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Transition Reports (1977) - Commerce Department: Consolidated Issues (2)
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Transition Reports (1977) - Commerce Department: Consolidated Issues (2)
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The original documents are located in Box 33, folder "Transition Reports (1977) -
Commerce Department: Consolidated Issues (2)" of the John Marsh Files at the Gerald R.
Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald R. Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
Digitized from Box 33 of The John Marsh Files at the Gerald R. Ford Presidential Library
Policy
OFFICE OF ASSISTANT SECRETARY FOR POLICY
International Trade and Investment Policy Issues
Multilateral Trade Negotiations
Special and Differential Treatment for
Developing Countries
Protection of U.S. Foreign Investments
Foreign Expropriation of U.S. Assets Abroad
Foreign Investment in the U.S.
Domestic International Sales Corporation (DISC)
and Foreign Export Tax Incentives
Export Financing
U.S. Tax Treatment of Foreign Income
Trade Practices of the European Community
Trade and Investment Practices of Canada
Japan's Trade Surplus with the U.S.
International Trade and Investment in Services
U.S. Generalized System of Preferences
Receptivity of LDCs to Foreign Investment
LDC Foreign Indebtedness
Technology Transfer and U.S. Trade
Brazil's Aviation Fuel Tax
Energy Policy Issues
Natural Gas Pricing
Decontrol of Petroleum Prices
Energy Tax Policy
Energy Conservation Policy and Implementation of
Current Programs
Impact of Clean Air Act on Coal Use and Development
Synthetic Fuel Financing
Outer Continental Shelf Leasing Legislation
Alaskan Oil Transportation
ALaska Natural Gas
Oil Company Divestiture and Petroleum Marketing
Practices Legislation
Energy Development Impact Assistance for
Interior States
Energy Conservation Contingency and Rationing
Plans
Strategic Petroleum Reserve
International Energy Supply and Demand
Energy Trade with Canada and Mexico
U.S. Role in the International Energy Agency
U.S. Role in the Conference on International
Economic Cooperation (CIEC)
Role of Department of Commerce in Energy
Resources Council
Strategic Resources and International Commodities
Policy Issues
North/South Dialogue on Commodities - - Process
Common Fund
Individual Commodities Discussions under UNCTAD
Resolution 93 (IV)
Food Import Policies
International Grain Reserves Policy
Strategic versus Economic Stockpiles
Interagency Decisionmaking on Commodity Policy
Oceans Policy Issues
Oceans Policy Formulation and Organization
Implementation of the Fisheries Conservation
and Management Act (1976)
Deep Seabed Legislation
Energy Issues Related to Implementation of
the Coastal Zone Management Act
Special Studies
Broadened Employee Stock Ownership
Locks and Dam 26
User Charges on Inland Waterways
Extending Right of Privacy Legislation to the
Private Sector
Ensuring Adequate Health Care at Reasonable
Costs
Impact of National Health Insurance on Business
The Civil Air Transport Industry: Implications
for U.S. Government Policy of Domestic and
International Trends
Government Policy and International Civil
Aviation
Shifts in the Inflation-Unemployment Trade-Off
Relationship
National Economic Planning: Processes,
Targets, Techniques
First Amendment Considerations Relating to
Federal Financial Assistance for Cable-TV
Systems
Improving Municipal and Social Services: The
Private Sector's Role
Corporate Social Responsibility: The
Government's Role
MULTILATERAL TRADE NEGOTIATIONS
Background
Comprehensive Multilateral Trade Negotiations (MTN) were for-
mally opened at the Tokyo Ministerial Meeting of September
1973. The Tokyo Declaration defined the scope and objectives
of these negotiations in which some 100 countries are now
participating in Geneva under the auspices of the General
Agreement on Tariffs and Trade (GATT). Broad U.S. objectives
and Presidential authority for the MTN are contained in the
Trade Act of 1974. In February 1975, six negotiating groups
were established to carry out the substantive work of the MTN:
tariffs, nontariff measures, sectors, safeguards, agriculture,
and tropical products. In November 1976, an additional group
was established to explore possible improvements in the frame-
work of the world trading system (GATT reform).
Issue
The issue is how best to ensure progress in the MTN toward the
overall U.S. negotiating objective of obtaining, in both the
industrial and agricultural sectors, greater and more equitable
market access, and the harmonization, reduction or elimination
of tariff and nontariff barriers which distort and limit trade.
Commerce, as a key agency in the Executive Branch's trade
policy decision-making apparatus -- coordinated by the White
House Office of the Special Representative for Trade Negotia-
tions (STR) --is particularly concerned that MTN results
reflect the importance of industrial goods in U.S. trade.
Progress in the MTN has been slow for economic and political
reasons, but also due to the sheer number of participants and
the magnitude and complexity of the subject matter. Important
issues never before the focus of trade negotiation, notably
those in the nontariff barrier area, are involved. Presently,
three questions are especially critical to further progress
in the MTN: agreement on a tariff reduction formula, resolu-
tion of the dispute over agriculture, and a framework for
negotiations with developing countries. In addition, there
is an overall question of the timeframe for the negotiations.
Analysis of Issue
The United States has been pursuing its negotiating objectives
by taking an active role in all the MTN groups, and concen-
trating on resolving the critical questions mentioned above.
In the area of tariffs, the U.S. has proposed a reduction
formula producing significant overall reductions, with modest
harmonization, of the duties of the major trading countries.
However, other countries, especially the European Community
2
and Japan, are far less interested in achieving substantial
overall reductions than in harmonization (i.e., cuts concen-
trated in a limited number of high duties) and have, therefore,
proposed their own formulas. If significant overall cuts are
not achieved, many in the U.S. may view the MTN as a failure.
In almost every functional group, there is a procedural
dispute over the treatment of agriculture. Essentially a
U.S. -EC problem, the dispute centers on the EC desire to treat
agricultural goods apart from industrial products and the U.S.
insistence that agriculture and industry be treated together
throughout the negotiations. Due to this disagreement, the
negotiating group on agriculture has not met in nearly a
year, and work in a number of other groups has been severely
inhibited. To achieve future MTN progress, some accommodation
with the EC must be reached.
The developing countries (LDCs) are playing a critical role in
the MTN. Their principal objective--the achievement of
special and differential (S&D) treatment for, and less than
full reciprocity by, the LDCs, as mandated by the Tokyo
Declaration--pervades every area of the negotiations. The
U.S., along with the other developed countries, has attempted
to convince the LDCs that multilateral trade liberalization
on a most-favored-nation basis offers more secure benefits
than discriminatory devices, and to encourage progressive LDC
liberalization of their trade regimes through staged acceptance
of the responsibilities and obligations of the international
trading system ("graduation"). The ultimate resolution of
this basic issue remains in doubt since many LDCs reject the
U.S. approach, demanding a sweeping restructuring of existing
international economic relationships based on the S&D concept.
Finally, with regard to timeframe, the United States has for
some time advanced the idea that the MTN should be completed
by the end of 1977 in order to give a sense of immediacy to
the trade negotiations and to avoid a negotiating crisis just
before the U.S. negotiating authority expires (end of 1979).
This objective was reaffirmed at the June 1976 Puerto Rico
summit meeting of the major industrialized countries. The
U.S. is hopeful that the existence of a deadline will
encourage greater progress, but mindful that the date is
arbitrary and major differences among participating countries
still remain. In addition, economic uncertainty in Europe,
a slowdown in U.S. economic recovery, and the possible
effects of further oil price increases may slow down progress
in the MTN. The United States has floated the idea inter-
nationally of a Ministerial meeting in the spring of 1977 to
provide further political impetus to the negotiations.
3
Schedule
With the change in the U.S. Administration and the membership
of the EC Commission in January, there will be a need to take
a fresh look at the status of the MTN. Commerce is preparing
an overall strategy paper which, along with material prepared
by STR, will have to be reviewed at the policy level by the
new Administration SO that the basic political decisions
needed to make further progress in the MTN can be reached as
soon as possible.
SPECIAL AND DIFFERENTIAL TREATMENT FOR DEVELOPING COUNTRIES
Background
Continuing efforts by less developed countries (LDCs) to restructure basic
international economic relationships in a manner which will better promote
their economic development form the basis for many of the trade issues con-
fronting the U.S. and other developed countries (DCs). For a number of
years LDCs have pursued their trade objectives not only in the forum of the
General Agreement on Tariffs and Trade (GATT) but also in the meetings of
the United Nations Conference on Trade and Development (UNCTAD). More
recently, broad-ranging LDC proposals for reform of the international economic
system have been made in other forums, including the UN General Assembly (UNGA)
and the Conference on International Economic Cooperation (CIEC). The U.S. has
sought to confine detailed consultation and negotiation on trade issues to the
GATT and the current Multilateral Trade Negotiations (MTN) because of the
technical nature of many of the issues, the more pragmatic nature of discus-
sions, and the greater relative influence of the DCs in this forum. The Tokyo
Declaration, which constitutes the basic MTN charter, emphasized the need to
provide special and differential treatment for LDCs, a concept the U.S. sup-
ports when such treatment is feasible and appropriate.
Issue
Specific LDC proposals in the trade field center on special and differential
treatment (S&D) to improve access for their exports of manufactured and semi-
manufactured goods in the markets of DCs, although their proposals also cover
other aspects of trade relations. While the U.S. and other DCs are on record
as supporting the principle of S&D, U.S. acceptance of S&D has been coupled
with emphasis on the need for LDCs to assume progressively greater obliga-
tions under the rules of the world trading system as their economies develop.
Formulation of provisions to grant S&D, as agreed on by participants in the
MTN, is an issue which runs throughout Commerce's MTN-related activities and
raises basic questions about the traditional U.S. trade policy principles of
reciprocity and most-favored-nation treatment.
Analysis of Issue
The U.S. faces the S&D issue in the context of the Tropical Products Nego-
tiations, the ongoing work of the MTN groups (tariffs, subsidies/counter-
vailing duties, standards, government procurement, safeguards, quantitative
restrictions), and the newly constituted Framework Improvement Group.
In the Tropical Products Negotiations the U.S. is constrained by the Trade
Act and commitments to the business community not to grant unreciprocated
concessions to the LDCs participating in the negotiations. Consequently,
we are seeking contributions from LDC participants prior to conclusion of
the negotiations. If the U.S. accords S&D treatment through implementation
of concessions now without LDC commitments for some degree of reciprocity,
2
we could be placed in the position at the conclusion of the MTN of obtaining
little or nothing in terms of meaningful LDC concessions and with a negoti-
ated package which is unacceptable to both the Congress and U.S. business.
Negotiations on the topics under consideration in the other MTN groups are
less advanced. Particularly in interagency development of positions, various
possibilities for S&D are being explored, and the U.S. has made some sugges-
tions in the negotiating groups. Throughout its consideration of possible
S&D measures, the U.S. Government has regarded such measures as a temporary
exception to the normal rules and has sought means of ending S&D as the econo-
mies of LDCs develop (termed the "graduation" concept).
In developing appropriate terms of reference for a group to consider means of
improving the international trading framework, the establishment of which has
stemmed from strong LDC initiatives, the U.S. in discussions with both DCs and
LDCs worked for inclusion of the graduation concept. Under its terms of
reference, the group is to seek to negotiate improvements in the international
framework for the conduct of world trade, particularly with respect to trade
between developed and developing countries, and differential and more favorable
treatment to be adopted in such trade.
In the Framework Improvement Group the U.S. will be confronted directly with
the necessity of considering its traditional commitments to the principle
of reciprocity and also to the most-favored-nation principle in the context
of trade relations with LDCs. Accommodation to LDC positions implies movement
by the U.S. away from its traditional principles and requires close consulta-
tion with both the Congress and the private sector. Development of the
concept of graduation, including how it might be implemented and negotiated,
is likely to be an essential element in gaining acceptance of changes in
traditional U.S. trade policy to benefit LDCs.
Schedule
The crunch on S&D provisions will probably come earlier in the case of
the Tropical Products Negotiations than in the other areas. Specifically,
timing of the implementation of concessions in the Tropical Products Nego-
tiations is a current issue. Other DCs have indicated their willingness to
implement most of their concessions (consisting primarily of GSP improve-
ments) unilaterally January 1, 1977 or soon thereafter; the U.S. position
continues to be to seek contributions from the LDCs prior to implementation
of the U.S. offers which would encompass MFN tariff reductions. In an
attempt to overcome the present impasse, interagency agreement has been given
to consideration of possible provisional implementation, i.e., implementation
of U.S. concessions with the understanding that adequate LDC contributions
will be forthcoming at the end of the MTN or U.S. concessions will be with-
drawn. The MTN Delegation has been instructed to employ this option only if
our negotiators believe it would substantially improve the chances for mean-
ingful progress. The U.S. will come under increased pressure to modify its
position early in 1977.
PROTECTION OF U.S. FOREIGN INVESTMENTS
A. UN Code of Conduct on Transnational Corporations
Background
UN involvement in issues relating to transnational corporations (TNCs) --
the UN term for multinational corporations -- originated with Chile's
complaint in 1972 over the alleged interference by ITT in its internal
affairs. As a result, the UN Secretary-General, at the request of
the Economic and Social Council (ECOSOC), appointed a group of 20
Eminent Persons from developed and developing countries to examine
the impact of TNCs on world development and international relations.
The recommendations of the group, which included two U.S. representa-
tives, led to the formation within the UN of a Commission on Trans-
national Corporations (UNTNC) and a subordinate body, the Information
and Research Center on TNCs. The Eminent Persons Report proposed an
elaborate, legally binding code of behavior. To date the Commission
has met twice and has agreed to an elaborate work program involving
extensive information gathering and also agreed, as a first priority,
to complete a draft code of behavior by the end of 1977. An Inter-
governmental Working Group (on which Commerce expects to be represented)
is scheduled to meet in New York in January and February 1977 to begin
to prepare an annotated outline of a code.
Issue
The main issue is whether the code recognizes and incorporates the
following principles which we and other OECD countries regard as basic.
Essentially the U.S. and most developed countries insist that a UN
code conform to the following principles: that the code be voluntary,
nondiscriminatory, recognize existing international law, place
obligations and responsibilities on both companies and governments,
provide for international arbitration in settling investment disputes,
and, in cases of nationalization of foreign-owned property, provide for
prompt, adequate and effective compensation. A number of these
principles are not accepted by developing countries, although they
are contained in the OECD code and associated documents which were
accepted by 24 OECD members in Paris in June 1976. Resolution of these
differences is essential if a UN code is to be accepted.
Analysis of Issue
No special analyses are underway at present since an annotated outline
is still to be developed by the UNTNC and none is expected much before
the January 1977 meeting. The extent of possible compromise will
depend on how negotiations develop. Our starting position is the
principles contained in the OECD code which developed countries
- 2 -
generally accept. There is a good deal of doubt whether a workable
compromise is possible. On the issue of a voluntary versus a binding
code, we will not compromise, and at the present time the developing
countries want a binding code.
Schedule
In addition to the January 1977 meeting, another meeting is scheduled
in New York between April 25-May 6, 1977. Subsequent meetings will
be scheduled as necessary. Although a target date at the end of 1977
is scheduled for completing a draft, few countries regard this as
feasible. It is widely expected that discussions will continue into
1978.
B. UN Code of Conduct on Transfer of Technology
Background
In September 1975 the UN General Assembly adopted a resolution calling
on all states to formulate a code of conduct for the transfer of
technology to assist the special needs of developing countries. The
resolution specified that such work be conducted in the United Nations
Conference on Trade and Development (UNCTAD) and recommended that a
draft code be completed by mid-1977 with a final draft for adoption
by the end of 1977. To carry the work forward, an intergovernmental
group of experts was established to elaborate a draft. The group of
experts held several meetings in 1975-76 and are scheduled to hold
three more meetings in 1977. As a result of these negotiations two
draft proposals were produced, one submitted by Group B (the U.S. and
other developed countries) and another by the Group of 77 (the developing
countries). The documents revealed a wide gap in the two positions
on several key points and no drafting was attempted pending the outcome
of UNCTAD IV. This conference, which was held in Nairobi in May 1976,
hoped to adopt a resolution which would resolve the legal character
of the code, i.e., whether it was to be voluntary or legally binding
and to establish terms of reference for actual drafting and adoption.
Agreement was not achieved, and the nature of the code was not resolved
because Group B and the Group of 77 each were intransigent in maintaining
their respective positions. The final resolution skirted this issue
and recommended that work on the code go forward with a goal to complete
a draft by mid-1977; that provisions be formulated ranging from mandatory
to optional without prejudice to final action on the legal character
of the code; and that the UN General Assembly convene a conference
at the end of 1977 at which all decisions on adoption of the code,
including its legal character, would be made. An expert group met
in Geneva from November 8-19 to continue further its work on the
code.
