Energy Security: Evaluating U.S. Vulnerability to Oil Supply Disruptions
and Options for Mitigating Their Effects (Chapter Report, 12/12/96,
GAO/RCED-97-6).

Pursuant to a congressional request, GAO reviewed the effectiveness of
the Administration's 1995 National Energy Policy Plan (NEPP) in reducing
the vulnerability of the U.S. economy to oil supply disruptions and
price shocks, focusing on: (1) the economic benefits of importing oil
compared with the potential economic costs of vulnerability to oil
shocks; (2) the extent to which the U.S. economy's vulnerability to oil
shocks will likely change over time given the programs and policies
contained in the Administration's 1995 NEPP and other relevant factors;
and (3) options for reducing the economy's vulnerability to oil shocks.

GAO found that: (1) the U.S. economy realizes hundreds of billions of
dollars in benefits annually by using relatively low cost imported oil
rather than relying on more expensive domestic sources of energy; (2) by
comparison, oil shocks impose large but infrequent economic costs that,
when annualized, are estimated to cost the U.S. economy tens of billions
of dollars per year; (3) the economic costs of oil price shocks depend
largely upon the rise in the price of oil coupled with the nation's
level of oil consumption, rather than the level of imports; (4) as long
as market forces prevail, world and domestic oil prices will be the same
and will rise and fall with changes in world oil market conditions; (5)
under these conditions, an incremental decrease in oil imports would
reduce the benefits of such imports without substantially lowering the
costs of oil price shocks; (6) oil supply disruptions impose significant
economic costs, and reliance on imported oil imposes military and other
costs that are not easily measured; (7) while adopting the NEPP's
initiatives may keep the economy's vulnerability to oil supply
disruptions below what it otherwise would be, the Energy Information
Administration's forecasts indicate that by most measures the economy
will not likely be significantly less vulnerable through 2015, primarily
because the demand for oil is projected to increase; (8) only over a
longer period do energy analysts anticipate significant improvement, and
that depends on technological advances in such areas as energy
efficiency and alternative fuels; (9) while their views varied, almost
all of the experts GAO consulted about options for reducing the
economy's vulnerability to oil supply disruptions said that, in the
short run, the United States should rely on rapid and large releases of
oil from the Strategic Petroleum Reserve to blunt price increases at the
onset of an oil supply disruption; and (10) in the long run, the experts
generally favored research to develop cost-competitive alternatives to
petroleum.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-97-6
     TITLE:  Energy Security: Evaluating U.S. Vulnerability to Oil 
             Supply Disruptions and Options for Mitigating Their
             Effects
      DATE:  12/12/96
   SUBJECT:  Oil importing
             Domestic crude oil
             Economic policies
             Energy supplies
             Energy consumption
             Alternative energy sources
             Fuel research
             Petroleum prices
             Energy efficiency
             Energy shortages
IDENTIFIER:  DOE National Energy Policy Plan
             Persian Gulf
             Strategic Petroleum Reserve
             Project Independence
             EIA National Energy Modeling System
             EIA Annual Energy Outlook
             Gross Domestic Product
             North American Free Trade Agreement
             DOE Oil Technology Program
             NAFTA
             Europe
             Japan
             Germany
             United Kingdom
             France
             Italy
             
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Cover
================================================================ COVER


Report to the Chairman, Committee on the Budget, House of
Representatives

December 1996

ENERGY SECURITY - EVALUATING U.S. 
VULNERABILITY TO OIL SUPPLY
DISRUPTIONS AND OPTIONS FOR
MITIGATING THEIR EFFECTS

GAO/RCED-97-6

Vulnerability to Oil Supply Disruptions

(308887)


Abbreviations
=============================================================== ABBREV

  Btu - British thermal unit
  CBO - Congressional Budget Office
  CFCC - Continuous Fiber Ceramic Composites
  DOD - Department of Defense
  DOE - Department of Energy
  EIA - Energy Information Administration
  EMF - Energy Modeling Forum
  FEMP - Federal Energy Management Program
  FY - fiscal year
  GAO - General Accounting Office
  GDP - Gross Domestic Product
  GNP - Gross National Product
  IAC - Industrial assessment centers
  IEA - International Energy Agency
  IHEM - In-House Energy Management
  MIT - Massachusetts Institute of Technology
  mmbd - million barrels per day
  mmby - million barrels per year
  NAFTA - North American Free Trade Agreement
  NEMS - National Energy Modeling System
  NEPP - National Energy Policy Plan
  NICE-3 - National Industrial Competitiveness through Energy,
     Environment, Economics
  OECD - Organization for Economic Cooperation and Development
  OPEC - Organization of Petroleum Exporting Countries
  ORNL - Oak Ridge National Laboratory
  PNGV - Partnership for a New Generation of Vehicles
  R&D - research and development
  SPR - Strategic Petroleum Reserve

Letter
=============================================================== LETTER


B-273024

December 12, 1996

The Honorable John R.  Kasich
Chairman, Committee on the Budget
House of Representatives

Dear Mr.  Chairman: 

This report responds to your request that we assess the effectiveness
of the administration's 1995 National Energy Policy Plan in reducing
the vulnerability of the U.S.  economy to oil supply disruptions and
price shocks (oil shocks).  The report estimates the economic
benefits of importing oil and compares these benefits with the
economic costs of past disruptions.  The report also provides
measures of the economy's vulnerability to oil shocks and forecasts
the likely impact of the administration's initiatives and other
factors on these measures through the year 2015.  Finally, the report
provides the views of oil experts and industry analysts on the most
effective strategies for dealing with the economy's vulnerability to
oil shocks. 

We are sending copies of this report to the appropriate congressional
committees, the Secretary of Energy, and other interested parties. 
We will also make copies available to others upon request. 

Please call me at (202) 512-3841 if you have any questions about this
report.  Major contributors to this report are listed in appendix
VII. 

Sincerely yours,

Victor S.  Rezendes
Director, Energy, Resources,
 and Science Issues


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

Since the early 1970s, the world oil market has experienced three
major supply disruptions that harmed the U.S.  economy.  All three
originated in the Persian Gulf.  Concerned that growing dependence on
low-priced imported oil, especially from the Persian Gulf, increases
the economy's vulnerability to oil supply disruptions and price
shocks (oil shocks), the current administration, through its 1995
National Energy Policy Plan, has adopted policies and programs
intended to reduce that vulnerability and its associated economic
costs. 

As requested by the Chairman, House Committee on the Budget, this
report assesses (1) the economic benefits of importing oil compared
with the potential economic costs of vulnerability to oil shocks, (2)
the extent to which the U.S.  economy's vulnerability to oil shocks
will likely change over time given the programs and policies
contained in the administration's 1995 National Energy Policy Plan
and other relevant factors, and (3) options for reducing the
economy's vulnerability to oil shocks.  To accomplish these
objectives, GAO asked the Department of Energy's Energy Information
Administration to estimate the economic benefits of importing oil
using its modeling capabilities and assessed existing studies on the
historical and projected costs of oil shocks.\1 GAO also used
projections of domestic oil savings and production resulting from the
Department of Energy's programs and the Energy Information
Administration's long-range forecasts of vulnerability measures. 
Finally, GAO consulted with 19 recognized oil industry, oil market,
or oilsecurity experts representing a wide range of views on energy
policy issues. 


--------------------
\1 The results of the Energy Information Administration's modeling
should not be construed as advocating or reflecting any policy
position of the Department of Energy. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

The current administration issued its biennial National Energy Policy
Plan in July 1995, as required by title VIII of the Department of
Energy Organization Act, enacted in 1977.  Partly to reduce the
nation's vulnerability to oil supply disruptions, the plan includes
programs for increasing energy efficiency, substituting alternative
energy sources for oil, and increasing domestic oil production.  It
also states as a policy that the administration will seek to dampen
the effects of an oil supply disruption by drawing down the nation's
Strategic Petroleum Reserve in coordination with related actions by
other countries.  Besides reducing the economy's vulnerability to oil
shocks, the plan has two other goals--maximizing energy productivity
and preventing pollution.  GAO's review focused on reducing the
economy's vulnerability to oil shocks.  Such vulnerability depends
largely on the likelihood or probability of a disruption, the extent
to which the economy depends on oil, and the nation's ability to
respond; GAO's review focused primarily on the latter two areas. 

Oil accounts for about 40 percent of all U.S.  energy consumption. 
Declining domestic oil production and relatively low world oil prices
have increased the nation's reliance on foreign sources.  If prices
remain low, oil imports are projected to rise from about 50 percent
of the nation's oil consumption in 1995 to over 60 percent over the
next 20 years. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

GAO estimates that the U.S.  economy realizes hundreds of billions of
dollars in benefits annually by using relatively low cost imported
oil rather than relying on more expensive domestic sources of energy. 
By comparison, oil shocks impose large but infrequent economic costs
that, when annualized, are estimated to cost the U.S.  economy tens
of billions of dollars per year.  More importantly, substituting more
costly domestic production for oil imports without lowering overall
oil consumption would be unlikely to substantially lower the costs of
oil supply disruptions.  In essence, the economic costs of oil price
shocks depend largely upon the rise in the price of oil coupled with
the nation's level of oil consumption, rather than the level of
imports.  As long as market forces prevail, the price of domestic and
world oil will be the same and will rise and fall with changes in
world oil market conditions.  Under these conditions, an incremental
decrease in oil imports would reduce the benefits of such imports
without substantially lowering the costs of oil price shocks. 
Nevertheless, oil supply disruptions impose significant economic
costs, and reliance on imported oil imposes military and other costs
that are not easily measured. 

While adopting the National Energy Policy Plan's initiatives may keep
the economy's vulnerability to oil supply disruptions below what it
otherwise would be, the Energy Information Administration's forecasts
indicate that by most measures the economy will not likely be
significantly less vulnerable through 2015, primarily because the
demand for oil is projected to increase.  Only over a longer period
do energy analysts anticipate significant improvement--and that
depends on technological advances in such areas as energy efficiency
and alterative fuels. 

While their views varied, almost all of the experts GAO consulted
about options for reducing the economy's vulnerability to oil supply
disruptions said that, in the short run, the United States should
rely on rapid and large releases of oil from the Strategic Petroleum
Reserve to blunt price increases at the onset of an oil supply
disruption.  Many experts also said that the United States might be
able to limit the economic damage through the effective use of
monetary policy by adjusting interest rates and the money supply.  In
the long run, the experts generally favored research to develop
cost-competitive alternatives to petroleum, particularly in the
transportation sector, which is responsible for most of the nation's
oil consumption.  While some experts suggested raising taxes on
domestic gasoline consumption to increase the price, lower the
demand, and make alternatives more cost competitive, they also
recognized the existence of opposing views on this option and the
potential for public opposition to it. 


   GAO'S ANALYSIS
---------------------------------------------------------- Chapter 0:4


      ESTIMATED BENEFITS OF
      IMPORTS EXCEED LIKELY COSTS
      OF DISRUPTIONS
-------------------------------------------------------- Chapter 0:4.1

Estimates of the day-to-day economic benefits of using low-priced
imported oil exceed the estimated economic cost of occasional oil
supply disruptions.  Moreover, to the extent that imports were
replaced with higher-cost domestic oil, the benefits from such
imports would decline, but the cost of oil shocks would remain
largely unchanged.  The large benefits accrue from not having to rely
on more expensive domestic sources of energy for the share of the
nation's energy needs that is supplied by imported oil.  The analysis
done for GAO by the Energy Information Administration (EIA) estimated
the annual cost to the U.S.  economy of reducing imports.  On the
basis of this analysis, GAO estimates, for example, that reducing the
expected growth of future U.S.  oil imports by between 2.0 million
barrels per day (mmbd) and 3.2 mmbd below the forecast level of 11.4
mmbd in 10 years would cost the United States between $50 billion and
$100 billion per year in 1994 dollars in lost gross domestic product
(GDP).  This hypothetical reduction represents only a portion of the
nation's actual oil imports, and the cost would increase if imports
were further reduced.  Thus, the nation's current level of oil
imports provides hundreds of billions of dollars in economic benefits
per year.  These estimates are based on the expected pace of
technological development and future oil prices.  If the pace of
technological development is faster than expected, then the estimated
benefits of oil imports would be lower than reported here.  Moreover,
the United States could lower its imports without reducing economic
growth. 

In comparison, the estimated annualized costs of occasional oil
supply disruptions are considerably smaller.  Such costs are
concentrated in the periods following disruptions, but when averaged
over time, estimates of past and potential future costs ranged from
$22 billion to $73 billion per year.  Furthermore, substituting
increased domestic oil production for imported oil would reduce the
benefits from imports but would not substantially lower the costs of
future disruptions.  As long as oil prices are set in the marketplace
and the United States is a part of the world oil market, U.S. 
consumers and businesses would pay the same higher world oil price
for both domestically produced and imported oil during a disruption,
with likely similar economic consequences.  Under these conditions,
the costs of a disruption depend on the level of oil consumption
rather than the level of oil imports. 

Reducing oil imports by increasing more costly domestic production
would increase output and employment in the domestic oil industry,
but this benefit would be more than offset by losses in other sectors
of the economy.  EIA's analysis found, for example, that reducing oil
imports by 4.7 mmbd in 2015 would increase output in the mining
sector (which includes the drilling and production of oil) by about
$16 billion per year.  Increases in employment would accompany such
increases in output.  However, reducing imports would also reduce
output and employment in most other sectors, and the total estimated
net decline in GDP would be about $100 billion per year. 
Furthermore, reductions in oil imports would be unlikely to affect
the net trade deficit.  That deficit is largely determined by the gap
between savings and investment and by the government budget deficit,
which are unlikely to be substantially affected by changes in the
level of oil imports. 

The economic benefits of importing low-priced oil are at least
partially offset by the human and financial costs of military and
national security operations in the Persian Gulf, where many of the
world's low-cost reserves are located.  According to different
studies, the costs of preserving the stability of oil supplies range
from as little as a few billion dollars per year to as much as $65
billion per year.  However, it is unclear how military or security
costs would change if the United States imported less oil.  In
addition, reliance on low-cost oil from the Persian Gulf may entail
other unmeasurable costs, such as a reduction in the number of
options available to U.S.  foreign policy decisionmakers.  The
environmental costs of oil consumption are excluded from this
analysis because they derive largely from the consumption, not from
the source, of the oil. 


      U.S.  VULNERABILITY TO OIL
      SHOCKS IS UNLIKELY TO
      DECLINE SUBSTANTIALLY OVER
      THE NEXT 20 YEARS
-------------------------------------------------------- Chapter 0:4.2

The 1995 National Energy Policy Plan (NEPP) contains many policies
and programs aimed at reducing the economy's vulnerability to oil
shocks.  These generally include (1) energy efficiency programs to
reduce the consumption of oil or develop alternative energy sources,
(2) fossil energy programs to increase the production of domestic oil
and other fossil fuels, and (3) policies to draw down the Strategic
Petroleum Reserve and other oil stocks during an oil supply
disruption and facilitate the diversification of international oil
supplies.  However, it is difficult to assess the impact of these
programs and policies on the economy's vulnerability because the NEPP
does not offer ways to measure this vulnerability or quantify the
initiatives' long-term effects on it. 

GAO and Department of Energy (DOE) officials agreed on several
measures of the economy's vulnerability to oil shocks--the
concentration of world oil production, the excess world oil
production capacity, the oil intensity of the U.S.  economy, the oil
dependence of the U.S.  transportation sector, and the level of world
oil stocks.  Although DOE officials believed that the level of oil
imports should also be included, they agreed that it is a weak
measure because, as discussed, the economic effects of disruptions
are largely the same regardless of the level of imports.  DOE
officials projected that, if other factors remained constant, their
energy efficiency programs could collectively reduce the nation's oil
consumption by about 2.1 mmbd by 2010 and by up to 3.5 mmbd by 2020. 
In addition, they projected that their fossil energy programs could
collectively increase U.S.  oil production by about 0.8 mmbd by 2010
and by up to 1.4 mmbd by 2020. 

While adopting the NEPP's initiatives may keep the economy's
vulnerability lower than it otherwise would be, EIA's projections
indicate that increases in the demand for oil may offset many of the
gains.  EIA's forecasts that assume a continuation of DOE's existing
policies and programs show improvement by 2015 in only one measure of
vulnerability--the oil intensity of the U.S.  economy.  The other
measures are expected to remain nearly the same or worsen during the
forecast period.  EIA's forecasts that assume greater technological
advances indicate improved trends for the applicable measures, but by
2015 these measures are still at nearly their current level except
for the oil intensity of the economy, which shows greater
improvement.  DOE officials point out that the measures would be
worse without the NEPP's initiatives and that the initiatives result
in other benefits, such as reduced pollution and greater domestic
economic activity and employment.  Despite these potential benefits,
only over a longer term do energy analysts see the potential for a
significant reduction in the economy's vulnerability to oil shocks. 


      EXPERTS IDENTIFIED OPTIONS
      FOR MITIGATING VULNERABILITY
-------------------------------------------------------- Chapter 0:4.3

While their views varied on the advantages and disadvantages of
individual options, oil experts and industry analysts offered several
near- and long-term ways to reduce the nation's vulnerability to oil
shocks, some of which also appear in the NEPP, but with some
important differences.  For the near term, they generally agreed that
early use of the Strategic Petroleum Reserve (SPR) during an oil
supply disruption is the most effective tool available to mitigate a
disruption's adverse economic effects.  Many also believed that a
market-oriented trigger, such as the sale of options to purchase SPR
oil, is needed to avoid time-consuming governmental decision-making
and ensure a rapid and sufficient drawdown of the SPR at the onset of
an oil crisis.  The NEPP calls for using the SPR early during a
disruption but does not call for a market-oriented trigger. 

While not directly related to oil markets, monetary policy was cited
by some experts as potentially effective in offsetting the short-term
economic costs of an oil supply disruption.  Although most of these
experts believed that monetary policy is an important tool for
offsetting the effects of an oil shock, some said that the
relationship between the two is complex and requires more detailed
study.  The plan does not indicate what the nation's monetary policy
should be during a disruption, but DOE is currently studying this
issue, with input from Federal Reserve officials and others, and
plans to release the results by the end of 1996. 

Over the long term, the experts generally favored research to develop
cost-competitive alternatives to petroleum, especially in the
transportation sector.  They also generally believed that the federal
government should participate in energy research, particularly basic
research, but did not favor federal mandates or subsidies to promote
the use of alternative fuels.  In addition, while acknowledging
potential political and public opposition, some experts nevertheless
suggested raising the domestic gasoline sales tax in order to
increase the price and thus both lower the demand for gasoline and
increase the cost-competitiveness of alternative fuels.  Other
experts pointed out that higher gasoline taxes would increase
consumers' costs.  The NEPP contains research initiatives related to
alternative fuels and calls for the continued implementation of
current mandates and subsidies for their use.  The plan does not
suggest raising gasoline tax rates. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5

GAO is not making any recommendations in this report. 


   AGENCY AND OTHER COMMENTS AND
   GAO'S EVALUATION
---------------------------------------------------------- Chapter 0:6

GAO provided a draft of this report for review and comment to DOE and
the energy or modeling experts consulted during GAO's study.  DOE was
critical of the report, while the experts who responded
overwhelmingly agreed with the report's overall message. 

In summary, DOE said that GAO's approach to analyzing the economic
benefits of importing oil is seriously flawed and yields no insight
into the overall consequences of oil imports.  GAO estimated the
economic benefits of importing oil by assessing the costs to the
economy of lowering imports through hypothetically increased oil
prices and an oil import fee.  GAO validated this approach
extensively with the 14 economic or modeling experts listed in
appendix II of this report, as well as others.  GAO believes that
information on the extent of the economic benefits, coupled with
information on the extent and source of the costs of oil supply
disruptions, provides an important perspective for policymakers
considering the implications of the nation's expected growing
reliance on oil imports.  DOE also said that GAO did not perform an
adequate analysis of the expected changes in the economy's
vulnerability to oil shocks largely because the report does not show
the results both with and without the effects of DOE's programs. 
GAO's objective, which has been clarified, was to assess the extent
to which the U.S.  economy's vulnerability to oil shocks would change
over time given the effects not only of DOE's programs but also of
projected increases in the demand for oil and other important changes
in the economy.  To respond to this objective, GAO relied on EIA's
published or readily available energy forecasts, which consider all
of these factors but do not present the incremental effect of each
one.  Such an analysis might demonstrate DOE's view that the report's
measures of vulnerability would be worse without DOE's programs--a
view that GAO emphasized in both its draft and final report. 
Appendix VI contains the complete text of DOE's comments, along with
GAO's detailed responses.  In addition, chapters 2 through 4 conclude
with summaries of DOE's applicable comments and GAO's responses. 

The energy or modeling experts listed in appendixes I and II of this
report who commented on a draft overwhelmingly agreed with the
overall message, and several said that the report will make an
important contribution to the continuing debate on energy security
issues.  Their detailed oral or written comments are technical in
nature or address the emphasis given to various issues in the report. 
These comments are not included in the final report but are
summarized at the end of chapters 2 through 4. 


INTRODUCTION
============================================================ Chapter 1

Oil is an important source of energy used to fuel the world's
economic activities.  It currently accounts for about 40 percent of
the energy consumed in the United States.  In 1995, the United States
consumed nearly 18 million barrels of oil per day (mmbd), or over
one-fourth of the oil consumed in the world that year.  Although the
U.S.  share of the world's oil consumption is projected to decline to
just above 22 percent in 2015, largely because consumption is
projected to increase in developing countries, the share of the
nation's energy consumption met by oil is expected to remain the same
in 2015.  This high level of oil consumption, coupled with declining
domestic oil production, has resulted in a growing reliance on
imported oil.  Compared with alternative domestic sources of energy,
imported oil represents a relatively low-cost source of fuel to the
U.S.  economy.  Imports supplied about 50 percent of the nation's oil
consumption in 1995 and could supply over 60 percent by 2015 if oil
prices remain low. 

Because the world's lowest-cost oil reserves are currently
concentrated in the Middle East, especially in the Persian Gulf, the
United States and other oil-importing countries will rely more on
this historically unstable region to supply a rising share of their
oil imports.  The current administration has expressed concern that
the rising U.S.  reliance on low-cost imported oil, especially from
unstable sources, threatens national security by increasing the
economy's vulnerability to world oil supply disruptions and price
shocks (oil shocks).  The extent of the economy's vulnerability
depends on the likelihood or probability of a disruption, the
economy's dependence on oil, and the nation's ability to respond to a
disruption.\1 To reduce this vulnerability, the administration has
proposed several programs and policies in its 1995 National Energy
Policy Plan (NEPP). 


--------------------
\1 This study focuses primarily on the potential economic effects of
an oil shock and the nation's ability to respond.  We do not attempt
to assess the likelihood or probability of an oil shock. 


   THE NATIONAL ENERGY POLICY PLAN
---------------------------------------------------------- Chapter 1:1

Title VIII of the Department of Energy Organization Act, enacted in
1977, requires the President to submit a comprehensive biennial
national energy policy plan that includes information on a number of
energy issues.  Title VIII sets broad provisions for the preparation
of the NEPP, requiring administrations to set national energy
objectives; identify the strategies to achieve the objectives;
project energy supply, demand, and prices; provide the data and
analysis to support goals and strategies, and invite public input. 
Since the requirement for a national energy policy plan was enacted,
successive administrations have used the NEPP as a vehicle to define
their visions of the nation's energy future and to set forth specific
objectives and methods for achieving those objectives, but conformity
with the provisions of title VIII has varied among the plans.  In
reviewing the six plans submitted between 1979 and 1991, we found
that each plan developed its own approach to setting objectives
instead of following the provisions of title VIII.\2 Besides reducing
the nation's vulnerability to oil shocks, the administration's plan
has two other goals--maximizing energy productivity and preventing
pollution.  Our review focused only on reducing the nation's economic
vulnerability. 


--------------------
\2 Excluding the current administration three administrations have
prepared six energy plans in response to title VIII since 1979.  See
Energy Policy:  Changes Needed to Make National Energy Planning More
Useful (GAO/RCED-93-29, Apr.  27, 1993) for a review of the first six
plans' conformity with title VIII's provisions. 


