Energy Roundup

Forecasters of developments in energy markets have begun to take on an uncomfortable resemblance to those who predict stock market movements on the basis of the results of the Super Bowl. The major difference seems to be that the stock market people have been correct more often.

Few years illustrate the difficulty of anticipating energy trends better than 1981. Amid today's oil glut, it is difficult to remember that as late as the last half of 1980, pessimism about the world oil market was widespread. In the summer of 1980, before the war between Iraq and Iran broke out, widely respected oil economist Wallace J. Levy had written an article for Foreign Affairs with the forbidding title, "Oil and the Decline of the West," in which he foresaw an imminent series of "major crises" possibly involving wars among importing countries and "economic-financial" chaos.

When the Iran-Iraq conflict began, such headlines as "If oil facilities are ablaze, can $2-a-gallon gas be far behind?" and "Yamani sees oil rising to $50" were commonplace. In its outlook for 1981, the oil industry's closely watched newsletter, Petroleum Intelligence Weekly, on January 5, estimated there would be a 2 million barrel-per-day (mmbd) shortfall lasting into the summer unless production from the Organization of Petroleum Exporting Countries increased to 27 mmbd.

Falling use, falling prices

OPEC output did not increase to 27 mmbd; instead, it averaged 22.4 mmbd for the year. But if there was a shortfall of any less, it was a well-kept secret. Starting in February, nominal world oil prices fell steadily throughout the year, dropping on average approximately $5.00 per barrel on the spot market, and were down even more taking inflation into account. This occurred despite no substantial increases in Iraqi and Iranian production. By the end of 1981, few people were predicting significant oil price increases for any time in the near future.

Several reasons are offered for this unexpected turnaround. Some attribute it to the increase in non-OPEC production. Others cite the final lifting of oil price controls by President Reagan. And still others point to the stagnant economy. Each of these may contain a kernel of truth. But the most convincing explanation is that, through price-induced conservation and increased use of other energy sources, the oil-consuming nations are making the transition away from an oil-based economy faster than anyone had anticipated.

The United States provides an excellent example of this trend. According to the American Petroleum Institute, in 1981 petroleum consumption dropped approximately 5 percent from 1980 levels, and imports of crude oil and petroleum products fell 15.7 percent—to 5.7 mmbd. These reductions followed substantial cutbacks made in the previous year. In the last four years, imports have dropped more than 3 mmbd.

Certainly, some of this can be chalked up to the sluggish economy. But the drop in oil consumption has outpaced the economic slowdown. And other energy sources also are being used more efficiently. The energy/Gross National Product coefficient, which measures the relationship between energy consumption and GNP growth, has fallen from 59.4 thousand Btus per GNP dollar in 1972 to 46.7 in the third quarter of 1981. The drop is real, not just apparent.

Other industrialized countries, notably Japan, also made solid success in reducing oil use. The Department of Energy estimates that consumption in the non-Communist countries has fallen 2.7 mmbd in 1981.

As a result, the oil sales of those OPEC members demanding the highest prices suffered. Countries such as Nigeria. Libya, and Algeria saw exports plunge, in some cases by more than 50 percent, and demanded that Saudi Arabia, which was producing more than 10 mmbd until September 1981, reduce production. The Saudis, probably motivated more by concern for the long-term value of their huge reserves than by sympathy for oil consumers, demanded that the other OPEC members reduce prices to make them consistent with the $34 level the Saudis desired for their Arabian Light crude oil.

This was the basis for the September Geneva OPEC agreement establishing $34 as its "benchmark" price, with other members allowed to charge no more than $38, depending on the quality and location of the crude oil involved. But this so-called unification did little to ease the pressures caused by the drop in demand. In December Saudi Arabia reduced production to 8.5 mmbd to help maintain the $34 benchmark price, and most other OPEC members adjusted their prices slightly downward. February 1982 saw further weakening of prices, by both OPEC and non-OPEC countries, and a further cut in Saudi production to 7.5 mmbd.

A Reagan atmosphere

This easing of pressures on the international oil market gave the Reagan administration the atmosphere it needed to proceed toward the free-market energy policy the president espoused during his campaign. The lifting of oil price controls, eight months prior to their scheduled expiration under President Carter's time-table, was the first step in this effort.

