33. Memorandum From the Chairman of the Council of Economic Advisers (McCracken) to President Nixon1

  • SUBJECT
    • Oil Import Controls

The Cabinet Task Force on Oil Import Controls has completed its report, which should reach you shortly.2 This memorandum is intended to outline the background, to highlight the main issues, and to summarize the options before you.

Background

Mandatory oil import quotas were instituted in 1959 under the authority of the National Security Clause of the Trade Agreements Act. For most of the country, imports are limited to 12.2 percent of domestic production, but for the West Coast they are equal to the estimated difference between demand and domestic supply. During the last 10 years numerous departures from these basic rules have been permitted to take care of special interests, and many other claims for exceptions are pending.

Since domestic production has not been keeping pace with demand, it is expected that either imports will have to be increased or prices will rise. Imports, including those exempt from quotas, now account for about 20 percent of total supply. Domestic production is insufficient in part because the principal producing States (Texas and Louisiana) engage in prorationing with a view to keeping prices high. Unless Alaskan discoveries are even larger than anticipated, they will not make up for the slow growth of output in the “lower 48.”

Because the domestic price of crude oil is about 65 percent higher than the world price, the import quotas represent a considerable burden on consumers, estimated at roughly $5 billion per year. Not all of this accrues to domestic crude producers, since they forego a considerable amount of output as a result of prorationing. Some of the benefits go to importers, who can buy at the low world price and sell at [Page 79]the high domestic price. Still another part of the $5 billion is a sheer waste that benefits nobody. The quota system is popular in Texas and adjoining States, where it is considered Lyndon B. Johnson’s greatest political achievement, but unpopular in most other areas, especially on the East Coast and in Hawaii.

During the first nine years since quotas were introduced the domestic crude price stayed constant, but in February 1969 the major producers, led by Texaco, raised it by 5 percent. Further price rises are likely unless appropriate action is taken. Another development during the quota period has been the replacement of the Middle East by Canada as the second largest source of imports, which has made our supplies more secure. Venezuela continues to account for about half of all imports.

The Issues

Since no one is suggesting that the domestic market be thrown entirely open to imports, there are six issues in the decision about any change in our policy.

1. The mechanism of control. The choice here is between quotas and tariffs; the following considerations are relevant:

a.
A quota system is already in existence, but it has not worked well. Many exceptions and other special deals have been made, and many additional ones could be made with equal or greater justification. Enforcement, especially in the case of Canadian oil appears to be lax. If a quota system were to be retained, it would have to be completely overhauled (see Option III). A tariff system of the preferential type suggested in Option IV would not be easy to manage either, but it would represent a clean break with the past.
b.
Under quotas as now administered those allowed to import receive a windfall, which under a tariff would go to the Treasury. It is possible, however, that a part of the windfall is currently passed on to consumers. Moreover the windfalls under a quota system could be appropriated by auctioning the import licenses.
c.
A quota system (even if modified by an auction) enables the producing States to keep prices high by prorationing. Since imports are proportional to domestic production (except on the West Coast), control over domestic production is tantamount to control over total supply, and hence over price. Prorationing is estimated to reduce domestic output by about 20 percent, about as much as total imports; we could therefore be roughly self-supporting at current prices if prorationing were prohibited under the antitrust laws. Under a tariff system prorationing would be ineffective; the domestic price could not be higher than the price of imports plus the tariff.
d.
Under the present quota system it is necessary to determine who can import (at present mostly the refiners). Under tariffs, and under quotas combined with an auction, everybody could import. However even in the latter two cases it would be technically feasible to exercise some discrimination among importers if this were considered desirable on grounds of equity.
e.
A quota system in conjunction with prorationing causes more rigidity in both prices and quantities than a tariff. Or to put it in another way, a tariff interferes less with a free market.

2. The domestic price level

At present the price level, as already mentioned, is fixed by producers through the prorationing device. The principal constraint on their ability to raise prices appears to be the relatively open market on the West Coast. As long as we have quotas and permit prorationing there is little the Government can do about the price.

