The fear of falling oil prices

Linda Diebel February 7 1983

The fear of falling oil prices

Linda Diebel February 7 1983

The fear of falling oil prices

In 1973 a little-known group of oil-producing nations, the Organization of Petroleum Exporting Countries (OPEC), flexed its muscle with a suddenness that sent shock waves throughout the international economy. In the midst of the Arab-Israeli war, the emerging cartel vented its fury toward Israel and the West by imposing a global oil embargo. Then, in just more than two months, OPEC quadrupled the world oil price. Western nations panicked when almost overnight they faced a world oil price of $11.65 (U.S.). But last week when OPEC nations failed to reach a new pricing agreement in Geneva, the Western world reacted in precisely the opposite fashion. Most industrial nations viewed a potential collapse in oil prices with horror.

The widespread fears of a sharp decline in the world price—now officially set at $34 (U.S.) for a barrel of Saudi light crude—were summed up by First Boston Corp. oil analyst William Ran-

dol. The situation, he said, is “scary as hell.” And the new realization that oil price fluctuations—up or down— threaten global economic stability gave extra weight to Saudi Arabian Oil Minister Sheik Ahmed Zaki Yamani’s claim that the world economic system has now become dependent on OPEC’s existence. The rupture in Geneva will not destroy the cartel, he maintained, because “everybody needs OPEC, including the consumer.”

On the surface the expected drop in world prices appears to be beneficial for the consumer. Said Edwin Rothschild of the U.S. Citizen-Labor Energy Coalition, which lobbies for lower energy and utility rates: “I think it is wonderful news that the OPEC countries cannot agree to maintain an artificially high price for the rest of the world.” And leaders of such debt-ridden oil-importing countries as Argentina and Brazil agreed. But the real benefits to consumers, at least in Canada and the United States, are not easily calculated. The outcome depends, according to in-

Linda Diebel

dustry analysts, on how low prices go. Federal treasuries have based fiscal policies largely on tax flows from oil revenues, and even a $1 drop in the international price would cost Ottawa, for one, about $375 million and the United States about $1.5 billion. In the United States a decline in government revenues would increase pressure for an additional oil-import tax. And for Canada a price plunge might mean that Energy Minister Jean Chrétien would have to restructure national policies that are based on the assumption of steadily rising world prices. As well, the domestic petroleum industry might have to abandon high-cost development in the Arctic and on the East Coast in a world satiated with cheap oil, said Robert Plexman, an oil analyst with the Montrealbased firm of Levesque Beaubien Inc.

In areas outside North America the consequences of a price decline could be even more disastrous. Expressing a widely held view, French Energy Minister Edmond Hervé commented, “If oil prices collapsed, our whole monetary

system, the whole international banking system would be put into question.” Ironically, the first casualties would be the treasuries and creditors of such oil-exporting countries as Mexico, Venezuela, Nigeria and Indonesia, which have borrowed heavily, based on the collateral of oil in the ground. Now they need revenues to pay their enormous debts. Defaults, as Yamani observed, could set off “a chain of bankruptcies among U.S. oil companies and banks in the United States.”

It is a grim scenario. First Boston Corp.’s Randol predicts “carnage all over the oil industry” if prices fall, and he added that the “banks are scared to death.” Still, most analysts softened their initial apocalyptic warnings and, like Levesque Beaubien’s Plexman, estimated that falling prices will level off at about $30 a barrel. Texaco’s chief economist, Tor Meloe, explained from his White Plains, N.Y., office: “There will likely be agreement among the OPEC members. The chances improve as they all get closer to the edge of

the cliff and look down.”

The 13 OPEC members edged to the brink at last week’s meeting in the elegant Inter-Continental Hotel on a slope overlooking Lake Geneva. There, they failed to agree to a price and production package that might have reasserted the cartel’s control over a declining share of the world oil market. Texaco’s Meloe said that his company was “surprised” at the breakdown, because delegates had originally agreed to cut OPEC oil production to an average of 17.5 million barrels a day—a million barrels less than a compromise worked out a month ago.

But Saudi Arabia’s Yamani, backed by Persian Gulf states, insisted that African producers—Libya, Algeria and Nigeria—stop discounting their higherquality crude by as much as $4 a barrel or the Saudis would not agree to the new production ceiling. He accused the Africans of cutting Saudi competitiveness by charging too meagre a differential to equalize the advantage of producing a superior product closer to world markets. Said Kuwait’s oil minister, Sheik Ali Khalifa al-Sabah: “If they cannot [stop undercutting] or if they think this is too excessive, we are amenable to lowering prices.” Then Iran entered the fray, demanding an increased market share at Saudi Arabia’s expense. As Saudi oil production has declined to less than five million barrels a day, Iran’s output has soared to more than three million.

But the control of oil has always been political, and “this time the Iranians are really out to break the Saudis,” remarked British author and economist Anthony Sampson, who wrote the 1975 oil industry exposé The Seven Sisters. Adding yet another political complication, he told Maclean's that Yamani had reason to believe that Britain’s oil producers intend to cut the price of North Sea oil by $3 a barrel. Said Sampson: “You have all of these non-OPEC oil producers like Britain, Norway and Mexico playing the game—to produce and sell as much as possible, as quickly as possible. It’s full of hypocrisy.”

