OXFORD l N m

E N E R G Y STUDIES

= FOR-

The Impact of Oil Prices on Demand, Supplies

and the Petroleum Industry

Robert Mabro

Oxford Institute for Energy Studies

WPM 7

1986

The contents of t h i s paper d o not r e p r e s e n t t h e v i e w s of t h e Members of t h e Oxford I n s t i t u t e f o r Energy Studies .

Copyright Q 1986 Oxford Institute €or Energy Studies

ISBN 0 948061 13 8

POSITIOA PAPERS

The O x f o r d I n s t i t u t e f o r Ene rgy S t u d i e s f r o m t i m e io t i m e

p u b l i s h e s p a p e r s on t o p i c a l o i l and energy i s s u e s . These p a p e r s

a s ses s t h e s t a t e o f i n f o r m e d o p i n i o n on t h e p r o b l e m a t h a n d ,

p r e s e n t a l t e r n a t i v e v i e w s a n d , wheneve r r e l e v a n t , make p o l i c y

s u g g e s t i o n s . The i r purpose is t o c o n t r i b u t e t o t h e d e b a t e t h a t

su r rounds i s s u e s of c u r r e n t importance.

This p o s i t i o n paper is based on t h e p roceed ings of a n I n s t i t u t e

m e e t i n g o f i n d u s t r i a l i s t s and e x p e r t s , h e l d i n Oxfo rd o n 4 t h

F e b r u a r y 1986. The m e e t i n g a d d r e s s e d t h e f o l l o w i n g q u e s t i o n :

What i s t h e i m p a c t of r e c e n t c h a n g e s i n t h e w o r l d p e t r o l e u m

m a r k e t on t h e s t r u c t u r a l f e a t u r e s o f t h e o i l i n d u s t r y ? This

p a p e r is n e i t h e r a summary o f t h e d e b a t e n o r a r e p o r t o n t h e

d i f f e r e n t v i e w s exp res sed . Its a u t h o r i s e n t i r e l y r e s p o n s i b l e

f o r t h e c o n t e n t s and c o n c l u s i o n s w h i c h r e f l e c t a s much h i s own

o p i n i o n s as t h o s e of t h e p a r t i c i p a n t s .

EXECUTIVE SUMWRY

The d o u b l e s q u e e z e on OPEC’s o i l o u p u t c a u s e d by a f a l l i n t h e world demand f o r o i l and a r a p i d growth i n non-OPEC s u p p l i e s i s p r e v e n t i n g t h i s o r g a n i z a t i o n from performing a p r i c e s t a b l i z a t i o n r o l e . The c u r r e n t o i l p r i c e c r i s i s i s t h e consequence of t h e s e developments.

In t h e absence of o u t p u t r e g u l a t i o n , p r i c e s w i l l c o n t i n u e to f a l l i n t h e medium term t o w a r d s m a r g i n a l e x t r a c t i o n c o s t s and t o f l u c t u a t e v e r y e r r a t i c a l l y a r o u n d t h i s t r e n d . T h e r e a r e no a u t o m a t i c and r e l i a b l e p r i c e s t a b i l i z e r s i n t h e short run.

Low o i l p r i c e s ($15-18) c o u l d r a p i d l y induce s u b s t i t u t i o n of f u e l o i l f o r c o a l i n power s t a t i o n s . However, p o l i t i c a l and i n s t i t u t i o n a l f a c t o r s ( t h e p r o t e c t i o n o f c o a l ) m a y r e d u c e t h e s i g n i f i c a n c e of t h i s impact.

I n t h e l o n g e r term low o i l p r i c e s would s t i m u l a t e demand through b o t h s u b s t i t u t i o n and income e f f e c t s . The m o s t o p t i m i s t i c f o r e c a s t e s t i m a t e s a maximum i n c r e a s e i n o i l demand by 1990 of 3- 4 mb/d ( s u b s t i t u t i o n ) a n d 1.0 mb/d (GDP e f f e c t ) . A m o r e p e s s i m i s t i c v i e w about e l a s t i c i t i e s p u t s t h e i n c r e a s e a t 2-3 mbld ( s u b s t i t u t i o n ) and 1.0 mb/d ( income) . Thus t h e i n c r e a s e i n demand by 1 9 9 0 , o v e r and a b o v e any i n c r e a s e e x p e c t e d t o h a v e t a k e n p l a c e i n t h a t y e a r w i t h o u t a p r i c e f a l l (2.0 mb/d ) , w o u l d r a n g e from a minimum of 3.0 mbld t o a maximum of 5.0 mb/d.

The i n t r o d u c t i o n o f a n i m p o r t l e v y i n t h e US and h i g h e r e x c i s e t a x e s i n o t h e r OECD c o u n t r i e s is a d i s t i n c t p o s s i b i l i t y . I f t a r i f f s and t a x e s a r e i n t r o d u c e d i n major i m p o r t i n g c o u n t r i e s t h e i n c r e a s e i n o i l demand by 1990 i s u n l i k e l y t o exceed 2-3 mbld.

Non-OPEC s u p p l i e s a r e g e n e r a l l y expected t o r i s e by 1.0 mbld i n 1990 compared w i t h 1985. The p r i c e f a l l h a s l i t t l e i m m e d i a t e e f f e c t on non-OPEC s u p p l i e s e x c e p t i n t h e US. The i m p o s i t i o n of a t a r i f f wou I d l e a v e t h i s s u p p l y o u t 1 ook u n c h a n g e d . Non-OPEC s u p p l i e s i n 1990 may be 1.0 mb/d lower t h a n i n 1985 i f p r i c e s a r e low and c o n s u m i n g c o u n t r i e s do n o t i n t r o d u c e new t a x e s and t a r i f f s .

The main c o n c l u s i o n s a r e : ( a ) A low o i l - p r i c e s t r a t e g y m a y p r o v e c o s t l y f o r OPEC i n t h e medium t e r m , b e c a u s e t h e r e v e n u e l o s s e s i n c u r r e d t h r o u g h low p r i c e s w i l l n o t be r e c o u p e d t h r o u g h demand i n c r e a s e s and r e d u c t i o n i n non-OPEC s u p p l i e r s u n t i l t h e ear ly 1990s.

(b) A s t r a t e g y aiming a t b r i n g i n g t h e p r i c e of o i l i n t o t h e $22- 25 r ange would be t h e l e a s t a t t r a c t i v e . It would i n v o l v e r e v e n u e l o s s e s and p r o v i d e no s t i m u l u s t o demand.

( c ) Non-OPEC c o u n t r i e s and t h o s e O P E C c o u n t r i e s f o l l o w i n g a n o u t p u t m a x i m i z a t i o n p o l i c y w o u l d l o s e most from a low p r i c e s t r a t e g y . The r e v e n u e loss w o u l d n o t be m i t i g a t e d by f u t u r e i n c r e a s e s i n ou tpu t .

