HOW TO KEEP OPEC ON ITS BACK Worries that cheap oil will make the U.S. too dependent on imports are fueling support for a tariff. But that would hobble the economy, boost inflation, and destroy jobs. Better ideas: lift price controls on natural gas and promote exploration.
By Peter Nulty RESEARCH ASSOCIATE Alicia Hills Moore

(FORTUNE Magazine) – WITH GASOLINE PRICES averaging well below $1 a gallon, tanking up at the pumps leaves many an American motorist with a sense of well-being he hasn't felt in years. Nevertheless, a lot of people worry that the bad consequences of low- cost oil might outweigh the good. An opinion poll in April found that 60% of the public fears that cheap oil could so damage the U.S. petroleum industry that it would leave the country dangerously dependent on imports. More than half said they favor a tax on imported oil. A tariff would produce double benefits: it would help home-pumped oil compete with imported crude and raise billions for the impoverished national treasury. Fear is understandable. Memories are fresh of the Arab oil embargo, ever- spiraling prices, and interminable lines at the gas pumps. No one wants his economic well-being or national security held hostage by a foreign power. But the benefits of cheap oil are nothing to sneeze at either. So what policy makes sense? Plenty of proposals are floating about, the most popular being to slap a tax of $5 or $10 a barrel on imported oil. An import tax would let U.S. oil producers raise prices by the amount of the tax and make America's high-cost wells profitable. That would cut demand for imports by keeping in operation more than 400,000 so-called stripper wells, each pumping a measly ten barrels a day or less but totaling 8% of the oil used in the U.S. For the moment an import tax looks like a nonstarter in Washington. Though the proposal has the support of some important Republicans, including Pete Domenici, chairman of the Senate Budget Committee, the Reagan Administration is dead set against any tax increases. However, the pressure for an import tax could become irresistible if oil prices do not rebound soon. Many oil experts predict that Saudi Arabia or OPEC as a whole will cut production enough to push prices back up to $20 a barrel or so by late summer. If those predictions prove false and prices stay down, says a Washington energy consultant, ''Texas will go bonkers.'' The import tax sounds simple and, with the price of crude way down, relatively painless. In operation, however, it probably would prove wondrously complex and more costly than proponents claim. At the same time, the dangers of increasing dependence on OPEC seem vastly overblown. The warnings come mostly from people who have a vested interest in the domestic oil industry or are philosophically predisposed to government's playing a large role in energy. At bottom the tax would preserve jobs -- and profits -- in the oil industry at the cost of fewer jobs in other industries, slower economic growth, and faster inflation. The Congressional Research Service estimates that a $5-per- barrel tax on imported oil would reduce economic output by about $28 billion next year, add nearly a full percentage point to the inflation rate, and eliminate 300,000 jobs (net of jobs saved in the oil industry). The import tax is a woefully inefficient way to raise federal revenues. Data Resources Inc., an economic forecasting firm, estimates that the budget deficit would decline by only 25 cents for each dollar in oil import taxes. The other 75 cents would be offset by higher federal energy expenses and lower income tax payments resulting from slower economic growth. An increase in the federal excise tax on gasoline would be a less disruptive way to narrow the deficit. But a gasoline tax would apply to domestic as well as imported oil and would not help U.S. producers. Sheltering the oil industry would create havoc for other businesses. U.S. petrochemical companies would face higher costs for feedstocks than foreign competitors. The petrochemical industry almost certainly would demand relief from the tax. So would farmers, textile makers, and other heavy users of petroleum. Senator Phil Gramm, one of the few Texans in Washington who oppose the tax, points out that Canada, Mexico, and Venezuela might claim exemptions from taxes on their oil under trade treaties with the U.S. Says Lloyd Unsell, president of the Independent Petroleum Association of America: ''The import fee would look like a giant sieve.'' THE BENEFITS of cheap oil are considerable. Wharton Econometrics, another forecasting firm, estimates that a price drop to an average of $15 a barrel this year would reduce inflation by 1.5 percentage points, add 1.4 percentage points to economic growth, and create some 500,000 jobs, net