Cheap Oil!
By Stephen Koepp.
The epic oil plunge of the 1980s started out slowly and a bit remotely. To most people, it was just a downward-sloping diagram on the financial page, an abstract reminder of the mysterious world of desert oil wells, filthy-rich Arabs and the irritating antics of OPEC. But suddenly oil's new situation is hitting home with the wallop of a 42-gal. oil barrel dropped on the front porch. Last week consumers, businessmen and traders around the world watched in awe as the price of crude dipped below $10 per bbl. for the first time in almost a decade. Oil, which as recently as January was selling for $26 per bbl., was on a breathtaking--and dangerous--ride down a slippery slope.
For citizens in petroleum-gulping countries from the U.S. to South Korea, oil so cheap is an unexpected and unbelievable windfall. A Vermont homeowner may enjoy a heating-fuel bill cut nearly in half next winter. An Italian consumer can celebrate the lowest inflation in 14 years. A family in Chad stands a better chance of getting adequate food because petrochemical fertilizers have become less expensive. A motorist in the Philippines can enjoy a 30% drop in the price of premium gas.
The fortunate ones can scarcely enjoy their energy feast, however, without noticing the look of distress on the faces of their neighbors. For the same plunge that benefits oil users has battered the regions that produce petroleum. In Saudi Arabia, an Egyptian worker is likely to lose his high- paying job and return home to poverty. A Mexico City family may no longer be able to afford meat and vegetables because government food subsidies have been slashed. A well-drilling entrepreneur in Oklahoma could face bankruptcy and the loss of his business to creditors. A bank loan officer in California may be forced into a different career because the oil-lending business has declined.
Like the petroleum crisis of the past decade, which threatened the industrial might of the West, the oil slide is changing the balance of economic power. The price drop, from a peak of $35 per bbl. in 1981, has greatly reduced the flow of billions upon billions of dollars from consuming countries to the producers. The so-called petrodollar drain of 1979-83 had contributed to the worst global economic slump since the Great Depression. But cheap oil will act as a giant tax cut, or perhaps a lottery jackpot, for the consumers and businesses of such large industrial countries as the U.S., West Germany and Japan. Many economists think that bargain petroleum will bring a go-go era of healthy growth that could last until the early 1990s. Citizens are likely to enjoy a garden of economic delights, including a better chance of finding jobs, and lower prices for petroleum-based products ranging from polyester clothing to phonograph records (see following stories).
While falling oil prices are picking up the world economy, they are shaking it at the same time. Developing countries from Mexico to Indonesia, which had built their economies and their dreams on oil revenues, now watch in anguish as those hopes of prosperity evaporate. The repercussions could go well beyond economics as those countries express their resentment toward consuming countries, many of which are rich industrial lands. The crisis could inflame tensions in the Middle East, in particular, where oil revenues have dropped from $237 billion in 1980 to an estimated $110 billion last year. Last week Israeli Prime Minister Shimon Peres, who visited the U.S. to confer with Secretary of State George Shultz, called the oil plunge a threat to peace in the Middle East and urged Western countries to begin a modern-day Marshall Plan to aid the region, using some of the money saved by lower oil prices.
The U.S. has a sore spot as well. The oil-patch states of Texas, Oklahoma and Louisiana have been so severely affected that their troubles could spoil the rest of the country's party, at least in the short run. Bankruptcies and layoffs plague the oil business and nearly every industry connected with it. Though the Labor Department announced last week that U.S. unemployment dipped to 7.2% in March, down a notch from 7.3% in February, the jobless rate has stayed unexpectedly high at least partly because of the oil- patch slump. Unemployment in Louisiana has reached 13.2%.