THE W A C T OF LOW O I L PRICES 08 DEMAHD, SUPPLIES BHD THE PETROLEUM INDUSTRY

Robert Mabro

1. TBE ORIGIBS AND CAUSES OF THE FALL IN O I L PRICES

The r e c e n t c o l l a p s e of o i l p r i c e s on s p o t and f u t u r e s

m a r k e t s f o r c r u d e s and p r o d u c t s is t h e r e s u l t of i m p o r t a n t

s t r u c t u r a l and economic deve lopmen t s which began t o unfold in t h e

l a t e 1970s, and which h a v e r a d i c a l l y t ransformed t h e f e a t u r e s of

t h e world o i l i n d u s t r y . I t is u s e f u l io d e s c r i b e v e r y b r i e f l y

t h e s e main deve lopmen t s , f a m i l i a r a s t hey m a y be t o o b s e r v e r s of

t h e energy scene.

F i r s t , wor I d o i l c o n s u m p t i o n b e g a n t o d e c l i n e i n 1 9 7 9 and

t h e downward t r e n d c o n t i n u e d t o a s s e r t i t s e l f o v e r a number of

years . T h i s phenomenon was n o t w e l l p e r c e i v e d a t i t s s t a r t

b e c a u s e everybody's a t t e n t i o n was t h e n c o n c e n t r a t i n g o n t h e

s u p p l y i n t e r r u p t i o n s and t h e p r i c e r i s e s b r o u g h t a b o u t by t h e

I r a n i a n R e v o l u t i o n . The p r i c e r i s e s of 1979180 d i d no t i n i t i a t e

t h i s demand f a 1 1 b u t c o n t r i b u t e d to t h e c o n t i n u i n g d e c l i n e i n

subsequen t years; they p r o v i d e d r enewed i n d u c e m e n t s f o r e n e r g y

c o n s e r v a t i o n and f o r s u b s t i t u t i o n of c o a l and g a s f o r o i l .

Secondly, t h e r e was a c o n s i d e r a b l e expans ion of non-OPEC o i l

s u p p 1 i e s b e g i n n i n g i n t h e mid-1970s and c o n t i n u i n g unabated t o

d a t e . Th i s growth was p a r t l y due t o t h e re-emergence of Mexico

a s a m a j o r w o r l d p r o d u c e r and t o t h e d e v e l o p m e n t of t h e l a r g e

N o r t h Sea o i l r e s e r v e s , and p a r t l y t o new s m a l l e r s c a l e

p r o d u c t i o n i n a l a r g e number of c o u n t r i e s a 1 1 round t h e world.

D e c l i n i n g world demand for o i l and growing non-OPEC s u p p l i e s were

accommodated by a c o n s i d e r a b l e r e d u c t i o n i n OPEC's ou tpu t . The

a g g r e g a t e p r o d u c t i o n of OPEC's member c o u n t r i e s f e l l by abou t 45

p e r c e n t between 1979 and 1985.

T h i r d l y , t h e demise of t h e o l d o i l c o n c e s s i o n s y s t e m i n t h e

O P E C r e g i o n , t i m i d l y b e g u n i n t h e l a t e 1960s b u t v i r t u a l l y

c o m p l e t e d by 1979-80, t r a n s f o r m e d t h e s t r u c t u r e of t h e wor I d

p e t r o l e u m market. The l a r g e volume of i n t e r n a t i o n a l l y t r a d e d o i l

t h a t u s e d t o move t h r o u g h t h e i n t e r n a l c h a n n e l s of v e r t i c a l l y

i n t e g r a t e d c o m p a n i e s is now t r a d e d a t arm's l e n g t h i n e x t e r n a l

markets . These markets i n v o l ve a l a r g e number of p a r t i c i p a n t s on

b o t h t h e s u p p l y s i d e ( n a t i o n a l a g e n c i e s o f OPEC member c o u n t r i e s )

and the demand s i d e (major and minor o i l companies, i ndependen t

r e f h e r s , o i l t r a d e r s and o t h e r t r a d i n g houses).

The d e m i s e of t h e o l d c o n c e s s i o n s y s t e m i n t h e OPEC r e g i o n

c o i n c i d e d w i t h t h e emergence of t h e North Sea , a new o i l p r o v i n c e

e x p l o r e d and d e v e l o p e d u n d e r a c o m p e t i t i v e , f r e e - e n t e r p r i s e

regime i n v o l v i n g a l a r g e number of l i c e n s e e s . The North Sea made

a s i g n i f i c a n t c o n t r i b u t i o n t o t h e expans ion of an open market i n

i n t e r n a t i o n a l o i l . A very b i g p r o p o r t i o n of North Sea o i l o u t p u t

i s t r a d e d a t arm's l e n g t h . T h i s p a r t l y r e f l e c t s t h e r o l e of

f i s c a l f a c t o r s , and p a r t l y t h e s i g n i f i c a n t i n v o l v e m e n t i n t h e

N o r t h S e a of f i r m s w i t h no d o w n s t r e a m i n t e r e s t s i n N o r t h West

Europe.

F o u r t h l y , t h e d e r e g u l a t i o n of US o i l comple t ed by t h e Reagan

A d m i n i s t r a t i o n i n t h e e a r l y 1980s s t r e n g t h e n e d t h e l i n k s between

t h e v a s t d o m e s t i c o i l m a r k e t i n t h e US and t h e w o r l d p e t r o l e u r n

2

m a r k e t . S p o t a n d f u t u r e s t r a d i n g i n WTI became c l o s e l y

i n f l u e n c e d by t r a d i n g i n B r e n t and v i c e versa . T h r o u g h t h e

m e d i a t i o n of B r e n t , an i n t e r n a t i o n a l c r u d e , c h a n g e s i n t h e

c o n d i t i o n s of t h e US o i l market a r e now be ing t r a n s m i t t e d t o t h e

markets for A f r i c a n , Med i t e r r anean and Gulf crudes.

I n s h o r t , t h e c u r r e n t s i t u a t i o n i s c h a r a c t e r i s e d by a huge

imba lance between p o t e n t i a l s u p p l i e s and a c t u a l demand f o r o i l

a n d by t h e e x t e r n a l i z a t i o n o f o i l t r a d e i n d y n a m i c a n d

compe t i t i v e marke ts.

Supplyldemand imba lances were, of cour se , impor t an t i n the

p a s t , d u r i n g t h e c o n c e s s i o n e r a ; b u t t h e y w e r e t h e n a b s o r b e d

i n t e r n a l l y by o i l c o m p a n i e s and t h e i r h o s t c o u n t r i e s . The

c o n c e s s i o n s y s t e m and t h e i n t e g r a t e d s t r u c t u r e o f t h e i n d u s t r y

e n a b l e d c o m p a n i e s t o r e s p o n d t o c h a n g e s i n demand by v a r y i n g

a l m o s t a u t o m a t i c a l l y t h e e x t r a c t i o n r a t e s f r o m t h e i r p r o l i f i c

Middle E a s t e r n f i e l d s . I n t h e s u b s e q u e n t p e r i o d , w h i c h we m a y

c a l l t h e OPEC era, any e x c e s s of p o t e n t i a l s u p p l i e s o v e r demand

was a l s o absorbed f a i r l y p a s s i v e l y by OPEC member c o u n t r i e s as

was p e r f e c t l y e v i d e n t i n 1975-78 and i n 1981-85. The b e h a v i o u r

of o i l companies i n t h e 1950s and 1960s and t h a t of OPEC i n l a t e r

y e a r s caused p r i c e s t o remain f a i r l y s t a b l e d u r i n g t h e r e l e v a n t

e p i s o d e s ; i t a l s o l i m i t e d t h e a m p l i t u d e of p r i c e v a r i a t i o n s i n

open m a r k e t s .