   U.S.  CONCERNS ABOUT
   VULNERABILITY TO OIL SHOCKS
---------------------------------------------------------- Chapter 1:2

The United States has long been concerned, as a nation, about its
vulnerability to oil shocks.  Occasionally, the U.S.  government, as
well as the public, has equated this vulnerability with dependence on
"oil imports," implying that curbing oil imports would solve the
vulnerability issue.\3 For example, the first major energy policy
initiative taken by the U.S.  government after the Arab oil embargo
in 1973 was Project Independence.  Three weeks after the embargo,
President Nixon announced that by the end of the 1970s, the United
States would have developed the potential to meet its own energy
needs without depending on any foreign energy sources.  Project
Independence sought to achieve this goal by increasing domestic oil
supplies, primarily through higher prices, and by rapidly expanding
the development of nuclear energy.\4

Several other studies performed by federal agencies since the 1980s
have linked the nation's oil-shock vulnerability to oil imports.  In
1980, DOE issued a report stating that "our dependence on imported
oil makes us vulnerable."\5 The study recommended several policy
options, including "adjusting the price of imported oil to make it
clear that continued imports include a tangible cost to the nation
which must be compensated for in some way." A study by the
Congressional Research Service in 1983 measured the economic
vulnerability of the United States and its Western allies caused by
hypothetical disruptions in supplies of imported oil from the Persian
Gulf.\6 This study emphasized building up governmental and private
stocks as a way for the United States and its allies to address their
vulnerability.  The final Reagan Administration plan, issued in 1987,
stated that "higher [oil] import dependence would increase the risk
of major supply disruptions that are damaging to our economic
well-being and energy security."\7 This plan examined the pros and
cons of different policy options but did not recommend any specific
policies. 

More recently, in response to a petition filed by the Independent
Petroleum Association of America to investigate the impact of
imported oil on the nation's security, the Department of Commerce
issued a study concluding that the nation's growing reliance on
low-cost crude from unstable foreign sources threatens national
security by increasing U.S.  economic vulnerability to oil supply
disruptions.\8 Following this study's recommendation, the Clinton
administration proposed continuing its present efforts to improve
U.S.  energy security rather than adopting a specific
import-adjustment mechanism.  These efforts are contained in the most
recent plan. 


--------------------
\3 For reasons discussed in chs.  2 and 3 of this report, we believe
that the U.S.  economy's vulnerability to oil shocks is linked more
to the nation's dependence on oil and participation in the world oil
market than to the level of oil imports. 

\4 Robert Stobaugh and Daniel Yergin, Energy Future:  Report of the
Energy Project at the Harvard Business School (1979), p.  277. 

\5 Reducing U.S.  Oil Vulnerability:  Energy Policy for the 1980s
(Nov.  1980). 

\6 Western Vulnerability to a Disruption of Persian Gulf Oil
Supplies:  U.S.  Interest and Options (Mar.  24, 1983). 

\7 DOE, Energy Security, A Report to the President of the United
States (Mar.  1987). 

\8 Department of Commerce, The Effect of Imports of Crude Oil and
Refined Petroleum Products on the National Security (Dec.  1994). 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:3

As requested by the Chairman, House Committee on the Budget, this
report assesses

  -- the economic benefits of importing oil compared with the
     potential economic costs of vulnerability to oil shocks,

  -- the extent to which the U.S.  economy's vulnerability to oil
     shocks will likely change over time given the programs and
     policies contained in the administration's 1995 National Energy
     Policy Plan and other relevant factors, and

  -- options for reducing the economy's vulnerability to oil shocks. 

To assess the economic benefits of importing oil relative to the
potential costs of vulnerability to oil shocks, we asked DOE's Energy
Information Administration (EIA)\9 to use its National Energy
Modeling System (NEMS) to estimate the potential losses in the
nation's aggregate economic output, or gross domestic product (GDP),
that would be caused by reducing oil imports by different amounts.\10
The reductions are induced by higher oil prices attained through
hypothetical alternative scenarios, including a decline in oil
production by the Organization of Petroleum Exporting Countries
(OPEC) and the imposition of an oil-import fee.\11 We also searched
the available literature and obtained estimates of the historic and
future economic costs associated with past and potential future oil
shocks.  Appendix II discusses our efforts to measure the benefits of
importing oil. 

To assess the extent to which the U.S.  economy's vulnerability to
oil shocks will likely change over time, we reviewed the plan and
other applicable documents, interviewed DOE and EIA officials, and,
in consultation with DOE, developed measures of vulnerability.  We
obtained DOE's projections for how much its energy efficiency and
fossil energy programs are expected to decrease the demand for oil or
increase the supply.  We did not, however, analyze these programs'
prospects for success in achieving the projected results.  We also
used EIA's forecasts to assess potential future changes in the
measures of vulnerability. 

To identify options for reducing the economy's vulnerability to oil
shocks, we selected and interviewed a cross section of oil-industry,
oil-market, and oil-security experts representing a wide range of
views on energy policy issues.  These experts came from academia, the
energy industry, and government.  We also reviewed the literature on
economic and energy policy, including studies by most of the experts
we contacted.  We also reviewed previous GAO reports.  Appendix I
lists the people we contacted in responding to this objective. 

Our evaluation was limited in several respects.  Estimates of the
economic benefits of oil imports or the costs of oil supply
disruptions may not be calculated with complete accuracy.  For
example, our estimated results do not include certain
hard-to-quantify costs and benefits, including such costs as the
military expenditures that are made with multiple objectives in mind
and the potential loss of human life that may be associated with
ensuring the security of oil from foreign sources.  In addition,
future market developments, technological advances, and changing
international relationships make precise forecasts of future events
difficult. 

Although our evaluation of the 1995 NEPP's programs and policies
focused on the impact of reducing the economy's vulnerability to oil
shocks, many of the programs and policies address multiple goals,
such as environmental improvement and economic development.  Finally,
although we solicited views from a cross section of experts on the
most effective options for reducing the economy's vulnerability, the
options presented in this report may not be representative of all
experts' views on this topic. 

We discussed our analysis of the data on measures of vulnerability
and the effects of the plan's programs with the EIA and DOE officials
who provided the data.  We also discussed the modeling results in
chapter 2 with the Director and staff of EIA's Office of Integrated
Analysis and Forecasting.  We provided copies of a draft of this
report to DOE, which led the administration's effort to develop the
1995 NEPP, and to the experts in energy or modeling listed in
appendix I or appendix II of this report.  The comments we received
and our responses are summarized at the end of the applicable
chapters.  Appendix VI contains the complete text of DOE's comments,
along with GAO's detailed responses. 

We conducted our review from August 1995 through November 1996 in
accordance with generally accepted government auditing standards. 


--------------------
\9 EIA is an independent statistical and analytical agency within
DOE. 

\10 NEMS is a scientific, policy-neutral methodology designed by EIA
to assist policymakers and the public in assessing the impact of
various policy initiatives.  See app.  II for more information about
NEMS and its use in this report. 

\11 OPEC was created in 1960.  Its current members are Algeria,
Gabon, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi
Arabia, the United Arab Emirates, and Venezuela.  The Persian Gulf
members of OPEC are Iran, Iraq, Kuwait, Qatar, Saudi Arabia, and the
United Arab Emirates. 


IMPORTING LOW-COST OIL PROVIDES
LARGE ECONOMIC BENEFITS AND MAY
NOT SUBSTANTIALLY INCREASE THE
ECONOMIC COST OF OIL SUPPLY
DISRUPTIONS
============================================================ Chapter 2

GAO estimates that U.S.  consumers and businesses gain hundreds of
billions of dollars in benefits annually from access to relatively
low-cost foreign oil.  These benefits accrue from avoiding the
expenses of relying more extensively on higher-cost domestic energy. 
By most estimates, the day-to-day benefits for the United States of
relying on low-cost foreign oil substantially exceed the occasional,
but severe, costs of disruptions to the world oil supply.  More
importantly, reducing the nation's reliance on foreign oil by
increasing domestic production would probably do little to decrease
the economic cost of such disruptions because it would not
substantially reduce their likelihood or cost.  Dependence on oil
itself--as distinct from dependence on oil imports--coupled with
participation in the world oil market, causes the U.S.  economy to
bear the consequences of disruptions.  Regardless of the level of
imports, the U.S.  economy could suffer economic harm from a
disruption, particularly if the disruption were severe or
long-lasting. 


   DURING NORMAL MARKETS, THE
   ECONOMIC BENEFITS OF IMPORTING
   LOW-COST OIL ARE LARGE
---------------------------------------------------------- Chapter 2:1

Both a recent study by the Department of Commerce and the 1995 NEPP
recognize the benefits to the U.S.  economy of access to relatively
low-cost foreign oil, but these studies do not quantify the benefits. 
On the basis of the analysis that EIA performed at our request, we
estimate that U.S.  consumers and businesses gain hundreds of
billions of dollars per year by avoiding purchases of costlier
domestic energy.\1 While these estimates should be interpreted as a
rough guide to the magnitude of the economic benefits, they are
broadly consistent with the results of past studies.  These benefits
accrue without substantially affecting the nation's long-term trade
deficit or harming overall domestic employment, but they may also
impose military and diplomatic costs that are difficult to identify
or measure.  The environmental costs of oil consumption are excluded
from this analysis because they depend largely on the level of oil
consumption, not the source of the oil. 


--------------------
\1 This analysis should not be construed as advocating or reflecting
any policy position of DOE or EIA. 


      BENEFITS OF IMPORTING
      LOW-COST OIL COME FROM
      AVOIDING COSTLIER
      ALTERNATIVES
-------------------------------------------------------- Chapter 2:1.1

U.S.  consumers and businesses benefit from importing low-cost oil
because they pay less for energy than they would if they were to rely
more extensively on higher-cost domestic oil or alternative fuels. 
In addition, with the money they save by buying cheaper oil, they can
increase their consumption of energy and other goods and services. 
Hence, the economic benefits of importing oil can be approximated by
calculating the expenses that Americans avoid by not relying more
extensively on comparatively expensive domestic oil or alternative
fuels and the increased opportunities for consumption that arise from
lower energy prices.  Similarly, businesses benefit because their
products can be more competitive with those of other countries that
also have low energy prices.  Because oil is an important commodity
that is widely used in the United States, the benefits of importing
oil accrue continuously to most American consumers and businesses. 
According to a study of oil production published by DOE's Oak Ridge
National Laboratory (ORNL), some Persian Gulf countries can discover,
pump, and ship oil very cheaply--in some locations for perhaps as
little as $1 to $5 per barrel.\2 In contrast, the cost of
discovering, pumping, and shipping oil or producing alternative fuels
is much higher in the United States.  The costs at currently
producing sites could approach the current world oil price, which has
fluctuated between $17 and $26 per barrel during the past year. 
Other sources of energy could be developed at prices that exceed the
current world oil price.  If the United States were to rely more
extensively on domestic production, domestic oil prices would rise to
reflect the higher production costs.  The prices of gasoline and home
heating oil would also rise, as would the prices of goods and
services that require large amounts of energy in their production,
such as plastics and air travel.  Correspondingly, imports of these
goods and services would rise to supplant domestic production.  Even
the prices of alternative energy sources, such as natural gas, would
rise as the demand for these fuels rose.  Our analysis of the
benefits of importing oil depends on the pace of technological change
assumed in EIA's reference case.  If, however, technology advanced
more quickly than EIA assumed in its reference case, then the cost of
domestic oil or its alternatives could fall to a level that would be
more competitive with the cost of imported oil.  With a decline in
the gap between the costs of domestic and imported oil, our estimates
of the benefits of imports would correspondingly decline.  More
importantly, the United States could simultaneously improve its
energy security and maintain domestic economic growth. 


--------------------
\2 David L.  Greene, Donald W.  Jones, and Paul N.  Leiby, The
Outlook for U.S.  Oil Dependence (ORNL-6873, May 11, 1995). 


      IMPORTING LOW-COST OIL
      PRODUCES SUBSTANTIAL NET
      ECONOMIC BENEFITS
-------------------------------------------------------- Chapter 2:1.2

From EIA's analysis, we conclude that U.S.  consumers and businesses
benefit by hundreds of billions of dollars each year from importing
oil.\3 We obtained these estimates by asking EIA to model two
approaches for decreasing U.S.  oil imports and to compare the
estimated GDP under these approaches with the reference case reported
by EIA in its Annual Energy Outlook 1996.  The reference case,
discussed at greater length in chapter 3, reflects EIA's projection
of the most likely future trends in energy markets and the U.S. 
economy.  Because the benefits from importing oil cannot be measured
directly, we estimate them indirectly by measuring the harm that
would be caused by reducing imports from their current level.  The
differences between GDP in the reference case and GDP in the
reduced-import cases represent the economic benefits of importing oil
because these differences measure the savings realized by using
imported oil instead of relying on relatively more expensive domestic
sources of energy.  Under one approach, as foreign production
gradually declines, the world oil price rises, causing domestic
prices to rise.  Alternatively, under the other approach, the
domestic oil price rises above the world oil price through the
imposition of an oil import fee.\4 Both approaches use market
mechanisms to reduce oil imports by raising the price of imported
oil, thereby discouraging consumption and encouraging domestic
production.  In general, compared with regulatory approaches, market
mechanisms have the advantage of reducing imports at the lowest
possible cost to the U.S.  economy.  Furthermore, most experts agree
that if policymakers wish to lower oil imports, an oil import fee is
an effective and comparatively low-cost method to do so.  (App.  II
describes in greater detail the methodologies and results of
measuring the benefits of oil imports.) Both approaches provide an
estimate of the benefits to the U.S.  economy of importing oil and
are useful for illustrating the large gains attributable to buying
oil from the cheapest source, rather than imposing restrictions to
enhance domestic energy production.  Because of the many
uncertainties in estimating the benefits of imports, the estimates
are best interpreted as rough guides to the magnitude of the benefits
of oil imports, rather than as precise estimates. 

Using one approach, EIA analyzed the effect of an increase in the
world oil price resulting not from a policy change but, for instance,
from a gradual decrease in foreign oil production.  According to
EIA's reference case forecasts, the United States will import 11.4
mmbd of oil at a price of $22 per barrel in 2005, measured in 1994
dollars.\5 Figure 2.1 shows that if the price of crude oil were to
rise to $32 per barrel in 2005--$10 per barrel higher than
expected--U.S.  oil imports would be about 9.5 mmbd, or about 2 mmbd
lower than currently projected.  Nevertheless, the higher price would
only slow the growth of oil imports because they would still exceed
their current level of 8.3 mmbd.  According to EIA's analysis,
slowing the growth of imports by 2 mmbd would decrease GDP by an
estimated $50 billion per year in 2005.  A larger reduction in U.S. 
oil imports would impose a greater-than-proportional cost on the U.S. 
economy.  For example, a $20-per-barrel increase in the price of oil
by 2005 would reduce oil imports by 3.2 mmbd rather than 2 mmbd--a
60-percent larger decline in oil imports--and would double the annual
economic cost from about $50 billion to about $100 billion by 2005. 
Figure 2.2 shows the effect on GDP of raising the price of oil $20
per barrel above the price projected in EIA's reference case for
2005. 

   Figure 2.1:  U.S.  Oil Import
   Levels Under Various Future Oil
   Price Scenarios

   (See figure in printed
   edition.)

Note:  Oil prices in 1994 dollars. 

Source:  EIA. 

Using the other approach, EIA also estimated the benefits of oil
imports by examining the economic consequences of reducing imports
through the imposition of a hypothetical oil import fee.  The import
fee level was selected to reduce oil imports by approximately the
same amount (3.2 mmbd) as an increase of $20 per barrel in the price
that EIA currently projects for oil in 2005.  Unlike the previous
approach, an oil import fee would raise the domestic oil price above
the world oil price and would increase the manufacturing costs of
domestically produced goods relative to those of imported goods.  To
bring about such a reduction in oil imports, EIA estimated that the
import fee would need to be about $22 per barrel in 2005.\6 Unlike
higher world oil prices, an oil import fee would raise substantial
revenue for the government.  The economic effect of reducing imports
by imposing an oil import fee on the U.S.  economy depends critically
on how the fee revenues are used.  EIA estimated two scenarios for
the fee revenues.  In one scenario--the deficit-neutral scenario--the
fee revenues would be rebated to American workers and businesses
through a reduction in the Social Security payroll tax, and the
federal deficit at full employment would remain unchanged from EIA's
reference case.  In the other scenario--the deficit-reducing
scenario--the fee revenues would be used to reduce the federal
deficit below the level in EIA's reference case.  We believe that the
deficit-neutral scenario provides a more accurate representation of
the long-term economic effects of reducing oil imports because, under
the deficit-reducing scenario, the beneficial effects of reducing the
federal budget deficit are combined with the harmful effects of
reducing oil imports and relying on relatively more expensive
domestic alternatives. 

As figure 2.2 shows, the deficit-neutral oil import fee would have
only small effects on the U.S.  economy during the first 10 years. 
However, after 2005, reducing imports would impose large economic
costs.  By 2015, the fee, which by then would reduce imports by 4.7
mmbd, would reduce GDP by more than $100 billion per year.  The cost
of reducing imports would be hidden temporarily because rebating the
fee would temporarily encourage spending.  However, the long-term
cost of reducing imports would eventually overwhelm the short-term
benefits accruing from the fee rebate.  In contrast, under the
deficit-reducing scenario, which is not shown here, GDP would fall
immediately when the oil import fee was introduced.  By 2015,
however, GDP would return almost to its baseline level.  However, we
believe that the increase in GDP would result from the beneficial
effects, particularly a decline in interest rates, of reducing the
federal deficit rather than from reducing the nation's oil import
level.\7

   Figure 2.2:  Changes in GDP
   From High World Oil Prices and
   a Deficit-Neutral Oil Import
   Fee

   (See figure in printed
   edition.)

Note:  Changes are relative to EIA's reference case. 

Source:  EIA. 

The results of these two scenarios allow us to estimate the benefits
of importing oil by measuring the costs of reducing imports by
approximately 2 mmbd to 3.2 mmbd.  We chose these particular
reductions because estimating the full benefits of the nation's
current level of imports--8.3 mmbd--is beyond the model's technical
capability.  Nevertheless, these relatively modest reductions in
imports would impose costs on U.S.  consumers and businesses ranging
from $50 billion to $100 billion per year.  More substantial
reductions in imports would impose more than proportionately larger
costs.  As a result, we conclude that given today's technology and
prices, relatively low-cost oil imports provide hundreds of billions
of dollars in benefits annually to U.S.  consumers and businesses. 


--------------------
\3 The Impacts on U.S.  Energy Markets and the Economy of Reducing
Oil Imports, DOE, EIA, SR/OIAF(96-04), (Sept.  1996). 

\4 GAO does not endorse an oil import fee or any particular energy
program or policy goal.  We selected an oil import fee rather than
other alternatives, such as domestic production subsidies or import
quotas, for illustrative purposes only.  Most experts believe that an
oil import fee would be among the most cost-effective methods for
reducing imports.  Using other methods for illustrative purposes
would, therefore, provide even larger estimates of the benefits of
buying oil from its cheapest source. 

\5 Oil imports refer to crude oil and refined products made from
crude oil, such as gasoline.  Of the current import level of 8.3
mmbd, 7.4 mmbd are in the form of crude oil and 0.9 mmbd are in the
form of refined products. 

\6 The oil import fee is applied to all oil imports except those from
Canada and Mexico, which are trading partners of the United States
under the North American Free Trade Agreement (NAFTA).  We assumed
that these countries would meet their domestic demand with their
domestic production and export their excess production to the United
States. 

\7 The results of the two oil import fee cases may depend on whether
foreign exchange rates are allowed to adjust to changes in imports or
whether they remain fixed at their baseline levels, as the analysis
assumes.  Discussions with EIA analysts suggest that allowing
exchange rates to change when an oil import fee is imposed could
temporarily increase projected GDP, especially between 2005 and 2015. 
By 2015, however, the long-term effects would be similar under either
assumption.  See app.  II for additional details. 


      RESULTS OF OTHER STUDIES ARE
      CONSISTENT WITH THIS
      ANALYSIS
-------------------------------------------------------- Chapter 2:1.3

The results of EIA's analysis are broadly consistent with those of
earlier studies of the benefits of oil imports.  In 1986, we reported
that a $10-per-barrel tariff on imports of refined crude oil products
coupled with a $5-per-barrel tariff on crude imports would cost
consumers about $73 billion annually.\8 In addition, a similar
$5-per-barrel tariff on crude oil and refined products would reduce
GDP by between 0.5 and 1.0 percent, or between $38 billion and $77
billion, given the current size of the economy.\9 Similarly, in 1987,
DOE reported that a $10-per-barrel oil import fee would cost the
economy $253 billion over 8 years, or about $32 billion per year.\10
A more recent study based upon projections of supply and demand from
six different world oil models estimates the costs of reducing oil
imports.\11 This analysis estimates that doubling the price of oil
would not necessarily reduce the level of imports in the future. 
However, such a policy would reduce GDP by between $122 billion and
$366 billion between 1989 and 2010, or between $6 billion and $17
billion per year.  The differences among the results of these studies
reflect differences in their assumptions and goals, as well as
uncertainties in estimating the benefits of oil imports.  For
example, the study based on six world oil models includes only the
direct effects of reducing oil imports on businesses and consumers;
it does not, like EIA's analysis, include the indirect effects on the
U.S.  economy.  This study also estimates the reductions in wealth
transfers out of the United States that would occur at different
import levels if an oil shock were to occur.  Nevertheless, the
studies arrive at the same basic conclusion:  Comparatively low-cost
oil imports provide large benefits to U.S.  consumers and businesses. 


--------------------
\8 The results from other studies were adjusted for inflation that
has occurred since the studies were published.  These results are
stated in 1994 dollars for consistency with EIA's analysis. 

\9 Petroleum Products:  Effects of Imports on U.S.  Oil Refineries
and U.S.  Energy Security (GAO/RCED-86-85, Apr.  15, 1986). 

\10 Energy Security:  A Report to the President of the United States
(DOE/S-0057, Mar.  1987). 

\11 Hillard G.  Huntington, "Limiting U.S.  Oil Imports:  Cost
Estimates," Contemporary Policy Issues, Vol.  XI (1993). 


      REDUCING OIL IMPORTS IS
      UNLIKELY TO INCREASE TOTAL
      DOMESTIC EMPLOYMENT OR
      REDUCE THE TRADE DEFICIT
-------------------------------------------------------- Chapter 2:1.4

Reducing oil imports would provide obvious benefits to the domestic
oil industry and would increase employment in the domestic energy
sector.  However, the benefits to the domestic oil sector would be
more than offset by the harm to other sectors of the economy.  As
part of its analysis, EIA assessed the effect of an oil import fee on
different sectors of the economy.  As figure 2.3 shows, by 2015
production would rise in the mining sector, which includes oil
production, by about $16 billion per year if the deficit-neutral oil
import fee were imposed as described earlier.  However, higher oil
prices would then decrease output in other sectors of the economy,
and the net effect on the economy would be negative.  According to
EIA, changes in employment by sector would accompany changes in
output in each sector--broadly speaking, industries suffering
relatively large decreases in output would be the most likely to
suffer relatively large decreases in employment. 

   Figure 2.3:  Changes in
   Economic Output Caused by
   Imposing a Deficit-Neutral Oil
   Import Fee

   (See figure in printed
   edition.)

Note:  Changes are relative to EIA's reference case. 

Source:  EIA. 

EIA further divided the manufacturing sector of the economy, which
would experience the greatest losses, into its components.  As figure
2.4 shows, with a deficit-neutral oil import fee, output would
decline relative to EIA's reference case in all manufacturing
industries by 2015.  As discussed in appendix II, the effects of the
deficit-reducing oil import fee would be qualitatively similar but
quantitatively smaller because the effects of paying higher prices to
reduce oil imports would be offset by the benefits of reducing the
federal budget deficit. 

   Figure 2.4:  Changes in
   Manufacturing Output Caused by
   Imposing a Deficit-Neutral Oil
   Import Fee

   (See figure in printed
   edition.)

