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American import policy and the world oil market
American import policy and the world oil market
M.A. Adelman
The cartel of the producing nations dams up the great potential oil surplus and is rapidly increasing prices and undermining security of supply. American imports, even as projected, are too small to remove the surplus and should be disregarded; American policy has thus far strengthened the cartel, might change, and should be carefully observed. 1
President Nixon's special energy message of 18 April 1973, contained few surprises. It is an interim statement at best, dominated by the temporary shortage of refining facilities. As regards world oil, there is for the m o m e n t peace between the domestic and international segments of the American oil industry. For the first time in 25 years, there is no substantial difference between domestic and world prices, and both are rising. Domestic producers can sell all their output, importers are free to import, and the main concern of the government is not to rock the boat. There is also a somewhat uncertain call for de-regulation of natural gas prices, but the Congress will probably not deliver us Professor M.A. Adelman is at the soon from this folly which has cost us, and others, dearly. Department of Economics, MassaStrenuous attempts will be made at greater self-sufficiency, but chusetts Institute of Technology, there will be little effect before 1980, when imports are expected Cambridge, Massachusetts 02142, to reach around 10 million barrels daily. This has been generally USA expected for a year and it has aroused much concern outside North America, for exactly the wrong reasons. There is no danger o f the United States bidding away scarce oil. First, it has no power to do so. The American (and other) multinational oil companies take orders from their masters, the producing nations, no matter who owns them. Second, oil continues as before in great potential over-supply, which the growing price-cost gap will even aggravate. Far more can be profitably developed and produced at current prices than the market will absorb. The cartel of the OPEC nations exists to keep the potential from being developed. These unfounded fears of American pre-emption of oil supplies have distracted attention from the fact of control by the cartel which, the more it is rewarded for making oil expensive, the greater its power to make it yet more expensive. Prices will rise and supply be ever more insecure for years to come. The United States has supported a cartel harmful to American interests. As this is perceived, American policy may change, but ] This article draws upon a book, "The probably not soon.
World Petroleum Market" (Johns Hopkins Press, 1973), and a study o f American
policy,
'Is the Oil Shortage Real', in
Foreign Policy, Winter 1972 by the author. "The World Petroleum Market" is reviewed by Peter Odell in this issue of
Energy Policy. page 167.
Price and availability of world oil unrelated to supply-demand The rate of growth o f US imports is of minor or no importance for the world availability and price of oil. Projected higher con-
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sumption rates, even if they happen to be correct, say nothing about scarcity and price, because they omit supply. One does not cut with one blade of the scissors. 'Competition [fierce, bitter, frenzied] among buyers for a limited supply' is a truism embellished with poetry. Supply is always limited. So is demand. What matters is their relation in a mineral industry. Stocks of mineral resources, including petroleum, are renewable and replaceable, by discovery and development. If the stock is used up faster than it is being replaced, then all else being equal the cost of replacement will rise. Under competitive conditions, the price rises too. But the Persian Gulf cost has actually fallen. The market price is already 10-20 times the cost in the big concessions, and will be raised much higher. Therefore to curtail US imports would be no help to other nations, nor will increasing US imports hurt them. Indeed, theory suggests and experience proves that in a non-competitive market, growing demand may tend slowly to increase competition and to p u t down prices. The unpredictable expansion after World War II was accompanied by a decline of over 50% in real price (ie, adjusted for inflation). Hence it is not an altogether favourable development that growing American imports will be much offset by the slackening growth rate of European imports. At current prices and even more at expected higher prices much new oil will be developed out of known and newly found pools all over the world over the next decade, and produced in preference to Persian Gulf oil. But supply is already so excessive that unless new discoveries are gigantic, they will have little to do with the availability and price of world oil. So long as the cartel is strong, the price will remain way beyond supply and demand.
High prices and insecure supply - two faces of monopoly Monopoly means control of supply, hence ability to stop it. High prices and insecure supply are two sides of the same coin. The OPEC nations' cartel (not OPEC itself) is strong today because the consuming nations have shown no resistance and have rewarded the cartel for disregarding agreements and threatening embargo. In February 1973 Sheik Yamani of Saudi Arabia warned that resistance to the monopoly meant 'war', in which case 'all civilisation and industries of [consuming] countries will be destroyed'. This threat of supply stoppage was made to frighten consuming nations, and no-one can say it failed.