Today the s i t u a t i o n is r a d i c a l l y d i f f e r e n t . The major o i l

companies have long ceased t o perform a p r i c e s t a b i l i z a t i o n r o l e

b e c a u s e of a f u n d a m e n t a l c h a n g e i n c i r c u m s t a n c e s . OPEC, w h i c h

took over from t h e companies i n t h e 1970s, i s now f i n d i n g i t s e l f

3

u n a b l e t o s t a b i l i z e t h e m a r k e t . Whe the r t h i s i s a t e m p o r a r y

s i t u a t i o n or no t is a moot p o i n t . And, i f t empora ry , whether i t

w i l l t a k e O P E C ( o r some new a s s o c i a t i o n o f o i l e x p o r t e r s ) a f ew

weeks o r several y e a r s t o r e g a i n c o n t r o l o v e r t h e p r i c e of o i l i s

a l s o a v e r y complex q u e s t i o n .

So l o n g as an imbalance between p o t e n t i a l o i l s u p p l i e s and

demand a t any p r i c e p e r s i s t s , and so long as p roduc ing c o u n t r i e s

r e m a i n u n a b l e to a g r e e on an o u t p u t r e g u l a t i o n mechan i sm, o i l

p r i c e s will c o n t i n u e t o f a l l i n t h e medium term towards marg ina l

e x t r a c t i o n c o s t s and t o f l u c t u a t e very e r r a t i c a l l y around t h i s

d e c l i n i n g t r e n d i n b o t h s p o t and f u t u r e s marke t s .

T h e r e is no d o u b t t h a t we a r e f a c i n g t o d a y a s i t u a t i o n of

f a l l i n g o i l p r i c e s i n weak, v o l a t i l e and n e r v o u s markets. FOK

t h e p u r p o s e of t h i s p a p e r , l e t u s assume t h a t o i l c o m p a n i e s ,

governments and a l l r e l e v a n t economic a g e n t s w i l l soon beg in t o

p e r c e i v e f u t u r e energy d e v e l o p m e n t s i n terms of low and v o l a t i l e

o i l p r i c e s . We w o u l d t h e n l i k e t o a d d r e s s a n u m b e r o f

fundamental q u e s t i o n s about t h e e f f e c t s of t h e s e expected p r i c e

movements on t h e demand f o r o i l , t h e s u p p l y of non-OPEC o i l and

t h e s t r u c t u r e of t h e p e t r o l e u m i n d u s t r y .

4

2. TBE FALL IR O I L PRICES AND TEE DEMAND FOB OIL

Low o i l p r i c e s c o u l d induce a s u b s t i t u t i o n of f u e l o i l f o r

c o a l i n power s t a t i o n s equipped w i t h d u a l bu rne r f a c i l i t i e s , o r a

s w i t c h from c o a l - f u e l l e d power s t a t i o n s t o i d l e o i l - f u e l l e d power

s t a t i o n s i n c o u n t r i e s w i t h e x c e s s c a p a c i t y i n e l e c t r i c i t y

g e n e r a t i o n . Today t h e s p o t p r i c e of c o a l i n R o t t e r d a m i s

a p p r o x i m a t e l y $50/t. A 1 l o w i n g for c a l o r i f i c d i f f e r e n c e s ,

t r a n s p o r t and h a n d l i n g d i f f e r e n t i a l s , t h e e q u i v a l e n t f u e l o i l

p r i c e i s $ 1 0 0 / t . T h i s s u g g e s t s t h a t c r u d e o i l c o u l d b e g i n i o

d i s p l a c e c o a l i n power s t a t i o n s and i n s t e a m - r a i s i n g i n d u s t r i a l

p l a n t s when i t s p r i c e f a l l s t o w a r d s $15-18/b. Some o b s e r v e r s

b e l i e v e t h a t a t t h e s e p r i c e s t h e room f o r s u b s t i t u t i o n a g a i n s t

c o a l i s s i g n i f i c a n t , e v e n i n t h e s h o r t term, and p a r t i c u l a r l y i n

t h e OECD r e g i o n w h e r e many power s t a t i o n s h a v e f u e l - s w i t c h i n g

f a c i l i t i e s . They b e l i e v e t h a t t h e s e e f f e c t s t e n d t o be u n d e r -

e s t i m a t e d ; and they a rgue t h a t t h e s u b s t i t u t i o n of f u e l o i l f o r

c o a l would r a p i d l y s t a b i l i z e c r u d e o i l p r i c e s a t around $17-18/b

w i t h o u t any o u t s i d e i n t e r v e n t i o n .

I f t h i s v i ew t u r n e d o u t io be c o r r e c t , t h e s y s t e m w o u l d be

s e l f - s t a b i l i z i n g a t p r i c e s l i t t l e d i f f e r e n t from t h o s e a t t a i n e d

on s p o t m a r k e t s f o r c r u d e o i l i n l a t e J a n u a r y l e a r l y F e b r u a r y

1986. It s h o u l d be no ted , however, t h a t t h e speed of a d j u s t m e n t ,

5

and t h u s t h e t i m e r e q u i r e d f o r s e l f - s t a b i l i z a t i o n t o take p l a c e ,

d e p e n d more on p r i c e e x p e c t a t i o n s t h a n O Q t h e l e v e l of p r i c e s

a c t u a l l y a t t a i n e d a t any g i v e n time. The shor t - t e rm ad jus tmen t

r e l a t e s t o l o n g - t e r m p e r c e p t i o n s of p r i c e movemen t s . I f t h e

c u r r e n t o i l p r i c e c r i s i s i s p e r c e i v e d as a temporary anomaly, no

a t t e m p t w i l l b e made t o s u b s t i t u t e c o a l o r g a s f o r o i l ,

i r r e s p e c t i v e of t h e sho r t - t e rm a d v a n t a g e s of such a p r o c e s s .

Can w e r e a l l y e x p e c t a l a r g e s u b s t i t u t i o n e f f e c t f r o m low

o i l p r i c e s i n t h e s h o r t r u n ? To a n s w e r t h i s q u e s t i o n i t i s

necessa ry t o review b r i e f l y t h e s i t u a t i o n i n OECD c o u n t r i e s . I n

F r a n c e , t h e EDF w i l l s w i t c h t o o i l as s o o n as p r i c e s t i l t t h e

b a l a n c e i n f a v o u r of t h i s f u e l . T h e r e w i l l be no p o l i t i c a l or

i n s t i t u t i o n a l i n h i b i t i o n a g a i n s t s u c h a move. W i t h i n a few

months c o a l c o u l d be d i s p l a c e d g i v i n g r i s e t o a new demand f o r 4

m t of o i l . I n I t a l y very l i t t l e c o a l i s u s e d for e l e c t r i c i t y

g e n e r a t i o n , and t h e c o a l l f u e l o i l s u b s t i t u t i o n i s s u e d o e s n o t

r e a l l y a r i s e . I n Germany, t h e c o a l i n d u s t r y i s a p o l i t i c a l