- 3 -
Issue
The basic issue concerning the code is whether it is voluntary or legally
binding. There is also disagreement on other basic issues, including
recognition that the guidelines must recognize the validity of inter-
national law and treaties; that responsibilities for implementation
of the guidelines apply to both parties; that the guidelines outline
responsibilities of enterprises and governments; that access to tech-
nology be based on mutually-agreed terms and conditions, including
price; that restrictive business practices be avoided; and that parties
to a technology transfer agreement have free recourse to international
arbitration in cases of disputes. The developing countries view access
to technology as a universal right, stress primacy of domestic law,
are less concerned with confidentiality of technology transfers and
do not favor international disputes settlement.
Analysis of Issue
The degree of flexibility and compromise depends on whether the code
is to be voluntary or not and Group B will insist on this point, arguing
it would be seriously inhibited in its ability to draft a code without
having in mind the premise on which it is proceeding. At this stage,
however, only procedures for drafting are being considered and thus
no attempt to stake out firm positions has been undertaken. Moreover,
given the highly technical and complex nature of the document the basic
position of Group B countries is contained in its draft proposal and
there is no need to go beyond this statement at this time. In addition
we will seek the advice of the State Department's Advisory Committee
on Transnational Enterprises which was consulted on the OECD code as
negotiations proceeded.
Schedule
Three more meetings are scheduled in 1977 but it is doubtful that an
agreed draft can be completed for consideration by the end of 1977.
FOREIGN EXPROPRIATION
OF U.S. ASSETS ABROAD
Background
In the last decade developing countries became increasingly aggressive
in seeking solutions to their problems of slow per capita economic
growth. This has often led to expropriation of private foreign investment.
The USG believes such a seizure of private property leads to an environment
that is not conducive to the flow of capital and technology essential
to economic development. Nevertheless, the USG recognizes the rights
of sovereign states to nationalize or expropriate foreign-owned property
so long as any taking conforms with international law which requires
the takings to be 1) non-discriminatory; 2) for a public purpose; and
3) accompanied by prompt, adequate, and effective compensation.
Numerous U.S. laws impose sanctions against countries which
expropriate property owned by U.S. citizens are not taking steps
to compensate the former owners. The major laws are the Hickenlooper
Amendment to the Foreign Assistance Act withholding aid if expropriated
property is not paid for or steps taken to insure payment the Gonzalez
Amendment to legislation involving the InterAmerican Development Bank,
Asian Development Bank, and World Bank and requiring the U.S. to withhold
support for loans; and Section 502 (b) (4) of the Trade Act of 1974 requiring
the withholding of trade preferences.
The CIEP Interagency Staff Coordinating Group on Expropriation meets
every 4-6 weeks to review countries' progress in resolving outstanding
expropriation cases. The Group has been concerned that expropriation
remains a serious problem and has noted that several recent national-
izations have involved entire economic sectors. The Treasury Department
has also charged that the Group is not applying the law "fearlessly"
and even-handedly and believes present policy fails to focus adequately
on broad U.S. economic (rather than political) interests affected by
expropriation and does not sufficiently stress deterrence.
The CIEP Group is therefore, reviewing USG expropriation policy
with a view toward deterring expropriations, limiting their scope,
and contributing to fairer settlements. An Economic Policy Board
decision of July 15, 1976 further directed the CIEP group to 1)
identify and analyze USG economic interests affected by actual or
- 2 -
potential expropriation disputes in potash, bauxite, etc., 2) examine
possible changes or improvements in policies or operations to assure
that the USG economic interests are adequately taken into account,
including improving the existing "early warning system" and better
coordination of key policy decisions; 3) formulate recommended guidelines
to enable the USG to more effectively protect its own economic and
other interests in particular cases; and 4) explore possible multilateral
actions which might be taken to further U.S. and other investing
country interests in expropriation cases.
Issue
The main issue is whether the existing machinery and procedures for
dealing with expropriation cases is adequate or whether changes along
the lines proposed by Treasury should be introduced.
Analysis of Issue
In regard to the EPB directives, several drafts have been reviewed
by the CIEP members that discuss either U.S. interests in the bauxite
and potash expropriation disputes or proposed guidelines for evaluating
progress in the settlement of expropriations. Commerce has supported
development of guidelines for the evaluation of progress as long as
the guidelines were reference points and not inflexible criteria which,
when not met, required specific responses. A number of steps have
already been taken to implement other approaches to increase U.S.
expropriation policy effectiveness including seeking to negotiate:
1) a judicial remedies convention to provide a better basis for bringing
suit against expropriated property; and 2) a multilateral investment
insurance scheme which would also be consistent with the proposal for
an international resources bank.
Other procedures suggested to help deter further expropriations are to
1) include guidelines in international MNC codes of conduct setting
forth general conditions under which multinational enterprises should
be able to operate and 2) negotiate additional Friendship, Commerce,
and Navigation (FCN) treaties with interested countries.
Commerce has consistently favored increased information sharing, developing
greater awareness among Foreign Service Post staffs of the importance
of investment matters, and the use, on a limited basis, of contractors
for valuation of expropriated properties. We also believe the USG
should develop a more timely response to, and active participation in,
- 3 -
resolving significant disputes before they reach the stage of high
level confrontation where flexibility among the parties involved is
difficult to obtain. Nevertheless, we realize that expropriatory
acts must be considered in the larger context that encompasses the
entire economic/political relationship between the United States and
the country in question and takes into consideration other investments
U.S. citizens may have in that country. Furthermore, discussions with
business have repeatedly shown that companies themselves often do not
favor USG involvement in business disputes because they feel that such
intervention raises to the political level a dispute that may not have
political overtones in itself and tends to harden positions making
resolution more difficult. Commerce continues to favor international
agreements, such as codes of conduct, a multilateral insurance scheme,
and a judicial remedies convention as reasonable and effective methods
to increase investor protection.
A Treasury proposal for the establishment of a Special Representative
for Overseas Investment within Treasury with the objective of preventing
expropriatory acts was rejected by the CIEP Group because of concern
that it would result in a less flexible and balanced expropriation
policy without increasing its effectiveness. The recent success of
a high level U.S. negotiating team in resolving the expropriation by
Peru of the Marcona Mining Co. supports the Group's position that the
current framework is sufficiently flexible to allow USG response to
be fit to the situation.
Schedule
Papers on bauxite and potash with recommendations for USG action,
if any, should be completed in the 1st quarter of CY 1977, as should
any guidelines which may be approved by the group.
An investment insurance program and a judicial remedies convention will
involve negotiations over several years.
Development of international codes of conduct is an ongoing process,
with the UN currently in the initial stages of its code development.
The OECD just concluded agreement on its code. FCN treaties would
be signed over the next 10-20 years.
FOREIGN INVESTMENT IN THE U.S.
Background
The acceleration and changing complexion of foreign direct
investment in the United States has produced some public
concern and the introduction of various restrictive bills in
Congress, all unsuccessful. The Administration has opposed
these bills, reaffirming its open-door, non-discriminatory
policy; but it has set up monitoring and special case consul-
tative procedures involving Commerce. Commerce and Treasury
have sent extensive reports to Congress which provide under-
pinning for current policy. Nevertheless, more restrictive
bills are expected and specific investment transactions may
offer problems.
Issue
Ensure that existing U.S. policies, laws, regulations and
administrative programs in regard to foreign investment in the
United States are sufficient to serve the national interest.
Analysis of Issue
The traditional open-door, non-discriminatory policy toward
foreign investment in the United States has been questioned in
light of its recent accelerated growth, the emergence of new
investor countries -- particularly Japan and the Middle East
OPEC countries --, takeover efforts by foreign firms, and concern
over increased foreign interest in acquiring agricultural land
and other natural resources. Foreign investors are subjected to
limited restraints regarding communications, transportation,
banking, energy, and publicly-owned land, and to Defense Depart-
ment clearances respecting acquisition of U.S. firms performing
on defense contracts.
The various bills in the Congress which would screen, regulate,
and restrict foreign investments have been consistently opposed
by the Administration as unjustified by foreign investment
developments. However, it conceded that information on foreign
investment was insufficient and supported the passage of the
Foreign Investment Study Act of 1974 which required Commerce and
Treasury to conduct extensive studies and submit reports to
Congress on direct and portfolio investments in the United
States respectively.
2.
The Commerce nine-volume, 2,500 page report submitted to Con-
gress in June 1976 found no basis in the motivation, composition,
magnitude, conduct, or economic effects of foreign direct in-
vestments to warrant any change in the existing policy, but it
recommended legislation strengthening data gathering authority
and the continuation of monitoring and analytical activity. It
found current policies, laws, regulations and procedures adequate
to deal with current and foreseeable inward foreign investment
developments.
In mid-1975, after a full-scale Executive Branch policy review
and in recognition of a need for mechanisms to become better
informed on a current basis on inward foreign investment
activity and to be able to deal with investments having national
interest implications, the President, while reaffirming existing
policy, issued an Executive Order establishing an interagency
Committee on Foreign Investment in the United States with policy
coordination and special case review responsibilities. It also
provided for the establishment of a monitoring, analysis, and
reporting facility in Commerce.
The Committee, chaired by Treasury and with Commerce representa-
tion, has focused on foreign government investments, and in the
few cases considered has found no basis for intervention on
national interest grounds. Foreign governments have been asked
to consult on their intended investments. The Committee has no
special legal power to prohibit specific investments, but pro-
spective investors are unlikely to proceed in the face of an
adverse reaction by the United States Government. Commerce has
implemented its monitoring responsibility through the establish-
ment of the Office of Foreign Investment in the United States,
which has undertaken a broad-scale data gathering, analysis and
reporting program.
In October 1976, the President signed the International Investment
Survey Act of 1976, introduced by Senator Inouye and supported by
the Administration. The Act provides the President broad authori-
ty to collect data on both inward and outward foreign direct and
portfolio investment; it further requires benchmark statistical
surveys every 5 years, the preparation of statistical and
analytical studies, and the provision of reports to Congress.
An Executive Order assigning responsibility to Commerce, Treasury
and other agencies is in preparation.
3.
It is anticipated that public concern about inward foreign in-
vestments will continue to be manifested in restrictive bills
in Congress. Specific investment transactions, such as OPEC
country investments in U.S. petroleum production, could require
searching examination of the implications for the national
interest. It is recommended that restrictive legislation con-
tinue to be opposed, but that Commerce have a flexible position
on specific cases brought before the Committee on Foreign
Investment in the United States.
Schedule
This issue is a continuing one. Commerce's Office of Foreign
Investment in the United States plans publication of industry
sector and economic impact analyses respecting foreign direct
investments throughout the year.
DOMESTIC INTERNATIONAL SALES CORPORATION (DISC)
AND FOREIGN EXPORT TAX INCENTIVES
Background
The Domestic International Sales Corporation (DISC) provisions
of the tax code allow U.S. exporters to defer the imposition of
Federal Income taxes on basically one-half of their export
profits by forming special corporations called DISCs. This tax
incentive was designed to give U.S. exporters some of the tax
advantages enjoyed (1) by foreign exporters through the tax
incentives and rebates provided by their governments, and (2)
by U.S. multinational companies due to the fact that the
earnings of their foreign subsidiaries are generally insulated
from U.S. taxes until repatriated. By correcting this imbalance,
it was hoped that U.S. exports would increase and our balance of
trade would improve.
As of October 1, 1976, there were 9,090 DISCs, and about 75
percent of U.S. export sales were accomplished through DISCs
in 1976. Estimates made by the Department of the Treasury,
based on its April 1976 report to Congress on the DISC, indicate
that in 1976 this incentive will have increased exports more
than $8 billion at a cost of approximately $1 billion in deferred
tax- revenue.
Because of concern in Congress and elsewhere about the current
revenue loss attributed to the DISC, which is higher than
anticipated when the law was passed, this benefit has been
somewhat curtailed in both the Tax Reduction Act of 1975 and
the Tax Reform Act of 1976.
In 1973, the European Community, supported by Canada, instigated
a formal complaint under the General Agreement on Tariffs and
Trade (GATT) against the DISC, charging that the DISC is a
prohibited export subsidy violating GATT rules. As a countermove,
the United States made similar charges against tax provisions in
France, Belgium and the Netherlands which are designed to reduce
or eliminate taxes on the export earnings of their firms. Each
country concerned staunchly defended its practices as consistent
with GATT rules. On November 2, 1976, GATT panels ruled that
elements of all four of the tax practices in question are illegal
under the GATT.
Issue
Should the DISC be: (1) maintained as is; (2) curtailed to reduce
further its revenue loss to the Treasury; (3) repealed or
modified unilaterally; (4) repealed or modified as part of a
negotiation with other governments to eliminate tax schemes
which directly or indirectly subsidize exports.
2
Analysis of Issue
Unless France, Belgium and the Netherlands act concurrently with
the United States to abide by the recent GATT decision, it is
unlikely that the support for the DISC in Congress will be
seriously affected. Although the opponents of the DISC will
have the argument that parts of it have now been found to be
illegal under the GATT, many Congressmen will not want to re-
peal the DISC unilaterally, because it would obviously discrim-
inate against U.S. exporters vis-a-vis foreign exporters.
Further, the chief argument of the DISC opponents, that the
DISC is ineffective, has been implicitly refuted by the GATT
decision. Accordingly, the problem is to see if the DISC can
be used as a "bargaining chip" in negotiations to eliminate
comparable tax benefits for exporters worldwide, or at least
with respect to the four countries involved in the current
GATT decision.
However, unilateral and timely dismantling or modification of
the DISC program offers the advantage of avoiding retaliation
by other countries for our use of an illegal practice. Canada,
for one, seems likely to seek some form of retaliation or com-
pensation. We cannot yet be certain, however, that the European
practices will be removed and ending the DISC without an end
to the European practices seems likely to prompt loud criticism
from U.S. industry. Accordingly, consultations will be arranged
with the Europeans to discuss ending our respective practices.
There is a larger question however. Many countries seem to have
practices similar to those that have been declared illegal.
(We understand that the Treasury Department is attempting to
catalog these.) Removal of the DISC, with or without removal
of the French, Belgian or Dutch practices, would place U.S.
exporters at a disadvantage with respect to exporters of
countries using similar practices. This problem has already
been referred to by all four countries in GATT meetings. The
United States has also suggested that a broader GATT examination
is needed of the trade effects of national income tax practices,
possibly leading to new or clearer international rules.
Schedule
Consultations are likely to be held with the Europeans in December
or early in 1977 to discuss removal or modification of our res-
pective tax practices. We are also likely to propose early in
1977 an examination of the trade impact of national income tax
practices.
Further review of DISC cost effectiveness will be possible after
Treasury's next report to the Congress becomes available on
April 15, 1977.
EXPORT FINANCING
Background
Since 1934, the Export-Import Bank, an independent Government agency, has
been engaged in financing U.S. exports. For short and medium repayment
terms of up to five years, Eximbank guarantees and insurance promote the
extension of private export credit by eliminating most of the risks of
default. In the long-term area, Eximbank provides its own direct loans
to alleviate a deficiency in the supply of private credit which otherwise
would impede the sale abroad, particularly in LDC's, of high-value capital
equipment items warranting extended repayment terms. Eximbank direct
loans also provide some assistance to U.S. exporters in competing against
foreign suppliers who are liberally financed by their own governments.
Finally, under its discount loan program, Eximbank offers a liquidity
incentive to the private sector to extend export loans by commiting it-
self to refinance such loans in time of need.
Recent authorization levels are as follows (in billions of dollars):
FY-76
FY-75
FY-74
FY-73
FY-72
Total Authorizations
$8.6
$8.3
$9.1
$8.5
$7.2
Long-term Finance
3.1
3.6
4.9
3.8
3.4
Direct Loans
2.1
2.5
3.8
2.3
2.2
Related Financial Guarantees
1.0
1.1
1.1
1.5
1.2
Short- and Medium-term Finance
5.7
4.6
4.2
4.7
3.9
Regular Bank Guarantees
0.6
0.4
0.4
0.5
0.5
Insurance
3.5
2.9
2.6
2.5
2.2
Discount Loans
1.2
1.1
0.9
1.6
1.0
CFF Loans
0.2
0.2
0.3
0.1
0.1
Eximbank operations do not depend on formal Congressional appropriations.
Rather, Eximbank obtains the funds needed for its net loan disbursements
principally by borrowing on the private financial markets via the U.S.
Treasury. (The guarantee and insurance programs entail no, or negligible,
net expenditures.)
