Impact of OPEC Accord Already Felt at the Pump : Gasoline’s Jumped 3 Cents a Gallon Even Before the Cuts in Output Take Effect
The ultimate success of the price-fixing and production-cutting plan by the Organization of Petroleum Exporting Countries remains far from clear, but it is certainly working at the moment.
A surge of nearly 25% in crude oil prices to more than $18 a barrel has shown up almost as quickly at the pumps, where gasoline prices across the country have spurted about three to five cents a gallon in the three weeks since OPEC reached its hard-won agreement.
The speedy increase in wholesale and retail prices has occurred even though virtually all the gasoline currently being sold to motorists was refined from petroleum bought before crude oil prices began their surge.
By contrast, the more gradual decline in retail gasoline prices early last year as the price of crude tumbled was explained at the time as a normal delay while the cheaper crude oil worked its way through the refining system and reached the gasoline pumps.
‘Cheap Stuff in the System’
“Then, they said it was because they still had expensive oil in the system. Now, they’ve got cheap stuff in the system and they’re already raising prices,” said Scott T. Jones, vice president at Chase Econometrics and a former oil company economist. “They’ll raise prices every chance they get.”
The Los Angeles-based Lundberg Survey of gasoline prices released Sunday found that the average price nationally climbed three cents a gallon, to 87.9 cents, in the three weeks ended Friday. The figure is a sales-weighted average of all grades of gasoline, both self-serve and full-serve.
The increase was “pretty dramatic” said survey publisher Trilby Lundberg, who said the OPEC action came at a time when upward pressure on prices had already been building.
Chevron, a leading gasoline retailer in the western United States, put its retail increase at about 5 cents a gallon “primarily” as a result of the OPEC action.
Economists say the normal tendency of prices to climb faster than they fall might have been accelerated by the weakened condition of the oil industry, which was severely damaged by last year’s price collapse and has a genuine need to widen its slim profit margins. After crude prices began to tumble a year ago, gasoline prices fell from a December 1985 average of $1.22 per gallon to a 1986 low of 84.4-cents a gallon in November.
“I think the market welcomed the opportunity to go up,” said James Huccaby, manager for pricing at Chevron USA in San Francisco. “Certainly from a consumer’s standpoint, it sure does appear that we raise prices faster than we lower them. But we’ve been operating at pretty low margins. Our prices have been barely enough to cover refining costs.”
Lundberg said that despite the quick rise at the pumps, dealers are actually realizing a penny less per gallon now than they were before the OPEC meeting because wholesale prices have been rising even faster than retail.
Wholesale Prices Up
At the wholesale level, Huccaby said, prices have already increased about eight cents a gallon since the OPEC accord. The trade publication Oil Daily said some wholesale gasoline prices last week had reached their highest levels since July.
Oil industry officials say that even if the price of crude oil did not climb any further, gasoline prices could be expected to edge up another three cents, for a total increase of eight cents a gallon. That would be in response to the recent $3-a-barrel increase, to $18, for crude oil.
Similar price increases are being registered in the spot markets for heating oil and other petroleum products.
Consulting economist Irwin M. Seltzer calculates that if the OPEC agreement remains in place all year and drives crude oil prices to the $18- to $20-a-barrel range, it will add half a percentage point to the nation’s inflation rate in 1987 and reduce economic growth by about the same amount. Oil’s price collapse was the main reason for a drop in the producer price index last year.
“The effect is not good because some of the benefits of the lower prices were just now beginning to materialize,” said Seltzer, director of the Harvard University Energy and Environmental Policy Center. “But it’s good news if you’re a Texan or an Arab.”
While the rise in gasoline prices is based on the increase in the cost of petroleum, the spurt in crude oil prices has more to do with the psychology of the oil markets than the economics of it. OPEC’s new system of fixed prices does not officially take effect until Feb. 1, and it isn’t yet clear whether the cartel’s members are cutting production as promised.
