In the most realistic test of how the U.S. government would deal with a new world oil crisis, the Reagan administration's free-market approach turned an oil shortage into a national "economic disaster," according to reports by 10 states that participated.
The type of crisis postulated in the two-month test, coordinated by the International Energy Agency, was very similar to what could occur, government and industry analysts said, if further escalation of the Iran-Iraq war cuts the flow of Persian Gulf oil.
"The threat of such a thing happening is very serious. And I'm not talking about six months from now. I'm talking about six weeks," said James Akins, a Middle East expert and former ambassador to Saudi Arabia, who forecast the 1973 Arab oil embargo.
Since completion of the test June 17, The Washington Post has obtained internal government documents, evaluations by the 10 states that participated and three IEA reports providing the most detailed look to date of how the Reagan administration would deal with a new oil crisis and what the impact would be on the United States.
In the exercise, which hypothesized a partial blockage of oil exported from the Persian Gulf, the Reagan administration took no regulatory action and let the price of crude oil, now $28.63 a barrel, rocket to $98.
This huge increase, which sent the retail price of gasoline and home heating oil soaring to more than $3 and $4 a gallon in some parts of the United States, had the effect of lowering consumption in this country by 18 percent.
The administration contended that the test thus proved that letting the free market determine the price of oil in a crisis would reduce consumer demand sufficiently to eliminate the need for government regulation to restrain prices and consumption or allocate supplies.
"This is a significant achievement and reaffirms the validity of President Reagan's market-based approach to energy emergency preparedness," Assistant Energy Secretary William A. Vaughn declared following completion of the exercise.
But strong disagreement came from states participating in the test, which surveyed widespread business and industrial shutdowns, bankruptcies, massive unemployment, commuters unable to afford gasoline, farmers abandoning their crops and low-income and elderly residents without heat or electricity.
"The administration's refusal to deviate from its allocation-by-price scenario transformed the petroleum crisis into an economic disaster in which petroleum supplies were adequate for those who could afford them," the Vermont State Energy Office said in a post-mortem.
Florida Gov. Robert Graham's Energy Office, criticizing the administration's "general disregard for the enormous and social costs" of its approach, urged that "the federal government's policy of total reliance on the uncontrolled market . . . be reconsidered."
The 20 other nations belonging to the IEA, formed at U.S. urging in 1974 to coordinate efforts of the industrialized world to minimize the impact of future oil emergencies, also were highly critical of the Reagan administration's decision to let the price of oil soar.
"The whole idea behind the IEA is to keep emergencies from resulting in vastly higher oil prices," a Dutch official said. "That can't work if the other 20 countries are trying to restrain demand and hold down prices and the United States allows the price to go through the ceiling." The Test
The IEA's emergency system depends on the willingness of its members--the major European industrial nations plus the United States, Japan, Canada, Australia and New Zealand--to share the pain equally in a major world oil disruption.
If forecasted oil supplies fall short of historical use by more than 12 percent, each member country is required to cut domestic consumption by 10 percent. The IEA then activates a sharing system to ensure that available supplies are distributed equally among members.
To test the system, the IEA periodically notifies members that a hypothetical disruption has taken place. Members then devise a new supply plan based on the amount of oil available, and the IEA calculates which nations should share oil.
The countries and their member oil companies then hypothetically redirect oil supplies to mitigate the crisis.
This test, the fourth since the agency's creation, was to be particularly significant. For the first time, the IEA planned to include the element of price.
But at an IEA Governing Board meeting last Oct. 28, the United States suddenly announced that it opposed any consideration of pricing.
A major reason for the switch, Energy Department official Romulo L. Diaz Jr. explained in a subsequent memorandum, was "concern that a simulated world price would erode support in the Congress for the president's market approach to energy emergencies."
While the other IEA members, according to State Department memos, strongly opposed the switch, the United States, as the most important member of the agency, prevailed. No price information would be generated as part of the test.
Hence, the other countries "expressed shock when, in its first official communication in the test, the Energy Department announced that by its calculations, world oil prices would increase to $98 per barrel in the month following the hypothesized oil supply interruption," Deputy Assistant Secretary of State E. Allan Wendt reported in a memo June 3. The Free Market
In addition to the U.S. government, 19 major American oil companies belong to the IEA.
Under a special antitrust exemption, they provide information on world oil supplies and movements to the IEA secretariat. In a crisis, the IEA would rely to a great extent on member oil companies to make the sharing system work.
Each country asks its oil companies to "volunteer" as much oil as can be spared to meet that country's sharing obligations.
