We must now compare these variables of FOB price and transportation with the price at which the oil sold in this country. Here it will be sufficient to look at the table and curve showing well-head prices for West Texas Sour, a comparable crude. See Chart II.

It is obvious that the price of domestic crude has little relation to the price of foreign crude, and has no relation at all to the changes in transportation cost. 1. Referring again to Appendix E, estimated FOB prices of imports from the Persian Gulf rose by $0.41 bbl from the 3rd quarter 1970 to the 4th quarter 1971 or by 30%; the American price rose by $0.24 bbl, less than 8%. The inner movements within the period had no relation, the whole American rise being accomplished by the end of 1970, and the price remaining perfectly steady thereafter, while most of the foreign rise was in 1971.

2. Treating the AFRA schedule, which reflects long-term transportation costs, we note that in 1970 freight rates rose from $1.08 bbl to $1.51 bbl or 40%; during the same period domestic oil rates remained virtually stationary. In 1971 the AFRA rates fell by one-fifth; American oil prices actually rose slightly at the beginning of the year and remained perfectly steady thereafter. Of course the picture is even sharper if spot rates are considered. The steady level of American crude prices persists against foreign freight rate fluctuations rising by as much as 200% and dropping by as much as 83% from the peak.

It seems certain that American prices, essentially steady throughout this pe riod, were responding to market forces independent of those affecting transportation costs or even prices of foreign crude. This is the conclusion of OEP itself in a report to the President. So entirely independent were they, that when foreign oil costs were forced up above the American price, oil from distant sources ceased to be imported. If the foreign costs had been the dominant force, not only would the foreign oil have been marketable here at a higher price, but it seems quite probable that the domestic price would have risen concomitantly. The reverse happened domestic supply was still available at the lower American price and it promptly filled the demand. When the market forces on foreign tonnage modified, and charter rates fell so sharply, the differential was reestablished, and the normal flow of quota oil resumed.

Another factor enters the picture.

The public does not consume bulk crude oil, but its products-gasoline, heating oils, jet fuels. In the short run, each of these markets is dominated by its own competitive conditions, in addition to crude prices. Thus, competition on the retail gasoline level has tended to limit price rises during the last decade. Crude is not the dominant factor here: between 1960-1971, according to the Independent Petroleum Association of America, the weighted average price of three main refined products (motor gasoline, kerosene, light fuel oil) east of California rose by $0.39 or 7.8%, to $5.36 bbl.; crude oil prices moved up $0.54, or 18.4%, to $3.18 bbl. See Appendix F. In the same period refinery operating cost alone was up by $0.19 bbl.

Examining the price movement of the refined products with specific reference to foreign tanker rates, it is obvious from Chart I and Appendix F that there was no correlation whatever. This is statistically verified.

We therefore assert with confidence that increases in transportation cost have no effect on the consumer's price under prevalent conditions.

Our confidence is fortified by a further fact. The actual increased cost from using American ships is far below the tremendous jumps in foreign freight rates in these years, which had no effect at all on American oil prices.

The same rapid fluctuations that we have just examined in freight rates from the Persian Gulf to the East Coast have characterized rates on the Caribbean/ U.S. run. For medium-size tankers they were at World Scale 100 in early 1967, averaging W62 for the first half year; they increased to a high of W200 by September 1967. After receding to more normal levels around W100 in 1968 and 1969, rates rose again in 1970 with the spot rate reaching a peak of W302 in November. Thereafter, a steep drop to W61 in September 1971 took place, as tanker supply grew to meet and somewhat exceed demand. It is of interest to note that during this five-year period, efficient American tankers, if available, could have been profitably employed in the spot Caribbean market about onethird of the time. Long-term chartered tonnage shows a somewhat more stable trend, although also subject to considerable fluctuation.