Brief Success Seen
Despite several recent signs that the OPEC members are determined to abide by the Dec. 20 agreement, many analysts remain skeptical that the cartel will succeed for more than a month or two with its complex system of fixed prices and reduced crude oil production.
“It’s still too early to tell about this (OPEC) agreement, but the bottom line right now is the market believes the agreement’s going to hold,” said John Hill, a vice president at Merrill Lynch Futures in New York.
William Hermann, the chief economist at Chevron, added: “Maybe there’s a lot of wishful thinking.”
Crude oil prices, which had already begun climbing from the $15 range in the days before the OPEC agreement was reached, have continued to increase for nearly a month on the bet that OPEC will succeed with its plan to produce less oil and return to a system of fixed, “take-it-or-leave-it” prices averaging $18 a barrel.
By Friday, a contract for February delivery of a barrel of benchmark U.S. crude oil was selling on the New York Mercantile Exchange for $18.77--a nearly 25% gain since mid-December despite no appreciable change in the world glut of oil that was the fundamental cause of last year’s price collapse.
Such optimism tends to become a self-fulfilling prophecy for a time, because the mere belief among oil traders that prices are going up will prompt oil companies to buy crude now and hold on to inventories in the expectation that they will fetch more money later. Those actions have the effect of tightening supplies--and thus driving up prices further.
Over the course of the year, however, the prices at the pumps will depend largely on the real-world actions of the OPEC nations. So far, most have shown a strong will to hold to the plan.
Kuwait announced last week that it canceled contracts with two unidentified oil customers that had refused the sheikdom’s fixed oil price, an apparent sign of resolve on Kuwait’s part. Saudi Arabia was reported to have slashed last week’s production by more than the new quota system required.
Cuts by Others
Norway, Malaysia and other non-OPEC producers have shown support for the OPEC agreement. The Norwegians have indicated plans to cut North Sea oil production by up to 10%. Meanwhile, OPEC members have notified customers that they are phasing out old contracts and will replace them with the new fixed prices as of Feb. 1, and there were unconfirmed reports of at least one large customer agreeing to the new terms.
But skeptics noted that Norway has recently opened new oil fields that are producing as much as the nation now proposes to cut, with the effect that just as much Norwegian oil will be entering world markets now as before. And while oil-rich Kuwait might be strong enough to cut off recalcitrant customers, poorer OPEC members might be unable to resist the temptation of capturing extra business by selling at lower prices.
The chief obstacle remains the refusal of Iraq, now producing about 2 million barrels a day versus the 1.466 million barrels assigned to it by the cartel, to agree to the deal. Expansion plans are expected to enable the Iraqis to boost production to 2.5 million barrels daily by June. That would make Iraq’s potential overproduction almost equal to the entire 1.2-million-barrel reduction contemplated by all of OPEC under the new agreement.
To What Level?
Some, including energy expert and ex-oilman G. Henry M. Schuler of Georgetown University, argue that Iraq’s self-interest lies in restricting production, thus keeping prices up. But it remains to be seen what production level Iraq believes would yield it the most oil revenue to finance its war against Iran.
Until recently, OPEC leaders figured that Iraq’s overproduction was being partly offset by Iran’s underproduction because Iraq’s bombing of Iranian oil facilities have prevented Iran from producing as much oil as it is allowed by OPEC quotas. In recent weeks, however, Iran has surprised oil experts by returning damaged facilities to production.
“Iran is getting pretty good at fixing its facilities,” said international oil analyst Thomas Lewis of Duff & Phelps in Chicago. “These are all things that are going to help undermine the agreement. We regard the OPEC agreement as an impressive but largely inconsequential accomplishment.”
Adds economist Seltzer:
“The success really will depend on Iraq’s ability to bomb its fellow cartelist. That’s a wonderful way to make a business deal. That’s why I’m reluctant to say it still stick any longer than six months.”
