Wedge Grows Among Cartel Nations : Oil Glut Shakes Up OPEC, Prompts Ties to Customers

When the oil minister of Saudi Arabia sat down with the chairman of Texaco at a London hotel last month, they did some business that could ripple far beyond the bounds of their little $2-billion refinery deal.

Buying into Texaco oil refineries in Louisiana, Texas and Delaware, as well as 11,500 service stations emblazoned with the familiar Texaco star, the Saudis were dealing another blow to the Organization of Petroleum Exporting Countries.

The world’s biggest oil exporter was dramatically advancing a commercial strategy that some believe will drive a permanent wedge between the haves and have-nots in OPEC’s 13-nation membership, enhancing the oil security of industrial nations in the bargain.

By joining Kuwait and Venezuela in linking their oil fields directly to foreign consumers, Saudi Arabia appears to be hedging its bets--protecting itself against the likelihood that today’s world oil glut will last indefinitely. In that case, it is in the Saudis’ interest to have guaranteed buyers--that is, their own refineries--for their crude.

The rush to sign up long-term customers is clear evidence that today’s glut of oil has shaken OPEC to its roots, and some say it has hastened the day when the 28-year-old cartel--as currently constituted--passes from the world stage.

But whatever satisfaction the passing of today’s OPEC might bring in the West, it would not redistribute the oil with which the Middle East is so richly endowed. Another price-regulating entity based on the same accidents of geology would probably evolve, most oil experts say.

And the ink was barely dry on the Texaco-Saudi agreement when the OPEC oil ministers, surprising many of their skeptics once again, jury-rigged another last-ditch agreement to cut production. The cartel is not very healthy, but it is still in business, managing in fits and starts to keep oil prices several dollars higher than a free market would suggest.

“It has become fashionable to consider OPEC to be a paper tiger. Not so,” says Irwin Seltzer, director of the Energy and Environmental Policy Center at Harvard’s Kennedy School of Government. “OPEC must be counted as one of the world’s most durable and successful cartels.”

Impact in Doubt

While overseas linkups such as the Texaco-Saudi arrangement are generally viewed as positive for this nation’s energy security, it remains to be seen whether this is an undisguised blessing for oil-consuming nations. And some argue that the potential for such so-called “downstream” integration by OPEC’s national oil companies is too limited to have a great impact.

But with the oil shocks of 1973 and 1979 a fading memory, these structural shifts in world oil markets make one thing clear. For OPEC, the third energy crisis is at full pitch, masquerading as cheap and plentiful oil.

Racked by back-yard financial woes due to plummeting oil revenues, and plagued by widening, seemingly hopeless conflicts in their own strategies, the nations of OPEC peer out at a dim future that promises years and years of too much oil at too low a price.

Already, the organization has seen nearly half its 1981 crude oil flow displaced by conservation, other types of energy and a gusher of crude from other countries. Last year, OPEC nations took in a paltry $96 billion in devalued dollars from oil, less than one-third what they realized in 1980.

The cartel’s inability to control the market has it pleading for support from the likes of Malaysia, Colombia and other non-OPEC nations, which collectively are cranking out too much oil to suit OPEC. Such loyal OPEC members as Indonesia, Venezuela and Nigeria hint at bolting the cartel.

Indeed, one of the few gluts worse than today’s oil glut may be the one in forecasts of OPEC’s demise. To Eliyahu Kanovsky, an Israeli economist who attracted attention by predicting all this in 1982 when it was a far tougher call, OPEC’s newly desperate plight is a permanent one.

Kanovsky says greed and internal disputes doom the cartel and that the deterioration has accelerated sharply since the price collapse of 1986. The professor at Bar-Ilan University in Tel Aviv likes to tweak the Establishment voices of the early 1980s that predicted OPEC dominance and $50- or $100-per-barrel oil by now.

Kanovsky contends that the astounding oil wealth generated in some Arab states during the 1970s--Saudi Arabia, with half the population of Canada, took in a staggering $119 billion in a single year--created an insatiable demand for more. That led to OPEC’s enormous miscalculations of 1979-81 when, misreading the market’s response to the Iranian Revolution, the cartel ratcheted its official prices up from $13 to an unrealistic $34 per barrel.

Sees Political Pressure

When prices eased and then tumbled to $9 in 1986, what he describes as political pressure to continue heavy spending on arms and other needs prompted these nations to open the oil spigots in a self-defeating bid to make up for the lost oil revenue. With OPEC production quotas thus violated, the cartel has become a mockery of itself.

