12. Memorandum From the Director of the White House Energy Policy Staff (Freeman) to the Executive Director of the Cabinet Task Force on Oil Import Control (Areeda)1

This is in response to your request at the October 13 meeting2 for suggestions as to possible policy alternatives. My thinking is, of course, tentative and subject to change as we all give these matters further thought.

The Essence of the Problem

Thus far we have not given sufficient attention to what seems to me the essence of our problem—a concrete definition of national security. Just what is it an oil import policy is supposed to guard against, what damage to the United States is likely to occur if oil imports are interrupted, and how likely is it to happen?

The oil import control program can be usefully compared to an insurance policy. We have devoted considerable attention to determining the annual premium for the present policy which we know is quite large. What is still vague is the amount of the face value of the policy and how often is it likely to pay off.

The submissions suggest that in the absence of any oil export control program we will still be able to provide our military establishment with sufficient petroleum in any conceivable emergency. The military needs are such a small fraction of the U.S. market that it is inconceivable that petroleum supplies for the Armed Forces could be put in jeopardy by the absence of an import control program. In fact, the military considers widely dispersed sources throughout the world to be an asset.

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We are thus speaking of security of oil supply for civilian uses—motor vehicles, space heating, and the like. The task force staff has provided an estimate of the potential shortage in an emergency. An emergency involving the interruption of Arab oil is the contingency which gives us serious concern.3 Under free trade, by 1980 we would be importing some 3.5 million bbl/day of Arab oil—some 20 percent of our supply. Task force staff estimates show that various U.S. reserves, inventories and emergency increases in production could come within 0.5 million bbl/day of filling the gap. Emergency increases from non-Arab countries might also be available.

An oil shortage for the civilian economy of even 1 million bbl/day or 10 percent of supply that might occur once in a decade would be costly to the economy. But it could be accommodated by mild rationing (or stockpiling in advance). One measure of the cost would be the value of the crude—some ¾ of a billion dollars (at 2.00/bbl)—a small fraction of the annual cost of the import control program. Perhaps the measure should be higher. Prices would go up in such an emergency and the indirect losses to the economy and inconvenience to the public are additional costs difficult to measure.

It should also be kept in mind that a continuation of a control program based on quotas could itself result in a shortage of oil for consumers. Energy demands are growing so rapidly in the U.S. that greater oil imports will undoubtedly be needed with or without a control program. Oil will continue for many years to be plentiful in the world market. A future program should weigh the benefits of making available needed supplies from abroad year in and year out against the danger that some day imports may be interrupted.

To return to our insurance analogy, we are then faced with evaluating an insurance policy which is designed to assure oil supplies for our civilian economy. The potential shortage of oil without an import control program cannot be expected to cause monetary losses as great as the annual cost to the consumer of the present program, but there would be indirect damage to the nation from an oil shortage and the inconvenience it would cause.

If we accept the premise that the sole purpose of the import control program is to assure security of oil supplies to the U.S. market and agree that only civilian consumers are in any danger of curtailment, [Page 42]then we might ask whether the American consumer wants the government to intervene in the market so as to increase his collective petroleum bill by some $5 billion annually ($8 billion by 1980) in order to avoid perhaps a once in a decade shortage.

It is, however, clear from the study that the present program—despite its stated purpose—involves more than just an insurance policy for oil consumers. There are foreign policy considerations including the assurance of a U.S. market for Venezuelan and Canadian oil, balance of payments considerations, and the impact on the domestic oil industry and the economy of the producing states of any sharp departure from present supply patterns.

We should also be concerned with shaping new policy so as to eliminate the government induced inefficiencies in the oil industry. These inefficiencies are a direct result of the present import control program and other federal and state policies that provide a solid wall of protection for the domestic oil industry from lower cost foreign sources, and supports production from inefficient, marginal sources and the operation of small inefficient refineries. The result is materially to increase the unit cost of domestic production thus inhibiting its ability to compete with foreign sources.

The objectives of a new import policy should therefore be to:

(1)
Guard against any real possibility of interruption of oil supplies at a minimum cost to consumers.
(2)
Encourage greater efficiency in the U.S. industry.
(3)
Satisfy essential foreign policy considerations.
(4)
Avoid sharp increases in U.S. balance of payments deficit.
(5)
Avoid sharp dislocations in U.S. industry and the economy of producing states.

An Option for Consideration

If one looks at the basic considerations that should shape our policy, a powerful argument emerges in support of opening our domestic petroleum market freely to Western Hemisphere sources.

The free trade arrangements, of course, would be confined to Western Hemisphere production and appropriate arrangements will need to be worked out, especially with Venezuela and Canada, to assure that we do not indirectly increase our reliance on Eastern Hemisphere sources. Beyond that it would be desirable to develop a mechanism to assure that Western Hemisphere production can be expanded in an emergency and that it will, in fact, be made available to the U.S. market.