Middle East politics irrelevant to security or price Internal political disputes and revolutions have never disrupted supply. With the exception of the Suez Canal closures, all supply crises have resulted from direct company-government conflict over money. Today the Suez Canal is obsolete and of negligible importance for the oil trade. It probably never will be important. A settlement between Israel and the Arabs is devoutly to be wished, but it will be no help in oil supply. Nor does the current unhappy stalemate do any harm. Neither the Arabs nor non-Arabs 92
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(who supply 45% of OPEC oil) have the slightest reason to accept less than the traffic will bear, merely because there is peace in the Middle East. They will take what they can get. Iran has cooperated with Israel not because of 'friendship' but because they wanted another means of transport (the Trans-Israel Pipeline) to save money and be less vulnerable to threats. The United States opposed the pipeline in 1957 and 1968, friendship or not. All things considered, the cartel makes peace more precarious. Even a modest proportion of the huge revenues generated by the cartel price, rising to a target of $ 5 per barrel, $366 000 millions in 1972-1980, can fuel wars and disrupt the world monetary system even if there is no intent to disrupt, z If any one Arab producer stopped shipments to the United States, that would be his problem, not the US's. Even if they all did so, but maintained shipments to the rest of the world, there would be confusion and waste as some tankers were re-directed, some shipment records were faked, and as non-Arab oil was swapped, on the high seas or the computer, for Arab oil. It would be a nuisance profiting non-Arab producers and costing everyone else, but the gain in e d u c a t i o n - to e v e r y o n e - might even be worth the cost. The lesson of 1967 (when Britain and Germany were ' b o y c o t t e d ' ) was well summed up a year later by the then Secretary General of OPEC - there is no such thing as a selective embargo. To have a real problem, as the Oil Import Task Force stated in 1970, and State Department concurred, one needs a cut-off of all Arab oil to all the world. Recently the chief State Department energy planner explicitly ruled out a total Arab stoppage: 'some Arab governments, at least, could not survive l i t ] ' ? This rules out the State Department's own argument, widely echoed in Europe, that the United States must modify its Middle East Policy for the sake of oil. It would be futile. The Wall Street Journal and N e w York Times have also warned that it would be dangerous to submit to such blackmail. The obsession with 'Arab oil' only ignores the nature of a market monopoly: unless the producers controlling the great bulk of o u t p u t act together, they fall apart and there is no customer dependence. The cartel will not stick together in order to serve the political interests of half the group. But for the sake of more wealth, they may well stick together and risk crashing defeat. OPEC revenues 1972-1980 inclusive: (a) Assumed 1980 Persian Gulf price $5 per barrel, company margin 50 cents, tax $4.50; (b) 1972-1980 Persian Gulf tax increase, from $1.55 to $4.50 is 14.2% per year. Assuming output rises 8% revenues increase, at 23.3%; (c) 1980 revenues are $15.3 thousand millions x (1.233) 8 = $81.7 thousand millions; (d) Cumulative 1972-1980 revenues are: $15.3 x [ (6.57-1) /0.233] =$366 thousand millions. Prices and per-barrel taxes are higher away from the Persian Gulf. The assumed $5 price has been suggested by the Department of State and Commerce 3 James E. Akins, in Foreign Affairs, April 1973
World price may surpass the USA Unlike the pre-cartel days, the price difference of foreign and domestic oil no longer matters. The world price will be raised much higher and may surpass the domestic American price. The cartel may be better off with a smaller than a larger share of the US market, at a higher price. Moreover, cartel prices will tend to become a patchwork of discrimination. The less competition in any market, the higher the price, and vice versa. For example, residual fuel oil prices will be set to equalize with the equivalent cost of nuclear electric power; while petrol prices rise all the more rapidly.
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The American multinational oil companies Laying aside American interest, it would be a misfortune to the world economy to oust American (and British and French) companies from oil production in the OPEC countries. They contain the great bulk of the know-how. In oil finding and development, governments have done rather poorly. Therefore to avert a real, not phony, shortage, it is in the interest of the non-communist world, and not only the United States, that these companies stay where they are. The problem is that the companies are today the cutting edge of the cartel of the OPEC nations.
Oil companies as tax collectors essential to a cartel A cartel exists to keep the price well above the competitive level. Each m e m b e r is perpetually tempted to expand output because the profit on the incremental sale will be very large. If everyone does this, o u t p u t expands, prices fall, and the cartel disappears. If some do this, taking business away from others who then retaliate, the price erodes and the cartel crumbles gradually. A seller must not act independently. He must keep the faith and have faith that everyone else refrains from selling incremental barrels at better prices. There are two ways of holding the cartel together. Either output is limited and allocated to each seller, letting the price find its own high level, or else the price is fixed and all transactions must be monitored to detect any price reductions. The OPEC nations use the second method. Their taxes are income taxes only in form, excise taxes in fact, in cents per barrel. In effect, the tax is the price charged by the government. Taxes are fixed by each nation in the knowledge that the others are charging about the same. If one charges more, the others are quick to match it. Only within narrow limits can one manoeuvre for higher output, because taxes are a public record. The companies' margin above tax, to cover costs and profits, can be left free to fluctuate. The oil companies, as the tax collectors who market the oil, are indispensable to the cartel. For if the host nations could not fix, in concert, a few taxes to a few companies, easily compared and che'cked, they would have to agree on and then monitor, hundreds of complex deals all over the world. If they went downstream into the sale of refined products, their problems would be multiplied. Cartels usually fall apart. Their members understand perfectly well the strength that lies in union. N o b o d y who knows the first things about competition will call the failed cartelists ignorant or stupid. But the history of world oil shows the difficulties. • Even a small tightly knit private cartel eroded in the 1930's. • OPEC attempted and failed to restrict and allocate output - in 1965, 1966, and 1968 - despite their recognition in 1960 that it was in their interest to do so. • On several occasions OPEC governments shaded taxes to obtain incremental output and revenue. • Sheik Yamani, Saudi Arabian oil minister, worked for years to obtain 'participation' to head o f f nationalisation, which he truly 94