"sacred cow". Some s u b s t i t u t i o n a g a i n s t c o a l may t a k e p l a c e bu t

a s i g n i f i c a n t s h i f t i s l i k e l y t o b e r e s i s t e d by p o l i c y

i n t e r v e n t i o n . I n t h e UK t h e scope f o r f u e l o i l s u b s t i t u t i o n i s

s i g n i f i c a n t bu t t h e C e n t r a l E l e c t r i c i t y Genera t ing Board (CEGB)

m a y be c o n s t r a i n e d by c o n t r a c t u a l a r r angemen t s w i t h t h e N a t i o n a l

Coal Board ( N C 3 ) . The f i n a n c i a l and p o l i t i c a l impact on t h e NCB

of a s w i t c h a g a i n s t c o a l cou ld i n h i b i t t h e ad jus tmen t . I n t h e US

it i s t h o u g h t t h a t c r u d e o i l p r i c e s w o u l d h a v e t o f a l l b e l o w

$15/b t o make f u e l o i l c o m p e t i t i v e w i t h c o a l .

The p i c t u r e i s t h e r e f o r e pa t chy and u n c e r t a i n because f u e l

o i l s u b s t i t u t i o n m a y be r e t a r d e d by p o l i t i c a l and i n s t i t u t i o n a l

6

r e s t r a i n t s i n some of t h e s e c o u n t r i e s . Furthermore, some e x p e r t s

p o i n t o u t t h a t S o u t h A f r i c a n c o a l i s e x t r e m e l y c h e a p and c o u l d

c o m p e t e w i t h f u e l o i l a t l o w e r p r i c e s t h a n t h o s e m e n t i o n e d i n

t h i s p a p e r . Some a l s o r e m a r k t h a t t h e p r i c e s of s u b s t i t u t e s -

n a m e l y c o a l and g a s - w i l l t h e m s e l v e s f a l l i n r e s p o n s e t o a

d e c l i n e i n o i l p r i c e s .

The s h o r t - t e r m i m p a c t of l o w e r p e t r o l e u m p r i c e s on t h e

demand f o r o i l m a y a l s o come f r o m an i n c r e a s e i n m o t o r i n g

s t i m u l a t e d by l o w e r o i l p r i c e s and from some i n c r e a s e i n

p e t r o c h e m i c a l p r o d u c t i o n i n r e sponse t o e x p e c t a t i o n s of b r i g h t e r

economic growth. The growth i n g a s o l i n e consumption i s l i k e l y t o

occur t h i s year € o r a v a r i e t y of non-p r i ce r e a s o n s ( f o r example,

a change in h o l i d a y p a t t e r n s i n t h e US t h i s summer). T h i s would

s imply c o n t i n u e a t r e n d begun l a s t year: o i l p r i c e s need n o t f a l l

t o p r o d u c e t h i s s h o r t - t e r m a n d r a t h e r i n c i d e n t a l e f f e c t .

F i n a l l y , growth in p e t r o c h e m i c a l p r o d u c t i o n , though p r o b a b l e , i s

u n l i k e l y t o be v e r y s i g n i f i c a n t i n t h e s h o r t term. I n s h o r t , we

m a y w i t n e s s a s m a l l o v e r a l l s t i m u l u s t o t h e demand f o r o i l i n t h e

s h o r t t e r m ( a y e a r o r e i g h t e e n m o n t h s ) b u t w e s h o u l d n o t e x p e c t

t o o much.

I t i s e v i d e n t t h a t l o w e r o i l p r i c e s a r e more l i k e l y t o

s t i m u l a t e demand i n t h e l o n g e r term, t h a t is a f t e r 3 or 4 years,

t h a n i n t h e immediate f u t u r e . The i n t e r e s t i n g q u e s t i o n s are how,

and how much? To a p p r o a c h t h e s e i s s u e s we n e e d t o a s s u m e t h a t

o i l p r i c e s f a l l t o a c e r t a i n l e v e l ( s a y $ 1 5 - 1 8 / b ) and r e m a i n

f a i r l y s t a b l e € o r a s u b s t a n t i a l p e r i o d o f t i m e . We s h a l l also

a s s u m e at t h i s s t a g e o f t h e a r g u m e n t t h a t t h e b e n e f i t s to t h e

7

f i n a l consumer of l o w e r p r i c e s a r e n o t c a n c e l l e d by t a r i f f s o r

e x c i s e taxes . These assumptions a r e r e q u i r e d for t h e c l a r i t y of

t h e a n a l y s i s ; t h e y d o n o t r e f l e c t our v i e w s a b o u t l i k e l y

developments.

A 40 p e r c e n t r e d u c t i o n i n o i l p r i c e s f r o m 1985 l e v e l s

( a 1 l o w i n g b o t h f o r a f a l l i n n o m i n a l d o l l a r s and f o r a drop i n

t h e exchange v a l u e of t h e d o l l a r vis-a- vis t h e yen and European

c u r r e n c i e s ) cou ld i n c r e a s e t h e demand f o r o i l by 1990 by as much

a s 3-4 mb/d t h r o u g h t h e s u b s t i t u t i o n e f f e c t and by a n o t h e r 1.0

mb/d t h r o u g h t h e p r i c e i m p a c t o n w o r l d G D P g r o w t h a c c o r d i n g t o

o p t i m i s t i c e x p e r t s . I f we assume t h a t t h e p r i c e e l a s t i c i t y o f

demand is h a l f as l a r g e o n t h e w a y down as o n t h e w a y up , t h e n

t h e s u b s t i t u t i o n e f f e c t on o i l demand w i l l n o t be h igher t h a n 2-3

mb/d.

To t h e s e i n c r e a s e s we must add the 2 mb/d r i s e i n t h e demand

f o r o i l w h i c h was e x p e c t e d t o o b t a i n by 1 9 9 0 had o i l p r i c e s

remained pegged a t 27-281b. I n s h o r t , lower o i l p r i c e s c o u l d add

a t m o s t 5 mb/d and a t l e a s t 3 mb/d t o t h e l e v e l of e x p e c t e d

demand f o r o i l i n 1990. T h e r e i s a s i g n i f i c a n t d i f f e r e n c e

b e t w e e n t h e e n d - v a l u e s of t h i s r a n g e , b u t s u c h a r e t h e s t a t e o f

t h e a r t and t h e e f f e c t s of u n c e r t a i n t y .