The Caribbean and other shorthaul origins in the past three years still provided more than 50% of our crude imports, and the American flag tanker fleet, as it now stands, was mainly intended for short-haul operation. Economic forces

would continue to compel its utilization in the range of its maximum efficiency even after enactment of the bill. Of course, provision of adequate port facilities would allow construction of a fleet of VLCCs the rates for which would be much lower on the long runs than the present fleet can afford. At the same time, it must not be forgotten that the Cabinet Task Force urged concentration on Western Hemisphere sources out of regard for defense.

Assuming that American ships at least for the near future will thus concentrate in the Caribbean, North Africa and Nigeria, and that relatively efficient vessels of 50,000 dwt and larger will be utilized (see Appendix H), the following estimates can be made:

1 Source: U.S. Department of the Interior, "Worldwide Crude Oil Prices, Fall 1971". Data are for September 1971. 2 Rate for a 60,000 deadweight ton U.S. tanker.

Note: Weighted average increase in transportation cost equals 11 cents.

$0.34 .78

.90

In sum, the use of American vessels to carry 50% of crude imports from the three sources yields an average increase in transportation costs of the order of 11c per barrel (weighted according to actual average U.S. imports in 1969-1971). Not only is this cost modest in itself, but it is below the sharp swings witnessed in foreign charter rate. Increases in foreign freight rates in a short time of 50¢ to $1.50 bbl have been shown without the smallest visible effect on prices, especially since these prices have included the American freight rate for a decade. There is a final test of the validity of our conclusion.

During 1971, about 338,000 dwt of American shipping actually engaged in the foreign trade (see Appendix G), principally the short Caribbean run. This is tonnage of the integrated oil companies. There was also some additional American tonnage chartered by the oil companies which was used in the same way. As these Americans vessels cost more to operate than foreign tankers, their use produces an added freight differential. Is it as some argue-passed on to the consumer in higher oil prices; or is it-as we assert-absorbed without effect on oil prices?

Let us first suppose that the freight differential is in whole or in part added to the oil price. At current international freight rates independent tankers cannot recover out-of-pocket expenses (let alone capital costs), and even our more modern units are driven into layup. Oil company tonnage the argument goescan afford to carry this cargo even in generally less efficient vessels and at much higher cost because oil companies can raise oil prices to the extent of the added

cost. Independent owners operate in a highly competitive climate, and must look to tanker operation as their sole source of revenue. At low international freight rates they are displaced from the foreign market. But if oil company tankers can afford to carry foreign oil at low rates while the more efficient independent tankers cannot, it is only because the former-thanks to a high measure of vertical integration and market power-can transfer the added cost to the consumer.

Thus, two corollaries derive from the proposition that the added cost of using U.S. tankers would increase the price of oil:

1. The price increase could occur if, and only if, the seller's organization is vertically integrated and possesses a significant degree of market power, and 2. If this were so, the character of the industrial organization it would imply would inevitably lead to the economic displacement of independent tankers—a competitive oil transportation service-thereby causing a further reduction of competition in the oil business.

The second proposition, that the freight differential is not transferred to the consumer, of course proves our claim. In this case the freight differential is in general absorbed by the integrated oil company and debited against part of the ticket value which inures to the import quota holder. Quite predictably, this proposition is confirmed by inspection of crude and refined oil prices during the relevant frames. These series, as we have seen, remained invariant in the face of considerable fluctuation of the volume of U.S. tanker tonnage engaged in the foreign trade.*

PART THREE-BALANCE OF PAYMENTS

The Committee will wish to estimate the cost of a program that reserves carriage of a substantial part of future U.S. petroleum imports to American-flag tankers. There is no cost to the government. If we are right, there is no cost to the consuming public. The sole effect is to transfer to the carrier sector of the industry a part of the grant the government has previously conferred on the refining sector.

But the Committee will also wish to estimate the cost of not having such a program. This cost will be reflected in the balance of payments. It is clear it will be heavy.

The volume and cost of tanker transportation required in the coming years will be a function of (1) the quantity of waterborne oil imports; (2) the sources of the oil and the relative importance of the suppliers; and (3) the cost of constructing, financing and operating a sizable new tanker tonnage. Under these influences, the negative balance of payments will be expanding greatly in the next decade.

