Opec Takes a Stand, Maybe

By Barbara Rudolph

For months, the Organization of Petroleum Exporting Countries had seemed ready for the obituary columns. The oil ministers of the 13-nation group, which once cowed energy-importing countries and commanded banner headlines with every pronouncement, had become a group of divided and argumentative men, powerless to halt a long slide in petroleum prices. Last week, though, OPEC suddenly sprang from its deathbed and caught the world's attention once again. After nine days of tense meetings in Geneva, the cartel adopted a plan to slash its daily oil production by some 17% in the hope of driving prices back up. The move, like the appearance of a ghost, both surprised and disconcerted the industrial nations and gave at least a temporary morale boost to the world's petroleum producers.

The oil market reacted immediately and forcefully to the new plan, which calls for OPEC to reduce its production by roughly 3.5 million bbl. a day, down to a daily total of about 16.7 million bbl. The price for next month's delivery of the benchmark West Texas Intermediate crude jumped 30% in two days, to $15.08 per bbl. and closed the week at $14.82. Boasted one OPEC official: "We have weathered the storm. Talk about OPEC on its knees? We are standing tall again, and we are here to stay."

The accord, though, is a fragile one. Many observers are skeptical about the ability of OPEC to hold to its quotas in the face of a worldwide oil glut. Never in its 26-year history has the group sustained production cuts for any length of time. One or more of its members have always managed to cheat on agreements. Moreover, the current plan is only an interim one. It takes effect on Sept. 1 (the delay results mostly from existing contracts that must be honored) and expires on Oct. 31. The cartel has no guarantee that its members will renew the pact.

If OPEC somehow sticks to its agreement and prices keep rising, heavily indebted petroleum-producing nations like Mexico and Venezuela would clearly enjoy a boon. The production cut would also help the oil-patch states in the U.S., which felt the pinch as the price of Texas-grade oil fell from about $27 per bbl. in January to a low of $9.75 in April. Consumers, though, would face more expensive heating oil and gasoline, and if prices continue to climb, the increase could rekindle inflation and eventually weaken the world economy.

Such dangers seemed remote when the OPEC representatives gathered on July 27 at the 18-story glass-and-concrete Geneva Intercontinental Hotel. Most of the ministers were convinced that the meeting would prove as futile as their three earlier sessions had this year. Sighed Indonesian Oil Minister Subroto, as the session began: "This will be a short meeting. The political will is lacking." The members had not been able to agree on specific production quotas for each country.

The spark for a settlement came, surprisingly, from Iran. On the morning of Aug. 2, Iranian Oil Minister Gholamreza Aqazadeh approached Sheik Ahmed Zaki Yamani, his Saudi Arabian counterpart. The two men talked for about 90 minutes in Yamani's suite, which had a sweeping view of Lake Geneva. Since OPEC members were unwilling to make long-term promises to limit their oil production, Aqazadeh reasoned, Why not try an interim measure? He suggested a temporary return to the group's 1984 quota of some 16 million bbl. a day.

As part of the plan, Aqazadeh offered an unexpected concession. In the past, Iran had insisted that its production quota be twice as large as that of Iraq, with whom it has been at war for the past six years. But this time Iran dropped its usual demand. Iraq would be exempt from the agreement and could continue to produce at full capacity, about 1.8 million bbl. of oil a day. Iran would not really suffer either. It would keep pumping at present levels, lifting some 2.3 million bbl. a day.

Within three days, the cartel endorsed the plan. It requires the Saudis to slash production from a July average of 5.8 million bbl. a day to 4.35 million. Kuwait and the United Arab Emirates are also called upon to make hefty cuts, reducing their combined output by roughly 40%, to some 1.85 million bbl. a day.

This is far from the first time that OPEC has tried to cope with oil prices, which have been falling since 1981 because of sluggish world demand. The group has periodically imposed quotas, but they never stuck. For most of this decade, Saudi Arabia, OPEC's largest producer, kept its production far below capacity. Last year, though, it began a new strategy of boosting output and flooding the market. A price war ensued, as Yamani knew it would.

