dollar in declining price, I think the impact on the State of Alaska is probably 10 times that. Senator MURKOWSKI. That is true, but under these conditions sometimes a low profile- [Laughter.] The CHAIRMAN. I just wanted to get your interest. Senator BINGAMAN. Mr. Chairman, they have always been wealthier than we have, but we do what we can. Senator EVANS. Mr. Chairman, they have been wise enough to set up a permanent fund which means they are the only semiendowed State in the country. Senator MURKOWSKI. We do not really need any more of those observations. [Laughter.] The CHAIRMAN. We can scarcely have a better witness to lead off, trying to outline for us with some perspective the scope of the challenge that our country faces and that the world faces today. Having occupied diverse roles within the administration, the Secretary of Defense and the Secretary of the Department of Energy and other roles within Government, and certainly as a scholar and a statesman outside, we look forward to hearing your testimony, Dr. Schlesinger. You are very welcome here. STATEMENT OF HON. JAMES R. SCHLESINGER Dr. SCHLESINGER. Thank you, Mr. Chairman. Mr. Chairman, I shall insert my direct prepared remarks into the record. The CHAIRMAN. They will be placed in full in the record. Dr. SCHLESINGER. I will summarize the major points, bearing in mind Senator Murkowski's admonition that you are looking for remedies rather than further analyses of the problem. Let me say at the outset that I am delighted to be back in this committee room; it provides me with a remembrance of things past. I discussed this very subject of rapidly changing oil prices in this committee room a few years ago, but at that time the direction of change was upward rather than downward. The consequences, however, of volatility remain substantial, irrespective of the direction in which they move. Let me start with a brief comment on what is known in the United States as the energy problem. There is an impression abroad as energy prices drop that the energy problem is over because the public uses as the yardstick to the energy problem whether or not prices are rising, but there is no single energy problem. The energy problem is, in fact, a congeries of problems. The performance of energy markets is but one of three energy elements in that energy problem. It is the impact of the operation of energy markets upon the general performance of the economy and upon national security that makes the problem exceedingly complex. The decline in energy prices which are generally welcome from a consumer standpoint in the short term and generally welcome from the standpoint of the overall performance, the macroeconomic performance of the economy, is but one element of the problem. Indeed, right now, one observes euphoria on Wall Street in the financial markets generally and the euphoria comes in large degree from that drop in oil prices which provides an economic stimulus which offsets the suppression of macroeconomic activity that occurred in the 1970's, and that reaction within its sphere is correct. A drop in oil prices is the equivalent of a drop in taxes. However, there are other aspects of the problem, most notably, the national security aspects and the impact on long-term oil supply. The problem with energy is that in order to provide security of supply and in order to deal with national security problems, one wants high energy prices; and, by contrast, if one wants economic stimulus and if one wants to satisfy the consumer, one wants low energy prices. We cannot have both at the same time. So the art for the policymaker is to strike a balance in the national interest. The oil markets at the present time are demoralized. They have been demoralized deliberately by actions of the cartel leader, which has decided that it must induce cooperation in constraining oil production from major non-OPEC producers and most particularly the United Kingdom. The drop in oil price, the rise in production, was intended to intimidate Mrs. Thatcher and the United Kingdom into collaboration. But as Argentine generals some years ago discovered, the Iron Lady does not intimidate very easily. As a result, we have continuation of demoralization and turmoil in these oil markets and no one knows when that will end. That depends upon analytical factors more than economic factors. The consequences in the United States, as you know, are severe. Much of our production is stripper well production. The United States is the highest cost oil province in the world amongst major producers. By contrast the Saudis, to produce oil at 50 cents or a dollar a barrel, at $15 a barrel their cash-flow remains about $14 a barrel, whereas in the United States producers have difficulty covering out-of-pocket costs. For the highest cost producer to look with indifference upon the lowest cost producers, cutting prices is shortsighted. The latest estimate that I had coming out of Texas was that if oil prices remain at $15 a barrel for 6 months, we will have 30,000 well abandonments in this country and that those well abandonments will continue over the long haul. If oil prices remain low, it does not pay to invest the resources in the maintenance of production. Heavy oil is being shut in in the State of California for overpowering economic reasons. The market