The q u e s t i o n of i m p o r t l e v i e s and e x c i s e t a x e s , w h i c h w a s

s e t a s i d e f o r a moment, m u s t now be a d d r e s s e d . In t h e U S t h e r e

i s much t a l k a b o u t t a r i f f s and t a x e s . T h e r e a r e l o b b i e s i n

f a v o u r of an import l e v y and l o b b i e s committed t o f r e e t r a d e i n

e n e r g y w h i c h a r e s t a u n c h l y a g a i n s t any i n t e r v e n t i o n . The

i n t r o d u c t i o n of a t a r i f f on o i l now a p p e a r s more l i k e l y t h a n one

would h a v e thought i n 1985 f o r t h e s i m p l e r e a s o n t h a t t h e budget

8

d e f i c i t i s s u e i s becoming more p r e s s i n g and t h e g o v e r n m e n t i s

strongly t e m p t e d t o f i n d an easy s o u r c e o f r e v e n u e . D e s p i t e a

s t r o n g U S p o l i c y commitment t o f r e e e n e r g y t r a d e , r e v e n u e

c o n s i d e r a t i o n s m a y p r o v e o v e r - r i d i n g . Th i s i s n o t t o say t h a t

t h e i n t r o d u c t i o n of a n i m p o r t l e v y ( o r some o t h e r t a x ) i s a

f o r e g o n e c o n c l u s i o n ; t h e r e i s s t i l l a l a r g e b u t c o n t i n u a l l y

s h r i n k i n g marg in of u n c e r t a i n t y on t h i s i s s u e .

The EEC w i l l f i n d i t d i f f i c u l t t o a g r e e on a common e x t e r n a l

t a r i f f f o r o i l ( o r energy) imports . Such a measure would r e q u i r e

t h e agreement of a l l member c o u n t r i e s and t h e i r i n t e r e s t s O Q t h i s

i s s u e are s u f f i c i e n t l y d i v e r s e t o p r e c l u d e a n unanimous dec i s ion .

Bowe v e r , g o v e r n m e n t s c a n i m p o s e e x c i s e t a x e s o n p e t r o l e u m

p r o d u c t s ( o r wary t h e i r r a t e s ) i n d e p e n d e n t l y of o n e a n o t h e r .

Th i s is t h e c o u r s e European governments a r e l i k e l y t o f o l l o w and

t h e i r s t a t e d o b j e c t i v e s w i l l i n c l u d e t h e f a m i l i a r l i n e s on t h e

l o n g - t e r m n e e d t o c o n s e r v e " s c a r c e " e n e r g y r e s o u r c e s and t o

r educe dependence on o i l imports . O f cou r se , t h e r e v e n u e mot ive

w i l l a l s o be a t t r a c t i v e , and the need t o p r o t e c t c o a l i n Germany

o r o t h e r energy e l s e w h e r e w i l l p l a y a r o l e .

J apan i s u n l i k e l y t o change i t s f i s c a l o r t a r i f f regime i n

r e s p o n s e t o l o w e r o i l p r i c e s . I t wou ld g a i n a c o m p e t i t i v e

a d v a n t a g e o v e r Europe and t h e US i f t h e s e c o u n t r i e s p u s h e d o i l

p r i c e s up d o m e s t i c a l l y th rough t a x a t i o n and J a p a n d i d no t .

To sum u p , l o w e r o i l p r i c e s w i l l e l i c i t a s m a l l demand

r e s p o n s e i n t h e s h o r t t e r m , a n d w i l l c o n t r i b u t e m o r e

s i g n i f i c a n t l y t o demand g r o w t h i n t h e medium a n d l o n g t e r m , i f

e c o n o m i c f o r c e s a r e a l l o w e d t o o p e r a t e w i t h o u t p o l i t i c a l o r

9

f i s c a l in tervent ion . A s it is natural to expect some government

in tervent ion , a t l e a s t i n a few OECD countr ie s , w e can conclude

t h a t the long-term demand e f f e c t s w i l l be dampened. With t a r i f f s

and taxes , t h e drop i n o i l p r i c e s may not add more than 2-3 mb/d

t o t h e l eve l of expected o i l demand i n 1990.

10

3. LOWEB O I L PRICES bAD NOH-OPEC SUPPLIES

Lower o i l p r i c e s w i l l s h u t down s t r i p p e r w e l l s i n t h e US bu t

h a v e l i t t l e immediate e f f e c t e l sewhere . I n f a c r some companies

m a y respond t o lower p r i c e s by i n c r e a s i n g t h e i r p r o d u c t i o n from

e q u i t y s o u r c e s i n o r d e r t o improve c a s h f lows. (Some o b s e r v e r s

b e l i e v e t h a t t h e o p p o s i t e cou ld happen w i t h companies h o l d i n g up

p r o d u c t i o n and w a i t i n g f o r p r i c e s t o r i s e a g a i n . ) C o s t s of

p r o d u c t i o n from e x i s t i n g o i l f i e l d s a r e low i n most p a r t s of t h e

wor ld o u t s i d e t h e US, e v e n i n t h e North Sea where they a r e below

$5/b f o r 90 pe r c e n t of UK and Norwegian ou tpu t .

T h e r e i s no d o u b t t h a t some s m a l l f i r m s w i l l f a c e t h e

p r o s p e c t of bankruptcy because of cash-f low problems a r i s i n g from

t h e i r i n d e b t e d n e s s t o b a n k s and t h e i r huge t a x b i l l s . But

bankruptcy need n o t a f f e c t p r o d u c t i o n : i n most c a s e s it w i l l o n l y

l e a d t o a change i n t h e ownership of a s s e t s .

A t S15/b, 70-100,000 b /d of o i l p r o d u c t i o n m a y be c l o s e d i n

US s t r i p p e r w e l l s ; a t $10/b, 700-800,000 b/d cou ld be l o s t on t h e

assumption t h a t t h e r e is no t a r i f f . The loss of p r o d u c t i o n c o u l d

be f a i r l y r a p i d w i t h i n a 3 - 4 month t i m e p e r i o d . Yet s u c h a

v o l u m e of s h u t - i n p r o d u c t i o n m i g h t i t s e l f i n d u c e t h e U S

government t o impose a t a r i f f t o p r o t e c t t h e domes t i c p e t r o l e u m

i n d u s t r y . And a t a r i f f t h a t p r e v e n t e d o i l p r i c e s in t h e US from

11

f a l l i n g b e l o w $ 1 7 o r 1 8 / b would c a n c e l a l l t h e s e p a r t i c u l a r

supp 1 y e f f e c t s .

Lower o i l p r i c e s m a y r e d u c e t h e p r o d u c t i o n o f o i l t h a t

depends on e x p e n s i v e secondary o r ter t iary r e c o v e r y . T h i s e f f e c t

i s d i f f i c u l t t o c a l c u l a t e , b u t i t i s not a l w a y s m e n t i o n e d and

t e n d s t o be u n d e r e s t i m a t e d when it is.

It i s c e r t a i n t h a t lower o i l p r i c e s w i l l a f f e c t e x p l o r a t i o n

and t h e d e v e l o p m e n t o f new o i l f i e l d s , t h u s r e d u c i n g p o t e n t i a l

o u t p u t a f t e r 1 9 9 0 i n m o s t of t h e w o r l d , a n d p e r h a p s b e f o r e 1990

i n t h e US. I n t h e US t h e o i l r e s e r v e b a s e i s s m a l l i n r e l a t i o n

t o o u t p u t , and p r o d u c t i o n responds very r a p i d l y t o a d e c l i n e i n

t h e r a t e of e x p l o r a t i o n and development .