Note:  Changes are relative to EIA's reference case. 

Source:  EIA. 

Reducing oil imports would probably not substantially reduce the
long-term U.S.  trade deficit.\12 Although crude oil and natural gas
are the fifth largest category of imports--following transportation
equipment, electronic and electrical machinery, nonelectrical
machinery, and textiles and apparel--they accounted for only 6.8
percent of the nation's total imports as of 1994.  Moreover, the
trade deficit is ultimately determined by factors such as the
aggregate level of savings and investment, including the federal
government's budget deficit, that are unrelated to oil imports.  In
the short term--such as during the months following an oil supply
disruption--increases in oil prices or reductions in oil imports
could affect the U.S.  trade deficit.  However, in the long term, if
oil imports decreased, then total U.S.  exports would eventually
decrease or other U.S.  imports would increase in order to keep the
trade deficit near its initial level.  According to most of the
experts we contacted, the U.S.  trade deficit is determined by the
difference between the nation's total savings and total investment
needs.  When domestic investment needs exceed savings, the shortfall
attracts foreign investment in the United States to meet such needs. 
The inflow of foreign funds, created by the savings shortage,
eventually returns to foreign countries because the United States
imports more goods and services than it exports.  Thus, according to
these experts, the trade deficit stems from saving too little rather
than from importing too much oil.\13


--------------------
\12 The term "trade deficit" sometimes refers only to the merchandise
trade deficit; however, our use of the term refers to the entire
current account deficit. 

\13 For a simple but more complete discussion of this relationship,
see Charles L.  Schultze, Memos to the President (Washington, D.C.: 
Brookings Institution, 1992), p.  117. 


      RELIANCE ON IMPORTED OIL
      IMPOSES MILITARY COSTS AND
      MAY REDUCE FOREIGN POLICY
      FLEXIBILITY
-------------------------------------------------------- Chapter 2:1.5

The benefits of importing oil are at least partially offset by the
financial costs and risk to human life of military and national
security operations and the continued U.S.  presence in the Persian
Gulf.  These costs, however, are hard to compare with the incremental
costs of reducing oil imports.  Even if we could identify the share
of total military spending resulting from the need to secure oil
imports, it would be difficult to forecast how military costs would
change if the United States imported less oil but still imported a
sizeable amount.  Nevertheless, in 1991 we reported that the
Department of Defense (DOD) spent $27.2 billion during fiscal years
1980-90 for military programs and other activities directly related
to missions in Southwest Asia, which includes the Persian Gulf area. 
In addition, DOD invested $272.6 billion in programs that were
motivated by requirements outside the Persian Gulf but have proved
useful in that region.  These figures exclude the incremental costs
of Operations Desert Shield and Desert Storm, which were estimated to
be about $61 billion but were mostly covered by U.S.  allies.\14

The military or security costs of importing oil depend on the portion
of these spending totals that can be attributed to oil imports. 
Various research projects used different assumptions to estimate the
cost of preserving the stability of oil supplies.  Such estimates
range from a few billion dollars per year to as much as $65 billion
per year. 

Depending on potentially less stable sources of petroleum may also
reduce the nation's flexibility in foreign policy.  The United States
and its allies may be constrained from pursuing foreign policy
actions for fear of alienating oil producing nations and provoking
them into actions that would increase world oil prices.  With lower
import levels, the United States might be less inclined to commit
troops or more willing to call upon its allies to defend oil supply
lines.  Moreover, the lack of flexibility could interfere with
cooperative efforts by oil importing nations to avoid bidding up
world oil prices after an oil supply disruption.  Finally, the lack
of flexibility might make international conflicts more difficult to
resolve peacefully.  While the magnitude of such human and financial
costs is not known precisely, the costs are no less real.  Whatever
costs are attributable to preserving the stability of oil supplies
directly offset the benefits of importing oil from the regions
affected by U.S.  military actions.  Some experts argue for an oil
import fee--ranging from $1 per barrel to $10 per barrel--to pay for
these costs. 

Some experts, as discussed in chapter 4, also argue for a tax on the
consumption of all oil, whether domestic or imported, to address the
environmental costs of oil consumption.  Estimating these
environmental costs is beyond the scope of this report because the
costs generally arise from the consumption rather than the
importation of oil.\15 Moreover, concerns about the environmental
impact of oil consumption do not reduce the benefits of obtaining oil
from its cheapest source. 


--------------------
\14 Southwest Asia:  Cost of Protecting U.S.  Interests
(GAO/NSIAD-91-250, Aug.  14, 1991). 

\15 In some cases, imported oil may impose greater environmental
costs than domestically produced oil because imported oil often
arrives by tanker rather than oil pipelines and some oil exporting
countries may have lower environmental standards than the United
States. 


   THE ECONOMIC COSTS OF MARKET
   DISRUPTIONS ARE LARGE BUT
   MAINLY UNRELATED TO THE LEVEL
   OF OIL IMPORTS
---------------------------------------------------------- Chapter 2:2

Oil supply disruptions impose large costs on the U.S.  economy
because they increase the costs of consuming oil and cause consumers
and businesses to make costly adjustments in their routines.  While
these costs can be significant and can impose hardships on American
consumers and businesses, they are not likely to exceed the
day-to-day benefits of obtaining oil from its cheapest source.  More
importantly, even if imports were lower, the economic impact of oil
supply disruptions would not be substantially reduced given the same
level of oil consumption.  U.S.  participation in the world market
causes the effects of oil supply disruptions on the U.S.  economy to
be felt regardless of the level of oil imports. 


      OIL SUPPLY DISRUPTIONS
      IMPOSE LARGE COSTS ON THE
      U.S.  ECONOMY
-------------------------------------------------------- Chapter 2:2.1

When oil supply disruptions occur, rapidly rising energy prices
impose hardships on American consumers and increase operating costs
for U.S.  businesses by imposing two types of costs on the U.S. 
economy.\16 First, higher oil prices harm the economy by reducing the
economy's potential GDP, which is the amount that the U.S.  can
produce when all resources are fully employed.  Potential GDP is
determined by the nation's resource base, which consists of its labor
force, natural resources, and capital stock and the productivity of
these resources.  In response to the high energy prices, firms may
use less energy, which reduces the amount of output that can be
produced with a given amount of capital and labor.  Second, because
market disruptions occur suddenly rather than gradually, they impose
additional costs, known as adjustment costs, on consumers and
businesses; that is, until adjustments can be made, the economy's
total output will be even less than it could be, given the new lower
potential output level.  For example, most individuals cannot quickly
change from heating oil to, say, natural gas if oil prices rise
unexpectedly.  However, if price increases are anticipated,
individual homeowners can make long-term decisions, such as whether
to heat with oil or natural gas. 

The impact of oil supply disruptions on the U.S.  economy depends
more on how much oil the nation consumes than on what fraction of
that consumption is imported.  Nevertheless, estimates of the costs
of oil supply disruptions provide a useful context for evaluating the
gains from importing oil.\17

  -- Studies of the costs of past shocks show that they can impose
     large costs on the economy.  For example, a 1980 study of
     countries in the Organization for Economic Cooperation and
     Development (OECD)\18 estimated that the 1973-74 oil shock cost
     these countries 2.9 percent of their national incomes.  In
     today's domestic economy, if this shock had the same impact on
     the United States as it did on the other members of OECD, it
     would cost about $209 billion during a shock year.\19 Because
     shocks do not occur every year, the annual cost, averaged over
     time, would be smaller.  Another study, published by the Oak
     Ridge National Laboratory, estimated that oil shocks may have
     cost the U.S.  economy as much as $73 billion per year, on
     average, between 1972 and 1991.\20

  -- In 1990, DOE simulated the cost of potential future oil supply
     disruptions.  According to its forecast, the estimated net
     present value of three hypothetical oil supply disruptions
     between 1990 and 2020 is $650 billion, or about $22 billion per
     year.  In addition, a study by the Oak Ridge National Laboratory
     reports that the estimated net present value of losses in gross
     national product (GNP)\21 and of economic adjustment costs from
     hypothetical oil supply disruptions between 1993 and 2010 could
     be $400 billion, or about $22 billion per year.\22

Like estimates of the benefits of importing oil, estimates of the
costs of oil supply disruptions should be viewed as rough estimates
that provide a general guide to the magnitude of such costs.  Both
types of estimates are subject to the same uncertainties and
difficulties. 


--------------------
\16 We focus on the economic costs because, according to DOD, the
military requirements for petroleum fuels could be satisfied under
current planning scenarios. 

\17 The results from other studies were adjusted for inflation that
has occurred since the studies were published.  These results are
stated in 1994 dollars for consistency with EIA's analysis. 

\18 OECD is an intergovernmental organization established to
stimulate economic growth in its member countries.  OECD consists of
countries with developed, market-based economies, including the
United States. 

\19 William D.  Nordhaus, "Oil and Economic Performance in Industrial
Countries," Brookings Papers on Economic Activity 2 (1980), pp. 
341-388. 

\20 David L.  Greene and Paul N.  Leiby, The Social Cost to the U.S. 
of Monopolization of the World Oil Market, 1972-1991 (ORNL-6744, Mar. 
1993). 

\21 Until recently, "GNP" was used instead of "GDP" to measure U.S. 
economic performance.  GDP is now preferred, but the two terms are
essentially interchangeable. 

\22 David L.  Greene, Donald W.  Jones, and Paul N.  Leiby, The
Outlook for U.S.  Oil Dependence (ORNL-6873, May 11, 1995). 


      REPLACING OIL IMPORTS WITH
      DOMESTIC OIL PRODUCTION MAY
      NOT SUBSTANTIALLY LOWER OIL
      SUPPLY DISRUPTION COSTS
-------------------------------------------------------- Chapter 2:2.2

Reducing oil imports by purchasing currently noncompetitive domestic
oil would not substantially reduce the U.S.  economy's vulnerability
to the effects of sudden increases in oil prices.  Experience has
shown that such increases can cause economic disruptions, regardless
of how much oil is imported or produced domestically.  Oil supply
disruptions anywhere in the world would cause the price of oil to
rise in the United States, and the economy would bear the
consequences even if oil imports were much lower.  Import fees,
regulatory actions, domestic production subsidies, or other programs
aimed at artificially increasing the production of domestic oil or
alternative fuels and, thus, reducing oil imports below the level
determined by world oil prices, as discussed above, would
substantially decrease GDP but would do little to decrease the impact
of oil supply disruptions.\23


--------------------
\23 Ch.  4 of this report discusses options for reducing the negative
effects of oil shocks. 


         INTEGRATED WORLD MARKETS
         CAUSE OIL SUPPLY
         DISRUPTION COSTS TO BE
         FELT GLOBALLY REGARDLESS
         OF IMPORT LEVELS
------------------------------------------------------ Chapter 2:2.2.1

The integration of the U.S.  oil market into the world oil market
means that the United States cannot isolate itself from the effects
of oil supply disruptions.  As long as oil prices are set in the
marketplace, oil price changes in one part of the world affect oil
prices everywhere, including the United States.  Reducing oil imports
would not reduce the negative effects of oil price increases on U.S. 
consumers, most businesses, or the economy as a whole, although it
would, as discussed later in this chapter, benefit a segment of the
economy--domestic oil producers and their stockholders.  Rising
prices would increase domestic production and transfer wealth from
consumers to domestic rather than foreign producers.  However, unless
the United States were to shift fundamentally away from a
market-based economy and ban all oil imports and exports, reducing
oil imports could not substantially reduce the effects of oil supply
disruptions on the U.S.  economy. 

Experience demonstrates that countries cannot insulate themselves
from the effects of oil supply disruptions.  For example, following
the Iraqi invasion of Iran in 1979, the world oil price rose to $76
per barrel (in 1994 dollars).  At that time, Great Britain was
rapidly approaching independence from oil imports because its
production from the North Sea oil fields was sufficient to supply
most of its domestic demand for oil.  Nevertheless, according to some
experts, this oil supply disruption precipitated one of Great
Britain's worst economic recessions.  At the same time, Japan
experienced virtually no economic downturn, even though Japan depends
almost entirely on oil imports.  Some analysts argue that Japan's
monetary policy was better able than that of other industrialized
nations to accommodate the rise in oil prices, suggesting that
monetary policy could play an important role in determining the level
of economic harm caused by an oil price shock.  (The potential effect
of monetary policy is discussed further in ch.  4.) Similarly, in
1986, neither the United States nor the other industrialized nations
experienced an economic boom when oil prices declined sharply around
the world.  Taken together, these experiences suggest that import
levels, by themselves, do not determine a nation's vulnerability to
oil supply disruptions:  Low import levels do not shield a country
from such disruptions any more than high import levels pose a threat
to its economy. 

Even if the United States were to undertake the expensive task of
reducing its oil imports, it could not insulate itself from the
effects of oil supply disruptions.  For one thing, its economy is so
closely tied to the economies of its major trading partners that it
could not help but feel the effects of disruptions on them.  For
another thing, the United States has committed itself, through an
agreement signed with the International Energy Agency (IEA), to share
the burden of energy market disruptions when they occur.  Under this
agreement, the United States is responsible for maintaining strategic
petroleum reserves and using these reserves in concert with other
members of IEA to mitigate the effects of oil supply disruptions. 
(Ch.  4 contains a more complete discussion of the use of strategic
petroleum reserves.)


         REPLACING OIL IMPORTS
         WITH DOMESTIC OIL
         PRODUCTION WOULD HELP
         U.S.  PRODUCERS DURING
         DISRUPTIONS, BUT THE
         OVERALL ECONOMIC EFFECT
         IS UNCERTAIN
------------------------------------------------------ Chapter 2:2.2.2

Reducing U.S.  oil imports would benefit domestic oil producers and
their stockholders as prices rose during oil supply disruptions.  If
the United States were to rely more heavily on domestic producers,
then during oil supply disruptions the higher prices would accrue to
domestic, rather than foreign, producers of oil.\24 Transfers of
wealth from consumers to producers can be substantial during oil
supply disruptions and depend on the magnitude, frequency, and length
of the disruptions, the quantity of oil consumed, and the
responsiveness of oil consumption to oil price changes.  While such
transfers would benefit U.S.  producers, they would come at a price
to the U.S.  economy as a whole because, as discussed earlier, oil
imports provide large net benefits to American consumers and
businesses.  Reducing imports would ensure that, during oil shocks,
more wealth would be transferred to domestic than to foreign oil
producers.  However, reducing imports would also decrease the
economywide benefits of obtaining oil from its cheapest source. 


--------------------
\24 To the extent that domestically produced oil is owned by
foreigners, these wealth transfers would not be reduced. 


   OBSERVATIONS
---------------------------------------------------------- Chapter 2:3

The U.S.  economy derives large net economic benefits from obtaining
oil from its cheapest source.  Such benefits accrue continually to a
wide spectrum of the U.S.  economy.  The economic costs of oil supply
disruptions are also large, but occasional, and historically they
have been smaller than the cumulative benefits of oil imports.  More
importantly, replacing oil imports with domestically produced oil
would only marginally lower the potential costs of disruptions
because oil prices are set in the global marketplace and the price
for all oil rises during disruptions.  Even if the United States were
to produce all of the oil it consumes, as long as the domestic
economy is integrated into the world economy and oil prices are set
in the marketplace, oil disruptions anywhere in the world will have
substantial effects on the U.S.  economy. 


   AGENCY AND OTHER COMMENTS AND
   OUR EVALUATION
---------------------------------------------------------- Chapter 2:4

DOE said that our approach to analyzing the economic benefits of
importing oil is seriously flawed, relies on unlikely scenarios, and
yields no insight into the consequences or optimal level of oil
imports.  Although both DOE and the Department of Commerce have
reported that there are benefits to importing relatively low-cost
oil, neither has attempted to measure such benefits.  Our approach
does so by estimating the costs to the economy of lowering oil
imports through hypothetically increased oil prices and an oil import
fee.  We validated this approach extensively with the 14 economic or
modeling experts listed in appendix II of this report, as well as
with others, and we stand by the results showing that the overall
economic benefits are very large compared with past economic costs of
occasional oil supply disruptions.  We defined the modeling scenarios
to reduce imports at the lowest possible cost and thus provide a
conservative estimate of the benefits of such imports. 

Calculating the optimal level of oil imports was outside the scope of
GAO's review.  Existing studies have already addressed this issue,
although they have not conclusively determined whether the current
level of imports is above or below the optimal level.  In any event,
as this report points out, it is not the level of oil imports that
largely determines the economic costs attributable to rising prices
during an oil supply disruption.  Rather, it is the overall level of
oil consumption.  This distinction could have important implications
for policymakers considering, for example, proposals designed to
increase domestic oil production in order to increase the nation's
energy security. 

The experts who reviewed our draft report were nearly unanimous in
supporting our methodology and the message of our report.  One expert
did, however, say that we did not adequately include the
environmental or military costs of oil imports in our analysis.  We
did not include the environmental consequences of oil imports in our
report because such consequences depend largely on the nation's level
of oil consumption, not on whether the oil was imported or produced
domestically.  Even if domestically produced alternative fuels
supplant some oil consumption, the nation's economy continues to
benefit from obtaining the oil that it does consume from its cheapest
source.  Although we agree that the military costs of oil imports are
important, we state that these costs may not change if the nation's
total oil imports change.  The only other expert who specifically
addressed this point agreed with our conclusion.  In addition,
several of the experts offered technical suggestions or suggestions
about the emphasis given to various points in the report.  For
example, one expert thought we might have overstated the claim that
lowering imports would leave the nation's trade deficit largely
unchanged.  Another expert, however, said this conclusion was correct
and deserved more prominence in our report.  Where appropriate, we
have revised the report to reflect these suggestions. 


-------------------------------------------------------- Chapter 2:4.1

The following chapters of this report explore in more detail the
factors that most affect the U.S.  economy's vulnerability to oil
shocks, the extent to which current initiatives will likely lower
such vulnerability, and the views of experts on what initiatives
would be most effective. 


SUBSTANTIAL REDUCTIONS IN THE U.S. 
ECONOMY'S VULNERABILITY TO OIL
SUPPLY DISRUPTIONS ARE UNLIKELY
OVER THE NEXT 20 YEARS
============================================================ Chapter 3

The current National Energy Policy Plan (NEPP) seeks to reduce U.S. 
economic vulnerability to oil supply disruptions but does not provide
a way to measure progress in achieving this goal.  Several measures
of the world's supply of and demand for oil, as well as the extent of
the U.S.  economy's reliance on oil, can be used to assess the
nation's vulnerability.  Changes in the world oil market since the
1970s have reduced that vulnerability, but oil market disruptions and
their related economic effects remain a threat.  Our analysis, based
on EIA's forecasts, shows that the nation's vulnerability will grow
by some measures and decline somewhat or stay the same by other
measures.  Overall, however, the U.S.  economy will remain vulnerable
to oil market disruptions for at least the next 20 years, even after
accounting for many of the benefits anticipated from the NEPP's
initiatives.  Without these initiatives, the situation may even
worsen, but only over longer periods do energy analysts see a
potential for significant improvement--and that potential depends on
overcoming technological barriers and on the price of alternatives
becoming competitive with that of oil. 


   THE NEPP SETS REDUCED
   VULNERABILITY AS A GOAL BUT
   DOES NOT OFFER WAYS TO MEASURE
   PROGRESS
---------------------------------------------------------- Chapter 3:1

A major goal of the NEPP is to reduce the U.S.  economy's
vulnerability to oil market disruptions, but the plan does not
include measures for assessing progress over time. 


      THE NEPP SETS REDUCED
      VULNERABILITY AS A GOAL
-------------------------------------------------------- Chapter 3:1.1

The NEPP establishes a goal of keeping America secure, which it and
DOE officials interpret, more or less, as "reducing the vulnerability
of the U.S.  economy to oil shocks." More specifically, the NEPP's
goal is to

     "keep America secure by reducing our exposure to events beyond
     our control.  The United States depends on reliable and
     competitively priced energy supplies to fuel stable economic
     growth.  However, our economy relies on oil for 40 percent of
     our energy needs, which are being met increasingly by
     potentially unstable sources of world oil supply.  While
     existing energy policy and improved macroeconomic policies can
     help reduce the economic harm from supply disruptions, our
     economy continues to be vulnerable to oil price shocks."


      GAO IDENTIFIED MEASURES OF
      VULNERABILITY
-------------------------------------------------------- Chapter 3:1.2

The NEPP does not include ways to measure the extent of the economy's
vulnerability or changes in that vulnerability over time.  In
discussing appropriate measures with DOE officials responsible for
preparing the NEPP, we agreed with these officials that the following
measures are important.  Later in this chapter we discuss the extent
to which these measures have changed since 1975.  We also discuss the
changes in the measures that are indicated by EIA's forecasts through
2015. 

  -- Concentration of world oil production.  This measure can be
     expressed as the ratio of the Persian Gulf's oil production to
     the world's total oil production.  The higher the ratio, the
     more production is concentrated in the historically unstable
     Persian Gulf and the higher the potential for significant
     disruptions. 

  -- Excess world oil production capacity.  This measure can be
     expressed at any given time as the difference in millions of
     barrels per day (mmbd) between the world's total oil production
     capacity and the world's total oil consumption.  The greater the
     excess production capacity, the lower the vulnerability because,
     as excess production capacity increases, so does the ability to
     replace disrupted supplies with excess or surge production. 

  -- Oil intensity of the U.S.  economy.  This measure can be
     expressed as the ratio of barrels of oil used in the U.S. 
     economy to real gross domestic product (GDP).  The lower the
     ratio, the lower the vulnerability because the oil price
     increases accompanying a disruption represent a smaller fraction
     of the economy and therefore have a smaller economic effect. 

  -- Oil dependence of the U.S.  transportation sector.  This measure
     can be expressed as the percentage of the U.S.  transportation
     sector's fuel consumption that is met using oil.  The higher the
     percentage, the higher the vulnerability because vulnerability
     is directly linked to consumption.  Some industries, such as the
     electricity-generating industry, have developed the ability to
     switch to other fuels during a disruption.  The transportation
     sector, however, is almost 97-percent dependent on oil and
     accounts for nearly two-thirds of the nation's total oil
     consumption. 

  -- World oil stocks.  This measure, which includes strategic stocks
     such as the Strategic Petroleum Reserve, indicates, on the basis
     of daily world oil consumption, how many days world oil stocks
     or inventory will last if used to replace disrupted oil
     supplies.  The measure can be expressed as the ratio of the
     total world crude oil and refined petroleum product inventories
     to the daily world oil consumption.  The larger the ratio, the
     lower the vulnerability, reflecting the greater capacity to
     replace disrupted oil with oil stocks on hand. 

  -- Dependence of the U.S.  economy on oil imports.  This measure
     can be expressed as the percentage of U.S.  oil consumption met
     through imports.  As we explain in chapter 2, we believe that
     this measure is a weak indicator of vulnerability because
     vulnerability is linked to dependence on oil, not merely to
     dependence on imported oil.  Nevertheless, as we also explain in
     chapter 2, domestic as well as foreign oil producers benefit
     from the higher prices that prevail during disruptions.\1 In
     addition, increasing domestic production could increase the
     nation's opportunities for mitigating the effects of a
     disruption.  Tax policies, for example, could limit wealth
     transfers from U.S.  consumers to U.S.  producers.  Also,
     increasing domestic production could increase the nation's
     policy options if, during a severe or catastrophic disruption,
     oil were not sufficiently or readily available in the world
     market at any price.  For these reasons, we have included the
     percentage of U.S.  oil needs met through imports as a measure
     of vulnerability. 


--------------------
\1 To the extent that the benefits from higher prices go to domestic
producers instead of foreign producers--and the wealth transfers from
other sectors of the economy to the oil industry remain within the
United States instead of going to other countries--then the U.S. 
economy as a whole may benefit from increases in domestic production. 
As previously noted, however, the wealth transferred to domestic
producers would come at the expense of the oil-consuming sectors of
the economy. 