Under the alternative favored by the Task Force majority the price level would in principle be the sum of the world price and the tariff, and the tariff would have to be set accordingly. In the short run a reduction in prices would benefit consumers and reduce the industry’s profits, but in the longer run there is not necessarily a conflict. Consumers would not want to be entirely at the mercy of foreign producers, which might be the result of a zero or very low tariff. A very low domestic price might also bring exploration to a virtual halt and seriously reduce State revenues from oil production. It would also have adverse effects on the supply of natural gas, which is often found as a byproduct of the search for petroleum. On the other hand a modest reduction in prices might satisfy consumer pressures without doing appreciable harm to the industry. In fact there is a strong case for undoing the price increase of February 1969, which was considered to be an outright challenge to the new Administration. Moreover consumers should certainly reap some benefit from the large increase in low-cost oil supplies resulting from new discoveries in Alaska, Canada and elsewhere.

It has to be recognized, however, that the world price is not absolutely fixed, so that the tariff level may have to be revised in the light of experience.

3. National security

The calculations in the Task Force report suggest that national security is not an important factor in the choice between the principal options (III and IV). Even at the domestic price of $2.50 per barrel favored by Secretary Shultz, the U.S. would not become unduly dependent on Eastern Hemisphere supplies, provided that preference is given to Western Hemisphere oil. The present quota system, according to the report, does not give adequate protection to national security.

4. Balance of payments

The report also indicates that the balance of payments is not a major consideration in the choice between the main options. Since so much domestic output is now lost by prorationing, a transition to a tariff with a somewhat lower domestic price would not significantly increase imports for some years. If a quota system were continued, imports would probably [Page 81]have to increase more than under a tariff (unless prorationing were outlawed), but the additional imports would come mostly from Canada and Venezuela (who would spend a large part of the proceeds here).

5. Foreign policy

Any decision you make, whether in favor of a quota or a tariff, would have a major impact on our relations with Canada, Venezuela, Iran and the Arab countries, and a lesser impact on Europe. The present system favors Canada but does not otherwise discriminate between the Western and the Eastern Hemisphere. Some such discrimination would be desirable under a tariff. It may also be necessary to give special treatment to Iran. You will no doubt be advised on these foreign policy aspects by the State Department and the NSC staff.

6. Program management

There is unanimous agreement in the Task Force that, no matter which direction you choose, the oil import program needs to be managed more carefully. In the past many important decisions appear to have been made ad hoc and without proper administrative safeguards. This is one of the reasons why the quota program has degenerated into a crazy quilt of special deals. The Task Force favors the establishment of a cabinet-level committee of management with responsibility for reviewing market developments and drafting of regulations, but not for day-to-day operations.

