Big Oil's Surprising Problems

By Christopher Byron

Supplies are up, demand is down, and profits are falling

It has been a long time since the 13 members of the Organization of Petroleum Exporting Countries were unable to sell every barrel of crude they pumped, or since oil companies such as Exxon, Mobil Oil and Gulf Oil suffered from declining profits and bulging inventories. But that is precisely the situation in the suddenly upside-down world oil market. Skyrocketing prices and sagging demand have brought on a continuing petroleum mini-glut.

Oil company inventories around the world are now swelling with a surplus of excess production that oilmen estimate may amount to as much as 1 million to 2 million bbl. of daily output. The situation is particularly pronounced in the U.S., where petroleum consumption dropped by 5.2% in the first quarter, after declining by 8% last year.

The effect on oil companies, which led American corporations in profits last year, has been dramatic. Refineries are now operating at a record low 66.3% of capacity. According to Daniel Lundberg, the Los Angeles-based consultant who tracks U.S. gasoline prices, the wholesale cost of gas has dropped by an average of nearly .8-c- per gal. in the past two weeks. As a sign of a softening market, Atlantic Richfield and Texaco are now offering selected dealers a 4-c--per-gal. discount on wholesale prices.

Industry analysts predict that as a result of the weak market, first-quarter earnings, which the companies will begin to release this week, will be down sharply. Said Dillard Spriggs of New York's Petroleum Analysis Ltd. research house: "Virtually every company will be affected by the downturn." Exxon and Mobil are expected to see earnings drop about 25%, while Gulfs earnings may decline more than 40%. Overall, of course, Big Oil will still remain very profitable. Some companies, such as Standard Oil of California, may well show modest increases over first-quarter 1980 profits, which were enormous.

Small refiners, however, are in more serious trouble. These companies, known in the industry as teakettle refiners because they have operations of less than 30,000 bbl. a day, have sprung up since the mid-1970s to take advantage of Government subsidies built into the oil price controls that President Reagan abolished in late January. Without those federal subsidies, many small refineries cannot make a profit. About 40 such firms have already shut down along the Gulf Coast, and more closures are likely to follow.

Decontrol of the domestic oil industry is also accelerating a shake-out of retail gas sales. Government regulations previously forced oil companies to keep some unprofitable marketing operations open, but now the firms can close them down. Texaco, which has long proudly proclaimed that it sold in all 50 states, is reducing the number of its stations in the Midwest and Great Lakes regions. Shell Oil will soon no longer sell in upstate New York, upper New England or Minnesota.

Faced with large supplies and low sales, oil companies are paying lower prices for crude or refusing to buy it. Standard Oil of California, which markets under the Chevron brand, Phillips Petroleum and Marathon Oil have all announced that they are cutting by $1 per bbl. the amount they will pay for certain grades of domestically produced crude. Atlantic Richfield has reduced purchases from Nigeria by 60,000 bbl. a day, and industry experts say that Ashland Oil has indefinitely suspended purchases of some 90,000 bbl. a day of crude from Mexico, along with another 17,000 bbl. daily from the African country of Cameroon. In the past two weeks, Mexico, Ecuador and Egypt have cut their crude-oil prices between $1 and $3 per bbl.

The weak oil market is now putting OPEC on the spot. During 1980, the cartel's production dropped to nearly a decade low of 27 million bbl. a day, even though Saudi Arabia, the group's single biggest producer, has since last autumn been pumping daily almost 2 million bbl. over and above its self-imposed output ceiling of 8.5 million bbl.

The Saudis could tighten up world oil supplies at a stroke by simply cutting back on their "excess" production. But the desert kingdom, for now at least, is holding output high and depressing prices, ostensibly to force other OPEC members to support a Saudi plan to link the price of oil to inflation and the value of key world currencies. Such a pricing formula would bring about a moderate but steady long-term rise in petroleum prices.

The Saudi pricing proposals are expected to be one of the main topics for discussion at the meeting of OPEC members in Geneva on May 25. But it is unlikely that the 13 nations will be able to agree at that session on a change in the way oil prices are fixed.

Some Western observers, however, now wonder if Saudi Arabia is also keeping production high because it simply needs the oil income. Despite its large foreign reserves, the country is pushing development so rapidly that it is hard-pressed for cash. Writes Douglas J. Feith, general counsel of the Center for International Security in Washington: "A Saudi production cut from 10 million to 5 million bbl. a day would cut Saudi revenues in half--from the current $120 billion a year to around $60 billion. But official Saudi spending is at the rate of $96 billion a year, and thereby hangs a grim tale for the Saudi regime."

Whether the Saudis maintain current production or not, oil-consuming nations can hardly rest easy. Temporary surpluses in 1978 and 1980 quickly evaporated after the outbreak of the Iranian revolution and the Iran-Iraq war. A pickup of the U.S. and European economies and the resulting increased demand for oil would wipe out the mini-glut just as quickly this time. Says Ulf Lantzke, director of the Paris-based International Energy Agency: "We are in balance at the moment, but it is a rather fragile balance." With some 60% of world oil reserves buried under the sands of the always volatile Middle East, world oil supplies will remain fragile at best.

--By Christopher Byron. Reported by Gary Lee/Washington and Bruce van Voorst/Brussels

With reporting by Gary Lee/Washington, Bruce van Voorst/Brussels

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