Most oil companies have indicated since formation of the IEA, however, that they would not volunteer to divert supplies to other countries--at the risk of not having enough for regular customers--unless guaranteed that all oil companies would be equally disadvantaged.
To achieve this, most member countries established so-called "fair sharing" programs. Until 1981, the United States accomplished this under the domestic crude oil allocation system.
In early 1981, however, the Reagan administration abolished oil allocation and price controls. The oil industry, while generally welcoming deregulation, nevertheless noted that a standby fair-sharing system was needed. The industry also reiterated that it would not volunteer to share oil in an emergency unless such a system was in place.
The Energy Department, however, has not established such an emergency program and did not use the fair-sharing system in the test.
Instead, to meet the U.S. obligation to provide 22 million barrels of oil to other IEA nations, the administration relied heavily for the first time on voluntary pledges from independent oil companies and large industrial users, including U.S. Steel, Monsanto Co., Union Carbide, Burlington Industries, Inc. and Corning Glass Works.
In the opinion of several government officials, the appeal to many of these companies to volunteer oil was blatantly political.
Deputy Assistant Energy Secretary Ronald L. Winkler, in a memo April 29 seeking help from outside companies, said: "If we cannot demonstrate that the free market and voluntary programs work, even during this simulation, that will be turned against us up on the Hill."
Vaughn, in a letter to General Motors Corp. Chairman Roger B. Smith urging him to aid this "important test for the Reagan administration's market-based energy programs," said:
"Your company's participation in making simulated voluntary offers would greatly assist in demonstrating that mandatory and intrusive government regulatory programs are not needed to respond to energy emergency situations and that cooperative and voluntary programs will, indeed, do the job."
Smith, whose company volunteered to surrender some of its oil during this mock emergency, later wrote Energy Secretary Donald P. Hodel declaring: "The success of the test reaffirms our belief that President Reagan's market-based approach is the best way to deal with the issue of emergency preparedness."
While non-IEA member companies volunteered to provide 35.8 million barrels of oil, letting the United States comfortably exceed its sharing commitment, many industry and IEA observers expressed doubt that this oil would be available in a real emergency.
"Oil company representatives participating in the allocation system in Paris found many of these offers dubious," the State Department's Wendt said in the June 3 memo. "Oil was reported in locations where no oil facilities exist, or in vessels too large to enter the specified port or in quantities greater than the United States normally imports.
"In response to IEA questions, DOE acknowledged that, in the press of tight deadlines, they had 'made up' details relating to some of these offers," Wendt added. The States
U.S. allies' concern about how the administration's approach would affect them in a new oil crisis was at least matched by the 10 participating states.
Despite the administration's insistence through most of the test that free-market allocation would move petroleum products to where they are most needed, New York and California each reported a fuel oil shortage on the East Coast and a glut in the West.
Maine's Office of Energy Resources complained that during the test "no administration spokesman confronted the real crisis: the hardship created by the huge increase in oil prices.
"The tourist industry faces a bleak summer . . . . Many schools, hospitals and mills have suffered. Coal prices have also skyrocketed due, we suspect, to hoarding," Maine reported.
"Our utilities have also been hard hit . . . and are seeking emergency rate hikes. We are hearing from many consumers who cannot afford to heat their homes and/or hot water and commute to work," Maine added.
"The impact of the disruption and high energy prices on the low-income group would be devastating," Florida said.
All of the states echoed Wisconsin's complaint that the federal government "had abdicated its responsibilities for formulating a comprehensive economic response package."
In its final hypothetical message to the White House, the Wisconsin Division of State Energy said: "Although Milwaukee's situation is severe, there are several other major U.S. cities in worse shape.
"We hope it will not take the economic collapse of one of these cities, probably ensuing riots and accompanying destruction and death, before the administration realizes that its policies have failed the country and must be changed."
Nor was the hypothetical crisis in the IEA exercise the most severe oil shock possible.
A Congressional Research Service study released yesterday examined two other Persian Gulf disruption scenarios and concluded that they could produce a catastrophic drop in the U.S. Gross National Product of as much as 28 percent.
"Looking at the IEA test results, looking at the comments from our allies, from the oil companies themselves and from the states, the Reagan administration's approach clearly does not pass the test," said Rep. Mike Synar (D-Okla.), whose House Government Operations subcommittee is to open hearings Thursday on U.S. preparedness for oil emergencies.
"I believe in the free market, but I am a pragmatist," he said. "Reality dictates that something more than the free market is going to be necessary in a crisis."