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and repeatedly warned, would be 'a disaster' because it would remove the companies as a buffer, lead to competition and undermine world prices. More recently, having achieved 'participation', he has stated that if there was nationalisation the governments would form a cartel (which they already have) to raise prices even higher than with 'participation'. If so, then for years he has laboured to avoid higher prices and higher revenues for his government. This is not even slightly credible. After Iraq seized Kirkuk fields in June 1972, and threatened to sell at 'reduced and competitive prices,' OPEC members formally pledged to avoid replacing Iraq production. But they proceeded to do so, by a record output expansion at the Persian Gulf. There has been a doubt about-face in Iran, which is particularly keen to expand output because the penalty or opportunity cost of waiting for receipts is probably no less than 20% per year. Hence Iran faces a very difficult choice or trade-off. They do not wish to undermine prices or weaken the cartel of which they were one of the principal architects. Yet a dollar received five years hence is worth only 40 cents today, while a dollar received ten years hence is worth only 16 cents. Hence a rapid expansion of output may be their best bet even if it risks a collapse of the cartel. This is no complete and sufficient explanation for Iranian policy. It only proves that even the strictly economic interests of the cartel members may be pretty far apart. How to remove companies as tax collectors is not now on any agenda. (Although, aside from special authorisations, American and European company subservience to a collusive price agreement among governments seems clearly in violation of US and EEC anti-monopoly laws.) But it is entirely practical. The companies could remain as contractors for exploration, development and production, paid by the governments in money, or a share of oil, etc. The current regime in Indonesia shows that this is a practical solution with which both parties can live. The United States will not and also should not make any such move at present. The other large consuming countries, particularly France, Germany, Italy, Japan, and perhaps even Great Britain, would do their utmost to have their own companies succeed the Americans as tax collectors. Frightened as many are by the Washington scare talk about a world wide energy crisis, it may take them years to calm down. They are under the delusion that having their own companies in place somehow gives them 'access' to the oil, which Anglo-American companies would deny them. The old Gaullist delusion is mighty yet, in defiance of logic and experience. The special French relation with Algeria, where high oil prices were to be offset by export rights, and 'security of supply', brought only a decade of increasing burdens and final expulsion from the 'secure' oil. Yet a special relation is what the Europeans are now seeking, gripped by the same delusion of getting past 'les Anglo-Saxons'. But where Europeans drew back from paying $ 200 million for a scrap of paper conferring a share of Abu Dhabi offshore, Japanese grasped it at $800 million! The
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American import policy and the world oil market fever must run its course, and the dear lessons of experience will not be learned except at first hand arLd the second (or third?) time around. Hence using the tax law or antitrust law or any other device to force American companies into the status of contractor would only lose valuable time. American companies would be succeeded by European or Asian, who would only learn by some painful experiences, slowly. Hence the suggestions for a counterorganisation of consuming countries are beside the point. None of them is addressed to the relevant question: how to get the cartel o f f our backs? But the United States could cease to terrorise its friends. 'Fears of Europe and Japan that Middle Eastern oil they were counting on to cover their needs will be diverted by the U.S. for its own use in a few years weren't dispersed by the recent explanation of a top United States official to the [OECD] n a t i o n s . . . If anything, they're now even more worried because the U.S. clearly warned them that nothing will stop it from importing the oil it needs'. 4 Another recent example is discussed below. The US government has practiced this intimidation in public and private. When it stops, it will be time to begin discussing cooperation.
"The oil industry today is different' A number of arguments are now offered to the effect that even real nationalisation, the producing nations or direct sellers, will not help - the rise in prices is inevitable, and we should not try to resist it. If this is believed, it is a self-fulfilling prophecy. Any special explanation had better be a good one. We will examine three. 'Production will be restricted because oil in ground apprec&tes faster than money in bank'. In developing a given reserve, a barrel sold today is a barrel less for sale tomorrow. Hence its future value (return above cost), discounted to the present, is part of the cost today. If the value rises at an annual rate higher than the discount rate, it is worth waiting before starting production. But the principle governs only when the price is an outside fact, not determined by the operators. Under a cartel system, even if the future value of the barrel were zero, and it was a case of sell it now or never, the cartelist would not produce it. For if everyone did so, it would wreck prices. This kind of self-restraint has been in force for decades. Hence to suggest that Persian Gulf production 'may be restricted' in the future is to be 50 years out of date. The price decline of 1957-70 was only a minor relaxation, as control of supply diminished, before the dramatic reversal since then. Under non-competition, the comparison of oil price changes with interest rates is simply irrelevant. If the price were jacked up to the ultimate ceiling tomorrow, and held there, the rate of increase of interest rates would be zero, but it would still be the most profitable level. Even where the operator takes the price as an external fact, th6: comparison o f present and future prices must have a specific time frame. For example, take 7% as a safe interest rate and assume the
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American import policy and the worm oil market price will increase at that rate, doubling in ten years. If costs remain constant, the net value of a barrel ten years hence, discounted to the present, is a bit higher than its value today. But it does not follow that the price will again double in 1982-1992, by eight times as high in 2000, and so on. There is a prohibitive risk in trying to forecast prices that far ahead. It follows that the government of Kuwait, in restricting annual o u t p u t to about 1% of reserves, hence holding back over half their current 66-year stock for after 2000, is making a mistake. They may have other, sound, reasons.