For most Americans, the question that gnaws like an engine knock is how much time they will have to enjoy cheap oil. Will it give the U.S. a long, easy journey or just a nostalgic joyride? The highly volatile price of oil could jump several dollars a barrel in only a few days, or it could lie low. Many energy experts have begun warning that oil prices below $10 per bbl. will set up the U.S. for another oil shock in the future. In fact, when adjusted for the inflation that has taken place over the years, today's oil price is virtually as low as it was in the pre-oil-crisis days of 1973, when crude cost about $4 per bbl. If prices stay at this level, U.S. producers could be devastated, and the country could return to the dreaded dependence on foreign oil that it has largely escaped. Says M.I.T. Economist Lester Thurow: "At this price level, we will probably shut down a lot of our wells, so that instead of importing about a third of our oil needs, we will end up bringing in about 40% to 45%."
President Reagan so far has extolled the benefits of cheap oil and avoided talking about the dark side. But last week the Administration showed the first signs of concern about the disruption of domestic oil production. Speaking to reporters on Monday, Energy Secretary John Herrington laid down a warning to Saudi Arabia, the country that helped start the current price war by drastically boosting its output. The kingdom's strategy has "created severe problems for the American petroleum industry," Herrington said, and could have "political implications" for the Saudis if they continue it.
While that statement heartened U.S. oil drillers, along came a more dire forecast by Mani Said al-Oteiba, the Oil Minister of the United Arab Emirates. He declared OPEC--the Organization of Petroleum Exporting Countries--to be in disarray and predicted that prices could fall as low as $5 per bbl. His remarks helped send the price of West Texas Intermediate, a benchmark crude, tumbling to $9.75 per bbl. Tuesday on the New York Mercantile Exchange.
Oil prices whipsawed upward later the same day when Vice President George Bush, a former Texas oilman, seemed to imply that he would try to persuade the Saudis to throttle back their output. At a press conference Bush gave as he prepared to leave on a trip to the Middle East, the Vice President said, "My plea will be for stability of the marketplace." But a senior White House aide quickly denied that the Administration would depart from its free-market philosophy, "even if it means the oil price drops to $1." The seemingly conflicting comments generated jitters in the oil-trading pit of the New York Merc, where the price of West Texas Intermediate edged back up to $12.74 at week's end.
Even the passing idea that the Administration might want to ask OPEC to withhold oil from the market struck many experts as a colossal irony. Said Robert Hormats, an investment banker with New York City's Goldman Sachs and a former Assistant Secretary of State: "Talk about a world being upside down. Only a few years ago, we were asking them to raise production as much as possible."
The U.S. has come a long way from the 1970s, when it suffered through two oil shocks. The first came in 1973, when the Arabs embargoed oil in retaliation for U.S. support of Israel; the second in 1979, after the overthrow of the Shah of Iran cut off that country's supply. The shortages, even though they were never greater than 10%, enabled the oil producers to crank prices ever higher. OPEC became a nasty acronym in the West, the favorite villain of cartoonists and columnists.
U.S. consumers responded bitterly, some of them by hoarding fuel and getting into fights at filling stations. Eventually an effort to conserve took hold. At one point, President Carter declared conservation "the moral equivalent of war." Consumers turned off unnecessary lights, rode bicycles, dialed thermostats down to 65 degrees F and drove 55 m.p.h. instead of 70 m.p.h. Meanwhile, rising prices made it economical for utility companies to convert to coal-fired and nuclear-powered plants and for other businesses to install new energy-efficient equipment. Some homeowners even began heating their houses and pools with solar panels. Result: the U.S. reduced its reliance on oil imports from 8.6 million bbl. per day in 1977 to 4.3 million bbl. last year. Even better, much of that supply came from such newly expanded sources as Mexico and Britain rather than the volatile Persian Gulf countries.
While learning their lessons, though, the industrial nations suffered great economic hardship. The price increase virtually sucked money out of the countries as fast as they could print it, which slowed growth and aggravated inflation and unemployment. Many Western countries finally began to break free of that pattern this year, thanks to falling interest rates and the decline in oil prices. Conservation measures now enable the industrial economies to grow without increasing energy use at the same rate. Between 1973 and 1985, the U.S. economy expanded by almost one-third while energy consumption fell slightly. Says Rimmer de Vries, chief international economist for Morgan Guaranty Trust: "We used to be hooked on oil. But now the tight relationship between oil and growth has been considerably loosened."
