PAGENO="0001" MULTINATIONAL CORPORATIONS AND UNITED STATES FOREIGN POLICY 7%o19~ HEARINGS BEFORE THE SUBCOMMITTEE 0N MULTINATIONAL CORPORATIONS OF THE COMMITTEE ON FOREIGN RELATIONS UNITED STATES SENATE NINETY-THIRD CONGRESS SECOND SESSION ON MULTINATIONAL PETROLEUM COMPANIES AND FOREIGN POLICY JUNE 5 AND 6, JULY 25, AND AUGUST 12, 1974 PART 9 0 ~7 2~5T?L&~ Printed for the use of the Committee on Foreign Relations U.S. GOVERNMENT PRINTING OFFICE 45-426 WASHINGTON 197~ For sale by the Superintendent of Documents, U.S. Government Printing Office Washington, D.C. 20402 - Price $2.70 PAGENO="0002" COMMITTEE ON FOR,EIGN RELATIONS I. W. ~IJTMItIGHT, ~rl~an~a~s, dhdlrm~an -~ JOHN SPARKMAN, Alabama MIKE MANSFIELD, Montana FRANK- C~1URCIT, Idaho STUART SY~IING~UON, Missouri CLAIBORNE PELL, Rhode Island GALE W. McGEE, Wy~ming~ EDMUND S. MUS~IE~4aine GEORGE McGOVERN, South Dakota HUBERT H. HUMPHREY,Minnesota PAT M. HOLT, chief of Staff An~rnun M lAmt, £Yhi~fCZerk 1 ~UBCOMMI~EE 6N~ MULTH~AT~ONAL OORPbEA~UIONS FRANK CHURCH; Tdah6, Chairman STUART S7MIN~JPO$~ $is$ourl CL1FPORDP,CASE~ ~nw ~rsey EDMUND S. MUSKIE, Maine CHARLES H. PERCY, illiuois JIiROMK LEVINSON, Oliléf iJounsa JACK 13LJpt,.48sOciat~ Countei (II) d-~ORGE D. AIKEN, Vermont * CLTFFORD P. CASE, New Jersey JACOB ~. JAVITS~N~w ~forl~ HUGH SCOTT, Pediis3th1ani~ JAMES B. 1~EARSON, gansas cIU-RtE~ ii.~1~RCY, ~Wnois * ROBE-AT ~: cFRrFrr~~; Michigan PAGENO="0003" CONTENTS Hearing days: Page June 5, 1974 1 June 6, 1974 73 July 25, 1974 167 August 12, 1974 231 Testimony of: Blair, John M., Professor, department of economics, University of South Florida, Tampa, Fla 192 Collado, Emilio G., director and executive vice president, Exxon Corp 118 Katz, Hon. Julius, Acting Assistant Secretary of State for Economic and Business Affairs 146 Kauper, Thomas E., Assistant Attorney General, Antitrust Division, T)epartment of Justice; accompanied by Richard Sayler, and Joel Davidow Simon, Hon. William E., Secretary of the Treasury; accompanied by Gerald L. Parsky, Assistant Secretary of the Treasury 231 Stobaugh, Professor Robert B., chairman, Harvard Business School energy project, Harvard University, Cambridge, Mass 167 Sawhill, Dr. John C., Administrator, Federal Energy Office; accom- panied by Joseph C. Bell, Assistant General Counsel, and Mel Conant, Assistant Administrator, International Energy Affairs - - - 1 Tavoulareas, William P., president, Mobil Oil Corp.; accompanied by George A. Burrell, general counsel, Mobil Oil Corp 73 Insertions for the record: Prepared statement of Dr. John C. Sawhill, Administrator, Federal Energy Office 6 Statement of Senator Clifford P. Case 14 Prepared Statement of Thomas E. Kauper, Assistant Attorney General, Antitrust Division, Dept. of Justice 45 Prepared statement of William P. Tavoulareas, president, Mobil Oil Corp 79 Letter to Dean Rusk, Secretary of State, from John MeCloy, dated January 11, 1967 115 Letter to Lyndon B. Johnson, U.S. Senate, from Herbert Hoover, Jr., Acting Secretary, dated September 28, 1955 117 Letter to John Foster Dulles, Secretary of State, from Senator Lyndon B. Johnson, dated September 9, 1955 118 Prepared statement of Emilio 0. Collado, director and executive vice president, Exxon Corp 123 Chart-U.S. taxes paid by U.S.-based major oil companies 133 Responses of Atlantic Richfield Co. to questions submitted by Senator Frank Church 144 Prepared statement of Robert B. Stobaugh, professor of business admin- istration, Harvard University Graduate School of Business Admin- istration 182 Gulf Oil Corp., world petroleum supply and demand, March 1970 207 Documents-agreement effected by exchange of notes between the United States and the United Arab Republic on investment guarantees, dated June 29, 1963, and July 16, 1974 250 Response of Hon. William E. Simon, Secretary of Treasury, to a question by Senator Clifford P. Case 257 Responses of Hon. William E. Simon, Secretary of Treasury, to questions by Senator Charles Percy~. 268 Responses of Hon. Gerald L. Parsky, Assistant Secretary of Treasury, to questions by Senator Clifford P. Case 279 (III) PAGENO="0004" * *; * * ** * ** *(* 1 ** * *1 *~* *: * 1?, * *` ~ ** * 1 1 * * ** PAGENO="0005" MULTINATIONAL PETROLEUM COMPANIES AND FOREIGN POLICY WEDN~SDA~', JUNE 5, 1974 UNITED STATES SENATE, SUBCOMMITTEE ON MULTINATIONAL CORPORATIONS OF THE COMMITTEE ON FOREIGN RELATIONS, Washington, D.U. The subcommittee met, pursuant to notice, at 10:10 am., in room 4221, Dirksen Senate Office Building, Senator Frank Church [chairman of the subcommittee] presiding. Present: Senators Church, Case and Percy. Senator CHURCH. The practice of this subcommittee has been to swear the witnesses. Would you stand, please, and be sworn? SWEARING OF WITNESS Do you swear that everything you are about to testify to in these hearings will be the truth, the whole truth, and nothing but the truth, so help you God? Dr. SAWHILL. Yes, sir. Senator CHURCH. You have a prepared statement for the subcom- mittee. It is rather lengthy. Would it be possible for you to summarize the statement as you go through it? TESTIMONY OP DR. JOHN C. SAWHILL, ADMINISTItATOR, EED1~BAL ENERGY OFFICE; ACCOMPANIED BY JOSEPH C. BELL, ASSISTANT GENERAL COUNSEL; AND MEL CONANT, ASSISTANT ADMINIS- TRATOR, INTERNATIONAL ENERGT AFFAIRS Dr. SAWHILL. Yes, sir. Senator CHURCH. And submit the entire statement for the record. Dr. SAWHILL. Yes, sir. Senator CHURCH. Please proceed. Dr. SAWHILL. Thank you very much, Mr. Chairman. Our statement today addresses the role of the Federal Energy Office [FEO] in the international energy arena and also specifieull~, some of the actions we have taken recently to better define the rela- tionship in international oil between the United States and other countries and the international oil companies. First, I would like to give you an overview of what the Federal Energy Office is doing as it interacts with a number of agencies in the executive branch in the international energy area. We are preparing (1) PAGENO="0006" 2 for discussion with other consuming countries' elements of the coordi- nated system of stockpiling and conservation. We are working with ~other countries to establish a data system which will allow for more precise and coherent means of evaluating and forecasting the world ~energy market. We are working with other governments to develop joint research and development projects. We are developing a set of international energy policy recommendations as part of an overall set of Project Independence proposals; and, finally, we are working with some of the international oil companies on the current round of negotiations, particularly as it relates to priee. If I could, before getting into the details of some of the specific things we are doing, disci~ss some of the recent developments in the international ep~rgy areaS, Of coilrrse, in the upcoming meeting in Quito, Ecuador, OPEC will be considering ~ proposal to inci~ease the produ~cer government tax on company-owned or equity oil from 55 percent of the postedprice to 87 percent. To us, this is not a matter of indifference, and it would be an error to assume that the companies would be able to absorb such a tax increase. This action, should it be adopted, would raise the price of international oil. Td date, the pro- ducing companies have been mixing their equity oil with the more expensive participation or buy-back oil which they have purchased. Their prices have in turn been based on the weighted average cost of both their cheaper equity oil and the more expensive buy-back oil. The recent OPEC staff proposal to increase the tax on equity crude will raise the price of equity crude virtually to that of buy-back crude and eliminate the companies' ability to sell a cheaper composite barrel. Parenthetically, there has been some confusion about the prof- itability of international oil companies. For example, if we take Saudi Arabian light, crude, the difference between the cost of equity crude, $7.11; per barrel and buy-back crude at $10.86 ~er barrel is $3.73; but it would be erroneous to assume that this is the profit on the transaction because the transaction is really a combination of the buy-back crude ajid the equity crude, and the profit narrows considerably when. we look at these, as a combination. As I indicate intlie testimony on page 5, if we takéa hypothetical example using a 60 to 40 ratio of buy-back to equity crude, a weighted average cost for equity and buy-hackcrude would be $9.34 per barrel. If the world oil price, therefore, is in the $10 range, this cost would yield a profit margin of about 66 cents rather than the higher figure of $3.73. One other recent development that we might comment on briefly is the proposal by Saudi Arabian Minister of Petroleum Yamani on lowering the posted price of oil from $11.65 to $9, that is a reduction of $2.65. Since we do not know yet how this proposal might be com- bined with other issues such as participation agreements or the taxation rate on equity crude, it is difficult to draw any firm con- clusion or to really assess the full implication of the Yamani proposal. Now, if I could turn to our regulatory framework. With respect to prices of oil in the United States, we have a comprehensive regiila- tory system of price regulations for petroleum products administered by our office under the Emergency Petroleum Allocation Act of 1973. The act requires that producers bepermitted to pass forward to con- PAGENO="0007" 3 sumers increased product cost on a dollar per dollar basis. For im- ported product in crude, these increases are measured by increases in landed cost, that is, the cost of crude or product landed in the United States. We discuss in some detail in the testimony the definitions of landed crude and how we require accounting practices to be administered, Basically, turning to page 8, FEO has two sets of controls over transfer prices. First, we require companies to measure cost by customary accounting practices which arO generally accepted and historically and consistently applied and; secondly, we have explicit authority to go beyond the general standard and insure in specific cases that companies use a proper measure of cost to justify allowable price increases. In transactions between affiliated entities, the landed cost or transfer price charged by a foreign affiliate to its U.S. affiliate may be computed in a variety of ways, and companies naturally chose those for which the tax and other legitimate business reasons are most advantageous to their collective enterprise. Ordinarily, these transfer prices will not affect prices in the marketplace as market prices will be determined by ordinary supply and demand conditions. Under price controls, the determination of transfer prices is very important. if the transfer price between the international affiliate and the U.S. affiliate is accepted for determination of landed costs, the profits of the affiliated entity as a whole can be increased by raising the transfer price. And this is the way in which that can occur: profits will be higher for the international affiliate due to the higher transfer price, but the U.S. affiliate will not suffer a corresponding decrease in profitability because under current controls it can recover the higher transfer price through higher domestic prices. In sum, U.S. users will pay higher prices which will be reflected in higher profits to the international operations of affiliated entities. There is an obvious incentive for transfer prices to be increased, that is in order to maximize profitability, but such an increase to the disadvantage of U.S. consumers. In the fall of 1973, the Cost of Living Council's Energy Division, working in conjunction with the Internal Revenue Service, for- malized its process of reviewing price increases put into effect by refiners pursuant to the predecessor of section 212.83, which is currently in our regulations; and the testimony goes on to describe how in January we iiiitia ted a refinery audit review program consisting of a team of IRS auditors which we trained in latter January and early February to conduct the audit process. We now have dispatched auditors to the headquarters of 30 of the largest refiners in the country to begin an on-site audit process. This is still continuing with 94 auditors already in the field and with plans to add about 60 more in the future. Under this audit program, specifically as it relates to this transfer price question, we have issued a notice of probable violation to Gulf Oil Corp. questioning the validity of $463/2 million in cost claimed by Gulf in support of price increases since November 1973. rrhe FEO questions whether Gulf had consistently applied its customary accounting procedures in a generally accepted manner in the computation of landed costs with respect to certain imports of crude oil purchased from foreign affiliates. PAGENO="0008" I 4 We are presently reviewing the answer which Gulf submitted last week in response to this notice. In addition, based upon preliminary information from the audits, it appears that certain firms are using accounting procedures which do not accurately reflect costs. Such procedures may have enabled some multinational oil companies to increase crude oil costs to their U.S. affiliates and may explain in part some of the significant increases in international profits reported by major oil companies. One should be cautioned that any inflation in transfer prices is not necessarily the result of deliberate violation of F1EO regulations but in many cases may result merely from the application of customary accounting procedures which because of present market conditions, do not accurately reflect costs. As this committee knows well, prices for foreign crude have accelerated dramatically over the past year. The use of different accounting methods which formerly may have produced relatively insignificant differences may now result in sub- ~tantial differences in cost and have a significant impact on product prices to American consumers. In addition, the present unsettled market conditions have apparently resulted in various companies giving quite a different meaning to the word "market" when this entity is used as an accounting standard for setting transfer prices. In light of this problem, FEO determined that it was necessary to exer- cise its powers pursuant to our regulations to disallow increased costs in excess of increased actual cost. Accordingly, we published in the Federal Register on May 20 some proposed regulations. In general, these proposed regulations attempted to determine what the actual cost of crude oil or product would have been to the U.S. affiliate if it had purchased the crude oil or product in an arms-length transaction. rfhis yardstick is used in order to find a transfer price equal to that which would have resulted from ordinary market forces. To the extent that it is successfully applied, the arms-length measure should result in refiners having as nearly as possible the same measure of actual cost whether or not the product is purchased from a related party.. Our preferred method of cost is the comparable sales method pur- suant to which a comparable market price is computed on the basis of all sales to unrelated parties in the month of measurement. From these sales we exclude certain very high and very low prices and try to take an average of the middle 60 percent, In cases where we do not have sufficient information from independent sales to determine in a timely manner and with reasonable precision the comparable market price, we provide as an alternate a net cost method as a means of computing the transfer price. Turning now to another subject: international coordination. Representatives of key nations involved in the Energy Coordinating Group {ECG} have been informed of our proposed regulations affecting transfer pricing as they will apply to U.S. international oil companies or any importers of crude. In doing so, we have recognized the wide- spread international interest in the subject and the intention of a number of governments to take comparable action. We are asking the representatives of these governments to review our proposal and make whatever comments they wish. Moreover, we believe such a step on our part is a necessary extension of our priority effort to enlarge upon our knowledge of international oil pricing. PAGENO="0009" It is highly likely that the ECG meetings will result in an agreement to exchange comparable information between and among states. It is then particularly important that the key importing states have a common approach to the issue of gathering and exchanging data on the activities of the oil companies so that the information received and exchanged can be readily assessed. In this area, we have submitted a proposal to the Energy Coordinat- ing Group which, with minor changes, we think will be accepted. rrurning now to the next session of my testimony, on page 16, insuring reasonable prices and s~ipply security. As I have already mentioned, we have underway a series of related studies which will lead us to select the most effective course the U.S. Government should perform in helping insure reasonable prices and supply security. Since we are dealing with an international commodity in which other govern- ments play a crucial role, we have been examining the techniques utilized by other countries to extend their influence over oil in interna- tional trade. We have been assembling information on the practices of such countries as Germany, United Kingdom, France, Italy, Canada, as well as Saudi Arabia, Iran and Indochina. In parallel with this effort we have begun an intensive and far-reaching study of the alternatives open to the U.S. Government in order for it to have an effective voice on the terms by which oil is imported into this country. The principal conclusions of the study will be transmitted to this subcommittee as soon as they are available.* The study will benefit from proposals which have come from many sources, including congressional committees. Your own inquiry, we feel, is a very vital source. Since the issues involved are so important and pressing, we have taken several critical steps to make fully evident to the international oil companies the depth and extent of the U.S. Government interest in the matter of oil. We have asked that FEO be informed in advance of any agreements which would have an important effect on the terms under which oil is supplied to our country. I have, along with others, repeatedly cautioned the companies to be fully alert to the need to bring prices down. Moreover, we have through bilateral and multi- lateral diplomatic channels, made clear to producer governments the serious concern of the U.S. Government over the present high prices and their effects on the world economy. While the United States is exercising its regulatory power to affect the cost of imports where transfer prices are involved, our activity may need to he increased to give effect to general U.S. Government energy policies. For example, it may be advisable that oil companies be required to file with the U.S. Government all their agreements with producer governments. In doing so, I feel we may want to move deliberately. We know that the international system for the supply of oil is an immensely compli- cated underta1~ing and is performing with impressive efficiency. 1\/iillions of barrels of oil a day move around the world through a vast logistics system. It is a system which is an essence of international concern with the vital interests or the great majority of states in- extricably involved. It is not a system that we or others can afford to *See Subcommittee on Multinational Corporations committee print, "U.S. Oil Companies and the Arab 011 Embargo. The International Allocation of Constricted Supplies," Jan. 2, 1975. PAGENO="0010" 6 see diminished in its effectiveness. Steps which the United States and other governments may take with regard to this system must have an impressive degree of coordination lest the actions of individual states, taken singly and without due regard to the actions of others, fragment or vitiate the whole effort. Turning briefly to overall energy policy. As you know, it is the goal of Project Independence, the focal point of our overall energy policy, to eliminate the critical vulnerability of the United States to substantial interruptions in supply. Elements of the project-such as domestic resource development, energy research and conserva- tion-are being rapidly fashioned. Our target date for the completion of the "blueprint" study is November 1 of this year. We are reviewing our past effort to improve our capability should another embargo occur. We are also actively participating in the development of international arrangements to deal with the effects of any supply interruption, no matter what its cause, through common efforts. Critical to this effort is the long-term effort to conserve. This area is the one and truly vital area in which consumer govern- nients can take immediate steps of considerable consequences both to reduce their dependence upon imports and to improve their ability to handle sudden supply cutoffs. Finally, I would like to talk about interagency coordination. You have asked for our assessment of the adequacy of interagency co- ordination in the international energy area. In view of the short time which all of us in the Government have had to deal with the new challenges of the energy crisis, I believe that excellent progress is being made in bringing together the various parts of the U.S~ Government in order to successfully pursue the definition and imple- nientation of a sound U.S. energy policy. We have obviously still not yet achieved as close an interaction as we all want, but there is daily evidence of expanding and continuing interchange with CIEP, [Co-uncil on International Economic Policy~, NSC [National Security Council], the Department of State, Treasury, Interior, Commerce, and Defense, as well as with other interested agt~ncies. I believe that we are now in a position in which the U.S. Government can marshal and coordinate its efforts to deal effectively with our energy problems. Thank you. I have with me Mr. Melvin Conant who is Acting Assistant Administrator for International Affairs in the Federal Energy Office and Mr. Joseph Bell from our General Counsel's office. They will assist me in answering your questions. [Dr. Sawhill's prepared statement follows:] PREPARED STATEMENT OF Dn. JOJIN C. SAWHILL, ADMINISTRATOR, FEDERAI~ ENERGY OFFICE Mr, Chairman and members of the committee, I am pleased to have the op- portunity to appear before you this morning to discuss the Federal Energy Office's role in the international energy arena. It is clear that the U.S. Government must play a larger role in the international system of acquisition, processing and distribution of oil. We are attempting to determine the best way of doing this while a;~ the same time preserving and. supporting the industry in those areas where it makes a major and virtually irreplaceable contribution to world energy markets. In particular, I would like to discuss with you, today some of FEO's views toward the international oil companies and the potential consequenes ot some of the most recent proposals for pricing by OPEC and individual producing countries. I also wish to deal with our proposed regulations on the standards PAGENO="0011" 7 governing transfer prices between domestic ~nd interbational affiliates of inter~ national oil companies, along with the other questions raised in your request for testimony. Let me first give you an overview of FEO activities in the international area. Basically, FEO assures the consistency of energy related policy and actions taken domestically with those taken internationally. In that role, FEO interacts, on a wide .variety of matters with the other agencies of the Executive Branch con- cerned with international affairs. Some of the specific activities which we are actively involved in include: Preparing for discussion with other consuming countries elements of a en-. ordinated system of stockpiling and conservation, as well as the sharing of inter- national energy resources in the event of an interruption in supply. Working with other countries to establish a data system which will allow for a more precise and coherent means to evaluate and forecast the world energy mrket. Working with other governments to devclop joint research and development projects. Developing a set of international energy policy recomrnenda~ions as part of the full set of Project Independence proposals which are to be submitted to the President later this year. Au important part of this work is an interagency study which we have underway which will for the first time indicate the full true cost of imported oil including risk of interruption and national security implications, Working with international oil companies in an effort to solicit their active cooperation in obtaining lower prices. We hope that these efforts and others which I will discuss in more detail in this testimon~r will provide the basis for a more stable and secure international market for energy. RECENT DEVELOPMENTS Before discussing specific FEO activities with respect to the price and supply of oil, I would like to mention recent developments which could have significant impact. At its upcoming meeting in Quito, OPEC will be considering a proposal to increase the producer government tax on company owned, or equity oil, from 55 percent of the posted price to 87 percent. This is not a matter of indifference~ and it.would be an error to assume that the companies would be able to absorb such a tax increase. This action, should it be adopted, would, raise the price of ipternational oil. To date, the producing companies have been mixing their equity oil with the more expensive participation, or buy-back oil which they purchase. Their prices have in turn been based on the weighted average cost of both their cheaper equity oil and the more expensive buy-back oil. The recent OPEC staff proposal, to increase the tax on equity crude will raise the price of equity crude virtually to that of buy-back crude and eliminate the companies' ability to sell a cheaper "compos- ite" barrel. Parenthetically, the complexity of the international crude oil pricing system and this mixing of equity and buy-back crude has led to some cotifu~ion concerning company profits on these crudes. For example, using Saudi Arabian Light, a common reference crude oil, the difference between the cost of equity crude at $7.11 per barrel and the price of "buy-back" crude, provisionally established at 93 percent of Posted Price or $10.84 per barrel, is $3.73 which if it constituted "profit" would look enormous. But this is not necessarily the case. In fact, the buy-back price does not necessarily represent the market price and, as I have pointed out, the cost to the company is a composite of both the equity crude it is permitted to lift and the buy-back oil ~hieh it must take. The ratio of buy-back oil to equity oil and the price of buy-back oil have not yet been fully determined in some countries, and consequently the precise cost of oil to the companies is not known. However, constructing a hypothetical example using the 60/40 buy-back to equity ratio and again using Saudi Arabian Light prices, a weighted average cost for equity and "buy-back" crudes would be $9.34 per barrel. If the world market price for oil is in the $10.00 range, a $9.34 cost would yield a profit margin of about 66 cents. Profits will, of course, vary from company to company and country to country, and this should be considered only an illustrative computation. REOTILATORY FRATTEWOITK With respect to prices of oil in the United States, we have a comprehensive regulatory systeni of price regulations for petroleum products administered by FEO under the Emergency Petroleum Allocation Act of 1073. The Act requires PAGENO="0012" 8 that producers be permitted to pass forward to consumers their increased product costs on a dollar-for-dollar basis. For imported product and crude, these increases are measured by increases in "landed costs"-that is, the cost of crude or product landed in the United States. The term "landed costs" is defined in FEO regulations to mean, for purposes of complete arms-length transactions, the purchase price at the point of origin plus the actual transportation costs. For arms..length transactions the price paid is, of ~course, an actual cost to the purchaser which we must be permitted to recoup. For purposes of products purchased in a transaction between affiliated entities, the landed costs of the product is computed by use of the "customary accounting procedures generally accepted and consistently and historically applied by the firm concerned." That is, the regulations look to the "transfer price" which the company has customarily used between its affiliates. Similarly, in the case of products shipped pursuant to a transaction between affiliated entities, the trans- portation element in landed costs is computed by use of the same standard. In some cases, however, customary accounting practices may not accurately reflect actual costs; To deal with these cases, the regulations contain language enabling FEO to look behind company accounting procedures. Specifically, the regulations provide in Section 212.83(e) that: "Whenever a firm uses a landed cost which is computed by use of its customary accounting procedures, the FEO may allocate such costs between the affiliated entities if it determines that such allocation is necessary to reflect the actual costs of these entities or the FEO may disallow costs which it determines to be in excess of the proper measurement of costs." Thus, FEO has two sets ox controls over transfer prices: first, FEO requires companies to measure costs by customary accounting practices which are generally accepted and historically and consistently applied; and second, it has explicit authority to go behind that general standard and insure, in specific cases, that companies use a proper~ measure of costs to justify allowable price increases. In transactions between affiliated entities the landed cost or "transfer price" charged by the foreign affiliate to its U.S. affiliate may be computed in a variety of ways, and companies naturally ch~ose those which for tax and other legitimate business reasons are most advantagdbus to their collective enterprise. Ordinarily, these transfer prices will not affect prices in the marketplace as market prices will be determined by ordinary supply and demand conditions. Under price controls the determination of transfer prices is very important. If the transfer price between the international affiliate and the United States affiliate is accepted for the determination of landed costs the profits of the affiliated entities as a whole can be increased by raising the transfer price. Profits will be higher for the international affiliate due to the higher transfer price, but the U.S. affiliate will not suffer a corresponding decrease in profitability because under current controls it can recover the higher transfer price through higher domestic prices. In sum, United States users will pay higher prices which will be reflected in higher profits for the international operations of the affiliated entities. There is an obvious ipcentive for transfer prices to be increased in order to maximize profitability, but to the disadvantage of U.S. consumers. ENFORCEMENT In the Fall of 1973, the Cost of Living Council's Energy Division, working in conjunction with the Internal Revenue Service, formalized its process of reviewing price increases put into effect by refiners pursuant to the predecessor of Section 212.83. In January 1974, after the authority was delegated to FEO, Form FEO-96 was issued, requiring refiners to enumerate all the calculations called for under the pricing formula in order to justify their price increases. These forms must be submitted on a monthly basis and FEO has required refiners to file forms covering the period beginning with the month of November. In addition, on January 10, 1974, FEO announced the establishment of a Refin- ery Audit Review Program (RARP), designed as a comprehensive audit package to verify the costs which refiners had been reporting in support of price increases. A team of Internal Revenue Service auditors was trained during the latter part of January and in early February to conduct the audit process, and an exhaustive set of guidelines (an audit checklist) was developed as an enforcement tool for ~use by the auditors. Beginning in early February, these auditors were dispatched to the headquarters of 30 of the largest refiners to begin the on-site audit process. PAGENO="0013" 9 This audit is ~sti1 continuing with 94 auditors already in the field ~tnd with plans to add about k~O more in the futureS One enforcement action has already been initiated by FEO On May 8, 1974~ tt Notice of Probable Violation was issued to Gulf Oil Corporation questioning the validity of $46.5 million in costs claimed by Gulf in s~ipport of price increases since November 1973. The FEO questioned whether Gulf had consistently applied its customary accounting procedures in a generally accepted maimer in the computation of landed costs with respect to certain imports of crude oil pur- chased from foreign affiliates. FEO is presently reviewing the answer which Gulf submitted last week in response to the Notice. In addition based upon the preliminary information from the audits, it appears that certain firms are using accounting procedures which do not accurately reflect costs. Such procedures may have enabled some multinational oil companies to increase crude oil costs to thefr U.S. affiliates and may explain in part some of the significant increases in international profits reported by the major oil corn- panics. One should caution, however, that any in~ation in transfer prices is not necessarily the result of deliberate violation of FEO regulations but in many cases may msult merely from the application of customary accounting procedures wlb1icb, because of present market conditions, do not accurately reflect costs. As this GommIttee knows well prices for foreign crudes have accelerated dramatically over the past year. The use of differcht accounting methods which formerly may have produced relatively insignificant differences may now result in substantial difference in costs and may have a significant impact on product prices to American consumers. In addition, the present unsettled market conditions have apparently resulted in various companies giving quite different meaning to "market when that is used as an accounting standard for setting transfer prices. I'nopOsnti REGULATIONS In light of these problems, FEO h~s determined that it is necessary to exercise its powers pursuant to Section 212.83(e) to disallow increased costs in excess of increased actual costs, Accordingly, FEO has published in the Federal Register. of May 20, 1974, proposed regulations setting out in detail the standards which FEO proposes to use in exercising this authority. In general, the proposed regulations attempt to determine what the actual cost of crude oil or product would have been to the U.S. affiliate if it had purchased the crude oil or product in an arms-length transaction. This yardstick is used in order to find a transfer price equal to that which would have resulted from ordinary market forces, and to the extent that it is successfully applied, the arms- length measure should result in refiners having as nearly as possible the same measure of actual costs whether or not the product is purchased from a related party. FEO's preferred measure of costs is the comparable sales method pursuant to which a comparable market price is computed on the basis of all sales to unrelated parties in the month of measurement. From these sales the regulations identify a representative contract price by excluding both very high and low prices. In cases where there may be insufficient information from independent sales to make it po~sible to determine in a timely manner and with reasonable precision the comparable market price, the proposed regulations provide that the net cost method will be applied. Under the net-cost method, cost increases are meas- ured on the basis of increases in the net cost of the product to the affiliated entities plus the market value of any services performed by the non-United States affiliates. In some instances the use of market prices ma~ not permit a firm actually to recover all of its increased cost outlays, and in those instances the firm may calculate its costs on the net-cost basis, To the extent that increased costs calculated pursuant to the customary accounting methods used by affiliated entities exceed increased actual costs as measured either by increases in comparable market prices or in net cost, they will be disallowed by FEO pursuant to the authority of Section 212.83(e), This authority will be exercised with respect to all landed costs incurred beginning October 1973. INTERNATIONAL COORDINATION Representatives of key nations involved in the Energy Coordinating Group have been informed of FEO's proposed regulations affecting transfer piicing as they will apply to U.S. international oil companies (or any importers of crude). In doing so, we have recognized the widespread international interest in the subject and the intention of a number of governments to take comparable action. PAGENO="0014" 10 We are asking the representatives of these governments to review our proposal and to make whatever comments they wish. Moreover, we believe that such a step on our part is a necessary extension of our priority effort to enlarge upon our knowledge of international oil pricing. It is highly likely that the ECG meetings will result in an agreement to exchange comparable information between and among states. It is particularly important that the key importing states have a common approach to the issue of gathering and exchanging data on the activities of the oil companies, so that information received and exchanged can be readily assessed. In this area, U.S. representatives have submitted a proposal to the working `group of the Energy Coordinating Group which, with minor chauges accepted it subject to the approval of the participating governments. It provides for the establishment of an international data system. which will collect and evaluate empirical data to answer specific questions submitted by participating states. Data will first be gathered from the public domain. To the extent that gaps remain, the Finance Ministries (Treasury in our case) will supply further data needed to answer the specific questions. States have the obligation to submit only those data which will be of a non-discriminatory and non-proprietary nature. Non-discrimi- natory is defined to mean that no stAte must give data to another which the recipient state would not have access to under an equal application of its own laws and institutions. If, after this procedure there is still a data gap, then a specific request for data will be submitted to the companies for reply. We believe that this system provides a valuable first step in providing adequate information an the international oil' companies without infringement upon their apprOpriate rights. We expect that this FEO initiative represents only the first step in deepening our effort to be fully informed on oil import terms. ENSURINO REASONABLE PRICES ANR SUPPLY SECURITY As I have already mentioned, we have underway a series of related studies which `will lead us to select the most effective course the U.S. Government should per- form in helping ensure reasonable prices and supply security. Since we are dealing with an international commodity in which other govern- ments play a crucial role, we have been examining the techniques utilized by other countries to extend their influence over oil in international trade. We have been assembling information on the practices of such countries as Germany, the United Kingdom, France, Italy and Canada; as well as Venezuela, Saudi Arabia, Iran and Indonesia. In parallel with this effort we have begun an intensive and far~reaching study of the alternatives open to the United States Government to have an effective voice on the terms by which oil is imported into the U.S. The principal conclusions of the study will be transmitted to this subcommittee as soon as they are avail- able. The study will benefit from proposals which have come from many sources including Congressional committees. Your own inquiry is a particularly vital source. Since the issues involved are so important and pressing, FEO has taken several critical steps making fully evident to the international oil companies the depth and extent of United States Government interest in the matter of oil. We have asked that FEO be informed in advance of any agreements which would have an important effect on the terms under which oil is supplied. I have-along with others-repeatedly cautioned the companies to be fully alert to the need to bring prices down. Moreover, we have `through bilateral and multilateral diplomatic channels made clear to producer governments, the serious concern of the U.S. Government over the ptesent high prices and their effects on the world economy. While FEO is exercising its regulatory power to affect the cost of imports where transfer prices are involved, our activities may need to be increased to give effect to general United States Government energy policies. For example, it may be advisable that oil companies be required to file with the U.S. Government all their agreements with producer governments. In doing so we want to move deliberately. We know that the international sys- tem for the supply of oil is an immensely complicated undertaking, performing with impressive efficiency. Millions of barrels of oil a day move around the world through its vast logistics system. It is a system which is the essence of "inter- national" with the vital interests of the great majority of states inextricably involved. It is not a system that we or others can afford to see diminished in its effectiveness. Steps which the U.S. and other governments may take with regard PAGENO="0015" 11 to this system must have an impressive degree of coordination lest the actions of individual states, taken singly and without due regard to the actions of others, fragment or vitiate the whole effort. OVERALL ENERGY POLICY It is the goal of Project Independence, the focal point of our overall energy policy, to eliminate the critical vulnerability of the U.S. to substantial inter- ruptions in supply. Elements in the Project-such as domestic resource develop- ment, energy research and conservation are being rapidly fashioned. Our target date for the completion of the "blueprint" study is November 1 of this year. We are reviewing our past effort to improve our capability should another embargo occur. We are also actively participating in the development of inter- national arrangements to deal with the effects of any supply interruption, no matter what its cause, through common efforts. Critical to this effort is the long term effort to conserve. This is the one and truly vital area in which consumer governments can take immediate steps of considerable consequences both to reduce their dependence upon imports and to improve their ability to handle sudden supply cut-offs. There is full appreciation of this effort among our allies. INTERAGENCY COORDINATED Finally, you have asked for my assessment of the adequacy of interagency coordination in the international energy area. In view of the short time which all of us in the Government have had to deal with the new challenges of the energy crisis, I believe that excellent progress is being made in bringing together the various parts of the U.S. Government successfully to pursue the definition and implementation of a sound U.S. energy policy. We have obviously still not yet achieved as close an interaction as we all want, but there is daily evidence of expanding and continuing interchange with CIEP, NSC, the Departments of State, Treasury, Interior, Commerce and Defense as well as other interested agencies. I believe that we are now in a position where the U.S. Government can marshall and coordinate its efforts to deal effectively with our energy problems. Mr. Chairman, thank you. I would be pleased to respond to your questions. Senator CHURCH. Thank you, Mr. Sawhill, for your statement. THE ROLE OF THE OIL COMPANIES IN THE MIDDLE EAST During our earlier hearings when this subcommittee looked rather thoroughly into the role of the multinational oil companies in the Middle East, the elaborate arrangement into which they had entered among themselves and with the governments, we had a number of executives of the oil companies here to testify and one of them admitted in his testimony that the companies really had no further leverage in dealing with the governments. This admission was coupled with an inability on the part of any of these witnesses to demonstrate that the companies had an economic incentive, to try very hard to bring the price down. Obviously their profits have gone up in tandem with the tremendous revenues that are now being realized by these oil producing countries. So if it is true, and the testimony seems to bear it out, that there is hi~tie incentive and no leverage, then does it not follow that if we are to have influence on oil prices in the future the U.S. Government must take a more active role? GOVERNMENT MUST BE MORE ACTIVE Dr. SAWHILL. Yes, sir. As I said in my testimony, it seems to me that we must take a more active role. Tne thing that concerns me is the nature of that role. We do have a mechanism that is working. We PAGENO="0016" 12 do, as you say, h.ave some problems with that mechanism because our companies do not have adequate leverage in. dealing with foreign governments; I agree with that. The question is as to what kind of role the Government should take? I have already initiated certain steps. We may need legislation to go beyond that. I have asked the companies, as I said in my testimony, to file with me any major agreements that they make with international countries. I have met with company executives and tried to use the weight of my office, if you will, to (liscoura~e them from signing any long-term agreements at current inflated prices; I have communicated to them our Government's feeling that the present price is too high and they should use their best efforts to reduce prices. Further, we have initiated the regulations that I described, which are fairly complex in nature, which would govern the transfer price between foreign affiliates arid domestic companies. Senator CASE. Would you permit a question-- Senator CHURCH. Yes. Senator CASE [continuing]. Just for clarification? TRANSFER PRICING What is the effect of your determination of a transfer price that is allowable for what purpose? Would you testify a little bit? Dr. SAWHILL. Yes, sir. Senator CASE. What is your authority and what happens if you make a decision in this matter? Dr. SAWrnLL. If I could step back for a minute. Senator CASE. Please do, because this is a very complicated thing and I would like to put it in one syllable words instead of the jargon that we all so easily slip into that the trade has used for a long time. Dr. SAWHILL. Yes, sir. The reason why this price is so terribly important is that it sets the basis for which consumer prices in the country are determined. rfhe oil companies transfer oil into this country at a price, and we then permit them to use this price to deter- mine the cost of the crude oil in their refineries. That price can pass right through on a dollar-for-dollar basis to the gasoline pump or to the heating oil truck. Senator CASE. In other words, to get down to the very brass tacks, you do have authority to fix prices? Dr. SAWHILL. Yes, sir. Senator CASE. What prices? Do you fix the price at which the company sells gasoline at retail? Dr. SAWHILL. What we do: we fix the margin of profit that they make. We require them to limit their margins to the margins that they maintained in May 1973. Senator CASE. Profit on particular sale~ or margin of profit overall? Dr. SAWHILL. The margin of profit on particular products like gasoline, for example, or heating oil; but the margin of profit you see is based on the price at which they bring oil into this country. Senator CASE. And you have the authority to tell them you can take account only of x dollars of the cost? Dr. SAWHTLL. Yes, sir.. PAGENO="0017" 13 Senator CASE. In other words, you determine what their cost is, in effect, in cases where there is no arms-length transaction? PROPOSED REGULATIONS Dr. SAWIIILL. That would be the effect of the proposed regulations that we have issued. Senator CASE. You have not done that so far. All of this is tentative and hypothetical and for the future? Dr. SAwmLL. Well, let us not say it is hypothetical. We have issued regulations for comment for a 30-day period because it is such a complex subject. Senator CASE. I am. not critical, I am. trying to find out where we stand. Dr. SAWHILL. We initiated a refinery audit program in early Jan- uary. We sent auditors to the 30 largest refineries, and we then de- termined that this was the subj ect on which we were going to have to issue regulations. In May, we issued that regulation for a 30-day comment period. I would expect we would have final regulations on this subject about the first of July. But they will be retroactive; they will apply to transactions since October 16, I believe. Senator CASE. how will they apply to an individual who goes to the gas station and buys gas? Dr. SAWHILL. If we find that this transfer price has been inflated and then used in turn to inflate gasoline prices, we will require the companies to reduce their prices in subsequent months until they have made up tile overcharge, if you will. Incidentally, we used this same technique when we found errors or violations of our regulations in this country, forgetting about the transfer price. When we found a company, for example, that had a margin wider than that permissible on its gasoline sales, in the next month we required them to have a nar- rower than permitted margin in order to compensate for the previous wider margin. WHY GASOLINE PRICES DIFFER Senator CASE. The reason I bring this out is most people have been wondering what the dickens is going on with gasoline prices fixed by the companies in different places at different amounts and what kind of regulation is it? The answer has been: there has been none in effect so far except the threat that there might be what you call a rollback or a requirement that the company reduce prices in the future if you determine now that they have charged too much in the past. Up to now there has been no price regulation, right? Dr. SAWHILL. No, sir; that is not correct. Senator CASE. Please tell us why it is not. Dr. SAWHILL. As in the past, there has been no regulation on the transfer price. Senator CASE. That is the price that the company is allowed to charge itself for what it pays its affiliate when it brings oil into the country? Dr. SAWHILL. Yes, sir. As you know, that accounts for only 38 percent of our supplies. 70 percent--- Senator CASE. Thirty-eight percent of the supply of gas? 45-426--7~---2 PAGENO="0018" 14 Dr. SAWHILL. Petroleum. Senator CASE. Sold in this country? Dr. SAWHILL. Yes, sir. The remaining 62 percent is supplied by our own domestic production, and that we have had control on all along. We have maintained controls on the companies for all of the products that they sell in this country. In other words, we have had a price control program in effect ever since the Cost of Living Council initiated the program. Senator CASE. The thing that I am trying to get at is to give you a chance to explain to the people why it does not seem to be working more effectively. Dr. SAWHILL. It is working Senator CASE. Why does the price of gas vary so much? Dr. SAWHILL. From one part of the country to another? Senator CASE. Yes; and from one city to another. Dr. SAwrnLL. The reason it varies so much is that some companies are more heavily dependent on imported oil, and some companies are more heavily dependent on domestic oil. Senator CASE. In New Jersey where much more than 38 percent seems to be- Dr. SAWHTLL. Imported because ~t comes into the Bayway Refinery. That comes in at a higher cost than the domestic price which we control, and the gasoline stations have to charge a higher price since they are selling oil from foreign countries. Senator CASE. What you are telling us for the first time and I am not being critical, because it is complicated and a delicate mechanism that we do not want to destroy-up to nbw we have not had any handle on the price that a company is allowed to charge itself for gasoline that it buys from its affiliates? Dr. SAWHILL. Yes. The honest answer to you is that we have not done it effectively. We have had regu'ations requiring them to use customary accounting practices. Senator CASE. You have already indicated, and I have a little statement here, Mr. Chairman, I would like to put in the record, with a fine quotation from Sir Josiah Stamp and it is generally en- lightening of the proceedings here, some literary cuts to them. On this point, that the use of these customary procedures has resulted in great distortion of actual facts. [The information referred to follows:] STATEMENT OF SENATOE Cnirronn P. CASE Since we are going to talk about statistics for the next few minutes, I thought I'd quote to you from Sir Josiah Stamp, who in 1896 became head of the Inland Revenue Department of England, their version of the Internal Revenue. Said Sir Josiah: The Government are very keen on amassing statistics. They collect them, add them, raise them to the nth power, take the cube root and prepare wonder- ful diagrams. But you must never forget that every one of these figures comes in the first instance from the village watchman, who just puts down what he damn pleases. Within the next two weeks, the Department of Commerce will publish revisions of the United States balance of payments of every year since 1966 in order to correct for a major reporting problem which resulted in the over-statement of the income this country receives from its niultinational corporations by as much as $1.5 billion per year. PAGENO="0019" 15 Apparently oil companies for tax reasons have operated outside the United States through domestically-incorporated branch entities which lose money in order to take advantage of the depletion rate on wells located outside the United States. At the same time, reporting their dividends from their ownership of com- panics like Aramco, the same U.S. oil companies have included sums which never were sent to this country. The income figures were overstated because they did not include trading losses which, for legal and tax reasons, were taken by a domestic corporation. These unreported outflows were included in the "errors and omissions" entry in the balance. There does not seem to have been any deliberate intention to mislead the Government. The overstatement of U.S. national income from oil companies was considerable. In 1973, the total excess in stated inflows was $1.5 billion. Earlier in the 1970's, the benefits to the U.S. balance of payments from multinational investment appears to have been overstated by around $1 billion per year. It is worth noting that the massive study of multinational corporations published by the Finance Committee a year ago estimated that the total multinational corporation- generated balance of payments inflow to the United States in 1970 was $5.8 billion. We have now learned from the Commerce Department that the supposed balance ot payments benefit to the U.S. of the untrammelled expansion of foreign direct investment has been overstated by around 20 percent because of the reporting system used by the oil industry alone. This cannot but raise questions in our minds about other parts of the balance of payments reporting system. Yet, in calculating the costs and benefits of the multination~J corporation to the domestic economy, balance of payments statistics are in some ways the most clear-cut. Estimates of the -employment effects of foreign investment for example are far more prone to error, since such numbers can only be derived at all through a hypothetical argument: what the U.S. job picture would be like if multinational investment had not taken place. Since the political and tax costs of virtually unlimited direct overseas invest- ment by U.S. multinational corporations must be balanced against the flow of payments and the creation of jobs, the factual data must be as reliable as possible. I commend the Commerce Department's decision to revise the balance of pay- ments numbers for the oil industry. We must also learn from this revision a certain amount of skepticism regarding statistics and regarding the benefits of foreign investment they are adduced to prove. Dr. SAWHILL. Yes, sir; that is why I say we have to get much more deeply involved in that subject. Senator CASE. And without being critical, at least without charging malice to the companies, what they have done is give a picture to themselves and to the world that does not reflect the facts and we are trying to get to the bottom of it. Dr. SAWHILL. I should have said in our investigations we found some companies that have maintained consistently a very narrow margin on the oil coming into this country so that we should not hope that this is going to result in some kind of a massive price rollback because many companies in fact have been following practices which have maintained their margins at the May 1973 levels even on the oil they are bringing into this country. BALANCE-OF-PAY MENTS EFFECTS OF COMPANIES Senator CASE. Well, I just want to at this point, because you did raise it then, I will not interrupt again because you have got your flow of questions, I know. This is in a very important part of this subcommittee's interest in the matter. Dr. SAWHILL. Yes, sir. Senator CASE. Because roughly 20 percent of balance-of-payments benefit attributed to the companies has been the result of overstate- ment. That is a lot when you are talking about balance of payments PAGENO="0020" 16 and when you are trying to figure out whether we benefit, this country benefits more from this kind of investment than not. A 20-percent error just in this one industry or 20 percent-- Dr. SAWHILL. I am not quite clear on the 20-percent figure that you are talking about. Senator CASE. Well, the Commerce Department suggests that the supposed balance-of-payments benefit to the United States of the expansion of foreign investment has been overstated by about 20 percent because of this reporting system used by the oil industry alone. Dr. SAWHILL. Well, I was not familiar with that. Senator CASE. The Commerce Department study, I think you will have access to it and you will use it, of course. Dr. SAwrnLL. Yes, sir. Senator CASE. I think it is an enormously important development. Again, not being critical, in the sense of charging anybody with malice, malevolence or anything like that, when you do not have the actual facts, you might just as well be subject to some kind of malevo- lent influence. Dr. SAWHILL. Yes, sir. Senator CASE. It is just as important from the standpoint of the job you are trying to do and it is a ~crery important job. Dr. SAWHILL. I have a copy of your statement here which I see refers to that. Senator CASE. That is right. Thank you. Senator CHURCH. Would you like the full statement to appear in the record? Senator CASE. Yes, at the initiation of these proceedings, following the comment by the subcommittee chairman. Senator CHURCH. All right, without objection, the statement of Senator Case will be published in the appropriate place in the record. Mr. Sawhill, as I see the picture, there are two maj or subj ects to consider. One is how we can temper the price that will be charged for crude by the producing governments; the other has to do with the price control mechanism downstream. Dr. SAWHILL. Yes, sir. CRUDE OIL PRICING Senator CHURCH. Let us go back to the beginning. The facts are, as you know, that the price of crude has been in- creased by staggering proportions in the last year or 15 months. Now we are told that the producing governments that are the members of the OPEC organization are considering further increases in the tax imposed on these oil companies, and you have testified that if that increase in tax takes effect the companies cannot be expected to absorb it and, therefore, such a move by these producing governments will result in further increases in the price of gasoline here in the United States? Dr. SAWHILL. Yes, sir; and throughout the world. Senator CHURCH. Now, given the enormous inflationary thrust of these oil prices, the fact that all experts tell us that the prices are not related at all to the economics of oil but are political in character, then it seems to me that a very real obligation falls upon the Govern- PAGENO="0021" 17 ment of the United States to take a more active role in trying to influence the governments, the foreign governments concerned, not to increase the price still further. And I take it by your testimony, that all that you are prepared to propose at this time, reading from your statement, is the following, "It may be advisable that oil coin- panies be required to file with the U.S. Government all their agree- ments with producer governments." Well, I cannot take issue with that, but it seems to me like dropping a pebble of sand on the beach to stem the tide. What real meaningful role is that for the Government at all? To say to the oil companies, after the fact, "Please file your agreements with us.,' CONSIDERING REGULATION OF INTERNATIONAL OIL coNTRACTs Dr. SAwmLI~. I was not considering this would be after the fact. You know, this is a difficult thing and frankly, we have just begun to study it and it is something that I hope tO work with your conimit~ tee on in coming up with some solutions because it is terribly important for the country. It might be desirable, for example, for there to be a prenotification of these agreements with the U.S. Government with our Government having an opportunity to have some say in whether or not the agree- ment could become effective. That was really the type of mechanism of my way of thinking. Senator CHURCH. Let us take, for example, the present highly significant negotiations that are going on between the Saudi Arabian Government and the American companies that own Aramco. Dr. SAWHILL. Yes. Senator CHURCH. rfhis, it seems to me, gets to the very fundamen- tals. If the Saudi Arabian Government proceeds to acquire Aramco it could have very important consequences on the future price of oil in this country. There is also the new proposal for increasing the tax on that part of the oil that you referred to as "equity" oil. Dr. SAWHILL. Yes, sir. Senator CHURCH. rihat can have highly important consequences, as you yourself have admitted in your testimony. Now, is the Government playing any role at all in these current negotiations or is this being left to the companies and Saudi Arabia to work out together? Dr. SAWHILL. The Govermnent is playing a role. It is playing a role both through our office and through the State Department. It is being kept advised of the progress of the negotiations. The Saudi Arabian Government, as you know, representatives will be arriving in this country today and stay here through the balance of the week and, of course, we will express to them our feelings about the need for lower oil prices, although the principal purpose of the meeting is to develop a framework for a special relationship between the Saudi Arabian Government and our country. Senator CHURCH. I take it from your testimony nothing has changed. We were told in earlier hearings the pattern in the past has been for the Federal Government to stand aside while the oil PAGENO="0022" 18 companies negotiate and then to be informed after the fact. The role of the Federal Government even at times when the Government's own permission was necessary to enable the oil companies to join together and bargain collectively has been very peripheral, and it seems to me that has not changed, from what you tell me it is still very peripheral. DON'T KNOW HOW TO INVOLVE THE U.S. IN NEGOTIATIONS Dr. S~WHILL, I did not testify at your previous hearings, Senator, and I have only been in my present assignment for about a month. Immediately upon undertaking this task we did launch an effort to study the very subject that your committee has been studying. I guess what I am saying this morning is we have not really come up with any very good answer yet about how to involve the U.S. Govern- ment in these negotiations. I do not dispute at all that the Govern- ment has to become more involved, has to take a more active role, but exactly how this takes place I am really not prepared to make any recommendations to you this morning. Senator CHURCH. Well, I think that is a fair statement. I do not mean to press you beyond what is. reasonable here in view of the fact that you have been in your position only briefly and you are now looking at this very serious question for the first time. But let me make this suggestion to you. The State Department, it seems to me, needs to be apprised of the serious view you take of these negotiations that are presently under- way and the impact that they may have upon the economy of this. country, and I would hope you would use your influence in the administration to persuade the State Department, if that is possible, to bring the Government more directly into the picture. Dr. SAWHILL~ Yes, sir. THE STATE DEPARTMENT'S OIL RESPONSIBILITY Senator CHURCH. In the past the State Department's attitude toward oil has been one of singular abdication, it has all been left to the oil companies, with the ~onsequences that we have all experienced. Dr. SAwrnLL. Well, or course---- Senator CHURCH. Right now the State Department is asking the Congress to approve a very large increase in the aid program. There is a renewal of aid being advocated for Arab countries despite the fact that Saudi Arabia and Kuwait and certain of these oil-rich Arab countries have immense surplus reserves which they are investing in the Western World-fl--the profits of this heightened, what I call, "hijacked" price for oil. Congress is being asked to initiate a new aid program for Arab countries like Syria, Jordan, Egypt, and possibly others. We are becoming very deeply involved again in the politics of the Middle East by virtue of the part that our Secretary of State has played in the disengagement arrangement with Syria, Egypt and Israel, and all of this, it seems to me, suggests that though the com- panies may have very little leverago, and American Government does have considerable leverage, and if we do not use it we are simply missing an opportunity to temper what now ha.s become the most serious inflation in more than a quarter of a century and the price of fuel is the most important factor in the current inflation. PAGENO="0023" 19 So I would urge you to do everything you can to persuade the State Department and the administration to bring the Government more actively into the picture in connection with these ongoing negotiations. Dr. SAWHILL. I might tell you this. That iii response to our urging there was a telegrath that we drafted and the State Department has sent a telegram to all of the maj or consuming natio~is expressing the U.S. Government's concern about the price of oil and particularly about the proposals to increase the tax paid cost. We have thet with the State Department as recently as last night expressing our concern about this and developing with them a procedure where we intend to be meeting with the major oil companies in discussing this subject with them, keepin.g ourselves informed on the status of negotiations and telling the companies of the importance we attach to lower price. Now I know that you are stating and 1 am agreeing that we have to go beyond this and the way in whieh we go beyond it is something that we hope that we can work with your subcommittee on formulating the policy because at this point we just do not have a policy. Senator CHURCH. Well, we better get one soon. Dr. SAwHILL. I agree. Senator CHURCH. Or there will not be much left out there to negotiate about. DID THE ARAMCO SHAREHOLDERS CONSULT GOVERNMENT? Mr. LEVINSON. Elaborating on what Senator Church has said, you ha ye said that you want a framework at the same time in connection with the role of the Government and the companies and you are targeting for November 1. Now, yesterday the directors of Aramco, which are vice presidents of four major share holding partners, met with Sheik Yamani, I believe, in Geneva. We were in California last week and one of those directors had his bags packed and was ready to take off. Have any of them consulted you beforehand as to what the U.S,. Government would think would be, acceptable and favorable terms of reference for their negotiations? Put more specifically, one of the issues is the question of trading off their access, that is, the companies' access to crude on a preferred basis for price. They want the preferred access to crude. They may be willing from their point of view to trade off and increase the price. What role does the U.S. Government have before the fact in dis~ cussing this kind of an issue, because you could express your concern but then be presented with a fait accomphi. Dr. SAwmIL. At this point I do not have any authority to do other than tell the companies that we are very concerned abotit an increase in price and we have done that. You say what can I do beyond? I cannot order the companies how to negotitate. Mr. LEVINSON. Do you need legislative authority to require them to consult with you before entering into these negotiations? You just said you do not have authority. Do you need legislative authority? Should we write such legislation which requires the companies to ~onsu1t with the relevant U.S. Government authorities before entering into such negotiations? PAGENO="0024" 20 LEGISLATION IS NEEDED Dr. SAWHILL. I think we are going to have to have some legislation in this area, yes. The specifies of that legislation, I do not quite know what it should be. There are all kinds of agreements that the coin- pariies make. I think one of the things we are going to have to do is delineate those kinds of agreements where prior consultation is necos- sary and those kinds of agreements where it is not. That is part of the process that we are going to have to go through in order to really understand and come up with something that is useful as an important tool for the U.S. Government but at the same time does not interfere with the day-to-day operations of our international oil system. Senator CHURCH. May I say since my years in the Senate have led me to become rather skeptical of consultations as such, because we often talk about consultation between the executive branch and the legislative branch and I have never felt that it ever amounted to much. Dr. S WHILL. I do not know; I have been up here 75 times since the first of the year. Senator CHURCH. Not to consult, to answer questions. Dr. SAWHILL. That is a form of consultation. SHOULD GOVERNMENT APPROVAL BE REQUIRED? Senator CHURCH. But is it within the authority of our own Govern- ment and would it be useful in connection with any future legislation that we may consider to require the approval of the Federal Govern- ment before American owned oil companies could enter into a pact with a foreign government? Dr. SAWHILL. Yes, I think we are going to have to move to some- thing like this. My only difficulty now, and I wish I could be more specific, is to define those particular kinds of transactions where the Government should have a right of prior approval and those kinds of transactions which are more day-to-day kind of transactions, but in concept- Senator CHURCH. You are thinking not only in terms of consultation mmd the supply of information in a timely fashion to the Government but you are also thinking in terms of the possibility of requiring gov- ernmental approval? Dr. SAWHILL. For example-- Senator CHURCH. Before an American company could finalize an arrangement with a foreign government? Dr. SAWHILL. Yes. One of the companies that we have been con- sulting with recently has a partnership with a British company and the British company has been in prior consultation and has had to obtain the prior agreement of the British Government. The American company in fact did the same with us. And then we in turn discussed with the British Government the kind of terms that would appear reasonable to both of us. But I think this has to be formalized, it cannot continue to be as informal as it has been in the past. Senator CHURCH. Is it your understanding, as it is mine, that exist- ing law places no requirement upon American-owned companies to secure any kind of governmental approval, they are free to negotiate as they please, and as far as the law is concerned can enter into binding PAGENO="0025" 21 agreements with these Arabian governments whether or not the agree- ments are thought favorable to the American people by the U.S. Government? Dr. SAWHILL. Yes; that is my understanding. Senator CHURCH. I think ,this is a matter of great interest to the Congress and your recommendations with respect to how the law can be firmed up will be very important for us to have. Senator Case. Senator CASE. I wonder if your consideration of this point will be broad enough to permit you to consider the possibility of opening this whole matter to competition; for instance, requiring a producing company, if they want to sell oil when it comes to the United States, to sell it in the open market, or Aramco sell it in the open market, at whatever price it commands? This is obviously heresy in terms of the traditional ways the companies have been dealing. That is one possibility. Another is to have complete U.S. Government control of these transactions so if we are in a weak position as a bargainer in respect to petroleum and other energy sources and in a strong position in regard to agricultural products and other things that the world wants from us, the strengths and weaknesses can be balanced. And how can this be handled in a free enterprise system without Government regu- lation of exports and imports? COMPANIES WILL PLAY SMALLER ROLE Dr. SAWHILL. Well, it seems to me that what we are going to see evolvmg in the world, the reality of the world oil situation, is that the companies are going to have less and less of a role to play in the nego- tiating process because the companies are going to have less and less a share of oil ownership. In other words, I guess what I am saying is over time equity oil is going to become less and less important. Senator CASE. Equity oil, because there are one or two kids out here who have not heard the word, means the oil that the companies own as opposed to the share of their production which the producing countries take; right? Dr. SAWIIILL. Right. The equity oil is the oil they own and they pay a tax, a $7 tax, then they can sell in the marketplace for the price it. will bear. Currently Aramco's agreement is 75 percent equity and 25 percent owned by the Arabian Government. Senator CASE. Which they sell to the company? Dr. SAWHILL. To the companies or it is put up at auction or to be sold to anybody. Senator CASE. Is there any free market at all? Dr. SAWHILL. There is a free market to the extent that the com- panies do not take it. Senator CASE. Is there any real world market for petroleum as there is in- Dr. SAWHILL. There is a free market to the extent that as the coun- tries are gammg more and more control over the oil-in other words, as there is less and less equity oil-the countries are beginning tu put more and more of this oil up for auction. For example, a few weeks ago Kuwait put up over a million barrels a day at auction and this will produce a free market. So I guess what I am saying-- PAGENO="0026" 22 Senator CASE. What did the proceeds, as a matter of fact---- Dr. SAwrnLL. They have not had the auction. Senator CASE. It has not been had yet? Dr. SAWHILL. No. But there are instances in Libya, for example, the price last January was about $14 a barrel. Today there is some up for auction at $12.40 and there are no takers. Saudi Arabian light, which is a standard crude, has been up for auction at prices of $10.40 or $10.50 and there have been no takers. So there is a free market to the extent that the major companies do not take this participation or buy-back oil. What I am suggesting is that over time more and more of the trans- actions are going to be participation oil, less and less equity oil. In Kuwait, ~s you know, recently they moved to a 60-40 agreement where 60 percent of the oil is buy-back or participation and only 40 percent is equity. Senator CASE. In general, are the companies trying to prevent the auction of crude oil? Dr. SAWHILL. Well, the companies would like to maintain a larger share of so-called equity oil beca.~se the profitability on that is greater. Senator CHURCH. What it seems to me you are saying, Mr. Sawhill, is that to the extent that a free market is going to be reestablished in international oil, it will be done by the efforts of the Arabian Governments and the Iranian Government. Certainly it will not be done by any efforts on the part of our own Government. NEGOTIATIONS WILL BE GOVERNMENT TO GOVERNMENT Dr. SAWHILL. Well, I guess what I am saying because of what is happening in the world the negotiations will have necessarily been more government to government rather than company to govern- ment because the companies will not have any equity participation in this oil to negotiate with. It will all be participation oil which the governments are then selling on the world market. The logical buyers in most cases will be the international oil companies which have the facility to move this oil around the world and the marketing outlets for the oil in the other places in the world. Senator CHURCH. In another part of your statement you mentioned the effort that is ctirrently underway to coordinate with other con- sumer governments and work Gut a kind of common policy with respect to oil? Dr. SAWHILL. Yes, sir. AN INTERNATIONAL CONVENTION ON OIL TAXATION Senator CHURCH. Have you explored or has the State Department, to your knowledge, explored the possibility of a tax convention which would enable these consumer governments to impose a tax upon the oil companies that would be the same? Here is what I am getting at. We have discovered in our hearings that for a long time now the big oil companies have paid little or no tax to the Federal Government on their foreign earnings. When we point out how unfair this is to other businesses that have to pay very substantial taxes, the reply always is that if you tax our foreign earnings you will nut us at a PAGENO="0027" 23 serious competitive disadvantage with other multinational oil com- panies that are foreign owned which are not taxed. We have dis- covered in our contacts with some of these governments that they are being told the same thing, that when they propose a tax they are being told you must not do that, that would put us at a competitive disadvantage with the American companies. Now, it seems to me that we might establish a common front between the consumer governments so that some tax could be imposed upon these very large earnings vtitliout putting any of the companies at a competitive disadvantage, one with another. Is that being explored? Dr. SAWHILL. To my knowledge, it is not being explored. I guess I have two comments on that. One, this would require an agreement among a number of different countries and I think that it has been difficult, as I understand, in the past for the Common Market itself to agree on a common policy or tax convention. Second, we are moving, as I said in my testimony, to collect infor- mation and to collect information on a common basis with other coun- tries so that we can jointly approach this problem of how to treat the international oil companies. Sen ator CHURCH. Well, we have been told that both the British and Dutch Governments would be responsive to an American lead. Their feeling is that the American Government is uninterested in leading. Dr. SAWHILL. Let me say this: that our Government through our Agency has taken the lead in studying the whole role of the interna- tional oil companies. This is one of the areas in which we have taken the lead in the energy coordinating group and we are working with the Italians and the British and some of the other countries in sort of defining a common consuming country policy in the area, and while we have not addressed the subject of tax, yet it would certainly be something that could be on the agenda. Senator CHURCH. That is fine. I hope you will put that subject on the agenda). I think it is a very important one. And as you move along we would appreciate being kept informed of any significant steps you might take in this field. [Discussion off the record.] THE PRICE CONTROL PROGRAM Senator CHURCH. In nty 10 minutes I would like to move down- stream considering the price control program that you have had in effect. I assume that you are going to work out the problems of the trans- fer costs so that it will- Dr. SAwHILL. Yes, sir. Senator CHURCH. it will result in no more than a dollar-for-doll ar pass through. But the price control mechanism, it seems to me, is failing to do its job. If the companies were to be permitted only to pass through the increased costs to them, and if, as you say, the price control mechanism is based upon a formula that is to maintain their margins, why is it PAGENO="0028" 24 that the profits of the major oil companies have increased so dramati- cally? Dr. SAWHILL. Well, I think there are a number of reasons for that. One, they have increased their profits outside of the United States that is, in products they sell in Europe and Japan and other countries where they do not have similar types of price control programs. Second, in a period of very rapidly rising prices, companies that account for their inventories on the so-called FIFO (First in-First out) method find their profits inflated because they are selling bar- rels that are acquired at a lower price today at a higher price. If their accounting was on a different basis they would not show these large profit increases. Third they have had increases in the profits of some of their related operations, such as their transportation operations and petrochemicals operations which have increased in profitability. And finally, and importantly, the price of domestic oil has increased. It was allowed by the Cost of Living Council to increase to $5.25 a barrel and the price of so-called new oil is uncontrolled in this country, and as a result of congressional action the price of stripper well oil is also uncontrolled. So we have had very large increases in the new oil and stripper well oil because of the general increase in world market prices and I think these are the reasons for the profit increases. Senator CHURCH. Now the administration chose to release new oil from price controls. Dr. SAWHILL. Yes. Senator CHURCH. The Congress added the stripper oil. Can you give us the percentage figure on how much of the domestic oil remains under price control and how much is free of price control? Dr. SAWHILL. I think of the total domestic oil, approximately 70 percent is under price control and. 30 percent is free. Senator CHURCH. All right, now, the purpose of the freeing of~ the new oil from price control was to give an additional incentive to increase domestic production. To what extent has this concession resulted in increased production? DRILLING ACTIVITY HAS INCREASED Dr. SAWITILL. What it has resulted in has been increased drilling activity. Drilling activity in the first 3 months of this year was up some 30 percent over drilling activity in the comparable period in 1973. So to the extent that it has encouraged drilling activity down the road, it should encourage increased production. Mr. LEVINSON. Is it not a fact in the last 2 months domestic crude output was 2 percent less than a year ago? Dr. SAWHILL. Yes. I do not think that is a very relevant fact. That is a fact but it is iiot relevant to this discussion. Because the important thing is what is happening to drilling activity since we would expect and I think we will find that once drilling activity increases we will find increases in production. Now, I do not know this for a fact but it may be that production would have declined even more if we had not had the higher prices for oil. The oil production in this country has been declining since 1970. Exploration has actually been declining since the middle 1950's, and now we are seeing a turn around in exploration in drilling and that should lead to a turn around in production. PAGENO="0029" 25 Senator CHURCH. Well, if you had a 30-percent increase in drilling, then the present price arrangement has been sufficient to furnish the industry with at least enough inducement to increase drilling rather markedly. Dr. SAWHILL. Yes, sir. Senator CHURCH. I would hope that that would encourage you to hold the price line since that is the only way you have to temper the inflationary impact of these hijacked prices for imported petroleum. Dr. SAWHILL. It is my expectation, frankly, that we will see prices top out at current levels and actually begin to decline. If we look at the world supply and demand picture for petroleum we see that there is some surplus of supply. The production has returned to its preembargo levels of about 50 billion barrels a day consumption in the first half of this year. It will probably be 48 billion barrels a day and maybe get up to 49 billion in the second half. So we do have some gap between production and consumption. Whether it is a million barrels or million and a half is a little bit hard to estimate. But the fact that we have supplies exceeding demand is one of the reasons we have been urging the companies to not sign any long-term contracts for supplies at these inflated prices and also one of the things that leads me to believe that oil prices will come down, and not only abroad but also in this country, since the price of new and released oil in this country and stripper well oil is directly related to the price of the world prices. Senator CHURCH. Is it not so that absent the controls we now im- pose the domestic price would rise to the world price? Dr. SAWHILL. Yes, it would certainly rise. Exactly where it would level off is a little hard to say, but it would rise significantly above the controlled level of $5.25 that we will maintain. Senator CHURCH. You intend to maintain that level? Dr. SAWHILL. Yes, sir. Our authority for price controls expires February 1975, so we certainly cannot maintain it beyond that date. Senator CHURCH. Unless Congress extends your authority? Dr. SAWH~LL. Yes, sir. Senator CHURCH'. `I think that in turn depends upon whether you hold the line* effectively kind not' let' your program go the way that the general price control program went, which was into a shambles; and thus there was no public support left for the `extension of' general controls.,J think there will be real support for your controls if you hold the line and manage your program in'sueh a way' as to' inspire con- fidence. ` ` ` ` `` Dr. SAWUILL. Well, there are really three elements to' the program. There is price of crude oil, which we have discussed; there is the maintenance `of margins, and at their May 1973 levels, which we are constantly auditing to insure its being maintained, and then there is this transfer price question which we previously discussed, Senator CHURCH. Senator Case. Senator CASE. Thank you, Mr. Chairman. IS VERTICAL INTEGRATION HARMFUL? First, a very broad question. Will you take into consideration in your study, and I mean this seriously, the possibility that maybe we had better not continue the general practice of having the vertical integration that exists in the oil industry. Perhaps we should have a PAGENO="0030" separation between the companies that produce the oil, and the distribution system which the same companies now operate all as subsidiaries of the big American-owned companies with one exception? Dr. SAWHILL. Well, this certainly has to be an important element of energy policy. I will say this. That we really have not done much in that area to date. We have, however, and I ,1~ave said, aLthough we do not have any legal force to achieve this, that I did not think it was appropriate for the large major companies to acquire additional gasoline stations and to extend further into the marketing ~side of the business than they ha\te already extended. Now that is not a real problem today. Texaco, for example, with its thousands of sta- tions around the country, owns only 25. I think it would be a mistake for a company like Texaco to begin making a major move to acquire a lot of stations as company~owned. stations. Senator CASE. What I am really getting at is the question of desira- bility of, separating the oil companies from the production end of this busines~. Dr. SAWHILL. Well, the argum~nt-~-- Senator CASE.. The purchasers from the real producers, not the people, who handle the mechanics, but that is to, say, the oil countries. Dr. SAWHILL. The argument that has been advanced, as I under- stand it, for separating the producing end of the business from the re- fining-marketing end of tl~e business is that through our own tax laws as well as through the oil companies acëounting method they have developed most of their profits in the producing side of the business and the.margins in the refinery and marketing side of the business have been very narrow. This has. obviously discouraged to some extent people from entering the refinery and marketing end of the business. Senator CASE. I am talking about the situation in which these four big companies through, in Saudi Arabia, Ararnco, really have had a ~ionopo1y on the whole show and there is not any separation between production and purchase and marl~eting and distribution, except the increasing intervention of the producing countries. Would it not be better whatever value of the system had in the past, to separate the distributing companies from the production business as far as our. Go~~ernment can bring this, about and have real competition between the buyers and the distributors for whatever production is available? *. , , Dr~ SAwHILL. Well, it seems to .me that you in eft~ect, will achieve that as the producing countries take over a greater and greater portion of the supplies. It seems to me, in effect, you will see a wore competi- tive market developing. I was saying as you. find the producing governments taking over a larger portion of the supplies and putting it up for auction, I think you will find a more c9mpetitive market developing. Senator CASE. Would it not be better to let it go the whole way and really have a free system in which we would see what was going on in which these companies would be operating for the benefit of themselves as distributors and not be any lQnger having to fool around with the producing countries? Dr. SAWHILL. Well, yes, but to the extent that the producer coun- tries acquire all of the company's ownership interest in the oil produc- tion facilities all the companies are really doing in effect, is operating these facilities for the benefit of the producing countries. PAGENO="0031" 27 Senator CASE. Yes. Dr. SAWUILL. And distributing aud marketing the product. Senator CASE. Under this practice of buy-backs--in which these big oil companies, or Aramco as their agent, buy from the producing countries their share and then add it to equity oil which they already own, the free market is stopped or reduced. A free market, would result from the coui~tries selling this to the world. Dr. SAWHILL. Well, some of the oil is sold through buy-back arrange- ments. Some of it is sold on an open auction to the extent that the companies do not take oil. Senator CASE. Do they not take all they can get hold of now? Dr. SAWHILL. No, not in every case. rfhere are auctions going on. Senator CASE. You did say that, but it did not seem to me, and I do not think you suggested that it really produced the kind of open market where you have plenty of full supply and willing sellers and willing buyers and so forth. * Dr. SAwHILL. I think what we will find over time that we are going to see a great deal more competitive activity in the acquisition of these foreign supplies.. Senator CASE. What about the question of the separation between transportation, refining, and retail distribution? Dr~ SAWHJLL. I would not think that would be so important to see a separation there. To a large extent you have a separation today that refiners do not own the distribution facilities, they have franchise dealers but they do not own the facilities. It is more like the auto- mobile industry in that regard. I think it would be a mistake to see a closer, an ownership link develop between refiners, the maj or refiners anyway, and the largemajor companies and the distribution facilities, because I think the consumer gets a great benefit out of having a diverse khid of competition in the marketplace. It has really been the smaller companies that have come into the market that have brought with them innovations like self-service stations and 24 hours of service and lower prices in some cases. I think we need to maintain a very active independent segment of the market and that is one of my responsibilities in administering the allocation program. Senator CASE. Going back, if I might, to the point where Mr~. Levin- som has pointed out to me in regard to the matter of the amount of bny~back as opposed to the oil sold at auction. In Saudi Arabia the great bulk of the~ oil goes to the companies aa part of their entiti~mentr-~- Dr. SAWthLL. Yes, sir. Senator CASE [continuing~. And only 5 or ~ percent:is sold to others. TilE REASONS FOR EUY-BAC~S Dr. SAWHILL. Yes, sir. I guOss thei~e are a couple reasons for this. It is these very companies that have the facilities to transport and market this oil around the world. On the other hafld, this is a decision by the Government, not a decision by the companies, so the Govern- ment itself is making the decision to keep a ready access to the companies who in turn can market its product for it. Senator CASE. In effect, as it works in practice for the most part the companies get the first choice, that is, they have the first refusal? Dr. SAWHILL. Yes. But as I say, this is because of the relationships PAGENO="0032" 28 that they have developed with the governments and also because of the fact that they have the facilities to market it. Senator CASE. I have about two more minutes. I would like to go to one other matter which is enormously important to us in New Jersey. I am hoping we will never come to another situation of gasoline shortage like that which we have in the beginning of this year-~- Dr. SAWIIILL. So am I. GASOLINE ALLOCATION PROGRAM Senator CASE. And the latter part of last year. It was characterized, among other things, as I am sure you know, by inequality among the States in the amount of oil-gasoline supplied. Dr. SAWIIILL. Certainly that was true in the month of February and to some extent in March. Senator dASE. I want to suggest to you that is intolerable to have happen again. Dr. SAWHILL. I do not think it will happen agait~. Senator CASE. Can you do something about seeing that it does not happen again? Will you let me talk for a minute, then I will not open my mouth while you reply. The fact was we were continually told more oil, more gasoline, was going to be allocated in New Jersey, and those statements meant only a company had said to the administration down here we are going to send in a little bit more. That was not an allocation. If you are going to allocate gas, allocate it. It is not possible for us any longer to continue in a condition of shortage in which inequality among the various States and areas of the country exist, for whatever reason. Even if all of the oil in the world was out in one State, they should not: have a larger supply for their customers than we have in the most remote section. That is the fUnction of government that has to be, I think a~sume4 by the Federal Oovernment and operated through your afflee4 That was not done befbre. Dr. SAWmLL. Not in February, no. Senator; C~sE. It certaini~ was net, and Ihope ~ei~y much that this will burn it~elf in in the ~jonaciou~uess of e~erybody1 if ~you ~re going to have less than unlimited supply, it has to be allocated so that everybody has his equal share. By that, I do not mean 83 percent jIl New Jersey and 100 percent in North Dakota, or something else of that kind. `And I am only using. North Dakota~it could be any State because there were States in which this happened and there were no shortages at all and there was hardship in New Jersey and that is not a tolerable thing. Dr. SAWHILL. To some extent I think that was a function of our own ineptness, as you will, as we moved to regulate an industry in a very short period of time. Senator CASE. We kept talking about the effect, we were effectively allocating, when we were not, w~ were reporting what the company said they were going to do voluntarily. Dr. SAWHILL. We were ordering the companies----- Senator CASE. I did not see a single order go out. Everything I traced down was the fact the oil company had discovered there was a little more oil here so they would send it in. PAGENO="0033" 29 Dr. SAWHII~L. I hate to tell you how many orders we have issued to the oil industry. It is in the hundreds to allocate supplies. Senator CASE. 1'he question must follow why did we not have equality? Dr. SAWHIIJL. You did not have equality in February because we were introducing a program---- Senator CASE. It was not then working. Dr. SAWHILL. Not as effectively as it should have. We were talking about a program. We had to go out and hire about 2,000 people in a 6-week period who never heard of the oil industry before and did not have any expertise in it, were not permitted to come from the oil industry. Senator CASE. You could hav~e taken all of the gas stations and companies and made them enforce this system. You could have doiie it if you wanted to. Dr. SAwifiLL. No. Listen, the oil industry in this country is terribly complex and it is not just a question of issuing a lot of orders by some bureaucrat like me. You have to know what you are talking about and understand pipe flows in the country. I could have ordered gasoline to be shipped out of Idaho and into New Jersey and it would have been physically impossible. Senator CA~E. Sometime then we had better call the thing to a halt and start fresh because the inequality among people and the requirement that a person just has to fight, and I mean literally physically fight, for a chance to get a little gas which is accidentally there, is just no system for the future. I am just trying to say for the future we are not going to stand for this any more. Dr. SAwHILL. Well, I think we have today a system that is working much more effectively than the system we had last February. We have had a little time now to train these people and to understand ourselves a little better how the oil industry operates. Senator CAsE. When you 5til say you are trying to persuade the companies to give you the information about their operations, this troubles me~ Dr. SAWHILL, No. Senator CAsE. There should be something, it seems to me, very clear. Dr. SAwHILL. I do not think I said that. Senator CAsE. In your statement-we hope to get the companies to give us these agreements, to give us this information we are trying to get the information. Dr. SAwrnLL. Well- Senator CASE. It is time we had all of the information. Dr. SAWI~ILL. We have now authority--- Senator CASE. You say that oil companies should be reqidred to file with the Government all their agreements with producer governments. AUTHORITY TO OBTAIN AGREEMENTS LACKING Dr. SAwHILTJ. Yes, sir; we do not have authority to get those agree- ments. We do htwe authority, however, to get information on reserves and costs and inventories and so forth. As a matter of fact, we have tak~n over from the American Petroleum Institute the publication of the weekly statistics on the industry because they are all coming into our office now and we are sending out teams to audit what is happen- 45-426-75---3 PAGENO="0034" 30 ix~g. We do no,t have tj~e village watchman out there putting down ~hat he damn p~e~ses, or i~ ~ie does we send somebody and ~9ok over his sl4o1~lder. I ~m quoting fr9r~i your sta~tement. , Senator CASE. I will take this occasion-this is a little bit offbe~at- then the end r~sult i~ the American individual consumer we a~ c~_ cerned about and a period like that which we wei~t through before cannot be tolerated again else we are going to have to have imm~ediate rationing because whe~a you have a supply less than acleqi~ate for everybody's desire, YOtI ar~ going to have to ration. Dr. SA~VHILL. Yes, sir. But y~u put an ~I1ocation program into law. We haye now put that into, place and we are administering it and I think that the experience we have gained over the last 6 months would preclude a situation `ike last winter happening again wl~ere we have these kinds of inequalities. Senator CASE. My last comment is please do not come back to us and say the law is inadequate, tell us iww if tl~ie law is adequate, in your judgment, and if you need more laws. Later if .we do have ~ crunch we do not want to have Congress told jt was your fault. Dr. SAWHILL. No; I do not think we feel the allocation law is. inadequate. We d~d feel that the crude program presented difficulties. to us and we came up and made some changes but I would say by and large, we feel the law is working satisfactorily right now. Senator CHURCH. Senator Percy. Senator PERCX. Mr. Sawbil, I would first like to say how ple~sed I am that you have this job. My owi~ rel;ati.onshi~ with yoti on, a nuwb~ of coin,mittees, the Permanent Investigating Committee of Government Operations and this conn,n,ittee have indicated, I think, that the country is well served by your presence in a very, very dif~- cu~t job. Dr. S~tWHILL. Thank you very much. Senator PERCY. What I see and concede as ou~r primary responsi- bility in these hearings is to learn what we can from the past and then help chart a course for the future. Taking into account what new responsibilities tho Federal Government may have in this whole field of energy, and what we can learn from past and present ex- periences in many, many different fields., we are going to have to define what is the role of the private sector, what is the role of government. So I. would like in our questioning, to concentrate very briefly on the role of Government as' it rela1~es to ~he private sector, then get into the security of our supplies in the fuel and energy field, and finally to conclude with some policy alternatives touching o~i taxes and data,, that is how we can operate in this field to get enough information, to work from. I would like to a~k your comments on the President's trip to the' Middle East and what function that cau~ Serve in the futur~ of our energy problems. I would like to start on th~e role of, Oov~rnment. It seems to me we did allocate to the private sector through agreement with the Justice Department and through the grace. of their letters t~ enable the oil industry to Operate as a un,it in bargaining `abuoad. And I think the facts are very clear we have for a period of decades the lowest fuel costs in the world. There is no question about it, heating PAGENO="0035" oil, gasoline, whatever it was. Tt seems to inc our interests were well served at that time~ Obviously, we should have gone after greater income tax payments in th~ TJni~ted States during that period of time but that was our fault and we canno1~ blame anyone but ourselves for that. But I would like your judgment as to how effective the role of Government has been since it began to play a larger role. It seems~ to me that thro~ugh the whole testimony that we have had here, an& you must have followed it, our performance in government ~~ras a pretty sorry performance. It looked to me like the U.S. Government pulled the rug out from under the negotiators when they were in the midst of these very tough negqtiations in 1971. We woold have been better not to have meddled in this thing and left them to perhaps a tougher more consolidated position. Now, have you felt that the role of Government in those negotiations was particularly helpful and served any unique purpose? GOITEnNMENP'S nOLE WAS SMALL Dr. SAWHILL. Well, of course, my own feeling ai~d understanding of the situation is that the GoveTnment did not play a very large rol,e and, therefore, I do not think that the Government role helped or hurt appreciably. I think it was pretty much a role of being kept informed, naturally advising the companies we wanted a lower price, but I just do not think the Government was sufficiently involved to have ha~ a major im~pact on the negotiations one way or the other. Senator Puncy. Were you familiar with the request that the State Department made to the oil companies to sp~Iit these negotiations? That was a very, very crucial point. Dr. SAWRILL. Yes, sir. Senator PERCY. In these negotiations the companies obviously, if they defied the State Department and U.S. Government, might have e~posed them.sehtes to a great deal of risk, but in retrospect following the Government ~id net exactly strengthen their hand. Dr. SAWHILL. No, it did not; and I am really not familiar enough with that situation to comment on it intelligently. Senator PERCY. I am concertied ahout the ~ffectivenes~ of the Federal Government right now. The State Department obviously has a major role in this but we have a vacancy in the Deputy Secre- tary position. We have had for months a vacancy in the Under Secretary for Economic Affairs. We have just appointed a new Assist- ant Secretary in charge of the Economic Bureau. We are going to get a new Chairman of the Council of Economic Advisers. IS THE U.S. GOVERNMENT ORGAN1ZHD TO HELP? Does it look to you, outside of your particular activity, that we are really in a position and organized as a Federal Government to offer a great deal of assistance and help or are we playrng musical chairs, just moving people around to till these vacancies with people who can effectively deal with this issue? Dr. SAWHILL. Well, my own feeling is that our office has got to play a very important role in this process and that we in our capacity PAGENO="0036" 32 of having overall responsibility for energy policy and reguTating the important element of the energy industry, have to bring the expertise that we have to bear on this question. We have built up a very dedicated and hard working, and, I think, knowledgeable staff of people in this area. They have been partici- pating actively in the agreements with the consuming nations. They visited the Middle East and we will be working closely with this committee on trying to define what role the Government should play and whether indeed, what type of new legislation we might need to define this role. As I understand, the Department of State will be here to testify tomorrow and I think it might be a little inappropriate for me to discuss their staffing. Senator PERCY. Would it strengthen your hand if you had really effective counterparts in other branches of Government, in the White House, in the State Department, in the Commerce Department, such as you probably have in the Treasury Department? They have always been the best organized in this field and they have been under this administration and they still are today. I trust and hope and believe- Dr. SAWHILL. I think so. Senator PERCY. Do we have and are there not things the executive branch of government should be doing now to beef up their operations? If we are going to offer assistance and help and be real partners in some of these problems with the private sector, do we not have a role\ to play. Should we not go back and say let us get the finest indit~iduals in this country in every one of these positions and not have~ihe loop- holes, duplication, overlapping, and confusion that we now seem to have? Dr. SAWUILL. To the extent that there ate unfilled posts there and it is going to strengthen our ability to support the industry and regulate them to have those posts filled, yes. Senator PERCY. The Congress is on the verge of adding to the con- fusion. The leadership of the Senate, Senator Mansfield, Senator Scott, and others, got together to create a temporary Commission or~ Supplies and Commodities, for 6 months and a quarter of a million dollars, to take a look at the structure and organization and to make recommendations. The Commerce Department Committee took that little bill and increased it to a 3-year commission, made it a permanent, at least a 3-year term on the commission, and increased the quarter of a million dollars to $3 million, $1 million each. It will be on the floor very soon. I value your judgment as to whether you feel the original concept of a temporary commission to take a look at the structure and orga- nization and then get out might be best or would a 3-year long pull, heavily staffed operation be better. Which would you prefer of these alternatives? SHORT STUDY PREFERABLE Dr. SAWHILL. I think I would prefer the former, that is, the quick look, because it seems to me we have studied this problem. We have the statistics. We do not have to rehash those. We need to take adook at the statistics that we have and come up with some policy recom- mendations. I do not think we need a 3-year study. I think we need a quick study so that we can get on the job. PAGENO="0037" 33 Senator PERCY. I agree with you and appreciate your support be~ cause I think it' will have some weight with some of my colleagues, all, of whom I know respect you highly. I would like to talk about and get your thinking on the problem of sharing oil supplies during a crisis because this may be a fundamental strategy of the consuming countries in time of critical shortage or when we are again embargoed or boycotted. What are we going to do? How are we going to respond? The airlines seem to be able to get to- gether and share their miseries and profits when they are struck by one labor union and it has been a very good device to ofiset power with some power. We seem powerless. We are a pitiful