Furthermore, let me just say that the reliance on either a gasoline tax, or a tax on imported oil, to reduce U.S. consumption to lower the world oil price where there is neither a Malthusian shortage nor an Arab embargo is unwise. Such a conservation policy that merely drives up the price to the consumer in order to reduce the quantity demand of imported oil will not alter the price inelasticity of demand. The cartel will not break as a result of the Arabs squabbling over the spoils. As an economist the obvious action is to break or change the price elasticity of demand for oil, and that requires a change in the availability of substitutes rather than just making oil more expensive. From the economist's standpoint, this can only be done by making alternative sources of energy available which are profitable to produce at less than cartel prices, and whose production management are not controlled by business firms who have a vested interest in maintaining the current monopoly price in fossil fuels.

In other words, the cartel is likely to be broken for economic reasons only when significant additional supplies exist which are not under production controls of OPEC nations or companies which have a large vested interest in maintaining current high wellhead prices in order to preserve the capital value of their large underground reserves. S. 489 is therefore an important step in the proper direction.

Moreover, if we were to adopt the Ford policy of driving up oil import taxes and so on, it would merely mean, for the man in the street, that the U.S. Government has joined the OPEC ripoff as far as the consumer is concerned, whether the Ford administration promises to return these taxes to the American public via a reduction of other taxes, thereby redistributing income from consumers of energy to other taxpayers. If such a redistribution is socially desirable, then it should be accomplished via reforming the Federal tax structure independent of the problem of the energy crisis.

The primary objective of any rational energy policy must be to reverse, and hopefully eliminate, the recent growth of monopoly power in the international and domestic energy-producing industries; for it is the growth of monopoly power and not a Malthusian shortage of resources that has created the energy crisis. Questions of redistributing income and questions of taxing to prevent pollution are very important and meaningful questions, but they should not be confused with the energy crisis.

For the United States to either self-embargo the American consumer via import quotas or higher taxes in order to break the cartel when there are extensive low-cost fuel supplies readily available, is a halfbaked solution to a critical problem. One woud hope that the consuming nations woud leave embargos and higher oil taxes as a policy for the Arabs; for such policies must involve unnecessary hardships for

consumers.

It is essential to recognize that what is required, if we are to break the cartel, is a policy which makes the demand for OPEC oil price elastic. If the demand was price elastic, then some members of the OPEC group would realize they can increase their earnings by lowering the wellhead price. A price elastic demand for an industry whose current prices are substantially above real production costs, and where additional low-cost supplies are technologically availabe, will automatically unleash forces which will reduce monopoly power. Essential

to such a policy is an existence of large alternative sources of supply produced by independent producers at prices below the current supply price of oil. I go into the economic theory of fossil fuel production and the importance of these alternatives in economic theory.

In essence, what the theory says is that the rate of production flow per-annum depends upon the producer's vision of his profits in the future vis-a-vis his profits today. Every barrel brought out today earns a certain profit. If you keep it in the ground, someday in the future it will bring out a certain dollar profit. The producer compares the discounted future profits with the current profit. If he thinks that it is going to be more profitable in the future than in the present, he will retard current production. If he thinks it is going to be less profitable in the future than the current, he will accelerate current production. This is what economists call user costs.

In a world where the future is uncertain, what we have is a bootstrap theory of the time rate of exploration of fossil fuels; current expectations of producers about future prices relative to costs play the pivotal role.

If you have competition in such markets, you will have stability of prices and production flow only if the producers vision that there should be stability. If they think that the future will not be significantly different than today or the recent past, then this average view is that user costs are zero, and the rate of flow of production will be relatively stable over time. If, however, they expect significant change, then they will accelerate or decelerate.

For example, in the 1930's with the discovery of the huge Texas fields, there was expectations that price would collapse relative to costs of production. What happened then was production expanded very rapidly currently to avoid the collapse that was expected, and expectations made it so. This is a very important thing what you expect to occur, you will then take actions. If enough people have the same set of expectations, this is exactly what will happen.

Between 1972 and 1975, there was a growing rate of monopoly. Price relative to marginal cost was expanding internationally. This led many people to believe that the domestic price would rise relative to cost of production, and then that means user costs are positive and they would hold back on supplies or retard production.