Falling oil prices have greatly eased the problem of global inflation. Economists expect U.S. consumer prices to rise about 1.7% in 1986, the least since 1965 and about half the level forecast at the beginning of the year. Defused inflation has in turn enabled central bankers around the world, including the U.S. Federal Reserve Board, to stimulate their economies with fairly easy credit. When the leaders of the seven major industrial countries meet for an economic summit next month in Tokyo, they may push even harder for growth by agreeing to lower interest rates or cut taxes. Walter Heller, who was chief economic adviser to President Kennedy, believes that the U.S. economy will start growing at a healthy 4% to 5% rate by the end of the year.
A much lower oil bill will help the U.S. make progress against its two most stubborn economic problems. Boosted by cheap fuel, a robust economy could reduce federal budget deficits by a total of more than $100 billion during the next three years, according to one estimate. Less costly oil imports should cut the U.S. trade deficit, which hit $148.5 billion in 1985, by some $30 billion a year.
Wall Street has become so enthralled by cheap oil that the slight rise in crude prices at the end of last week helped trigger a spasm of disappointment in the stock market. Fearing that petroleum has already fallen as far as it can go, investors sent the Dow Jones industrial average plummeting a record 82.50 during the week, to close at 1739.22. Earlier the Dow had ended the first quarter up 17.6% since the beginning of the year.
The anticipated U.S. growth spurt may be delayed for several months while / the economy absorbs the oil-patch troubles. The beleaguered economies of Texas, Louisiana and Oklahoma, which account for 10% of total U.S. goods and services, are large enough to create a drag on the rest of the country. Major American oil companies have made billions of dollars in budget cutbacks, and that will at least temporarily offset the increased spending by other firms preparing for the good times ahead.
Western Europe will experience a slight lag as well because its manufacturers will have difficulties selling goods to struggling oil-producing countries. Even so, European countries are poised for a quick takeoff. "There should be no major downside risks for Europe, since they are not significant producers of oil," observes Alan Greenspan, chairman of the Council of Economic Advisers under President Ford. Europeans, who have historically paid higher gasoline prices than have Americans, cheer the oil slide as if it were a sporting event with the home team winning. OIL REACHES PREHISTORIC PRICES, exulted Spain's financial daily Cinco Dias.
Thanks partly to low-cost fuel, Europe is expected to show real growth of about 3.5% this year, its most vibrant performance in a decade. Several governments aim to use the opportunity to make fundamental improvements in their economies. Italy's Prime Minister, Bettino Craxi, for example, hopes to reduce the country's runaway budget deficit, which is expected to hit $50 billion this year.
Japan, which imports 99.8% of the oil it uses, could save as much as $23 billion on crude this year, which will help offset the loss of export business it has suffered because of the rapid appreciation of the yen. Oil-using nations that are less well off will benefit too. In sub-Saharan Africa, lower expenses for transportation and farming could start to raise living standards after many years of decline. Some countries with state-owned oil companies, notably India and Pakistan, have so far refused to pass savings along to consumers, deciding instead to spend the money on government programs. That position has riled consumers, who see it as a hidden tax.
Though oil prices have been drifting downward since 1981, the current price war began when Saudi Arabia got fed up with its OPEC partners. For years the kingdom, which holds about one-fourth of the world's oil reserves, tried almost single-handed to prop up prices by curbing its production. The country wound up slashing its output from a peak of 10.3 million bbl. a day in 1981 to ! a low of 2 million bbl. a day last June. During that time its annual oil revenue fell from $113 billion to $28 billion. Many of the other twelve countries in OPEC, meanwhile, conducted a thriving business by secretly cheating on the group's voluntary agreements to cut production.
