Economic Cost of U. S. Crude Oil Production

Abstract

The economic cost of U. S. domestic oil averaged about $2.00 a barrel, compared with about $2.50 for imports. The disparities between prices and economic costs result from such influences as transfer payments, taxation, balance of payments, a "national security insurance premium," and underpricing of by-product natural gas. Present tax laws partially compensated for the disparities. Half of U. S. domestic production would have been forgone without the depletion allowance or the expensing of dry holes and intangible drilling costs. Introduction The cost of domestic crude oil has figured importantly in discussions of U. S. energy policy since the mid-1950's. This paper will focus upon measuring the economic costs of domestic oil vs imported oil and relating the size of that domestic supply to alternative income tax systems. In Part One we shall estimate the economic costs of finding and producing U. S. crude oil for the base year 1965, excluding any transfer payments such as royalties or lease bonuses and omitting all income tax effects, whether liabilities or offsets. This calculation evaluates the economic resources that were consumed in producing that oil supply, which then becomes the point of reference for examining the effects of tax point of reference for examining the effects of tax preferences, import restrictions, or other policy preferences, import restrictions, or other policy instruments. In Part Two the economic cost of imports is derived by correcting the price of imported oil for two significant externalities-the balance-of-payments impact and the economic risk borne implicitly by the consumer of oil imported from insecure sources. The "dollar drain" generated by incremental oil imports is measured, and a scarcity premium, or implicit devaluation, is assigned to the U. S. dollar, reflecting the fact that a dollar paid abroad is more costly to the U. S. economy than one paid domestically. This is a device long used in project evaluation in underdeveloped countries whose currencies were officially overvalued. The security premium or risk premium is approximated as the cost of maintaining crude oil inventories or security stockpiles large enough to bridge "probable" interruptions in imported supply. Such a measure, if deemed adequate, would render imported oil equivalent to domestic oil, and the inventory cost thus reflects the hidden differences in "value". Comparison of the economic costs of imports and domestic supply, as appropriately derived, leads to the conclusion that imports were probably more costly than domestic oil, even though prices of imports were less. The role of income tax policy in fostering domestic production is treated in Part Three. For a given price production is treated in Part Three. For a given price level, the effect of different tax regimes upon supply is determined, considering (1) elimination of the percentage depletion allowance; (2) capitalizing, of percentage depletion allowance; (2) capitalizing, of intangible drilling costs; (3) capitalizing of dry holes; and (4) combinations of these. The U. S. domestic crude oil supply is shown to be extremely sensitive to tax incentives, whence it is finally concluded in Part Four that the mandatory restrictions on imports, Part Four that the mandatory restrictions on imports, even though far from optionally designed, implied no significant net cost to U. S. economy and that the tax environment was indispensable in facilitating this balance. JPT P. 643