OPEC’s Price Push Lacks Fuel : Economic Uncertainty, Iran Problems, Glut Weaken Cartel’s Clout
The Navy and the stock market crash might prove as important as the law of supply and demand when oil ministers from the 13 members of OPEC convene this week in Vienna, and all three factors suggest the same outcome of their year-end meeting: no increase in the official price of oil.
That would mean a setback for pricing hard-liners led by Iran and a delay in a widely predicted timetable that had the Organization of Petroleum Exporting Countries boosting its price to $20 a barrel from the current $18 by the end of the year.
There are oil experts who still hold to that view, noting that unchanged prices actually mean lower real prices because of the sharp fall of the dollar, the currency in which oil is traded worldwide. By one estimate, the $18 official price established a year ago is the equivalent of about $15 today in terms of what the money will buy.
But the consensus is that, if oil prices change at all, they are more likely to drop than to climb unless OPEC drastically cuts output. The reasons include brimming oil company inventories, weak spot prices, deep economic uncertainty and the diverse fallout from Iran’s deepening feuds with the rest of the world, including the new U.S. military role in the Persian Gulf.
Iran’s growing isolation was underscored last week by a bitter public exchange between its oil minister and his Saudi counterpart that seemed to promise an especially prickly meeting, even by OPEC standards. Some concluded they would do well to maintain the status quo.
“To hold the price at $18 would be a big accomplishment,” said Hossein Tahmassebi, the chief economist at Ashland Oil Co., who sees a $3 per barrel fall in spot prices early next year.
However, the cartel hopes to take other steps at this week’s meeting to strengthen OPEC in the longer term. The top priority has been attached to bringing Iraq under the year-old production quota umbrella, a move that would trim the cartel’s total production and arguably diminish cheating by other members as well.
Already, Saudi Arabia and other members of the moderate Gulf Cooperation Council have signaled their intent to come to terms with Iraq. Success on that front would lend stability and believability to the organization’s year-old effort to re-establish its control over oil markets, analysts agree.
But OPEC remains divided over how quickly it should move, and that dispute overhangs this week’s meeting.
OPEC’s largest producer, Saudi Arabia, and allies Kuwait and the United Arab Emirates, continue to counsel patience and stable prices to gradually make the United States, Europe and Japan more dependent on OPEC’s low-cost oil.
The idea was spelled out last month by OPEC’s president, Nigerian Oil Minister Rilwanu Lukman, at a November meeting in Indonesia: “Our long-term strategy is to keep the price of oil at such a level that it would encourage people to use more oil necessities and discourage the development of very expensive oil, such as in the North Sea and the Alaskan area.”
That scenario has already begun to play itself out since a glut of oil collapsed the world price of crude to $10 from $30 a barrel in the first half of 1986. Their domestic economies devastated--OPEC producers saw revenue plunge to $81 billion from $135 billion--cartel members agreed in December, 1986, to slash production and set an official price of $18 a barrel.
That price has come to represent a comfort zone for key OPEC members and has the virtue of being too low to make it worthwhile for the United States and other non-OPEC producers to keep pumping and looking for oil. The moderate price has caused consumption to rise, non-OPEC production to fall and the cartel’s share of the world oil market to begin climbing after a five-year drop.
Easier for Some
Over the past year, Saudi King Fahd has consistently advocated prices at $18 a barrel through 1988. In a U.S. speech in November, Saudi Oil Minister Hisham Nazer noted that his country’s massive oil reserves give it “a longer time horizon in looking at the global oil industry.”
But patience is easier for such sparsely populated, oil-rich members as Saudi Arabia and Kuwait than it is for hard-pressed members with less oil and larger populations to support. They seek higher prices now.
As this week’s meeting draws near, as many as nine OPEC members fall in the latter category. The price hawks are led by an increasingly desperate Iran, its oil production badly damaged by Iraqi fighter planes. A higher price would offset the effects of production volumes that reportedly fell 500,000 barrels a day below Iran’s quota last month.
“Iran will endorse no decision which should fall short of compensating for the slump in dollar value,” Iran Oil Minister Gholamreza Aghazadeh told Tehran Radio last week.
That would require at least a $2 per barrel increase, which is what Iran has proposed, or a big increase in production. But the amount of extra production needed to make up for the dollar’s fall would flood the market further. And by most accounts, this is no time for Iran to plausibly advocate higher prices.
Isolated this year from its Arab neighbors and fellow oil producers because of its adventures in the Persian Gulf and elsewhere, Iran also finds its crude oil embargoed by the United States and France. The embargoes forced it to slash oil prices $2 to $3 below the official OPEC price to sell several tankers full of temporarily unwanted Iranian crude.
“Here you have Iran discounting oil by $3 a barrel, yet in Vienna they will be the leader in trying to raise prices,” said John S. Herrington, the U.S. secretary of energy. “Is that consistent? No.”
Meanwhile, Herrington and others say the presence of an armada of U.S. and other Western naval vessels in the Persian Gulf has emboldened Saudi Arabia and Kuwait to stand up to Iran on many issues, including oil prices. Moreover, the partnership between Iran and the Saudis that helped forge the December, 1986, price-fixing accord vanished with the violence in the holy city of Mecca, Saudi Arabia, in July.
Such hostilities led to the historic Arab summit in Jordan in November that realigned the region’s entire balance of power against Iran. It remains to be seen whether the mutual commercial interests of OPEC will override the political and diplomatic censure, but most expect an accommodation rather than a breakdown of the quota and pricing system.
