(FORTUNE Magazine) – EVER SINCE crude was discovered at Titusville, Pennsylvania, 134 years ago, U.S. oil producers have been a source and symbol of American industrial prowess. Five of the great Seven Sisters were American. Texas wildcatters drilled the U.S. until it became the biggest oil power in the world, then moved on to the Middle East and made Saudi Arabia the champion. Oceangoing roustabouts from south Louisiana opened up the North Sea oil and gas fields. Now this quintessentially American industry is leaking away like oil into sand. Domestic crude production has been shrinking by roughly 3% a year since 1986. Only about 700 drilling rigs are out exploring, compared with more than 4,500 in 1980. Proven reserves have fallen from 30 billion barrels in 1980 to 25 billion. This year imports will supply almost 50% of the domestic market, up from 25% in the mid-1980s. About 450,000 oil industry jobs have been lost over the past decade. Of the roughly 15,000 independent oil companies that operated ten years ago, only 8,000 remain. Some 4% of the country's refining capacity has shut down in the past two years. More refineries will close soon as clean-air regulations require the industry to spend about $37 billion, $6 billion more than the book value of all the refineries in the country. Barred by environmental concerns from drilling in the most promising areas, big American companies are pipelining tens of billions of dollars into exploration and development projects abroad. Many nations -- China, Russia, Vietnam, Argentina -- that once vilified Big Oil are now courting it and laboring mightily to build petroleum industries of their own. Joining the oil rush overseas are fast-growing or newly aggressive companies such as Lasmo of Britain, Repsol of Spain, Elf Aquitaine of France, Statoil of Norway, and Broken Hill of Australia. American oil's big shrink has generated a special form of anxiety. The Independent Petroleum Association of America, a lobby for small oil and gas producers, warns that imports are reaching the ''peril point'' -- the 50% level at which, the group says, America can be held hostage to wars, embargoes, or pricing decisions made by foreigners. And oil's contribution to the trade deficit worries many people. Arguing that preserving domestic production is a matter of national interest, Bennett Johnston of Louisiana, chairman of the Senate energy committee, favors putting a variable fee on imports, which would raise the price of crude oil in the U.S. to at least $24 a barrel, almost $8 above the current world price. President Clinton promised during his campaign to do something to help the domestic industry. As FORTUNE went to press, Energy Secretary Hazel O'Leary was putting the final touches on the Administration's domestic energy initiative, a package of measures she hopes will spur the production of natural gas and at least slow the decline of oil. That's about the best anybody can realistically hope for. Relaxing certain environmental restrictions -- a move that might actually reduce pollution -- could conceivably reverse the trend. Even so, barring a miraculous discovery -- a Saudi Arabia beneath the frozen Arctic wastes -- domestic production will keep heading downward. So what? Wounded pride aside, the decline of domestic oil is not a big deal for America. The oil and gas producing industry accounts for a fifth of a percent of GDP, and the growing natural gas industry has already surpassed that. With the oil industry increasingly globalizing, the ''national security'' issue is bogus. Besides, America can take consolation in the emergence of a different oil industry, one that's smaller, more technologically sophisticated, and a world leader in innovation. WHO LOST U.S. OIL? ''Blame Ricardo,'' says economist Larry Goldstein, president of Petroleum Industry Research Foundation Inc., an industry- sponsored think tank in New York City. The 19th-century British economist devised the theory of comparative advantage and free trade between nations. He also described agriculture as an industry in which costs rise inexorably as the farmer cultivates the best land first and then expands to stonier, less productive acres up the hillside. Both principles shed light on the plight of oil in the U.S. Oil production is a classic Ricardian industry. The biggest, richest fields typically get exploited first. The U.S. is the most developed oil region in the world, and thus U.S. producers are working farther up Ricardo's stony hillsides than their counterparts in other countries, finding oil in smaller and smaller quantities at ever higher cost. According to Ted Eck, chief economist for Amoco, the cost of finding oil in the U.S. is about $5 per barrel, vs. about $1.50 in the Persian Gulf region. The bizarre oil boom of the Seventies only made matters worse. Domestic production peaked in 1970, when the U.S. was the world's largest producer, and started declining as new discoveries became more difficult. When America lost the ability to expand production, the