The submissions do not seriously question the security of supply of Western Hemisphere sources. The major sources (Canada and Venezuela) have proven their reliability in past crises. The sea lanes are as secure as shipments from the Gulf Coast to the Eastern Seaboard [Page 43]and perhaps more secure than from Alaska. While the governments of some South American countries appear unstable, continuation of their exports of oil is important to their economy and they do not constitute a significant source for the U.S. in the foreseeable future.

Foreign relations considerations would appear to favor such an approach. I should think the President would welcome the opportunity to provide such a tangible demonstration of his response to the aspirations of Latin American countries for greater trade with the U.S. The same can be said for our relations with Canada. Balance of payments problems apparently would be minimal because hemisphere imports generate a greater return trade and because of the special financial arrangements with Canada.

A Western Hemisphere approach would not cause severe domestic dislocations, especially if there were a transition of a couple of years because the additional supplies would by no stretch of the imagination swamp the market (barring an Arctic “Middle-East”).

The problem with the Western Hemisphere approach alone, however, is that it would do little to reduce the cost of the control program to the U.S. consumer. Without the competitive pressure of Middle Eastern oil on the U.S. market, U.S. consumers are likely to pay close to existing prices.4 In any event, some imports from outside the Western Hemisphere are necessary because we would not want to shut off the U.S. market to such friendly oil producing nations as Indonesia, Iran, Nigeria and others now and in the future.

It would, therefore, seem desirable to utilize the availability of low-priced Middle Eastern oil to provide some degree of competition for Western Hemisphere sources. One option is complete free trade. However, complete free trade does raise a problem of supply interruptions, poses a threat to Venezuelan sales in the U.S., and apparently would adversely affect balance of payments. If for these or other reasons a control program is desirable, then a tariff at some level on non-Western Hemisphere sources should achieve these policy objectives with a minimum cost. The tariff should be at a level that would enable Western Hemisphere sources to compete with Middle Eastern oil in the absence of market demand prorationing and yet low enough to minimize the cost of the control program to consumers. The appropriate level of the tariff would appear to range from $0.25 to $1.00/bbl.

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The tariff approach provides a number of rather crucial advantages over a quota system, although there are, of course, some drawbacks, too.

(1)
It would, in effect, impose a ceiling price for domestic production that would provide major savings to consumers over a quota system.
(2)
It would assure the availability of oil in adequate quantities to meet growing U.S. needs.
(3)
It would provide the U.S. Treasury with a source of new revenue.
(4)
It would eliminate incentives to operate inefficient small refineries.

The drawbacks to the tariff system seem to be the need to justify something new to our trading partners and the difficulty of fixing the appropriate level. As the first, it would seem that a finding that Western Hemisphere oil is secure and Eastern Hemisphere oil is not can be supported. Consuming nations of Western Europe would have no real interest in objecting. As to producing nations, such a policy would appear to present a greater opportunity than present policy. The problem of the appropriate level is one that deserves serious thought but it need not be fixed for all time and could be adjusted upward if Arab oil penetrates the U.S. market excessively. At any rate, the possible disadvantages of a tariff should be weighed against the rather compelling advantages over the quota system which provides no competitive leverage and strictly limits oil supply.

Transition

There probably is not sufficient time to implement any major new policy on January 1, 1970 and any sharp change should probably be avoided in any event. It would also undoubtedly require many months to explore the details of any new policy with other nations. However, in considering this particular option, some notion of “how you get there from here” would perhaps be helpful even if it is only a first sketchy attempt.

One simple change that could be made for next year that would move us down the road to a Western Hemisphere policy would be to eliminate the change made in 1963 and place Canadian imports outside the quota as they originally were. This act would, in effect, increase overseas imports in 1970 by the amount of the Canadian imports, not an insignificant number. It may then be feasible to move into the Western Hemisphere free trade plus a tariff on other imports by January 1, 1971, with everyone having a year to plan for the change. The tariff on Eastern Hemisphere sources could be initiated at say $1.00/bbl and reduced in stages over several years. Small refineries and others dependent on the value of import tickets may present special problems. [Page 45]The existing quotas could be frozen and reduced in stages over a period of years to coincide with reductions in the level of the tariff. In any event, those who are receiving special benefits are bound to be adversely affected by any measures to bring equity and reform to the program.

S. David Freeman
5
  1. Source: National Archives, RG 220, Records of the Cabinet Task Force on Oil Import Control, Box 22, Meetings Files, OST (Freeman) October 21, 1969, Policy Alternatives. For Official Use Only.
  2. Summarized in Document 15.
  3. The really serious problems would be faced by Western Europe. However, it does not appear that any conceivable U.S. import control system would enable us to fill the gap of a prolonged unavailability of Arab oil to Western Europe. I therefore assume that such a contingency would be covered by NATO war plans. [Footnote in the original. A handwritten notation reads: “No—NATO area does not include Middle East & does not provide for aggressive actions.”]
  4. If Alaska and the Canadian Arctic prove to be another “Middle East” the situation would, of course, be different, but in that event there would be no justification for any control program because such prolific Western Hemisphere sources could meet world market competition. [Footnote in the original.]
  5. Freeman signed “Dave” above his typed signature.