Eximbank's direct loan program tends to be market-related. The cost of
Eximbank borrowing and the Bank's long-run objective of earning a profit
are major determinants of the interest rate charged on its direct loans:
presently, 8.25 percent for 6-year loans guaduating upward to 9.5 percent
for 14-year loans. Furthermore, Eximbank requires that its loans not
exceed 30 to 45 percent, typically, of the value of the U.S. export in-
volved, with the remainder covered by a cash downpayment and by commer-
cial bank financing at floating market rates. The private participation
may be protected by an Eximbank financial guarantee, if necessary. On
the other hand, some foreign countries provide their exporters with credit
that is basically insulated from money market conditions.
Issue
To ensure the adequacy and competitiveness of the U.S. export financing
system (Eximbank, FCIA, commercial banks, etc.)
Analysis of Issue
In recent months we have heard expressions of concern from the business
community that Eximbank was not providing maximum support and encourage-
ment for U.S. exports. At the request of the President's Export Council,
Commerce is contracting for an independent appraisal of the U.S. export
credit system. The U.S. Chamber of Commerce, the Machinery and Allied
products Institute, and perhaps some other groups, are also understood
to be studying the adequacy and competitiveness of Eximbank financing.
The major concern appears to be with Eximbank's long-term credit support
for capital goods exports, activity in which appears to have declined in
the past fiscal year (see above table.)
The issue lacks precise definition as it presently stands. The recent
Eximbank management which took office in January 1976 tended to maximize
private lending and to limit the Bank's own involvement to the minimum
necessary to offset shortfalls in maturities, risk inhibitions, and
foreign credit competition. It also changed numerous program details,
such as new restrictions on aircraft loans, a more cautious attitude on
lending to certain LDC's, and new constraints on financing exports to
foreign subsidiaries of U.S. corporate parents. Each one of these changes
could be unobjectionable if taken in isolation, but collectively they may
have made Eximbank a more conservative institution generally.
Currently, however, any deficiency in Eximbank's responsiveness appears
to be partly offset by an ample supply of lendable funds at cheap inter-
est rates at commercial banks. The problem may become more critical
if monetary conditions should tighten. Moreover, U.S. exporters using
Eximbank financial packages may be at an interest rate disadvantage vis-
a-vis foreign competitors if Eximbank's market-related rates are not com-
pensated for by flexibility in other credit dimensions.
The Treasury has welcomed these program changes at Eximbank and views them
as consistent with a floating exchange rate regime minimally affected by
special balance of payments measures. A reduced Eximbank direct lending
program also accords with Treasury's general desire to restrain Government
borrowing on the private capital markets.
Schedule
1st Quarter 1977: A new Eximbank management will be appointed.
2nd Quarter 1977: The Commerce and other studies of Eximbank financing
should be completed.
3rd Quarter 1977: Congressional hearings on the renewal of Eximbank's
charter legislation should commence. Commerce and business groups will
have an opportunity to express their views on Eximbank's future orienta-
tion and to suggest changes in the legislative mandate as needed.
U.S. TAX TREATMENT OF FOREIGN INCOME
Background
The United States taxes the worldwide income of U.S. citizens
and corporations. However, for foreign source income this
treatment is generally mitigated by the provision of (1) a
dollar-for-dollar tax credit for foreign taxes paid, (2) deferral
of taxation on the unrepatriated earnings of U.S. owned foreign
corporations and (3) a limited exemption from U.S. taxation of
the earned income of U.S. individuals living abroad. All of
these mitigating provisions have been questioned in Congress
and elsewhere over the past several years, mainly on the
ground that they encourage U.S. companies to make investments
and conduct operations abroad and thus "export jobs" from the
United States. As & result, the Tax Reduction Act of 1975 and
the Tax Reform Act of 1976 have circumscribed more tightly the
foreign credit and deferral mechanisms, and the latter legisla-
tion erased part of the earned income exemption for individuals.
It is expected that during the course of the 95th Congress efforts
will again be made to further limit or eliminate the tax credit
or deferral benefits for U.S. multinational corporations, and
perhaps to restore some of the earned income exemption benefits
lost by the 1976 act.
In addition, regulations promulgated by the IRS on various
features of the tax code which affect the taxation of foreign
source income occasionally are either too stringent or less
helpful than they need to be to enforce the provisions of the
tax code to which they relate. This has been particularily
true of IRS Regulation 1.861-8, first proposed in June 1973.
It treats in detail the allocation of deductions U.S. multi-
national corporations can claim in computing taxable income from
business operations within and without the U.S. The regulation
as originally proposed would require many U.S. multinationals to
transfer deductions from domestic to foreign operations, reducing
their foreign taxable income and increasing U.S. source income.
Its immediate consequence will be to increase significantly the
overall taxes paid by these corporations. Accordingly, economic
double taxation of U.S. multinationals will inevitably occur.
Particularly hard hit would be U.S. multinationals which have
large expenses for R&D, and some have indicated that this regula-
tion would compel them to move their research establishments out
of the U.S.
Because Commerce Secretaries Dent and Morton, the business
community and other Federal agencies expressed concern on the
R&D impact of this proposed regulation, the Economic Policy
Board was given the task of studying the question and, if
necessary, coming up with alternative proposals. In June
1976 the Commerce Department supplied the EPB with a study
which surveyed 76 P&D intensive multinational companies on
what the proposed regulations would do to impel them to reduce
2.
their R&D establishments in the U.S. or move them out of the
U.S. As a result the Treasury and IRS came up with a compromise
on November 8, and IRS issued a new 1.861-8 proposal regulation,
which mitigates somewhat the tax burden the 1973 version would
have imposed on U.S. multinationals because of allocations
abroad of R&D and interest expense. Public comment on this
new proposal is due by December 7, 1976 and hearings are to
commence on December 16, 1976.
Issue
(1) Should the Department initiate, support or oppose the
variety of suggestions that will be broached in Congress and
possibly within the Administration to change or eliminate the
foreign tax credit, the opportunity to defer U.S. taxes on the
unrepatriated income of U.S. held foreign affiliates, and the
earned income exception for U.S. taxpayers living abroad.
(2) If not approved by the EPB and made final in January of
1977, should Commerce recommend to the EPB that the IRS November
8 compromise proposal on the 1.861-8 regulation be (1)
made final, (2) studied further, (3) modified further, or (4)
scrapped in favor of making the 1973 proposal final.
Analvsis of Issues
(1) Inasmuch as any proposals to change- the tax code in terms
of its treatment of foreign source income are likely to come
from outside the Department of Commerce, their nature is not
yet known and precise issues have not been defined. However,
it is incumbent upon the Commerce Department to analyze such
proposals when it is called upon for comment by Congress or
the Administration, and perhaps to initiate new tax legislation
when a strong and justified need therefor is expressed by the
business community.
(2) Commerce has not yet had time to assess the impact the new
proposed regulation 1.861-8 will have on the continued ability
and inclination of the U.S. multinationals to keep a strong R&D
establishment based in the United States. However, the industry
and other public comment expected to be filed with the IRS by
December 7 and the public hearings to commence on December 16
should put the Department in a position to make at least a tenta-
tive analysis and recommendation to the EPB on this important
matter. It may be that the impact of a new proposal will
not be sufficiently clear for a definite decision to be made on
the possible alternatives until a further survey of affected
companies (and a study of that survey) is made. Accordingly, if
no final decision is made before the end of January 1977, the
new Administration may have to review the problem and decide what
to do about IRS efforts to write a regulation on section 861
allocations.
3.
Schedule
(1) Nothing Scheduled
(2) -- Receipt in early December of analysis of hypothetical
effect new 1.861-8 proposal will have on R&D-intensive
multinationals, i.e., whether they will use gross-to-
gross alternative or sales alternative to lighten the
tax burden. This analysis will be made by Mr. Roy Blough,
under contract with the Department.
-- Receipt of synopsis and critique of public and industry
comments due to be filed with the IRS by December 7.
This synopsis and critique is also being done by Mr.
Roy Blough for the Treasury Department.
-- Attendance at the IRS hearings scheduled to commence
on December 16th.
-- After the hearings are over preparation of Commerce
Department recommendation on the compromise 1.861-8
proposal. This is to be submitted to EPB task force
on international taxation, for consideration at a
meeting scheduled to be held after hearings, but
before January 1, 1977.
TRADE PRACTICES OF THE EUROPEAN COMMUNITY
Background
Collectively, the European Community (EC) is the largest foreign
market for the United States and our second largest supplier.
It accounts for one-fifth of our total trade. Further, at the
end of 1975 U.S. private direct investment in the EC was valued
at $39 billion, nearly one-third of our direct investment
worldwide. In view of the magnitude of this economic relation-
ship, our commercial interests are often affected by trade and
other policies of the EC itself or its member states.
For example, the EC recently altered the application of its
commitments under the Florence Agreement covering trade in
scientific instruments for scientific and educational purposes
so as to afford increased protection to its domestic industry.
When the EC expanded its membership to include the U.K.,
Ireland and Denmark, it entered into free trade agreements with
the seven remaining EFTA countries which included highly re-
strictive origin rules. These rules limit the amount of
third-party content that can be included in a product if it
is to qualify for proferential treatment.
Three EC member states currently maintain programs to insure
exporters against increases in their production costs in ex-
port contracts. These programs distort trade and in the U.S.
view are export subsidies not sanctioned by the GATT. The
EC maintains a vast network of preferential trade arrangements
with Mediterranean countries and developing countries, parti-
cularly in Africa, which are inherently discriminatory. Within
the EC such major countries as Italy and the U.K. confront
trade deficits, currency pressure, and loss of international
monetary reserves and have introduced or may impose restric-
tions on their imports. It is in the U.S. interest to develop
ways to reduce the restrictive impact of these various measures
which have grown out of the EC's customs union or which have
been taken for balance of payments reasons.
Issue
Prevent the adoption of, or obtain modification of, those trade
practices of the European Community and its member states which
distort U.S. trade and investment.
2
Analysis of Issue
The Department should where necessary defend the rights of U.S.
businessmen--both traders and investors-- to fair access to the
EC and its member states. This requires a vigilant watch over
current actions as well as proposed policies, whether at the
level of the EC itself or by its member states. The economic
and political importance of the EC to overall U.S. interests
requires that the Department insure that U.S. commercial interests
are pressed vigorously, yet with sensitivity to the longer run
evolution of the EC.
Schedule
At the present time the U.S. is engaged in bilateral consulta-
tions with the EC over its implementation of the Florence
Agreement and its rules of origin. We have engaged GATT
Working Parties in consideration of member countries' schemes
of export inflation insurance and Italy's prior deposit
scheme for foreign exchange. The rules of origin issue is
nettlesome and is expected to take considerable time--perhaps
in the framework of the MTN--to resolve. We are hopeful that
by mid-year 1977 real progress can be made on the Florence
Agreement and export inflation issues, and that Italy will
have found it unnecessary to maintain measures restricting its
imports.
TRADE AND INVESTMENT PRACTICES OF CANADA
Background
The Canadian economy, which has been under wage and price con-
trols for the past year, has been characterized by slow growth,
inflationary pressures, and relatively high unemployment.
Coupled with economic nationalism, these economic develop-
ments have invited governmental intervention in such areas
as inward foreign direct investment, industry sectoral
development, and regional economic development. The extent
of our economic relationship with Canada means that its
domestic policies often have direct and important implications
for the U.S. (In 1975 U.S. two-way trade with Canada amounted
to more than $44 billion. U.S. direct private investment in
Canada was over $31 billion at the end of 1975, representing
some 80 percent of total foreign direct investment in that
country.)
Canadian governmental actions have included import restric-
tions in the textile sector, "offset" on major import
transactions and threatened import protection for aircraft,
and rejection of specific foreign investment proposals.
Government involvement has also increased in the development
and marketing of Canadian energy sources. That country's
recent large deficits in automotive trade with the U.S. has
brought pressure on the Canadian Government to seek changes
in our 1965 bilateral free-trade agreement, which would
require greater production of auto parts in Canada.
Issue
Formulate policies to safeguard access for U.S. trade and
investment into Canada and to moderate Canadian pressures to
revise the U.S.-Canada Automotive Agreement in a way which
would adversely affect U.S. commercial interests.
Analysis of Issue
The size and complexity of our economic relationship with
Canada dictates that the Department keep a careful surveillance
over Canadian actions and respond quickly and appropriately
to steps by the Canadian Government which adversely impact
on our commercial interests. Insisting on our GATT rights
and making known our official displeasure over specific actions
2
in a timely fashion provide a useful approach to the problem.
Exchange of visits by the Secretary and his counterpart in
Canada provide another.
Schedule
Currently the U.S. is engaged in consultations with Canada
under Article 19 of the GATT because of restrictive import
measures Canada has taken which have affected U.S. textile
trade. We are consulting with Canada under another GATT
article to seek relief for U.S. liqueur exports coinciden-
tally affected by Canadian restrictive action aimed at the
EC. These consultations should be concluded by the spring
of 1977. The Department expects to continue to press Canada
bilaterally whenever its trade and industrial policies or
screening of foreign investment appear unfair to U.S. economic
interests.
JAPAN'S TRADE SURPLUS WITH THE U.S.
Background
Japan is the second largest trading partner (after Canada)
of the United States, or third largest if the European Com-
munity is considered collectively. In 1975 it bought almost
$10 billion of our goods and sold us over $11 billion of its
merchandise. Since 1965 the United States has regularly
posted deficits in its trade with Japan. For the past
three years the deficits have been less than $2 billion.
However, the situation has now changed significantly. Japan's
trade surplus with the U.S. in 1976 is running at an annual
rate of some $6 billion. On a global basis its surplus
this year may be considerably higher.
A major share of Japan's imports is made up of industrial
raw materials and agricultural and other commodities. Its
exports are primarily manufactured goods. Such an imbalance
has negative employment and income implications for Japan's
trading partners, including the U.S. While an important
reason for this development may be differences in the rate
and timing of economic recovery in Japan and the rest of the
world, questions still remain concerning Japan's relatively
high import duties, its highly effective nontariff barriers
(NTBs), and the Government's role in promoting Japanese
exports. For example, Japan applies environmental and safety
standards on automobile imports in a particularly onerous
fashion. Further, Japanese Government procurement policy is
very restrictive.
Issue
Formulate policies to deal with Japan's sizable trade surplus,
including the possibility of obtaining improved market
access in Japan.
Analysis of Issue
There is currently underway a study of the U.S.-Japan trade
relationship by an interagency group chaired by the Office
of the Special Representative for Trade Negotiations, in which
Commerce has a lead role. Given the immediate concern over
the size of Japan's trade surplus in 1976, there is a need to
focus on possible actions by the U.S. Government to press
Japan to improve access to its market. Improvements might
2
take the form of specific steps to ease such NTBs as the
administration of Japan's standards on automobile imports or,
more broadly, to reduce duties on products of particular
interest to the United States. In addition, and over the
longer run, there is a need to develop a better understanding
of how the Japanese Government influences private business
decisions affecting imports and exports, as a basis for
efforts to ensure fairness in that country's system of
foreign trade.
Schedule
It is expected that the interagency study will be completed
by the end of 1976. Over the next three months the analysis
of options and a decision on possible actions should be made.
Irrespective of the outcome of this interagency effort, the
Department should continue its own analysis of Japan's
trading system through 1977, pressing for change where
circumstances indicate.
INTERNATIONAL TRADE AND INVESTMENT IN SERVICES
Background
The service industries (transportation, communications,
advertising, auto leasing, data processing, hotels, banking,
motion pictures, construction/engineering, etc.) have been
providing the bulk of U.S. economic growth and now account
for about 2/3 of U.S. GNP and employment. The United States
is not alone in being a services-oriented economy; services
account for about 50 percent of GNP in the other industrial
nations.
Services are hard to define, measure, and analyze. Despite
their predominant importance in the U.S. and other
economies, little is actually known about the economic
behavior of the service industries.
The factual background has been particularly lacking for
international commerce in services, and services have
generally been overlooked in policy formation and in
previous trade negotiations. The Trade Act of 1974,
however, included services for the first time within the
President's trade negotiating authority. This inclusion was
at the request of service industry representatives, who
stated that their international problems had not been
receiving adequate policy attention by the government.
Issue
How should policy attention to the international problems of
the U.S. service industries be improved? The issue relates
largely to changes that might be needed in policy forums and
mechanisms. A particularly important aspect is deciding how
much attention should be devoted to service industry trade
problems in the Multilateral Trade Negotiations (MTN) and
the means by which particular problems would be selected for
negotiation.
Analysis of Issue
Commerce played the lead role in an interagency study on
service industries' international commerce, an exhaustive
study that was the first comprehensive examination of this
issue. The study found that service industries'
participation in world trade is actually quite small. U.S.
service industries export only about $7 billion per year,
compared with over $100 billion annual exports of U.S.
merchandise. Most services by their nature cannot be
exported; they must be produced when and where they are
consumed.