   CHANGES IN THE WORLD OIL MARKET
   HAVE LESSENED U.S. 
   VULNERABILITY TO OIL SHOCKS,
   BUT THE ECONOMY IS STILL
   VULNERABLE
---------------------------------------------------------- Chapter 3:2

Significant changes in the world oil market since the 1970s have
decreased the risk of an intentional coordinated disruption of the
world oil supply.  Consequently, the U.S.  economy is less vulnerable
to oil shocks today than it was 20 years ago.  Nevertheless, the
effects of future shocks could still be great enough to warrant
finding ways of mitigating the costs. 


      CHANGES IN THE WORLD OIL
      MARKET HAVE LESSENED
      VULNERABILITY TO OIL SHOCKS
-------------------------------------------------------- Chapter 3:2.1

Several changes in the world oil market have, according to DOE and
others, reduced the U.S.  economy's vulnerability to oil market
disruptions. 

First, the deregulation of the domestic oil market and the
development of a viable futures market and other oil trading markets
has made the world oil market more efficient, allowing world oil
prices to adjust quickly and fully to all available information about
actual and potential changes in world oil supplies.  Unregulated
markets also make prices less subject to manipulation.  Because
prices adjust quickly during a disruption, the threat of potentially
costlier physical supply shortages is greatly reduced.  Furthermore,
higher prices encourage consumers to conserve oil while rewarding
producers for quickly increasing oil supplies.  The development of a
futures market allows producers and oil traders to mitigate the
impact of future price changes by purchasing futures contracts that
stipulate a quantity and price for oil to be delivered at a future
date set in a contract.  Each of these features of a more complete
market tends to reduce the economic impact of an oil market
disruption. 

Second, the United States and some of its allies have developed
strategic petroleum reserves, enabling them to respond more
effectively to an oil market disruption now than they could have done
during the early 1970s.  The United States currently has about 575
million barrels of oil stored in the Strategic Petroleum Reserve. 
This strategic reserve--along with others, largely in Germany and
Japan--could increase world oil stocks as a percentage of world oil
consumption.  We should note that the level of private or industry
stocks is also important and that both governmental and private
stocks are included in the level of world oil stocks discussed
earlier as a measure of vulnerability. 

Third, although the transportation sector continues to rely heavily
on oil, most other sectors of the U.S.  economy, especially the
electricity-generating industry, have reduced their dependence over
the past 20 years.  These other sectors have increased both their
efficiency in using oil and their flexibility in using other fuels,
such as natural gas.  Thus, the effects of any given oil shock on the
economy is likely to be less now than in the 1970s. 

In addition to the above changes that tend to reduce the effects of a
disruption, OPEC is less likely now to coordinate a disruption of the
world oil supply than it was in the 1970s.  OPEC has lost some of its
market power because the divergent interests of its members have
weakened its ability to act cohesively.  Moreover, since the 1970s,
world oil supplies have become more diversified as more countries
have developed production capabilities.  (This trend, however, is
expected to reverse itself in the long run because the largest and
least costly known reserves are concentrated in the Persian Gulf. 
Such concentration, as discussed above, is one of the measures of
vulnerability to oil market disruptions.) In addition, the economic
interests of the oil-importing and the oil-exporting countries have
become interdependent.  Members of OPEC, for example, have large
investments in oil-importing countries, and damaging the economies of
the oil-importing countries may not serve their interests. 
Additionally, the dissolution of the Soviet Union has lessened the
competition for influence in the Persian Gulf between the East and
the West.  Finally, OPEC has increasingly recognized that higher oil
prices can reduce the demand for its oil by making alternative energy
supplies and energy technologies more viable. 


      THE U.S.  ECONOMY IS STILL
      VULNERABLE TO POTENTIAL OIL
      SHOCKS
-------------------------------------------------------- Chapter 3:2.2

Although changes in the world oil market over the past 20 years have
reduced the U.S.  economy's vulnerability to oil shocks, the risks of
future shocks are still present and, as discussed in chapter 2, their
costs to the economy could be large, particularly if the disruptions
were large or long-lasting.  Also, the demand for oil around the
world is expected to rise, particularly in the developing world,
pointing to new competition for available supplies.  As discussed
above, DOE and many of the energy market experts we spoke with
believe that the risks of disruptions arise because many of the
world's cheapest accessible reserves are concentrated in a few
countries, some of which are in a politically unstable region of the
world. 


   THE NEPP DOES NOT INDICATE THE
   EXTENT TO WHICH ITS INITIATIVES
   WILL REDUCE VULNERABILITY TO
   OIL SHOCKS
---------------------------------------------------------- Chapter 3:3

The NEPP contains a number of initiatives aimed, directly or
indirectly, at reducing the economy's vulnerability to oil shocks. 
These initiatives generally fall within one of the following three
major areas:  (1) energy efficiency programs aimed at decreasing the
demand for oil or replacing oil with alternative fuels; (2) fossil
energy programs aimed at increasing the production of oil or other
fossil fuels; and (3) policies for drawing down the Strategic
Petroleum Reserve (SPR) to reduce the effects of an oil shock and for
facilitating the diversification of oil supplies in non-OPEC nations. 
For the most part, however, the NEPP does not indicate to what extent
its initiatives will individually or collectively reduce the
vulnerability of the economy as a whole, nor does it indicate how its
initiatives will affect the specific measures of vulnerability
discussed above.\2 To assess the effects of the NEPP's initiatives on
the economy's vulnerability, we asked DOE to provide us with
information on its programs and policies.  DOE provided the following
information on its energy efficiency and fossil energy programs.  \3


--------------------
\2 For a few--but not most--initiatives, the NEPP estimates how much
energy will be saved or produced. 

\3 We did not independently assess the likelihood that DOE would
achieve its projected decreases in the demand for oil or increases in
the domestic supply of oil. 


      ENERGY EFFICIENCY PROGRAMS
-------------------------------------------------------- Chapter 3:3.1

In presenting oil displacement benefits, DOE grouped its energy
efficiency programs into "planning units." Table 3.1 presents DOE's
estimates of how much oil will be displaced by the energy efficiency
planning units with the greatest projected effects, as well as by all
of the programs together.  In addition to the initiatives for
increasing energy efficiency, these programs include research and
development (R&D) to promote the use of alternative motor fuels--such
as natural gas, alcohol, and electricity--and renewable energy
technologies--such as technologies for deriving energy from wind, the
sun (solar energy), and the earth (geothermal energy). 



                               Table 3.1
                
                 Estimated Oil Savings Attributable to
                 DOE's Energy Efficiency and Renewable
                            Energy Programs

                (Projections in millions of barrels per
                                 year)

Year                                              2000    2010    2020
----------------------------------------------  ------  ------  ------
Hybrid Vehicle Research R&D                          0     180     300
Transportation Biofuels R&D                          5     150     219
Electric Vehicle R&D                                 4      46      37
Fuel Cell R&D                                        0      13     140
Light Weight Vehicle Materials R&D                   0      32      35
Light Duty Engine R&D                                0      39      43
Heavy Duty Engine R&D                                1      73     237
Chemical Related R&D                                 1      25      50
NICE-3\a                                             6      12      13
Petroleum Related R&D                               36      90      65
======================================================================
Total                                               53     660   1,139
======================================================================
Total for all energy efficiency programs          88.6   767.6  1269.5
----------------------------------------------------------------------
\a NICE-3 (National Industrial Competitiveness through Energy,
Environment, Economics) provides seed funding to state and industry
partnerships for projects that develop and demonstrate advances in
energy efficiency and clean production technologies. 

See appendix III for a complete list of the programs in each planning
unit, including a brief description of each program and the amount
recommended for it by the Congress for fiscal year 1996. 

According to DOE, in addition to displacing oil, an objective of
energy efficiency programs is to increase the ability of key
industries to switch to other fuels if necessary during an oil supply
disruption while continuing to use low-cost oil under normal market
conditions. 


      FOSSIL ENERGY PROGRAMS
-------------------------------------------------------- Chapter 3:3.2

DOE believes that its fossil energy programs--including those for
oil, natural gas, coal, and other fossil fuels--can reduce the
economy's vulnerability to oil shocks by boosting domestic oil
production or replacing oil with other fossil fuels.  Table 3.2
summarizes the increases in domestic oil production that DOE
anticipates from its Oil Technology Program.  This program supports
research on characterizing oil reservoirs, enhancing oil recovery
techniques, and developing new oil exploration technologies. 
Appendix IV lists the Oil Technology Program's budget categories and
subcategories and the amounts allocated to each in fiscal year 1996. 
DOE did not provide us with estimates of how much oil its natural
gas, coal, and other programs could, in total, replace.  It did,
however, estimate that the use of coal-derived liquid fuels could
replace 2 million barrels of oil per day by 2030, but it had no
earlier estimates for this program. 



                               Table 3.2
                
                     Total Increase in Domestic Oil
                  Production Attributable to DOE's Oil
                           Technology Program

                     (Millions of barrels per year)

Year                                              2000    2010    2020
----------------------------------------------  ------  ------  ------
All oil programs                                   110     295     520
----------------------------------------------------------------------

      STRATEGIC PETROLEUM RESERVE
      AND DIVERSIFICATION OF
      NON-OPEC OIL SUPPLIES
-------------------------------------------------------- Chapter 3:3.3

According to the NEPP, policies that effectively deal with potential
disruptions in international oil markets can reduce the economy's
vulnerability to the costs of such disruptions.  The NEPP therefore
affirms the administration's commitment to drawing down the SPR in
coordination with other members of the International Energy Agency
(IEA).  (See ch.  4 for more information on the use of the SPR.) In
addition, the administration says that it is facilitating efforts to
increase oil and gas supplies in non-OPEC countries, such as Russia. 
For example, DOE officials said they are helping foreign governments
to implement regulatory reforms and laws that can facilitate foreign
investment in the oil sectors of their countries.  DOE did not
estimate the supply increases anticipated from these efforts. 


      PROGRAMS' OVERALL EFFECTS
      ARE DIFFICULT TO ASSESS
-------------------------------------------------------- Chapter 3:3.4

The information we received from DOE does not clearly assess the
extent to which DOE's initiatives will reduce the economy's
vulnerability to oil disruptions.  First, the information does not
reflect the extent to which the initiatives will result in changes to
the measures of vulnerability discussed above.  Second, the
information does not take into account important factors such as
anticipated increases in the demand for oil or other expected changes
in the economy. 

DOE estimates, for example, that if all of its energy efficiency
programs are successful, oil consumption will decline by just over 1
billion barrels per year, or about 3 million barrels per day, by
2020.  Currently, domestic consumption is about 6.6 billion barrels
per year, or 18 million barrels per day.  Decreased consumption could
decrease vulnerability, as measured by several of the indicators of
vulnerability discussed above.  World oil stocks could increase, the
economy could rely less intensively on oil, and the transportation
sector could reduce its dependence on oil.  Projected reductions in
consumption, however, could be offset by projected increases in the
demand for oil.  In its reference case, EIA forecasts that the
economy's demand for oil will grow, increasing oil consumption by
almost 3.5 million barrels per day from 1994 to 2015--or by slightly
more than DOE expects to reduce consumption through its energy
efficiency programs by 2020.  Moreover, as we mentioned in chapter 2,
the United States is part of the world oil market and, when viewed in
the context of the world market, the projected decline of 3 million
barrels per day represents only a small fraction of world oil demand,
which EIA projects in its reference case to rise from about 68.5 mmbd
in 1995 to about 98.9 mmbd in 2015.  Also, as discussed later, EIA's
reference case forecast recognizes, at least to some extent, the
impact of many of the initiatives contained in the NEPP. 

DOE projects that its fossil energy oil programs will increase
domestic oil production by about 520 million barrels per year, or
about 1.4 mmbd by 2020.  As discussed earlier, however, increasing
domestic production may not significantly reduce the economy's
vulnerability to oil supply disruptions.  In any event, the changes
resulting from these programs, like the changes resulting from DOE's
energy efficiency programs, need to be assessed in the context of the
U.S.  economy's as well as the world's increased demand for oil. 

DOE officials correctly point out that projections of future
consumption would be even higher if they were not offset by the
reductions in oil consumption or increases in domestic oil production
anticipated from the NEPP's initiatives.  DOE officials also point
out that energy efficiency programs have important objectives in
addition to lowering the economy's vulnerability to oil disruptions,
such as reducing energy costs to businesses and consumers, preventing
pollution, cutting greenhouse gas emissions and urban air pollutants,
and contributing to the nation's research and technology base. 
Similarly, DOE officials believe that the fossil energy oil program
serves other goals and objectives, such as promoting the nation's
leadership in basic and scientific research and technology, improving
the stewardship of federal lands and the nation's oil and gas
resources, protecting the environment, lowering the costs of domestic
oil, and assisting the states in complying with energy mandates and
managing their own resources.  While the NEPP's initiatives, if
successfully implemented, could produce these beneficial effects, our
analysis did not assess the likelihood of their achieving such
results. 

To better assess the effects of the NEPP's initiatives on the
economy's vulnerability, we used forecasts from EIA's Annual Energy
Outlook 1996 and International Energy Outlook 1996, along with other
information provided by EIA, to show the changes in the measures of
vulnerability anticipated by 2015.\4 The results appear in the next
section of this chapter. 


--------------------
\4 Annual Energy Outlook 1996 With Projections to 2015
(DOE/EIA-0383(96), Jan.  1996) and International Energy Outlook 1996
With Projections to 2015 (DOE/EIA-0484(96), May 1996). 


   EIA'S LONG-RANGE FORECASTS
   INDICATE CONTINUED
   VULNERABILITY TO OIL SUPPLY
   DISRUPTIONS
---------------------------------------------------------- Chapter 3:4

EIA's projections indicate that the United States will remain
vulnerable to oil supply disruptions in 2015, the last year of EIA's
forecast, even after accounting for the effects of many of the NEPP's
programs.  Only over longer periods do energy analysts see the
potential for significant reductions in vulnerability. 


      EIA'S FORECASTS INDICATE
      LITTLE REDUCTION IN MOST
      MEASURES OF VULNERABILITY
      OVER THE NEXT 20 YEARS
-------------------------------------------------------- Chapter 3:4.1

In the figures that follow, the reference case combines historical
data and EIA's reference or base case forecasts to show how current
programs and policies are likely to affect the measures of
vulnerability discussed above.  For perspective, we have included
historical information dating back to 1975.  EIA's forecasts reflect
a number of assumptions about anticipated economic growth, population
increases, technology developments and other factors.  Appendix V
contains tables showing, where available, forecasted changes that
differ from those in the reference case, assuming lower and higher
economic growth in the United States or lower and higher world oil
prices. 

For its reference case forecasts, EIA assumed varying levels of
technological improvements that could reduce oil consumption or
increase domestic production.  These levels are based primarily on
EIA's examination of historical trends in technological advances but
also reflect EIA's judgment about the likely impact of those NEPP
initiatives that had been implemented at the time the forecasts were
prepared.  In incorporating the reductions in consumption or
increases in production to be realized from DOE's energy efficiency
and fossil energy programs, EIA was generally less optimistic under
the reference case than DOE was in developing the estimates discussed
above.  In part, this difference occurred because EIA did not include
credit, as DOE did, for research and development programs whose
technologies are in the early stages. 

EIA did, however, develop selected "high technology" forecasts of
energy supply and demand, which we used to show the potentially
greater effect of technological achievements on three of the measures
of vulnerability that we present in this report.  The high technology
forecasts are based on five of the "stand-alone" runs of the NEMS
model that EIA prepared for the Annual Energy Outlook 1996 to
illustrate the potential effect of higher technological success in
reducing the U.S.  demand for energy and/or increasing the U.S.  oil
supply.  According to EIA, stand-alone runs represent the impact on a
single sector of the energy markets, without considering the impact
of interactions with other sources.\5 Four of these runs were used to
forecast potential reductions in the demand for oil in the
residential, commercial, industrial, and transportation sectors. 
These runs were made by assuming higher energy efficiency in
buildings and energy-consuming equipment.\6 The fifth run, a high oil
and gas technology run, was used to forecast potential increases in
the supply of domestic oil.  For this case, EIA assumed reductions in
the costs of exploration and development and in refineries'
consumption of fuel and increases in the amounts of recoverable oil
and gas.  According to EIA analysts, the high technology forecasts
project at least as much--and sometimes more--technological success
in decreasing oil consumption as DOE's energy efficiency programs
predict, and about the same increase in oil production as DOE's
fossil energy programs predict. 

Even the high technology cases, however, do not reflect the effects
of all of the NEPP's initiatives.  For example, the forecasts do not
attempt to estimate DOE's success in diversifying international oil
production outside the Persian Gulf.  Also, the high technology cases
do not reflect all of the economic benefits that may accrue from
deploying such technologies.  Rather, the high technology cases
attempt to recognize the gains that could be achieved from an energy
perspective if new technologies were successfully developed and
deployed in the marketplace more rapidly than EIA assumed in its
reference case.  For many of the NEPP's initiatives, success in
reducing the economy's vulnerability to oil shocks hinges on
developing and deploying technologies in the marketplace. 


--------------------
\5 We also analyzed these three vulnerability measures using EIA's
high technology results from pilot integrated technology runs that
consider some of the interrelated effects of supply and demand.  The
integrated runs result in even somewhat worse outcomes with respect
to these vulnerability measures, due primarily to potentially lower
world oil prices that could result from combined program impacts. 
However, the integrated runs also show that higher rates of
technological progress could result in increased economic output over
the period, again because of the potentially lower world oil prices. 
A complete analysis of the economic costs and benefits of higher
rates of technological progress was not performed for these runs
because their primary purpose was to examine energy markets.  See
Issues in Midterm Analysis and Forecasting 1996 (DOE/EIA-0607(96),
Sept.  1996). 

\6 In the residential and commercial sectors, EIA's high technology
forecast assumes that consumers choose to replace their capital stock
with the most energy efficient technologies available in each
forecast year, regardless of cost.  In the industrial and
transportation sectors, the high technology forecast assumes that
future gains in efficiency will equal those achieved since 1970. 


         CONCENTRATION OF WORLD
         OIL PRODUCTION
------------------------------------------------------ Chapter 3:4.1.1

Figure 3.1 indicates that the concentration of world oil production
in the Persian Gulf declined from about 1976 to 1985 but has been
rising since then and, under the reference case, is expected to
continue rising.  Table V.1 indicates that this trend is anticipated
when low as well as high oil prices are assumed.  This forecast
reflects the fact that most of the world's low-cost oil reserves are
located in the Persian Gulf.  To the extent that the potential for
instability in this region remains, so does the possibility of
disruption for supplies that would be difficult to replace from other
sources of production. 

   Figure 3.1:  Concentration of
   World Oil Production, Reference
   Case

   (See figure in printed
   edition.)

Source:  EIA's Annual Energy Outlook 1996 and other EIA publications. 


      EXCESS WORLD OIL PRODUCTION
      CAPACITY
-------------------------------------------------------- Chapter 3:4.2

Figure 3.2 shows that excess world oil production capacity is
expected to decline slowly from 1996 to 2015, making disrupted oil
supplies more difficult to replace through this means.  The figure
also shows that most of the excess production capacity has resided
and is forecast to continue residing in OPEC's member states,
including the Persian Gulf states, making it less useful during
disruptions emanating from this region.  The sharp rise beginning in
about 1980 primarily reflects the decrease in oil consumption
relative to production capacity brought about by the oil shocks and
reactions to the high prices of the 1970s, according to EIA analysts. 
The drop beginning in about 1986 primarily reflects the increase in
oil consumption brought about by sharply declining oil prices.  Table
V.2 indicates similar declines under lower and higher oil prices than
the reference case assumes. 

   Figure 3.2:  Excess World Oil
   Production Capacity, Reference
   Case

   (See figure in printed
   edition.)

Source:  EIA's Annual Energy Outlook 1996 and other EIA publications. 


      OIL INTENSITY OF THE U.S. 
      ECONOMY
-------------------------------------------------------- Chapter 3:4.3

Figure 3.3 shows that oil consumption per million dollars of GDP will
decline slowly under the reference case, indicating that even though
oil consumption is expected to increase, GDP will increase somewhat
faster.  A reduction in oil intensity would lessen the economy's
vulnerability to disruptions because, all else being equal, oil
disruptions of the same magnitude would have increasingly less effect
on the economy.  However, in terms of oil's share of the nation's
total energy consumption--including energy from coal, gas, nuclear,
and other sources--EIA's reference case projects little change over
the forecast period from the 38.5 percent in 1995. 

According to EIA's reference case, the domestic economy will be 19
percent less oil intensive in 2015 than it was in 1995, primarily
because more efficient oil use is projected.  The decline is
projected to be greater for the high technology case, reflecting even
more efficient energy use and some success in introducing alternative
fuels.  The high technology case should be considered an upper-bound
estimate, though, because it includes reductions in the demand for
oil achieved by increasing efficiency through technology and
substituting alternative fuels, but it does not take into account the
effects on price of lowering demand, which could lead to a partial
rebound in consumption and a consequent increase in oil intensity. 
In addition, it does not include the costs of developing such
technology.  Also, the analysis does not assume any increases in the
supply of oil that could result from technological advances.  Such
advances could result in lower prices and higher demand.  Oil supply
disruptions under either the reference or the high technology case
would still likely impose large overall costs on the U.S.  economy. 

As figure 3.3 shows, the declines in oil intensity were greater
between 1975 and 1985 than are projected for the future.  This
forecast reflects, in part, EIA's view that it was easier and less
costly to gain energy efficiency and substitute other fuels for oil
in the past than it is likely to be in the future.  For example,
according to EIA analysts, the electricity-generating industry has
already largely switched from oil to other fuels.  Table V.3
indicates that for both the high economic growth case and the high
oil price case, the projected decline is slightly greater than for
the reference case.  For both the low economic growth case and the
low oil price case, it is smaller than for the reference case.  For
all cases, however, the economy's oil intensity declines. 

   Figure 3.3:  Oil Intensity of
   the U.S.  Economy, Reference
   and High Technology Cases

   (See figure in printed
   edition.)

Note:  For the high technology case in this figure, EIA's four demand
runs were combined to form a consolidated high technology case for
demand.  GDP is in 1987 constant dollars. 

Source:  EIA's Annual Energy Outlook 1996 and other EIA publications. 


      OIL DEPENDENCE OF THE U.S. 
      TRANSPORTATION SECTOR
-------------------------------------------------------- Chapter 3:4.4

As the left half of figure 3.4 indicates, the transportation sector's
reliance on oil, measured as a percentage of the total energy used
for transportation, will decline, but only very slightly over the
forecast period, both for the reference and the high technology
cases.  It is important to note that the scale for this half of the
figure starts with 90 percent to show the difference between the two
cases.  In either case, the transportation sector will remain more
than 90-percent dependent on oil.  Table V.4 indicates that the
modest decline in oil dependence is projected to be the same under
assumptions of low and high economic growth, as well as of low and
high oil prices.  This forecast reflects EIA's modeling results
showing that alternative fuels will continue to have only limited
success in displacing petroleum during the forecast period. 

The right half of figure 3.4 indicates that oil consumption in the
transportation sector will continue to rise under the reference case
but will level off under the high technology case and even begin to
decline somewhat before the forecast period ends compared with the
reference case.  According to EIA analysts, this decline is expected
because greater efficiency gains are anticipated under the high
technology case.  However, for both the reference and the high
technology cases, the level of oil consumption is projected to be
higher throughout the forecast period than in 1995. 

   Figure 3.4 Oil Dependence of
   the U.S.  Transportation
   Sector, Reference and High
   Technology Cases

   (See figure in printed
   edition.)

Note:  The high technology cases in this figure were based on EIA's
transportation demand run. 

Source:  EIA's Annual Energy Outlook 1996 and other EIA publications. 