This was followed by proposals for drastic cuts from the energy budget drawn up by the Carter administration. Special targets for reductions were programs to stimulate conservation and solar energy. Outlays for conservation programs were reduced by 10 percent in fiscal year (FY) 1981 and 40 percent in FY 1982 even though Congress eventually funded these programs at levels above what the president had requested.

Budget cuts also hit the infant synthetic fuels effort that only a year earlier had been proclaimed a cornerstone of the U.S. energy program. U.S. Department of Energy subsidies to several synfuels projects were eliminated. The Carter administration had requested $886.3 million for coal liquefaction and $216.4 million for coal gasification. Congress, responding to the Reagan administration's proposals, appropriated $98 million for liquefaction and $52.6 million for gasification. The Synthetic Fuels Corporation also moved more slowly than earlier was planned to provide financial support to synfuel projects.

The only major exception to the administration's energy budget cutting was made for nuclear power programs. The Carter administration's budget request for nuclear was increased by approximately $200 million, including funds for the controversial Clinch River breeder reactor project, designed to demonstrate the commercial feasibility of one type of breeder reactor. After a difficult floor fight, the administration prevailed and the program was funded for an additional year.

The administration also announced its intention to reduce the regulations that it claims are obstructing nuclear power development. Despite this, the industry continues to be plagued by a variety of problems. As in each of the last three years no new plants were ordered in 1981, and a number that had been ordered were canceled or deferred, including some already under construction. Prospects may not have been enhanced this year by the late January accident that caused the release of radioactive gas from a plant outside Rochester, New York. The facility may be shut down for several months.

The difficulties encountered in attempting to revive nuclear power have not swayed the administration from its energy policy course. The FY 1983 budget request maintained funding for nuclear power and called for further cuts in other programs. In the new budget request, 47 percent of energy funding goes for defense-related work, 20 percent to fill the Strategic Petroleum Reserve, and only 27 percent for other energy programs. The solar energy and conservation budget is reduced to $101 million from the previous year's $518 million.

The new budget also followed through on the president's pledge to dismantle the Department of Energy. The latter proposal, which would disperse most of the agency's functions to other parts of the government, is receiving only a lukewarm response on Capitol Hill from both Republicans and Democrats. In particular, many lawmakers are having trouble with the proposal to transfer much of DOE's defense-related functions to the Commerce Department.

Natural gas pricing looms as another political battleground. Under the Natural Gas Policy Act of 1978, price controls on some categories of natural gas will be phased out by 1985. Accelerating this process and including it in all types of natural gas would seem logical, in light of the administration's emphasis on letting the market determine energy prices. However, the short-term price increases that are thought likely to result from this policy could make it unpopular in an election year, and some observers feel that, in order to get accelerated decontrol through Congress, the president may have to break his pledge to veto a windfall profits tax on producers. The clash of interlocking and sometimes conflicting interests makes natural gas pricing a fascinating spectator sport, and one for which it is impossible to predict an outcome.

All bets off if glut evaporates

All of this could be eclipsed if the world oil market returns to the instability that characterized it in 1979 and 1980. The consensus is that it will not. In its December 1981 report DOE predicts no growth in demand for oil and in the non-Communist countries. Combined with some expected increases in exports from Iraq and Iran and higher production from non-OPEC countries such as Mexico, the prognosis is for continued downward pressure on prices, with no important change expected until the Western economies renew sustained economic growth in 1983 and beyond. In this view, the only factor working to maintain prices at or near their present level is Saudi Arabia's willingness and ability to reduce production, possibly to levels as low as 6 mmbd.

But those who predicted stability in past world oil markets have been just as wrong as those who made gloomy forecasts for 1981. The intricate economic models failed utterly to predict the price increases of 1973-74 or 1979-80. Their careful calculations of supply and demand were overpowered by unforeseen production cutbacks, political instability, and economic and political opportunism. No one needs to be reminded that the Middle East remains a volatile area and any event or decision that significantly affects Saudi Arabia's production levels once again could send spot market prices through the roof.

Such a development might lead to a new spate of articles fretting over the imminent "decline of the West." But wise observers will know that future predictions may be as exaggerated as those of the past. As some facetiously suggest, perhaps the best thing to do would be to look back at the Super Bowl. Historically, oil prices never have risen significantly in a year when a National Football Conference team was the winner. The victorious San Francisco 49ers of the NFC thus may have assured U.S. consumers of a year of breathing space. On the other hand, the OPEC countries play soccer, not American football. The national and world energy economies remain vulnerable to swift kicks.