'Producing countries will have nothing to do with their money, and won't expand production'. This is obviously not true of Dan, Venezuela, Nigeria, Algeria, Iraq, and Indonesia. But let us assume that half of projected 1980 OPEC revenues are not spent for current consumption, real investment, or armaments. Gross domestic capital formation in the industrialised countries in 1980 should be around $800 000 million a year. Investment outlets are the last thing we need worry about. It is true that Kuwait has decided to limit its production to 3 MBD or about 15 BD per citizen (excluding resident aliens), s At this rate, Saudi Arabia should aim at 75 MBD to 105 MBD, or over ten times current output. Yet it could be argued that countries like Saudi Arabia simply cannot obtain the personnel to manage a huge investment portfolio, may not be able to invest at short term, and will therefore be almost compelled to limit o u t p u t to escape drowning in unmanageable wealth. This argument is not a logical error like 'oil in ground - money in bank' discussed above. The alleged fact may be left to the conjecture of those better informed than myself, but the logic is only a special case of a well known economic theorem, the 'background bending supply curve'. There is an important implication. If prices were reduced, and revenues with them, additional m o n e y would become more desirable. Thus a price cut is twice blessed. Or, as was said earlier, the greater the revenues, the greater the nations' power to extort even more revenues. 'Only Saudi Arabia will have any potential spare producing capacity in 1980, and by giving up market share if necessary, they can limit production" At $ 5 per barrel, it seems very unlikely that only one or two countries will have potential for profitable expansion. But let us assume it. There is an unstated major premise - that every producing country has its outlets assured by long-term contracts with the consumers. But some consuming countries may grasp the element of truth in this argument. It is to their interest to stop long-term contracts, and make the sellers compete frequently. Then all of the o u t p u t becomes marginal output, on which the seller is subject to pressure to shade prices in order to maintain sales. Hence a practical suggestion which can be put into effect at any time, though periods of actual surplus capacity are most favourable.
4 Petroleum Intelligence Weekly, O c t o b e r , 1972 s M B D = million barrels per day; similarly B D = barrels per day.
Import quotas as a means to lower prices Import quotas can be put up for competitive sealed bids, like any other valuable licence. Packages of quotas could be available for
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periods up to three years, and should be freely traded. Any producer government with its own oil would be certain of a home for that oil - they need only bid high enough. Or a government could make a special deal with its company to lower tax per barrel on incremental output. This kind of collusion is beneficial. No country would be left secure in its sales and revenues. Company affiliations would not matter. Even an integrated producer-refiner would need to obtain tickets as often as anyone else. The more transactions, the more chances for newcomers and interlopers to make incremental sales, the more opportunity for misunderstandings and betrayal and fear of betrayal by the members of the cartel. OPEC governments doubtless would try to agree not to underbid. But this would be difficult to supervise and enforce. For example, when a company bought 'too many' import tickets, they would claim it was at their own expense, without their host government's help. The American market is very large, profitable, and expanding. Refusal to bid would hand it over to a minority of OPEC and some non-OPEC producers, who could have it all very cheaply. It would be very easy for a government to announce a boycott, while selling its oil through third parties who would bid for it. Governments already counting on receipts from large sales to the USA would find it necessary to find outlets for several million barrels daily. The b o d y administering oil imports could be charged to exclude from bidding for a longer or shorter period any parties, including governments, whom it found, after a hearing, to be in collusion. The economic penalty for collusion might be an effective deterrent to some. In addition, any companies, foreign or domestic, private or governmentally owned, are subject to the anti-monopoly laws, eg Article 85 of the Treaty of Rome, or Section 1 of the Sherman Anti-Trust Act. But the chief sanction would be the hope of gain and the fear of being left out. There is a definite cost to this constant re-contracting and trading in quota tickets. But it is tiny compared with the huge price increases which the cartel has in store, on top of those already imposed. Consideration ought to be given to preference (eg, rebates) for more secure sources of oil. Indonesia refused to sign the embargo threat in February 1971 and has proved itself to be a more secure source. Nigeria was not yet a member of OPEC, and we ought to presume them innocent until proved guilty of waging economic warfare. The most insecure oil is obviously from Libya and Saudi Arabia. Planning should also begin to raise internal excise taxes on oil products as high as possible. It is a foregone conclusion that oil prices will be raised to the point of maximum return, where further increases would lose so much sales as to be counterproductive. The more the consuming country pre-empts in taxes, the less is left for the cartel, the smaller its revenue, and the less its power. The higher excise tax revenues are then clear gain to the whole consuming country. The attacks by the OPEC nations on the internal taxes 'ai-e hinting at a truth the consuming countries may learn in the next ten years.
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Some injurious suggestions for preference It is instructive to ponder some types of preference seriously considered in the USA today. In September, Saudi Arabia suggested that their exports to the United States be free of quota, in return for which they would make substantial investments in the United States. Kuwait has made a similar proposal to the EEC. Such a deal would damage the importer. 'Assurance' of supply is not to be taken seriously. Discretion and control of imports would be lost. Aside from the need to repatriate interest and dividends: at any time the owners could either sell out, or borrow huge amounts on the security of their investments, and sell the importing country's currency. At best the importer would be living on capital, giving permanent assets in exchange for current consumption. The State Department must have known that no such agreement would be possible under the US law, but that the more suspicion that it was possible would alarm Europeans and Asians. They were reported to be 'enthusiastic' over the proposal, and gave it much publicity.
Conclusion The effect of American policy has been and remains to strengthen the cartel. The force of inertia is such that no quick change is to be expected. Hence it is safe to count on rising world prices and growing insecurity in the next few years, perhaps for the rest of the decade. But since the policy rests on illusion, and is harmful to American interests, it may change. One needs to watch American policy rather than growth of American imports.