      WORLD OIL STOCKS
-------------------------------------------------------- Chapter 3:4.5

Figure 3.5 indicates that the level of world oil stocks, as measured
in days of consumption, has remained about the same since 1980 and is
expected to stay at this level at least through 1997.  \7 Any decline
in stocks increases the economy's vulnerability to disruptions
because it reduces the nation's ability to replace disrupted oil
supplies with stocks on hand.  EIA did not forecast future stock
levels beyond 1997 because stock levels are assumed to reflect
short-term fluctuations, such as those caused by the effects of
weather, which are not explicitly incorporated into the long-term
projections.  Although such levels are difficult to forecast, about
19 million barrels of oil in the SPR have been, or are currently
being, sold to meet operational or budgetary needs, and additional
sales are being considered to meet deficit-reduction goals and fund
the reserve's future operations.  Furthermore, as long as the oil
industry remains committed to cutting costs, private oil stocks are
not likely to rise over the long term.  Some oil market experts told
us that oil companies are trying to reduce their operating costs by
adopting "just-in-time" inventory management techniques that keep
inventories and related costs to a minimum but provide little buffer
during oil shocks.  According to one of these experts, such practices
are already causing more volatility in oil prices and may result in
even more pronounced price swings during oil supply disruptions. 

   Figure 3.5:  World Oil Stocks

   (See figure in printed
   edition.)

Source:  EIA and the Organization for Economic Cooperation and
Development. 


--------------------
\7 Many of the world oil stocks are located outside OPEC, largely in
economically developed countries.  Some of the oil included in stocks
is needed for operations and therefore may not be available for use
during supply disruptions. 


      DEPENDENCE OF THE U.S. 
      ECONOMY ON OIL IMPORTS
-------------------------------------------------------- Chapter 3:4.6

Figure 3.6 indicates that the percentage of the nation's oil
consumption met through imports rather than domestic production is
expected to increase under the reference case until about 2005, when
this percentage will begin to decline gradually.  Under the high
technology case, the percentage of imports is expected to peak and
begin to decline earlier, in about 2000.  This high technology
projection should also be considered an upper-bound estimate because
the analysis assumes that (1) decreases in oil consumption achieved
through technological advances would displace only imported and not
domestically produced oil and (2) both lower demand and higher supply
would reduce prices, causing a partial increase in consumption and a
reduction in domestic production, thus raising imports.  In addition
the effects of technological advances in oil production in other
countries are not reflected in the analysis. 

Table V.5 indicates that in the low oil price case, continuing
increases in the percentage of imports are expected throughout the
forecast period.  However, in either the high or the low economic
growth case, or in a high oil price case, the percentages are
expected to peak at some point.  This expectation reflects EIA's
assumption that technological advances lower domestic production
costs and that oil prices will increase enough to stimulate increased
domestic oil production in all but the low oil price case.  In all
but the high technology and high price cases, however, the percentage
of imports is forecast to be higher in 2015 than in 1995.  In the
high technology and high price cases, the percentage of imports is
expected to be slightly lower in 2015 than in 1995. 

   Figure 3.6:  Dependence of the
   U.S.  Economy on Oil Imports,
   Reference and High Technology
   Cases

   (See figure in printed
   edition.)

Note:  The high technology case in this figure combines the data from
all five of EIA's stand-alone runs. 

Source:  EIA's Annual Energy Outlook 1996 and other EIA publications. 


      SUBSTANTIAL REDUCTIONS IN
      VULNERABILITY ARE NOT
      ANTICIPATED UNTIL AFTER 2015
-------------------------------------------------------- Chapter 3:4.7

Although the projected changes in the previously discussed measures
of vulnerability do not show significant improvement over 1995
levels, particularly if low oil prices prevail, EIA's forecasts do
indicate some positive trends.  For example, the use of alternative
motor fuels continues to increase, particularly in the later years of
the forecast and, according to EIA, increasingly reflects consumers'
choices rather than compliance with mandates.  Efficiency gains,
particularly in the high technology cases, produce significant oil
savings.  Finally oil imports peak and begin to decline at some point
in all but the low oil price forecast.  Also, as we reported in June
1996,\8 both DOE and EIA project greater use of biofuels,
particularly beyond 2010, when such fuels are expected increasingly
to replace gasoline.  Moreover, in an April 1996 article that he
co-authored, DOE's Deputy Secretary discussed the potential of the
NEPP's initiatives to reduce the economy's vulnerability to oil
shocks.  In particular, he focused on research designed to increase
energy efficiency and replace oil with alternative fuels.\9 According
to the article, such research will not lead to energy independence in
the next 15 years, but its results offer a chance in the years
thereafter to blunt any foreign threat to raise oil prices
dramatically and to limit the economic and geopolitical influence of
Persian Gulf oil. 


--------------------
\8 Motor Fuels:  Issues Related to Reformulated Gasoline, Oxygenated
Fuels, and Biofuels (GAO/RCED-96-121, June 27, 1996). 

\9 Joseph J.  Romm and Charles B.  Curtis, "Mideast Oil Forever," The
Atlantic Monthly (Apr.  1996), pp.  57-74. 


   OBSERVATIONS
---------------------------------------------------------- Chapter 3:5

Many changes in the world oil market have lessened the U.S. 
economy's vulnerability to oil shocks, but, according to our analysis
of EIA's projections, the economy is likely to remain vulnerable for
the next 20 years, even when success is assumed for many of the
initiatives in the most recent NEPP.  While the economy's
vulnerability might be even greater without such initiatives, the
United States and the rest of the world are likely to continue
depending on oil to meet a substantial portion of their energy needs,
particularly for transportation, and to rely increasingly on
potentially unstable supplies from the Persian Gulf.  Only over
longer periods do energy analysts see the potential for significant
reductions in the economy's vulnerability through, for example, the
use of alternative fuels.  Given the persistence of this potential
threat, limited financial resources, and the length of time required
to determine the success of initiatives aimed at reducing the
economy's vulnerability, it is important to make the right policy
choices now.  In chapter 4, we present the views of oil experts and
analysts we consulted on options for dealing with this threat. 


   AGENCY AND OTHER COMMENTS AND
   OUR EVALUATION
---------------------------------------------------------- Chapter 3:6

DOE said that we did not adequately analyze the impact of the NEPP
programs designed to reduce the economy's vulnerability to oil
shocks, largely because we do not show changes in the measures of
vulnerability both with and without DOE's programs.  Our objective,
which we have clarified, was to assess the extent to which the U.S. 
economy's vulnerability to oil shocks will change over time given the
programs and policies contained in the NEPP, as well as other
relevant factors, such as increases in the demand for oil and
expected changes in the economy.  Our approach for this objective was
to use EIA's published or readily available energy forecasts that
consider such factors, as well as the impact of DOE's programs, but
do not indicate the incremental effect of each factor.  An analysis
of the measures of vulnerability with and without DOE's programs
might support DOE's view that the economy would be more vulnerable
without DOE's programs, and we stated this view prominently in both
our draft and final reports.  We also included in the draft and final
reports measures of the programs' impact provided to us by DOE. 
These measures are expressed in terms of projected barrels per day of
increased domestic oil production or decreased oil consumption. 
However, as we state in the report, these measures are not very
useful for indicating how DOE's programs will affect the economy's
vulnerability to oil supply disruptions because they are not
expressed in terms that measure vulnerability.  Neither do they
consider projected increases in the demand for oil and other expected
changes in the economy that could affect vulnerability.  While EIA's
forecasts do not isolate the impact of DOE's programs, we believe
that they are more effective than DOE's measures for assessing
vulnerability because they are expressed in terms that measure
vulnerability and they take into account other important and relevant
factors.  As we stated in our report, EIA's forecasts do not consider
all of the initiatives designed to reduce the U.S.  economy's
vulnerability to oil supply disruptions, but we believe that they are
the most objective and comprehensive estimates available. 

Two of the experts who reviewed our draft report suggested that oil
companies now tend to keep inventories of crude oil to a minimum in
order to cut costs.  This practice can reduce the stocks available to
respond to disruptions and increase the volatility of oil prices
during both normal and disrupted markets.  One expert also suggested
that the probability of future disruptions is real, given the
continued volatility expected in the Persian Gulf region.  Finally,
one expert said that the unilateral oil trade sanctions imposed by
the United States on other countries reduce the sources of oil
available to the United States during a supply disruption. 

Where appropriate, we have revised the report to reflect the comments
we received from DOE and others. 


EXPERTS HAVE IDENTIFIED OPTIONS
FOR MITIGATING THE ECONOMY'S
VULNERABILITY TO OIL SUPPLY
DISRUPTIONS
============================================================ Chapter 4

Oil experts and industry analysts whom we interviewed suggested a
number of options for reducing the economy's vulnerability to oil
supply disruptions.\1 They cited four options most frequently:  (1)
an early release of SPR oil, (2) more effective use of monetary
policy, (3) further research and development to make alternative
fuels more competitive with gasoline, and (4) increases in gasoline
taxes to discourage consumption and make alternative fuels more
competitive.  The first two are seen as ways to mitigate the impact
of disruptions once they take place; the last two are seen as ways to
reduce the economy's vulnerability to disruptions over the long
term.\2

The experts differed in their opinions on the desirability of
individual options because they held different views on the role of
government in markets, as well as on the potential impact of the
options.\3 Almost all agreed that the SPR provides the best tool now
available. 


--------------------
\1 The oil experts and industry analysts we consulted and their
organizational affiliations are listed in app.  I.  We hereafter
refer to this group of people as the experts. 

\2 Most experts who addressed the potential for increases in domestic
oil production to lessen price increases during disruptions said that
such increases would not help much because, as discussed in previous
chapters, the price of all oil increases during disruptions.  Several
did note, however, that efforts to increase domestic oil production,
particularly those directed at lowering related production costs, may
be justified on other grounds, such as improving resource management
or increasing economic activity and jobs in this industry. 

\3 One expert believes that the government should not play any role
in mitigating the economy's vulnerability to oil shocks because
today's deregulated oil market has become increasingly flexible and
self-correcting.  He cited the existence of an active futures market
as helping to provide such flexibility and to correct oil prices
during oil shocks.  We discussed some of these issues in ch.  3. 


   EXPERTS CONSIDER EARLY USE OF
   THE SPR THE BEST AVAILABLE TOOL
   FOR MITIGATING OIL SHOCKS
---------------------------------------------------------- Chapter 4:1

Nearly all of the experts we spoke with and the studies we reviewed
indicated that drawing down the SPR at the onset of an oil crisis is
the best tool now available to mitigate the potential costs
associated with short-term disruptions in oil supplies.  According to
the experts, the industry's expectations have such a significant
effect on petroleum prices during a crisis that a drawdown of the
SPR, or at least an announcement of a drawdown, is necessary early in
a crisis to effectively dampen price increases.  In theory, even with
a release of SPR oil, prices would likely continue to rise, serving
to reduce demand and provide incentive for increased oil production,
but such increases would likely peak at lower levels than they would
without a drawdown.  Many of the experts criticized the government
for releasing oil from the SPR too late during the Persian Gulf war. 
To guard against delays in the future, several suggested some kind of
automatic "trigger" for releasing SPR oil. 


      EXPERTS CRITICIZED DELAY IN
      USING THE SPR DURING THE
      PERSIAN GULF CRISIS
-------------------------------------------------------- Chapter 4:1.1

Several experts criticized the decision to delay a release of oil
from the SPR during the Persian Gulf war.  During this crisis, the
first major drawdown of the SPR ever was announced in January 1991,
more than 5 months after Iraq invaded Kuwait and 3 months after oil
prices peaked.  These experts believe that the administration waited
too long to release oil from the SPR.\4

Shortly after Iraq's invasion of Kuwait, DOE explained that it
intended to use the SPR only to offset physical supply shortages in
the United States and that it had relied on market forces to
encourage the production of additional supplies and discourage
consumption during the early months of the crisis.  However, the
experts argued that basing the policy for drawing down the SPR on
physical shortages during a crisis missed the point because such
shortages are virtually impossible in a market environment.  Rather,
if supplies were disrupted, prices would rise with a potential
detrimental effect on the economy.  Rising prices, however, could
also induce increased oil production and decreased consumption.  One
expert noted that production was sufficient to meet consumers' needs
even during the more severe price shocks of the 1970s.  This expert
noted that the apparent shortages experienced then occurred because
consumers and businesses increased their own private inventories out
of fear that physical shortages would occur.  In these cases, fear of
physical shortages encouraged behavior that exacerbated the
disruption.  Thus, this expert believes that a release from the SPR
can calm the market by ensuring a supplier of last resort.  Many of
the experts we contacted also believe, contrary to the
administration's view in 1990, that the price increase during the
early months of the crisis was large enough to justify using the SPR. 
Some of the experts described the SPR as an "insurance policy" that
American taxpayers have purchased against oil shocks and their
economic consequences.  Therefore, an early drawdown to prevent a
potential price run-up of the type observed during the Gulf crisis is
the only way to obtain the reserve's benefits. 

However, some also believe that the release of SPR oil during an oil
supply disruption should depend upon the disruption's potential
magnitude and duration.  Hence, the higher the likelihood of a
massive and sustained disruption, the greater the potential value of
retaining SPR oil for future use.  For example, in a report issued in
December 1994, the Congressional Budget Office (CBO) stated that the
administration's decision not to release SPR oil during the Persian
Gulf war might have been justified on the grounds that potential
additional losses in oil supplies as the war progressed might have
caused a later release to yield even larger economic benefits.\5
Nevertheless, CBO recognized that the lack of a clear policy for
releasing oil from the SPR and the government's early indecision
about using the SPR could have added to the uncertainty about oil
supplies already plaguing the oil markets. 

The current administration's policy on drawing down the SPR, as
stated in the NEPP, is to rely on market forces to allocate supplies
in the event of a disruption and to supplement supplies through an
early drawdown of the SPR in large volumes and in coordination with
the nation's allies and trading partners.  One stated purpose of the
most recent announced drawdown of 12 million barrels from the SPR was
to dampen the impact of gasoline price increases that occurred during
the spring of 1996.\6 According to DOE, this sale was directed by the
Congress before the price increases took place in order to raise $227
million for other programs in fiscal year 1996, but its timing was
accelerated. 


--------------------
\4 While the world price of crude oil dropped by about $10 per barrel
after DOE announced that oil would be released from the SPR, DOE
acknowledged that the true effect of the drawdown could not be
separated from other factors, including, most significantly, the
early success of the air war against Iraq at that time. 

\5 CBO's report, Rethinking Emergency Energy Policy (Dec.  1994),
contains options for setting the price of SPR oil once a decision has
been made to draw down the reserve so as to increase the impact of a
release in the marketplace. 

\6 DOE conducted a test sale in September 1990, selling 3 million
barrels.  More recently, DOE sold 5.1 million barrels of SPR oil to
pay for the closure of the Weeks Island storage site, which has
structural integrity problems. 


      EXPERTS FAVOR AUTOMATIC
      TRIGGER FOR SPR RELEASE
-------------------------------------------------------- Chapter 4:1.2

To ensure more effective use of the SPR during an oil shock, many
experts we consulted favored adopting a market-based trigger
mechanism that would automatically release oil from the SPR at the
appropriate time.  The trigger mechanism cited most frequently is the
sale of options.\7 Under this approach, the government would sell
options to those wishing to guard against rising oil prices.\8 The
sale could be in the form of a competitive bid, to buy SPR oil at a
predetermined price called the "exercise" or "strike" price.  In
exchange, the government would receive a one-time up-front payment of
a fee, called a premium, from the buyer.  The strike price would,
then, become the minimum price that would trigger an SPR drawdown
during an oil crisis.  In theory, the sale of options could serve two
useful purposes.  First, it could help to reassure the oil market
during an oil crisis that a decision to use the SPR would not be held
up by governmental decision-making, but would instead be made by the
oil market itself.  Second, the payment of premiums from the sale of
options would generate revenue for the government while the oil
remained in storage.\9

Another question about the SPR is its appropriate size.  We did not
discuss this issue in any detail with the experts, but those who
expressed a view said that the SPR should be larger than it is
currently because, among other things, the nation's consumption of
oil is increasing.  In addition, one expert suggested that the SPR is
not large enough to play a significant role in large or long-term
disruptions because such disruptions would greatly exceed the
capacity of the reserve to affect the world oil market.  As discussed
in chapter 3, world oil consumption was about 70 million barrels per
day in 1995.  Nevertheless, as part of its fiscal year 1997 budget
submission to the Congress, the administration indicated that in 2002
it plans to sell enough SPR oil to raise $1.5 billion to help achieve
a balanced budget in that year.  DOE also indicated that legislation
may be required to authorize such a sale.  More recently, DOE
announced that it would carefully analyze the size of the SPR and
other related issues before selling any oil in 2002. 


--------------------
\7 An option is a contract that gives the holder the right, but not
the obligation, to purchase or sell oil at a predetermined price for
a specified period of time in exchange for the payment of a one-time
premium.  The contract also obligates the seller, who receives the
premium, to meet these terms. 

\8 In testimony before the House Committee on Government Operations,
we also noted that the use of options was a possible way to avoid
delays in releasing SPR oil (GAO/T-RCED-90-105, Sept.  5, 1990). 

\9 A potential drawback of the options approach is that the
government could receive less money for the oil sold from the SPR if
the prevailing market price during an oil shock exceeded the strike
price by more than enough to offset the present value of the total
revenue from the premium payments.  However, one oil options expert
suggested that this drawback could be mitigated by adopting a
multitier price-setting release mechanism.  Using this mechanism, the
government would sell the options in tiers so that increasing volumes
of oil would be sold at increasing prices. 


   EXPERTS BELIEVE APPROPRIATE
   MONETARY POLICY COULD LESSEN
   THE ECONOMIC IMPACT OF
   DISRUPTIONS
---------------------------------------------------------- Chapter 4:2

Some of the experts whom we contacted believe that monetary policy
could be effective in partially offsetting the economic harm caused
by oil market shocks.  Broadly speaking, oil market shocks harm the
economy by reducing GDP in two different ways:  They permanently
reduce the economy's potential GDP, and they temporarily reduce GDP
below the new lower potential.  While monetary policy is set by the
Federal Reserve and is outside the purview of energy policymakers,
some experts believe that it could be effective in offsetting the
temporary reduction in GDP.\10 Experience with past oil shocks shows,
however, that choosing the best monetary policy is difficult and may
depend on prevailing economic conditions.  DOE is currently studying
the role of monetary policy in offsetting the harmful effects of oil
shocks. 

Oil shocks harm the economy by reducing the economy's potential GDP,
which is the amount that the United States can produce when all
resources are fully employed.  Potential GDP is determined by the
nation's resource base, which consists of its labor force, natural
resources, and capital stock and the productivity of these resources. 
In response to the high energy prices, firms may use less energy,
reducing the amount of output that can be produced with a given
amount of capital and labor.  Hence, the productivity of labor and
capital declines.  In addition, a rise in oil prices may render
older, more energy-using capital prematurely obsolete.  Firms may
retire some of their machines and factories that are heavily
dependent on fuel, thus effectively reducing the nation's capital
stock and potential GDP.  The Federal Reserve cannot offset this
damage to the nation's potential economic output unless the price of
oil falls to its previous level.  Moreover, the increase in oil
prices would cause a one-time increase in the economy's overall price
level. 

Oil shocks can also harm the economy because the economic costs of
adjusting to them can cause the nation's GDP to fall temporarily
below the new lower potential.  In a severe form, this reduction in
GDP could be sufficient to cause a recession.  Monetary policy may be
effective in offsetting this source of economic harm.  For example,
according to one of the experts we consulted, effective monetary
policy could help the economy achieve its new lower potential GDP
without causing a sustained increase in inflation.  The Federal
Reserve might be able to accomplish this result by allowing a
one-time increase in the money supply.  The increased money supply
would lower real (inflation-adjusted) interest rates, which would
stimulate investment and spur GDP growth.  The challenge for the
Federal Reserve would be to ensure that the one-time increase in the
money supply did not signal a sustained expansion of the money supply
that would produce a sustained increase in inflation.  However, this
view is not universally held by all experts.  Others argue that the
Federal Reserve would probably have little or no success in
offsetting a drop in GDP caused by an oil shock. 

Monetary policy decisions during oil supply shocks could also have
adverse economic consequences.  According to some of the experts that
we contacted, decisions made during past shocks may have exacerbated
economic problems caused by the shocks.  One expert stated that the
recession in the United States and Europe that followed the 1979 oil
shock was caused, in part, by government actions to fight inflation
by reducing the money supply and increasing interest rates.  The NEPP
also points out that shortcomings in previous economic policy
reactions have amplified the negative effects of oil price increases
and helped trigger economic recessions. 

While some of the experts we contacted said that monetary policy can
help to mitigate the potential adverse economic impact of oil shocks,
they also said that the relationship among monetary policy, oil
shocks, and economic performance is only partially understood. 
Moreover, as stated above, monetary policy choices would depend on
the economic conditions at the time of the shock and policy decision
about which economic goals receive the highest priority.  According
to the experts, more research is needed to understand the
complexities of these economic relationships.  DOE is currently
conducting a study, with input from Federal Reserve officials and
others, that includes an analysis of the effect of monetary policy
choices on economic performance during oil shocks.  This study is
expected to be released by the end of 1996. 


--------------------
\10 The Federal Reserve, through its Federal Open Market Committee,
is independently responsible for setting monetary policy for the
United States.  In general, monetary policy may be used to pursue the
broad objectives of stabilizing prices and employment while fostering
economic growth.  The Federal Reserve can pursue these objectives by
influencing interest rates and the availability of credit. 


   EXPERTS SEE RESEARCH AND
   DEVELOPMENT ON ALTERNATIVE
   TRANSPORTATION FUELS AS THE
   MOST PROMISING LONG-TERM
   SOLUTION
---------------------------------------------------------- Chapter 4:3

Most of the experts we consulted said that in the long term,
sustained research and development on alternative transportation
fuels and vehicles may hold the key to significantly reducing the
economy's vulnerability to oil shocks.  Most of the experts also
believe that the federal government should play a role in funding
basic research in this area.  A smaller number supported a federal
role in applied research or demonstration programs, and almost none
supported federal mandates or subsidies to encourage the use of
alternative fuels or vehicles.  Some of the experts said that the
failure of the market and industry to place a high value on basic
research in this area justifies a role for the federal government. 


      EXPERTS SUPPORT FEDERAL
      RESEARCH AND DEVELOPMENT FOR
      ALTERNATIVE FUELS AND
      VEHICLES
-------------------------------------------------------- Chapter 4:3.1

Many of the experts we consulted believe that the economy's long-term
vulnerability to oil shocks may be greatly reduced through research
on alternative fuels and vehicles whose use could curb the demand for
oil in the transportation sector.  Alternative fuels include natural
gas, ethanol, methanol, propane, and electricity.  As discussed in
chapter 3, the transportation sector is the largest user of oil,
accounting for almost two-thirds of all oil consumed in the United
States.  According to DOE, in 1994, oil supplied about 97 percent of
the energy consumed in the transportation sector.  This sector's
consumption exceeded the nation's total domestic oil production by 38
percent.  Therefore, the development of alternative fuels and
vehicles that can cost-effectively decrease the transportation
sector's use of oil could substantially reduce the economy's
dependence on oil. 

Advances in U.S.  research on alternative fuels and vehicles could
have worldwide implications.  Such advances could reduce not only the
nation's, but also the world's, dependence on oil and vulnerability
to oil supply disruptions. 

Although many experts supported federal funding for research on
alternative transportation fuels and vehicles, many indicated that
the federal role should be limited to funding research to develop
technological options.  Several of the experts, including oil company
representatives, said that the market should ultimately determine the
market penetration rate and the use of such fuels and vehicles.  They
cautioned against federal involvement in mandating the use of
alternative fuels or vehicles or subsidizing the commercialization of
alternative fuels.  One expert expressed the view, however, that
subsidies and mandates may be needed to offset the advantage that
petroleum-based fuels derive from an existing infrastructure for
refueling.  \11

Governmental subsidies can be costly, as we found in a 1992 report on
the lessons learned from other countries' experiences with
alternative fuels.\12 Furthermore, any wavering in financial or other
commitments may lead to a negative response from consumers and
industry.  Among other important lessons, we learned that consumers
want (1) the prices of alternative fuels and alternative-fueled
vehicles to be competitive with the price of gasoline, (2)
alternative fuels to be conveniently available, and (3) alternative
fuels and vehicles to perform as well as gasoline fuels and vehicles. 


--------------------
\11 DOE and other federal agencies are currently implementing several
programs that selectively mandate the use of alternative fuels or
provide subsidies for their use. 