The study found that the service industries' role in foreign
investment was surprisingly large. Service industries
account for almost 1/5 of total U.S. foreign affiliate sales
(other than petroleum), and their sales are growing faster
than those of U.S. goods-producing affiliates overseas.
The international problems of the service industries were
found to be overwhelmingly related to investment issues.
Trade problems were in the minority and were found to be
either unique to the particular service industry (such as
maritime transportation) or to be remarkably similar to the
trade problems of goods-producing industries. Government
procurement and other non-tariff barriers typified the
latter.
The study concluded that a highly-selective approach to
service industry trade problems should be undertaken in the
MTN, focusing on those trade barriers most related to the
problems already under discussion in the MTN. The potential
trade benefits from the MTN are overwhelmingly related to
goods -- not services. The study also concluded that the
investment problems of the service industries are not being
adequately addressed. Their investment problems could mount
in importance rapidly and are in need of significant policy-
handling improvement. The problems of the insurance
industry require particular attention.
Schedule
The study of service industry trade and investment has been
completed, and all but one of its recommendations have been
approved by the Economic Policy Board. The remaining
recommendation (pertaining to a broad-ranging services trade
and investment consultation committee) needs to be resolved.
Subsequent to final approval of the recommendations,
implementation awaits the formation of an inter-agency
working group.
U.S. GENERALIZED SYSTEM OF PREFERENCES
Background
The U.S. Generalized System of Preferences (GSP), authorized
by Title V of the Trade Act of 1974, was implemented
January 1, 1976. The GSP fulfills a commitment made in the
OECD and UNCTAD by the United States and seventeen other
developed nations to extend general tariff preferences
to developing countries to aid in their economic and
industrial growth. The United States was the last of the
developed countries to implement a scheme. Under the U.S.
GSP, over 2,700 items from beneficiary developing countries
enter the United States duty-free.
Issue
The interagency Trade Policy Staff Committee (TPSC), of
which Commerce is a member, is responsible for the
general management of the GSP, which includes the
administration of public procedures whereby interested
parties may request modification of the GSP product
coverage. This latter task involves the review of requests
received and the formulation of recommendations to the
President for appropriate action on each request. The
second semiannual review of such requests is currently
underway. A general policy review of the operation and
management of the GSP is planned for the spring.
Analysis of Issue
Regulations governing the administrative procedures for
the modification of the GSP product coverage were published
by the Office of the Special Representative for Trade
Negotiations on December 31, 1975. Under the regulations,
petitions requesting the addition of a product and those
requesting a withdrawal must contain information relevent
to the import-sensitivity of the product. Reviews are
scheduled so that changes are made twice a year (on
March 1 and September 1). Approximately thirty-five
petitions have been accepted for the second review now
in progress. In addition several other products in which
2
beneficiary countries have a significant interest will
be considered for possible designation as eligible products.
The TPSC will hold public hearings on all of the products
under review and then decide on the economic merit of
each request.
The general policy review scheduled for the spring
will address several issues which have become increasingly
important during the first year of the GSP's operation,
including (1) revision of the regulations governing the
administrative procedures for product coverage modification;
(2) clarification of the customs regulations regarding the
rules of origin; (3) establishment of policy regarding the
expansion of the product coverage, including the handling
of diplomatic requests by beneficiary countries; (4)
consideration of ways to improve the GSP which do not
necessarily entail expanded product coverage; and (5)
establishment of policy in regard to redesignation of
countries which have been excluded by the competitive need
limits.
Schedule
The TPSC will submit its recommendation regarding products
being considered in the current review to the President in
late January. Any resulting changes, along with
adjustments required by other provisions of the Act
(primarily the competitive need provisions), will become
effective March 1, 1977. No definite dates have been set
for the general policy review, but it is anticipated that
it will be conducted during March and April, 1977.
RECEPTIVITY OF LDCS TO FOREIGN INVESTMENT
Background
In recent years many LDCs have come increasingly to view the history
of trade and investment relations between the developing and indus-
trialized world as having favored the developed nations and exploited
the LDCs. They have been moved by the growing income gap between the
rich and poor nations to adopt nationalistic economic policies which
are hostile to the interests of the industrialized countries. These
policies have been characterized by such actions as expropriations
of foreign-owned assets, unilateral changes in investment contract
terms, forced dilutions of foreign equity, and attempts to control
or cartelize world supplies of key commodities.
The world faces a severe capital shortage in coming years, which
obviously will have its harshest impact on the LDCs. In that inter-
national flows of private investment are an effective means to help
meet the capital and technology requirements of these countries, it
is vitally important that they establish and maintain an investment
climate which attracts foreign-owned business enterprises. The strident
language and harsh policies utilized by many LDCs against foreign
investors have undermined their investment climate. In the long run,
this has worsened their capital shortage problems and denied them
badly-needed technology.
Some LDCs have sought to improve their terms of trade by attempting to
raise the export prices of their key industrial commodities. Most
attempts at forming cartels -- for example, in phosphates, bauxite,
copper, iron ore, and tungsten -- have been largely unsuccessful.
However, efforts to force up world prices and/or restrict supplies
have caused deteriorating trade relationships and have rendered the
processors of these materials less confident of their access to supplies.
These efforts also have forced up the prices of manufactured goods,
which further impacts on the LDCs.
Issue
The main issue is how to increase receptivity of LDCs to receipt of
foreign investment as a principal means of fostering their development.
Analysis of Issue
The USG believes that a free and unimpeded international flow of trade
and investment will result in the maximum benefit for the world as
a whole. The United States attempts to reduce investment risk in the
LDCs for U.S. investors through the Overseas Private Insurance
Corporation (OPIC), which provides political risk insurance and
guarantees.
- 2 -
The USG also participates in various attempts to devise investment codes
to specify the conditions under which international investment should
occur. One such code was formulated within the OECD as part of a
broad declaration on international investment and multinational enter-
prises. Other efforts are continuing in various UN agencies and in
the Conference on International Economic Cooperation (CIEC). The USG
is of the opinion that such codes should be voluntary, and that they
should specify certain responsibilities of host governments to foreign
investors, as well as vice versa.
Such codes can prove useful in restoring world confidence in the value
of international investment, and OPIC can eliminate some of the major
impediments to U.S. investment in the LDCs. However, it is ultimately
up to the LDCs themselves to pursue policies which attract investment
from abroad and which promote freer trade.
Schedule
The OECD Guidelines for Multinational Enterprises were implemented
in June 1976, as part of a broad policy statement on international
investment. The USG is also working to ensure an environment more
receptive to unimpeded international trade and investment in the
various international agencies whose work is ongoing in this field --
ECOSOC, UNCTAD, the ILO, and the Commission on Transnational Corpora-
tions (UNCTNC) in the UN, and in CIEC and the Organization of American
States (OAS). Both ECOSOC and the UNCTNC hope to have recommendations
on drafts for codes ready for presentation to the next UN General
Assembly session in the summer of 1977. This schedule is considered
somewhat optimistic.
LDC FOREIGN INDEBTEDNESS
Background
Adverse economic developments during 1973 and 1974 have
impaired the economic prospects for most of the non-oil
exporting developing countries (LDC's). A sharp increase
in oil prices, higher food and fertilizer prices in 1974,
and sharp declines of other commodity prices, together with
inflationary and recessionary tendencies in the developed
countries, have placed serious burdens on the balance of
payments of LDCs. Concomitantly, many of these countries have
been unwilling or unable to cut back on their economic
development programs. Despite drawdown of international
financial reserves, disinvestment in stocks, and official
support from many sides, including IMF as well as IBRD
assistance, these LDCs have incurred large current account
deficits (on the order of $27 billion in 1974 and $35 billion
in 1975) and increased their external debt substantially to
close the widening gap. This debt is estimated to total at
least $151 billion.
Issue
The debt problems of the LDCs continue to be examined in
several international fora, and LDC debt relief is now a
principal issue in the North/South dialogue between developed
and developing countries. The LDCs are pressing for not
only generalized debt relief but also for a moratorium
on repayments owed by the least developed countries.
The creditor countries, including the United States, have
resisted these demands, have focussed attention on the
overall balance-of-payments situation of the non-oil LDCs
and have looked for ways to improve the traditional
case-by-case approach to the debt crisis situation.
Analysis of Issue
Commerce has taken an active policy interest in the debt
problems of the LDCs. Improvement of the LDC debt
servicing situation is necessary to avoid disruption in
international trade and investment. Accordingly we have
participated actively in discussions in the National Advisory
Council on International Financial and Monetary Policies
(NAC), preparations of U.S. positions for the Commission on
International Economic Cooperation (CIEC), and inter-agency
discussions preparatory to IBRD-sponsored individual country
Consultative Groups. We have agreed with Department of
2.
Treasury positions which emphasize that LDC balance-of-payments
difficulties should be met by adopting domestic and external
policies which avoid the need for debt relief. However,
we have also, along with Treasury, been sympathetic to the
need for individual debt relief where needed, and to the
acceleration of the flow of resources to the developing
countries, where justified. With regard to the poorest among
them, we are also willing, with other agencies, to consider
broad-gauge solutions involving official assistance, improved
access to capital markets, direct investment flows, and
specific financial programs under the guidance of the IMF and
the World Bank.
Schedule
We do not anticipate that there is any possible early positive
resolution of this issue.
TECHNOLOGY TRANSFER AND U.S. TRADE
Background
Technology is an important determinant of trade flows, as
well as being instrumental in economic growth and productivity
advances. A key foreign concern in the 1950's and early 1960's
was the "technology gap" that existed as a result of the huge
U.S. technological lead. Increased foreign research expendi-
tures and the transfer of U.S. technology to other nations
through U.S. multinationals, licensing, and other channels
have acted to reduce this gap with other developed nations.
The less-developed nations (LDCs), however, have not benefited
as greatly from technology flows. The LDCs believe the effec-
tiveness and rate of technology transfers to their economies
must be increased if they are to attain a faster rate of
economic development.
Issue
Accelerated technological growth in the developed nations,
partially as a result of U.S. technology transfers to them,
has caused concern regarding the future competiveness of U.S.
exports. Many observers believe that U.S. manufactured goods
are not price-competitive in world markets, and that U.S.
products are purchased abroad principally for their technolog-
ical superiority. Transfers of U.S. technological "know-how"
are believed by many to allow foreign nations to produce for
themselves products they would otherwise have imported from
the United States. This, it is feared, leads to reduced U.S.
exports, higher U.S. imports, and the "export" of U.S. jobs.
The large decline in the U.S. manufactured goods trade balance
between 1964-72 is frequently cited as being the result of
declining U.S. technological advantage.
Other observers believe that technology is but one of many
factors influencing trade flows. They point to the overvalued
dollar as the principal reason for declining U.S. trade balances
through 1972, noting the huge surpluses in manufactured goods
trade enjoyed by the United States since the 1973 devaluation.
Thus a variety of issues regarding government policy toward
the restriction or promotion of U.S. technology transfers are
of current concern. At the core of most of the issues is the
question of whether such transfers are beneficial or harmful
to U.S. trade and economic welfare. The argument has also
extended to national security, when defined in the broadest
sense of overall economic strength.
One of the most pressing aspects of the issue is the desire of
the LDCs for more rapid inflows of technology. Key questions
relate to the availability, utility, and price of such transfers,
as well as to the consequent results on world trading patterns.
Some observers claim that increased transfers of technology to
the LDCs would enhance their economic growth and the size of
their markets for U.S. goods. Others claim that the result of
such transfers would be reduced LDC markets for U.S. goods and
increased exports of LDC goods to the United States. Thus they
fear jobs as well as technology would be transferred.
Analysis
A major problem is the lack of facts. Claims and assertions
are in abundant supply, but few statistics and measurements.
exist. Most participants to the issue argue from the basis of
individual "case studies". There is little agreement on how to
define or measure technology flows or even on how to define a
"technology-intensive" product. The assessment of costs and
benefits is thus extremely difficult.
In addition, the relationship between technology and trade
performance is still little more than theoretical. The degree
to which U.S. trade performance requires a technological lead
needs further analysis to relate trade and technology transfers
to other economic forces such as exchange rates, labor costs,
and factor productivity. Little is known about the longer-term
economic welfare implications of comparable technological levels
among developed nations. Policy actions could have far-reaching
implications, and have to be based on the soundest possible
factual basis.
Schedule
As a means of improving the factual base, BIEPR's Office of
Economic Research is constructing a consistent means of identi-
fying U.S. and foreign output having a high technology content.
This measure, which should be of significant aid in assessing
trade patterns and impacts, is scheduled for completion by
mid-summer 1977. As a further step, a conference has been
proposed to assess the economic implications of faster foreign
technology growth. If approved, the conference would be
scheduled for November 1977. The LDC aspect is being addressed
by the Department through the Interagency Working Group on
Technology. Immediate tasks include formulating plans for a
National Conference in 1977 to involve the private sector in
the transfer of industrial technology to the LDCs, and identi-
fying the legislative and budgetary constraints of government
agencies in helping the LDCs to develop an indigenous techno-
logical capability.
BRAZIL'S AVIATION FUEL TAX
Background
Commerce has been requested by the National Air Carrier Associa-
tion, on behalf of Trans International Airlines, Inc. (TIA) and
World Airways, Inc. (World), to make a finding that Brazil does
not grant substantially reciprocal privileges (i.e., fuel tax
exemptions) to U.S. carriers in connection with the purchase of
aviation fuel in Brazil. Such authority derives from Sections
309 and 317 of the Tariff Act of 1930, as amended, and Section
4221 of the Internal Revenue Code of 1954, as amended, which
provide for the exemption of foreign air carriers from the pay-
ment of U.S. cutoms duties, and internal revenue taxes (i.e.,
certain Federal excise taxes) on the purchase of supplies
(including fuel) in the United States on a reciprocal basis.
The extension of these exemptions to the aircraft of a particu-
lar country requires a finding by the Secretary of Commerce that
a country allows, or will allow, "substantially reciprocal
privileges" to aircraft of United States registry. In 1953, the
Department issued a finding that reciprocity exists in the case
of Brazil. As a result Varig, the Brazilian flag carrier,
enjoys full tax exemption on its purchases of fuel supplies
in the United States whether for its scheduled or charter opera-
tions.
In Brazil, only Pan American and Braniff receive exemptions
from the Brazilian federal aviation fuel tax (the so-called
"sole" tax) which currently amounts to 34.9 cents per gallon.
This exemption applies to both the scheduled and charter opera-
tions of these two U.S. airlines. However, TIA and World, the
two U.S. non-scheduled carriers serving Brazil, are not accorded
exemption from this tax.
Issue
Should Commerce rescind the 1953 finding of reciprocity with
respect to the fuel tax, which would require Varig to pay a
1.5 cents per gallon tax and scheduled U.S. carriers could be
made liable for a 34.9 cents per gallon tax in Brazil.
Analysis of Issue
In June, the Brazilians made an informal commitment to U.S.
Ambassador Crimmins to extend the fuel tax exemption to U.S.
2.
supplemental carriers. However, the Brazilians have been
dragging their feet ever since, and it now seems doubtful that
further progress can be expected. Because of the importance
of this subject and its implications for U.S. -Brazil relations
generally, we are recommending that the Economic Policy Board
consider the matter and provide guidance.
Schedule
Commerce findings and recommendations will be ready for
submission to the Economic Policy Board within 30 to 60 days.
ENERGY POLICY
There follow a series of 18 energy issue papers
dealing with various aspects of energy policy. They
involve energy pricing policy, conservation, Outer
Continental Shelf development, impediments to coal
development, synthetic fuel development, Alaskan energy,
oil company divestiture, impact assistance, contingency
planning, a variety of international questions, and the
role of Commerce in the Energy Resources Council.
The Ford Administration's energy policy is set
out in the Project Independence Report as updated in the
President's February 1976 Energy Policy Statement and the
1976 National Energy Outlook. A Congressional scorecard
of legislation enacted and not enacted is attached to
this paper.
We are working with FEA on an Energy Policy White
Paper which will provide a more comprehensive overview
than the issue papers which follow. This paper will be
prepared in time for testimony December 16 by Secretary
Richardson, as Energy Resources Council Chairman, and
FEA Administrator Zarb, before the House Interstate and
Foreign Commerce Committee's Energy and Power Subcommittee.
There are also certain classified papers which can be made
available on certain of the international energy items.
The papers which follow deal with items which the
Commerce Office of Policy has particularly followed.
There is also attached to this paper tables prepared by
FEA which show the anticipated impact of President Ford's
program on 1985 import vulnerability.