By last summer, Saudi royalty started to feel like the suckers of OPEC and grew impatient with Oil Minister Sheik Ahmed Zaki Yamani. "He does not know what he is doing," declared one prince. "We should cut and run from OPEC. Why should we suffer to protect them?" Finally in September, the Saudis quietly decided to throw their production into high gear and reclaim the country's lost market share. The giant petroport at Ras Tanura and the offshore loading terminal at Ju'aymah sprang to life, their 56-in. pipes spewing more than 4 million bbl. a day.
Even though the Saudis stayed inside their OPEC quota of 4.3 million bbl. a day, they could not help creating a huge surplus that angered many of their colleagues in OPEC, notably, the Libyans, Algerians and Iranians. Yamani, defending his country's action, has blamed non-OPEC producer Britain for contributing to the glut and has called on London to cut output. Britain stoutly refuses.
The 13 ministers of OPEC, along with delegates from five other producing countries, met late last month in Geneva in an attempt to patch together an agreement for sopping up the glut. The nine-day marathon session degenerated into what one delegate called "a state of unprecedented disarray." Even the meeting quarters seemed a mockery of the group's onetime ability to intimidate the industrial powers. Because most of the Hotel Inter-Continental was already booked, the ministers had to cram into a tiny conference room for their meeting.
Indonesian Energy Minister Subroto gamely tried to work out a compromise plan to cut production, but several delegates refused to budge. "Not one barrel," said Venezuelan Oil Minister Arturo Hernandez Grisanti, who is currently OPEC's chairman. Even as Saudi Arabia's Yamani was calling for other countries to cut back, he was at work in his Geneva hotel room lining up a large order for new oil deliveries, according to Kenneth Miller, executive editor of Petroleum Intelligence Weekly.
The OPEC delegates are scheduled to meet again on April 15 in Geneva to ponder further how to halt the price decline. Whatever is decided, the mere appearance of unity at that session would at least temporarily send oil / prices back up. But many experts doubt either that OPEC can reach an agreement acceptable to all its members or that members would actually honor any commitments to cut production.
The one factor most likely to rein in the Saudis would be pleading and threats from their gulf brethren. "The pressures on the Saudis will increase. They have to ask themselves whether they can continue to take the heat from countries that need oil revenues, and the answer is no," says Henry Schuler of Georgetown University's Center for Strategic and International Studies. Iran has claimed that its brutal February advance into Iraq was partly a warning to the Saudis. Said Iranian President Seyed Ali Khamene'i: "We shall respond to fists by fists. The price war is no less important to us than the military war at the front."
Tough talk like that demonstrates the ominous desperation of regimes suffering from dried-up oil dreams. Says Hormats: "The geopolitical impact of the oil-price collapse is immense and unpredictable." A Bank of America report issued last week predicts that average inflation in the Middle East will jump from 28% to 40% by 1988 and that the region's economic growth will be a slow 1% to 2% a year. Oil producers, especially those with heavy foreign debts, may pick the U.S. as a worthy target. Writing in the current issue of Foreign Affairs, Edward Morse, a former Deputy Assistant Secretary of State, maintains that the oil slump could further taint the attitudes of those countries "toward the West in general, and the U.S. in particular, provoking a likely nationalistic response based on a belief that Western governments somehow engineered the price collapse. It would possibly further fuel Islamic fundamental nationalism in the Persian Gulf."
The mass exodus of hundreds of thousands of laid-off migrant workers --mainly Egyptians, Palestinians and Pakistanis--from the Persian Gulf could overtax their native lands and stir political unrest. While singling out no particular country, Secretary of State Shultz cautioned last week, "History teaches that nations in deep economic distress are more vulnerable to political instability, to the simplistic appeals of demagogues who preach siren songs of war and confrontation as a diversion from home."