The a d v e r s e i m p a c t on o i l i n v e s t m e n t w i l l b e d u e t o t h e

f o l l o w i n g f a c t o r s . ( a > Lower o i l p r i c e s w i l l r e d u c e t h e

i n v e n t o r y v a l u a t i o n i n b a l a n c e s h e e t s , t h u s r e d u c i n g t h e e q u i t y

base of companies and ( o t h e r t h i n g s b e i n g e q u a l ) t h e i r access to

c r e d i t . Compan ies w i l l h a v e l i t t l e o p t i o n b u t t o c u r t a i l

i n v e s t m e n t b u d g e t s - e v e n t h o s e a l r e a d y approved f o r 1986 o r 1987

which were i n e v i t a b l y based on o l d a s sumpt ions about o i l p r i c e s .

Ib) L a r g e c o m p a n i e s w i l l be t e m p t e d t o u s e some of t h e i r c a s h

r e s o u r c e s t o pu rchase cheap a s s e t s r e l i n q u i s h e d by less f o r t u n a t e

compe t i to r s . They n i l 1 i n c r e a s e t h e i r o i l reserves by a c q u i r i n g

e x i s t i n g r e s o u r c e s , and t h e l i k e l y t r a d e - o f f i s a r e d u c t i o n of

i n v e s t m e n t e x p e n d i t u r e f o r t h e d i s c o v e r y of new r e s e r v e s . ( c >

I n v e s t o r s may f e e l t h a t t h e c o s t s of new inves tmen t i n a r e a s such

as t h e N o r t h S e a o r t h e A r c t i c c a n n o t be j u s t i f i e d a t c u r r e n t

p r i c e s and t h a t t hey s h o u l d d e l a y o r e v e n s c r a p any p l a n s f o r t h e

development of h igh -cos t o i l .

1 2

The importance of t h e s e c o n s i d e r a t i o n s s h o u l d n o t be under-

e s t i m a t e d , b u t i t i s wrong i o b e l i e v e t h a t t h e y a r e t h e o n l y

d e t e r m i n a n t s of t h e i n v e s t m e n t d e c i s i o n . Companies m a y t a k e t h e

view t h a t t h e long-term p r o s p e c t s f o r o i l demand r e q u i r e them t o

d e v e l o p such a d d i t i o n a l s o u r c e s of s u p p l y , o r t h a t p r i c e s w i l l

r i s e i n t h e 1990s and y i e l d a good r a t e o f r e t u r n o n h i g h - c o s t

i n v e s t m e n t u n d e r t a k e n i n e a r l i e r y e a r s . I f t h e s e v i e w s a r e

s u f f i c i e n t l y w i d e s p r e a d , and i f t h e y a r e s h a r e d by b a n k e r s ,

f i n a n c e w i l l be f o u n d and i n v e s t m e n t w i l l c o n t i n u e . I t i s

i n s t r u c t i v e t o n o t e i n t h i s c o n t e x t t h a t companies h a v e r e c e n t l y

b e e n p a y i n g v e r y l a r g e sums f o r d i f f i c u l t a c r e a g e i n t h e N o r t h

Sea, a n i n d i c a t i o n pe rhaps of buoyant e x p e c t a t i o n s f o r t h e 1990s.

The g r o w t h of non-OPEC s u p p l i e s h a s b e e n s y s t e m a t i c a l l y

u n d e r e s t i m a t e d b y f o r e c a s t e r s i n t h e p a s t t e n years. Most

p r e d i c t i o n s , made under o l d assumptions about o i l p r i c e s , pu t t h e

i n c r e a s e i n non-OPEC s u p p l i e s a t 1.0 mb/d by 1990. Some

o b s e r v e r s , a1 lowing f o r t h e u n d e r e s t i m a t i o n b i a s , t h i n k t h a t t h i s

i n c r e a s e c o u l d be as h i g h as 3.0-3.5 rnbld; b u t t h i s i s a m i n o r i t y

v i e w w h i c h i s s i g n i f i c a n t l y a t odds w i t h t h e b u l k of i n f o r m e d

op in ion . Lower o i l p r i c e s need n o t a f f e c t t h e growth of non-OPEC

s u p p l i e s u n t i l t h e end o f t h i s d e c a d e , p a r t i c u l a r l y i f t h e US

i n t r o d u c e s a n i m p o r t l e v y , w h i c h w o u l d i n e v i t a b l y p r o t e c t

s t r i p p e r we1 I s a n d a d v a n c e d r e c o v e r y . A f t e r 1 9 9 0 p o t e n t i a l

s u p p l i e s i n t h e non-OPEC r e g i o n w i l l a l m o s t i n e v i t a b l y dec 1 i n e

because of a f a l l i n i n v e s t m e n t i n t h e p r e c e d i n g p e r i o d , bu t t h e

size o f t h e r e d u c t i o n m a y b e o v e r s t a t e d by t h e c u r r e n t

conu e n t i o n a 1 wisdom. Expec ta t ions of a r o s i e r 1990s m a y s u s t a i n

some inves tmen t a c t i v i t y .

13

Our q u a n t i t a t i v e f o r e c a s t i s t h a t non-OPEC s u p p l i e s w i l l

increase by 1 mb/d i r r e s p e c t i v e of what happens t o the oil price .

Should the US decide against the introduction of a t a r i f f , non-

OPEC s u p p l i e s i n 1990 might remain a t t h e i r 1985 l e v e l or d e c l i n e

by up t o 1 .0 mb/d.

14

4. THE SUPPLY ARJJ DEHBW BBLBBCE

These v a r i o u s e s t i m a t e s of t h e impact of lower o i l p r i c e s on

demand and supp ly can be now brough t t o g e t h e r . Assume t h a t WOCA

demand for o i l would h a v e i n c r e a s e d by 2 mb/d b e t w e e n 1985 and

1990 u n d e r p r e v i o u s p r i c e a s s u m p t i o n s ; t h a t non-OPEC s u p p 1 i e s

would h a v e i n c r e a s e d by 1.0 mb/d; and t h a t O P E C p r o d u c t i o n i n

1985 ave raged 16.0 mb/d. T h i s i m p l i e s t h a t OPEC p r o d u c t i o n would

h a v e i n c r e a s e d t o 1 7 mb/d i n 1990 compared w i t h 16 mb/d i n 1985.

Lower o i l p r i c e s and unchanged f i s c a l r e g i m e s i n t h e OECD

c o u n t r i e s w o u l d i n c r e a s e WOCA demand € o r o i l i n 1 9 9 0 by a n

a d d i t i o n a l 3-5 mb/d and r e d u c e non-OPEC s u p p l i e s by up t o 1.0

mb/d. T h i s i m p l i e s t h a t OPEC p r o d u c t i o n w o u l d r i s e i n 1 9 9 0 t o

21-24 mbld, compared w i t h 1 6 mb/d in 1985.

Lower o i l p r i c e s c o u n t e r a c t e d by t a r i f f s and h i g h e r t a x e s i n

OECD c o u n t r i e s ( o t h e r t h a n J a p a n ) would i n c r e a s e WOCA demand f o r

o i l by a maximum of 2 mb/d a b o v e t h i s b a s e l i n e and l e a v e t h e

i n i t i a l f o r e c a s t of non-OPEC s u p p l y i n c r e a s e s unchanged ( a t 1.0

rnbld). In such a c a s e t o t a l OPEC p r o d u c t i o n would r e a c h 19 mb/d

i n 1990, compared w i t h 16 mbld i n 1985.