impotent giant in the consuming areas of the world as we deal with Jamaica on the one hand and the oil producing countries on the other. LEAKAGE OF OIL THROUGH THE EMBAiiGO I would like to look back a little bit to see what we can learn from this experience. There were news reports that the international oil companies were diverting oil from non-Arab sources to the United States. Did such diversion occur on any significant s~ale that you know of? Dr. SAWHILL. Not on any significant scale that I know of. Senator PERCY. How much oil was diverted to the United States in this process? Dr. SAWHiLL. I do not really have a good estimate. I can try to supply you with a better answer to that question for the record. Senator PERCY. Do you know from what countries oil did come dur~ ing that period? Dr. SAWHILL. There was some talk, although I never really saw hard evidence, there were some diversions from Japan, but I would. have to review the statistics again and make these available to you. Senator PERCY. From what producing countries did the oil come from? If you would rather discuss this with us in executive session, I mean if you feel it would not serve our national interests to have it public information, I think we would respect that. Dr. SAWHILL. I think that ~night be more appropriate. Senator PERCY. I would rather not like you to take the fifth, if, you don't have to do it. I would like to learn as much as we can and I think the public should have as much information as we can get, with the exception of where it might hurt our national interest. Who cud make the decisions to divert oil to the United States? Dr. SAWHJLL. The companies did. Senator PERCY. What criteria were used by the international com- panies in determining how much oil. to divert and to whom to divert it? Dr. SAWHILL. I do not think I have a good answer to that question. WERE COMPANIES INSTRUCTED ON mvEnsloNs? Senator PERCY. Did the FEO or any other organ of Government instruct the companies as to the amount of oil they should bring to the United States? Dr. SAWHILL. No, we did not set specific targets for them to bring 1it. We continued to urge them to bring as much as possible. At the PAGENO="0038" 34 same time we recognized the interest in all of the ~otmtries of the world in having sOme kind of equitable share of the world's supplies. SENATOR PERCY. Are you able to ~ at all from your knowl~ edge as to whether internationni oil companies would divert supplies based upon what they consid~redto be a national need, for ~n~tanoe, in the United States, or was it simply the prtht and losa compulsion that motiYa~ted and helped formulatethese decisions. Dr. SAWrnLL. No, I think it went weTh beyond the profit and loss statements. As a matter of fact, I think there are imports eomin~ iitto this country threti today that the oil companies could more profitably put in other countries of the worId~ Senator P~cr. Were you consulted at FEA, and you were deputy head at the time, on diversions of' oil to the United States? Dr. SAWHJLL. Well, we were consulted by the companies as they explained to us hoW they felt our reg~tiIat4ons were discouraging and making it less profitable to bring supplies into this country than to take it mto other parts of the world and we made the point very strqu~ly that we loft it was important and in our national interest to br1~g these supplies into thIs co'untr~r. Senator Pnucy. So the questh~ti of the donflict between the profit and loss statement and American nation~il interest did arise? Dr. SAwmLL. l~es. Senator iPuncv. And what was the companies' attitude? Dr. SAWHIIAL. I think the companies---- Senator PERCY. Did they indicate it Was difficult for them to over- look the profit incentive where they could earn more in the world market by diverting oil other places than iti bringing oil supplies into this country? Dr. SAWHTLL. Well, they pointed out that it Was a conflict but I think almost uniformly they said they felt the national interest came first. Senator PERCY. And do you feel that in that respect, in every in- stance that you know of, and evety company that you know of, na- tional interest then ruled rather than a profit ai~d loss statement given the profits looked as they were they were going to be at least adequate? Dr. SAW~JILL. Yes, I think that I could say yes to that question, although I do not Want to pretend I have done a thorough study of it so that It am aware of all of the transactions that took place. Mr. LEV1NSON. Has anybody in the U.S. Goveñiment? FEO did not do any kind of a study. I take it that he presumes that no one else did a study. I am asking whether or not anybody in the U.S. Government knows, with certainty what transpir~d with respect to the qu~stions Senator Percy is asking. Dti you know what criteria prevailed among the companies, within the companies? Dr. SAWHILL. No. Mr. LEvTNso~c. Do you know whether anybody in the U.S. Govern- ment has inquired as to this matter or made any kind of study outside of FEA? Dr. SAWHILL. Well, we will know this information because we are sei~ding a questionnaire to the companies which will develop that information for us. Mr. LEVINSON. You are sending a questionnaire to the compan!es which will develop this information for you? PAGENO="0039" Thy. SAWIht~L. yes, sir; ~t is part o~ this ~éuer~J questionMir~ we are seladrng out in ~conne~ijion *ith our tth~is:té~ of prfcitig i~egulatio~is to get a Co~pléte undérstandj~ o~ how supplies have nioved through- ~it the ~oi4ct ahd at what prices they have mpveci. Mi~. ~ And will you report to the Cdng~ss on that~ Dr. ~ ~t *iJ1 b~ h~y to. Sèñátor ~xifjncii. We ~~rouId like to have ~ co~r of that stud~ Dr. SA*~I~UJ. YCs, sir. SeiiatOr P~RCy.. ii think t shoI~dd go 1~ácI~ t~ ~nah ~bs~lutel~y certain that I uñdèrsta~id ybki cor~e~tfy. ~OO tóst~ed that ii~ ~rth~r pldgmefit atid to ~~our knowledge no significant diversions occurred; is that cori'ect? Dr. SAWHrLJL~ Yes, sir; tli~it is correct. senator P~mcy. We ha~re heard a gr~at dea' about supposed ~eaics, JiOWeVèt', a~id this *~s disCUsse~ a gre~t deal in the ~ràb Georg~ Pié~cy ol~ axOn testi~ed before th~~ su7bcoiinmjttee that, to his kn~leclge, there had been no leaks ~ate~er into the Cnlthd ~t~s fro~xi any Arab cotthtFy after tl~e enibargo had been ini~Osed. ~To your knowledge, *Ci~è theI~e ahy leaks in the embargo. "LEAKAGE" WAS OiL SHIPPED PEE-EMBARGO Dr. SAWEILL. We thought at the titne that we were seeing some leakage but in retrospect it appears that what we thought was leakage was actually oil that had been shipped prior to the imposition of the embargo and stored in third countries and later shipped into this country. So, our *best estimate is that there werC no significar~t leakages. Senator PERCY. In looking at the role of Government and what iole the Federal Government 5h~uld play, do you believe that the 13.5. Government should have taken a more aethre role in directing the diversion, whatever diversion might hai~~ occurred, and in creating circumstances favorable fOr leaks? Dr. SAWiIILL. Well, in terms of creatilig the circumstances favorable for leaks, that was really almost more of a political question and not a question that we had a great deal of colitrol ~veF. Senator PERCY. The national interest was endangered. We were even talking about getting enough oil for crnr fleets to operate and certainly rampant inflation running as a result of this. I am just trying to find what you think the role of Government is and what we should do in a Crisis. Should we sit there and sweat it out or should we really get in and do everything we can? Dr. SAWEILL. I think as a result of what we went through that we need a much better information base. We need a much better under- standing of the movements of oil and probably need the authority to direct movements of oil. Senator PERCY. As I recall, Mr. McCloy talked a good deal about security of supply and when people say that the United States gains security of supply from the fact that American companies are engaged in the production of oil overseas, are they not really talking about leaks and diversions then? ~r. SAwmLL. Yes, diversions, certainly. *Se~ Sübeoi~Eidttee on Mdltinaiioaai Cor~orat1ons committee print, `US. Ofl Coin- panies and the Arab Oil Embargo: The International Allocation of Constricted Supp1les,'~ Jan. 2, 1975. PAGENO="0040" 36 Senator PERCY. And if the companies are talking about it saying that this is why we need them to operate abroad and why we need t~ be strongly represented, then why, when we went through the worst crisis the country has ever been faced with, during which a few nations standing together, were, blackmailing u~ and embargoing us and attempting th change our whole foreign policy and having a disastrous effect upon the value of the dollar and family earnings, and the economic structure in this country, why were we a pitiful, giant sitting here doing nothing, unable to capitalize on the presumed benefits we had because American companies dominated the business in at.. tempting to break this embargo and bring more supplies to the United States. Yet you testify that during that whole period of time there were very little diversions, very few leaks. Dr. SAWHILL. Yes, as I say, I would be glad to review with you the specifics of this in executive session of the committee. However, you know I think the term little or very little is probably descriptive. As I say, I think today if we were to seek a reimposition of the embargo we would be in a much better position to address this whole question. because we have a much better information base. We understand~ a lot more today. Senator PERCY. Do you feel then, based on the information, th~ experience we have gone through, that we would be as a country, as a Nation and Government, better prepared than we were in the last crisis? Dr. SAWHILL. Unquestionably. Senator PERCY. Providing we fill the jobs that are available and providing everyone knows what to do on their job, do you think we are really prepared for a crisis if it came at this date, with as many vacancies as we have in the Government~ as many changes occurring~ as much confusion as we seem to have? Dr. SAWUILL. I can only speak for my own area of responsibility and we have filled our vacancies. Senator PERCY. What steps can be taken by your office-the statutory backup for which the Senate has just provided, what can your office do-to better prepare ourselves for the presumed next crisis that we always have to count on having, though we hope we will not? PEA CAN COPE WITH FUTURE EMERGENCIES Dr. SAWHILL. In terms of future embargo; I think we would be in a lot better position today with 3,000 or 3,500 trained people on board to move quickly into an equitable allocation program. I think we understand a lot more about conservation now and could initiate conservation measures much more quickly and, finally, we are trying with the help of the Senate to move ahead on a coal conversion program to get our utilities converted more rapidly to coal and, of course, I will not spend a lot of time but you know we are conducting a number of efforts to just increase our own domestic energy supp1ie~. Senator PERCY. Do you consider conservation vital and important enough to receive continuing emphasis? Dr. SAWHILL. Yes, sir. Senator PERCY. And is it a part of your responsibility to emphasize through these public hearings the need for people to not let down, feel the crisis is over and go back to their old ways of consumption, PAGENO="0041" 37 because if we do that, in my judgment, we will not have learned a thing, Dr. SAWHLLL. I agree with you. And I am not only trying tormake that point to the consuming public but also importantly to the business leaders of this country. THE 55 MILE-PER-HOUR SPEED LIMIT Senator PERCY. I have introduced a bill, not very popular with the truckers, but it does have the ~ttpport of Jennings Randolph and the rankh~g Republican on the Public Works Sub~ommittee, Senator Stafford, to make indefinite the 55 mile-per-hour speed limit on the national highways. Does the administration support that position? Dr. SAWHILL. We will strongly support it and do whatevei~ we can to see that it is enacted. Senator PERCY. I appreciate that very much. I think that it' is one of the very minor sacrifices we can make in convenience and if we just take into account it will save 8,000 to 10,000 lives a year, just mod- erating our speeds on the highways. think of what that would do. There are more deaths, excess deaths because of that extra 15 or 20 miles an hour than we have had in Vietnam year after year. Dr. SAWHILL. I feel very strongly about that. I sent a telegram to all of the Governors in all 50 States recently urging them to strictly enforce the 55-mile-an-hour speed limit. Senator PERCY. You mentioned that you are doing a report on the diversion issue which you would supply to us. Are you asking for the items that were moved and the margins in the different markets? Dr. SAWHILL. Yes, I think we will get most of that information. I am not sure we will have information on margins everywhere in the world but we will have certainly information on margins in this country. PRESIDENT'S MIDDLE EAST TRIP Senator PERCY. And before I go into the final phase of it on policy alternatives, I would like to ask about the President's trip to the Middle East. Do you feel that by his going to Saudi Arabia and by his going to the other three Arab countries, that he can by his physical presence there indicate the great importance we attach to stability and peace in that area? Do you feel at the same time he can do everything within his power to insure a reduction in price? Not because of the damage it does to us, it does daniage to us but we can survive it better than almost any other country, but the irreparable damage that this has done to a third of the world, to the developing countries. It has particularly to those countries that have literally no raw ma- terials or other exports. The ripple effect will be felt for generations to come and the oil countries know this. Can the President by his presence there, ii~ your iudgment, can he prAvent this tactic and technique from becoming a permanent part of our bargaining procedures between producing and consuming countries? PAGENO="0042" Dr. SAWHILL. I feel the President's trip will have great symbolic i~alue to the people all over the world that a chief executive of this country would undertake to visit these countries and I think it will iriçleed have a very great effect on bringing the kind of `peace and stability we so badly need to this part of the world and insuring that the risk of future embargoes is substantially reduced. Senator CHURcH. I just want to express my own respectful dissent. I cannot for the life of me see how a Presidential visit to the very area of the world, the very countries so deeply involved in havipg hijacked this price to begin with, is going to `be laid upon as anything~ Qther than a reward to them. The President has nothing to negotiate * out there. All the negotiation~ are complete. Now, if he gives them tJ~e h~n\Qr of kiis presence as tjie world watches, it see~rus to me the only conclusion that will be reached is that the Presidential blessing has been bestowed. There is hardly anything te bless them for. Senator PERCY. I would like to answer the Chair. I could not dis- ~gree more. Senator CHtrRcH. I tb~nk that is clear from your statement and from mine that we are in disagreement. You made yours and I hav& made mine. Senator PERCY. I cannot possibly see why the President's presence oi~t there in that area of ~the world weui4 not help. I cannot see any' injury from it. I thjn~ it ~Ls his duty and responsfbility to e~pge in that trip, when Sadat himself invited the President, the :P~esident t~o reject it, after Sadat has been extraordinarily helpful as he has been statesmanlike in this whole matter, without h~s statesmanlike~ attitude we could not have accomplished it, and for the President to rebuff the invitation. I think would be wrong. Senator CHURcH. I ini~ist say- Senator PEnCY. If I could finish and I will be happy to come back to you. Second, I cannot help but think it is going to be immensely helpful to the state o Israel. It will mean a great deal to 2~ million people for the President of the United States to be in Israel and indicate by his presence our deep concern `about peace and seouri~ty in that area. Certainly with the trip from Israel to Moacow, or vice versa, I would hope it would be possible for the President to bring up delicate and tender points abnut emigration from the Sovi~et ~Jnion and the~ repression and harassment of Jews in the Soviet Union. I think that Is~rael would be pleased. So when Israel and Arab states are both p~ease4 by the trip of the ~re~ident, I will not even go into the sub- ject 9f Moscow, but I do feel that can be extraordinarily helpful' and galvanizing of the bureaucracy. 4fter all that trip was set up a year ago and again lie is there ~t th~e invitation ~of Mr. Brezhnev. He is not goIng just on his own, asking to go, as the press have implied,, as a diversion :frorn Watergate. That ~s perfectl,y ridiculous. It is a business trip ~f grave consequences involviflg again the super powers ,of the world finding a way to lessen the level of terror. N~ow I will be happy t~ yield. Senator CIrURCH. I want t~ thank you very much. Well, first of all, I do not know the Russian trip is relevant to this discussion and I expect that there is something for the President to discuss with the Russian leaders. As for Sadat's invitation, my PAGENO="0043" i~tnderstanding was it was an o~pen invitation, there was no time date fixed. ft way be that great good t~an come from ~this tri.p to the Middle ~ast. I suspect some good will come to the ?resldent T~om the trip.. But whatever can be done out there-~ Senator ~P~ncv. He has~earued alittle bit df that, Senator CHunca. I just wonder what the real purpose of it is. The reasons that the Senator has g~iven are re~sdns that can be given for a Presidential trip anywhere to any part of the world at au~ tune. If tIio~e are sufficient reasons, the President would spend precious little time in Wa~hington. I find the ai~gument not entirely convindiug. Then we are disagreed on that point and it really has not any relevance to the hearing this morning. So I would like to say to you though, Mr. SaWhil1~, since I do have a proposal to make, and it comes dire~tly out of your testimony this worulng, and ~ think a proposal might be helpful-you have suggested ~n vt~rioi~is ways today that you have need for greater ii~formation. You have suggested in your own testimony today that you think th~t any settlement reached between the companies and the producing çgoye~uments ought to be supplied to your office. We have also est~bli~hed by questions and answers you think the Government should be entitled to more than information and that governmental approval of these agreements wo~ild be in order. So I am going to instruct the staff to prepare legislation that would give to your office the authority to require timely information from the companies with respect to any nego~iations on oil prices, thus enabling you to participate during the meaningful stage of those negotiations, and also that would require the Government's approval of any setfleaient between the oil companies and the producing govern- ments relative to the price of oil. I would hope that you would be prepared to he'p us in drafting legislation of this kind. Do I understand from your testimony that you would be prepared- Dr. SAWHILII. Yes, sir. Senator CRUnCH [continuing]. To support legislation of this kind? Dr. SAW~rLL. And we will work closely with you in the preparation. Senator CHUHCH. I would hope so, because I think out of tins hearing we might draft some legislation to fill the gaps that now exist and better enable you to do your job. Senator PERCY. The last area that I wmad very much appreciate your guidance and help on, all of us would, is in connection with the tax bill now before the House Ways and Means Committee where they are proposing to repeal the domestic depletion allowance. Do you support the House passed or the Ilouse position on this, the Ways and Means Committee desire to repeal the domestic de- pletion allowance? Senator PERCY. Do you believe that the repeal of the depletion allowance without some countervailing modification of the foreign ta~ credjt would increase the incentive of oil companies to invest abi'oad rather than here at howe? Dr. SAWHILL. Yes, and that is why I think the two have to be coupled together. PAGENO="0044" Senator PERCY. Do you believe it fair to increase tax on domestic operatior~s while leaving those imposed on foreign operations effectively at zero? Dr. SAWHILL. It would seem to me rather than think about it as a way of fairness it is a question of what kind of incentives do we want to give the companies? I think the incentives we want to give them are to invest in this country to develop our own supplies in the Outer Continental Shelf and Gulf of Alaska and other maior frontier areas and to the extent that we have a differential burden we are not going to give them that incentive and we will get greater investment outside of the United States rather than inside. Senator PERCY. Is it not our national policy enunciated by the President, and I would think overwhelming support of the American people, to develop a greater degree of self-sufficiency? I will not say total self-sufficiency for I think that is pie in the sky and if I can say so, political rhetoric. I do not see it in the cards. But certainly we can get greater self-sufficiency. Will it not be desirable to encourage tax policies that will provide incentives for investment domestically rather than abroad? Dr. SAWHILL. I am not entirely sure what the House position is but on the question of- Senator PERCY. It is a phaseout over 3 years. ENDING DEPLETION INCREASES COSTS Dr. SAWIXILL. Yes, of the depletion allowance. Of course, to the extent that we raised the taxes of the companies, we are in effect in- creasing their cost. And to the extent that these increased costs have to be passed on to consumers in terms of higher prices, in effect, what we are doing when we change the tax structure to raise taxes is to ultimately raise prices to consumers. The alternative would be to re- duce the profits of the companies, but to the extent that we reduce profits of the companies then we give them less funds for the important work that they have to do in bringing on new supplies. The other things that concern me about the depletion allowance, and I do not have as good information on this as I should, is that the group that seems to be most concerned about its elimination is the independent producer, and the independents in the industry drill about 70 percent of the wells that are drilled. And to the extent that this will hurt them and limit their access to the capital markets, as they claim it will, then eliminating the depletion allowance will result in a greater concentration in the producing sector in the major oil com- panies relative to the independents, and I am not sure that would be a favorable development. Dr. SAWHILL. Yes, it would. WILL OIL COMPANY PROFITS DECLINE? Senator PERCY. I would like to read a portion of an editorial from the Wall Street Journal that appeared the other day. I do not know whether you saw it or not. I would appreciate a reaction because they start to look ahead and they look ahead in a way that is in- PAGENO="0045" 41 teresting and I am wondering whether their fQrecast is as gloomy as yours might be, It said: Now that Europe has built up its inventories to pre~embargo levels, surplus oil is beginning to appear. As price continues to work against demand and the high price continues to call forth new supply, the trickle may widen to a gush. And if during the next six months the world economy softens as central banks fight inflation, there would be a glut. If so, Congress should understand that those 1T,S. oil company profits will be devastated. Forced to pay the artificial OP~EC price in order to maintain market shares, companies would nibble away profit margins first; OPEC would not be hit with the problem until the first buyer that runs through its profit margins drops out of the picture. Congress could hasten this process of destructiveness by imposing new taxes on the industry at this time, essentially by changing the treatment of the foreign tax credit. Do you have a reaction to that? Dr. SAWIIILL. Well, I think that that probably overstates the case a little but in terms of the decline in the profitability of the oil com- pany. I have to agree world supply and demand conditions are abotit as described in the editorial, that is, we will see some excess of supply and some lower pressure on prices, but I do not think it necessarily has to result in a significantly reduced profl1~ margin for the companies. Senator PERCY. Do you believe that repeal of the foreign tax credit as it applies to payments to oil producing governments would tend to increase the pressure on OPEC to bring down the artificially high priced levels? Dr. SAWIIILL. I do not think that it would. Senator PERCY. In 1971 the Shultz Commission suggested that the United States might establish a strategic reserve by means of constructing additional crude oil storage and production facilities which would be held in reserve until needed to avert a crisis. In your opinion, should this suggestion have been put into effect at the time that it was made, which would have helped us operate during the crisis on the embargo? STRATEGIC RESERVE A POSSIBiLITY Dr. SAWHILL. Yes, we are continuing to look at the full scheme of storage, not only of storage of oil but stockpiling of coal, because I do think one of the ways in which we can reduce our vulnerability and at the same time maintain access to imports of oil from around the world is by developing storage facilities in this country. Senator PERCY. Would you support such a proposal today then? Dr. SAWHILL. We are still studying the economics of storage. We certainly support it on a limited basis. I would like to know more about the economics before I could give my unqualified support. Senator PERCY. Do you have target dates which you have given your own people? I would like all of the facts necessary so a decision may be made and a recommendatioii made by you Dr. SAWELILL. November 1 is our target date. Senator PERCY. November 1 of this year? Dr. SAWHILL. Yes, sir. tor PERCY. I would like to ask you also about other things you doing in FEA, to get ready in the event that we do have an ~ency. For instance, are you developing standby plans for gasoline PAGENO="0046" 42 rationing, going ahead with the study you had on a crash basis end mothballing and putting at Jeast on the shelf various alternative routes we can, follow should we be taced wtth this situation again? F~A' CONTTh~G~ENCY PLANS Th~. SAWmLL. Yes, we did complete end mothbalF our plan on gasoline rationing. One of the contingency pI&n~ we are de~eloping is a contingency plan in~ the ev~t of a coa~I strike this winter beca~use that would require us to get, ~r might require us to get, into some kiud~ of coal allocation program, so we ai~e currently studying ~onl inven-~ tories, w~ere they are, how many days supply the differet~t utilities have so we would be in a position to move~qiiiek1y in the event of a coal stril~e. Sena~tor PEnc~. Do' yo~ support proposals ~o give the Gerxm~ent~ access as' a matter of right to all financial and reserve figures of the major oil companies? I would like to say, in asking the question, that I have fought very hard to protect trade secrets~ to protect all of those things which are necessary to preserve incentive in the incentive system. Certniul~y? we alL go to extreme to pa'~teet incentive system. Certainly we all go bo~ extreme to protect patent policy. We get in the quasi~area here now where we get into an industry that we all depend on as we are this thñustry. What is the right national policy now with respect to data, information, financial figures, production, supply figures? Is it the right and' duty of the Government to know? Where is the line between those ateas where we can invade~ and those areas of' privacy that are perfect1~ legitimate? Dr. S~WE1LL. As long as we have the ability to n~aintthn the con~ fidentiality of these records I think that generally we should have access to reserve any financial information and indeed ~$e do have access to the financial information because we are currently auditing the 30 major refiners right now to assess thá~ compliance with our price regulations, and that of necessity requires us to have access to their financial records. Senator Pnacy. Do you believe the statutory power we have given to your Agency is adequate to get whatever information yore feel is needed? Dr. SAWIIILL. Yes. Senator Fnncv. Finally, just' two inst questions. in looking at the dev~lopment of alternative energy sourtes~ do you believe that our coal, oil shale, nuclear, arid othei altern~ative O~nergy supplies should be controlled by the same companies which control our oil supplies? What is your feeling about a compafly being an energy company at against'being an oil company? OIL COMPANY OWNERSmr OF COAL REsnavns Dr. SAWHILL. Well, of course, the oil companies have moved out into this field and on the oriC hand, I must say that it is desh~able because the oil companies are the only companies really that have the capital' n~sources to rejuvenate the' coal industry and to make the very large investments in the nuclear structure that are going to be required if we are going to bring nuclear facilities onstream. On the PAGENO="0047" other hand, I ~tllink~it h a legitimate concern that we not concentrate all of the energy industry ih this country in just a f~ew large companies. So frankly, I find i~ somewhat of a dilemma. Senator PERcY. Yet, I think there is a case not of an oil company hut I think l(ennecott Copper that owns Peabody- Dr. ~AwmLL. Peabody Coat Senator PERCY. They have put in three-quarters of a billion Uoliars to develop those resources. It does take a huge amount of mOney. What is your feeling about a copper company being in the coal business; is that contrary to national interests, or is it perfectly ac- ceptable, because they do have management, they do have the resources, and they certainly have the foresight to get into it at a time when it did not look v~ery profitable to be in the coal business. Dr. SAWHILL. Yes. I would not want to comment oh the specific case because it is before the Federal Trade Commission~ In ~ener~i, I think that I can see nothing wrong with a copper company 6wning a coal company, particularly when it is willing and ready to supply this coal company with the capital needed to develop its facilities. Senator PERCY. Finally, what is your opinion of the proposed Federal Oil and Gas Corporation which would act as a yardstick of cost and profits, according i~o the sponsors of the legislation, in the industry? Dr. SAwHILL. Before giving you my opinion I might give you ah opinion of a group that is opposed to it, and that is the Sierra Club, which has called it a rubber yardstick. My own opinion is that we do not need a Federal Oil and Gas Corporation, +ather we need to provide some regulation to the industry, and more importantly, adequate incentives to get on with the important job of dril1~ng. Senator PERCY. Well, 1 thoroughly concur with you. The last one, I am not sure how you do feel about it. I feel equally strongly about chartering oil companie~ putting them under strict Federal regulation, control, like we h'~d the benevolence of the Federal Gov- ernment to rejuvenate and enliven the railroad industry all these years through Federal regulation and cthitrol. How do you feel about just increasing the regulations and control? Dr SAWHILL I do not really think that is the answer When we talk about Project Independence, this is not something that the Gov~. erument can achieve, this is something that has to be achieved by private industry I b is our job to provide the climate under which private industry can get on with the important task of developing our energy sup~hies4 Senator PERcI I feel very strongly the oil companies have to in- crease their tax load. Their tax contributions to the U.S. Federa~l Government should be increased by billions of dollars a year, but I would like to see it done in such a way there will be no disincentive for exploration development. Have you proposed or testified~ on this issue as to the best way you can devise to increase the tax contribution of oil companies but do so in a way that will not be counterproductive to the very thing we want, increased domestic sources of suppl5r? Dr. SAWHTLL. We have not testified on that issue, although we would be prepared to testify. Senator PERCY, Would you be prep~ed to testify on that then? Dr. SAwmLL. Yes, sir. PAGENO="0048" 44 Senator PERCY. I would certainly urge that our appropriate com- mittees, the Finance Committee, ask for your testimony and I will talk to Senator Long about that. Mr. Chairman, I would like to just express appreciation. to the witness for the conciseness of his answers. We can cover four times as much territory without the rambling that sometimes we do here and we tend to hear. sometime. I think you have been an extraordinarily helpful witness and I want to express appreciation to the staff that has done such a fine job in outlining the areas for exploration for us. It has been immensely helpful to, I know Senator Case and myself, and I am sure the chairman. Senator CHURCH. In view of the hour, I do not know whether we can say the conciseness of the answers would match with the concise- ness of the questions, but I do~ want to say to Senator Percy that I agree with him and the emphasis he has placed upon the need to see to it that the major oil companies pay more than token taxes to the Federal Government. In that connection, I have in mind the minimum tax we decided to impose on individual taxpayers, who because of their various tax havens and various loopholes ended up paying little or nothing. I think that a similar tax could be imposed on American companies doing business abroad. If all of the concessions that are given result in their paying little or nothing to the Federal Govern~ ment there ought to be some kind of minimum tax imposed on profits from foreign operations in this case and I will have such a proposal to introduce in the Congress this week. I hope that the Senate can turn its attention to it. It is particularly important where the oil companies are concerned because consequences have been such as to provide tremendous inducement to them to invest abroad rather than here, ai~d we must turn that incentive around. Senator PERCY. I would say, Mr. Chairman, history is going to record the fact probably tb~tt this subcommittee will ha~ve the biggest return on investment for the American taxpayer of any committee I have served on. I tend to think weneed to bring out the facts that were brought out here. I did not realize some of those facts before at all. I was shocked. I find the business community shocked that we have this inequity. The need for the past policy has long since passed and to the credit of the oil companies I think they understand this and appreciated it. They are primarily concerned, not about paying more taxes, but having us write punitive legislation. They were ab- solutely within. th~ bounds of law, that was the policy of the country at that time, for 20 years, but the policy is now going to change. I think no committee or subcommittee has done moie to help bring about that policy change than this subcommittee and I think we should report that. Senator CHURCH I think that is a good place to stop this morning Unfortunately, we will not be able to hear our second witness, Mr Kauper My apologies to Mr Kauper He might be here in the room by now. . Would it be possible for you to return this afternoon at 2 o'clock? Mr. KAUPER. Yes, I think so. Senator CHURCH. I~think it would be better if ~e~put the~remainder of the hearing over until 2 this afternoon. PAGENO="0049" 45 AFTERNOON SESSION [Present: Senators Church and Case.] Senator CHURCH. Mr. Kauper, would you please stand and be sworn? Do you swear that everything about which you testify will be the truth, the whole truth and nothing but the truth, so help you God? TESTIMONY OP THOMAS E. KAUPER, ASSISTANT ATTORNEY GEN- ERAL, ANTITRUST DIVISION, DEPARTMENT OP JUSTICE; ACCOM- PANIED BY RICHARD SAYLER; AN~D ~OEL DAVIDOW Mr. KAUPER. I do. Senator CHURCH. I have been delayed by a rolicall vote in the Senate and I am told that there are other roilcall votes anticipated this afternoon. I am wondering, Mr. Kauper, if we could insert your statement into the record and proceed directly to questions. Would you have any objection to that? Mr. KAUPER. That is all right with me, Senator. Senator CHURCH. In the interest of time then we will insert the full statement in the record as though read and Mr. Blum will commence with the questions this afternoon. [Mr. Kauper's prepared statement follows:] PREPARED STATEMENT or THOMAS E. KAUPER, ASSISTANT ATTORNEY GENERAL, ANTITRUST DIVISION, DEPT. OF JUSTICE Mr. Chairman and Members of the Committee: It is a pleasure to appear before this Su1~committee. These hearings have foci~ised on the broad foreign policy and Competitive issues highlighted by the current oil shortage and price rise. The relevant period which these hearings have covered has included events preceding the fihin~ in 1953, of the Antitrust Division's Oil Cartel case, to the present. I have bee~t asked to discuss the competitive issues which have arisen during this timespan, and to explain the past and possible future role of the Department's antitrust enforcement in regard to limitations on free competition in the inter- national production, distribution and sale of petroleum, I think it might be helpful to set out some general antitrust principles which may be relevant in this discussion. As you know, the prohibitions against monopo- lization and restraint of trade contained in the Sherman Antitrust Act extend to the foreign commerce as well as the domestic commerce of the United States. Our courts have held consistently that if a conspiracy has the intended and actual effeôt of restraining United States foreign commerce, the violation is not im- munized because some or all parts of the plan were formulated or carried out beyond the borders of the United States. On the other hand, it is equally well- settled that the Sherman Act, like any other United States statute, can have no direct application to the sovereign acts of foreign states within their territories. This limitation on Sherman Act jurisdiction is significant at present, since the period from 1953 to 1974 has been one during which foreign governments have seized an ever more active role in regard to the ptoduction and pricing of oil. To my knowledge, it has never been the Antitrust Division's position that joint ventures for the production of natural resources are per ze illegal; rather, the reasonableness of a particular joint ventl4re is tested in the context of the unique facts and economic facets of the industry involved. Such joint ventures, if large enough to be economically significant, should be analyzed in terms of whether they are neces~ary devices to spread costs and risks, whether they eliminate actual competithn or likely potential competition in a concentrated market, whether they are reasonably open or accessible to firms which need to join them or deal with them, and whether they are operated in such a way that they artificially restrain production or raise prices in the markets which they supply. 45_~426_75_L~~_4 PAGENO="0050" 46 From an historical perspective, the more recent activities of the Department of Justice iii international oil start with the litigation known as the JnternatiQnai Oil Carlel case.' The complaint in that cdse, Which thO D~partiiient filed in 1953, allegnd that eompanies~ noW knoWfi a~ 1~x~ton, Mobil, SoCal, texaco and Gulf had operated a worldwide cartel to insure that each firm would retain a fixedshare of the market. Specifically, thO complaint alie~ed that the defendants and øther entities had conspired to: -securC~ maintain end exercise control of foreign productiofi and supplies of crude petroleum and refined products; -cause dom~tic production of' petroleum and products to be curtailed or re- stricted in ampunts related to importations of foreign petroleum and prodiiets and to the extent necessary to maibtain the level of dOmestic and world l)rices of petroleuth and products agreed upon bythe dOfertdants; -divide among themselves foreign producing and marketing territories; -agree upon, maintain and correlate domestic and world prices ~f petroleum and products; -control hhports of petroleum afid products in the UnitedStatos; and -exclude United States petroleum companiCs other than defendants and their subsidiary and affiliated companies from opportunity to import into the United States petroleum atid products produced in foreign countries by de- fendafits and othOt petroleum companies. This description of the complaint is not ex~raustive; the list Of allegations goes on, as I am sure you are aware.-~Th{s SubcOmmittee has also heard testimony from current and former Antitrust Division attorneys who worked en that ease. I have read their testimony andbelieve that a detailed elaboration of the complaint would only duplicate nmterinl altitady before thl~ Subcommittee. The Oil Cartel cases were settledin large part by a series of consent judgments negotiated between 1960 and 19fi3: The case was finally terminated in 1968 by the dismissal of SoCal and Mobil, without prejudice to our filing a new action. The decrees which were entered prohibit, among other things, price fixing~ market allocation, interference with entry by competitors into U.S. and foreign markets and allocation or limitation of crude oil production in a foreign nation. On the other band, the decrees provide enpressly that the companies are not prohibited- that is, prohibited by the decrees-from participating ifl joint production opera- tions, joint refining operations, joint pipeline operations or joint storage opera- tions in foreign nations. This does not mean that these consent decrees legitimized fQr all time joint arrangements among domestic oil companies in their operations abroad. A business practice is not renderOd immune from antitrust attack simply because it is es- pressly not prohibited by a previous antitrust decree. The limitations contained in the decree merely establish that such conduct would not constitbt~ civil or criminal contempt of the judgment, but leave entirely open the question whether such conduct would be upheld if challenged in a new and separate antitrust suit. As these hearings have revealed, and I believe usefully so, the history of oil company foreign joint ventures has always been greatly complicated by foreign policy and national defense considerations. These ventures, although conducted by private firlus, have almost never bpen analyzed solely as business activity. Strong overtones of governmental policy have, it seems, usually affected both the activities of the companies and those ~g the Gov~rnment charged with overseeing the companies' activities. For exafttple, it appearC that the large joint venturO in Iran known as the Iranian Consortiuni ~was created with the encouragement and involvement of the U.S. Government in oFder to insure the stability of a relatively pro-Western government in that country. Because of that ipvolvement, the National Security Council, acting with the concurrence of the President, in 1954 adopted a resolution, which Wa~ made known to the Justice Department, that the Antitrust Division should make no effort to challenge or dismantle major oil company joint ventures in the Middle East. Nevertheless, as my ~arlier testimony indicates, the Department continued to seek and did achieve other relief in the Oil Cartel case. I know of no discusSions in recent years between the Justice Department and the State Department or the National ~ecaiity Council on the subject of the need to avoid legal challenge to joint ventures for the production of crude oil in the Middle East. 1 United States V. Standard Oii Conipasiy, Civil No. 1779-53 (D.D.C. 1953). PAGENO="0051" 4~;7 I ha\Te a1~o been asked to di~c~iss the ant~u~t ~ti~& concerning joint bargaining rwitli OPEC and the. Bu~ines~ ~e~4ôw cIearanc~s wMch the Antitrust DivIsio~i b~sued in rega~d1 to that b~rgainitig~ I understand that, ~n late 1970 and sub- ~e~uent1y, OPEC demanded fro!ifl t&ie oil companies a majol' iii~rease in tax take~ posted price and govera~aiental pa!ti~$patidn. OPEC swmmoned the companies to a conferenue ii! Tehran to diseuss it~Fa4~ion and the OPEC nations' asserted mood br more revenme. ~t is my understandiflg thmt the oil oompa~ioies consulted with the l~tate Department c~)acormng the foreign poboy ~n~I natic~na~ security issues arisimg from the OPEC deman~ and with the Justk~e Department about possible. ~nti- trust issues. The eom~panies requested the Justice Depattrnent to provide them with a favorable Business Review letter in regard to the joint negotiating tactics which the Companies contemplated using. A general description of the Department's Business Review Procedure may be in order herC, The Antitrust Division is not permitted to give advisory legal opinions to private compansss; nor does it have autherity to exempt any condnet from the operation of the antitrust laws. Nevertheless, persons contemplating joint business conduct have often been anKious to obtaii'l sothe form of indication as to the Department's attitude concerning that conduct. The Department has established a procedure under which a specific proposed course of actiOn will be reviewed by the Antitrust Divisi&i and in appropriate oases, we will ropl~r with a "Business Review" letter stating our present enforcement intention in regard to the intended course of action. Such a letter dces not legally bind the Division, since it expresses only the Division's present enforcement intentions. Nor does it have any effect on the right of other parties who have standing to sue under the antitrust laws. In 1971, the oil companies represented to the Division thpt they contemplated two strategies. First, they would create a negotiating team to make unified, lower counteroffers in respense to OPEC demands, at the same time notifying OPEC of this approach. Second, in regard to Libyan demands and the threat of Libyan exprc~priation, they would bind themselves to an oil sharing arrangement so as to keep in business any firm whose properties in Libya werO expropriated. The Division felt, at that titne, that the Libyan sharing agreement seemed to provide important protection for the smaller oil companies operating in Libya which had no other alteraative sources of crude oil. As this Subcommittee has shown, in Libya oil concessions to the smaller companies were interspersed wlth concessions to the majors, and it appeared that the Libyan Government would focus its demands on a smaller company without alternative crude oil sources. These proposed actions raised novel antitrust issues, but our files indicate it was then believed that these actions were necessary as a countervailing force to the producer government cartel with which the oil companies Were confronted, and that these actions would more likely have a beneficial than an adverse effect on U.S. foreign commerce. It is important to recall that the stated intent of these proposed arrange- ments was to maintain oil priceS at lower levels than would exist if the OPEC nations could negotiate with the companies one-by-one; increasing the terms required for settlement with each negotiation. Subsequent to the original 1971 Business Review letter, various elements of the agreements continued to operate, and the companies from time to time advised the Department of State and the Justice Department on events which werO occurring. The companies also requested that the original Business Review be supplemented to clear subsequent conduct. In light of subsequent developments, the Division authoriSed a pumbet of additional, supplementary Business Review letters. Your Subcommittoi, of course, has copies of all of those letters. In October, 1973, OPEC announced that it wished to reopen all the matters agreed to in 1971 and 1972, and it summoned the oil companies to a bargaining session in Vienna. The companies requested that the Department conhrm that the previously issued Business Review clearances would also be applicable to this new round of joint bargaining in Vienna. The companies again stressed the impor~ tanee of acting quickly, since prenaration for the Vienna conference was scheduled to begin almost immediately. The Division decided that the matter was of such importance that it should be reexamined as thoroughly as poss~hle in the time available, rather than merely relyIng on the fact that in thq past, Business Review letters had been granted in similar circumstances, Accordingly, we requested that knowledgeable officials of 14 oil companies who had been and were participating in OPEC negotiations or the sharing agreement coipe to the Antitrust Division and be interviewed separately concCrning the Competitive effects of their previous joint conduct and their reasonS for believing that fnture cooperation among them was necessary and would benefit American consumers. PAGENO="0052" 48 I might say that, in these interviews, all of the companies represented that they believed joint bargaining had achieved better results, at least in terms of holding off price increases for some period of time, than would have been achieved if each company had negotiated alone from the outset. And, all companies ex- pressed the view that the sharing agreement had helped in strengthening the hand of the small companies with limited crude reserves. Besides conducting these interviews over a two-day period in Washington, we dispatched two attorneys to New York to examine, to the greatest degree possible under the time constraints we had, the minutes and cable traffic of the oil company joint bargaining com- mittee-known as the London Policy Group. We also requested production from Exxon Corporation of all top management documents relating to joint bargaining with OPEC. These documents were produced, and analyzed by our staff. One major purpose of our 1973 review was to determine whether the oil com- panies had gone beyond the Business Review clearance by discussing topics such as domestic competition in the U.S. or downstream prices on oil affected by the OPEC bargaining. A second major focus of our review-both in our questioning and document search-was to determine whether the companies had bargained at arm's length with OPEC, had obtained a less costly settlement than would have occurred had they bargained separately, and had acted in a way which was as fair and helpful to the smaller oil companies as to the major firms. On the basis of this investigation, and in light of a thorough analysis of the relevant legal precedents undertaken by our Foreign Commerce Section, we con- cluded that it was appropriate to extend the earlier Business Review clearance to apply to the 1973 bargaining at Vienna. Nevertheless, the 1973 Business RevieW letter contained a careful statement concerning some of the limits on the clearance being granted. The letter, which I signed, stated: We feel it necessary to emphasize, however, that we view such intimate cooperation among high executives of competing oil companies concerning crucial factors involving cost and supply as potentially raising serious anti- trust dangers. Accordingly, we view this as an area which we must subject to constant review and reevaluation. Thus, it is likely that we will request extensive additional documentation of the lack of adverse antitrust conse- quences. Moreover, it should not be assumed that this letter authorizes any joint activity going beyond the subject matter of the Vienna negotiations, or provides any assurance that the Antitrust Division will grant similar Business Reviews in the future. Lastly, let me stress that our non-disapproval is in no way initended to sanction or authorize any joint oil company action which tends to reduce the supply of petroleum to the United States, such as joint agreements with OPEC concerning production levels of refinery construction, or joint agree- ments among oil companies to halt production or cease lifting oil in any country, to boycott oil from any country, or to chase so-called "hot oil." Because of the importance of the international petroleum industry and of the issue of how to deal with cartels composed of producer goverments, we have continued to monitor activities under the Business Review letters for joint bargaining with OPEC. Our current thinking has led us to consider whether cOnditions since 1971 have now so changed in the Middle East as to warrant a different approach. We are now involved in an inquiry to determine whether the letters were based on facts which are substantially changed. It is also our feeling that, in light of this inquiry, clearances contained in our letters should not be relied upon to justify future conduct by the companies. Current issues we are now studying are twofold: First, the subject matter of the bargaining has evolved from issues of royalties (a buyer-seller or government- taxpayer relationship) to ones of government participation, involving buy-back arrangements and other problems of distribution. The increasing amount of governmental ownership of the oil has transformed the OPEC countries into actual or potential competitors of the oil companies, thus making joint discussions among them more cartel-like in nature than merely buyer to seller or govern- ment to taxpayer. Second, our continuing study of the records of the ~London Policy Group indicates that what was to be an ad hoc organization has become a quasi-permanent institution for oil company cooperation, and that the discussions and studies within it tend to approach sensitive competitive areas of supply, cost, demand, control of downstream distribution and possible exclusion of independents by means of exclusive buy-back arrangements. All this is not to say that the original Business Review letters are somehow withdrawn, that granting of the original Business Review clearances was a mis- take, that we are now prepared to conclude that the oil companies are behaving PAGENO="0053" 49 improperly or illegally, or that there is any legal reason why their present conduct must end. We are simply taking the position that the possibility of changed cir- cumstances has made the advice contained in the Business Review clearances granted to date inapplicable as to future conduct. I would like to conclude my prepared testimony by discussing our ongOing efforts to preserve and enhance competition in the petroleum industry. At the outset I should say that the Federal Trade Commission, under our liaison proce- dures, has issued a complaint against Exxon and other major oil companies. This is a massive case, which could ultimately involve structural relief. Because both agencies try not to duplicate efforts and waste limited resources, this case tends to preempt much of the domestic antitrust field. Nevertheless, we in the Department have not simply been sitting on our hands. In testimon~r a few months ago I announced the creation within the Antitrust Division of an Energy Unit. Let me amplify w1i~t was intended and what has been done. Six attorneys and two economists, a number of them previously familiar with energy issues, are presently assigned to the Unit. More will be added. The Unit's initial task is to investigate whether the recent oil shortage or oil price rise were caused or accompanied by any antitrust violations in the domestic or foreign commerce of the United States To be frank, I must state that although the Unit began with numerous complaints and issues to investigate, there was no area in which we then had strong reason to believe an antitrust violation wa~ probable rather than merely possible. Since its formation, the Unit has concentrated on learning what information is available either in the Government or from other public sources, narrowing the issues to the most relevant and significant ones, and selecting the methods of investigation thought to be most appropriate and effec- tive. One phase of the investigation will involve an examination of how the major Middle Eastern joint ventures have been operated and what their effects have been, Portions of the investigation are now underway, and we hope to complete the first full phase of the investigation within a year. As I have indicated in several speeches during the past year, I believe that ~" this Subcommittee's exploration of the historical background involving inter- national oil serves a useful purpose. I think it will serve to bring to the attention of the public, the relationship of the oil companies, this government and the governments of the oil producing nations. As advocates for the free market system, we would prefer to see the development of effective buyer and seller competition in the oil business with a minimum of government interference or cartel activity on either side. Absent this, however, we believe that the United States Govern- ment should take a more active role to insure protection for the interests of consumers as well as the producing companies. Mr. BLUM. Mr. I~auper, our record shows the antitrust division of the Justice Department has issued six business review letters which, allowed the oil industry to set up a joint group to negotiate with the OPEC nations. Is that accurate? Mr. KAUPEE. Well, I am not sure the precise number is six. I think that is accurate. The only part of that statement I would question, is that the Department "allowed" them to do it. They can do it whether they have a business review letter from us or whether t~iey do not. We do not ere~te any kind of exemption. Mr. BLUM. As witnesses described the group, it included a number of regular committees and subcommittees that dealt with a very wide range of industry issues. When those issues could not be resolved the group held "meetings of the chiefs," as they referred to them. Given that degree of company cooperation and the enormity of the impact of their joint actions on the United States, what steps did the Department of Justice take to be certain that the public, interest was being protected and the law was being obeyed when these men were meeting? DEFINITIO1~ OF BUSINESS REvIEw LETTERS Mr. KAUPER. Let me be clear, first of all, that we understand what the business review letter is. It is simply a statement that, given what they have pre~ented to us as their plan of action on those facts, we PAGENO="0054" 50 do not intend to sue. Now, we are not normally in the business of being a regulatory agency, we are a law enforcement agency~ We have monitored ~nd have ~h~d ~per~ochc reports from tl~em. We have not had lawyers attending their meetings. We are n~v in the process, as I thmk my statement indicates, of cva~luating a good deal of docu- me~itati~n made avaUabfe in ~ounectiçm with a numb~r of those meetings ~nd of. assessing the currency of the business review letters themselves. The statement indicates that insofar as we are ~ow conducting further investigations, and because the issues have moved to some degree from what they. igin&~1y were at the time the business review letters were issued, thØ ki~Mir ~view, the letters themselves no longer can be relied upoh. Phat~Is, the facts are sufficiently different, the issues are sufficiently ~ that it ~o~ild not be appropriate to rely entirely on those letters at the present time. They were given, as I think you know, for specific negotiations, and I think there was no intention on our part to set up some kind of quasi-sovereign grom~p which was going to continue over a long period of time discussing a wide variety of issnes. We are monitoring those documents now but I think it should be understood that we have never peretived our role as being one of a regulatbry agency. We have no such authority. Mr. B~uM. I was not describing the Department of Justice as a regulatory agency. I am talking about deciding whether or no~ the law was being violated. The better part of the international oil industry was in regular conference. It seems to me at least that someone from the Antitrust Division should have been finding nut what was happening in that conference. Our testimony. indicates that the first time you began to read that cable traffic-by you, I mean the Antitrust Division-and began to ask questions, was January 1974, after our hearings were announced. Why did it take 3 years? DELAY IN ANTITRUST DIVISION INVESTIGATION Mr. KAUPEn. I think you have to peep in mind t1~at the particular negotiations as to which the letter was issued were entered into in 1971. I think you know from your hearings the circumstances under which that letter was issu~ed. Immediate negotiations were about to commence. I think it is probably fair to say that the business review letter was issued primarily as a matter of principle, that is, given the fact that the negotiations were commencing, the view of the Division was at that time that joint negotiations of the issues raised in that particular negotiation were not something we were going to challenge. Now, that being the case, and as you also recall, the agreements were arrived at in connection with those 1971 negotiations, I thinit it probably is fair to say that we did not regularly monitor thereafter. We had a letter which basically said we are going to not sue on a certain set of circumstances. The companies were well aware there were bounds beyond which they could not go. But I think we would~ have to say we did not regularly monitor that traffic. PAGENO="0055" Now, the issue then again arose, as you recall, in the fall of 197~ when a new deir~and was ~na&~' by OPEC, and a new business review request. At that time we monitored a good t~eal of activity. I think it is 1~rue, however, again in the timefr~me which we had, we did not monitor that cable traflic at th~t time. We are now monitoring it, as I think you are aware. M!r. BLuM. Why did you not deem it important enough to monitor or get into? `1 here were ~fi~e separate occasions when the conipatues came back ~nd said, "Look, we are doing more." Why didn~t someone go and look? M~r. KAUPmi. You must keep in mind once again what the issues were as they were presented ~from `business review to business review. One, for ~xanipie, contemplated a 1-~e~r extensien of the sharing agreement. That was the specific ssue which was before us. In each. case we were dealing With ~a specific question ~Which was presented to us. `Now I suppose one can say, and `I think all of us in that crisis have perhaps learned something from hi~dsight, that perhaps that should have been more closely monitored bn our part as it was going along.. I am not so sanguine as to think that perhaps it shon!d not have' been, but at the same time, we were dealing with specific issues, that were in large part issues not so much of fact as of a legal principle, that is, the principle of joint negotiations. Now, there is also obviously a question as ~to whether they were negotiating over things not covered by the business review letter, and that now is a matter obviously of considerable concern. As the institutions seem to have become somewhat more permanent, par- ticularly, I `think- Mr. BLUM. I take it `by what you have said that the Antitrust Di-~ vision is now looking at the full structure of the London Policy Com~ mittee, all of its various subcommittees and the works of those subcommittees, in an effort to determine whether the activities were within the bounds of the law? Mr. KAUPER. Yes. CLASSIFICATION OF BUSINESS REVIEW DOCUMENTS Mr. BLUM. When these business review letters were first issued, t~e Jutire Thpartrnent and the State Department went to great pains to keep them and the underlying documents from both Congress and the public. As recently a~ ~ihnmary 1974 1 believe ~ou wrote to Senator I~Iar1 of the Antitrust ~`ubcom'rnittee sa' jug thut the under- lying material conki not be turned over, to the Atititrn~t Subcomrnit- tee ; is that correct? You cited reu~oi~ ol na tiona I ~erurli v, I beii~ cc. j\4 kAurEn. ~es, sir; some ok tlic (ioeuu1e~us were el~s~hen. I think I should add, liowevet, that there were brictings of a uunber of Mlembeis of the Congics~ Ironi time to time, in~ludn~ members of the Antitrust. Subeomtnittcc, on the issoe:~ that were raised ~ the bushiess review letters. Lint u, we (.InI ~ot fail to inform Ilusi ~f I he ex~stcnee of the letters. The documents 1 hemselves were We `were advised by the State Depart ment there were ser~uitc re~aoiis for doing so. PAGENO="0056" 52 cert~ id ha~re to ag PAGENO="0057" ~53 Senator CHURCH; So the theory apparently of the Department in such cases, apart from the very practical consideration the Department has to comply- with Presidential orders, I suppose, is that there is some inherent power in the Presidency to waive the law when the President makes the determination that it is in the national interest `to do so? Mr. KAUPER. Well, I suppose that is the conceivable possibility in some circumstances. Another possibility is that there may be two statutes that appear tp conflict and somebody has to resolve which one is applicable. But in ~many of these circumstances we are dealing with the kind of violation, if it is a violation, that is not what we would refer to as a per se type of violation. There is an element of discretion involved as to whether to bring the case. For example, if I can give you just an illustration Qf the kind of thing where it seems to me it is purely within antitrust policy to Consider that sort of issue. There is the sort of circumstance where because a foreign government is involved and the advice received from the State Department or some other appropriate agency is that if certain action is taken by the Antitrust Division it will provoke a governmental response the effect of which may be not only to undo what the Justice Department is trying to do but competitively make it worse. That kind of circumstance could arise and it seems to me considerations of such concerns is entirely within the province of the antitrust laws themselves. Similarly, on the question-"Is there effective relief to be obtained should we bring this action?"-I think it is appropriate to take that sort of consideration into account. Senator CHURCH. Sure. Any enforcement agency, whether it is the Justice Department or whether it is a prosecuting attorney's office, has to exercise a `certain measure of discretion in determining what actions to bring. I am aware of that. In 1950, though, or thereabouts, the Justice Departihent did make a determination to bring an antitrust suit against the big oil companies based npon the thesis that the companies were in violation of the anti- trust laws did it not? Mr. KAUPER. That is correct. Senator CHURCH. And so that element of discretion was exercised~ and in the opinion of the Justice Department at that time the anti- trust laws were being violated and, as we know from our previous testimony, this suit was changed from a criminal suit to a civil suit and then it was watered down to the point of being in effect called off.. Is that true? That was done on orders from on high? Mr. KAUPER. Yes, I think that is quite accurate. I would not contest those facts. Senator CHURCH. The facts bear that out. We have already dis- closed those facts. WHAT IS BEING DONE TO POLICE NEW NEGOTIATIONs? So I would like to bring us up to date. It is true that the general picture is changing very rapidly in the Middle East and it is hard to know from day to day what the shape of it is going to be. I would. not think in these cfrcumstances that the Deiiartment could suddenly PAGENO="0058" M get a fix on thjs thtuatio~i butT d~o thitik thM~ the i t&i~o~k1ng ~rr~aige~ ments be~twE~en the rtutj~or cornp~tthe~ tli~tt We 1~~e di~io~ed in the ~oürse of these hearings, ~vhieh p~rsisted foi1owin~ the ~bitr~dofrm~rnt of the antittu~t suit, and ih tac~t were extehdCd still further, ~nd f~he ~rery real pos~ib~1i~ty that these inte hn~kthg~ arr~ngek~iertt~ ~wffl perhaps in a new form, maybe, that the gover~iment's con~rft ~~iii tnke owners~hi~p~ 6f the fad e~ in their re~ec%i~e ceuntries, bui~ then we already see developing bi~y-back agreements itbich may ~ety w~fI preserve the substance o~t this aTr~g~ment, ~M~h clearly eb.ables the major companies lo e~ntrol the marketing ~f inoet of the e~nth~. NoW, what is the Jnst+ce Dep~rtn~ent d~*~g, pre~ent1Yy iii thm~i~thrM~ this si~tuat~ a~ ~*Jiat ~cti~n tnigh'~ be takët~ td p~c*&nt th~ er~atidh of a ne~* and e~n Ct~geF th~o~r on the paft of the~e big e~M~ panies h~ the aftermath of ~his changing sitnation that is h* ~ft4~*~j7~? Mr. RAtJ~~. WeAl, We are eondiictmg~ at the n~.onent~-~-yoo i~ieed the *ord mordtoring-We are eondu'etint~ a b~oader i~stitihn than :1 think tb~ Word monitoring v~enM sngge~t, beeattee the w~Fd monitoring si~ggests to mc We are ~!ooking ipl~ ~t the jthtt ne~etM- ~tioti issue. Senator CWt~ncm Yes, tell a~ What yen are doing. Mr. KAT1~n. The hnrestigation is broader than that. I de n~t 1cran~t, Senator, in o~en hearing to go into too much ~einii a~ to *hat are looking at but obviousi~r, We are looking at a ~a±iet~r of r~eA~- tionships between the oil cothp~i'ies, Whether they a~ré th tI4~ fb!~~M ~f existing refatiomiships or whether they are in the form of What One might project the outcome of thin very fast-moi~iug situation c6uTd be. This is a rn~tter of me4or concern with us now and we ~ft, I think it is probably fthr t~ say~ With eonCefn o~rer the jOiirl negetia- tons, but it has become apparent, I think, to e~etybodSr that We ~tre dealing with issues someWhat larger thah that. That investigation is ongoing now, we have ~ m~th~beF of personnel involved in it, and hopefully, we will begin to get so~tie fairly good fix on some of this within the not too distant future. Eut ~s you huve suggested yourself, this is a situation which is changing a4most daily airrd~ with the oil-producing countries themselves taking en ownership interest, we are obviously now having to focus on the iMpaCt that uray have n~on the e~isting relationshi~s of the oil companies. That also m and of itself would include the issue of buy-backs, wInch is a matter of ~onsidrrable concern, for the reacon I think which you your- self suggested. Mr. Th~ui~r. I would like to pirk up again with the document declassi- fication problem, if I may, because the issue r~eeds some further Tesolution. We had testimony here, and we released documents iii the Course of these hearings that showed the safet~r net agreements and associated documents were not classified until April 2~, i97~, which \* at Some time nfter Ralph Nader had filed suit under the Freedom of Informa$on Act to force their disclosure. Did anybody in the Department of i~tstiçe call the State 1~epart- ~ment and ask that they be classified to prevent disclosure? Mr. KAnPER. Did we ask them? Mr. BLUM. Yes. PAGENO="0059" Mr. ~ That suit has gone on for Sô~iiO tii~e and my recollec- lion is that, as you know, we were the ones who classified the d~cu~ ments. This was done in discussion ~vith the State Department. Who initiated that discussiou i~ am not quite sure I can r~con~truct. We had asserted defenses to the productioh of those docu~ments in the suit and it was felt that because, among other reasoAs, we were in fact asserting security interests that it was appropriate on the advice of the State Department to classify them, I do not know that I can say that we initiated it or they initiated. Mr. BL~M. in other worde, you cannot answer that yes OT no? Mr. K~u~R. I do not think at the moment I really can without going back and trying to reconstruct what occurred. Mr. Bi~uM. You said in a ~pecch before the antitrust section of the Michigan bar in February 1974, on energy matters, that history telLs us `restraints of trade which develop in relationships born in a crisis tend to endure long after the crisis each. Given the degree to whIch this industry has been working together, even before the 1971 negotiations, what do you propose to do to thsnu~atit1o this "London Policy Group" structure when the crisis ends? Is anyone on notice that the atrrange~. meats andy the intercompany contact must be terminated? DISMANTLIN~i INDUSTRY GROUPS WILL BE DIFFICULT Mr. I~AUPER. I think you are asking what seems to me is the kind of question which I was attempting to direct some attention to because it is not always clear that after the fact you can effectively dismantle a given structure. The disruption and what you get when you are all done may not he a significant enough improvement to justify the expenditure of resources that would do it, ~articulariy if there are significant forces in the market working changes in any event. The point I was trying to make, I think, was exactly that; namely, that structures are extremely di~fflcuit to undo and while it has been relatively common to make short-run decisio~ based on short-run crises, such decisions are often made without any reali~ation of what their stru~ctural consequences may be and that such consequences may be impossible to undo later. I Mr. BLUM. You are saying then, given what ha~ been put together, even assuming you were to sue successfully, relief might be very difficult to achieve? Mr. KAUrER. Ycs~ sir; I think one tends to find that companies do not voluntarily restructure themselves. We have litigation of that sort going on now, not in this industry, but I think you can appreciate what the problem is. It is a very difficult thing to do and to do with the assurance that when you arc all done you have substantially in1~ proved the situation. Mr. BLU.i~i. Our records show that the Aramco chiefs have met a number of times in August and September of 1973 to discuss how to handle buy-back negotiations, Rave they sought business review letter ~clearance On this subject? Mr. K~UPER~ Are you talking about spec~flcahiy Aramco? Mr. BLUM. Yes. Mr. KAUPER. Not to my knowledge. Mr. BLTIM. Were you aware that these meetings were taking place? PAGENO="0060" 56 Mr. KAUPER. I do not think I was aware that there were specifically meetings of Aramco. Mr. BLrmr. These are the presidents of the four Aramco shareholders, Texaco, Standard of California, Mobil, Exxon. Mr. KAUPER. I assume that is who you mean. Mr. BLUM. Has the Department made any effort to find out what is happening? I assume since you did not know about the meetings you could not have. Mr. KAUPER. Well, this is obviously part of what is involved in any investigation that is going on. One has to keep in mind when you are t~lldng about a joint venture, as such, one has to assume that the joint venturers meet, from time to time. Mr. BLUM. Let me get very explicit about this. What is under dis- cussion is the price of buy-back oil, that is, what these companies will jointly pay the Saudi Arab Government for the oil they take. The terms of reference they are using are the market price and percentages of the market priced I wonder if you could explain for our record, how the presidents of the four largest American oil companies can meet and discuss the market price of oil and percentages of it for joint buy-back purchases and not violate the Sherman Act? BUY-BACK NEGOTIATIONS ARE IN A JOINT VENTURE CONTEXT Mr. KAUPER. Well, I think you have to keep in mind you are talking about in the context of a joint venture. Now, you may take a position that the joint venture itself is a legal problem, but there is surely inherent in the notion of a joint venture the idea that certain of the joint venturers can meet to discuss the business of the joint venture. Now, if that discussion carries over into what are our prices going to be in the United States, how are we going to market oil which we otherwise have in various parts of the world, that clearly does not fall within my rationale. Ypu are getting to a point you are talking plain old-fashioned prk~e-fixing. But there surely is inherent in the notion of the joint venture the right of the joint venturers to discuss the business of the joint venture. Mr. LEVINSON. Perhaps to put it in specific focus in your statement you lay out the criteria by which one should judge joint ventures. Have you evaluated the joint ventures in the Middle East in terms of these criteria, or are you inhibited in any way from going back to reassess whether or not these joint ventures and the way in which they operate, the offtake rules, the production limitations, which are inherent, and the rulemaking within the joint venture framework constitute antitrust violations? Are you inhibited in any way by the existing consent decrees? Mr. KAUPER. I think the answer to that is no. Mr. LEVINSON. That is the answer to my question. Have you assessed or are you in the process of assessing those joint ventures in terms of the joint venture criteria in your statement? Mr. KAUPER. I think we are assessing a number of these relation- ships including to some degree the joint ventures. Let me add to that. PAGENO="0061" 57 There is a difference between looking at the formation of a joint venture and the time frame in which it was formed, on the one hand and the effects which joint ventures may have viewed at a much later point in time when there are interrelationships between them or where you are talking about what may be a monopolization kind of situation. The formation of a joint venture-looking at it at the time in which those joint ventures came into being-in light of these criteria, poses quite a different issue, it seems to me, than if you look at them today and say who controls how much. After all these joint ventures came into bei)ng at different times, there were difi~erent needs f or risk capital by the oil companies, they had different commitments at different times. So I think probably what would be the more accurate statement is that we are looking at the effect of them now rather than the question of their initial formation. Mr. LEvINsoN. In other words, in effect, 20 years after the for- mation ~f the Iranian. consortium, the Department no~W feels it is appropriate to review the effects of whatever may have been the rationale for their formation at their inception. Is that a fair statement? Mr. KATJPER. I think that is a fair statement. Mr. BLUM. Our understanding is that in the course of the buy-back negotiations, in more than one situation, one member of the joint venture has suggested, "I will go it alone because I as an individual company will be able to get a larger market share and because I do not want to be tied to the percentage of the joint venture that I had." Does this not in itself raise serious questions about the effect ef the joint venture. Doesn't it put the issue of whether the joint venture is the appropriate vehicle for buyback negotiations? Mr. KAUPER. Well, I suppose it raises a question whether it is in the interest of the companies themselves to try to adhere to a joint venture approach. To a degree that seems to me to be a business decision. Now, I think what you are suggesting, if I c~n carry it the next step, is that it may suggest that it is not the business of the joint venture at all. Now I do not really want to speculate on what the facts might show as to whether that is so or whether it is not, but I think I understand the rationale of your question to be that even assumin there is a right of joint venture to engage in certain conduct wit respect to the joint venture, if in fact it is not a joint venture interest, then perhaps it simply is a collateral side agreement. Mr. BLUM. As I understand it, the rationale for the joint bargaining which was allowed by the business review letters and other subsequent joint activity, was that by joint action the companies could get bargaining leverage. We have had repeated testimony and I think you heard some of it this morning, that the bargaining leverage of the companies has been very seriously eroded to the point where they have very little left. Does not that now destroy the rationale that was behind the granting of the business review letter? PAGENO="0062" RATLONALE FOR B~SINE~S REVIEW LETTER US GONE Mr. L~u~n, I think this is obviously one of the circumstances w& are referring to in the written statement which I have submitted, that is, whether we are now at a point where we are no longer talicing levcr~ age. There may not be any leverage to be applied any more, we may simply be in the setting of unilateral demand made by the OPEC countries, in which case there really is to a degree, I suppose, a con- siderably lesser rationale. Now, it may be that there is leverage still possible thvou~h joint negotiations on some particular issues which may arise. That is one of the items which I think we have to look at. But certainly the suggestion has been not only from the testimony this morning but from other' testimony I have read that has been submitted to this committee, that perhaps the notion of leverage through joint bargaining simply does not exist, that we are now in a position of simply having unilateral demands and having to respond to them, and that is all there is to it Mr. BLUM. One witness, Mr. Rooney, testified that he thought it worked in reverse. That is to say, by joining together, each company was assured that if it pvc in it would not be stuck out there alone., Everyone else would give in as well, and the price increase would be. passed through to the customers. Mr. li~Aiw~R. Yes. Mr. BLUM. Is this one of the effects that was considered? Mr. MIAUPER. This is a possibility and I suppose more of a possibility now than it was then, I think, however, that the testimony before this committee and our own assessment of this situation in terms of the joint bargaining tended to indicate that at least for some period of time it may have forestalled more rapid increases, and that there was a period of time in which there was in fact some leverage which came through the fact of joint negotiations. Now, whether historically if we get a little far away from it and look back at it we conclude that that was in fact the ~ase, I do not know that we really can say; but I think one also would have to say that even if there was up particular leverage which they were in. fact able to bring about, it is not clear to me that that necessarily would mean there is an antitrust violation. That is, in one sense, even if the joint bar- gaining was ineffective and simply ended up with a price that the unified OPEC nations would have imposed anyway, it is a little difficult to say the joint bargaining has itself caused any restraint on price activities. It may have been a neutral effect but it may not have caused any harm. Senator CUUEcR. I personally have found no fault with the Depart- m,ent'~ decision to grant these business review letters at the time they were granted because of the predicament which the major companies found themselves faced with OPEC, an organization of producing countries bargaining collectively for those governments. The im- portance of establishing a common front on the part of the companies, I think, was a need probably to proceed that way. But what really concerns me is an arrangement growing out of the present flux that reestablishes all of these devices by which the major companies have effectively squelched competition always, of course, in the name of free enterprise, but the limited role that has been left to competition PAGENO="0063" 59 in the eu i~a4nstry, hig oil, ~s so eo~spicuous that I would hope that th& Department wopid c efnUy review any arrangements and vigorously enforce the ~titrust laws if they exe found to be violated. Mr. L~ur~n. I think that is what we are atte~ptiug t~ do now, Se~iator. I think the wriitten statement which I have submItted indi~ cates why we h~ve some concerp. now about the business review letters. I thinlç it should be understood we are not withdrawing them, we are not s~yh~g what the companies have done was illegal, but rather we are simply saying we have reached a point where there are different circumstajices and indoed there are different issnes now being made the subject pf negotiations and that these letters really do not apply to that new set ~f circumstances. In addition, we do have an opgoing investigation, and again in those circumstances while that is going on I think just as a matter of fairness the industry oi~ght to know that. But clearly we are looking at a broad range of new issues~ issues which conic about throug~ p~rtieipatipn, issues relating to buy-backs, and whether or not we are go.ihg to simply go back into what we have had before, which is obviously of consider- able concern. Senator CuuRdH. If there was any overriding foreign policy reason for setting aside the antitrust suit in the fifties, those ~ea~ons have long sliwe been rendered obsolete by events. The same set of considera- ti~is no longer apply t~ the American j~oJicy in the Middle East and~ therefore, the Department of Jnstice may find that it will not be blocked by a v~gorons en~orcenIent o~ the antitrust laws should the facts call for it in the future. I think that if the companies were put on notice to this effect it would be altogether constructive. They them-. selves would keep that in mind a~ they mal~e and enter into the ar- rangements with the producing countries and thus might avoid in- frictions of the antitrust law that could bring about another ~uit against them. Mr. KAIJPER. Oh, I think that is quite true, Senator, and I think this is obviously one of the reasons for indicating to them that we are examining some of these relationships, quite clearly. ~`ORMAL PnOCEDIJRE FOR NATIONAL SECtR1TY EXEMPTiONS Mr. BLUM. Mr. Kauper, in colloquy with Senator Church you indicated that the national security question was a difficult one to resolve, that there were conflicts from time to time, between the interests of the State Department and the interests of the Justice Department, and the discussion went on to say that there was no specific national security exemption of the antitrust lawg. If the ~ntitrust laws are to be set aside for national security reasons, is n~t the proper thing to do for you to come to Congress and say, "Look, we must have exemption here," in a formal proceeding so that people are on notice that there is a way of resolving it and a formal way of doing it? In the past, as one reads the record, the way it has been done is by a telephone call. In the case of some of these incidents, a National Security Council resolution was used, but typically a tele- phone call from someone in State to someone at Justice and a rather informal procedure in which the documents then are removed from both public scrutiny and congressional scrutiny has prevailed. PAGENO="0064" 60 Would you not favor some kind of formal procedure with perhaps notice or with a procedure for notification to Congress? Mr. KAUPER. That might be desirable. I am a little reluctant to see us somehow proliferating exemptions to the antitrust laws in any formal sense, but I think it obviously could be desirable that the Congress be notified that this sort of action has been taken. Mr. BLUM. The problem, of coui'se, is we have had proliferating exemptions but without the benefit of either legislation or notification. If we are going to have them we probably should have the legislation and notificatiou so as to at least follow some reasonable form. Mr. KAUPER. Do not misunderstand me. My general belief is if one is going to have exemptions from the antitrust laws they ought to be in a statute. I have said that many times before, and I think it is as applicable here as anywhere else. On the other hand, I think one has to be a little leery about describing this as though it was necessarily some form of exemption. There are places where security considerations are brought to bear when one is not talking about exemption from the antitrust law but rather simply plugging a factor of foreign policy into a judgment as to whether a business is engaging in a reasonable course of conduct or whether it is not. I think that the documents that this committee has accumulated and released with respect to the conduct of 1953-54 would tend to show it was an override judgment. I think that is clear. But I think there is also an area in which the foreign policy concern simply goes to the issue of is this unreasonable conduct, and that, as you know, is built by history at least into the language of the statute. Mr. BLUM. Well, now, tiave you made this kind of judgment with respect to international or multinational corporations in other in- dustries as well? Is this a frequent policy issue? Mr. KAUPER. You mean the foreign policy consideration? Mr. BLUM. Yes. Mr. KAUPER. Not that I arri aware of. Mr. BLUM. How about a remedy for some of this difficulty we are faced with in the petroleum industry that would call for spinning off of some of the joint ventures? A suit which would bring divestiture or spinoff of some of the producing joint ventures in the Middle East, perhaps following the theories that were used in the General Motors case, section 7 might be appropriate because these joint ventures were after all, in many cases the results of acquisition. Mr. KAUPER. Well, here again, you may be getting back into a test of some degree of the legality of these ventures and their formation which poses quite different issues than where we are at the present time. They did nqt after all arise simultaneously, they arose over a period of time, with different capital coming in. It is possible, of course, to think in terms of spinning them off, dividing them up. That poses some rather difficult issues since to some degree these also reflect judgments by the host countries as to how they want to deal and you are into a concession relationship with a host country that may make a~ny kind of effective relief of that sort very, very difficult to obtain. One has to keep in mind here that you are also dealing with another party to the transaction, a party which is a sovereign nation, and that makes questions of antitrust relief in the domestic courts of the United States rather difficult. PAGENO="0065" 61 Senator CHURCh. I think that though in theory the propositionr that Mr. Blum has suggested to you is supportable in practice~ I eaiino't imagine~ how the executive branch could say in a case like the antitrust case that, although it was the view of the Justice Department that the laws of the country were being violated, .the matter was being set aside because of considerations ~f higher c&noern. I mean to formally notify the Congress that the law was being disregarded would~invite a hor- net's nest of protests and I just do not see how as a practical matter you could proceed in this way. Mr. KAUPER. F think it would be extremely difficult, Mr. Chairman. Senator CHURCH.' Still it is very irritating for us to find out many years after. the fact what happened behind closed doors and until this subcommittee brought the fact to light very little ~~as known pub~ licly ~bout whatever happened to the antitrust action against the big oil companies. Mr. KAUPER.~ Well, I ~think, Mr~ Ohairman, bringing to, light some of the material by your subcommittee probably informed all of us about something of what had happened, too. Senator CHURCH. That is right. VERTICAL INTEGRATION IN THE PETROLEUM INDUSTRY Mr. BLUM. We have in the course of these hearings de1~el9ped a con~ siderable amount o~ material on the ipipact of vertical integratiofl in the petroleum industry, that is~ the effect on the marketplace of having producersof crude also be in the business of transporting, refining, and m~trketing, and there is considerable suggestion that people who are not in the business of producing crude are at a serious competitive disadvantage. Is this one of the considerations that. you are taking into account in the course of this inveatigation? ~re you considering looking at breaking up the vertical integration of this industry as a possible remedy? Mr. EAUPER. I think you have to keep in mind-and I have to be a l~tt1~ careful because I do not want to be in the position of com- menting on a sister agency's proceedings-but as I recall, there ~vas dialogue this morning with Senator Case on this issue as well, that the Federal Trade Commission, of course, has a proceeding against a number of the major oil companies in which vertical integration is a part of the complaint. I do not think it would be appropriate 1~or me to comment on that particular proceeding other than to say that because it is ongoing and because of our normal liaison procedures with the Federal Trade Commission we are not directly involved in the question `as you presented it, that is, should we take steps to divest or whatever would be necessary to break tip that vertical relationship. That does not mean it is an irrelevant fact to assess the impact of some of these other arrangements, it is a competitive fact of life and obviously has to be understood in order to fully analyze some of these other arrange- ments. But I think on the question of vertical integration so far as it might be a major focus of antitrust inquiry at the moment, that is before the Federal Trade Commission now. 45-426--75--5 PAGENO="0066" 62 Mr. LEVINSQN. What happens if the Federal Trade Commission budget is cut by $1 million? Mr. Whitten's subcommittee is apparently going to cut it, we understand. That $1 million would in e~Fect, eliminate that special oil group they have formed. Does that mean a~ long as FTC is charged with this issue you will step aside and leave it to them, but if they are undercut by bUdgetary considerations that you ~wi1l step back into the issue? Mr. i(AuPER. Well,I do not know that we have crossed that bridge with the Federal Trade Commission. I think that cut would be an unfortunate event. I am not altogether sure whether the impact of the cut would be felt on that particular proceeding or on the broader energy study which Congress has in effect ttsked the Federal Trade Commission to keep going. If th~ Commission were to reach a point where it said we no longer can proceed with this then I suppose `there is a question whether, at that point, we should step in and see what we can do, Mr. LEVINSON. The reason 1 asked that is that I guess th~ part that really disturbs us is the sense that the Aiititrust Division of the Justice Department is not in the forefront in insuring that the antitrust laws are an effective vehicle for enforcing the competition policy of the Government. Let me refer to an article which appeared in the London Economist of May 4, 1974, in which after Mr. Jamieson, head of Exxon, had given a press conference in London, they state that: There are still some nagging questions to ask Mr. Jamieson. The German Cartel Office alone of the industry's world critics seems'to have fastened onto the main one. Last year, supplies tightened even befOre `the oil embargo gave them another squeeze but did the resulting price rises reflect these niarket forces alone, or d~d concerted action by the companies come into the picture, too? The companies nianaged to assert their oil supplies delivery quite effectively during the embargo. Who can be atsured they acted `independently on prices? As the German Cartel Office has ~iso discovered, no' one country on its own can get to the bottom of this. My `question is two-fold. One, why is it that the German Cartel Office has to be in the forefront? Why is not the U.S. Government in the forefront through the Antitrust Division and, two, what efforts are now being made or will be made in the future to coordinate with offices like the German Cartel Office to insure a coordinated approach rather than a fragmented approach on the part of governments? FEDERAL TRADE COMMISSION ACTiViTY SHOULD BE CONSiDERED Mr. KAUPER. I think so far as the Antitrust Division and its activity, it is probably not accurate to judge the Government's response in antitrust terms based solely upon what the Antitrust Division does. We have the Federal Trade Commission which is in- volved in a great deal of this activity. This Congress has itself re- quested them to play a very major role in the whole question of energy, and we are very much concerned that we do nothing to impede that vei~y important case which they have pending. That does not mean we are not looking at questions of whether there may be criminal violations involving hardcore collusion, but I think one has to recognize that we have two agencies that are in\rolved, not just one. Now, insofar as the relationship with other cartel offices, we have had discussions with the German Cartel Office, we will be having more. PAGENO="0067" 63 We have periodic discussions with the cartel office of the European Economic Community and that has included some discussions of / petroleum. Those presumably are going to continue. I think in assessing, however, the role of the German Cartel Office one has to keep in mind the Germans have quite a different statutory scheme than we do and they can deal with what they refer to, as abuse of economic power, which in their judgment, includes certain price conduct which may not be conspiratorial, it may be unilateral in circumstances where we cannot act. They have quite a. different scheme and quite a different way of going at the thing. I think you are quite right that the German Cartel Office's ultimate bottom line was that there is not much any individual country, at least so far as a country the size of West Germany, is able to do about this. As I recall, I think that is a fair statement of what their conclusion was. Senator CHURCH. Senator Case. Senator CASE. One of the things that is very intriguing to me is the question of how we can acquire adequate information from the executive branch as to what it is doing without writing a statute which requires it, and also. at least by implication, validating that action. There will be a decision to prosecute, to delay prosecution,. to take other action in relation to the national security or a particular security issue which may be active at that particular moment. I am just asking you as a lawyer, would it not b~ possible to require information as to all matters of that kind in some fashion without the same statute authorizing it? Mr. KAUPER. You are talking, I gather, about simply. supplying information to the Congress? Senator CASE. Yes; and making it public generally, too, as far as that goes. Mr. ,KAUPER. Well, I think that obviously one answer to. part of this is greater openness in the operations 91 the place like. the ~nti~ trust Division generally. There was reference to the suit, for example, that Mr. Nader brought. Prior to that time, although we did not finalize it until after the suit, we were moving in the direction of greater openness. We have now amended our rules, for example, to provide the Business Review Letters be made public, so that if we either grant or deny a letter that is a matter of public knowledge. This, it seems to me, is a.. very desirable way of proceeding and it not only tolls the Congress, it tolls the public as well. Nov, if we were into a national security matter, a real national security issue, then I suppose there might be some reason not to advise the public and it would be necessary to find some way to. notify the Congress. Whether any such issues are likely to arise I do not know.. But in explaining why there is a national security issue, there could be some problem in terms of how much information is made public. But I would suppose it is possible to work some kind of system of notifica~ tion without saying that we have built into the statute some whole new exemption, if that is what your question is. . Senator çAS~. I think it applies to the question of antitrust laws and other actions, too. S~ometimes if the national security is deeply involved eiiou~h I would say the President has to break the law and hope that he will be supported by the peopie afterward. President PAGENO="0068" 64 Lincoln did this in the matter of a number of actions that he took, though quite contrary to the Constitution, and other Presidents have done this, too. This does not make his actions lawful, at leest iiot in the sense that there is something you have said ahead ef time he can do, but I think if you have inherent powers this is the kind of inherent power he has. It really is not a power at all, it iS an obligation to take a chance. Mr. KAUPER. I think that is exactly right. Senator CHURcH. Only to be exercised in the extremities. Senator CAs~. Only to be exercised iA effect, to get away with it. Mr. KAUPER. Yes, sir. Senator CASE. But knowledge is also important here. NATIONAL SECUEITt GOES TO "REASONABLENESS" OF CONDUCT Mr. KAUPER. I think, Senator, we would probably all agree, and maybe it is the most extreme example that one could never envision, but if one can imagine a' Go~~ernment law enforcCment action in. cir-' eümstances where the effect of filing suit might be war, I take it we would probably all agree that we would opt for nnt filing the Go~- ernment antitrust actioi~. I suppo~e that perhaps is the fnrthest extreme.' "Then, it is a question `of degree in terms of what you mean by a ~ecurity ~tiéstion, and whether you are' really talking about overn~iding a straight antitrust judgment. Now, in terms of when you report, you have a rather difficult issue there because `it is nOt very common that you `simply arrive at a judgment that there is a clear violation of the `antitrust laws, or any other law, fcir that%ia'tter, and because of a' security reason you are ~not going to enforce it. In most antitrust questions foreign `policy considerations-to the extent that they ever do arise, and it is very unusual really-are one factot in deciding whether the conduct is it~ self unnecessary, unreasonable, and, therefore, in violation' Of the statute. It is not a question of override. `I think, hOwever, as I indi- cated to the chairman, that the documents that were put out with respect to the oil cartel case, do tend to indicate at least a belief that what was being done was an override.' I think it actually was reported in those terms. Mr. BLUM. Perhaps it was a little less formal than that override, but we did have testimony from former Attorney General Mitchell that he received a phone call from U. Alexis Johnson at the State Department with respect to the Business Review Letter issued in January 1971 stressing the urgency of the situation `and the need for immediate approval. Perhaps that is less of a directive but it has an effect on the weighing and balancing of the law and actual needs of national security. Mr. KAUPER. Yes, I suppose n.ne can say that in that sort of cir- cumstance that simply having a statement we need this by thus and thus a date is simply a view of another sister agency which one takes into account or does not take into account depending on how he views the information that he needs. I am not sure I view the phone call that says the interest of X department is as follows as constituting some kind of an overriding force any more than to agree that I would not view' it any differently than if I got a similar call from a Member of the Senate. PAGENO="0069" Mr. BLUM. Former Attorney, General Mitchell viewed it that way and that iswb at he iudica~ted in his testimony. I1~' took `it very, very seriously. Mr. I~AUP~R~. Of, cpurse, obviously, there becomes a point when precisely that is what may happen. Mr. LEVIN50N. Your real test will come in contrary circumstances really, when if you conclude that you have serious issues in connection with Saudi Arabia and the activities of the four Aramco partners that you want to push fnrther as to whether that will be alleged to interfere with, delicate negotiations with Saudi Arabia now takimr place over the political arrangements between the two countries aria whether a vigorous antjtrust action of whatever nature interferes with that. That is the context really, in which the national security political cousid~ration really comes up. Mr. KAUP~R. Yes, sir. Mr. LEVINSON, The concern is whether antitrust in the international envirCn.ment, ~f it is subject to national security and international political considerations, given the history that we have seen, can really be effective. rrhat is the test and that is what one has to ask, and if it cannot afford these overriding considerations then one has to ask what afternatives do we turn to? INCREASED COORDINATION DESIRABLE Mr. KAUPEE. That is right. That is a~ fair enough question. I am not totally sure I can an~swer in terms of whether or not at a given monieui~, with a given proposed action or som~tbing ~14ch is being contemplated, there ~re such security or political r~sons that that course is not followed. If that is the case, and cer1~airdy there is some indication, of that sort of judgment having heen made in the past, thentliequest~on i~ how then do ~ e ~t~y to deal with it?, On~, of the problems, of course, `is that the actions of. a single govern~ ment may themselves provoke a kind of security problem whereas actions by ..~ ~iumber would not and, therefore~ one of the.answers may lie in the form of increased coordination among the enforcement. agencies of a number of different countries where there is now a much stronger unity of purpose among a whole series of nations rather than one nation coIning in unilaterally and in the eyes of many being disruptive. As this committee, of course, is worrying with the problem of multinationals, this is one of th~ questio±is, it seems to me, which is now. being discussed as to whether we need some kind of increased coordination or some kind of convention which ha~ a broader base than a single, country for enfor~ement purposes. Mr. BLTJM. Do you have a legislative proposal `with i~espect to the exchange of information among antitrust authorities? Mr. KAUPER. We do not at the moment, no. Mr. BLUM. Would you want to develop one for us, because this is an area very much of interest to the subcommittee and one we would be anxious to consider. Mr. KAUPER., I think that prior to the submission of any such legislation, and I do not mean to suggest that it is inappropriate, we have bad discussions with some other countries, their enforcement officials, about, this problem, and I think that is the spadework that really has to be done first in order so that we all can understand what the restraints are on each other. PAGENO="0070" 66 ~Mr. BI~tM. Is that spadework underway? Mr. KAu~rn~. Them have been- some discus~ions and there are going to be some more, yes. Mr. BLUM. It would be very helpful if you could inform us of the outcome of those discussions? Mr. KAUPER. We would be happy to. Mr. BLUM. So at an appropriate point legistation could be drawn? Mr. KAu~ER. Yes. * Mr. BLUM. `The question was raised about whether it is appropriate to use antitrust internationally-what happens to a domestic com- petitor who is left behind if there has been an override or weighing and balancing in which national security has meant no antitrust enforce- ment internationally. Of course, that do~s not happen to the domestic competitor, and what you get is an uneven situation where some people in the marketplace obey the law and some people do not. Mr. KAUPER. If you are assuming an override situation I suppose that is true, yes. Mr. BLu~u. Is that one of the factors you take into account? Mr. KAUPER. Yes. I think obviously one has to concern himself with whether either enforcement action or a lack of it is handicapping a particular group of competitors or indeed a particular significant competitor. Mr. BLUM. One final area that involves the tax laws. TAX LAWS AND COMPETITION The foreign tax credit gives an enormous competitive advantage to people who keep their refineries and produce their oil outside of the United States. Has the Antitrust Division attempted to study that kind of com- petitive impact on domestic rofiuiers or even factor in the question of competition policy to the Internal Revenue Service and relevant committees of Congress? Mr. KAUPEE. I am not sure I could say that we have on that specific question. Mr. BLImI. Should you not be doing that because of the dimensions of the problem? Mr. KATJPER. You may very well be right. We do spend a fair amount of time with other departments and agencies trying to con- vince them that competition policy is not simply the province of those who enforce the antitrust laws. Indeed, I think there are a good many departments which are fully cognizant of that and which do concern themselves with competition and that has got to be part of the answer some of these problems in the international arena as well as domestic. Other Government programs, other Government policies, have to take into account competition as well. `On the particular one you suggest, I suppose, perhaps we ought to have some immediate concern with that problem. We are not, however tax experts in any sense of the word. Mr. BLUM. Indeed. But I suggest the co~ucern is immediate, the dimensions in terms of the amount of money involved is very large, and there is pendipg legislation, an array of legislation on the subject and it will probably be very helpful if you put some effort into that~ PAGENO="0071" 67 Finally, the Internal Revenue Service has for sometime been en- gaged in attempting to audit oil company tran~fer prices and I wonder if there has been any exchange of information between the Internal Revenue Service and the Antitrust Division on this question~ par~ ticularly with respect to what constitutes a price and whether there is a market, which seems to be the problem that perplexes IRS. I RS is confronted with a situation where the companies tell them there is no market in crude oil, we sell it all to ourselves. Obviously, the question of whether there is a market is one that has been involved in investi- gating the buy-backs. Is there any communication between the two agencies? Mr. KATJPER. I am not sure there has been communication on that particular issue. 