BUSINESS

Why OPEC price cuts pose a threat

Ian Anderson December 20 1982
BUSINESS

Why OPEC price cuts pose a threat

Ian Anderson December 20 1982

Why OPEC price cuts pose a threat

BUSINESS

Ian Anderson

In New York last month Energy Minister Jean Chrétien was exchanging drinks and pleasantries with the United States’ pinstriped financial elite when a bombshell question was casually raised. Why, Chrétien was asked, is Ottawa really going to bail Dome Petroleum out of its $8-billion sea of debt? To protect the integrity of Canadian banks, replied Chrétien candidly. Ah,

sighed his U.S. questioner____“It’s your

turn now. It will be ours in 1983.”

The financier’s comment was more than glib repartee. As the Organization of Petroleum Exporting Countries' prepares for a Dec. 19 summit in Vienna, Western governments are increasingly worried that OPEC’s bitter feuding over oil prices and production quotas will erupt into a round of price cutting that may wreak havoc on Western oil industry balance sheets and cut dramatically into government tax revenues. That worst-case scenario might unfold if the tensions wracking OPEC explode in firecracker rounds of price slashing. Within months the oil price, now officially set at $34 (U.S.) a barrel for light Saudi crude, could plunge below $20 a barrel as such developing nations as Nigeria and Indonesia attempt to enlarge their market share to meet their debt and development commitments. In that case Saudi Arabia might be tempted to open the taps of its vast reserves in an

attempt to “discipline” the market. As a result, oil prices would plummet.

Such turmoil might have been good news for the West 10 years ago. No longer. Western governments have profited from their oil taxes to the point where a dollar drop in the international price would cost Ottawa alone about $375 million in lost revenue and Washington about $1.5 billion. Even worse, sharp drops could well force such oilproducing nations as Mexico or Venezuela to renege on their huge foreign debts. Oil companies such as Dome would be doomed. A panic and Depression-style run on the banks is painfully conceivable. “What I would regard as a real disaster case would be an oil price drop to $25 [a barrel],” says Royal Bank of Canada Senior International Economist Curt von dem Hagen.

That prospect is no longer beyond belief.

The Saudis have failed to dominate an oil market that actually shrank by six per cent in the first half of 1982.

The long world recession, coupled with price-prompted conservation, has created an

oil glut. In Canada gasoline sales have been slashed by an estimated 1.5 billion L this year. OPEC production will plummet from 30.9 million barrels a day in 1979 to 19.4 million in 1982. And such nations as Libya and Nigeria are scrambling to keep their share of the shrinking pie by cutting prices. The result has been a drop to $29 on the “spot” market for a barrel of high-quality Saudi light oil.

Canadian policymakers are just starting to muddle through the potential ramifications of a price cut. It is now accepted that world oil prices will not increase, even before inflation is taken into account, for at least two years. That puts Ottawa in a painful policy position. Under the terms of the 1981 Ottawa-Alberta pricing agreement, the government had set out to raise the price of domestic oil to 75 per cent of the world price. In the process, tax and royalty revenues would also swell. But the scheme was based on Ottawa’s prediction that prices would rise. Instead, they have fallu en, and, already, do3 mestic prices are ap-

proaching the 75-per-cent target. Since 1980 Canadian oil has jumped from $18 to $32 a barrel, and a $4-a-barrel hike is scheduled for Jan. 1. But a subsequent hike scheduled for July 1 is unlikely to be approved as Canadian prices touch the 75-per-cent ceiling. In that event, the federal treasury will lose about $1.5 billion in new taxes.

While lower oil prices should do much to revitalize the economies of Canada’s major trading partners, the country’s energy sector will inevitably suffer. Megaprojects are already on the shelf because of high interest rates, but even in a low-interest world Imperial Oil has said it could not go ahead with its proposed Cold Lake tar sands plant unless oil prices rose. A senior Gulf Canada executive estimates that the megaprojects require a twoto three-per-cent growth in inflation-adjusted oil prices through to 1990 to become feasible.

The Dec. 19 showdown in Vienna will pit the so-called “low absorbing” OPEC nations, such as Saudi Arabia and Kuwait, against such nations as Nigeria and Venezuela, which absorb virtually every cent of their oil revenue into ambitious development plans. Saudi Arabia wants to maintain an orderly market to ensure that it will be selling its only resource 30 years from now. But for other OPEC nations the future is now. As a result, production quotas and price pacts have been ignored.

The nub of the problem, however, is how OPEC should manage its first controlled decrease. Nations facing debt and development crunches, says the Royal Bank’s von dem Hagen, must keep up a constant flow of dollars. They would have to follow any initial price cut with further cuts of their own in order to carve out a larger share of the market. Says von dem Hagen: “If Saudi Arabia were to reduce its posted price to $27, pretty soon the OPEC price would be $25.” For now, the Saudis are not expected to carry out their threat. But the current rift outlines starkly how different the basic interests of OPEC members have become.

Oil analysts agree that, in a “surprise-free” world, there should be an oil surplus until 1985, at least, and no serious shortage before 1990. As a result, Western politicians face a tough choice, says Energy Probe economist David Brooks. They may allow prices to fall or maintain the higher levels to promote new supplies and greater conservation. Should they choose to let the oil price drop, says Brooks, “It is incumbent upon them to say they are putting us in a dangerous position.” What is clear, however, is that policymakers cannot simply let market forces rule. Governments, as well as energy companies and their bankers, have too much at stake. Big Oil is becoming synonymous with Big Government. 0