OPEC Dilemma

OPEC Dilemma How to handle the glut

Twice in the past ten years the Organization of Petroleum Exporting Countries has sent the price of crude oil spurting, bringing riches to the 13-nation oil cartel and economic agony to just about everyone else. But now the combined effects of conservation and worldwide recession have left oil prices skidding, created a global supply glut where once there was scarcity, and shaken the foundations of the formidable cartel.

This weekend, when the ministers of the world's least loved cartel gather in Vienna, the session is apt to be the stormiest ever. The members are poorer than they once were; oil exports lifted the current account balance of the OPEC nations to a record $109 billion surplus in 1980, but this year there will be a deficit, estimated at more than $15 billion. The delegates must face the painful fact that they can no longer control both prices and production at high levels, a nettlesome problem because OPEC members have shown little inclination to live with production quotas.

This has become abundantly clear since last March when Saudi Arabia, the group's biggest producer at 7.5 million bbl. per day of output, forced through what amounted to a 9.6% production cut. Its purpose: to take up slack in the market and prevent petroleum prices from slipping below the cartel's official $34-per-bbl. bench-mark level. Once they had agreed to the cuts, Iran, Libya, Venezuela and several other cash-squeezed member states began pumping crude at levels above their ceilings (see chart), as well as discounting the price to their customers. As a result, by last week prices on the unregulated spot market had dropped to $29 per bbl., down from an alltime high of $42 two years ago. Meanwhile, a worldwide glut of oil has developed, swelling to more than 4 million bbl. per day in excess of demand.

In an effort to halt the slide, Saudi officials have been pressuring OPEC's discounters to stop their cheating on prices and production. If necessary, the Saudis recently began hinting, Riyadh would start price cutting, offering gargantuan discounts that would drive all other exporters from the market.

In fact, the cautious and conservative-minded Saudis are much more likely to use a carrot at Vienna than a stick. The betting is that they will favor holding the official price at $34 per bbl. As for production, the Saudis might decide to raise the spring quotas by about 10%, which would legitimize the cheating with a return to pre-March levels, while perhaps trimming their own output to keep the glut from growing worse. At the same time, the Riyadh government would stand ready to provide low-interest loans to help tide over financially squeezed cartel members until the world economy starts to recover and, the Saudis hope, oil sales begin to improve.

To the Saudis, a compromise approach is much more appealing than a high-risk strategy of dramatically slashing prices in order to drive other members into line. Reason: though economists generally agree that a slow and moderate decline in prices to, perhaps, $25 to $28 per bbl. would on balance be a long-term tonic for the wavering world economy, a sudden and wrenching break in prices brought on by runaway discounting could prove perilous for oil exporters and importers alike.

As the loan problems earlier this year at Oklahoma City's Penn Square Bank attest, a further decline in oil prices would put pressure on many bank balance sheets. That is because billions of dollars have been lent out since the late 1970s to exploration and development companies that, until recently, had been counting on ever higher prices for their discoveries. If prices were now to collapse, banks would have little choice but to write off many of these loans as worthless.

Worse, financial experts like Rimmer de Vries, chief international economist for Morgan Guaranty Trust Co., are worried that a further slump in prices would gravely aggravate the already large financial problems of such debt-ridden oil-exporting nations as Mexico and Nigeria. Together, the two nations have borrowed at least $90 billion from foreign lenders. A gentle price decline, as opposed to a nosedive, would not be disastrous, since lower oil prices translate into lower worldwide inflation and thus lower interest rates for debtors.

An oil price rise seems out of the question, barring some blowup in the Middle East. But oilmen cannot afford to rule that out. The big fear is that the stalemated 27-month war between Iran and Iraq might suddenly spill over into a generalized Persian Gulf conflict, enveloping Saudi Arabia and other producers.

For consuming and exporting nations alike, the ultimate message pre-Vienna is already clear enough: when it comes to oil, collapsing prices, like runaway increases, can threaten the world economy, at least in the short run. Many bankers are saying that the best they can hope for in Vienna is no change in price. That is probably what they will get.

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