Commentary Magazine

Oil Heat

I found the musings of Thomas W. Merrill and David M. Schizer on energy policy wanting in their casual empiricism and misguided in their policy prescriptions [“The Petroleum-Tax Giveback,” October 2009]. The authors begin by trotting out the usual statistics on how much of the petroleum consumed by the U.S. originates in the Middle East, Venezuela, Angola, and other regions known for instability and hostility to America. Pardon my pun, but this is a crude perspective on global oil markets. As it travels from well to refinery to distribution channels, petroleum may change ownership a dozen or more times. It is not only Iran and Russia that, in the authors’ words, “do not supply oil directly”; no one does.


The interaction of oil corporations, brokers, and commodities exchanges together create an enormously resilient networked system that has for many decades delivered reliable energy across the globe. The authors claim that the 1973 price shocks and the events relating to the Iranian revolution of 1979 are evidence of supply insecurity and harmful price volatility. But U.S. government data show that during both crises, imports of crude and refinery inputs and outputs showed no change from normal seasonal variations.

Blame for the “shortages” and queuing that so many of us remember can be laid squarely at the door of the federal government, whose misallocation of resources across “administrative districts” led to oversupply in some locations and shortages in others. (In 1979, for example, petrol was as scarce as a hen’s tooth within the 495 Beltway of Washington, but those Washingtonians brave enough to venture to rural Virginia found as much fuel as a station wagon required for a week of busy activity.)

When Messrs. Merrill and Schizer turn to the Obama administration’s energy policy, they are correct to observe that environmental objectives are the main driver. Oddly, though, they criticize the cap-and-trade scheme for limiting carbon emissions on the grounds that it is both inflationary and deflationary and therefore at cross-purposes. But the key critique of cap-and-trade is that the economic incidence falls upon consumers, having been passed forward by producers of electricity. As consumers have little choice about using electricity, no conservation is induced, and generators of electricity enjoy a windfall as they are insulated from the cost of compliance.

Messrs. Merrill and Schizer propose a sliding tax on petroleum that fluctuates inversely to its price: when prices fall, the tax goes higher to support transition to new technology and encourage supply security, and vice versa. Unconsidered by the authors is that stabilizing commodity costs using put and call options to create a floor (or “collar”) and ceiling around prices has been widely practiced by businesses and traders for decades. Such hedging is part of the basic toolkit for risk-and supply-chain managers.

The authors’ key mistake is their assumption that price volatility is an obstacle to long-range planning. This is contrary to industry reality. Their plan would merely have government do what businesses from airlines to transport companies to utilities already undertake as a matter of sound corporate governance. Moreover, the refund feature in their plan already exists in competitive markets. Companies that manage their price risks are able to offer lower prices to consumers and thereby increase market share. (Unless the authors also intend to ban the use of options and futures, a sensible manager could even hedge away the threat of their proposed tax.)

In sum, the authors’ plan reminds me of the legal fantasy of the 1978 Natural Gas Policy Act, which regulated the price of natural gas according to the depth and vintage of the well from which it was derived. Huge market dislocations resulted, and exploration was discouraged. The only ones who benefitted were the government lawyers hired to track down arbitrageurs and determine whether a comingled unit of natural gas was “new” or “old,” “deep” or “shallow.” Although there may be environmental reasons to reduce the use of petroleum, energy independence and security are spurious foundations upon which to construct a policy that interferes with our remarkably resilient system of petroleum-energy delivery.

Oxfordshire, England


To the Editor:
Doesn’t the authors’ plan mean that people will be inhibited from spending the same amount on petrol only in the first quarter the plan is in force? Because for subsequent quarters, they will just keep getting reimbursed the previous quarter’s charge and apply that toward their expenditure. Net-net, this will have an affect equivalent only to the reimbursement period—–and that’s it!

London, England


To the Editor:
How unfortunate that this article must tug its forelock in obeisance to the concept that carbon dioxide released by human activity is heating up the atmosphere to a degree relevant to the weather. The real problem with carbon-capture schemes and cap-and-trade scams is that they are based on this probable mistake and so are monumentally wasteful.

Vancouver, Canada


To the Editor:
Professors Merrill and Schizer’s article on Obama’s energy policy (or, rather, lack thereof) contained thorough analysis of the state of affairs, as befitted esteemed academics. Their plan, though, closely mirrors a suggestion voiced by Charles Krauthammer numerous times. But unlike Mr. Krauthammer, who, by the way, candidly acknowledged that his plan is unlikely to be implemented, the authors suggest that the “charge” be refunded to the consumers.

The authors’ idea seems to contradict the stated goal of the plan: to influence American driving habits. I humbly suggest that such a refund will be treated as, well, a refund on the purchase of gas, thus bringing the perceived price at the pump to pre-plan levels and negating any change of driving habits from the higher price.

