Energy Security and Independence

One of the enduring aspects of every presidential campaign since 1976 has been the issue of energy security, sometimes framed as "energy independence". This issue leaped onto the public agenda after the First Oil Shock in 1973-4. US consumers saw prices rise drastically in a very short period of time, but more importantly, large shortages occurred, resulting in gas stations running dry, and lines of cars snaking more miles and miles waiting for gasoline. President Nixon fired up a commission to study the issue, and they came up with "Project Independence", an initiative to reduce net imports of energy to zero by 1980.

The results? In 1973, we imported (on net, imports minus exports) about 6 million barrels per day of crude oil and other petroleum products. By 1977, that number was up to about 8.5 million. In the wake of the Second Oil Shock it fell to about 4 million in 1985, but after that it climbed relentlessly for the next two decades, reaching over 12.5 million barrels per day in 2005. Then things changed. The number started to decline. At first, most analysts believe this was due to the great recession, but as the economy started to recover in 2009 and 2010, it was clear that oil imports were still on a down trend. The reason why? The rapid rise in domestic oil production caused by exploitation of tight oil deposits, employing the techniques of horizontal drilling and hydraulic fracturing, which had been developed in shale gas plays. By 2014, net imports were back down to 5 million barrels/day, and it is expected that they will continue to decline over the next half-decade. This number is about 4 million barrels/day in 2018. Thus, science, technology, innovation and entrepreneurship have worked were government intent failed miserable for two decades, despite each president over that time claiming that "energy independence" was an important goal. 

I would like to note that the EIA website is an excellent source of information, analysis and statistics about energy production and use in the US and world today. As a professional energy economist and analyst, I probably visit this website about 75% of my days at the office - it is one of the most useful things that the Department of Energy does, in my opinion.

In the late spring of 2011, President Obama pushed this topic to the top of the agenda, with oil climbed back over the \$100 level and gasoline prices exceeding \$4/gallon in much of the country. In fact, with the stated objective of reducing supply shortages (shifting the supply curve and reducing prices), several of the world's governments, including the US, announced plans to release some of their Strategic Petroleum Reserves to the market in June of 2011. This release did have a minimal short-term price impact, but the quantities of oil released were very small- 28 countries together committed to release 60 million barrels of oil. For perspective, the US released 30 million of the barrels, the equivalent of about 1 and 1/2 days of US oil consumption.

So, despite all the talk, we continue to import about a third the oil we burn in this country - another example of actions speaking louder than words. So, why do we do this? Because it makes economic sense, at least at the microeconomic level. We use crude oil overwhelmingly for transportation - it is the most convenient, lowest opportunity-cost transportation fuel we have. Much of its convenience comes from the fact that it has more energy per pound or gallon than any other fossil fuel. We consume this oil because it is the economically optimal thing to do - we want the cheap and easy transportation that we get from oil. We want to drive, we want to fly, we want to have goods shipped by truck.

Normally, this would be uncontroversial: In a market economy, if people wish to purchase the lowest opportunity-cost good out of a range of options, we generally cheer the ability to do so. But there is so much political noise made about reducing oil consumption. Why is this? Some people will point to the fact that there are some externalities that arise from consuming oil - externalities that are not properly included in the price that we pay for crude oil. These include:

1. Pollution costs: driving cars soils the air, creating smog and ozone and harming many people with respiratory ailments in places such as Los Angeles and Houston.
2. Carbon emissions leading to climate change.
3. Highway and city road congestion: because driving is cheap, and most roads are not priced on a per-use basis, people have an incentive to "consume" too much highway, leading to congestion, which is a massive external cost imposed on everybody else who has to use the road, at least in places like the Boston-Washington corridor, where population levels are very high, and many of the roads get very full. This is a scenario I am familiar with every day, as I live in a semi-rural part of Central New Jersey, about 50 miles away from either Philadelphia or New York.
4. Balance of trade costs: the money we ship overseas would better stimulate economic growth if it stayed in the country. This is a macroeconomic argument, so it is largely beyond the scope of this course.
5. Much of the world's oil comes from unstable regions, and so the US has been paying for a large military in order to keep order around the world to keep the supply of oil flowing. The cost of this military expenditure is not directly included in the cost we pay at the gas station.
6. Oil prices are very volatile, so being independent would shield us from large swings in the price of oil.

Arguments for and against each of these statements can be made. For example, we certainly have lots of regulations concerning air pollution from vehicles, much of which can be found in the Clean Air Acts of 1970 and 1990. This means that our cars and our gasoline are subject to much more stringent regulation than in a "free" market, and we correspondingly pay quite a bit more than we otherwise would for both cars and gasoline. We spoke at length about climate change regulation in the last lesson, so I do not wish to revisit that issue here. To the third point, there are Federal and State gasoline taxes that are designed to fund the construction and maintenance of highways, which is the classic way of dealing with a public goods problem, which is what the public highways are (remember what a public good is - non-rival and non-excludable).

It may be true that a reduction in the importation of oil would allow a reduction in defense spending, but the public does not see any direct linkage between the two, and when we examine the actions of consumers, who are also taxpayers, it appears that the convenience of having plentiful and comparatively cheap oil is something that people are willing to pay for in the form of higher income taxes to pay for a military. I do not recall any politician ever running who promised to reduce military spending if per capita gasoline consumption declined, and I suggest that such a candidate would have great difficulty getting elected. But, that is a political question.

The seventh point bears some more examination. What if we did not import any oil, would we be shielded from global prices? Do a little thought experiment: let's say oil sells for \$50 everywhere. Then the price goes up to \$100 in the rest of the world. Would US producers be happy to sell for \$50, or would they try to sell for \$100 to, say, China or Japan? Obviously, they would try to sell to the highest bidder, meaning, if US consumers wanted the oil to stay here, they would have to bid the price up to match the world price. So, even if we did not import any oil, the price in the US would still move with the world price. The only way to stop this would be to ban exports, which is a practice that runs into opposition with a long history of US trade policy. In order to be "independent" of world prices, we would have to sever trade ties with the rest of the world, a set of actions that would severely harm the country economically.

Thus, you should now have a better understanding, from an economic perspective, of just why politicians talk a lot about reducing oil imports, but why consumers seem more than happy to ship in foreign oil, except when recession hits. We consume oil, both domestic and foreign, because we derive benefits from doing so - more than from any of the alternatives. And there are alternatives - we will talk about this in the next section.