THE PRICE OF OIL is likely to drop dramatically in the coming years -- and we may have to prevent that from happening.
Why on earth keep up the price of oil, a source of inflation, of joblessness, of weakened U.S. industries, debt-ridden U.S. customers abroad, declining American influence in the world and much else?
Because, on balance, the threat to national security and to the U.S. and international economy might well be more severe if we have a wild swing between high and low prices, as is likely in the years ahead.
We have, of course, already begun the price decline part of the swing. OPEC's latest "unified" $34-a-barrel benchmark price was a last-gasp attempt to support slipping oil prices that trimmed the wings of some high- flyers like Libya, which had been charging over $40 a barrel.
OPEC has agreed to that $34 price at least until the end of this year. Because of inflation, that means a 10 percent real price cut by January.
On top of that, some OPEC nations have started offering discounts in order to increase their share of a declining export market. The price for "resid" -- the oil that fires industrial boilers -- has been dropping since June. Prices of home heating oil in the United States have dropped more than 25 percent in the past few months despite the coldest winter in memory.
The spot market for crude has been running up to $3 a barrel below contract prices -- and there are still few takers. Gasoline prices here are dropping; refineries are up to their ears in fuels that are moving slowly.
As a result, some oil stocks on Wall Street have dropped by more than half in the past year alone.
Sheik Yamani, the Saudi oil minister, keeps pushing back his estimate of when the oil glut will end. But he is daydreaming if he sees it happening anytime soon. Rather, the stage has been set for international oil prices to go into a spin -- not a temporary fluctuation over a couple of months, but increased supplies and falling demand that should persist for years.
The result is that OPEC's worst nightmare could come true: a price collapse, a drop of more than 50 percent before the end of 1985, perhaps much sooner. This could happen partly because prices will not be adjusted to inflation and partly through actual price cuts and discounts. In this way, prices could drop to as low as $15 a barrel in today's dollars.
In the best tradition of Reaganomics, consider supply-side questions first.
One reason the United States wants to maintain good relationships with the Saudis is that they are the only country in the oil world that can dramatically increase their output at will to keep prices more or less stable during an emergency.
An example of their value to the industrial world came in 1979-80, when oil prices increased 150 percent, to $36 a barrel or more, in the wake of the Iranian revolution. "Radical" states like Libya wanted to jack up the price of oil to whatever the market would bear. But that policy is not in the long-term interest of Saudi Arabia, since the Saudi fields will be pumping well into the 21st century. The last thing the Saudis want is to encourage the development of synthetic oil and other alternatives too soon.
So what did the Saudis do as the price of oil skyrocketed this last time? They increased their output from the usual 8.5 million barrels a day to 10.5 million barrels. The additional 2 million barrels helped create such a glut on the oil market that buyers could refuse to pay the higher prices the "radical" producers were trying to charge.
Soon you saw news stories that had one oil company after another curtailing operations in Libya. Qaddafi's prices were too high in the face of the growing glut.
With much grumbling, the high-priced producers last year agreed to the relatively low Saudi "benchmark" price of $34 a barrel. In exchange, the Saudis agreed to drop back to their normal 8.5-million-barrel-a-day production.
But as it turned out, it was not enough for the Saudis to keep their side of the bargain. Their production right now is below normal, at 8 million barrels, and the glut hasn't even diminished.
The trouble is that OPEC is still capable of exporting 24 million barrels of oil a day, but demand has declined to less than 19 million barrels. The result is millions of barrels per day excess capacity. That excess is likely to become even larger in the future.
No problem, say the producers. The Saudis will simply have to lower their production enough to mop that glut up.
There's the curve ball. The Saudi ruling family can't. It has so many checks to write to keep itself in power that a lot of people think the Saudis can't reduce their income below that represented by 7.5 million barrels a day. To reduce it below 6 million barrels would create internal economic and political agony that they are anxious to avoid.
Thus, it is first of all questionable whether they can end the current glut.
And on top of that, there seems to be some question whether the glut could be ended later in this decade even if the Saudi royal family were overthrown and a successor regime, against all odds, refused to pump any oil at all.
Again, the numbers tell the tale. Europe's North Sea production is slated to increase by at least 1.5 million barrels a day. Mexico's production is expected to increase by something like 3 to 5 million barrels. If Iran and Iraq decided not to decide anything in their war and just declared a ceasefire, their combined production would be likely to increase by 4 million barrels. If they should declare peace, both with each other and the Ayatollah's Great Satan (the West), the increase by 1990 could be as much as 6 million barrels.
Who would mop up a glut like that?