1 do not know that we have received any inquiry from them or been particularly plugged into their decision on whether there is or is not a real market. I cannot say we have had any direct contact with them on it. Mr. BLim~. Finally, is your staff equipped to handle these questions? Is it adequate? Mr. KAUPER. Well, that is always a question of judgment and de- gree, I suppose. I think my answer to that would have to be that we are going to have to add staff to the unit as this goes along. That will within any normal kind of resource allocation mean taking resources ofT of something else and in that sense I suppose I would have to say no, not totally adequate. On the other hand, there are other matters of lesser consequence froni whom we can take people or from whom we can take new pe~ple, people who are coming in and put them on this kind of matter a~ opposed to something else. I am not sure that the consequences would be disastrous. Mr~ BtuM. Given the dimensions of this industry, its impact on the economy, is not there really a need for some permanent expertise in the Antitrust Division on oil? Mr. KAUPER. Yes, sir. Mr. BLUM. And is it not fact that you ha~re not really had that? Mr. KAUPER. We have lost a good part of it, as I think you know, and are now trying to rebuild it. That is indeed part of what we are now trying to accomplish. Mr. BLUM, Is there any legislative remedy that you feel is required to give you a strong~er hand in solving some of the problems we have just discussed? Mr. KALYPER. Well, I think that probably the immediate legisla- tive needs are more procedural than substantive. We have pending, for example, before the Congress at the present time a proposal to increase our authority with respect to the use of the so-called Civil Investigative Demand, which is one of our primary information- gathering devices in terms of compelling the production of ihforma-. tion, at least in situations where there is no immediate criminal conse- quence involved and where we could not appropriately use the grand jury. We view that as a very important piece of legislation. Mr. BLUM. Then, in addition to the Federal Energy Office, the Antitrust Division is having data access problems. Perhaps we should include you in the access legislation. PAGENO="0072" 68~ Mr. KAUPER. I do not want to be misunderstood on this. The Civil Investigative Demand legislation has nothing particular to do with this industry. It would broaden our enforcement powers in. terms of any investigation. I do not know that I would ntean to suggest from that we have peculiar problems of information in this industry7 and I do nOt think I would want that connotation put on it. I do not think we have problems with this industry that are too much greater than we have with any other. Mr. BLTJM. Is there any other legislative suggestion? Mr. KAJPER. I think this is the major item we have pending here at the moment. Now we have also sought some other things which I think re~illy do not bear very directly on the problem that we are discussing today. Mrs. LEwIs. Senator Case asked me to ask a few questions. He was a little curious about some of the testimony that John MeOloy gave in response to some of his questions on February 6. McCIoy said, and I ani~ quoting now from the transcript: "We had several business review letters. I was anxious to get as many as I could. Several times they said don't bother us any more, we can't be giving you. business review letters every time we take a step." That is the end, of Mr. McCloy's statement. Was it in fact ,a business review letter that Mr. McCloy wanted, do you know? NEGOTIATIONS FOR BUSINESS REVIEW LETTERS Mr. KAUFER~ Well, he certainly has sought business review letters; yes: There is some question, I think, whether at the time of ~the first business review h~tter whether he specifically waflted something in the form of a business review letter. 1 was not with the Division at that tuiTe, but I think, as I recall, I think perhaps that he actually wanted it, ,ii~;tbe form of a business review letter as such. Certainiy~ pa later occasions there have been requests for such letters~ Mrs. LEWIS. Having gotten one, he knew what lie wanted~ to ask for? , , Mr. KAUPER Well, I ,~uppose you could look at it that way.'; Mrs., Luwis. I ask~d because thei~e wa~ a certain amount of negotia- tion going on between the Justice Departrnent'and the State Depart- ment and Mr. MeCloyas to exactly what the quid pro quo was, was there ITet? Mr. KAUPER. At what point in time are we talking about?. Mrs. LEWIS. At various points. Let Us take the period during the Tehran trip negotiations, the first day. 1\4r. KAUPER. You are talking about 1971? Mrs. L~WIS. 1971, yes. "Mr. KAUPER. Well, whether there were a certain degree of negotia- tions I am not quite sure. Again, I am a little handicapped because I have to base it on what others have said, not having been around at that time. I suppose it could be characterized as that iii terms of meetings between staff personnel, Mr. McCloy, some of the oil people, in terms of what it was they really wanted, and what it was they really proposed to do, among other things. You have to keep in mind that the companies were suddenly con- fronted with a demand by OPEC to appear. The Justice Department was confronted with a request from them and things proceeded on a PAGENO="0073" 69 kind of hurry-up basis. I think that is quite clear. Whether you char- acterize it as negotiation or discussion or whatever, that fact was brought forth pretty clearly. Mrs. LEwIs. According to the testimony of Ambassador Akins, on October ii, he implied in his testimony that the Justice Department could have had someone present at the London policy group meeting but the Justice Department chose not to make this request. Does that jibe at all with anything you niight have been told? Mr. KAUPER. I think that is probably an accurate stater~ent. Mrs. LEwis. Do you regret now that this request waS not made? Mr. KAuPER. No; I do not think so. Let me put it in terms of even going back to the days when I was in practice and 1 had instructions to keep clients out of trouble at trade association meetings. Every- body always knew that if a lawyer wqre present there would be no discussion of things that were outside of the bounds anyway. If there were going to be such discussions they would occur somewhere else. It has never seemed to me that the presence of a Division lawyer at a given meeting is any assurance at all that there is nothing going on, it simply means that that particular meeting at which he is in attend- ance at is not a meeting at which other items ave. discussed, if there is a propensity to 4iscuss such items anywhere. Mrs. LEwIs. Does your skepticism extend also to the twice-daily reports that you received indirectly from Mr. Mcaoy as to what was going on and what was not going on? Mr. KATJPER. I suppose, sure, it is possible one does ~iot get full reports or, that Mr. McCioy does not get full reports. But I would hasten to add that I have no basis whatsoever ~n terms of the reports to question his good faith if dealing with us. At the moment I have absolutely none. I think one always has to recognize if a group of businessmen, whatever the industry, have come to a conclusion that they want to fix prices or allocate markets they normally do not do it in the pres- ence of lawyer, nor do they keep mihutes of it, nor do they file reports of it. Mrs. LEwis. We have not yet printed the Libyan Producers Agreement but courtesy of a Weekly Oil Journal we have got a good copy of it and this is the agreement of January 15, 1971, section 2, subpart (e), and it essentially says "If a party cannot get Libyans crude because of the Government of Libya restrictions, other suppliers shall be obligated to provide the preexisting european and We~tern Hemisphere customer commitments only." That is to say Persian Gulf backup crude, to use the lingo, could be available bnt only to the extent of preexisting market share of the independent producer in Western Europe and the Western Hemisphere. Does that not seem to have a certain bearing on restraint of trade within the Western Hemisphere like the United States? BACKUP CLAUSE NOT A MARKET DIVISION Mr. KAtJPER. Well I suppose your suggestion is that in and of itself a formof marketing differentialis saying we will hold a certain marl~et share; whether or not one can legitimately read what is essentially a backup agreement among them, which is designed after all, to hold the kind of status quo as in and of itself some form of market division? PAGENO="0074" 70 I do not think I would read it that way. It seems to me if you have a situation where the question is how much call do you have for, call it backup oil or whatever you want, obviously there has to be some concept of what that commitment is, and to put it in terms of their existing relationships it seems to me is hardly surprising and I do not know in and of itself that that carries any connotation that it is out of bounds. Mrs. LEwIS. We have been given to understand one reason Japan is not included in this sort of freeze that subpart (e) is talking about is that it was feared that an attempt might be made by the independents to penetrate the Japanese market to a greater extent than hitherto, if their crude sources were from the Persian Gulf rather than from Libya. Does that seem to you to make any sense? Mr. KATJPER, I am not altogether sure I am followino~. Mr. LEwis. Backup oil comes from a different geographic location, is more accessible to Japan, and the argument seems to be that if they were getting their backup crude from the Persian Gulf they might be tempted to try to catch the very much more profitable Japanese market, so they did not include Japan in order to keep the inde- pendents from having a go at it. Mr. KAUPER. Well, here again, keep in mind the context in which you have this. You have it in the cOntext of an agrOement among these companies to supply a portion of what I assume is their oil in what is also viewed as a kind of emergency situation. Now, if one assumes that ~therè Was some merit to the idea of a sharing agreement, then it seems one also has to recognize that companies are presumably not going to enter into a sharing agreement if the effect of it is going tQ be that they are in a sense going to take away customers of their own. I have some real difficult~r with viewing that as an unreasonable restraint in and of itself. Mrs. LEwis. I appreciate that. In his testimony on January 31, Mr. Rooney of Bunker Hunt said before the sharing agreement was signed the companies were obliged by their fear of competition to be tough in their negotiations with the Libyans, they were afraid that if tF~eir competitors got a better deal on price or participation theit oil would become too expensive. Then he said, "When you go into business you always worry about what your competitor is doing. If you can pass it on they can pass it on. And having the same terms of reference you kind of eliminate the psy- chological fear of being able to pass it on~" I am quoting this, "because you are in the same boat. This was a fallout of the safety net." It seems to me to imply the safety net agreement helped reduce price competition between all of the participants. This is the way I read what Mr. Rooney was trying to say. JOINT POSITION WORKS BOTH WAYS Mr. KAUPER. I am not sure I would read it that way. I think what he was suggesting, perhaps because of the presence of the agreement the stance taken by individual companies was not as strong as it might otherwise have been, There obviously is considerable debate over what the effect of such an arrangement may be, that is, did it strengthen the PAGENO="0075" 71 hand of the cothpanies in terms of their bar~ai~iing, knowing that if they took a hard position and were cut back there would be oil avail- able to them. It certainly would not be unreasonable to assume that that would strengthen their hand, Or did it, by saying you will not be subject to some l~ind of competitive pressures, in essence say to them, well, don't worry about it, because in a way we are all in the same situation. I think the feeling in the Division at that time was that this would strengthen the hand in terms of dealing with the Libyans and that in addition, it provided some protection to some of the smaller companies who were peculiarly dependent on Libyan crude. Mrs. LEwis. Mr. Rooney was from one of the smaller indekendents, peculiarly independent. Mr. KAUPER. Yes. Mrs. LEwIs. And his reading of it was rather different than yours. Mr. KAIJPER. Yes, and I must say that in our discussions that we have had with a number of these companies, including Bunker Hunt, their feeling at the time was that they thought this was a good idea, that it would strengthen their hand. Now, it may not have worked the way they anticipated, but the idea-there is some precedent-for example, in the United States the airline agreement, I think somebody referred to it here this morning, is the same basic kind of idea. More- over, I think it ought to be understood that there is nothing in that agreement that wo~ild have precluded any company from cutting its own deal. Indeed, certainly the history of the Libyan neg.otiatiQns would indicate that some of them did. Mrs. LEwIs. I want to quote Mr. Rooney one more time. He talked about the independents having to start something called, I'm quoting again "a leapfrog committee". The independents were afraid when the negotiations were split between the Persian Gulf states and Libya, the majors negotiating with the Persian Gulf countries might get a l~etter deal than the independents in Libya and they feared again for their share of the markeL Mr. ~ooney testified that he told the majors in the London policy group meeting "You are selling us down the river" when it was decided the negotiations would be split. Is it not your view that the decision to divide the negotiations between the Libyans and the ind~endents and majors on the one hand and Persian Gulf producers and the majors on the other, had the anticompetitive consequences that Mr. Rooney seemed to feel it did? Mr. KAUPER. Well, I do not think one can conclude that. There has been a good deal of talk about that decision to split the negotiations not so much in terms of whether it worked to the detriment of a particular group of producers as opposed to another but whether it weakened the hand of the oil companies in toto. That was a judgment, it seemed to me, that was a business judgment or alternatively perhaps a judgment imposed by somebody else, but certainly not, it seems to me, an antitrust judgment. Mrs. LEwIs. You do not think that the Business Review Letter somehow required that negotiations be unified? Mr. KAUPER. No, 1 do not think there is anything in the Business Review Letter that required that Mrs I EWIS So ~ ou do not think somehow the Business Review Letter did not apply to the negotiations once they were split? PAGENO="0076" 72 Mr. KAUPER. No; it seems to me that that was within the context of the Business Review Letter. Mrs. LEWIS. Thank you. VIGOROUS ANTITRUST ENFORCEMENT NECESSARY Senator CHURCH. I have no further questions. I do want to make this comment. I think that it ought to be the responsibility of the Department to vigorously enforce the antitrust laws, and judging from what our hearings have revealed, I cannot think of an industry that needs a more thorough or penetrating review when it come~ to the antitFust laws of this country than the oil industry, and I should think that this would have top priority within the Department, Now, if in the future there comes a time wI~en the Department is again sidetracked by `the President, or a decision of the State Depart- ment, taken in the name of the national interest or the security interests of this country, I would hope that the Congress could be informed so that we might reviewt~he matter and participate in some fashion. The way this whole scet~e is `opening up again, ~he Department of Justice is challenged to look at the new arrangements with great care and to try nnd inject ~ larger measure of competition into the activities of the big oil companies, it should either do that or give up the effort. Perhaps we `have long Since lost the fight against monopoly in this country. Giant combinations see~a to grow and to dominate the economy as never before d~spit~ our antitrust laws~ Possibly the Congress should rewrite these laws in ways that would make them more effective, but the Department has a very central role to play in all of this and I hope very much that you will play it. Mr. KAUPER. We will try. Senator CHURCH. If there are no further questions, thank you very much for your testimony. The hearings will resume at 10 a.m, tomorrow morning. [Whereupon, at 3:50 p.m., the hearings~ were recessed, to reconvene at 10 a.m., Thursday, June 6, 1974,] PAGENO="0077" MULTINATIONAL PETROLEUM COMPANIES AND FOREmN POLICY THIfl~SDAY, JUNE 6, 1974' UNrr~r STATES SENATE, Sum~oMMITTEE ON MULTINATIONAL CoRroEATro~S, OF THE COMMITTEE ON FOREIGN RE~IoNs, Was? gt'o12~, D.C. The subcommittee met, pursuant to recess, at 10:05 a.in., in room 4221, Dirksen Senate Office Building, Senator Frank Church [chair- man of the subcommittee] presiding. Present: Senators Church and Case. Senator Cntmcu. The hearing will come to order. SWEARING OF WITNESS Mr. Tavoulareas, I wonder if you would stand and take the oath, please? Do you swear that `all of the testimony you are about to give will be the truth, the whole truth and nothing but the truth, so help you God? Mr. TAVOULAREAS. Yes, sir. Senator Cnui~oru. I note you have a prepared statement. Would you like to read it at this time ~ TESTIMONY OP WILLIAM P. TAV~ULAREAS, PRESIDENT, M0~IL OIL CORP., NEW YORK, N~Y.; ACCOMPANIED BY GEORGE A. BUR- BELL, GENERAL COUNSEL, MOBTL OIL CORP. Mr. TAVOTJLAREAS. Yes, Senator, I have a prepared statement and I give you a choice of whether you want me to read the entire statement or whether you would rather me put the statement in the record and read excerpts from the statement. Senator CHURCH. I would prefer that you take the latter course, if that is acceptable to you, because of the time considerations. Mr. TAVOIJLAREAS. It certainly is. My name is William P. Tavoulareas. I am president, and a director, of Mobil Oil Corp. I have spent almost my entire business career with Mobil. PERFORMANCE OF PETROLEUM INDUSTRY POST-WORLD WAR II I start with the proposition that the performance in tb~ post-World War II era by the international petroleum industry of its function of' meeting the Free World's petroleum ~ecd~ with. abundapt ~uppli,es. at, (73) PAGENO="0078" 74 st~abl~ and moderate prices must be judged excellent by any reasonable standard. The industry managed to carry on this international `business on a commercial basis and achieve the record I have described through three wars in the Middle East, the Korean war, and the Vietnam war. OPEC DEMANDS Commencing in 1970, certain members of OPEC, and then OPEC itself, became more aggressive in their demands for alteration in the terms of existing arrangements. These negotiations were conducted in an atmosphere of threats of unilateral action if the companies did not submit to their demands. In addition, the demands of certain of the OPEC countries began to have definite political overtones. Even in this period~ however, the industry in the various negotiations starting in 1971 demonstrated an ability to continue to negotiate and operate on a commercial basis. It was only in the fall of 1973, coincident with the outbreak of the fourth Arab-Israeli war, that the Middle Eastern producing countries took united ~nd unilateral action which brought on the first unmanageable crisis of supply in the Free World since World War II. It was political, rather than commercial actions which intervened in the relations between the producing countries and their customers. These political decisions eventually induced the unprecedented uni - lateral, nearly fourfOld, increase in the cost of oil. PRIVATE OIL .COMPANY APPEOACH VEIWUS GOVERNMENT APPROACH Considering this record, the private oil company approach has much to recommend it over the alternative of government-to- government confrontation. If the matter of oil supply becomes a government-to-government matter, commercial problems inevitably become political problems. Private oil companies tend to insulate or reduce political problems. In this connection it has been asserted in testimony before this com- mittee that the negqtiations which were carried On from 1971 until 1973 with the `OPEC countries were disastrous. I thoroughly disagree with this appraisaL These negotiations actually were quite successful. EFFECTS OF 1973 ARAB-ISRAEL CONFLICT By and large, the negotiated agreements between the oil companies and the producing governments resulted in the flow of oil at reason- able prices. `Coincident with the outbreak of the Arab-Israeli conflict in 1973 the Middle Eastern producing countries took the matter of supply and price into their own hands. The basic facts are well known to you. If the war had not intervened the supply picture would not have been critical and posted prices would not, in my opinion, have reached $11.65 in the Persian Gulf. Much has been made in these hearings of the handling, or `what at least some members of the subcommittee seem to regard as the mis- handling, of the so-called Oil Cartel case. PAGENO="0079" 75 - COMPETITIVENESS OP THE INDUSTRY I would like to address myself to the conclu~ion your chairman has drawn from this episode in a letter of April 11, 1974 addressed to John J. McCIIoy to which Mr. Mc'Cloy has now, I understand, responded. In that letter the chairman deplored the failure of the U.S. Government to pursue the Cartel case to a successful conclusion which would have, in his words, "injected competition into the industry." He stated, and I quote, that if such a course had been followed: our country would find itself in less dire straits today in the area of energy supply. an industry more Infused with multiplicity and pluralism would [not] have built s~ little space capacity for the day oi~ reckonii~g with OPEC. Judged by any reasonable criteria, the record shows that the indus- try has been highly competitive. You have had ample testimony dem- onstrating that point. JOINT VENTURES AND THE CARTEL CASE There is no logic in the suggestion that if the joint producing ventures in the Middle East had been broken up as a result of the Cartel case this would somehow have improved the bargaining posi- tion of the industry in dealing with the Middle East Governments in the 1970's. Consider the bargaining position. The pattern of oil development in Libya comes closer to the type of situation which is apparently thought preferable. There were many small separate concessions and many independent companies with interests in the country. What did this do to the industry's bargaining position? Far from strengthening that bargaining position, not only was the industry weakest in Libya hut it was the Libyan Government which, in the summer of 1970, took advantage of this condition of pluralism to start the chain of events which eventually led to the complete unilateral action of OPEC in October 1973. There is, furthermore, no support of any kind that I am aware of for the proposition that the result of the joint producing arrange~ ments which existed in the Middle East was inadequate spare capacity to meet any demand reasonably to be anticipated~ FREE WORLD CAPACITY/FREE WORLD DEMAND You have received a statement from Mr. George Piercy of Exxon detailing their estimates as to available Free World capacity in rela- tion to Free World demand. Those figures indicate a consistent excess producing capacity in the Free World even to this day. The conclusion I draw from these figures i~ that the petrolenm shortage which had begun to emerge in 1973 but whIch actually became a crisis only as a result of the war-induced embargo was not the result of any failure of the industry in estimating demand. Rather; it was the result of their failure accurately to predict the impact of unilateral and unanticipated governmental action on the actual avail- ability of planned capacity. PAGENO="0080" COMPANY RISES Nor did the existence of the joint producing interests in the Middle East in any material way prevent other companies from entering the area t~n~I securing valuable additional concessions. I suggest to you that the reason there are&t more American corn- panies in the Middle ~East with developed reserves today has nothing to do with the joint ventures there. Rather, it is the result of the unwillingness of companies to take the risks involved, particularly those who had no assured outlets abroad for any production they might find. Stated another way, it is the result of conscious, negative investment decisions by many substantial American oil companies. It has nothing to do with whether or not Aram~o, IPC, or the Iranian Consortium is a joint venture. ROYALTY AS INCOME TAX Let me comment on one other matter which has been touched upon in these hearings. It has been stated that that decision resulted in the conversion of a royalty into an income tax. The fact is that no royalty was, or ever has been, converted in Saudi Arabia to an income tax. A royalty was paid prior to 1950 and has been paid continuously since that date to the Saudi Arab Government. It has also been suggested that the result of these foreign-tax-credit pI'ovisions is that taxes paid in Saudi Arabia can somehow reduce U.S. income taxes to be paid on income attributable to operations in the United States. This was not the case in 1950 and has never been the case since. Let me repeat that statement. The foreign tax credit has never reduced U.S. income tax on income derived from operations in the United States. Finally, there is no basis of which I am aware for the suggeStion that this decision created an incentive for U.S. oil companies to invest in prQducing ventures outside the United States, rather than within the United States. The fact is that if a company were to choose between a foreign area and the United States solely on the basis of the amount of taxes to be paid on a given exploration venture the clear choice would have to favor investment in the United States. This is so because the total taxes paid on a foreign venture would always be at least equal to those paid in the United States and could be greater. In recent years taxes on foreign exploration ventures have been greater in every case of which I am aware. OVERSEAS EXPLORATION The actual reason for exploration overseas has been very simple. First, the oil potential overseas was very great. Since World War II the oil industry's foreign discoveries have amounted to more than 10 times total U.S. reserves at any one point in time. Second, there has been limited prospective acreage available for exploration in the United States and, particularly in recent years, significant environmental restraints. As a matter of information, Mobil's capital expenditures on explo- ration and production have, notwithstanding these facts, been con- sistently greater in the United States than abroad. PAGENO="0081" 77 TTIE FOREIGN TAX CREDIT Elsewhere in the Congress proposals have been, made to abolish or mo~1ify the application of the foreign tax credit to the oil and gas producing operations of U.S.-based companies. Most developed coun- tries of the world exempt foreign-source income from taxation, or allow a credit for foreign taxes paid. For example, many countries; such as Canada, Germany, United Kingdom, Mexico, and Japan, aliow a foreign tax credit for foreig~i taxes paid. The Netherlands, France, and Italy', on the other hand, follow a system of "territoriality" under which any foreign-source earnings which have borne a foreign tax may be repatriated, without any further tax. For existing production such action would simply create a cost dis- advantage for U.S~~based companies, and therefore, a tendency to higher prices for petroleum in international trade. Of considerably more importance is the fact that in the all-important race., for new concessions it would make the U.S,-based companies less attractive as c~ricession holders to the foreign country govern,ments than their for- eign based competitors~ At a time when the United States faces a period in which it will be a substantial importer of petroleum, elimination of the foreign, tax credit for petroleum producing operations would seem clearly not to be in the interests of the United States. If, through tax policy and other controls, you disable our U.S. com- panies from competing with their foreign counterparts and' make them economically unattractive as concession holders to. foreign govern- ments, they will tend to disappear from the international scene. VIABLE ALTERNATIVES In the near term are there any viable substitutes for the handling of oil matters through industry-producing government negotiations? Some have suggested that the role of the oil companies be displaced by direct government negotiations. The arrangement has a certain emo- tional appeal; however, the examples of direct government negotia- tions do not give us confidence that this solution would be a satisfac- tory one. The past records of govei~nment-to-government negotiations are full of examples of political decisions which have overridden the oil supply consideration. I submit, `for example, that private com- panies are likely to do more to protect the public's interest in keeping costs down than governments wilL Unless a proper political atmosphere is constantly maintained, a consuming country government cannot assume that an arrangement which it negotiates with a producing country will, in fact, be stable merely because both parties to the arrangement are governments. The experience of the French with the Algerian oil agreements illustrates perfectly the fragility of sovereign-to-sovereign agreements incorpo- rated in larger political settlements. There is one other very practical problem with any government-to- government solution. That is, the comp1e~ity of international trade in petroleum. There are well over 100 countries in the free world which import petroleum and almost 100 which also export petroleum. It is an understatement to say that trade in petroleum is multilateral. Saudi 45-426---75-6 PAGENO="0082" 78 Arabia exports go to about 60 countries. Which nation on the import- ing side is going to he authorized to negotiate for all? Or are all the importers going to try to sit down and negotiate jointly with Saudi Arabia? If it's not a joint negotiation, the government-to-government solution is going to result in bilateral barter arrangements of the kind France has made, or attempted to make in recent months. Barter arrangements inevitably tend to Balkanize world trade and, in this case, to support the presently high price level of crude oil in the Mid- dle East. But if it is to be a government-to-government solution it must be one or the other. The first presents imffiense practical diffi- culties, while the second is clearly undesirable. If direct negotiation by governments is not the solution, what improvements can be suggested in the present system? Clearly, it must be recognized that any action which excludes U.S.-based corporations will not similarly impede the operation of foreign-based companies or their government sponsored counterparts. Instead, the U.S. Government can ~iay a very positive role in creat- ing the atmosphere necessary to insure the stability of commercial arrangements in world trade. It must be emphasized to the producing countries that their emergence as major forces in international mone- tary and trade channels carries with it a share of the responsibility for the stability of these international systems. CRITICISM OP TIlE G0VE1~NMENT Considerable criticism has been leveled at the conduct of the U.S. Government's relationships with the American oil companies. It seems appropriate that the relationship be better defined in the foreign area. Foreign consumer governments have long expected that our foreign competitors keep them informed on producing-country negotiations. We, for our part, have always assumed an obligatio~i to keep the U.S. Government informed. The U.S. Government has the right and the obligation to inform itself as to these important negotiations, and to take whatever diplo- matic steps it considers appropriate in connection with them. In short, international trade in oil badly needs stability. Since the producing country governments, are sovereign and not subject to a superior law, it is necessary for the consuming coulitries to persuade them that their best interests will be served through the maintenance of stable conditions in which commercial commitments can be freely made and relied upon. So long as we are dependent for energy upon imported oil there is no way oil companies can stop upheaval caused by wars. Oil companies neither make wars nor haVe the ability to stop them. Potential disrup- t~on of oil supply, however, can be reduced by continuing the policy of 50 years of e~icouraging U.S. companies to establish a presence in as many different producing areas around the world as possible and encouraging exploration for oil there. I am pessimistic about the ability of the United States to achieve energy self-sufficiency by 1980. But we must get on with the job. We are fortunate that certain of the producing countries have been willing to increase production. We are doubly fortunate that they are willing to promise further increases PAGENO="0083" 79 even though they have no practical way to use all the income generated from present production. We can't expect them to continue this policy while we do noththg at home to solve the problem. TITE NEED FOE OOOFERATIo~ To summarize, there is a need for more cooperation and understand- ing between industry and Government. Much of the problem this time was caused, by the suddenness with which the shortage came on. There was inadequate time, inadequate avenues of communication to explain what was happening, and an atmosphere of mistrust and suspicion which, unfortunatehr. still exists. Better understanding between gov- ernment and the industry would cer~ain1y ameliorate these problems. But the positive role of the Government in petroleum matters should continue to be political, while that of the companies should be com- mercial with better coordination between the two. Thank you. [Mr. Tavoulareas prepared statement follows :J PREPAEEn STATEnUrNT OF WILLIAM P. TAVOULAREAS, PRRSIDEN~r OF MOBIL OIL Conr. Mr. Chairman, members of the multinational subcommittee, my name is WiL' 11am P. Tavoulareas. I am president, and a director, of Mobil Oil Corporation. I have spent almost my entire business career with Mobil, You have invited me here today to testify regarding the future shape of the international oil industry, I appreciate the opportunity the Subcommittee has provided to make this opehing statement. I would like to start by cónnnenting on various aspects of, the international petroleum industry which have been touched upon by the Subcommittee in its earlier hearings. I start with the proposition that the Performance in the post-World War IT era by the international petroleum industry of its function of meeting the Free World's petroleum needs with abundant snpplies at stable and moderate prices must be judged excellent by any reasonable standard. During the period in which the Industry was in a position to deal with matters of exploration, production, transportation and price on a Predominantly commercial, as disting'uis1~e4 from a political, basis, supply was plentiful; prices were moderate, and in the decade of the Sixties indeed were steadily declining; and demand never &rceeded supply. The Industry managed to carry on this international business on a commercial basis and achieve the record I have described through three wars in the Middle East, `the Korean War, and the Vietnam War, Commencing in 1970, certain members of OPEC, and then OPEC itself, became more aggressive in their demands for alteration in the terms of existing arrange- ments. These negotiations were conducted in an atmosphere of threats of uni- lateral action if the companies did not submit to their demands, In addition, the demands of certain of the OPEC countries began .to have definite political over- tones, Even in this period, however, the industry in the various negotiations starting in 1971 demonstrated an ability to continue to negotiate and operate on a commercial basis. It was opiy in the fall of 197~, coincident with the outbreak of the fourth Arab-Israeli war, that the Middle Eastern producing countries took united and unilateral action ~hich brought on the first `unmanageable crsis of supply in the Free World since World War II, I believe this record is highly instructive for the future, The only time the international petroleum `Industry has been unable to perform its function since World War II was that period which followed the political decisions to which I have referred. These were decisions made for reasons which had little or nothing to do with the oil Industry or its performance. It was political, rather than com- mercial actions which intervened in the relations between the Producing coun- tries and their customers, These political decisions eventually induced the unprecedented unilateral, nearly fourfold, increase in the `cost of oil. A~s one thinks about the future of International petroleum supply these basic facts are worth pondering. Considering this record, the private oil company approach has much to recommend it over the alternative of government-to~ PAGENO="0084" government confrontation. If the~ matter of oil supply bec~mes a governinent~to~ governmeiit matter, commercia' problems inevitably become political problems. Private oil companies tend to insulate or reçluce political probIem~, they are highly competitive and their re~1ations with the producing countries have been based on commercial and economic functions. For example, in 1~7O the then new government o~ Libya could not tolerate a U.S. Government presence in the form of Wheelus Air Force Base, but Libya has to this day tolerated the presence of U.S-based oil companies. Diplomatic relations with the United `States were sev- ered by Egypt in 1967 but this did not interfere with the subseqttent entry and opera~on of private U.S. petroleum interests in Egypt. Private oil cOmpanies managed to hang oEm in Indoilesia dttrlng the Sukarno regime so that when a change came in 1966 they were well established and ready to expand their opera- tions~ Iraq severed diplo~natic relations with the United States in 1967 and has maintained a militant anti-U.S. stand ever since. Nevertheless, it permitted the interest of two U'. S.-based oil eoinpaldes to continue in certain producing areas until 1973 when political consi4eration~, a~cented by the October war, Intervened. That private oil companies can operate under many circumstances where gov- ernments may not be permitted to do s~ has apparently been time judgment of those responsible officials, of our Governmeat who have given thought to this matter over a period of almost half a century. I say this because I believe every administration since that of Woodrow Wilson has, as an incident of its foreign policy, fostered and encouraged' the presence of U.S. private companies in the large oil producing areas of the world. I submit that this policy has consistently been In the interest of the Un~ted'States, the ~c,onsumer, an'4 the Free World. In this connection it has been asserted in testimony before this Committee that the negotiations which were carried on from 1971 until 1973 with the OPEC countries were disastrouS. I thoroughly disagree with this appraisal. These nego~ tiati'ons actually were quite successftt'l. Although governments were constantly seeking a larger government "take" from the production of oil, unrelated political events played a sign'lftcant part In encouraging OPEC to abrogate the agreements. Even in the face of these developmer~ts, the oil companies were able to moderate demands and to operate without any signIficant increase in price. By anti large, the negotiated agreements between the oil companies and the producing governments resulted in the flow of oil at reasonable prices. Coincident with the outbreak of the Arab-Israeli conflict in 1973 the Middle Eastern pro- ducing countries took the matter of supply and' price into their own hands. The basic facts are well known to you. Posted prices on which government "take" is determined had been essentially stable for the twenty-year period ending in 1970, while the market prices had declined as, `Incidentally, did the profits of the companies. Under the Teheran Agreement, posted price for Arab Light, a repre- sentative crude, had risen to what now appears to have been a very modest amount, namely $3.01 per barrel, on October 1, 1973. But since that time, as a result of unilateral actions by OPEC and the outbreak of the war, posted price for that crude has reached $11.65. In this regard, it is significant that Saudi Arabia, the largest producer, has continued its efforts to lower posted prices within `OPEC. `So I submit that the' 1971 negotIations cannot be deemed a disaster. If the war had not intervened the supply picture would not have been critical and posted prices would not, in `my opinion, have reached $11.65 in the Persian Gulf. Much has been made in these heEmrings of the handling, or what at least some members `of the Subcommittee seem to regard as the mis-handling, of the so-called Oil Cartel case. It seems odd that such weight should attach to the complaint by obviously disappointed staff lawyers in the Antitrust Division of the Department of Justice that a criminal case was not pressed b~ the Government over 20 years ago. That decision was considered carefully by highly placed, responsible officials of the Government. A civil case was brought instead but not even these civil charges were proven in Court. I say were not proven because even the civil case was never brought to trial'. It was eventually dismissed as to Mobil and it was either dismissed or, in effect, settled as to the other `defendants. I `don't believe any useful purpose is now served by going back into this past history but, cer- tainly, if it `has any bearing on tod~my's issueS all of' the facts should be presented and the full record of the Government's motivation and conduct disclosed. I would like, however, to address myself to the conclusion your `Chairman has drawn from this episode in a letter of April 11, 1974 addressed t.ø John J. MeCloy to which Mr. McCloy has now, I understand, responded. In that letter the Chair- man deplored the failure of the United States Government to pursue the Carte~ PAGENO="0085" case to a sticces~fu1 conclusion which would have~ in his wortls, "injected cnm- petition into the industry" He stated, and I quote, that if such a course had been followed: 1. ". . . our country would find itself in less dire straits today in the area of energy supply." 2. "Vigorous price competition such as the, kind Libya encouraged during the 1960's, if widely spread throughout the industry would have denied the Persian Gu1i~ sheikdoms their financial cushions. . . 3. ". . . an industry more infused with multiplicity and pluralism would [not] have built so little spare capacity for the day of reckoning with OPEC." In the ilr~t place, these are puzzling and, to some degree, quite contradictory statements. Judged by any reasonable criteria, the record shows that the indus- try has been highly competitive. You have had ample testimony demonstrating that point. Indeed, so much low-cost petroleum was made available to the Free World that until recently alternative energy sources were uneconomic and there- fore not stimulated. On the basis of this record, I don't see bow it can be main- tained that more competitive conditions would have led to the development pf greater spare production capacity. If it is suggested that lower prices could have been brought about, would this not have produced greater dissatisfaction on the part of the producing countries? Would not OPEC have been galvanized into more drastic action at an even earlier date? Actually, OPEC owes its formation to reductiOns in posted price which took place in 1959 and 1960. in the second place, there is p0 logic in `the suggestion `that if the joth~t producing ventures in the Middle East had been broken up as a result of the Cri~rteZ case this would somehow have improved the bargaining position of the industry in dealing with the Middle East Governments in the 1970's because there would have been more producing capacity in the Middle East. These are con- clusions supported by no evidence of which I am aware and are contradicted by much of which I am. Consider `the baagainlng position. The pattern of oil development in Libya comes closer to the type of `sitpation which is apparently thought preferable. There were many small separate concessions and many independent companies with interests in `the country. What did this do to the industry's bargaining position? Far from strengthening that bargaining posi'ti'on~ not only was the industry weakest in Li1~ya but it was the Libyan Government which, in the summer of 1970, took advantage of this condition of pluralism to start the dhain of events which even'tuaUy led to the complete unilateral action of OPEC in October, 1973. Libya picked out the independent company they believed was least able to resist and applied maximum pressure to it. This assertion is, furthermore, inconsistent with the criticism leveled at the industry for failing ha early 1971 `to insist that there be single over-all negotia- tions between all of the OPEC countries, including Libya, on the `one hand, and all of the companies, on the other hand. How can it be argued that pluralism, on the one hand would have provided a better bargaining position and, at the same time, that `the Government is to be criticized for not insisting that the industry hang together during the course of the negotiations? There is, furthermore, no support `of any kind that I am aware of for the proposition that the result of the joint producing arrangements which existed in the Middle East was inadequate spare capacity `to meet `any demand reasonably to he an'ticipated~ You have beard testimony and you haye gathered extensive figures indicating the relationship of capacity and production in the two key ~ountries, `Saudi Arabia and Iran. It has been made clear that, the way these arrangements `operated capacity in excess of the total estimated demand of the o~takers was consistently and regularly installed In `the case of Are mco, as a matter of regular practice, that. excess was 20%. in. `the. case of Iran, excess capacity to the extent of 10% `of aggregate demand was regularly in~t'alled~ Iii the ease of `the `other joip.t veirtures in the Middle East in which Mobil is a participant, capacity is installed on the basis of the aggregate `requirements of the participants in `the venture. You have received a statement from Mr. George Piercy of Exxon .det~iling their estimates as `to available Free World capacity in rel~tioJn to Free World demand. Those figures' indicate a consisteo~t excess producing capacity in the Free World even to this day and demonstrate that the problem is not a' failure of the indu~try to install adequate capacity. "Rather, it is the actions `of govern- ments which have prevented the pse of available capacity that `ha's caused the shortage. PAGENO="0086" 82 You are aware from that testimony that Free World demand for petroleum is hovering near the 50,000,OQQ barrels per day mark. Let me provide you with e partial list of capacity which had been installed by the industry and which, because of political actiOn of one kind or another, has not been available to it: Barrels per day Libya Between 1, 000, 00k) and 2, 000, 000 l(uwait About 1, 200, 000 Abu P1mb! ~~__ About 300, 000 If we were to include the Alaska Pipeline plus delays in offshore production and environmental restrictions, It would add from 2 to 2.5 million barrels per day. These constraints total over 6,000,000 barrels a day, or about 12% of total Free World demand. The industry might reasonably have anticipated that this capacity would be available at this time. The conclusions I draw from these figures is that the petroleum shortage which had begun to emerge in 1973 but which actually beCame a crisis only as a result of the war-Induced embargo was not the result of any failure of the industry in estimating demand. Rather, it was the result of their failure accu- rately to predict the impact of unilateral and unanticipated governmental action on the actual availability of planned capacity. For example, they did not foresee that a small group of environmentalists could delay the construction of the Alaskan pipeline for five years. They did not foresee and predict the supply embargoes or the substantial unilateral increases in price in October and Decem- ber, 1973. They, ot course, did not foresee the new outbreak of hostilities In October, 1973. However, they did predict, to the point of almost being obnoxious, that if real efforts were not made to ease the Arab-Israeli conflict the Arabs would eventually use oil as a weapon. These predictions were largely disregarded and usually considered unjustified or self-serving. Nor did the existence of the joint producing interests in the Middle East in any material way prevent other companies from entering the area and securing valuable ~c1ditional concessions. In the 1950's and 1960,'s vast areas, originally held under Concessions by joint-interest groups~ were surrendered. These, and areas never before covered by concession interests, were open to companies of all nations to come in and explore. Many `did. 1~or example, by 1970 Aramco held less than 14% of the total area of Saudi Arabia under its concession, while in Iran the Consortium held less than 12% of the total area of Iran, As a matter of fact, in the period since 1960 no less than 147 new concession have been granted by the Middle East countries, Including Libya and Egypt, to' no less than 113 different companies. Bear in mind that up until well `after World War II the United States was more `than self-sufficient In oil. Pew American companies could be found who were willing to take `the huge risks involved overseas. The United States Government tried to interest ut least a dosen companies to take up interests in IPIJ but only fire were willing to do so. Furthermore, three `of these had dropped ~ut before commercial production began in the mid-1930's, leaving only Exxon `and Mobil. As late as 1954 there was at least one large American company which felt it was too risky even `to buy int'o the established `reserves of the Iranian Consortium. I suggest to you that the reason `there aren't more American companies in the Middle East with developed `reserves today has* nothing `to do with the joint ventures there. Rather, it is the result of the unwillingness of companies to `take `the risks involved, particularly those who bad no `assured outlets abroad for any production they might find. Stated another way, it is the result of conscious, negative investthen't `decisions by many substantial American oil companies. It has nothing to do with whether or not Aramee, IPO, or the Iranian Consortium is a joint venture. For example, you might `ask `Standard of Indiana wh~ they sold wha't is now Creole Petroleum `to Exxon back in 1930, or why they declined in 1954 `to take a piece Of `the Iranian Consortium. Even `my own eom'nany turned town the opportunity to acquire a larger share of Aramco immediately after World War II. This decision was made because of the `risks involved and because `of lack of outlets for the crude oil. Under the foregoing circumstances I fail to see any basis on which the failure of the United States 20 years ago to pursue the Cartel case niore vigorously than it, in fact, did can be argued to be the cause of inadequate Spare producing capacity in the year 1974. Nor is It a failure on the part of the industry accurately to forecast demand. If there has been any failure on the part of the industry, it is its failure to predict `the political events which have deprived it of the use of planned capacity it had every reason `to belleyc would be available. PAGENO="0087" 83 Let me eomment Oil one other matter which 1ia~ been touched upon in these hearings. That is the matter o~ the adoption by the ~Saudi Arab Gove~nrnent in 1950 of an income tax, My cornrnen1s relate to two aspects of this ineident. The first is that there seems to be a substantial misconception as to what happened at that thee and what its consequence for the companies was. In addition, an implication seems to have appeared that this decision somehow created an incentive on the part of oil companies to invest in oil exploration ventures outside the United States rather than within the United States. It has been stated that that decision resulted in the conversion of a royalty into an income tax. The fact is that no royalty was, or ever has been, converted in Saudi Arabia to an income tax. A royalty was paid prior to 1950 and has been paid continuously since that date to the Saudi Arab Government. Furthermore, it has always been treated as a deduction, not as a tax credit, for the purpose of calculating U.S. income tax liability. All that happened in 1950 was that Saudi Arabia did what almost every developed western country bad already done, namely, to adopt an income tax. It was also following the precedent of `Vènezuëla, one of the major oil-producing competitors of Saudi Arabia. Saudi Arabia could not afford to adopt a tax structure which would put its oil at a competitive disadvantage with Venezuela, which, at that time, was Its major competitor for European outlets. Once the income tax was adopted, the income tax paid to the Saudi Arab Government became creditable against the U.S. tax liability of the producing company `with respect to Income earned in Saudi Arabia as a resfll't of provisions of the Internal Revenue Code which had been around since 1918 and which in one form or another appear in the tax laws of the other principal industrialized countries of the world. It has also been suggested that the result of these foreign-tax-credit provisions is that taxes paid in Saudi Arabia can somehow reduce U.S. income~taxes to he paid on Income attributable to operations in the United Sta'tes. This was not the case in 1950 and h~s never been `the case since. Let me rep~at that statement. The foreign tax credit bus never reduced U.S. income tax on income derived from operations in the United States. Finally, there is no basis of which I am aware for the suggestion that `this decision cr~ated an incentive for U.S. oil companies to invest in producing ventures outside the United States, rather than within `the United States. The fact is that if a company were `to choose `between a foreign area and the United States solely on the basis of the amount of `taxes to be paid on a given explora- tion venture the clear choice would have to favor investment in the United States. This is so because the total taxes paid on a foreign vefittire wotild always be at least equal to those paid in the United States and could be greater. In recent years taxes on foreign exploration ventures have been greater in every case of which I am aware. The actual reason for exploration overseas has been very simple. First, the oil potential overseas was very great. Since Wprld War TI `the oil industry's foreign discoveries have amounted `to more than ten times total U.S. reserves at any one point ~n tipie. Second, there has beqn limited prospective acreage available for exploration in the United States and, particularly In recent years, significant environmental restraints. As a matter of information, Mobil's capital expenditures on exploration and production have, notwithstanding these facts, been consistently greater In the tinited States than abroad. ElsewhOre in `the `Congress proposals have been made to abolish or modify the application of the foreign tax credit to the oil and gas producing operations of United States-based companies. Most developed countries of the world exempt foreign-source income from `taxation, or allow a credit for foreign taxes paid.' For example, many countries, such as Canada, Germany, United Kinadom, Mexico and Japan, allow a foreign tax credit for foreigh `taxes paid. The Nether- lands, France and Italy, on the other band, follow a system of "territoriality" under which any foreign-source earnings which have borne a foreign tax may be repatriated without any further tax.' 1 The Foreign Paz Credjt and the U.S. Oil Industry, p. ~i (~tay 1974), Petroleuth In- dustry Research Foundation. Inc., 122 E. 42nd St.. N.Y., NY., 10017. U.S. Stake in World Tr~de & Tnvest~enf. p. 45. Nat'l AaSn. ~ ~fftr~. (j972). `New Proposals for Taxing Foreign Income, pp. 11 and 1.~, Nat'l Assn. of Mftrs. (1972). PAGENO="0088" 84 Thus, the amount of home-country taxes pa~ by Royal Dutch Shell to The Netherlands and the U.K., jy BP to the U.K., by CFP to France, by ENI to Ttaly, and by various Japanese producing companies to Japan, would not increase if the US. enacted legislation to change the credit for foreign income taxes to a deduction. Only the taxes of the competing U.S. companies wOuld increase. Thus, on each dollar of profits from foreign sources before hon~e-country tax, these foreign competitors would retain $1.00 after all taxes, while their U.S. counterparts would be required to pay a U.S. tax of 48~ and would retain only 52~l after all taxes. For existing production such action would simply create a cost disadvantage for United States-based companies, and therefore, a tendency to higher prices for petroleum in international trade. Of considerably more importance is the fact that in the all-important race for new concessions it would make the U.S.- based companies less attractive as concession holders to the foreign country governments than their foreign based competitors. Because of the effect of home-country taxes~ the economics of the U.S. producer would be s:uch that be could not afford to offer as favorable treatment to the hos~ country as could his European or Japanese-based competitors, because they ~vill continue to enjoy the full benefit of a foreign tax credit. The eminent tax scholar, Stanley S. 5urrey, then Assistant Secretary of the Treasury for Tax Policy, in testimony in the late 1969's at hearings before the Senate Foreign Relations Committee with respect to the proposed U.S.-Brazil income tax treaty, reiterated a fundamental and international accepted premise regarding the foreign tax credit: "American investment would not proceeçl at all wi~thout the foreigp tax credit because then, as the Chairman pointed out, two taxes would be in posed and the overall burden of two taxes would be so great that international investment [by U.S. companies] would practically cease." At a time wher~ the United States faces a period in which it will be a substantial importer of petroleum, elimination of the foreign tax credit for petroleum prq- ~1ueing operations would seem clearly not `to be in the interests of the United States. My comments have made it obvious that I believe the long-term interest of the United States lies in strengthening rather than weakening the U,S.-base~ inter- national oil eompaI~ies. Weakening these companies i~, in fact, a kind of neè- isolationism. If, through tax policy and other controls, you disgble our U.S. co~panies from competing with their foreign counterparts and make them eco- nomically unattractive as concession holders to foreign governments, they will tend to disappear from the international scene. This Committee would already have experienced one of the effects of such neo-isolationism, The Senate has recently sought information from Aramco shareholders regarding the technical capability of the oil fields in Saudi Arabia to continue present production levels, as well as eventually to reach 20,000~000 barrels per day. Flow would you expect to get that information if U.S. companies were not in Saudi Arabia? As a matter of fact, Saudi Arabia has been more cooperative than most sovereigns in permitting information to be given to the U.S. Government. In passing, I might also say that if you are concerned about the technical capability of a country with from 165 to 250 billion barrels of proved reserves to sustain production of 20,000,000 barrels per day, you should he downright alarmed about the ability of the United States, with reserves of 30 to 35 billion barrels, to sustain production of 10,000,000 barrels per day. Now, let me comment more specifically on the future. And let me focus first on the very near term. I believe the best policy for the United States to follow is a modernization and improvement of the one it has followed for th~ last fifty years. Thi~ is doing what it can to foster the presence `of ~LS-based companies in the principal producing areas of the world, Its further objective should be to bring about the depoliticization of oil as rapidly as possibl~ Indeed, I believe this is the only sensible alternative the United `States has for the near term because in that near term it is dependent upon oil for its energy needs and there is no reasonable possibility of meeting that need except by imported oil. Hearings before the Committee on Foreigp RelatIons, U.S. Senate, 90th Congress, Iflrst Session, on the Tax Convention with Brazil, Executive Journal (1967), pp. 19-20. Profes- cor Surrey reaffirmed his view that the foreign tax credit should be retained, in an appear- ance before the Ways and Means Committee of the House of Hepresettatives in connection with tax reform, February 5, 1973. PAGENO="0089" 8~ The obvious first step in attempting to restore a degree of normalcy to the h~teraationa1 petroleum busi~iess ~ the bringing abQut pf some settlement fti the Middle East One would hope Secretary of State J~tissinger and the Adminis~ tration will continue their record of ~ueçess jn the preliminary but all-Lmportant steps which have already been taken in this direction. Only thrOugh such a settle- ment will it be possible for the n~atter `of oil to be treated by the producing countries again as a commercial, as distinct from a political matter.. Assuming, through the form of some kind of political settlement, some semblance of a return to normalcy can be brought about, some people. may still question whether there are viable alternatives to the pattern of ~iegotiation of oil matters which has developed in the past ~ew years, It is necessary to. examine alternatives available to uS as we approach the problem of trying to develop a viable syste~ for the future. In the near term are there any viable substitutes for the handling of oil matters through industry-producing governn~ent negotiations? Some have suggested that the role of the oil companies be dispiaced by direct government negotiations. The' arrangement has a certain emotional appeal; however, the examples of direct government negotiations do not give us confidence `that this sol'utiop would be a satisfactory one. The past records of government-to-government negotiations are full of examples of political decisions which have overridden the oil supply con- sideration. I `submit, for `example, `that private companies are likely to do more to protect the public's interest in keeping costs down than governments will. Unless .a proper political atmosphere is constantly maintained, a, consuming country government cannot assume that an arrangement which it negotiates with a prod~icing country will, in fact, be stable merely because both parties to the arrangemeiTit are governments. The exp~rien'ee of the French with the .Algerian oU agreements .illustrates perfectly `the fragility `of sovereign-to-sovereign agree- inents jncorpora'ted in larger po'li~jcal settlements. . A gpvernment. pego'tiated arrange~ent Is vulnerable to, a weakness which is not present with private negotiation's, When political difficulties arise, it is often impossible to' keep `them from interfering with the commercial funeti9~ With the private, ccunpapies `t'his is,n'9t the ç~ase. Indeed~ Aramco has been able, to continue operating in Saudi Arabia during `the period ~ben exports from lSaudi Arabia tc~ the United States were totally emba~goe4. ` . ` . . .~. There is one, qthei~ very practical problem with any govern~en't4o~go~etnm'efl't solution.. That is~ the eo~plexi'ty of international trade' in petroleum. There are well ovei~one hundred countries i~ the Free World which import petroleum and almost one hundred which also expert petroleum. It is an understatement to s~y tbp~ trade `in petroleum `is ~nultiiateral. ~audi Arabian,exports go to about sixty countries. Which nation on `the importing side is going to be authorized to negotiate for all? Or are all `the importers going to try to sit down and negotiate jointly with Saudi Arabia? If `it's not a jQint negotiation, tI~e gov~rnmenhto- government solution is going to result in bilateral barter arrangements of the kind France has made, or attempted to make in recent months. Barter arrange- ments inevitably `tend `to l3alkanize world `trade `and, in this case, to `support the' presently high price level of crude oil in the Middle East. But it it is to he `a government-to-government `solution it must be one or the `other, The first presents immense `practical difficulties, while the seeopd is clearly undesirable. If direct negotiation by governments is n'ot the solution, what imp~oyemeflts can be suggested in the present system? Clearly, it must be recognized that any action which excludes U.S-based corporations `will not `similarly impede the operation of foreign-based companies or their government sponsored counter,- parts. Consequently, the best approach for the United States to adop't is to thake use `of the U.S. companies as a means of ensuring the fair `treatment of American interests around the world without at `the same time di~crimina:ting against the interests of other countries. We `are not suggesting `that the U.'S. oil companies become political instruments of `the United `States Government. In that event they would be subject `to all of `the problems we have ju'~t mentioned in connection with a government agency. Instead, the United States Government can play a very positive role in creating the atmosnh'ere necessgry to ensure the stability `of commercial arrane~emen'ts in world trade. It must be emphasized to the producin\g countries that `their emer- gence as major forces in `international monetary `and trade channel's carries with it' a share of the responsibility for the stability of these international systems. PAGENO="0090" 86 The prothicing c&initries will e~pect that the nffijor con~um1ng countries and ~oinpanies will assist them in the orderly investment of their foreign exchange rOserves, and in the development of their internatioba,I trade. As they proceed to realize this goal, they wlll~bécome aware of the need for fiscal stability to protect the value of their trade and Investments. Considerable criticism has been levelled at the conduct of the U.S. Govern- ment's relationships with the American oil companies. It seems appropriate that the relationship be bettor defined in the foreign area. Foreign consumer govern- ments have long expected that our foreign competitors keep them informed on producing-country negotiations. `~Ve, for our part, have always assumed an obligation to keep the UM. Government informed. But the process of informing the Government has been informal and necessarily confidential. Clearly, it is not possible to conduct a negotiation on the front pages of the daily newspapers, just as it Is not possible to conduct delicate foreign policy negotiations lb that fashion. HOwever, the 15.5. Government has the right and the obligation to inform itself as to these important negotiations, and to take whatever diplomatic steps it considers appropriate in connection with them. In our judgment, the organiza- tions which are entrusted with the conduct of our foreign policy should similarly be entrusted with the government role in support of American access to foreign oil. In sort, the international trade in oil badly needs stabili'ty~ Since the producing country-governments are sovereign and not subject to a superior law, It iS neces- sary for the consuming countries to persuade them that their best interests will be served through the maintenance of stable conditions jn which commercial commitments can be freely made ~nd relied upon. In such a stable framework the oil industry is clearly capable of meeting the needs of the consuming nations of the world; and the record of the industry gives us confidence to make tba~t fore- cast. If we do not have stable conditions, neither the companies nor the con- suming countries will be able to enjoy reliable supplies at reasonable prices. I can sum up my views on this matter by quoting from an interview with one of the world's foremost historian, Arnold Toynbee. The editors of Forbes maga- zine recently asked Mr. Toynbee for his views on multinational cooperation. This, in part, is what Mr. Toynbee had to say: "What I see is that the multinational corporation fills a vacuum. There is ~n increasing tnisfit between the fact of global economic life and the ~ol1tical organization of the world, in 140 local, So-called sovereign states. They aren't really sovereign because they are dependent upon the rest of the world for raw materials, and sometimes for food itself, in order to live. But they are as sovereign aS they can contrive to he. Most of the ecopomic troubles of the world are due to this misfit between the antiquated political setup of local states and the real, global economic setup. "Multinational corporations precisely bridge this gap." For the longer term is there any way to avoid the energy crisis we experienced as a result of the Middle East War last fall? Ctui Project Independence succeed in making the United States self sufficient by 1~80? Is a national oil company some kind of panacea? Is some other energy source capable of rapid development? So long as we are dependent for energy upon imported oil there is no way oil companies can stop unheaval cause by wars. Oil companies neither make wars nor have the ability to stop them. Potential disruption of oil supply, however, can he reduced again by continuing the policy of 50 years of encouraging U.S. com- panies to establish a presence in as many different producing areas around the world as possible and encouraging exploration for oil there. I am pessimistic about the ability of the United States to achieve energy self- sufficiency by 1980. There seems to me little possibility of a resolution of the fundamentfil dilemmas between environmental considerations and resource de- velopment within the next year or two. Such resolution, together with the estab- lishment of priorities In resource development, would he absolutely essential to any hope of success because of the tremendous lead time~ involved in the kinds of resource development required. Indeed, It is already too late, in my opinion. But we must get on with the job. We are fortunate that certain of the pro- ducin~ countries have heen willing to Increase nroduction. We are doubly fortu- nate that they are wlllinr to promise further increases even though they have no practical way to use all the income generated from present production, We Forbes magazIne, Apr. 15, 1974. PAGENO="0091" 87 can~t expect them to continue tub policy while We do nothing at home to solve t1~e problem. Tl~ere are alrea4y voices hein~ raisec~ in th~se countries in opposi- tion even to present production levels. A national oil company of the kind p~o~osed would, in my jiidgment, be a hindrance rather than a help. It can~t be used as h standard to judge the per~ formance Of pth~ate oil companiCs If it is to operate by different rules. If it won't pay the same taxes, if it will be able to borrow ~noney on government credit, and is to be given 20% of the most promising acreage free in future lease sales, how can it be used as a measuring stick? Furtherniore, the efficiency record of government oil companies has not been impressive. I-low will it speed a solution to the self-sufficiency problem to put 20% of the most lrospe~tive aereage in the hands of a new and untried entity which must start from scratch in creating an organization and efficient systems of operation? The answer is, in my opinion, that it will do just `the reverse and slow a solution to the petroleum sël~-sufficiency problem of the United States. To summarize, there is a need for more cooperation and understanding between `indhstry and government. Much of the problem this `time was caused by the suddenness with which the shortage came on. There was inadequate time, made- qtrate avenues of communication to explain what was happening, and an atmo- sphere of mistrust and suspicion which, unfortunately, still exists. Better under- standing between government and the industry would certainly ameliorate these problems. But the positive role of the government in petroleum matters should continue to be political, while that of the companies should be commercial with better coordination between the two. Now I'd be happy to try `to answer your questions. Senator CHURCH. Thank you very much for sunmarizing your statement and the full text of the statement will appear in the record ~s though read. ATTITUDES OP TEE OIL COMPANIES My impression, Mr. Tavoulareas, is that everything is changing in oil except the attitude of our oil con~panies. You have takeil up each of a number of suggestions that have been made an4 opposed all of them, and I take it from my perusal of your statement that your position is that nothing should be done that would change present law or policy. Is that correct? Mr. TAVOULAREAS. No, I wouldn't say that is correct. Senator CHURCh. What changes in present law and policy are you p~repared to advocate? Mr. TAVOtIAREAS. I would like to before I answer that go back over a period of stability that existed from World War II up to 1973 and find out why we had stability during that period. Senator CHURCH. We are familiar with that period1 we have looked into it very thoroughly, and with the changes that brought on this rapid escalation of petroleum prices. So that I would appreciate it if you could respond to my question. Mr. TAVOULAEEAS. I intend to. NEED FOE POLICY CHANGES Senator CIIUECTI. What changes in present' policy or present law do you think advisable in light of the current problem that we face? Mr. TAVOT~LAREAS. Well. I knew you were familiar with the post World War II record of oil and I was going to p~it a background for my suggestion. PAGENO="0092" 88 During the period prior to 1970 we had surplus and we had lack of politiôai involvement. Today we have a lot ~f political involvement and we have a shortage. What we ought to be working toward is a better. political atmosphere and we aught to be working toward trying to restore the balance of supply and demand and we ought to be dorng everything to encourage increased exploration around the world. IL just cannot see myself that if we assume shortage, and, thus we assume lack of leverage on the part of the oil companies, why anybody else would have more leverage. THE COMPANIES' LOSS OF POWEU Senator CHURCh. It has been admitted to us by highly placed exec- utives of the oil companies that whatever leverage the companies once had has really disappeared and exists no longer. Mr. TAVOITLAREAS. Well- Senator Cinmon. FU~thermQr~, it is hard for us to see what incen- tive oil companies really have any more to insist upon lower prices. When you combine these two things together, I don't see what ease is left for the proposition that under existing circumstances the corn~ panics need no backup from Government. I haven't personally proposed that the companies be displaced by government but it .seein~ tO me that if: it~ `is true~ as `the oil executives themselves have admitted, that their leverage has all but disappeared then we are facing a new and different ~ituati~n' in which the Govern- ment rnigh~ play a construptive role in backing up the oil companies in the hope that ~e could ~cure from the `Arab and the Other oil- produein~ gOyer~1menth more satisfactory agreemeftts upon futnre prices foi crude oil Mr. TAVOITLAREA~. Thete *ere `~hre~ ti~ereñt' poiiits'you were mak~ ing. `Let me ~nake it very clear we a~e not satisfied with pi~esent condi- tions. They have to be called unsatisfactory by any standard. `However, these events which have happened. over the 3-month Period at the end of 1973, tliey ~rO `irer~r ~seriOiis, ~ ,oecurren'cés, Now~ we must addres~ ourselves to a ~ay to try to irnp~o~e otir position. All I am saying is. I have heard the proposals made and in eaèh case I am convinced thatthosc ~ropo~als will make no improvement. Senator CHURCH. Well, then, what *oiild you have to propose? Mr. TAv0uLAREA5. The second thing you said which I would like to comrn~ent on is we don't c~ire about increased costs. That is unt'rue~ 1 have heard it said many times. `I ju~t can say it is untrue. I will be glad to elaborate to the extent you want me to elaborate. Senator CHITImCH, Let us just assume, I don't want to* argue that proposition, that the oil companies genuinely desire to bring prices down, even though this is a highly profitable period. Let's say in the overall estimate of the industry it would be advisable in the long term to bring prices down. I am willing for the sake of argument to make that concession t~ you. Even so, it is hard for me to see what real leverage the companies have any more with the governments because th~ situation today is utterly different from what it was in the earlier period. PAGENO="0093" Mr. TAV0ULAE~AS. Now, what I gue'ss we ar~ both looking for is how w~ get a better negotiatiug posture and you certainly get one by recreating the situation where we have leverage. I cannot believe that p'utting the Government on the scene and assuming, if you continue to have shortages, and we con~tinue t~ try to divide up the same pies that exi~t in the Middle East and ii~directly discoui~age exploration throughout the world, will be an improvement. If I thought it was an improvement believe me I would say to you let's do it, because what am I in the business fOr? I am in the business to try to'get crude to supply my ships, my refineries, and my market. If I thought what you were proposing would do that, and I couldn't do, it, I would certainly be for it.' I am tryir~g to say, inmy opinion, I don't think it would be better. As a matter of fact, I think it could be ~wOrse, and I can enume~rate why I think it could be wth~se. Senator CntRCH. Let's getour facts straight. First of ali~ I haven't proposed that the Government move into the oil business or undertake to compete with the oil companie~, and cer- tainly I have no interest at all in any `Government role that would tend to discourage iiierease'd productiOn. `What I am concerned about is that we get a little mOre' muscle in our negotiating posture. It is obvious that the Government of the United States has a good deal of leverdge ~left with the Arab governments. The role we play in the political situation, which you yourself say has eome to' nsurp the scene in the Middle East, the role of `our Government' in those ongoing negotiations has been a~ver~ critical one. We are being asked to support a very snbsta~itiai new aid program in the Middle East, so the Government' of the. United States hasn't last all leverage in that area. I am afraid tiiat the companies have. Mr. TAVOULAREAS. I guess- ` SenatOr Cnuncm It' `doesn't follow it ~s a practical `proposition for you to say that the' Governm~rit should play no `role when your com- panies have in effect admitted that they have'no'le~erage left. What you are really saying, it `seems to me, is'th'row ourselves upon the mercy of the Arab governments but for `heaven's sake keep the American Government out of it. Mr. TAVOULAREAS. Any backup that yOu can give to our negotiatiOns we endorse, but in order to define that backup we have to have a proposition. I was addressing myself to the propositions I have heard put for- ward, the propositions I understood were put forward. We wish we had had more backup from the American Govei~nment in the last few years. With that generality I agree. THE PEA'S PROPOSAL Senator CHURCH. Let's move on because I would like to get to the point that these questions are leading up to. If that is so, then why don't you address yourself to the proposal that I have made? Just yesterday Mr. Sawhill was here. He strikes me as having been a very responsible Federal official. He has tried very hard to manage PAGENO="0094" 90 a difficult assignment. He testified that he would favor the enactment of a law that would guarantee the Federal Government full and timely a~cess to all information relating to the negotiations between the companies and the producing governments so that the Federal Gov- ernment would not only be advised of these negotiations as they pro- ceed but could in turn advise the companies. Second, he said that he would favor inclusion of a provision in such a law that would require the Federal Government to approve any final settlement between the companies and the foreign governments relating to oil prices. Now, what would be. your position with respect to that kind of a law? Mr. TAVOULAREAS. With the first part of it I have no problem, access to information, consultation, no problem on those. Let's examine for a moment what approval would mean. Let's take some examples. No. 1, we have a new Tehran negotiation. You can make a reasonable case for government being very closely involved and would like to have some kind of say in the final negotiation. Let's now take the other extreme, and auction off crude. Let's take a spot sale. What would it mean ?~ For example, Mobil was going to bid in a MiddleEast auction for 1 million barrels, of which I anticipated bringing 200,000 barrels to the ITnited States and 800,000 abro~zd, Would you contemplate approving.that kind of deal? Senator CHURCH. No, I ~ for a momex~t contemplate that. An auction sale of that kind is a free market sale. What I am referring to are contracts, long-term ëontracts of the kind that the oil companies have entered into in the 1~ast and which no doubt the Arab govern- ments would be wanting in the future, establishing a new price for oil that could have an im~nense impact on the economy of. the United States. Fuel prices, as you know, are the principal element fueling the present inflation. Now, what I would suggest is a law. that would not only require full disclosure of with respect `to negotiations leading up to such. con- tracts, but also would require government approval. Let me suggest one ~reason why I should think this might prove helpful to the companies, companies that now admit they have lost their leverage. If you were in a position, for example, to say to Arab governments that you cannot enter into a long-term contract because your own government won't permit it, I should think that would strengthen your bargaining position with the Arab governments. Mr. TAVOULAREAS. My guess-~- Senator CHURCH. If you are in a position where you cannot say that, then you are pretty much going to have to accept the terms that they insist upon. Mr. TAVOULAIiRAS. Well, let me comment. ~ou keep repeating one point. You keep on saying we have lost our leverage. We certainly have lost our leverage in price negotiations. I don't thi.nk the TJ.S. Governm~ent will get that leverage back until we get out of the period of shortages. Senator CASE. Until what? Mr. TAVOULARE~S. UntIl we get out of th~ period of shortages, until we get to a period where we again have a siippl.y and demand balance.. PAGENO="0095" 91 I don't know how anyone gets b~k the leverage or until OPEC cartel breaks up. The government will be no better off in the price negotia.- tions than we are. Let's remetuber the kind of leverage we continue to have that you don't have-may I finish one point. We have been told and the Saudi Arabian minister has said time and time again we need and want the Americancompanies here. We need their technical `know- how, we need their markets. That is a form of leverage. What do they need ~from the U~S~ Government? We are only talking about leverage. I don't understand it. Let me address myself further to your statement that- Senator CHtTRCII. I can't accept those propositions. Mr. TAVOULAREAS. I understan:d. "THE POLITICAL WAR CAUSED TIlE SHORTAG~S" Senator CHuRcH. We have a Saudi Arabia delegation here in Wash- ington right now negotiating with the Government. Furthermore, it `seems to me' to be fundamentally contradi~tory to say on the one hand that the present price is due to a shortage, and then to say in your statement that the present price is the direct result of a political conflict emanating from the war between the Arab gov- ernments and Israel. Obviously that was the thing that resulted in prices increasing between 400 and `500 percent. `Mr. TAVOULAREAS. Completely consistent. Senator CHuRcH. It was a political price. Mr. TAVOULAREAS. The political war caused the shortages. If you read my statement itery closely, we say that as a result of the political war and political events we had a boycott, therefore', we had a shortage. There is nothing inconsistent with those statements. Senator CHURCH, If the boycott caused the shortage then it ~an be quickly corrected with the lifting of the boycott. I don't see that the problem is really one of shortage. There isn't really a shortage of oil supplies against present needs. We have been told by many witnesses there is no serious shortage of that character at the present time. The price is a political price; it has been imposed for political reasons. Therefore, it seems to me that the Government might have some 1ev- era~e in bringing that price down. Mr. TAVOULAREAS. You said that you did not want government in- volvement in short-term deals or in auction. You said you wanted them involved in long-term deals. Are you saying you predict long-term surpluses? Senator CIIuRcH. No, what I am saying is this. In the past the companies ha~ve entered into relatively long-term agreements with the Arab governments with respect to price. Those agreements have not been kept, they have been quickly broken. In fact, our testimony shows that the last agreement, the Tehran agreement, was in the process bf being broken and prices were going u~ prior to the war and your companies have been put on notice that you could expect substantial additional increases in price. Nevertheless, whether or not they h~tve been kept, you have entered into these relatively long-terth ~greemeiits and you have negotiated them with the Arab governments. PAGENO="0096" Now, I do&t know what the future will hold if the past is any measure of the future. It is entirely possible you will be in new nego- tiation~ of that kind. What I am sayino' is that you may find your own bargaining posi- tion strengthened ~F the Government were able to back up the com- panies anti bring additional leverage to bear on the oil production governments. NEGOTIA~INO FOR TEE COMPANIES Mr. TAVOTJLAREAS. Let me go back to the basic statement. You said it would be a protectiou for us to be able to say we need a home government approval. I suk&it it will be just the opposite. We used to send out to negotiate with these people the operating heads of the operating c?uipanies in the area. In the case of Aramco it is a profitmaker; in the case of other companies it is a nonprofitmaker. They quickly said we want to talk to the people who can make deci- sions and sign. We finally sent higher and higher levels a~id they said if you can't ifegotiate you can't ~igii, don't come out here. Now, if we go out there ~and say we Ameriban compaities can't sign but the Frenèh and the German and Japanese company can sign, I assure you~ Senator, in my opinion it will be a very short period of time where the Government of Saudi Arabia will say we don't nego- tiate. We can negotiate a deal ~s good asthe Government cane If there is no surplus neither one is going to negotiate a good deal. Senator CHURCH. I take it then you would disagree with Dr. Sav~hill that giving the Government a backup role, the right of final approval, with respect to these agreements, would not be helpful? Mr~ P~AVOULAUE~AS. Well, letm~ say this~ I did not hear,,what Dr. Saw- hill said. I did not readthe testimony. I read somereports in the news- papers and they were tw~ different u~eports.~ I would be surprised if Dr. Sawhtfl said the only way ho thinks we caa operate is for him~ to have final appro~val authority. I would have thought Dr. Sawhill was very happy with what is going on. We keep him fully informed. We keep the State Department informed. Senator ChURCH. I would suggest that you read the testimony. We will mak~ it available to you, the full record, so that you can judge on the basis of his own testimony as to what he had to say; Mr. TAVOULAREAS. If he said, as you say, that it will improve the negotiating position for us to be able to say that we can't sign a deal until we get U.S. Government approval, whatever that might mean and, I don't know what it means, then I must say I disagree with him. I think that will weaken the negotiating position. THE INDUSTRY~S OBJECTIONS Senator CHURCH. You said earlier, having expressed the industry's objection to all suggestions that have been made, that you had some suggestions of your own to make. Could you tell us what those are? Mr. TAVOTJLAREAS. Well, I have not opposed all suggestions. There have been some suggestions that we have more consultation. I agree with that. There have been sugge~tions that government try to work much more in the political field. I agree with that, I have heard sug- PAGENO="0097" 93 gestions made we ought to tr~ to get the whole atmosphere back on a commercial basis. I agree with those things. So I don't think I have disagreed with everything I have heard. I tried to address myself just to the things that I disagreed with. Senator Cirniron. Yes. But those proposals with which you disagree are the proposals that would change existing law and present practice. Do you have any proposals to make of your own? Mr. TAVOTXLAirEAS. Yes, sir. Senator CHtrnoii. I would like to get them on the record because we want to get industry's proposals along with those that have been made by the critics, Mr. TAVOIJLAREAS. Senator, I am sure we are both sitting down together in a period of frustration, confusion and trying to do what is right for the American people and the world and I am not against government for government's sake. I think that is silly indeed. If the Government could improve the situation I will endorse it and say I am for it. I just say some of the proposals I have heard I don't think will not be either workable or acceptable to the Government of Saudi Arabia, that is my point. I jotted down last night, the things I think would improve this situation and maybe after a period of time if this doesn't do the job we have to look at something else. I would like to have greatly increased consultation between the Government and the companies with the understanding that we both have a role to play. Many of the propositions I have heard: "Well, the government ought to play a bigger role, but how do we secure our input? We can't get you fellows together because there are antitrust problems." If we asked an oil company man to do so we will have the Hill coming down on top of our heads. I think that is a very foolish result. Here we are, people with knowledge being told if we ask for your advice it will be the most horrible thing for the American people. I say, there should be consultation where both of us have a role to play. DEV~LO~tENT OF ~EW ENEirGY SUPPLIES We ought to pass laws of the United States that will increase the possibility of developjug new energy supplies quickly. We are going through a period of. talk, talk, talk and no action. Senator Ciiuiroi~.; What changes dq you thin1~ should be made t~iat would encourage increased domestic production? Mr. T~voVLAREAs. Well, wh~n it i~ ~Jl overt apparently the two sides of the equation seem to be environment versus supplies, There is no doubt we have the energy resource base. More than one report says America has the energy resource base. We are only talking about the constraints we put.on ourselves. When you speal~ of constraint, almost every case becomes environ- mental. I say that . someone is going to have to make the decision as to which has priority in each case. I can give you some specific proposais. I will be very happy to do it or tell you in generalities. 45-426-75-7 PAGENO="0098" 94 If you ask me what I would do I will tell you what I would do in this area. Senator CHURCH. Your idea for the country is to stimulate new- Mr. TAVOULAREAS. Supply sources. Senator CHURCH. For energy b~i relaxing the environmental con- straints. Does that sum up the general position? Mr. TAVOULAREAS. Well, I think we can do the job without a lot of harm to the environment. That is why I don't want to endorse that. Other people don't think we can do the job. When we decide there is a possible harm to the environment someone has to make the dcci- ~sion whether the supply source or the environment is more important. This is clearly a decision for government, not a decision for companies. So I think we ought to work on increasing the supply source in the United States. I have heard a lot of people, oh, no, let's only concentrate on curtail- ing demand. Well, I think then you have taken the options away from the American people because the curtainment of demand is a decision in which the American people don't get what they want and we haven't the supply base to make up the difference. You have really made a decision. Senator CHURCH. You mean by that you are against a conservation program that is voluntary in character? Mr. TAVOULAREAS. No, no, I am for conservation. Our problem is we have to define conservation. Some people would say conservation means 1,000 percent assurance that not one blade of grass is spoiled. Well, someone has to define what we mean but make it very clear. We believe in conservation; we believe in the environ- mental protection. The next thing I would do is to say is that in the conduct of our foreign policy, we should recognize the important role of the oil exporting countries. I think in the past we haven't quite recognized the importance of the role they play. I didn't say have it dominate the foreign policy, I merely said, recognize the role. Next I would encourage increased exploration by American com- panies in the world to bring supply and demand in balance. Almost every suggestion I have heard is a suggestion of who can do better in splitting up the present pie. Splitting up the present pie doesn't make one more barrel of additional reserves. And to the extent you tell companies we are going to take that away from you, you ai~e going to encourag~ it to be taken away. This discourages exploration else- where. Recognize the, fact that we cannot expect cduntrie~ like Saudi Arabia to consistently increase production which they don't need while we do nothing here at hometo help ourselves. Consult with other consuming countries to foster a spirit of coopera- tion rather than competition, not with the idea of confrontatiOn with the producing countries. In this regard I don't think we can ask other countries to do more than we are doing ourselves. For example, we see certain coi~ntries in the Common Market setting goals on nuclear development by the year 1985. which we in the United States are not willin~ to do ou~- selves. I think we ought to examine this very carefully. Some people ~ay don't build nuclear plants. In thy opinion I say build them. That is another way of creating surplus supplies in oil. PAGENO="0099" 95 Those are the things I would do, Senator, in order to improve the posture of the companies and the Government in the month and years to come. Senator CHURCH. It seems to me that some of these proposals are pushing an open door. I don't know of any serious deterrent now to expanded exploration and development in this country. The price con- trols have been modified in order to encourage the production of new oil. We were told yesterday by Dr. Sawhill the number of new wells being dug is up 30 percent. We are bringing in the Alaskan oil. We are encouraging new oil exploration off the coasts on the Continental Shelf. We are in the process of adopting here in the Congress a multi~ billion dollar research program to make the country more self-sufficient by stimulating the production of coal, cleaning up coal, substituting~ it for petroleum, getting on with an accelerated atomic program for nuclear reactors. The Government will soon begin an expanded pro- gram in other alternative sources for fuel. The shale production is beginning in Colorado. Geothermal exploration is going on in the West. If we want to stimulate domestic production and make ourselves more ~e1f-~ufficient it seems to me we are doing all of these things flow or will soon be doing them on a very, very large scale. Mr. TAVOULAREAS. I think these are more things which you hope the U.S. Government is starting to do rather than things that are being done. You said we are building the Alaskan pipeline. Not 1 foot of line has been laid. Senator ChURCH. The law has been passed, the clearance is there, it is going forward as fast now as the engineers can put it together. Mr. TAVOULAREAS. No; we need over 100 permits to build that line. Not one of them- Senator CHURCH. Is there anything further Congress can do about that? I wish you would let us know. We have done everything in our power. You speak of fair and reasonable standards. Let's apply one. By any fair and reasonable standard we are engaged now in a gigantic effort, I think, to achieve a larger measure of self-sufficiency. Mr. TAVOULAREAS. Let me give you some examples. Senator CHURCH. I am not saying that every obstacle has been re- moved but I am saying the general thrust is clearly in that directiou. Mr. TAVOULAREAS. iiming is all important, Senator. We have some acreage on the Atlantic coast that has some good geology. People tallç ~bout leasing that in 1976 or 1977.. I hardly think that is moving fast enoi~g~. We have some acreage offshore Alaska. 1!Ve have some acreage ini~h~ SantaBarhara Channel.That is not going up. We had ~~/2 years of d~lay on the Alaskan pipeline. We talk about shale. We are a long way, The people who have bid recently on shale no* have to go through extended envirOnmental Impact studies and can be held up for 3 or 4 years until legislation on enviroi~mental impact st~teipents come out of Congress. So while you sa~i you have done some things, you have also done other things which impede us. PAGENO="0100" 96 Senator CHURCH1 I think the only con~ideratiou isn't ~acçelerating' production. We have to balance that, as you youi~se1f have said. We have to have reasonable measures to protect the environment itself.. I am really saying I am not disagreeing with many ~f your recom- mendations, but it seems to me we are engaged in doing that as best we can, keeping other considerations also in mind. We have had testimony before this subcommittee by a number o~ witnesses who have said we ought to alter the tax laws because the present tax laws have created great incentive for investment abroad. You have taken issue with that. Other experts have laid a rather persuasi~re case before us. Obvi- ously any tax system that creates incentive for additional investment' abroad is not one that is calculated to promote self -sufficiency at home. I. take it that you believe there should be no changes in the tax laws as they affect the oil industry? Mr. TAVOULAREAS. Can I just make one more comment about your first statement? Senator Crnmcu. Yes. Mr. TAVOULAREAS, My problem is that we don't appear to ~iderstand' the importance of timing and the leadtimes necessary. I talked to a coal expert, and I am no expert in coal, and I have talked to nuclear experts. They say the time period has moved from 5 or 6 years up to 8 or 10 years. So when we say we are moving, we are moving at a snail's pace. If we move at a snail's pace I don't think this is accom- plishing the job. THE PURPOSES OP THE POREIG~ TAX CREDIT Let me ~nove over to foreign tax credit. `This unfortunately I think has been one of the most confused subjects I have ever heard discussed ~ith much more mist~oncep.tion than I have heard in my life about what a law wassupposed to do. The foreign tax credit was supposed to avoid double taxation. We haye, foreign tax laws in.every major country around the wotld, and' in, ~a,~idition to foreign tax laws we have certain companies which give additional encouragements. Now, if you put an American company in a position h~ a produci~ng oountry s~ that the American company has to pay more taxes than a competitor, we will slowly put that A~iieri~an co~npan,y at a competi~ tive disadvantage. For example, i~ the Saudi~ Arabian G~vernm'ent charges today a $7 tax and rcyalty o~i eq~uity ofl a~ci a b~gher take on buy ba~k oil and a I~rench or Gerip~n cornpany ;p~ys nq addit~onal tax, or as a matter, of fact, are given incei~tive~ to explov~, and an American conipany has to pay an açlditional tax becans~ it `4oesn't get foreign tax credit, we are only talking. about the time when ~t~ie American comp:anies are no longer competitive. S Then afl of the control you are looking, for that you are trying to get over the American companies will all be gon~ because we are going to see the greatest proliferation we ever saw ~f foreign countries ai4ta~ haven cowitries getting into this business. It is going t~ defeat. You said your objective is to get Governmen,t thore `involved. How do von get involved? By helping a French compaiiy in Saudi Arabia and a Panamanian company in Saudi Arabia. ` S PAGENO="0101" 97 Senator' CHURCH. Most, if not all, of these foreign countries have :a large measure of Governthe'nt importation tax, such as British Petro~ leum, and i~ is true of most European companies I know aboui; so ;they are hot purely private companies to begin with. They have got ~the Gçr~rernment rather deeply involved. I don't propose any similar arrangement in this country. My proposal, it seems to me, has been a ~very moderate' one, that being the Government should give our own nompanies as much backing as possible in connection with their nego. tiations with the Arab go~ternments. Mr. rfAV0ULAREAS. I will accept that. / Senator CHURCH. The problem that I have with the tax question is `simply this: I can understand it might be devastating all of a sudden to eliminate all foreign tax credits. You find yourself in a radically different position. And the dislocation that that could bring on could be fairly serious. On the other hand, our income tax laws are so filled with loopholes and tax havens of ~arious kinds that we discovered in the Congress some `years ago that a great many people, very wealthy people, were getting by without `paying any tax~ at all. It wasn't that they were `illegal, they simply had expert advice of the kind that `enabled them to take advantage of these loopholes and taX havens in some way as `to eliminate their tax to the Federal Government. We sought to correct that by writing into `the law a minimum tax. It said if you can take advantage of all of these loopholes and tax havens in such `a way as to eliminate your tax, legally, you neverthe- less ~wil1 have a minimum tax you must pay, because no person, and I think it follows no industry, should be permitted a free ride in a society such, as ours. I have concluded from the evidence that has been presented to this `subcommittee that a similar approach cOuld well be taken with respect `to foreign tax credits and foreign investments by large multinational norporations. If through the tax credits and various other concessions ~that are made it ends up that the industry pays little or nothing, then there ought to be a minimum that the industry pays in any case. In fact, I do intend to introduce `a bill that would impose a mini~ mum tax requirement. What I am getting at, is that our figures, and they are your figures. which I think are accurate, show that the major American-owned oil companies, after taking into consideration both the foreign `and the ~doihestic operations `of these companies, paid very little to the Federal Government in `taxes. In 1972, Texaco paid 1.7 percent of its net profit in taxes to the Federal Government. Mobil paid 1.3 percent; Gulf, i.2 percent; SocaL `2..~ nercent; and Exxon, ~.5 percent. Now, the figures are borne out over the 196~ to 1971 period. Tre- `mendoiis oil companies with profits that ~re calculated in the billions are flaying nothing more than token taxes to the Federal Government. `This is a situation that I think the industry itself would want to `see corrected since we expect other businesses to pay 48 percent in `ta~s on their profits. Mr. TAv0ULARRAS, I would like to respond to that. PAGENO="0102" 98 You have covered a number of subjects. 