However, several delegations accused the Saudis of intentionally leading other OPEC members into a trap to force a battle and an eventual compromise, whether in the form of higher differentials or lower prices. Explained Data Resources Canada analyst James Osten: “The week before the meeting there was a lot of pressure put on the Saudis to get in line and reduce prices. People told the Saudis to ‘fix’ the problem, and a lot of very senior oil executives were flying around the world.” He said a lot of oil companies stopped buying and began to use up their stockpiles, expecting a price decline. Other analysts pointed out that the Saudis were well aware

that the price had to come down in order to enhance their sales. Exxon, Texaco, Standard Oil and Mobil, for instance, are committed through the Arab-American Oil Co. (ARAMCO), in which they are partners, to purchase Saudi oil at $34 a barrel. But Saudi light is already available on the “spot” market for as little as $28 a barrel, and it could go lower. Noted a Platt’s Oilgram News report: “The Saudis had to go through this motion of an unsuccessful OPEC meeting as a face-saving gesture to permit a price cut... it seems apparent [that Yamani] is trying to deflect blame for a price cut to non-OPEC members, especially the United Kingdom.” But Yamani’s prediction that the North Sea price would drop “within a few days” gained credence when British National Oil Corp. (BNOC) officials admitted that their major clients had requested a price review at the end of January, instead of March. British analysts said last week that the smart money, seeing the prospect of increased North Sea sales at lower prices, is now buying into oil. At a subsequent meeting, British Energy Secretary Nigel Lawson and industry leaders agreed that the British industry should not “rock the boat.” And, although the pound fell to an all-time low of $1.5175 (U.S.) in the aftermath of the Geneva failure, Sir Archie Lamb, a director of Britoil,

BNOC’s private sector exploration arm, said that he saw no reason for “urgent and dramatic” North Sea oil price cuts.

Persian Gulf countries could suffer poorer years ahead, but the drama of a price decline will centre on other continents. “Mexico’s problems are simply staggering,” said Larry Birns, director of the Washington-based Council on Hemispheric Affairs. “Already, to service its foreign debt, the government has had to institute austerity programs that are hurting the poor in a bad way.” Slightly less than half of the country’s foreign exchange will come from oil exports this year, according to Mexican finance ministry statistics. Vaughan Montes, an economist with the Mexican Project at Wharton Econometric Forecasting Associates, said he does not believe that Mexico could service its debt if oil prices fall by even $2 a barrel. (The current account deficit would rise to $4.8 billion.) Prospects of a $25-billion

restructuring of Mexico’s debt at week’s end allayed international fears of immediate collapse but did little to change Birns’s prediction that “Mexico is in for its most turbulent political phase in modern history.”

Nigeria, meanwhile, is already reeling from an economy depressed by lower oil revenues. As unemployment mushrooms, the government has declared roughly two million foreign workers—most of them Ghanaians—to be “illegal aliens” and ordered them out of the country. The result has been chaos at the port of Lagos, as tens of thousands of people fight for places on the few boats arriving to

carry them out of the country.

In Canada a dramatic decline in world oil prices might render national oil-pricing policies unworkable. Under the terms of the 1981 Ottawa-Alberta pricing agreement, oil produced from wells drilled after Dec. 31,1980, sells at the full world price, while the price of older supplies is scheduled to increase in stages to 75 per cent of world price. Since then Canadian oil has jumped from $18 a barrel to $29.75—about a dollar below the 75-per-cent limit, using $34 (U.S.) as the world base—and another $4-a-barrel increase is scheduled for July 1. Now, with world prices at least stable if not in decline, industry spokesmen see little likelihood that the July increase will be implemented. Said an energy ministry official: “If the price of oil doesn’t go up, we don’t need a crys-

tal ball to tell us our revenues will fall. We’re drawing our own conclusions.” Industry analyst Osten calculates that a $6 price decline will cost Ottawa $1 billion and the producing provinces $800 million.

At the same time, Levesque Beaubien’s Plexman said that the Canadian energy sector will suffer as megaprojects remain stalled because of the difficulties of long-range planning. Analysts fear that the uncertainty will make companies more hesitant to explore off Newfoundland without a federal-provincial offshore agreement, amd last week’s breakdown in talks between Chrétien, the island’s premier, Brian Peckford, and Energy Minister William Marshall heightened their concern. While Chrétien insisted at week’s end that “ those guys don’t want the responsibility of an offshore deal,” Marshall labelled the federal attitude “shocking.” For its part, Alberta stands to lose $1.5 billion in natural gas revenues during an oil glut, and provincial Treasurer Louis Hyndman has been preaching the need for restraint. The Calgary-based Independent Petroleum Association of Canada, meanwhile, wants new pricing talks with Ottawa and Alberta within the next month. “We’re putting together a paper on the aggregate effect of the price decline on the industry,” said association spokesman Joe Horler. “The simplest way of mitigating the effect is to 3 remove the ceiling.”

uncertainty following the collapse of the OPEC talks, predictions have been “knocked for a loop,” in the words of one Canadian industry spokesman. “Everyone is still scrambling, and it is clear that companies, bankers and governments have a great deal at stake.” One clearly accurate prediction, however, came from the cryptic Yamani. “February,” he said in a classic understatement, “will be an interesting month.” The only postscript, as international observers hold their collective breath, is that the interest will probably hold well into March, April and beyond.

With Peter Gorrie in Edmonton, Michael Clugston in Halifax, William Lowther in Washington, Daniel Burstein in New York, Iain Guest in Geneva, Carol Kennedy in London and Clifford Kraus in Mexico City.