“Governments are like individuals,” Kanovsky says today. “When they receive money, they spend it. So if revenues fall, the highest spending level reached becomes a floor. There is no loyalty to OPEC per se. When the minister of finance needs money, the minister of oil starts selling oil. . . . The clash of interests is too strong for the cartel to last.”

Although his perspective may reflect the Israeli view that the United States panders too much to the oil-rich Arab world, Kanovsky could well be proven right about OPEC’s self-destruction. The prospect has been seized on by some leaders as a source of great comfort.

“I don’t think OPEC can come back together,” says a confident John S. Herrington, the outgoing U.S. energy secretary.

Likely to Be Replaced

But it is only the latest body to fix world oil prices, after the Texas Railroad Commission in the 1920s and the multinational oil giants in the 1950s and 1960s. Most agree that entrenched political and economic interests around the world would ensure that some structure would emerge to take OPEC’s place.

“OPEC needs to provide a new approach to regulating the market,” says Edward N. Krapels, president of Energy Security Analysis Inc. in Washington. “If OPEC fails to provide it, such direction will in all likelihood come from somewhere else.”

Economist Mohammed Akacem of the University of Colorado, a former adviser to the Saudi government and to Algeria, another OPEC member, foresees a new “mini-cartel” by the mid-1990s that he dubs GOPEC. The “G” stands for Gulf, a reference to the Persian Gulf where about two-thirds of the world’s oil lies.

Sheik Ahmed Zaki Yamani, the deposed Saudi oil minister, agrees. Noting that OPEC is already dominated by those members with the most oil, he says those with less oil and bigger populations will drop out and the organization will evolve into a smaller but no less powerful creature.

The Richest, Poorest

The richest--those whose oil would last longest at today’s production rates--are the United Arab Emirates, Kuwait, Iran, Iraq and Saudi Arabia, in that order, ranging from 105 to 226 years. The poorest are Gabon, Ecuador, Indonesia, Nigeria and Algeria, at 9 to 38 years.

The Saudis have by far the most oil in the ground, conservatively estimated at 170 billion barrels.

“By the mid-1990s it will be a different organization than it is now. Some members will disappear as exporters of oil,” Yamani told a biographer in “Yamani: The Inside Story,” published in Britain this year. “The bulk of OPEC’s oil will come from the Gulf.”

Referring to declining U.S. oil production and an eventual fall in the oil flow from other non-OPEC sources, Yamani said: “The Arab producers will find themselves in a very powerful position. Oil as a political instrument has already been used once with success. This time no one would have to use it. They would just have to talk about it.”

Economist Akacem’s GOPEC would roughly coincide with the current Gulf Cooperation Council: the Saudis, Kuwait, the U.A.E. and non-OPEC members Qatar, Oman and Bahrain. Hardly a lesser organization, his new cartel would exclude Iran and Iraq but still control roughly 43% of the world’s oil reserves.

Without the troublesome Iranians or non-Gulf members, whose smaller oil reserves and greater need for money tend to make them pricing “hawks,” Akacem figures GOPEC would be a more stable outfit.

But even today, with the cartel’s fortunes at a low ebb, many respected energy experts contend that OPEC is functioning better than is generally realized. Without it, some say crude oil would be selling today at $6-$8 per barrel instead of $12-$15.

“Its members are sitting on some 7 to 11 million barrels (per day) of idle producing capacity, successfully keeping it off the market,” says Harvard’s Stelzer. “Were there no cartel, this capacity would undoubtedly come into production, easily driving prices down to as little as one-half of current so-called depressed levels.”

Merely noting that the Middle East holds about 70% of the known and economically recoverable crude oil, excluding the Soviet Union and East Bloc, does not do justice to this lopsided geological predicament. The fields are unusually prolific, the oil is high quality and the cost of producing it is minuscule--perhaps 50 cents a barrel in Saudi Arabia versus $15 in Bakersfield, Calif.

Region Grows Richer

The oil riches of the Gulf are literally ancient news. But today’s slower production rates, fresh assessments of the region’s oil reserves and the rapid depletion of non-OPEC reserves as other countries produce flat out, are making the place even richer in both relative and absolute terms.

To be sure, estimates of how much oil is under the earth’s surface are based partly on black art and political need. By definition, the estimates rise and fall with oil prices, discoveries, production and science. In the past year, one U.S. agency said the nation’s known oil reserves had increased--but another sharply reduced its estimate of the amount of undiscovered oil.

