Senator BRADLEY. The question that I am often asked is, "Terrif ic; let us fill the reserves, let us build the stockpile." Then people say, "But we will never draw them down." Mr. Verleger has given us one reason why we will never draw them down, because people figure that the payoff will be bigger tomorrow.

You have given us a second reason why they won't draw them down, because expectations of a cutoff, increasing in size or lengthening in duration, argues for keeping it full.

Will you give us some guidelines as to how we could assure that stocks will be optimally drawn down? Yours is a governmental judgment—and yours is a private sector judgment. How can we assure ourselves that we can actually use this tool and it is not just like another 100 missiles and another 100 missiles and another 100 missiles all acquired in the name of deterrence.

Mr. VERLEGER. Let me interject 1 second on the question of the length of the war. I think the decision was proffered to draw down stocks at this point as the war remains isolated between Iran and Iraq.

Given the supply/demand situation in the world next year, with recession in Western Europe, recession quite possibly here, we can get by as long as Saudi Arabia continues to produce at its present volume. We may not even need all of Saudi production. The world supply situation was in glut prospectively in 1981 before the war began. Given a recession, there is no reason why the market won't stay in balance.

Senator BRADLEY. If you believe what Sheik Yamani said in the press, that Iran and Iraq will be producing as much as they were before the Iraqi-Iranian war by the fall of 1981-

Mr. VERLEGER. OPEC will have a serious problem because they will have to accommodate roughly 51⁄2 to 6 million barrels a day of oil.

Senator BRADLEY. Isn't that precisely at the time we should move to fill?

Mr. VERLEGER. To fill the strategic petroleum reserve.

Senator BRADLEY. I want you to address the question of how we can assure a drawdown policy that maximizes public interest.

Mr. VERLEGER. I suggested one, by the fee on oil imports. The other question is on the strategic petroleum reserve. In all other strategic commodities the Government drawdown strategy has always been come a crisis, hold on to it. Morry Adelman has suggested to take the spot market price internally and always be willing to sell it at that price plus 20 or 30 percent.

It turns out that the literature on stock selling and stock drawdowns for stocks of wheat and other commodities have produced rules on how you should go about selling, what price rules, what quantity rules you should set. Those people who have looked at the literature-and I have only skimmed it-say it is extremely compli

cated.

Senator BRADLEY. You are saying that you make the strategic petroleum reserve available to combat high spot prices by saying you will sell it to anyone who wants to purchase it at spot plus 30 percent?

Mr. VERLEGER. Or 20 percent. Last month's spot. That is Adelman's suggestion. Others have suggested that that rule-—

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Senator BRADLEY. Wouldn't the first purchase on that basis suddenly blow the roof off the spot market?

Mr. ALM. That is the possibility. I was going to make a number of observations, starting with an observation about drawing down stocks.

I think Phil has done excellent work, but I would argue that decisions on building and drawing down stocks are more than economic decisions; they are decisions on perceptions of the way the world is going.

Certainly, one cost of a big stock pile is an attempt by oil companies to assure maintenance of their supply channels, even to the point of building up large stocks. Of course, the fact of decontrol is another reason; they know that future oil prices will be higher. If you look at the U.S. pattern-and the pattern of stock drawdown is different in every country-indeed we have been drawing down stocks. Our stocks right now in total stocks are down to 1.35 billion barrels. They have been much higher, almost 25 million barrels higher. Our stocks are being drawn down.

You have a short-term problem and long-term problem. If you have a large strategic petroleum reserve, which is what we all would like to see happen, then you have a strategic consideration whether that becomes your first line of defense against increases in spot market prices.

If there is one lesson from Iran, it is that you need to use the stockpiling in a very predictable way. I would argue that whatever the trigger is in terms of deciding that there is an interruption, you would want to then indicate publicly what the withdrawal from the strategic petroleum reserve would be for some time in the future as a way of reducing panic.

