Falling world oil prices are brightening the prospects for faster economic growth in the United States.
But while the outlook may be better for the United States and other oil-producing nations, further drops in oil prices will put the squeeze on oil exporters and an already struggling U.S. oil industry.
A decline in crude-oil prices from a current world average of approximately $26 a barrel to $20 -- coupled with a comparable drop in natural gas costs -- could within a matter of months lower prices for all goods and services by a percentage point or more, economists estimate. The drop in price levels should then show up as faster economic growth.
The price breaks flowing from the huge amount of excess production capacity available among the member nations of Organization of Petroleum Exporting Countries could be smaller or larger than that, of course. The sharper and more sudden the oil price drop, the more trouble it would mean for the oil industry, its bankers and some heavily indebted oil exporters, such as Mexico. Mexico, able to sell only about half its 1.5 million barrel-a-day target, cut its prices last week by about $1.25.
A large price drop would also put enormous pressure on Saudi Arabia and other members of OPEC to try even harder to put their cartel back together again. With most of its members undercutting official prices to boost sales, the last OPEC session earlier this month ended in total disarray. The oil ministers will try again next week, but few observers expect them to succeed -- particularly after non-member Mexico cut its prices.
The question is whether prices will continue to fall in relatively small steps or plummet all at once. If a big price slide gets started, it might not stop short of about $15 dollars a barrel, some economists believe. It could drop that far because it would only be at or below that level that some oil wells would be shut down because it would cost more to produce the oil than it would bring on the market.
Actual marginal costs of production are usually closely guarded secrets, but in parts of the Middle East they undoubtedly are under $2 a barrel.
In 1972, just before the Arab oil embargo, world oil prices averaged $3.39 a barrel. A $15 a barrel world price would be equal to $6.50 in 1972 dollars.
At an average price of $26 for a 42-gallon barrel, output of crude oil and natural gas liquids in the world's non-communist nations is worth more than $400 billion a year. That's roughly 3.5 percent of their total gross national product. Natural gas production is worth about another $100 billion, another 0.9 percent of GNP.
If current oil prices fell by about one-fourth, to the neighborhood of $20, and natural gas prices followed, there would be an effective transfer of about $125 billion from the owners of oil and gas -- and the governments that tax its value -- to energy consumers. Coal prices could also go down somewhat.
Part of the transfer would come in the form of initially higher profits for companies using oil and gas because the costs of doing business would fall. The users' profits would go up until competition in their own industries forced them to pass the cost savings along to their customers. With virtually all of the world's industrial economies operating well below full employment levels, markets are loose enough to force the savings to be passed on.
Consumers using gasoline, home heating oil and natural gas also should benefit directly. Each $1 decline in crude oil prices is worth about 2.4 cents per gallon.
A decline in the wellhead value of natural gas prices comparable to that needed to reach a $20 oil price would be about 45 cents per thousand cubic feet. For residential customers, who pay more for getting the gas to their homes than for the gas itself, such a drop would mean an average reduction of about 7 percent or 8 percent in their gas bills.
Of course, the market for each energy product is different and each is affected by a host of other factors.
For instance, prices for residual fuel oil -- a very heavy oil used primarily in industrial boilers -- was propped up for a time last year by the long coal miners strike in Britain. When that strike ended in March, residual fuel prices on the European spot market collapsed from $29 a barrel to $21.40, where they still stand. The drop in the United States was $6.25 to a current $23.25.
Meanwhile, to the consternation of American and European drivers, the price of gasoline has been going up at the same time crude prices have been coming down. Again, some special factors are at work.
Gasoline inventories were unusually high during most of 1984, and prices were pushed down to the point that many refiners were losing money. Finally, around the first of the year, refiners began to cut production and get their gasoline stocks back to more normal levels. They did so and prices firmed substantially.
Meanwhile, the reduction in the allowable lead content in regular gasoline, the first step of which occurred July 1 with the next due Jan. 1, has also helped firm up the market, oil analysts said.
Between February and May, the latest data available from the Energy Information Administration, the national average retail price for gasoline climbed nearly 10 cents a gallon to $1.22 -- exactly the same level as in May 1984. However, over those same 12 months, the refiner acquisition cost of crude oil went down about $1.75 a barrel and producer prices for gasoline rose slightly.
Added together, those figures indicate that refiners were able to increase their profits on gasoline by about 4 cents a gallon or more.
But gasoline stocks are back to more normal levels, and some analysts expect gasoline prices to begin a normal seasonal decline once the summer driving season is over. In other words, future crude oil price cuts are more likely to show up at the pump.
Home heating oil prices on the spot market, not subject to so many unusual forces at the moment, have dropped to $29.30 a barrel, their lowest level in more than five years.
Just how likely is a major price break? Economist Alan Greenspan of Townsend-Greenspan & Co. recently described the situation this way for his clients:
"In the next several months, oil prices will experience significant downward pressure as the summer low in consumption in the northern hemisphere affects the supply-demand imbalance . . . Saudi Arabia is under growing internal economic and political pressures to raise its production from the 2 1/2 million barrels a day currently prevailing. Given a soft market even in the face of currently suppressed OPEC production -- probably under 15 million barrels a day -- any significant increase in supply would place accelerating downward pressure on the price level.
"Such price declines," Greenspan continued, "would reduce the revenues of several OPEC countries who are in dire social and political need of them. The uncertainty is, of course, that countries like Nigeria, who are producing below capacity, could raise output over a period of several months by several hundred thousand barrels a day and dump the additional crude oil on the spot market for whatever price it would yield.
