OPEC Knuckles Under

By Charles P. Alexander

As demand for crude falls, the group cuts prices for the first time

I am truly troubled and with OPEC distressed, OPEC's major crisis is no longer suppressed, The market is stagnant, the price of crude oil depressed.

That bit of doggerel is the opening stanza of a poem written by Mani Said al Oteiba, Oil Minister of the United Arab Emirates, to commemorate the marathon twelve-day meeting in London of the Organization of Petroleum Exporting Countries that ended last week. The minister's lament reflected the mood of desperation that led OPEC to slash its official bench-mark price from $34 per bbl. to $29, the first cut in the group's 23-year history.

For OPEC, it was a grudging admission of declining market clout. For oil-consuming nations, it was a turning point that could mark an end to the economic stagnation they have suffered since OPEC first flexed its muscle a decade ago. OPEC'S action, said U.S. Treasury Secretary Donald Regan, is "good news for the U.S. and for the world economy. It will mean less inflation and a strong shot in the arm to the budding economic recovery." Data Resources, a Lexington, Mass., consulting firm, estimates that cheaper oil will boost America's real G.N.P. growth rate this year from a previously projected 1.7% to 2.2% and will slow expected inflation from 3.8% to 3.1%.

Before delegates from the 13 OPEC members had even left London, many energy experts were saying that the continuing oil glut would force prices down further. To keep that from happening, the members agreed to individual production quotas designed to limit their overall output this year to 17.5 million bbl. per day. That is 1.3 million bbl. less than the average rate for 1982, but 3.5 million bbl. more than the current rate. Said a hopeful Sheik Ahmed Zaki Yamani, Saudi Arabia's Oil Minister: "I have a strong feeling that this [agreement] will work out and that OPEC will be back in the driver's seat."

Maybe so. But at the moment OPEC is clinging to the rear bumper, and market forces are dragging the group down the road. Because of slumping demand for oil, OPEC'S production has plummeted from 30.6 million bbl. per day in 1979 to a current rate of 14 million. Unless demand snaps back sharply, the target ceiling of 17.5 million bbl. per day will be irrelevant. Even after last week's reduction in the bench-mark price, many oil buyers still balked. Said Barry Good, senior oil industry analyst with the Morgan Stanley investment firm: "I have a sense that the traders believe the price has to drop more." U.S. Energy Secretary Donald Hodel predicted that the cost of crude would fall to about $25; some experts, including Alan Greenspan, chairman of the Council of Economic Advisers under Gerald Ford, see it going perhaps to $20 unless OPEC sets lower quotas.

Whether or not prices keep tumbling may depend on the actions of OPEC'S oil-producing competitors. Mexico, which last week lowered the charge for its Isthmus crude to $29 per bbl., is staying in line with OPEC prices. Egypt, however, lowered the price of its best crude from $29 to $27.25, and the Soviet Union has been aggressively discounting its oil to raise foreign exchange (see box). At the same time, Britain is under pressure from customers to undercut OPEC by dropping the $30.50 per bbl. price on premium-quality North Sea oil.

OPEC is counting on a surge in demand to firm up prices. For several weeks, oil refiners have been shunning OPEC crude and drawing down their inventories at a particularly rapid clip--some 4 million to 5 million bbl. per day--in anticipation of price cuts. At some point, the refiners will have to start rebuilding their stocks. In addition, the emerging economic recovery in the industrial nations could spur oil consumption and send prices back up.

Some experts argue, however, that inventories are still higher than necessary, partly because of an unusually mild winter. Said Stephen Smith, an energy economist at Data Resources: "With storage costs still significant and traders aware that they can pick up all the oil they need in five minutes on the spot market, there's no incentive to start buying yet." Greenspan points out that the fear of shortages that led refiners to hoard oil in the past few years is largely gone.

Even if demand bounces up to OPEC's target level of 17.5 million bbl. per day, the group still faces the danger of widespread cheating on quotas. Similar production agreements in the past have crumbled as several countries, including Iran, Nigeria and Venezuela, offered under-the-table price discounts to raise sales. These nations are buffeted by economic and financial difficulties that will make more cheating almost irresistible.

Venezuela, for example, has run up a foreign debt of $25 billion. The country's per capita output of goods and services has sunk to a level about 15% below where it was in 1978. Faced with a drop in oil revenues this year of at least $4 billion, Venezuela has shelved plans for construction of a new railroad, a steel mill and several highways. With an election coming in December, the government is already getting edgy about political unrest. Three journalists were jailed two weeks ago for criticizing the President.

In Nigeria, the slowdown in oil revenues has shaken the government of President Shehu Shagari. Imports have been cut in half since 1981, and food prices have risen 25% in the past year alone. To ease unemployment, the government in January abruptly expelled more than 1 million illegal foreigners who had come to Nigeria from neighboring countries. Up for re-election in August, Shagari is determined to boost oil sales, even if it means getting into a price war with other producers.

Given the financial needs of the poorer OPEC countries, Saudi Arabia has reluctantly accepted the role of "swing" producer, responsible for cutting output enough to match supply with demand. But despite vast reserve assets of $150 billion, the Saudis are running out of room to maneuver. Having already reduced output from 9.6 million bbl. per day in 1981 to 3.3 million now, even the Saudis are facing a potential budget deficit this year, perhaps as high as $20 billion. They may not be willing to tolerate that kind of sacrifice much longer if others in OPEC keep on cheating.

The possibility that OPEC will collapse, causing a sharp break in oil prices, alarms many energy experts. They warn that such a drop could derail conservation efforts, slow development of alternative energy sources and ultimately increase the industrial nations' dependence on imported oil. For that reason, they advocate a tax on oil, or at least on imported crude, to keep energy prices from plunging too far. Said Arnold Safer, president of Energy Futures Group, a Bethesda, Md., consulting firm: "We'd better hold our guard up. We should impose a tax to keep up the thrust of domestic conservation and exploration. If we don't, we could become vulnerable to another OPEC episode."

Besides encouraging conservation, such a tax would help narrow the swollen federal deficit. With that in mind, New Mexico's Republican Senator Pete Domenici has drafted a bill calling for a $10-per-bbl. import fee. In January, the Administration proposed a contingency tax of $5 per bbl. on both imported and domestic oil that would take effect in 1985 if the deficit is still huge. But the White House opposes an immediate oil tax. Said Treasury's Regan: "At this point, I don't think you'd want to increase taxes. We are just coming out of a recession."

An oil tax would have many drawbacks. It would offset the economic gains from lower oil prices. It would fall unevenly on different regions of the U.S. New England for example, uses far more heating oil than other parts of the country. The tax would land heavily on the poor, since they spend a high percentage of their incomes on energy. Finally, unless other industrial nations passed similar measures, American products made with more expensive energy would be less competitive in world markets.

Despite these problems, proponents of the tax say that it is an essential element of national defense. It would be a costly security measure, but so are planes, tanks and battleships. Only an oil tax, its advocates argue, can ensure that OPEC will never climb back into the driver's seat.

For the moment, OPEC's quick recovery seems a highly unlikely prospect. Oil Minister Oteiba seemed to say as much in his minor epic poem. To OPEC members who were threatening the group's unity, he wrote sadly:

My friend, you are misled! We have greatly argued, until Our tongues became heavy as lead.

--By Charles P. Alexander.

Reported by Jay Branegan/Washington and Bruce van Voorst/ New York

With reporting by Jay Branegan and Bruce van Voorst This file is automatically generated by a robot program, so viewer discretion is required.