\12 Alternative Fuels:  Experiences of Brazil, Canada, and New
Zealand in Using Alternative Motor Fuels (GAO/RCED-92-119, May 7,
1992). 


      SOME EXPERTS SEE
      EXTERNALITIES AS JUSTIFYING
      A FEDERAL ROLE IN RESEARCH
-------------------------------------------------------- Chapter 4:3.2

Some of the experts we consulted believe that the existence of
external costs not included in the price of oil, or externalities,
justifies federal involvement in research on alternative fuels and
vehicles to reduce the economy's dependence on oil.  The experts
cited several externalities, including OPEC's power to influence the
world price of oil and to cause a world oil crisis and associated
economic disruptions.\13 The environmental cost of using oil,
especially the air pollution caused by the transportation sector, is
another external cost that might decrease if alternative fuels were
used in place of oil. 

In addition, some experts argued that the federal government should
take the lead in funding basic research for alternative fuels and
vehicles because such research, if successful, would confer more
benefits on society than a private party who undertook such research
would be able to recoup.  Furthermore, it may take a long
time--perhaps several decades--for research to make alternative fuel
prices competitive with oil.  For these reasons, the private sector
may be unwilling to invest in such research and a federal role may be
justified. 

Although many experts supported the government's participation in
energy research, there was no consensus on the optimal level of
federal funding for such research.  A leading energy expert told us
that the optimal level of federal funding for alternative energy
research should be determined by the estimated cost of the
externalities associated with oil consumption.\14

While most experts we consulted favored federal research for
alternative fuels and vehicles, a few did not believe that such
research was a cost-effective way to mitigate the economy's
vulnerability to oil shocks.  These experts questioned whether much
has been gained from federal investments in such research over the
past two decades, arguing that despite these expenditures, oil
consumption, especially in the transportation sector, has not
decreased.  They believe that uncertainties associated with the cost
and convenience of alternative fuels and vehicles reduce the
likelihood of their being able to compete with conventional fuels and
vehicles within any reasonable period of time. 

Very few of the experts mentioned research to improve fuel efficiency
in the transportation sector or in other sectors as an option to
reduce the economy's vulnerability.  One who did address the subject
believes that increases in fuel efficiency may be overtaken by
increases in demand, as has occurred historically.  In a recent
report the Office of Technology Assessment stated that in predicting
the eventual outcome of research to improve fuel efficiency, a key
unknown is whether the demand for travel will keep on growing and
overwhelm the effects of efficiency gains or whether it will instead
reach a plateau or grow very slowly so that rising efficiency will
reduce total energy use.\15 We note, however, that according to
proponents of energy efficiency measures, a large amount of oil could
be saved at a reasonable cost through greater energy efficiency. 


--------------------
\13 Some experts believe that because of the economic interdependence
between OPEC and the oil-importing nations, OPEC is not likely to
deliberately precipitate an oil crisis through embargoes similar, for
example, to the 1973-74 crisis.  However, as discussed previously,
many fear that the risk of an oil supply disruption has not been
eliminated because the Middle East remains politically volatile and
internal conflicts affect the stability of some core members of OPEC. 

\14 There is no consensus among the experts we consulted on the
estimated amount of the external costs associated with oil
consumption, or even on their components.  Some included factors such
as OPEC's market power, environmental pollution, the macroeconomic
adjustment costs associated with oil price spikes, the military costs
attributable to protecting oil imports, and even the costs of
developing and maintaining the SPR. 

\15 Office of Technology Assessment, Saving Energy in U.S. 
Transportation (July 1994). 


   EXPERTS SEE A HIGHER GASOLINE
   TAX AS A WAY TO DECREASE OIL
   CONSUMPTION
---------------------------------------------------------- Chapter 4:4

Many of the experts suggested that a higher federal gasoline tax
could reduce the economy's dependence on oil and vulnerability to oil
shocks by lowering the consumption of oil.  At the same time, they
were aware of the potential political and public opposition to such a
tax, as well as the widespread public support for recent proposals to
lower existing gasoline taxes.  While there was no consensus among
the experts on what the optimal tax rate should be, most of those
supporting a higher gasoline tax believe that it must be high enough
to bring about an appreciable reduction in oil consumption.  Gasoline
taxes in Western Europe and Japan are already much higher than in the
United States.  Higher gasoline taxes may have adverse effects on the
economy, but these effects could be lessened through offsetting
changes in fiscal or monetary policy. 


      EXPERTS BELIEVE A HIGHER
      GASOLINE TAX COULD HELP
      REDUCE U.S.  OIL CONSUMPTION
-------------------------------------------------------- Chapter 4:4.1

Many of the experts we interviewed believe that substantially
increasing the federal gasoline tax rate would help to decrease the
demand for motor gasoline, thereby reducing oil consumption and
vulnerability to oil shocks.  As discussed, the transportation sector
is fueled almost entirely by oil, and this sector alone accounts for
about two-thirds of the nation's oil consumption.  Furthermore, EIA
forecasts under its reference case that the transportation sector's
demand for oil will grow by about 25 percent between 1994 and 2015. 
Many of the experts we consulted attributed much of the
transportation sector's high and rising demand for oil to the
relatively low price of gasoline in the United States--a price many
believe does not fully reflect all of the external costs of using
gasoline discussed above.  In a 1992 study, we found that U.S. 
gasoline prices did not reflect all of the external costs associated
with gasoline use.\16 Our study identified "vulnerability to oil
supply disruption and price shocks" as one of the external costs of
the transportation sector's heavy reliance on petroleum.  It also
found that a higher tax on gasoline was an option that could be used
to reduce the nation's dependence on oil and ultimately help secure
the U.S.  economy against oil price shocks. 

Other studies have also found that reducing the economy's
vulnerability to oil shocks would justify higher gasoline tax
rates.\17 According to several of the experts we consulted, such a
tax must be sufficiently high to bring about a sizable and
sustainable reduction in the demand for oil because, overall, the
demand for gasoline in the United States does not respond very much
to small increases in price, particularly in the short term.  In
addition, some experts believe that by boosting the price of
gasoline, a higher gasoline tax could, over time, stimulate and
facilitate the development of alternative fuels, making their price
more competitive in the marketplace. 


--------------------
\16 Energy Policy:  Options to Reduce Environmental and Other Costs
of Gasoline Consumption (GAO/RCED-92-260, Sept.  17, 1992). 

\17 See, for example, Jonathan Haughton and Soumodip Sarkar,
"Gasoline Tax as a Corrective Tax:  Estimates for the United States,
1970-1991," The Energy Journal, Vol.  17, No.  2 (1996), pp. 
103-126.  See also Sanjeev Gupta and Walter Mahler, "Taxation of
Petroleum Products:  Theory and Empirical Evidence," Energy
Economics, Vol.  17, No.  2 (1995), pp.  101-116. 


      THE AVERAGE RETAIL GASOLINE
      PRICE IS MUCH LOWER IN THE
      UNITED STATES THAN IN
      WESTERN EUROPE
-------------------------------------------------------- Chapter 4:4.2

On average, the retail price of gasoline is much lower in the United
States than in Western Europe or Japan.  For example, as of June
1996, the average price of gasoline at the pump was about $1.29 per
gallon in the United States, compared with a combined average of
about $4.11 per gallon in Germany, the United Kingdom, France, and
Italy.  This wide difference between the average retail price of
gasoline in the United States and in these countries is almost
entirely explained by the prevailing differences in gasoline taxes. 
As of June 1996, the gasoline tax averaged around $0.38 per gallon in
the United States,\18 compared with a combined average of $3.22 per
gallon in Germany, the United Kingdom, France, and Italy. 

According to the Office of Technology Assessment's report cited
above, European automobile fleets are more efficient than U.S. 
fleets, partly because Americans purchase large numbers of light
trucks for personal use and partly because American automobiles are
larger than their European counterparts.  The report also noted that
per-person travel and energy consumption in Europe, while growing,
should remain significantly below U.S.  levels for several reasons,
including differences in geography and the wide disparity between
European and U.S.  gasoline prices.  The NEPP also notes that
gasoline prices in the United States are lower than in other
industrialized nations, contributing to high rates of motor vehicle
use. 

A substantially higher gasoline tax could, however, negatively affect
the U.S.  economy in the short term unless it were offset by other
changes to fiscal or monetary policies.  A higher gasoline tax could
slow economic growth by reducing consumers' disposable income and
raising costs for businesses using gasoline-powered light-duty
vehicles. 


--------------------
\18 This consists of 18.3 cents for federal tax and an average of
19.77 cents for all the states and the District of Columbia. 


   OBSERVATIONS
---------------------------------------------------------- Chapter 4:5

The options most often recommended by the experts we consulted are
generally included in the NEPP, but there are some important
differences.  For example, both the experts and the plan propose
early use of the Strategic Petroleum Reserve and the appropriate use
of monetary policy to mitigate the impact of oil supply disruptions
once they take place.  The plan, however, does not adopt the
automatic market-based trigger recommended by many of the experts to
avoid delays in releasing oil from the reserve.  The plan cites the
importance of monetary policy but stops short of stipulating a role
for such policy during oil supply disruptions.  DOE is currently
studying the role of monetary policy in more detail. 

Both the plan and the experts see further research and development on
alternative transportation fuels and vehicles as a way to reduce the
economy's vulnerability to oil supply disruptions, particularly in
the long run.  The plan, however, calls for continuing existing
mandates and subsides for the use of alternative fuels, which the
experts generally do not favor.  Although the higher gasoline taxes
recommended by many of the experts are not part of the plan, even the
experts who favor this option are aware of the potential political
and public opposition to it. 

The plan contains a number of initiatives aimed at increasing
domestic oil production, but most of the experts who addressed this
issue said that while such efforts may be justified on other grounds,
such as increased domestic economic activity and employment, such
initiatives would not significantly reduce the nation's economic
vulnerability to oil supply disruptions for the reasons discussed in
chapter 2. 


   AGENCY AND OTHER COMMENTS AND
   OUR EVALUATION
---------------------------------------------------------- Chapter 4:6

DOE said that the experts we consulted essentially endorsed the
NEPP's core programs.  Yet despite some similarities, important
differences separate the NEPP's proposals from the views of these
experts.  We outlined these differences in the preceding observations
section in both the draft and final report. 

One expert commenting on our draft report said that during prior
disruptions, oil production capacity exceeded consumption, but
precautionary and speculative buying still drove up oil prices.  This
expert believes that using the SPR is the most effective strategy to
prevent such price rises.  Another expert said that the size of the
SPR should be increased and opposed the recent sale of SPR oil to pay
for other federal programs.  Finally, one expert said that higher
gasoline taxes in this country would raise the cost of doing business
and adversely affect the nation's international competitiveness. 
Where appropriate, we have revised the report to take these comments
into consideration. 


EXPERTS AND INDUSTRY ANALYSTS GAO
CONSULTED ON OPTIONS FOR DEALING
WITH U.S.  VULNERABILITY TO OIL
SUPPLY DISRUPTIONS
=========================================================== Appendix I

M.  A.  Adelman, Professor Emeritus, Massachusetts Institute of
Technology. 

Douglas Bohi, Senior Fellow, Resources for the Future. 

Richard Brown, Thomas Hogarty, Edward Porter, American Petroleum
Institute. 

Peter C.  Fusaro, President, Global Change Associates. 

Lawrence J.  Goldstein, President, Petroleum Industry Research
Foundation, Inc. 

William W.  Hogan, Professor, Harvard University. 

J.  Daniel Khazzoom, Professor, San Jose State University. 

Edward N.  Krapels, Director, Energy Security Analysis, Inc. 

W.  C.  Lonquist, President, Memorial Exploration Company. 

Michael C.  Lynch, Research Affiliate, Massachusetts Institute of
Technology. 

John R.  Moroney, Professor, Texas A&M University. 

Edwin S.  Rothschild, Energy Policy Director, Citizen Action. 

Michael R.  Ryan, Manager, Regulatory Affairs, Texaco, Inc. 

John Saucer, Senior Energy Analyst, Smith Barney, Inc. 

Irwin M.  Stelzer, Director, Regulatory Policy Studies, American
Enterprise Institute for Public Policy Research. 

Vito Stagliano, Visiting Scholar, Resources for the Future. 

Philip Verleger, Jr., Vice President, Charles River Associates, Inc. 

Robert J.  Weiner, Associate Professor, George Washington University. 

Roy Willis, Senior Vice President, Independent Petroleum Association
of America. 


ESTIMATING THE BENEFITS OF
LOW-COST OIL IMPORTS
========================================================== Appendix II

This appendix describes the Energy Information Administration's (EIA)
methodology for estimating the benefits to the U.S.  economy of
access to low-cost oil imports.\1 It also expands chapter 2's brief
description of the results of EIA's analysis.\2


--------------------
\1 We would like to thank EIA's Office of Integrated Analysis and
Forecasting for their assistance in the modeling and analysis phases
of our study.  However, this analysis should not be construed as
advocating or reflecting any policy position of the U.S.  Department
of Energy or the Energy Information Administration.  We would also
like to thank M.  A.  Adelman, Massachusetts Institute of Technology;
Douglas Bohi, Resources for the Future; Stephen Brown, Federal
Reserve Bank of Dallas; Richard Farmer, Congressional Budget Office;
Bert Hickman, Stanford University; William Hogan, Harvard University;
Hillard Huntington, Stanford University; Daniel Khazzoom, San Jose
State University; Edward Krapels, Energy Security Analysis, Inc.;
Alan Manne, Stanford University; Bradley McDonald, World Trade
Organization; James Sweeney, Stanford University; Sidney Winter, The
Wharton School of the University of Pennsylvania; and Mine Yï¿½cel,
Federal Reserve Bank of Dallas, for their assistance in designing our
study.  Nevertheless, the views expressed in this report do not
necessarily reflect their views. 

\2 The Impacts on U.S.  Energy Markets and the Economy of Reducing
Oil Imports, DOE, EIA, SR/OIAF(96-04), (Sept.  1996). 


   TWO APPROACHES ILLUSTRATE
   BENEFITS
-------------------------------------------------------- Appendix II:1

At our request, EIA used its National Energy Modeling System (NEMS)
to evaluate the impact of higher oil prices on U.S.  oil import
levels and subsequently on U.S.  macroeconomic performance.  EIA
developed and maintains NEMS to forecast the effects of energy
policies or programs and changing world energy market conditions on
the U.S.  and world energy markets.  NEMS can also be used to
forecast the effects of changing energy markets on the U.S. 
economy.\3

To estimate the benefits of oil imports to U.S.  consumers and
businesses, we asked EIA to pursue two different approaches.  The
benefits of oil imports cannot be measured directly, so economists
estimate them indirectly by measuring the harm that would be caused
by reducing imports from their current level.  Hence, we designed
these approaches to illustrate the cost to the U.S.  economy of
reducing oil imports by relying on more expensive domestic sources of
energy.  Similarly, the well-being of consumers and businesses cannot
be measured directly, so we use Gross Domestic Product (GDP) as a
proxy measure of their well-being.  We compared GDP under these
reduced oil import cases with GDP under the reference case in EIA's
Annual Energy Outlook 1996.  This reference case, discussed at
greater length in chapter 3, reflects EIA's projection of the most
likely future trends in energy markets and the U.S.  economy.  The
difference between GDP under the reference case and GDP under the
reduced import cases represents an estimate of the cost of reducing
oil imports or, alternatively, the benefits of importing oil at the
current level.  Under one approach, higher world oil prices, caused
by a gradual decline in foreign production, gradually reduce imports. 
Under the other approach, a hypothetical oil import fee raises the
prices of imports, reducing their levels.  We chose an oil import fee
for two reasons.  First, unlike higher world oil prices, an oil
import fee is an option that U.S.  policymakers could choose. 
Second, many of the experts we consulted agree that if policymakers
wish to lower oil imports, an oil import fee is an effective and
comparatively low-cost method of doing so.  Other options for
reducing oil imports, such as implementing regulations to limit
imports or subsidizing domestic production, impose costs at least as
high as these two approaches.  Thus, the choice of an import fee was
entirely for illustrative purposes; we do not endorse any particular
energy program or policy goal.  In order to isolate the economic
effects of reducing oil imports from those of other possible
concurrent changes, such as changes in the money supply, we generally
assumed that other economic policy instruments would remain unchanged
from EIA's reference case.\4 Both approaches provide an estimate of
the benefits to the U.S.  economy of importing oil, and both are
useful for illustrating the large gains derived from buying oil from
the lowest-cost source, rather than imposing restrictions that would
enhance noncompetitive domestic energy production.  Because of the
many uncertainties in estimating the benefits of imports, the results
of applying the two approaches are best interpreted as rough guides
to the magnitude of the benefits of oil imports, rather than as
precise estimates. 


--------------------
\3 More information on NEMS is available in The National Energy
Modeling System:  An Overview (DOE/EIA-0581(96), Mar.  1996). 

\4 While the Congress or the Federal Reserve could change fiscal or
monetary policy to minimize the effects of reducing imports on GDP or
other economic indicators, such changes could confound the
measurement of the gains from trade. 


      HIGHER WORLD OIL PRICES
------------------------------------------------------ Appendix II:1.1

EIA modeled four cases to measure the effects of higher world oil
prices on U.S.  oil imports and macroeconomic performance.  In these
cases, the world oil price was assumed to rise gradually, by 2005, to
$5, $10, $15, and $20 per barrel above the forecast price in EIA's
reference case ($22 per barrel in 2005), in 1994 dollars.  Figure
II.1 compares the price paths for two of the higher-price cases--the
$10 and $20 cases--with the path for EIA's reference case.  As the
figure shows, oil prices rise more quickly for the higher-price cases
than for the reference case.  For the $10 case, the world oil price
is about $32 per barrel in 2005, or about $10 per barrel higher than
for the reference case.  The differences in price between the
higher-price cases and the reference case are assumed to result from
a gradual decline in world oil production, not from a deliberate
policy choice by the U.S.  government.  The higher prices are assumed
to be phased in over a 10-year period to minimize the adjustment
costs created by price changes.  After 2005, the prices in the four
higher-price cases are assumed to grow at the same rate as the price
in the reference case. 

   Figure II.1:  World Oil Prices
   Under Three Scenarios

   (See figure in printed
   edition.)

Source:  EIA. 


      IMPORT FEE
------------------------------------------------------ Appendix II:1.2

Imposing an oil import fee would raise the domestic oil price above
the world oil price.  This result contrasts with the results of
higher world oil prices, which apply equally to all markets, foreign
and domestic.  As figure II.2 shows, the world oil price would
decline slightly relative to EIA's reference case if the United
States were to impose an oil import fee.  This decline would occur
because lower oil consumption in the United States would lower the
world's total demand for oil.  Figure II.2 shows the relationship
that would exist between the world oil price and the domestic oil
price if the United States were to impose an import tariff sufficient
to reduce imports by the same amount as the $20 price increase in the
case described above.  For any given year, the vertical distance
between the domestic oil price and the world oil price is the import
fee.  Although the oil import fee would be imposed only on imported
oil, the price of domestically produced oil would rise to the same
level, creating an increase in revenue for domestic oil producers. 
In this case, the hypothetical fee, like the price increases in the
higher-price cases, is implemented over a 10-year period to minimize
the adjustment costs that it would impose. 

   Figure II.2:  U.S.  and World
   Oil Prices With an Oil Import
   Fee

   (See figure in printed
   edition.)

Source:  EIA. 

For the import fee case, it was assumed that crude oil and refined
crude oil products imported from the United States' North American
Free Trade Agreement (NAFTA) partners--Canada and Mexico--would not
be subject to the oil import fee.  It was also assumed that the
volumes available from Canada and Mexico would be limited to the
volumes available for export from Canada and Mexico after these
countries met their domestic consumption needs with their domestic
production.  For all of the import fee cases, all excess production
was imported into the United States.  The import fee was applied
uniformly to all other foreign production. 


   HIGHER OIL PRICES REDUCE OIL
   IMPORTS
-------------------------------------------------------- Appendix II:2

Under both of the approaches that we asked EIA to model, the price of
domestic oil increases; in the one case, the domestic price rises
with the higher world price, while in the other case, the oil import
fee raises the price.  Higher domestic oil prices increase domestic
production and decrease domestic consumption; as a result, oil
imports decline.  Figure II.3 shows that in the four higher-price
cases, imports fall relative to EIA's reference case.  For example,
if the world oil price is $10 higher than expected by 2005, imports
will be about 2.0 million barrels per day (mmbd) below EIA's current
projection.  Similarly, if the world oil price is $20 higher than
expected, imports will be about 3.2 mmbd below EIA's current
projection.  By 2015, imports will continue to decrease by a total of
2.9 mmbd and 4.7 mmbd, respectively.  Nevertheless, figure II.3 also
shows that oil imports will continue to rise relative to their
current level, at least initially.  In its reference case, EIA
projects that imports will rise from the current level of about 8.3
mmbd to a peak of about 11.9 mmbd in 2012 before declining slightly. 
In other cases, imports will continue to rise above the current level
initially.  In the $5- and $10-higher-price cases, imports in 2015
remain above the current level.  Only in the $15- and
$20-higher-price cases do imports fall below the current level. 
Because the oil import fee was designed to produce the same effects
on imports as the $20-higher-price case, the fees effects on imports
are not shown separately. 

   Figure II.3:  U.S.  Oil Import
   Levels Under Various Future Oil
   Price Scenarios

   (See figure in printed
   edition.)

   Notes:  Changes shown in left
   half of figure are relative to
   EIA's reference case.
   Prices are in 1994 dollars.

   (See figure in printed
   edition.)

   Source:  EIA.

   (See figure in printed
   edition.)

Increased crude oil prices have predictable effects on the U.S. 
energy sector:  Domestic oil production increases while the
transportation sector's demand for fuel declines.  Increased crude
oil prices have indirect effects on the production of natural gas and
coal and other aspects of the energy market, but these effects are
modest relative to the direct effects on oil production and the
transportation sector's demand for oil. 

When domestic oil prices rise, either because world oil prices
increase or because an oil import fee is imposed, oil imports fall. 
They fall because domestic production increases and domestic
consumption decreases.  Figure II.4, which refers to the
$20-per-barrel-higher-price case shows that the increases in domestic
production exceed the decreases in domestic consumption, but both
contribute significantly to reducing imports.  For example, in 2005
under the $20-higher-price case, increased domestic production
represents 73 percent of the reduction in imports while decreased
consumption accounts for 24 percent.  The import reductions in figure
II.4 arise from the $20 increase in the world oil price but would be
similar if the import fee were imposed.  The primary difference would
be a decline in oil imports coupled with a rise in refined product
imports.  In the tariff cases, refined products imports would rise
relative to oil imports because inexpensive imports become available
under NAFTA.  Figure II.4 also demonstrates that the majority of the
increased domestic production is in the form of oil.  (Because
increases in domestic production arise from changes in several
sources of energy, not just oil, EIA measures the contribution of
each form of energy in quadrillions of British thermal units (Btu)
rather than barrels of oil.) Decreases in domestic consumption come
largely from the transportation sector, as figure II.4 also shows. 

   Figure II.4:  Impact of
   $20-Per-Barrel-Higher Oil
   Prices on U.S.  Energy
   Production and Consumption

   (See figure in printed
   edition.)

   Note:  Changes are relative to
   EIA's reference case.

   (See figure in printed
   edition.)

   Source:  EIA.

   (See figure in printed
   edition.)