As long as we have price regulation, that expectation is still around because deregulation will mean large rises in prices relative to cost, and, therefore, it would be in the interests of the entrepreneur to hold back on production.

Senator ABOUREZK. Do you know what the present cost of producing a barrel of oil domestically is?

Dr. DAVIDSON. On an average you mean? Somewhere around $4 a barrel; $4 to $5 a barrel. On the margin it is much higher. There are a lot of low-cost oils as well. A lot of the cost depends upon the lease bonus that one pays or has paid in the past. The lease bonus is a reflection of what you think the oil is worth in the ground. If you think it is going to go up a lot, you will pay a large lease bonus. Then when the cost comes out, and the oil comes out, a large part of that cost will be reflected in the lease bonus.

If you talked about production costs, it would even be lower. But if you include the lease bonus in it—

Senator ABOUREZK. Exclude the lease bonus and give us an estimate of average production cost.

Dr. DAVIDSON. OK. Because I have some statistics on how much the lease bonus is onshore and offshore as a percentage of total costs, and it is an interesting number.

Senator ABOUREZK. Yes, we would like to have it for the record as well.

Dr. DAVIDSON. Yes, I can make them available.1 If we get right from the history of the east Texas fields where user costs drove the price very far down, it required Government action to stabilize this industry. We had the Connally Hot Oil Act, we had State prorationing, we had import quotas, et cetera, all of which provided stability. And one must remember that this is an industry-certainly since the 1930'swhich has not had very much free competition in oil and gas production.

Current events have created an environment where now domestic producers and property owners expect rapidly rising wellhead prices not only of oil and gas, but of coal. If coal is a division of an oil company, their coal division is going to be required to earn equal returns for the other divisions. If oil is very profitable, the pressure will be on management of the coal division to make coal very profitable.

Senator ABOUREZK. Well, certainly, they will not allow their coal division to sell coal on a cheaper BTU equivalent than they are oil?

Dr. DAVIDSON. That is quite right. What will happen is that coal will continually catch up. When you deregulate old oil and if you deregulate natural gas, this will just put another spoke in pushing up the price of coal. In October, when OPEC turns the cartel screw again, we will see the price of domestic production rising in all of these industries again.

This will continually occur because the demand is very price inelastic because the competitive fuels are controlled by the same growing monopolies, either the OPEC countries or other nations like Canada and Mexico, who find it in their interest to join the OPEC. Canada is the blue-eyed Arabs to the north of us. Mexicans have announced they have 20 billion barrels of crude reserves now, but they will raise the price of oil exported with OPEC even if they are not a member of OPEC. They have already indicated that, according to a news article. So what one can see is that there is a control of this market, and that is being ultimately controlled by the shieks in the gulf coast.

Now, John Maynard Keynes once pointed out that economic progress depends on the spirit of enterprise which, in this context, refers to the activity of producers motivated by a desire for action rather than inaction in operating under stable conditions to produce a steady flow of output. Keynes recognized that in an uncertain world, some men's proclivities would always turn to the possibility of making speculative

1 The following answer was subsequently submitted:

Lease bonus costs are a substantial portion of E. & D. Data provided in a recent FPC opinion indicates that for the Nation as a whole, one-third of total E. & D. costs for successful nonassociated gas properties are lease acquisition costs. If dry hole costs are included in the calculations, the figure is approximately one-fifth of total E. & D. costs. Similar information was not readily available for oil properties. By making some reasonable assumptions and using statistics provided by USGS and World Oil, I estimate that lease bonuses in 1972 varv from a low of 25 percent to a high of 65 percent of total E. & D. for offshore oil properties. Accordingly I would think that a rough estimate of between one-fourth to one-third is representative for all oil and gas properties in the United States.

profits via supply manipulations. As he noted, "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation."

The current supply situation for oil and gas and the cartelized supply of fossil fuels around the world is due to enterprise becoming engulfed in speculative as well as monopoly practices. Thus, what is involved here is to get oil and gas producers to believe that the monopolies that they currently have cannot long exist. That will create a negative user cost, and it will encourage current production.

The way this is done is via the price elasticity of demand, Senator, which is a complicated economic tool. In essence, when the price goes up, if demand is price inelastic, as you raise the price, total revenue will rise. Therefore, if you are faced with that situation, it is highly desirable for you to raise the price. If demand is price elastic and you lower the price, total revenue will rise, while if you raise the price, total revenue will fall, then it is less desirable to raise prices.

