US Oil Security and the Oil Import Tariff Question

Oil protectionism is back as an issue in the USA, specifically in the form of lobbying by smaller producers for an oil import tariff to help bolster the prices they receive. The true hallmark of a bad idea is that it never really goes away. When the idea is one that can serve as a totem, a flag to rally around in hard times, it becomes doubly dangerous. Then the argument becomes the following. Times are tough, something must be done, the government seems to be doing nothing, therefore we must save ourselves by getting them to do something drastic. The most obvious example of this is protectionism. It is hard to think of any industry that has lobbied for protectionism when business was going well, but easy to think of many that started lobbying when the climate began to turn icier. Given the above, it is perhaps not surprising that the low oil price environment of 1998 and early 1999 has left its own legacy of defensive items on the US energy policy agenda.

The straightforward lobbying approach of “give us a tariff so we get more money” is somewhat too unsubtle to ever succeed. So, the problem for the protectionists is that they need to create a burning issue on which an oil tariff can ride as the obvious solution. The flag has then got to be somehow firmly attached to this cause, and preferably tied with a strong strand of xenophobia.

Casting around, two mounts were found. One is a donkey, the other a thoroughbred with a pedigree dating back to Troy. The mule in this story has been the idea of accusing the major crude oil exporters to the USA of dumping oil and ruining the domestic oil industry. This has scored well in terms of getting the stars and stripes up the pole to gain public support, but has two main drawbacks. The first is that the government should not be happy about a process that immediately becomes quasi-judicial, and threatens to become a full long legal process against countries which, other things being equal, they would prefer to get along with.

The second problem is that the dumping charge has absolutely no economic merit in this case. Dumping means to sell in a foreign market below the marginal cost of production. Crude oil exporters to the USA have not been selling at prices below their own marginal cost. If someone can produce something for a cost of $5 and sells it for $12, while some US production has a cost of, say, $13, then they are not dumping. They are just a lower cost producer. If some domestic oil becomes unprofitable at the prevailing world price then it is simply too expensive.

It is an absurd idea to believe that exporters were happy about selling at low prices because it made life difficult for US producers. The cumulative loss of export earnings while prices were low was not exactly balanced by the effects of the often temporary shutting in of US stripper wells. In total, the protectionists’ first mount has not proved to be ideal, but at time of writing it is still careering towards what one hopes is a fall at the first fence. However, should it clear that fence, the nag will run and run.

What is proving to be a far more promising approach for the protectionists is the issue of oil import security. As a cause this has the history and the public’s memories of the first oil shock going for it, and they can paint the picture of an America whose prosperity is vulnerable to the actions of foreign powers. As an issue it also comes with its very own Trojan horse. An inquiry under Section 232 of the Trade Expansion Act may not in itself sound very exciting. However, it was as the result of such an inquiry that oil import tariffs were imposed in 1975. Sanctions against Iran were also first imposed on the basis of a Section 232 report. And, conveniently for the protectionists, the US Commerce Secretary is currently undertaking another report under the section to determine if US national security is being undermined by the level of oil imports. If he concludes that it is, (and all previous Section 232 inquiries have reached that conclusion), then the President has authority to impact on the oil import regime should he wish to. Were it not then for the Commerce Secretary’s current investigation, the oil import tariff question would have little steam. As it is, the issue still lurks in the wings.

The first question to address is precisely what the USA is vulnerable to. A common answer is “the economy is vulnerable to supply shortfalls and sharp increases in the price of imported oil arising from dependence on oil from unstable regions”. It sounds plausible, but can be dismissed on the basis of three propositions.

Proposition 1 : Supply shortfalls are never made manifest
The price of oil adjusts upwards and balances available supplies (including draws on inventories) with demand. There may be a period of dislocation while supplies reallocate, but no actual shortfall emerges.

Proposition 2 : The price of all oil rises
Domestic oil rises in price to the same extent as imports. In terms of the impact on the price index, it is not the proportion of imports that matters, but the total demand for oil. A country that is self-sufficient suffers the same immediate price impact as one that is not. The difference of course arises in longer term balance of payments effects, and whether the oil windfall accrues to domestic or foreign producers. However, these effects are not those which are normally brought to the fore as a security issue, and indeed they can be fairly limited for any short to medium term disruption.

Proposition 3 : It does not matter who you import from
Imagine that some catastrophe removed the entire exports of Libya and Iran from the world market. The USA has sanctions in place against both countries, and would not be directly impacted on. However, countries that do import Libyan and Iranian supplies would bid up the price of oil in the spot markets to make up the loss. The price of all oil rises, including that which the USA imports and that which it produces domestically. The impact is then the same, all that the pattern of imports determines is who will be the first to enter the spot market in strength. It follows that the often quoted measures of percentage dependence on OPEC or percentage dependence on the Middle East carry no useful information at all about potential vulnerability to shocks.

The three propositions have force even before note is taken of the US Strategic Petroleum Reserve (SPR). This gives even more flexibility, and an associated power to directly limit price increases. It is a useful thing to have in a crisis, but it should be noted that the cost has not been trivial. When one adds up the cumulative operating cost plus the interest foregone on the capital tied up in the SPR, it begins to emerge as an insurance policy with a very expensive premium. It looks even more expensive when one considers that much of the oil was bought at high prices, and in current money terms these prices are higher than would be likely in anything but a crisis of full Armageddon proportions.

An oil import tariff increases costs to US industry and consumers and reduces the competitiveness of US exports. These costs are born permanently, and are set against the potential, and we would suggest at best minimal, benefit of having lower imports should a crisis emerge. A very certain loss is being put against a very uncertain gain.

An oil import tariff is not a good way to bolster the US domestic oil industry, should that be what the President wishes to do in the light of the, I fear inevitable, findings of the Commerce Secretary’s report. However, when one weighs up the populist appeal of what, for much of public opinion, would be patriotic anti-foreign oil measures against that of more constructive supply side measures (which would be seen as either overly pro-oil or anti-environmentalist), a niggling fear arises that the protectionist cause may not after all be a totally hopeless one. And of course what may look now like an anti-dumping donkey may instead prove to be a very dark and dangerous horse indeed.

By: Paul Horsnell

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Energy Security , Oil

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