1 wish I had time to make my own charts, it might show the figures ~a little difterent. Let me say one principle. You hav~ given the inference from that report, because we are talking about foreign tax credit, that if we didn't have it, if we didn't have foreign tax credit we would have paid more U.S. income taxes. if we ha~ no foreign operations we wouid pay no addi- tional U.S. income taxes. We have to remember that. ii we had no foreign operations we pay no additional U.S. tax. Those tax flgui~es should be related to Ti .S. income not to foreign income, in no way does the foreign tax credit reduce 11.5. income taxes on U.S. income made in the United States. Senator CHURCH. I understand that. But you also understand that if you didn't have this foreign income tax credit your taxes on yonr overall profits to the U.S. Government would be greatly enlarged. Mr. lAVOULAREAS. Yes. I understand that if I thdn't have a toreign tax credit I wouldn't be in business. Senator CHURcI-I. We keep passing like two ships in the night. I have already said that I would think that the elimination of the foreign tax credit would do very great injury to the companies because you built your whole operation on the basis of such credit and I have suggested instead we have some kind of minimun~ tax which would put you in the same position as other citizens, individual citizens of the country, who because of the various tax concessions and sanctuaries they can take advantage of under the law end up paying little or nothing. We impose on them a minimum tax. We say in any caseyou must make that much of a contribution to the support of your Government and your country and your society. Mr. TAVOULAREAS. When you take U.S. citizens, in effect, all operat- ing within the U.S. sphere and put the same kind of tax burden on them, that is a reasonably fair thing to do. As a matter of fact, since all my income is practically from salary, I didn't mind seeing a minimum tax on people who didn't pay tax. We are talking about putting a tax on operations which must compete in the world. Now, whether you put a minimum tax of 10 percent or eliminate the foreign tax credit, you are saying, well; I woh't do the horrible; I will do what is a little horrible. If you can get all of the countries in the world to say, "I will put the same minimum tax and pñjust my tax laws the same way," then we will have no impediment. To 1~he extent we have a tax that other countries don't have, I will tell you we are going to slowly be put out of business. Senator CHURCH. All right. THE AMERICAN COMPETITIVE DISADVANTAGE ABROAD Yesterday I suggested to Dr. Sawhill that this subcommittee staff in its contacts with other representatives of the oil industry and also governmental representatives of other coufltries, other consuming countries, have had pointed out to them that the same argument is being made by the European countries which say you must not tax us for foreign earnings because that would put us in a competitive disadvantage with the American companies. So obviously the argument is made on both sides of the street. PAGENO="0103" 99 Mr. TAVOULAREAS. Sure. Senator CHURCH. T~ suggested that it might be advisable for the consuming country governments to get together on a tax conVention that would impose a reasonable tax but one that would not have the effect of putting any one company at an economic disadvantage with another. Mr. TAvOULAREAS. Well, if you make the proposition that says I want a minimum tax provided all of the industrialized countries and tax haven countries of the world do the same thing. I have no objection. SCnator CHURCH. Well, I think this should be an objective of Ameri- can foreign policy. We are now apparently establishing, attempting to establish, some rapport with other consuming countries that are faced with the same problem we are, and I think this minimum tax approach is one that the industry could live with and it would be, as you say, what was your phrase? Mr. TAVOULAREAS. Pregnant. Senator CHURCH. That is better. Mr. TAVOLTLAREAS. A little bit of a disaster. Senator CHURCH. I think it would be injecting a little bit of fair- ness into the general tax picture that would really serve the long-term interests of the oil industry. Mr. TAvOULAREAS. Well, let me say this. I think if we were all equally taxed by our home governments around the world, including havens, because otherwise you are going to i~ake havens increase, it would be one situation. Let's assume you get all of the consuming countries of the world to adopt this, which I have some question about. Let's think about the reaction of the Middle East governments. Recently I was in certain Middle East countries aiid they were taik~~ ing about excess profits taxes the U.S. Government was thinking about putting on oil companies. They unfortunately had it all mixed up. They thought the U.S. Government was talking about excess profits on foreign income rather than domestic income, and I tried to straighten them out, Other parts of OPEC, whether they understood, are going to put excess profits taxes on and two countries told me I can assure you that if your U.S. Government says this oil is very high priced and it adds more taxes to the burden, then we will match that tax for tax. This is what they told me. I think you have to bear ~liat in mind when you are proposing this kind of tax. ARAB PROFITS Senator `CHURCH. Well, from all that I have seen and heard I think the Arab governments, far from being appeaseable on the question of price, have determined that their highjacked prices can be made to stick in the Western World and now they are reaping the harvest, $50 billion in surplus revenues. THE ShORTAGE AND THE EMBARGO Mr. TAVOULAREAS. Because of a shortage, not surplus, Senator CIrnnChT. Well, I don't know whether it is shortage. I don't think that there is a shortage of supply. We haven't any facts to bear out there is any present shortage of supply in the world. PAGENO="0104" 100 Mr. TAVOTJLAREAS. Senator- Senator Ciiuiwn. That is with respect to the oil that is in the ground and available. You say the shortage was brought on by the embargo and that is true, it created a shortage, but the embargo was imposed for political reasons and now it has been lifted. Mr. TAVOULAREAS. Let me say this. If you follow it very closely~ in Cairo last week the Ministers met again and they saw some temporary surpluses in the world of oil supply, and having seen some temporary surplus of wrnrid supply, and that is wl~at you are addressing yourself to, and I am personally happy there are some surpluses, the proposal was made by one of the countries that if this surplus creates an effect on price let'a all agree to cut back our production. Every country except one voted for that. So I think to count on surplus is at least tricky, ~t least unwise, because they are telling you they will make no surplus. In the ease of Kuwait, they put oil up for sale, for au~tion. You said befbre it is a free market. If it really is a free market, I wouldn't mind so muth. They didn't get the price they liked and pulled it off. It is not really a free market. Senator CHURCH. But if that were the general way of sale they would really finally have to come to terms with that market. They could hold the oil for a time, if it had a competitive condition exist- ing among the oil producing companies and a really free market as far as the sale of oil was concerned. You don't have that~ Mr. TAVOULAREAS. I wish. Senator CrnTRCH. You have an OPEC which is a cartel by the pro- ducing governments. You have a lot of factors that operate against you. Mr. TAVOULAREAS. We understand that. Senator Cimneli. furthermore, we now have a US. f~reign aid program advocated that will take further pressure off these govern- ments to generate their own resources. Mr. TAVOtTLAREAS. You are going to get surplus in my mind by developing more uncontrolled production, or if for some reason cer- tain countries decide t~ey are not sure they want to be with some of these extreme demands of all of the OPEC countries, this Is where we ought to direct our attention. Senator CHUncH. Senator ease will be here in a few minutes. I don't think I have further questions, but Senator Case may have some. Before I ask you to step down I would like to give him that opportunity. While we are waiting, Mr. Blum has some questions he would like to put to you. MOBIL AS A CRtDE SHORT COMPANY Mr. Br.UM. Mr. Tavoulareas, traditionally Mobil has been considered a crude short company. Would you elaborate a bit on that description and why it is applied to the company? Mr. TAVOULAREAS. Well, I think ~t started off with our position in the tTnited States. We have reUnery capacity and markets, let's say, approximately. double our crude production. PAGENO="0105" 101 That is not unlike many companies, because we have many, many more companies in crude production than we have in ~refining iii the United States. There are a certain few companies, almost totally sel~ sufficient, there are some more than self-sufficient, but they have ~ refineries. We start off in the United States calling Mobil a crude short company. As we move outside of the United States we would like t~ have more crude. However, over the years we have developed rnarket~ and refineries about equal to what we thought our availability would be. Now that availability only came from our own concessions, in some cases from long term very favorable purchase contracts, so in our foreign operations I wouldn't call us crude short. Would we like to have more crude? Of co irse we would. Because we could build bigger markets. THE OFFTAKE RULES AND ARAMOO Mr. BLU3I. It is our information in the course of your dealing over the years with Aramco you have consistently pressed for relaxation of the offtake rules to enable your company to buy Aramco oi.I at a favorable price and Mobil has been a leader in this; is that right? Mr. TAVOULAREAS. That is right. Mr. BLUM. And that several times on several occasions you have had the price of oil, over lift oil, as it is called, decrease so you could take more. Would this be because you did not want to be limited to a 10 percent share of the total oil coming out of the ground of Aramco? Mr. TAVOULAREAS. We were never limited to 10 percent share of the oil. Mr. BLUM. At reasonab'e low cost. Mr. TAVOULAREAS. At a price that we thought we could market the oil. There is no doubt about it, I think all this proves to me~ is there is severe competition even in joint interest ventures. Mr. BLUM. What was your leverage in the Ararnco agreements in getting the arrangements changed? In other words, if I had 30 percent of that. and I saw you coming along saying give me very inexpensive oil, why would I agree with you to give you it? * Mr. TAVOULAREAS. You finally drew two conclusions, One, I could probably get the oil at a cheaper price than the present arrangement and you would rather see the production dedicated to Saudi Arabia in that case. Mr. ELUM. In other words, it is a way of moving crude, it is a way of selling more oil, if you don't get the oil you will go somewhere else ai~id get it. Mr. TAVOULAREAS. This actuaflv proved why Aramco was so suecess- fuul, it had four companies sell its crude, having all of the facilities of four companies available. Mr. BLUM. It is our understandin~r that there are buy-back nego- tiations under way now and we are talking about that right now. How i5 that going to be handled. whether or not we are going to work with four companies handling the buy-backs. How will that be handled among the four companies? Will you be Iiin~ted to a 10 percent share of buy-back oil? PAGENO="0106" 102 Mr. TAVOuLAREAS. Well, the government has 25-75 right now. I am sure the government will get more than 25-75 very soon, what with the Kuwait settlement. We have to assume that Arabia will have at least the same deal as Kuwait. Now, let's look at the bacl~ground of these negotiations. We are really taking a snap shot in time in a very fast changing structure. The government said we want to participate in the concessions and us part of that participation the government said we would like to have you dispose of all of your oil and we were very happy to dispose of some of the oil because we have built markets. These negotiations on buy-back have been really part and parcel o~f the participation negotiations and as long as that remains I think the buy-back negotiations are a part of the participation negotiations~ Now, over and above that oil vastly increasing quantities of oil have become available to the government itself. On that we feel ourselves completely free to negotiate on our own. Mr. BLUM. Is that now a matter of discussion among the Aramco partners or are you negotiating freely to buy oil from the Saudi Arab Government? Mr. TAYOTJLAREAS. We haven't got a settlement on exactly what our new deal is. I wish we could get a settlement. Mr. BI2uM. At various meetings you have held of the Aramco chiefs in August, and later, was discussion of how these buy-back arrange- inents were going to work a subject and were you pressing then for opening up of the availability of that buy-back oil? Mr. TAVOULAREAS. Well, we have a joint venture. We have to define what we mean by the scope. To the extent of whatever we are talking ubout comes within the scope of the joint \renture, we felt our~selves morally and legally bound to negotiate within the framework. Where we feel that what we are talking about might be outside of the scope, we might find ourselves free to go our own way. There are many times, I must say, during the negotiations where companies make all kinds of statements like husbands and wives make all kinds of statements between themselves. Don~t confuse those negotiating tactics with substance. Mr. LEvIwsoN. `The issue is, aren't we reaching a point where the structure is changing sufficiently so that we ought to really consider whether the previous arrangements make any sense? I refer specifi- cally to the fact as participation oil increases, does it make sense any loneer for the four companies to negotiate jointly for preferred access? Why not cut everybody loose and see who can make the best deal? That is the issue. YAMANi'S VIEWS ON NATIONALIZATION T mentioned to you in the October 1972 interview Sheik Yamani said ho was opposed to the nationalization because it would lead to price cutting and bickering among the producing countries. Why isn't it in our interest to do everything to force that situation where producing countries are competing among themselves with a multiplicity- Mr. TAVOULAREAS. I think it goes back to the type of questioning we were discussing with Senator `Church. PAGENO="0107" 103 We have had a very, very competitive oil industry up through 1973. I think anybody by any standard would have to say it is very competitive. Then the period of shortage comes in. Now, you are asking during this period of shortage do you think whether one company negotiates Or five would be better. In my opinion, as long as there is shortage, the governments will insist upon getting the highest price anybody offers. It could work the opposite of what you are saying. It could work the opposite. In time of surplus, what you are saying may make sense; it can't during a period of shortage. Mr.~ LEvIN50N. We are trying to look today beyond the future struc- ture essentially and the question was directed toward that. We are looking further than next year or the next 6 months. Mr. TAVOULAREAS. I think you don't really have to work on changing the structure; it is being changed automatically. These governments are insisting upon having more and more oil available in their own right. Now, we don't have to speculate as to whether this is going to mean higher or lower prices; we are going to find out. Unfortunately, a couple of examples we have didn't work out very well. We saw, in the case of Iran, the oil was available to everybody and some people bid as high as $22. In the case of Kuwait, they didn't get the price they wanted and $)ulled it off the market. So those two examples that we had didn't work the way that you are hoping. There is no doubt in my mind, however, we are going to get closer as we get down the road to what you are suggesting. TIlE ARABS RESTRUCTURE Mr. BLUM. Mr. Tavoulareas, you said that the Arab governments are restructuring. The restructuring we have had under discussion ~s going on the meetings of the Aramco chiefs and you are restructuring not company-government arrangement - by intercompany arrangements. I am wondering if this shouldn't be something the U.S. Government should participate in ~ Mr. TAVOULAREAS. Will you explain it a little more? Mr. BLUM. The question is the scope of the joint venture. rrhe ques- tion is whether you have access as an independent coinpa~ly or you will go independently and buy back oil that is not an issue between you and the Saudis, that is an issue among the partners. My question is, shouldn't the U.S. Government be particinating in this kind of basic restructuring of a partnership that controls roughly 20 percent of the free world supply ~ Mr. TAVOULAREAS. Well, we have to define scope and different type scope changes. Within the scone of the joint venture, we use all of the negotiating tactics possible in order to get our negotiating position put on the table. We had a discussion on this toint back in my office about the disaster or the fact the companies didn't stick together in Libya and now I am hearing a proposition it would b~ much better for the world if you companies didn't stick together. I get puzzled by the 180-degree switch. PAGENO="0108" 104 Mr. BLUM. I am not asking the rightness or wrongness of the action.. I am asking the question about Government participation in the fun- damental restructuring or redefinition that is going on, and I am say- ing not that it is right, wrong, or otherwise in how you are doing it,, but that should the U.S. Government be involved and active and, know in detail what is at stake in these meetings yt~u are holding to decide what is and what isn't included in Arameo. Mr. TAVOULAREAS. Let me tell you this: There is no time ii~ history that I know of where the U.S. Government was interested in some- thing and we didn't tell' them. As~ a matter of fact, I think we have' always been forthcoming. If some people say we are not, we ought to correct that. There is no doubt about that at all. We have dealt wt1~ the State Department, more recently FEO [Federal Energy Office],. and we heard something else. We checked with the State Department and told them what was going on. We called FEO and Simon's office. It would affect each of these people. If there is someone else in the Government you want us to talk to, I would be happy to know who that is. We have been doing what you are talking about. Mr. BLUM. Is the FEO or Mr. Sawhiil's office aware of these re- structuring negotiations? `Yesterday we asked the Justice Department about it and they weren't aware. Have you informed them? We are talking about Aramco, we are talking about August, we are~ talking about September, we are talking about participation. Mr. `TAVOULAREAS. Well, if you are talking about the restructuring going On and the participation, the U.S. Government has been fully aware. If you are talking about buy-back oil, you are talking about two subjects. Mr. BLUM. The buy-back aspect. Mr. TAVOULAREAS. Mr. Sawhill is fully aware. Mr. BLUM. He is? Mr. TAVOULAREAS. He is aware as much as I am. That is all I can. tell you. I know I have had conversations with him very recently. Mr. LEVINSON. To put the question in its bluntest terms, four vice presidents of Aramco, which are the shareholder partners, were meet- ing yesterday, or Tuesday, I guess it was, with Yainani in Geneva. or Vienna. Mr. TAVOULAREAS. Geneva. THE ROLE OF THE U.S. GOVERNMENT IN NEGOTIATIONS Mr. LEVINSON. Th~ question is what kind of consultation takes place and with whom with U.S. Government officials as to what posi- tion the companies are taking and what Yainani and the Saudis are after? Was this related to the fact that the Saudi de1e~ati*on is here' now for the purpose of negotiating some kind of umbrella agreement? Does one part of the U.S. Government know what the other part of the U.S. Government is doing and how you fit into it? Mr. TAVOULAREAS, I can't answer whether one part of the Govern-~ ment knows about the other part of `Government. I have a hard time trying to run a company to say nothing of trying to run the Govern- ment. In terms of their awareness, let me tell you all I know. Mr. LEVINSON. Did they check in before they met? PAGENO="0109" 105 Mr. TAVOtTLAREAS. I know of one company at least that had a dis- cussion with the State Department before this meeting. Let me tell you what I know about it and I d~n't know everythmg~ I haven't got a report. The boys came back and I have been in Washington getting ready for this meeting. All we were told is Dr. Yamani would like to meet you people in Geneva and we had all kinds of conjecture as to what he wanted to talk aboi~it, I will get a report when I get back a~ to what was discussed. I can't behe~e that anything fundamental happened or otherwise I think I would have been told. We have members of the Aramco board, the Gpvernment is a paftner, the Government is a partner 25 percent. These tour vice presidents you are talking about are board members. Are you suggesting that when the Saudi partners want to have a meeting and I say I can't have a meeting, I have to consult? Mr. LEVINSON. You know very well that there is a whole course of dealing over the past 2 years on this very issue. The question of whether four companies will continue to have a preferentia' access to Saudi oil and on whatterms is the kind of long-term arrangement that Saw- hill was talking about yesterday and Senator Church was concerned about in terms of talk about the future structure of oil. That is nOt an abstraction; it is what are you going to negotiate with the Saudis over, that is, the structure of the buy-back arrangements. A good part of the Saudi oil gets into the world markets. Our only point, and it was Sawhill's as well yesterday, is what are the points at which the U.S. Government ought to have a role, what the role ought to b~ what is the consultative process, is there to be an approval process and, if so, at what stage? We have just focused on that. It is a concrete example of bringing this question of consultation and approval down to some concrete points rather than vague generalities. Mr. TAVOULAEEAS. On consultation we have complete agreement in principle. If it is not worked out mechanically right we will work on how we can improve that kind of consultation. I agree it is needed. Let's talk about approval. I have a grave pi~obiem. I have a tre- mendous problem. If I thought for a moment that approval is a thing that would help our bargaining position, maybe I would endorse it. From what I heard it will only hurt our bargaining position. Mr. LEvn~soN: I am not talking about your bargaining position: I am talking about the long-term interests of the United States. Mr. T~VOULAT~EAS. Tha1~ is what I am talking about. Mr. tEVINsoN. That mtiy not be the same in every case consistent with yours. Mr. TAVOULAREAS. You are wrong. If we don't serve the interests of our customers we will not last. We understand that. We have always understood it. We have been in existence for over a hundred years because we believe we have served the interests of the people we serve. Any time we get to a situation where we doji't serve the interest of people we serve we won't be in business no matter what the document says. Mr. LEvINSON. As a general proposition that may be right. Mr. TAVOULAREAS. I am talking about any specific instance and we ~cvill talk about it. PAGENO="0110" 106 Mr. LEVINSON. I have given you one instance. All we are trying to do is locate the points at which the contact between the companies take place. What are the nature of the contacts. Is it just to inform? Does the U.S. Government feel it has a substantive contribution to make and assessment, independent assessment aside from yrn~r own desirability of terms of the free market negotiations, and if it does, who makes that decision within the U.S. Government and how do you determine it? Mr. TAVOULAREAS. We have talked since some of j~hese others; we went back to the people we contacted and said is there anything at all wrong in what w.e are doing in terms of consultation? We had absolutely no complaints. Now, in terms of how U.S. Government coordinates, really, I can't do that. I will tell you one example where I get concerned, I gave it to you in my office. If the Federal Energy Office says we want to be the ones who say this is the price at which you can import to the United States, I think they have that right, I don't question it. They may or may not be right, bift that is their decision. Someone ought to tell us the Internal Revenue will accept the same price. I don't see how we can be ~in a position at all of being told by FEO $9.50 is right and 4 years from now heur that the Internal Revenue couldn't care less what the FEO says; that is not right. THE PRICE TRANSPARENCY ~r. LEv~NsoN~ The problem is even more general than that. In the rçce,~it Erus~els meeting of the energy action group yo~i had the observa- qi~ by the German Government they are concerned about wha~t they c~1~ed price transparency. They couldn't understand how the com- panies could tell the U.S. Congress their high profitability was due to the European operation and at the same time show margins or profits in the European operation. They said to the U.S. representa- tives there we have to have international consultation; it is not only a problem within the U.S. Government but it is a problem among the consuming nations. And there is no question it is a problem. What we `ire after is where do the companies fit into this process? Mr. TAVOULAREAS. Let me comment on transfer prices. I went down myself to see Sawhill 3 months ago and put on a piece of paper and gavejiim a chart which showed all of the combinations of government take and every equity ownership and what various transfer prices will yield to us in profit. So we have disclosed all that to the Government. And I gave exactly the same thing to the German Government. I was there about 2 months ago. TERMS OF REFERENCE FOR NEGOTIATIONS Mr. BLUM. One `final question along this line. How would you feel about a proposal that would force you to check terms of reference that are given to a negotiating team before the nego- tiating team in fact receives them rather than a final signoff and. approval of terms of preference? You do this all the time, The chiefs met and said this is what the negotiating posture should be. PAGENO="0111" 107 Mr. TAVOrLAREAS. I have no objection to showing terms of reference except we found `out to our own chagrin that almost every tune we extended the terms of reference they appeared in th~ newspapers around the world before the Arabs saw them or OPEC saw them~ Let me tell you this has happened to us time and time again. In one case they had a whole copy of it. Now, I guess if you fellows can convince us and say to us we can assure you there will be absolutely no leaks to the press in the world before we negotiate, but I don't think, I haven't had that ±aith and I don't think you can give us that. Mr. BLUM, You are saying the problem of sharing terms of iefer~ ence with government is government immediately leaks it Mr. TAVOtLAREAS. I didn't say that. Mr. BLU~r, Or there is a danger? Mr. TAVOULAREAS, `There is the danger. Now, we told governments-U.S. and foreign governments-that the area in terms of terrain and where we were going and at one time,, as a matter of fact, the companies wondered if we shouldn't dig deeper and we were told by `certain consuming countries at that level we think keepiiig the supply flowing is much more important than a few more cents a barrel. INVALIDITY OF TEJIRAN AGREEMENT Mr. LEvINs0N. Your statement is a very comprehensive statement and you address the whole panorama of things, dealing with past and present and future. If I could just run through this very quickly with you, we won't trouble you any more. You state at page 4 of your statement that under the Tehran agree- ment, posted price of Arabian light on October 1, 1973 was $3.01. On page 5 of your statement you state without the October 1973 ArabJsraeli war the supply picture would not have been critical, and posted prices would not have reached $11.65. Isn't it true Sheik Yamani put you on notice as early as August 1973 that the Tehran agreement was finished and threatened that OPEC would double the posted price in `October to $6.02? Isn't that a fact? Mr. TAVOULAREAS. That is a fact. Mr. LEVINSON. And lie also, in August and September, threatened to cut back production for a variety of reasons, did he not? Mr. TAVOULAREAS. Yes; can I comment there? Mr. LEv[NsoN. Of course. Mr. `TAVOULAREAS. If you would list the threats that we gOt from various governments at various times and assume they are all accom- plishments. the prices, we wouldn't have been in there 10 years and the pnce wouldn't he $11, Mr. LEVINSON. I understand. All I am ~ddressing is the fact in your statement you seek to create the impression up through the October w~ir volT essentially had a stable situation and the import of the two quesdons J asked you is essentially to illustrate the fact that it wa~ indeed hh~hlv unstable at that point `and the Tehran agreement was shaky and falling apart. Mr. TAv0ULAREAS, Let me give you an example. PAGENO="0112" 108 When the Tehran agreemeflt came along the governments were asking approximately three times mOre than we finally settled on. If you want to quote at that time isn't it a fact they told you it is going to go three times and we sat down and negotiated and we finally didn't agree on thr~e times. They certainly told us before the October war we are going to, get way more. The fact remains the October war intervened and they moved unilaterally. Mr. LEvIN50N. They told you they were going to move unilaterally without the October war? Mr. TAVOTJLAREAS. No, they told us they were going to move unilater- ally in 1971. Mr. LEVINSON. Before the Octobet' war, Yamani told you the Teh- ran agreement was finished, we are going to double the price. You know it. I know it. Mr. TAVOULAREAS. He told us many things that didn't happen. Mr. LEVINSON. On page 5 df your statement you refer to much has been made in these hearings as to the handling of this case, and you attribute your difficulties to an effected or disappointed, staff lawyers in the Department of Justice. Yesterday we heard testimony from Mr. Kauper, present Assistant Attorney General of the Antitrust Division andhe said: For example, it appears that the large joint venture in Iran known as the Iranian Consortium was created with the encouragement and involvement of the U.S. Government In order to insure the stability of a relatively pro-Western governthefl't in that country. Because of that l~volvement, the National Security Council acting with the concurrence of the President in 1954 adopted a resolution, which was made known to the Justice Department, that the Antitrust Division should make no effort to challenge or dismantle major oil company joint ventures in the Middle East. `Thus the Department never squarely confronted the legality or illegality of the joint venture arrangement in the Middle East. Mr. Kauper in his statement in his testimony stated that this was for overriding reasons of national security. `That is just to clarify the fact, to amplify a point of your own statement and clarify the interpretation of what happened. Mr. TAVOULAREAS. Well, I haven't read Kauper's statement. I under- stand lie made it clear joint ventures are legal. Mr. LEVINSON. All I am saying is that he said `that they were con- strained by the National Security Council from confronting that issue with respect to joint ventures in the Middle East. Mr. TAVOULAREAS. Constrained at that time. I don't know. I thought he said yesterday joint ventures are legal. I am talking about what he said yesterday. Let's not worry about what he said, the Govern- ment said in 1948. THE MOBIL BONUS AND PROFIT Mr. LEVINSON. Mr. Tavoulareas, your company recently paid a bonus of 1 month's salary to all of its employees. A recent article in the New York Times noted the major oil companies have won nearly every objective they have sought in recent years. Either Government or the marketplace has made possible one controversial development after another: approval of the Alaskan oil, oil pipe rollback of environment timetable, et cetera. PAGENO="0113" 109 in what way h~s Mobil Oil Co. suffered as a consequence of the energy crisis? Mr. TAVOTJLAREAS. Well, let me say I don't know what objectives we have won that we have gotten. I wanted an Alaskan pipeline by the year 1973. Not 1 mile or it h~s yet been built. I didn't want the environmental standards on such a very strict timetable as has been ~adopt.ed. We have got them. We don't want shortages-we have short- ages. I don't want a stock price of ~40 a share~ I have a stock price of $40 a share. I don't want to be threatened with punitive legislation but we are being threatened with punitive legislation. I don't know what ~objective we have achieved. Mr. LEvIN50N. You had a 66-percent increase in first quarter profits of 1974 over 1973. Mr. TAVOtLAREAS. Let~s talk about that a moment. You have to understand bookkeeping profits. We have put out a long release. I think it would be well if I explain it. We show an earnings increase in the first quarter of this year over last year. More than 100 percent of the earning increase has to do with liquidation of low-cost inven- tories. Let~s understand what that means. It means our inventories on the books at, say, $4 a barrel and we were able to sell those inven- tories for $9 or $10 a barrel. We had to replace those inventories with $10 a barrel crude. We lost mouey. Mr. LEvIN50N. You are not going to sell that inventory at a lower price-the replacement for inventory. In other words, you ~re not taking a loss on your replacement, are you? Mr. TAVOLTLAREA5. I have to hold inventories to do business which rre more than two times greater than the last time. I have to borrow the money and have to pay the interest on it. Do I Ii I~e high cost inventory too- Senator CASE. May I ask you as a matter of interest what do your footnotes to your income statement show in this regard? Do they call attention to the fact that the profit is an unusual profit? Mr. TAVOULAREAS. Yes. Senator CASE. And because of the reason that you give? Mr. TAVOULAREAS. Yes, sn. Senator CASE. As against the first quarter of 1973? Mr. TAVOULAREAS. We put out a long public release which described ~this in great detail. Senator CASE. You have done a number of those? Mr. TAvOULAREAS. Yes, we have. Senator CASE. Discussing the Congress and- Mr. TAVOULAREAS. Yes, we have. Senator CASE. It is a very fine thing. We can all benefit by the kind ~of thing that you are going through now- Mr. TAVOULAREAS. We appreciat~ that. Senator CASE [continuing]. And you are putting us through. (lo ahead. Have you got the balance sheet there, your 3 month's statement ~there? Mr. TAVOTJLAREAS. No. Do any of our people have it there? Senator CASE. Will you put it in the record, whatever you sent out? 45-426-75-8 PAGENO="0114" 110 Mr. TAVOULAREAS. We will put in the record both our earnings; release explanation for last year as well as the first quarter of this year. Be very happy to do that, Senator. [The information referred to is in the Subcommittee files.] Senator CASE. Since we got on this matter of discussions in the news- papers, you have been very active in dealing with the public in matters~ of charging us, that is to say, the Government, with not anticipating the shortage-energy shortage-and have held the industry up as a shining example of foreknowledge. I wish you would go into that a little bit because I remember a statement by Gulf not more than a year or so ago which said there is~ no possibility of any shortage. Mr. TAVOULAREAS. I don't know what Gulf said. Senator CASE. And I just don't remember in the past that you have been recalling to us iii public indicating that you have been riding right and we have been inefficient. I don't doubt we have been inefficient. PETROLEUM PRICES-UNITED STATES VERSUS ELSEWHERE Mr. TAvOULAItEAS. I think we all have to share the blame, Senator CASE. I would like to speculate with you a little bit. I have always been interested in the way in which prices for petroleum in this country have been so much lower than the rest of the world- petroleum products including gasoline. I wondered how it happened and whether it has contributed to our complacency about the limited supply of petroleum products and has made us neglect other sources of ene~gy and developed to the point where that is the real problem we face: reliance on a single energy source, and to what extent has; the complicated structure of the oil industry contributed to that, not in a matter of anybody being the devil in this thing, but people are going to do what they can do in business, and they have done it. NaEurally, business urges its own point of view, whicli has included, in effect, monopoly of production and control in the few hands of wise men able to know what is best. 1 wondered if they have known what was best. This can be twisted around and I hope you will take full advantage of the possibility to sound as if I was complaining that the oil industry had produced gasoline at low prices in the United States for a dozen yeais or more. Tsn?t that a fact except it was artificially done at the expense of not only the world outside of the lJnited States but also at the e~pense of the succeeding generations of Americans for the benefit of people currently. I do suggest it hasn't been the wisest policy in the world and I wish. you would sort of comment about this because it is perfectly ohviou~,, it seems to me, even the enormous supplies in the Middle East are exhaustible, in fact~ and at the rate of acceleration of energy con- sumnption are going to be exhausted within your. lifetime and miiie~ and that our chief concern overriding everything else ought to he to develop other possible sources. Mr. TAVOULAREAS. Well, you are asking me to comment on a number of things and I will try to comment on them as we go along. PAGENO="0115" 111 On the first, I do not mean to complain, I will explain, on the use of the *ord monopoly that has been used many times, but we have figures, for example, which shows concentration of the four largest companies in various industries in the United States, for example, in the petroleum refining, the first four largest companies have 33 percent of the market. In producing, some of these figures are much less because we have many more people in producing operations in the United States than we have in the refining. Senator CASE, When I said that, that was a loose expression, I did not mean to make it an accusatory one, but God knows you have been working like everything in order to maintain a position where you did not control the whole world, but you had a kind of leverage through what you did control. It was an important element for which you have taken rightful credit in the stabilization of the industry. Mr. TAVOULAREAS, Well, we always looked and tried to find the oil we needed for our markets, and that is all our objective has ever been. In terms of the warnings we have given about shortages, I think I would like to send you-for the record-some speeches we have made in this regard. IThe information referred to is' in the Subcommittee files.] Senator CAsE. I wish you could dig them up. I had a magazine pass' my desk the other day which quoted Mobil Oil oi~ the question of your campaign and the rest of the public to show how good you had been and how terrible we were in the matter of predictions to what was coming. This was a rather cute little thipg which, in effect, somebody from your company said this is a lot of nonsense, we have plenty of supplies. Mr. TAvOULAREAS. I am going to get to that. Let me say one of the things I regret about the frustrations we are all finding during this period, we are all becoming adversaries one against each other, and it could be much better if we could work together and try to solve the problem. There is no question about that and sometimes when we-- Senator CASE. President Johnson used to talk about that. Mr. TAVOULAREAS leontinuingi. Sometimes we talk about Govern- ment. It is not fair. We do not like to be talked about as the industry, we like to be talked about as Mobil. We do not think we are the industry, we think there are some things that make u~ di'fferei~t. I am sure you feel the same way about your part of Government. I can think of a few warningS. I remember as long ago as the import hearings when people were `talking about keeping the, con~trols on and limiting oil to the United States. Mobil made a suggestion we do the onpos~te; since our oil reserves were getting more exhausted than the oil, reserves around the world, we ought to depend more in time of peace on foreign oil so we have potential in reserves in time of war. We proposed a `formula which was adopted by the railroad-Texas Railroad Commission. I can certainly send you the formula. In terms of shortage of re~oiii'ces, Senator, there have been two recent reports that say very clearly we have no shortage of resource base. The only shortages we have are the shortages that we put on by our own con~ straints. So I think in terms of resource base, whether it is oil or coal or shale or nuclear, I do not think we should get in. We are in the oil business. But I think more important is the people of the United PAGENO="0116" 112 States have no shortage of resource base. The question is developing that resource base. In terms of exhaustible supplies of oil, there is no doubt but that there must be a finite end of oil supplies. I think-and our geologist tells me-we are very far from that end point. The question is we need to be allowed to drill irt places in the United States wheFe we have not drilled before and we need to drill around the world in many places we have not drilled. Let us hope we find other resources as large as the Middle East. Neve~the1ess, if there is an exhaustible supply of oil, then our coun- try ought to start developing, quickly, coal and nuclear and other sources. I was not talking in terms of only dependence on oil. Senator CASE. Especially is it not true we should not be fully dependent on oil controlled by other sovereign states. Mr. TAVOTJLAREAS. Well, let me make ~ comment about that. I said it before in my speech. I think we are lucky at this time in the history we have a country like Saudi Arabia that is willing to expand its production and tell you I will expand my production for a few years hence, but the thing that Saudi Arabia is going to continue to expand its production, exhaust its reserves, take back money which it has no need for, is a very foolish way to depend on our policy. Senator CASE. I do not see how any sane person could disagree with that proposition. Mr. TAVOULAREAS. So I think it is important to understand objec- tives of Saudi Arabia. Here is what they tell me. Why should we con- tinue to raise production if you fellows do nothing about solving your problem yourselves? We have almost no answer to that one. Now in terms of price. You said why have you always noticed the prices were lower in the United States than abroad, and for that purpose I am going to take the gasoline price which is the price we all know much more about. We had a situation for years when we were talking about 35 to 40 cents for gasoline, and I am talking about 20 years, while in most foreign countries we were talking about the price of 50 cer~ts a gallon and above. The main difference between those two prices was home governixient taxes. There was cheaper foreign oil available, let us say, in the $2-a-barrel range as compared to $3 a barrel for the domestic crude. That would have made 2 `cents a gallon difference, but beyond the major difference was local home government taxes on gaso- line. This is one of the things that Middle East governments say. You talk about my price of $7 a barrel or my price of $10 a barrel. Your Government charges you now almost as high as a dollar a gallon tax on gasoline. Senator CASE. Say this is to what countries? Mr. TAVOTJLAREAS. Well, many countries. As an example in a coun- try like Greece, the price of gasoline is $2.25 a gallon. A great part of that is tax. Senator CASE. How would that translate into price per barrel? Mr. TAVOULAREAS. Well, if it were a dolh~r a gallon it is $42. Half a dollar would be $21 per barrel-almost all countries have half a dollar. So they say do not talk about me raising the price to the con- sumer. I do not agree with them. I think one is a tax within the coun- try and the other is a tax which affects international commerce. There is quite a difference between them. But this is the claim they make. PAGENO="0117" 118 That is the main reason for the difference all through the years. In Europe for many years with the small roads and thinking of cars as a luxury, they always had a high price for gasoline which automatically produced small cars. We had cheap energy here, we produ~ed bigger roads and bigger ears. Now, as we see energy costs going up, we are going to go back to smaller cars. I think the trend is already well on its way. There is no doubt you can claim that to some extent the people have gotten spoiled by the low cost of energy, particularly in gas, for example. In the case of gas, a premium fuel, the U.S. Government has controlled the price of gas over many years. The basic problem with the gas Oontrol is they say we give you cost plus, is that not fair ~ Well, if we could replace those reserves at the same price it would be fair. But if we cannot replace those gas reserves at the same price it is not fair. That is basically the fallacy with it. Nevertheless, it created abnormal demand on a premium fuel and we now have a very, very serious shortage of gas in the United States. Senator CASE. This policy of low-cost petroleum products, especially gasoline, it has been a policy, of course, approved by the industry, but also implemented by government, and in your judgment, the govern- ment share was controlling. Is it a fact that the higher price in Europe, for instance, the fringe areas like `Greece, Germany, Britain, and France, has been entirely due to the difference in governmental taxes ~ Mr. TAVOULAREAS. No. In other words, certainly up till last October, I would say the major reason has been taxes on gasoline. Since last October, however, they have suffered a four-fold increase in the price of their crude oil. Sentor CASE. Of course, in these countries is it not true that there has not been free market of gasoline, it has been gasoline has been controlled in effect, by oil companies controlled by their governments ~ Mr. TAVOULAREAS. Well, almost every country differs. There are cer- tain countries, for example, which have price controls on gasoline and have had them for many years. Certain countries have a policy of a price control. For example, France still yields a good profit. Another country may have much more strihgent price controls, and Germany has no price controls. In Italy for some time we actually were selling at a loss because of government controls, All that did was encourage companies like BP and Shell to remove themselves from Italy. The Italian Government is quite worried and has come to each one of the American companies and said, "I hope you will not remove yourself." The net result was tremendous losses and the two companies obviously decided they could not take losses. This changes from country to country. SAUDI PRODUCTION AND POTENTIAL Senator CASE. Then, we will have some questions for the record if you do not mind. Mr. TAVOULAREAS. Yes, sir. Mr. LEvIN50N, At page 16 of your statement- Mr. TAVOULAREA5. 16? PAGENO="0118" 114 Mr. LEVINS0N. Yes. You refer to the subcommittee inquiry into the actual potential Sauth production. Given the fact that the U.S. Got- ernment is now in the process of negotiating with the Saudis on this overall arrangement to which I previously alluded, do you contend that it is unreasonable of the Government to seek and learn as much as possible about the situation with respect to the actual potential production in Saudi Arabia? Mr. TAvOTJLAREAS. Let me say this. I did not read this section but perhaps I should refer to what we are talking about so everyone under- stands it. What we were saying is this: We have heard the Senate has been inquiring into the ability of Saudi Arabia to continue its present production and, of course, to increase production up to 20 million barrels in the future. I imagine some people in government would say the reason we believe that is legitimate is because some people are say- ing Saudi Arabia is a country we can depend upon, especially if we better know what its reserve potential is. Mr. LEvINsoN. Does that seem to be a- Mr. TAvOULAREAS. Let me finish for a moment. rfhat does not seem unreasonable, Here we have a situation where Saudi Arabia has announced 165 billion barrels of reserves. Aramco has reserves in the ground and almost every geologist will say that is a conservative figure as to what its potential is, 165 billion. It has produced 8.5 million barrels a day and ~omeone says I have concern as to whether those reserves can produce this number and higher num- bers. All I say here is if you are really concerned we ought to put some of our concern to the United States *here we only have maybe 30 to 35 billion barrels of oil and produce 10 million barrels a day. it is hard for me to understand the great concern. Now, beyond that, almost everything I have heard is that I am not sure the American companies should continue to operate in Saudi Arabia or they are not useful any more. How long do we think we are going to have access to information if those companies are not operat- lug there? How long do you think the Saudi Arabian Government is going to permit our Government to `say I want all details about every- thing you have in your country? How would we feel if some of these governments caine over and said I want to know this and this and this about you? Mr. LEvINsoN. The only question which was elicited by your com- mentary, is the information upon which the U.S. Government makes policy, where it gets its information and reliability of it and the rea- sonableness of its getting such information. I just wanted to elicit the concurrence that you would have that it is not unreasonable for govermnent to be concerned. Mr. TAVOULAREAS. I do not think it is unreasonable, I think you had better be careful in how you get the information. I think it is legitimate. Mr. LEvINsoN. In your statement you elaborated on the background of the foreign tax credit, which has been a subject of considerable discussion. As Senator Church said, he i5 introducing some legis- lation on that. So this is relevant and important in terms of getting the proper background. All that happened in 1950 was Saudi Arabia did what almost every developed Western country had already done, namely, to adopt an income tax. That is not quite the way we understand it from Mr. PAGENO="0119" 115 MeCloy, who wrote a letter on January 11, 1967 to the Secretary of State, Dean Rusk, which dealt with Internal Revenue Service audit of the international petroleum companies and giving the Department his opinion this audit was inadvisable. IEEe gave a fairly concise descrip- tion of the background, somewhat at variance from your own, and, therefore, I would like to simply read it and have you comment to ~determine whether it is accurate or not. TAXES AND ROYALTIES Quoting from McCloy's letter, he said: I believe that the Department of State has a particular respousibility to make ~known to the Treasury Department the implications of its proposed attack on ~crude oil prices, because the present system of providing substantial revenues to the oil producing countries of the Middle East by means of a combination of royalties and of local income taxes on the producing companies (creditable under U.S. tax law) was recommended to the oil companies and to the foreign govern- ments involved by the Department of State and the Tteasury Department. These departments recognized that it was in the national interest of the United States to keep such nations stable and friendly to the United States and thereby ensure American access to the vast reserves there located. If the oil companies did not provide the necessary revenues by paying substantial taxes to producing countries, large amounts of direct foreign aid might well be required. In other words, the Saudi Arabian Government just did not enact an income tax like other industrialized countries, the origin of this lies in a State Department and rr~reasury decision to encourage the enactment of such legislation. Mr. TAVOULAREAS. Let me say I do not think there is anything incon- sistent in what you read and what we ~aid. All we said was the Saudi A~rabian Government enacted an income tax like all other countries did. All you are saying is the Treasury Department told them they should enact an income tax. Was it wrong for them to enact an income tax? Mr. LEVINSON. Let me add in terms of where the original derived from, Was it initiated by the Department of State? You are right, it may not be inconsistent, but it is an elaboration of where it derived from. I would like to make the letter part of the record. Senator CASE [presiding]. No objection, it may be done. IThe letter referred to follows:] MILBANK, ITADLEY & McCLoy, Jan'uary 11, 1967. To: Da~x Rusir. I would like to draw to your attention certain aspects of the audit now in process of the income tax returns of American international oil companies for the years 1959 through 1965 which I believe seriously threaten not only the interest of the United States in foreign oil production and reserves but also the ~delicate diplomatic relationships of this country with the oil producting coun- tries which the Department of State has built over the last several decades. I do so, because it appears to me that inadequate consideration has been given to various by-products of the contemplated attack on the international crude oil price structure which in my opinion could be fal~ more serious in their effects than purely revenue aspects of the malter. Briefly, the IRS has indicated to the international oil industry that it is con- sidering disregarding for United States tax purposes the price~ at which crude oil is sold from the oil producing countries on the ground that such prices are, ~n its opinion, too high. I hardly need remind you that the governments of the PAGENO="0120" 116 oil producing natiens in Latin America, North Africa and the Middle East would' react most strongly to even a suggestion by a branch of the U.S. Government that the prices which they receive for crude are too high. Of course, you will recall the intense resentment caused, particularly in Venezuela, when the 1IT.S.~ imposed its import quota program In 1959 because this foreclosure of the U.S. market contributed to a weakening of foreign oil prices. I believe that the Department of State has a particular responsibiIit~ to make known to the Treasury Department the implications of its proposed attack on crude oil prices, because the present system of providing substantial revenues' to the oil prdducing countries of the Middle East by means of a combination of' royalties and of local income taxes on the producing companies (creditable under U.S. tax law) was recommended to the oil companies and to the foreign govern~ ments involved by the Department of State and the Treasury Department. These departments recognized that it was in the national interest of the United States to keep such nations stable and friendly to the United States and thereby ensure American access to the vast oil reserves there located. If the oil companies did not provide the necessary revenues by paying substantial taxes to producing countries, large amounts of direct foreign aid might well be required. For example, in 1950, after Aramco had resisted for nearly four years intense pressures by the Saudi Arabian Government to relinquish its contractual rights to tax exemption in Saudi Arabia, the Department of State took the positio~, when consulted by Aramco, that a 50-5Q income tax arrangement, based on the pattern previously established in Venezuela, appeared to be to the advantage of all concerned. Aramco thereupon did submit to Saudi Arabian income taxes' which approximated 50% of its net operating income. Similar income taxes were imposed on oil conipanies by Iraq and Kuwait shortly thereafter. Following the nationalization of the Iranian oil industry in 1951, Mobil Oil Corporation, Standard Oil of California and three other American oil companies' were advised by the then Secretary of State of a determination by the National Security Council that it was in the security interests of the United States that they participate in a consortium for the reopening of the Iranian oil industry on terms within the framework of a Proposed Iran Consortium Plan, which was submitted to the oil companies by the United States Government. The consortium arrangement which closely followed the Proposed Plan, was accepted by the companies and enacted by the Iranian legislature. It provided for a 50% income tax obligation similar to those in Saudi Arabia, Iraq and Kuwait. In the cases of Saudi Arabia and Iran, the Treasury Department issued rulings holding that such taxes were creditable against U.S. taxes. It continues to be in the national interest of the United States to maintain stable friendly governments in control of the vast oil reserves of the Middle East and if such goals are not achieved by means of the present system they will have to be paid for by foreign aid apprOpriations or other means. Because of the extreme importance of this whole matter to the national interest~ I am enclosing a memo prepared by Mobil and Socal, whom I represent, which considers in greater detail the important questions of policy which the audit necessarily raises. I also enclose a study by the Chase Manhattan Bank entitled "Balance of Payments of the Petroleum Industry." The companies are prepar~ lag briefs on the legal questions, which will be submitted to the Treasury Depart~ ment in the near future, and which will be furnished to you on request. I may say here, however, that I believe that the tax law provides ample scope for the Treasury Department to take the fundamental considerations of national interest and fairness to the companies into account in exercising its statutory discretion. As is pointed out in this memorandum, the balance of payments position of the could be substantially affected by a reduction in the prices at which oil is sold abroad by American companies. Coming at a time when the balance of payments situation is still a matter of deep concern, I suggest that any action to reduce what has been a major favorable factor would not he in our national interest. ~The memo is, of course, a highly confidential document. and I am rure it will be treated as such. I strongly commend it to your careful attention hecau~ I believe it essential that Treasury, in exercising its statutory discretion, be made fully aware of the interests of the Department of State in the matter. J'OHN J. MOCLOY. PAGENO="0121" 117 RISKS IN IRANIAN CONSORTIUM Mr. LEvINSON. In terms of elarifying the reco~d, you have noted in your statement that the companies invested in the Middle East because of their assessment of risks, at least with respect to the Iranian con- sortium. I would like to read one excerpt of a letter from 1-lerbert IHoover, Jr., to then Senator Lyndon Johnson, dated September 28, 1955, in which he states: So far as I know, there were no agreements in conneetioh with arrangements for the resumption of production of oil in Iran bearing on the importation of oil into the United States. It is my understanding that the original selection of participants in those arrangements was made on the basis that they were engaged in the production and marketing of Near East oil throughout the world, and could and would absorb the Iranian production without unsettling world markets. The only point of that being that at least with respect to the Iranian consortium criteria, according to Hoover, did not seem to be the willingness of the companies to invest, but the fact that they had other markets and could get the oil back without. That is the end. Mr. TAVOULAREAS. Could I comment on that? Mr. LEVINSON. Yes. Mr. TAvOTJLAREAS. You made an observation- Senator CASE. It might be well at that point to insert in the record the full text of the letter from Mr. Hoover to Senator Johnson, and also the letter from Johnson to the State Department, Mr. Dulles, to which that was a reply. [The letters referred to follow:] `SEPTEMBEn 28, 1955. Hon. LYNDON B. JoHNsoN, U.~S. senate. DuAR SENATOR JOHNsON: In your letter of `September 9 to the Secretary you raised certain questions cpncerning the operations of the Iranian Oil Consortium and the importation of Iranian oil into the United States. Mr, A. P. King, Jr., President, Texas Independent Producers & Royalty Owners Association, has written me a letter on the same subject. [So far as I know there were no agreements in connection with arrangements for the resumption ot production of oil in Iran bearing on the importation of oil into the United States. It is my understanding that the original selection of participants in those arrangements was made on the basis that they were engaged in the production and marketing of Near East oil throughout the world, and could and would absorb the Iranian production without unsettling world markets.] As you are aware the matter of imports of foreign oil into the United States has for some time been, and continues to be, the subject of attention by the Executive and the Congress. The matter is under active study at this time by Arthur S. Flemming, Director of Defense Mobilization, who recently directed the attached letter to the principal American companies engaged in the importa- tion of foreign oil into the United States. I am sure that in his consideration of the matter Dr. Flemming will take fully into account the effect of oil imports upon the position of domestic independents in supplying domestic oil requirements. Sincerely yours, HERBERT HoovER, Jr., Acting secretary. PAGENO="0122" 118 U.S. SENATE, OFFICE OF THE DEMOCRATIC LEADER Washington, D.C., 5epternber 9, 19~i5. Hon. J~Ox~N FOSTER DULLES, R~eoretary of I5tate, Washington, D.C. DEAR Mn. SEcRETARY: It is of vital importance to the domestic oil producing industry that the consortium to handle the return of Iranian oil to world ma~kets~ not result in further increases in already heavy imports of oil into the United States. Oil producers in Texas are raising the question as to whether there has been any v&olatiçn~ of agreements-written, spoken or implied-by the companies authorized to e~igage in the consortium. It has been their understanding, and mine, that care was to be taken to see that this oil did not serve to jeopardize the position of American independents in supplying domestic requirements. Are assurances to this effect still to be considered valid? It is reported that several independent members of the Iranian consortium have exchanged theIr shares of Abadan refined products for Persian Gulf crude, the explanation for the trade being that the crude can be imported into the United States at a tariff considerably below the tariff for refined products. I am sure you will understand that these developments are causing considerS able concern among the domestic oil producers of my Stale and other states. Your comments are urgently invited. Yours sincerely, LYNDON 13. JOHNSON. Mr. TAVOU~REAS. You did refer in my office to a `etter along these lines and I received the letter this morning for the first time. I guess the key words you must be referring to is without unsettling world markets. This is a letter written by Herbert Hoover to Senator John- son. In the process of picking the companies, we were not involved. This is the first time I ever saw this letter, aiid ever knew anyone ever made that statement. Now, you say this may be inconsistent with the fact that there were risks involved. There were very real risks involved in 1954, so much so that one major company would not go in on the deal. There is noth- ing inconsistent. Maybe it is only elaboration. Mr. LrwINsoN. I think the record is now complete. Senator CHURCH. I want to thank you very much for your testi- mony this morning and we apologize for the fact I had to be absent during part of it and may have to absent myself again. There is another comffiittee dealing with legislation that relates to my State and to my region of the Pacific Northwest with a very important mat- ter bejore it and I have had to divide my time. Mr. TAVOULAREAS. I want, to thank you very much for allowing me to appear. Senator Crnmtcxi. Mr. Collado, we will ask you to be sworn. Do you swear that all the testimony you are about to give will be the truth, the whole truth, and nothing but the truth, so help you, God? Mr. COLIJADO. I do. TESTIMONY OP EMILIO G. COLLADO, DIRECTOR AND EXECUTIVE VICE PRESIDENT, EXXON CORP. Senator CHURCH. Thank you. You have a prepared statement. How do you wish to proceed? Mr. COLLADO. What I thought I would do is give you some high- lights of the prepared statement and not go through the whole docu- PAGENO="0123" 119 ment. You have it. It is not very long but it is longer than I think you would like me to read in full. Senator CHURCH. Very well. Your prepared statement will be included in the record. Mr. COLLADO. My name is Emilio G. Collado. I am a director and executive vice president of the Exxon Corp., and I appreciate this opportunity to present to the committee my views on the subjects requested by the Chairman. In particular, I shall attempt to identify the roles of governments and companies that, in my view, will best accomplish the basic energy supply goal, namely, adequately and eco- nomically meeting future energy needs with the maximum security of supply. These subjects and these relationships~ as I think you know, Senator, have for a long time been of great interest to me, and I have approached them not only from the corporate point of view but at other times and places from both the governmental and in some cases international relations points of view. Senator CASE. We are aware of that. That is one reason why we have looked forward to your testimony. Mr. COLLADO. Thank you very much. FOuE0ASTING ENERGY NEEDS Any forecasting is perilous. But forecasting in an environment as uncertain as today's international oil market is hazardous in the extreme. It is helpful, in thinking about the future, to recall some of the developments of the past which have brought us to where we are today. I believe lhat it is important, first, to understand that the energy problem which confronts us is not just a short-term, emergency phenomenon. It is true that the political events of the past few years, and in particular the outbreak of the Israeli-Egyptian war in October of 1973, resulted in drastic shortages of oil and sharp increases in price. But judged from a longer range standpoint, our situation is a product of age-old forces of supply and demand. ENVIRONMENTAL CONTROLS VERSUS SUPPLY AND DEMAND For some time, there have been signs that all was not well in energy demand-supply relationships. Environmental goals, good in them- selves, have increased the need for energy and retarded its develop- ment; the production of coal has lagged; nuclear construction is seriously behind schedule; reserves of natural gas have been depleted by unwise regulation. Meanwhile, the demand for energy has increased. relentlessly, and oil has had to fill the gap created by th.e shortfall in other energy forms. Until recently, this presented no difficulty, as new discoveries of oil exceeded consumption. But, now, the disturbing fact is that new discoveries of oil are barely keeping up with con- sumption, and the prospect is that they will soon be overtaken. All these considerations emerged ~e1l before the oil embargo and the pro- duction cutbacks of recent months. What they suggest is that in think- ing about the future, we must address the basic, continuing problem- not just the manifestation of the moment. PAGENO="0124" 120 What recent events have done is. to dramatize the problem. Changes which were expected to occur gradually over a period of years sud- denly were forced upon us within the space o~ months. For two decades, the real price of Middle East oil had been drifting downward due to new supplies being developed and to vigorous competition in the international industry. But, today, because of steps taken by OPEC governments, Middle East crude oil prices are four times what they were as recently as October of last year. Crude prices elsewhere, except where controlled, have tended to move in step. The fact i~ that although the structure of the industry remains strongly competitive, as can be seen by developments in the product market, the pricing of crude oil is now largely determined by governments. The resulting price in~ creases, combined with the inconvenience of shortage and the use of oil as a political weapon, have brought nervousness and distress to the world's consumers. More recently, the situation has improved. But the long run lesson is clear. The United States and other countries must proceed with all reasonable haste to expand and diversify the energy base. THE ROLES OF dOVERNMENTS AND COMPANIES Both governments and private companies will have their roles to play. In my judgment~ the principal objective of the U.S. Government should be the restoration, to the fullest extent possible, of a workable environment within which the oil and other energy industries can use their skills, imagination, resources, and facilities to meet energy needs. Since the energy issue is fundamentally intern~tional in nature, working effectively with other countries should form a large part of policy. A specific example would be the attainment of intergovern- mental agreements against the contingency of future, major disrup- tions in oil supply. More generally, it should be government's goal to achieve a broad relaxation of international tensions. If the world's institutions are to function effectively, there must be a basic under- standing among nations on the international rules. This should be a natural quest for governments, consumers, and producers alike. I believe that the history of the post-World War IT period demonstrates the vital contributions which private international companies can make in an environment of enlightened international relations. As I see the interests of different groups of nations today, the oil producing countries want to establish themselves as an important factor in the modern world through wise and profitable use of their resources. The consuming countries seek assured supplies of raw mate- rials at reasonable prices. These interests are reconcilable. But. if they are to be reconciled~it is imperative that Government as well as industry have a hard-headed view of what is possible. We in the United States should proceed on the assumption that this country will need a steady and substantial flow of imported `oil well beyond 1980. In return, we and other consuming countries can offer assured access to Western technology, management technit~ues, and the capital goods which are essential to the development of producing country economies. Senator CASE. Would you not add agricultural products to that? PAGENO="0125" 121 Mr. `COLLADO. There is a food problem here but I did not choose in a short statement to get into it. A great deal of what I am talking about here' applies in considerable measure if not equally to other materials, minerals, foodstuffs and other agricultural products. It is not limited to oil. I just happened today, Senator, to limit myself to oil. Senator CASE. Thank you. Because the United States is not only a consuming country, it is also a producer of natural resources, that is, food. Mr. COLLADO. This pattern should assure satisfactory' rewards to both sides. THE ECONOMICS OF INThRNATIONAL OIL A second set of facts which the Government must clearly under- stand concerns the true economics of international oil markets. Failure to do so could lead to decisions which might soothe the emotions of the moment but which would impede progress toward long-run goals. There has, in particular, been a lot of misinformation, accepted as fact, about oil company profits on Middle East crude oil. It is widely stated that the companies are making about $4 per barrel. This figure is apparently arrived at by subtracting the royalties and taxes paid by companies on owned oil production, from the so-called posted price of Middle East crude. The economics of our own operations indicate that the actual profit number is a small fraction of this difference. We have not been selling at posted prices. We have sold to both affiliated and nonaffiliated customers at prices that, in our judgment, have been consistent with competitive market conditions. These prices have been significantly lower than posted prices. The result is that, overall, Exxon's Middle East and African crude profit has been con- siderably less than 50 cents per barrel, not $4 per barrel. It should be understood, also, that total company profit margins are mueh more responsive to competitive pressures than are payments to producing governments. The impact of easier supply conditions is already evi- dent in international markets. It is, therefore, a cause for concern that OPEC countries are currently spealçing of the need for further increases in their revenues, Based on our economics, any increase would almost certainly have to be reflected in higher costs of the consumer. One far-reaching aspect of the higher costs of oil which govern- ments must be concerned about is the balance-of-payments problem. This is a difficult prob~em, but iu principle, I believe it can be handled. What must be done is to find ~ way to accommodate the very large investmeiits which will arise as an offset to oil flows, while avoiding the i~isks of sudden, massive tr~insfers of funds. One way to moderate the balance-of-payments problem as well as the impact of high prices for euergy is to promote increased efficiency in the use of energy. The operation of the market will contribute sub- stanti~liy to this~ end. A governmentally spo~isored "conservation ethic" should be promoted. Appropriate tax policy and support for greater efficiency in energy-using devices would help. `So, too, would ~eisible policies cm mass trai~ispDrtation, PAGENO="0126" 122 OTHER ENERGY SUPPLIES Senator CHURCH. You do place very important emphasis upon the importance of conservation. Mr. COLLADO. Yes, sir. Finally, it should be a major concern of government to foster the development of new energy supplies from indigenous sources. This suggestion applies particularly to the United States, which is fortunate to possess large, untested areas that are prospective for discoveries of conventional oil and gas, as well as extensive reserves of coal and oil shale. The role of the U.S. Government should be to serve as a catalyst to the efforts of private companies to expand in these new directions. Accelerated leasing of Federal acreage, particularly in off-shore areas, resolution of environmental conflicts that impact on resource develop- ment, support of industry research into new energy processes--these are some of the things which government can usefully do. AVOIDING PRICE CONTROLS AND TAX INCREAS~ES Two related negative policies which should be avoided are long-term price controls and punitive tax increases. The more extreme tax pro~ posals, particularly the removal of the foreign tax credit, would drive U.S. companies from the international scene. One cannot help wonder- ing if the supporters of these proposals are fully aware of the impli- cations. Congress appears to be caught between an urge to punish the oil companies and a desire to get on with improving the energy out- look. These may not be completely compatible urges. PE1iTfORMANCE OF THE OIL COMPANIES Mr. Chaii~man, the international oil companies have performec~ and, with the. proper support, will continue to perform two primary functions. These are, first, the efficient operation of international logistics and marketing networks; and second, the expansion of energy supply. The changes which have recently occurred in the industry do not lessen the need for these functions. Indeed, they are more needed than ever. The networks of facilities which the private companies have created smce World War II are vital to the world's energy trade. If they did not exist, they would have to be created. But more than just the facil- ities is involved; it is the accumulated experience, technology, mana- gerial know-how, and planning competence which make the system work. The operations and decjsions are of such complexity and inter- natiorial scope that it does not make sense that they could be easily assumed by the nonexperienced. All this is to s~y that the transporta~ tion, supply allocation, refining, aiid marketing activities of the com- panies comprise a vital economic functiop. And no other ecoflomic entity is as well equipped to do the job as the private international oil companies. . With respect to the expansion of energy supplies, there is much which the companies can do, and which they will do with the neces- sary Government support. I would urge this committee, as well as others in Congress who are concerned about energy matters, to reflect on the magnitude of the task before us. PAGENO="0127" 123 FUTURE NEEDS AND PLANS Assuming a moderated rate of energy consumption in the United States of oniy 3 percent (that is, one-third below the historical rate of 4.6 percent), we would need half a million new oil and gas wells in this country over the next 15 years. We would need more than 60 new oil refineries and an equal number of plants for oil shale and for majdng synthetic oil and gas from coal. We would need more than 30 new nuclear plants each year by the middle 1980's, or a new plant every 2 weeks, We would need more than 140 new coal mines, including a large number of small, deep mines as well as high-capacity surface mines. And even after all this, we would still have to import large amounts of energy. Faced with such tasks, we need, all of us, to keep clearly in mind what our goal is, and what is likely to bring it about. Mr. Chairman, I should like to conclude by mentioning some of the things which Exxon and its affiliates plan to do in the next several years. In your letter you asked me to do that and this is a very brief version. We recently announced a $16 billion spending program for the 1974-77 period. Escalation is maldng that seem small. Some of the key projects included in that program are: 1. A share in the Alaskan pipeline and in development of the Prudhoe Bay field. 2. A share in an Athabasca tar sands processing plant in Alberta, 3. Four new coal mines for power generation, with others under consideration. 4. Construction of a large coal gasification pilot plant, de~ign of a coal liquefaction pilot plant and further research in the basic tech- nologies relevant to these processes. 5. Uranium exploration and mines, research in enrichment tech- nologiesand in the nuclear fuel recovery cycle. 6. A major refinery expans;ion in the United `States. Above all, the company is committed to a worldwide exploration and development program designed to increase supplies of conven- tional oil and gas in the United States, the North Sea, Canada, and in diversified locations throughout the less developed world. Half of the entire $16 billion program is devoted to exploration and develop- ment. However, as I have indicated, punitive taxation, price controls, limited leasing of acreage, and other restraints could cripple our efforts. I hope that this will not be the case. Thank'you, Mr.Chairman.. [Mr. Collado's prepared statement follows;] PREPARED STATEMENT or EMILI0 G. COLLADO, DIRECTOn AND EXECUTIVE VICE PRESIDENT, EXXON CORP. My name is EmiIio G. Collado. I am a Director and Executive Vice President of the Exxon Corporation. E~~on representatives, as you know, have p~r1~cipated t~ctiveIy in the study being carried on by your Cothmlttee.. We believe, as do you, that an understanding of the role of the multinational ~ how it is changing with the times, is vital to intelhgent legislatiye ~1ecis~o~s,, I, therefore, appreciate this opportunity to present to the Qomnnttq~ our views on the subjects requested b~ th~ Chairman! the future of the ~nterna~iona1 oil industry~ alt~rnatlve energy iii~vestm~rits and th~ 1hIp1I~atidns of these for U.S. foreign policy. In particular, I shall attempt to identify the respective roles of PAGENO="0128" 124 governments and companies that, in our view, will best accomplish the basie energy supply goal, namely adequately and economically meeting future energy needs with the maximum feasible security of supply. These are matters whieh have been of special interest to me for many years, anc~ I believe that my expe~ rienees in government, in international affairs and in the academic world, as well as in the oil bUsiness, give me some qualification to address them~ Gentlemen, any forecasting is peyllous. But forecasting in an environment as uncertain as today's international oil market is hazardous in the extreme. It is helpful, in thinking about the future; to recall some of the developments of the past years and months which have brought us to where we are today. I believe that it is important, first, to understand that the energy problem which con- fronts us is not just a short-term, emergency phenomenon. It is true that the political events of the past few years, and in particular the outbreak of the Israeli-Egyptian War in October of 1973, resulted in drastic shortages of oil snd sharp increases in price. But, judged frOm a longer range standpoint, our situation is a product of age old forces of supply and demand. For some time, there have been signs that all was not well it~ energy demand- supply relationships. Environmental goals, good in them~elves, have increased the need for energy and retarded Its development; the production of coal has lagged; nuclear construction is seriouSly behind schedule; reserves of natural gas have been depleted by unwise regulation. Meanwhile, the demand for energy has increased relentlessly, and oil has had to fill the gap created by the shortfall In other energy sources. Until recently, this presented no difficiilty, as new dis-~ coveries of oil exceeded consumption. But, now, the disturbing fact is that new discoverieS are barely keeping up with consumption, and the prospect is that they will soon be overtaken. Reserves of oil are still very large and there is more to be found, but increasingly it has become clear that oil alone cannot be counted on to meet the expanding energy needs of the world. All these consid- erations emerged well before the oil embargo and the production cutbacks of recent months. What they su.ggest is that in thinking about the future we must address the basic, continuing probleth-not alone the manifestation of the moment. What recei~t events have done is to dramatize the problem. Although in many parts of the world the oil industry continues to function pretty much as it haS in the past, actions taken by OPEC have transformed the industry in the member countries and substantially affected its economics everywhere. The shock pre- sented by these developments came because changes, which were expected to occur gradually over a period of years, suddenly were forced upon us within the space of months. The speed of change was of an order of magnitude greater than industry and customers had known bOfore, and Its dir~etion was different. For two decedes, the real price of Middle East oil had been drifting downward due to new supplies being brought on aiid to vigorous competition in the international industry. But today, because of Steps taken by OPEC governments, Middle Eastern crude oil 4~rices ~re four times what they were aS recently as October of last year. Crude prices elsewhere, except wh~re controlled, have tended to move in step. The fact is that ~a1though the structure `of the industry remains strongly competitive, as can be seen by developments in the produCt tnarket the pricing of crude oil is now large~y determined ~by governments. The resulting price increaseS, combined with the ineonvurilmice of ~shdrtage and the USk~ of' oil as a political weapon, have brought nervousness and distress to the world~s consumers. More recently, the situation has improved. Hostilitips ~n~the Middle East have abated; oil is flowing once again at prewar levets; t~re are indications `that supply and demand, tempor~tri1'y at least, are in rottghbalance at tnday~s~~roduct prices. But tQday's prices remain much higher than before and security of supply continues uncertain. Some producing countries have indicated that they will con- tinue to hold production doss~n becan~e they believe rapid depletion is not in their interests. The long-run lesson is clear. The U.S. and other countries must proceed with all reasonable haste to expand and diversify the energy base. In `the years ahead, the U.S. and other consuming governments, either through greater attention to energy policy or through direct involvement, will be major factors in shaping the fhture of the oil business and of ~nergy companies gen- erally. Their objective should be the restçratlon, to the fullest extent possible, of a workable environment within which the oil and other energy industries can use their' skills, imagInationS, resources and facilities to meet energy needs. PAGENO="0129" 125 There is a temptation in times of stress to think first of modifying laws, impos- ing regulations, seeking culprits. But `to develop and exploit sources of energy requires above all a, good workitig environment, political and economic, in which those with experience and know-how can operate. Since the energy issue is fundamentally international in natpre, however much we may be tempted these days to think in nationalistic terms, working effectively with other countries should be a major goal of U.S. policy. An example is the question of how countries should work together to allocate oil supplies in times of major emergency. Our own view is that this is a responsibility of govern- ments, and we `would hope that a standby inter-governmental agreement could be reached against the contingency of major disruptions In the future. Ranking even higher on the government's pi4ority list should be a general relaxation of international tensions. The current effort to resolve major political issues in the Middle East is fundamental in this connection, and its success `to date is most encouraging. [f the world is to progress, if its institutions are to function effectively, there must be a basic irnderetanding among nations on the international `rules. In particular, there must be a' wide acceptance of fair deal- ing in international trade. This should be a flatutal quest for governments, con- sumers and producers alike, and its importance `has never been greater. The history of the post-World War II period demonstrates the routrihutions which private international companies can make in an environment of enlightened international relations. These contributions were `of `major importance to the economic recovery and `progress of the F~ree World as well as to its security. As we interpret the views of the producing countries, their primary interest is in establishing themselves as an important factor in the modern world through the wise and profitable use of their resources, including the development and diversification of their economies. The interests of the consuming countries lie in assured supplies of raw materials at `reas'~nable prices. We believ,e that these interests are reconcilable. For both sets of countries, there is advantage in progress toward international monetary stability. For both, the long-run bene1lt~ from having a viable international system will outweigh the victories of tempo- rary bargaining strength. [f such results are to be achieved, `it is imperative that government as well as industry have a hard-headed view of what is possible. For our part, we in the United States should proceed on the assumption that this country almost cer- tainly wil' not be self-sufficient in energy by 1980. A steady and substantial flow of imported oil will be vital to the U.S., as well as other consuming countries, well beyond that `date. [n return for a continuing flow of oil at reasonable prices, the consuming countries can provide in exchange assured access to Western technology, management techniques and the capital goods which are essential to the development of producing country economies. This pattern, applied on a realistic basis, could assure rewards to both sides. A second set of facts which the government `must clearly understand concerns the true economics of international oil markets. There has been considerable talk of oil company profits in the order of $4.00/B on sales of Middle East crude. This figure is apparently arrived at by substracting the royalties and taxes paid by companies on owned oil production, from the so-called posted price of Middle East crude. The economics of our own operations indicate that the actual pro~t number is a small fraction of this difference. ,Et~on sells crude oil to both affiliated and non-affiliated customers at prices that, in our best judgment, are consistent with competitive market conditions. rrhese prices `are significantly lower than posted prices. On the other side of the ledger, we have to pay producing governments not only royalties and taxes on our own production, but also buy-back prices for oil accruing to the governments under the terms of participation agreements, While these buy-back oil prices are still being negotiated in most instances, it is almost certain that they will result in a significant `added payment burden to both the oil companies and the oil consumer. The upshot of this is that, overall, Exvon's Middle East and African crude profit is considerably less than 50~/B, not $4.00/B. Moreover, total company profit margins are much more responsive to com- petitive pressures than are payments to producing governments. The impa~t of somewhat easier supply conditions is already evident in international markets. It is, therefore, a cause for concern that the OPEC countries are currently speaking of the need for further increases in their revenues. Although to some extent OPEC justifies its demand on grounds of keeping up with world inflation, 45-4'26--75---9 PAGENO="0130" 126 primarily its argument appears to be that the higher payment can be extracted from allegedly high èompany crude profits without affecting the consumer. Infact, based on Exxon economics, an increase would a1mo~t certainly have to be reflected in higher costs to the consumer. One far-reaching aspect of the higher costs of oil which governments must be concerned about is the balance-of-payments problem. Much has been written about this. Unquestionably, it is serious. The International financial markets are not accustomed to handling the massive amounts of money which will be involved. Much government and financial ingenuity will be required. In the ease of the lesser-developed, resource-poor countries, the financial drain could be ruinous. But in principle, I ielieve the problem can be handled. Above a level defined by the capacity of oil exporting countries to absorb exports from consuming coun- tries, an OPEC decisionto produce more oil is th~fact a decision to invest more abroad. Conversely, greater consumption in the consuming area amounts to a decision by one or more consuming eountties to accept more investment by OPEC. What must be done is to find a way to accommodate these investments while avoiding the risks of sudden, massive transfers of funds. Unquestionably, accom- modation would be easier if the Industrialized countries of the world were to find ways of curbing their inflatlons; i~ør it is fear of depreciating currency values which underlies much of the problem~ One `way to moderate the balan~e-of-paymentS problem as well as the impact of high prices ~for energy is tepromote increased efficiency in the use of energy. The operation of the tharket Mn cbntri1~ute substantially to this end. But addi- tional steps can be taken. Agovernifletitally spon~ored "conservation ethic" could be promoted. Appropriate tax policy a~d support for greater efficiency in energy- using devices would help. So, too, would sensible policies on mass transportation. ~inally,it should be a majOr concern of government to foster the developmeOt of new energy supplies from 4ndlgetious sources. Even If the measures already discussed were to result in a reasonably assured flow of 1nt~rnational suppltes during the next decade, consuming countries would need to accelerate the pro- duction of domestic energy. This suggestion applies particularly to the U. S~, which is fortunate to possess large, untested areas that are prospective tor dis- coveries of conventional oil and gas, as well as extensive reserves of coal and oil ~bal'e. Exxon supports a diligent effort to return to a reasonable degree of energy self-sufficiency. Our own plans, In addition to major efforts `in oil and gas, call for steady expansion of coal and nuclear resources. Additionally, we are doing research in other energy areas, including greater efficiency in the conversion and storage of energy. The role of the U.S. Govertiment should be to serve as a catalyst to the efforts of private companies to expand in these new directions. `Accelerated leasing of federal acreage, particularl~ in off-shore areas, resolution of environ- mental conflicts that impact on resource development,' support of industry research Into new energy processes-~--these are some of the things which govern- ment can usefully do. `Two related negative policies rcvhich should be avoided are long-term price controls and punitive tax Increases. flopefully, the U.S. will move away from energy price controls as soon aS possible. The outlook on tax legislation is less bright. The more extreme proposals, particularly the removal of the foreign tax credit, would drive U.S. cortiPanies from the internatiOnal scene. They could no longer compete with foreign companies. One can't help wondering if the sup- pOrters of these proposals are fully aware Of the implications. Congress appears to be caught between an urge to punish the oil companies and a desire to get on with improving the energy outlook. Let me quickly restate the government actions which I have recommended. Governments should seek: L A proper environment foi~ business. 2~ Emergency supply agreements among nations. 3. Relaxation of international tensions. 4. A realistic assessment of the facts. 5. International monetary stability. 6. Greater efficiency in energy use. 7. Development of indigenous energy sources. 8. AvoIdance of punitire tax measures. If these steps are taken, I am convinced that the nation's energy prospects will be improved. A more precise articulation of government~s role would be helpful, but given the uncertainties of the situation, this is as difficult for me PAGENO="0131" as 1 imagine it is for you. ~s I 1~tve already said, in my view the key is e~ta'b~ lishing the right environment withjn which t1~e i~1ustry can work, Thereai~ter, to the extent possible, competitive forces should be allOwed to work their disci- pline, with the oil companies continuing their role as effective and flexible sup- pliers `of energy~ The international oil companies have performed 4nd, with the prOper support, will continue to perform two primary functions. These are, first, the efficient operation of international logistics and marketing netwØrks and, second, the expansion of energy supply. The changes which have recently occurred in the industry do uot les~eu the need for these functions. Indeed, `they are more needed than ever. The networks of facilities which the private companies have `created since World Way II are vital to the world's energy trade. Without them, there would be no hope of delive~i~g products to the consumer at anything like a reasonable price.' if they didn't exist, they would have to be created. But more than ,~ust the facilities is involved; it is the acc1~nmlated'experienee, ~hnology~ man~tgeri'a~ know~how a~d planning competence which make ~he system work., The operations and~ decisions `are of such complexity, and international scope that it doemi't make sense that they could `be easily assumed by the non-expe~icneed. All tills m to say that the transportation, supply allocation, refining and~marketjng activities of the cQmpanles comprise a vital economic function. And no other economic ~ntity Is as well equipped to do the job a~ tile private international oil companies. Whether circumstances will permit them to function as effectively as they would like is another matte~. A specific concern shared by most oil companies today is the adequacy of crude supplies. The investment requirements for mod- ern relln,ing facilIties are so enormous that any company must be concerned about making investments without some `asSurance that the crude feed Will be forthcoming. For the ~ompanies, therefore; making arrabgements to secure ertidO supplies on a stable and continuing basis has top priority. It has been suggested that `there is no, need for the companies to do this, tb~t inter-government~~ arrangements to secure crude oil would work ~jtist as well, and perhaps better. I do not share this belief. There could he no prescription more likely to politicize `the world's oil trade. Private companies have often shown an ability to continue operations when governments are no longer civil toWard one another. Adequacy and security of supplies will depend ultimately on the second of the oil company functions mentioned above: the expansion of energy supplies. There is `much which the companies can do here, and Which they `will do with the necessary government support. 1 would urge this Committee, as well as others in Congress who are concerned about energy matters, to reflect on the magnitude of the task before us. The amount of oil and gas which we need to find~ th~ expansion of effort intb new energy forms which will be required is trudy huge. Assuming a moderated rate `of energy Consumption in the U.S. of only 3% (i.e., one-third below the historical rate of 4.6%); we would need half-a-million new oil and gas we1l~ `in this country `over the next fifteen years. To put this into perspective, there are some 650,000 produCtive wells in eidstence today. We would need more than 60 new oil refineries to supply 11.5. r~qulrement~. We would need an equal number' of plants for `oil shale and for making synthetic `oil and gas from coal. We would `need more than 30 new nuclear plants each year by the mic~4le 1980's, or a new plant every two weeks. We would ,need `more than 140 new coal `thines, including a large number `of small, deep mines as well as high-capacity surface mines. And even after all this, `we would Still have to impoi~t largeamounts of energy, ` Faced with ~uch tasks, we need, all of us, to keep clearly in mind what on~- goal is, an4 what is likely t~ bring it about. F'~r many years to come, the prin- cipal involvement of the oil companies Will continue to be with' oil, and gas from conventional Sources, ailcl in this thPy will need the ftilI support of their govern- ment. But increasingly, they will need to do other thjpgs. There `are tbo~e who worry about oil companie~ ~nves,tjng in `other energy forms. To my thinking the best efforts of every energy company, oil and otherwise,. will he needed if we are to work our way out oi~ our energy problem. The oil companies have techniCal uompetence, managerial e~perlence and a desjre t'o get on with the job. These can be valuable assets in a time of need. CONOi~VDTNG COMMENTS Mr. Chairman, I should like to conclude by mentioning some of the things which Exxon and its affiliates plan to do in the next several years. We recently PAGENO="0132" 128 announced a $l~ billion dollar spending program for the 1974-4077 period. Some of the key projeCts included in that progra~m are: 1. A share in the Alaskan pipeline and in development Of the Prudhoe Bay Field. 2. A share in an Athabasca tar sands processing plant in Alberta. 3. Four new coal mines for power generation, with others under consideration. 4. ConstructiOfl of a large coal gasification pilot plant, design of a ~oal licine- faction pilot plant and further research in the basic technologies relevant ts these processeS. 5. UraniUm exploration and mines, research in enrichment technologies and in the nuclear fuel recovery cycle. 6. A major refinery expansion in the United States. Above all, the Company is committed to a worldwide exploration and develop- ment program designed to Increase supplies of conventional oil and gas in the United States, the North Sea, Canada, alid in diversified l~c.atiOflS th~ongbout the less developed world. ~lalf of the entire $l~ billion program is devoted to exploration and development. However, as I have Indicated, punitive taxation, price controls, limited leasing of acreage, and other restraints c~Uld cripple our ~fforts. I hope that this will not be the ~ase~ Thank you, ~Ir. ~f~bairmafl. Senator Q~mnoH. Thank you very much, Mr. Collado, for your ~tatemertt. ~~XON'S ALTh1~NATtVB ~iN1IRG~ PLANS `~n the latter part of that statement in which you summarize the future inve~tinent plans of Exxon, would it be accurate to say that you are reaching outside of oil into other forms of energy? You men- tion the four new coal mines for power generation in whiCh the corn- pany is advancing with others under consideration. To what extent does this future commitment envision Exxon becoth- ing what you might call a general energy company rather than an oil company? Mr. COLLAD0. Well, we view it as our goal to move in whatever direc- ti~n~ we find what I would call feasible investment opportunities, opportunity to do something about the eikergy siWation. This is not a very new thing for us. On the other hand, if you look at our total operations, the oil and gas part of ofir total operations still is the overwhelming part of our business. We do have one of the most modern, if not the most modern, coal mines in the country in Illinois, now servicing the power com- pany in Chicago, and we have been in uranium mining for some time. We have in recent years entered the business of producing rods for refueling nucle9ir power plants, and ~ have made rather rapid very attractive progress in that area. This is ~till a very, very small part of our total business. Extraction of oil from tar sands and shale and conversion of coal into gaS and Iiauids. of couise, are old things with us. We have been doing research in this and participated in this for many, many years and our initial steps in the coal industry probably were more from the point of view of acquiring reserves for this purpose than for coal ~for direct burning. Ohanging times have made it attractive for us to go in the coal business as coal miners and not merely to use coal as raw material for conversion into gas and liquids, and so we are a little bit in all of these things. But if you look at our total business, we are mainly in the conven- 4ional oil and gas business but in an increasingly large number of places PAGENO="0133" 129 and in increasingly harsh environments such asthe north and the deep offshore. FREE ENTERPRISE IN ENERGY FIELD Senator CHURCh. Well, this broadening involvement on the whole energy front seems to be characteristic of all of the~ major oil com- panies. I can understand the reasons for it and I would think that prudent planning on your part would require that you diversify t~ some degree. However, from the Government's side, from the standpoint of pub- lic po~icy, I am concerned that we keep competition vigorous in fuel supplies and we avoid having various sources of fuel all brought under the control of single companies. I am not at all sure that the present laws properly protect against that kind of conglomerate monopoly developing on fuel. What view do you have with respect to this? I am a free enterpriser. I guess, an old-fashioned one who lIkes to believe competition is the best regulator of the marketplace. I want to see it kept very much in the picture where energy is concerned in the future. Mr. COLLADO. Well, I am glad you have said that, Mr. Chairman. I have been aware of your views in this matter and they are very simi- lar to my own. Frankly, I believe the only way we really get the maxi- mum progress and achieve what I would call proper goals of people- I am not talking proper goals of our company, I am talking about people generally-is by as great a competitive market as is possible. I think you have to unleash the abilities of individuals. You have got to have the Government lay down the ground rules, and frankly, I think ttfter laying dOwn the ground rules if the Government avoids intervention in the details of how the ground rules are carried out, that is the kind of situation we need to achieve. I guess I am a little old fashioned in that respect, but I like to remain old fashioned. The competitive market is certainly part of the old-fashioned phi- losophy and I certainly agree with you. I think one o~ the reasons why we go into these fields is because we are a compauy that is looking for profitable investments in order to get an attractive return for our shareholders and we are not particularly limited i.n what we go into, more limited by ideas and by men to carry them put than we are by anything else, and I hope it stays that way. I think we can do the job there and, frankly, these are areas that need ~to be developed and I suspect our moving into them has added competition. Certainly there are more people in some of the businesses I have just mentioned because of our having gone into them than before they went Into them. I think we make a strong additional competitor in those businesses and I do not think it is in any way moving toward monopoly. Quite the contrary, I think we are moving toward a broader participation of powerful competitors in each of these busi- nesses. I quite agree with you; I would not want to have a different situation. Senator CHURCH. Senator Case. Senator CASE. Just a couple of questions in addition to those that may be asked for the record. Senator CRunch. I wonder before you put the first question if I may be excused now because I have to go back and touch base again in my PAGENO="0134" 130 other committee. I apologize. After you are finished, Senator, we will recess until 2 o'clock this afternoon. OIL COMI'ANY PROI'ITS Senator CASE. ~J:obil Oil's rise in first-quarter profits was explained on the basis of a sale of low-cost inventories at current prices which were higher. Do you explain your increase in the first-quarter profits on that basis, too? Mr. COLLADO. We also made `a rather detailed statement of out t~arn- jugs when we released them and we have the statement that was given out. If you want it I can give you that. We have it here. In our case the earnings went up, the exact percentage was 89 per- cent, and the increase was attributable to a number of certain things. We had in the first place an extremely large increase in our chemical earnings. The chemical business as compared with as recently as 18 months or 2 years ago has been revolutionized, and our earnings ni that industry are not unique with our company. Qther companies in the chemical industry have done very, very well, Senator CASE. This is increase in quantity, that is to say, not just in price? Mr. CoLL~&io. Both. Our chemical plants~are absolutely full all over the world and they arc doing a very profitable business, I did not mention that. when I was talking about our expansiQil because I was only talking about the energy industry. But this piece of our business Is doing extremely well. : Secondly, we have a situation which is cOmpli~ated to describe bt~t we do have some earnings that' ~i1l result from currency .tr~u~slation into the dollar from other cu~rencjes of the, countries in which ~ operate. We haye some refieetio~is, of this in our ~cpunts and these can be quite sizeabie. In addition, to `that, we did havp some invento~y profits. They were by no means the tpta.l arnount ~f the ii~crease in our earnings. Senator `CASE. How ñ~uch was tha~n percentage? Mr. COLLADO. I fo~g~t. 1 thi~iak it was, $80 willion~ Our earnifigs in the first quarter were $705 million, which is ~about a $200, million increase over first quarter of .1973, and $8Q million wquld have been 40 percent of the increase. `Theia'jn `~çldition to that, there is just no questthn we.had a little more money in the United States because in t~eceinber the price control authorities increased the ceilings on crude oil and a little of that was reflected in our U.S. earnings ulthough quite frankly; because of the w~y the product prices are controlled there is a real lag. and we did not get much of that passthrough in the first quarter. But these, I think, are most of the elements of ~ur earn- ings increase. Senator CASE. Well, it is a terrible position to be in, to apologize for it. Mr. COLLADO. It used to be I was proud of our earnings and I still am, because in my opinion, we are just about now getting to the lower level of what is an adequate return `on investment, and without this I. would not be very happy as investment and financial officer of the company. With any return on investment much lower than this, I would be quite depressed. And I do not think there is anything out of PAGENO="0135" 131 ~rder about the earnings. I think they are pretty good. I hope they get a little better, and I am afraid they will not. Senator CASE. I am not asking you to make any predictions at all. Mr. COLLAnO. I do not predict earnings. That is one thing in this world I do not try to do. REPORTING INCOME AND BALANCE OP PAYMENTS Senator CASE. The Department of Commerce has published a revi- sion of the U.S. balance of payments for the several years since 1966. This publication, I understand, is going to correct a major reporting problem which has resulted in overstating the income that we have gotten from our multinational corporations, by as much as a half billion dollars ~i year. I am not making any accusations at all, I am just trying to get your comments on whatever the factual situation is. It apparently is true that the oil companies for tax reasons have operated outside of the United States through American corporate and branch entities which lose money to get the advantage of the depletion rate on wells that are located oi~tside of the United States. That the companies report their dividends from ownership of com- panies like Aramco, including sums which never have come to this country. Apparently the income, figures are overstated because they do not include trading losses which for legal and tax purposes were taken by. domestic corporations. I understand thal~ these unreported outflows have been inCluded in errors and omission entries, in the balauce-o~- payments statements. . . Apparently the, total excess stated outflow~ for oil ~oIppanies has beenrather large.. In 1973 I think it was sqmetl~ing like $11/2 billion. Earlier in 1970 the benefits to the U.S. balance of payw~nts from over- all multinational invç~tment appears to have $een overstated $1½ 1~i~Ilion a year. , It is estimated tba~ the total multinational-corporation-generated balance of payments as pi~blisbe4 by the rin~nce `çommitte~ a iear ago indicates that the inflow to the IJnit~4 States was $5~8 billion. `that is a very substantial eçntribution to the b~dar~ce o1~ payments,. and certainly to the extent .that it is sound aIlci solid is a matter multi- national corporations can poini to ,w~th a~ good deal ~f pride. Mr. COLLADO. Could I say something on this? Senator CASE. If we have an error in things, it kind of shakes your confidence in your own ability to justify these adval4tages against what many people have claimed to be disadvantages of multinational operations. And I would like you to comment in general. Mr. COLLADO. I would Jike to talk about this. I am not informed of the exact revision. I would like to talk a little about this subject. In the first place, I have, should I say, observed and attempted to work in the field of the balance of payments and in particular in the returns of foreign investment of the United States and more particularly of our own company, and we have been encountering great conceptual problems in doing this just as the Government found out when it attempted to control capital exports during the period when the Office of Foreign Direct Investment was operating. PAGENO="0136" 132 But, nevertheless, there is general agreement on broad concepts even though how you apply them has never b~en resolved, and probably is not about to be resolved. We have made very careful analysis within our own company; and, of course, during the period of controls which were instituted in the end of 1968, and only lifted a few months ago, we were required to make very complete reports. We have been making much less com- plete reports since 1934 or 1935. When I was in the Treasury Depart- ment at that time the then Secretary of the Treasury ordered regular reports of foreign investors, and they have been made ever since. 