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M.A. Adelman
The cartel of the producing nations dams up the great potential oil surplus and is rapidly increasing prices and undermining security of supply. American imports, even as projected, are too small to remove the surplus and should be disregarded; American policy has thus far strengthened the cartel, might change, and should be carefully observed. 1
President Nixon's special energy message of 18 April 1973, contained few surprises. It is an interim statement at best, dominated by the temporary shortage of refining facilities. As regards world oil, there is for the m o m e n t peace between the domestic and international segments of the American oil industry. For the first time in 25 years, there is no substantial difference between domestic and world prices, and both are rising. Domestic producers can sell all their output, importers are free to import, and the main concern of the government is not to rock the boat. There is also a somewhat uncertain call for de-regulation of natural gas prices, but the Congress will probably not deliver us Professor M.A. Adelman is at the soon from this folly which has cost us, and others, dearly. Department of Economics, MassaStrenuous attempts will be made at greater self-sufficiency, but chusetts Institute of Technology, there will be little effect before 1980, when imports are expected Cambridge, Massachusetts 02142, to reach around 10 million barrels daily. This has been generally USA expected for a year and it has aroused much concern outside North America, for exactly the wrong reasons. There is no danger o f the United States bidding away scarce oil. First, it has no power to do so. The American (and other) multinational oil companies take orders from their masters, the producing nations, no matter who owns them. Second, oil continues as before in great potential over-supply, which the growing price-cost gap will even aggravate. Far more can be profitably developed and produced at current prices than the market will absorb. The cartel of the OPEC nations exists to keep the potential from being developed. These unfounded fears of American pre-emption of oil supplies have distracted attention from the fact of control by the cartel which, the more it is rewarded for making oil expensive, the greater its power to make it yet more expensive. Prices will rise and supply be ever more insecure for years to come. The United States has supported a cartel harmful to American interests. As this is perceived, American policy may change, but ] This article draws upon a book, "The probably not soon.
World Petroleum Market" (Johns Hopkins Press, 1973), and a study o f American
policy,
'Is the Oil Shortage Real', in
Foreign Policy, Winter 1972 by the author. "The World Petroleum Market" is reviewed by Peter Odell in this issue of
Energy Policy. page 167.
Price and availability of world oil unrelated to supply-demand The rate of growth o f US imports is of minor or no importance for the world availability and price of oil. Projected higher con-
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sumption rates, even if they happen to be correct, say nothing about scarcity and price, because they omit supply. One does not cut with one blade of the scissors. 'Competition [fierce, bitter, frenzied] among buyers for a limited supply' is a truism embellished with poetry. Supply is always limited. So is demand. What matters is their relation in a mineral industry. Stocks of mineral resources, including petroleum, are renewable and replaceable, by discovery and development. If the stock is used up faster than it is being replaced, then all else being equal the cost of replacement will rise. Under competitive conditions, the price rises too. But the Persian Gulf cost has actually fallen. The market price is already 10-20 times the cost in the big concessions, and will be raised much higher. Therefore to curtail US imports would be no help to other nations, nor will increasing US imports hurt them. Indeed, theory suggests and experience proves that in a non-competitive market, growing demand may tend slowly to increase competition and to p u t down prices. The unpredictable expansion after World War II was accompanied by a decline of over 50% in real price (ie, adjusted for inflation). Hence it is not an altogether favourable development that growing American imports will be much offset by the slackening growth rate of European imports. At current prices and even more at expected higher prices much new oil will be developed out of known and newly found pools all over the world over the next decade, and produced in preference to Persian Gulf oil. But supply is already so excessive that unless new discoveries are gigantic, they will have little to do with the availability and price of world oil. So long as the cartel is strong, the price will remain way beyond supply and demand.
High prices and insecure supply - two faces of monopoly Monopoly means control of supply, hence ability to stop it. High prices and insecure supply are two sides of the same coin. The OPEC nations' cartel (not OPEC itself) is strong today because the consuming nations have shown no resistance and have rewarded the cartel for disregarding agreements and threatening embargo. In February 1973 Sheik Yamani of Saudi Arabia warned that resistance to the monopoly meant 'war', in which case 'all civilisation and industries of [consuming] countries will be destroyed'. This threat of supply stoppage was made to frighten consuming nations, and no-one can say it failed.