CONGRESSIONAL SCORECARD
PRESIDENT'S BILLS PASSED
&
CONGRESSIONAL ADDITIONS
BILLS REMAINING
EPCA:
STRATEGIC RESERVES
NATURAL GAS DEREGULATION
STANDBY AUTHORITIES
NATURAL GAS EMERGENCY
COAL CONVERSION
AUTHORITY
APPLIANCE LABELING
SYNTHETIC FUELS COM-
AUTO EFFICIENCY STANDARDS
MERCIALIZATION
PRICE CONTROL PHASEOUT
INSULATION TAX CREDIT
COAL LOAN GUARANTEES
ALASKAN GAS TRANSPORTATION
STATE CONSERVATION PROGRAMS
NUCLEAR LICENSING
NUCLEAR FUEL ASSURANCE
ECPA:
BUILDING STANDARDS
CLEAN AIR ACT
WEATHERIZATION
ENERGY INDEPENDENCE
CONSERVATION LOAN GUARANTEES
AUTHORITY
UTILITY RATE STRUCTURE DEMO.
ENERGY FACILITIES SITING
INSULATION DEMO. PROGRAM
UTILITY TAX INCENTIVES
UTILITY REGULATORY REFORM
OTHER: NAVAL PETROLEUM RESERVES
OIL SPILL LIABILITY
COASTAL IMPACT ASSISTANCE
URANIUM ENRICHMENT
ERDA ORGANIZATION
IMPACT ASSISTANCE
- New FEA Import Outlook: 1985
-
million barrels/day
15
-
-
Had No
Action Been
-
Taken
12 million barrels /day
10
Existing
Programs
7.3 million barrels/day
5
President's-
*
Entire
Program
0
*
Oct. 1, 1976
3.7 million barrels/day
-4-
Estimate of 1985 Imports if no Actions had Been Taken
Imports of reference case
5900
Deregulation of natural gas
2800
Decontrol of oil
1600
NPR production
200
Oil price effects
480
Synthetic fuels
350
Lower leasing schedule
400
11730
The lower leasing schedule change is an estimate by I.C.F.
Quantative numbers may be available by Friday.
Actions Already Taken
Effect on Imports
Decontrol of oil (supply and demand)
2080
NPR Production
100
Utility Load Management
300
FEMP
260
Appliance Labeling
40
Weatherization and building standards
340
Industrial conservation program
140
Auto fuel efficiency
780
Conservation guarentees
75
State conservation plans
300
4415
Actions to be Approved
Deregulation of natural gas
2800
Insulation tax credit
110
Accelerated OCS leasing
350
Synthetic fuels commercialization
350
3610
-5-
IMPACT OF PRESIDENT'S PROGRAM BY 1985
Import
Vulnerability
Reductions
-
Energy Supply
(000 B/D)
- Deregulation of Natural Gas***
2800
-
- Decontrol of Oil**
1600
- NPR Production**
100
-
- OCS Leasing
350
- - Synthetic Fuels Commercialization***
350
5200
Energy Conservation
- Federal Energy Management Program**
260
- Appliance Labeling/Efficiency Goals**
40
- Insulation Tax Credit***
110
- Weatherization and Building Standards*
340
- Industrial Conservation Program**
140
- Auto Fuel Efficiency**
780
- State Conservation Plans**
300
- - Decontrol of Oil**
480
- - - Utility Load Management**
300
- Conservation Guarantees**
75
2825
Emergency Measures to Reduce Vulnerability
- Standby Authorities**
1000
- Strategic Storage System**
2700
3700
TOTAL VULNERABILITY REDUCTION
11,725 MB/d
** Enacted
*** Passed at least one House
NATURAL GAS PRICING
Background
The Federal Power Commission (FPC) regulates the
prices of natural gas that is transported across State
lines or international boundaries, including gas from
the Outer Continental Shelf. Approximately 60% of the
U.S. gas production is thus regulated (often referred
to as "interstate gas"). The remaining 40% (referred
to as "intrastate gas") is produced and consumed within
the State of production subject to regulation only by
state authorities. Most intrastate gas is located in
Texas and Louisiana. The effect of price controls on
interstate gas has been to keep prices substantially
below the prices prevailing in the major producing States.
Because of this piice disparity, intrastate pipelines
have generally been able to outbid the interstate pipelines
for gas supply. The result is that Texas, for example, has
in effect preferential access to gas produced within its
own borders. Texas production declined last year about
5%, while her exports of gas declined about 15%. This
price disparity has been a major cause of gas shortages
in consuming States.
FPC regulatory policy is currently to vary the price
of gas depending on when the drilling of the well commenced.
1975 or later
$1.42/mcf (thousand cubic feet)
1973-74
$ .93/mcf
Pre 1973
$ .52/mcf or lower
Because of the large volume of natural gas sold under
those older FPC contracts, the average price received by
producers in April 1976 was only $ .40/mcf, although gas
sold in the interstate market from new wells obtains $1.42/
mcf and up to $2/mcf or better when consumed within the
producing State. The energy equivalent of imported fuel
oil is approximately $2.30/mcf in 1976.
In addition to making it difficult for consuming States
to gain access to onshore gas, the low regulated prices
have discouraged gas exploration and encouraged consumption,
thus producing our current shortage of natural gas.
-2-
Finally, gas utilities have traditionally "rolled in"
the prices of higher cost supplies, so that all customers
pay a portion of the higher cost. Now that supplies of
synthetic natural gas (SNG) and liquified natural gas (LNG)
have the potential to become significant (with prices
ranging as high as $5.00/mcf), the argument is made that
incremental customers (either the newest user, or an
industrial firm desiring more gas) should pay in full the
incremental cost of the gas.
Issues
1. Should the Executive Branch continue to seek
deregulation of new gas or place a tax on gas to
bring gas prices up to market levels?
2. If the Executive Branch does seek high prices through
some form of regulatory change, what solutions to
particular sectoral burdens resulting from such
higher prices should it seek?
Analysis
1. Higher Prices
It is clear that low prices for regulated interstate
gas have contributed to the current shortage of natural gas
by decreasing drilling, discouraging conservation, and
giving first claim on onshore gas to producing States.
These factors argue for decontrol. Opposition to decontrol
is based on the fact that controls currently succeed in
transferring large sums of money from producing interests
to consuming interests.
The Ford Administration proposed decontrol of new gas
while retaining controls on old gas. New gas was defined
to include both gas from new wells and gas that had been
sold within the producing State but was being shifted to
the interstate market. By this method, it was expected
that higher gas prices would gradually be phased in.
Even with decontrol of new gas, gas prices will remain
for many years far below the price of competing fuels; this
is due to the large volume of gas subject to long term
contracts and regulation. Traditionally, utility commission
regulation of prices to the final user is based on an average
-3-
of the cost of all gas bought by the regulated utility.
(This process is called "rolling in".) Thus, regardless
of the price paid by pipelines for additional supplies
of gas, the rolled-in price of gas will be low enough
to assure that incremental supplies can be sold. In
addition, the gas distribution industry has a major
incentive to increase the size of its capital base which
under State regulatory systems permits increased profits.
Since increased capital bases depend on enlarged markets,
gas utilities are inclined to market gas aggressively.
Finally, gas utilities seek to avoid the political pressure
which would result from customers going short of fuel.
These factors result in an industry willing to contract
for high-priced gas from supplemental sources, including
LNG imported from abroad, gas made from oil, and gas made
from coal. Such gas is today priced well above the price
of oil. Further, if the interstate market were not
regulated, industry could be expected to offer high prices
for new domestic gas in an effort to meet current market
demand. Such high priced new gas, when averaged in with
the price controlled gas, would still be competitive in the
period after decontrol.
However, prices immediately after decontrol can be
expected to tend to rise to levels that many would argue
are excessive. Consumers within non-gas producing States
will start to compete for gas which previosuly had remained
in producing States, thus in the medium term increasing
demand in relation to finite sources of supply. This will
cause prices in gas producing States to increase. The
problem may become especially acute in these States in that
contracts are generally shorter. Since such prices would
probably be above the price of oil, this could force massive
conversions from gas to oil in the Gulf Coast region.
2. Solutions to Particular Problems
Possible solutions include (1) imposing a cap on new
gas prices during a transitional period (this was incor-
porated in the original Nixon proposal in 1973) ; (2) imposing
a heavy tax on either all natural gas use or on sales of
regulated natural gas (see Tax Policy paper) ; and (3) using
"incremental pricing".
The third possible solution would force new or
expanding users to pay the price of the high-priced gas.
One possibility is to apply such pricing only at the
wholesale level, thus encouraging distributors and state
-4-
regulatory commissions to support conservation measures,
fuel switching and cessation of new deliveries. Incremental
pricing could also be extended to sales to final customers.
This version of incremental pricing, which has frequently
been proposed, would have industrial customers pay for high
priced gas, leaving the regulated, lower priced gas for
the benefit of residental customers. The theoretical
argument for having the industrial customers pay the price
of the new gas is that, in the absence of this gas, there
would be a shortage, which by standard curtailment practices
would be borne by the industrial user. Thus, the new gas
was really for his benefit and he should pay for it. It
is also argued that there is greater latitude for industrial
users to switch to coal or oil than there is for residential
and small commercial users. Such a policy would discourage
gas companies from contracting for high cost gas supplies
because they would have only limited markets for it.
In Congress, incremental pricing in the form of "soak
industry" has received support because it results in lower
prices to politically more potent homeowners and commercial
interests. In the simple form of guaranteeing cheap gas
to homeowners, incremental pricing guarantees that gas will
continue to undersell oil and electricity for new home
use. The result of such a policy, if coupled with absolute
priority in wholesale sales for gas allocated to homeowners
and smaller commercial users, would be rapid growth in
residential and commercial use. Nevertheless, current
analysis suggests the total cost of supplying gas, including
the cost of laying pipes in new suburbs, exceeds the cost
of heating such new developments by oil.
Schedule
Legislation to deal with the pricing of natural'gas
is likely again to be introduced into Congress. And,
incremental pricing issues will undoubtedly come up in
conjunction with legislative proposals such as to import
LNG, bring Alaskan gas to the "Lower 48", gasify coal, and
allocate oil to plants making natural gas from oil.
DECONTROL OF PETROLEUM PRICES
Background
The Energy Policy and Conservation Act of 1975 (EPCA)
authorizes petroleum and petroleum product price controls
which expire in 1981. Forty months after passage, May 1979,
the President may remove price controls from crude or
products without approval of Congress. In the interim, the
President may propose, subject to Congressional disapproval
(one house veto), the removal of price controls from crude oil
on a particular type of petroleum product.
With regard to petroleum products, middle distillates
(home heating oil and diesel fuel), residual fuel oil, naptha
jet fuel (military type jet fuel), and miscellaneous other
products (lubricating oils, industrial solvents, petrochemical
feed stocks, etc.) have all been decontrolled. A decontrol plan
for gasoline has been prepared by FEA and recommended to
President Ford for submission in 1977. If this plan is sub-
mitted and not disapproved by the Congress, kerosene jet fuel
and propane gas would be the only remaining products under
control. For those products decontrolled, prices have been
decontrolled at the refinery, wholesale, and retail levels.
Crude oil prices, on the other hand, are still controlled,
except for stripper oil (oil from wells producing less than
ten barrels per day). EPCA sets an initial ceiling on the
average composite wellhead price of all domestic oil of $7.66
per barrel. This composite price is designed to escalate over
time and is now slightly less than $8.00 per barrel. The
price control system provides for three tiers of controls:
(1) with regard to old oil (oil from wells producing pre-May
1973) now an average of $5.15 per barrel; (2) with regard to
new oil (oil from wells producing after that date) now an
average price of $11.65 per barrel; and (3) with regard to
stripper well oil which is now decontrolled.
Issues
1. Should the program of decontrol of product prices be
continued to include gasoline? Options available to the
Administration include:
2
a. Continue gasoline price controls;
b. Transmit to Congress full gasoline decontrol
package (FEA is now holding public hearings)
C. Seek decontrol of retail and wholesale gasoline
industry while retaining controls at the refinery
level.
d. Seek to provide through entitlements on product
imports sufficient foreign competition to keep
gasoline prices from rising to the world level.
2. Should eventual decontrol of crude oil prices continue
as a policy goal?
Analysis
1. Gasoline Decontrol
Gasoline accounts for about one-half of U.S. refinery
output. Because of refinery, wholesaler and gas station
competition, gasoline prices at all levels are now well below
the legal ceilings; the existing controls thus have little
practical effect at the moment. This situation is expected to
continue into the indefinite future with regard to service
station and jobber sales (wholesalers are referred to as
jobbers in this industry).
Gasoline retailers and jobbers would generally like to
be relieved of the burden of price and allocation controls.
And, since competition is expected to keep prices well below
legal ceilings, removal of controls at the retail and jobber level
should have little, if any, effect on consumer prices.
Removal of controls at the refinery level poses more
difficult questions. If the current surplus of domestic gasoline
production capacity should disappear, prices could move up to
the world level. Because American refineries can buy price
controlled domestic crude oil, they have raw material costs
substantially below the world level. Thus, if domestic gasoline
prices are permitted to move towards world levels, much of the
additional profits denied the major oil companies on crude oil
could be recovered through refinery profits resulting from high
gasoline prices. This could amount to $3.00 per barrel. We
3
cannot predict accurately whether competition between domestic
refiners will be adequate to hold refinery margins to a
reasonable level if gasoline demand growth resumes.
An alternative to continued detailed regulation of refineries
might be to use the entitlement program to encourage gasoline
imports, thus permitting foreign refinery competition to restrain
domestic prices. The entitlement program is primarily designed
to provide entitlements to a share of old oil production to
refineries which either have to import crude oil at international
prices or use disproportionate amounts of high priced new oil.
The program thus equalizes price differentials in different parts
of the country resulting from access to U.S. domestic oil produc-
tion. While the entitlements program is aimed primarily at
crude oil, it has been expanded to include imports of residual
oil in New England, thus reducing the high cost of "resid" to
the New England area.
If entitlements are provided just with respect to crude
oil, this provides an advantage to development of additional
U.S. refining capacity in that U.S. refiners under the entitle-
ment program can obtain access to U.S. domestic price controlled
oil; and the difference between the U.S. average price and the
price of imports permits the refinery, which has access to U.S.
domestic crude, to undersell or make additional profits where
there are no controls on the products produced. Entitlements
for gasoline importers would tend to neutralize this advantage.
Generally, providing entitlements to gasoline importers would
give the same subsidy to gasoline importers as domestic producers
of gasoline get.
2. Crude Oil Decontrol
The new Administration will have to decide whether to keep
crude oil price decontrol as a long-term goal. The gradual
crude price increases provided for in EPCA (approximately 10%
per year) appear unlikely to bring domestic prices to the world
level by May 1979 (at which time the President can remove price
controls without veto from Congress). Thus, the new President
will be faced with a decision on whether to permit crude prices
to rise to the world level by decontrol. Such decontrol would
transfer a substantial sum of money from consumers to producers.
It would also encourage production, and some conservation, by
providing for higher prices.
4
Schedule
1. Gasoline decontrol will have to be dealt with early,
since the Ford Administration may have already submitted its
plan to Congress. If it has not, it will be on the shelf ready
to go. (FEA is now holding public hearings in preparation for
possible transmittal to the Congress).
2. Although. the industry will undoubtedly ask for an
indication of the Administration's policy regarding crude prices
early in the Administration, the first major action forcing event
occurs in 1979 when Congress's veto power over Executive Branch
authority to remove controls expires.
ENERGY TAX POLICY
Background
Prices for both oil and gas are controlled. As a result,
these fuels are priced substantially below the cost of the
imported oil. Any reduction in oil imports arising from
greater conservation of oil and gas will save foreign
exchange costs of $13.37/barrel. In contrast, the average
crude price for domestic refineries is $10.38/barrel. The
energy content of imported oil is worth about $2.30 per
1,000 cubic feet (mcf.) of gas. In contrast, domestically
produced gas averages about $.41/mcf. when sold to major
inter-state pipelines. These pipelines in turn sell to
distributors (such as Washington Gas Light) at $1.00/mcf.
and to industrial users at an average of $.89/mcf. The
average retail price of natural gas sold to residential
customers is only $1.80/mcf.
The result of this underpricing of oil and gas is inadequate
incentive for conservation in that conservation opportunities
would cost more than the fuel saved even though the saving
on imports might justify the conservation measures as a
matter of national interest.
One way to resolve this problem would involve some type of
tax on oil and gas. Possibilities include separate taxes
on oil and gas at different rates; taxes on regulated sales
of these fuels to bring them up to market levels; or taxes
on particular uses of certain fuels, such as industrial
uses of oil and gas, or retail sales of gasoline.
Issue
What, if any, such taxes should be proposed?