1-low- ever, the point I would like to make is that I have very good infOrma- tion on our company and IL really do not have any special sources of information on any other companies, but I have observed the Corn-, merce Department estimates, and I have gone down and talked With the estimatorS both there and over at the Federal Reserve Board and at the Monetary Fund. There are lots of people working in this field, hut I have very, very little confidence in the figures that have come out. There have been years when the figures we submitted on earnings which were presumably included in the compilation were as high as 30 percent of the total record earnings, not only of oil companies but of all foreign investments of the United States. I have never believed those figures. Senator CAsE. You mean they were overstated in the Department? Mr. COLLADO. They were understated. I have thought that the total earnings for all companies were much bigger than the official figures stated by the Department of Commerce because I cannot believe our earnings are 30 percent of the total earnings of all foreign invest- ments made by all companies in the United States. To me this is utterly ridiculous. I want to say I am glad they are going to revise the figures, but they are going to have to go to another set of figures, in which I will probably not have much confidence. Senator CASE. flave you any explanation for this? Mr. COLLADO. I have an explanation for the particular phenomena I think that you are talking about. But not being aware of exactly what the information or the sourcet c~irn~ot be sure. This is something else that has been fully reported on and is fully understood at least by the people in Treasury and the OFDI [Office of 1~oreigu Direct Investment] organization that was charged with doing this and it certainly should have been by the Commerce Department because we have made this thing very clear. It is related to a discussion which I think you may have had in earlier hearings about the situation particularly of Aramco, but it is a'so in some degree true in other circumstances. That is that at least for purposes of direct investment control, rather artificial definitions of what constituted the foreign investor and what constituted the affiliated investment were laid down, and because of those rules, in my opinion, the income from certain oil activities was overstated in the external accounts and perhaps understated in the internal accounts. They put earnings into the foreign piece of the operations, and then put losses into the domestic piece. This is what happened. The com- panies had to acqnire oil almost entirely on the basis of the concession terms dictated by the countries in which they operated. They had to acquire oil at the so-called posted price and then they turned around and sold it in the market for what they could get, which in the sixties was considerably lower than the posted price. There is no secret about PAGENO="0137" 1a3 this. The i~icome. ta~c reti~irns clearly set it out, The returns that we submitted to the OFDI clearly set it out. And we used to go down and point out that their very formula, on the basis of which we were entitled to foreign investment quotas, put one number in and left the other number out, and we went down and explained this to them and pointed out that this was a quirk of the fine print. That is why I am a little leary when people say we are going to have a law, I want to see the fine print in the law and not just a one sentence explanation. Senator CASE. There is no charge of fraud or anything like that. Mr. COLLADO. There is no qecret about this, it has been known to numbers of people. Whether in fact that affected the way the Com- merce Department put out the numbers I have no way of knowing. Senator CASE. Apparently it is true. Mr. COLLADO. I think that is what is behind this. Senator CASE. It has affected it to the standpoint of about a 20- percent error roughly, over these years and that is the thing that bothers us. Mr. COLLADQ. I would question the number that they were changing. Changing number "A" by a billion and a half dollars does not im- press me much because I suspect number "A" was a billion and a half dollars off for other reasons. Could I say something about that chart which I have been looking at with something less than appreciation for about 2 hours, or would you prefer that I not speak to that chart? Senator CASE. Please go ahead. We want information, Mr. COLLADO. If I were a professor and a student brought that chart in, he would get a D because the data as well as tha headings are com- pletely misleading. Senator CASE. By the chart, I think for the record it should be stated that there is a cardboard panel in the back of us here prepared by our staff entitled, U.S. Taxes Paid by United States Based Major Oil Companies, and it should be included in the record so that the comments will be intelligible to those who have to read it. [The chart referred to ~`ollows:] US TAXES PAID BY US-BASED MAJOR OIL COMPANIES 1972 Company Net Income Before Taxes Percent Paid tn US Taxes Exxon $3.700 billion 6.5% Texaco 1.376 billion 1.7% Mobil 1.344 billion 1.3% Gulf 1.009 billion 1.2% SoCal 0.941 billion 2.05% Company Net Income Before Taxes Percent Paid in US Taxes Exxon $19653 billion 7.3% Texaco 8.702 billion 2.6% Mobil 6.388 billion 6.1% Gulf 7.856 billiQn 4.7% SoCal 5.186 billion 2.7% PAGENO="0138" 134 Mr. LE~tNS0N. I may be mistaken, but I do believe we obtained tha~t from Business International. I will check that. Mr. C0LLAD0. That does not change my view. Senator CASE. Let the record show what the facts are. Mr. COLLADO. In the first place, I presume it relates only to Federal income taxes, but the words "income ~ do not appear anywhere on that chart. I assume that is what it refers to but it does not say so. Senator CASE. It does not show the last line of the company, what is that? Mr. COLLADO. I cannot see that. My vision stops between Mobil and Gulf aDd the carafe gets mqst of Gulf. I only talk about Exxon because I see that up there. I happen to have in front of me the 1973 figures for Exxon, but I do not happen to have those fOr 1972. The 1973 figures are bigger. I would like to s~y something about' it. In 1973 the corporation paid taxes and other duties to all countries in the world in the: amount of $10,608 million. Of that, income taxes totaled $3,752 million; excise taxes tolalèd $2,298' million, ~tnd other taxes were $4,558 million. That in- cluded irhport duties, it included what we call sO~verance taxes and Sthte takes and all kind of taxes. Senator `CASE. ~t this point Mr. Blum has `a question that he wanted to a~k you ~bou~ thd f1gii±e'ai~d I wanted a shOrt oith too. But I Want to ask you when you `say takes' and dutie~, that includes, I a~sume, royalties? Ro~L~I1~5 AND oflinu PA~M~tTS Mr. COLLADO. No. I was going to say that, it does not include' roy- alties. Duties are import duties, customs duties. Mr. LEVIN50N. Payments to producing countries? Mr. COLLADO. Payment~ to the producing countries but not~ of royalties. Mr. BLUM. Do those numbers include payments to the consuming countries and to the government of Saudi Arabia? Mr. COLLADO. `Those which are under the category of income tax. We can come back to that. I know what you are going to say. It does not include royalties. ` ` " Senator CASE. `Designated as such? Mr. COLLADO. It does not. Senator `CASE, So we know what we are talking about. Mr. COLLADO. It does not include royalties, period. Royalties are stated in mostPersian `Gulf countriç~s as ~ percent or 4 shillings per ton gold. They, are stated and they are paid and they are not in this number. Venezuelan royalties are 162/s percent and based on a some- what strange pricing formula which make them much higher. That is not included ifl these nuihbers. Senator `CASE. That kind of payment which after a discussion in our State Departi~nt and at the highest level of our Government which was `allowed to be increased and charged by these foreign coun- trieq which is called taxes~ where do they come into the picture? Mr. COLLADO. Any tax that is accented by the Internal Revenue Serv- ice as an income tax is included in this. Senator CASE. That is all we want to know. PAGENO="0139" 135 Mr. C0LLAD0. I will come back to the other points. That was not what I was talking about. I would like to point out that in 1973 the earnings in the United States before tax were $1,326 million. That i~ from the domestic operation of oil, gas, chemicals, and other activities. We had income taxes of $417 million. That is 31.4 percent. That is by all accounts just exactly what the tax laws of the United States would say a mature oil operation would pay because 48 percent is the statutory rate. The actual rate paid by most manufacturing com- panies is around 40 to 41 percent because of all the things you are familiar with, accelerated depreciation, investment credits, and all these things, which are not loopholes, which are things very carefully legislated by yourself and your colleagues, and in the case of oil there is another roughiy~ 10 percent differential as a result of the applica- tion of the depletion allowance~ the 22 percent depletion allowance. Now, therefore, our effective; tax rate in the United States was 31.4 percent, which is an appropriate tax payment for earnings on income in the United States, and we do not. in any wa~y feel that we are get- ting a benefit that is held back from ~ome other l~ind of a person. We ha4 tothi worldwide income taxes of $3.7 billion Of Which $3.3 billion were foreign ~nd that tax rate came out to be 68.4 percent. In my opinion, that is a very high tax rate and one I resent having to pay. We do everything possible to keep that ~umb~r down. Senator CASE. Broadly sp6aking, would ~ou say that those taxes, those foreign taxes, could, you a~~ly them ais cost of goods purchased? Mr. C0LLAD0. No. Senator CASE, You could not do that? ~[r. COLLADO. They are proper income taxes. Senator CAsE. If you do that-- Mr. COLLADO. I we~it into that at some length in the Ways and Means Committee a few weeks ago and I think I have given the staff reference to the testimony in which I went into this subject. I would take the position that it depends country by country. Each country has its own form of income tax. No two of them are identical. In fact, they are quite different. On the other hand, this Government and other governments and ~ host of academics and professionals interested in taxes have spent the last 20 or 30 years wandering around the world haying conferences on harmonization of tax laws and we have edi~icathd everybody in the world, including ourselves, how this is done. So I do not think there was any special effort made to educate one particular country. There h&ve been Latin American tax meetings and all of the assistant secre- taries of the treasury and intern~d revenue servi~e staff from. ever~r country have been meeting for years and years. The literature on this subject is almost as big as thc literature on.multinat~onal corporations. In any event, the point I would make is that we have in our tax returns, and this is fully known in the tax writing comniittee~, and by their staffs, we have taken the position that we accept for credit, the stated income tax on the portion of the income that results from what we call the realized price or the transfer price, and we exclude from our claim for ~oreign tax credit, the portion of the income tax that is assessed on a plus differential between the realized price and the posted or reference price established by the producing governments. PAGENO="0140" 136 ~Each country has a different name for it. So we have not ever asked. ~for tax credit based on this excess and I think that is as far as I would like to go in deciding whether a tax is a tax or is something else. AIEI I know is it comes out of our hide and ultimately out of the consumer's hide. Unless the cOnsumer puts the money into the front end of the company nothing goes out anywhere else. Senator CASE. how are you able to allocate to your satisfaction your `earnings from domestic and from foreign production? Mr. COLLADO. How do we allocate? Senator CASE. Are you able to? Air. COLLADO. Oh, yes, very easily. Senator CASE. You do not have any problem with that? Mr. COLLADO. No. And our figures, I happen to have the annual report here. It is all clearly laid out and this is not a problem. TAXES PAID TO THE SAUDI GOVERNMENT Mr. BI1UM. If I may, Mr. Collado, I would like to pursue a point which I asked about before, whether in the total tax bill the amount that you pay the Government of Saudi Arabia is included. I believe you said, yes. Mr. COLLADO. Well, let me be a little careful about this. It is included but it is included a little differently. We have in recent years gone into a new method of accounting. I have got Mr. LeGrange here. Maybe he had better answer the question. But we have gone into the method of accounting that would take in our equity share of com- panies like Aramco, which is the source of our income from Saudi Arabia. So that we do include in our items in the income statement the proportion of Aramco. In earlier days we did not do it that way. We handled Aramco as ~n investment and only put the dividend in, As you know, this is a subject that the accountants have been discussing for years. Mr. BLUM. Of course, if you did just include dividends, von would report that net after tax and t~ie numbers that you would be able to show in the balance sheet would show in your total tax burden would be considerably smaller. Am I correct? Mr. COLLADO. If we did- Mr. BLUM. If you took dividends from Aramco that Aramco's pav- ing the tax you would be showing a much smaller number worldwide for total tax paid. Mr. COLLADO. Somewhat smaller. If you are going to start doing ratios there is going to be a brand new phenomenon and that is as our ownership interest in these operations declines in the future the per- centage of tax that we pay will go down and the cost of purchase of raw materials will go up, because when we buy back from a govern- ment we do not pay any taxes. We only pay taxes on equity. Mr. BLUM Well, I just wanted to stress that point because I believe there was a meeting of the accounthnts or the four Aramco comp- trollers of the four Aramco shareholders to discuss this very point which your comnany thought for public relations it would be most effective to include those taxes, taxes paid, in the annual report. PAGENO="0141" 137 Mr. Uoij~u~o. I do not believe that was the basis on which this dis~ cusslon took place. I can ask the accountants. T do not knew what they were talking about. I know in myown case it is very simple. Wedecided to go in for what is known ~s equity accounting because this is now the modei~n practice, and if you do that the taxes automatically get put in because they are part of it and you cannot escape it. There is no motivation other than to have a better representation of the total accounts and this is in full accord with all of the principlese~tablished by the accounting principles board which get sanctioned by SEC [Securities and Exchange Commission] usage. Exxon does not claim credit on its Federal income tax return for those taxes paid by Aramco. Mr. BLITM. Only one final question and that is why is it that Exxon has not ever included the earnings, dividend or value of its holdings in Aramco in its filings with the Security and Exchange Commission in its report? How do you disclose your dividend flows and the amount. of your equity investment in Aramco? Mr. COLLADO. We have certainly given the SEC everything they have asked for in the 10K. I will have to ask Mr. LeGrange. Mr. BLUM. I am asking whether Exxon has disclosed its dividend flow from Aramco and the amount of dollars from Aramco in the SEC. I believe it has not. Mr. LEGRANGE. The dollar investment in Aramco is disclosed and the net income we received, which is the net of dividend less the loss we sustain, is also in the 10K. Mr. BLUM. Thank you. I have no further questions. THE FUTURE OF !flTE OIL INDUSTRY Senator CASE. The only other question I have is a very general one about the future and about how in the future you think it would bc best for negotiations with producing countries to be conducted, whether on roughly the same pattern of negotiations as in the past, or whether since the conditions are so different, and we must assume will continue to be so different, there had better be something more of a government*to~governm~nt relationship rather than an operation in which the private companies did the negotiating with government. Mr. COLLADO. Well, Senator, this is a subject I have given a great deal of thought to. Senator CASE. Of course, that is why we want to hear from you. * Mr. COLLADO. It is not a subject on which I find it easy to give a very precise formula. This is a very difficult area. In the first place, our experience over the last several years has not been very encouraging as to the support or the action that our own Government or other consuming governments are likely to give or take. I am always an optimist and I hope it can get better, but it has not been very good. We witnessed it last fall and winter when the problem of embargo hit and the governments were completely unable, and in my opinioil, more or less unwilling to do anything about mdi- eating how the oil should be allocated. I have thought that the big problem we have is how to construct a better international trade and investment world, In my opinion, one tenet of such a world would be PAGENO="0142" 138 that the people do not withhold exports of vital things for noneco- nomic reasons. The United States itself has been guilt3r of doing this and I do not tl~iink it was a very good idea and it fortunately did not last very long. There has to be some rhyme or reason to what you do. Now, the problem we have confronted in the energy situation is a very simple economic one. If one were sitting in an academic hail somewhere remote from contact with this and looked at the presenta- tions that have been made by my con~pany, and by many, many other people, academics as well as corporate people, Government people, about the outlook for the oil and eiiergy situation, it was absolutely clear to everybody. We pointed out in 1969, at the time of the Shtiltz Commission and it has been pointed out innumerable times and places by different people, and made absolutely clear that the one thing that was developing was a very great dependence on Eastern Hemisphere sources of oil to make up the energy balance in;this country. Nobody said that the oil did not exist, they just said we are getting very, very heavily dependent on overseas supplies. Back in 1958 there wiis congressional trade legislation in force that contained national security clauses. President Eisenhower ordered an oil import quota system established to protect the national security. By 1968-69 the administration of such controls was in question `and the Shultz Commission was set up to review this matter. I think the Shultz Commission in the area of definition and cfiteria for n~tiona1 security wrote a magnificent report. U.S. DEPENJ~ENCE ON IMPORTS We hate been pointing out for years that this country was going to have a situation with very heavy dependence on imports. We have it today and we are going `to have' it f~r many years. Now, the fact of that the speed r~p of `demand, pThs the, lack of finding of new reserves' in massive `quantities in pi~c~s outside of the Persian Gulf' has meant that the Persian Gulf `countries, they were blessed with very, very large reserves became a key' source. When you have very, very large reserves, when you have' demand pushing on consumption, the situation can arise where one or two or three cOun~ tries, perhaps even only one country, has the `throttle that can be turned on and off. When a person is in that position he is what is known in economic terms as a~ monopolist. He does not even have to be in a cartel, he is a monopolist, one man boss of the show. `This was obviously `coming up. What we have been `saying throughout is that it is important to get that monopolist or his associates, junior monopolists, into a world trading picture in which they do not use that economic power. U.S. PRIORITIES VIS-A-V15 OIL Now, the political aspects of it were superimposed but the Arab nations already had the economic power. Under those' circumstances, the `Government of the United States has a trem~ndously important role because only it can in the first place estimate among all of the problems that the United States has, what is the importance or priority to be assigned to this problem. I' think this is a terribly important PAGENO="0143" 139 problem because I work at,, this, ~ll day lqn~, b~t, ~ was, in the State Department for many years and I know that there are 48 other prob- lems and the people who work on those think they are just as im- portant. This one is pretty important. I would not say it Is ~he most important. The point I am trying to make is that the `Government of the United States has a complete acrOss-the-board international relationship to maintain with many, many countries, including the ones that are in this position to control this particular product. The Government of the United States has got to .bring to bear all of the elements of its abilities and wisdom and it has got some trading points. We as companies have some trading points too. We have not given up by a long shot. We have `the internation~l 1ogi~tics system. Some- one may take it away from us but we have it today. We have the expertise. No government oil company ever found a major oil find. No one in Government ever drilled at 3,000 ~feet of ~fater. Np1~ody in the Government can deal with the problems `of the North, the transporta- tion. You have to have the people who know about these things. Maybe some day governments will get all of the expertise and we will be pushed out. But we have it today. I heard Mr. Tavoulareas say that the very gov~rnmenW that we are having these very' difficult relations with do not, want us to leave. They cannot run these things without us. Thider these c~rcumsthnces I think the Government of th~ United Stat~s has to support i~s, it has t~ ,do everything possible in the broad field. The' Government ö~ the TJnited. States is working on ~the monet~ary problem~ ~ very good part of the difficulty we aie havin~ i~ .t~e monetary p,r~~lem. As was said earlier, if you just want the consnmers to have e~eap gasoline all you have to do is take off the don~estic excise tax., Foreign increase in price is a small percer~tage `of the total price of your gasoline and `$10 a barrel is 25 cents a gallo~. . Senator CASE. $10 a barrel is 25 `cent~ a gallon? Mr. COLLADO. I think I am right. Did I do the a~ithmetic right? Divide 10 by 40. A' little less, 42 gallons in the barrel. `Senator CASE. What is the cost to the gas station ~ Mr. COLLADO. A relatively small transportation cost, relatively small refining cost, and most of the rest of it goes to Government. Senator CASE. Say it is a quarter. How much would 10 cents more be for all the other costs? COSTS OF TIlE DEALER Mr COLLADO About 10 cents and the rest of it goes to the dealer We are not usually the dealer The dealer is outside of our normal scope Senator CASE The dealer pays 35 cents ~ Is that what the dealer pays~ Mr COLLADO Roughly, I guess I could get you the numbers The average Exxon price to dealers is in the range of 30 to 33 cents per gallon depending on grade Senator CASE So if he charges 55 cents he is making 20 cents a gallon ~ PAGENO="0144" 140 Mr. COLLADO. No, he is paying about 12 cents tax, depending on the State. Senator CASE. There is where the tax comes. So it is onl~r 12 cents out of 55. Mr. COLLADO. When we talk about the $2 a gallon price in certain other countries, $1.50 of it is taxes. In Italy the taxes are very high. Senator CASE. We are talking about things here. Mr. COLLADO. I am talking across the board. Getting back to the U.S. problem-I would think the United States has a perfectly appro- priate role and one that frankly, we have urged that they exercise in some degree, by setting up this broad framework. But I must say there have been plenty of times when the Government did not want to f ace up to saying whether A or B was the right thing to do. Now, I started to say when we got off on the other point that the Secretary of the Treasury and his deputies are spending a great deal of time on reconstructing the international monetary system. If you get the international monetary system reconstructed a good deal of the problem we are talking about is much easier to confront and they are working at it. They have also made a very strong point of what they think is toO high about the present price of oil. They have been making speech after speech on this subject. This is not a new thing. Mr. LEVINSON. Just one thing. There is something that is a little bit disturbing in what you say. On the one hand, you tell tis Govern- ment has an obligation to support you, you feel they are generally doing that to provide the framework. Now, does that not really come back down to the case of Aramco that the 115, Government is supposed to establish this framework, which in effect has the consequence of pri- marily benefiting four major oil companies as long as this exclusive Ararnco agreement exists? Mr. COLLAD0. I think that statement is sheer nonsense. The Govern- ment of the United States has got to establish a framework in which producing countries and consuming countries can have decent inter- national trade. Who benefits from that primarily is consumers who have an assured supply, but the companies, what the companies make is a relatively modest return on investment and quite appropriate and all this business of preferential access is baseless. We have pref- erential access to some wells in Santa Barbara because we bid a fat price for them and figured out how to drill in deep water and we get preferential access when we earn it by our ability to run something. We do not get preferential access due to some backroom manipulation or devious arrangements. We made the investments in a very risky period. We were asked to make these investments, We made the investments. NEGOTIATIONS WITH THE SAUDIS Mr. LEVINSON. In the process of negotiating with the Saudi team, and the U.S. Government is in the process of negotiating with the Saudi team right this very minute as far as we know, there seems to be some major political 1mph~ations and financial consequences The only question I put to you is when the Government does that, for the ostensible purpose of assuring this country and its allies of `i secure PAGENO="0145" 141 source of oil at a reasonable price, does it not assume some other obli- gation withrespect to which companieshave access to that? Mr. COLLADO. No. ii think the anSwer is no, I do 4ot think so. Mr. L~vINsoN. Thank you. Mr. CoiLADo, The second thing I would say is we welcome the Gov- ernment of the United States sitting down with the Government of Saudi Arabia. I am really not well informed as to what they ale talk- ing about. The press releases are very general. If they can in fact make a nice viable comfortable arrangement between nations that will benefit not only United States and Saudi Arabia but presumably lots of other cOuntries, this is exactly what we are saying we want to have done. We have completely informed the Government of the United States of anything we kn~w about the progress of the circumstances in which we do business in these countries. People keep talking we are in the negotiation of buy back. From the records that I get of what has been going on in the last few months I kind of smile because when I i~egotiate I usually know what I am doing, but when I am just being told we are not about to take up subject or subject B---- Senator CASE. When you are told by the producing countries? Mr. CoLk&Do. Yes, we are not negotiating buy-backs. Senator CASE. This is---- Mr. COLLADO. We have kept the State Department and other agen~- cies of the United States very fully informed. In fact, sometimes I think we spend so ranch time informing them they are getting bored hearing from us. The fact of the matter is the full discussion before this famous meeting of last Tuesday took place last week and they knew everything we knew, and probably more because they have ambassadors who get information that we do not have. OIL ALLOOAPION DUEING TIlE E3~EAEGO Senator GASE. This is a parochial question, and is quite unrelated to anything else. Mr. Oou~no. Go right ahead. Senator CASE. I wonder why New Jersey had a lonsy supply of gasoline during the February shortage when Exxon is a Jersey com- pany, it has the refineries there in Bayonne, and why we got such a terrible deal. Mr. COLLADO. The allocation by States was not done by the com- panies, as you know. Senator CASE. No, I do not know that. My suspicion is that the companies gave the statement to the energy office and the so-called allocation by the energy office was simple mathematics adding up what the companies told the energy office they were going to put in. Mr. C0LLAD0. No; actually what happened was, and this is part of the very detailed operation of our domestic company which is handled from our houston base, and I am not personally the one who deals with this. I know about it in broad generalities but not in day-to-day details. As I understand it, the whole system was based on a historical 1972 statistic and each dealer was given ~ percent of what he had in 1972. Senator CASE. Not over the country as a whole? 45-426---75------1O PAGENO="0146" 14~, Mr. COLLADO. Yes, sir. Senator CASE. In New Jersey we got about ~3 percent and in other States they got 100 afid 100 plus of that figure. Mr. COLLADO. Well, not in our own com~p~ny, I am sure that was not the case. We did whathver the man dOwn the street told us to do. We did not have any leeway in this and we did not exercise any leeway. Senator CASE. Then I am ju~t trying to find ~ut~whO is responsible because New Jersey had a terribly bad deal. Mr. COLLADO. I ~an only tell you I live in Nassau County and we did, too. Senator CASE. When there is a shortage it is intolorab.le, and it should be evenly divided. Would yonagreC with that ~? Mr. COtLADO. I think the s~rstem, for all kinds ~f reasons which it took 6 months to figure out, did not work~ very'weli and that is the trouble with emergency systems; by the tim~ the immediate emergehcy is over you begin to figure~ out how to run the system. Senator CASE. Yesterday Mr~ Sawhill testified there ~were no ~ig- nificant diversion to the United St~tes o~f other than Arab oil durtug the embargo. Do you agree with that ~ Mr. COLLADO. That there were not o~ there were Mr. LEyINSON. There were not. He said there were no signifie~tnt diversions. Mr. COLLADO. I cannot spe~k bb~loi~siy, again~ for other conipanies.. I know in our own case it was quite cie~r. that~ in the first place, we have a lot of eêntra~tuai arrangements~ We cannot alter our conr traótual arrangements tOo quickly. Wedid tlir~e Uiings. Ones we~ofl1~ plied with all o~ the producing eoi~intries embar~oes as they order~ and we had no alternati~e berau~e otherw~is~ tJ~e~ epnsequences wpnl4 have been much more severe, and that was made abundantly clear to us by the officials of those countries who told iis~ :what would happen if we did not follow their quota systems. That set a basic problem because whe~e the embargoes wer~ put in~ any cust~mary plans were disrupted. Second, we respected all of our contractual obligations in the world, using force maj~ure equitable reductions. Clearly when we lost a very large fraction of our total worldwide oil we in a sense failed to comply with all of our contractual obligations. Then, finally, we distributed the crude oil to our affiliated companies on as equitable ha~is as we could and this entailed very large adjustments *ithin Europe but very small impacts on the United States. We did not bring any more here. We brought virtually as much as we had before. One month we took a couple of cargoes elsewhere. The net impact on the major trade move- ments was quite small but the big readjustment frankly, was among the countries of Europe where we had to do a major reallocation given the imnact of the embargoes and how it changed some of our flows. Actually, this is a job that in my opinion~ should have been done by Government and Government failed to do it. Mr. LEVINSON. Our Government had been in touch with you about this ~ Mr. COLTJADO. We were in touch with them but they were not in touch with us. Mr. LEVINSON. They did not give you any instructions? PAGENO="0147" T43 Mr. OOLLADO. Not a bit. They knew what we were `doing and they presumably hoped that the problem' would go away soon. I do Ziot know what the Government hoped, I Only' know what they sakL BENEFITS TO THE UNItED STAThS FROM THE OIL COMrANIE$ Mr. LEVIN50N. What benefit dpes the United States get from the fact that international oil companies are based here? You do not have to answer that. Mr. C0LLAD0. If they were not based herp. Mr. LEVINSON. We would not exist, I suppose, in the form in which- Mr. COLLADO. They would not exist in the form they do. Although we had a little colloquy earlier about. the balance of, payments, our company bring~ back well ovei~' ~ billion dollars a year in earnings and I think that is probably worth something in the United States and we bring it back,' too. Beyond that we certainly provide a lot of employment. We provide a lot of capital goods, exports from the t~nited States. We do all kinds of things~ W~ also procure and move around the world a lot of oil and I am not' so sure that `would be so easy to do if we did not have an establishment abroad. This is before oU~ going into the market and bidding up on an `auction. b~is. ,J do iiot think we would be anywhere near as effeptive as we are under the present arrangement. ` ` ` ` Mr. LEvINS0N. Did you eVer have any' feeling, of uneasiness at being subject to the kind~of international co~itrols. that internationa~istatus involves? Do you have any feeling about this? Mr. C0LLAD0.I have. ` Mr. LEvINso~.'Ey loyalty to the United States? Mr. CottAno. Between'my 27 years in this cOmpany and very happy and I hope fruitful ones, and m~r 13 or "14 years befOre that in. thq Oo~ernment of the United `States,' I have worked all sides of the problem and thought about it for a ~rery long time. There are poten-' `tial conflicts inevitably in anything you `do in life but there is no reason why you have to find yourself in a position where you do things that are morally incorrect. `You can always find a proper attitude to `take and you have to act this way. But you say am I evcr uneasy? I am uneasy practically all the time. I was uneasy this morning when I was coming down here in the car. I am going to be uneasy this afternoon. I have a difficult appointment at 2 :30, if I can make it. Mr. LEVINSON. If I do not let you go you are not going to have lunch ~nd I will not either. Mr. COLLADO. You have different degrees of uneasiness. This is a good business and an interesting one and a more fascinating one than ever and it has difficult problems. We have been talking up at the United Nations with the group of so-called eminent persons that are studying multinational corporations. That is a fine title. Around the hails of the United Nations they are called the College of `Cardinals. It does not matter what you call"them, in any case, they have devoted a great deal of time to exactly this problem. PAGENO="0148" l~4 You can list on paper that would fill up this table the potential confIiet~ of interest. Ray Vernon has written book after book on the potential conflicts of ±rit~rest. I tell Ray if he comes around and talks to me I will give him three additional chapters. But the point is we have been abli~ to operath for 100 years internationally and the number of major problems to which we had no solution were not so very many. We have got. a very difficult situation right now and I cannot tell you how it is going to be resolved but I am sure of one thing, if we have as little general progress among the consuming nations from 1974 to 1979 as we had from 1969 tO 1974, there are going to be cold nights. Mr. LEvIN50N. Among the consuming nations ~ Mr~ C0LLADO That is right. Mr. LicviN~oN. Well, I do not have any aBswer to this question. Mr. ~COLLAD0. I am an optimi~t. Things will get better and I agree with Senator Church, the Government, after what I consider a com- plete paralysis, has begun to move and hopefully it will move faster and better. We had almost no acreage put up for leasing for 4 or 5 years. You cannot d~rill if you do not have a piece of real estate to drill on. Leasing is very important. They are beginning to put it out. We spent a lot of money a few days ago down in the gulf. We have put out, I think, $600 million since last December in bids on 11.5. acreage but this was not happening ~n 1969~ 1970, or 1971. At the same time, you know what happened to nuclear powerp~ants. In Japan they can build one in4 years. In thiscountry it takes 10 years. Mr. L~vIwsoN. Of course, in Japan they are up to here in pollution, too. Mr. COLLADO. I just came back especially for this hearing and I am telling you it is not very pleasant, but the. fact is there has to be an intermediate course. This is the proper role of government to balanc~e. These hard deeisions are not corporate decisions. Mr. LEVTNSON. I think they are decisions that everybody has to con- tribute his share on and on that note, I guess if there are no other questions or anything further you would like to say or your counsel, we will adjourn. [\~\Thereupon, at 1 :30 p.m., the hearing w~s recessed, to reconvene at 2:30 p.m., this same day.] [Subsequent to the hearing, the foflowin~ information was received in response to questions submitted by Senator Church to Atlantic Richfield `Co.:] kmnnrlc RICHFIELD COMPANY, Washington, DC,, June 18, 1974. Hon. FRANK CnnncH, TJ.k~I, Senate, Washington, D.C. DEAR SENATOII Onuncu: In answer to your inquiry concerning the following issues under consideration by your ~oreign Relations Subcommittee, we will answer numbers 1 and 2 together by addressing number 2, the broaçler issue, first then proceed to the remainder: 1. Possible increase in Department of State budget to collect data for future neqot~ations with Middle East countries; 2. U.S. government negotiation involvement: Atlantic Richfield Company believes the proper role for the federal govern- ment in negotiations between oil companies and Middle Eastern producing governments should be one of support and influence behind the scenes, rather PAGENO="0149" ~i45 tliaii one of dire~t neg~itiation. Thils, the U.S. government ~1iou1d act i~i support of the efforts of American companies to resist unilateral breaclLes O~ the terms of their concessions or other forms of petroleum rights in foreign countries. fl-ic U.S. government should be a "behind-the~scenes" advisor to American negotiators, with the implicit improvement in company negotiating power that this implies. The freedom of producing governments tO raise prices may be limited in the short run by political considerations. Demand responses to higher prices are beginning to suggest that over the longer run price will be limited by the availability and cost of alternative coal and nuclear energy in the U.S. and Western Europe, and the needs of some producing governments for revenues for domestic operating expenditures and economic development. Thus the United Scates government should take no action which would, over the longer term, prevent price-limiting forces from operating, but rather create conditions which would stimulate such market forces. This includes Project Independence, and strong support and encouragement of friendly countries' efforts to expand their domestic energy supplies. The history of agreements with Middle Eastern oil producing countries has been one of continued violation whenever it is in the interests of the supplying signatory. On the other hand, our tradition has made us reluctant to violate business agreements simply because they have become less favorable to us. Long-term agreements at current high prices, would likely be honored longer after they became onerous to the U.S. than after they became unsatisfactory to producing countries. Thus we should avoid entering into them, and discourage friendly consuming countries from entering into them. One function of the U.S. government, in an advisory role, could be to unify the approach by U.S. oil companies to producing governments, particularly if direct cooperation between U.S. companies is Inhibited by the Justice Depart- ment. Even more importantly, a single policy focus should be provided to insure that the various cabinet departments pursue a consistent, coordinated policy toward producing countries. Such a policy should be directly and overtly related to producing country posture in petroleum supply negotiations. In particular, the policies of State, Defense, and Agriculture should be coordinated, and track with PEA determination of domestic supply, demand and pride considerations. As far as State Department budget increases for data, we believe that the present data collection activities of Interior, Commerce and PEA should not be duplicated and that data for advice to negotiations should come to the State Department from oil companies on an "individual issue" basis. Thus we do ii.ot support additional funds for data collection by State, although we believe it would be reasonable to provide a limited number of professional analytic posi- tions to analyze available data in the above context. 3. Revisions to U.S1. ta.s laws: Atlantic Richfield Company concurs in the views stated by the American Petroleum Institute concerning the Oil and Gas Energy `Tax Act of 1974, as reported by the Committee on Ways and Means and as proposed for amend- ment by Representatives William `Green (D-Pa.) and Charles Vanik (D-Ohio). Foreign Taa' Credit HR. 14462 as reported by the Committee on Ways and Means, would abolish the per-country limitation method with respect to oil and gas extraction activi- ties and require oil and gas companies, in applying the overall limitation method, to fragment and separately determine the foreign tax credit limitation on indi- vidual segments of their total foreign operations with a special 52.8% limitation being applied to determine the creditable amount of foreign taxes Imposed on producing operations. Representative Vanik has announced hi~ intention to propose an amendment to HR. 14462, which would eliminate the foreign tax credit a~ it applies to oil and gas extraction operations and reclassify such tax payments as deductible business expense. In addition to the proposed changes affecting the foreign tax credit, current legislative proposals would elhninate the allowance fOr percentage depletion with respect to foreign operations, and terminate the option to currently deduct intangible drilling and development costs incurred in foreign operations. - The adoption by the tTnited States of any of the changes described above, will have the effect of rendering U.S.' companies and their affiliates incapable of sOcces~fully competing against the nationals of other industrialized nations to PAGENO="0150" 146 acquire and develop mineral resources needed by the United States from diverse locations throughout the world. In such an event the U.S. will become increas- ingly dependent upon foreign owned companies, including companies owned by foreign governments, for supplies to meet our energy requirements. 4. Desirability of ea~elusivity ia"buy back" of crude fro~n producing countries by a few Awerican~ oil coinpaimier: Since the U. S. government cannot dictate contract terms to producing country governments, Atlantic Richfield Company interprets this question as one of diversion of buy-back crude at the border, through allocation or some other method. We do not support such an approach. Such a strategy, or a self-imposed prohibition by the U.S. oil companies, reduces incentives for these U.S. corn- panics' overseas exploration and thus could result in a loss of business to com- petitor countries and their, oil companies. We therefore urge the continuing support of such exclusivity, which we believe also stimulates competition between U.S. oil companies in see~i~g new supply areas overseas. 5. A Strategic Reserve: The best resei-ve is a strong~ functioning domestic industry. Government aims should be first and foremost to foster that, including whatever support may be needed for economic and secu~ity reasons for coal, shale, and oil exploration in remaining offshore, areas. In terms of emergency strategic reserves~ Atlantic Richfield Company believes that domestic consumption needs in the short and mi~dle term require full development of present and potential suppl~e~~ rather ~ban diveçsion of doreestic output to reserves. But w~ also helteva that the potential may exist in Naval Petroleum Reserve 4 (NPIt4) Jo provide emergency, ~ack-up. We therefore urge the expl~ratjon of th1~ reserve to characterize the potential for such emergency supply'. Shon1~l mgjor quantities of petroleum be .jdentified, we urge that the potential of, NPR 4 then he made manifest. thropgh the government- supported installation ~of extraction and transportation facilities that would make it possible to "turn on" ~iPR 4 should `such national security conditions aS a supply, emergency warrant It. This could provide a real countervalllpg force to a potential embargo. Respectively submitted, PHIL D. IjELrxTG. AFTflR~'OON SESSION Sena~Or Cnunctj, The'1~ariñg will come to order., Our witness this afternoon is Julius Katz, the Acting Assistant Secretary of State for Economic and Business Affairs. Mr. Katz, would you stand and be sworn, please? Do you sweai~ that all the testimony you are about to give ~i1l be the truth, the whole truth ~ncl nothing but the truth, so help you God? TESTIMONY OF HON. JULIUS KATZ, ACTING ASSISTANT SECRETARY OF STATE `FOR ECONOMIC AND BUSINESS AFFAIRS Mr. KATZ. ~ sir. Senator Curmoli, Pp ybu have a prepared statement? Would you like to go forward with your statement trnd then there will be questions? Mr. `KATZ. Thank you,' Mr. Chairman. I welcome the opportunity given me to testify today before the Subcomm~ttee on Multinational Corporations regarding the biter- national petroleum industry. - `The `future role of the industry is an element of one of the most important i~ues confronting our Nation regarding the future supply of energy. There Is wid~e recognition in this country and abroad of time need to move in the shortest time possible to increase the depend- ability, of energy resources. The period of transition to expanded PAGENO="0151" 147 production of conventional resources and to new forms of energy could be a di11~Icult ones with serious implications for the political and economic stability of the world. In these circumstances it is proper that the executive branch and the Congress examine together the role played by industry and Government respectively and consider the role to be played by Government and industry in the future with respect to the continued supply of our energy requirements. t.5. POLICY ON INTERNATIONAL OIL Remedies for the existing situation- As requested ~ you, Mr. Ch~irrnau, I will concentrate today on evolving U.S. policy to deal with the international energy problem. The basic goal of our policie~ is to insure adequate and secure energy ~upplies at prices that contribute to re~tsonaMe growth and to. an iMproved environment in a~1 the nations of our interdependent wo~id. J~ ~ursuit of this goal we are now engao~ed in ~A~ree initiatives. inter- nation~Jly, we are maidng a major e~f~rt to develop a scheme for ~ooperation among coi~suming countries. ~&t the same time, we are seeldug impro~êment of, our relations with producing countries. A~t te b,ase of our internat~oial. programs, ~o~rever, are the efforts at home thrdugh Project iud~pen~,oi~ce to increase our ~eIf-relian~e tl~roughi great~r Proth~ctión and ir~iprove4 ~onseryation practipes.. These three endeavois, involvwg o~ir domestic po~icies, and our activi tie~ abroad with consurnei~ and producers, are interrelated and are ciosely coordinated. For much of the past year, our concern wa~ with the adequac~i o~ Qil supply to meet our own requirements and that of the world econ~my. Tl~is remains a concern ovçr the long term, but it has been over- shadowe~ by a more immediate problem created by the fourfold in- crease in crude oil prices of last year. These price increases posh ~ serious challenge to the world economy. All oil importing countries face an adverse impact on their general price structures, balance çf payments, industrie~l output, and employment levels. The situation of the poorer countries is particularly acute. The additiohal cost of th~ir energy imports will exceed the official development ~issistance they are now receiving, and threatens to reverse their eeonornic gains in recent years. Some o~ the oil exporting countries, too, will find their develop- me~t aspiratidns eroded a~ high 0il prices feed global inflation. In today's interdependent world, no, country, even one self-sufficient in oil, could escape the effects of general economic and political u~- stability. Baked on this asse~srnent and the conviction that concerted inter- national action was ~ssentia1, the, President took the initiative in in- ~iting the world's ~3 largest energy donsumers to attend the Wash- ington Energy COr~ferençe in February of thi~ year. Twelve of the in+ited nations agreed to work to develop a cooperative program to deal with the problem. Intensive work has followed, centered in a body called the Energy Coordinating Group. Four meetings of the group have taken place and a further meeting is scheduled for the middle of this month. )Vhile I cannot today forecast the conclusions which are likely to be reached, I can say that solid progress has been achieved in developing a consensus on measures to be taken internationally. PAGENO="0152" 148 Working groups have produced proposals for cooperation in the related areas of conservation and demand restraint, accelerated de- velopment of conventional energy resources and measures. to deal with supply interruptions. The Energy Coordinating Group is also seeking to develop cooperative programs in the fields of energy research and development and in uranium enrichment. The group is following closely and coordinating views regarding the financial implications of the energy problem being discussed in the various international finan- cial institutions. The coordinating group has considered in some depth the possibility of joint consumer/producer meetings and has discussed a number of the issues which could be raised in such meetings. Finally, the group is also considering the role of the international oil companies. The sense of urgency and serious purpose displayed by the governments participating in the Energy Coordinating Group reflects a deep commitment to bring to a successful conclusion the work begun at the Washington Energy Conference. * Secretary Kissinger personally has carried our message of inter- national cooperation to Latin America. Our views have been made known to interested governments in all continents. The responses we have received have been on the whole positive and we are encouraged to press ahead. At the recent UNGA [United Nations General Assem- bly] special session on raw materials and development we and other consumer countries had the opportunity to make known our views and to initiate a dialogue between producer and consumer countries which we expect will continue. While ~e are working to develop multilateral programs of coopera- tion, we are proceeding to improve our bilateral relations with oil exporting countries. We have indicated our willingness to expand and give more concrete expression to cooperation in the fields of economic relations, including technological and industrial development, and defense relations with the world's largest producer outside the United States, Saudi Arabia. As you know, Mr. Chairman, talks are going on today and tomorrow in Washington between Ministers of the Gov- ernment of Saudi Arabia, led by Prince Fahd, and American officials, led by Secretary Kissinger. Let me state clearly and unequivocally that these discussions are not directed toward seeking bilateral oil deals. What we are seeking are ways of increasing cooperation across a broad spectrum of relations with Saudi Arabia in the belief that in so doing our mutual interests and those of the rest of the world will be served. We are prepared to increase cooperation with other oil producing countries where there is mutual benefit. We regard these efforts as fully consistent with the multilateral cooperation agreed to at the ~Washihgton Energy Con- ference and now being developed by the Energy Coordinating Group. The importance of Proiect Independence to our international oil policy does not require elaboration. The successful implementation of a balanced program of greater self-reliance will contribute substan- tially to our nation~il security. For this reason the Department of State endorses fully the ~ôals of Project Independence and is cooperating with other agencies in its development. PAGENO="0153" 140 ROLE or THE PEPARTMENT OF STATE You have asked me to outline the role of the Department of State in future negotiations on petroleum matters and to assess the coordina~ tion of energy policy within the administration, Secretary Kissinger ~nd the Department have played a leading role in developing and carrying out the initiatives to improve cooperation with consuming and prbducing nations. As I stated, we are also contributing to the development of Project Independence. In all of these efforts there is a high degree of cooperation among various agencies of the executive branch. Overall leadership of our international efforts is provided by Sec- retary Kissinger. Details are coordinated within the Department of State and the National Security CotinciL In addition, there has been active participation by officials of the Federal Energy Office, the Treas- ury, Interior, and Commerce Departments. The AEC [Atomic Energy Commission] and EPA [Environmental Protection Agency] are also intimately involved. The problem has been much less one of coordina- tion than of the complex nature of the issues involved. The Department of State will necessarily continue to play a major role as we move toward the goals we have established. THE ROLE OF TIlE COMPANII~S One of the most striking characteristics of the situation in which we find ourselves is the major change which has taken place in the role of the major international oil companies. Over a relatively brief pe- riod, the companies have lost or appear to be losing a number of the elements of the pre-em~nent position they have occupied in the world oil industry. The g~o~rernments of the prodi~cing countries have taken advantage of a basic shift in the world supply/demand balance for oil and have assumed virtually complete control oVer both the level of production and prices. The equity holdings of the companies in the Middle East are diminishing to what now appears 40 percent or less. Thus,, the companies appear to be moving increasingly toward a relationship with the producing countries in which they are engaged primarily in exploration and production services. This shift in decisionmaking power from the companies to the pro- ducing country governments has called into question some of the basic assumptions underlying consumer government oil policies. Given the fact that the companies do not presently determine the level of pro- duction or of price, consumer governments are questioning whether they can rely on the major companies as the sole suppliers of oil. At the same. time, the apparent disparity between rising oil prices and increased company profits has sparked demands for more Government control over the operations of the companies, or at a minimum, more public knowledge of these operations. We are now actively considering~ this question of the role of the companies in the Energy Coordinating Group. In cooperation with the other group members, we have tried to assess the future role of the companies and are in t\ie process of making recommendations as to PAGENO="0154" 150 the type of action or actions which might be taken. The `United States has expressed its willingness to cooperation with the other ECG countries in the exchange of information on the operations of the companies which will be used to assess the equity of allocation and pricing policies. The diminished role of the companies has, not surprisingly, led various consuming country governments to rais~ the issue of the extent to which they should now become directly involved in the oil industry. It seems inevitable that consumer gover~iments should and will be- come more directly involved in the oil industry. The problem is to define what this role should be. The ultimate character of the relationship between the companies and the producing governments~ i~ still not clear. The situation con- tinues to evolve, and we should be very careful about taking actions which might adversely influence its outcome. F~r example, I think it is likely that market conditions could again develoj~ so that companies might regain some of their former bargaining power over the price at *hich they will buy oil from the produce~s. At the same time, the oil companies ~contiijue to provide essential s~rvices in finding, p~oducing, shipping, rethuing, and distributing oil. These are services which we and all other countries will continue to require for the foreseeable future. We should take care that we do not unnecessarily impede the companies ~bility to provide such es- sent~ial services~ To do so could have seri~u~ adverse irn~act on our ~ future energy supplies, ~nd because of jthe eorftinulng importance of the international Q'l industry,. the ~nei~g~i supplies of the larg~ wQrld market, S~iuiilarly, we shbuld b~ ca~eful not to reduce that c0ni- petition which exists among the roalor cQmpanies This competition operates to the beuieftt of the con~umer, and it should be~ preserved. I do not think we should b~ under ar~y illusioi~s that d,ii~ect ne~otia- tion~ between consumer and pr~oduocr ~oyernment~ o~i the terms under which oil would be supplied might not create at least as many prob lems as they would solve The eo~'upanies have served and continue to serve a yery useful rble as ~ bultei betweer~ govei~nments, and to a, large extent help to insulate the oil mari~et from ptirely j?dl1~Ical consideration~., A more fundamental question arises from the faet that the tnited States is still committec~ to a market economy. It `may be true th~t the oil market operates imperfectly. But we should be very careful iii taking ahy actiou which might fundamenta~ly alter the present market orieflthtion of the oil industry. A market economy ~riay not be perfect, but~ like democracy, it seems preferable to the alternatiyes. A situation in which governments are negotiating directly on price and supply might permanently preclude any reduction in price brought about by the market forces of supply and demand. We should not now lOck our- selves into a system which forecloses the possibility of benefiting from a shift in the supply/demand balance and lower prices. That concludes my statement. Mr. LiWINSON. Senator Church asked me to receSs for a few minutes until he can get back, There is a vote on. [A recess was taken.] PAGENO="0155" 151 Senator CASE [presiding]. Mr. Katz, I am sure that Senator Church will be back shortly from the vote. I think he would like me to start again and in the interest of time, for all of us including yourself, I shall be very happy to. You finished your statement, I understand? Mr. KATZ. Yes, sir, I did. Senator CASE. I read your statement during our lunch. I think neces- sarily it is in pretty general terms which, of course, is understandable~ but I wonder if you could tell us rather more specifically just wha our position is now, what assurances have we given to our European friends, for example, and Japan~ about what we will do in the way of sharing if there is another squeeze. SEARING OIL SUPPLIES Mr. KATZ. Well, I think ~he statement that is most pertinent is the statement which was made by Secretary Kissinger at the opening of the Washington Energy Conference on 1~ehruary U of this year, and if I ~an recall it, I think that what he said was that as a part of an overall arrangement on energy we would be willing to share oil sUp- plies in emergencies if other countries with indigenous oil supplies were prepared to do the same. What we have been doing actually since that time has been to develop a program dealing with emergencies, havii~ig in mind npt merely the sharing of oil, but other measures that would be take4 to ,de~l with emergencies of any kind. Senator CASE. Do you have ~ current pàsiti9n on thi~ ~ Mr. KATZ. Yes, sir, our current pbsition is to ~ry to develop a pro- gram. Let m~ ,expl~in. We do no~ haye in uiind an arr~thgernent ~li~ch merely involves the transfer Q~ ~o~1 from ~ 4Uiiited, St~te~ to o±her countries in the event of an ~mer.gency. What ~ are ~e~k~ng is an a~rrangement among a nunl~r of ~owiti~i~s WhIch iuvoJye~ ~ iiumb~ of elements to deal with an em~rge4cy. Allocation of oil would be. one elem~nt of thi~ progi~m. This is a subject which has been considered fri the OECD ~Organiza- tion of Economic Cooperation, and. Development] ~s, well a~ in the ~nergy Coordinating Group. It is g9iñg oh ~1multaneously witksOthe overlap of countries. , , . , , . . Senator CASE. ITa~e you got any~vhere? , Mr. KATZ. Yes, we are making very good~progress. We do not hav~ a final result at this point but are still: in the developing process. Senator CASE. This is not limited to the allocation of petroleum but it includes it? Mr. KATZ. Yes. Senator CASE. Does it include, for example, individual countries production being part of the pie, ourS and others? Mr. KATZ. Yes, in our conceptiou it would involve supplies of oil which are on hand and which will be developed including stocks. It would include conservation measures, production, and oIl available in trade. PAGENO="0156" 152 POSITION OF ATOMIC ENERGY COMMISSION Senator CASE. There was a meeting of the energy group in Brussels of which I have heard some comment about Dixie Lee Ray's position. I wish you would comment on what she said. There was a suggestion there was an ambiguity introduced in the U.S. position by that. Mr. KATZ. I am sorry, Senator, I cannot identify that. I do not know what the context is. Senator CASE. Is this the first time you have heard of it? Mr. KATZ. Well, I do not understand specifically what statement is being referred to and what the ambiguity was. It has not been in connection with this subject. Senator CASE. Has not? Mr. KATZ. It has not been in connection with the subject of dealmg with emergencies. To my knowledge, she has made no statement on that subject. Senator CASE. Have you heard any discussions at all of Mrs. Ray's appearance at Brussels? Mr. KATZ. Well, I was present when she was present and I have been present at all of the meetings she has attended, I believe two meetings in Brussels. Senator CASE. You do know in general what went on and the re- actions there may have been to her appearance? Mr. KATZ. I am not aware that there were any reactions. I am aware that she was there. I was there at the same time. She made a statement. Apparently, Senator, there is a suggestion of something, that was controversial. I am not aware of anything that led to any controyersy or any particular ambiguity, Senator CASE. Well, this is very important, it seems to me. The sug- gestion was that something Mrs. Ray had said or the totality of her statement had detracted from the Secretary's former statement. Mr. KATZ. On the contrary. I am not aware of anything that Dr. Ray said that detracted from anything Secretary Kissinger said or anything that had caused any reaction other than a favorable reaction. Senator CASE. I am not making a charge. I am trying to find this out. People tell us things in general terms. We have to try and pursue the matter as best we can. I have nothing further to tell you than that~ Mr. KATZ. I am sorry, I just cannot- Senator CASE. If you were theie, and it is not a great group and there was some interest among m~mbers and discussion among repre- sentatives of different governments, presumably you would have heard something. Mr. KATZ. Yes, I would expect that I would have. Senator CASE, And you are not aware of anything else that Mrs. Ray may have said apart from the Brussels meeting on this subject that would suggest she did not fully support the positjon of the Secretary? Mr. KATZ. No, sir. Senator C~ ~E. You are not aware of any such thing? Mr. KATZ. No, sir, I am not. Senator CASE. Or of any other agency in our Government? PAGENO="0157" 153 Mr. K~rz. No, sir. I mean on an every day basis obviously, there are differences in details in-- Senator CASE. O~ course. Mr. KATZ [continuing]. In approach. But nothing that I would characterize as being a rn~jor difference m approach or policy. Senator CASE. As far as the Department itself is concerned, and the Secretary is concerned, he has not backed off? Mr. KATZ. No, sir. We continue to regard the subject of interna- tional cooperation' in energy and the specifics of the Washington En- ergy Conference intiative as one highly important to which we have devoted a great deal of time and resources. Senator `CASE. The man who was here this morning testifying for- TAXATION OF TIlE OIL COMPANIES Mr. KATZ. You must mean Mr. Tavoulareas. lie was here this morning. Senator CASE. Mr. Tavoulareas seems to feel that the U.S. oil com- panies can live with a 10~percent minimum tax on their international profits if it applies to foreign based oil companies too. Is there any project under discussion or either with other governments or within our own that you know about on a possible international tax treaty with other consumer countries to coordinate fax policies? Mr. KATZ. Not to my knowledge, Senator. It is possible that tho officials of the Treasury Department have consulted with other govern- ments about tax matters hilt if they are, I am not aware of them. The question of taxation has not arisen in our conversatiáns on energy except very recently, that is, within the past 10 days or so, in con- nection with the reports that OPEC is considering raising the tax rate. `That comes about, in part, because of a recommendation from a coin- mittee of OPEC which has referred to discussions in `consuming coun- tries about raising taxes. The statement has been made that, if there are excess profits and if they are to be taken, they would prefer to have them themselves rather than go to consuming countries. `There has not been discussion in the Energy Coordinating Group or else- where that I am aware of, of a tax treaty among consuming countries. Senator CASE. I was wondering whether this might not be some- thing at least that might be explored. I do not know if it would be useful or not but there is quite a variance between our tax rates and other consuming countries~ tax rates which might have some bearing upon an equitable sharing, for example. I just wonder if that might not be explored usefully. Mr. KATZ. I think it certainly could be and I suspect it will be now that the question is raised. Senator CASE. Has anybody raised that point, that is, taxation on the oil companies, any of the other countries in this connection? Mr. KATZ. No; not in any specific way. Not in the course of our discussions. Senator CASE. If it occurred to the producing c9untries maybe it is a little something to be grabbed here, I would think maybe some of the consuming countries might have done that too in light of the rather large increase at least for the short term. PAGENO="0158" 154 * Mr. KATZ. Of course. There has been discussion in a great many countries, in a number of consuming countries with particular refer- ence to recent reports of profit levels. This, I think, has stimulated interest in the producing countries in raising taxes. What I am saying is that the issue of tax levels, particularly tax levels in consuming countries, has not been raised in any group meeting of consuming countries in relation to the oil industry of which I am aware. Senator CASE. Put it around this way maybe. `This is what I am really trying to get at; not just the question of `taxation. Is there among the other consuming countries ~ny concern about the continuation of the whole international oil industry operation? Mr. KA~Z. Well, `as I in~licatèd hi `i~iy statemënt;Senator, there are a number of concerns that have been voiced. Senator CASE. You we~e not ve~r specific. Mr. KATZ~ Well, perhaps not, althot~gh what I was perhaps imply- ing rather than expressing explicitly was that the change that h~s taken pJa~e in the roJe of the companies in producing areas has giveii rise to cth'responding, questioi~s and issues about their role in consum- iug countries. For example, they are losing their equity interests in producing, countries and access to production, somp of these new arrangements provide that the producing countrie~ themselves will be marketing considerable quantities of oil. How then can consum~n~ countries be assured of meeting their supply req~uir,ements? So the question of security of supply has arisen and that is one of the issues. The other one is price, particularly in the face o~ the enormous price increases that have taken place in the last y~ar which have not been negotiated between companies and producing governments but have been imposed by the producing governments. The question has arisen that if the companies are not dealing with price should consuming governments be dealing with the producing governments? This is an issue that we have discussed in the `Coordinating Group. Particularly in connection with the possibility of a meeting between consumers and producers. Is price something that we should sepk to negotiate. Now there are different views on that, frankly. WI~[AT IS THE STATE DEPARTMENT'S POSITION? Senator CHURCH [presiding], Mr~ Katz, I do not mean to be disre- spectful of the Department, but I must say that this statement the' Department `ha~ presented through you remthcls me of a penitent at a confession. There just is nothing in it,, It would bp, refreshing if the~ Department has' no policy, just to come up and say so. I really do not think you have got' a `poliCy and' there Is nothing in this statement you have madp that would lea~1 me to be~ieve Otherwise.' You say there' are various questions being examined and various consultations going' or~, That is about it. I am concerned. We have had hearing after hears lug for the' whole of the past year, much of our tithe has been examin- ing the role of the oil companies in the Middle East, and all of the testimony tends to. bear out the `same conclusion: that, this is nothing new in the State Department, the State Department has never had any petroleum policy and has abdicated the responsibility for devel- oping one to the big oil companies through the years. PAGENO="0159" 1~5 Now, if that is going to continue to be the policy of the State De- partment in the face of the present shambles, well, let us say it, and put it on the record. Then, at least we will know where we stand. I think, however, it would not be a very prudent position for the Department to take since the companies themselves have admitted they have lost all of their clout, they have no further leverage, and since oil prices are the largest single factor in this runaway inflation. Some- where in this Government there has got to be a policy. We had Dr. John Sawhill here and he is groping for a policy. We asked him if he thought the Congress could supply some additional legislative authority, if that is what is lacking, and then we made ~ome suggestions. Ille agreed that one good thing would be to supply legislative authority requiring the oil companies to keep the Federal Government fully and completely advised on ongoing negotiations and permit the Government to take part in those negotiations, at least be thle to play an advisory role. Second, be said he would favor including in such `a bill authority for the Federal Government to approve, that is, require the approval of any settlement on oil prices by the Federal Government before the agreements between the oil companies wnd these various forei~i governments could take effect. Now, are you prepared to say how the State Department would view a bill of this kind in the light of Dr. Sawhill's endorsement? Dpes the State Department have `a position on this proposal?' TuE STATE DEPARPMENP'S t'otaor Mr. KATZ. `Mr. Chairman, may I first state that I regret that you did not find my statement satisfactory or responsive to your concerns. I would like to respectfully say, however, that I do not agree with your statement that we do not have a policy. Now, you may not agree with our policy but we do have a policy. Senator CHURCh. What is it? We have had 11 pages of presenta- tion which `does not even give us a hint of what it is. So if you have a policy, what is it? `Mr. KATZ. Well, I thought I spelled it out. But if what you mean by `a policy is our determining prices or determining precisely what private companies do in relation to the oil business, that is not our policy. `Our policy is to influence price levels, which we think ate too high, through `a combination of conservation or demand restraint and increasing production. We think that the remedy to prices is not a price agreement or price controls, but influencing' the supply and demand balance and letting that take place in the'marketplace. You may not agree with that policy but that is-~--~- Senator CHURCH. I do not foilow~ ~what yon are saying. Where do ypu propose to increase production? `Over here? Is t'hat the policy? Mr. KATZ. We would like to see it increased here because our domes- tiC policy is to increase our self~sufficieney. We Wduld like to see pro- duction of energy-oil in particular, but all forms Of energy-ex- panded everywhere. The price level is affected by what happens in the international market and we would `like to see the world balance shift in a more favo~rable direction. PAGENO="0160" 156 Senator (~rn5RcH. This portrays, it seems to me, a lack of familiarity on the part of the State Department with the oil picture. It has been endemic through the years. We have had all kinds of expert testimony up here for months now to the effect that there is not a shortage today in the world supply, that the shortage was created p~lit'ically for political reasons, an embargo was imposed for political reasons, the price went up 500 percent in less than a year for political reasons. None of this is related to the economics of oil at all. Mr. KATZ. I do not agree with that. Senator CHURCH. You do not agree with it. You are putting yourself iii a position contrary to the best expert testimojiy we ean get. Mr. KATZ. I do not think, Senator, with all respect, that that is a correct reading of testimony that I am aware of. We have had a situation for several years with very rapidly growing demand for energy, largely in the tinited States. Our own jemancl, growth of demand has been very rapid in recent years and it has been rapid in the world as a whole and we have not had the increases in supply required to deal with this1 If I may explain. Senator CHURCH. Our growth of demand has gone up 30 percent because of the shortage that has develop~d on the scene, is that your position? `Mr. KATZ. May I explain, I would like to carry this through. We have seen the situation coming for several years and there have been a number of people, and people inthe State Department have been in the forefront, pointing out the growing problem that we were facing. We, have seen what has happened to the price `of oil in the last several years. We have seen the ability of producers ~n the margin, not so marginal, but some of the smaller producers-~-to upset agreements arrived at with governments. This culminated in a situation with the outbreak of the war last fall and an embargo coming on top of that situation-of panic in the world with people paying unbelievable prices up to $22 a barrel for oil, `and against that background a general increase in the price level. This is not a situation which arose suddenly last October. It has been developing over a period of years. It is not going to be remedied in the space of 1, 2, or 8 months or even 1, 2, or 3 years. it requires a basic change in energy policy in this country and in the policies of other countries around the world. We do have a policy and the policy is directed toward meeting this basic imbalance in supply and demand, and this supply/demand `bah ance will be the primary determinant of prices, whether the Go~tern- ment negotiates price agreements with producing governments or whether international oil companies do that. Senator CASE. Is that not a factor? Is that not an impossible ap- proa'ch to this situation? Mr. KATZ, Yes, it is, and it is a view that some people hold. The view is that if we as `a government together with other governments sat down with OPEC, we could work out an agreement on prices. Senator CASE. May I just make my question a little hroader~ please? It not a question of prices, it is a question of how much are we going to be subject to a holdup or blackmail trying to affect our PAGENO="0161" 157 domestic policy or international policy in other matters, our position with regard to Israel, for example, specifically, but on the broad ques- tion of whether this country is not without resources either if it wants to use them. Have you any comment on the possibility of our use of our enormous resources in such a matter as this-and I wish you would talk about that rather specifically. I am not urging now that we hold back wheat and corn and agricultural produces from the rest of the world until we get a fair shaie here; but is it not possible that we do it? Mr. KATZ. There are a nuniber of possibilities. I have never thought that kind of approach would particularly work unless it included all of the consuming countries of the world against all of the producing countries of the world. Even then, it probably will not work because of the producers indigenous resources, their ability to tighten belts or because of leakages in the system. The fact of the matter is that the world needs considerable volumes of oil at the present time, some 45 to 50 million barrels per day which goes into world trade. We found in the recent crisis that we could do with less with more or less inconvenience. We are finding, at present high prices, that we are doing with less than we thought we could a year ago. The point is that general confrontations of this kind are not the way to solve the problem. The way, in our view, to solve the problem is to change the balance. We have to do something about our growth of demand and get that nnder control and do something about our own indigenous production which has considerable potential. EFFECTS OF THE OOTOEER WAR Senator CHIJROJi. With respect to that balance, D~would like to get back to dome of the testimony we have had just within the last few days on this question. We had two of the chief executives of the oil companies in here this morning. One of them, Mr. Coilado, said it is true the political events of the past few years have, in particular the outbreak of the Israeli-Egyptian war of October 1973, resulted in drastic shortage of oil and sharp increases in price. And his colleague, Mr. Tavoulareas, said: It was only In the fall of 1973, coincident with the outbreak of the fourth Arab-Israeli war, that the Middle Eastern producing countries took united and unilateral aCtion which brought on the first unmanageable crisis in the supply in the free world since World War II. We had just recently a letter from Mr. McCloy, who represents all of these big companies-and this must be the most important client that any lawyer ever had-and he is speaking for all of the members of the committee, and in spite of attempts to obscure it, the fact is it was the October war of 1973 and the immediate events and policies leading up to it which, by triggering embargoes, cutbacks, and price escalation by the producing countries, became the direct and proxi- mate cause of the recent and continuing scarcity of oil supply to the Middle East and North Africa and at greatly inflated prices. Mr. KATZ. That is not inconsistent with what I said. Senator CHURCH I find it very inconsistent with the ~ hole thi ust and general tone of your argument 4d-426- 7--11 PAGENO="0162" 1ö8 Mr. KATZ. Well, it is not, Mr. Chairman. Senator CHURCh. The character of this crisis has had everything to do with the present price. Mr. KATZ. I think there is no question that the war and the events which surrounded and followed the war had a- Senator Ciiuncn. Surely. Mr. KATZ ~[continuing]. Worsened this problem by several- Senator CHtmCH. It created it. Mr. KATZ. It did not create it, it worsened it. Senator CHURCH. I beg your pardon. I would say create. If you look at the mathematics it is true that the price was going up prior to the war. We pointed that out in this committee. The producing coun- tries were leaning very heavily on the companies and pushing the price upward, but when you compare what the price was before the war and' what the price became afterward in a 4-month period, you can see 400 percent is an entirely different baligame and that political- Mr. KATZ. Almost 200 of that came before the war. Senator CHURCH. The price- Mr. KATZ. It was a doubling of price. Senator CHURCH. The increase in price was directly connect~d with the events immediately preceding and following the war. Mr. KATZ. There was a 100-percent increase. There was a doubling of price in October at the time the war broke out, but the demand for the increase was made almost simultaneously with the outbreak of hostilities at a meeting in Vienna. In December there was another doubling of price. WHAT ROLE SHOUT~D GOVERNMENT' PLAT? Senator CHURCH. Yes. The point is that the tremendous escalation in price took place in the period that immediately preceded and fol- lowed the war, imposition of the embargo. All of this was political in character, it is not a result of the economics of oil. The present price is not really related to the economics of oil. None of the testimony bears this out. So I think the State Department has to take that view of it, too, and the question that I want to ask, I get back to the question you have not answered, is the earlier one that I put to you-and the same One I put to Dr. 5awhill. If the companies say they have no clout any longer, is there a role for the Government to play? Dr. Sawhill said yes. He thought we needed legislation that would give the Government a role to play in the negotiations, an advisory role, and also would require governmental approval of any long-term contract that is entered into between the companies and these foreign governments. Now, my question to you. Do you disagree with Dr. Sawhill in his position or does the State Department have a position in connection with this policy that you say you have formulated? Answer that question. GOVERNMENT APPROVAL OP PRICES Mr. KATZ. We have not specifically addressed the issue of approval of prices. I can see many reasons why we would not want to be in a position of approving prices. We have had some recent experience in PAGENO="0163" 159 that in Government and in this country. I do not think it was alto- gether a happy experience. Now, we can put a ceiling on oil prices. We can put a ceiling on the import price. We have a ceiling on domestic production today. At least for some large part of our domestic pro. duction. Incremental production is decontrolled but old productior~ continues to be controlled. We can put a ceiling price on imports but that will not necessarily insure that we are going to get any oil. Senator CHURCH. I understand that and I do not mean by my ques- tion to imply that the Government approval should relate to price alone. It may not even take price into account. But there are other things in an agreement that will affect the national interest about which the Government might want to take a very firm position and as it is now, of course, the Government simply is not involved; this is left to the companies and the other foreign governments. We have sort of a practice of leaving these things to these big multinational companies. If there was any merit to that practice in the past, it seems to me it would have evaporated as of the present because the companies them- selves admit that they have no further leverage with these govern- ments and it is clear that at least to a very substantive degree the present price is politically established. So that being the case, it seems to me we have to review old policies and think anew about our new situation. Mr. KATZ. I thirtl~ that is absolutely right. The fact that companies are not in a position to negotiate prices at the pres~nt time most cer- tainly leads to the question of whether governments should assume this role. It is a question which has been raised not only in this country hut in other countries as well, as I have indicated. The answer, however, as I have also indicated, is less clear and that is not to say that We do fiot have a policy. Our policy at this point is not to do that. It is not our policy at this point to ilegOtiate prices intergovernmentally because we do not know at that point that we bring to the bargaining table more than what the companies do. Senator CASE. `There are many things you could bring to the bar- gaining table. I suggested some of them before. I am not urging them but I am throwing them into the pot. Another thing might be an agree- ment with all consuming countries, the big ones, that none of them~ would pay more than a certain price. Mr. KATZ. That is an approach but I do not think it is one that we~ have considered to be feasible or negotiable. We can certainly as a~ Government bring to bear instruments of national power, some that you indicated, Senator, and there are some others, too. Senator CASE. You are faced with national power on the other side. This is not a normal bargaining situation. It may not be very strong but so long as this country is not prepared to march in with the Marines or anything else and take over these properties and the rest of the Western wOrld is not, then they have got just as much national power in the operation as anything in the world. POWER OF MONOPOLY Mr. KATZ. There is monopoly power or at least a large element of oligopolistic power on the other, or there are elements of that power PAGENO="0164" 160 on the other side arid they are saying well, if you want our oil you can have it at this price. Now, surely we can attempt to deal with that and say well, either we will not take your oil at that price, but that has other consequences, or we can invoke other policies, but it is our view that that is not a useful way to proceed. Senator CASE. It obviously is not necessarily useful to have half a dozen small countries accumulate hundreds of billions of dollars that they cannot spend usefully and which are ruining other countries and reducing the world economy to a shambles and including the monetary system of the world either, and I just wonder whether the time may not come when these unacceptable or unattractive and untraditional kinds of approaches may not have to be used in the situation which is in itself without precedent. Mr. KATZ. That may well be but we think we have a better way and we think--- Senator CASE. That is what we are trying to dig out Mr. KATZ. OK, that is what I have been trying to say. We think we can affect the supply/demand balance in the short term and in the immediate term and in the longer term by the domestic policies that we pursue in conjunction with the policies pursued by other major importing countries. We think we can also do it in our general rela- tions with producing countries, and I will say that in the immediate situation ahead we see the possibility that there can be some softening of the prices and some reversal of the present situation. NEW PROGRAM FOR SAUDIS Senator Cutrncrr. Well, I notice that in the paper here just recently we have been told we are getting all kinds of new programs going for Saudi Arabia. "United States has agreed to reequip and begin training Saudi Arabia's most politically and fastest growing military force, the Na- tional Guard. "Saudis to get U.S. arms. United States and Saudis act to develop multiple ties. United States and Saudi Arabia to strengthen economic and military cooperation." Everything is going on in the way of opening up new aid programs with these countries. I am certain that the arms sales and so on will involve concessional terms. It seems to me the State Department is not a bit hesitant in laying on these programs and yet extremely hesitant even to suggest that something might be done in return in obtaining a price of oil. Y~u say that is not the policy and you do not think it would be productive ~? Mr. KATZ. I want to be clear on this. It is not our policy to enter into, at this point, at least, to seek to enter into a price agreement. That is not to say that we have not raised the question of prices. We have made it very clear that we consider the present level of world oil prices to be much too high with very serious consequences for the world's economy. Mr. LEVINSON. Is there not an air of unreality about all of this ~ Here you have a high level Saudi delegation, lunching at the White PAGENO="0165" 161 House, a working group, and you are telling us on page 6 of your statement-let me state clearly and unequivocally-these discussions are not directed toward seeking bilateral oil deals, we are just intei- ested in deepening our relationship with Saudi Arabia. We are not interested in deepening our relationship, with the Saudis because they have a lot of sand but because they have a lot of oil. Is it not totally unrealistic to consider this in some antiseptic way? These deals with the Saudis are related to the fact they have the oil and we want it for ourselves and for our allies. Now, what is wrong with admitting that there is an explicit linkage? Mr. KATZ. There are a lot of things that I would regard as being unreal, but I do not find that situation being at all unreal. I think it is the real world. It is clearly in our interests for all kinds of reasons having to do with oil and energy policy, having to do with political stability in the Middle Eastern area and military stability as well, for us to expand and deepen our relations with Saudi Arabia. What I wanted to make clear in my statement is that we are not entering into an oil for arms or oil for industrial equipment or an oil barter deal. That is not our policy. We think that would be had policy. We have objected to it when other countries have done it and we see no point in doing it ourselves. Senator CASE. It is very difficult to argue with someone who is so darn decent about matters like this. Maybe I take it what you are saying, partly, things like this you do not talk about except in terms that are acceptable to world sensibilities and the sensibilities of the people you are dealing with. Actually, you use whatever methods are appropriate to the circumstances. We will leave it at that. I will be satisfied for the time being so long as we continue to get results and do not have entirely a one-way street. I cannot imagine countries of Europe getting together with us on an agreement not to pay more than a couple dollars a barrel. Once they began to get cold those governments would be out of office. Some- body who came along and said I will deal with Faisal directly if we get your oil would be the next government. This is perfectly under- standable in the real world, too. I am sure it is one reason why France, for instance, would not go along with any kind of a joint operation that we tried to get going here. Jobert would not sign on February 12. He was thinking about this. DEALING EFFECTIVELY WITH OPEC All I think what Senator Church and I are saying-Senator Church is always more rough than I am-P-that the people of this country also are not going to consider our Government is dealing effectively with the situation with the tools that we have that are not also used and that other sources are not being employed. If we are going to have an economw war, in that economic war and sensibilities are proper and reasonable, dealings are proper~ especially by the big guy against the little guy, we are not necessaHly the big guy in a situation like this unless we employ or are willing to employ the resources which we have, and I do not mean in a rough way, I just mean a down-to-earth kind of way. In the short term I am sure there is enough oil to go PAGENO="0166" 1~2 around but in the lopg term there is not, and. if all the energy sources w~ have now are going to be adequate to take care of the e~pedentia1 rise in dei~iand, ~e have to get going On that~ There sire ma~ny things but i do want to emphasi~e that the people must haye confidence in a government as thoroughly aware of interests of the conntry are as well as the interests of internati~nal politics thaybe and that they are being taken care of. Otherwise, we will ~ot be able to itiaintain a Govei~nment in this country eithci'. Mr. KATZ, Surely. Senator CASE. If there are tio other 4uestions, I have to go, but if I may leave you to the tender mercies of these gentlemen with the assur- ance that you may quit anytime you want to because you have no obli~ gation to he here unless a Member of the Senate is here. I do have to leave and Senator Church a~ked me to close the hearings except fo~ questions the staff may have. AGREEMENT AMONG CONSUMING NAT~ONS Mr. LEVINSON. There are two subjects, Mr. Katz. (1) Mr. Collado emphasized again and again when he testified this morning and said, Exxon felt that it was the function of governments to allocate in the purchase and not the function of the companies. The fact is that the companies had forced the allocation function, with the consequence of failure, to have government deal with this issue if we have another oil embargo and Sheik Yamani said that is a possibility. In the event political events do not move consistently with Saudi Arabian desires, will we be in a position to have an agreement among governments or will we still be dependent upon the companies as allocators? Mr. KATZ, Well, it is our objective to have a policy, to have an international arrangement which would not leave tbis task in the hands of comnames~ Mr. LEvIN5ON. You do not now have such an agreement within the energy action group? Mr. KATZ. No. Mr. LEVINSON. Do you have any idea when you are likely to have an agreement? Mr. KATZ. I cai~not predict that precisely. This will depend on the evolution of the general program. Mr. LEVTNSON. Now, since the companies did perform this function, have you made, or has the State Department made any effort to deter- mine, and acc9rding to what criteria, decisions as to who gets what and how much? Mr. KATZ. Well, I do nOt know that the companies perform that functidn in the se~ise of an international function. They perform it, I assunie they perform it in tei~ms of their o~rn cothpanv inter~st, Mr. LRVIN~o~T. Do we know how thu~h oil was diverted to the United States, if any. during the embargo period? Mr. KATZ. I could not tell you right now. I think Dr. Sawhill ~spoke to this yesterday and I prefer to leave the answer- Mr. LEvIN50N. He said there wa~ no diversion. Do you agree with that? Mr. KATZ. I prefer to leave this to Dr. Sawhiii. PAGENO="0167" 163 Mr. LEVINSON, No significant diversion? Mr. KATZ. He~has the statistics and he can judge th~t bet~ter than I can. Mr. LEvINSON. He stated that they were in the process o~ g~ting such statistics. Mr. KATZ. I have no independent statistics, Mr. LEVINSON. So the State Department has not made any attempt to get such statistics? Mr. KATZ. The Federal Energy Office is. the- Mr. LEVINSON. Mandated to carry that? Mr. KATZ. Yes. We are not seeking to duplicate t~t function. Mr~ LEVINSON. Thank you. I think Mr. Blum has a few questions and then we will close. TILE APQ Mr. BI~txM. Our record shows that during the 1960's when the oil companies had very serious disputes with the Shah of Iran the State Department knew the essential facts as to how the APQ [Averaged Programmed Quantity] worked, This is the formula for overlifting in Iran, and further, the record shows in 1971 during the negotiation, the Department had no access and did not even ask to see the company cable traffic with respect to the negotiations in which it became embroiled. how can the Department make policy without access to that kind of information as a mattei' of right? Mr. KATZ. I do not think it is necessary for us to have access tO the cable traffic, so long as we know what the contents of the negotiations are. I cannot speak to the situation in the 1960's, it was before my time. I would not agree that we did not know what was. going on in 1970 and 1971. LEGISLATION REQUIREMENTS OF STATE DEPARTMENT Mr. BLUM. Would the Department have any objection to legislation which would grant an Ambassador on the scene access to such cable traffic? Mr. KATZ. I do not know what on the scene means. Mr. BLIJM. The Ambassador in Iran, ~he Ambassador to Saudi Arabia. Mr. KATZ. No; I obviously w~uld not object to hai~ing that author- ity.