These r e s u l t s s u g g e s t t h a t the b e n e f i t s of lower o i l p r i c e s

t o OPEC c o u n t r i e s a r e s u b j e c t t o much u n c e r t a i n t y . It s h o u l d be

i m m e d i a t e l y s t r e s s e d t h a t non-OPEC e x p o r t i n g c o u n t r i e s , b e i n g

15

o u t p u t maximizers, s u f f e r a s t r a i g h t r e v e n u e l o s s from any d r o p

i n o i l p r i c e s . There i s no m i t i g a t i o n from i n c r e a s e d p roduc t ion .

The s i t u a t i o n i s d i f f e r e n t f o r O P E C c o u n t r i e s as t h e y w o u l d

e v e n t u a l l y see t h e i r o u t p u t r i s i n g i n r e s p o n s e t o l o w e r o i l

p r i c e s ( h e r e assumed t o be i n t h e range of $15-18/b) . T a b l e 1

shows t h a t i n t h e m o s t f a v o u r a b l e c a s e o u t p u t w i l l be 4-7 mb/d

h i g h e r i n 1 9 9 0 t h a n w o u l d be e x p e c t e d i n t h e a b s e n c e of a p r i c e

f a l l . If i n d u s t r i a l c o u n t r i e s r e s o r t t o p r o t e c t i o n , demand € o r

OPEC o i l i n 1990 w i l l be 2-3 mb/d h i g h e r t h a n o t h e r w i s e expected.

Assume t h a t O P E C e x p o r t e d 1 2 mb/d o f oil i n 1 9 8 5 and w o u l d

h a v e e x p o r t e d 12.5 mb/d i n 1990 i n t h e absence of p r i c e changes.

The more f a v o u r a b l e c a s e i n v o l v e s a maximum i n c r e a s e i n e x p o r t s

of some 56 p e r c e n t and a minimum of 3 2 p e r c e n t above expec ted

l e v e l s i n 1990. The i n c r e a s e s would be s m a l l e r , though r i s i n g ,

i n t h e i n t e r v e n i n g y e a r s . To a c h i e v e t h i s r e s u l t p r i c e s w o u l d

h a v e b e e n s l a s h e d by 33-45 p e r c e n t . I t i s easy t o i n f e r t h a t

t h e break-even p o i n t would p robab ly n o t be r eached b e f o r e 1989,

and t h a t OPEC w o u l d n o t b e a b l e t o r e c o u p t h e r e v e n u e l o s s

i n c u r r e d f r o m l o w e r o i l p r i c e s u n t i l 1 9 9 1 o r 1 9 9 2 a t t h e

e a r l i e s t . Things would n a t u r a l l y be s i g n i f i c a n t l y worse i f the

demand f o r OPEC o i l i n c r e a s e d by the s m a l l e r amounts p r e d i c t e d by

our l e s s f a v o u r a b l e c a s e ( p r i c e f a l l and t a r i f f s o r t axes ) .

The c o n c l u s i o n s of t h i s a n a l y s i s a r e t h a t a low o i l p r i c e

s t ra tegy is l i k e l y t o p r o v e c o s t l y f o r OPEC i n t h e medium term,

and t h a t s u c h a s t r a t e g y i s t o t a l l y i r r a t i o n a l f o r non-OPEC

e x p o r t i n g c o u n t r i e s , p a r t i c u l a r l y f o r t h o s e b e l o n g i n g t o t h e

t h i r d wor ld . It a l s o f o l l o w s t h a t a s t r a t e g y aiming a t b r i n g i n g

t h e p r i c e o f o i l i n t o t h e $22-25 r a n g e w o u l d b e t h e l e a s t

16

~ ~~ ~~

Tab le 1 : Demand f o r OPEC O i l Under D i f f e r e n t Assumptions

Demand f o r OPEC o i l 1985 16.0 mb/d

Demand f o r OPEC oil i n 1990 ( o l d p r i c e a s sumpt ion ) :

1985 demand i n c r e a s e due t o GDP growth d i sp lacemen t from non-OPEC s u p p l i e s

16 .O 2.0

- 1 . 0

17.0 mb/d

Demand f o r OPEC o i l 1990 ( p r i c e f a l l and no t a r i f f s )

1985 demand

i n c r e a s e due t o GDP growth

s u b s t i t u t i o n e f f e c t

a d d i t i o n a l GDP e f f e c t

d i sp l acemen t of non-OPEC s u p p l i e s

16 .O

2.0

2.0-4 .O

1 .o

0.0-1 .o

2 1 .O-24.0 mbld

Demand f o r OPEC o i l 1990 ( p r i c e f a l l and t a r i f f s )

1985 demand

i n c r e a s e due t o GDP growth

s u b s t i t u t i o n e f f e c t and a d d i t i o n a l GDP e f f e c t

d i sp l acemen t from non-OPEC s u p p l i e s

16 .O

2 .o

2.0-3 .O

-1 .o

19.0-20.0 mbfd

17

a t t r a c t i v e : t h e s e p r i c e s i n v o l ve r e v e n u e l o s s e s i n t h e medium

term and h a r d l y any b e n e f i c i a l impact for OPEC i n terms of h i g h e r

demand and lower non-OPEC s u p p l i e s . The gamble on low o i l p r i c e s

c a n n o t b e n e f i t OPEC c o u n t r i e s u n t i l t h e 1 9 9 0 s and t h e risk i s

t h a t t h e t ime needed t o r ecoup the i n i t i a l l o s s e s m a y t u r n o u t t o

be t o o long. Contrary t o common b e l i e f , glJ OPEC c o u n t r i e s w i t h

e x c e s s c a p a c i t y today would be a b l e t o i n c r e a s e t h e i r o u t p u t in

t h e 1 9 9 0 s a b o v e t h e low l e v e l s a t t a i n e d i n 1985. All h a v e

s u f f i c i e n t r e s e r v e s t o k e e p them i n t h e m a r k e t in t h e n e x t

decade. The d i f f e r e n c e s of v i e w s w i t h i n OPEC on t h e a p p r o p r i a t e

p r i c e s t r a t e g y h a s more t o do w i t h immediate r e v e n u e needs (t ime-

p r e f e r e n c e ) t h a n w i t h the s i z e of the country’s o i l r e s e r v e s .

18

We h a v e a s sumed so f a r t h a t o i l p r i c e s w i l l s e t t l e d u r i n g

t h e n e x t f i v e y e a r s w i t h i n a d e f i n i t e range. Th i s a s sumpt ion was

n e c e s s a r y f o r t h e a n a l y s i s of t h e p o s s i b l e impact of lower p r i c e s

on demand and supp ly .

A c t u a l p r i c e movements w i l 1 b e more c o m p l e x t h a n assumed.