Analysis
The theoretical argument for taxes to bring final prices
of oil and gas up to the price of imported oil is set out
above. Further, some conservation proponents contend that
the conservation argument for such taxes is even stronger
than the argument based on current underpricing. In
addition, proponents of a gasoline tax argue that automobile
use creates traffic congestion and air pollution in urban
areas which could be reduced by a gasoline tax to control
automobile use.
-2-
Opposition to such taxes has been strongest from those
who feel that they put an excessive burden on low and
medium income groups. But, income distribution objectives
can be achieved through accompanying energy taxes with
tax reduction for preferred classes. The one practical
problem is that the very lowest income groups have been
largely exempted from income taxes; hence any offsets in
this case would have to be made by direct payments.
Tax proposals have met with considerable opposition in
the Congress. The same forces that oppose deregulation
oppose taxes. On the other hand, energy taxes could provide
earmarked revenues for Government subsidies to energy
development or conservation. Unlike deregulation, however,
energy taxes shift resources to the public sector from
the private sector, although deregulation accompanied
by windfall profits taxes would have this same effect.
Some doubt the amount of conservation which would be
achieved by high prices, arguing that industries and
consumers do not pay that much attention to energy prices
(in most cases it is a small proportion of operating
expenses), and look only at first prices when purchasing
equipment, automobiles, and appliances. However, if the
tax is high, there is definitely potential for conservation,
much of it being of a type that people will not be induced
to undertake as long as energy is cheap.
Because oil and gas consumption varies with the region of
the country, tax proposals may impose inequitable burdens
on some areas. Oil use is concentrated on the East Coast
while gas use is especially heavy in the Southwest and
central regions (for home heating). Taxes on gasoline to
reduce automobile use encounter opposition because the
heaviest use is by residents outside of large cities while
the benefits of reducing automobile use accrue disproportion-
ately to residents of large metropolitan areas subject to
pollution and traffic congestion.
Schedule
No immediate decision forcing event other than pressure
to induce additional conservation.
ENERGY CONSERVATION POLICY AND IMPLEMENTATION OF
CURRENT PROGRAMS
Background
The Ford Administration's energy conservation policy
involves a series of energy pricing and conservation program
actions. In the short term (i.e., the next 1-2 years), energy
pricing, particularly increased prices of oil and natural gas
resulting from deregulation, was expected to achieve the bulk
of conservation. By 1985, however, the Ford Administration
expected to achieve conservation through a variety of program
and regulatory actions.
Thus, in addition to deregulation of oil and gas, the
Ford Administration proposed seven energy conservation initiatives
involving: (1) Federal Government energy management, (2)
conservation in buildings, (3) conservation in industry, (4)
conservation in automobiles, (5) airplane fuel conservation,
(6) conservation R&D, and (7) state energy conservation programs.
By 1985, the following reductions in import vulnerability
are expected from the following measures:
Thousands of Barrels
of Oil Equivalent Daily
- Decontrol of Oil**
480
- Deregulation of Natural Gas***
500
- Federal Energy Management Program**
260
- Appliance Labeling/Efficiency Goals**
40
- Insulation Tax Credit***
110
- Weatherization and Building Standards**
340
- Industrial Conservation Program**
140
- Auto Fuel Efficiency**
780
- State Conservation Plans**
300
- Utility Load Management
300
- Conservation Guarantees
75
3,325
** Enacted
*** Passed at least one House
-2-
As can be seen, 9 of the 12 actions have either been
enacted by legislation or implemented administratively. Of the
roughly 3.3 million b/d expected to be saved in 1985, the
measures currently being implemented are expected to achieve
savings of 2.8 million b/d. However, nearly 500,000 b/d in
savings are attributable to decontrol of oil, and actual decontrol
is until 1979 subject to Congressional veto. Nevertheless, we
believe the necessary authorities for approximately 85% of
President Ford's energy conservation program are in place.
Energy conservation, which is very much a "White Hat"
issue, is continually mentioned as the best means for reducing
in the short term U.S. energy vulnerability. Certainly, energy
conservation is conceptually an appealing way to reduce our
energy problem; conservation also has environmental benefits.
The problem is: neither the Executive Branch nor the Congress
has so far found ways in which the contribution of energy con-
servation can be significantly increased over and above existing
legislation without affecting economic growth or life styles
to a politically unacceptable degree. Some would argue that
the EPCA 27.5 mpg fleet average for automobiles requirement by
1985 is already too high a target in this respect.
There is also a coordination problem. Existing legislation,
in particular the Energy Policy and Conservation Act of 1975
(EPCA) and the Energy Conservation and Production Act of 1976
(ECPA), authorized many major programs to achieve a greater
degree of energy conservation. These programs involve 15 major
agencies. In many cases, several agencies are involved in one
aspect of the program. In all cases, there is a question of
how to link energy conservation R&D to the national conservation
programs. While coordination is taking place at the agency level,
no overall guidance is at present being provided to assure
harmonization of programs in meeting national goals.
Immediate action is required to effect better coordination
of Federal efforts in the area of energy conservation standards
in buildings. This need devolves in part from the need of
state and local governments with statutes already on the books
to meet schedules mandated by law. Efforts involve specifically
HUD, FEA, ERDA and the National Bureau of Standards. Essential
research tasks in NBS and ERDA are being delayed because of
the absence of coordinated leadership.
-3-
Section 162 of ECPA requires the ERC to prepare a
"report on national energy conservation activities which
shall be submitted to the President and the Congress annually
beginning July 1, 1977. If The report is to include (1) a
review of all Federal energy conservation activities in
relation to national conservation targets and plans, (2) an
analysis of sectoral conservation targets and progress
towards their achievement, (3) a review of progress under
State energy conservation plans, (4) a review of private
sector conservation efforts, and (5) an assessment of whether
existing conservation targets are adequate and whether
additional incentives, programs or mandatory measures are
necessary. The report is to be coordinated by the Chairman
of the ERC.
Energy conservation encompasses many different concepts,
all of which are important; among them are:
Manufacturing process efficiency
Service industry process efficiency
Product efficiency which involves product
equipment and materials substitution
Fuel efficiency by which the right fuel is
selected for the right task
Operational efficiency which begins with a
conservative attitude not yet acceptable to all
energy users, but relates to use of all building
vehicles, appliances and other energy consumptive
items within design parameters for optimal energy
efficiency
The ERC report should advise on each aspect of energy
conservation and the type and level of incentives and disincentives
appropriate.
Issues
As a matter of national policy, we should try to solve
as much of our energy vulnerability problem as possible through
energy conservation consonant with economic growth objectives.
The issues are:
-4-
(1) To what extent does energy pricing result in
greater efficiency and/or lower consumption?
(2) To what extent should our conservation efforts
be based on conversion from scarce to abundant fuels?
(3) What existing programs are not cost effective?
(4) What additional incentives or programs might be
desirable?
(5) To what extent, and in what areas, should mandatory
measures be used?
(6) What additional coordination of implementation of
existing programs is needed?
Analysis of Issues
While various analyses have been made of the effectiveness
of different kinds of conservation measures in achieving
our energy goals--by the Executive Branch, the Congress, and
others--and while a number of conservation programs are already
in place, we have yet to undertake an across-the-board
assessment of experience with current authorities which have
been in place long enough to permit their evaluation, make
projections of the likely energy impacts of current authorities
with which we have not yet had experience, and assess what is
most likely to be needed in the future. The first ERC report,
due in July 1977, could provide a vehicle for such an analysis.
It would also allow us to separate out energy conservation
as a priority part of the solution to the energy problem.
Since traditionally energy consumption has been closely linked
to economic growth, it is of the highest importance that we
carefully balance measures to achieve reduced energy consumption
goals with our economic goals. Any across-the-board analysis
should deal with this issue.
Based on current analysis, it is clear that a mix of
energy conservation measures is most likely to achieve cost
effective savings. Energy pricing is only a part of the answer.
At the same time energy conservation cannot in all cases be
willed from Washington. Mandatory energy consumption standards
in many cases may be difficult or impossible to implement
and may do more damage than provide benefits. In industry,
which consumes 43% of energy, it is most doubtful that energy
-5-
consumption standards would provide benefits in excess
of costs and would be virtually impossible to administer
in an equitable manner. Processes are different from,
say, one cement plant to another; and energy consumption
depends on capacity utilization, feed stocks and
availability of energy supply. With regard to consumer
products, it is possible to regulate energy consumption
by such products (e.g., automobiles, appliances) ; but
arbitrary standards may not optimize costs and benefits.
Information to consumers, through product labelling, on
the other hand, could bring about the same result on a
market basis. Nevertheless, where a product consumes a
significant proportion of a scarce fuel, such as gasoline
by autos, legislation has been enacted to require certain
energy efficiency standards. However, insufficient
analysis has been given to the precise level of these
standards.
Schedule
We have proposed establishment of an ERC Committee on
Energy Conservation to coordinate existing Federal programs
and prepare by July 1, 1977, the first report to the
President and Congress on this subject.
IMPACT OF CLEAN AIR ACT
ON COAL USE AND DEVELOPMENT
Background
The principal limitation on consumption of coal in
the United States is not the ability to produce coal or
transport it, but the size of the markets in which it can
be legally burned in accordance with provisions of the
Clean Air Act.
Public Law 91-604, the Clean Air Act Amendments of 1970,
provided for the establishment of National Ambient Air
Quality Standards (NAAQS) for several air pollutants. Primary
NAAQS, which provide for protection of public health with
an adequate margin of safety, were to be achieved by July 1,
1975. "Secondary" standards, set to protect public welfare,
are to be achieved as soon as practical. Enforcement of
these standards at the State level is provided for by the Act.
States are required to develop EPA-approved State Implementation
Plans (SIPs) incorporating NAAQS or more stringent state
standards.
New Source Performance Standards (NSPS), mandated by the
Clean Air Act, establish nationwide limits for emissions of
pollutants from all new stationary sources. The law requires
that NSPS reflect the degree of emission limitation achievable
through the application of the best system of emission
reduction, taking into account the cost of achieving such
reduction. The Administrator of EPA has determined that the
NSPS for SO2 can be met by stationary source utilization of
scrubbers (devices for removing SO₂ after burning) or low
sulfur fossil fuels. In the case of coal, this requires use
of coal with not more than .7% sulfur content.
The United States District Court for the District of
Columbia, in a decision upheld by the United States Supreme
Court, held that the Clean Air Act also requires that SIPs
must provide for the prevention of significant deterioration
of air quality in those areas where ambient air quality is
better than that required by secondary NAAQS.
The Supreme Court held that the reference in the Preamble
of the Clean Air Act to avoiding deterioration of air quality
requires emission regulations in areas which are now clean
in order to protect current levels of air quality. Depending
on the exact nature of the emission regulations adopted for
such now clean areas, the effect is likely to be either imposition
of costs in excess of benefits (there is no provision for
comparison of benefits versus costs in either the law, federal
-2-
regulations, or applicable court cases) or possibly
prevention of large scale development in certain rural
areas. New power plants and coal mining or gasification
facilities in rural areas are likely to be impacted by
these provisions.
In accordance with applicable Court decisions, EPA
has promulgated regulations to enforce the significant
deterioration ruling. These provide for dividing the
currently clean areas into three categories in each of
which different standards would be applied. The highest
standards would be applied to national parks and monuments
or to regions adjacent to them (Class I areas). The
lowest standards would be applied to areas intended for
development (Class III). The States would have considerable
discretion as to which areas would be classified into
which category. In virtually all cases, the level of
emission control would exceed that which could be justified
on the basis of identifiable economic benefits or protection
of public health. Justification of the "significant
deterioration" provisions thus rests on aesthetic consid-
erations such as preventing reduction in visibility, as for
example in certain Western areas.
In implementing the Clean Air Act, State regulation
exceeds in many cases the levels needed to achieve the
minimum standard of air quality required by Federal law.
This was frequently because regulations, which were designed
to deal with pollution problems in the most polluted urban
areas of the State, were made applicable to an entire State
or a large area of a State. The result was regulation far
in excess of what was required under national standards
for rural areas. It soon became clear that meeting these
standards in the eastern United States would require either
more low sulfur coal than was physically available or more
installation of scrubbers than would be possible in the
short run. This situation was dealt with by delaying enforce-
ment of regulations beyond the mid-1975 deadline, and by
efforts to relax regulations in rural areas.
Further, regulations under the Clean Air Act have
been written to require emission control such that air
quality was maintained even under the most adverse meteorolo-
gical conditions. This meant that the regulations adopted
were far more stringent than required to protect public
health and welfare under normal meteorological conditions.
-3-
An alternative strategy, referred to an intermittent
controls or fuel switching, is technically feasible.
This involves burning low sulfur fuels (oil, gas, low
sulfur coals) during periods of adverse meteorological
conditions, and burning high sulfur fuels (typical
eastern coals) at other times.
Issues
1. Should amendments to the Clean Air Act be
sought to permit development of large new
coal using facilities in rural areas?
2. To what extent should the Federal Government
encourage pollution regulations that vary
within the regions of a State?
3. To what extent should the Federal Government
encourage emission regulations that vary
with the meteorological conditions?
4. Should amendments to the Clean Air Act be
sought to permit standards to take into
account whether benefits exceed the costs?
Analysis
1. Amend Clean Air Act
Various proposals have been made to modify the Clean
Air Act to permit additional industrial development in
the now clean areas. These have ranged from removal of
the language of the Preamble of the Act that originally
created the problem to various proposals to set up new
regulatory systems for the clean areas. The parts of the
country most seriously affected are the western areas
where large new coal using facilities including power
plants and gasification facilities may be constructed
(Wyoming, New Mexico, Montana) ; various areas now relying
on natural gas which will be forced to convert to oil or
coal in the future; and rural areas in other parts of
the country.
-4-
A policy of no increase in pollution in unpolluted
areas, combined with the current policy of no new major
pollution sources in major urban areas which exceed ambient
air quality standards, places significant constraints
on siting of new coal using facilities. At worst, major
new pollution sources may be permitted only in the moderate
pollution areas where reduction in emissions from existing
sources permits the start-up of new sources without
either increasing the total level of emissions or exceeding
the legal standards. Another possible outcome involves
very heavy expenditures for the "best available" emissions
technology (scrubbers on every plant) but does permit
development to proceed.
2. Variable Standards
A policy of lower pollution standards in rural areas
appears capable of both reducing public health hazards
and encouraging the use of coal. The improvement in public
health results from the probability that major pollution
sources would relocate to rural areas if given the financial
incentive of low pollution costs. Given the lower population
densities in rural areas, the total intake of pollutants
into human lungs is likely to be reduced by a policy of
relocation more than a policy of maximum controls everywhere.
Current scrubber technology would provide for removal of
about 90% of emissions. A plant relocation from an area
of 10,000 people per square mile to an area of 100 people
per square mile would reduce the amounts of pollutants
breathed by 99% at low cost.
3. Intermittent Controls
A strategy of fuel switching during periods of adverse
meteorological conditions has considerable potential for
both achieving air quality and permitting the burning of coal.
4. Cost-Benefit Analysis
The current law, in effect, treats clean air as
something which is always worth purchasing regardless of
what the costs are, or whether they exceed the benefits.
An approach which would to a greater extent relate costs
and benefits has obvious attractions.
-5-
Schedule
Action on significant deterioration will probably
be forced by introduction of numerous amendments to the
Clean Air Act in the early days of the next Congress.
Modifications to State regulations for regional variations
in emission standards and fuel switching strategies will
from time to time require EPA approval or disapproval.
SYNTHETIC FUEL FINANCING
Background
Immediately after the petroleum price increase of late
1973 and early 1974, it was widely believed that synthetic
fuel (synfuel) development would prove economical. For
example, oil companies bid $400 million for oil shale leases
and expressed an intention to go into full scale oil shale
production. Belief in synfuel economic viability underlies
the million barrel per day goal expressed in the 1975 State
of the Union message.
It soon became clear, however, that shale oil and synthetic
fuel from coal development was, in general, not economical,
even at current high oil prices. Thus, the Administration
pushed for a program to demonstrate commercial synfuel plants.
A start could be achieved by using existing ERDA demonstration
plant authority. In addition, the Ford Administration supported
authority to encourage synthetic fuel development through grants,
price supports and loan guarantees. By making loan guarantees
non-recourse, the government would repay the loans if the
project failed. Such legislation was narrowly defeated in
the 94th Congress.
Synthetic fuel commercialization is different from research
and development. Most of the expense associated with a
commercial scale plant involves known technology--mining,
materials handling, oxygen production, steam generation and
petroleum refining. A commercial scale oil shale plant or
coal gasification plant involves a system composed of a series
of identical production units. Thus, oil shale and coal process
technology can be tested by building only one full scale unit.