The article did manage to introduce some levity into the otherwise somber discussion by suggesting that politicians won’t be tempted to turn the proposed revenue stream into a new tax. It is quite refreshing to discover such naiveté.

Newark, New Jersey


To the Editor:
The authors argue that their plan is not a tax, because proceeds collected would be refunded to consumers. Would the same be true if the government increased taxes to finance more-traditional transfer payments? I think all would agree that an increase in taxes to finance an increase in welfare payments, Social Security benefits, or income-tax credits would constitute “true” taxes. The alleged absence of a new government bureaucracy or expenses to facilitate their plan does not make the authors’ proposal any less of a tax.

Passaic, New Jersey


To the Editor:
In their timely essay on the failure of the Obama administration to address the serious issues associated with our oil “addiction,” Thomas Merrill and David Schizer state that the Yucca Mountain project in Nevada is a “nuclear-fuel reprocessing facility.” In fact, as authorized by the 1987 Nuclear Waste Policy Act Amendments, that facility is designed only to store spent unreprocessed fuel from commercial nuclear-power plants in the form in which it was discharged from the reactors—i.e., intact fuel elements or assemblies of such elements appropriately encased in sealed containers of extremely high integrity designed to withstand incredible natural and man-made forces.

Messrs. Merrill and Schizer also imply that so-called alternative technologies, e.g., solar and wind, might contribute to a reduction in petroleum consumption. Such technologies used in the generation of electricity will have practically no direct effect on oil imports, since oil is currently used to make only a tiny fraction of electricity, less than 1 percent in 2008. Of course, if the Obama administration continues to minimize or indeed eliminate the expansion of coal and nuclear plants, that percentage will undoubtedly increase, exacerbating our oil addiction.

Willowbrook, Illinois


Thomas W. Merrill and
David M. Schizer write:

Our proposal is aimed at reducing America’s dependence on petroleum, thereby enhancing national security and mitigating the environmental harms associated with petroleum consumption. We would put a floor under the price of gasoline, stabilizing consumer demand for energy-efficient innovations. To stabilize prices in this way, the government would collect a per-gallon charge from consumers, which would increase with a drop in the price of oil and decrease with a rise. The charge would be rebated so that, on a net basis, the government would not collect any revenue. The amount that any given consumer would pay to the government would depend on how much he consumes—the more he consumes, the more he pays—but the amount he receives would be fixed at the average per capita consumption. Those who are moreenergy efficient would receive a net payment, and those who are less energy efficient would make a net payment.

We agree with Lawrence Haar that oil is a fungible commodity. Our point is that the level of dependence on imported oil affects the balance of power between the U.S. and oil-producing nations. The more dependent the U.S. is on imports, the more accommodating it must be in dealing with oil–exporting nations; many of them are unstable or hostile to American interests, or both. We also do not doubt that major international oil companies and other sophisticated firms use hedging strategies to manage the risk of oil-price swings, as they should. The problem is that consumers do not use these techniques. When price volatility strikes, consumers overreact or simply freeze up. The firms that build autos or invest in alternative energy have not yet figured out how to hedge for swings in consumer demand. Part of our point is that by stabilizing consumer expectations on the downside, we smooth out economic bumps and facilitate the transition to alternative fuels.

We are in complete sympathy with Mr. Haar’s point that government intervention in energy markets has had very unfortunate effects in the past. Our proposal is designed to keep government intervention as simple as possible. The government would prop up the retail price of gasoline but not in a way that subsidizes energy producers and without government involvement in promoting specific energy-saving strategies. There is, of course, the option to do nothing, but that makes sense only if the external costs associated with burning petroleum fuel are negligible, or if the costs of intervention exceed the benefits. We do not think either proposition holds.

Shahid Jamil and Alexandre Peshansky suggest that our plan will have no incentive effect, because the added charge on petroleum fuels will be offset by the refund. But the fixed refund combined with the variable charge creates a strong incentive to profit from the differential by reducing consumption.

Ira Charak is right that Yucca Mountain is intended to be a long-term storage facility not a reprocessing facility, and we regret the imprecision in our description. We also agree that under current market conditions, there is little direct substitution between solar or wind and oil. But if the price of petroleum fuel were to rise permanently, we could expect greater substitution in the future—for example, if consumers switch to rechargeable electric cars or use electricity rather than oil for home heating.

Robert Aberman raises an interesting question about the definition of a tax, to which there is no single right answer. We use one definition—a charge designed to raise revenue to fund the government. Given that definition, our charges are not taxes, because they are not designed to raise revenue. We agree that a tax increase that funds welfare payments is a “tax,” as he suggests. But would a law that, say, required people to open a retirement account be a tax? We think not. At the end of the day, though, the question of whether our proposal is a “tax” is less important to us than whether it would work. We need to pursue national-security and environmental goals in a way that does not require government judgments about which technologies to promote, since, in our view, the government does not have the capacity to make these judgments effectively. Cracking this policy nut would go a long way toward securing our nation’s future.


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