The price elasticity of demand depends upon two things. It is a weighted average of income elasticities and substitution elasticities. This is a technical concept but I do not want to avoid it-the income elasticity demand, even the oil companies admit, are approximately one; that is, when your income goes up by 1 percent, you will buy approximately 1 percent more fossil fuels. The substitution elasticity depends on an alternative source of supply. If there are no alternatives who are willing to undersell, then the substitution elasticity is very small, and so the total price elasticity is very small. That is the situation we have now.

A high-substitution elasticity requires independent producers who have no major vested interest in maintaining or improving the capitalized value of oil crude reserves in the ground. This requires breaking up the conglomerate energy companies in order to permit alternative energy supplies to be produced by independent firms that can have expectations and objectives which differ from the major oil and gas producers.

It also requires, it seems to me, bringing in the independents, accelerating leasing, encouraging rapid rates of exploitation, and other activities which are not expressly involved here at this meeting.

To point out that what is involved here is, in essence, the availability of substitutes and I think you again, when you had your widget-andgidget example, were trying to provide the proper economic theory. If we have an alternative substitute, which can be produced at less than the cartel price, if only there were independent producers. Now, the cartel and the domestic producers of oil and gas value the oil and gas in the ground at a certain price, say $11 a barrel. That is the capitalized value, that is their assets.

If the price of oil falls, they will take a capital loss on all that underground oil. If coal were to come in at a lower price, then that would imply a capital loss on the value of assets in the oil divisions of the same company.

A rational producer observing that one of his actions causes the value of some of his assets to be lowered would not engage in selling that asset, and not take that capital loss. On the other hand, if these were independent producers, the fellow producing coal would have

no compunction about worrying about imposing a capital loss on another industry.

In fact, in economic theory and competitive theory we say that is what progress is all about. The guy who builds the better mousetrap can undersell the other guy, and that means the other guy may lose money or even go bankrupt, but the consumer gains.

As long as the oil and coal producers are kept independent, then the consumer will gain although it may involve certain capital loss on assets of the oil company. As long as they are under the same hat, so to speak, the decider is not going to say, "All right, let our coal division undersell our oil division, and we will take a loss on oil; we will make it up on the coal.”

It is obvious the object of the game for the conglomerate is to get a single price per BTU for all these things and maximize the profits of producing them all. Therefore, it seems to me that this bill is an essential to creating a competitive environment. Unless we do that, we are likely to be left with the old cartel running the energy industry. In fact you presented statistics, as others have, so I do not need to elaborate although there is a footnote here which gives all sorts of concentration ratios-which show that the control is much greater now, than it was 5 or 10 years ago when Continental first started taking over Consolidated Coal. I am in your hands now, Senator.

Senator ABOUREZK. Let me tell you, that is a good statement to begin with.

Dr. DAVIDSON. Thank you.

Senator ABOUREZK. Being an Arab, myself, I am not sure I like all the pokes you take at Arabs in here, but your economic theory is untouchable. [Laughter.]

Dr. DAVIDSON. Let me say, that if I was working for the industry I would suggest that they join them too. [Laughter.]

Senator ABOUREZK. They join OPEC?

Dr. DAVIDSON. Yes.

Senator ABOUREZK. Well, one thing that I think the Arabs do, before I get into the questioning, is that they sell their products very cheaply to their own people and charge high prices to non-Arabs. And we Americans have a lot to learn from that, we just do the opposite. We gouge our own people, and whatever we do to outsiders I am not sure, but

Dr. DAVIDSON. I have a number of students who are Arab graduate students and find that this is only good because, they argue, that in the past the West exploited the East.

Well, maybe the West has exploited the East. I did not want to get into that question. But the question merely is, from the West standpoint, it is not the Arabs so much as our own producers who-and multinational companies who are aiding this, aiding and abetting them. And it is an argument about the distribution of income-clear and simple.

Senator ABOUREZK. I think that is true. Some economists, Dr. Davidson, after looking at the concentration ratios and the overall energy industry, have concluded that there is insufficient control by any group, or group of firms in order for there to be the kind of monopolistic withholding that you have described in your prepared remarks. Would you expand on that with your opinion?