The Options

I.
Continuation of the quota system in its present form.
  • Pro: 1. The industry is familiar with the program and generally can live with it.
  • Con: 1. Continuing the program in its present form would mean rejecting all pending applications for special treatment, many of which have merit.
  • 2. Unless more imports are allowed, domestic prices would probably rise further.
  • 3. Consumers would be disappointed.
  • 4. This Administration would commit itself to the present program and a unique opportunity to overhaul the program would be lost.
  • Comment:
  • No one on the Task Force recommends this option.
II.
Abolition of the present system without replacement (i.e., a completely free market).
  • Pro: 1. Large benefits would be provided to consumers and prices would be significantly lowered.
  • 2. All management problems for the government would be avoided.
  • 3. A completely free market would be popular in most exporting countries (except for Canada, which would lose its favored position).
  • Con: 1. Serious injury would be caused to the domestic industry and to the oil-producing states.
  • 2. We would become so dependent on imports from insecure sources as to impair the national security.
  • 3. Considerable uncertainty would be created.
  • Comment: There is no support for this option in the Task Force.
III.
A modified quota program; some of the possible modifications would be:
a.
Increasing the import percentage gradually.
b.
Making further special provisions for petrochemical producers.
c.
Extending the present exemption of residual oil (used as boiler fuel in factories and institutions) from the East Coast to all parts of the country.
d.
Making special provisions for home heating oil (a politically sensitive item in the Northeast).
e.
Creating foreign trade zones where imported crude can be refined for export.
f.
Phasing out historical quotas.
g.
Creating a special preference for Venezuelan crude.
All of these modifications have been suggested by Secretary Stans or Secretary Hickel, or both. Other possible modifications would be
h.
Relating the import quota to demand rather than to domestic production (as is now done on the West Coast).
i.
Auctioning import licenses.
  • While much could be said about each of these modifications the following general points are more or less relevant to all:
  • Pro: 1. Since the quota system would be preserved, the oil industry would prefer this approach to Option IV.
  • 2. Some of the major defects of the present programs would be rectified.
  • 3. Consumers might get some benefit from the proposed relaxations.
  • 4. If an auction system were adopted, the Treasury would gain considerable revenue.
  • Con: 1. Some of the relaxations would further complicate the existing program and make it harder to administer.
  • 2. As long as prorationing is permitted, any increase in imports will be wholly or partly offset by a reduction in domestic output. To that extent the benefits to consumers will be annulled and the balance of payments worsened unnecessarily.
  • 3. Granting further special favors will increase the pressure for still more.
  • Comment: This option, in one form or another, is favored by Secretaries Hickel and Stans.
IV.
Transition to a preferential tariff-quota system.
This system would be designed in such a way as to:
a.
Let in Canadian oil free of duty, on the grounds that it is equivalent from a national security point of view to U.S. oil.
b.
Give preference to Western Hemisphere oil (other than Canadian) over Eastern Hemisphere oil, again because of the greater security of supplies.
c.
Put a quantitative limit on Eastern Hemisphere oil in order to safeguard against an underestimate of imports from this insecure source.
d.
Levy a slightly higher tariff on refinery products (such as gasoline and fuel oil) than on crude, so as to protect U.S. refineries; residual oil, however, would come in free (Note: this aspect has not been fully analyzed by the Task Force and may need reconsideration; the exemption of residual oil is open to question).
e.
Phase out the present quota system over a period of 3–5 years by reducing the tariff-free allocations gradually while at the same time making imports available to everybody on payment of the tariff. The tariff level would initially be set at $1.45 per barrel for crude (including the present tariff of 10 cents per barrel), but may be lowered subsequently in the light of market developments, including future discoveries in Alaska and elsewhere. This level would give an estimated wellhead price at the Gulf of $2.98 per barrel of crude, about 10 percent below the current level, and 5 percent below the level of a year ago. Various adjustments would be necessary to restore the West Coast to equal treatment with the rest of the country. (Secretary Shultz would reduce the tariff ultimately to $1.00 per barrel.)
  • Pro: 1. This system would be a decisive step towards more effective competition in the petroleum market by giving equal access to imports. Yet it does not expose the domestic industry to serious harm.
  • 2. It would put an end to prorationing by breaking the locked relationship between imports permitted and domestic production. Thereby the domestic industry would be made more efficient, and this would tend to limit imports.
  • 3. It would yield considerable revenues to the Treasury. The exact amount would depend on the treatment of products, but it would probably exceed $500 million per year after the transition is completed.
  • 4. It would lower domestic prices significantly, thus benefiting consumers and contributing to the fight against inflation.
  • 5. While not without operational problems it would probably be easier to administer than a quota system.
  • 6. The preferential feature would enable us to obtain imports from the sources we prefer on national security and other grounds.
  • 7. By providing a transition schedule it would give the industry time to adjust.
  • Con: 1. It would be opposed by most segments of the domestic industry, who would fear a loss of profits and investment values.
  • 2. Domestic exploration would be adversely affected, though probably not to a great extent if the Gulf price stays at $3.00. If necessary some of the tariff revenues could be used to subsidize exploration.
  • 3. A 10 percent reduction in the domestic price is less than some consumers expect. Here again, however, much depends on the tariff treatment of products.
  • 4. Under a tariff there would be greater uncertainty about prices and import volumes than under quotas combined with prorationing.
  • 5. There might be trouble with Venezuela, which claims equal treatment with Canada; Iran might also claim preference over the Arab countries.
  • Comment: This option is recommended in some cases with minor reservations, by five members of the Task Force (Secretaries Shultz, Rogers, Kennedy and Laird, and General Lincoln). It is also favored by all the observers, including the Council of Economic Advisers, except for the Chairman of the Federal Power Commission.
Paul W. McCracken
  1. Source: National Archives, Nixon Presidential Materials, White House Central Files, Staff Member and Office Files, Council of Economic Advisers, Hendrik Houthakker, Box 38, Oil Import Control TF—CEA Memoranda. No classification marking. A copy was sent to all members of the Task Force. Penned markings indicate Nixon read the memorandum.
  2. See Document 32.