My AEI colleague Mark J. Perry has written a short essay arguing that “Trump’s Energy Policy Is Deeply Flawed,” the central themes of which are:

• The lesson that “we learned in the 1970s” is that “growing dependence on OPEC oil . . . would do more harm than good.”
• An appeal to Saudi Arabia to increase oil production combined with reducing Iran’s oil exports to zero “adds up to shortages down the road.”
• Trump should stress “renewed efforts at energy conservation.”
• We should not trade “energy security for additional supplies from the Persian Gulf.”

These arguments are rather uncharacteristic of Mark, truly a first-rate economist and policy thinker. Let us begin with a first principle: The magnitude or degree of “dependence” on foreign sources of oil—even sources with a relatively high likelihood of supply disruption—is irrelevant. This basic analytic truth is driven by the international nature of the world oil market, in which there can be only one price, abstracting from such minor complications as differing transport costs, shifting exchange rates, and differing refinery characteristics. Accordingly, nations that produce all their own oil (“self-sufficiency”) and those that import all of their oil (complete import dependence) pay the same international price for oil and confront the same increases in that price caused by supply disruptions or any other conditions. The ensuing effects on exchange rates and other second-order parameters might differ, but the magnitude or degree of import dependence says nothing, literally, about vulnerability to the effects of supply disruptions. Consider the UK (virtually energy independent) and Japan (almost wholly dependent upon imported oil): The respective impacts of changes in international oil prices are identical.

Competition of ideas: Read Mark Perry’s original piece: Trump’s Energy Policy Is Deeply Flawed

What about embargoes? Analytically, an embargo is an attempt by a (group of) producer(s) to impose a higher price on one given (set of) buyer(s) than others. But remember our one-price principle: That dual price system cannot persist in the face of market competition. Those paying lower prices will have incentives to sell oil to those against whom the embargo is aimed, a dynamic process that equalizes prices across importers. Unless a (Middle East) oil exporter can impose a naval blockade against the targets of the embargo, the embargo cannot work as a matter of basic economics, although it might further some political purposes.

An engineer shows visitors a model of Saudi Aramco’s maritime yard in Ras al Khair, Saudi Arabia, November 29, 2016. Reuters

Consider the experience in 1973 and 1979, years with production cutbacks by Arab OPEC and long gasoline lines and market chaos in the US. The 1973 embargo was aimed at the US, the Netherlands, and a few other importers. The targets faced the same (higher) international prices as all other nations regardless of their degree of import dependence, and were able to buy as much oil on the international market as they chose. As a form of punishment for the US and the other targets, the embargo was an utter failure. But the federal government imposed price controls and allocation restrictions in the US, yielding the queues and other distortions afflicting the market.

Recall that there was no embargo in 1979, but there was an international supply cutback in the wake of the Iranian revolution. Accordingly, prices increased, but US price and allocation controls again yielded gasoline lines and market chaos. And so Mark’s argument that growing dependence on OPEC oil somehow would result in adverse effects, the nature of which is entirely unclear, is deeply problematic. Precisely what does Mark have in mind?

Next: An appeal to Saudi Arabia to increase oil production combined with reducing Iran’s oil exports to zero “adds up to shortages down the road.” As an aside, the word “shortage” has a specific meaning in economic analysis: an excess of the quantity demanded over the quantity supplied during some relevant time period. Any such condition should result in a price increase sufficient to clear the market—that is, to make the quantities demanded and supplied equal, reducing the “shortage” to zero. If a price increase defines a “shortage,” then we are in very ambiguous territory indeed, as any existing market-clearing price in principle could be lower, so that any price in any market higher than zero is evidence of a “shortage.” That obviously is not what Mark means, but the meaning of “shortages down the road” remains obscure.

More generally, an increase in Saudi oil production analytically would be an increase in resource availability for the US economy in the aggregate. That emphatically is a good thing as long as we allow individual preferences to determine “value” under the clear empirical truth that more is preferred to less.

Perhaps Mark means that Saudi excess production capacity would be insufficient to prevent price increases were Iranian exports forced to zero, presumably with military action. Saudi Aramco claims that its excess production capacity is 2 million barrels per day (mbd), while Iranian exports are about 2–2.5 mbd. Suppose Saudi excess production capacity is 1 mbd, so that a reduction of Iranian exports to zero would reduce international oil supplies by 1.5 mbd. World crude oil production is about 100 mbd, so that this hypothetical cut would be about 1.5 percent.  Under a conservative assumption about demand conditions (a demand “elasticity” of –0.1), that would yield a price increase of about 15 percent, which assumes away increased production other than by the Saudis and which would decline over time. Given a preexisting market price of $75 per barrel, prices would rise initially to about $86. Would that be a crisis?

Moreover, Mark seems to believe that no benefits would accrue from a cutoff of Iranian oil exports. That is far from clear even in the context of the oil market: The Iranian military threat to the rest of the Persian Gulf producers can be expected to have reduced investment incentives with respect to the maintenance or increase in production capacity, other things held constant. To the extent that an export embargo imposed on the Iranian regime might hasten its demise or reduce its foreign adventurism and terrorist activity—surely the effect would not be zero—the longer-run effect on the world oil market might be quite salutary. And this is apart from the broader foreign and security policy benefits that might accrue upon the replacement of the Iranian regime by something less inclined to engage in terrorism, military action elsewhere in the Middle East, etc. Mark’s argument seems to shunt all this aside.

With respect to “renewed efforts at energy conservation,” I do not understand how private incentives to “conserve” energy differ from socially efficient incentives and therefore precisely why Trump should stress such efforts. “Conservation” means a shift in the consumption of some (substantial) amount of “depletable” resources from the current time period into some future period; given that the market is not consuming all energy resources in the current time period, the market is “conserving.” Is there an argument to the effect that the market is not conserving enough? Mark seems to believe so, but he does not tell us why, and, more broadly, the analytic basis underlying the widespread applause for more “conservation” remains entirely obscure. In brief, the market has powerful incentives to allocate the consumption of depletable resources over time so that the expected economic return to conservation—primarily the price of the given resource—rises at the market rate of interest.

Note that the major recent disincentive to conserve has been the corporation income tax, which essentially has forced much of the private sector to use a discount rate higher than the social discount rate. The cut in the corporate income tax rate enacted in the recent tax legislation is consistent with enhanced incentives to “conserve,” for which Trump deserves substantial credit.

And so on. In the public debate, “energy security” has been defined poorly for decades, and the argument that such security is inconsistent with additional supplies from the Saudis simply is incorrect. There just seems to be something about oil that leads otherwise very smart people to endorse weak arguments, an unfortunate reality with which we have many decades of experience. Is it global warming?