According to some expectations, offshore imports of oil may reach 13 million B/D by 1985, compared with less than 3 million B/D in 1970. Waterborne imports of crude oil alone may exceed 8 million B/D; in 1970 this movement stood at 650,000 B/D.

Compounding the effect would be increased reliance on more distant sources of oil supply in the future, particularly from the Persian Gulf. A 60,000 DWT tanker discharging on the east coast can carry about 1.1 million tons of cargo annually from the Caribbean, but only 300,000 tons from the Persian Gulf. Thus, five times as much capacity is necessary to move a given volume of oil from the Persian Gulf as from the nearest offshore source.

Moreover, the cost of operating and constructing foreign-flag tankers, while still materially below that of the U.S., has been increasing at a high rate. Construction costs in particular have risen, in recent years, more than 50% for a VLCC. Our almost total dependence on foreign-flag vessels for oil imports makes this a significant and growing negative factor in our balance. Sophisticated payments analysis requires examination of reflows attendant upon expenditures. an elaborate study in itself.

In estimating the impact of the bill on the balance of payments, we have limited our analysis to tanker transportation alone, because we believe all other propensities to offset will be experienced regardless of vessel flag. This makes it unnecessary to examine reflows anticipated at different levels, which are a function of the basic import rather than of its carriage. It must not be overlooked that on transportation account alone, the entire negative factor at

The Wholesale Index for Crude Prices (1967-100) remained at 113.2 from December 1970 to date while the index for refined products actually declined from 107.3 in August 1971 to 106.1 in December 1971.

present is tanker transportation. In 1970, the negative balance was $61 million; but tanker payments accounted for an outflow of $393 million; without them, sea transportation would have been a positive factor of $332 million. This alone justifies concentration on oil transport.

Our analysis has also been restricted to the estimated savings on crude oilno allowance was made for the heavy offshore transportation of residual oil, or of refined products, naphtha, or LNG. All estimates are expressed in 1971 dollars (no allowance is made for inflation). Also, it was assumed that the U.S. by 1980 would be typically utilizing 100,000 DWT vessels, and 250,000 DWT vessels by 1985. This presumes that a sufficient number of suitable terminals would be available, and that less efficient vessels still in active service would be diverted to other appropriate trade.

The Balance of Payments appendix (Appendices I-XIV) contains our calculations.

We estimate that the transportation cost of crude oil alone, barring passage of this bill, will generate an annual deficit of more than $1.2 billion in 1980 and $2 billion in 1985. The cumulative deficit for the period 1975-1985 would be $14 billion.

ESTIMATE OF BALANCE OF PAYMENTS DEFICIT ON TANKER TRANSPORTATION ACCOUNT, WITH AND WITHOUT 50 PERCENT U.S.-FLAG CARRIAGE

1 This compares with the projected increment of more than 90,000,000 d.w.t. by 1985 published by the National Petroleum Council and a forecast of 125,000,000 for total U.S. tanker demand in that year by the Maritime Administration.

However, enactment of the bill would save about 40%, approximately $500 million in 1980, increasing to nearly $800 million in 1985.

These estimates are heavily understated. It must be remembered that they exclude the enormous inflow of residual oil, and take no account of the large quotas for naphtha that are contemplated.

Tanker rates are also volatile, as we have seen, and susceptible to extreme rises during periods of international tension. Although oil company fleets on a worldwide basis account for about 35% of the total, and perhaps 80% with additional tonnage chartered to them on a long-term basis, the impact of a sharply rising spot market on average transportation cost cannot be minimized. In the span of one year-1970-the average transportation cost on all charters rose by more than 50%.

In the past, the effect of rising foreign tanker rates on the U.S. was minimized by our small dependence on foreign oil and our large reserve crude capacity in the Gulf Coast. When high tanker rates made it more economical to increase domestic rude output and reduce imports, such a substitution occurred. Now, unless reserve capacity is magnified, or dependence on foreign carriage is reduced, the U.S. will bear the full weight on its international account of any sizable increase in tanker rates.