Middle East politics irrelevant to security or price Internal political disputes and revolutions have never disrupted supply. With the exception of the Suez Canal closures, all supply crises have resulted from direct company-government conflict over money. Today the Suez Canal is obsolete and of negligible importance for the oil trade. It probably never will be important. A settlement between Israel and the Arabs is devoutly to be wished, but it will be no help in oil supply. Nor does the current unhappy stalemate do any harm. Neither the Arabs nor non-Arabs 92
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(who supply 45% of OPEC oil) have the slightest reason to accept less than the traffic will bear, merely because there is peace in the Middle East. They will take what they can get. Iran has cooperated with Israel not because of 'friendship' but because they wanted another means of transport (the Trans-Israel Pipeline) to save money and be less vulnerable to threats. The United States opposed the pipeline in 1957 and 1968, friendship or not. All things considered, the cartel makes peace more precarious. Even a modest proportion of the huge revenues generated by the cartel price, rising to a target of $ 5 per barrel, $366 000 millions in 1972-1980, can fuel wars and disrupt the world monetary system even if there is no intent to disrupt, z If any one Arab producer stopped shipments to the United States, that would be his problem, not the US's. Even if they all did so, but maintained shipments to the rest of the world, there would be confusion and waste as some tankers were re-directed, some shipment records were faked, and as non-Arab oil was swapped, on the high seas or the computer, for Arab oil. It would be a nuisance profiting non-Arab producers and costing everyone else, but the gain in e d u c a t i o n - to e v e r y o n e - might even be worth the cost. The lesson of 1967 (when Britain and Germany were ' b o y c o t t e d ' ) was well summed up a year later by the then Secretary General of OPEC - there is no such thing as a selective embargo. To have a real problem, as the Oil Import Task Force stated in 1970, and State Department concurred, one needs a cut-off of all Arab oil to all the world. Recently the chief State Department energy planner explicitly ruled out a total Arab stoppage: 'some Arab governments, at least, could not survive l i t ] ' ? This rules out the State Department's own argument, widely echoed in Europe, that the United States must modify its Middle East Policy for the sake of oil. It would be futile. The Wall Street Journal and N e w York Times have also warned that it would be dangerous to submit to such blackmail. The obsession with 'Arab oil' only ignores the nature of a market monopoly: unless the producers controlling the great bulk of o u t p u t act together, they fall apart and there is no customer dependence. The cartel will not stick together in order to serve the political interests of half the group. But for the sake of more wealth, they may well stick together and risk crashing defeat. OPEC revenues 1972-1980 inclusive: (a) Assumed 1980 Persian Gulf price $5 per barrel, company margin 50 cents, tax $4.50; (b) 1972-1980 Persian Gulf tax increase, from $1.55 to $4.50 is 14.2% per year. Assuming output rises 8% revenues increase, at 23.3%; (c) 1980 revenues are $15.3 thousand millions x (1.233) 8 = $81.7 thousand millions; (d) Cumulative 1972-1980 revenues are: $15.3 x [ (6.57-1) /0.233] =$366 thousand millions. Prices and per-barrel taxes are higher away from the Persian Gulf. The assumed $5 price has been suggested by the Department of State and Commerce 3 James E. Akins, in Foreign Affairs, April 1973
World price may surpass the USA Unlike the pre-cartel days, the price difference of foreign and domestic oil no longer matters. The world price will be raised much higher and may surpass the domestic American price. The cartel may be better off with a smaller than a larger share of the US market, at a higher price. Moreover, cartel prices will tend to become a patchwork of discrimination. The less competition in any market, the higher the price, and vice versa. For example, residual fuel oil prices will be set to equalize with the equivalent cost of nuclear electric power; while petrol prices rise all the more rapidly.
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The American multinational oil companies Laying aside American interest, it would be a misfortune to the world economy to oust American (and British and French) companies from oil production in the OPEC countries. They contain the great bulk of the know-how. In oil finding and development, governments have done rather poorly. Therefore to avert a real, not phony, shortage, it is in the interest of the non-communist world, and not only the United States, that these companies stay where they are. The problem is that the companies are today the cutting edge of the cartel of the OPEC nations.
Oil companies as tax collectors essential to a cartel A cartel exists to keep the price well above the competitive level. Each m e m b e r is perpetually tempted to expand output because the profit on the incremental sale will be very large. If everyone does this, o u t p u t expands, prices fall, and the cartel disappears. If some do this, taking business away from others who then retaliate, the price erodes and the cartel crumbles gradually. A seller must not act independently. He must keep the faith and have faith that everyone else refrains from selling incremental barrels at better prices. There are two ways of holding the cartel together. Either output is limited and allocated to each seller, letting the price find its own high level, or else the price is fixed and all transactions must be monitored to detect any price reductions. The OPEC nations use the second method. Their taxes are income taxes only in form, excise taxes in fact, in cents per barrel. In effect, the tax is the price charged by the government. Taxes are fixed by each nation in the knowledge that the others are charging about the same. If one charges more, the others are quick to match it. Only within narrow limits can one manoeuvre for higher output, because taxes are a public record. The companies' margin above tax, to cover costs and profits, can be left free to fluctuate. The oil companies, as the tax collectors who market the oil, are indispensable to the cartel. For if the host nations could not fix, in concert, a few taxes to a few companies, easily compared and che'cked, they would have to agree on and then monitor, hundreds of complex deals all over the world. If they went downstream into the sale of refined products, their problems would be multiplied. Cartels usually fall apart. Their members understand perfectly well the strength that lies in union. N o b o d y who knows the first things about competition will call the failed cartelists ignorant or stupid. But the history of world oil shows the difficulties. • Even a small tightly knit private cartel eroded in the 1930's. • OPEC attempted and failed to restrict and allocate output - in 1965, 1966, and 1968 - despite their recognition in 1960 that it was in their interest to do so. • On several occasions OPEC governments shaded taxes to obtain incremental output and revenue. • Sheik Yamani, Saudi Arabian oil minister, worked for years to obtain 'participation' to head o f f nationalisation, which he truly 94