Now, waiting for a strategic petroleum reserve, you have the question of what do you do to encourage private stock buildup and drawdown. The first question is buildup. This is obviously not the time to build up private stocks. When this war terminates and production is resumed-and I assume both Iraq and Iran will want to build up production quite quickly after the war because of its economic impact-there will be a tendency among the Western nations to hope that there will be a period of market softness and that the West can achieve some benefits by shaving prices.

I would argue that this is a disastrous course of action because in no time at all as the markets get soft OPEC will begin to cut production. We will get the same price impact; we will lose our chance to build up stockpiles and when the next high market comes, we will be in the same box we are in now: We won't have the kind of reserve, both public and private, that we want.

I think it is critically important when production is restored that the West use that window-and there will not be many windows like it-to build up stockpiles as quickly as it can without placing undue price pressures on the market.

Senator BRADLEY. When you say "as quickly as you can," you mean all stockpiles, not just the reserve?

Mr. ALM. Public and private.

Senator BRADLEY. What incentives would you put in place now so that when that favorable market condition exists you will have a very large fill?

Mr. ALM. I have not looked at this in detail. Philip suggests $1 a

barrel per year.

Senator BRADLEY. That is about a $1 billion loss of revenue. How many extra barrels?

Mr. ALM. Let us assume we had 300 million barrels in the private stockpile, $300 million a year; is that right? The question is-and what one would have to think about-are the national security benefits worth $300 million a year in the private stockpile, and what is the tradeoff between that and filling the strategic petroleum reserve?

Senator BRADLEY. Why do you say dollars?

Mr. VERLEGER. I picked the dollar as a rough estimate. One would have to look more carefully at the cost of holding oil to decide whether that really gets you what you need. It depends also on the conditions in the spot market. If the spot market prices really collapse when Iran and Iraq come back, you need much more than $1.

My answer is that I would not do it this way. I would look more to the price support program, adopt the USDA approach, which is to buy commodities from farmers and leave them on the farms. They also have selling rules associated with the crop support programs.

Senator BRADLEY. This is a theory particularly popular at Yale? Mr. VERLEGER. Yes.

Mr. ALM. Can you combine that with the food stamps?

Mr. VERLEGER. I would use the money rather than paying the money to small refiners.

Mr. ALM. There are other possibilities. In the report we released yesterday, we indicated the possibility of requiring the stockpiles to be built up like many European nations do, a requirement that refiners hold some percentage of their annual throughput. Then the third option is the public-private corporation, such as exists in the Federal Republic of Germany, that stores both public and private stockpiles.

Senator BRADLEY. Let me go back to my original question and see if I don't summarize what is Bill Hogan's point:

I would like to know if all the panelists agree with this formulation: that if the interruption is likely to be small in size and short in duration, it should be handled by demand restraint rather than by stock drawdown.

If one assumes a relatively large interruption of long or uncertain duration, then the private companies will be reluctant to draw down stocks at the outset because the price is going to go up. From a public standpoint, you are going to want to stretch out supplies over a longer period of time. It follows from this that if you believe the interruption will be short in duration and small in size, you are not going to want to draw your stocks down. If it is a small blip, you might handle it with demand restraint. Is that right or wrong? Mr. VERLEGER. I am not sure what you mean by demand restraint. If it is temperature controls-

Senator BRADLEY. Don't get concerned with what the policies are, but decreasing consumption.

Mr. VERLEGER. The only way I can envision decreasing consumption, in my view, is higher prices, either through taxes or through the marketplace. That is it.

Mr. ALM. Our experience in Iran and this experience seem to be very similar. A gasoline tax, I think, right now would make a lot of sense. If you take a look at the history of the Iranian experience, from January through May gasoline demand was high, despite the fact that we knew that we were approaching a shortage, we knew that gasoline lines were highly likely.

It strikes me that we are facing somewhat the same situation

now.

In answer to your question, I would do both.

Senator BRADLEY. Could you argue the opposite formulation, namely that you draw stocks down as your primary response only if you are fairly certain you are dealing with a very small interruption and that you rely on demand restraint as your initial response to an interruption if you believe that it will last a long time or if its magnitude and duration are uncertain? Trying to get a balance for these policies is fairly important. You would do nothing?

