What Would Reagan Do About Energy?

This is the second in an occasional series of exclusive articles in which leading conservatives who served in the Reagan Administration explain how they believe the principles of Reagan conservatism ought to be applied today and in the coming years. This week, Don Hodel, who served in Reagan’s Energy and Interior Departments, addresses the issue of energy.

I was President Reagan’s secretary of Energy from 1982 to 1985. President Reagan was a “hawk” on energy, that is, he understood that it was in our national interest from both national security and economic standpoints to have a sound energy policy. What he would do on energy would be significantly affected by what he could do, considering the hostility of some members of Congress to approaching energy from a rational standpoint, but, here is what I think he would do (or try to do):

The President would affirm his energy policy: minimize America’s dependence upon foreign sources of energy by seeking a balanced and mixed supply of energy resources at a reasonable price. Those sources would primarily include conventional resources (oil, natural gas, coal and nuclear), alternative and renewable resources, and conservation.

Let me briefly describe the situation for some of these resources. If time and space (and attention) permitted, a thorough discussion of each could fill books:

Oil. There is a lot more oil to be discovered and produced than we have been led to believe, as the recent discovery of what may be a 15-billion-barrel field in the Gulf of Mexico shows. That field alone would increase our reserves from 29 billion barrels to nearly 45 billion barrels. A small portion of the Arctic National Wildlife Refuge in Alaska (ANWR) is expected to yield perhaps 16 billion barrels, if the spurious arguments in Congress in opposition to its exploration and development can ever be overcome. About two-thirds of the oil already found remains in the ground after the initial production is finished, and much of it can be recovered using more sophisticated and expensive methods. President Reagan would have encouraged finding new oil and producing as much as possible of the oil that has already been found. Reagan would have continued to push strongly for development of the Section 1002 area of ANWR as has President Bush.

Recognize, therefore, that, for the foreseeable future, plentiful oil is going to be the “energy standard setter” that affects the price of many other energy sources as well as almost everything else in our economy.

President Reagan would have expected the price of oil to fall below $70 per barrel (as it has done) at some point, simply because we know from experience during his administration that high oil prices cause several things to happen, including: Demand for oil declines because people cut their oil usage and shift to other energy sources, more money is invested in alternative resources and conservation, and investors put much more money into exploration and development of higher-cost oil sources and oil substitutes.

Remember, also, that if the current efforts to produce oil from Colorado and Utah oil shale succeed, the U.S. will once again be the nation with the largest oil reserves in the world. Somewhere between one and two trillion barrels of oil are estimated to be in oil shale. To see how a resource such as oil shale can become a factor, look at Canadian tar sands that, with oil at $70 per barrel, have become a major source of world oil supply.

President Reagan would not give up on oil and would not base our future plans on a faulty expectation that it is soon to be depleted. We will “run out” of oil only if we “run out” of political will to allow the energy industries to develop the resources that are available. And the worst decision the U.S. could make would be to impose rules on the American economy that artificially make oil permanently much more expensive while the rest of the world remained free to use it at a lower price. The President would oppose such rules because he would have known that the shift in competitive advantage to other countries would cost the U.S. jobs, economic strength and, ultimately, quality of life.

Natural gas. More natural gas, possibly much more, could be discovered than currently predicted if the government would help instead of hindering the exploration and development efforts off shore and in the mountain states of the West.

Coal. The U.S. is “the Saudi Arabia of coal.” Technologies are imminent that will allow us to make synthetic gas and liquids from coal, which could make a huge difference in our energy supply and the world balance of power, provided the world price of oil does not plummet for too long a time.

Nuclear. Quite correctly, President Reagan was a staunch advocate of nuclear energy. It is encouraging to see a renewed effort to build nuclear power plants, and he would take a strong public stand in favor of expanding our nuclear electric generation.

Whatever excitement and enthusiasm we feel for alternatives, renewables and conservation, the fact is (and it will remain so for years to come) that our energy future will be primarily determined by how well we develop and use oil, gas, coal and nuclear.

Thus, regarding conventional energy resources, I think the President would be his usual optimistic self, and he would encourage Congress to take steps to make these promising facts into a reality of available energy supply.