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and repeatedly warned, would be 'a disaster' because it would remove the companies as a buffer, lead to competition and undermine world prices. More recently, having achieved 'participation', he has stated that if there was nationalisation the governments would form a cartel (which they already have) to raise prices even higher than with 'participation'. If so, then for years he has laboured to avoid higher prices and higher revenues for his government. This is not even slightly credible. After Iraq seized Kirkuk fields in June 1972, and threatened to sell at 'reduced and competitive prices,' OPEC members formally pledged to avoid replacing Iraq production. But they proceeded to do so, by a record output expansion at the Persian Gulf. There has been a doubt about-face in Iran, which is particularly keen to expand output because the penalty or opportunity cost of waiting for receipts is probably no less than 20% per year. Hence Iran faces a very difficult choice or trade-off. They do not wish to undermine prices or weaken the cartel of which they were one of the principal architects. Yet a dollar received five years hence is worth only 40 cents today, while a dollar received ten years hence is worth only 16 cents. Hence a rapid expansion of output may be their best bet even if it risks a collapse of the cartel. This is no complete and sufficient explanation for Iranian policy. It only proves that even the strictly economic interests of the cartel members may be pretty far apart. How to remove companies as tax collectors is not now on any agenda. (Although, aside from special authorisations, American and European company subservience to a collusive price agreement among governments seems clearly in violation of US and EEC anti-monopoly laws.) But it is entirely practical. The companies could remain as contractors for exploration, development and production, paid by the governments in money, or a share of oil, etc. The current regime in Indonesia shows that this is a practical solution with which both parties can live. The United States will not and also should not make any such move at present. The other large consuming countries, particularly France, Germany, Italy, Japan, and perhaps even Great Britain, would do their utmost to have their own companies succeed the Americans as tax collectors. Frightened as many are by the Washington scare talk about a world wide energy crisis, it may take them years to calm down. They are under the delusion that having their own companies in place somehow gives them 'access' to the oil, which Anglo-American companies would deny them. The old Gaullist delusion is mighty yet, in defiance of logic and experience. The special French relation with Algeria, where high oil prices were to be offset by export rights, and 'security of supply', brought only a decade of increasing burdens and final expulsion from the 'secure' oil. Yet a special relation is what the Europeans are now seeking, gripped by the same delusion of getting past 'les Anglo-Saxons'. But where Europeans drew back from paying $ 200 million for a scrap of paper conferring a share of Abu Dhabi offshore, Japanese grasped it at $800 million! The
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American import policy and the world oil market fever must run its course, and the dear lessons of experience will not be learned except at first hand arLd the second (or third?) time around. Hence using the tax law or antitrust law or any other device to force American companies into the status of contractor would only lose valuable time. American companies would be succeeded by European or Asian, who would only learn by some painful experiences, slowly. Hence the suggestions for a counterorganisation of consuming countries are beside the point. None of them is addressed to the relevant question: how to get the cartel o f f our backs? But the United States could cease to terrorise its friends. 'Fears of Europe and Japan that Middle Eastern oil they were counting on to cover their needs will be diverted by the U.S. for its own use in a few years weren't dispersed by the recent explanation of a top United States official to the [OECD] n a t i o n s . . . If anything, they're now even more worried because the U.S. clearly warned them that nothing will stop it from importing the oil it needs'. 4 Another recent example is discussed below. The US government has practiced this intimidation in public and private. When it stops, it will be time to begin discussing cooperation.
"The oil industry today is different' A number of arguments are now offered to the effect that even real nationalisation, the producing nations or direct sellers, will not help - the rise in prices is inevitable, and we should not try to resist it. If this is believed, it is a self-fulfilling prophecy. Any special explanation had better be a good one. We will examine three. 'Production will be restricted because oil in ground apprec&tes faster than money in bank'. In developing a given reserve, a barrel sold today is a barrel less for sale tomorrow. Hence its future value (return above cost), discounted to the present, is part of the cost today. If the value rises at an annual rate higher than the discount rate, it is worth waiting before starting production. But the principle governs only when the price is an outside fact, not determined by the operators. Under a cartel system, even if the future value of the barrel were zero, and it was a case of sell it now or never, the cartelist would not produce it. For if everyone did so, it would wreck prices. This kind of self-restraint has been in force for decades. Hence to suggest that Persian Gulf production 'may be restricted' in the future is to be 50 years out of date. The price decline of 1957-70 was only a minor relaxation, as control of supply diminished, before the dramatic reversal since then. Under non-competition, the comparison of oil price changes with interest rates is simply irrelevant. If the price were jacked up to the ultimate ceiling tomorrow, and held there, the rate of increase of interest rates would be zero, but it would still be the most profitable level. Even where the operator takes the price as an external fact, th6: comparison o f present and future prices must have a specific time frame. For example, take 7% as a safe interest rate and assume the
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American import policy and the worm oil market price will increase at that rate, doubling in ten years. If costs remain constant, the net value of a barrel ten years hence, discounted to the present, is a bit higher than its value today. But it does not follow that the price will again double in 1982-1992, by eight times as high in 2000, and so on. There is a prohibitive risk in trying to forecast prices that far ahead. It follows that the government of Kuwait, in restricting annual o u t p u t to about 1% of reserves, hence holding back over half their current 66-year stock for after 2000, is making a mistake. They may have other, sound, reasons.