Mr. VERLEGER. I said that if one is worried about it, I would use an import fee on imports of crude product, because firms learn by repetitive experience that that would give a signal that profits are to be made, and they would build inventories in normal periods. After Iran and Iraq come back, that would mean you would not have a softening of demand or OPEC production; OPEC production would remain relatively strong, and we could build up oil inventories quickly. In June and July OPEC had a problem of substantial overcapacity. Producing countries in the cartel would have liked to sell more oil. In 1979 what happened, in my view, is warm weather, and there were large consumers who could build up gasoline stocks.

You are right, I almost invariably would rely strictly on the market or a tariff to do it. I wouldn't do it today because I don't see a shortage next year as long as this war remains within the confines of Iran and Iraq.

Mr. HOGAN. I don't agree with your formulation Senator. Let me say why: The problem with it is that it leaves out two critical variables. One is the size of the existing tax or tariff to capture the externality of oil consumption, and the other is the size of the stockpile that is in place when you are trying to make a decision about whether or not to draw down stocks or to use demand restraint. It is unlikely that the optimal answer would be to use all of one instrument or all of the other. So, some combination is certainly going to be right.

There are many ways we are now using oil every day, oil consumption, that are much less important than increasing the size of our strategic reserve. The reason they are less important is because the reserve is so small.

If we had a total public and private stockpile, above normal use, on the order of the billion barrels we talked about for the United States, or maybe double or triple that for the world, then a strategy of drawing down the stockpile in order to moderate some of the spot market increases, coupled with tariffs in order to moderate demand at the same time, would be optimal.

Or if we had a very large tariff in place already, the best policy might be primarily stock drawdown and very little demand restraint, because we would already be at the margin of balancing demand with the true cost of oil.

In the present situation we have neither case. We have low stockpiles and no tariff. It might be that the market will soften this year and Yamani will be right. But we don't want to make the mistake of ignoring the possibility that the war continues or expands. It involves a small probability but a significant probability that the entire Persian Gulf will be inflamed and the stocks we have now will be more valuable later than they are now.

The possibility that IEA adopts is very shortsighted, that the demand restraint option should be much more exercised and we should moderate the seasonal drawdown of our inventories. We certainly could not keep them constant. We should not be ignoring the demand restraint and we should not be ignoring the potential value of those inventories much later, given the probability that the war could expand.

Mr. ALM. I would advocate four things and pretty much agree with what Bill said:

One, immediate decontrol of crude oil prices, not a huge act, but it would decrease demand 15 percent and have symbolic value. Second, I think a gasoline tax would be a useful restraint now. Third, I would draw down private stocks. Indeed, there is nothing the Government has to do. They are being drawn down anyway. Since that is the case, I think within IEA a reasonable drawdown program is probably sensible, but I would not terminate filling the strategic petroleum reserve. Indeed, I would expand fill. The reason is that the strategic petroleum reserve is currently very smallone-tenth of the legislated goal. Considering the threats we face in the next decade, building the reserve is critical to our national security.

I think it was a big mistake to terminate the fill before. If we don't have the resolve to fill the reserve now, we will never find that perfect time to do so.

Senator BRADLEY. Let me ask you if you have taken a look at the economics of a Government strategic petroleum reserve, the Government filling saltmines and the Government establishing Government above-ground storage in the various regions around the country?

Mr. ALM. We did that when I was at DOE. As a result, the storage in saltdomes is considerably cheaper. I think it is twice as cheap. As I recall, it is 30 to 40 cents a year compared to 80 cents to $1 to store above ground.

I could find the actual numbers for the record, if you like. Senator BRADLEY. How long can you store the oil?

Mr. ALM. In the saltdomes?

Senator BRADLEY. Yes, before the oil changes in consistency. Mr. ALM. Crude oil, of course, is easily storable. Product storage is a problem; you have to keep the products moving in and out of a reserve to prevent deterioration.

Mr. VERLEGER. You can store crude above ground and below ground. Gasoline particularly deteriorates.