~ I dQ not feel particularly deprived hi not having it now so long as I feel confident about the facts. I, do not ~el that I need to se~ every single company telegram to know that. DOCUMENTS RELATING.. TO UNITFD STATES~IRAQI ~EL~LO~SHIPt: Mr BLUM Now, to shift for a minute The subcoi~nmittee recelvQd ~ number of recently declassified documeuts frçm the Depaitpith~rt of State relating to United S~ates-Traq. ~elationsb:ips. Amói~g, the ~ocu- ments was a~ memorandum. from the legal advi~ory~ dated Octçber 24, 1964, saying that there was ~o legal iustificatidn ~or the~Departmeut PAGENO="0168" 164 working to keep independent American companies from bidding for concessions in Iraq. Yet, for 7 years it was Department policy to pre- vent independent companies and companies of other nationalities from enteiing Iraq. Why was this done? Mr. KATZ. I cannot answer that. I am not familiar with the docu- ments. I am not familiar with the events and I had no prior knowledge that you would be raising that question. Mr. Br~uM. French hostility to the United States on energy matters can in part, we believe, be traced to the history of the French interest in the Mideast concession. The French perception is they were fore- closed from participation in important concessions as the result of a United States, British, and Dutch company combination. Is not the U.S. Government now paying the price for the performance of the U.S. companies? Mr. KATZ. Since I cannot comment on the premises of your question I would rather not comment on the conclusion. Mrs. LEWIS. First of all, do U.S. oil companies have the State De- partment's backing in their current buy-back negotiations with the Saudi Arabian Government? Mr. KATZ. I am not aware that there are negotiations going on at this particular moment. Mrs. LEwis. Well, currently used in the general sense. Mr. KATZ. There are no negotiations going on at this precise moment and-- ARAMOO NEGOTL~TIflNS Mr. LEVINSON. During the past year did the companies, the Aramco partners, have periodic negotiations broken off from time to time and resumed from time to time, over this issue? I think the thrust of the question is. do you feel that you are adecmately informed as to the content and terms of reference and perimeters within which the com- panies are negotiating? Is it the Denartment's policy to seek to give guidance or eive an opinion as to what constitutes from the point of view of the U.S. national interest acceptable or unacceptable perim- eters? Mr. KATZ. Well, I think on the first point, Yes. I feel that I am adequately informed. No, we do not seek to give guidance except where there is a problem or impasse. We might express a judgment in a particular case but we do not as a matter of courSe pass on those negotiations. We do not approve them. We feel that we need to be in- formed about them and I feel that we are informed about them. Mr. BI~uM. What is the purpose of being informed? It is very puzz1in~ if in fact the purpose is not to come to some kind of jud~menf. Mr. KATZ. It may be that we will want to express a judgment and I am aware- Mr. Bttmr. These negotiations do involve increasing the major vol- umes which in turn have an important impact upon price. Mr. KATZ. And we may very well in the course of those negotiations wish to express a point of view. That has not arisen so far. Mrs. LEWIS. In effect these negotiations involved the latent power that Senator Case was talking about of the TTnited States which is brought to bear very indirectly through the oil companies. PAGENO="0169" 165 Mr. KATZ. What they have involved so far in the case of Aramcois, I think, as you know, an agreement to transfer 25 percent of the equity of the Saudi Government with buy-back, I think, of 20 percent of that. So 5 percent of the oil at this point is going to the Saudi Government. rihe question has not arisen in that case. In case of Kuwait, the agree- ment has been to go to 60 percent. No agreement has been reached on the prices of the buy-back oil. We are following that very closely. NEGOTIATIONS WITH THE OPEC COUNTRIES Mrs. LEwIs. Just for our records, according to his testimony, Mr. McCloy met with Under Secretary of State Johnson on January 7, 1971, and with whom he discussed the proposal for unified negotiations with the OPEC countries. Did you then get a call on January 25, 1971, from Mr. McCloy; that is, you personally Mr. KATZ. I cannot tell you from my memory whether that particu- lar date- Mrs. LEWIS. Could you provide an answer to that question for the record? Mr. KATZ. Did I get a call on that date? Mrs. LEWIS. Yes. Mr. KATZ. All right. Mrs. LEWIS. And, specifically, did the call tell you that a decision had been made to divide the negotiations between `Tehran and Tripbli, the two groups in the Persian Gulf? Mr. KATZ. Yes; I do recall a conversation like that. I cannot fix the precise date. Mrs. LEWIS. We would appreciate it if you could respond to that question for the record and specifically tell us whether he suggested that yOu make a Call to the Justice Department in order to get anti- trust clearance of the decision to split the negotiations. [The information referred to follows:] My records `indicate `that I received a telephone call from Mr. McCIoy on January 25, 1971. As I testifled on June 6, it is my recollectjon that Mr. MeCloy informed me of the decision of the companies to proceed with negotiations with the Persian Gulf producers and to seek parallel negotiation with Libya. Mr. MeCloy suggested that I inform the Justice Department of this development. I have no record or recollection that Mr. McCloy asked me to get "anti-trust clearance". In our view the decision to proceed to negotiate with `the Persian Gulf was consistent with the basic premise `of Justice Department business review letter whether or not Libya was a party `to `the negotiations. Thus the question of seeking further review by the Department of Jus'tice would not have arisen and to the best of my recollection did not arise. It did seem appropriate, however, that Justice be advised immediately `of `the decision of the companies to proceed to negotiate without Libya. Justice was so advised. Mr. KATZ. I would have to go back and look at the record on that but I would doubt very much that he would have put the question in that way and I cannot recall that he ever asked to have me get antitrust clearance because I do not think there is a question of anti- trust clearance. I think it might have been a question of informing the Department of Justice and that might have been very appropriate and I would have agreed to. Mr. LEVINSON. The cable record of this was released in the course of the hearings. If you have any difficulty we will be happy to make that available. PAGENO="0170" 166 Mr. KATZ. I think I have seen Mr. MeCloy's record on this and I have no difference with that but I do not think it was in terms of getting the Department of Justice clearance, that is not what the cable said. Mr. LEVINSON. What I was going to suggest is that you look at the exact terms of the cable and verify that independently with your record. Mr. KATZ. All right. THE STATE DEPARTMENT AND PUBLIC INTEREST Mr. BLUM. We have heard yesterday from the Department of Justice which explained it `was not their function to be the w~tchdog in terins of protecting the public interest in these negotiations. Exactly who should protect the public interest? Who should he minding the store ~ When these negotiations are going on, and they are going on abroad with your people supposedly monitoring, should not the State* Department be minding the store? Mr. KATZ. You say supposedly your people monitoring them. I do not know. Mr. BLTJM. Yes; the State Department. You said the State Depart- ment is kept closely informed and advised. Mr. KATZ. Yes. Mr. BLUM. Should not the State Department be the agency to pro- tect the public interest to see what is negotiated has something to do, with benefits to the average citizen of the United States, consumers, as well as to the company? Mr. KATZ. That depends on what your criteria are for making that kind of judgment. I `do not think we are in a position or in the busi- ness of making judgments on questions such as price except in par- ~icuiar circumstances or where there is an opportunity to exert influence. On that and questions of equity interest or other kinds of arrangements or questions of compensation we make rough kinds of judgments, but we are not in the position to judge that a particular transaction or the details of a particular transaction are or are not in the public interest. We do not have that kind of mandate. We do not have that kind of authority. We do not have that kind of govern- ment, We do not have that kind of economic system. You may not like that but that is' the way it is. Mr. BLUM. You are most explicit on that point. Mr. LEVINSON. It is not a question of whether we like it or not, it is a question of probing the perimeters, what is the proper role of the Government. Mr. KATZ. That is fair enough. Mr. LEVINSON. Mr. Katz, thank you on behalf of the subcommittee whose members are not here. Mr. KATZ. Thank. you. `Mr. `LEVINSON. Thank you very much. [Whereupon, at 4:15 p.m., the subcommittee was adjourned, subject to the call of the Chair.] PAGENO="0171" MULTINATIONAL PETROLEUM COMPANIES AND FO1tEIGN POLICY THU1tSDA3~, JuLY 25, 1974 TJNImD STATES SENATE, SuncoMMIT~rEE ON MULTINATIONAL CORPORATIONS OP TIlE COMMITTEE o~ FOREIGN RELATIONS, Wa$hi~gton, D.C. The subcommittee met, pursuant to recess, at 10 a.m., in room 4~21, Dirksen Senate Office Euildin~, Senator Frank Church [chairman of the subcommittee] presiding~ Present: Senators Church, Muskie, and Case. Senator CHUROIr. The hearing will please come to order. We have two witnesses this morning. Each has a lot to say. So we had better get started right on time. Our first witness is Professor Robert B. Stobaugh, who is chairman of the Harvard Business School Energy Project, of Harvard Uni- versity. SWEARING OP WITNESS Professor, we take only sworn testimony in these hearings. Do you swear that what you are about to testify to in these pro- ceedings will be the truth, the whole truth~ and `nothing but the truth, so help you God? Mr. STOEAtTGH. I do, Senator CHUROII. We are pleased to welcome you this morning, Professor. You have a prepared statement which I understand you are going to summarize. The whole statement will appear in the record as though read in full. Mr. STOBAUGH. Yes. TESTIMONY OP PROP~ ROBERT B. STOBAUGH, CHAIRMAN, HAR- VARD BUSINESS SCHOOL ENERGY PROJECT, HARVARD UNIVER~ SITY, CAMBRIDGE, MASS. Mr. STOBATJGH. Part of my opening statement will include some material that is not spelled out in my written statement. I do this to give an overview of the subject so as to put some of the actions detailed in my written statement into perspective. Senator Cmn~oH. Proceed the way you think best. Mr. STo~AUGIL Thank you. (167) , PAGENO="0172" 168 ALTERNATIVE METHODS TO THE EMBARGO When the embargo and cutback were declared last October, there were three different alternative methods for solving the problem. One was for the governments of the major consuming countries to get to- gether and agree on some type of sharing or allocation process. There were a lot of discussions in the OECD, but there was a failure of the major consuming nations to agree to a method. To illustrate some of the complexities involved, at one end of the spectrum was the Japanese, who wanted the oil to be shared on the basis of overall energy needs of the entire economy. At the other end of the spectrum was the United States, who wanted oil to be shared on the basis of imports. And since we had a lot of domestic oil pro- duction then, of course, we would have come out relatively well if we had reached agreement to share on the basis of imports. In the middle were some of the European countries which tried to resolve this big difference. The French, for example, made proposals that the oil be shared on the basis of the needs of certain key sectors of the economy. That proposal created a problem because transporta- tion, fpr example, was a very large uSer in the United States; whereas I understand that the French were proposing that transportation requirements be given a low priority receiving about half share in terms of allocations. So, as a result of these differences in needs of different countries, the countries could not agree on how to do it. Hence, that left two other methods to solve the problem. One would have been for the U.S. companies to have been forced to pool their available oil under the Defense Production Act, and then it would have been administered by an emergency petroleum supply committee. I do not think the com- panics were too keen on that because it would have made a lot of their own data public. The third solution was for the companies to do it individually, and of course, that is what happened. Mv own judgment is, and I think that this judgment is shared by a number of the executives of the major oil companies-I understand that Mr. Piercy stated this to you and I know Mr. Geoffrey Chandler of Shell has stated the same thing-it is a government function to allocate a scarce resource during a crisis. But that is my own oninion, so I think that the governments did not meet their responsibilities during this time. ALLOCATION OF OIL DURING CRISIS Senator CHURCH. What you are saying, Professor, is that the con- sumer governments were unable to agree to a formula for the alloca- tion of available oil during the period of the crisis, they have agreed to no formula since that time? Mr. STOBAUGH. Yes. Senator CHURCH. On the other hand, the producing governments have long since managed to form an effective and unified front through the formation of the OPEC arrangement? That means that the indus- trial nations of the Western World, the nrincipai consumers of p~tro- leum, are in disarray, while the producing governments are working efficiently together. PAGENO="0173" 169 Isthat a fair summation of the current situation? Mr. STOBAUGH. Yes; I think that is a good summation of it. Of course, the producing governments have some differences be- tween them, but basically they are cooperating and working together and doing it effectively, whereas the consuming governments are not. That left this vacuum and still leaves a vacuum for the oil com- panies to occupy that position of power. It is as Mr. Tavoulareas said, the multinational companies moved into the power vacuum, they were the only ones there to do it. When they moved in there, that did not mean that they did not have pressures on them; they had a lot of pressures on them from different countries. The producing governments were able to exert the most effective pressure because the companies have large networks of tankers, refin- eries, marketing outlets, and need crude oil to run them, and the pro- ducing governments were more or less unified and, therefore, exerted pressure which the companies succumbed to. Whereas there was pres- sure from the consuming nations, there were so many pressures from so many different nations, what the companies did was attempt to keep each of the consuming nations more or less happy, but without suc- cumbing exactly to what each consuming nation said. In the first place, they did not have enough oil to do whatever the consuming nations said. There was pressure within the companies, too, because I am pretty sure that a subsidiary manager of a major oil company located in a consuming country would be exerting pressure on headquarters to get his fair share of allocation or to get as much as possible. So the management of these companies were subjected to a lot of pressure both from without and within the firm. Senator `CHtmcu. Let me ask this question. THE EMBARGO AND ROLE OF THE OIL COMPANIES Given the situation, an embargo imposed by the Arab governments against the United States, a shortage from the oil supply available to the Western governments to form a united front dealing with the crisis, and the producing governments working effectively together, what would have happened if the oil companies had not been there, and had not filled that vacuum? For example, the Arab governments had embargoed not only the United States, but the Netherlands as welL The Netherlands, being a small country, would have been hard put to secure its fair share of the oil available had it been left to the consumer governments to decide upon a formula, assuming they could have reached one. Yet I am told that the ambiguity of the situation with the oil com- panies filling the vacuum and working it out in a Byzantine way resulted in the Netherlands receiving sufficient oil throughout the whole period Qf the embargo. Mr. STOBAUGH. Yes, that is my impression. Before the embargo, the Netherlands was dependent 71 percent on Arab oil. Once the embargo took effect, as far as I can find out, and I do not hive statistics because the Netherlands still has not published any statistics for that period, as far as I can find out the Netherlands suffered no more than its European neighbors. Even the European PAGENO="0174" 170 neighbors who were on the top priority list to receive Arab oil seemed to suffer about as much as the Netherlands did. So there was certainly non-Arab oil being produced and delivered to the Netherlands. I do not know the source of that, but we have some data to suggest it might be Nigerian since the United States received less Nigerian oil during the embargo than it had before, and I would guess some Iranian oil went there, since the Japanese received less Iranian oil during the crisis. Senator CHURCH. Well, would it, be fair to say-and if it is not I know you will say so, because I am quite uncertain about all of this- that the oil companies, in taking care of the needs of the Netherlands, frustrated the Arab objective of embargoing the Netherlands; that is to say, they managed to give effective protection to the Netherlands despite the efforts of the Arab governments to embargo that country, but that they carried out the embargo rather faithfully with respect to its application to the United States? Mr. STOBAUGH. Yes. In terms of the Net~herlands, they frustrated the intent of the embargo even though, as far as I can tell, they lived up to the letter of the embargo, but certainly they frustrated the intent. Senator CHURCH. That is what I mean. Mr. STOBAUGH. Whether the Arabs knew that they were frustrating the intent, I do not know. I would guess they probably did know. And I do not know what would haye happened if the Arabs had told Shell or Exxon or some big company, not to take non-Arab oil and deliver it to the Netherlands. I do not know what would have happened then. But I think it would have increased the probability of some n'iajor international confrontation. In terms of the United States, the figutes I have, show that there was relatively little diversion, in fact very small diversion of oil to the United States, even though there were some increases of Iranian oil to the United States. We do not. know whether this came out of in- creased Iranian production or whether it was diversion from another customer. But overall, the United States lost a little of non-Arab oil. During the height f the embargo we had less non-Arab oil than we had before the embargo. Senator CHURCH. Beading from page 3 of your statement, you bear this out by saying: It appears that the United States on the average through the crisis lost a slightly larger proportion of its oil supply than did the rest of the world. The United States during its four worst months was down an average of 6.1 percent from September, whereas the rest of the world during its worst fo~ir months was down only 3.4 percent from September. Mr. SPOBAUGH. That is correct. Senator CHURCH. It would seem. to follow then, arid also on page 3 in the previous paragraph, you say: By l~ebruary, when the United States suppl~r was at its lowest mait, the rest of the world had a greater supply than in September. Mr. STORAUGIT. Yes, that is correct. Senator CHURCH. That would then support the conclusion that the international oil companies faithfully executed the embargo against thern United States, although they managed to finesse the matter in taking care of the needs of the Netherlands ~ PAGENO="0175" 171 Naturally, it would be easier to do that than to do the same for the United States. I recognize the difference, the disparity. Mr. STOBAIJGH. In both quantity of cut-back and volume of oil needed, but I think that isn't a sound conclusion because not only did the United States lose a greater proportion of its total oil supply and a greater portion of its total energy than the average for the rest of the world, the United States actually lost non-Arab oil during the embargo period. In other words, at the height of the embargo, we were getting fewer barrels per day of non-Arab oil than we were before the embargo. Senator MUSKIE. The figures Senator Church has pulled out of your statement indicate the embargo had an effect upon the United States that it did not have upon other countries, but how far short of the Arab goal did the impact on the United States fall? Mr. S~rOBAtTGIt. As far as I can see, what the Arabs wanted to happen to the United States happened; that is, Arab oil was essentially cut off. Before the embargo we were importing 1.2 million barrels a day of Arab crude oil. During February we only imported 19,000 barrels a day. In other words, we lost 98 percent of all of the Arab crude oil that was supposed to come in. We have not yet analyzed the sources of U.S. rroduct imports. Senator MusKIE. But the net figure was 6.1 percent down; is that right? Mr. ST0EAtIGH. Yes, and that is an average for all oil imiiorts, both crude and products, for a number of months. At the height, which was February, we lost 7.4- percent of our oil, and January, 6.9 percent, and then March, we started back up, we only lost 5.3 percent. Senator MuSKIE. Those percentage figures, even the highest one, is not sufficient to account for the total cut-off of the Arab oil imports, is it? Mr. STOBAuGH. I believe it is. Senator MusKIE. Is it? Mr. STOBAUGH. Well, according to the best data I have it is. Senator Cnuacu. On page 4 of your statement lies the answer to Senator Muskie's question. This is where you say- U.S. crude oil imports were reduced by some 30 percent between August and September 1973 at the height of the shortage. More than 98 percent of the Arab oil that the U.S. had been receiving was lost. Imports of Arab oil dropped from 1,200,000 barrels a `day In August and September down to only 19,000 barrels a day during January-~February. Total supplies of non-Arab oil dropped very slightly, about 2 percent. So any embargo that is 98 percent effective is a pretty successful embargo. Mr. STOBAUOH. Yes, and the unknown factor in this picture is the difficulty in tracing product imports that come from different refineries that are not in Arab lands to know whether or not they were using Arab oil, and we have not had neither the data nor the time to trace product import. But the crude oil number shows very dramatically the effect of the embargo and I had done a piece earlier in the year in the Wall Street Journal in which I mentioned the capability of switching of non-Arab oil to the United States, If you take the case of Iran, for example, Iran was producing around 6 million barrels a day and we were importing about `200,000 barrels a day before the embargo-nt th~ PAGENO="0176" 172 height of the embargo we were importing a little over 400.000 barrels a day. So we increased Iranian imports about 200,000 barrels a day up to this level of 400~000, which is still a very small percentage of overall Iranian production. So that there was an enormous potential for switching non-Arab oil to the United States that did not happen. DIVERSION OF NONARAB OIL TO THE U.S. Mr. LEVTNSON. Do you have an opinion as to why it did not happen? In other words, it did not happen because the companies feared politi- cal retaliation from the Arabs, or because other markets were more profitable, such as the Japanese and German markets? I believe that there have been some stories to the effect that indeed, West Germany had a glut of oil along about February or Mardi, Mr. SPOBATJGH. This goes to~ the heart of what these companies are doing, and when you look at their time horizon they plan to be around for a long time, 25, 50 years, indefinitely. They have a very long plan- ning horizon and the big companies tend not to be short-term profit maximizers because they know if they make a -fast buck this year then they are going to be subjected to much more governmental pressure i.n the future years. So as much as I can tell I believe they attempted to allocate oil in a general way to all markets as a percentage of the demand in that market. Now, their allocation was not perfect because presumably they did not get together and decide exactly which company was going to deliver where. They were allocating individually. But the net result appears to me comes out pretty close to the statement that Geoffrey Chandler of Shell said, that the industry attempted to allocate oil to all markets as a percentage of demand. From what we can tell on price data, there were several deliveries made to the United States in which crude oil was supplied to the United States at a lower price than could be obtained elsewhere. I would guess there were some deliveries to the United States where they got the highest price that could be obtained. We are limited on price data because we are working with aggregates and the only way we will find out for sure the decision rules used by the companies would be to get data on individual companies on their product movements and on their profit margins, and until we get that it will be difficult to say exactly which group of companies did what. Senator CHURcH. Is that data available? Mr. STOBAUGH. The data are available only within each individual company. The data are not available to me or to the public or to the Government right now. Each company has its own pieces of data used for planning but nobody else has them. DATA FROM FEO Senator CHURCH. This committee has asked the Federal Energy Office to supply us with this data, operating on the assumption that the Federal Energy Office can obtain it, and Mr. Sawhill has promised that he will deliver it to the committee as soon as he has it in his own possession. I do t-iot know what problems will be entailed between the Federal Energy Office and the companies in acquiring data. PAGENO="0177" 173 Senator MtJsKIE. Do ynu conclude that the embargo against the United States would not have worked unless the companies had made it work? Mr. STOBAUGH, Well, I think the Arab embargo would have worked because the Arabs have such large oil reserves and such large pro- duction no company, either United States or foreign, would want to take a chance of not being allowed ever to buy Arab oil again. Senator MU5KIE. For that reason they made it work? Mr. STOBAUGH. Yes; that is the reason they made it work. Now, for the non-Arab oil, the fact that not more came into the United States, you have to say, well, what would the situation in the world have been if we did not have the major oil companies? Senator CHURCH. Well, I should think that if the administration were prudent, it would want to acquire all of the data possible concern- ing the ways the companies allocated oil during the period of the crisis, because we may be faced with another embargo. I noticed that the Saudi Arabian Oil Minister as has been reported in the press, took the occasion of Secretary Simon's recent visit to Saudi Arabia to warn him that the Arab States are ready to reim- pose their oil embargo unless the United States i~nanages to squeeze more territorial concessions out of the Israelis. I think it is very clear that it is a prospective happening that we have got to prepare for. Given the success of the last embargo, it is entirely possible that the Arab governments will choose to impose another embargo. Meanwhile, we had better find out all we can and prepare ourselves for that eventuality. Mr. STOBAUGH. I think that is correct. THE OIL COMPANIES AS AGENTS FOR ARAB GOVERNMENTS Senator MUSKIE. That is the reason for my question. For the reason you have stated, the oil companies became the agents of the Arab gov- ernments in enforcing embargoes, is that not so? Mr. STOBAUGH. That is correct. Senator MUSKIE. Is there any reason to believe that if there is a new arrangement with ownership in the Arab governments, and the companies acting as their marketers, that the same agency relation- ship will not exist? Mr. STOBAUGH. No; I would assume it will exist. Senator MUSKIE. Now, if that kind of arrangement does exist, if that is that kind of agency, then both with respect to the supply and price, the companies will be representing their Arab clients; is that not so? Mr. STOBAUGH. The companies will be doing what the Arab pro- ducers tell them in terms of where they can deliver crude oil and products made- Senator MUSKIE. That is effective agency, as I read it, not as a lawyer but as practical terms, and it seems to m~ that poses the problem what substitute arrangements can we make to make sure that the interests of American consumers and the American people are also represented. At the moment there are none. 45-426-7~-----i2 PAGENO="0178" 174 Mr. STOBAtrGIT. Well, if you look at the picture from the position of the oil companies, here on the one hand they have a very strong group of nations, that they are going to have to depend on for decades for crude oil, putting explicit pressure on them. On the other hand they have a lot of diffuse pressure from the consuming governments and essentially no pressure from the government of the nation in which they are headquartered, so naturally they are going to react to this strong pressure. Senator MU5KIE. I understand the pressure that moves them to pursue their own self-interest. I do not quarrel with their pursuing their own self-interest. But the question I am raising is whether it makes sense for us as a country and as a people representing con- sumers to put control of the situation in the hands of these companies who are pursuing their own self-interest for whatever laudable motives they may raise? Mr. STOBAUGH. If you go back to some of their past history, the companies were doing this world allocation function when they were allocating production allotments to the Middle East countries. So they in effect had a very strong bargaining position with the pro- ducers and more or less determined which ones could produce. They did it partially economically and partially for long-term political survival with them. Now, then, the pressure has turned and they are still doing the same role; that is, allocating the scarce resource, but they are trying to keep each of the consuming countries somewhat happy by spread- ing the available resource without having anyone hurt too greatly. I would guess they would say that they might very well be doing the United States a favor by not bringing all of the oil back to the United States and having the Europeans or Japanese or others take a very large suffering, for example. Senator CHURCH. Your testimony bears out what other testimony we have received clearly shows, and that is that during the last energy crisis the American-owned companies not only faithfully executed the orders of the Arab governments, but thought themselves to be virtually hostages of these governments. We are often told that it is to our national advantage that these great multinational companies are American owned. If this is so, what leverage could this give us in coping with a new embargo should one occur, or is there any leverage here at all that the U.S. Government t~ould utilize to make certain that we get as much oil as possible to meet our needs? THE ROLE OF THE U.S. GOVERNMENT DURING THE EMBARGO Mr. STOBAUGII. I think that if a new embargo happened and a cut- back happened the companies would be no match for the Arab govern- ments. That is quite clear. And if pressure is to be put on the Arab governments it would have to be from about the only source of power in the world that can do it, and that is the U.S. Government. If you want to solve the problem without putting pressure on the Arab governments, then I think we would have to ask how would we like to see the oil allocated. We have the potential power to tell the PAGENO="0179" 175 companies that are headquartered here to bring back a certain spread quantity of oil to the United States. It is not clear to me that we would ever use that power. I doubt that we would use it. As I understand it, the U.S. Government did not attempt to use it in the last embargo. As I mentioned in my statement, according to Dr. Sawhiil, he told the companies to bring back as much as possible but then said but more or less treat everybody equitably. And that was about as strong a statement as was given to the U.S.-headquarte.red companies. Senator Cmjncn. We have had testimony that the U.S. Government during the crisis actually did not ask the companies to do anything, just left them on their own to make their decisions as they saw fit. Mr. STOBAUGH. Weli~ I would- Senator CHURCH. Well, from a realistic standpoint, would it not follow that if our own Government had directed the companies to allocate a sufficient supply of oil to the United States to avoid a short- age here, and the companies had undertaken to abide by that instruc- tion, the Arab governments would have retaliated by further reducing the supply of oil made available to the American companies? Mr. STOBAUGH. They might have, and it is difficult to make a con- jecture on which I would have much confidence because I judge that the Arabs were frightened themselves during the embargo and that one of the reasons that they did not reduce the production further is, and they said they were going to~ was because of the fear of damage to some of the western economies. If we had brought back more oil here and the European economy had been hurting more than it did I do not know what the Arab action would have been. Senator MUSKIE. It has been suggested that the companies could not have implemented the Arab policy as effectively if the companies had not been integrated, that is, if the producing function had been sepa- rated from the distribution and marketing function. Do you believe that to be so? Is that a valid conclusion? Mr. STo~AUGH. Well, you would have to say what would the situation be if they were not integrated? If you take Saudi Arabia, for ex- ample, there are only four companies operating there, or four owners of Aramco. It is clear that it is easier to have an embargo be in effect when you only have four companies to deal with than if you had many companies to deal with, But if for one alternative, they were selling oil to 100 companies and all the tankers were independently owned and each tanker bought oil, it would certainly, have been harder for the Saudi Arabians to enforce the embargo. On the other hand, if they are dealing with relatively few companies who own tanker fleets and then took them to the refineries, I would expect that there would be pressure on the tankers picking up oil to only take it to refineries where they said they were going to take it, otherwise they may never be allowed to stop in the Arab countries again. Senator MUSKIE. What you are saying is, with integrated companies the pressure was put on the principal if you broke it up, the pressure then would shift to the tanker companies. Is that what you are saying? Mr. STOBAUGH. Yes. Senator MU5KIE. So that finding a way to break up the integrated structure of the companies `would not solve the problem? PAGENO="0180" 176 Mr. S~POBAI1GH. Well, on this particular problem it would make it a little harder for the Arabs, if you divested, say, production from tank- ers, but it would still be possible for them to do it. Mr. LEVINSON. Does it not really come down to the fact in the absence of a united front among the consuming countries, where they have got a plan and are willing to pool and confront the Arabs with a unified approach, that we are going to continue to be vulnerable be- cause our agents are vulnerable; that is, the companies? Mr. STOBAUGH. I think that is right, that until the consumer gov- ernments get together in one way or another, the producing govern- ments are going to have the upper hand, and that is clear. Mrs. LEWIS. Have we not missed the chance to create that kind of unity among the consumer governments? Mr. STOBATJGII. Well, I understand we are making attempts right now to bring consuming governments together. Whether we will be successful I do not know. But we certainly had a golden opportunity to bring the consumer governments together some time ago when it was a lot cheaper to stockpile oil in Europe, and that had been suggested, especially to the Europeans, but they showed no great indication of stockpiling oil to help them bargain with the oil-producing nations. Even today I see no great urgency on anyone's part to move forward with some kind of emergency stockpiling and pooling arrangement. But I think that should be the No. 1 priority of the consuming governments. Senator CHURCH. Well, all of the momentum has gone out of the effort to bring the consuming governments together, has it not? Senator MUSKIE. Will we have to borrow the money from the Arabs to do it? Mr. STOBAUGH. It seems like we are putting our emphasis more on how to borrow the money back than how to get the prices down. Let me say both within Europe and within the United States there are a lot of powerful interests that are interested in higher energy prices and I believe that one of the reasons the Europeans never moved forward that much on stockpile was because they have the coal interests and atomic energy interests and others that have a healthier situation if oil prices go up. So I think that the consumer is probably the least represented group of people in any of the societies. You have a lot of special interests that are more represented, so I do not think there has ever been any big urgency on any government's part to beat down oil prices. Senator MUSKI-E. You had not been listening to the debate on the Senate floor. The consumer is overrepresented. Mr. STOBAUGH. I judge that if we did not have these severe balance- of-payments problems that we would not be as concerned as we are now about high oil prices. In other words, if we could find a way to pay for them I do not think there would be too many governments worried about them. POSSIBLE SOLUTIONS Senator MUSKIE. Have you worked out in your own mind a blue~ print for action to change this situation and give us a fairer chance in influencing the flow of oil, the production of oil and the price of oil? Mr. STOBAUGnJ, Well, I think that, first, let me say I do not have a simple answer. PAGENO="0181" 177 Senator MU5KIE. You have company. Mr. STOBAUGII. But let me tell you some of the directions that I think would be needed to take to reach a better solution. One is getting to- gether consuming governments in terms of pooling their oil reserves so that they will be in a much better position in terms of any future slowdown. The second thing I think I would do is to attempt to force the oil- producing nations to put their oil up for bid in one way or the other, because oil prices have begun to soften from time to time now because there is more oil being produced than there is consumption. From what I understand, very shortly the inventory storage is going to be full and somebody is going to have to cut back production. Well, I read this week where the Kuwait Governtuent says they are not going to put any more oil up for bid because that is dangerous, it might lower the price. They are just going to announce that certain price and then any company that wants it can come and take it, and if they do not take it at that price they will close down production. So I think we ought to free up the market and get bidding into it. Senator CHtmcH. To do that is going to take a great deal more of governmental intervention on the part of our own Government than has occurred up to now, because all of our testimony in the past seems to bear out the fact that the companies themselves are less interested in the reduction of price than they are in an assurance of their arrange- ments for supply, and they will bargain away the price for a continued assurance of those arrangements any time. In fact, that has already happened in Kuwait, where once again the companies are breaking the line-one company leading the way. And once again the consumer is going to get gouged. You have already said that the consumer is the least represented element in any Western society and the vested interests largely domi- nate. I agree with that. But if something is not done about this price. its impact upon the Western economy could very well bring about disastrous consequences. We are beginning to see the effects of this today. We must recognize that the era has changed, when the Iranian Government is loaning the British Government $1.2 billion to bolster its faltering economy. We aie going to have a foreign aid program in reverse. We must recognize time has changed when one-fourth of Krupp is purchased by the Shah of Iran. I do not know whether that is to give him greater assurances of future arms supply or just what. But it certainly is significant. We are living in a brand new world and, of course, we have not awakened to that fact. Perhaps we will not until that world falls in on us. Mr. STOBAUGU. I think that is right, that the United States will end up being the biggest borrower of any nation because we have the capacity to take their funds. So we will end up owing more than any other nation. LONG-TERM SUPPLY CONTRACTS Mr. LEvIN50N. To put a specific on your general recommendation about trying to free and turn this into a spot market one way or another, would you support a proposal to prohibit long-term supply contracts between U.S.-based companies and OPEC countries, except with specific approval of the FEA Administrator or some other gov- ernmental authority? PAGENO="0182" 178 Mr. STOBAUGIT. I think that I would support some kind ef proposal where the U.S. Government would place sonic type of ceiling on what the price could be or that approval of the U.S. Government had to be obtained before the company could agree, and I think that way the company might have more bargaining strength when it bargained with a producing nation, because the company could say, "if we sign too high a price we are going to have big political turmoil back home and we cannot do it. We m~y not get approval." Mr. LEvINsoN. That authority does not presently exist ~ Mr. STOBAUGH. I do not know whether it does or not. Senator CrnmcH. It does not. SOLUTIONS Mr. STOBAUGII. But I think that is the third point I wanted to men- tion in answer to Senator Muskie's question awhile ago. The third part of any solution is that the U.S. Government is going to have to use some of its political strength because the companies are no match for the Arab governmen~5. As far as that matter, hardly any one of the consuming nations are too. Once you get into how the U.S. Government can use its political strength, I do not know. On the one hand, people make a case that if the U.S. Government puts too much political pressure on our allies, such as Saudi Arabia and Iran, they may be overthrown and more radical elements may take over and we will be worse off. I do not know enough about the politics to make an accurate predictioft as to how much pressure and in what forms we could put on the producing nations. But I think that if we could en- courage Saudi Arabia in some way or another to continue to step up production and to sell it to a number of companies that wanted to buy it, I think we would see lower oil prices and a healthier world economy. One of the things that brought about the upset that we are going through now is the very sharpness of the rise. If it had been a gradual rise over a 20-~year period of time the world economy would have been able to adjust to it, but coming so sharply we have major economic problems in virtually every modern industrial society now, Mr. LevINsoN. Do you consider that it is any kind of solution to get the Saudi Arabians to buy $10 billion of U.S. Treasury securities? Mr. STOBAUGH. Well, I guess I would have to ask what would happen if we did not get them to buy that? If the alternative were shutting dowh production because they did not have any place to invest their money, and if we could not keep them from shutting down production, that would be worse than getting them to buy $10 billion in Treasury bills. If the alternative is we could get them to keep producing and take a lowem price and, therefore, have less surplus funds, then that would be a better solution, and I just do not know how much political power we can use effectively with the Saudi Arabians. That is the key, because they have the major excess surplus production capability. They are producing around 9 or 9½ million barrels a day, something in that range. They can go up to 11 million barrels in a fairly short time, in a year. They can go up to 20 million barrels a day over a period of a few years, and that is an enormous amount of potential excess production capacity. So they certainly have the power to have a major impact on world oil prices. PAGENO="0183" 179 Senator MUsIUE. How long could they sustain 20 million barrels a day? Mr. STOBAUCH. I do not know how many years but it would be many, many years. Senator MU5KIE. Into a time when you and I will not be ,around to worry about it? Mr. STOBAUGH. I would be dead before they had to stop 20 million barrels a day production. STRATEGIC STORAGE Senator CHURCH. What you are saying surely underscores the impor- tance, does it not, of moving ahead in a very determined way to secure as large a measure of national self-sufficiency in our energy supply as we can? Mr. STOBAUGH. Broadly stated, I would agree with that statement, but I think it can be a mix of domestic energy supply and strategic storage. I do not think we have given enough thought to the question of strategic storage and frankly- Senator CHURCH. How much would you have to store in order for it to be really a meaningful factor in the event of another embargo? Mr. STOBATJGH. Pardon? Senator CHURCH. How thuch would you have to store for it to be a factor o.f much influence in the case of another embargo? Mr. STOBAUGIT. Well, we are relatively better off than, say, the Europeans and Japanese because we have so much domestic produc- tion. We could probably have a plan that we could cut back imports and cut back consumption some-and consumption is now being cut back because of higher prices. We could have a plan where consumption is reduced a little and all we would have to do is have a strategic storage to make up for a certain portion of our imports. It is not like having to have 6 rnonth~' supply of all of our consumption. So I have not calculated exactly how much we would have to have under certain conditions but I think that storage could he part of the mix. Senator CHURCH. Is any effort now being made to dramatically in- crease our storage capacity? Mr. STOBAUGH. I know of none. The work that I know of on Project independence is moving mnch more toward domestic productive capac- ity in a lot of areas. Some of the plans, frankly, scare me. I heard a plan the other day for shale oil production that would take away a lot of water from the farmers in the West and- Senator CHURCII. If you think that scares you, it terrifies me, espe- cially because the only part of the West that has any water that could he diverted happens to be my part, the Northwest in general and Idaho in particular. Mr~ STOBAUGH. We might be given a choice of taking water away from the farmers and doing what they are talking about, "exporting far~ing~~ out of Colorado and those States because the farmers would have to leave or have strategic storage. I would rather go toward a strategm storage situation. I think that is the kind of sophisticated trade-off we need to make, and I do not know that they are being done now, but I would hope they would begin to be considering it. PAGENO="0184" 180 Senator CHURCH. Yes. If you want another civil war, I will tell you the best way to get it is to start an effort to seize and divert water supplies. Senator MU5KIE. It would be a big help for the Maine potato growers. VERTICAL INTEGRATION Senator CHURCH. Just one other area to cover here that I do not think we have covered in our questions so far. You have had considerable experience wQrking in the refinery end of the oil business. Would you describe your feeiings with regard to the pros and cons of-I was going to say integration of the industry- but I believe we have covered that. Mr. STOBAUGH. Let me mention one other point. We talked about vertical integration in terms of what happens during a crisis and how easy or hard it is to effect an embargo. There are a lot of other questions on vertical integration that come up. One is whether or not it gives com- panies economic power and, therefore, produces monopoly profits, and it think certainly during a crisis time it might. During normal times the answer is less clear. But on the benefit side of vertical integration you have a more efficient network of operations if you can have a refinery designed explicitly for a crude source and then that refinery is also designed for the market outlets of the company. You get a specialized refinery that will not cost as much to build as would a more generalized refinery which would run on a lot of different crude oils, That kind of cuts-- Senator CHURCH. Have not the big oil companies begun to build specialized refineries because of cost factors and then found themselves in a less flexible position to deal with international events? Mr. STOBAUGH. That is right. In order to achieve economies of operation they did build the specialized refineries so normal times cost and prices would be lower than they would otherwise. During an emergency, they lost their flexibility; the companies are making these kinds of decisions. SUBSTITUTES FOR OIL Senator CHURCH. I do not know whether you are prepared to answer this question or whether it falls within your range of specialty. To what extent would it be possible for us to substitute coal for oil, given our very large supply of coal in this country, and thus substantially reduce our dependency on foreign oil? Mr. STOBAUGH. 1 think there are very large possibilities there. In fact, I think that coal is the single source with the most potential that will do us any good for quite a long while. I think that the economies are such that we can pay a lot of money to do a first-class job of re- claiming land for strip mining and still have coal very economical compared with alternative sources. I think that is a potential bright spot. Senator CHURCH. I would think so, too, and I agree especially with what you said about reclaiming the land afterward, doing the neces- sary conservation work rather than viewing this oil and energy crisis as an excuse for abandoning our concern about a cleaner environment, which seems to be the tendency and even the easy assumption that PAGENO="0185" 181 people are making, and beating a retreat in this general effort, I should think the logic of the situation would be just the opposite. The higher prices imposed by foreign governments has enabled us to pro- ceed with a larger mining of coal and do so in an environmentally acceptable way. The economics of it will work out for us now, where- as before they might not have worked out. It seems to me so obvious that the opposite conclusion that most people have reached, and that is being pushed on us by industry is in fact the valid one. Mr. STOBATJGH. I would not reduce environmental or pollution con- straints at all. I would enforce them. And from what I can see, the much higher prices now means we can do a lot better job of cleaning lip. The reason coal lost markets during the past couple of decades is because of the very, relatively very low oil prices. Now that oil prices have gone up so much we can afford to do a lot more cleaning up of coal, and a lot more reclamation of the land. Shipping charges, which used to be relatively high, now do not seem so high at all. So I think we have money to do things that should be done in terms of environ- mental and general pollution control. Senator CIrnRcH. Now, on the side of conservation, looking again toward a greater measure of self-sufficiency, if we just wade in against Detroit and began to build sensible automobiles in this country, would that not have a very large effect on the consumption of gasoline? For instance, if we built cars that would average 24 or 26 miles to the gal- lon because they are smaller cars, rather than 6,000-pound 350-horse- power, 7 percent efficiency, 7-miles-to-the-gallon automobiles, that we are so attached to? Mr. STOBATTOII. No question about that. Since our gasoline consump- tion is over 6 million barrels a day it is by far the largest single item, and if we could reduce that quite a bit certainly it would help. Senator CHtTRCIT. W~ll, do you think the market forces will bring this about or do you think some kind of forthright governmental action will be required? Mr. STOBATJGH. Market forces have helped, but I think we will have to have higher prices than we do now on the gasoline question in order to bring gasoline consumption closer to the standards that you are talking about. But I think there are other things that could be done in terms of a combination of governmental action and market forces, such as, for example, on parking in central cities I would guess that the cars that go in there probably are not paying their fair share as far as pollution and space and similar items. So I think there are a lot of other actions that would be moving in the direction of charging people for full value, including damage to the environment. Putting in that kind of a system would help the market forces work. If you take something like the depletion allowance, for example, if we got rid of that, I would judge that that would make oil prices higher and gasoline prices higher because I think that there is a good case to be made that the depletion allowance is a concession or a subsidy of the consumer. So eliminating the depletion allowance would help reduce consumption. Senator Ciruiici~r. Well, I am not going to pursue this further be- cause we get into the psychology on that kind of thing. I ~just wonder whether the price factor is all that determined whether the free market really can be relied upon to produce these results or whether gasoline PAGENO="0186" 182 is something like steak-people have got to have it once they becOme accustOmed to it, regardless of the price. Here people cannot traffic any way but by automobile, since we have built our society in this fashion. Do ~ou think price is going to:be that much of a factor in determining our consumption or in changing the habits of automobile manufac- turers ~ I do not knOw. I suppose this is a question that cannot be answered definitively by anyOne right noW, I would think it would take more direct Government action than simply to rely on the v~aries of the marketplace. Mr. STOB.UTGH. The marketplace, particularly on automobile and gasoline consumption, will take quite awhile to do because one of the ways it will have an effect-and let us say if gas were $1 a gallon- would be that people would gradually, and some of them quickly, begin to buy smaller ears. But we still ha~re these big cars on the road and it would take a number of years to work through the car stock. So especially in gasoline, the short-run price elasticity is very low compared with longer term; but longer term I think it would have an important effect0 Senator Cnu~cH. Thank you very much, professor. Ycur testimony will be very helpful to us. [Mr. Stobaugh's prepared statement follows:] PREPARED STATEMENT OF ROBERT B. STOBAUGH, PRoFESSoR OF BUSINESS ADMINIS- TRATION, HARVARD UNIVERSITY GRADUATE ScHooL or BUSINESS ADMINISTRATION Mr. Chairman and Members of the Subcommittee: I have been asked to discuss the costs and benefits to the United States of the foreign operations of U.S. oil companies, especially the five so-called "majors" that are headquartered in the United States-~Exxon, Mobil, Texaco, Standard of California and Gulf, I was requested to focus specifically on the role of the~e companieS during the recent crisis lasting from October 1973 through March 1974, which was caused by the cutback of Arab oil production and the Arab embargo on shipments to certain countries including the United States. My research assistant, Mr. Howard I~ailes, and I have obtained statistics from a number of governments, statistics which are publicly available, and have nrtalyze~i them to determine n~hat happened to the fIo~ts of oil during this crisis. We have combined these with press reports and my knowledge of the industry in order to judge what criteria the companies used to arrive at their decisions which resulted in these flows. We made some comparisons between the U.S. supply position and that of the rest of the world in the aggregate. We obtained detailed information on only five countries-the United States, Japan~ West Germany, the United King- dom, and France. We, have four main conclusions about what happened in those crisis mopths: (I) The United States seems to have lost a greater proportion of its total oil suppl.V and~ of its total energy suoply than the aver~ige for the rest of the world. By total oil supply I mean supplies from all sources, including dOmestic, and all kinds of petroleum products, not just crude oil. (2) For tke ot~ier four major consuming countries that we studied, we were unable to estahlish the exact percentage losses because we did not have the figures on imp~rts of reth~ed products for any country except the United Staten Bitt, as well as we can determine from our analysis of the ~taf a that we da ha re. and from press reports, the consuming countries of the wOrld did not ~eeul to differ very widely in the degree of their losses. Our results seem somewhat consistent with the statement made by a Royal `Dutch/Shell executive that thq industry allocated oil to all markets as a percentage of deñ~and.~ 1 Gc'o~rey Ci~andIer, "The Changing Shape of the World 011 Industry," PetroTeu~a Reviett', iune 1974. PAGENO="0187" 183 (3) There were so~te diversioscis of crude oil from the normal destinations, but very little was diverted into the United States. V.5. imports of Iranian oil were increased by about 200,000 barrels a day, but this might not have represented a diversion from other destinations bechuse Iranian production increased more than this amount. (4) In some cases, but not always, crude oil was supplied to nations, including the United States, at a lower price than could have been obtained elsewhere. Thus, some, but not all, of our examples are consistent with Dr. Sawhill's state- ment of June 5 to you that the oil companies made shipments into the United States that they might have more profitably sold elsewhere. I will present some of the statistics that support our conclusions, will indicate our ideas as to why these patterns resulted, and then will discuss the issues related to the broad question of the costs and benefits that the United States incurs through the foreign operations of the five U.S. majors. In September 1973, the United States had available 17.6 million barrels of oil daily (including both crude oil and refined products, domestic output and imports). This daily average increased slightly during October and November. But as the effect of the Arab cutbacks began to be felt, the supply dropped sharply in December and continued to drop through February, when the bottom was hit-at a level of 16.3 million barrels a day, about 7.4 percent below the September level (Table 1). This drop was due~ almost entirely to the drop in imports. U.S. production remained almost level. TABLE 1-U.S. SHARE OF OIL AVAILABLE TO CONSUMING NATIONS, SEPTEMBER 1973 THROUGH FEBRUARY 1974 [Millions of barrels daily and percentsj 1973 1974 September October November December January February March 1. Oil available to world ` 58. 3 59. 2 57. 7 54. 8 55 4 57. 2 58. 0 2. Oil available to United States (see lines 6-9 below) 17. 6 17. 7 18. 3 16. 8 16. 4 16. 3 16. 6 3. Change in oil available to linited States (percent of September) 4. 6 +4. 0 -4. 6 `-6.9 -7. 4 -5. 3 4. Oil available to rest of world (including Communist states) 40. 7 41. 5 39. 4 38. 0 39. 0 40. 9 41. 4 5. Change in oil available to rest of world (percent of September) +2.0 -3. 2 -6. 7 -4. 2 +. 5 +1. 7 6. U.S. production of crude oil ° 9. 1 9. 1 9. 1 9. 1 9. 1 9. 0 7. U.S. productionofnaturalgasliquids5 1.7 1.7 1.7 1.7 1.7 1.7 8. U.S. crude imports 4 3. 8 4. 0 4. 1 3. 0 2. 9 2. 9 ~ 9. U.S. product imports 5 2. 9 2. 8 0 3, 4 3. 0 2. 7 2. 7 0 Includes monthly crude oil production figures, obtained from various issues of `Oil and Gas Journal" and U.S. natural gas liquids production (see note 5). Lagged by 1 month on assumption that production in countries other than major export- ing countries was the same each month and that it taint an average of 1 month to transport oil from producting nation to consuming nation. Various issues of "Oil and Gas Journal." The variations from month to month are quite small, with the yearly average hovering around 1,740,000 barrels daily; thus, 1,700,000 daily was assumed for each mouth in this analysis. Source: Bureau of Mines as reported in Federal Energy Office, "Monthly Energy Indicators," May 1974, p. 19. 4 U.S. De~artmeet of Commerce, "Imports Commodity by Country," monthly, various issues, and news release CB 74-83, Apr. 8, 1974. This source was not available for March figure and data from the Federal Energy Office are not consistent with this source. Therefore, March was estimated by taking the increase in imports from February to March as reported by Fed- eral Energy Office, "Monthly Energy Indicators," and adding it to the February imports reported abpye. Estimated from graph presented in Federal Energy Office, "Monthly Energy Indicators," May 1973, p. 18, Basic data are from Bureau of Mines through January 1974 and American Petroleum Institute after that. This increase from October to November 1973 seems unusually high; however, the November import figurfa seem more normal if compared with earlier months judging by seasonal trends in 1972; see Federal Energy Office, op. cit.~ p. 18. The rest of the world, being generally closer to Arab sources of supply, began to feel the cutback quicker than the United States. Their low point was reached in December, at a level 6.7 percent below their September level. By February, when the U.S. supply was at its lowest mark, the rest of the world had a greater supply than in September. It appears that the United States on the average through the crisis lost ~ larger pr~portion of its oil supply than did the rest of the world. The United States, during its four worst months, was down an average of 6.1 percent from September, whereas the rest of the world, during its four worst months, was down only 3.4 percent from September (Table 2). PAGENO="0188" 184 TABLE2.-CHANGE (N ENERGYSUPPLIES OFG1LAND TOTAL ENERGY, UNITEDSTATES VERSUS REST OFTHE WORLD NOVEMBER 1973 THROUGH MARCH 1974 [Percentage of supply in September 19731 Oil supply Total energy s ~Jnited States° upply 1 Rest of world United States Rest of world During worst morths~ Average during worst Z mo Averageduringworst3 me Average during worst 4 mo -7. 4 -7. 3 -6.5 -6. 1 -6. 7 -5. 5 -4.7 -3. 4 -3. 5 -3. 4 -3.1 -2. 9 -3. 3 -2. 7 -2.3 -1. 7 1 Includes oil, natural gas, solid fuels, water power, and nuclear. 2 Calculatedori baxis that oil provides 47.2 percent of total energy in UnitectStátes and 49.0 percent in rest of World (1973 averages as calculated from OP Statistical Review of the World Industry 1973," p. 16.) Source: Calculated from data in table 1. But oil snpplies are only part of the world's energy. If we assume that the other supplies of energy did not change, then the United States loss of energy was 3.5 percent during the worst month. After we correct for the fact that the United States is slightly less dependent on oil for energy than the rest of the world, the United States still seems to have lost a slightly greater share of its total energy supply than did the rest of the world. All the losses given so far are based on changes from September 1973. A more significant measure of the losses would be a comnarison between projected supply and actual supply. This method shows that U.S. supply in February was about 20 percent below that projected prior to the crisis. I do not have similar compari- sons for other countries. With this overall picture, there was some activity involving oil diversions. Because of linilted time, we focused our analysis on the imports of crude oil, which in the aggregate were much greater worldwide than imports of refined products. U.S. crude oil imports were reduced by some 30 percent between August- September 1973 and the height of the shortage, January-February 1974 (Table 3). More than 98 percent of the Arab oil that the U.S. bad been receiving was lost-imports of Arab oil dropped from 1,200,000 barrels a day in August- September down to only ~9,000 a day during January-February. Total supplies of non-Arab oil dropped very slightly, about 2 percent. TABLE 3.-U.S. IMPORTS OF CRUDE OIL BY COUNTRY OF ORIG1N, AUGUST-SEPTEMBER 1973 AND JANUARY- FEBRUARY 1974 [Thousands of barrels dailyj . Country of origin August- September 1973 January- February 1974 Difference Total Total, Arab States Total, non-Arab States Vene2uela Canada Nigeria Angola Iran 4,114 1,203 2, 911 633 1082 524 59 229 2,885 19 2,866 493 960 462 1 47 430 -1,229 -1, 884 -45 -140 -122 -62 -12 201 Indonesia Ecuador Bolivia Mexico 237 60 0 12 275 90 11 116 38 30 11 4 Trinidad All other non.Arab2 64 11 1 65 117 1 6 1 SubstantiaH~ higher volumes ware received from~ these countries in December than in January~February, as follows: Angola 62, Mexico 27, Trinidad 90, Netherlands AntilleS 21. 2 Includes Netherlands Antilles which was zero in August-September and in January-February, but higher in December (see footnote 1). Source: U.S. Deoartment of Commerce, "Imports Commodity by Country," monthly, various iSsues, and news releas CB 74-83, Apr. 8, 1974. PAGENO="0189" 185 But if we push the analysis one layer deeper, we find that substantial cuts were made in U.S. imports of crude oil from some non~Arab suppliers, principally Venezuela, Canada and Nigeria. We believe that Venezuelan oil was diverted away from the United States so that the Venezuelan government could provide more oil to other Latin American countries; 2 the Canadians reduced exports to the United States in order to make up for reduced supplies of Arab oil received by Canada.3 We have no data as to where the Nigerian oil was diverted but speculate that it might have been to the Netherlauds, which, prior to the embargo, was dependent primarily on Arab oil. These cuts in imports of non-Arab oil into the United States were almost offset by increased imports from non-Arab sources, primarily from Iran, and to a lesser extent from Indonesia, Ecuador and several other countries in the Western Hemisphere. Imports of Iranian crude oil were almost doubled, increasing by 201,000 barrels a day. The increased imports to the United States from Iran and Indonesia might not have represented diversions from other countries because production in Iran and Indonesia was increased after the embargo started by an amount greater than the increase in U.S. imports (Table 4). Between September and December 1973, production in non-Arab nations was increased by .9 million barrels a day (from 38.4 to 39.3) compared with the largest cut in Arab production of 5.0 million barrels daily (from 20.8 in September to 158 in November, rising to 16.1 in December). TABLE 4.-WORLD CRUDE OIL PRODUCTION, FEBRUARY 1973 AND FROM AUGUST 1973 THROUGH MARCH 1974 (Millions of barrels cIaily~ 1973 Janu- ary 1974 Febru- ary March FObru- ary Aqgust Sop- tamber Ooto- ber No- vember De- camber Non-Arab States: United States 11. 0 Canada 1.8 Venezuela - - - 3. 3 Other Western Hemisphere 1. 8 Western Europe 4 Iran 5.8 Indonesia 1.2 Nigeria 1.9 Other Non-Arab 1. 4 Communist States 9. 1 Arab states: Libya - 2.3 Algeria 1.1 Morocco, Tunisia, United Arab Republic,Syria .4 Iraq 2.0 Kuwait 3.3 Saudi Arabia 7.2 Abe Dhabi 1.4 Bahrain, Dubai, Qatar, Oman 1. 2 Arab total 18.9 Non-Arab total 37. 3 World total 56. 2 111. 9 1.8 3. 4 1. 7 .4 5.7 1.4 2.1 1. 4 9. 5 10. 8 1.7 3. 4 1.~8 .4 5.8 L3 2.1 1. 4 9. 7 10,8 1.8 3.4 1. 8 .4 6.0 1.4 2.2 1. 1 9. 8 10. 8 1.8 3.4 1. 8 .4 6.0 L4 2.2 1.4 9. 8 10.8 1.8 3. 3 1, 9 .3 6.1 1.4 2.3 1. 5 10. 1 10. 8 1.8 3. 3 1 8 3 6.1 1.5 2.2 1. 5 10. 2 10. 7 1.8 3.2 1. 9 .4 6,2 1.4 2.2 1. 6 10. 1 10. 7 1.9 3. 2 1. 8 .4 6.1 1.4 2.3 1. 5 10.2 2.1 1.1 .4 2.1 3.0 8.4 1.3 1. 2 2.3 1.1 .4 2.2 3. 5 8.6 1.4 1. 3 2.4 1.1 .2 1.8 3. 1 7.8 1.3 1. 2 1.8 .9 .1 1.9 2.6 6.3 1.2 1. 0 1.8 .9 .1 2.1 2. 5 6.6 1.0 1. 0 2.0 1.0 .2 1.8 2.8 7.5 1.2 1. 1 1.9 1.0 .2 1.8 2.8 7.8 1.3 1. 1 1.9 1.0 .3 1.8 2. 8 8.1 1.5 1. 1 19.6 38. 5 58. 1 208 38.4 59. 2 18.8 38. 9 57. 7 15.8 39, 0 54. 8 16.1 39. 3 55. 4 17.6 39. 6 57. 2 17.9 39. 5 57. 4 18.5 39. 5 58. 0 Source: "Oil and Gas Journal", various issues, modified by addition of 1,700,000 barrels daily of natural gas liquids in the United States (see table 1, footnote c). In our analysis of the oil supplies of the other four major consuming countries, we found that using September 1973 as a base was misleading, primarily because of unusually low imports into the United Kingdom in this period. Therefore we based our analysis on the average supply for January through September 1973. Because we did not have statistics on product imports from Japan, West Germany, the United Kingdom, and France, and because December is the last month for which any import statistics presently are available on the United Kingdom and France, our analysis is quite incomplete. 2 Petrolewm Intellioence Weekly (i.e. P1W), Jan. 14, 1974, p. 12. ~ P1W, Nov. 12, 1973, p. 9. PAGENO="0190" 186 But with these caveats, it appears that Japan w~is slightly better off than the United States, Which in turn was somewhat better off tl~an West Germany, the United KingdQm, and France (Table ~). As with the United States, a comp~ri- son of projected supply with actual supply would be more significant than other comparisons and would show a greater loss for Japan, because its oil consumption had been growing more rapidly than that of the other countries. TABLE 5-ESTIMATED SUPPLIES OF CRUDE OIL AND TOTAL ENERGY, SELECTED COUNTRIES, NOVEMBER 1973 THROUGH FEBRUARY 1974 [Percentage of January--September 1973 averagej Crude oil Energy 1 1973 1974 1973 1974 Novem- Decem- Jan- Fob- Novem- Decem- Jan- Feb- ber ber uary ruary ber ber udry ruary UnitedStates3 Japan West Germany United Kingdom France +4.0 +2.4 +3. 4 +6. 2 +14.2 -4.2 +4.7 -11. 1 -12. 5 -~16.5 -4.9 -9.0 -6. 4 (3) (8) -5.1 +2.0 13. 2 (3) (3) +1.9 +1.9 +2. 0 +3. 2 +10.3 -2.0 +3.4 -6. 5 -6. 5 12.0 -2.3 -7.2 -3. 4 (~) (3) -2.4 +1.6 -7. 7 (3) (3) 1 Assumes following importance of oil in total energy supply and assumes shortfalls in imports of products in same percentage as for crude oil based on data in BP Statistical Review of the World Oil Industry 1973, p. 16.) 2 includes production of natural gas liquids in oil supply. 3 Not available. Note: imports of products are believed to be much greater for United States and West Germany than for other countries on the list. Source: National statistics of each country. We attempted to determine the extent to which prices in various nations affected the supply of imj2orted oil to those nations. The rapid changes in the the price of oil by the producing nations obscures some of the possible price effects because of differeuc6s in the time it takes to `ship oil from a given produc- ing country to various consuming countries. iranian oil provides an example. In February, Iranian crude oil was imported into the United States at $7.55 a barrel, compared with $8.61 in West Germany and $9.73 in Japan (Table 6). The higher price of oil to Japan may have been caused by shipments to the United States and West Germany - of a greater portion of oil exported from Iran prior to the large price increase of January 1 than in shipments to Japan. PAGENO="0191" TABLE 6.-QUANTITIES AND PRICES OF IMPORTS OF CRUDE OIL, SELECTED COUNTRIES, DECEMBER 1973 THROUGH FEBRUARY 1974 IThousands of barrels per day of imports and dollars per barrelj December 1973 January 1974 February 1974 United West West Kingdom United States Japan Germany United States Japan Germany United States Japan West Germany Indonesia: Thousand barrels per day 217 736 203 720 355 782 Dollars per barrel 5. 21 6. 46 6. 42 7. 49 9. 09 11. 68 rap: Thousand barrels per day 145 217 1575 397 437 1249 352 422 1240 254 Dollars per barrel 4. 97 4. 41 4. 41 5. 21 5.00 5. 19 6. 48 7. 55 9. 73 8. 61 Nigeria: Thousandi barrels perday 191 474 159 256 4711 22 261 454 25 216 Dollars per barrel 7. 24 6. 77 7. 77 7. 23 9. 71 8. 69 9. 74 11. 86 14. 70 11. 71 Angola: - Thousand barrels per day 62 19 77 23 Dollars per barrel 5.41 11.99 12.89 7.84 Ecuador: Thousand barrels per day_ -- - 56 - -90 90 Dollars per barrel 6. 58 ---- 8. 70 11 56 Venezuela: Thousand barrels per day 87 627 7 57 559 13 18 421 18 22 ~ Dollars per barrel 5. 14 5.03 6. 70 5. 38 7.23 892 7. 81 10. 30 9. 37 9.39 "~ Trinidad: Thousand barrels per day 90 76 56 Dollars per barrel 5 98 9. 94 12.90 Canada: - Thousand barrels per day 725 9(37 951 Dollars per barrel - 4. 98 6.61 Foreign currencies converted to U.S. dollars by following factors: United Japan, Kingdom, Germany - divide by: multiply by: divide by, December 1973 280.0 2. 32 2. 7 January 1974 299.0 2.7 Februaryl974 ~-- 287.6 2.7 Note: France published no price data for year 1973, Britain, no data for 1974; exchange rate for Gernias- mark assumed to be same in January and February as in December. Source: National statistics of each country. PAGENO="0192" 190 to friendly consumers and apparently also to controlling the destination of ship- ments from refineries using Arab oiL The strength of tim producing nations, especially those with large `Oil produC- tion, is not surprising. Since an assured supply of crude oil is needed to keep an oil company's vast network of facilitieS operating, those nations Which provide a company with an important share of Its crude oil s~1pplies naturally have a large influence. Thus, it ~was prCdirtable that Mr. Jungers, the Aramco chief executive, would take qu1~ action `to reduce his company's production In `Saudi Arabia as soon as he heard thC ~tng's message on the radio ~that production would be e~it.~ Saudi Arabia provided on the average' over one-third of the world- wide production of Ara~nco'~ parents (Exxon, Mobil, Texaco and Standard of California) and an even greater share of their reserves. Similarly, Gulf is heavily dependent on one country-Kuwait-for its crude oil supplies.19 But yet in spite of obeying the producing nations' Orders, the companins Still managed to negate the apparent intent of the orders-~whieh was to punish some nations and reward others. For in the end, there is no evldenöe that the nations deemed to be "friendly" by the Arabs got a larger share of available oil than the "unfriendly" ones. I would gUess that the Arabs knew that the diversion of oil would take placeS I do not know what would have happened if all Arab countries had ordered all 011 firms operating In their territory not to divert any oil, either Arab or non-Arab; but I presume the Arabs realized that this would have increased the probability of an international confrontation between nations. The top managements of the `oil companies were' able to cope with the eon- *straints and pressures through the use of giant computer facilities. These corn- putOrs take Into account the capabilities and constraints inherent to the system, such as availability of tankers, quality of crude oil, the capacity and processiI~g capabilities of refineries and the ability to swap products with other firms. Also, the computer programs consider any constraints specified by management, such as providjng a specified amOunt of products to each country. The comj~uter theU Indicates to: management how-~-within these constraints-available crude oil should be allocated to maximize the profit for the firm. Management is thus ~able to try out various policies with the computer. They then pick the desired policy and relay the message to the layers of managers that operate the worldwide facilities. I do not know what criteria these companies used to allocate their available petroleum -supplies, but the aggregate data for the countries that We studied seem to be generally consistent with the statement of Geoffrey Chandler of Royal Dutch/Shell: "The allocation of oil as a percentage of demand to all markets appeared to be the most equitable and practicable course of action in the circum~ stances. Indeed it was the only defensible course if governments were not collec- tively to agree on any alternative preferred system. For the companies, even if this seemed the only way to avoid inviting their own destruction, it was ~ no means the most economically attractive. ~ 20 For the sake of a discussion of the costs and benefits associated with. the foreign operations of the U.S. companies, I assume that in Mr. Chandler's state- ment his description of allocating oil is an accurate one, although data from individual firms would be necessary to confirm this. To do a proper cost/benefit analysis, one needs to know what would be the situation If these five U.S.-based firms did not exist, and it is difficult to know the answer to this conjecture. I assume however that If legislation were adopted to harm the U.S. oil firms operating abroad, then a variety of foreign-owned entities would fill the gap-private companies, such as Royal Dutch/Shells as well as many cothpanies which would be owned by the governments of both producing nationS and consuming nations. What costs to the United States exist because of the foreign operations of U.S. firms? These firms use the U.S. name and flag, and some critics claim that U.S. foreign policy at times has been negatively affected and that part of our military expenditures abroad are to protect U.S. economic interests. As you well know, these complaints are directly against U.s, multinational enterprises in general, not just the oil companies. I am not sure how one p1ace~ a value on this "cost" to the United States. ~ Fort une, February 1974, p. 58. 19 1973 Annual Reports of the Major Oil Companies. 20 Geoffrey Chandler, "The Changing Shape of the Oil Industry," Petroleum Review, ~une 1974. PAGENO="0193" 191 Another cost sometimes attributed ~to the foreign operations of U.S. companies Is the export of capital. The assertion is made that those opei~ationS reduce the amount of investment within th~ United States. Ilowever, the U.S. Tarth~ Com- m1~siofl, in its study of niuitthatlonal enterp1~i~eS, dis~gr~es with such a con- clusion because U.S. monetary ~Olicy~ is so much mere dominant in affecting U.S. investment than the amount of funds involved in U~S. foreign direct invest- memt.n The Tariff Commission study is consistent with those econometric studies which conclude that demand fQr goods rather than supply of funds is the major determinant of investment in the United States.~ This 4uestiofl has not been studied specifically for the oil industry, but I would guess that the amount of oil Investment abroad is much less important than other factors in determining oil investment at home. The major detei~miflants, I think, are the market for petroleum and the degree of prob~bili~y that exploration will be successful. }Iowever, if investment abroad does detract from investment In the United States, then the fl.5. economy (In~luding tax revenues) suffers accordingly. Several benefits can be named. The foreign operations of the U.S. companieS create a number of well-paid jobs in t1~e United States, These are in headquarters an4 In research and development within the o~1 firms-also in the managemE~nt, laboratories and factories o~ the supplying industries. u.s. stockholders of the parent companies pay taxes on the diridends they receive because of the foreign earnings. But both the jobs and taxeS are small compared with the size of the overall U.S. economy. r2he U.S. balance of payments also benefits from oil operatioi$ abroad. The net benefit ranged from $40Q million to $1.3 billion in the years 1966_72.23 Eat these numbers are small compared with over $100 billion In U.S. expOrts this year. The major benefit is lik~ly to be the role played by these firms In the interna- tional oil industry. During nOrmal times they are ethci~ent in the operation of their worldwide networks. During a time of severe shortages, the United States could have a mere asSured supply of oil than if It were depending solely on oil companies bead0~aartered abroad. flat It is unlikely that the United States will receive a much greater proportion of Its needs than other nations, unless th~ U.S. government gives a direct order to the U.S. companies to allocate oil QU this basis. As for that, the U.S. government's actions are likely to be restricted by considerations similar to tliose during the recent crisis. Still, the fact that U.S. companies control an Important ~hare of the world's oil could give the United States more power in attempting to arrange an International sharing agreement f~r usO in an emel~geflcY. The issues are complex and the supply of oil important. Thus, we should ensure that if legislation reduces the foreign activities of the U.S. oil companies, including the majors, then something is available in their place to meet U.S. needs. One implication is that foreign taxation should be treated as a multilateral question, perhaps through the O~CD countries. In th1~ way perhaps all foreign direct investors, Including non-oil as we'l as oil firms, could be taxed by their home governments on a comparable basis. I think that the U~S. gqvernmeiit should take the ipitlattsre in bring aboi~t sudi an agreement. Another area for action hy the U.S. government, aitd again this does not solely apply to oft firms, is to~ investigat& joint ventures to determine whether they violate U.S. antitrust laws. Thank you for the invitation to testify. I will be bapp~ to try to answer any of your questions. Senato~ Qinmoii. Our next witness i~ Prof. John M. Blair, of the Departñaent of Economics, tJ'n~versity of South Florida. Please stand and be sworn. ~ U.S. Tariff CommisSion, The l~tultlnat1O'ia1 Corporation and the World Thlonomy (WaShington, U.S. ~everflmønt ~rlnting office, 1973), p. 649. ~ See Dale W. rorgensofl and Calvin D.. Siebert, "A Comparison of Alternate Theories, of Corporate Investment Behavior," The Asseriocsn Eoo4ioW4O Review (September 1968), pp. 6S1-712. ~ t'relithin~try r5vlsêd figures prepared for publication In gurvey of Current Business) J~Iie 1974. PAGENO="0194" 192 SWEARING OF WITNESS Do you swear that everything you are about to testify to in this proceeding will be the truth, the whole truth, and nothing but the truth, so help you God? TESTIMONY OP PROP. jOHN M. BLAIR, DEPARTMENT OP ECoNØ~icS, UNIVERSITY OP SOUTH PLORIDA, TAMPA, EllA. Mr. BLAIR. To the best of my knowledge. Mr. Chairman, If am here in response ~o your letter of invitation of May 13. Before I begin my testimony, I woñld like to make one brief comment. Your letter referred to my long experience as a petroleum expert beginning with my authorship of the staff report to the Federal Trade Commission on the Int9rnational Petroleum Cartel. While I directed the preparation of that report, wrote part of it, and edited it, there were others who were very actively involved in its prej~aration. I would like to have the record indicate that much of the original writ- ing was done by Mr. RQy Prewitt, who came to the Comilnission from Cornell and became on~ of the world's most knowledgeable economic authorities, I believe, on the petroleum industry. Unfortunately, he died last year shortly after retiring.. Another person who made a major contribution was Mr. J. W. Adams, also deceased. Mr. Adams was with the Federal Trade Commission from nearly the time of its original inception in 1914. These two men, plus a young economist by the name of Meyer Alpert, must share in whatever credit attaches to the preparation in the preparation of that report. At this point, I would also like to express my appreciation for the technical assistance given me in the preparation of growth rates in this statement by Prof. George Steinke, and Mr. Tom Thomas of the University of South Florida. Senator CHuI~dn. Thank you very much. HISTORY OF PETROLEUM INDUSTRy Mr. IE3LAIR. In the history of concentrated industries, the usual sequence has been a progression from market control through collusion, conspiracy, and cartels to the nonprice competition of oligopolis- tic interdependence. Under this interpretation; the coming together of major oil companies and their entering into formal cartel agree- ments such as the Achnacarry and Red Line agreements, would be seen as forms of conduct of an earlier and cruder day which, in all probability, have given way to more modern and sophisticated means of market control. To determine whether the old cartel agreements (or some more modern var~nts thereof) are only relics of a forgotten past would require a new investigation similar to that which underlay the FTC Staff Report of 1952 on The International Petroleum Cartel, conducted by an agency, or congressional committee, with the manda- tory powers, the determination, the resources, and the time necessary to obtain and analyze the underlying documents. But if such docu- PAGENO="0195" 193 ments were unearthed, their existence would come as something of a surprise. rrhis analysis therefore assumes the absence of meetings or agree- ments to fix prices, divide up markets, awl in other ways directly eliminate competition. But, on the other hand, it does not assume that in a rapidly growing industry such as international oil noncompetitive behavior will result from oligopoly alone. There must in addition be other factors at work. Most of this analysis will be concerned with these øther factors. From a broad historical point of view, the period beginning in the late 1920's and extending somewhat beyond the end of World War II could be thought of as the cartel era in international oil. Most of the postwar era might properly be regarded as the period of oligopolistic interdependence. And, in light of very recent developments, we could now be entering into a third phase-an era of bilateral monopoly, with the producing countries acting as sellers awl the companies as buyers, possessing, however, the exclusive right to purchase. Senator CUTJROII. This development is the very one that our previous witness expressed grave concern about, is it not? Mr. BLAIR. In my judgment, it will be a change more of form than substance. I base that only upon the limited and fragmentary informa- tion that has appeared in the trade press and elsewhere concerning these new arrangements. But if the companies which in the past have held the concessions are to be given the exclusive right to purchase, *they will then be able to control the supply, which is the heart of the control of price. Senator CnURcIT. Yes; j~ist the way that they used to be able to do it, Mr. BLAIR. And still do in many parts of the world. Senator CITURCIT. Tinder their elaborate- Mr. BLAIR. Concession agreements. Senator CHURCIL Interlocking arrangemelTits? Mr. BLAIR. Yes, sir, which I shall get to. CONCENThAPION IN INTE1TiNATIONAL OIL The fundamental requirement for market control by noncollusive means is of course a concentrated industrial structure. For many years it has been an accepted tenet of economic thinking that the behavior of prices, profits, and output will differ from that expected under classical-and neoclassical-theory where the industry is oligopolistic; that is, a major share of its output is accounted for by a small number of it~ leading, and usually large, firms. As can be seen below, this is the structural form of international oil: {The information referred to follows:]. CONCENTRATION RATIOS OF WORLD CRUDE OIL PRODUCTION, 19721 [In percentj Mideast OPEC countries United States Free world supply 4 largest companies 7 largest companies 64.4 90.9 52.9 77. 2 30. 3 39. 1 48. 3 70. 0 1 Source: Subcommittee on Multinational Corporations, Hen rings, pt. 4, p. 68. PAGENO="0196" 104 Mr. BLAm. If economists had to select one figure as representing the point at which oligopoly begins, there would probably be a con- sensus that it is in the neighborhood Of control by the top four com- panies of around half the output. In recent years this judgment has been corroborated by a number of empirical studies finding that above a 50-percent concentration ratio-that is, control by the four largest companies of 50 percent or more of the industry's output-the behayior of prices, profits and margins does in fact differ noticeably from that at decidedly. lower levels of concentration. By this standard, the inter- national oil industry would clearly qualify as oligopolistic. Inciden- tally, the lower concentration ratios shown for the United ~t~tes understate the effective control of the' market si,nce the private meatis of control have beeti supplemented by governmental intervention- "market demand" prorationing and the' imj~ort quota-which, as de- mand has now come to exceed capacity, have become unnecessary. Senator CASE. What does the market demand in quotations `mean? Mr. BLAIR. Sir, a distinction is drawn between that restriction\ of output whicli is required ir~ order to preserve the. gas pressures and thus conserve the supply `of oil which nature has deposited in the grpund and the further limitation pu production, ,referred to as "market demand" prorationing, which is imposed simply to maintain or enhance the price. Senator CASE. Thank you. Mr. BLAIR. In the hearings of tl~e Subcqmmittee on &ntitrust and Monopoly, the commissioner of conservation of the State of Louisiana testified, if my memory iscorrect, around 1969 that the amount of pro- duction in Louisiana that was shut in simply to maintain the price, after all requirements of physical ~ had been met, was approximately 1 million barrels a day. 1~his would give you some idea of the extent to which production has been r~straiuied.., Senator CASE. That compared to' wha~t figure of actual production allowed in Louisiana? Mr. BLAIR. Something in the neighbo~hqoc1, for the State of Louisi- an~ of approximately one-third of what they could produce without doin'g harm to the resex~v~irs was withheld, for the' market dern~nd purposes.1 ` ` ` , . To return to the international scene, five of the seven international majors are American firms, and `two are British-Dutch, The U.S. firms are in turn made up of two segm~nts: Subsidiaries of the old Standard Oil Trust (Exxon, Mobil, and Sooai), and "non-Standard" niajors, Texaco and Gulf, which obtained eoncessions in areas from which the original Middle East operators had been e~ectively excluded by the I~ed Line agreement. The 1972 market shares of the seven companies are shown below in accordance with these company groupings. See 9ist Cong., 1st sess., Senate Subcommittee on Antitrust and Monopoly, hearings ~n Government Intervention in the Market Mechanism: The Petroleum Industry, pt. 2, 1969, p. i4. PAGENO="0197" 195 [The informatioil referred to follows :j CON~CENTFIATION OF FREE WORLD CRUDE OIL PRODUCTION, 1972 BY COMPANY GROUPS I tIn per~entj Mideast OPEC countries Un ited States F~ee world su~pIy Exxon, Mobil, and SoCaI__.. Gulf and Texaco BP and Shell Total 39.8 18. 7 32. 4 30.5 19. 0 27.7 18.7 13. 9 6. 5 28.3 17. 7 24, 0 90.9 77.2 39.1 70.6 1 Source: Derived from Subcommittee on Multinational Corporations, He arings~ pt. 4, p. 68. Mr. BLAIR. The 3 "Standard" companies alone produced nearly two-fifths of the Mideast output and almost a third of the OPEC total; that is the total produced by the 11 countries that are members of the Organization of Petroleum Exporting Countries. The five American companies, it can be seen, accounted for nearly three-fifths of production in the Mideast and nearly half in all OPEC countries. The British-Dutch companies accounted for just under a third of the Mideast output and more than a quarter of the OPEC total.2 The coutrol of the market indicated by these impressive market shares has been further strengthened by joint ownership of oil-producing com- panies and other interlocking relationships. COMMON ASSUMPTIONS' OI~ GflOWTIT RATE In addition to a concentrated structure, the achievement of noncom- petitive behavior in a rapidly growing industry also requires the shar- ing of a common point of view concerning the rate at wh'ich the indus- try should expand. Differing assumptioni~ on the desired growth rate would lead to differing expansion plans and thus to the danger of an oversupply, defined by industry spokesmen as `the coming on to: the market of a supply in excess of demand at the existing price. Referring to conditions during the 1960's, Subcommittee Counsel Henry asked Howard W. Page, senior vice president of Exxon, "Was your ma~jor problem having more oil than you could market at acceptable prices?" Page responded by saying, "That was one `of'the problems we had, yes~ along with the rest ,of the industry." Page's response to a similar question by Senator Percy was to the same effect. The Senator asked, "If you had been using the production capacity up to the fullest exteht, obviously it would have driven prices down considerably," to which Page replied, ~`h * ~ I mean if we had used any one to capacity, then we would have to shut the other buck.. There was no place to go with 2 Eleven countries are members of the Or~anizatlon of ~etro1eum Exporting Countries: six in the Mideast (Saudi Arabia, Iran, 1~uwait, traq, Abti flbabi, and Qatar); three in Africa (Libya, Nigeria, and Algeria); one in South America (Venezuela), and one in the Far East (Indonesia). In ~ ptoduction lxx these countries totaled 26,782,00& barrels a day, which represented 86.6 percent of the world p~odu~tion of 30,860,000 barrels a day, outside the United States, Canada, the Soviet Uniop, China, and the East European Com- munist countries. The remaining 4,12;8,00e barrels a day were widely dispersed among some 2 dozen other countries in relatively small ,qi~antities, a substantial proportion of which was produced by subsidiaries or affiliates of the seven international majors. Hearings before the Senate Subcommittee on Multinational Corporations, Mar. "28, 1974, pt. 7. PAGENO="0198" 196 it. You can't dump it in the sea. There is a law against it." ~ In other words, any expansion from one source that woñld cause overall supply to grow at an unduly rapid rate must be compensated for by a coi're~ spoi~ding decrease somewhere else. George T. Piercy, also a senior vice president of Exxon, stated, "Well, I think that if some capacity was brought on anywhere else in the world, as Mr. Page has said, it is like a balloon and you brought it on one place-you push it in one place, something has to give somewhere else because the fact that oil was brought in here or there does not in any way mean there is any more consurnption.~ One way of dealing with the problem is not to develop new sources in the first place. Page recounted the dismay occasioned by the dis- covery of a potential new source of supply, Oman: Just at this time, the producing department brought in their geo~ogist who bad just come back from Oman, and be stated, "1 am sure there i~ a 10 billion oil field there ;" and I said, "Well, then, I am absolutely sure we don't want to go into it, and that settles it." I might put ~some money in it if I was sure we weren't going to get some oil, but not if we are going `to get oil because we are liable to lose the Aranico concession, `our share of the Aramco concession, any~ way, if we were going to back up any further on it ~y going into new areas.° Senator CASE. May I interrupt to ask, in substance you agree with the proposition that there is only so much demand and that if they had produced more than that figure, whatever it was, they would have had to dump it into the sea? In other words, they had to close down somewhere because the world could only absorb a certain amount of petroleum? Is that true? Mr. BLAIR. I read the transcript, I have seen-~--- Senator CASE. I would like your opinion, not what somebody else said. Mr. BLAIR. You have raised that question before. Senator CASE. Did I? Mr. BLAIR. According to the transcript. Senator CASE. I thought I did. It has been in my mind. Mr. BLAIR. Obviously it has. Senator CASE. It is nice to see you again. Mr. BLAIR. Thank you, sir. I happen to think that overproduction is necessary and desirable. In fact, it is essential if we are going to have a weeding out of those producers who are not sufficiently efficient, to cope with the lower price resulting from an expansion of supply in excess of the existing demand. I own a farm in southern Maryland. I sell two crops that have traditionally not been supported by Government price supports. Senator CASE. What is that? Mr. BLAIR. Maryland tobacco, and cattle. Senator CASE. Government price supports- Mr. BLAIR. Not on tobacco, We Marylanders reject it. Senator CASE. You mean you do not come in with- Mr. BLAIR. Not in Maryland. And at times there has been over- production. That overproduction has eliminated farmers whose pro- duction was too small, as well as those whose production was too large 4 11)1(1. ~ Ibid. ~ Ibid. PAGENO="0199" 11~7 for efficient operations. To a very large extent the great efficiency of American agriculture is due to the fact that the normal operation of competitive forces, which at times can be quite cruel, eliminates those producers whose costs are above price when the market is depressed. Senator CASE. I am very glad to get your views again, to have them restated. I realize that the old believers in the free economy of our youth are still adhering to the ancient ways. But I asked you about oil. I was not talking about agriculture. Is there something different about oil? The point is made to us often that after a certain slack is met or eliminated, there is not anything to do with oil except dump it or shut off a well. If the ships are not there you cannot keep on producing, and the ships will not be there, if there is no place to put it when it comes to its destination. Mr. BLAIR. In a competitive market-and the oil industry at times it has been quite competitive in different parts of the world when too much was produced, the inefficient producers were retired from the market, sometimes permanently. There is no reason why- Senator CIrnRdn. In this situation, does this not mean that the most expensive oil just shuts in? Mr. BLAIR. Absolutely. Senator CHURCH. So if you get an oligopolistic industry, that through its agreements is able to control supply, then they are able to maintain a price that sustains all elements of the industry, inefficient parts as well as the more efficient parts. Is that not the way it happens? Mr. BLAIR. Yes, sir, Moreover in the oil industry the discipline of the market is further weakened by the fact that, being fully integrated, the major companies can more or less apportion their profit and their cost to that stage which happens to be of greatest benefit to them. In the past that has been the production level because of the tax features. Tt is at the stage of production that a flim derives the greatest benefit from percentage depletion, expensing intangible drilling costs and foreign tax credits. The whole structure of the oil industry is quite different from what would have evolved without the special taz bene- fits granted to the industry by the TJ.S. Congress. Senator CASE. Suppose we had that oil drop jo its lowest possible level, I do not know how far-I am trying to find out whether the old completely free system would have worked in this thing and worked as well as what we had. If, prices had dropped, would that have been ~ good thing? Would it have been a good thing to have even less coal produced, less research into other resourceS, if possible energy resources? God knows we had little enough and would we not have become more completely depend- ent upon these Arab countries, for instance, if We had done that? I wonder if that would have been a good idea. We are dependent enough as it is, but not quite as completely as if petroleum had gone down to half the price. Mr. BLAIR. Senator, I do not think that what has takOn place in the oil industry cotild under any circumstances have been much worse. in fact, we have had the worst of ~l1 possible worlds. Senator CASE. I wonder if that is a faIr thing. Our prices for Oil on the whole have been les~ than anywhere else in the world over the last ~5 year~. Mr. BLAIR. No, sir. PAGENO="0200" 198 Senator CASE. Where else have they been cheaper? Mr. B~&rn. Europe and Japan. Senator CASE. You meanS because you çtre not taking rnto account the taxes? Mr. BLAIR. No, I am taking into account the taxes. I am referring to the effect of the import quota. We had at the behest of the oil industry an import quota in the t~nited States which was put into effect on a mandatory basis in 1959 and remained in effect until 197Q. Under that import quota, American buyers, including American chem- ical companies, had to pay at least $1.25 more for a barrel of oil than their competitors in Europe or Japan or any place else in the world, Senator CASE. We have bigger cars. We would have had even bigger cars than we have had. We have much more complete reliance upon petroleuni than anywhere else in the world because of the low price. II just wonder whether, much as I yearn for the same kind of thing you yearn for, the old days, I just wonder whether they are possible, that is all, and whether they would produce the things we want. Are we not really turning now to more o± a world in which each country is going to try and within itself decide what its size should he and the allocation of its resources? Are we not forced to do that in the face of the nationalism in other countries? Mr. BLAIR. Senator Case, there are always objections that can be made to the operation of the competitive market. The competitive market subjects enterprises to a very hard form ~f discipline. It has, however, certain important advantages that no other form of public policy possesses; not oniy does it bring about a price which is economi- cally desirable, that is, it calls forth the supply needed to meet the existing level of demand, but-and this is often overlooked-it exerts a1 constant down~vard pressure on costs. Under public utility regula- tion the rates of a piiblie utility may be set in such a way as to yield only a fair or reasonable markup above cost, but there is no way of seeing to it that the utility constantly reduces cos~ and keeps abreast of new technological developments. Only competition provides that incredibly valuable discipline. A further function performed by competition-no other form of public policy provides, a reward to the enterprise that introduces an innovation, a new technology, or product that either exploits a demand that had not beep tapped before or results in a reduction in cost. `One of the great problems in the Soviet economy has been the lack of such incentives operating within state enterprises. Their tech- nological backwardness, which they are now acknowledging, is n~t the result of an inadequate supply of trained engineers and techni- cians~ In fact, they turn out a greater number of engineers than the Western Wprld, than the United States each year. The problem is that their new idea~ their new concepts, that would contribute to indus- trial progress are not received. There is no place for them. Rather than trying something new, which might interfere with production,. the plant managers seek to achieve their production norms by relying up9n the existing and older technologies. That is the fundamental reason why the economies of~ the Communist countries are lagging increasingly behind the Western World. Senator CAsE. Well, now, take agriculture, not Maryland tobacco or some of these fancy little jobs, but the broad basic crops. We have never had a free agriculture in my adult life in this-country, or yours, PAGENO="0201" 199 and yetwe have achieved enormous prodictivity, and I wonder if this is something that really could be applied across the board any more? You are generally regarded as a populist. It i~ a good thing; and a Brandeis man, and that is a good thing. But I ~wonder if there is i~ot an inconsistency, I know you-~-I am not saying~ even suggesting that you suggest that labor unions ought to be abolished because the labor market has interfered with their operation. You certainly do not sug- gest that ëontrols on banking ought to be abolished because the banks otherwise could operate more effectively in dealing with money and whit not if they were not regulated. What you are really saying, within certain limits, free enterprise is most desirable, and I agree with you. Is it not a question of where we place the limits? You want low- interest rates. To that end you are not going to permit the rich banker to charge what the traffic will bear. Is that not tru~? Mr. BLAIR. I would like to think of myself as an economist. Senator CASE. Sure. Mr. BLAIR. Economists have to relate their own personal philosophies to the realities of the real world, otherwise they are more or less whistling in the wind. Senator CASE. What a man believes is what he is. That ancient Greek doctrine is really true. Mr. BLAIR. Unhappily, what I believe is not what the world is. Senator CHURCH. That may get us back to oil. [Laughter.] Mr. BLAIR. I enjoyed the colloquy very much. Senator CHURCH. I listened with fascination and it seemed to me that the point toward which you were homing in, perhaps, had to do with who does the regulating. If there is one thing we have not in international oil today, it is a free market. The whole structure has been built on an entirely different principle, and today it is not only the oligopoly that exists with the major oil companies controlling so large a part of the tothJ production, but it is overlaid by the fact that the Arab governments themselves have imposed prices for oil that have nothing to do with the cost of production, nothing to do with the market. They are political prices that have been imposed for entirely different reasons. We do not have the element of a free market h~re at all with which to deal. Now, im that ~ituatjon, what are we.to do? Are we to leave It to the companies to ~ontrol or attempt to control production and price by making new deals with the Arab governments, changing the form but not the substance of the old arrangemonts~ or are we to nndertake through Government action steps that might have some chance to change this arrangement? I think the real question we are faced with, is not the ideal of a free market operating without obstruction of governments or without ob- struction of oligopoly, but an existing situation that is quite different How do we cope with it? Mr. BLAIR. Mr. Chairman, I do have some suggestions as to pubfic~ policy which I get to toward the end of my statement. I would be very unhappy to have to paraphrase what I have carefully writtem out. Senator CHURCH. All right. PAGENO="0202" 200 Mr. BLAIR. And introduce it before presenting the analysis on which it is based. Senator CirnRcIT. Go ahead with your presentation. Mr. BLAIR. Thank you, sir. IL am introducing that ca~reat only with respect to recommendations on public policy. I would be glad to talk about anything else when.. ever you care to interrupt. Senator CHURCH. Yes. A STABLE GROWTH IN SUPPLY Mr. BLAIR. The achievement of a consensus among rival oligopolists on a desired growth rate would, of course, be greatly facilitated if the rate were assumed to be relatively stable over an extended period of time. In the Mideast, Africa, and similar environs, a leadtime of several years is usually required between a decision to make a sub- stantial expansion in productive capacity and the installation of the production, storage, and transportation facilities necessary to bring it onstream. And the leadtime becomes even longer if new refining capacity is required. T5nder such circumstances, widely varying as~ sumptions from 1 year to the next as to the rate of increase in supply would make it difficult, if not impossible, for each oligopolist to plan for precisely that increase in his output which would maintain his share of the market but not produce an oversupply. Whether simply a means of implementing mutual interdependence or the product of collusive agreement, worked petroleum supply has exhibited a remarkably stable annual growth rate, as reflected in the output of the leading producing countries-outside North America and the Communist bloc. This is revealed in chart 1 which shows for 1950-72 the yearly average increase in aggregate output of the 11 members of OPEC-Saudi Arabia, Iran, Kuwait, Iraq, Abu Dhabi, Qatar, Venezuela, Libya, Nigeria, Algeria, and Indonesia.7 The compound growth rate and a measure of the "closeness of fit" have been computed by- (a) plotting the actual increase in aggregate output; (b) fitting a regression line to these observations; (o) determining therefrom the compound rate of increase in output-the "average growth rate"-and (d) measuring the deviations between the I~egression line and the actual observations, thereby indicating by a coefficient of determination (R2) the extent to which the actual increases are "explained" by the estimated growth rate. This chart, like the others used in this analysis, has been drafted on semilogarithrnic paper by means of which a given percentage change occupies the same vertical distance anywhere on the chart. [Chart 1 referred to follows:] ~ In 1972 all but 1 produced at least 500,000 barrels; t~heexcéption; Abu Dhabi, pro- duced 474,000 barrels and exhibited an astonishing annual growth rate of 36 percent. PAGENO="0203" 201 CHART 1 CRUDE OIL PRODUCTION ACTUAL vs. ESTIMATED CR0 mR RATE, 1950-12 M~s./BbtJD. Mr. BLAIR. For the 11 countries as a group, the average annual per- centage increase in output during 1950-62-the "estimated" growth rate-works out to be 9.55 percent. The measure of the closeness of fit of the regression line to the actual observations-the coefficient of determination or R square-is an astonishing 99.9 percent. In other words, an assumption that oil production would increase at an average SUF./BbI./Yr. 10 5. 4 (9.55%) 13.70 10.96 8.32 5.48 2.74 ~1 52 54 56 58 60 62 64 66 68 70 72 (SOURCE: DERIVED FROM ORGANIZATION OF PETROLEUM EXPORTING COUNTRIES, STATISTICAL BULLETINS.) PAGENO="0204" 202 annual rate of 9.55 percent explains all but one-tenth of 1 percent of the actual change. Mrs. LEwIs. I am a little bit puzzled. What is the estimate? Is the estimate that you are comparing using the regression analysis 9.55 times or estimates made by the oil companies themselves? Mr. BLAIR. No, Mrs. Lewis; the term "estimate" is used in ref ~rring to the growth rate, which has been estimated by fitting a linear trend by least squares to the logarithms of the data. It is a standard sta- tistical technique. Mrs. LEwIs. You are testing our own 9.55 force growth rate hypoth- esis, not the estimates made by the oil company? Mr. BLAIR. The 9.55 is simply the result of the application of this orthodox statistical technique. As a matter of fact, for practic~illy the same period, Exxon, as I point out, arrived at exactly the same growth rate for the same area. Senator CHURCh. What you tell us in the chart, which is an astonish- ing straight line- Mr. BLAIR. Yes, sir. Senator CHURCH [continuing]. Is that the actual growth rate came within 99.9 percent of the estimated growth rate, right? Mr. BLAIR. I would put it somewhat differently. Senator CHURCII. Which you would have expected? Mr. BLAIR. The assumption that the supply would increase at an annual rate of 9.55 percent-the rate yielded, by this statistical tech- nique-would explain all but one-tenth of 1~ percent of the actual change. Senator CHURCH. Of the result that you obtained by observing the actual increase that did take place? Mr. BLAIR. Yes. Senator CHURCH. Does not this chart show then that astonishing amount of control exercised by the industry over growth? Mr. BLAIR. It is particularly astonishing in view of the widely diverse movements of its separate components. If each of the produc- ing' countries had been increasing its output at about the same rate, the steady rise in overall supply could be explained as merely the sum total of the behavior of the individual countries. But this explanation obviously falls if the different sources of supply have been expanding at widely varying rates and, even more strikingly, if some have been characterized by actual declines. That such has been the pattern of the international oil industry is apparent from chart 2 which shows for 1950-73 the yearly change in total production for each of the nine leading producing countries. The international supply picture is re- vealed as a composite of long-sustained steady increases-Saudi Arabia and Iran-of much slower rates of increase--Venezuela, Kuwait, and Iraq-of precipitous rises-Libya until 1970, Nigeria, Abu Dhabi, Indonesia-and of occasional pronounced declines-Iran in 1951-54; Iraq in 1957, 1967, and 1972; Nigeria in 1968; and Venezuela and Libya since 1970. Somehow the major oil companies have been able to orchestrate these and other aberrations into a smooth and uninter- rupted upward trend in overall supply. PAGENO="0205" [Chart 2 referred to follows:] 203 VENEZUELA SAUDI ARABIA IRAN NII~ERIA 1NbON~SIA KUWAIT AIIU DHANI LIBYA IRAQ 1950 52 54 56 58 60 62 (SOURCE: DER1VED FROM ORGANIZATION OF PETROLEUM EXPORTING COUNTRiES STATISTICAL EULLETINS.) Senator CHURCH. In other words, you take the Sources? Mr. BLAIR. Yes, sir. Senator Ciirmcii. In chart 2? Mr. BLAIR. Yes, sir. Senator Cirmwn. The various sources of oil worldwide are very uneven, some growing rapidly, some less rapidly, and some actually falling off from time to time. You would expect if the oil industry did not exercise a tremendous control over all sources, over supply, and had not positioned itself to orchestrate things to its own interest- CHARI2 PRODUCTION OF CRUDE OIL 9 LEADING PRODUCING COUNTRIEs 1950-73 PAGENO="0206" 204 that is, to control things-that these widely deviating sources of supply would result in a widely deviating rate of industry, overall industry growth. Yet, your overall industry growth is practically a straight line. Mr. BLAIR. Absolutely. Senator Cirnacii. Thus indicating a remarkable degree of control and coordination worldwide? Mr. BLAIR. Moreover, this control can be continued under the bi- lateral monopoly arrangement that seems to be in the works for the future if the concession-owing companies are given the exclusive right to purchase oil from the selling countries. Senator Crnrnoii. Yes. `The buy-back agreements will preserve in substance what the oil companies have previonsly enjoyed? Mr. BLAIR. If you will look at chart 2, you will see that between 1952 and 1954, Iraq production went simply off the chart. That~ of course, was a period immediately following the nationalization of the oil industry under Premier Mossadegh. Yet if you look back to chart 1 instead of the observations falling below and to the right of the trend line, which one would expect on the basis of the elimination of what was then one of the world's largest sources of supply, there is virtually no deviation whatever in the growth of actual production/as compared to the increase that would have been anticipated on the basis of the growth rate. Similarly, if one looks at chart 2, and focuses upon the Libyan pro- duction, one can see that during the middle and latter sixties, Libyan production was rising almost vertically. Had there not been compen- sating reductions in supply made elsewhere, actually they were made in the Mideast, the observation would have fallen above and to the left of the regression line. Yet the adjustments were made with such care and precision that the observations representing actual produc- tion continued to fall on the regression line. Senator CASE. May I ask a question for a moment? Would these charts have looked any different if you had a coin- pletely free market? Mr. BLAIR. I would hope so. Senator CASE. Now, I wonder. The rea son that some countries went down, like Iran, well, they took over, that was shut off, that was a political job, I take it? I mean Iraq. Mr. Br~&In. It was Iran that nationalized the oil industry under Premier Mossadegh, after which the companies boycotted the oil from Iran on the very logical grounds that since no compensation had been paid, such oil remained their property. Senator CASE. I mean really would not the first chart, is not all that shows is that the oil that is produced is consumed? Is that not all that shows? And would you not have deviations always adding up to that fact in the oil industry the same as you would in agriculture, except that you can store stuff a little while, a couple of years, maybe, as far as products go. Are you really showing anything more than demand has equaled supply, because you do not produce unless there is someplace to put it, which means demand? PAGENO="0207" 205 Mr. BLAIR. Senator Case, I would venture two answers to that question. First, as I will indicate shortly, the oil companies have sub- stantially underestimated the level of demand, which is one of the real causes of our present problems. One cannot take actual production as being indicative of what demand is and certainly not what demand would have been under alternative prices. Second, I would anticipate that in any competitive industry there would be substar~tial deviations around the~trend line both below and above it as different countries and different companies produce less than the demand called for and, alternatively, as they produce more. When they produce more, those companies and countries whose costs were above the lower price prevailing as a consequence of the over- production, would disappear. The discipline of the market would be operating, leaving only those firms which were sufficiently efficient to meet that lower price. Now, Mr. Chairman, on this question of efficiency-- Senator CHURCH. So, as I understand the answer to Senator Case's question, which is a very important one, you are saying that if there had been a free market and real competition operating in oil-these, and a lot of companies operating without interlocking agreements that enabled them to orchestrate the production from other sources when they needed to make up for shutoffs and that kind of thing- chart 1 would to a far greater extent reflect the variations that are shown in chart 2? Mr. BLAIR. I believe it would be absolutely impossible for chart 1 to reflect an absence of deviations to the extent indicated by that chart under the condition of anything approaching a free market. Mr. Chair- man, this suggests an ability to orchestrate different sources of supply which, as I said before, is astonishing. Senator CASE. No matter how it is made up, would it not always end up the same way? That is all I am talking about. Mr. BLAIR. Going back again to the two-part answer to your ques- tion, insofar as meeting total demand is concerned, the total supply that would be produced under competition would be somewhat greater because, as oil company officials have before this committee, this very subcommittee acknowledged, they have underestimated the demand. Therefore, if their production under competitive conditions reflected actual demand, their production would have been greater. Senator CASE. Yes; but that should not make any difference in chart 1, would it? Mr. BLAIR. It would mean the growth in supply would have been more rapid than the 9.55 percent shown by the growth rate. Senator CASE. The growth in supply? Mr. BLAIR. Yes, sir; if the increase in actual supply is as close as is shown here, to the estimated growth rate, and the growth rate in turn has resulted in an inadequate supply with respect to demand, that is, demand has been in excess of supply, then it logically follows, as day follows night, that the actual production would have been con- siderably, or would have been greater under competition than is shown on chart 1. Senator CASE. But your line on chart 1 would still be the same, I think. Mr. BLAIR. The line, no, the line I think would go- 45-426-75-14 PAGENO="0208" 206 Senator CASE. What would it look like? Mr. BLAIR. The line would be more ~harply inclined up to the left. Senator CASE. It cannot go much ~harpe~. .1 am not questioning that there have been effOrts at cor~trol or whether control has existed. All I am saying ~is that particular tl4ng I do not think proves much more than the oil that is produced is consumed. Mr. MEISSNEE. Is it not true that the line would have to be straight? YOu ~re fitting at least squares to the pattern of observations. It is not the slope of the line but the fit that interests us. There would be a sig- nificant deviation of the dots or of the actual observations off that line, therefore dropping your R-sq~uare fit? Mr. BLAIR. Absolutely. The B square, as you say, would be lower because the deviations would be greater. Also, the slope of the line would b~ more inclined. Senator Cnuiwn. Splendid. Let us proceed. THE 1JNDERESTIMAPI0N OF DEMAND Mr. BLAIR.' Not only have the international majors been able to secure a remarkable stability in the growth rate of supply; they have also underestimated demand, as is usually the case where an industry se- cures the power to adjust supply to its own demand forecasts. The penalt3r of producing too much, that is, a lower price resulting in de- creased revenues on all sales, is far greater than the loss from producing too little; that is, a failure to Secure revenues on just these sales that are foregone because of supply. Moreover, forecasts are generally eon- structed on the basis of past relationships between a product's use and measures reflecting demand (for example, GNP, per capiti~ income, population trends, et cetera). What this technique does not, and cani~ot, adequately allow for is the discovery of new uses for a product which, in the case of petroleum, have followed one upon the other in a bewil- dering procession, both as fuel (for example for powerplants) and as materials (for example plastics, synthetic fibers, fiberglass, and most recently graphite fibers). Nor, incidentally, can this technique accu- rately allow for the effect On demand of a price cha~nge *hen its extent, as in 1973, is well beyond the range of recorded experiences. `The tendency of the international oil companies to underestimate demand is illustrated in table 1, which shows for selected years, the modifications made over time by Aramco and Exxon in their forecasts. Mrs. LRwTs. A. weaker analysis of some material provided by Stand- ard Oil of California, where it appeared that they nearly always pin- pointed worldwide demand to within less than one~tenth of 1 percent of what it subsequently turned out to be, does that conflict with what you found in the Exxon data? Mr. BLAIR. The Aramco and Exxon data I think would conflict with the finding as you summarize it. Of course, as one moves closer to the year for which the forecast is made, the forecasts have a general PAGENO="0209" 207 tendency of becoming somewhat thOre accurate. Mrs. LRwis. ~ ~was using 3 years in advance. Mr. BLAIR. Well- Mrs. LEwIs. If you wish to examine that data, we want to make it available. I think it should be put into the record. Mr. BLUM, Mr. Chairman, in addition, if we put that in the record, there is some material we received from the Gulf Oil Corp. which absolutely substantiates what Dr. Blair is saying. It shows industry predictions over a period of 10 years being substantially understated, and the Gulf analysis is an effort to explain why. I ask that that be made part of the record, too. [The information referred to follows:] GULF OIL CORPORATION, WORLD PETROLEUM SUPPLY AND DEMAND, MARCH 1970 PETROLEUM DEMAND FORECASTS-HISTORICAL COMPARISONS As will be observed o~a the graph immediate'y following, our forecasts of petroleum demthd, historically, have been conservative. For example, in 1960, forecast free world demand for 1970 was 28.5 million B/fl; we now expect that during 1970, the free world will consume over 39 million B/fl-or 40% more than was estimated ten years ago. Even as recently as 1968, demand estimates for 1970 fell short of what now is needed by some 3 million B/fl-or 8%. And down the line-to 1980, and beyond-successive demand forecasts show even more pronounced divergencies from their predecessors. One's first question in observing this trend is: "Well, why not grind in a `counter-conservatism' factor based on history ?" Indeed, if such were done-as Is illustrated by the dotted line connecting historical demand points~ and projecting at the same incremental rate of change-we see that before too long, the demai~d for petroleum reaches an unrealistically high level, This is somewhat analogous to those population studies which augur that unless something soon is done, every square foot of the earth's surface will harbor a living human being by year X. We know this won't happen; however, we don't know where it will stop either. It is evident, then, that an inflection-or, a leveling-of the petroleum demand curve must occur witl4n the ~iext few years. Cognizance of one important factor in the recent energy history of the free world suggests that this change in shape of the demand curve will occur fairly soon. This is the "replacement factor." In past years, one ~f the reasons that demand for oil grew far in excess of expecta- tions was that petroleum derived energy in Western Europe and Japan replaced much energy previously generated by coal. Accordingly, the demand for oil grew at a greater rate than did that for total energy. We now feel that-throughout the next fifteen years-the substitution of petroleum for coal will be much less significant than it was in prior years. Our current forecast assumes that growth in petroleum demand will be more closely in line With growth in total energy demand. In spite of the above assumption that the "replacement factor" will not be as important in future years, it is possible that even these 1970 demand forecasts are conservative; history certainly justifies this suspicion. `tinfortunately, we cannot determine in what areas of product supply or geography any conservatism lies. If, once again, our estimates of future free world oil demand prove low, then a strain on productive capacity may* be appioached before 1980. As it is, coordination of the 1970 demand forecast to existing and speculative oil supplies suggests that demand will tax supply by the early 1980's. PAGENO="0210" 208 MILLIONS BID A HISTORY OF FREE WORLD PETROLEUM DEMAND FORECASTS Mr. MmssNEn. Would there not be a point here also in terms of how international oil supply figures are developed. Gç~nerally, don't you have a tabling process? In the Iranian consortium you have a group of companies that table their estimates of desired output, that is the com- panies have instructed their delegations to table certain supply requests out of the consortium. Each company makes these estimates based on their total worldwide demand projections and supply pro- jections. So anything that comes out of that consortium in terms of decisionmaking is a group decision that will most likely average a large group of projections rather than run on one company's projection. There also seems to be a tendency, as shown in our study of the APQ system, to restrict supply rather than to get oversupply out of a given consortium. This too would also fit in with your hypothesis. Mr. Bi~iu. Does your observation require comment? I believe I would agree with the import of what you have said. Senator CHURCH. That being the case, let us proceed, because we are beginning to run out of time and we still have a considerable state- ment to make here. I think we should refrain from questions to give the professor the opportunity to finish his statement first. Mr. BLAIR. The forecasts by Aramco- -designated in the table by "A"-relate to Saudi Arabia and are in terms of thousands of barrels a day; those by Exxon-designated by "E"-relate to the entire Mid- east and are in terms of annual growth rates.8 S The Aramco forecasts are as of the fall of the year; those for Exxon are projections made each year covering a span of 4 or 8 years. PAGENO="0211" ~0o In 1971 Aramco estimated that its 1975 production would total only 8,290,000 barrels a day; a year later it had revised its 1975 forecast upward to 9,300,000 barrels, and in 1973 the forecast was again raised to 11,260,000 barrels per clay, an increase of 35.8 percent in only 3 years. In 1969 Exxon estimated that by 1975 demand for Eastern Hemi- sphere crude would be rising at an annual rate of 7.2 percent; 3 years later its 1975 estimate was 10 percent. The last year before the com- panies obviously began to adjust their Mideast forecasts downward to make room for an expected continuation of the rapid increase in Libyan production was 1966. In 1963 Aramco had estimated that i~s 1966 produotion would total 1,955,000 barrels per day; only 2 yeats later the forecast was revised upward by a quarter to 2,445,000 barrels per day. But the most egregious error in estimate is represented by Exxon's forecast for 1966. In 1960 it had estimated that by that year demand for Mideast ci~ude would be rising at an annual rate of only 2.6 percent. The forecast was steadily revised upward until by 1966 it had been raised to 7.3 percent, nearly a threefold increase in 6 years. [Table 1 referred to follows:] TABLE 1.