History repeats itself: a guide from 30 years ago
Branko Terzic
Deloitte Services LP
Washington, DC
In the late 1970s, the United States tried to boldly remake its energy policy – rethinking everything from oil consumption to energy efficiency. The effort saw winners and losers, as well as bizarre plot twists, and dramatic unintended consequences.
Now, 30 years later, we face a similar policy shift – and many of the lessons we learned in the 1970s have been lost on today's policymakers and energy company executives. Yet, if it is true that those who cannot learn from history are doomed to repeat it, then today's national leaders and energy executives would be smart to look to the lessons from the past before making critical decisions today.
This is all clearly explained in a remarkable book published in 1990 by three MIT faculty members: Thomas H. Lee, Ben C. Ball Jr., and Richard D. Tabors. The book, ENERGY AFTERMATH: How we can learn from the blunders of the past to create a hopeful energy future (Harvard 1990), offers a compelling analysis of America's mercurial history with energy, and also provides a great platform to think about how today's energy decisions could play out in the future.
ENERGY AFTERMATH explains that the period between the end of World War II and the beginning of the 1970s saw global oil supply controlled by a handful of Western oil companies. The dominant characteristic of these companies was not their ability to allocate oil supply, but rather their ability to market that oil. During this period, prices for all forms of energy were generally low and oil prices set the ceiling. Most importantly, production capacity, which was controlled by Western companies, exceeded demand.
With oil trading freely on global markets, prices were relatively stable and supplies were secure, at least compared to later periods. As Lee, Ball, and Tabors explain, the international oil companies did not compete for supply, but instead functioned as vertically integrated companies that developed downstream markets. It was there that they competed for the end-use consumer by selling their refined products under internationally recognized brand names. These companies focused on convincing the consumer to "put a tiger in your tank" or "trust your car to the man who wears the star."
With Texas producing one-third of the nation's oil and the Texas Railroad Commission providing the allocation decisions, the US saw low oil costs with plentiful oil displacing coal in many uses, eventually capturing as large a share of the energy market as coal. Low oil prices drove the economy. With nothing to complain about, policymakers and consumers had the luxury of paying little attention to energy issues.
Then, in the early 1970s, a major change occurred that shook the worlds of politics and energy with equal magnitude: Saudi Arabia initiated the 1973 oil embargo to punish the US and the Netherlands for their aid to Israel during the Arab-Israeli War. As ENERGY AFTERMATH's authors point out, an event like the 1973 oil embargo had been germinating for years, particularly since the creation of the Organization of Petroleum Exporting Countries (OPEC) in 1959, when the five countries (Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela) sourcing 80% of global oil exports decided to operate more cohesively.
The 1973 oil embargo emboldened OPEC members to move from having concession relationships with the major international oil companies to controlling their own production directly and in concert with other OPEC members. OPEC restricted oil supply to the market causing prices to rise. The buyer's market became the seller's market, and the dominant international sellers were OPEC members. OPEC members were now selling their product in the marketplace and controlling the quantity available for sale. With relatively inelastic demand, in the short-run, small changes in supply caused dramatic spikes and drops in the market as OPEC exercised it newfound power.
The US government's response was to try to fill the "gap" between the curtailed OPEC oil supply and US demand by increasing the domestic supply of coal (but, interestingly, not natural gas), and hastening new technology in the form of subsidies for synthetic fuels and renewable energy sources.
Government policy was based on the official position, as stated in the National Energy Plan of 1977, that the world was running out of oil and would do so by 2010. Coal was abundant so it was advanced to lesson our dependence on oil. Natural gas was considered in such short supply that laws were passed prohibiting its use in power production or as boiler fuel, thus conserving gas supplies for residential home heating and other "essential uses."
These policies were based on the near-term analysis that the higher oil and other energy prices did not result in immediate demand changes. What was overlooked was that oil and other fuels were used by capital equipment and that the higher prices would eventually lead to the purchase of new, more efficient capital equipment which would lower future energy demand.
By the end of the 1970s, the higher OPEC prices did result in both decreased demand and in the stimulation of new non-OPEC oil supplies entering the global oil market. Starting in 1979, OPEC demand fell due to the higher prices six years earlier. The new higher OPEC prices had done what basic economics predicted was going to happen all along: They had depressed demand and attracted new supply.
In ENERGY AFTERMATH, Lee, Ball, and Tabors also conclude that "…we now know that long-term instability and unpredictability is systemic." By this, they mean that "prices will either rise, fall, or remain level." In their own words, it is "beyond the capacity" of analysts to predict either specific changes or trends. One of the lessons Lee and his colleagues draw is that forecasts are always wrong and that's why contingency planning must be a part of any policy. Models are "surprise-free," they assert, and that's why forecasts are wrong — "in real life, surprises are the rule rather than the exception," they say.
According to the authors, the misconceptions and wrong assumptions that drove national energy policy in the 1970s hardened into conventional wisdom or, more correctly, "myths".
The "myths" described in ENERGY AFTERMATH are more important now than ever, as America again tries to radically shift our energy direction. Examining each one offers both clues and cautionary notes for policymakers and oil and gas companies alike.
Myth 1 — "… the demand for energy would continue to grow." Demand for oil declined after 1979 and slowly returned over the next two decades. What's more, as the events of the last year have shown, global demand for energy, especially for oil, cannot be counted on as a constant.
Myth 2 — "… energy prices, especially the price of oil, would continue to increase until a backstop technology … became available." Numerous pundits would have been in agreement with this up to last spring, when the price of oil dropped like a stone. Again, this myth shows that there are no constants in the oil business.
Myth 3 — "… we were running out of oil." This idea still has some backers among the "peak oil" crowd, but runs against the current practice of extracting hydrocarbons from unconventional sources like oil sands and oil shales.
Myth 4 — "… access to [oil] supply had in itself an intrinsic value" and thus good relations with producers would "assure" supply. The assumption here is that certain producers would be willing to sell to their friends at below market prices when prices were tight. Thus, policies were introduced to favor certain oil producing nations.
Myth 5 — "… the negative effects of energy conversion and use, such as those on the environment, were separate from the energy sector and could be easily addressed, particularly through technological solutions." Clearly the combustion of fossil fuels leads to greenhouse gas emissions and technology will play a role in the mitigation and limitation, but only with clear and certain energy and environmental policies. In short, the reason that many in the energy industry are calling for "cap and trade" or some other legislation is that the solutions will not come from technology without appropriate policy.
Reviewing the myths of the 1970s and the subsequent actions taken by the US government, Lee, Ball, and Tabors make it clear that we have, as they put it, "misinterpreted events, made inappropriate assumptions and analysis, misused the laws of economics and commerce, and failed to use our understanding of the relative roles of the public and private sectors."
It is my modest suggestion that ENERGY AFTERMATH should be required reading for every policymaker and energy executive. It's long out of print but perhaps this article and subsequent demand will result in a reprint of the book.
In any case, the book raises a critical question: Are we still operating under energy myths, or are we ready to move ahead with the facts? Moreover, are we weighing new facts into our decision making?
As John Maynard Keynes advised: "When the facts change, I change my mind. What do you do, sir?" To me, that's a good place to start. Making today's critical decisions without looking at the lessons from the past, alongside the latest forward looking data, could just create a case of history repeating.
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