'Producing countries will have nothing to do with their money, and won't expand production'. This is obviously not true of Dan, Venezuela, Nigeria, Algeria, Iraq, and Indonesia. But let us assume that half of projected 1980 OPEC revenues are not spent for current consumption, real investment, or armaments. Gross domestic capital formation in the industrialised countries in 1980 should be around $800 000 million a year. Investment outlets are the last thing we need worry about. It is true that Kuwait has decided to limit its production to 3 MBD or about 15 BD per citizen (excluding resident aliens), s At this rate, Saudi Arabia should aim at 75 MBD to 105 MBD, or over ten times current output. Yet it could be argued that countries like Saudi Arabia simply cannot obtain the personnel to manage a huge investment portfolio, may not be able to invest at short term, and will therefore be almost compelled to limit o u t p u t to escape drowning in unmanageable wealth. This argument is not a logical error like 'oil in ground - money in bank' discussed above. The alleged fact may be left to the conjecture of those better informed than myself, but the logic is only a special case of a well known economic theorem, the 'background bending supply curve'. There is an important implication. If prices were reduced, and revenues with them, additional m o n e y would become more desirable. Thus a price cut is twice blessed. Or, as was said earlier, the greater the revenues, the greater the nations' power to extort even more revenues. 'Only Saudi Arabia will have any potential spare producing capacity in 1980, and by giving up market share if necessary, they can limit production" At $ 5 per barrel, it seems very unlikely that only one or two countries will have potential for profitable expansion. But let us assume it. There is an unstated major premise - that every producing country has its outlets assured by long-term contracts with the consumers. But some consuming countries may grasp the element of truth in this argument. It is to their interest to stop long-term contracts, and make the sellers compete frequently. Then all of the o u t p u t becomes marginal output, on which the seller is subject to pressure to shade prices in order to maintain sales. Hence a practical suggestion which can be put into effect at any time, though periods of actual surplus capacity are most favourable.
4 Petroleum Intelligence Weekly, O c t o b e r , 1972 s M B D = million barrels per day; similarly B D = barrels per day.
Import quotas as a means to lower prices Import quotas can be put up for competitive sealed bids, like any other valuable licence. Packages of quotas could be available for
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periods up to three years, and should be freely traded. Any producer government with its own oil would be certain of a home for that oil - they need only bid high enough. Or a government could make a special deal with its company to lower tax per barrel on incremental output. This kind of collusion is beneficial. No country would be left secure in its sales and revenues. Company affiliations would not matter. Even an integrated producer-refiner would need to obtain tickets as often as anyone else. The more transactions, the more chances for newcomers and interlopers to make incremental sales, the more opportunity for misunderstandings and betrayal and fear of betrayal by the members of the cartel. OPEC governments doubtless would try to agree not to underbid. But this would be difficult to supervise and enforce. For example, when a company bought 'too many' import tickets, they would claim it was at their own expense, without their host government's help. The American market is very large, profitable, and expanding. Refusal to bid would hand it over to a minority of OPEC and some non-OPEC producers, who could have it all very cheaply. It would be very easy for a government to announce a boycott, while selling its oil through third parties who would bid for it. Governments already counting on receipts from large sales to the USA would find it necessary to find outlets for several million barrels daily. The b o d y administering oil imports could be charged to exclude from bidding for a longer or shorter period any parties, including governments, whom it found, after a hearing, to be in collusion. The economic penalty for collusion might be an effective deterrent to some. In addition, any companies, foreign or domestic, private or governmentally owned, are subject to the anti-monopoly laws, eg Article 85 of the Treaty of Rome, or Section 1 of the Sherman Anti-Trust Act. But the chief sanction would be the hope of gain and the fear of being left out. There is a definite cost to this constant re-contracting and trading in quota tickets. But it is tiny compared with the huge price increases which the cartel has in store, on top of those already imposed. Consideration ought to be given to preference (eg, rebates) for more secure sources of oil. Indonesia refused to sign the embargo threat in February 1971 and has proved itself to be a more secure source. Nigeria was not yet a member of OPEC, and we ought to presume them innocent until proved guilty of waging economic warfare. The most insecure oil is obviously from Libya and Saudi Arabia. Planning should also begin to raise internal excise taxes on oil products as high as possible. It is a foregone conclusion that oil prices will be raised to the point of maximum return, where further increases would lose so much sales as to be counterproductive. The more the consuming country pre-empts in taxes, the less is left for the cartel, the smaller its revenue, and the less its power. The higher excise tax revenues are then clear gain to the whole consuming country. The attacks by the OPEC nations on the internal taxes 'ai-e hinting at a truth the consuming countries may learn in the next ten years.
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Some injurious suggestions for preference It is instructive to ponder some types of preference seriously considered in the USA today. In September, Saudi Arabia suggested that their exports to the United States be free of quota, in return for which they would make substantial investments in the United States. Kuwait has made a similar proposal to the EEC. Such a deal would damage the importer. 'Assurance' of supply is not to be taken seriously. Discretion and control of imports would be lost. Aside from the need to repatriate interest and dividends: at any time the owners could either sell out, or borrow huge amounts on the security of their investments, and sell the importing country's currency. At best the importer would be living on capital, giving permanent assets in exchange for current consumption. The State Department must have known that no such agreement would be possible under the US law, but that the more suspicion that it was possible would alarm Europeans and Asians. They were reported to be 'enthusiastic' over the proposal, and gave it much publicity.
Conclusion The effect of American policy has been and remains to strengthen the cartel. The force of inertia is such that no quick change is to be expected. Hence it is safe to count on rising world prices and growing insecurity in the next few years, perhaps for the rest of the decade. But since the policy rests on illusion, and is harmful to American interests, it may change. One needs to watch American policy rather than growth of American imports.
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