“It’s politics and economics, not geology,” says Charles D. Masters, chief of the world energy resources program at the U.S. Geological Survey. “We know where the oil is.”

The United States, for instance, is said to have about 28 billion proven barrels of oil left. That would last about nine years at today’s rate of production. But calculations like that have led to countless false alarms about “running out of oil.”

In fact, new discoveries, changed assessments of old fields, and shifting economics have kept this supposed supply at nine years or longer for more than 35 years.

Price Affects Estimates

Moreover, these supposedly exhaustible reserves are defined by today’s price and technology. The more the market will pay for a barrel of crude, the more barrels there are. And at $40 or more, the Western Hemisphere becomes a veritable Persian Gulf with mammoth reserves of heavy Venezuelan crude, Colorado oil shale and Canadian tar sands.

At such prices, of course, other forms of energy would become competitive as well, eventually forcing an end to the oil age. The fear is a repeat of the economic havoc imposed on the industrialized world the last time prices headed in that direction.

Over the next 10 years, the most critical difference between the oil outlook for Middle East nations and everybody else is that everybody else is producing all they can. The Persian Gulf nations, by contrast, are producing only about 65% of the oil they are capable of pumping today. And that does not take into account vast known oil fields in Iraq, Saudi Arabia and other nations that have not even been tapped yet.

While much has been made of the surprisingly resilient oil production in non-OPEC nations the last two years, the bigger picture showed a huge 1987 increase in estimated OPEC oil reserves--especially in the Gulf and Venezuela--and a net decline in the rest of the world.

By one estimate, that gives the cartel members 82% of the world’s 805 billion barrels of crude. The United States has about 4%.

Parts Still Unexplored

The ultimate reserves in some parts of the Middle East are not widely known, and the area has not been explored as much as the United States and other established oil regions. Some experts have put the potential of the world’s only known “mega-province,” in geologists’ parlance, in the Gulf at more than 700 billion barrels--almost half of it Iraq’s.

The non-OPEC oil gains “are cosmetic, in my opinion, compared to the prolific fields in the Gulf,” says Rajai M. Abu-Khadra, former adviser to Kuwait’s oil minister, now at the Center for Strategic and International Studies in Washington.

Abu-Khadra says: “These (Middle East) countries are not mature, developed fields like the U.S. And the fact that OPEC is not producing 30 million barrels a day (as in 1981) has in itself extended the life of their reserves.”

Abu-Khadra, like Yamani and others from OPEC nations, talks abstractly of the need for a “dialogue” and “cooperation” between the countries that export oil and those that consume it.

Some believe that need is now being met in concrete fashion by business deals like the one between Texaco and the Saudis.

Saudi Arabia will own 50% of three U.S. refineries and supply them with up to 600,000 barrels of crude per day. That is nearly 10% of current oil imports but less than the Saudis--who are now tied with Canada as the nation’s leading foreign oil supplier--currently ship here overall.

The new 50-50 venture, Star Enterprise, will also own or supply nearly 11,500 Texaco service stations in 23 Gulf and Eastern states when it begins operating on Saturday.

That single step will make Saudi Arabia the biggest overseas refiner of any OPEC nation. But Kuwait, which wholly owns two refineries and 4,500 stations in Europe, and Venezuela, with half-interests in four U.S. and European refineries and negotiating a part-interest in Unocal’s big Chicago-area refinery, are well-established in this burgeoning business.

It is paying off: With guaranteed outlets for so much of their oil amid the prolonged oil glut, the Venezuelans and Kuwaitis have enjoyed more stable oil output than their fellow OPEC members.

At least half a dozen other OPEC nations, in addition to national oil companies in Norway, Mexico, Brazil, China and other nations, have begun similar moves. It has been described as a return to the integrated structure of the world oil industry that prevailed before OPEC’s ascension in the late 1960s, except that governments are replacing multinational companies in the role of supplying oil from the wellhead to the gasoline pump.

Stake in U.S. Health

Despite the fact that such commercial links tend to lock the consuming countries into reliance on specific foreign oil suppliers, economists and others note that the United States already needs that oil and that our reliance of foreign crude is destined to rise. By giving the Saudis a direct stake in U.S. economic growth--the healthier our economy, the more oil we will need--the deal supposedly would discourage interruptions of supplies or steep climbs in price.

And the cheaper the crude, the more money the Saudis can make at the refinery end of the business. The venture vows to buy and sell at market prices.