Cumulative deficits of the order suggested will be difficult to offset in the current state of the nation's monetary affairs, and of the sharp worldwide competition facing American exporters.

CONCLUSION

We have endeavored to adduce the proofs that the relief which the SpongBeall bill would afford to a self-reliant but now hard-pressed sector of American shipping would entail a minimum of social costs, whether to the government or the public:

A. It involves no subsidy outlay by the government, unlike the other forms of cargo preference on the statute books.

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B. It involves not cost to the consuming public, because the higher costs of using American shipping would not be passed on.

C. It only involves transferring to shipping a small part of the benefit, the windfall, already conferred on other sectors of the oil industry by the quota system. At an average ticket value of $1 bbl, the windfall amounts to over $300 million per year for crude oil; only $33 million would inure to American carriers at their higher costs. This loss is temporary, since the expected large increase in imports will quickly restore and even augment their profits from this source. D. The departure it involves from free international shipping other nations long ago took on economic and military grounds fully applicable to us. No other nation is content to carry on its national fleet so small a fraction of this critical commodity.

There is a general observation concerning the 1970 Act.

The long-run viability of an American fleet competing in foreign trade will depend heavily upon the use of VLCCs to transport crude oil from the Middle East. Fortunately, with the passage of the Merchant Marine Act of 1970, the availability of construction subsidies that equalize domestic and foreign shipbuilding costs will go far toward minimizing the cost differential of a typical 250,000 dwt VLCC.

Assuming that the construction subsidy would equalize U.S. and foreign building and capital costs, we calculate that the weighted average increase in transportation costs by VLCCs would be significantly less than $0.11 bbl even with considerably longer voyages and no operating subsidies. Contingent upon port improvements to handle VLCCs, participation by U.S. tankers on voyages from the Middle East will not present serious problems. Of course, to the degree that the construction subsidy fails to fully offset the difference in building costs (particularly in the case of existing foreign-flag VLCCs, built prior to the recent rise in prices of new buildings) or to the extent that world tanker rates are depressed, the prospective incremental costs of using American ships would be somewhat enlarged. The possible availability of operating subsidy, at present shrouded in some doubt, will help narrow the gap. Even so, market rates will be decisive.

Of course, it should be made clear that direct subsidy is not to be superadded to cargo preference, even though in this case there would be no double subsidy, since the government will not be paying any part of the freight rate. Cargo preference is the only way to protect the current fleet, built and on order without subsidy. When and if the shift is made to VLCCs, the subsidy provided by the 1970 Act has a sound possibility of success.

Dr. LAURENCE R. KLEIN,

MARITIME OVERSEAS CORPORATION,

New York, N.Y., January 10, 1972.

University Professor, Department of Economics, Wharton School of Finance and Commerce, Philadelphia, Pa.

DEAR DR. KLEIN: We solicit your views on whether, in the circumstances described below, an increase in the transportation cost of a portion of crude oil imported to the United States East Coast from overseas (i.e., excluding Canada and Mexico) under the present quota system will of itself raise the oil price paid by East Coast consumers.

We express the order of magnitude of the relevant factors by using the most recent data available. All U.S. crude imports are strictly limited by a mandatory oil quota system. Allocations of such import quotas for the East Coast in 1971 averaged 800,000 barrels per day (B/D) compared with total U.S. demand of about 15 million B/D and East Coast demand of about 6 million B/D. Import quota licenses allocated, among others, to domestic coastal and inland refiners and to petrochemical producers are themselves freely exchangeable with a value related to the difference between the East Coast price of crude oil and the landed cost of foreign crude.

As of September, 1971, the Department of the Interior reports the East Coast crude price at $3.83 to $4.02 per barrel depending on quality. It also calculates the East Coast landed cost of overseas crude at between $2.15 and $2.78 per barrel for lower quality oil and between $2.57 and $3.11 per barrel for higher quality oil. The price spread for each quality derives from differences in point of origin and in tanker charter rates. The resulting difference between the East Coast crude price and the overseas crude landed cost ranges between $0.91 to $1.68 per barrel.