“They’re all a bunch of schizophrenics,” notes Sanford C. Margoshes, OPEC analyst at Shearson Lehman Bros. “After all, Iran and Iraq are bombing each other while they’re sitting at the same table at OPEC.”
However, Iran’s Aghazadeh stepped up the rhetoric last week, accusing the Saudis and other Arab members of OPEC of endorsing a price freeze for the chief purpose of damaging Iran’s war machine in retaliation for the Mecca incident.
That brought a blistering rejoinder from the Saudis’ Nazer, who charged that Iran has been violating both the price and production terms of the OPEC accord since May. Iran wants to raise official prices now so that Iran can keep discounting and “bar other OPEC producers from marketing their oil,” Nazer claimed. He accused Iran of unloading “its domestic problems on the rest of the OPEC states.”
Whatever the political fervor might dictate, the oil economics of the moment strongly suggest an accord that keeps prices where they are. Even the deputy oil minister of Algeria, a strong advocate of higher prices, conceded last week that “what is just and what is possible may be different.”
He was referring to consistent overproduction and deep price discounting by several OPEC members over the past several months. While the official OPEC quota is 16.6 million barrels a day, the members’ actual output has been in the 18-million to 19-million barrel range in the second half of this year.
Little Growth Expected
Since anxiety over the Persian Gulf situation has subsided, prices have softened to the point where West Texas Intermediate crude oil--which is typically $1.50 to $2 higher than the grades of crude used to arrive at OPEC’s average official price--has dipped below $19 a barrel, and several OPEC members are said to be charging less than the cartel’s benchmark for their own crude.
“There is a lot of downward pressure on prices,” said Energy Secretary Herrington.
The oversupply and weak prices wouldn’t be so bad for OPEC if the outlook called for economic improvement next year, but implications of the stock market crash of Oct. 19 have raised serious doubts about any growth in 1988 oil consumption. That, in turn, would preclude an increased need for OPEC crude.
The market crash in the Western economies has potentially dire consequences for the Arab oil producers for two reasons: A worldwide recession would lessen the need for oil to run cars and factories, while the crash itself has directly eroded the value of the massive overseas investments of the oil-rich Saudis, Kuwaitis and others.
“They’re worried as hell,” says Theodore Eck, the chief economist for Amoco Corp., who recently returned from discussions with OPEC officials. “They’ve even got their own personal money involved here. It’s just not a climate for raising oil prices.”
An official forecast last week from the office of OPEC secretariat that demand for the cartel’s oil next year will average 18.4 million barrels a day was considered too high--and dismissed by some as a Saudi-inspired bargaining ploy in their bid to hold prices down.
“The secretariat is dominated by the Saudis and Kuwaitis,” said an oil expert with ties to OPEC. “I think the secretariat’s people are smart enough to know that 18.4 million is too high.”
Iraq Ignores Quotas
Chevron Corp.’s chief economist, William D. Hermann, says: “That sounds like too much by about 1 million barrels.”
The biggest single overproducer by far has been Iraq, which refuses to abide by its OPEC-mandated quota of 1.5 million barrels per day. Locked in a bloody seven-year war with Iran, the Iraqis have demanded that their quota equal Iran’s 2.4-million barrel ceiling. Meanwhile, Iraq has been aggressively expanding its pipeline system, producing up to 2.7 million barrels daily, and driving Iran’s production as low as 1.9 million barrels through repeated bombing missions.
Now, the dominant Saudi faction wants to give Iraq what it wants--a move that would actually reduce the Iraqis’ production by 300,000 barrels a day while theoretically instilling some discipline among other members of the cartel.
“That’s an extremely positive move,” says Amoco’s Eck. “The reason Iraq is such a cancerous issue is that, when they’re ignoring the quota, others tend to think, ‘Well, we have problems, too.’ When you have one kid acting up in class, it’s hard to expect everyone else to behave.”
OPEC could raise the official production quota by 900,000 barrels, to 17.5 million barrels a day, and attribute the extra output to Iraq. But that would actually cut Iraq’s production and, in theory, reduce cheating by other members, notably the United Arab Emirates. Thus, in the hazy mathematics of OPEC, the quota would rise but production would fall--and prices would firm.
The rub is Iran, which has bitterly opposed any increase in Iraq’s official quota. It is that dilemma which has prompted some OPEC watchers to predict that the cartel will, indeed, raise posted prices this week as a concession to Iran for agreeing to the higher quota for its military foe.
“I give them two chances out of three that they’ll raise prices $2 a barrel in order to give Iraq a significantly higher quota,” says analyst Margoshes. “Fahd is on record at $18 a barrel, but it’s an orchestrated effort to weaken Iran’s resolve to raise prices. It’s a bargaining ploy. He has a very justifiable out, and that’s the decline in the value of the dollar.”
That appears to be the minority view, however. Most argue that the economic realities and the memory of 1986 will carry the day and both camps will reach an agreement to maintain the current price--which is, after all, a big improvement over last year’s $10 trough.
“We expect the Kuwait-Saudi camp to prevail,” says Paul Mlotok of Salomon Bros., a regular observer at OPEC’s unpredictable meetings. “If these two major producers refuse to sell at a higher price . . . what leverage do the others have? Can the price hawks threaten to walk out? This would simply lead to lower prices, which is the opposite of what they are demanding.”