of layoffs in the Southwest. FORTUNE believes the effects would be somewhat smaller than Wharton's estimates, but still large. The risks of rising oil imports are harder to quantify. Keeping foreign oil out will not help the U.S. if foreign producers raise prices. Since all producers, U.S. and foreign, charge the world price for oil, the shock to the U.S. economy would be just as great as in countries that import all their oil. The government could shelter consumers with price controls on domestic oil, as it did in the Seventies, but that almost certainly would give rise to renewed shortages. The oil world has changed radically in the past 15 years. OPEC had the power to make price increases stick in the Seventies because other oil producers could not take up the slack when the cartel reduced output. Oil prices have collapsed because non-OPEC countries have increased production mightily and OPEC could not agree to cut output enough to keep prices up. The era of high prices brought other changes that reduce the likelihood that the cartel will regain its muscle soon. Natural gas has become a much stronger competitor to oil, and new gas discoveries have created surpluses in the U.S., Canada, the Soviet Union, and elsewhere. Some experts predict that the surplus will end soon, but they have been saying that for three years. The U.S. economy depends less on oil than it used to. Conservation has reduced oil consumption by 15% and cut oil consumed per dollar of gross national product by 33%. Whatever the effect of the Soviet nuclear disaster on U.S. public opinion, the share of electricity produced by atomic power will increase by the 1990s (see Looking Ahead). Lower oil prices are bound to foster higher consumption. The American Petroleum Institute reports a 3.5% jump in the first quarter of this year. But much of the energy conservation of the last 15 years is built into today's more efficient manufacturing facilities and fuel-efficient autos and cannot be quickly reversed. Finally, the U.S. has 500 million barrels of oil, equal to more than three months of imports, stockpiled in the strategic petroleum reserve. OPEC accounted for 36% of U.S. imports last year and will supply a somewhat larger portion this year. The reserve would last more than six months even if OPEC united in a total embargo of the U.S. Since competition from new oil producers and from other fuels are what broke OPEC's back, U.S. energy policy should be aimed at enhancing that competition. One way is to encourage exploration for major U.S. oil deposits. Large, highly promising federal tracts in Alaska, off the coast of California, and in the & Gulf of Mexico have not been leased for exploration. Even if the tracts were opened, the federal bidding system discourages explorers. Winning bidders must make large, nonrefundable, up-front payments, called bonus bids, before they look for oil. The government could encourage more exploration by forgoing bonus bids in favor of collecting higher royalties on production. The government also should remove the remaining shackles on natural gas. Congress is considering several proposals to do that, but they seem to stand little chance of passing this year. One would repeal the Fuel Use Act of 1978, which prohibits new industrial boilers from burning natural gas even though it has been in surplus since 1982. Another measure would deregulate the roughly 45% of U.S. natural gas production, called old gas, still under price control at the wellhead. The Department of Energy estimates that lifting the last price controls would increase the output of old gas by around 5%, lower the average price of gas by about 15%, and reduce oil imports by 8%. With oil selling in the low teens, this would be a golden time to add to the strategic petroleum reserve. As imports increase, the cushion provided by the reserve gets thinner. The Reagan Administration has suspended purchases because, says Energy Secretary John Herrington, ''the national debt has just passed $2 trillion.'' But it makes more sense to buy when oil is cheap, and pay the interest on a slightly higher deficit, than to wait until the cost rises. Strengthening the competitive alternatives to OPEC oil would reinforce the lesson in free-market economics that the cartel is just learning. Indeed, anyone who fears that OPEC will leap blithely at the chance to repeat its performances of 1974 and 1979 need only look at what has happened to it since competition started driving prices down in 1981. OPEC oil revenues, which reached a high of $278 billion in 1980, could fall to $80 billion or less this year. In countries where oil revenues and GNP are nearly synonymous, that represents pain. The best restraint on OPEC will be knowledge that a dynamic energy market is at work.