"OPEC is currently producing 11 million barrels a day under effective capacity, with 6 million b/d of the excess in Saudi Arabia," he said. If Saudi Arabia began to increase its output -- it's current assigned OPEC quota is 4.3 million b/d -- it could be hard to halt the slide before the price falls below $20 a barrel for light crude, Greenspan concluded.
Oil industry executives, who have already seen their business hit by profit squeezes and a series of major mergers and restructurings, some forced by outside corporate "raiders," shudder at these prospects.
A senior corporate planner at one major U.S. oil company describes himself as "cautiously optimistic" about the future of his industry. But his optimism is based in large part on the hope that crude oil prices will, in fact, not fall as far as $20 and a belief that if they do, they would begin to climb again within a few years.
On the other hand, a $6 or $7 drop in crude prices is "not an extraordinary scenario" given the current turmoil in oil markets, the executive acknowledges. Should prices fall that far or farther, "I don't think it will last for a decade" because that would cause such severe economic problems in the exporting nations that "they would have to get their act together," he says.
As for the industry itself, the price declines that have already occurred, the big shakeout in downstream (refining and marketing) activities and mounting pressure from the investment community are already enough to ensure "that the next four or five years are going to be tough," the executive declares. "No one is projecting a surge in growth."
Yet if a company moves fast enough and does the "right things," such as shedding assets in unprofitable areas, it should be able to survive, and the survivors "will be in pretty good shape" once oil supply and demand get back into better balance again, he believes. "Sometime the non-OPEC production will level off" and prices start back up.
Some of those "right things" would be another round of cost squeezing and layoffs and large cutbacks in exploration and development programs, particularly in high-cost frontier areas such as Alaska. With an average crude price of $20 a barrel, "we would finish up what we are doing in Alaska and do no more," says an official with another major company.
"More refineries would shut, and companies would leave the peripheral [geographic] areas," this official continues. "Overseas, there would be attempts to sell assets to any comers, including joint ventures with some of the producers such as the Saudis.
"Companies that are deep in debt [as a result of recent mergers, acquisitions and restructurings] -- Texaco, Chevron and Mobil, for instance, will be in real trouble," he declares. "When do they ever get out from under their debt? A sharp drop [in prices] and the oil industry is in a lot of trouble. And the banks in the Southwest, and in Illinois and New York, will be in trouble, too."
One Texas banker, whose institution is a major lender to the oil and gas industry, says a price break would, like the declines that have already occurred, hit the service and supply side of the industry hardest. Those are the owners and operators of drilling rigs, pipe suppliers and the like. "With drill rigs already selling for 10 cents on the dollar, you could ask where it could go," he says.
The exploration and production companies, as opposed to the service and supply firms, have not been hit so hard, primarily because of an enormous drop in drilling costs that accompanied the end of the oil boom. As a result, actual well footage drilled has not fallen all that far despite a decline in average U.S. crude prices from $31.77 per barrel in 1981 to $24.15 in April, the latest monthly figure available.
The average wellhead price of U.S. crude is that low because it includes a fairly high proportion of lower-priced heavy oil from California and Alaska. The high cost of transporting the Alaska oil through the Trans-Alaska Pipeline -- more than $6 a barrel -- also reduces its value. In fact, the wellhead price is now below $17 a barrel, according to estimates by Petroleum Intelligence Weekly, a highly respected industry newsletter. At that level, the price is low enough that no federal windfall tax is due on the Alaska production.
That underscores an important point for the industry and the federal and state governments that levy taxes on the value of oil production: up to a point, the governments share the loss the oil companies are experiencing. The windfall profits tax, first levied in 1980, yielded $23.3 billion in fiscal 1981 when crude prices were highest. This year, the federal government estimated it would get $6.5 billion and the actual figure probably will be less.
If crude prices fell by $6 or $7, the yield would fall to only about $1 1/2 billion. Meanwhile, the severance taxes levied by various states would also fall, but not by such a large proportion.
However, both at the national level and in the energy-producing states, except perhaps Alaska, the general reduction in inflation and faster economic growth could offset the revenue losses. Even in Texas, oil and gas comprise only about 15 percent of the economy, the Texas banker points out. "A decline in the price of oil would be a net benefit for the Texas economy," he declares. "We consume an awful lot of gasoline here."
Opinions differ as to how hard financial institutions would be hit by a price break. Another Texas banker thinks $20 oil could effectively put a number of banks out of business as their loan losses mounted, particularly those that have made loans on the basis of the value of current production as opposed to the value of proven oil and gas reserves in the ground.
Certainly, some Texas banks are running analyses of their present loan portfolios with $20 oil as one prominent possibility.
At the Kansas City Federal Reserve Bank, economist Marvin Duncan is more sanguine. He thinks $22 to $24 oil is a better bet. And he, like the Texas bankers and the oil industry executives, stresses that it makes a great deal of difference whether a drop to $20 comes all at once or over a period of years.
Duncan says that banks in the Southwest and elsewhere have now had several years to get used to the prospect of lower oil prices. "This is not coming as a surprise to them," he says. It would mean that a headache the banks already have would be "a headache that continues into the future . . . Loans that are in workout circumstances would stay in workout longer, and at the margin, some would not come out. [That is, they would have to be written off as losses.] But it would not be a substantial shock to the financial system."
While Duncan expresses the view that the current price weakness is likely to stop at $22 to $24 a barrel, or, like Greenspan, warns, "If it falls abruptly it seems unlikely necessarily to stop at $20."
Should the price plunge that far, the losses to banks could be massive indeed, both on loans to energy companies in the United States and to entities in foreign oil exporting nations. At the same time, the impact on inflation and economic growth would be all the greater.
Just as was the case during the oil price shocks of the 1970s, the stakes in the future price of crude oil are huge for the whole world.