market turned apprehensively to OPEC for its marginal barrels -- as Ricardo's trade theories would have predicted. Then political crises erupted in 1973 and 1979 as the market panicked over OPEC's intentions and bid prices up from $2 a barrel to over $40. That set off a drilling boom in the U.S., where many oilmen, energy experts, and politicos believed that oil prices might approach $100 a barrel by the year 2000. Instead, prices collapsed to $10 in mid-1986. Much of the shrinkage and pain in the industry since then came from squeezing out the excesses of that boom. Speaking in a near whisper, the chairman of one major oil company says, ''No one likes to say it, but a lot of the jobs that were lost in the Eighties were not jobs of long standing.'' Along with the dead Ricardo, one can take to task the very much alive environmental movement. Environmentalists have persuaded Congress to prevent exploration and production on most of the outer continental shelf and in the Arctic National Wildlife Refuge (ANWR), untapped frontiers with the greatest promise of being truly fertile ground in the Ricardian sense. These areas might be dry -- or might be hiding resources as huge as Prudhoe Bay, which was found in 1968 and today produces almost 25% of all U.S. oil. There are hints that the potential is enormous. In the western region of the Gulf of Mexico, one of the few areas open to exploration, huge oil finds have been announced in the past two years. They are in waters so deep that development may not be economic at today's prices. Nevertheless, Shell Oil is taking the risk of developing two of its discoveries, called Auger and Mars, that lie under nearly 3,000 feet of ocean. The production platforms will cost more than $1 billion each, and when they are operating fully by the end of the decade they will produce a total of 150,000 barrels of oil a day. That would offset 60% of the 250,000-barrel-per-day annual decline in U.S. production. A bunch of discoveries like Auger and Mars could make a dent in the country's growing imports. Vast supplies of oil could lurk in ANWR as well. Arco recently discovered an estimated 500 million barrels nearby in the Beaufort Sea. Impressive as that sounds, it's not enough to justify the several billion dollars needed to produce the oil and transport it from the frozen wilds. But if other discoveries were to be made in, say, the refuge, they could combine to tip the economic equation in favor of development. That's precisely why many environmentalists don't want anyone to know what's up there. Their stance is not only adding to the import bill, but, ironically, is almost certainly adding to pollution as well. The ban on offshore exploration and production replaces domestic oil that would come ashore in pipelines with imported oil that comes by tanker. And tankers, according to a study by the National Academy of Sciences, leak or discharge 30 times as much oil into the sea as offshore production facilities. The study was conducted in 1985, before the big Exxon Valdez spill in Alaska forced a tightening of tanker safety standards. So the gap may have closed somewhat, but it's unlikely to have disappeared entirely. Tankers bouncing around on the waves, sometimes in close proximity to one another and to docks, are inherently riskier than a pipe lying peacefully on the sea bottom. But anything that might intrude on pristine wilderness is anathema to the environmentalists. Since the areas of greatest potential remain off limits, most experts see little hope for reversing the tide. An import fee such as Senator Johnston favors would encourage new drilling and keep some marginal wells operating. But hothouse pricing has forced new exploration in the picked-over lands of the lower 48 before, and the results weren't wonderful. When oil went to $40 in the late Seventies, the resulting fever of exploration halted the decline in U.S. production for barely two years, even as it created a lot of wasteful overinvestment and jobs that eventually dried up. In any case, import fees rank with BTU taxes in terms of unpleasant ripple effects. Says Russell Luigs, chairman of Global Marine, an offshore contract drilling company: ''With an import fee, you've got to start lining up the exceptions. It will make American chemical companies less competitive, so they'll want a break. Mexico and Canada send us a lot of oil; they're gonna want out. Import fees are an administrative nightmare.'' Energy Secretary O'Leary knows that particular bad dream well. In the 1970s she ran the Energy Regulatory Administration, which controlled the prices of imported and domestic oil. ''I don't want to live through that again,'' she says. ''Command and control is not the answer.'' ONE SMALL STEP that's easy to take and needn't cost much would be to offer tax and royalty breaks. For example, some 7% of U.S. production today is from about 150,000 so-called stripper wells producing ten or fewer barrels a day. States could forgive royalties paid by such marginal wells on