   REDUCING OIL IMPORTS IMPOSES
   LARGE ECONOMIC COSTS
-------------------------------------------------------- Appendix II:3

Higher prices for oil would impose large costs on the economy.  As
discussed earlier, these costs, or macroeconomic losses, represent
the gains realized from the nation's current level of oil imports. 
In the higher-price cases, such as the $20-higher-price case shown in
figure II.5, GDP declines relative to EIA's reference case as oil
prices rise and imports decline.  Specifically, in the
$20-higher-price case, by 2005 GDP has declined by about $100 billion
annually.  It continues to decline for another year, to about $110
billion, before improving slowly to about $100 billion per year below
the reference case in 2015.  The smaller higher-price cases show
proportionately smaller effects on GDP--the $10-higher-price case
reduces GDP by about $50 billion per year in 2005 and GDP remains
approximately constant thereafter.\5

The macroeconomic consequences of the oil import fee are more
complex.  Unlike higher world oil prices, the oil import fee
generates substantial revenues for the government.  These revenues
alter the economic consequences of reducing oil imports.  Although
many alternatives exist for using these revenues, we asked EIA to
focus on two cases:  In one case, the revenues are rebated equally to
consumers and businesses through reductions in the Social Security
payroll tax and the total federal budget deficit at full employment
remains unchanged from EIA's reference case, while in the other case,
the revenues are used to reduce the federal budget deficit.  How
these funds are used makes a large difference.  As figure II.5 shows,
when the fee revenues are used to reduce the federal budget deficit,
the economy is adversely affected through 2005, but GDP begins to
return to the reference case, nearly reaching that level by 2015.  In
the early years, the economy is adversely affected by higher energy
prices and lower import levels, while in the later years, interest
rates decline in response to the reductions in the federal budget
deficit, stimulating investment.  We believe that GDP returns to the
reference-case level because of the benefits of reducing the federal
budget deficit.  In contrast, when the fees are rebated to consumers
and businesses, the economy stays at or slightly above EIA's
reference case through 2005 but declines sharply thereafter.  In this
deficit-neutral case, the early results stem from the rebate, which
encourages consumption and ameliorates the near-term effects of the
oil import fee.  However, investment declines as interest rates rise,
and GDP begins to decline rapidly relative to the reference case
after 2005. 

   Figure II.5:  Changes in GDP
   From High World Oil Prices and
   Oil Import Fee

   (See figure in printed
   edition.)

Note:  Changes are relative to EIA's reference case. 

Source:  EIA. 

The effect of an oil import fee on interest rates depends on how the
fee revenues are used.  Figure II.6 shows changes in interest rates
from EIA's reference case under the deficit-reducing and
deficit-neutral cases.  In the deficit-reducing case, the rise in
energy prices increases inflation and temporarily increases nominal
interest rates.  This increase temporarily discourages investment and
interest-sensitive components of consumers' expenditures, such as
automobiles and housing.  However, over a longer time period, as the
temporary increase in inflation subsides, the continued reduction in
federal borrowing lowers interest rates slightly, encouraging
investment and long-term economic growth.  In contrast, in the
deficit-neutral case, nominal interest rates rise throughout the
period.  This rise discourages economic investment and limits
long-term economic growth, thereby reducing GDP in the long term. 

   Figure II.6:  Bond Rates

   (See figure in printed
   edition.)

Source:  EIA. 

Figure II.7 shows that each successive reduction of 1 million barrels
per day can be achieved only at a higher cost:  The cost of reducing
imports rises more rapidly than the rate of reduction in imports
themselves.  For example, the first $10 price increase reduces oil
imports by 2.0 mmbd by 2005, while the next $10 increase reduces them
by only an additional 1.2 mmbd.  Thus, doubling the price increase,
and the subsequent effect on GDP, is only 60 percent as effective in
reducing imports as implementing the original price increase. 

   Figure II.7 GDP Losses as a
   Function of Import Reductions

   (See figure in printed
   edition.)

Source:  EIA. 


--------------------
\5 According to EIA, the costs of reducing imports would be roughly
the same even if the current estimates of future prices prove to be
too high or too low.  In other words, the economic costs of deviation
from the expected future prices depend on the amount of the deviation
rather than the level of the future prices. 


   ECONOMIC CHANGES ARE REFLECTED
   IN VARIOUS SECTORS OF THE
   ECONOMY
-------------------------------------------------------- Appendix II:4

As discussed, higher world oil prices would reduce GDP.  This
reduction takes two different forms.  First, higher oil prices harm
the economy by reducing the economy's potential GDP, which is the
amount that the U.S.  can produce when all resources are fully
employed.  Potential GDP is determined by the nation's resource base,
which consists of its labor force, natural resources, and capital
stock and the productivity of these resources.  In response to the
high energy prices, firms may use less energy, which reduces the
amount of output that can be produced with a given amount of capital
and labor.  Hence, the productivity of labor and capital declines. 
In addition, a rise in oil prices may render older, more energy-using
capital prematurely obsolete.  Firms may retire some of their
machines and factories that are heavily dependent on fuel, thus
effectively reducing the nation's capital stock and potential GDP. 

Second, changing prices imposes adjustment costs on the economy
because individual businesses and consumers cannot adjust their
behavior instantaneously as prices change.  Figure II.8 shows the
reduction in potential and real GDP (including the adjustment costs)
under the $20-higher-price case.  By 2005, and for the remainder of
the 20 years covered by this study, real GDP fell by about $100
billion per year under this case.  Some of these costs are temporary,
and over a longer period, the losses in potential and real GDP would
tend to converge.  Besides reducing potential and real GDP, higher
energy prices transfer wealth from oil consumers to oil producers. 
Figure II.8 shows the additional wealth that would be transferred to
foreign oil producing nations if the world price of oil were to
increase. 

The oil import fee cases, not shown here, also reduce potential and
real GDP and transfer wealth.  The two cases affect the magnitude of
the potential and real GDP differently because the different uses of
the fee revenues have different effects on the economy as a whole. 
In particular, real and potential GDP losses would be substantially
less in the deficit-reducing case because, as described earlier,
reducing the federal budget deficit would decrease interest rates and
boost investment.  While an oil import fee, like higher world oil
prices, would transfer wealth from oil consumers, it would transfer
the wealth to domestic rather than foreign oil producers. 

Changes in GDP can be measured for its components--consumption,
investment, government spending, and net exports.  Figure II.9
focuses on changes in these components under the $20-higher-price
case.  In this case, consumption and investment fall by $85 billion
and $36 billion, respectively, by 2005.  They remain substantially
reduced throughout the study period. 

   Figure II.8:  Loss in Real and
   Potential GDP, and Wealth
   Transfer

   (See figure in printed
   edition.)

Notes:  Changes are relative to EIA's reference case. 

$20-per-barrel-higher-world-oil-price case. 

Source:  EIA. 

In chapter 2, we said that the trade balance--the current
account--would be likely to remain largely unchanged if oil imports
declined.  Little change would occur because, if oil imports fell,
total U.S.  exports would also fall or other U.S.  imports would rise
to retain the balance between total savings and investment needs.  As
discussed in chapter 2, the current trade deficit is caused by the
shortfall between domestic savings and investment needs and does not
depend on the level of oil or of any other commodity imported into
the United States.  If imports were to change, foreign exchange rates
would change to retain the balance between total savings and
investment needs.  The NEMS results, however, are based on the
assumption that exchange rates will remain at their baseline
level--they will not change as U.S.  imports change.  This assumption
was made because NEMS focuses primarily on domestic macroeconomic
effects, and its ability to incorporate international flows of funds
is limited.  In discussions with EIA, we agreed that raising the
domestic oil price above the world oil price would decrease oil
imports.  Depending on the effect of higher oil prices on the
competitiveness of U.S.  goods and services, NEMS' results could show
a change in the trade deficit because of this restriction on exchange
rates.  Nevertheless, we continue to believe, and EIA does not
disagree, that a more complete international model might show that
the net trade balance would remain essentially unchanged. 

   Figure II.9 Components of Real
   GDP Loss

   (See figure in printed
   edition.)

Notes:  Changes are relative to EIA's reference case. 

$20-per-barrel-higher-world-oil-price case. 

Source:  EIA. 

The imposition of an oil import fee, like higher world oil prices,
would likely bring benefits to domestic oil producers, who are
included in the mining sector of the economy.  However, these
benefits would be more than offset by reductions in other sectors of
the economy, and the net effect of reducing oil imports would be
negative.  Figures II.10 and II.11 show the economic impact of an oil
import fee on different sectors of the economy.  Figure II.10
reflects the assumptions of the deficit-neutral case, while figure
II.11 reflects those of the deficit-reducing case.  Differences
between the two cases can be traced to differences in the impact of
interest rates and prices, as well as of the total change in GDP. 
Interest-sensitive industries would feel fewer effects under the
deficit-reducing case because, as described earlier, interest rates
would fall slightly in this case but rise in the deficit-neutral
case. 

   Figure II.10:  Changes in
   Economic Output Caused by
   Imposing a Deficit-Neutral Oil
   Import Fee

   (See figure in printed
   edition.)

Note:  Changes are relative to EIA's reference case. 

Source:  EIA. 

   Figure II.11:  Changes in
   Economic Output Caused by
   Imposing a Deficit-Reducing Oil
   Import Fee

   (See figure in printed
   edition.)

Note:  Changes are relative to EIA's reference case. 

Source:  EIA. 

The manufacturing sector of the economy is further subdivided into
its components for both oil import fee cases.  Figure II.12 and
figure II.13 show the impact on output for the deficit-neutral and
deficit-reducing cases, respectively.  For both cases, the impact on
most manufacturing industries, including petroleum refining, would be
negative. 

   Figure II.12:  Changes in
   Manufacturing Output Caused by
   Imposing a Deficit-Neutral Oil
   Import Fee

   (See figure in printed
   edition.)

Note:  Changes are relative to EIA's reference case. 

Source:  EIA. 

   Figure II.13:  Changes in
   Manufacturing Output Caused by
   Imposing a Deficit-Reducing Oil
   Import Fee

   (See figure in printed
   edition.)

Note:  Changes are relative to EIA's reference case. 

Source:  EIA. 


OIL SAVINGS BY ENERGY EFFICIENCY
PLANNING UNIT
========================================================= Appendix III


   DESCRIPTIONS OF DOE'S ENERGY
   EFFICIENCY PROGRAMS
------------------------------------------------------- Appendix III:1

GAO requested that the Department of Energy provide detailed
information on the energy efficiency programs designed to reduce oil
consumption.  The Division of Applied Analysis, in the Office of the
Assistant Secretary for Energy Efficiency and Renewable Energy,
furnished the following descriptions, together with the data and
projections presented in table III.1. 


      IN-HOUSE ENERGY MANAGEMENT
      (IHEM)
----------------------------------------------------- Appendix III:1.1

This program aims to reduce energy consumption and utility costs for
DOE's facilities. 


      FEDERAL ENERGY MANAGEMENT
      PROGRAM (FEMP)
----------------------------------------------------- Appendix III:1.2

This program leads an interagency and public private partnership to
provide cost-effective financial options and technologies for
reducing the cost of energy used in the federal government.  In 1994,
the government spent approximately $9 billion on energy supplies for
its buildings, fleets, operations, and industrial processes.  The
programs in FEMP seek to reduce the cost of energy for the federal
government by 30 percent. 


      BUILDING EQUIPMENT AND
      MATERIALS
----------------------------------------------------- Appendix III:1.3

The programs within this planning unit conduct research and
development (R&D) activities to provide the building industry with
the advanced technology base needed for high-efficiency globally
competitive building components (equipment, envelope subsystems, and
materials) and to accelerate the adoption and use of these advanced
components.  Some of these technologies are advanced roofs, walls,
and foundations; heat pumps and chillers; advanced lighting and
appliances; and advanced glazing and electrochromic windows. 


      BUILDINGS SYSTEMS DESIGN
----------------------------------------------------- Appendix III:1.4

The programs within this planning unit conduct research and
development to improve the overall efficiency of the nation's
commercial and residential buildings by improving the performance and
integration of energy systems in buildings.  This goal is pursued
through the development and deployment of integrated systems and
controls to link heating, cooling, lighting, and other building
energy services in the most efficient manner possible; support of
infrastructure changes that accelerate the deployment of energy
efficient technologies for commercial and residential buildings; and
facilitation of the design and construction of buildings in the most
efficient and productive manner possible through the development and
deployment of tools and methods known as best practices.  Some of
these technologies are energy design tools, advanced commercial
buildings, and advanced residential housing. 


      CODES AND STANDARDS
----------------------------------------------------- Appendix III:1.5

This program implements legislatively mandated energy efficiency
standards, codes, and guidelines for buildings, building equipment,
and appliances to improve energy efficiency in the nation's
buildings.  Setting efficiency standards can improve the average
energy performance of buildings and equipment. 


      INDUSTRIES OF THE FUTURE
----------------------------------------------------- Appendix III:1.6

The programs within this planning unit are developing, jointly with
industry, visions of the future and technology "roadmaps," and
conducting research and development of advanced energy and material
efficient technologies to respond to industry needs.  Seven
industries, producing over $700 billion in annual shipments, are
partners.  These industries are chemicals, forest and paper products,
glass, metals casting, petroleum refining, steel, and aluminum.  A
large number of diverse technologies are under development.  A few of
these technologies are auto shredding and recycling, chemical
bioprocessing systems, wood pulp black liquor gasification, advanced
glass melting and process heating, aluminum casting, petroleum
refining separations and membranes, and steel plant waste oxide
recycling and aluminum melting, aluminum cell cathodes/inert anodes. 


      COGENERATION
----------------------------------------------------- Appendix III:1.7

This planning unit is developing technologies to both improve
conventional turbines and develop an advanced gas turbine for the
production of electricity and steam in industrial applications.  This
advanced turbine system is designed to be 15 percent more efficient
than new conventional turbines.  Specific technologies in this
program include, in addition to the advanced turbine system, a
ceramic retrofit gas turbine, a high-performance steam turbine, and a
retrofit to lower emissions of nitrous oxides. 


      ADVANCED MATERIALS AND
      CONTINUOUS FIBER CERAMIC
      COMPOSITES (CFCC)
----------------------------------------------------- Appendix III:1.8

The programs within this planning unit develop new alloys,
composites, and ceramics for a wide variety of industrial
applications.  Examples of these technologies include materials for
recovery boilers, nickel iron aluminides for steel mill rolls,
organic polymers, selective inorganic thin films, CFCC diesel engine
components, CFCC gas turbine components, and hot gas filters.  The
market for the advanced materials and CFCCs includes a large array of
manufacturing applications--including chemical production, plastics,
high-temperature processes, boilers, etc. 


      INDUSTRIAL TECHNOLOGY
      ASSESSMENT
----------------------------------------------------- Appendix III:1.9

These programs disseminate information about energy efficiency
techniques and technologies to potential users in industry and manage
various programs to stimulate their adoption.  Climate Wise is a
voluntary program in which industry adopts energy efficiency and
pollution prevention technologies to reduce greenhouse gas emissions. 
Industrial assessment centers (IAC) provide energy and waste
assessments to small and medium-sized manufacturers at no cost
through university-based programs that provide hands-on training for
students.  The Motor Challenge program works in partnership with
industry to help capture over $13 billion in estimated energy savings
by the year 2010 through the greater use of energy efficient
motor-driven systems.  The National Industrial Competitiveness
through Energy, Environment, Economics (NICE-3) program provides seed
funding to state and industry partnerships for projects to develop
and demonstrate advances in energy efficiency and clean production
technologies. 


      INVENTIONS AND INNOVATIONS
---------------------------------------------------- Appendix III:1.10

This program develops innovative energy technologies and increases
the nation's intellectual property base by supporting research,
development, and deployment by independent inventors of innovative
energy technologies and concepts. 


      STATE AND LOCAL PARTNERSHIPS
---------------------------------------------------- Appendix III:1.11

These programs facilitate the adoption of energy efficiency and
renewable energy technologies among states, municipalities,
institutions, and private citizens. 


      TECHNOLOGY ACCESS
---------------------------------------------------- Appendix III:1.12

These programs assist in moving renewable energy and energy efficient
technologies into domestic and international markets.  They address
market barriers that slow the acceptance of new and existing
technologies. 


      BIOFUELS RESEARCH AND
      DEVELOPMENT
---------------------------------------------------- Appendix III:1.13

This program seeks to develop low-cost biomass energy feedstocks and
cost-effective conversion technologies for liquid fuel markets.  The
technologies include biochemical conversion and the development of
woody and herbaceous crops for fuel feedstocks.  Cost-competitive
biofuels from waste are expected by 2000 and from energy crops by
2010. 


      ALTERNATIVE FUEL VEHICLES
---------------------------------------------------- Appendix III:1.14

The programs within this research and development planning unit
reduce oil consumption and environmental emissions in the
transportation sector in the near and mid-term through the
introduction and commercialization of economical alternative
transportation vehicles and fuels.  This goal is pursued through the
establishment of sustainable alternative fuel and vehicle production
industries, vehicle engine optimization, vehicle testing, acquisition
and dissemination of fleet performance data, coordination of fleet
purchases, and sponsorship of student competitions. 


      PARTNERSHIP FOR A NEW
      GENERATION OF VEHICLES
      (PNGV)
---------------------------------------------------- Appendix III:1.15

The programs within this planning group seek to produce a commercial
prototype light- duty vehicle with at least triple the efficiency of
conventional vehicles by 2004.  Specific technologies that contribute
to this goal include advanced batteries, hybrid vehicle propulsion
systems and components, fuel cell propulsion systems, advanced alloys
and composites for vehicle bodies and components, and ceramic
materials for propulsion systems. 


      CONVENTIONAL VEHICLES
---------------------------------------------------- Appendix III:1.16

The programs within this research and development planning unit
develop technologies to improve the energy conversion efficiency of
conventional combustion engines in vehicles, including both
light-duty vehicles and trucks, while simultaneously reducing
emissions.  This work includes incremental improvements to gasoline
engines as well as the development of a "clean diesel" with a
potential for a 20- to 50-percent efficiency improvement. 


      SOLAR TECHNOLOGIES
---------------------------------------------------- Appendix III:1.17

The programs within this research and development planning unit
develop and facilitate the commercialization of a range of solar
electric technologies to meet the nation's need for inexpensive,
reliable, and environmentally benign electric power.  These
technologies include photovoltaics (concentrators, flat plate
modules, single crystal silicon, and thin-film technologies), solar
thermal (dish/engine systems, parabolic troughs, and power towers)
and biomass power (advanced direct combustion, cofiring,
direct-fired, and gasification).  In addition to their other
environmental benefits, these technologies will cut greenhouse gas
emissions.  In addition, these technologies will help to maintain or
establish competitive industries that produce high-value technologies
for domestic consumption and export--particularly to developing
nations--contributing to long-term economic growth. 


      WIND ENERGY
---------------------------------------------------- Appendix III:1.18

This research and development program seeks to further develop and
facilitate the commercialization of wind energy technology to meet
the nation's need for inexpensive, reliable, and environmentally
benign electric power.  The principal technology is a utility-scale
horizontal axis wind turbine.  Additional work focuses on providing
design tools and supporting infrastructure development. 


      GEOTHERMAL ENERGY
---------------------------------------------------- Appendix III:1.19

This program is to reduce the cost of producing electricity with
geothermal resources and to facilitate the deployment of geothermal
heat pumps in commercial and residential markets.  These goals are
being accomplished through geothermal reservoir characterizations,
development of advanced drilling technology, development of
small-scale binary technology power plant prototypes, and geothermal
heat pump infrastructure support. 


      HYDROGEN RESEARCH
---------------------------------------------------- Appendix III:1.20

This planning unit supports the development of practical and
cost-competitive hydrogen energy technologies and systems.  This is
done through research and development of mid- to long-term
technologies to produce, store, transport and use hydrogen. 
Technology work focuses on electrochemical, photochemical, and
thermochemical production; physical storage; and solid-state storage. 


      ELECTRIC ENERGY SYSTEMS
---------------------------------------------------- Appendix III:1.21

The programs in this planning unit develop advanced power delivery
technologies that improve power quality, improve reliability, and
increase the efficiency of electric power distribution systems;
improve the value and effectiveness of renewable energy technologies
within conventional utility systems; and support systems analyses to
increase the use of renewable energy technologies.  In addition to
other contributions, this planning unit group includes
high-temperature superconductivity research and development, which
has potential applications in a wide range of electric and industrial
technologies, including generators, transformers, transmission
cables, motors and other electric end-use technologies. 


      UTILITY TECHNOLOGY ACCESS
---------------------------------------------------- Appendix III:1.22

The Integrated Resource Planning program develops tools and methods
to assist utilities, regulatory commissions, and consumer groups to
make more economic and flexible resource decisions.  Climate
Challenge is a joint initiative of DOE and the utility industry to
reduce greenhouse gas emissions through voluntary actions that make
economic sense. 


   SAVINGS IN CONSUMPTION EXPECTED
   FROM ENERGY EFFICIENCY PROGRAMS
------------------------------------------------------- Appendix III:2

These estimates were aggregated by "planning units" that contain
similar programs.  The initial funding year is the first fiscal year
the program was operating.  The budget for each unit is for fiscal
year 1996.  Estimates of reduced oil consumption are in millions of
barrels per year (mmby), in 10-year increments.  Estimates of total
reductions in consumption are presented in both mmby and millions of
barrels per day (mmbd). 

 



                                   Table III.1
                     
                         Oil Savings by Energy Efficiency
                                  Planning Unit

                              (Dollars in thousands)

                                      Initia
                                           l       Funds
Planning unit group/planning unit     fundin   available    2000    2010    2020
name                                  g year     FY 1996  (mmby)  (mmby)  (mmby)
------------------------------------  ------  ----------  ------  ------  ------
IHEM/FEMP\a
--------------------------------------------------------------------------------
IHEM                                    1977          $0       0     0.1     0.2
FEMP                                    1978     $17,100     0.8     2.5     4.2

Building Equipment and Materials
--------------------------------------------------------------------------------
Materials and Structures R&D            1977      $3,260     1.6     3.1     4.5
Space Conditioning R&D                  1977     $15,257     1.0     3.1     6.0
Windows and Glazing R&D                 1986      $6,106       0       0       0
Lighting and Appliance R&D              1980      $4,360     0.2     0.5     0.9

Building Systems Design
--------------------------------------------------------------------------------
Best Practices                          1978      $4,571     0.7     2.4     5.2
Commercial Buildings                    1985     $11,026     1.4     4.7     8.5
Residential Buildings                   1989      $6,865       0     0.3     1.6

Codes and Standards
--------------------------------------------------------------------------------
Lighting and Appliance Codes and        1979      $5,738     0.2     2.0     3.0
 Standards
Building Codes and Standards            1984      $8,901     0.4     1.4     1.6

Industries of the Future
--------------------------------------------------------------------------------
Forest and Paper Products Vision        1995     $11,553       0     0.3     2.6
Glass Vision                            1995      $1,414     0.2     0.5     1.2
Aluminum Vision                         1985      $1,449     0.1     0.9     2.3
Chemicals Vision                        1995     $13,840     1.0    24.8    50.1
Petroleum Refining Vision               1995      $6,726    35.7    89.7    64.9
Steel Vision                            1986      $6,780       0     0.2     0.2
Metals Casting Vision                   1990      $1,992       0       0       0

Cogeneration
--------------------------------------------------------------------------------
Cogeneration                            1992     $22,125     4.3     4.3     0.1

Advanced Materials and CFCCs
--------------------------------------------------------------------------------
Advanced Materials and CFCCs            1992     $17,476     0.1     1.1     3.5

Industrial Technology Assessment
--------------------------------------------------------------------------------
Climate Wise                            1995      $2,000     5.9       0       0
IACs                                    1976      $8,679     0.1     0.1     0.1
Combustion Technologies                 1977         $70       0     0.1     0.1
Motor Challenge                         1995      $5,332       0       0       0
NICE-3                                  1991      $6,000     2.1    11.6    14.7

Inventions and Innovations
--------------------------------------------------------------------------------
Inventions and Innovations              1975      $5,504     0.6     2.1       0

Grants
--------------------------------------------------------------------------------
Weatherization Assistance Program       1977    $114,196     0.2     0.6     0.9
State Block Grants                      1976     $26,500     5.9    13.8    14.1
Municipal Energy Management Program     1978      $1,843       0       0       0
Regional Biomass Program                1983      $3,940       0       0       0

Technology Access
--------------------------------------------------------------------------------
Commercialization Ventures              1994      $3,000     3.0    10.9    22.3
Information and Communications          1981      $2,940       0       0       0
International Market Development        1990      $2,907       0       0       0
Solar International                     1990      $4,000       0       0       0

Biofuels
--------------------------------------------------------------------------------
Biofuels                                1974     $27,200     5.0   150.0   219.0

Alternative Fuel Vehicles
--------------------------------------------------------------------------------
Alternative Fuel Vehicles R&D           1976     $29,303    12.1    46.6    24.1

PNGV
--------------------------------------------------------------------------------
Electric Vehicle R&D                    1976     $17,692     4.0    46.0    37.0
Fuel Cell R&D                           1987     $22,250       0    13.0   140.0
Hybrid Vehicle R&D                      1993     $57,690       0   180.0   300.0
Lightweight Vehicle Materials R&D       1993     $13,360       0    32.0    35.0
Propulsion System Materials             1983     $22,125       0       0       0
 (Ceramics)

Conventional Vehicles
--------------------------------------------------------------------------------
Heavy Duty Engine R&D                   1976      $5,454     1.0    73.0   237.0
Light Duty Engine R&D                   1976      $4,649       0    39.0    43.0

Solar Technologies
--------------------------------------------------------------------------------
Biomass Power R&D                       1992     $21,200     0.1     3.2    10.0
Photovoltaic Systems R&D                1974     $65,000       0     0.2     1.4
Solar Thermal Electric R&D              1976     $25,000       0     0.2     0.6

Wind Energy
--------------------------------------------------------------------------------
Wind Energy R&D                         1974     $32,500     0.7     2.1     7.7

Geothermal Energy
--------------------------------------------------------------------------------
Geothermal Energy R&D                   1973     $31,447     0.1     0.8     0.7

Hydrogen Research
--------------------------------------------------------------------------------
Hydrogen Research R&D                   1979     $14,500       0       0       0

Electric Energy Systems
--------------------------------------------------------------------------------
Electric and Magnetic Fields R&D        1978      $9,924       0       0       0
Energy Storage R&D                      1990      $2,000     0.1     0.3     0.3
High Temperature Superconductivity      1989     $19,000       0     0.1     0.9
 R&D

Utility Technology Access
--------------------------------------------------------------------------------
Climate Challenge                       1995          $0       0       0       0
================================================================================
Total (mmby)                                                88.6   767.6  1,269.
                                                                               5
================================================================================
Total (mmbd)                                                 0.2     2.1     3.5
--------------------------------------------------------------------------------
Note:  Oil savings are direct oil savings as reported and assumed to
be 5 percent of electricity savings. 

