The Future of OPEC

The surprisingly low 5-15 percent increase in the price of oil announced in December by the Organization of Petroleum Exporting Countries (OPEC) may be the beginning of a pattern of regular, steady rises in the real price of oil. The rationale for these increases is one few analysts would have taken seriously as little as a year ago—namely, the OPEC governments need more money.

Revenue needs of OPEC countries. The quadrupling of oil prices at the end of 1973 created a mood of euphoria among the OPEC governments. All of them began planning vast (and in some cases unrealistic) spending programs. The world anticipated a massive accumulation of petrodollars, unable to be spent by even the densely populated countries in OPEC. But within three years the euphoria had faded. The inflationary explosion after 1973 sharply raised the cost of heavy construction equipment, machinery, and consumer goods. In addition, the spending programs of the OPEC nations encountered serious obstacles such as port congestion, infrastructure bottlenecks, and administrative problems. Finally, the objectives of the OPEC expenditures—economic development, national defense, social welfare, foreign aid, and influence—have simply proved to be extraordinarily expensive. As a consequence, the oil-exporting governments are spending much more and getting much less than they expected.

Iran, for example, planned to spend 12 billion between 1973 and 1978 to lay the foundation for a modern state before the country's petroleum capacity begins to dwindle in the mid-1980s. After completing all projects, the Iranian Plan and Budget Organization projected a net revenue surplus of more than $11 billion. But before the end of 1975 the Iranian government already faced both balance of payments and fiscal deficits. A realistic recalculation of the cost of programs suggests that the total plan would cost at least 50 percent more than the initial estimate. Of this increase, approximately 15 percent would be caused by the higher price of imported goods if current trends continue; and 35 percent would be caused by domestic reasons. Even if Iran exports oil at full capacity from 1976 through the end of the Five Year Plan, it would accomplish only 53 percent of the economic development projects, 59 percent of the social welfare projects, and 88 percent of the public affairs projects. In addition, in order to maintain domestic political stability, the authorities in Teheran are facing pressures for additional programs—food subsidies, public housing, rural development. It is not surprising that Iran has been in the forefront of those oil-exporting countries pushing for dramatically higher oil prices.

Saudi Arabia is discovering that its oil earnings are buying even less than those of the Iranians when measured against the original expectations of the Central Planning Office in Riyadh. The Saudi Five Year Plan announced for 1975-1980 was supposed to cost $142 billion, but in fact it will cost much more than double that figure. Of the rise in program costs in the Saudi plan, 5 to 10 percent has thus far been "imported inflation," with the remainder attributed to domestic causes. Few outside analysts thought that the timetable contemplated in the plan was even faintly realistic. Now, subsequent calculations indicate that even if the Saudis were to stretch out their plan over a twenty-year period, and drop many projects altogether, they would still have to earn more than $25 billion per year to finance their budget on a current basis. With massive cutbacks and extensions of programs, Saudi financial reserves will probably peak in 1978 at not much more than $50 billion and decline steadily after that.

These projections suggest, among other things, that the threat that Saudi Arabia might cut back its oil production to 3 million barrels per day, or even 1 million barrels per day, at current prices, will soon be highly implausible except for short periods of time (for example, another Mideast war): the monarchy could do so only by paring back local food subsidies, water projects, military salaries, government employment, public housing, health programs, defense forces, and foreign aid to an extent that would have severe repercussions on domestic tranquillity. Despite the recent decision to hold price increases to only 5 percent, these projections also suggest that in the longer term many [sectors] of the Saudi elite will become more sympathetic to the urgings of their fellow members of OPEC for an escalation in the real price of oil.
Prominent among those members will be the high-population, high-mobilization societies—such as Algeria, Indonesia, Nigeria, Iraq, and Venezuela. Before 1980 ten or eleven of the thirteen members of OPEC—depending upon how the market for OPEC oil is divided— will be facing fiscal deficits.

Implications for oil-importing countries. Such a situation has some positive, and many negative, implications for the oil-importing states. On the positive side, it means that the petrodollar surplus "problem" is vanishing as abruptly as it appeared, along with the justification for policies designed to sop up those dollars. Certainly, the justification for selling massive amounts of military arms has disappeared. On the negative side, it means that the energy crisis was not a one-time event that the world can adjust to and then forget. Even the moderate governments of OPEC, such as Saudi Arabia, will experience increasing pressure to respond to the revenue pinch by raising the real price of oil as fast as the major market economies can adjust their policies to cope with the strain. Although this impetus to increase prices will ultimately be constrained by the price of substitutes, such as shale oil or gasified coal, in the meantime the increase could have a severely adverse impact on the weaker oil-importing economies, such as Italy, and a devastating impact on the Third and Fourth worlds. It is worth pointing out that although the non-OPEC, less developed countries (LDCs) gain back in OPEC aid about $5 billion per year of the $13 billion they are losing from past oil price increases, the levels of OPEC assistance to them are likely to decline because of the revenue squeeze described above—even if the price of oil is increased again. Iran has already reduced its aid allocations by 40 percent between 1975 and 1976.

In addition, the growing revenue needs of the OPEC states are having a paradoxical effect on the strength of the producers' group. On the one hand, the situation suggests that the members will push for higher real oil prices to alleviate their financial "squeezes." On the other hand, it suggests that OPEC itself will become more vulnerable as the group tries to apportion market shares among the constituent countries, most of whom need more revenues. One calculation of the probable demand for OPEC exports in 1980, for example, indicates a figure of 29-30 mbd (million barrels per day oil equivalent) at current prices, including oil, natural gas, and petroleum products. With the expanding appetite for revenues, this will mean that by 1980, with constant year-end 1976 prices, OPEC will have to absorb not merely 17 mbd in aggregate spare capacity but more than 6 mbd of spare capacity in the hands of governments for whom the marginal utility of the revenues foregone is high. Although the near-term matching of OPEC revenues with perceived OPEC needs will be close, the medium-term prospects—after Alaskan, North Sea, and other discoveries begin to produce—portray a far different picture. In the late 1970s and early 1980s, the market will be a mirror image of the post-1973 market, with more sellers than there are buyers at the given OPEC price. Consequently, conservation measures in the United States plus efforts to stimulate non-OPEC sources of supply will greatly complicate OPEC's future ability to operate as a cartel.

From the oil-exporters' point of view the economically rational strategy would be to perfect their structure as a cartel, assigning explicit market shares and rewarding compliance with regular and dependable price hikes. From the oil-importers' point of view the economically rational strategy would be to try to undermine the producers' ability to collude by playing upon the tensions among them. The cartel strategy would require the importers to adjust to steadily higher oil prices. The importers' strategy would mean trying to "break OPEC," using political, military, and intelligence-sharing contacts, as well as economic incentives, to reward those OPEC members willing to increase output at discount prices. The existence of a large amount of spare capacity in the hands of governments that need the revenues which such idle facilities could generate will leave OPEC vulnerable to the producers' strategy in the late 1970s.