So l o n g a s p o t e n t i a l s u p p l i e s e x c e e d t h e demand f o r o i l , p r i c e

s t a b i l i t y d e p e n d s u n i q u e l y on producers’ r e g u l a t i o n . Otherwise

p r i c e s w i l l f l u c t u a t e : t hey w i l l f i r s t t e n d t o f a l l t o very low

l e v e l s , t h e n bounce back, and t h e n s t a r t d e c l i n i n g again. On t o p

o f t h e s e c y c l e s w e m a y e x p e c t t o s e e c o n s i d e r a b l e d a y - t o - d a y

p r i c e v o l a t i l i t y i n b o t h s p o t and f u t u r e s markets. The re a r e no

a u t o m a t i c s t a b i l i z e r s f o r o i l p r i c e s i n t h e s h o r t term, no more

t h a n t h e r e are for copper , p e a n u t s or f o r e i g n c u r r e n c i e s . AS t h e

m a r g i n a l e x t r a c t i o n c o s t s of o i l a r e v e r y low and as s u b s t i t u t e s

a r e n o t i m m e d i a t e l y a v a i l a b l e for t h e w h o l e s e t of o i l u s e s ,

p e t r o l e u m p r i c e s c o u l d f l u c t u a t e o v e r a very w i d e r a n g e . Of

c o u r s e , t h e r e i s a lways a l o n g - t e r m e q u i l i b i u m p r i c e , b u t i t s

i n f l u e n c e is s l i g h t and remote: long-term f o r c e s do n o t p r o v i d e

much s h o r t - t e r m s t a b i l i t y t o o i l p r i c e s .

The i n t r o d u c t i o n of t a r i f f s o r o t h e r t r a d e p r o t e c t i o n

measures w i l l segment t h e wor ld p e t r o l e u m market , r e s t r i c t i n g t h e

19

area where o i l flows f r e e l y ; and t h i s s egmen ta t ion w i l l p r o b a b l y

c o n t r i b u t e t o g r e a t e r p r i c e f l u c t u a t i o n s . The p e t r o l e u m i n d u s t r y

w i l l h a v e t o l i v e i n a wor ld where o i l behaves l i k e an o r d i n a r y

primary commodity. Oilmen b e l i e v e t h a t they can l e a r n t o a d j u s t

and m a y w i l l p r o b a b l y s u r v i v e i t a l l . Markets w i l l c o n t i n u e t o

expand and d i v e r s i f y t h e i r f u n c t i o n s ; some l i k e Nymex m a y h a v e t o

a d a p t t o t h e changed f e a t u r e s of a p r o t e c t i o n i s t world.

Low o i l p r i c e s w i l l u l t i m a t e l y i n c r e a s e demand a n d t h e

i n d u s t r y w i l l no doubt welcome t h i s growth i n t h e a g g r e g a t e s i z e

of i t s market.

Low o i l p r i c e s may i n h i b i t i n v e s t m e n t as mentioned e a r l i e r ,

b u t t h e e x t e n t of t h i s e f f e c t i s d i f f i c u l t t o a s c e r t a i n . They

w i l l a l s o l e a d t o g r e a t e r i n d u s t r i a l c o n c e n t r a t i o n : some s m a l l

f i r m s m a y d i s a p p e a r and some mergers m a y t a k e p l a c e .

The i n d u s t r y will be f o r c e d t o become more e f f i c i e n t . There

is much g o l d p l a t i n g i n upstream i n v e s t m e n t and, t h e r e f o r e , t h e r e

a r e o p p o r t u n i t i e s f o r c o s t r e d u c t i o n s and improved technology.

The i n c e n t i v e t o e n s u r e t h a t t h e d o w n s t r e a m o p e r a t e s a s an

e f f e c t i v e p r o f i t c e n t r e , w h i c h i s a l r e a d y t h e r e , w i l l be

enhanced.

The e c o n o m i c s of c o n v e r s i o n r e f i n i n g m a y be a d v e r s e l y

a f f e c t e d by a n i n c r e a s e i n t h e demand f o r fuel o i l r e s u l t i n g from

t h e d i s p l a c e m e n t of c o a l . New a d j u s t m e n t s of t h e r e f i n e r y s t o c k

w i l l t h e r e f o r e be r e q u i r e d .

The o i l i n d u s t r y t e n d s t o p u t on a b r a v e f a c e when t h e

energy wor ld i s s u b j e c t e d t o shocks. T h i s was n o t i c e a b l e i n 1973

and i n 1979-80 a n d t h e r e a r e no r e a s o n s t o t h i n k t h a t a t t i t u d e s

w i l l be d i f f e r e n t i n 1986 . Companies w i t h l a r g e c a s h b a l a n c e s

20

and f a v o u r a b l e g e a r i n g r a t i o s b e l i e v e t h a t t h e i r r e l a t i v e

c o m p e t i t i v e a d v a n t a g e o v e r o t h e r s w i l l improve. Cold comfort

indeed: these r e l a t i v e ga ins must be set aga ins t an a b s o l u t e f a l l

in p r o f i t s and a reduct ion i n the v a l u a t i o n of companies on the

asset s i d e of the balance sheet .

21

6. CORCLUSIOH

The p r i c e s h o c k s o f 1973 and 1979 t r a n s f e r r e d income f r o m

o i l - i m p o r t i n g t o o i l - e x p o r t i n g c o u n t r i e s . A p r i c e c o l l a p s e i n

1986 w i l l o p e r a t e j u s t t h e same income t r a n s f e r i n r e v e r s e . The

i s s u e i s e s s e n t i a l l y a b o u t t h e i n t e r n a t i o n a l d i s t r i b u t i o n of

income. There a r e no r i g h t s and no wrongs: a l l depends on which

s i d e o n e h a p p e n s t o be. The e c o n o m i c i n t e r e s t s o f a n e t o i l

e x p o r t e r a r e at o d d s w i t h t h o s e of a n e t o i l i m p o r t e r and no

amount o f s o p h i s t r y w i l l c h a n g e t h i s b a s i c f a c t . Non-OPEC

e x p o r t i n g c o u n t r i e s l o s e r e v e n u e s when p r i c e s f a 1 1; OPEC members

l o s e r evenues f o r some y e a r s but m a y r e a p a d v a n t a g e s some t i m e in

t h e 1990s. If they h a v e a c h o i c e , non-OPEC e x p o r t e r s s h o u l d t r y

t o a r r e s t t h e p r i c e d e c l i n e . OPEC c o u n t r i e s h a v e cause t o s t o p

and wonder w h e t h e r r e w a r d s i n t h e 1990s a r e w o r t h t h e h e a v y

income t r a n s f e r of t h e 1980s.

The a v i d r e a d e r w i l l w a n t t o kno

d a y s to come. W i l l OPEC move f i r s t ?

l e n d t h e i r s u p p o r t to some O P E C p l a n ?

g e n e r a l p r i n c i p l e : a s i n a l l d i s t r i b u t

' what w i l l h a p p e n i n t h e

W i l l non-OPEC c o u n t r i e s

We s h a l l s i m p l y s t a t e a

o n a l i s s u e s , market power

i s a l l t h a t m a t t e r s i n t h e end. To g u e s s t h e o u t c o m e of f u t u r e

O P E C and non-OPEC d e l i b e r a t i o n s on p r i c e s t a b i l i z a t i o n i t i s

impor t an t t o know how much power o i l e x p o r t e r s s t i l l w ie ld . But

t h i s i s a m a t t e r o f j u d g e m e n t o n w h i c h r e a s o n a b l e p e r s o n s m a y

r e a s o n a b l y be expec ted t o d i f f e r .

22

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