-MODIFICATIONS OF FORECASTS OF CRUDE OIL PRODUCTION ARAMCO (SAUDI ARABIA) AND EXXON (MIDDLE EAST) 1975 1966 Aramco Aramco (thousand barrels Exxon (thousand barrels Exxon Date of forecast per day) (percent) per day) (percent) 1973 11260 1972? 9,300 10.0 1971 8,290 1970 1969 17.2 1966 2,445 7.3 1964 2, 120 6. 1 1963 1,955 5.9 1962 (2) 1961 (2) 5.0 1960 - (a) 2.6 1 Eastern hemidphere crude demand. 2 Not available. Sturces: Araruvco-"Historical Report 1963-73, "exhibit A, submission by company. Exton-Campiled from forecasts of "Free Fdr~ign Supplies', spbmission b~ company. Mr. BLAIR. Although qualified by a variety of explanations, oil industry spokesmen have conceded that demand has been under- estimated. flesponding to persistent questioning, Piercy of Exxon acknowledged: We did underestimate energy demands. That shortfall was reflected in oil. That, coupled with a loss of ability to produce in two or three nations which we have already mentioned has resulted in this all-out tight situation that we have today.~° ° As was truO of otluet fore~attb teach' duvin~ the lactter 1960's, Exnotu's estimate for Mideast crude was biased downward (4,2 percent) on the, basis of the assumption that Libyasi outpi~ut would continue the rapid rate of Increase manifested duRIng most of the 1960's. By ~97O it bad b~connu~ ~vldept that this was an un~ealistlc assumption. 1O Hearings before the Senate Subcomrr4ttee on MuItlnat1~na1 Corporations, Mar. 28, 1974, pt. 7. PAGENO="0212" 210 oLIO0PoLIST~C INTERDEPENDENCE Despite .a concentrated industry structure and a con$ensus on the growth rate, noncompetitive behavior could still not be achieved unless each oligopolist could depend on the others to avoid undertaking expansions that would significautly increase their shares of the mar- ket. What is involved here is an extension of a psychological consid- eration inescapably inherent in the structure of oligopolistic industries, In the classic formulation by :Edward H. Chaniberlain: If each seeks his maximum profit rationally and intelligibly, he will realize that when there are only two or a few sellers his own move has a considerable effect upon his competitors, and that this makes it idle tq suppose that they will accept without retaliation the losses he forces upon them. Since the result of a cut by anyone iS inevitably to decrease his own profits, no one will, ttnd although the sellers are independent, the equilibrimn result is the same as though there were a monopolistic agreement between them.1' In a competitive industry this psychological awareness is absent because each seller recognizes tha1~ his share of the market is so small that nothing he can do will affect his rivals. It is also absent in a monopoly since, by definition, there are no competitors to be concerned with. But in an oligopoly each of the leading producers ha~ a sufficient share of the market to make him acutely conscious of the injurious consequences on himself of reactions by his rivals to any competitive move that he might initiate. Observing that the term "oligopoly" is "altogether appropriate" to the oil industry, Paul I-I. Frankel notes that in addition to militating against the occurrence of price compe- tition, oligopoly has other consequences: Where there are only a few competitors, it is much easier for them tO band together in order to fix and maintain prices and, if appropriate, to agree on market shares for each of them, than either course would be if a great number of competitors were involved. Furthermore the chosen few can in certain cirCtim- stances act in parallel even in the absence of explicit agreements to that effect.n Imperfect competition theory was developed against the economic setting of the Great Depression. At the time price resistance to depressed economic conditions was widely regarded as a contributing cause of underconsumption. Hence it is understandable that this new contribution to theory was focused on short-term price behavior. Since World War II the conduct of large companies in oil and Ethç~r indus- tries raises the further question of whether the same type of psycho- logical considerations would also apply to an e~pansion of capacity that in time would make a price reduction inevitable. In other words~ would an oligopolist abstain frd~m expanding his capacity because of his expectation that his expansion would be matched by his rivals, thereby creating a futurd supply in exceSs of what the market could absorb at the then existent price. Certainly, the aggressive expansion by a rival would induce ah oligopolist to expand his capacitysimpiy to maintain his share of the market, even though he fully reáoghizes th~ consequences of what he is doing ofl overall supply. Only if each ohi~op- olist is confident that the expansion plans of his rivals will do no more than roughly maintain their established market shares can he reason- ably be expected to limit hi~ own expansion, How, short of c~o1lüsive agreements, is such a state of confidence to be achieved? ~1 Edward H. Chemberlain, Tire Theory of Monopolistic CompetItion, 5th ed., Harvard University Press, 1940, p. 48 ~emphas1s added]. 1~ H. Frankel, Mrttei: Oil irnd Power Politics, Frederick A. Praeger, 1960, p. 82. PAGENO="0213" 211 INFORMATION ON RIVALS' PLANS In world oil a number of sources of information are available on the basis of which each of the seven international majors should be able to arrive at a fairly accurate judgment of his rivals' plans. One is knowledge of the growth rates of the principal producing countries. Obviously, the steadier the growth rate, the greater its reliability as a means of predicting a `country's probable future production and thus of the supplies going to its concession-owning companies. For example, with i~iearly two-fifths of total OPEC production Iran and Saudi Arabia have exhibited extremely stable growth rates. The assumption that supply froni these sources would continue to expand at their historical rates would not have been seriously in error. CONTROL THROUGH JOINT VENTURE As it has evolved in oil, the jointly owned operating company has not only provided a means of implementing a jointly held concession but, for a given country, puts the power of implementation into the hands of fewer than half of the seven majors. This is apparent from table 2 which shows for 1971 the cumulative percentages of output and equity ownership of leading `OPEC countries accounted for by companies among the international majors.13 [Table 2 referred to follows:] ~ Where t~e distribution o1~ a country's production Is c1o~e to, but slightly less than, the distribution of equity ownership in an operating company enjoying a monopoly or near monopoly, the difference is usually accounted for by a relatively small amount of oil produced by a government or national company or by a minor concession holder. In Venezuela, there is no dominant jointly owned operating company. Where, as ip Abu Dhabl and Indonesia, there is more than one jointly owned eperating company, the distribution of equity ownership is shown only tor the largest. PAGENO="0214" TABLE 2.-7 OPEC COUNTRiES: CUMULATiVE PERCENTAGES OF PRODUCTION ANO EQUITY OWNERSHIP, 1971, BY COMPANIES AMONG THE 7 INTERNATIONAL MAJORS [In percenti Nuinberof companies Arabia -________________ Production Ownership Kuwait Production Ownership Iraq Production Ownership Abu Dhabi Production Ownership Indonesia ~- Production Ownership Nigeria Production Ownership 1 Venezuela - Production Ownership' :~ , I 2 28 57 30 60 54 92 50 100 24 48 24 48 41 56 24 48 40 50 80 100 36 72 47 76 3 85 90 72 72 63 60 90 82 t 94 100 70 72 95 85 1 No dominant joint venture. Source: Derived from Organization of Pctroleum Exporting Countries, statistical bulletin. PAGENO="0215" 213 Of the five countries with a dominant joint venture, majority stock control was attained in 1971 by only two companies in Saudi Arabia, Kuwait, and Indonesia and by three in Iraq andAbu Phabi (the two leading firms holding 48 percent). In terms of productibn more than half of the output was accounted for by only two firms in all but one of the countries, the exception being Iraq.'4 Because so much of each country's output is produced by SQ few of the majors, none of the oligopolists need be particularly concerned tht~t any of the countries will be the source of a price-weakening sur- plus produced by independents. What is more important, none need be greatly concerned that any of the countries will be the source of such a surplus produced by any of the other majors, since its increased profits resulting from greater production in a given country would probably be more than offset by reduced profits in the other countries in which i~t also operates. The extra dimension introduced by the joint venture into imperfect competition theory is an awareness by each oligopolist of the probable consequences on all of his areas of pro- duction of a competitive move he might initiate in any one of them. Senator CUTJRCH. Oligopolists have to get together then. Mr. BLAIR. They may not have to get together in the usual legal sense, Mr. Chairman, but correctly anticipate each other's reactions to their actions and govern their actions ~ccording1y. Senator CHURCH. Yes. And they have to, if that requires working out some machinery, find legal ways to do it. Mr. BLAIR. Or over time they could have learned enough about each other's reaction to make unnecessary the use of machinery which might have been neCessary in the past. Mi~. SLUM. Mr~ Chairman, the subcommittee has received a number of documents from the files of the Arabian-American Oil Co. which deal with the provisional Middle East industry growth rate calculated every year in accordance with the 1964 intercompany agreement.'~ This arrived subsequent to Dr~ Blair's statement. I wonder if we might make this part of the record at this point and ask him to look `at that and perhaps comment on it for the record.. I think it would be useful to have that. Mr. BLAIR. May I submit my comments? Mr. BLUM. Certainly. Senator CirnRC~-I. We will make this an appendix to the record, together with the professor's comments on it. Mr. BLAIR. Thank you, sir. *See Part 8, Hearings before the Subcommittee on Multinational Corporations. 93rd Congi-ess, 2nd SessIon, n Not included in table 2 Is Iran whose output is determined by a complicated procedure. The owners annually submit to the consortium their "nominations" representing the quantity they would like to lift from Iran. After being listed In descending order, the total to be produced (the ~PQ or "Averaged Programmed Quantity") is the "program figure of the participants whose liftings fell at or above a cumulative total of 70 percent of equity percentages." By limiting their "nominations" the 15.8. companies have reduced the total to which the 70 percent figure 15 applied. Between 1957 and 1973 Exxon's nominations have put it below the APQ In 14 of the 17 years: Socal's has put it below the APQ In 15: and Texaco was below in all ~7. Up to the amount represented by their equity i~hare of the APQ the participating companies tecelve oil at "tax-paid-cost" or about two-thirds of the posted price. But for any excess they had to pay the full posted price, later modified to a `halfway' price (the tax-paid-cost and the posted price), and still later to a quarter-way' price. Neither of the two would be considered "economically attractive' since as compared to a market price of about $L30. a "halfway" price for Iranian light woi~ked out to around $1.49 and a "quatter-way" price to $1.30. (Senate Subcommittee on Multinational Corporations, prepared statement b~ E. L. Shafer, Mar. 28, 1974, pi, `7.) PAGENO="0216" 214 ADJUSTING ~OR ABERRATIONS ~Mr. BLAIR. `The ability of the oil companies to maintain a smooth and steady rate of increase in overall supply despite extreme changes in important supplying countries can be illustratOd, on the one hand, by the loss of output resulting from Ira&s nationalization of Anglo- Iranian's properties and, on the other, by the rapid emergence of Libya as an important source of supply. As can be seen from chart 1, neither the former, which affected supply during 1951-54, nor the latter, which became important during 1965-70, had any discernible effect on the growth rate of overall supply. After several years of fruitless negotiations with the Anglo-Iranian Oil Co., the Iranian Government on May 1, 1951, nationalized the industry under the leadership of its Prime Mthister, Dr. Mossadegh. The last straw was the discovery by the Iranians that the companies had offered better terms to other Mideast producing countries, notably Aramco's 50-50 profit-sharing agreement with Saudi Arabia. But unhappiness with oil revenues was not the only cause of dissatisfaction. According to Mikdashi, "a crucial factor, no~ yet amenable to eco- nomic analysis~ was Persian dissatisfaction with the predominance of a major British interest (viz AIOC) in the country. Dr. Mossadegh himself acknowledged the importance of this social-political factor." The oil companies promptly reacted by imposing a collective boy- cott on Iranian oil: Prospective buyers were informed that legal action would be taken against them on th~ grounds that without a compensation agreement the oil was still the property of Anglo- Iranian. "The embargo * * * -was verjr effecti~ve due to the cooperation of the-eight major oil companies * * ~. Th~s oinbargohad, as intended, a p*nitive effect on Persia eeondmy." i5 Oil exports dropped from over $400- million in 1950 to less than $1.9 million in the ~-year period from J~uly 1951 to August 1953. Little difficulty was experienced in making up the deficit with oil from Arab countries: Oil was available-even to MOd-in abundance in ne~g~hbOring ~ountries, and world surplus production ca~city of crude oil was estimated- then at about 1.5 million barrels per day pressing from outlets.'~ As can be seen from chart 2, unusually sharp in~reasès between 1~51 and 1955 were registered by Kuwait and Iraq, while the production of Saudi Arabia was alsO aocelerated~ above Ith long-term trend. If between 1951 and 1955 Iranian production had held at its 1950 level, the net loss, after deductb~g 290 million barrels actually produced, would have totaled 910 million barrels. Some 800 million barrels would have been made up by the expansion a~bove what would appear to be the long-term growth rates of Kuwait, 300- n~illion; Iraq, 200 million; and Saudi Arabia, 300 million. Miscellaneous increases from smalle~ -Middle East countries, for example, Q'ata~, would -have corn- pletely closed the gap. In Mikdashi's words, Anglo-Iranian's total production "was substantially replaced by the end of 1954 with oil produced by subsidiAries from outside Persia)' - ~ Ibid "ibid. "ibid. PAGENO="0217" 215 An aberration in the opposition direction was the rapid emergence in the 1960's of Libya as a large-scale producer. Like the virtual dis- appearance of Iranian output ih the previous decade, compensatory changes in production were made to offset the sudden appearance of this sizable increment. In this case the adjustment process was facili- tated by the inveterate tendency of the companies to underestimate demauci. Had it not been for this fact the Libyan expansion, in the words of an internal Exxon document, would have caused the growth in Middle East output to have been "inordinately low." Under those circumstances the document observed, No known method of allocating the available growth is likely to simultaneously satisfy each of the four major established concessions; i.e., Iraq, Iran, Kuwait, and Saudi Arabia,18 From the very outset `Exxon emphasized that `the anticipated rapid growth in Libyan production would necessitate curtailments in the J~4äddle East. The company's 1961 forecast noted: t~uring the middle of th~ 1960-48 forecast period, the advent of large-scale production in Libya and increases in Sahara and other supply sources may restrict the growth of Middle East outlets.19 Libytni crude oil and NGL production is expected tO increase dramatically in the next years, achieving a leirel of 3.~ million barrels per day by 1971. This level i~ sufficient to make Libya the foremost, producing country in the Eastern ~Icmispbere in 1971, displacIng Iran to second place and Saudi Arabia to third. In cOntrast with historical ownership patterns' in North Africa and the Middle East, the bulk of the new increments of production will be produced by companies considered "newcomers" to the international oil trade without established captive outlets and without a significant stake in the Middle East. Since Libyan `oil is favorably situated with respect to the major lihiropean markets and has desirable low sulfur qualities, relatively little difllcultSr i~ capturing third party markets is expected.~° A similar pessimistic appraisal is to be found in an internal ~Iocu- rnent of Standard Oil of California. I~ a memorandum o~ t~ecember .G,, 1968, S. ~E. Watterson, assistant manager of its economics depart- ment, warned: * * * it will become exceedingly difficult, if not impossible, to ma1i~itain rela- tively rapid growth i~i the high level producing countries of the Middle East and still accommodate reasonable growth of crude production from new as well a~ old fields in many other countries outside of the Middle East.~' 18 The dtimept quoted Is ExxOh's "Foyeca~t of Free World Supplies" for 1969. The fojiowing analysis is based on these aninlal forecasts Cofitai5èd In Exxon's "Green Books." Thhse "Forecasts" have been su~pl1ed to and made available' b~' the Senate Subcommittee on i\fultthational Corporations. `9 Et~on's 1960 Forecast had predicted a `reduction In the growth for Middle East ~roductlon from an actual rate of 10 nercent for 1960-68 to only 4.2 percent for 1968-75. By 1968 the Increase In Libyan output bad become a cause for alarm, posing a real threat to the majors' continued control of the market. Not Only had its growth rate been vastly underesthnated, but the independents were proving to be far more Important than had been anticipated. 20 The predicted peak `of Libyan output, 3.5 million barrels per day, turned out to be only 6 percent above the actual peak of 8.8 million reached In 1970. 21 Senate Subcommittee on Multipational Corporations: Memorandum from S. B. Watter- son, assistant manager, economics department, to W. K. Morris manager of foreign opera- tions staff, Standard Oil Co. of California, Dec. 6, 1968. In the memorandum, production in 1969 was estimated on three bases: "A," that production would grow "at indicated availability In most countries outside of the Middle East" (i.e., African countries) ; "B," that It would grow at a moderately lower rate In Africa with a corresponding Increase In the Mideast; and "C," that It would rise at a "politically paiatabl&' rate In the Mideast, with a corresponding decrease In Africa. Africa was estimated to have available capacity which would permit a `3o'.9-percent rl~e over 1968, If the growth in the free world supply were to remain relatively stable at 8 to 9 percent, such an increase would require a 2-percent decrease In Mideast output. If the African potential were reduced by 10 nereent points, Mideast output would rise but only to a rate of 4.9 percent. Obviously, "further adjust- ments were necessary." `Under assumption "C," Middle East output was raised to an annual growth rate of 6 to 7' percent, by further reducing estimated production in Africa. The memo~-anr1uin notes that the activities under assumption "C" are those reported In the Blue Book. PAGENO="0218" 216 The heart of the problem ~ay in the fact that so much of the Libyan output was in the hands of independents who had neither the incen- tive to moderate their output nor the capability of offsetting it with reductions elsewhere: The downward revisions or adjustments of crude production in Libya and Nigeria for 1969 were made on the assumption that major companies with large interests in the Middle East would be required to moderate their liftings from Libya and Nigeria in order to maintain politically palatable growth in their liftings from the Middle East. Some companies, however, such as Occidental, COntinental and others, without large interests in the Mid4le East, will be under heavy pressure to expand production rapidly and, therefore, are not likely to limit their Libyan liftings. Their Libyan oil will be competing vigorously with the majors' oil from the Middle East and Africa. Responding to questions based on this memorandum, G. L. Park- hurst, former vice president of Socal, testified: * * * we were going to have an awful time meeting the demands of the Irani- ans and the Saudis * * * my only reaction was to tell the people who were trying to move Saudi Arabia and Iranian crude oil, 4'Get to work even harder than you have been working because we just can't let this thing happen." ~ In 1970, mirabile dictu, the problem which had given rise to such deep concern within Exxon and Socal--and undoubtedly within the other majors as well-was resolved. Libyan production, which bad been growing rapidly, turned sharply downward, dropping from its peak of 3,318 million barrels per day in 1970 to 2,761 in 1971, to 2,239 in 1972, and to only 2,100 in 1973. In it~ 1972 forecast Exxon promptly revised its Middle East growth rate upward from 4.2 percent to the historical rate of 10 percent. The effect of the Libyan reversal in tl~e Mideast is apparent from chart 3 which eompai~es for the area~s f~our principal producing countries their actual production with their esti- mated growth rate for the period 1968-72. Between 1965 and 1970 actual production fell below the growth rate for 5 years in the case of Saudi Arabia and Iran and 4 years in the case of I~uwait. After Libyan production had turned downward in 1970, output in both Saudi Arabia and Iran rose to levels above their historical growth rates. That this did not take place in Iraq was probably the result of the growing controversy between the companies and the Government. [Chart 3 referred to follows:] 2i Hearings before the Senate Subcommittee on Multinational Corporations, Mar. ~8, 1974, pt. 7. In a subsequent memorandum to the subcommittee, Mr. Parkhurst discounted the value of his economist's forecast on the grounds that the predictions f~r 1973 bad been in error. Ignored is the fact that the reason for error-the assumption of a continued Libyan expansion-disapPeared after 1970. PAGENO="0219" 217 CHART 3 CRUDE OIL PRODUCTION ACTUAL vs. ESTIMATED GROWTH RATE, 19~8-12 2.74 2.47 2.19 1.92 1.64 1.37 1.10 .82 .55 .27 BiIs,fObI./V' 10 iRAN SAUDI ARABIA MiIs./RbhfD, * 10.99 9.32 5.48 2,74 2.47 2.19 1.92 1.64 1.37 1.10 .82 .55 lcI.08 8.22 548 1958 60 62 64 66 68 70 72 1958 60 62 64 66 68 (SOURCE: DERIVED FROM ORGANIZATION OF PETROLEUM EXPORTING COUNTRIES, STATISTICAL BULLETINS.) PAGENO="0220" 218 THE INTERNATIONAL CONTROL MECHANISM Mr. BLAIR. Over the years there has clevelopcd an intricate mecha- nism of controlling international production wMdh, with certain necessary difference~, bears a striking resemblance to the control mech- anism long operative in ~the United States. In each, the initiating action is a forecast of overall suppiy. Although termed a forecast of demand, the forecast for the United States, prepared by the Bureau of Mines, really measures supply to be produced and historically has run somewhat below actual demand. An example was cited by a con- gressiotial committee: When the Bu~au of Mines through their montldy forecasts of demand, un~der- estimated the demand by close to 2 percent for each of the years 194~ an~ 1947, the ~spot shortages followed as night the day. The mechanism was wound too tight.~ For the world oil trade outside the United States somewhat similar forecasts, in the form of annual growth rates, are prepared by itiost, if not all, of the seven international majors. And theyhave also tex~ded to runsomewhat below actual demand. As Piercy of Exxon acknowl- edged, "We did underestimate demand * * ~ 24 Forecasts are made for the "free world"-excluding the United States, Canada and the Cogimunist countries-for the Eastern Hemis- phere and, of greatest importance, for the Middle East. The growth rate during T958~272 for the five principal Mideast countries averaged 9.91 percent a year, wliich incidentally, turns out tp be the idetitical figure cited by Exxon in its 1970 forecast: The region's (Mideast) oil production is forecast to average 9.3 percent per year growth through 180, about the same as the 9.9 percent per year growth since 19~0. After determining the size of th~ pie, the next step is to divide it up among the governmental bodies with jurisdiction over the oil pro- ducir~g areas. In the United States this function has been performed by the Interstate Oil Compact Commission at which representatives of thi~u various oil-producing States agree on the amoutitto be procluceci by each. In the world oil trade the function is perfot~med directly by the seven majors which determine the rate at which oil is to be pro- sluced in each of the oil-producing, countries. Since the latter i~50's the piv~otal rate appears to have be4un that of Iran, `To bring Iranian production back into the flow of supply an agreement in 1954 was nego- tiated under which Iranian output after 3 years was to keep pace with the "average growth rate" of the Mideast. Although no exact rate was specified, the desire of the U.S. `Governm~ntto build up Iran as a bastion against Communist influence was recogni.~ed by alL~5 It is, therefore, not surprjsin~ that of all the major producing coun- tries, Iran during 1958-72 enjoyed the highest growth rate-12.46 percent a year, which, incidentally, happens to be almost exactly the rate cited by Exxon. Iranian production * * * would expand 12.5 percent per year during 1967 and 1968, in accordance with agreements ~ 81st Cong., 1st sess., Senate Small Business Committee, final report, S. Rept. 25, p. 28. ~ Hearings before Senate Subcommittee on Multinational Corporations, Mar. 28, 1974. pt. 7. ~ Mr. 0. L. Parkhurst, former vice president, Standard Oil of California testified: "* * * in Iran the agreement sponsored by the U.S. Government in 1954 obligated the participants in general terms to keep Iran's production rate up to the growth rate of the area." (Hearings before the Subcommittee on Multinational Corporations, Mar. 28, 1974, pt. 7.) PAGENO="0221" 219 already made with the government.26 An annual growth rate of 12.46 percent for Iran is well above the rate for the Mideast as a whole- 10.24 percent-and~ among the long-establishç~d producing countries, is approached only by the 11.49 percent rate of Saudi Arabia. With a high growth rate established for Iran, the owners of Aramco were faced with the necessity of maintaining a roughly comparable rate for Saudi Arabia. To E~don, Socal, ~exaco, and MObil, the Aramco concession was far more important tilun their partieipation in the Iranian consortium. Emphasizing the necessity of maintaining good relationships with King Ibn Saud, Page testified: * * * If we hac~n~t played ball with him, we cottld haVe lost the Aramco conces- sioti, which is not something fOr us to lose. It is the biggest concession in the world, and we had 80 percent of It as against a concession one-quarter as big in which we~ bad 7 percent. So you k~iow what you had better do in these eases.2' Under the circum~tanees it is not surprising that production in Saudi Arabia moved np almost in tandem with Iranian output. Agaifl, deviations from the growth rate (11.49 percent) were few and far between. With output growing at such an extraordinary pace in both Iran and Saudi Arabia, the `area'S existing "glut of productive capacity"- to use Page's term-would soon have reached formidable proportions had production in the other Mideast countries been allowed to ri~e at anything like the same rates. But during 1958-72, the increase in production of Iraq and Kuwait averaged only 5.12 percent and 5.93' perernt, respectively, less than half the rates of Saudi `Arabia and Iran and well below their own previous rates. Reflecting the rapid expansion in Libya, in Iraq the growth rate fell from an average~of 8.11 pereent during 1958-64 to only 3.11 percent during 1965-70; in Kuwait it declined from 11~98 percent to 4.45 percent. According to Page, the' relatively slow growth rate in Iraq stemmed from a dispute between the' oil companies and the Iraqi GovernmOnt. Feeling that efforts to develop their country's oil resources had left much to be desired, the Iraqi Government in 1961 enacted the so- eall~d law 80 Of the 1~assim regime, restricting the concession held by the Iraq Petroleum Co. to area~ in which it was then producing' and foreclosing it from a number of extremely promising fields. But this, controversy was `certainly not the only reason for the low rate of pro- duction. In response to the question, "what would have happened"if Iraq production had also surged during the 1960's," Page responded: I admit we would `have been in one tough problem, and we would have had to lower our liftings from the (-Iranian) ConsQrtlum down to the ininimrum we could possibly take there and meet the agreement. Remeiuber we were tailing more than agreement called fQr out of Iran, you seç, and we were tal~in~ an equal amount, though, from, Saudi Arabia, we would have bad to cut back on both of those and we would hare had to slow down on otir development of Libya, which nobod~y wanted to do, but this was discussed at a time when people came ~ Exvon, Forecast otFr~e World $upplies, 1967. 27 Hearings before the SubCommittee on Multinational Corporations, Mar. 28, 1914, pt 7.- As an example of the importance attached to the Aramco concession Page recIted the circumstanceS under which Ibn Sand had given his approval to the resumptioli of Iranian production: "~ * * this was discussed with the lOng In Sapdi Arabia, the id lOng, Ibn Saud, and be was told that the Aramco partners Were being asked to go into the (Iranian consortium), that as a result we would not be able to incfOase our liftings appreciably for a while' in Aramco, and we were going in solely oil the basis that there might be chaos `out in the area if we didn't, and would he agree with this and recognize that we weren't doing this because we wanted more oil anywhere, beCause we had ade- quate oil in the Aramco concession but we were doing it as a political matter at the request of our Government. and he said, `Yes, but,' he said, `in no case should you lift more than you are obligated to lift to satisfy the requirements of doing that job.'" (Ibid.) PAGENO="0222" 220 to me and said, "Can you swallow this amount of oil?" and ~~0f course, with Iraq down," the answer was, "Yes, I am going to have a lot of problems and some tough problems, but I will "undertake to do it." And I was successful, that is all I can say.~ But if Iraq bad come on, it would have been that much harder.28 According to Exxon's yearly forecasts Kuwait has been used as ati "evener" by n~eans of which actual Mideast output is brought into balance with the supply called for by the overall growth rate. Thus, "Kuwait production is estimated by difference after reviewing possible company supply positions" (1963) and "Kuwait output is determined to be the difference between Eastern Hemisphere demand and supplies from all other sources" (1964). Quite apart frdm such major disturb- ances as the Libyan expansion, the international oil companies are constantly confronted with unexpected Orcurrences, such as unusually mild-or severe-winters, interruptions in pipeline and tanker trans- portation, delays and breakdowns in refinery operations and a multi- tude of problems involved in trying to achieve a nice articulation of suppiy with markets thousands of miles away. To prevent such inter- ruptions from upsetting the smooth ~nd orderly increase in overall supply, production in Kuwait has not infrequently been contracted when supplies from other sources appeared excessive and expanded when they seemed insufficient.29 The performance of this fun~tion can be seeu most clearly in chart 2 unlike the sthady undeviating upward trend~ of Iranian and Saudi Arabian output increases in Kuwait's. output have been recurrently interrupted by years of slow growth or actual declines. In short, for countries producing some three-fifths of tctal OPEC output the international majors would be provided with reasonably accurate foreknowledge of their rival's supplies by assuming growth rates of 10 percent for the Mideast in a whole, 11-12 percent for Iran and Saudi Arabia and 5-6 . percent for Iraq and Kuwait. Countries with slow growth rates are also unlikely to be the sources of unexpected increases in supplies. During 1958-7~ Venezeulan production grew at an average rate of only~ 2 percent and indeed, since 1970 has moved noticeably downward. The addition of Venezuela and Qatar-~ivith a growth rate of 7.95 percent-to the four Mideast countries brings to 73 percent the share of OPEC production which can be said to have been readily predictable. Two of the remaining OPEC countries-Nigeria and Abu Dhabi- have registered spectacular growth rates-33.36 percent and 35.59 percent respectively-while production in a third, Indonesia has also been moving up sharply since the midsixties. Two factors, however, militate against the emergence of these countries as sources of unconr trollable excess supply. For one thing, independent producers are virtually nonexistent, accounting in 197~ for only 6 percent of the production in Nigeria, 3 percent in Abu Dhabi and none in Indonesia. Moreover, it would appear that companies bringing on new sources 28 ~° In this connection it should be recalled that companies with influence in Kuwait's production include not pnly the concession holders, Gulf, BP, but through long-term contracts, Exxon and ShelL PAGENO="0223" 221 of supply are expected to make more or less compensating reductions in their liftings from other sources. T&ius, Exxon's 1964 forecast ob- serves, "Major participants in the IPC group, the Iranian consortium, amj Nigerian production, are also the major offtakers of Kuwait crude. Therefore, to the extent the former fails to achieve offtake estimates, Kuwait would acquire most of the alternative outlet." And the forecast for 1967 states, "the downward revision for Persian Gulf production is primarily reflected in Kuwait's outlet and to a minor extent in Iraq's. Kuwait's growth would be retarded bec~iuse major offtakers of that crude are developing new production in Africa and elsewhere." Senator ChURCH. There is a vote on in the Senate and I must re- spond to it, but I will be back as quickly as I can. You continue with your testimony. I will read the part. Mr. BLAIR. Thank you. There remain only the two North African countries, Libya and Algeria. Accounting together for only one-eighth of OPEC output; their days as international oil's principal area of uncertainty appear to be over. In the United States the control mechanism has been implemented by the force of law. Production by individual wells in excess of their "allowables" is in violation of State law; shipments in interstate con~- merce of oil produced in excess of those allowables is in violation of Federal law. And the apportionment of total supply among the various oil-producing States is, by statute, exempt from the antitrust law~. But, except for a few restrictions made in the name of "conservation," the control mechanism outside the United States operates without the force of law. What makes it operational is not the legal power of some international authority-which does not exist-but the recognition by each oligopolist that his self-interest is best promoted by limiting his expansion to the extent and in the manner delineated above and by his expectation that the other oligopolists will be guided by the same con- siderations and act in the same manner. It should be clear that the seven international majors have succeeded to a remarkable degree in limiting to a predetermined rate the growth of overall supply. Essential to the achievement of this result must be the attainment of a second objective, that is, preventing significant changes in market shares, since pronounced gains by any one of the oligopolists would inevitably lead to defensive expansions by the others, thereby causing total supply to exceed the predetermined growth rate. How stable has the pattern of market shares proved to be? As can be seen from table 3, the trend in the concentration ratio for the seven companies as a group has been remarkably stable. Over the 5-year period, 1968-72, their share' of total OPEC output changed by less than I percentage point, the proportion moving narrowly within the range of a high of 79 percent and a low of 77.1 percent. In view of the many dramatic changes that have taken place within the interna- tional oil industry during recent years, complete stability in market shares among the individual companies is hardly to be expected, and indeed noticeable changes were registered by Exxon and Gulf-de- creases-and by BP and Socal-increases. [Table S referred to follows:] 4~S-426-75-i5 PAGENO="0224" 222 TABLE 3.-CHANGES IN SHARES OF PRODUCTION OF OPEC COUNTRIES BY COMPANIES, 1967-7~ (In percentj , 7 corn- Other corn Exxon Mobil SoCal Texaco Gulf BP Shell panies panies' 1972 15. 1 5. 5 9. 8 10. 0 9. 0 16. 9 10. 8 77. 1 11.0 1971 15. 9 5. 4 8. 7 9. 0 9. 9 17. 7 12. 4 79. 0 12, 6 1970 16. 8 5. 3 8. 1 8. 5 9. 7 16. 7 12. 4 77. 5 15. 4 1969 17. 8 5. 2 7. 9 8. 5 10. 1 15. 9 12. 0 77. 4 15. 4 19~38 19. 2 5. 4 7. 7 8. 4 11. 1 14. 4 11. 7 77. 9 15. a 1 Exclusive of CFP and government-owned and nationalized companies. Source: Organization of Petroleum Exporting Countries, Annual Statistical Bulletins. Yet, the principal explanation for such changes as did occur appears to lie not so much in the expected gains and losses aris- ing from the normal rivalry of firms competing with each other in the market as in the widely varying growth rates of the different countries in which the different firms happened to hold concessions. This is ap- parent from charts 4a and 4b which show for each of the seven-and for "other companies"-their crude oil production during 196i-~ in OPEC countries responsible for most of their foreign output.3° [Charts 4a and 4b referred to follow:] ~° The charts show for each company its production In any OPEC country which ira any year during 1967-72 acccounted for more than 200,000 barrels per day of the corn- pany's outputs. PAGENO="0225" 2~ VBNESIJELA SAUDI ARABIA IRAN . .~fRAQ SAUDI ARABIA IRAN ~..- .,IRAO CHART 4a PRODUCTION OF CRUDE OIL BY MAJOR COMPANIES 1967-72 MiI./BbL/d 10. EXXON MOBIL 9. S. 7. 6~ 1' 9. .7. .6 5. .4. .2. 10/.1 9. 7. 6 5. 4. 3. 2~ .9 .8 .7 .6 .5 .4 .3 .2 SOCAL SAUDI ARABIA INDOIJESIA,,'~ ~ TEXACO SAUDI ARABIA NOON ~ .,.~-. ~ IR~tJ~~ .1 1907, 68 69 70 71 ~72 1967 68 6~S 70 71 72 (SOURCE: DERIVED FROM ORGANIZATION OF P~TRQLEUM EXPORTING COUNTRIES, STATISTICAL ESULLET~NS.) PAGENO="0226" 224 CHART 4b (SOURCE: DERIVED FROM ORGANIZATION OF PETROLEUM EXPORTING COUNTRIES STATISTICAL BULLETINS.) Mr. BLAIR. The decline in 1~xxon~s share of OPJ~C production is in a sense a cost of the farfiung nature of its operations. It was theleading producer in countries which for one reason or another have chosen to reduce their rate of production, to nationalize the properties of conces- sion holders, or both. Above-average increases registered by Exxon in PRODUCTiON OF CRUDE OIL BY MAJOR COMPANIES 1967-72 BRITISH PETROLEUM 1967 68 69 70 71 72 1967 68 U9 70 71 72 PAGENO="0227" 225 Saudi Arabia and Iran were more than offset by below-average per- formance in Venezuela, Libya, and Iraq. In recent years the Govern- ment of Venezuela has been following a deliberate policy of restrictionism to conserve its resources; ~` the Government of Libya restricted output in an effort to increase its revenues and the Govern- ment of Iraq nationalized the Iraq Petroleum Co., of which Exxon was part owner. The loss by Gulf was also due to an exogenous factor but of a different character. Most of Gulf's foreign output consists of Kuwait crude which, because of its high sulfur content, has encoun- tered environmental resistance in Western markets. In contrast, the improvements ip~ market share registered by Socal- as well as the lesser gain by Texaco-are traceable to the simple fact that nearly all of their foreign 1roduction comes from nations enjoy- ing rapid growth rates-Saudi Arabia, Iran, and Indonesia. Produc- tion in the first two also benefited Mobil, but the. loss in Iraq prevente4l Mobil from increasing its share of the OPEC total. Responsible for the improvement in BP's market share were its gains in Iran-where it has an equity ownership of 40 percent-and the even more precipitous rises in the newer producing countries of Nigeria and Abu IDhabi. Thus, had it not been for factors exogenous to the relationship of the companies with each other, the changes in market shares, limited though they were, would have been virtually nonexistent, which, of course, is to be expected of the "live and let live" policies of a tight and mature oligopoly. The exception was Libya where, earlier, concessions had deliberately been granted to independence who were not important producers else- where. Thus, an important increment to supply fell into the hands of firms willing and anxious to secure a "market position" even, if neces- sary, through price competition. The growing strength of the Libyan independents during the latter 1960's can be seen in the grid of chart 4b showing foreign output of "other companies," which are in effect, the independents. In 1970, however, the growing strength of the in- dependent was reversed. Restrictions by the Libyan Government and nationalization in Algeria combined to reduce the output of "other companies" from 3,573,000 barrels per day in 1970 to 2,253,000 in 1972 and their share of OPEC production to 2,253,000 in 1972 and their share of OPEC production from 15.4 percent to 11.0 percent. Thus far, one effect of the drive toward nationalization would appear to be the removal of a troublesome thorn from the side of the majors. RESTRICTIONISM AND TIlE ANTITEUST LAWS Given a concentrated industry structure (without troublesome mav- ericks), a consensus among the oligopolists as to a desired growth rate for th~ industry and a forbearance from undertaking expansions that would either cause supply to exceed that growth rate or make signifi- cant inroads on a rival's market share, it would appear that output can be restricted (and price thereby enhanced) just as effectively through oligopolistic interdependence as through cartels or other overt forms of collusion. By its very nature, control of the market through oligop- oly need not leave behind any direct evidence of meetings, agreements, ~ See P. It. Ocleil in The Large International Firm Developing Countries by Edith Penrose, George Allen and Uuwln, Ltd., 1968, ch. XL PAGENO="0228" 226 or similar conspiratoriai conduct that would indicate a pei~ se viohition of the antitrust laws. Accordingly, it is not surprising that officials of the major oil companies apparently labor under no misgivings that anything they have done might contravene the U.S. antitrust laws. Piercy of Exxon . has insisted~ "We are not `a cartel in any way. We are not a monopoly."" Objecting to what he "sensed" as a. "feeling" that the inquiry has ~`rnonopoly ov~rtones, oligopoly and so forth," and that "this antitruSt thing permeates a lot of our problems," Pierey offered to have the sub- committee enlightened by "the company attorneys who have been in~ volved" in the old cartel case." Yet, as the electrical machinery cases so vividly demonstrate, the advice of lawyers and the wishes of man- agement are not necessarily one and the s~ime thing. In 1966 Or, Paul ~Frankel wrote: Although under the spell of U.S. antitrust policies, the official party line of International oil conipanies since the Second World War has been one of studied abhorrence of "collusion" with their competitors, there has persisted within their ranks a school of thought which recognizes the advantages of a concerted policy. Significantly enough, these tendencies were prevalent on the operational levels rather than at the top where the warnings of company lawyers tended to outweigh the ens Cu coeur of the businessman.84 Piercy's protestations of innocence are apparently based on the im- pression that the antitrust laws proscribe recorded meetings and signed agreements but countenance everything else. Such an interpre- tation ignores a substantial body of antitrust law developed by the antitrust agencies and the courts over a long period of time. Although largely ignored in recent years, the doctrine of conscious parallelism has never been overturned and must still be regarded as the law of the land. While brought to its highest state of development in cases in- volving the conscious following by individual producers of delivered price systems, there is no reason why the doctrine should not also be applicable to the conscious limitation by individual producers of their expansion to the extent and in the manner described above. It has been long recognized that express proof of agreement is not required to establish a violation of section 1 of the Sherman Act, to say nothing of section 5 of the Federal Trade Commission Act. In the well-known Interstate Circuit case the Supreme Court held: Acceptance by competitors, without previous agreement, of an invitation to participate in a plan, the necessary consequences of which, if carried out, is restraint of interstate commerce, is sufficient to establish an unlawful conspiracy under the Sherman Act.'8 The high watermark in the development of the law against parallel- ism was a decision by the Supreme Court upholding the order by the Federal Trade Commission in the Rigid Steel Conduit ease. I would like to point out that former Commissioner Everett Mac- Intyre, who is in the room this morning, was in charge of the investi- gation and trial of that case. Manufacturers of rigid-steel conduit were charged with engaging in unfair methods of competition in violation of section 5 of the Federal 82 HearIngs before the Subcommittee en Multinational Corporations, March 28, 1974, pt.7. 84Paui H. Frankel, Mattel. Oil and Power Politics, Frederick A. Praeger, 1966, p. 134. ~ Interstate Circuit, Inc. v. United States (306 U.S.. 208 j930), at 222. PAGENO="0229" 227 Trade Commission Act. Specifi~ally, the Commission's complaint charged violation of th~ law on two counts-cotrnt 1, that the respond- ents had conspired to u~e a delivered-price system of pricitig and, Qount 2, that the respondent~ had independently followed a common course of conduct, each with the knowledge that the others did like- `wise. Under the latter the Commission held that fOr any seller indi- vidually to quote prices under a facing point system with the knowl- edge that his rivals wei~e doing the same and with the result that such practices eliminated competition among them is itself an unfair method of competition in violation of section 5 of the Federal Trade Commis- sion Act. The Supreme Court split four to four on the issue, thus sus- taming the decision of the Seventh Circuit Court of Appeals on May 12, 1948, upholding the Commission.36 Had Justice Minton participated in the decision, it undoubtedly would have been five to four, since he had previously been a member of the seventh circuit court and joined in its decision on that case. In the context of the international oil industry, the question would be whether it is lawful for competing sellers, individually but with the knowledge that their competitors are doing likewise, to plan their ex- pansion in terms of the same industry growth rate; to limit their ex- pansion to the end that supply does not exceed that growth rate nor make inroads on their competitors' market shares; and to offset expan- sions in some areas, which otherwise might cause the growth rate to be exceeded, with compensating reductions elsewhere. Legal scholars~ of whom I am certainly not one, may quickly dis- miss this suggestion. But it should be remembered that in enacting the antitrust laws Congress deliberately used broad phraseology. Recog- nizing that when it came to devising new and better means of suppress- ing competition, "the inventiveness of the mind of man knows no bounds," the congressional purpose was to frame a body of law that could be kept an courant with changing business practices and condi- tions, If through failure of enforcement the law on conscious parallel- ism is permitted to remain in a state of innocuous desuetude, the congressional purpose will be frustrated, and the antitrust laws will sink into oblivion to which they have been consigned by critics of both The right and the left. Mr. BLTJM. The subcommittee has received from the Department of State, which has declassified it, an annex. to the petroleum cartel report on which you wor1~ed, and that annex has been classified secret for many years, since the report was first written. The annex deals with the activities of the American companies in Iraq. I would like that made part of the record at this point and I would lil~e to ask you, if you remember that annex and what its signifi- ~cance was,* Mr. BLAIR. May I take a look at it? IDociiment handed to the witness for his inspection.] Mr. BLAIR. In connection with whatever I have to say about this `annex, it should be remembered that the report appeared in 1952, which is some 22 years ago. My memory may be quite imperfect. This does appear to be the annex that was deleted at the request, as I re- call, of the State Department, and possibly the Central Intelligence `°i68 Fed. 2 at 175 *See Spheommittee on Multthational Corporations Committee Print entitled, "The Inter- national Petroleum Cartel, The Iranian Con8ortium and U.S. National Security," Febru- utry 21, 1974. PAGENO="0230" 228 Agency. The subject with which it was concerned donsisted of activi- ties by the Iraq Petroleum Co. which, as you know, is owned by the major oils, by five major oil companies and Mr. Gulbenkian to delay production in Iraq and to keep knowledge of this from the Iraqi Government. The State Department, as I recall, made at the time a persuasive argument that the appearance of such information would be detrimental to the maintenance of good relationships between the U.S. Government and the Government of Iraq. I would have liked to have seen this annex appear in the Commission's report. However, its importance should not be exaggerated. It consists of only some six pages. As a matter of fact, it has been corroborated recently by a state- ment put into the record of your hearings by Senator Muskie, who, on March 28, 19'74, introduced into the record extracts from what he referred to as "this intelligence report dated February 1967," a part of which was as follows: There is every evidence millions of barrels of oil will be found in the new concessions. Some of these new oil reservoirs have been discovered previously by IPO but they were not exploited because of the distance to available trans- portation, the heavy expense of building new pipelines and the fact that IPO has had a surplus of oil in its fields that are already served by existing pipe- lines. The files either proved that IPC had drilled and found wi]dcat wells that would have produced 50,000 barrels of oil per day, the firm plugged these wells and did not classify them at all because the availability of such information would have made the company's bargaining position with Iraq more troublesome. Many of these areas had been returned to the government and some of the petroleum concession conflicts between government and IPO. Mr. BLuxr. The essential point is that the companies were interested in withholding new discoveries because they were afraid they might have to produce those discoveries, leading to a surplus of oil. This was one part of the control mechanism. I take it the reason to agree to deprecate the importance of those pages is it was simply one part of the larger scheme of things at the time, the very important thing was getting the cartel report itself published, not whether you had all of the full detail. Mr. BLAIR. Further, I would add that any reasonable man who studied the facts set forth in the report would not have been particu- larly surprised by the practices detailed in these particular pages. Their removal did not in my judgment seriously vitiate the importance and substance of the report. Mr. BLUM. You mentioned conscience parailelisms, the kind of con- science parallel being illegal under the antitrust law, that is peculiarly the province of the Federal Trade Commission. It is the Federal Trade Commission Act we are discussing, section 5, and as we have heard from representatives of the Justice Department, the allocation of anti- trust responsibility~has been to give the international aspect of oil to the Denartment of Justice and the domestic aspect to the Federal Trade Commission. Does that strike you as being proper or a proper way to do the allocation in view of what the legal authority is? Mr. BI~IR. In my judgment this is an artificial separation which really tends to make effective enforcement all but impossible particu- PAGENO="0231" 22~ l~rly since the eliminatiim of th~ im~port quota. :Eoreign supplies are becoming increasingly ithportant in U.S. coPsumption. Furthermore, the Federal Trade Commission Act contains in one of the subsections of section 6 a specific grant of authority authorizing the Federal Tradte Commission to obtain information relating to the activities of U~S. firms engaged in foreign commer~e. Mr. &t~M. And this apparently has not been done to any great de- gree, certainly not in th~ oil industry. Mr. BLAIR. Yes. I might add there, Mr. Blum, that in its report issued on concentration a year and a half ago, the Commission listed its activities in the field of peh~oleum over a long period of years. For some reason it failed to mention the staff report to the Federal Trade Commission on the International Petroleum C~irtel. Mr. BLUM. Is it possible that wa~ because it was finally published by the Small Business Committee? Mr. BLAIR. Possibly, but this would hardly explain its failure to make any reference ~whatever to a report that, after all, was prepared at the Commission hv the Commission's staff. Mr. BLUM. Earlier you talked about the patterns of behavior of the Middle East winding up being the same even though the formal change, if companies got exclusive right to buy crude oil, that is what we have been talking about here as buy-back oil, and we now have a situation in Kuwait where a large American company, Gulf, has bid a very high price for the exclusive rights to oil at a time when the market shows that there is a glut, there is actually a surplus. Why would a buyer pay more than the market might demand in a circumstance like that? What is his motivation and what might be done to change that situation? Mr. BLAIR. There is as you know, a widespread and common misap- prehension that in dealing with the oil-producing countries the com- panies have been in the role of buyers-that their posture has been more or less analogous to that of, say, Sears, Roebuck in purchasing tires to be sold under the Allstate label from the various tire manufacturers. As a purchaser, Sears seeks to obtain the best quality of tire possible at the lowest possible price. That has not been the position of the major oil companies in dealing with the producing countries of the world. They have not been buyers, but holders of concessions. The rewards to them- selves are a function of the quantity and the price obtained for the product. In other words, the higher the price, the greater their profit. It is not merely that they have not been buyers, it is that their incen- tive has been the reverse. Instead of trying to secure lower prices, their revenues have been enhanced by securing a higher price. As long as this situation continues any hope that the oil companies will operate as monopsonistic buyers utilizing their monopoly power to obtain price concessions which in turn can result in lower prices to consumers is, of course, nothing more than wishful thinking. Mr. Bi4imi. And this all stems from the fact that the companies have tied up the crude. If fr~any buyers could go for that crude, rather than just a very few buyers, this kind of situation wouldn't obtain. Is that correct? Mr. BLAIR. It is difficult to speculate about what might happen in the future under the circumstance you have outlined. However, it would be my expectation that if a given oil-producing country were to PAGENO="0232" 230 welcome and entertain solicitations from any and all buyers, we w~ulct. be presented with something approaching the market of cornpetitive~ theory. If demands in relation to supply were strong, the price would be bid up. At other times if there were a glut, as you mentioned exists~ at the present time, the price would fall. Consequently, one of the essen- tial steps to the establishment of anything approaching cornpetitive~ conditions in international oil would be the proffering of oil by the~ oil-producing countries to any buyers that were interested in~ securing it. Mr. BLUM. Let. me put that another way. If the major companies lose control of supply, they lose the ability to pass along whatever cost in- creases they incur to the customers, and, therefore, lost that situation in which the incentives are to pay a higher price. In fact, they are then forced into a market discipline situation where the incentives reverse. Is that another way of putting it? Mr. BLAIR. Yes. But attempts to control what they pass along are fruitless since as concession holders it is virtually impossible `to effec- tively police the price at which an integrated oil.company transfers its' oil from, say, the production stage to the refining stage, and then from refining to mariteting. The companies have substantial control over where they allocate their overhead costs. The price at each of these stages thus becomes largely a function of their own decisions as to the locus of the allocation of their overhead costs. If something like a free market or true market were established in the sale of oil, the companies' then would be.securing oil at an objective out of pocket cost figure. This' would make the control of margins at least theoretically possible. Mr. LEVINSON. There is one further thing which, subject to Senator' Church's concurrence, that I would like to get in to the record in con-V nection with this question of benefits to the United States and the rol& played by the oil eompanies; this relates to the balance-of-payments statistics and margin of error which has now been retrospectively ap- plied to the Commerce Department estimates `of the amOunt `of `benefit' that the United States derives in balance-of-payments terms from the' companies. ` `, [The information referred to `above is retained in the sub~omniittee files.,] ` , [Whereupon, at 12:50 p.m., the subcommittee recessed,' `subject to the call of the' Chair.] , PAGENO="0233" MULTINATIONAL PETROLEUM COMPANIES AND FOREIGN POLICY (Briefing by Hon. William E. Simon, Secretary of the Treasury] 1~ONDA~ AUGUST 12, 1~74 TJNITED STATES. SENATE, SUBCOMMITTEE ~N MuLTINA~rIoNAI~ Con~on~&TIoNs o~ TIlE COMMITTEE ON FOREIGN RELATIONS, Washington, D.C. The subcommittee met, pursuant to notice, at 10:10 a,m., in room 4221, Dirl~sen Senate Office Building, Senator Frank Church [ehair~ man of the subcommittee] presiding. Present: Senators Church,, Fuibright, Sparkman, and Symington. Senator F1J~BRIGIIT. The committee will come to order. We are very pleased this morning to welcome our new Secretary of the Treasury, the Honorable William Simon, who has recently, as we all know, taken a trip to the Middl,e East. On behalf of Senator Church, the chairman of the subcorpmi~te~, we welcome you, Mr. Simon, ~ñd yoti have a prepared statement you wish to presei~it ~ STATEMENT 0]? HO~'T. WILLIAIVJ E. `ST1VtOI'~T, `SECflETARY OP TE~ TREASURY; ACCOMPANIED BY GERALD L. PARSlEY, ASSISTANT SECRETARY OP TRE TREASURY Secretary SiMoN~ Ye~, sir, I do. Senator ]?ULBRIGnT. Will you proceed, please, sir? Secretary SIMON. Thank you. Mr. Chairman and members of the subcommittee, I am delighted to have the opportunity to be here today to discuss my recent trip to the Middle East and Europe. As part of the discussiOn, I, think it is important to focus on how th~ United States aud world economies wi~Il be afl~ected by increased capital flOws totbe oil exporting countries. In additiOn, I w~ll brieñ~ discuss the price of oil and the current supply. Tho purpose of my trip was to continue our recent diplomatic efl~orts to achieve a durable and lasting peace in the Mideast. I believe that peace and economic progress are interrelated issues. Without peace, we cannot have economic progress. With economic progress, however, we can minimize the possibility of renewed hostilities. (231) PAGENO="0234" 232 Fortunately, the diplomatic efforts of the President and Secretary Xissinger in recent months have established a fran~ework for peace and stability in the Middle East that hasn't existed for three decades ~nd President Ford intends to pursue this policy in the months ahead. After my own meetings, I'm optimistic that we can help Middle Ea~ ~ä~hnj~ri~ str~gtkth~ ~iiir ~~1io~nié$ and achiè+e needed indus- trialization and development, which, in turn, will contribute greatly to the cause of peace. Before outlining the highlights of each of my visits, it would be ~iseful to ~I~ai~i. the background of Jio*~ the trip devel~ped. Prince Fahd of Saudi Arabia visited the United States in early June, and at that time we established a ~ftint Snndi-U,S. Economic Commission. This was a major step in establishing closer economic relations between the United States and Saudi Arabia-and we agreed to have working groups meet in Saudi Arabia in July. Subsequently_when the Presi- dent visited Egypt and Israel and suggested that I visit those coun- tries-we thought it would be useful to go to all three Mideast coui~- tries and to open the working group sessions in Saudi Arabia. Euwait was the final stop on the Mideast portion of our trip-and :offered us an opportunity to bring the first high-level U.S. delegation to a country which has increasingly occupied a critical role not just in energy affairs, but world economic affairs as well. The balance of our ~trip was thwoted to continuing our economic consultations with finance ~tninisters and other leaders in Germany, Italy, France, and England. As I'll des~ribe in detail, all of our meetings, whether they were with heads ô1~ state, finance ministers, petroleum ministers, central bankers, or members of the private sector, were based on mutual con- cerlis: Striving for political stability and economic stability * * * and our shared pursuit for peace and economic prosperity. In order to make this a little bit shorter, Mr. Chairman, I will high- light the various portions of my testimony. EGTPr The specifics of our visit in Egypt consisted of: the establishment of our joint economic relations, the reaffirmation of the OPEC agree- ment, meetings of the working groups and five subcommittees that cover investment and industrialized foreign trade, agriculture, and ~f course, tht~ Suez C~inal Reconstruc~tion and Development. Egypt's e~onomy is in a state cif deterioration due to the fact that it has been totally controlled for the last 20 years and our e1~ort~ to ~assist them in liberalizing their economy is consistent with what Pres- ident Sadat and Deputy Prime Minister Hegazi goals to attract for- eign investment and help them get back on their economic feet again. Ther~ is much we can do to assist not only in the h&rd aid areas, such as the $250 million that we have requested for appropriations~ assist~ ance under th~ Public Law 480 program for agriculture, the Export- Import Bank, as well as the Wbrld Bank, but also in what I call the soft side of the assistance area, as well as the technical, ~coflomic and financial expertise that we can bring to this country as well as the encouragement we can give to our private sector by explaining the new Egyptian investment law which will act as an incentive to attract investment. PAGENO="0235" 2~3~ I~i~A1~L After my talI~s in Egypt~ I visited: Israel ~or 11/2 days of intensive consultations with the Pviin~ Minister and key members of the. Israeli Cabinet. We moved in a deliberate fashion to find ways to assist Israel m attracting investment and to expand trade with our country. We established a Joint United States-Israel Committee on Trade and In- vestment, co-chaired by Israeli Finance Minister Rubbinowitz.and my~ self, and the establishment of four subcommittees dealing with invest~ ment, trade, raw materials, as well as research and development. rfhe Finance Minister is going to visit us in the tinited States for the first meeting of the Joint Committee in early November. We also agreed to explore ways to establish a joint United States~- Israeli Economic Council consisting of private U.S. businessmen and Israeli private business and government representatives. SAUDI ARABIA The visit to Saudi Arabia, which followed the talks in Egypt and Israel, was part of our continuing effort to establish a closer economic relationship with this country. The trip followed the President's Juu~ meeting in that country as well as Prince Fahd's visit in Washington in June. We established the Joint Saudi-United States Economic Commission and the Joint Working Groups to deal with the specific areas of industrialization, manpower and education, science and technology, and agriculture. At the outset, it is important to point out that Saudi Arabia's growing accumulation of monetary reserves-which today exceed their ability to absorb them domestically-has confronted them with a two~ part challenge: First, how can they spend their resources at home in such a way a~ to diversify their economy and industrialize their country, so that their reliance on oil income can be diminished? Make no mistake about it, the Saudis are looking beyond the day of oil primacy. Second, how can they invest their funds abroad in a fashion that will maximize profit without creating unwieldy and unwanted pr~s- sures on the world monetary system? During the visit, w~ held inten~e and broad-ranging discussions not only on Saudi Arabia's economic goals but alsQ on their investment objectives as well. The subject of oil prices of course came up in every conversation~ We outlined a proposal for investment in U.S. Treasury Special Issues, and began an initial discussion of the advantages both countries would share in negotiating a tax treaty. Further, we discussed the impact of world oil prices on the devel- oped and less developed countries. The Saudis clearly recogmze the effects of high oil prices and have been working toward achieving more reasonable prices. In this regard I believe it's important, to note that during our visit, Oil Minister Sheik Alimed Zaki Yamani an- nounced the Saudis' intention to hold an oil auction in August. The amount of oil to. be auctioned is, at this point, uncertain, but we received assurances that the bid price will be accepted. PAGENO="0236" 234 Finally, we opened the initial meeting of the Joint Working Group ou.Industrjalizatioii, This group and the group focusing on Manpower and Education met for a week after I left. These groups had repre- sentation from Our Departments of State, Commerce, Labor, TIEW, and AID. Assistant Treasury Secretary Gerald L. Parsky remained behind to coOrdinate both groups. My statement for the reco~'d discuss~ in greater specifics of the Satidi statistical and industrial information regarding the Saudi economy as well as the other areas that were established in the soft assistance, and technical expertise that we will prOvide them. KUWAIT Following our stop in Saudi Arabia, we made a brief visit to Kuwait. Our meetings there were especially significant from a number of viewpoints. First, they marked the first visit of a high-level delegation to this critical oil-producing country which, in the last decade, has come to occupy a position of growing importance in the world community. Second, I had extensive and quite frank discussions with Kuwait's Minister of Oil and Finance Abdul Rahman Atiqi regarding the price of oil. There are still considerable differences of opinion on this subject, however, our dialog was most constructive dialog and opened the way for future discussions. Third, we had an opportunity to discuss the Kuwaitis investment objectives, as well as their willingness to assist not only developing Arab countries, but countries throughout the world through such vehi- cles as the Kuwait Fund. The Kuwaitis were most interested in re- ceiving as much information as possible regarding the Treasury special issues. rrhey recognized that the U.S. capital market is the most liquid and stable in the world economic community and were interested in the unique opportunities special issues made available to the large- scale investor. With respect to energy issues, I think it was especially significant that they asked that we send our Treasury energy experts to give them a thorough briefing on the econometric studies which support our view that lower oil prices are not only in the interCsts of the consuming nations but the producing nations as well. These meetings took place within days after my departure from Kuwait, and Minister Atiqi asked that we continue such discussions in the future. In regard to Kuwait, you have asked what discussions the US. Government had in relation to the agreement recently reached by the Gulf Oil Corp., to purchase a substantial amount of oil from Kuwait. We learned in early July that an agreement with respect to such ~ purchase was under discussion between Gulf and the Kuwaiti au- thorities in the aftermath of the Kuwait's decision not to accept lower bids in an auction which had recently been held. We then held a num~ her of discussions with the Gulf officials to make known to them our judgment that there is today a surplus of worldwide production rela- tive to current demand and that therefore, there would be, strong downward pressure on oil prices. We also pointed out that, while we are cognizant of the threats of various producers to cut their levels~ PAGENO="0237" 235 ~Of present production in an attempt to sustain the present high price levels, in our judgment such high prices are not in the interest of either -the oil producers or the consumers. We were aware that only a fraction of the oil being discussed by ~Gulf was likely to be shipped to the United States, since the bulk would be used in overseas operations. However, we were also aware of -the significant precedent the proposed agreement might have in other areas. We do not know all of the reasons for Gulf's decision, but it is my -understanding that among the factors taken into account was the ~company's interest in insuring against unfavorable treatment in the future of Gulf's equity interest in the Kuwait Oil Co. Gulf receives oil from Kuwait as a result of a ~0-percent interest in the Kuwait Oil Co.-which, as a result of prior agreements, owned 60 percent by the Government of Kuwait. The oil received by Gulf as a result of its equity ownership is pur- chased at a lower effective cost. Further, I understand that Gulf was concerned about their ability to participate in future purchases of the oil being sold by the Government of Kuwait from the Government's `~share of the Kuwait Oil Co. It is important to consider very care- fully the Government's role in such matters. In my judgment, it is proper for our Government to provide ad- vice to U.S. companies. But I do not believe the decisionmaking re- ~sponsibili1~y on the operation of their foreign trading activities and their foreign investment should be assumed by the U.S. Government. In addition, the U.S. Government should exercise and does exercise -control over the conditions under which any foreign oil-whether pro- duced in U.S.-owned operations abroad or not-is permitted to enter into the United States. For example, we have in effect today a sys- -tern of oil import fees which provide a measure of incentive for U.S. consumers to rely on domestic production as compared to foreign pro- -duction. Further, we are giving continuing attention to such laws and reg- ulations which influence the degree to which the United States be- ~coines dependent on foreign sources of supply. Such an approach is part of our desire to establish an integrated ~energy policy while allowing individual companies to maintain re- sponsibility for their business operations. STTh!MAR~~ OP OIL POLIOY views Before discussing the European part of the trip, I thinl~ it would be appropriate to summarize certain other oil policy issues that cer- tainly were underlying my visits in the Mideast. I am sure that men~bers of this subcommittee are well aware of the viewpoint I have expressed about the present surplus and future de- *chnrng price of oil. But I would like to add to the overview, I have -already given publicly. At various times during my talks, I stressed the fact that cutbacks in production, even apart from the political and security implications for the producers, would turn out to be economically harmful to the producers for three reasons. In the first place, the price effects of ~such cutbacks would inevitably lead to such further intensification of PAGENO="0238" 236 research and investment relating tp alt~rnat~ve sources of energy and to alternatives to energy use that 1~he effect, would be to reduce tl~e total value which the exporters would receive~for their oU over the life of theit producing fields. Cutbacks might bring a higher price for a short period, but they would bring a more than offsetting reduction in revenues for a long time thereafter-in view of lhe importers increased commitment to alternatives. In the second place, maintenance of present costs of export oil- even with no increase-would threaten severe economic-and, in some cases, political damage to a large number of consuming countries to an extent which could result in damaging backlash on the producers as well. In the third place, our Treasury studies of supply and demand elas- ticity indicate that reductions in demand need not be very great to reduce the total size of the oil market significantly. Reductions in demand due to present prices coupled with increases in competing supplies will result in a steady reduction in OPEC's market. Thus, Treasury studies show that for a wide range of plau- sible demand and supply elasticities, recent price increases, if main- tained, will cost OPEC a sizable fraction of its sales. I sensed real concern in Saudi Arabia and Kuwait about these ques- tions. Both governments have requested that we continue our discussions of energy issues and, in particular, they are interested in our esti- mates on the projected U.S. needs for oil from the oil-producing coun- tries. In conjunction with some of the discussions in the Middle East on the responsibility of oil producers to aid lesser developed nations, I would like to provide the subcommittee with the following examples of constructive actions taken by the OPEC countries. And there fol- lows the illustrations of the special facility in the International Mone- tary Fund, expansion of the Kuwaiti fund from $600 million to over $3.2 or $3 billion, Iran's direct bilateral project assistance in Vene- zuela's recent loan to the World Bank, and other specific examples. Most' producing nations reco.gnize the responsibility that they have to accept a major portion of the burden, the economic problems that have been created in the oil-consuming countries throughout the world. EnnorE After my discussions in the Mideast, I was pleased to have the op- portunity to meet with a number of European leaders. In my view, a close acquaintance, and frequent and informal con- versations with those responsible for economic~ and financial policy abroad are more than a useful tradition-they are an essential part of our management of an increasingly complex world economy. There is no substitute for a face-to-face discussion of the ~current problems `our nations face domestically as well as internationally. On this occasion, I particularly welcomed the chance to meet Minis- ~er Fourcade in France and Minister Colombo in Italy, since both had missed the Committee of Twenty Meeting in Washington in June *beeau~e of the pressing domestic matters. PAGENO="0239" ~237 This subcommittee hasnin its ~reviOus hearings touched on the prob- lems of recycling oil money, and I will offer some comments on that situation in light o~f my taik~ in Europe. Many of our discussions in Euro~e were cbnc~ntrated on~ the probleths of financiug oil surpluses and de~Oits and the ability of private financial markets to handle the anticipa1i~d vast flows of funds. Let me make clear at the outset that there was general recognition that the private markets face Si serio~is challenge. There will be strains in the face of this; challenge. But no one was talking about impend- ing failure of financial markets generally or of the monetary sys- tem. Nor was there worry that oil moneys will be capriciously shifted from one market to another thereby disrupting the foreign exchange and financial markets. All of our experience confirws that the financial authorities of the Arab countries intend to manage their oil revenues in a conservative and responsible manner. The problems of recycling oil revenues do not arise from this source, They derive rather from the very large magnitudes involved and the abrupt adjustments required to handle such magnitudes. OPEC oil revenues are presently running at an annual rate of some $100 billion. That is on the basis of present oil prices, and subject to a great many uncertainties. Some of these revenues are spent on imports and other current consumption, and the balance is available for investments and loans and so on. There are uncertainties, here, too, but again it is convenient to think in terms of perhaps some 60 percent of total OPEC oil revenues avail- able for investment in one form or another-roughly $60 billion at the present annual rate. By any standards, this represents a lot of money to be recycled. I should caution very strongly, however, against extrapolating these figures into the future. You kno~v already my views about oil prices. In addition, there are estimates which suggest that the OPEC coun- tries may be able to make rapid strides toward expanding their im- ports and spending their oil revenues. Given these prospects, there is in my view no basis for some of the extreme projections of OPEC investments exceeding the trillion dollar level within a decade or so. But no one sI~ould ignore the potential difficulties facing both the private financial markets and governments in dealing with the large capital flows expected this year. That is the matter which we discussed in Europe. As far as the private markets were concerned, we were careful to approach this question quite apart from the difficulties of a few in- dividual banks which have overextended themselves in trading pri- marily in the forward exchange markets, but clearly some of these institutions si~iply got in overtheir heads. Apart from thes~e cases, we observed that the private financial sys- tem was doing a remarkable job of handling very large expanded operations. The financial intermediaries are~of course, adjusting their practices in the face of changed circumstances, in particular proving themselves unwilling to pay the same rates for short maturity deposits they can- not easily use as for longer term deposits they can relend prudently. 4~-426-75--i6 PAGENO="0240" 238 They are also becoming more active as brokers, arranging direct placements. And the lenders are exploring other channels for their funds, thus easing the pressures on the financial intermediaries. I refer here not only to the talks we have been having with Middle Eastern financial authorities about possible purchases of U S special securities but also about such developments as the recently announced Iranian advances to France and the United Kingdom, and their in vestment in the Krupp concern in Germany. It is true, of course, that world capital markets are very large even in comparison to prospective OPEC oil moneys. To take the U.S. market alone, U.S. corporate assets are estimated at well in excess of $2 trillion, and equity and debt securities outstanding at the end of last year amounted to some $1.8 trillion. Even the relatively young "Euro currency" market had at the end of last year, before the new oil prices had much impact on capital flows, grown to over $150 bil- lion. Today, that market probably approaches $200 billion. As for the role of governments in facilitating the flow of money through private markets and d~rectiy in the recycling process., the first responsibility of governments is to maintain those economic and financial conditions conducive to sound economic activity. In the present circumstances, this means firm policies to deal with inflation and the avoidance of sharp turns in policies. I can see nothing but trouble if we yield to inflation. A second area of governmental responsibility involves the surveil- lance and supervision of banking practices. Cases of faulty management in the foreign exchange dealings of some banks, for example, suggest it is a time for careful attention by super~ isory authorities to the practices of individual institutions In my talks in Germany, I was interested to have an explanation of the steps being taken there to obtain better control of bank activities. Yet another role of governments, or more commonly, of central banks, is that of assuring the smooth functioning of the financial sys- tem as a whole. The public authorities cannot be asi~ed to provide compensation for the mistakes of management. They can properly be asked to see that the solvency prpblems of one institution do not snowball into severe liquidity problems for the entire system. Beyond facilitating flows of funds through the private markets, there is also a proper role for governments directly in the recycling process. Here I think first of the problems of the countries most seriously affected by the oil price increases. Not surprisingly these are the poor- est countries of the world. I am encouraged that the oil exporting countries are beginning to recognize their responsibilities by expand- ing their assistance, both directly and indirectly, to some of these hardest hit countries. But there remains an urgent need to organize the necessary assistance for some countries where action by the oil exporters and reallocations within existing programs do not bring these problems to a manageable level. Progress toward that end was initiated at the June meeting of the Ministers of the Committee of 20 when it was agreed that a new De- velopment Council would be established and that it would give prior- ity attention to the problems of these most seriously affected countries. PAGENO="0241" 239 That 0-20 meeting alsO agreed on another important step involving governments in the recycling process, by establishing the special oil facility in the International Monetary Fund that I mentioned earliei Governments and central banks of the main countries have, in addi- tion, an extensive network of swap arrangements developed first in the 1960's. Although not appropriate for long-term financing of oil deficits, they can serve usefully to assist in dealing with short-term pressures in the exchange markets. The responsibility of governments does not end with these steps. In my conversations abroad, we were very keenly aware of the need to follow closely developments in the markets and, if necessary, de- velop new mechanisms to channel oil funds. We will be working on contingency plans which will allow us to act quickly and positively The breadth and diversity of U.S. capital markets suggest that we will attract a substantial share of OPEC funds. My European col- leagues expressed some concern, in fact that these flows to the United ~States would exceed levels needed to finance our increased oil bills. Although they recognized there was no evidence that such excessive inflows to the United States were in fact occurring they were interested in what our reaction would be. Our reaction to this potential problem is already a matter of record. Earlier this year we removed our `capital controls and opened our `markets to foreign borrowers again on the basis prevailing before im~ `position of restraints over a decade ago. Under these circumstances, should there be substantial investments in U.S. Government securities, this would reduce our official borrowing from domestic sources and free resources for lending abroad. We have offered OPEC nations an opportunity to place a portion of their funds in special U.S. Government securities, and there is deep interest on their part in such placements. But this is a matter of convenience, not an attempt to attract exces- sive investments here. No special inducements are offered-merely the opportunity of gov- ~ernment-to-government transactions which enable the investor to trans~ act very large sums without influencing the market against himself. It is a facility we would offer-and have offered-a number of foreign nations holding very large dollar balances. To a large extent, I returned from my meetings in the Middle East and Europe reassured that a firm basis exists for dealing with the criti- cal problems of the day in a cooperative framework. We have put the mechanisms in place that will enhance economic development and at the same time establish closer relationships with these countries. Strengthening their economies is in the best interest of the entire world. I believe we have taken the necessary first steps in that effort and now we must work together to implement these initiatives. I am confident that we have the will and the resources to succeed in this critical task. Senator CHURCH. Thank you very much, Mr. Secretary, for your ~statement. I apologize for my tardiness. I had a little problem wIth a reluctant automobile on the way back from the seashore this morning and I arrived a little late. I am sorry about that. PAGENO="0242" 24O~ THE ECONOMIOS OF OIL~ Let me start by saying th4 ii~ the co~irse pf th~ hearings ~qf this subcommittee into the role of the international oil companies, one fact has stQod out above all other~; that is, th~ fact tb~at the present price of oil has nothing to do with the economics of oil. We had testimony that the actual~eost ~f raising a barrel of oil in the Middle East is around 25 cents n barrel, Th~ posted price estab- lished by the government is $11.65 a barrel. There is rio question that it is plainly written in the history of events that the price that has presently been imposed on the Western world is a political price and that being the ease, I question seriously whether ordinary principles of economics which assume a free market are really relevant in this situation. We may all be guilty of continuing to underestimate the effect of these hijack prices on the economics of the Western world, but I think we do that at our peril. Oil prices are the singlemost important factor fueling the present inflation. Oil prices have turned the balance of payments of every Western country from a surplus to a deficit. It seems to me that unless we deal very forthrightly with oil prices, we cannot claim seriously to have any kind of anti-inflationary pro- gram at all. We are just beginning to understand the potential in- volved ifl the reinvestment of these bloated profits from the sale of oil in the Western world. The other day I noticed that the Iranian Government had pur- chased a quarter of Krupp in Germany. That is the first purchase, one-fourth of Krupp, of the Krupp subsidiary, and is a very signifi- cant investment in German industry. The Iranian Government, reversing what has been the traditional role of the rich West extending help to the underdeveloped countries of the world, has now loaned $1,200 million to the United Kingdom, what surely must be a new page in the histories of the world. And the banks in Europe and even here in the United States are expressing anxiety over the effifeet of short-term deposits of this magnitude being loaned to their own governments on a long-term basis and subjecting the banks to the jeopardy of a possible collapse if these deposits were suddenly withdrawn. These are just the opening glimpses, I think, of the serious trouble that we face in attempting to adjust prices that have been elevated 500 percent by the Arab Governments. Now, given the political character of these prices, what makes you believe that they are going to come down of their own accord ~ secretary S~MON. Let me make a comment or two, Mr. Chairman, on what you said. I agree with you 100 percent that the present oil problem is much more a political problem than it is an economic one because the market is not being allowed to function today when a group of nations who own 67 percent of this critical resource arbitrarily set a price which they can maintain for a period. The response of the consuming world to these high prices has been a significant reduction in demand. PAGENO="0243" 241 Today~we can se~e' ~i sifrplus of ~il~ our estimates, slightly in excess of 2 Muon barrels a day, which is quite sigiñfic~ant. The~ sWrag~ taAks arefullallover the world at pres~it and if p11~o- di~ctio~ remained ~t this level it would create downward pressures on priCes, ahd that 1s probably the mOst impoitant thin~ I ~aid. SehatOrCHtEC~L M~y I ask you about that ~ I think it is the mo~t importhnt thing you have said, and I think we should inquire into it furth~. Do you think that the Arab Governments aDè susceptible to this dOwnward presSure ?# Normally in a free m~rkCt, the surplus of oil that suddenly has appeared would have that effect on price, bnt just within the past few days the Gñlf Oil Company, if my infotmatioñ is correct, has agreed to pay a still higher price to Kuwait fot buy-back oil, a price that breaks the line and probably is more likely to lead, if past history is any guide to the future, to a general increase in the price level as the other companieS :fatll in place. That has been true in the past. I do not see why it should not be true now. Secretary S~tMoN. They are still averaging their own participation oil with the higher priced oil from the countries which e~ects a reduc- tion in the delivery price here as long as they continue to own 40 per- cent of the çil that comes out of the ground, but that is obviously a temporary thing, too, Mr. Chairman. But one thing-you made a com- ment, I wanted to agree with what you said at the outset. In my fl- nancial experience in banking and dealing with the markets and the handling of these funds, I recognize that the lender of these funds needs a stable liquid market, understanding the character of the lender involved here. They are extremely conservative and, as I said in my testimony, responsible investors who wish to diversify their invest- ments throughout the world and invest in a broad range of equity, fixed incomes, and real estate type investments. It is clearly in their best interests to work with the other countries in the world to make sure that these investments do no disrupt the financial system. There has been much said about strains and we are going to have strains. I have recognized this from the beginning, and again in my testimony I pointed out what we can do to assist the strains in the marketplace. But I think the point that you brought up, which I have been harping on for a long time, our problem is not the recycling of the funds and the reflows, it is very basic, it is in the oil prices, and that is where we move from the economic to the political. In the market we are allowed to operate right now I could say with certainty that the price would decline slightly because there is a stirplus. senator CHURCH. But the market won't be allowed to operate. That has been the whole history of oil in the Middle East. Secretary SIMoN. You asked me the question. Senator CHURCH. This is what disturbs me so. I think that even if the finances of these newly rich nations, now the richest of nations, are conservatively managed, Sand I take your testimony as evidence that they will be, it is the oil price that is the key. These countries havedis- covered that they can make the price stick in Ithe Western World and thus enrich themselves as xiever before, and given the dependency of the Western World upon this oil, it seems to me that the ordinary laws of economics cannot be expected to function. PAGENO="0244" / 242 Secretary SIMoN. For a time, that is correct, Mr. Chairman. Senator ORURCIr. Well, for how long a time? Secretary SIMoN. Well~ I think everyone would have a diiferent judgment on what the effect of additional supply coupled with the~ large reduction in demand as a result of these higher prices, will have~ in the future one could say with the activity that is going on world- wide now: the exploration and new finds, the North Sea, the commence- ment of our Trans-Alaska Pipeline and additional exploration there,. and secondary and tertiary recovery; ~th~e is going to be even greater pressures on declining prices at ~the end of this decade, but that is a~ long time to live with oil prices-~--- Senator CHURCh. That is precisely the point. Secretary SIMON [continuing]. At this level. BRINGINO DOWN PRICRS Senator CHURCH. We are facing the prospect o:t living with these ~irtificially high prices for a relatively long period, and I am interested in determining if we cannot adopt a nation~il policy that will give us some measure of ho~ie that we can bring theseprices down. It seems to- me that our policy of the past ha~ been one of governmental appli~a- tion, oil companies have been given a free, hand: to negotiate prices an~T contracts with these governments without our own governmental s~per- vision and indeed with a considerable athount of governmental indifference. is that going tochange and in what way ~ Secretary SIMoN. Ca~ I comment on that? I think it will. Let's put it this way: I think-it is changing. First, you said are the Arab Governments sus~ptible to a reduction in the oil prices? I cannot make a general statement yes or no. There are certain governments that s~e the advantage of a loWer price. I thjnk the -Saudis have been quite vocal in their public st~tethents atid are willing to see; a lower price and wishing to see a lowè~ price of -oil,- recogni~ing that With their ~rast ~reserves' in that country that they wbuld like the ~urance for ~ long time ~f a stable market fOr the on1~ e~mrno-dity in their co~ntry. They also recOg~iize th~t these present prices -a~ cati~ing gFeat dtimage in the `world. Tlnfortunatehr thjs is nbta comm~n judgment in the OPEC nations, but Sa~idiArabia `does hive 95 percç~nt p~resen~ly of the world's proiren reserves. They~ have increased production. 1 believe they / will continue to increase production, and hopefully bpeii tip The rest of their country for ~x- ploration, which is going to bring a great deal of additional oil into the world n~arkets. This is not a unanimous, opinion. There are others- with shorter time span reserves of oil. / The longer they can keep this price rigged, if you will, the better it is going to- be as far as they are concerned. THE ooVEnN~rENT's ROLE Prior to my trip to the Mideast, I worked extremely close with Secretary Kissinger in making sure that the economic policy, do- mestic and international, was consistent with our foreign policy be- cause the two are inextricably related. PAGENO="0245" 243 I have met with Henry every day since my return from the Mich~ast and I can say that we are in the process of developing a national policy an this whole area, aricludmg what the role of the U.S. Govern~ ment will be in the future. Senator CIIUROXI. Well, getting to that key point, the testimony before this subcommittee has ~retty clearly established, in fact the exe~utives of the big oil companies have themselves confessed that they have very little leverage left when it comes to price. They were unable to show us what incentive they had for bargaining, particularly in view of the very large profits that have accrued to the oil companies along with the governments from these higher price levels. So the suggestion to us is that the Government of the United States is going to have to play a role if we are going to protect the consumers of this country, and if we are going to be serious about trying to temper, the inflation. When Mr. Sawhill was before the subcommittee, he stated that he did not presently have the authority to approve long- term supply contracts between major oil companies and oil production countries, and that he thought he ought to have such authority. Furthermore, he said that he ~vould cobpèrate with the committee in drafting appropriate legisl~tion. We have drafted a bill which. would give the Government of the United States the authority not only to give advice during the negotiating stages between these com- panies and the foreign governments, but which would require the ap- ptoval of the American Government before a contract could take effect. What is your position on such a proposal ~ Secretary SIMON. I just saw this piece of legislation over th~ week- end; Mr. Chairman, and this ~Eoes not reflect the overall administration position on this at present. T think that the U.S. Government has tc~ play a ~stronger role in every area of the Mideast, whether it be the oil pricing or other areas. We ha~'e been having meetings for many months with Aramco and Gulf, but perhaps in a little mOre passive fashion than we, should in the future. ~ut in the specific approving of ~ rontract after the negotiatioiis hav~ been completed, I am not ~et sure what that does for us. I would like to see the Government out front in this area. But does that put us out frQut or does that put us in the back seat after the flCgotiations are over? Is it the Government's role to approve each contract once it is made in a specific area ~ I think that we can do more good by perhaps being out in front and working with the oil companies. We do not have the expertise, really, in Government, the techr~ical expertise to deal in an awful lot of these negotiations, but w~ ean deal' with expertise in what is best for our national security, redefined ec%nornicaliy as well as militarily. Senator CHURCH, Well, this bill I should think would contemplate putting the Government out front. It doesn't simply ~require governmental approval of the contract,~ but it assumes close liaison between the Government and the com- panies during the period of negotiation. So while I agree with you that we should put the Government out~ front, I suggest that that is the purpose of this legislation. PAGENO="0246" 244. Your recent experience with -the Gulf case seen~s. to be very much in point. Here you were in contact with the compaAy,- asT understand it, but you -had no legal authOrity to~really ma~ke any decisions in the case, and when the company decided to go. ahead and~ acc~pt a still higher price, thus bTeaking- the price line~ there was i~othing you could do about it. Secretary SI~roN. `The option was clear, Mr. Ch~irman, either they accepted this price or they did without the oil. It-was for a very short peri-od of time. The contract runs to September, -at which point they will again have negotiations for whateve1~ the next period is, probably a very short periodof time. - - TIlE SAUDI ARABIAN AUCTION In the interim we will work as we discussed with the Saudi Arabian Government on the oil auction that has been tentatively set for the month of August. I have not seen an official announcement that the auction is going to take place, although as I said, Minister Yamani announced that the auction would be held in August while I was over there. Mr. LEVIN50N. There was a subsequent report in the Middle East Economic Survey which reported the auction had been canceled by Yamani. Secretary SIMQN. I read that and 2 days before I read in the same Middle East source that he was going to auction a million and a half barrels a day. I am sort of waiting for an official announcement on whether or not it is off. If so, why has it been postponed, has it been canceled~ exactly what are the details? When I find out, I will cer- tainly advise you. Senator CrnntcH. Did Yamani tell you he was going to go to an auc~ tion or that the Saudi Arabian Government would consent to an auction? Secretary SmI0N. Yes, he did, Mr. Chairman, and after we discussed - this in private conversation, he held a press conference and reiterated it. Senator Crnm~on. And as far as you know he has not told you any- thing to the contrary? - Secretary SIMON. I have not heard officially that it is off, but I have read reports that are disquieting. ENDORSEMENT 0]? THE BILL Senator CHURCIT. Well, -getting back once more to the question1 if indeed you want the Government to get out in front to deal with this problem, I catinot quite understand why you would not endorse what Mr. Sawhill has endorsed in a legislative proposal that would give the Government authority to act in the premises both during the negotia- tions for new oil contracts and after the fact. Secretary SIMON. There again, Mr. Chairman, I would like to have the opportunity to study it and perhaps think of some alternatives which might accomplish the same objective. I think we are both going rn the samC direction in looking for the best role that the Government can play ahd still maintain the free enterprise system that I think has done our country so much good. But we are dealing with a particu- lar problem here that takes some rethinking. PAGENO="0247" 245 Senator CHURch. Yes. Thank you very much. Senator Futhright. Senator FIThJBRIGIIT. Thank you very much. ECONOMICS AND POLITICS OF THE MIDDLE EAST Mr. Secretary, I was very pleased with the initial part of your st~itement, in particular, not that I am displeased with the rest of it, the coupling of the economics of this situation in the Middle East and the political aspects of it. The origin of this tremendous increase in the price of oil grew out of political activities, in effect war; did it not? Secretary SIMoN. Yes. Early increases started, sir, in 1971 and the big explosion came at the end of 1973. Senator FULBEIGHT. The big increase started in 1971? Secretary SIMON. No; earlier smaller increases last year, it was about four times, but it had already doubled between 1971 and 1973 so it has gone up as the chairman said. Senator FULBRIGHT. Do you think the first part, then, was politi- cally inspired or was that the work of the economic forces? Secretary SIMON. It was probably the working of economic forces, but the increase was relatively small at that point and not- Senator FULBRIOIIT. Were other things comparably going up, coal and others? Secretary SIMON. Yes; there was a general price rise. Senator FULBRIGHT. It was not a political increase? Secretary SnI0N. I don't believe so, no, sir. Senator FULBRIGIIT. I am bothered about the distinction between economic and political increase. Of course, it has been my observ~- tion, either domestically or internationally, that nearly all profit- making corporations charge whatever the market will bear, don't they? Is that not generally true? Secretary SIMON. I would say that that is the way the system works worldwide, supply and demand, yes, sir. Senator FULBRIGIIT. And it does here. We do have these situations in which various commodities under certain circumstances demand very large increases that have no rela- tion to the cost of the commodity? Secretary SIMON. That is correct. Senator FULmUGIIT. Either from such lowly commodities as as- pirin. I doubt that the ingredients for aspirin are more than one-tenth of the actual marketplace. Most of that is advertising and all sorts of things. That is true in many other things. Coming back, what I like about your statement is the recognition that this is directly related to the peace and stability in the Middle East, ~nd unless we do get a political settlement of that conflict, it is going to be extremely difficult to manage the economics, is it not? Secretary SIMON. That is correct, sir. Senator FULBRIGHT. So I do not think they can be disassociated. I have a feeling that these arguments that this is purely political could lead to political retaliation. They may not be relevant to the exclusion of the conflict itself. And this is what I hope you and the Secretary of State keep very much in mind. PAGENO="0248" 246 I do not see that there i~ much prospect of a stable price structure in oil so long as the conflict itself is not resolved. Is that correct? Secretary SIMON. I would say that that~ is a prime ingredient, yes, sir. Senator Fur1muoiip. If it is not- Secretary SIMON. Of course there is one other ino~redient where it does become economic, and that i~ looking at the ä~esires of these countries, looking beyond their day, as I said, of oil primacy and what they wish to have in their country as far as industrialization and diversification. They need the cooperation not only of the United States, but ef many countries in the world in the area of manpower, labor and resources and export. So it is in their best interests to assist and cooperate in this. Senator FULERIGHT. Sure it is. Secretary SIMoN. But it is the politic~d aspects that override those, I hasten to add. Senator FULBRIGHT. Even making those successful is dependent on the solution of the political problems. Secretary SIMON. Yes, sir. DEVELOPMENT OF OTHER RESOURCES Senator FULBEIGH~. I think several things you mentioned are very encouraging. I believe you referred to some cooperative group for the development of utilization of their resources. There has been a great deal of talk about the use of their surplus gas, for example, to change it into fertilizer, which is very short all over the world, and that price of the fertilizer has also gone up tremendously. But if they could use that fertilizer or use aluminum, there is a great shortage of aluminum- Secretary SIMON. That is going to be going on not only in Saudi Arabia which flares between 2 and 4 billion cubic feet of gas a day, but in Kuwait, and Egypt, which is finding significant new reserves each day. All of them are looking not only ~t fertilizers but also at petrochemical plants. Senator FULBRIGHT. This is what I mean; this is a very hopeful sign, if you can pursue that. Those agreements involve large investments, particularly by our own companies, and their money. I know some of our aluminum companies and others are negotiating now for fertilizer plants and aluminum companies. This seems to me to be much more consistent with our long-term interests than the approach of some kind of a political retaliation. I do not think that would be effective. The economic approach that you have suggested together with the approach of the Secretary in solving the political war that is going on is about the most helpful approach to it, and I think that should be ~pursued most vigorously. I think above all the settlement of the war itself is important, and I hope the Secretary will be able to resume his active participation in that now that we have a new government. I think we can concentrate on these problems. But. if the settlement is not solved, then these other activities which will be much more expensive, such as conversioi~ of coal. Even conservation here at home can be done. That does bring into effect the economic pressures upon these political prices, doesn~t ~it? PAGENO="0249" 247 `Secretary SIMON. Yes, sir, it does. Senator FULBRIGHT. A very slight reduction in the waste of our ~energy here at home, such as reducing the mUeage of aUtomQblleS to ~55 miles an hour, or a few other things~ and improving' our buildings, ~and so on, can have a big effect upon it, because we are such big ç~on- ;sumers of oil. There are alternatives to political retaliation on the Arab States, aren't there? Secretary SIMoN. Yes, sir, but they take time. Senator FULBRIGHT. We can control those if we have the will to do it. Secretary SIi\iON. Yes, sir. GOVERNMENT PARTICIPATION Senator FtJLBRIGIIT. I am not clear what the Government can do. The suggestion seems to be implicit that the Government step in and. negotiate these contracts. I am not necessarily against government participation. I am not sure how it works. If you told Gulf Oil not to make a contract, would that really pro- mote our objective or not, or would it simply make Gulf Oil go out of business and somebody else pick it up? `Secretary SIMON. That is correct, sir. Senator FULBRIGHT. I don't know where this ends. `]I1he Government intervention, at least partial intervention has usu `adly not been successful. If you take it over all together and manage it completely, there may be some possibility, though I find very few examples of efficient government operation. There are some in some countries, not particularly this country, but in others there have been. But we have been going through this recently and subsidizing Lock- heed, for example, or Penn Central. If we nationalize the railroads that would make some sense to me because other countries have success- fully done that. But to bail out inefficient management makes no sense `at all to me. If we are going to have private enterprise and we reward those who are inefficient, it seems to me to be self .