In the case of coal high BTU (pipeline quality) gasification,
the only process that is available for immediate commercial-
ization is the Lurgi process. This was developed in Germany
before World War II and has been used in numerous foreign
countries. Production of Low BTU, non-pipeline quality gas
for on-site power generation and industrial use has also been
tested from a technological point of view in many different
parts of the world.
Thus, justification of a synfuel commercialization program
does not rely on technical research considerations per se.
Rather, it is argued that the environmental and economic impacts
of full scale commercial operation can only be understood by
-2-
actually building and operating several full scale plants.
It is further thought by some that a demonstration of U.S.
alternatives to OPEC oil might be useful in keeping prices
down. Others argue that such a program would confirm the
fact that the cost of most synfuels is far above current
oil price levels and thus support the OPEC argument that
oil at current OPEC prices is still a bargain.
The quantities of fuel that will be produced from synfuel
commercialization will be quite small (250, barrels of oil
equivalent/day) and are thus unlikely to make a substantial
contribution to self-sufficiency. Two hundred fifty thousand
barrels of oil a day would be only 1.4% of current U.S.
consumption. However, in the case of natural gas, the quantities
of gas that could be produced might be significant if directed
towards California markets.
In the last several months, a number of new developments
have occurred with regard to development of shale oil. Most
of the shale oil experimentation has involved above ground
shale retorting (heating of the shale rock SO that the oil is
forced out) ; this technique, however, has a number of environ-
mental problems, in particular disposal of spent shale and
air pollution. On the other hand, Occidental Petroleum has
developed a process which would do the retorting in the
ground (modified in situ process). This process reduces
considerably both the spent shale and air pollution problems.
It also involves a much lower capital cost, approximately one
third of the equivalent surface shale retorting.
Occidental is currently considering joint development
with Ashland of one of the Colorado Federal oil shale leases,
and a modified development plan is expected to be submitted
to the Interior Oil Shale Supervisor in the next several weeks.
Occidental believes that its process is economic at current
oil prices, and states that it does not need Federal Government
financial assistance to move forward.
One further special problem involves the fact that ERDA
is using its research authority to construct a full scale
gasification plant using eastern coal in Illinois. A very
high proportion of the cost of synthetic gas involves the cost
of coal. By far the lowest costs are achieved by using cheap
Western coal strip mined from thick deposits. Western coals
also have certain technical advantages relating to their
agglomeration properties at high temperatures. The Texas
gas that would have gone to California can be replaced with
Western gas from coal. The excess capacity in existing
pipes can then be used to deliver the natural gas that would
-3-
have gone to California to the East. The result is very
low cost transportation. There appears virtually no chance
that high BTU synthetic gas developed from Eastern high sulfur
coals will be cheaper in any part of the country than gas
from Western coals delivered by the above described exchange
process.
Issue
Should the new Administration propose a program of
assistance to industry to commercialize synfuels?
Analysis
With regard to liquid fuels from coal, the costs appear
to be above current oil costs by a large margin. There is
not yet an economical coal liquifaction process ready for
commercialization. Although several processes are in the
pilot plant stage and appear technically feasible, the most
immediate commercialization issues are unlikely to involve
liquifying coal.
Three full scale plants have been proposed by natural
gas companies (two in New Mexico for the California market,
and one in North Dakota for the Midwest) to produce pipeline
quality gas from coal. All would use well developed German
technology and appear technically feasible. Nevertheless, the
cost of the gas from these projects would be above the cost of
oil refined and delivered to industrial users who would be
interested in such synthetic natural gas to replace current
natural gas supplies subject to cut off.
There is a nationwide gas shortage. While the shortage
is not yet serious for the areas in Michigan and Wisconsin
that could be served by the North Dakota plant, the Michigan-
Wisconsin Pipeline situation will gradually grow worse.
The shortage in California is more serious and is expected
to grow gradually worse with the depletion of supplies in
West Texas.
To actually finance the proposed synthetic gas plants,
investors must be assured of recovering their investment
plus a normal return. Such assurances can be provided
either by the gas customers through what is called an "all
events tariff" coupled with rolling in the price of the
synthetic gas with the price of controlled domestic gas, or
by direct Government guarantees or some other form of subsidy.
-4-
Under an all events tariff, the gas distributors would in
effect commit to pay the cost of the synthetic gas plant
regardless of what these costs were. Naturally, consumers
and utility regulatory commissions (e.g., the California
Public Utility Commission) are reluctant to commit the
gas consumer to such large and unknown expenses.
With regard to shale, the situation is less clear.
Above ground oil shale development is probably uneconomic
at current prices of oil with which oil from shale directly
competes. Further, environmental opposition to above
ground oil shale development remains strong. On the other
hand, if Occidental, or some other company, proceeds with
in situ retorting and Occidental's assertion is correct
that their process is economical at current prices, oil
shale may well proceed, at least to the stage of demonstrating
commercial production at a level of approximately 50,000
b/d. The modified development plan which Occidental is
currently working on with Ashland should give us some
indication. Finally, since Occidental claims they do not
need Federal financial assistance, it would seem that we
should defer considering major Federal financial assistance
pending review of the development plan. This view is shared
by the Department of Interior; but not ERDA which is
considering additional funding for demonstration of above
ground retorting.
Finally, the basic question of whether the new
Administration should propose a synfuel financial assistance
program involves an assessment of whether the real impediment
to commercial development in fact involves scale-up uncer-
tainties and the possibility of reduced oil prices which
would undercut synfuel economics.
If synfuels are clearly uneconomic, we probably
should not subsidize their development. If, on the other
hand, they are likely to become economic in the medium
term (i.e., before 1990), then an argument can be made
that the Federal Government should provide necessary
incentives to get the industry started. The question is:
are incentives really necessary? They may not be for
shale. An "all events tariff" might be a more effective
way to get synthetic natural gas started and would place
the choice and risk on those utility commissions and consumers
directly affected. Coal liquifaction is probably uneconomic
given the present state of the art.
-5-
The above analysis, of course, does not preclude
Federal R&D assistance to assist in developing new
technologies which have potential for producing synfuels
at economic prices. This is the primary role of ERDA.
Schedule
1. Shale oil decisions will be forced by the expiration
of the one-year suspension of lease payments on the
existing shale oil leases in late 1977.
2. Pressure from gas users and project proponents for
Federal support for coal gasification plants can be
expected early in the Administration.
OUTER CONTINENTAL SHELF
LEASING LEGISLATION
Background
Major amendments to the Outer Continental Shelf
Lands Act to change the OCS leasing process were debated
in the 94th Congress, passed both Houses, and actually
resulted in a Conference Report. However, due to industry
and Interior opposition and the rush of other legislation
in the waning days of that Congress, legislation was in
fact not passed.
The legislation would have encouraged leasing methods
other than cash bonus bidding, including bidding on the
basis of the percentage of the value of production given
to the Government (royalty bidding) or on the basis of a
percentage of the profits going to the Government. Other
provisions would have encouraged oil company exploration
before leasing, provided for an Offshore Oil Spill Pollution
Fund, and distinguished between development and exploration.
The legislation also provided for a greater role for State
and local governments and contained various provisions of
a procedural nature which Interior felt would greatly delay
OCS development.
There is continued dispute between those concerned with
environmental protection and those concerned with energy
development regarding development of the so-called OCS
"frontier" areas in the Atlantic, Pacific, and off Alaska.
Most of the good acreage in the Gulf of Mexico has been
leased, and any large increases in offshore production will
have to come from these other areas.
A surplus of relatively high sulfur oil is currently
expected on the West Coast, and any additional OCS leasing
in the Pacific and off Alaska would add to the surplus and
hence the amount of West Coast oil that must be transported
to the eastern part of the country or sold abroad. Assuming
that offshore oil also has relatively high sulfur content,
questions are raised
whether
additional leasing
in these areas would add to any surplus.
Issues
1. What, if any, amendments to the Outer Continental Shelf
Lands Act should be sought in the new Congress?
2.
What areas should be offered for leasing?
-2-
Analysis
1.
Amendments to Outer Continental Shelf Lands Act
The Department of the Interior, which administers
Outer Continental Shelf energy exploration and develop-
ment, had major objections to the proposed amendments
as they passed the House and Senate. Oil companies
also objected to these amendments as being disruptive
to orderly and balanced development of offshore oil
and gas resources.
On the other hand, while Commerce agreed with
Interior that additional OCS legislation was probably
not necessary, we were not as convinced that the OCS
Amendments, as they emerged from Conference, would be
totally disruptive of OCS development. We were in
the process of preparing an analysis for Secretary
Richardson in this respect when the Congress decided
not to pass the bill this session.
We can expect new OCS legislation to be introduced
in the 95th Congress. Given NOAA's expertise in the
area and based on environmental baseline studies which
it does for Interior, we should take an active role
in working within the Executive Branch, and as appropriate,
with Congress in assuring that the new Administration's
position and any legislation which emerges from the
Congress is balanced between developmental and environ-
mental concerns.
2. OCS Leasing Schedule
This item is currently the subject of ERC discussion.
Interior is proposing a stretch out of the schedule
with the following characteristics:
-- It extends the schedule into 1980 and provides
for consideration of six sales a year.
--- It provides for sales on approximately a
yearly basis (8 to 14 mos.) in the Gulf of Mexico in
order to minimize drainage of common resource pools
on adjacent lease sites, and to provide for leasing of
deep water acreage and acreage contiguous to new
discoveries.
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-- It provides for second sales in frontier
areas in the event that commercial discoveries are
made.
-- It defers the decision on whether to consider
leasing off Oregon, Washington and Northern California
until the results of the call for nominations and
request for comments are fully analyzed.
--- It defers the decision on when to consider
leasing in the Outer Bristol Basin off Alaska until
additional environmental studies are completed.
--- It limits the leasing area of consideration for
the Beaufort Sea and Bering/Norton off Alaska to that
which is shoreward of the 60 foot isobath or the
shear zone (between sea ice and shorefast ice).
Commerce believes that lease schedules should
be based on information to be derived from the Bureau
of Land Management (BLM) /NOAA OCS Environmental
Assessment Program. Waters adjacent to Alaska are
extremely rich in fisheries resources. Effort should
be made to minimize the impact of offshore development
on these resources.
It is also important that coastal zone management
programs be operational in at least those coastal areas
directly impacted by lease sales, prior to approval
of field development plans. Alaska should be given
adequate time to meet this goal.
For these reasons, NOAA had proposed lease
schedule changes off Alaska. These changes were
generally taken into account in the new Interior
proposed schedule.
Schedule
1. OCS legislation will probably be reintroduced in
the Congress and will move rapidly since much of the
work has already been done.
2. Several of the decisions to lease will prove
controversial. This will be true of leasing off New
England in the vicinity of George's Bank (scheduled
-4-
for June 1977) , the South Atlantic (scheduled for
September 1977), and for leasing in the vicinity of
Kodiak Island off the South Coast of Alaska (scheduled
for November 1977) .
3. The Department should early take an active role in this
area in the new Administration.
ALASKAN OIL TRANSPORTATION
Background
There will initially be substantially more oil avail-
able to the West Coast of the United States after start-up
of the Alaskan oil pipeline than there will be refinery
capacity or markets to absorb it there. The surplus in
1978 is expected to be on the order of magnitude of 500,000
barrels per day (b/d). At the time of passage in 1973 of
legislation providing for construction of the Trans Alaska
Pipeline, it was generally believed that all of the North
Slope oil would be consumed on the West Coast. This assump-
tion no longer appears valid due to a combination of events
which have occurred since 1973. The economic slow down,
the Arab oil embargo, subsequent higher oil prices and
conservation, as well as the opening to production of the
Elk Hills National Petroleum Reserve, have all contributed
to changing the West Coasts' demand/supply situation.
The Alaskan oil is also of relatively high sulfur
content and produces a high yield of residual fuel oil
making it unsuitable for many of the existing West Coast
refineries. The refineries in the State of Washington
(except for the Atlantic Richfield refinery) were built to
use low sulfur Canadian crude and cannot process Alaskan
crude without substantial modification. The California
refineries can physically process the oil, but to a large
extent lack the desulfurization facilities to produce the
low sulfur products required to meet California air pollu-
tion regulations. Thus, Alaskan oil cannot displace current
imports of low sulfur Indonesian oil.
While refinery modifications to use Alaskan oil are
possible, current price controls do not provide for recovery
of the cost of such. modifications. Such modifications are
not expected in the near future.
Current law forbids export of oil transported through
the Alaskan pipeline except for exchange with an adjacent
country (Canada) to facilitate transportation; or if the
President finds that "such exports will not diminish the
total quantity or quality of petroleum available to the
United States, and are in the national interest". If the
President decides to recommend such exports, Congress has
veto power by concurrent resolution. Since this alternative
involves administration of export controls, Commerce will
have an important role to play in any such possibility.
-2-
If the oil is shipped to Japan or other Far Eastern
countries, it would presumably take the form of an exchange.
This is a technique commonly used in the petroleum industry
by which oil in one location is exchanged for oil in another
location more convenient to the user. In this case, we would
exchange Alaskan oil for Middle Eastern oil purchased by the
Japanese but delivered to the East or Gulf Coast of the
United States, thus achieving a transportation cost saving
and a better matching of crude inputs to refining capacity.
A number of U.S. domestic transportation alternatives
are being considered including:
1. A proposal by Standard Oil of Ohio (SOHIO) to build
a pipeline from the Los Angeles area to West Texas
through in part converting 800 miles of an existing
natural gas line to oil. Beyond West Texas, the
oil would be transported in existing pipelines which
are expected to have surplus capacity due to declin-
ing oil production in West Texas.
2. A proposed "Northern Tier" pipeline from the State
of Washington to Minnesota where it would connect
with existing pipelines for Chicago, serving refin-
eries in Montana, North Dakota, and Minnesota, whose
existing pipeline connections are with Canada.
3. A number of northern refiners are proposing a pipe-
line from Kitimat in British Columbia to Edmonton,
Alberta. Here it would connect with the Canadian
Trans-Provincial Pipeline and the Rangeland Pipeline
to Montana. Current existing excess capacity in the
Trans-Provincial Pipeline would be used to ship oil
to the Northern Tier and Midwestern markets.
4. Use of U. S. flag ships through the Panama Canal to
Gulf Coast ports.
5. Use of foreign flag tankers through the Panama
Canal to the Virgin Islands for refining there and
shipment of product to East Coast ports.
Issues
1. Should the United States Government encourage construc-
tion of a pipeline from the West Coast to the eastern
United States and, if so, which one or ones?
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2. Pending completion of such a pineline, should oil
be exchanged with Japan in the short run or should
U.S. flag tankers be used to transport the oil
through the Panama Canal? Or should Japanese exchanges
constitute a long run solution?
3. Should a Virgin Islands option be chosen?
4. Should any special effort be made to encourage
refinery modifications on the West Coast and if so
how?
Analysis
1. West-East Pipeline
FEA analysis shows that any of the pipeline routes have
lower costs than using the Panama Canal. The Kitimat and SOHIO
pipeline routesappear to have the most advantages in relation
to costs. However, none of the pipeline routes could be in
operation before completion of the Alaskan Pipeline. Thus, the
short run decision is likely to be between the use of the Panama
Canal and exchanging some of the oil with Japan, which would
require Presidential approval and Congressional concurrence.
a. Kitimat Pipeline
The Kitimat pipeline would carry both Indonesian crude
destined for the refineries along the border and Alaskan
crude destined for U.S. refineries in the Chicago area
and elsewhere. It might also be used to transport
Alaska oil to markets in eastern Canada in exchange for
continued deliveries of Canadian oil to U.S. refineries.
This route, being entirely within Canada, requires no U.S.
support. Because of the closeness of Kitimat to Alaska,
it involves the shortest ocean haul of any of the routes.
It appears to have Canadian support and does not appear
to involve any significant environmental opposition.
b. SOHIO Pipeline
This proposal is furthest along in terms of planning and
would probably be the first pipeline to be constructed
if necessary permits are granted. SOHIO has petitioned
the Federal Power Commission for abandonment of Fl Paso's
natural gas pipeline and has sought necessary permits to
cross Federal lands. In addition, permits will be required,
inter alia, from the California Air Resources Board and FPA
in connection with air quality in the Los Angeles area.
Opposition centers on air quality questions in the Los Angeles
area which does not now meet primary air quality standards.
If the air quality questions can be resolved, the SOHIO
pipeline proposal has much to commend it; but must be
assessed in relation to Kitimat. As Alaska oil production
-4-
builds up, however, a good argument can be made that we
will need both a SOHIO and a Kitimat Pipeline.