One goal of the Saudis' tactic was to drive high-cost non-OPEC oil producers out of business and thus limit energy exploration. To some extent, the swamp 'em and stomp 'em strategy has worked. In the U.S., for example, the number of active drilling rigs has fallen from 1,911 a year ago to fewer than 800 today.

Equally important, the Saudi strategy forced the other OPEC members to think seriously about quotas or face the prospect of almost bottomless oil prices. Before last week's agreement, some experts were predicting a price of $6 per bbl. by the end of the year. Says Sanford Margoshes, who follows the industry for Shearson Lehman Brothers: "Producers have suffered exquisite pain, and pain makes one wise." Arnold Safer, an energy consultant based in Bethesda, Md., believes "it was a do-or-die situation in Geneva."

Experts are divided about whether the OPEC pact will ultimately hang together. Shearson's Margoshes declares flatly that "it will hold." Says John Toalster, an analyst at Hoare Govett, a London brokerage firm: "The agreement represents a watershed for OPEC." The clan will stick together, these observers conclude, because oil producers have finally realized that they have nothing to gain and everything to lose from plummeting prices.

But many other analysts doubt that OPEC's plan will work. Even if members abide by the agreement, they are fighting a formidable oil glut. Some 200 million unsold barrels of oil linger on the market today, and the inventory has been building at the rate of 2 million bbl. a day. Despite the cutbacks, some experts argue, there would still be a surplus that would depress prices.

Political tensions could destroy the truce among OPEC nations. Relations between Iran and Saudi Arabia have been strained for years. The Saudis have been financing Iraqi attacks against Iran, which has itself fired upon Saudi oil tankers in the Persian Gulf region.

OPEC will undoubtedly find it difficult to enforce the pact. Poorer producers, including Libya and Algeria, have a strong incentive to pump more oil than they are allowed. Both Saudi Arabia and Kuwait have warned that they will abandon the new plan if other OPEC members pump just one barrel more than their quotas allow.

The organization also confronts some forces that are beyond its control. One wild card is what action will be taken by non-OPEC producers. Last week several of them agreed to cut back their own output in support of the OPEC accord. Mexico will slash production by 10%, to 1.35 million bbl. a day. Said Mexican Oil Minister Alfredo del Mazo: "This effort represents an important cooperation in the stabilization of the market." But Britain has no intention of cutting its output of 2.6 million bbl. a day.

Though higher prices could mean salvation for many American producers, they reacted cautiously to OPEC's action. Ernest Angelo, president of Montero Operating, a small oil-exploration firm based in Midland, Texas, believes, "People may have opened a bottle of beer or two but no champagne." Energy Secretary John Herrington said the increase in the value of oil "is going to help. Whether it will re-establish the viability of the (U.S. oil) industry, it's too early to say."

For Texas, though, oil's tentative comeback will probably not solve its budget crisis. Since each $1 drop in the price of a barrel of oil means a loss of $100 million in state revenues, Texas is expected to run a deficit of $3.5 billion this year. As a result, Governor Mark White last week called for a temporary 1.125 cents increase in the Texas sales tax, a $1.4 billion cut in public spending and a 3% reduction in pay for state employees.

In worse straits are the oil-producing debtor nations, such as Mexico and Venezuela, which have relied on petroleum revenues to keep up with their interest payments. Mexico receives 70% of its export earnings from oil. Any rise in prices is thus a blessing both for these debtors and for the U.S., European and Japanese banks that have loaned them money.

Consumers and most businesses, however, have no reason to cheer. Jan Lundberg, a California-based energy consultant, predicts that in the U.S., the average price of regular unleaded gasoline will jump 10 cents, to about 80 cents per gal. within a month or so. If the cost of oil keeps rising, airlines, trucking companies and utilities will be hurt.

For now, oil consumers and producers must wait to see if OPEC will indeed slash its output and maintain higher prices. Cutbacks are easy to promise but painful to carry out. The only true test of OPEC's strength is time.

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With reporting by Robert Kroon/Geneva and Christopher Redman/Paris, with other bureaus