Shultz made the statement at a Washington lunch for Israel's Peres, whose warnings of increased instability in the Middle East are taken seriously in the capital. On the one hand, Israeli officials say their country has been strengthened diplomatically by the oil glut. The declining petropower of the Arab countries has emboldened many Third World oil-using nations to renew contacts with Israel broken off during the 1974 oil crisis. But closer to home, some Israeli officials see increased potential for an attack by Syria, which has fallen on hard times partly because beleaguered Iran has cut off its subsidies to the Damascus regime.
In his new "Marshall Plan," Peres suggests that the major beneficiaries of the oil glut should ante up $20 billion to $30 billion for a fund to spur development in Egypt, Jordan, Lebanon, Syria and Israel. The proposal, even if not considered utopian, would face many obstacles, including the U.S. need to cut its budget and the reluctance of Arab countries, which have so far refused to join a program initiated by Israel.
Another strategic question is how the Soviet Union will respond to the loss of revenue from its oil exports to Europe and Japan. Sales of about 1.3 million bbl. a day last year provided the Kremlin with about 60% of the currency it spent on Western grain and technology. The Soviets could retaliate by trying to increase their influence over troubled oil producers like Libya. Soviet spokesmen now routinely characterize the oil-price decline as a conspiracy by "Western monopolists."
The most immediate threat to the U.S. is financial. Bankers fear a default by hard-pressed oil producers, notably Mexico, which owes $97 billion, or Nigeria, a $17 billion debtor. Mexico alone owes about $70 billion to U.S. institutions, including Chase Manhattan and Bank of America. The banks, and probably the whole U.S. financial system, would be staggered if Mexico were to walk away from its debts.
In recent weeks, though, bad loans in the U.S. oil patch have joined the long-standing Mexican problem at the top of bankers' worry lists. Energy loans gone sour have already forced the federal bailout of one major U.S. bank, Continental Illinois, in 1984, and the latest surge of bankruptcies in the energy belt could at least cause some smaller institutions to collapse. The top U.S. banks have an estimated $40 billion in oil and natural gas loans on their books, and more than half of the money has been lent to vulnerable small companies.
The three U.S. agencies that regulate banks--the Comptroller of the Currency, the Federal Reserve Board and the Federal Deposit Insurance Corporation--said last week that they plan to ask Congress to relax laws that prohibit interstate banking. Reason: the regulators have begun preparing contingency rescue plans in which several big-city banks would stand ready to take over faltering institutions in the oil patch.
The main long-term danger to the U.S. is increased reliance on foreign oil. Many business leaders and politicians have taken note that ultralow oil prices are threatening to stunt domestic production. Gerald Greenwald, vice chairman of Chrysler, sees the peril of another oil shock. Says he: "We've been burned twice before, and we see the elements of No. 3 taking shape."
The concern is that low prices have erased the profit margins of many U.S. producers, forcing them to shut down their wells. While Persian Gulf countries can pump oil for less than $5 per bbl., many U.S. wells cost $12 or more per bbl. to operate because much of the easily accessible crude has already been tapped. Some oil analysts believe that one goal of the Saudi price-war strategy is to bankrupt many of these high-cost producers, wipe out the glut and then boost prices once again when the competition is gone. Most forecasters think that oil prices below $10 per bbl. are a distortion caused by OPEC's overproduction and cannot last for long.
In the meantime, though, the unnaturally low prices can cause plenty of havoc. Small U.S. oil companies have already shut down thousands of so-called stripper wells, which individually produce fewer than 10 bbl. a day but collectively supply the U.S. with about 15% of its total production of 9 million bbl. a day. If most of those wells close, the country could lose a sizable portion of its reserves. Says Allan Martini, a senior vice president at Chevron: "Once some old wells stop pumping, it's almost impossible to get them producing again. It isn't a question of turning the tap off and bringing it back later." The U.S. can ill afford to give up reserves, since it holds only 4% of the world's known supply, in contrast to about 55% in the Middle East.
