have just performed a Nazi Doctor experiment and we don’t have many better alternatives in the short run.

AnonymousJuly 19th, 2008 at 10:04 pm

-the Republican policy of “drain America first”I guess the author somehow missed the $700 billionwe are sending out of the country every year topay for imported oil. (drain Arabia first)?And the fact that existing domestic production is indecline along with that of some some our major supplierswho will soon be using more of their production internally.The looming issue is not only price, it is raw supply.Can you say rationing ? It is the Democrats, not Republicans who have beenpromoting the "drain America first policy."Drain our cash reserves, drain our balance of payments,drain our national security, drain corporate viablity, and finally drain every American’s wallet.Ah, but there is always the SPRO. Don’t the Democrats want to drain that too?

Jeff FrankelJuly 20th, 2008 at 8:57 am

Lots of good comments. To the first two (Guest and Anonymous), yes I believe that a carbon tax or cap and trade system are the right response. I don’t have a strong preference between the two; in fact economic theory says that they are equivalent — leaving out the admittedly important complications that can come from (i) uncertainty, (ii) distribution, and (iii) political acceptability. A carbon tax would be preferable in the sense that it is politically less liable to give windfalls to fossil fuel producing firms, as grandfathering of tradable permits would do. Cap and trade would almost be more palatable to the public politically than the word "tax," and also would mesh better with the global climate regime if, like, Kyoto, it remains quantity-based rather than price-based.Moving on, when I called the President’s action "moot", I simply wanted to record that the policy change doesn’t take place until Congress lifts its own moratorium. But I did indicate that I think it is perfectly legitimate for a politician to take positions or actions, for example to signal one’s preferences, even knowing they are unlikely to take effect. And yes, even though I think the US would be better off, — economically, environmentally, and security-wise — if we imported less oil, no I am not worried about the fuels we import from Canada (although those tar sands do have extra high environmental costs).Marcus makes lots of good points. It is true that my argument about Draining America First only works if you believe that the biggest risk — a cut-off of Gulf oil — would be a very long-term phenomenon. Otherwise, one could imagine in theory doing the off-shore exploration and drilling and infrastructure development with a legislated proviso that no oil is to flow unless and until the world loses access to Gulf oil and the price goes over (say) $300 a barrel. But I doubt if that is practical; the environmentalists and the oil companies would both prevent it. Regarding the environmental costs, I agree that they are high, potentially very high; I did in fact mention them, but did not elaborate on the point, in order to keep the post short.Moving to the next Anonymous, I would have said that "Drain our cash reserves, drain our balance of payments, drain our national security, drain corporate viablity, and finally drain every American’s wallet." describes very well the consequences of Republican presidents’ actions like the Bush fiscal policy, not the actions of Democratic presidents. But I am very glad that you and whose party persuasion (apparently) differs from mine are reading my blog, and responding. I fear that the internet is contributing to a trend where most Americans only listen to or read people with whom they are confident they will agree.JF

Marcus AnonymousJuly 20th, 2008 at 3:58 pm

JF,You must have read my post too quickly. You said: "Regarding the environmental costs, I agree that they are high, potentially very high".On the contrary I emphasized that the environmentalists are exaggerating the risks. When I’ve gone swimming at the beach and looked at the offshore oil rigs, I regarded them as interesting.Marcus Anonymous

Most Read | Featured | Popular

Blogger Spotlight

Emre Deliveli The Kapali Carsi

Emre Deliveli is a freelance consultant, part-time lecturer in economics and columnist. Previously, Emre worked as economist for Citi Istanbul, covering Turkey and the Balkans. He was previously Director of Economic Studies at the Economic Policy Research Foundation of Turkey in Ankara and has has also worked at the World Bank, OECD, McKinsey and the Central Bank of Turkey. Emre holds a B.A., summa cum laude, from Yale University and undertook his PhD studies at Harvard University, in Economics.

Economics Blog Aggregator

Our favorite economics blogs aggregated.