\a The FEMP numbers in this table represent incremental oil savings
resulting from fiscal year 1996 efforts in federal facilities only;
they assume 20 percent energy savings in the year 2000 and 30 percent
energy savings in the year 2005 (EPACT, Ex.  Orders 12759 and 12902
goals). 


INCREASED OIL PRODUCTION RESULTING
FROM DOE'S OIL TECHNOLOGY PROGRAM
========================================================== Appendix IV

DOE projects that its Oil Technology Program will increase domestic
oil production over the next decades, as shown in table IV.1: 



                               Table IV.1
                
                  Projected Increases in Domestic Oil
                               Production

                (Increases in millions of barrels of oil
                                per day)

                                                     Fiscal year
                                                ----------------------
                                                  2000    2010    2020
----------------------------------------------  ------  ------  ------
Increase                                          0.30    0.81    1.42
----------------------------------------------------------------------
Source:  DOE. 

Funding for the Oil Technology Program has varied significantly in
the last few years, as shown in table IV.2: 



                               Table IV.2
                
                  Funding for Oil Technology Program,
                          Fiscal Years 1993-96

                         (Dollars in millions)

                                                                Approp
                                                                riated
                                                                 funds
                                                                availa
Fiscal year                                                        ble
--------------------------------------------------------------  ------
1993                                                              56.1
1994                                                              74.3
1995                                                              75.2
1996                                                              55.7
----------------------------------------------------------------------
Source:  DOE. 

The funding for fiscal year 1996 is allocated to four subprograms, as
shown in table IV.3: 



                               Table IV.3
                
                    Funding for Fiscal Year 1996 Oil
                         Technology Subprograms

                         (Dollars in millions)

Subprogram                     Funding          Activities
----------------------  ----------------------  ----------------------
Supporting research             $33.5           Includes reservoir
                                                 characterization,
                                                 drilling completion
                                                 and stimulation,
                                                 production, and
                                                 exploration.
Demonstrations                   11.1           Includes cost-shared
                                                 projects with
                                                 industry for
                                                 reservoir
                                                 characterization,
                                                 drilling techniques,
                                                 and enhanced oil
                                                 recovery.
Environmental research           5.5            Includes risk
                                                 assessment and work
                                                 on reducing water
                                                 produced during oil
                                                 production.
Oil-refining programs            5.7            Includes pollution
                                                 prevention (e.g., to
                                                 curb airborne
                                                 emissions produced
                                                 during refining),
                                                 environmental
                                                 compliance, and
                                                 upgrading of refining
                                                 technologies.
----------------------------------------------------------------------
Source:  DOE. 


MEASURES OF VULNERABILITY UNDER
ALTERNATIVE SCENARIOS
=========================================================== Appendix V

The tables in this appendix show how the measures of vulnerability
discussed in chapter 3 would be affected under scenarios
incorporating different assumptions about oil prices and/or economic
growth.\1

In each of the tables, we used EIA's forecasts to produce the values
for the measures.  EIA's reference case reflects EIA's views about
the effects of current policies and programs on oil demand and supply
and on other factors.  EIA's forecasts are based on assumptions about
trends in economic growth, demographics, and technological
developments.  For comparison, we also include, when available,
values for EIA's alternative scenarios, which differ from the
reference case with respect to EIA's assumptions about world oil
prices and/or U.S.  economic growth. 

For the low-world-oil-price case, EIA assumes that world oil prices
drop below current prices for the next few years and then gradually
return to current levels, where they remain throughout the forecast
period.  For the high-world-oil-price case, EIA assumes that world
oil prices increase to $32.61 per barrel in 2010 and continue rising
to $33.89 in 2015.  All prices are in 1994 constant dollars. 

For the low-economic-growth case, EIA assumes lower rates of growth
for population, labor force, and labor productivity than the
reference case, resulting in higher prices, higher interest rates,
and lower growth in industrial output.  Under this case, economic
output increases by 1.5 percent a year over the forecast period.  For
the high-economic-growth case, EIA assumes higher rates of growth for
population, labor force, and productivity than the reference case. 
Because productivity gains are higher, inflation and interest rates
are lower than in the reference case.  Under this case, economic
output increases by 2.5 percent a year between 1994 and 2015. 



                               Table V.1
                
                 Concentration of World Oil Production

                  (Percentage of world oil produced by
                        Persian Gulf suppliers)

Case                                      1994  2000  2005  2010  2015
----------------------------------------  ----  ----  ----  ----  ----
Reference case                            26.8  30.6  35.3  39.2  44.3
Low oil price                               \a  32.7  38.7  44.7  50.1
High oil price                              \a  28.1  31.0  35.0  40.7
----------------------------------------------------------------------
\a Not applicable. 

Source:  EIA, International Energy Outlook 1996. 



                               Table V.2
                
                  Excess World Oil Production Capacity

                  (Production capacity in millions of
                            barrels per day)

Case                                      1995  2000  2005  2010  2015
----------------------------------------  ----  ----  ----  ----  ----
Reference case                            3.16  3.13  2.14  2.05  2.02
Low oil price                               \a  4.04  3.26  3.09  2.99
High oil price                              \a  3.04  2.17  1.79  1.71
----------------------------------------------------------------------
\a Not applicable. 

Source:  EIA, Annual Energy Outlook 1996 and other EIA publications. 



                               Table V.3
                
                   Oil Intensity of the U.S. Economy

                   (Intensity in barrels of daily oil
                consumption per million dollars of GDP)

Case                                      1995  2000  2005  2010  2015
----------------------------------------  ----  ----  ----  ----  ----
Reference case                            3.23  3.04  2.88  2.75  2.61
Low economic growth                         \a  3.07  2.93  2.81  2.70
High economic growth                        \a  3.01  2.84  2.69  2.54
Low oil price                               \a  3.09  2.95  2.84  2.73
High oil price                              \a  2.98  2.79  2.66  2.53
----------------------------------------------------------------------
Note:  GDP in 1987 constant dollars. 

\a Not applicable. 

Source:  EIA, Annual Energy Outlook 1996 and other EIA publications. 



                               Table V.4
                
                       Oil Dependence of the U.S.
                         Transportation Sector

                  (Oil as a percentage of total energy
                        used for transportation)

Case                                      1995  2000  2005  2010  2015
----------------------------------------  ----  ----  ----  ----  ----
Reference case                            97.0  97.0  96.2  95.0  94.1
Low economic growth                         \a  97.0  96.2  95.1  94.0
High economic growth                        \a  97.0  96.2  95.1  94.2
Low oil price                               \a  97.0  96.3  95.1  96.2
High oil price                              \a  97.0  96.0  95.0  94.0
----------------------------------------------------------------------
\a Not applicable. 

Source:  EIA, Annual Energy Outlook 1996, and other EIA publications. 



                               Table V.5
                
                 Dependence of the U.S. Economy on Oil
                                Imports

                 (Imported oil as a percentage of total
                         U.S. oil consumption)

Case                                      1995  2000  2005  2010  2015
----------------------------------------  ----  ----  ----  ----  ----
Reference case                            49.9  53.7  57.4  57.3  55.7
Low economic growth                         \a  53.2  57.2  57.0  55.0
High economic growth                        \a  53.9  57.4  57.5  56.5
Low oil price                               \a  58.2  64.3  67.2  68.4
High oil price                              \a  48.0  47.1  46.4  45.4
----------------------------------------------------------------------
\a Not applicable. 

Source:  EIA, Annual Energy Outlook 1996 and other EIA publications. 



(See figure in printed edition.)Appendix VI

--------------------
\1 The level of world oil stocks is not included in this appendix
because EIA has not projected this measure beyond 1997. 


COMMENTS FROM THE DEPARTMENT OF
ENERGY
=========================================================== Appendix V



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on the Department of Energy's letter
dated October 18, 1996. 

1.  Our comments on the general points made in DOE's cover letter
appear in the executive summary and in the applicable chapters of
this report.  In the remainder of this appendix, we address each of
the detailed comments made in DOE's letter and attachment. 

2.  According to DOE, the experts we consulted essentially endorsed
the programs in the National Energy Policy Plan (NEPP).  We stated in
the draft report that the options most often recommended by the
experts we consulted are generally included in the NEPP.  However, we
noted in chapter 4 that there are important differences between the
plan and the experts' views.  For example, many of the experts favor
the use of an automatic market-based trigger to release oil from the
Strategic Petroleum Reserve, while the plan does not adopt such a
strategy.  Also, the experts do not generally favor the continuation
of mandates and subsidies for alternative transportation fuels such
as are called for in the plan.  In addition, most of the experts do
not believe that the plan's initiatives for increasing domestic oil
production would significantly reduce the nation's vulnerability to
oil shocks, although some said such initiatives could be justified on
other grounds. 

3.  GAO's ownership of the assumptions used in the analyses performed
by EIA at GAO's request was clearly stated in chapter 2 and appendix
II of the draft report, where EIA's modeling was discussed in detail. 
As the draft report indicated, the approaches used in the modeling
were GAO's and the views expressed in the report do not necessarily
reflect EIA's views.  We revised the final report in several places
to make this distinction even clearer.  However, in chapter 3 and
appendix V of both the draft and the final report, where we present
EIA's forecasts of the vulnerability measures, we relied on EIA's
assumptions, which are summarized in the report where appropriate. 

4.  We believe that our study provides very useful information to
policymakers.  The NEPP and a study by the Commerce Department
recognize that oil imports provide economic benefits, but they do not
quantify such benefits.  We attempted to measure the magnitude of
these benefits by estimating the incremental (marginal) cost of
reducing the nation's imports below the current level.  We found that
such costs increase with the size of the reduction in imports and
that the total benefits of importing relatively low-cost
oil--expressed as the costs of eliminating all oil imports--are very
large.  We also found that the economic costs of oil shocks are large
but depend primarily on the nation's level of oil consumption, not on
the level of oil imports.  Thus, an incremental decrease in imports
would yield an incremental reduction in the benefits derived from
imports but would leave the costs of oil shocks largely unchanged. 
This finding could have important implications for policymakers
considering, for example, proposals designed to increase energy
security by increasing domestic oil production. 

We agree that this report does not identify the optimal level of oil
imports.  Such an analysis, which was outside the scope of our
review, would depend, in part, on the external costs of oil imports. 
Existing studies have already addressed this issue, though they are
somewhat inconclusive about whether the current level of imports is
above or below the optimal level. 

We disagree with DOE's claim that our methodology does not measure
the benefits of oil imports.  We validated our modeling approach by
discussing it with the 14 experts listed in appendix II.  While
analysts may differ on the technical details of the model's
formulation or the use of GDP as a measure of economic well-being,
the basic approach is broadly accepted. 

As discussed in chapter 2 and appendix II, we chose scenarios that
reduced imports at the lowest possible cost and thus provide a
conservative estimate of the benefits of oil imports.  These
scenarios are useful because they illustrate the benefits that would
be forgone if imported oil were replaced with more costly domestic
oil. 

We agree with DOE that our analysis, which was designed to estimate
the benefits of oil imports, does not address the role of DOE's
programs in reducing the economy's vulnerability to oil shocks.  This
issue is addressed in chapter 3 of our report. 

5.  We agree that today's relatively low oil prices have both
benefits and costs, and our report indicates that low oil prices,
while benefiting many sectors of the economy, may harm certain other
sectors, especially domestic oil producers.  In our view, our
analysis is particularly useful for demonstrating the relative
magnitude of the benefits and costs of low prices, showing, as it
does, that the overall benefits to the economy exceed the costs to
individual sectors. 

We also agree that low oil prices can increase the nation's oil
consumption and, in turn, the economy's vulnerability to oil price
shocks.  EIA's low-oil-price forecasts of the vulnerability measures
discussed in appendix V of our report clearly demonstrate this point. 
To the extent that DOE can successfully and cost-effectively
implement programs such as alternative fuel and energy efficiency
initiatives that decrease oil consumption, even when low oil prices
prevail, the economy's vulnerability could be lowered.  However,
EIA's forecasts for the vulnerability measures discussed in chapter 3
of our report indicate that the projected increase in demand for oil
may offset much of the decrease in consumption resulting from such
programs.  This is particularly so under forecasts that assume
continued low oil prices. 

6.  A baseline analysis that would show the incremental or separate
impact of DOE's programs on our measures of vulnerability was outside
the scope of our review and not necessary to meet our objective.  Our
objective was to assess the extent to which the U.S.  economy's
vulnerability to oil shocks would change over time given such
programs and policies, as well as other relevant factors, such as
increases in the demand for oil and expected changes in the economy. 
We clarified our objective and made other corresponding changes in
the final report to make it clear that we did not intend to measure
the separate impact of DOE's programs.  Because the NEPP did not
contain measures of vulnerability, we developed them in concert with
DOE officials.  We then used EIA's published or readily available
energy forecasts that consider all of these factors, including, as
discussed under comment 7, the potential impact of DOE's programs.  A
separate analysis of the vulnerability measures with and without
DOE's programs might support DOE's view that the measures we used
would be worse without such programs, and we stated this view
prominently in both our draft and our final reports.  We also
included in the report the measures of the programs' expected
incremental impact that DOE provided to us.  These measures are
expressed in terms of projected barrels per day of increased domestic
oil production or decreased oil consumption.  DOE's measures are not
very useful, however, in showing how the programs will affect the
economy's vulnerability to oil shocks because they are not expressed
in terms that measure vulnerability.  Neither do they take into
consideration projected increases in the demand for oil and other
changes expected to take place in the economy that could ultimately
affect its vulnerability.  We think our approach significantly
enhances DOE's measures of program impact with respect to assessing
expected changes in vulnerability because it does take these factors
into consideration.  Although, as stated in the report, EIA's
forecasts do not consider all of the initiatives designed to reduce
the economy's vulnerability to oil supply disruptions, we believe
that they are the most objective and comprehensive estimates
currently available. 

7.  EIA's reference case forecasts for the measures of vulnerability
presented in our report take into account EIA's views on the likely
success of DOE's current policies, programs, and technology
development programs in meeting their objectives.  The high
technology forecasts assume even greater technological success for
current and planned programs.  Technological advances are a
cornerstone of DOE's efforts to reduce the economy's vulnerability to
oil supply disruptions.  According to EIA officials, the high
technology forecasts provide at least as much and, in some cases,
more credit for increased oil production or decreased oil consumption
than DOE claims for its programs.  It is these forecasts, not the
information provided by DOE's Fossil Energy and Energy Efficiency
Programs, that we used to assess potential changes in the measures of
vulnerability. 

We believe that the extent to which the impact of DOE's programs will
be offset by increases in the overall demand for oil is very
relevant, particularly in evaluating the extent to which the
economy's vulnerability to oil shocks may change.  The expected
increases in oil consumption have a dramatic impact on the
vulnerability measures presented in our report. 

Our analysis neither assumes nor implies that the nation's oil
consumption should be held at 1996 levels.  Rather, we point out that
one of the NEPP's three major goals is to reduce the economy's
vulnerability to oil supply disruptions.  Our approach was to develop
measures that could be used to objectively assess progress in
achieving this goal over time. 

8.  According to DOE, the potential results of its programs are not
reflected in our report.  We agree that DOE's programs may have
economic and other benefits in addition to their contribution to
reducing the economy's vulnerability to oil disruptions, and we
provided examples in the draft and final reports of such benefits
that were provided to us by DOE.  Assessing the extent of these
benefits, however, was outside the scope of our review.  With respect
to reducing the economy's vulnerability to oil shocks, we state in
chapter 3 that DOE's programs are designed to increase the domestic
oil supply, decrease the demand for oil, and maintain strategic oil
stocks.  As discussed above, we also included data provided by DOE
that show the potential for such programs to increase domestic oil
production and decrease consumption. 

However, as we also discuss in these comments and in the report, we
believe that programs aimed at increasing the domestic oil supply may
not substantially decrease the nation's economic vulnerability to oil
disruptions over the next 20 years.  We also agree and state in the
report that successfully decreasing the demand for oil could lessen
the economy's vulnerability and might have other economic benefits as
well.  As discussed above, however, while the forecast reductions in
consumption attributable to DOE's programs may keep the measures of
vulnerability from becoming worse than they otherwise would be, such
reductions may be more than offset by the increases in oil demand
projected in EIA's forecasts.  We also agree that maintaining and
appropriately using strategic stocks can help cushion the effects of
oil shocks; however, we note in the report that such stocks have been
declining and may continue to do so in the future, even though oil
consumption is expected to rise.  We believe that an objective gauge
of the economy's vulnerability to oil shocks that considers these and
other relevant factors in the world oil market is needed and that our
measures of vulnerability provide such a gauge. 

We have clarified chapter 3 of our report to indicate that an
objective of DOE's programs is to increase the ability of key
industries to switch to other fuels if necessary during disrupted
markets while continuing to use low-cost oil during normal markets
(or increase the elasticity of demand).  Our draft report pointed out
that some industries, such as the electricity-generating industry,
currently have such capabilities.  However, the transportation sector
depends on oil for 97 percent of its energy and accounts for about
two-thirds of the nation's oil consumption.  In this area, EIA's
forecasts do not indicate any significant change over the next 20
years.  While oil shocks and accompanying increases in oil prices
might make alternative transportation fuels more attractive, a
significant amount of time would be required to make the transition
to such fuels, while the economic effects of shocks are felt almost
immediately.  In addition, the cost of producing vehicles with a
standby ability to operate on alternative fuels and of developing the
infrastructure for standby alternative fueling could be very high in
this key industry. 

9.  As discussed under comment 6, we disagree that energy market and
macroeconomic forecasts with and without DOE's energy efficiency and
fossil energy programs are necessary to assess the extent to which
the economy's vulnerability to oil shocks will change over time given
these programs and other relevant factors.  Also, as discussed under
comment 8, an integrated analysis of the macroeconomic and other
benefits of DOE's programs was outside the scope of our review, but
we included DOE's views on such benefits in both the draft and final
report. 

10.  We agree with DOE that the measures of vulnerability in our
report provide useful indicators of the economy's vulnerability to
oil shocks.  Taking that as a given, we also believe that projected
changes in such measures that consider the effects of programs
designed to reduce the economy's vulnerability are useful indicators
of how well such programs may work.  We used EIA's forecasts of such
measures, which are the most comprehensive empirical evidence
available.  We believe that the results show how persistent the
economy's vulnerability to oil shocks may be. 

See comment 4 for our response to DOE's statement about reducing oil
imports at the margin. 

11.  We strongly disagree with DOE's summary comment.  As discussed
above, we believe that we have constructed a sound methodology to
answer our objective and that we have interpreted the results
correctly.  More importantly, we believe that we have gone beyond the
information provided in the NEPP and in related documents supplied by
the administration by developing useful measures of the economy's
vulnerability to oil shocks and by assessing potential future changes
in such measures given the potential impact of the administration's
programs, potential increases in the demand for oil, and other
relevant factors.  We agree with the many experts who commented on
this report and said, overwhelmingly, that it would make an important
contribution to the continuing debate on energy security. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix VII


   RESOURCES, COMMUNITY, AND
   ECONOMIC DEVELOPMENT DIVISION,
   WASHINGTON, D.C. 
------------------------------------------------------- Appendix VII:1

Bernice Steinhardt, Associate Director
Gregg A.  Fisher, Assistant Director
Godwin M.  Agbara, Senior Evaluator
William Lanouette, Senior Evaluator
Jay R.  Cherlow, Assistant Director for Economic Analysis
Elizabeth R.  Eisenstadt, Communications Analyst


   OFFICE OF THE CHIEF ECONOMIST
------------------------------------------------------- Appendix VII:2

Joseph D.  Kile, Senior Economist



RELATED GAO PRODUCTS
============================================================ Chapter 1

Motor Fuels:  Issues Related to Reformulated Gasoline, Oxygenated
Fuels, and Biofuels (GAO/RCED-96-121, June 27, 1996). 

Electric Vehicles:  Efforts to Complete Advanced Battery Development
Will Require More Time and Funding (GAO/RCED-95-234, Aug.  17, 1995). 

Electric Vehicles:  Likely Consequences of U.S.  and Other Nations'
Programs and Policies (GAO/PEMD-95-7, Dec.  30, 1994). 

Gasohol:  Federal Agencies' Use of Gasohol Limited by High Prices and
Other Factors (GAO/RCED-95-41, Dec.  13, 1994). 

Energy Supply:  Energy Potential of Municipal Solid Waste is Limited
(GAO/RCED-94-200, Sept.  20, 1994). 

Energy Policy:  Ranking Options to Improve the Readiness of and
Expand the Strategic Petroleum Reserve (GAO/RCED-94-259, Aug.  18,
1994). 

Alternative-Fueled Vehicles:  Progress Made in Accelerating Federal
Purchases, but Benefits and Costs Remain Uncertain (GAO/RCED-94-161,
July 15, 1994). 

Geothermal Energy:  Outlook Limited for Some Uses but Promising for
Geothermal Heat Pumps (GAO/RCED-94-84, June 3, 1994). 

Fossil Fuels:  Lessons Learned in DOE's Clean Coal Technology Program
(GAO/RCED-94-174, May 26, 1994). 

Naval Petroleum Reserve:  Limited Opportunities Exist to Increase
Revenues From Oil Sales in California (GAO/RCED-94-126, May 24,
1994). 

Energy Conservation:  Contractors' Efforts at Federally Owned Sites
(GAO/RCED-94-96, Apr.  29, 1994). 

Energy Conservation:  Federal Agencies' Funding Sources and Reporting
Procedures (GAO/RCED-94-70, Mar.  30, 1994). 

Energy Policy:  Changes Needed to Make National Energy Planning More
Useful (GAO/RCED-93-29, Apr.  27, 1993). 

Energy Security and Policy:  Analysis of the Pricing of Crude Oil and
Petroleum Products (GAO/RCED-93-17, Mar.  19, 1993). 

Alternative Fuels:  Experiences of Brazil, Canada, and New Zealand in
Using Alternative Motor Fuels (GAO/RCED-92-119, May 7, 1992). 


*** End of document. ***