Alternative Resources and Conservation. The President might be expected to ask, “If conventional resources are so important and abundant, why should we put much effort into these other energy sources?” I would answer that while, today, each (wind, solar, geothermal, energy-efficient lighting and appliances, etc.) is relatively small in output or savings compared to conventional resources, the fact is that in the aggregate they become important. More importantly, as investment is made by the private sector in developing and improving such energy sources (or means of saving energy in the case of conservation), it is probable that significant enhancements will occur that will greatly increase the ability of these sources to compete with conventional energy sources. When that occurs, they could rapidly increase their contribution to the nation’s energy supply. Since these sources are domestic, not imported, they, together with domestic production of oil and coal, truly do hold the long-term prospect of reducing our dependence upon foreign sources of energy.

While the foregoing is what I think the President would do, there is a dagger aimed at the heart of alternatives and conservation: a falling oil price. They have received a tremendous boost in recent years out of a period of high oil prices and from government subsidies. There is a threat that falling oil prices will inhibit exploration for new oil and gas resources and means of gasifying coal as well as all those investments in other energy resources.

I think the President would request an analysis of what might be done to reduce the risk that falling oil prices would disrupt our national effort to reduce our dependence upon imported oil.

Investment Deterrent

The looming problem for energy investments across the board is that their funding could disappear. This is precisely what happened in the past. High oil prices stimulate investment in every energy and conservation source. That is followed by the cancellation of energy projects, including alternatives and renewables and the loss of enthusiasm for conservation, and so on, during the dramatically lower oil prices. The mid-1980s is a classic and painful example.

The current lower oil price is a storm warning to many investors and developers of alternative energy sources. How far will the price fall and how long will it stay down? The answer given by analysts and experts will have a profound effect upon the willingness to invest in energy resources and upon conservation. Once investors back out, once energy projects are shut down, and once manufacturers of efficient energy products have to cut back production, lay off workers and shut plants, history tells us that they will not rush back into production when the oil price rises. At best, they will wait until they are sure that the higher prices “are here to stay.” At worst, they may be permanently out of business.

Even if the price does not fall to levels that render competing energy sources uneconomical, the mere uncertainty about future oil prices becomes a deterrent to investment decisions regarding every energy source. President Reagan would have been fully aware that world oil consumption declines in the face of high prices. However, this takes time to manifest itself, because users have to invest in new equipment or design in order to be more fuel efficient or national or regional economies have to slow down. Enhanced oil recovery and expanded exploration budgets plus tar sands, oil shale and coal gasification may add millions of barrels of hydrocarbon capacity to the world supply. High oil prices meant that more wind, solar, hybrid vehicles, etc., have been built and ordered, further reducing demand for oil, but over a longer time period. China has already begun to try to cut the growth in its oil demand and India will follow suit, either by government action or by market response. Investors in energy resources
have to consider that it is possible that there will be a world wide economic slow down caused partly by high energy prices. If there were a sharp, short, but large oil price increase resulting from an oil supply crisis originating, for instance, in the Middle East, such a price “shock” could result in dramatic cuts in consumption and even greater economic decline, leading to further, long-term reduction of demand.

Those who are familiar with market response to falling prices may wonder why oil pricing does not follow the conventional market pattern. Part of the reason for oil prices’ falling and staying down for an extended period is that production does not drop immediately in response to lower demand (and, therefore, lower prices). Once an oil well is drilled, the owner will continue to produce oil from it until the price of oil drops below the operating cost of the well. So, imagine a well that would not have been drilled or brought into production when the price of oil was less than $50 per barrel. Assume that once it is producing, the actual incremental cost of operations is about $20 per barrel. That means that the owner will earn net operating revenue as long as the price of oil exceeds $20 per barrel and in most cases will continue to operate the well so long as the price is at or above $20 per barrel.

I believe that we would be able to report back to the President that there is a way to avoid many of these adverse results to our national policy of seeking less energy dependence upon imports resulting from a sharp drop in oil prices, and I believe that the President would have welcomed any reasonable proposal because he would have seen the importance of accomplishing that goal.