C. Northern Tier Pipeline
Because Canada is in the process of phasing out crude
exports to the United States, Northern Tier pipelines
and refineries are faced with a loss of supply, a
problem that has caused considerable Congressional
concern. Further, because these refineries were
designed to process low sulfur Canadian crude, the
replacement oil used would likely be Indonesian, and
the Alaskan oil transported through the Northern Tier
Pipeline would probably go to Chicago and other
Midwestern markets where the refineries have been
designed to process high sulfur oil. This project
appears unlikely to proceed because of high cost,
lack of support from any of the refineries that it would
serve, and because of local opposition from the State
of Washington to becoming an oil port for inland cities.
2. Exchanges *
FEA analysis shows substantial savings in transportation
costs through exchanging oil with Japan. These savings are
of the order of magnitude of $1 per barrel. The basic reason
the potential for savings exist is because of the closeness
of Japan to Alaska and the ability to use non-U.S. flag ships
in connection with such exchanges. In contrast, direct trans-
port to the eastern United States involves either an across the
Rocky Mountain pipeline, or a circuitous routing through the
Panama Canal using more expensive U.S. Flag Jones Act tankers.
Security risks from exchanging oil appear minimal. Since
the Alaskan pipeline legislation was passed, the International
Energy Agreement has been created with the U.S. a member. This
provides that the industrialized countries will share oil sup-
plies in the event of a crisis on the basis of consumption and
net imports. Under crisis circumstances, if the agreement is
implemented, exports would be subtracted under the formula and
thus U.S. supplies would be unaffected, at least as a result
of Japanese exchanges.
*
(Also see Maritime Administration issue paper "West Coast
Oil Surplus and U.S. Flag Tankers")
-5-
Even in the absence of an IEA, any delivery of oil to
Japan through an exchange agreement would be contingent
on continued deliveries of Japanese purchased exchange oil
to our East and Gulf Coasts at equivalent prices. If
Japanese purchased exchange oil were in fact not forthcoming,
the United States could retain access to the Alaskan oil.
Since any crisis caused by a cutback in oil production is
likely to be accompanied by a surplus of tankers on world
markets, it should be possible to transport the oil to the
parts of the United States in need of it.
The principal risk involves damage to U.S. -Japanese
relations that would occur if deliveries of Alaskan oil were
discontinued after some years, even if such discontinuance
were in response to Japanese failure to continue deliveries
of Middle Eastern oil to the United States. In more normal
times, there would probably be some foreign relations benefits
from increased trade with Japan arising from an exchange
agreement. Since Japan would share in the transportation
savings, she should welcome such exchanges.
Further, any risk of damaging U.S. -Japanese relations
in the event of Middle East curtailment to both countries
could be minimized if the exchanges were structured only as
a temporary measure pending completion of a pipeline from
West to East. With the knowledge that Alaskan oil was only
a temporary source of supply, the Japanese would not count
on it for long term needs.
Another problem involves U.S. domestic politics. It
may be difficult to explain why we are shipping U.S. oil to
Japan in exchange for Middle East deliveries. The fact that
we would be protected in the event of curtailment might be
difficult to put across to the American people.
Finally, using non-U.S. flag tankers for the exchange
would undoubtedly bring about political pressure from the
maritime unions who would view such exchanges as a subterfuge
to avoid Jones Act requirements. Indeed, in this respect,
Senator Stevens in Congressional hearings in September asked
FEA Deputy Administrator Hill whether Alaska oil shipped to
Japan would be on U.S.-flag tankers, and Hill replied that it
would be. If oil is shipped to Japan on U.S.-flag tankers
the advantageous economics of Japanese exchanges become more
marginal. If imports from the Middle East in exchange are
required to be carried on U.S. tankers, the economics of
such exchanges are likely to become negative.
Transport of Alaskan oil through the Panama Canal on
-6-
Jones Act U.S.-flag tankers adds $1.15 per barrel more to
the cost of that oil. While there are expected to be suf-
ficient Jones Act tankers or U.S.-flag tankers which could
be converted to Jones Act tankers for this purpose, the
economics appear to be negative, except as a short term
solution pending completion of the west-east pipeline.
Commerce can be expected to be the subject of a certain
amount of lobbying from maritime interests in favor of using
Jones Act tankers through the Canal as a result of its
Maritime Administration responsibilities.
3. Virgin Island Option
The Virgin Island option is essentially a means of
avoiding the Jones Act requirements to use Jones Act U.S.-flag
tankers in the U.S. coastal trade. Transport to and from the
Virgin Islands is exempted from Jones Act requirements. On
the other hand, proposals have been made to eliminate this
exemption. This option could be expected to be vigorously
opposed by U.S. maritime interests. Prevention of the use
of this route would, however, require new legislation since
no governmental approvals are required for Amerada-Hess (the
relevant refinery) to buy Alaskan oil and transport it in
foreign flag tankers.
4. West Coast Refinery Modifications
In the short term, the economics are negative on
converting West Coast refineries to permit them to process
Alaska high sulfur crude because of price controls on gasoline
and certain other refined products. Without controls, West
Coast refinery modification would probably be economic. At
some point, it may prove economic for West Coast refineries
to increase their capacity to process Alaskan crude. Decontrol
of gasoline prices, or controls on Alaskan crude prices to
keep its delivered prices sufficiently far below Indonesian
prices would accelerate the conversion process.
Schedule
Because of the impending completion of the Alaskan pipeline
in mid-1977, resolution of this issue will be among the earliest
energy issues facing the new Administration. The ERC commis-
sioned a study under FEA leadership of alternate Alaska crude
transportation routes. This study is in the process of being
circulated in draft for State comment. It is planned to prepare
a decision memorandum for the President based on this study.
Most of the alternatives require Federal action. The pipelines
require various kinds of Federal permits; non-Jones Act U.S.-flag
tankers will have to be converted to Jones Act requirements; ex-
changes will have to be approved by the DoC after a Presidential
/
finding and Congressional concurrence. If a decision is made
to construct a pipeline, an early start is desirable.
ALASKA NATURAL GAS
Background
The Alaska Natural Gas Transportation Act of 1976
requires the Federal Power Commission (FPC) to recommend
a system to deliver North Slope natural gas to "Lower 48"
States from the three systems which have been proposed and
applications for which are now pending before that agency.
Hearings have now been completed, and the Administrative
Law Judge is expected to transmit his findings (a public
document) to FPC by the end of the year. The FPC is then
to make its recommendations to the President by May 1, 1977;
these recommendations are to be supported by a report
explaining the basis of the decision, expected delivery
volume, costs, prices, environmental impacts, and other
relevant factors, including expected "Lower 48" regional
impacts. The Act provides for Federal agencies, States
and other interested persons to comment to the President
on the FPC recommendation by July 1, 1977. In the same
time frame, the Council on Environmental Quality is required
to hold hearings on FPC's environmental impact statement.
The President is then to decide by September 1 whether a
system should be approved and which system. Congress would
then have to approve the decision by joint resolution within
sixty days. Provisions are made for submittal of new
proposals in the event of Congressional inaction.
The three routes proposed are as follows:
a. Arctic Gas proposes an approximately straight
line pipeline route from Prudhoe Bay to Chicago.
This route would cross Northern Alaska and the
Arctic National Wildlife Range. It has thus
encountered environmental opposition. This route
proceeds through Canada to the McKenzie River Delta
gas fields and then south along the McKenzie River,
entering the United States in Montana. One leg
would then proceed to the Chicago area past a coal
gasification site in North Dakota and from Chicago
to Pennsylvania. Another leg would leave the main
line in Canada to proceed to the West Coast. This
project would carry both Canadian and U.S. gas in
the Canadian part of the route. By helping to
develop Canadian gas, this route would hopefully
encourage Canada to continue deliveries of Canadian
gas to U.S. markets now dependent on Canadian gas
and provide an inducement to achieve greater Canadian
flexibility in connection with phasing out Canadian
oil to Northern Tier refiners.
-2-
b. A second pipeline route proposed by the Northwest
Pipeline Company would parallel the existing oil
pipeline to the vicinity of Fairbanks and then follow
the Alaskan Highway into Canada. This more circuitous
route avoids the need to construct new highways and
cross the Arctic National Wildlife Range. Once in
Canada, this pipeline would connect with existing
lines from Canada to the United States permitting
deliveries to both the Midwest and West.
C. El Paso has proposed a route roughly paralleling
the existing oil pipeline to Valdez. At the Alaska
coast, the gas would be liquified and transported by
sea to California. By displacement, the gas now being
transported from Texas to supply California could be
diverted to supply other parts of the United States.
Finally, it should be noted that the legislation contains
a provision which may require that gas be delivered both
east and west of the Continental Divide. If there is no
way around this provision, at least one of the existing gas
pipelines will need to be reversed to permit gas deliveries
from California to Texas, and hence to other parts of the
United States.
Issues
1. Will Alaska natural gas prove economic, whichever route
is chosen?
2. If so, which route should be proposed?
3. What, if any, Federal financial assistance should be
given to facilitate the chosen project?
4. What Executive Branch studies must be undertaken early
to facilitate an informed Presidential decision?
Analysis
1. Is Alaska Gas economic?
Analysis shows that costs of Alaska natural gas projects
range from $6 billion to over $20 billion, depending on
estimates of cost overruns and construction delays. Most
current analysis estimates a cost of $10 billion as being
likely and that economic benefits will probably be positive
-3-
if major cost overruns are avoided. However, because
of the possibility of cost overruns or construction
delays similar to those encountered on the Alaskan oil
pipeline, it cannot be taken for granted that construction
of an Alaskan natural gas transportation system is
necessarily desirable or that construction of such a system
on a "crash basis" is preferable to a more orderly
construction schedule.
Normally, it could be argued that the overall economics
of any system to transport Alaskan Natural Gas to the
"Lower 48" would be determined by the companies involved.
The companies would clearly not make the necessary investments
if they did not think they could sell the gas delivered
in "Lower 48" markets at a profit. However, the companies
involved are asking for an "all events tariff" to assure
recovery of any costs involved. The companies have in
effect asked for a tariff which would cover the possibility
of noncompletion of the project and prolonged interruption
of service. If such a tariff or a Federal guarantee is
in fact provided, market constraints on the project are
considerably reduced. Therefore, the Federal Government
must undertake the best possible analysis on overall economics.
2. What route?
If it is determined that Alaskan natural gas is
economic, the question remains whether the specific route
proposed is the least costly one. The Arctic Gas proposal
involves direct delivery to final users. The proposed link
from the Chicago area to Pennsylvania could be eliminated
by diverting Gulf Coast natural gas now going to the Midwest
to lines serving the East Coast. The proposed leg to the
Western United States could be eliminated by either injecting
Alaskan gas into existing Canadian lines for delivery to
the West Coast or by diverting West Texas gas going to the
Eastern United States to Pacific Coast markets. On the
other hand, the cost of the El Paso project might be reduced
by delivering some gas to Washington rather than California.
3. What form of financing?
The companies involved may request Government financial
guarantees to protect bond holders against the risk of
failure to complete the line, a major escalation in cost,
or an interruption of deliveries once construction is
completed. Assistance can be either in the form of a
Federal guarantee which places risk on all taxpayers or in
the form of an "all events tariff" which places the risk
only on the customers of the natural gas.
-4-
4.
What studies are needed now?
An Executive Branch update study of the overall
economics of Alaskan natural gas transportation is needed.
Such a study should analyze costs and benefits of the
Alaskan natural gas delivery systems in relation to discount
rates, oil prices, cost overruns, construction delays and
alternative sources of natural gas supply. In particular,
such a study should update construction cost figures and
the likelihood of delays.
Schedule
The President will have to make his decision by
September 1, 1977. The additional economic analysis
needed should be started immediately in the new Administration
drawing, as appropriate, on analysis already underway or
completed.
FORD
OIL COMPANY DIVESTITURE & PETROLEUM MARKETING
PRACTICES LEGISLATION
Background
There was a great deal of discussion of these two issues
during the last session of the 94th Congress. Divestiture
ivolves questions of both horizontal and vertical divestiture.
Horizontal divestiture involves forcing the major oil companies
to dispose of their interests in energy industries other than
oil and gas, including coal, nuclear power, and geothermal
development. Vertical divestiture involves limiting the major
oil companies to one level of the oil industry, for example,
production, refining, pipelining or marketing. The proposed
Petroleum Industry Competition Act of 1976 (S. 2387) would
have reorganized the petroleum industry by requiring that the
assets of the 18 largest U.S. vertically integrated oil companies
be divided into separately owned and controlled production,
transportation, refining and marketing segments.
In addition, the Congress considered proposals such as the
Petroleum Marketing Practices Act (H.R. 13000) to regulate the
marketing practices of the major petroleum companies. Early
versions of the bill would have prevented major companies from
increasing the volume of gasoline that they sold through
service stations they themselves operated. Later versions of
the bill were limited to preventing arbitrary cancellation or
failure to renew service station leases or franchises.
Issues
1. Is horizontal divestiture desirable?
2. Is vertical divestiture desirable?
3. Would some type of petroleum marketing legislation
be desirable?
Analysis
1. Horizontal Divestiture
Proponents of horizontal divestiture argue that control
of, say, coal and/or nuclear companies by the major oil companies
reduces competition between fuels. Opponents of such horizontal
divestiture argue that oil company capital flowing into coal or
GERALD
2
nuclear power companies makes a useful contribution to developing
these resources and provides additional competition within
those industries. It is also argued that if petroleum companies
are forbidden to own coal resources they will have only limited
incentive to do research on coal gasification or liquifaction,
thus reducing the chance of these technologies being commercial-
ized. From the viewpoint of the investor in such companies, it
is argued that being in several energy industries provides
additional diversification and makes it possible to employ the
capital resources of a firm in whatever part of the industry
that provides the highest return. A final argument is that any
horizontal divestiture program would involve some disruption of
general operations and impose unnecessary cost in money and
management time in dealing with lengthy and costly litigation.
2. Vertical Divestiture
Proponents of vertical divestiture argue that vertical
control reduces competition. For example, pipeline control may
prevent competition in refining and marketing, and control of
foreign oil may create difficulties for non-integrated refining
firms. Marketing firms frequently find themselves in the position
of buying the product they sell (for example, gasoline) from
a firm that also serves some customers directly. This has led
to frequent complaints that the independent operators are being
"squeezed." In addition, some simply feel that the major oil
companies are too large.
Arguments against vertical divestiture include the fact
that the current system results in economies. If is further
argued that refineries and pipelines can be better designed if
the quality and quantity of crude to be processed are known in
advance. It is further argued that vertical divestiture would
go far beyond current anti-trust law, involve reorganization of
well over $100 billion of assets, demand thousands of man hours
of top management and professional attention, and dramatically
increase investor uncertainty. It would do this at a time when
the oil companies' management and capital resources should be
focused on the achievement of reduced energy vulnerability.
From the point of view of improving our bargaining power vis-a-vis
the OPEC cartel, vertical divestiture would tend to weaken the
set of parties on our side of the transaction.
Further, concentration levels in the refining and marketing
areas of the petroleum industry have not changed significantly
in the last twenty years. For the largest eight firms, concen-
tration ratios for both refinery capacity and gasoline marketing
declined by 1% between 1955 and 1974. Concentration levels for
3
petroleum refining are less than the average for all U.S.
manufacturing, and new entry and expansion by independent refiners
has been appreciable over the last 15 years. From the point of
view of profits, petroleum firms have experienced an after tax
return on net worth comparable to that found in other industries,
and less than that of the chemical, drug and health related
industries. In the period 1965-72 the average return on net
worth for the 18 largest U.S. based petroleum companies was 11.9%
VS 12.4% for all industries excluding petroleum.
The consumer will normally benefit from vertical integration
because profit margins at each stage can be reduced. For
instance, a service station operator wishing to achieve a small
increase in volume will realize only the profits from the retailing
stage of the operation. A vertically integrated firm making the
same decision can look forward to increased volume for its retail,
wholesale, product transportation, refining, and crude transpor-
tation operations. The result will frequently be that an
integrated firm will decide to reduce prices when a chain of
separate firms would not. On the other hand, the greater incen-
tive to cut prices is what causes independents to feel that they
are being squeezed.
3. Petroleum Marketing Practices
The attempts to prevent petroleum companies from operating
their own gasoline stations in order to protect small operators
and limit their ability to cancel independent operators' leases
or franchises are all aimed at assuring competition at the
retail level and protecting small businessmen at a time when some
retrenchment at the retail level is inevitable.
As noted above, vertically integrated service station
operations can result in lower prices to the consumer. As a
practical matter, oil companies do not appear to eliminate
independent service station operators in favor of company owned
stations; independent station operators have proved themselves
as having a greater incentive to produce good results.
Schedule
Both vertical divestiture and petroleum marketing practices
legislation are expected to be introduced into the first session
of the 95th Congress.
GERALD