Fereidun Fesharaki, a pre-revolution adviser to Iran’s oil ministry who now heads the energy studies program at the U.S.-funded East-West Center in Honolulu, says that Kuwait’s “downstream” experience--the industry’s term for refining and selling oil products--has amounted to a role reversal with healthy results.

As an aggressive peddler of gasoline through its “Q8” service stations in Europe, Kuwait finds itself buying the cheapest available crude oil, not necessarily from its own fields, to better compete with other gasoline refiners and retailers.

‘Major Lesson’

“You could see the transition from a crude seller to a product seller,” says Fesharaki, who has been studying OPEC’s downstream moves for several years. “It is a major lesson for the OPEC producers. It makes them understand the point of view of the consumer. People talk about the need for dialogue between consuming and producing nations. That’s what this is.”

The Reagan Administration has taken almost the same position. Nonetheless, new foreign stakes in U.S. energy resources make some officials skittish, and they argue that the issue needs study.

Antitrust concerns, focusing on the power of the Saudi-Texaco enterprise to undercut other refiners on price, have been raised by independent oilmen and others. A Washington-based consumer group, the Citizen-Labor Energy Coalition, and several U.S. senators have called for congressional hearings.

“We’ve been told year after year that the Middle East is the most vulnerable area of the world and that we must become less dependent on foreign oil. This ties us even closer to an unstable part of the world,” says Edwin Rothschild of the consumer group.

Fears have also been voiced that such deals will tend to depress oil exploration.

L. F. (Buzz) Ivanhoe, a Santa Barbara geologist whose estimates of the world’s undiscovered oil are widely cited in scientific journals, says that to the degree Texaco or other partners of OPEC nations are promised a long-term supply of crude, they will quit exploring for new reserves.

With such guarantees--Texaco says the Saudi deal assures it 4 billion barrels over 20 years--Ivanhoe declares: “There is no reason in the world why an oil company has to do any more exploration for new reserves.”

This nation’s open-arms response to the Texaco-Saudi venture contrasts sharply with the British government’s move this year to limit Kuwait’s rising ownership of stock in British Petroleum. Even as the British moved to shield their premier oil company, it has gone almost entirely unnoticed in the United States that Kuwait--through its stake in BP--now owns perhaps 5% of the oil reserves of Alaska.

Melvin A. Conant, an influential Washington oil watcher who publishes the newsletter Geopolitics of Energy, says the United States should limit such investments from any one part of the world. He also suggests the foreign government agree to store enough oil for U.S. markets to last 90 days as a strategic reserve in times of tight markets.

‘Things Can Go Wrong’

“If nobody’s watching, all kinds of things can go wrong,” he says. “Other than that, the advantages are overwhelming.”

For OPEC, this trend toward integration creates yet another bone of contention--possibly a final one--because the financial motives of those members with downstream operations will funda-mentally conflict with those that remain only crude oil producers.

“Those with refining and marketing assets . . . may find they have more in common with the (multinational oil companies) than with other OPEC members,” says an analysis by the Petroleum Finance Co. of Washington, an oil trading and finance firm.

Those OPEC members looking most aggressively for overseas refineries, in addition to the Saudis, Venezuelans and Kuwaitis, are the United Arab Emirates and Nigeria. Those least likely to tie up with overseas refineries, because of probable objections by the host nations, are Iran, Iraq and Libya.

Limited Weapons

About the only power left in their hands would be to drive prices down, not the sort of oil weapon that strikes fear in Western consumers.

For all the positive reaction to such commercial deals, some doubt that they will ever account for significant share of the world oil market. John Wood-Collins, a former oil executive now at Arthur D. Little, says that “a dramatic revolution in the structure of the industry is unlikely to occur.”

And even those who consider it an important development that makes the United States more secure, such as the analysts at the Petroleum Finance Co., hedge their enthusiasm with a familiar Middle East qualification: “barring any unforeseen outbreaks of hostilities between or against producing nations.”

Next: The nation’s uncomfortable energy options.

World Oil Reserves Free World 808 Billion Barrels: Africa: 6.8% Latin America: 14.1% North America: 4.0% Western Europe: 2.8% Asia & Pacific: 2.4% Middle East: 69.9% Total World 887 Billion Barrels Communist Nations: 8.9% Other Free World: 15.5% OPEC: 75.6% Source: Arthur Andersen & Co./ Cambridge Energy Research Associates