The odds of finding more oil are declining at the moment because tumbling prices have forced oil companies to slash their exploration and drilling budgets. Last week Ohio-based Standard Oil said that it will spend only about $450 million this year looking for crude, a 50% cut from 1985. The cutbacks affect not only the U.S., but also the allies from which it buys oil. In Britain's offshore fields, observes Petroleum Intelligence Weekly, "concern is starting to center on a spending slowdown that could leave the North Sea industry ill equipped to pick up again."
The oil bust has spoiled the economics of alternative energy sources as well. Many of the ballyhooed 1970s-era programs to extract petroleum from oil shale and tar sands have been mothballed because they cost too much to operate. The hundreds of mom-and-pop solar-power companies that sprang up in the past decade have mostly folded, even in the Sunbelt. Says Susan deWitt, executive director for the California Solar Energy Industries Association: "Our customers no longer feel the urgency to pursue renewable energy." The U.S. is not alone in that regard. Brazil's innovative alcohol-fuel program will be cut back 13% this year.
A major factor that will help keep the U.S. from being at OPEC's mercy, at least during the next few years, is that America's energy-conservatio n record is not likely to be reversed. Thanks to federal fuel-economy standards and competition from efficient Japanese imports, new U.S.-made autos now average about 26 m.p.g., nearly double the mileage of cars in 1973. New refrigerators are about 72% more efficient than they were in 1972. While a few Americans may decide to indulge in such frivolities as heating their outdoor swimming pools during the winter or driving their Cadillacs at 80 m.p.h.--though the law still mandates a 55-m.p.h. limit--most conservation measures are already built in. In recent weeks, dozens of economists across the land have been soothing energy alarmists by intoning the same line: "No one is going to rip the insulation out of the walls." Says Energy Secretary Herrington: "The country is never going back to 1973. We have had a major changeover."
Another backstop against an OPEC-induced shortage is the strategic petroleum reserve started in 1975 by President Ford. By the end of May, the U.S. will have filled a series of hollow salt domes in Louisiana with about 500 million bbl., enough to meet U.S. oil-import needs for 100 days. The Reagan Administration has proposed stopping short of the final goal, 120 days' worth, as a way of cutting the federal deficit. But at these oil prices, the Administration is now thinking of continuing to stock up before the discount binge ends.
What else can America do to prevent another oil shock? The question has taken on renewed urgency in Washington. Among other proposals, the Administration wants to streamline the process for licensing nuclear-power utilities and plans to seek more money to support research into clean-burning coal plants. But the most talked-about concept in Congress is a tax on imported oil, which would pay the twin dividends of reducing the budget deficit and helping to prop up domestic suppliers by increasing the price. Says Heller: "The gains we make from the drop in oil prices ought to give us a kitty for helping the losers." As retail energy prices drop lower, the imposition of a small tax could be increasingly painless for consumers.
President Reagan, however, remains adamantly opposed to any increased tax. Some economists believe that the levy could harm the international competitive position of U.S. companies. Says Michael Tusiani, a New York City energy consultant: "An oil-import fee would make the cost of energy more expensive for U.S. manufacturers." The problem in passing a new tax into law would be persuading the whole country to accept an additional burden that in the short run appears to help only the J.R. Ewing types. "Most Americans seem to have little sympathy or understanding for the plight of the U.S. oil industry," says Sam Nakagama, a Manhattan economic consultant. Thurow concurs: "If you impose a tax on New England to subsidize Texas, there would be a big fuss."
In contrast to how it fared in the difficult decade of the 1970s, the U.S. now stands as a winner in the energy game. Even a brief era of low-cost oil will give the country an opportunity to enhance American prosperity without fearing the old nemesis of inflation. Yet in enjoying this good-times atmosphere, the U.S. cannot afford to forget the tough lessons of the past. It should aim to preserve its oil independence so that the economy can keep cruising down the road instead of sputtering to the curb once again.
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With reporting by Barry Hillenbrand/Bahrain and Frederick Ungeheuer/New York, with other bureaus