OPEC and the World Oil Market

THE MARKET for oil from the Organization of Petroleum Exporting Countries (OPEC) remained generally weak throughout 1978 until massive strikes by oil field workers hit Iran in the late fall. Demand averaged about 5 percent lower than in 1973 (down to 29.4 million barrels a day). The maximum sustainable production capacity of the OPEC countries was 36.6 million barrels, requiring member states to absorb 7.2 million barrels or almost 20 percent in spare capacity. Nevertheless, using the crisis in Iran and the decline of the purchasing power of the dollar as justification, OPEC voted in December to raise oil prices 14.5 percent by the end of 1979.

Forecasts of the evolution of future supply-and-demand conditions in the world oil market varied greatly. While generalizations are hard to make, it is fair to say that government sources, both U.S. and international, tended to be more pessimistic than nongovernment forecasts. The former have tended to predict that global consumption could overtake physical production limit: as early as the early eighties, leading to a sharp price boost. Most private forecasts estimated, however, that supply and demand would remain roughly in balance through the 1980s, with no market justification for a rise in real oil prices during that time.

Three events during the year served to illustrate, however, just how precarious the supply-and-demand balance for world oil can be.

The Iranian crisis. The most serious were the breakdowns of oil production in Iran in October-November and, again, in December. Long a symbol of stability in the Gulf, the shah faced attacks from groups across the spectrum of Iranian society, some of whom were protesting the pace of modernization in Iran, while others were demanding a broader and more equitable distribution of the fruits of modernization. These protests culminated in a strike among oil field workers that cut petroleum production from a normal 5.8 million barrels per day to 1.1 million barrels in November. Again in December, as demonstrations against the shah mounted in intensity during the holy holidays of Moharram, output dropped further and production was completely shut down near the end of the month.

Not only did the long-term outlook for the regime in Iran remain uncertain, but the upheavals there underscored how volatile is the mix of conservative, radical, traditional, and modern groups that characterize all the countries in the Gulf area. Moreover, the threat of sabotage on the part of striking workers served to remind both producers and consumer governments that large clusters of oil-producing facilities in the Gulf are extraordinarily exposed to even small-scale hostile activities.

A second ominous but less evident occurrence was the decision by Saudi authorities to roll back Aramco's expansion plans by 25 percent—from a target of 16 million barrels in sustainable daily production capacity by 1983 to 12 million by 1986. At the same time the Ministry of Petroleum ordered Aramco to concentrate on the development of heavy and medium crudes, rather than Arabian light. This forced Aramco to cancel outright several large engineering projects aimed at facilitating pressure maintenance in Ghawar (the largest oil reservoir in the world) and at dewatering and desalting the resultant output.

The rationale for this change of plans, according to Saudi authorities, lay in their acceptance of estimates by the Aramco partners (Exxon, Mobil, Texaco, and Socal) that no more than 12 million barrels a day will be needed in the mid-1980s to keep the world oil market in balance at constant (or slowly rising) real prices. The Saudi decision, however, removes any cushion for error in the companies' forecasts and makes adjustment to higher demand much more difficult. The absence of infrastructure and support facilities for fields producing Arabian light means that easy capacity expansion in Saudi Arabia will not be possible in the early 1980s. Without the necessary pressure maintenance, dewatering and desalting systems in place, sustainable new production will require a lead time of two to three years rather than the six months to one year that was necessary in the past to bring facilities online.

The third event of importance for the international oil market was eminently benign rather than ominous—the expansion of published estimates about the extent of Mexican oil reserves. At the beginning of the year Mexican authorities calculated proved resources at 16 billion barrels, and expected Mexican output to reach 2.3 million barrels per day by 1982. In March, Pemex moved its production schedule ahead by 10 years (2.3 million barrels by 1980). By September, President Lopez Portillo used the figure of 200 billion barrels in calculating his country's proved, probable, and possible reserves (Saudi Arabia's proved and probable reserves are placed at 177 billion barrels). Finally, at the end of the year, Pemex released revised estimates of 40 billion barrels proved and 45 billion barrels probable reserves. While a great deal more drilling is needed to ascertain the true extent of Mexico's hydrocarbon resources (in November Pemex announced yet another huge reservoir of possibly 100 billion barrels in Chicontepec, north of the better-known Reforma fields), many private forecasters were suggesting that the country could easily become the Western Hemisphere's largest exporter (ahead of Venezuela) early in the 1980s with a total daily output of 4 to 5 million barrels before the end of the decade.

This auspicious beginning for Mexico as a major force in world energy markets was marred, however, by an increasingly acrimonious dispute with the U.S. government about the export of associated natural gas to the North American market. In 1977 Mexico had reached agreement with a group of private U.S. companies to sell 2 billion cubic feet per day at a price of $2.60 per thousand cubic feet, which is higher than the controlled U.S. ceiling. The Mexican government then began construction of a major pipeline leading north toward the U.S. border. The U.S. government, however, stepped in to block that deal, offering instead tough new proposals to protect U.S. consumers from higher gas prices. At this point, despite broad indications that export of the gas to the U.S. market, even at the U.S. ceiling price, constituted the most profitable alternative for the Mexicans, the Mexican government declared that it would use its gas internally.

This dispute constituted a notably inauspicious start for a U.S.—Mexican dialog that includes energy cooperation, the development of petroleum-based downstream industries, the encouragement of Mexican industrialization, and the provision of Mexican jobs for would-be emigrants. Over the longer term, the adverse consequences of the gas dispute could be even more serious. If the production of Mexican gas for internal use rather than for export to the United States were to become a symbol of national pride for the Mexicans, it could constrain the rate at which Mexico expanded crude exports.

Now that the United States has passed comprehensive legislation leading to the decontrol of natural gas by 1985, the Carter administration should be able to offer the Mexicans a more generous pricing formula in order to reopen gas negotiations.

Strategic reserves. The crisis in Iran emphasizes the need of the United States and the other major oil importers not only to restrain petroleum consumption but to take seriously the task of building emergency petroleum stocks. During the past year the Carter administration, with congressional authorization, set itself the task of establishing a 500 million-barrel oil reserve by 1980 with an ultimate goal of 1 billion barrels by 1983. The latter was calculated to insulate the United States against a cut-back of 5 million barrels per day for more than six months. Technical problems in storing the oil and the assignment of a relatively low priority to this project by the Department of Energy kept the program well behind schedule in 1978, and budgetary constraints are threatening the development of the second 500 million-barrel portion in the early 1980s. The events in Iran are a reminder, coming from one of the less suspected directions, that we need to insure ourselves against the contingency of supply interruptions. Moreover, the other members of the International Energy Agency (lEA) as well will need to take their storage programs more seriously. Under current lEA guidelines, most members now carry approximately seventy-day supplies. But the definition of stocks is quite loose, and there is no distinction between special emergency reserves and the normal working inventories of private companies. The coming year should be an appropriate time to work within the lEA to tighten the definition of emergency stocks and begin to make them into a viable contingency reserve. Since Iranian oil figures more prominently in European than in U.S. supply, the Iranian troubles are apt to trigger the concerns of our lEA partners even more than our own.