Spoiling for an Oil-Price War

By Stephen Koepp

"A price war? We don't want a fight. It would be very hectic," said Sheik Ahmed Zaki Yamani, Saudi Arabia's oil minister. But chaos is exactly what the Organization of Petroleum Exporting Countries produced last week when several members of the group threatened to launch an all-out campaign of slashing prices to boost OPEC's declining share of the world oil market. The pronouncement sent petroleum traders into a temporary selling frenzy. On the futures market in New York City, the January-delivery price of West Texas Intermediate, the U.S. benchmark crude, took a record two-day plunge of $3.51, to $25.23 per bbl. Some traders lost millions of dollars overnight. "It was the oil market's 1929. It was catastrophic," said Peter Beutel, a petroleum specialist for Manhattan's Rudolf Wolff Futures.

Prices pulled out of their spin later in the week, when more cautious members of OPEC played down the threats. But oil-industry experts predicted that an even more dramatic decline could be on the way. By next spring the seasonal drop in demand for heating oil is likely to aggravate the global petroleum surplus. "This collapse occurred in anticipation of trouble," said Constantine Fliakos, who follows the oil industry for Merrill Lynch. "You can imagine what will happen when the real flooding of an already glutted market begins." A price war would be a risky, last-ditch change in strategy for OPEC, which has been floundering in an ocean of crude. For the past four years OPEC has tried to shore up prices by limiting the worldwide oversupply. The cartel squeezed its output from a peak of nearly 32 million bbls. per day in 1979 to just 18 million now. But such competitors as Britain and Mexico defeated that strategy by selling more oil. Like a lonely gas- station owner watching all the cars whiz by, OPEC cannot figure out how to stop its rivals down the street from taking away its business.

So when the ministers assembled at Geneva's Intercontinental Hotel last week for their regular semiannual meeting, several wanted to slash prices in order to attract customers. Oil Minister Tam David-West of Nigeria, whose country has foreign debts of at least $22 billion and depends on oil for 95% of its export earnings, threatened to match North Sea competitors "barrel by barrel and cent by cent."

Even before the formal proceedings began, Saudi Arabia's Yamani and a few other delegates issued informal price-war ultimatums. Declaring that all the world's oil producers should share in the burden of the oversupply, the ministers called on non-OPEC countries to cut back their output, or else. They apparently hoped their threat alone would make competitors fearful of a superglut and persuade them to slash production. But the message backfired. While it succeeded in panicking oil traders, the tough talk failed to frighten Britain or Norway enough to make them tighten their spigots. British officials said that they would not accede to Yamani's wishes.

Shocked by the market's spasms the day after their remarks, OPEC delegates proceeded carefully. Instead of deciding to switch to free-for-all prices, the ministers appointed a committee to consider strategies. When the market continued to plummet, the ministers finally restored order by making soothing remarks. Said Alirio Parra, the chief adviser to Venezuela's oil minister: "We are astounded by the way the market has reacted." While individual members will no doubt continue to make under-the-table discounts, as they have for several years, no official price cuts are likely to come until the group meets again in February or March.

Even so, any threat of oil prices plummeting to $20 or even $15 renews concerns about the financial stability of strapped petroleum producers like Mexico, which desperately needs oil income to pay its $96 billion debt. Rapidly falling prices would deal another blow to the U.S. energy belt. Banks and drilling companies there have seen the value of their energy investments tumble with previous drops in the price of oil and natural gas. Says Alan Edgar, a petroleum analyst for the Dallas investment firm Schneider, Bernet & Hickman: "The bankers have got to be nervous. Next year will be the worst for the oil patch."

For the U.S. as a whole, cheap oil has far more positive effects than negative ones. Says Robert Ortner, chief economist for the Commerce Department: "It is a very potent boost for the economy." Since energy costs make up about 10% of the Consumer Price Index, smaller oil bills provide the economic elixir of growth without inflation. Many businesses get a huge profit lift from lower energy costs. The airline industry, for example, saves $110 million for every 1 cents drop in jet-fuel prices.

It would be at least 45 to 90 days after a drop in the cost of crude before the price of such consumer products as gasoline and heating fuel would be affected. Refiners tend to delay passing along the savings to customers until competitive pressure forces them to do so. Yet gasoline prices, which currently average $1.21 per gal. in the U.S. compared with a peak of $1.42 in March 1981, could fall about 2 1/2 cents for every $1 decline in crude prices. The response of heating-fuel prices to an oil-price drop depends partly on the weather. A particularly cold winter would keep supplies tight and prices up, while a warm one would likely cause a decline.

While OPEC's woes inspire visions of energy-to-burn for U.S. consumers, petroleum experts warn that the cartel could get the upper hand again in the 1990s. By then, many alternative sources, notably Alaskan and North Sea oil fields, will be on the decline. Low crude prices could help OPEC make a comeback by discouraging exploration for new sources. Says Elihu Bergman, executive director of Americans for Energy Independence: "We shouldn't let down our guard. We should take advantage of this to prepare for the future."

For the moment, though, the market and not OPEC clearly sets the price of world oil. If the cartel tries to roust its rivals by cutting prices, OPEC may set off a downward spiral that it will be powerless to stop.

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With reporting by Lawrence Malkin/Geneva and Raji Samghabadi/ New York