-defeating. Secretary SIMON. I agree with you. U.S. ARMS SALES Senator FIJLBRIGIIT. In the Middle East the consistency of our objective of peace and settlement is quite understandable. What really bothers me, is that at the same time we are going out of our way to induce these countries to buy enormous amounts of arms. The worst possible way they can use their resources is to buy mili- tary hardware instead of fertilizer plants. But we are the biggest arms salesmen in `the world and here is where I find a basic inconsistency with the Government policy. You and the Secretary of State are doing one thing and the Pentagon is doing another, and I must say I have great difficulty reconciling those two. I am afraid that a policy of emphasizing the sale of arms, because they are easy to do, relative to building a fertilizer plant, seems to me to be very negative in the long `term.. Secretary SIMON. I think basically we a~e doing both. We are going ~ahead with the building of all of the various plants, industrialization and diversification of their countires, and at the same time they recog- nize that they indeed are not terribly strong militarily, even though they are going to be very strong financially. PAGENO="0250" 248 Senator FtTLBRIGHT. They do not need to be strong if you get a political settlement. They haven't been strong. And this is a very worrisome aspect of it. The progress in the sale of arms being so quick, it is far preceding the building of plants. I dQ not know 0± any fertilizer plant that has gone up but we have already transferred planes. They are already in being, and lots of them, They are always easy to do, and quick. Secretary SIMoN. And there are lots of countries in the world other than the United States that supply them. Senator FULBRIGHT. Sure there are. We are the biggest arms sales- man, and others. Secretary SIMON. And there are others that could be just as big as we if we chose not to do it. Senator FULBRIGHT. I would hope you could use your influence to shift the emphasis from military hardware to fertilizer plants, if I may use this as an example, of something useful to do. Secretary SIMoN. We are, sir. THE SAUDIS AND OIL PRICES Senator FULBRIGHT. As for the political settlement, I am a little worried about an attitude that seems to be very current here-that is that there is something very evil about Saudis selling their oil at a high price. They have never attacked anybody that I know of and they seem fo have been made the butt of this whole thing as if there is something intrinsically, inherently evil about what they have done. They have not been the leader as far as pushing the price of oil up. Conversely, they have been the ones who wish to have a more rea- sonable price. In Ecuador, they made it very plain publicly they would like to see the price of oil brought down. Is that now true? Secretary SIMON. I read that. Senator FULBRTGHT. If there is anybody taking a strong stance for higher price it is Iran; is it not? Secretary SIMON. Yes, sir. Senator FULERIGHT. And for quite a while. I read an interview in one of the German papers, in which they say the Shah thought the proper price for oil was $30 a barrel because it was worth that in petrochemicals. Is that not true? Secretary SIMON. I read that, sir. Senator FULBRIGHT. Is that an accurate statement? Secretary SIMON. Not in my judgment, sir. Senator FULBRIGHT. Well, I mean accurate as to what was said? Secretary SIMON. Yes, I believe it is, but I did not hear him say it. Senator FULBRTGIIT. I read it in ~ Ge~man newspaper. The Shah is a very capable man and lie sees this as an opportunity. I am bound to say, even with regard to the Shah, that it is not unknown in this country and others that people take advantage of an opportunity if they are engaged in business. Secretary SIMON. Yes, sir. Seirntor FITLERIGHT. So this is not all that unusual and I am a little apprehensive about attaching to this situation great moral and politi- cal overtones which seem to imply that there is something inherently PAGENO="0251" 249 evil. I think that is distracting us from the main objective, which is to bring about a more cooperative atmosphere. Secretary SIMoN. That is what we are attempting to do, 5enator FULBRIGHT. I think that is what your statement indicates. Secretary SIMON. Yes, sir. Senator FTJLBRIGIIT. And particularly the part of it with regard to the political relationships in the area and the economics of it. Secretary SIMoN. Yes, sir. Senator FTJLBRIGHT. And they are really inseparable if we are to do the job properly. Secretary SIMoN. Yes, they are. Senator FIJLBRIGHT. Thank you very much. I think it is an excellent statement and I think your trip is very hopeful we can move toward cooperation with these countries. Thank you very much. Senator CII1JBCH. Senator Case ~ Senator CASE. Thank you, Mr. Chairman. Mr. Secretary, it is good to see you again. Secretary SIMON. Thank you, Senator Case. Senator CASE. There isn't any question about the importance of the job you have been trying to do. We just want to have a little bit more in the way of specific facts for an understanding. SECRETARY SIMON'S NEGOTIATIONS ABROAD In the first place, you would not think that-I am not being cap- tious-take the top of page 5, the first half of your statement-you speak out "we", "I"-who are "we" on this trIp? "We exchanged, we discussed." Secretary SIMoN. We brought an interagency team made up of representatives from State and the Commerce Department, ~A1D, In- terior and the various compollents that bring together economic and financial assistance for th~ise countries, Senator. Senator CASE. So that the "we" there, "we" exchanged comments, "we" discussed the possibility, "we also discussed ways, not only did "we" discuss- Secretary Sm1:oN. That "we" is the Egyptians and us in the exchange of documents, etcetera. Senator CASE. Well, the point I am making, and this is worked out in the latter part of your statement~ the distinction between the "we" and "I." There is a habit in some circumstances also of using the editorial or in some cases royal "we," which is a bad habit to get into. Secretary SIMON. Yes, sir. Senator CASE. And that is all I am talking about. I just wanted to b~ sure what "we" really meant here. On top of page 5, "we" exchange documents. What documents did you exchange, Mr. Secretary? Secretary SIMoN. That involved th~ investment guartu'itee agree- ment. Egypt has seized about $71/~ million worth of various U.S. entities and they agreed to start negotiating the claims against them, and until they agreed to that, OPIO [Overseas Private Investment Corpora- PAGENO="0252" 250 liion] ~vas tionoperabie in that country and their agreement to do this and move toward negotiations for the settlement of these claims en- .abled us to do this, Senator CASE. Do you have copies of those documents with you? Secretary SIMON. No, sir, but I can supply them to you. Senator CAaE. I would think it would be well if you would. Secretary SIMoN. I will supply them for the record. Mr. PAESKY. The documents themselves were exchange of notes he- tween the Se~retary and Egyptian officials but we will supply those for the record. We are reactivating the old agreement that was in existence. [The documents referred to follows:] UNITED ARAB REPIJBLIC INVESTMENT GUARANTIES Agreement effected by e~vchange of note,~ signed at Cairo June 29, 1963; entered into force June 29, 1963. The American Ambassador to the Minister of Treasury and Planning of the tJnite~~ Arab Republic CAIRO, June 29, 1963. EXCELLENCY: I have the honor to refer to conversations which have recently taken place- between representatives of our two governments relating to investments in the- United Arab Republic which further the development of the economic resources. and productive capacities of the United Arab Republic and to guaranties of such investments by the Government of the United States of America. I also have the honor to confirm the following understandings reached as a result of those. conversations: 1. The Government of the United States of America and the Government of the United Arab Republic shall, upon the request of either Government, consult concerning Investments in the United Arab Republic which the Government of the United States of America may guaranty. 2. The Government of the United States of America shall not guaranty an investment in the United Arab Republic unless the Government of the United Arab Republic approves the activity to which the investment relates and agrees that the Government of the United States of America may guaranty such investment. 3. If an investor after exhausting all other channels of settlement or conversion transfers to the Government of the United States of America pursuant to an investment guaranty, (a) lawful currency, including credits thereof, of the United Arab Republic, (b) any claims or rights which the investor has or may have arising from the business activities of the investor in the United Arab 1~lepublic or from the events entitling the inyestor to payment under the invest- ment guaranty, or (c) all or part of the interest of the investor in any property (real or personal, tangible or Intangible) within the United Arab Republic, the Government of the United Ar~tb Republic shall recognize such transfer as~ valid and effective, within the scope of the laws applicable In the United Arab Republic. 4. Lawful currency of the United Arab Republic, including credits thereof, which is acquired by the Government of the United states of America pursuant to a transfer of currency or from the sale of property transferred under an investment guaranty shall be accorded treatment by the Government of the United Arab Republic with respect to exchange, repatriation or use thereof, not less favorable than that accorded to funds of nationals of the United States of America derived from activities similar to those in which the investor had been engaged and in accordance with foreign. exchange regulations applicable in the United Arab Republic. Such currency may in any event be used by the Govern- ment of the United States of America for any of its erpenditures in the United~ Arab Republic. PAGENO="0253" 251 5. Any dispute regarding the interpretation or application of the provisions of this Agreement or any claim against the Government of the United Arab~ Republic, to which t1~e Government of the United States of.America may succeed as tratisferee or which may arise from the events: causing payment under an investment guaranty shall, upon the request of either Government be the subject: of negotiations between the two Governments and shall be settled in such. negotiations. If within a period of three months after a request for negotiatious, the two~ governments are unable to settle any such dispute or claim by agreement, the dispute or claim ~bal1 be referred upon the initiative of either government to an arbitral tribunal for final and binding determinatiob. The arbitral tribunal shall be made up for each case separately, with each government appointing one arbitrator; these two arbitrators shall designate a president by common agree- ment who shall be a citizen of a third state. The arbitrators shall be appointed~ within two months and the president within three months of the date of receipt of either governments' request for arbitration. If s~ithin the time specified either ~f the governments fails to designate its own arbitrator, or if the third arbitrator is not agreed upon, they, in the absence ~f any other agreement, shall request the President of the International Court of Justh~e to make the necessary appointment by choosing the arbitrator or arbitrators. Upon receipt of a note from Your Excellency indicating that the foregoing provisions are acceptable to the Government of the United Arab Republic, the Government of the United States of America will consider that this note and. your reply thereto constitute an Agreement between our two governments on thia subject, the Agreement to enter into force on the date of 29 June 1963. Accept, Excellency, the renewed assurances of my highest consitleration. JOHN S. BADEAU His Excellency `ABD AL-MONIIEW AL-E:AISS0UNI, Minister of Treasury and Planning of the United Arab Republic, Cario. ___________ The Minister of Treasury of the United Arab T~epublic to the American Ambas~ador UNITED ARAB REPUBLIC MINISTER OF TREASURY OFFICE OF THE MINISTER CARlo, June 29, 1963. ExCELLENCY T have the honour to acknowledge the receipt of your note of June 29, 1963, which reads as follows: "I have the honor to refer to conversations which have recently taken place between reptesentatives of our two governments relating to investments in the UAR which further the development of the~ economic resources and productive capacities of the UAR and to guaranties of such Investments by the Govern- ment of the United States of America. I also have the honor to confirm the following understandings reached as a result of those conversations: "1. The Government of the United States of America and the Government of the PAR shall, upon the request of either Government, Consult concerning investments in the PAR which the Government of the United States of America may guarantee. "2~ The Government of the United States of America shall not guarantee an investment in the UAR unless the Government of the IJAR approves the activity to which the investment relates and agrees that the Government of the United States of America may guarantee such Investment. "~ If aul investor after e~cbaustihg all other channels of settlement or cOn- ve~'sion, transfers to the Government of the United States of America pursuaht to an investmetit guaranty, (a) lawful, currency, including credits thereof, of PAGENO="0254" 252 the U.A.R., (b) any claims or rights which the investor has or niay have arising from the business activities of the investor in the UAR or from the events en- titling the investor to payment under the investment guaranty, or (c) all or part of the interest of the investor in any property (real or personal, tangible or intangible) within the U.A.R., the Government of the U.A.R. shall recognize such transfer as valid and effective, within the scope of the la~vs applicable in the UAR. "4. Lawful currency of the United Arab Republic, including credits thereof, which is acquired by the Government of the United States ~f Athericá pursuant to a transfer of currency or from the sale of property transferred under an investment guaranty shall be accorded treatment by the Government of the United Arab Republic with respect to exchange, repatriation or use thereof, not less favorable than that accorded to funds of nationals of the United States of America derived from activities similar to those in which the investor had been engaged and in accordance with foreign exchange regulations applicable in the United Arab Republic. Such currency may in any event be used by the Government of the United States of America for any of its expenditures in the United Arab Republic. "5. Any dispute regarding the interpretation or application of the provisions of this agreement or any claim against the Government of the United Arab Republic, to which the Government of the United States of America may suc- ceed as transferee or which may arise from the events causing payment under an investment guaranty shall, upon the request of either Government be the subject of negotiations between the two Governments and shall be settled in such negotiations. "If within a period of three months after a request for negotiations, the two governments are unable to settle any such dispute or claim by agreement, the dispute or claim shall be referred upon the initiative of either government to an arbitral tribunal for final and binding determination, The arbitral tribunal shall be made up for each case separately, with each government appointing one arbitrator; these two arbitrators shall designate a president by common agreement who shall be a citizen of a third state. The arbitrators shall be appointed within two months and the president Within three months of the date of receipt of either governments' request for arbitration. "If within the time specified either of the governments fails to designate Its own arbitrator, or if the third arbitrator is not agreed upon, they, in the absence of any other agreement, shall request the President of the International Court of Justice to make the necessary appointment by choosing the arbitrator or arbitrators. "Upon receipt of a note from Your Excellency indicating that the foregoing provisions are acceptable to the Government of the United Arab Republic, the Government of the United States of America will consider that this note and your reply thereto constitute an Agreement between our two governments on this subject, the Agreement to enter into force on the date of 29 June 1963." I have the honor to inform Your Excellency that the terms of the foregoing note are acceptable to the Government of the United Arab Republic and that the Government of the United Arab Republic consider Your Excellency's note and the present reply as constituting an Agreement between our two Govern- ments on this subject, the Agreement to enter into force on the date of this reply. Accept, Excellency, the renewed assurance of my highest consideration. A. KAISSOTINI His Excellency JoHN S. BADEAU, Ambassador of the United ~S'tates of America Cario. AMERICAN EMBASSY, Cairo, Egypt, Jn~y 16, 1974, ExCELLENCY We have the honor to refer to the Agreement effected by exchange of notes between our Governments on June 29, 1963 on the subject of investment guaran- ties which are Issued by the Government of the United States of America. The Government of the United States of America is pleased to advise that if your Government agrees, the investment Incentive programs of the United States of America which are the subject of the aforesaid Agreement and which are now PAGENO="0255" 253 referred to as investment insurance and investment guaranties and are currently administei~ed by the Overseas Private Investment Corporation, can be resumed in connection with projects that are approved by the Arab Republic of Egypt. The Government of the United States of America also agrees, if your Govern- ment is willing, that when your Government or an agency thereof has entered into a contract with a private United States finn for construction or other pro- fessional services to a project sponsored by your Government, such a contract shall be considered the approval and agreement required by paragraph two of the exchange of notes dated June 29, 1963. In all other cases, individual project approvals and agreements by your Government shall be requested. We would appreciate receiving Your Excellency's confirmation that the fore- going is acceptable to the Arab Republic of Egypt. Accept Excellency, the renewed assurances of our highest consideration. WILLIAM E. SIMoN. HERMANN F'. EILT8. His Excellency MOIIAMMED ABDOL Aziz HEGAZI, First Deputy Prime Minister of the Arab Rcpublic of Egypt, Cairo. CAnio, EGYPT, July 16, 1974. EXCELLENCY: I have the honor to acknowledge receipt of your note of July 16 which reads as follows: "We have the honor to refer to the Agreement effected by exchange of notes between our Governments on June 29, 1963 on the subject of Investment guaranties which are issued b~ the Government of the United States of America. The Government of the United States of America is pleased to advise that if your Government agrees, the investment incentive programs of the United States of America which are the subject of the aforesaid Agreement and which are now ~eferred to as investment insurance and investment guaranties and are currently administered by the Overseas Private Investment Corporation, can be resumed in connection with projects that are approved by the Arab Republic of Egypt. The Government of the United States of America also agrees, if your Govern- ment is willing, that when your Government or an agency thereof has entered into a contract with a private United States firm for construction~er other professional services to a project sponsored by your Government, such a contract shall be con- sidered the approval and agreement required by paragraph two of the exchange of notes dated June 29, 196& In all other cases, individual project approvals and agreements by your Government shall be requested. We would appreciate receiving Your Excellency's confirmation that the fore- going is acceptable to the Arab Republic of Egypt." I wish to confirm that the foregoing is acceptable to the Government of the Arab Republic of Egypt. Accept, Excellency, the' renewed assurances of my highest considerationS A. M. HEGAZY. His Excellency Hu1IMANX PIiEDERIcK EILTS, Ambassador of the United states of America, Cairo. Senator CASE. In a sense this constituted an agreement between the countries, did it not ~ Secretary SIMON. Thttt they will commence negotiations' on the set- tlement of these claims, yes, sir. Senator CASE. Well, I think in line with our new spirit of coopera- tion, openness, these agreements' ought to be made available to the Congress. Secretary SIMoN. Yes, sir. Senator CASE. And if there are matters which require action by the Congress, we can decide that after we see them. Secretary SIMoN. Yes, sir. 45-426----75--1 7 PAGENO="0256" 254 Senator CASE. On page 6, the third paragraph, you say you explored additional ways in which we. can work together to attract private in- vestment to Egypt, not just from the United States but from all parts of the world, particularly investments made jointly with the benefit of the U.S. technological contribution. I do understand the matter of improving the investment climate and attractiveness in Egypt by our technological help, and I would like to come back to that again. Here I would like to have an explanation about the application, if any, of this guarantee program. It is contemplated that the United States should guarantee a for- eign investor in Egypt. Secretary SIMON. No, sir, it is not. Senator CASE. How would the activation of the guarantee program work? Secretary SIMoN. It is consistent with the nOtion that having a strong econom.y and a broad ecQnomy in Egypt, taking advantage of their highly skilled, literate educated peoples, that it is not just the United States of America that is going to do this job in their country alone, that there are otherS areas for investment, funds from Saudi Arabia, as well as, many of the European coinmuiiities. Well, how can this best be done? As I said, in some of my informal comments at the beginning of my statement this, morning, the Egyptian economy is in a stage of deterioration due to 20 years of controls on their economy. How can they liberalize their economy to attract investment, to give converti- bility to foreign e~ç~hange in their country for the repatriation ~f profits which had been forbidden, which is ~ `obvious ~remendons im- pediment `to foreign investment? They have established free zones and we worked with them' in the establishment of these free zones to attract investment where investment from all over the world could come in and build whatever the facility `would be and they `could manage it with a great degree of freedom. We can publiCize the new Egyptian investment law through our normal Department of Commerce channels to American industry so that we list the various investments that the Egyptians desire in their country. We will then assist them in contacting the right people to do this. We discussed the Development Project Institute which would pro- vide feasibility studies. It always sounds like a good idea to build a petrochemical or fertilizer or perhaps even a steel plant. Senator CASE. I understand that. We do not disagree with any of that at all. It is most desirable, I am sure. My specific question is, what are we going to do to help them attract private investment from the rest of the world? We are not then going to guarantee those investments. Secretary SIMoN. No, sir, we are not. Senator CASE. We are not, I take it, doing anything about a tax treaty to attract other investments, American investments? Secretary SIMON. No, we are not. PAGENO="0257" 255 S~i~o~ CA~sE. That comes down to No. ~, which is making known the ateas in ~hie1i there are opportunities, and we are going to publi- ci~e to the i~st of the world, not the United States, to the rest of the ~vorld the investment opportunities in Egypt. Is that what ~ou mean? &eretaiy SrMON. The very fact we have a joint Development Proj- ect Lnstitn±e that looks into the feasibility of various industries ~for their country means that these studies would be made known, and hi this fashioua It would be made known to the mest of the world, but i~t would not be p.ublici~ing it to Germany or Saudi Arabia, we would be j~ist assisting Egypt in doing it. Senator CASE. I wanted to find out what we were going to do to help them get toreign investment other than American investment in. Egypt. I wi&ersthand the technological help, of course. THE TAX TREATY What about o~ top of page 7~ would ~QU give me the details of. the~ tax ti~aty which you di~cussed under subheading (3)? Secretary SIMON. This work takes a long time. Obviously it ends. up for Senate ratification, any tax treaty, but, tI~ere is one thing, one problem with the tax treaty that .1 am told weiiad with Egypt in the. past. Tliiere was a tax sparing provision and we explainel to them~. at great length that this tax sparing ~vould not be part of a tax treaty,. this would. be part of. the normal perfunctory treaty that removes: impediment from the investors in the United States going to a foreigm country. It would not be of an, extraordinary nature whatsoever. This work is just commencing now. , Senator CASE. In other words, it is not contemplated to give tax benejlts to American investors in- Secretary SIMON. There will be, no tax sparing, which was as you remember, Senator, a big hangup in the past. That is correct, sir. Senator CASE. What is the potential for investment in Egypt? In what kind of things would a priyate investor, assuming political times were good and all the rest of it, what is there in Egypt that would attract private investors? Secretary SIMON. I think there are two primary areas that they are looking at right now. One is the Suez Canal reQpening and all the money that they are going to need for collateral areas around it, such as housing, to move all of the people who have been evacuated back to the Suez Canal. They will need a massive housing program. There are pages of projects for that free zone in the Suez Canal looking ahead over the next 3 or 4 years, and it totals up in the area of $5 billion, ` Another area that I found quite exciting in discussions with their Petroleum Minister is the recent indication of new finds in petroleum and natural gas in Egypt. It appears that they could be, producing a million barrels of oil a day by 1980. They are today producing close to 500,000 barrels a day and consum~ lug 220,000, if my memory serves me. Senator CASE. On what date might they get a million barrels? PAGENO="0258" 256 .Secretary SIMON. By 1980. They have signed 12 exploration con- tracts already for new exploration wells to be. drilled this year and they expect to sign between 25 and 50 more over the next year. Senator CASE. What part of the cotintry is that? Secretary SIMON. All over the country. They have five zones in the country that they are exploring. The. most productive have been offshore so far. Senator CASL Now, tax treaty and other incentives, the top of page ~, that might stimulate private investment in Israel. Could you give us some idea of what you have in mind. Secretary: SIMoN. There again the other incentives primarily in- volve removing the existing impediment to private investment because of their totally controlled economy. . Senator CASE. Are there things that inhibit American investment in Israel now? Secretary SIMON. In Egypt? Senator CASE. We are talking about Israel, the top of page 9. Secretary SmI0N. Tam sorry, I was still on Egypt, 1 think other incentives that might stimulate private investment in Israel would be the Joint Council. Their businessmen and our business- men are exploring ways to show the attractiveness of the investment climate in Isra~l. We haire found these councils have worked very well in the past and the fact that the Government presence is there ançl interested in doing this in itself iS an encouragement to companies to go to other countries. Senator CASE. I am not against any of this. I just want to know what we are talking about. What about the tax treaty? Secretary SIMON. That would be the same type instrument, no ta~ sparing a swë discussed with Egypt. Senator CASE. Aren't our tax relations with Israel already in as good a shape as they can be? Secretary SIMON. There is no tax treaty, Senator Case. Senator CASE. What does a tax treaty do that needs to be done? * Secretary SThtoN. One major area is double taxation. It removes the threat of double taxation which is consistent with international finan- ciald~alIngs. Senator CASE. That is a rather broad description. What does double taxation mean? * :SecpetaIy SIMON. You would be taxed in their country as well aS in the other countries. Senator CASE. You are going to put in some money, we will say you are gOing to invest in Israeli business, you get dividends from that. Does this mean that the dividends that are paid to you will not be taxed in Israel and that you will get more money than the other investors, for instance, in Israel? Secretary SIMON. No, you would be treated on an equal basis in Israel with the other investors in Israel, but you would not be subject to the taxation at the 48-percent rate here, or whatever portion it is, as well as the 48 percent that Israel might have, which, of course, would take care of any profits you might- PAGENO="0259" 257 S~enator CASE. Let's forget the corporate business. Let's say you, my constituent from New Jersey, decided to put $5 million, if you are wealthy, into an Israeli company. Now what kind of ta~ benefit would you get~ Secretary SIMoN. Well, the tax benefit, I would pay taxes on profits that are repatriated to this country but there again the only thing it d~es- Senator CASE. Wouldn't you pay American income taxes on the divi- dends that are paid? Secretary SIMoN. When they are repatriated to this country, yes, I would. I would not, if on that $5 million I invested I made a profit of a million and they wished to tax me at x percent. It would not be subject to the taxes here in the United States simultaneously, until I brought the money back to this country. Senator CASE. But you would be then, so it is a matter of delaying and not a matter of being taxed only once? Secretary SIMoN. For taxes in 1 year that is correct. Senator CASE. But you could go on and the idea is you could reinVest this in Israel. Secretary SIMON. Yes, sir. Senator CASE. And expand your wealth enormously and your $5 million would become $50 million in 10 years without any ~Arnerican tax. Secretary SIMON. Of course-~----- Senator CASE. When you die, which God knows we are not looking forward to, there would be no tax at all on the $50 million? Secretary SIMON. When it is repatriated to this country, there is a tax on it, Senator. Senator CASE. You have reinvested this money and now you have shares in Israel, the Israel General Motors and Israel General Electric. Secretary SIMON. I believe-I~ am not an expert in this foreign estate tax area on what happens when one dies, but I will supply that for the record. I think this estftte tax would enter into the assets held all over the world. Senator CASE. I am not an expert either but I just want to kfloW what we are talking about when we talk about a tax treaty. Secretary SIMON. I will supply for the record all of the specifics of the standard tax treaty that we ar~ talking about. Senator CASE. It wish yçu w~ould. [The infor~nation referred to follows:] ~Hon. Fiwn~ O~arnca, Ch/r*rnan, Subeommitt~?A3 on MijZti~vt'tOfldi (I'~rporatiOfls, Co n~ttce on Fore1~On ReleUoias, U.S. Senate, Washington, DXI. THE SECRETARY OF THE TREASUR~, Washington, p.C., Septens7~ier 1~2, 19~4. DEAR ~\in. CHAIRMAN: The follo~iug is my respor~se tp a questjon which Senat9r Case requested at the August 12 bearing of the Subcomrni1~tee on Mttltinational Corporations reg~rdipg the function of Income tax treaties. Bilateral income ta~ treaties for the avoidance of double taxation serve several important putpoaes (1) Treaties reduce the prospect of loable taxation of international flows of jucome by granting primary taxiEg authority to one taxing jurisdiction with the other country gixing a tax credit or e~ceniptiofl i~or the same income. They permit PAGENO="0260" 258~ the establishment of common definition of terms and of rules fo~r a~Thssrai4ing in~me and e~pense~ for this purpose. (2) With respect to business profits, treaties provide that ~ resident oi~ one country may be taxed by the Other only to the extent that that r etent has made a substantial economic penetration into that other country by virtue of maintain~- ing a "permanent establishment" there. (3) With respect to personal service Income, treaties generally provide tbat a resident of one country who is temporarily present in the other for the purpose of providing personal services, either in a dependent or independent capacity, will not be subject to tax in the other country unless certain tests are met, gen- erally including a physical presence there for at least 183 days during the taxable year. (4) Treaties provide for reduced rates of withholding tax on investment in- come to avoid a heavier aggregate tax burden for residents of one country Invest- ing in the other country than would obtain for such residents If they invested at home. (5) Treaties assure non-discriminatory treatment under the tax laws of one country for residents of the other or for corporations of the first country owned by residents of the other. (6) Treaties authorize consultation and exchange of information beti~een the tax authorities of the two countries both as to matters of tax evasion and to prevent cases of double taxation. These general principles are embodied in all of our income tax treaties. The specthc provisions vary from treaty to treaty, as each treaty is separately negoti- ated, taking into necount specific features of the tax laws of each country, and economic relations between the two. If I may be of further assistance to you, please let me know. Sincerely yours, WILLIAM E. SIMON. SAUDI ARABIA'S MONETARY RESERVES Senator CASE. Secretary Simon, down at the bottom of the page, the heading of "Saudi Arabia," you make the statement that Saudi Arabia's oil accumulation of monetary reserves today exceed their ability to absorb them domestically. This is, of course, the nut of the problem on this side, and the other side is where are we going to get the money or the consuming countries to pay these prices. That is really what we are talking about. Secretary SIMON. Yes, sir. Senator CASE. I guess I will pass that for a moment with a com- ment. If income exceeds their locaj capacity to absorb, maybe the best thing for them to do is to either reduce prices that they are charging or else reduce production so they can keep the oil in the ground and have it for the future. Secretary SIMoN. There are two other things they. can do, also. One, obviously, is to invest, and the other i~ to aid the other countries of the world that are being so severely a~ected by these oil price increases. Senator CASE. A number of questions in detail on this whole thing which I will not take the time because of my suggestion for a reason- able time limit on each;of us sharing the time period. But broadly speaking, it looks to me as though all those things that are proposed. and I am not criticizing von. I am just making this comment, are nothing else but band-aids, the tiny possibility toward even meeting the problem that could be handled by cutting these prices, and I can't see how lending money to a poor country is going PAGENO="0261" 259 to help that country. I really can't see it. What it needs is reduced prices for petroleum that it must have and to ~ut it in further hock to these producing countries or to the othei~ ~ountries is going to do them no good at alL I know you have said this privately to them. I know our Govern- ment has made this point clear. I think we should shout it from the housetops that all this business of these tiny funds that are being set up by these countries out of enormous acchmuiation of monetary reserves that are being extorted because of the temporary advantage, which in the long run, as you point out is going to be no advantage at all, and this is going to turn to ashes in their mouths, and they should be made much more clear to the world than it has been, and again I ani not talking about you, you understand this, and your wOrk at it, but it is so clear this is what we ought to be shouting about, WHAT IS THE U.S. RECEIVING? And this brings me to this point Are we getting anything except a smile from these countries, these oil-producing countries, in exchange for the enormously valuable technology that we are promising them, the help in all kinds of scientific matterS, the help in educating their young people, the seminars, this advice and what not? What are we getting br it, what are they paying u~ for it, except as I said before, a smile? And you know that I have said this before, I am getting to be a tiresome old man, but know that old American song, "Sweet Alice Ben Beau." It goes something like-remember-"Sweet Alice Ben Beau, with hair so brown," or something like that, "she blushed with delight if you gave her a smile and trembled with fear if you frowned." Can we stop having any such attitude so that we are nOt going to blush with delight when somebody smiles and we are not going to tremble with fear when somebody frowns? I am not against detente. I am just saying that this thing ought to be done on a parallel basis. We do not give them all the technology that we have got in exchange for a smile, and we do not invest in long-term projects in exchange for a smile. It seems to me that our emphasis ought to be almost on the single thing, reduèe these prices. This will help the world. This will help the poor countries and nothing else will. Everything else is going to con- timie throwing things out of whack. You suggest this year we are at the annual rate of an accumulation of wealth by the Arab oil-producing countries, $100 billion; is that correct? Secretary SIMON. This year. Senator CASE. What was the rate last year? Secretary SIMoN. I would say it would be in the area of 30 to 40; but I do not have- Senator CASE. Roughly, 3 years ago, before this started; what was the rate? Secretary SIMoN. It would be 25 percent of that or less; 20 percent. Senator CASE. Twenty? Secretary SIMON. Because they have gone up between fourfold and fivefold since 1971, Senator. PAGENO="0262" 260 Senator CASE. $6 billion 3 years a~go and $35 billion last year and $100 billion this year. Now, where are the consuming countries getting ~this money? Secretary SIMoN. Consuming countries are going to get the money, as you say correctly, by borrowing it. That is what they have been do- ing, Senator, and I agree with you. What happens ~s that we continue, and we do this in lots of other areas, do less by attacking the results instead of the causes of it. This is way I said in response to Mr. Fiil- bright that the problem is not necessarily the aid, the borrowing, the financial markets. aithough they are going to be problems, that is man- ageable; but the oil prices are not manageable. We ought to be shout- ing this from the rooftops because ii do not think anybody properly assessed yet what the true damage, what the changes are going to be in many countries in the world politically as well as economically, looking a decade ahead if they were allowed to remain at this level. WHAT CONCESSIONS HAS OPEC MADE ON PRICE? Senator CHURCH. Could we get an answer to your question? Senator CASE. The question is-you didn't mean to avoid it- Senator Crnuicii. You haven't had a chance to answer it. I think it is a really terribly important question. Senator Case was saying that looking at all of the new offers of American aid and assistance, tech- nology, sales of military equipment, and what have you, we are now throwing out our largesse upon the Arab countries, the oil-producing countries. What are we getting back for it? Secretary SIMON. It is not a matter of~- Senator CHTTRCII. What is the quid pro quo, what concession has been made on price? Secretary SIMON. We are really not throwing out our largesse. We have made this arrangement with Saudi Arabia, period, and with Saudis who are in our ç~mp, if you will, on reduction of oil price and cooperation in this area. Senator CTTURCII. There is $250 million for Egypt in the new aid package. There is additional money for Jordan. There is money for Syria. It seems to me that it is clear that our policy now has become one of extending very substantial aid to these countries in one form or another. You have just had negotiations; you are helping them open up the economy of Egypt; you have had negotiations with the Saudi Arabian Governmeiit and others, and all looking toward a larger measure of American cooperation. What did we get back for it? Secretary SIMON. There again you have to take it country by coun- try, We take Saudi Arabia, who believes as we do~ sincerely, that the price, of oil should be reduced, that we should be dealing with a market price of oil, not with the price that is established by a cartel. Mr. LEVINSON. What are they going to do? Are they going to auction or are they not going to auction? Are they going to buy $12 billion worth of U.S. Government bonds? Secretary SIMON. No. There again I am giving you my opinion. On the second question, as far as buying $12 million worth of Gov- ernment bonds, I would say absolutely not. People do not look at the numbers very carefully when they make that suggestion, and there PAGENO="0263" 261 again I have seen that amount appear in the newspapers. Everything that appears in the newspapers is not always accurate. This year, Saudi Arabia is going to get $25 billion from their oil revenues. Senator SYMINOT0N. If this is going to be a general discussion, I would like to get into it. Senator CHURCH. I will get back when my time comes. Senator CASE. I want to throw onES question in for the record. I would like to know, did any of your discussion include any agreement or suggestion of agreement that a foreign, that is to say, Middle East investments in this country, and Middle East deposits in American banks would not receive special treatment, wonid be sequestered or what not? Secretary SIMON. We absolutely did not. First, we never discussed expropriation or anything like that. They will not receive special treatment, no devaluation, backing or inflation backing or gold back- ing or what have you. No, sir; they will buy the same special issue Treasury securities that our institutions here in the United States, and all other investors in the world do. Senator CASE. Did they ask in the event of a future embargo their funds on deposit in this country be blocked or sequestered? Secretary SIMON, No, sir; they did not. Senator CASE. It is a possibility, is it not? Secretary SIMON. The subject of embargo in our conversations was never brought up. THE SAUDI AUCTION Senator SvMINGTO*. Mr. Secretary, I want to sa~ I welcome you, and I think our interest in military matters and diplomatic matters are subordinated by the necessity for equal interest in economic mat- ters. I hope that you will clarify some of these problems for us. I haven't got many questions. I was interested in page 10. You say there is gOing to be an auction- maybe there won't be, but' m~vbe there will be-in Saudi Arabia. What do you think would be the i'esuit of that auction? `Would there be a price decrease? Is that the i'nrplicatio~n ~ Secretary SIMoN. Right now we `h~C~e a posted prh~e of $11.65 which translates at 93 percent to be about $10.85 a barrel. The reáent auction that was held in Kuwait resulted in much lower bids than the 93 per- cent of posted price. They' decided not to sell at that le~rel. Had they Sold, obviously there would have been cheaper oil to the tune of 1,20Q,000 barrel's a day in the hands of many oil marketei~s around the world and that would put pressure on the price of oil. The Saudi Arabian Oil Minister, ~t amani, has told us that he will sell the oil at what I anticipate to be lower bids than the 93 percent of posted price because of the surplus available and lack of storage capacity in the world. fiR EFFECTS OF THE AUCTION Senator SYMINOTON. Then the answer would be that you expect the auction to result in lower prices? Secretary SIMON. Yes, sir. PAGENO="0264" 262 Senator SYMINGTON. Thank you. Do you think that would have a worldwide effect? Secretary SIMoN. Not immediately, no. sir, because the majority of the oil would be down at the 93 percent of posted price and this would have to be a continuing process to bring the overall price down. COMPETITION AND PROFITS IN OIL INDUSTRY Senator SYMINGTON. There are two transcontinental or interconti- nental airlines that the United States has competing against govern- ment, as you know, and they tell us that because of the increase in the price of oil they will go broke, unless they get some help from the Government. On page 17, you say: In my judgment it is proper for our government to provide advice to U.S. companies, but I do not believe decisionmaking responsibility on the operation of their foreign trading activities and their foreign investments should be assume~I by the U.S. Government. I read a book called "Power Play," I am confident you have read it, about the oil companies in the past. Secretary SIMON. I have not. Senator SYMINGTON, You haven't read it? Culminating with the so- called agreement in Scotland between Standard of New Jersey and British Petroleum and Shell, as I remember it, in the past the oil com- panies ~iave had it pretty much their own way when it came to setting price. I am wondering if there is any connection? We do not have any oil in my State to speak of and I am wondering if there is any connection when we have companies that stand or fail on the price of oil that are competing against governments, if you see what I am getting at. For example, the excess profits; there has been a lot of talk about a heavy addition of profits to the oil companies. Has there been any relationship between that and the companies that are losing money because Gf what they are forced to pay. for oil? Secretary SIMON. We attempted in the allocation program, Senator, to deal with the great problems of the airlines that fly internationally and in an attempt to equalize the domestic and the bonded fuel. It is a terribly difficult problem for many of them and we continue to work on it. I met with the Eastern Airlines people last week.. Every time you attempt to give an airline some assistance as far as their contracts are concerned, you are obviously taking away from someone else. And we go back to the initial problem of the oil price and how we get that down and what are the politics that come first before the economics. THE METZENBATJM LETThR Senator SYMINOTON. Thank you. Now, there has been a letter in the Senate sent to the leadership. and they got a group of us together to talk it over. It was written by Sena- tor Metzenbaum, and perhaps we can call it the Metzenbaum letter. Last year we paid $25 billion for oil. This year we will pay $1O~ billion for oil. Secretary SIMON. He means the world? PAGENO="0265" 263 Senator SYMINOTON. Yes. And of that $80 billion they could only absorb in improvements $20 billion, which would leave $60 billion that they could invest. He said~ for example, in that $60 billion they could control the 13 largest companies of the United States by controlling 51 percent of the stock. You and I both know that you don't need any- thing like 51 percent to control a large corporation. I am wondering if you have any apprehension about it. One other figure he gave was the highest monetary reserve control this country every had, which was in 1949, when it had 561/2 percent. Extrapolated, he felt the oil companies would have 70 percent of the world monetary reserves by 1980. That is roughly only 6 years from now. On that basis, is there any apprehension on the part of the rllreasury Department about the capacity, or possible capacity of these very heavy dollar holding corporations and other currencies, too, to take a major economic position in the U.S. economy which might result in serious trouble, for example? We know often in our business as poli- ticians, that corporations attempt to control p~Iitical policy. Would you comment on that? Secretary SIMoN. I 4~ould say that we share the coi~cern of this po- tential and I discussed this. I discussed this in both SaudiArabia and Kuwait, which were the two oil-producing countries which I visited. Kuwait by far is one of the most sophisticated of the countries, They have been buying equities in the United States for some time but they have no intention of buying control, if you will, of major corporations and putting all their eggs in one basket. They have to do several things. And this holds true for both Saudi Arabia and Kuwait. They wish to industrialize and diversify. They are going to need a great deal of this money to accomplish this over the future. They will, at the same time, be making investments in companies, whether it is cement, or steel, that are going to be supplying them with all of the materials to do the job in their country because that is good business. Now, we have antitrust laws, we have Defense Department regula- tions, we have the Securities and Exchange Commission, that sets up regulations on foreign investment in this country, and perhaps we ought to continue to take a look to make sure that we have sufficient safeguards. Our policy has always been one of encouraging free trade and com- merce and giving people within the constraints of national security, both military and economic in this country, the ability to invest here, if that is what they wish. EGYPT's NUCLEAR REACTOR Senator SYMINGTON: Switching to another point which bears on my final series of questions: We entered into a reactor agreement with Egypt; as I understand it, in the not too distant future they could be an exporter of oil. As a member of the Joint Atomic Committee we figured that out that utilizing plutonium, which is automatically part of the waste that you canliot get rid of when you have a fission re~ actor, they could make at least 200 Hiroshima bombs a year from the deal as it was reported in the press. France, a~ you know, has not only not signed the agreement; it has not even ratified the Noii-Prolifera- tion Treaty. PAGENO="0266" 264 r am wondering why it is necessary to give a nuclear reactor to Egypt if they will soon be an exporter of oil? Secretary SThEON. Actually ~this is consistent with reducing the world demand for petroleum. This world has relied on oil and natural gas for about 66 or 67 percent of its energy. And with the diversifica- tion of electric generating facilities, all of the other sources that can come on stream, it is a good idea for people to diversify for their own interest. The oil that they are going to be exporting is going to be important in the petrochemical and fertilizer area and it is going to provide them with foreign exchange that they need so badly in the future. Senator SYMINOTON. Well, as you know, there are a good many people who are worried, including some of our best scientists, about the danger of nuclear proliferation., Secretary SIMON. Yes, sir. Senator SYMINOTON. Do you feel that that danger is secondary to the shortage in oil? Secretary SIMON. Oh. no. I would consider that a primary concern. Senator SYMINOTON. I am Ilot trying to ask a trick question. There was a book put out, called "Curve in Binding Energy" in which the author pointed out the danger incident, there being five members of the Nuclear Club. By the time the book was printed, we know there is a sixth. We know there is a country in South America working hard to become the seventh. Inasmuch as you are giving them the way, the means of making the material with which to make weapons, I was wondering if that has been given consideration as we deal in these reactors. Secretary SIi~roN. It has, Senator, and I would say that is a primary consideration, not a secondary one, to the energy portion of your question. The adequate safeguards are going to have to be built intO these agreements to make sure that it does not occur. ~*Senator SYMINOTON. I appreciate that. And I think at some point we will have to get into the definition of adequate safeguard because I am confident that the cOmpany that made the arragements' did not realize very soon there will be an atomic explosion. Secretary SIMoN. Yes, sir. INFLATION Senator SYMINGTON. One other point that I would like to ask about. Your problem really is, your greatest problem it would seem, is the problem of inflation, and we have now double digit inflation. As one who went through the 1932 depression, there are some things that are `developing that are comparable to the problems in those days. For example, failure of the bank in Austria, failure of the bank in Germany, the Fed, which of course could not have been done, which was set up putting over a billion dollars over in the New York Bank and so forth. Have you got a policy you are going to announce, a policy as our Secretary of the Treasury, to attempt to control this inflation, and at least keep it out of the double digit aspect? Secretary SIMON. Yes, sir, we most certainly are. We met with President Ford on that subject 2 hours after he was sworn in last week and I can assure you that that is No. 1 on his list. PAGENO="0267" 265 Senator SYMINOT0N. It is No. 1 on his list? Secretary SIMoN. On everybody's list. Senator SYMINGTON. On your list, too? Secretary SIMON. Yes, sir. Senator SYMINGTON. Could you give us a rough idea what your plans are? Secretary SIMON. Well, of course, the rough ideas are pretty much the fundamental ideas that have been talked about a great deal in the past but have never been applied with any consistency at all, except on a very temporary and sometimes very ad hoc basis. The fundamen- tal thrust of my suggestion is in the Federal spending area. We have been dominant in our presence in what we have been spending for such a long period of time, that it has obviously contributed to the upward pushing of prices because it creates greater demand. At the same time, our borrowing to pay ~or the deficit financing has an up- ward ratchet on interest rates. Today our presence is 62 percent of the capital markets in the United States, U.S. Government and federally sponsored agencies and we have to move back from that. Senator SYMINGTON. `One more question. I~CONOMIO PRIORITIES Do you' think that the best way to move back is to curtail the bil- lions that we are putting out of the country. We are very close to $100 billion in our military budget and we have been talking all morning about our oil problems. `Or,' do you think we should curtail our social programs here at home? Secretary Sri~roN. Well, I think that in looking at the priorities of the budget one can argue about that $305 billion and ~~here the spe- cifics should be cut for a long time. I must admit that ~reside~t Nikon made an awful lot of good points to me personally on many occasions in talking about the risk of the United States becoming a second-class power and reducing the defense budget that has already been reduced 30 percent in actual dollars since 1960, so my bias is to look at other areas for cuts. `` Senator SYMINGTON. I understand of the $305 billion, only around $64 billion is controllable, you might say, beyond the law, so that you can actually operate on it, and 70 `percent of that is military expenditures. In any case, would you comment for the record how you feel about that? Secretary SIMON. I have never used the termuncontrôIlable just be- cause Congress has passed laws that legislate spending. I think that we have to constantly relook at all of our priorities and that is why this new budget mechanism that was signed into law a couple of weeks ago is going to be so useful in getting a dialog between the executive and legislative branches of government in looking at the whole picture and seeing where this country should move in on niany areas before we con- tinue to legislate incremental costs that are creating such a burden on us financially as well as- Senator SYMINOTON. Like veterans benefits and social security? PAGENO="0268" 266 Secretary SIMON. I think that our social security and the welfare programs have a tendency to overlap each other, perhaps in certain areas they create a disincentive to work. I think all of these things have to be looked at. Senator SYMINGTON. You may come up with some suggestions to that end. Secretary SIMON. I think that what we would like to suggest and what we will be suggesting is a dialog between the Congress and the executive to discuss these areas and whatever else is practical, recogniz- ing that, of course, we want to take care of the needy in this country and the aged and the disadvantaged. Is there a way, a better way, to skin a cat economically and financially? Senator SYMINGTON. Thank you. Senator CHURCH. Senator Percy. AGREEMENTS WITH EGYPT Senator PERCY. Secretary Simon, I think it is quite apparent to all of us that in this first testimony of a Cabinet official in the new Presi- dent Ford's administration you could not have picked a more complex subject, one that cuts across more lines and more areas than this. I will be meeting-and I would like to put my question in a different way, very much along the lines of those of Senators Case and Church and Symington. I will be meeting on Wednesday with my agricultural advisory board. They are hardheaded, 26 hardheaded practical farmers in the Midwest chosen because of their outstanding success, their per- ception of world problems and their capablity to relate these problems to America. But first and foremost they are farmers. I wish to try to picture how I am going to explain all of these ar- rangements that you have made in the Middle east to them, because I know I will get some questions on it. I am going to start out by saying that you have two problems you are dealing with, President Sadat's role in ending the war and then the price of oil. They are two separate problems, somewhat interrelated, but we are on a two-track system in a sense and you had to deal with both of those when you were out there. How do you answer, let's say, a farmer from Illinois when he points out all of these programs that you have developed with Egypt, even given the President Sadat's magnificent role, when Egypt is an oil producer of a sort-they produce a half million barrels a day. That is, I understand, enough for 100 percent of their consumption and exports of 250,000 barrels a day. So the oil price does not adversely affect them domestically on their own needs and they still get the benefit of the increase in price. This givLes them almost $900 million, maybe a billion this year in their export revenues and they are increasing their produc- tion to about double what they are now doing, a million barrels a day, by 1980. How do we justify to practical midwestern farmers who say to us, now, with all of that money OPEC has got out there, $100 billion, $60 billion of which can be available for investment? How can I justify developing a program for Egypt, which includes a possible program of Public Law 480 sales of U.S. agricultural products to Egypt on the basis of long-term loans on favorable terms, at reduced interest rates? PAGENO="0269" 267 This is obviously very sensitive to the American consumer. I know you have a good answer for it but how would you suggest I explain it to this practical hardheaded farmer who says "how come?" How come we would use the facilities of the Export-Import Bank to assist exports to Egypt on long-term credit basis when that money comes from the U.S. Treasury and guarantees. Furthermore, why work together and qualify Egypt for the maximum in financial support in the World Bank, International Monetary Fund, other official agencies, when all that good money comes from the United States of America. Secretary SIMON. First, Senator Percy, we are only interested in helping them to the extent that we are helping them now. They are interested in sincerely helping themselves to once again bring their economy back from what I described as the advanced stage of deterioration. I consider the hard aid, if you will, that we have requested from Congress, $250 million, as relatively small compared to their over- all need for aid and in comparison to what they are getting from all of the other countries in the world, recognizing that our prime objec- tive is a durable and lasting peace in the Mideast. EGYPTIAN SUPPORT ]~ROM ARAB SOURCES Senator PERCY. Can you tell us how much support they are getting from the Arab countries who have such large surplus amounts to invest? Secretary SIMON. When the Suez Canal closed in 1967, Saudi Arabia and two other oil-producing countries signed the Kartoum agreement with Egypt which compensated them for the revenues that had been lost from the closure of the canal. Egypt received from Saudi Arabai last year a loan over and above the Kartoum agreement and an additional $250 or $300 million. King Faisal was just there recently and I do not know what agreement they reached on other aid. Although I would assume the Saudis will give them even more help to put them back on their feet. We have for years, as you well know, and I understand that it is a controversial subject in this country, supplied many of the less for- tunate nations in the world with Public Law 480 to help feed the world. I think that it is a responsibility exercised with good conscience as to ~vhat indeed we can supply the rest of the world and still take care of our American people here at home. And that is what we are in the process of exploring now. While the Egyptian economy is in this terrible condition, we need to help them bridge this gap, while they are doing all the things, re~ opening the Suez Canal, continuing the exploration and production of oil and gas in their country and inducing other industries to come in to regenerate their economy, they need help. I think it is a good idea for all of the world to help them. Senator PERCY. What I am wondering, though, is whether those needs could come from countries that are close by, their neighbors. They share so much in common. Why have those nations bought U.S. securities? Isn't it possible to recycle the other way around and have it go direct to Egypt and then have the Egyptians buy with dollars food at world prices from wherever they want? PAGENO="0270" 268 Secretary SIMoN. That is exactly what ~s going on right now. The surplus of funds immediately is large enough for them to do, to per- form both roles, Kuwait and Saudi Arabia in particular are doing both, not only continuing an investment program but looking at what their responsibilities are for direct aid to the other countries. PROBLEMS OF TIlE DEVELOPING NATIONS Senator PERCY. I will be in India later this summer if we go on recess and I assume we will, talking with their Government, Mrs. Ghandi and others about some of the common problems that the de- veloping nations face. How bad is the situation in countries like India, Pakistan, and Bangladesh which are dependent upon OPEC oil and paying these very high prices? What special concessions have been made to those countries, and by whom, and are those special concessions at all ade- quate for the kind of a situation that they face trying to industrialize their nation? How can they do. so with oil prices four time what we have been paying in the past? Secretary SIMON. I think with countries such as India, the oil price translates itself immediately to one of food and the very existence of the people and their ability to buy food. I can supply for the rec- ord the assistance that ilot only the United States but the World Bank and the rest of the world have supplied to India in the form of aid. Our current intentions are under study now because our agricultural report cOmes out this afternoon, I believe, on what the harvest is going to be. [The information referred to follows:] THE SECRETARY OF THE TREASURY, Washington, D.C., September 12, 1974. Hon. FRANK CHURCH, Chairman, Subcommittee on MuUtnational Corporations, Committee on Foreign Relations, U.S. Senate, Washington, D.C. DEAR Mn. CHAIRMAN: The following is my response to questions which ~enator Percy requested at the August 12 hearing of the Subcommittee on Multinational Corporations regarding aid extended to India. Since December 1971, U.S. military and bilateral development assistance to India has been suspended. In PY 74, however, the U.S. provided $53M worth of PL-480 Title II assistance and $29M in debt relief while other aid donor coun- tries, e.g., the U.K., Canada, France, Germany, Japan and others provided $47M in bilateral assistance and rescheduled $150 million of payments on India's debts falling due. The World Bank and IDA also committed about $400 million in fresh aid to India last year. Including the U.S. share of multjlateral loans made to India through the IBRD/IDA and Asian Development Bank, the total U.S. contribution to aid to India last year amounts to $242 million, out of $1.1 billion from all western nations and institutions. (See attached table for details.). India also received assistance from Communist Bloc countries, most notably ~ loan of approximately $191 million. India has arranged with Iran and Iraq for concessional purchases of petroleum products worth collectively about $250 million this year, an amount equivalent to about one-third of India's oil requirements at 1973 prices. Loans from major oil exporting nations for future oil deliveries plus other loans not tied to petro- leum sales are in various stages of negotiation. The value of these loans is of the magnitude Of over $1 billion spread over the next few years. Terms are generally at 2M~ interest with 10 years maturity including 5 years grace. PAGENO="0271" 269 Until the recent oil crisis, the GOT allowed only the USSR to assist in its limited oil exploration program. I)uring the past six months, however, the GOT has encouraged foreign oil exploration flrans to bid on the development of likely off-shore deposits and two U.S. led oil groups have recently agreed to conduct preliminary seismic operations in the Bay of Bengal, near the Bangladesh border. Indian oil officials also Ijave stepped up their oWn exploration activities and in recent months have sought help from the U.S. Federal Energy Administration in obtaining faster delivery tune of oil rigs from 15.5. suppliers. If T may h~ of further assistance to you, please let me know. Sincerely yours, WILLIAM E. SIMQN. Enclosure, FOREIGN AID AND DEBT COMMITMENTS TO INDIA, 1973-74 [In millions of dollarsj Country Approximate Actual debt share of. mel- Bilateral restheduled tilateral aid Total United States 53 29 160 242 Develop loans - Public Law 480 (II) Canada (0) (53) 87 2 24 113 France 50 10 28 83 Germany Japan United Kingdom Others Total Nonconsortium: U.S.S.R. (mainly wheat) Other bloc 73 53 36 162 81 48 25 154 141 19 55 215 37 18 70 125 522 179 398 1,099 191 13 - Senator PERCY. How-and this is in line with Senator Case's ques- tion-can we at this time really champion the cause of the developing n~itions and help them solve this problem in even a more dynamic way than we have? Certainly you are in the best position to do that~ Many of us have been talking about the irreparable harm being done to the third world by these unconscionably high oil prices. Secretary SIMON. That is first and foremost. We have to work on bringing the high price of oil down to manageable levels, Senator PERCY. When you talk about bringing the price down, what do you have in mind~ Secretary Simon? Are you able to say what is a possible expectation or reasonable hope for bringing the price down from the present level? Secretary SIMON. I think a reasonable hope would be that we would see no cutback in production by the oil producers who can indeed cut back and bring supply and demand into equilibrium. I also hope that in the near future we have a market price of oil rather than one that is arbitrarily set by a cartel. Senator PERCY. Of course that is the problem and that is- Secretary SIMoN, That is we move in. Senator PERCY. That is what Senator Fuibright is for, when you have these kinds of margins, new sources of supply, quickly developed, inOreased supplies will bring prices down as they seek merely to cover their cost and get a reasonable return on investment. But here the oil- producing countries arbitrarily, no matter what the production cost is, set that price, so there is no free flow of the market. Are you looking for auctioned oil to start to bring that price down? 45-426---75------1S PAGENO="0272" 270 Secretary SIMoN. That i~ most definitely one of the mechanisms, but it is not only the auction. I would put the production levels as the most important criteria for continuing with the present surplus in the world today and that is what I am working with the Secretary of State on- a scenario to deal with this problem and other economic and foreign policy considerations. U.S. STRATEGY TOWARD OIL PRICES Senator PERCY. Can you describe for us in Some greater detail what the U.S. strategy toward oil prices actually is and report to us on the working group of the Washington Energy Conference that was estab- lished last February, as to what progress they have made? They have come out with some sharing arrangements now, is that true? Secretary SIMON. Yes. Senator PERCY. If we get into a crisis again, they will share, which would then help us give a little better bargaining position. What other things can the group of consuming nations do to improve our bargaining position? Secretary SIMON. Senator, the agreements that were tentatively proposal and now we are taking a look at it here and will be consulting reached, and I stress "tentatively" because in many countries and in this country as well the agreement will require ratification by the amount of energy in this country and I think we could exercise more conservation methods and I would be in favor of reintroducing some with the Congress on the arrangements that were made, which will certainly be extremely helpful. I think in t'he areas of demand restraint, that while consumption is down in response to the higher prices worldwide, consumption could be cut more. As Senator Fulbright said, we use an extraordinary of these measures. That is Bill Simon's personal opinion. Congress and any other governments. We just came back from the last meeting of the energy coordinating group in Brussels with the sharing THE 55-MILE-PER-noUn SPEED LIMIT Senator PERCY. You do fully support the 55-mile-per-hour limit? Secretary SIMON. I most certainly do, not only from the point of view of energy, but also because there has been a 25 percent reduction in the loss of lives, which I think is more important than the conservation. THE IMPORTANCE OF SAUDI ARABIA AND IRAN Senator PERCY. Is our strategy in the Middle East dependent then to a great extent upon the cooperation of Saudi Arabia? Secretary SIMON. Yes, I would say so. With Saudi Arabia owning 25 percent of the proven reserves, they are certainly the hub of the wheel in this area. * Senator PERCY. Could you comment on Iran? Any comment that you wou]d like to make and if you prefer to make it in executive session, we will accept that. But I wondered if you could comment on your reason for not going to Iran and also what it was that caused you PAGENO="0273" 271 to be piqued at Iran. Why is it that we are not, after having worked very closely with Iran through the years on many programs and having a close persona] relationship with their government, why are we not relying and looking to Iran also in this situation? Is it just strictly their attitude on oil prices that is totally inconsistent with our objective to get oil prices down? Secretary SIMoN. Let me put this in perspective: Iran is not alone in feeling that these prices are reasonable. They felt, as most, I would say, of the oil-producing nations felt, that they had been given their oil away for many years and had not been compensated adequately, so they feel that now they are getting adequate compensation on what the replacement cost is, if you will. We have some economic judgments that. are at variance with this point of view. When my initial visit to the Middle East was initially set up as a result of Prince Fahd's visit here in June and the establishment of the joint working group. In July, the President and Secretary Kissinger went to the Middle East and promised that the Secretary of the Treasury would not be far behind. We decided with Secretary Kis- singer that Kuwait should be on the stop because Henry had promised that he would attempt to go to Kuwait. He was frankly going back and forth so rapidly that he was unable to do it. We considered Kuwait extremely important in this general area. I had already set up meetings with my counterparts in Europe, in- cluding Chancellor Schmidt, to discuss the economic and financial aspects of the problem that had been created by high oil prices. When I was queried on this subject, I was accused of leaving Iran off the itinerary due to the fact that I could not get anywhere with them be- cause the Shah was so intransigent on the issue of oil prices. I replied something to the effect that "yes, indeed, he is a nut on that subject, and so that is fine." We all know what was printed after that. The fact of the matter is I went to 14 locations in 16 days and that was about the extent of how long I could be away. There will be trips to other countries in the Mideast, and an extension of the visits we have taken, and Iran continues to be an advocate of higher oil prices as do other countries as well in the OPEC cartel. Senator Pi~ncv. What kind of a role would you like to see Iran play? They are a very, very important element in the picture and have been extraordinarily important to our position in that part o~ the world, and will continue to be. What would you like to see them do at this stage and what do you think is reasonable to expect Iran to do in their own long-range interest of world stability and peace? Secretary SIMoN. I would hope that they would join together with Saudi Arabia in working toward a lower price of oil. Especially in view of what is in their economic self-interest to do so on the assurance of a market as well as the understanding of what these high oil prices are doing to some of the economies of the world, not only the lesser developed nations, on which it is having a devastat- ing effect, but also some of the more industrialized nations of the world, and how indeed this is going to be compounded, looking into the future. . PAGENO="0274" 272 Senator PERCY. I would like to indicate that if you want to answer the following question in executive session, you certainly may. It would be helpful to the committee and the subcommittee if we knew whether any secret agreements with Saudi Arabia, either verbally or written understanding, had been entered into dealing with oil prices and supplies. Secretary SIMON. Absolutely not, Senator Percy. THE EMERGENCY SHARING AGREEMENT Senator PERCY. How does the recent negotiation of the Emergency Sharing Agreement between the ifidustrialized nations affect our bargaining position with the OPEC countries? Do you think ~t has any material effect or is helpful in any way? Secretary SThX0N. I think, the fact that, the oil-consuming nations of the world recognize the critical importance of the overall energy issue. Oil sharing is just one facet of it; it deals with the reintroduction of an embargo, if you will, We are working on other and more important areas in the cooperative agreements that we are moving toward in the areas. of IR, & P., alternate sources of energy, conservation, and demand restraint. I think all of the components of this consumer country cooperative package are important. THE PETRODOLLAR CRISIS Senator PERCY. What role do you see in the petrodollar crisis for the free market, U.S. Government, World Bank, International Mone- tary Fund? Secretary SIMON. I think they are all coming into play. When we talk about the recycling of dollars, every one of those institutions and other methods are being presently employed by the producer nations both in the form of direct aid, direct industrial agree- ments, between Iran, say, and France, Iran and Italy, with Iran lend- ing a billion or two to the United Kingdom, and the oil-producing countries subscribing in excess of $3 billion to the special facility in the International Monetary Fund to deal with this problem. All of these things come into play. Senator PERCY. We have all been shaken, particularly the Europe- ans, by the Herstatt situation. Do you feel that the present situation, given the petrodollar adjustment, floating exchange rates and tight money, portends grave trouble for the banking community in this country `and the world? David `Rockefeller the `other day, I think, used the word panic. He did this, I think, primarily because he simply wanted to point out the pos~ibility, if prudent conservative banking practices were not used, of banks becoming overextended in their at- tempt to gain profits at the expense of perhaps soundness. I think that warning on his part was well taken. How do you as Secretary of the Treasury relate the current problem we are talking about to the stability of the banking community in the world and how bud or good do you see the situation? What advice would you have to offer the banks? Secretary SIMoN. I agree that there exists the possibility of great strains in the financial markets and we have worked long and hard since well before the Franklin National problems came into being. And PAGENO="0275" 273 there again, I agree with Arthur Burns more than with any other Goyernment official working on the problem. This was a prime subject of concern during my conversations with the Finance Ministers overseas. Senator PERCY. How concerned are European governments? Secretary SIMON. They believe we should take a more active role as far as surveillance of these markets are concerned. They aren't as con- cerned with the United States domestic situation because we do have one of the most sophisticated regulatory systems in the ba~iking world today. rrhe Euromarket is a relatively new market and could experience greater pains than others due to the consortium that are operating in this market. I cannot relate the problems of the Franklin National Bank and the Herstatt and the missing management that brought about their problems. As I said in my testimony, they went over their heads and overextended themselves in forward exchange. I would thing this has cautioned and chastened much bank management in this country on overextension and financial prudence. COMMENTS ON THE FOREIGN OIL CONTRACTS BILL OF 1974 Senator PERCY. In a press conference of your very able Assistant Secretary, Mr. Parsky, as related in the oilgram, Friday, August 2, it indicated that you would come to this meeting on this basis: Treasury Secretary Simon opposes any move to make agreements between oil companies and producer nations subject to U.S. Government scrutiny and `will go before the Senate Foreign Relations Subcommittee on Multinational Corporations to say so. As I interpreted your earlier comments to Senator Church's ques- tion, that statement as it now stands is not exactly accurate. Secretary SIMON. No, sir. Senator PERCY. S~cretary Parsky, would you care to indicate whether this is an accurate repetitionof your views, and then perhaps either one of you could interpret. Yo~i do see, as I understand it, a role-it is a question of whether it comes in after everything is set in concrete or whether you come in ahead of time. Secretary SIMON., Or even if it i~ a good idea to set something in coiicr'ete, should we clearly define what this role of the U.S. Govern- ment should be' in these negotiations. Does it require~ a statutory lan- guage, Senator? Mr. PARSKY. I was trying to emphasize, at that point, Senator, that it was important for the Government to define its role in the process under which the negotiations were taking place. The question was raised as to whether or not contracts should be submitted to the Gov- ernment for approval, and for scrutiny. Unless we understand exactly what is taking place during the process of negotiation we really are entering into th~ process after it has all been concluded. We ~lo not have the expertise, I believe, in the Government to understand the intricacies of foreign trading operations of these individual companies. Senator CHnRCII. It is about time you get it, Mr. Secretary. Mr. PARSKY. Pardon me? Senator CHURCH. It is about time you get the expertise. Mr. PARSKY. Well, what- PAGENO="0276" 274 WHAT ROLE FOR THE GOVERNMENT IN INTERNATIONAL OIL Senator PERCY. It depends on how much expertise. I don't think we should try to duplicate in the Government the whole sophisticated system of the business community. We will never, with the kind of turnpver we have, and, all of that, develop that kind of expertise. I think on Senator Church's side of this argument, his legislation almost accomplishes what you say yoi~ want, because I cannot imagine an oil company entering into an agreement and binding themselves, when they know the Government must agree, without saying ahead of time. "How do you people in `Washington feel about this ?`~ What I am worried about is the legislation. It makes us a partner to it. We assume a degree of respQnsibility and I am not sure we should. Is it possible, is it p~ractical, for us to look through every single aspect of this agreement on antitrust, everything else? When we ap- prove a contract, does that really give clearance for antitrust ahead of time? Does it then say we made it with you? I would almost rather the Government to be in a position to criticize if the agreement is not in the national interest than to set some sort of guidelines which give a U.S. stamp of approval. I am concerned about having us sit there and be a third signator on every contract between two parties. I would be very concerned about our ability to do it and whether we should or not. Mr. PARSKY. That was the reference. Senator PERCY. I think we are all on the track of saying there probably has to be some new relationship and role. Secretary SIMON. Yes, sir. Senator PERCY. And I think we have to bring into account what is the most practical way that we can approach this problem and not bog us down in things that make us almost immobile. MOBIL OIL CO. PARTICIPATION IN MARCOR Mentioning Mobil, I wonder if I could ask for your comment on the capital flow situation, the recycling of these enormous profits of oil companies today. Exxon, had profits over a billion and a half, Te~xaco a billion, up 94, 95 percent. Mobil has now entered into an agreement with MARCOR. They will provide the working capital MARCOR needs for its expansion program. And as I understand it from the MARCOR management they desperately need that working capital. They might be restricted and Mobil has the capital to invest for the future. I haven't any idea whether it invades antitrust principles or laws or not. But excluding that, is this in your judgment a way you can recycle oil profits, domestic oil profits? Is this a way to put them back in the economy? Is it in our national interest to take an objective open. look at the situation like this? Secretary SIMON. Well, I understand the concern and the natural first reaction. I am going to be testifying before Senator McIntyre's committee later this week on the subject of oil profits ~nd we have been doing a study in the Treasury which is now completed on the components of profitability in the oil industry, and how, indeed, they made these major amounts of money with some editorial comments from the Treasury Department on what we have proposed. PAGENO="0277" 275 Now with all of the suggestions that have emanated from Washing- ton in the last 8 or 10 months since the embargo last October, about nationalization of the oil companies, regulating them like public utilities, and the other punitive comments that have been made, I would suggest this gives great pause to people who are running some of the major co'rporations in this country. They wonder as they look ahead and plan for their corporation 10 years hence what they are going to be allowed to do and what their obligation is to their share- holders who have invested their savings in their companies. Is it wise to begin to look to diversify their operations? Simultaneously, Mobil, in particular, is I believe investing some $1,600 million over a short period of time in exploration and development in this country, which is by far the largest amount ever. I must admit that that is v~hat the system has always been in this country, that enabled people who wish to make investments in various inaustries, ~ ssuming it conforms with the national security and anti- trust laws. I do not know anything about the antitrust side of jt. If that is all right, I see no reason philosophically to oppose that. Senator Pr~no~. There is an emotional reaction to it. I do not think we can let emotion get into it. From a practical standpoint does it serve the interests of this country and the consumer? It may well serve the interests of the consumer and our whole overall national interest. Do you think the profits are too much? Are we taxing the profits there? They have the money now. Secretary SIMON. If they are honestly earned profits, they shoula be allowed the investment. I have never been involved in the oil industry in any way when I was back in my other world and I attempt to look at the profitability of this industry from a purely cold financial analysis point of view. That is what we are doing in the breakdown of the profitability and extraordinary events of the last 2 years that brought this about and the majority of it is a one-time happening. When one looks at the replacement costs for these inven- tory profits that the oil companies have made, he finds a lot of this money is going to have to be poured back in to continue to supply the oil to the American consumer. PROBLEMS WITH U.S. SECURITIES BEING HELD BY FOREIGN GOVERNMENTS Senator PERCY. My last question is a short one. We have had experience with West Germany loaning the U.S. money. We worked out a part of our offset deals for NATO expenses and it was a very good arrangement until the Bundesbank called the notes one day. I happened to be in Germany at the time and asked the Chancellor about it and he did not even know about it. lie said the Bundesbank said it is a financial arrangement and they needed the money and they called the notes suddenly, which werO due and payable. Is there any similar thing in these special U.S. Government se- curities that you have discussed in the Middle East? Can you tell us something about the interest cost that we would be paying~ the terms of those loans and whether they are callable and on what sort of notice? PAGENO="0278" 276 Secretary SIMON. Well, they have an option. They can buy the special issues at the market. All our transactions are done at the market. If they came in and said, "We wish to buy in the 7-year area," it is at that particular time the markets chose what the yield is in the 7~year area. They would receive the same interest rate that our in- stitutions, the American people and foreign government indeed receive. They can keep these securities and subject themselves to fluctations in the marketplace and sell them back to us sometime in the future at the market price on the day they wish to sell, or they can sell them to us in the Treasury bill area with 2 days' notice, in the note area with 30 days' notice, and in the bond area, which is longer than 7 years, 60 days notice. If they* wish to do that they automatically, if it is prior to maturity, move back to the interest rate that is existent on that particular maturity on the day they sell it in the open market- place. I repeat there is no devaluation guarantee or inflation-proofing or gold backing on these securities. They are the same full-faith and credit of the U.S. Government which allows them to invest their funds in fixed income securities in the greatest credit worthy in- lrestment the world has ever known, It gives them the benefit ob- viously of avoiding a marketplace that cannot handle the size of the investment that they have, A fixed capital market cannot handle the $3 to $5 billion and this enables them to avoid the rise in price that would occur when the oil countries anpeared in the onen marketplace. Conversely when they wish to sell, the price would deline, so this is to their best advantage to do that and at the same time gives them the liquidity that they desire and indeed need. Senator Piu~cy. I wish you well in your efforts to get oil prices down, The alternative courses of action outlined as a result of these prices is very, very difficult. It is a slippery slope that you are on. Thank you. Senator CHURCH. Thank you. U.S. PROGRAM INADEQUATE Mr. Secretary, reflecting back upon the testimony this morning' and the questions that have been put to you, I have to conclude with Sena- tor Case that the only program that surfaces here is a ~`bànd-aid" proposition. The central question we have been asking and your principal con- cern in goin~g to the Middle East had to do with bringing prices down, or trying to get prices brought lown. We have agreed that is the basic problem facing not only the United States, but the rest of the Western W~r}d. Secretary SIMON. That was not the purpose of my trip, Mr. Chairman. Senator CHURCH. Well, this was certainly something you had very much in mind as you discussed the whole problem- Secretary SIMON. Yes, sir. Senator CHURCH [continuing]. With the various governments. And it is that particular question with which we are dealing today, given its inflationary impact, which I think is carrying us toward the brink. I have to say that there is no more evidence that we are seeing it today than in 1929-30. I hope that it does not come to that. But the dimensions of the problem are very great indeed. PAGENO="0279" 277 This subcommittee has been looking into multinational corporations for some time, as you know. We started our inquiry with `some interest- ing figures. Economists caine here to tell u~ about the phenomenal growth of the. multinational corporations. They pointed out to us that American-owned rnuitinatipnal corporations in `25 years since the end of the Second World War had invested $100 billion in foreign lands. $107 billion, I believe, was the figure in a 25-year period, and they all remarked upon this as a phenomenal outreach by American com- panies in foreign investment that had revolutionized the economy of the Western World. In 2 years the Arab oil-producing governments of the Middle East will have considerably more than that to invest in the Western World. We are talkin.g about 2 years, not 25. All of this is a direct result of this highly inflated price for oil. Now I am not being moralistic about this. I cannot blame them for getting all they can. I expect they would do that and it wasn't simply the war in the Middle East that brought this on because the other oil- producing governments, unconnected with the war in the Middle East, such as Iran, Venezuela, Canada, immediately fell into line once the new price had been established. So here we are faced with this tremendous inflated price for oil, and what have you suggested today in the way of reasonable expecta- tions for bringing it down? Nothing, I gather, other than the develop- ment of alternative sources which you have conceded will take a num- ber of years, and possibly the effects of conservation, though I cannot take any conservation programs seriously in this country wh~n we do `not even address ourselves to l)etroit and the production of those gas- guzzling monsters. I do not think that conservation is much more than window trimming. Even if we had adequate conservation, this `subcommittee has dis- covered in its inquiry into oil that if anything does not operate when it comes to determining the price of oil and the production of oil, it is the free market. It has not operated before; it is not operating now. And the big oil companies in their interlocking arrangements among themselves and with their special concessions in the Middle East have controlled both the price and production of oil for years. Now they ar~ seeking in the ~ew situation to do the same, by enter- ing into buy-back arrangements which will preserve their exclusive right to `purchase the si~nie arrangements by the international oil cartel with which this world has been plagued since the 1920's. They are now beginning a new arrangement with the same old controls that they have hadin the past. . This committee has sought to find ways to break out of that bind. Some of us on this committee have talked about the desirability of auctioning oil and e~tabii~sbing a free market for oil in the world, of breaking away from the old cartel `arr&~g~nien.t. Yet, Saudi Arabia, which is the only Government `out there that seems at least to talk about th.e' desirability of lower prices, has suggested that they would auction oil. This suggestion has been obviously undercut by the new 4teal between Kuwait end Gulf, because this new deal and the old pattern is establishing another line of higher prices and the other com- panies are going to fall in that pattern. You are not going to have auctions as long as this happens. The one chance we have of obtaining PAGENO="0280" 278 lower oil through auctioning seems to me to be going down the drain. I would conclude this by asking you this one question: Is there any- thing in~the administration's program seeking lower oil prices that does not lean upon long-term exclusions, such as improving alternative sources for oil and lessening our dependence upOn these producing governments, or the long-term effects of ~ conservation program in the use of oil? Is there anything besides that you have to offer this morning that would give us reasonable hope that something can be done in the short term to temper the high price of oil? Secretary SIMON. Obviously everything yoti have' mentioned, and I recognize this, is of a longer term n~ture to bringing on the alterna- tive sources, the cooperation among the consumers as well as the pro- ducers. I must admit that I do not think that our efforts in the eco- nomic and financial side are a "band-aid" because they are assisting us through a very difficult period, during the period of the reflow of funds and the economic cooperation which is going to solidify our reiatiohship in the future, but that does not deal with the problem of oil prices. Senator CHUnCH. Eight. Secretary SIMON. It relates more to political considerations than it does economic ones. As you and I fully agreed the market is not being allowed to operate, when the prices are arbitrarily set, and that is why I have been working with the Secretary of S~ate on this scenario. I would be delighted to comment on it further in executive session, Mr. Chairman. Senator CITURCII. We will tomorrow, Mr. Secretary, I understand. Secretary SIMON. One further thing, you mentioned the subject of Kuwait's arrangements with Gulf. As you know, this only runs through the end of September as far as the 94.8 percent agreement. This in my judgment does not necessarily relate itself to the Saudi auction and what Saudi Arabia will do with its own oil. It relates to what Saudi Arabia will do as far as the agreement with ARAMCO is concerned, because they are bound to negotiate at the same level 011 the ARAMCO portion of the oil, et cetera, but on the free oil that Saudi Arabia owns they are not bound to that. Senator CntrRcli. Well, I just feel that the pattern of the past is be- ing repeated, and in the absence of a different sufficiently strong policy on the part of the U.S. Government'this is bound to happen. The Gulf price will now become the new price for all of the American conces- sions in `the Middle East, and instead of having achieved a moderate reduction in oil prices from these highly inflated levels, we will have a still higher price. All of this suggests to me that the u.S. `Goveriiment cannot any longer afford to leave the matter of oil prices to the mt~jor oil com- panies as we have done in the past. We face a completely new revolutionary situation in oil. And if we are to protect the national interest the Government must play a much more central role. I am told Mr. Sawhill's staff is coming up to meet with the sub- committee on Wednesday, afternoon to suggest language changes. We are trying to cooperate with him in developing some legislation. PAGENO="0281" 279 He has indicated that he feels the need to have some authority in the premises where negotiations with foreign governments are concerned relating to the price of oil. I would invite you, too, or your staff, to participate because it Is very important to secure as much help as we can from you in giving us guidelines as to what kind of legislation might be helpful. We stand ready to do that and we invite you to offer that. Secretary SIMoN. I would love to, Mr. Chairman, thaiik you. Senator CHURCH. Thank you very much, Mr. Secretary. Senator FTJLBIiIGIIT. If I could ask just one question: Talking about the distinction between long and short term, is not the political settle- ment of a conflict the most important thing that the Government could bring about? Secretary SmI0N. Yes, sir, it is. Senator FULBEIGHT. Short term, the readjustment of the method of pricing by the oil companies is not a short-term problem. That will take a good deal of doing. If you organize a relationship between pri- vate enteiprise and the Government on setting prices~ would it not be a long-term problem? Secretary SIMoN. Yes; it is. Senator FULBRIGTIT. So it comes back to the thing that we do not like to face up to and that is the solution to the war in the Middle East. It is too difficult for us to face politically. Is that about right ?~ Secretary SIMoN. Well, I do not think that it is too difficult for us to faee~ Senator. I think that Secretary Kissinger- Senator FULBRIGHT. I didn't mean Secretary Kissinger, I mean the Congress. You don't have to comment on that. Thank you very much. Senator Ciiuncii. Mr. Secretary, I believe that Senator Case had a few questions he wanted to get answered. The answers will be submitted for the record. [The information referred to follows:] SENATE COMMITTEE ON' FOREIGN RELATIONS, SUBCOMMITTEE ON MULTINATIONAL CORPORATTQN, October ~3, 1974. Mr. THOMAS DUNCAN Legislative Affairs Office, Department of the Treasury, Washington, D.C. DEAR TOM: Following our conversation of October 22, I have enclosed some iuestions as asked during Secretary Simon's testimony and in written form at the hearing of August 12. We are in receipt of a letter dated September 12 from Secretary Simon to Chairman Church which, however, does not appear to respond completely to the questions raised by senator Case. As I see it, there are six areas in which Senator Case requested further information: Question 1. Senator Case wanted to know what documents were exchanged with Egypt under the Investment Guarantee Agreement and requested copi~s of them, as well as the exchange of notes between the Secretary and Egyptian officials~ Question ~. Senator Case requested information on the estate tax aspect of the `double taxation agreement specifically with Israel and also under the standard tax trea'ty.' He specifically wanted to know what the tax benefit to legatees iS under such agreements. Question 3. Senator Case wanted further details of the concessions regarding interest rates that were granted to Saudi Arabia and other countries in order to encourage them to purchase Treasury bills and a written question was submitted asking for details as to the amount of subsidy this involved. Did the agreement involve some guarantee against U.S. sequestering of funds in the event of a future oil embargo? PAGENO="0282" 280 Question 4. Senator Case requested in writing further information on the U.S.! Saudi Arabia joint commission, its membership and operations. He wants to know how much this commission is authorized to spend and how this sum is to he financed. What is the role of A.I.1D. and the Corps of Engineers in Saudi Arabia. How is this financed and coordinated? Question 5. The Senator requested information as to whether the Internal Revenue Service is considering a request for foreign tax credit to be granted in case of "buyback" oil agreements. Has any ruling been made? What was it? Is it anticipated that there will be a ruling in the near future? Question 6. Finally, can you give us details or the negotiations betwCen the U.S. Government and Gulf Oil regarding their agreement to purchase "buyback" oil from Kuwait at $10.95 per barrel and of Secretary Simon's role? Sincerely, VIVIAN Lvwis, Senior Minority Staff Member, Subcommittee on Multinational Corporations. DEPARTMENT OF THE TREASURY, Washington, D.C., December 30, 1974. Ms. VIVIAN LEWIe, Senior Minority Staff Member, Senate Committee on Foreign Relations, Subcommittee on Multinational ~iorporations, U.S. Senate, Washington, D.C. DEAR Ms. LEwIs: Per your request of October 23, 1974, I have enclosed addi- tional information relating to Secretary Simon's testimony of August 12. The questions posed by Senator Case come under my areas ofresponsibility and either myself or my staff would be happy to further assist you anytime in the future. Sincerely, GERALD L. PARSKY. Enclosure. Answer 1. See pages 250-253 of this hearing record Answer 2. The United States has not entered into a tax convention with Israel for the avoidance of double taxation with respect to estates oE inheritances. In November 1968 preliminary discussions were held in Jerusalem, but no drafts were exchanged and no subsequent discussions were held. A treaty with Israel relating to income taxes was signed on June 29, 1965. It was submitted to the Senate for advice and consent to ratification on the same date, but the Senate has never acted on that treaty. In any event, the treaty would have had no effect upon estates. We do not have a standard form of estate tax treaty, arid our usual income tax treaty does not effect the taxation of decedent's estates or legatees with respect to their inheritances. We have, however, concluded estate tax conventions with numerous governments ine~uding Australia, Finland, France, Ireland, Nether- lands and the United Kingdom. *Our latest estate tax conventions reduce the prospect of double taxation of property passing from a decedent to his heirs by granting primary taxing juris- diction to the country of domicile of the decedent; generatly, the country of which the decedent waS neither a citizen nor domiciliary taxes only real property and business assets located in that country. In a manner similar to our income tax treaties, these treaties also aid in tax administration. Because the U.S. taxes a decedent's estate on the value of his Ostate ~rt death, rather than taxing the Iegatiee on the value of his inheritance, estate kax conven- tions do not directly benefit any individual legatee. However, to the~exterit that they prevent an estate being taxed twice on the same assets they of course in- crease the amount available for distribution and thus benefit the legatees. Answer 3. During his trip to Saudi Arabia in July, Secretary Simon discussed with officials of the Saudi Arabian government in general terms the possible pur- chase of "speciat" Treasury obligations. These issues would be non-marketable, but would be at market rates and maturities. Thus, there would be no element of subsidy involved in any Saudi purchase of U.S. Treasury obligations. Our di's- cussions did not touch upon a U.S. guarantee against sequestering of fu~ids in the event of a future oil embargo. Answer 4. The Joint Statement on Saudi Arabian-United States Cooperation, which was signed in Washington on June 8, 1974 by Secretary Kissinger and Prince Fahd, established the Joint Commission on Economic Cooperation. The Joint Statement specified that the Commission will be headed by the Secretary of the Treasury for the United States and by the Minister of State for Finance PAGENO="0283" 281 and National Economy for Saudi Arabia,. Four working groups were formed: (1) industrialization, (2) manpower and education, (3) science and technology and (4) agriculture. Assistant Secretary of the Treasury Gerald L. Parsky serves as the executive secretary of the Commission and coordinates all of these working groups. The Saudi government has named Dr. Soliman Solaim as its coordinator. It has been agreed that USG experts provided to Saudi Arabia through the Joint Commission will be on a fully reimbursable basis. A Technical Cooperation Agreement which will formalize the reimbursable mechanism will be signed shortly. All), along with representatives from other IJSG agencies, participates at the working group level of the Joint Commission. AID has no indepedent programs in Saudi Arabia. Tip to now the Corps of Engineers has assisted in the development of military infrastructure in Saudi Arabia. For example, the Corps of Engineers has participated in the construction of military installations and cantonments. The Corps of Engineers has been requested to assist in the setting of standards for industrial construction. This request is under consideration by the Department of Defense. The services of the Corps of Engineers are paid for by the Saudi Arabian Govern- ment on a fully reimbursable basis and are coordinated by the Departments of State and Defense. Answer 5. We understand that the Internal Revenue Service has not received any requests for a ruling and therefore, has not ruled on the question of the avilability of the foreign tax credit in the case of taxpayers who have entered into "buyback" oil agteements with producing countries, nor do they expect to rule on this question in the uear future. Answer 6. The Administration learned in early July that an agreement with respect to such a purchase was under discussion by the Gulf/BP and the Kuwaiti authorities in the aftermath of the decision by Kuwait not to accept lower bids for its participation oil in an auction which had recently been held. U.S. Govern- ment officials then held a number of discussions with Gulf representatives to make known to them that it was the government's view that there was a surplus of world wide production relative to current demand and that there was, therefore, strong downward pressure on oil prices. The Treasury Department pointed out that while we were cognizant of the threats of various producers to cut their levels of production in an attempt to sustain high prices, in our view such prices were not in the interests of either the oil producers or the consumers. At the same time, we wCre aware that only a fraction of the oil being discussed by Gulf was likely to be shipped to the U.S., since the bulk would be used in overseas opera- tions, but we were also aware of the significant precedent that the proposed agree- ment might have in other areas. We do not know all of the reasons for Gulf's decisions but it is our understanding that among the factors taken into account was the company's interest in insuring agaihst unfavorable treatment in the future on its equity interest in the Kuwait Oil Company. Gulf receives oil from Kuwait as a result of a 20 percent interest in the Kuwait Oil Company-which is, as a result of prior agreements, owned 60 percent by the Government of Kuwait. The oil is received by Gulf as a result of its equity ownership is at a lower effective cost. Further, I understand that Gulf was concerned about being able to par- ticipate in future purchases of the oil being sold by the Government of Kuwait from the government's share of the Kuwait Oil Company. Secretary SIMoN. rihank you very much. I have another testimony this afternoon. Senator CHURCH. Thank you very much. [Whereupon, at 12:45 p.m., the subcommittee was adjourned sub- ject to the call of the Chair.] 0 PAGENO="0284"