their land that are about to shut down. There would be no significant loss to the treasuries, since a shut well pays no royalty anyway. O'Leary may be considering a royalty holiday for uneconomic and as yet undeveloped discoveries in the deep waters of the Gulf of Mexico. That would begin to bring the terms of doing business with the federal government more in line with the attractive deals offered by other countries. One reason oil money is fleeing the U.S is that most foreign governments allow companies to recoup their capital expenditures quickly and take the bulk of their own share later in the projects. Traditionally, the U.S. grabs more up front but allows the companies a bigger slice of the profits later -- which is appealing only when producers look for high long-run prices. Such incentives will do little to keep the U.S. dependence on foreign oil from growing, assuming the moratorium on exploration continues. But the perils of the U.S. decline have been greatly exaggerated. Oil is a global commodity, ; and whether a country imports 20% or 60% of its needs, it will pay the world price. The volatility that created chaos during the 1970s oil crisis has become much less of a threat. The U.S. strategic petroleum reserve and the futures market, for example, helped keep disruptions to a minimum during the the Gulf war. And the increasingly global integration of marketing and production gives producers everywhere more of a stake in keeping supplies stable. What about the cost of paying foreigners for all that oil? Imports came to $51 billion in 1992, almost 60% of the merchandise trade deficit. But compared with other imports, oil is a fairly minor player. The U.S. paid about $92 billion for imported autos and auto parts last year -- a sum that's equal to 108% of the trade deficit. Imported consumer goods cost $123 billion, 145% of the deficit. If the goal is to reduce the trade deficit by restricting imports, the argument quickly lapses into absurdity. Better to nail autos; with plenty of surplus manufacturing capacity, domestic automakers could easily ramp up production. No, the real issue is that correcting the trade deficit depends on increasing U.S. savings and investment, not on erecting barriers to imports in selected industries. So if it's goodbye, Big Oil, what will be left in its place -- an enfeebled shell unable to compete abroad and slowly expiring at home? On the contrary. The industry that survives will be remarkably vigorous, technologically sophisticated, and more competitive than in the recent past. In oil industry parlance, it won't be the tarry gunk at the bottom of the barrel that lives on, but the high-margin light fractions at the top. The industry always produced some natural gas along with its oil. Now it is evolving into a gas industry that will also produce some oil. Demand for gas is growing 3% a year (vs. about 1% for oil), and prices that were depressed for almost a decade have firmed from a record low of 90 cents per thousand cubic feet early in 1992 to $2.30 today. Drilling for gas, which has been depressed, is beginning to pick up. But Earl Swift, chairman of Swift Energy Co., who pays close attention to long-term cycles, thinks it's not increasing quickly enough to avoid some big price rises beginning as soon as next summer. And something is happening in the oil industry that Ricardo failed to foresee: Improvements in technology can overcome rising costs, just as fertilizer broke the Ricardian chains in agriculture. Because the U.S. is the world's high-cost oil region, American oilmen are on the cutting edge of developing technologies that drive down the expense of finding and producing oil. Among them: three-dimensional seismic techniques and deep-water production equipment (see box). These technologies will make U.S companies competitive overseas as well. Triton Energy of Dallas, for example, developed a computer system especially suited to collecting and interpreting seismic data in foothill regions where the deep strata have folded over and under themselves in what are called overthrusts. In the mid-Eighties, Triton honed the technology in the Rocky Mountain overthrust belt and then applied it to a foothills prospect in Colombia. It invited several giants with deep pockets to join in, among them BP and France's Total. Two years ago the group, with BP as operator of the project, confirmed that it had found about two billion barrels of oil in the Cusiana field. Triton's cut will be 10%, and the company -- with revenues last fiscal year of $110 million -- has begun exploring foothills in Argentina. The moral is simple: The U.S oil industry will get smaller, but boldness and imagination will help ensure its role as a world leader. And as oil folks have known since the days of the Titusville strike, fortune rewards the bold and the imaginative.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCE: U.S. DEPARTMENT OF ENERGY CAPTION: CRUDE AWAKENING In a historic transition, the U.S. will soon import as much oil as it pumps.