is disappearing. As we look down the line we see, as the Chairman has indicated, major reductions in capital expenditures. Exxon yesterday announced a cut in its capital budget of almost $3 billion. The estimates that we have would indicate that between 1981 and 1986 at $15 a barrel, the capital expenditures of the oil industry in the United States will decline by 75 to 80 percent. That means by the middle 1990's, we will be importing more than 9 million barrels a day, which was the estimate of the Department of Energy before the collapse of oil prices. By the end of the decade, we will be dependent on the outside world. Does one care about these free market forces in operation? If we could obtain all the oil that we needed from Canada, from Mexico, from the Western Hemisphere, we might not care, but 85 percent of the spare capacity worldwide today is in the Persian Gulf, the most volatile region of the world. There are security aspects that should concern us. Finally, under the heading of security and foreign policy, one should note that the volatility of energy markets brings great pressure to bear on oil exporting countries, many of which are friendly to the United States: The impact on Egypt, in which there was a riot of security police just 10 days ago; the impact on Indonesia which was perhaps our great accomplishment as a result of the Vietnam war. At $25 a barrel, development activities in Indonesia; at $15 a barrel, we see the development of political instability. Mexico, our neighbor to the south, is in severe difficulties, and one can run down the list of friendly countries. If oil prices were stable, these problems would not arise. But the new volatility in the oil market creates problems that are beyond the professional interest of economists per se to investigate. Thank you, Mr. Chairman. [The prepared statement of Dr. Schlesinger follows:] EMBARGOED UNTIL: 10:00 am March 14, 1986 STATEMENT OF JAMES R. SCHLESINGER UNITED STATES SENATE COMMITTEE ON ENERGY AND NATURAL RESOURCES OVERSIGHT HEARINGS ON "THE DOMESTIC AND INTERNATIONAL PETROLEUM SITUATION" March 14, 1986 Mr. Chairman, Members of the Committee It is for me a special pleasure to appear before this Committee today to examine the consequences of rapidly changing oil prices. For me this session provides a touch of nostalgia - a remembrance of things past. In previous years I testified before this Committee on precisely the same subject. On those other occasions, however, oil price movements were causing problems by moving upwards rather than downwards - as at the present time. The current decline, in a sense, implies a reversal of the macroeconomic difficulties encountered during the upsurge of oil prices in the 1970's stunted economic growth, unemployment, and a general rise in prices. The impact of falling energy prices is to ease inflation and to stimulate more rapid economic growth. Serious long-term problems that were then alleviated by the rise in oil prices long-term oil supply, and national security concerns now being intensified. Yet, since these are longer-term problems, they get relatively less attention. Indeed, in today's widespread euphoria regarding the macroeconomic benefits of falling oil prices, most notable in the financial markets, these issues are regularly ignored. - - are In recent years the excess capacity for oil production worldwide and the absence of steadily rising prices has led many Americans to a happy, if inaccurate conclusion: the energy problem is over. But the energy problem has not been solved; rather it is misunderstood. In fact, the energy problem is not a single problem, but rather a congeries of problems. It features the three interlocking elements of a.) the relationship of energy market performance to b.) economic growth and price stability and c.) security of energy supply and other national security concerns. The disquieting reality is that these elements operate at cross-purposes in terms of achieving national objectives. A rising oil price brings a serious deterioration in macroeconomic performance, but eases concerns about oil supply and national security. By contrast, falling energy prices bring rapid improvement for the overall economy, but a worsening of oil supply and national concerns, especially over the longer run. In recent years the interpretation of the nature of the OPEC cartel has substantially changed. In earlier years it had appeared to many, including myself, that the burgeoning demand for oil that had marked the period since World War II and the limited resource base implied that the cartel was partially exempt from the ailments that have historically afflicted other cartels. But in the '80s these conditions have been altered. A small decline in oil usage of about 10 percent along with a modest, if temporary, expansion of non-OPEC production has subjected the cartel in the 1980's to pressures that the members scarcely anticipated in the '70s. Their expectation of steadily rising prices and expanding revenues failed to materialize -- and (at least temporarily) has turned to ashes. What we see today may be described as "the normalization of OPEC" - an OPEC becoming more and more like an ordinary cartel. We observe "price wars" intended to intimidate uncooperative producers into controlling production. We have seen |