Offshoring Is a Dubious Policy When the Question is Oil Drilling

by: Jeffrey Frankel

President Bush yesterday removed a long-standing executive moratorium on off-shore oil drilling, 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.