War of The Open Spigots

By Barbara Rudolph

Falling temperatures usually boost the spirits of oil producers. As energy users in the Northern Hemisphere stoke their furnaces and fill up their oil tanks, demand for fuel begins climbing toward its annual peak. For members of the Organization of Petroleum Exporting Countries, who supply 40% of the world's crude, the season should be one of relative harmony. But not this year. The group is in the throes of an oil-pumping free-for-all that has sent prices tumbling to levels not seen in more than two years.

In the past six weeks, three leading gulf producers -- Saudi Arabia, Kuwait and the United Arab Emirates -- have opened their spigots, increasing OPEC's total output nearly 10%, to 21 million bbl. a day. Because worldwide demand for OPEC's crude amounts to only about 19 million bbl., the overflow has created a price-dampening glut. West Texas Intermediate, the benchmark U.S. crude, fell earlier this month to $12.60 per bbl., a drop of nearly $3 from its level in August and more than $7 from a year ago. The price edged upward last week, closing at $14.92 per bbl., reflecting expectations among oil traders that the glut may soon inspire OPEC to cut its production.

If it does not, experts like Robert Chandross, chief economist at Lloyds Bank in Manhattan, warn that prices could drop below $10 per bbl. and remain at that level for the next six months. That would mean a repeat by next spring of the oil-market collapse of early 1986, when OPEC overproduction sent prices crashing to less than $10 per bbl. While cheap energy helps most Western economies by lowering inflation, petroleum at prices below $10 or $12 per bbl. is a painful prospect for such indebted oil producers as Algeria and Mexico and the weakened U.S. energy belt.

The latest production binge had its origins in the eight-year Iran-Iraq war, which ended with an Aug. 20 cease-fire. During the conflict, Iraq desperately needed oil revenues to fuel its war machine. As a result, the country exceeded its OPEC production quota of 1.54 million bbl. a day. Now that the fighting has ended, Iraq will have enough pumping capacity to increase its production even more, from a current level of 2.7 million bbl. a day to about 3.5 million bbl. a day within the next 18 months. With 100 billion bbl. of reserves, Iraq ranks second only to Saudi Arabia among the world's producers. By contrast, Iran's heavily war-damaged oil facilities are currently unable to pump more than its quota of 2.4 million bbl. per day.

The United Arab Emirates was the next to flout its production quotas. Long dissatisfied with its limit of 948,000 bbl. per day, the U.A.E. announced last August that it would pump 1.5 million bbl., and now produces nearly 2 million. In response, Kuwait raised its daily output from 1 million to 1.6 million bbl.

Saudi Arabia was not far behind. Earlier this month it declared in a statement, "Saudi Arabia has done enough for OPEC. The kingdom cannot accept that some members have production privileges and others not." Fearing a loss of market share to other OPEC producers, the Saudis boosted their output at least 15%, to more than 5 million bbl. per day. Just as it did in 1986, OPEC's longtime leader is trying to force restraint upon oil producers by pushing prices uncomfortably low. The Saudis last week sounded conciliatory, however, possibly because they believe their point is getting across.

This week OPEC's pricing and strategy committees will meet in Madrid in an effort to hammer out a production agreement that its members can abide by. If that effort fails, as many experts believe it will, OPEC ministers will get another chance to resolve their differences when they reconvene in Vienna in late November.

Low energy prices will help the industrial countries keep inflation in check. A $5 per bbl. drop in the price of oil typically translates into a 1% fall in U.S. consumer prices. Economists are predicting that U.S. inflation could reach 5% next year, vs. an estimated 4.5% for 1988. But if oil drops below $12 per bbl., says John Makin, director of fiscal policy studies at the American Enterprise Institute, inflation could ease slightly instead of rising.

The prospect is ominous, however, for indebted developing countries that can ill afford a collapse in the value of their oil exports. In Algeria, falling oil revenue and prolonged government austerity measures have been blamed for triggering the recent riots that have killed as many as 400 people. Mexico, which relies on oil for 40% of its total export income, expects that oil revenues will fall below $6 billion this year, compared with exports worth $7.8 billion in 1987. As a result, Mexican President Miguel de la Madrid has announced $220 million in new cuts in the government's $90 billion budget. The price slump is also likely to intensify Mexican demands for another renegotiation of the country's $104 billion foreign debt.

The U.S. oil patch is relatively better able to withstand another round of low oil prices. The '86 energy rout forced many marginal producers to pack up their drill rigs for good. The firms that remain in the industry are better capitalized and more efficient. Even so, many oil-patch banks and real estate investors, still reeling from the last slump, may be unable to survive another one.

Yet most investors realize that U.S. oil properties will be quite dear someday, since the country's 25.3 billion bbl. in estimated reserves are less than one-sixth of Saudi Arabia's. Last week twelve companies demonstrated their faith in the value of the finite resource by bidding a combined $7.3 billion for the oil and natural-gas assets of Houston-based Tenneco, which is selling those properties to concentrate on its gas-pipeline and construction- equipment businesses. Chevron agreed to pay $2.6 billion for the firm's stakes in the Gulf of Mexico, while T. Boone Pickens' firm, Mesa Limited Partnership, will pay $715 million for Tenneco's midcontinent reserves.

Yet these are decidedly long-term investments. For the moment, oil prices seem capable of deep downward swings. Indonesia's Subroto, the OPEC secretary- general, has warned that prices could fall as low as $5 per bbl. if Saudi Arabia and the other overproducers were to keep flooding the market. If such predictions fail to spur the group toward cooperation over the next few weeks, OPEC may be setting the stage for the oil-price collapse of '88.

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Cynthia Davis

[TMFONT 1 d #666666 d {Source: New York Mercantile Exchange}]CAPTION: NO CAPTION

DESCRIPTION: Closing price for crude oil, October 1987-October 1988.

With reporting by Gisela Bolte/Washington and Adam Zagorin/London