On the demand side, meanwhile, a persuasive argument can be made that structural changes are now occurring in every major energy-consuming sector of the industrialized countries. Not only has it become unthinkable to build a new oil-fired electrical generator, for example, but old ones are being converted to coal and new looks are being taken at hydroelectric and nuclear power. Long-term plans to reduce dependence on oil are ubiquitous in industry, housing, commerce and transportation.
Furthermore, there are reasons to think that these sectors will continue to restrain their use of petroleum. And it is unlikely that their consumption will be affected significantly by declining oil prices.
This is an important point. It implies that the demand for oil is likely to fall substantially if prices rise, but will not increase very much, if at all, if prices should decline. Major industrial capital investments require a 20- or 30-year perspective on prices. Such oil consumers have been fooled twice by unexpected large price hikes and are unlikely to subject themselves to a potential third blow. (Fool me once, shame on you; fool me twice, shame on me; but three times?
The new energy consciousness is not reversible. Innovations will lead to spectacular progress both in supply and demand. The sum of these trends should lead to a substantial reduction in the world's dependence on OPEC in the 1980s.
Sheik Yamani's plan is also the current conventional wisdom in the West about what will happen through this decade: that oil prices will increase slowly and steadily ahead of inflation. But that plan is heading for a fall. Market forces won't let it happen.
Instead, as production capacity increases and demand decreases, we can anticipate attempts by some of the oil-exporting countries to keep their former share of a decreasing oil- consumption pie by pumping more than ever. This, of course, will only exacerbate the oil glut, increase the downward pressure on prices, and probably create conditions for an even steeper decline in the years ahead -- perhaps even to a surprisingly deep and prolonged collapse of international oil prices.
There is an important caveat to this forecast: It presumes that there will not be a truly cataclysmic interruption of oil supplies from the Persian Gulf area in the next few years.
Nonetheless, this is much less of a constraint than that which existed only a year or two ago. At that time, the potential removal from the market of any of the major Gulf producers -- Iran, Iraq, Qatar, Kuwait, the United Arab Emirates, Saudi Arabia -- might have sent oil buyers scrambling for high-priced supplies.
Today, as we have seen, the situation has changed. Thus, the conclusions of this argument depend only upon the continuation of the Saudi capacity to export. And, if things continued to work right in the rest of the world, it would appear that for the first time, even the total interruption of >Saudi>> production might soon become tolerable.
So, you say, this is wonderful, right?
Well, not if you give it deeper thought. A significant drop in the cost of oil imports would provide some economic as well as psychological rewards.
But what if, as those prices fell, it only led to a tighter long-term U.S. dependence on what might soon be viewed as "cheap, sensible," Middle Eastern oil?
Because major investments today have to appear to continue to make sense in the 21st century, I do not expect a price decline to have very much of an effect on demand.
However, in the long run, as the planet is depleting its low-cost conventional oil, prices presumably will have to head back up at some point -- perhaps in 10 years or so. What, then, if a price decline in the '80s ends up having significant impact on the availability of oil and gas supplies in the 1990s?.
Indeed, there is abundant evidence that oil exploration and development have already decelerated sharply in the United States as a result of softening prices. Proposed synthetic fuel projects are being abandoned left and right. Even the interest in alternatives like solar power or geothermal is weakening because they are often not economic unless the price of oil continues to rise.
While these projects would not have had much of a near-term impact on supplies, their larger potential contributions in the 1990s and beyond might be seriously degraded by a prolonged decline of oil prices in the 1980s.
What it boils down to is if we want to develop the technologies that would free us once and for all from imported oil, we've got to keep the price up. If we want continued progress in the transition to secure, nonpolluting, renewable resources, the best way is to slap an import tax on imported oil before it's too late.
If the price of oil really starts to drop, you could expect pressures to keep the price up from the following groups with special interests to protect. You have to realize that, as painful as it was for some groups to adjust to constantly rising prices, it would be painful for these to adjust to decreases.
Those who would feel the pain include:
The oil and gas producers, who obviously prefer the higher prices, and who could not justify increasingly exotic North American frontier exploration and development without them;
The U.S. providers of oil rigs, pipelines and other oil service industries, who have geared up heavily for the recent rapid growth of exploration and development;
The alternative energy industries, from the makers of wood-burning stoves to solar hot-water heaters, whose existence has been dependent on the expectation that high energy prices would persist;
The energy conservation enterprises, from the makers of storm windows to weatherstripping to fiberglas insulation, whose phenomenally rapid growth has contributed greatly to the present glut;
The U.S. auto industry, which has committed an unprecedented $50 billion to retooling to produce small, energy-efficient cars, and which might find public preferences returning to large, luxurious models the means of production of which have been thrown away;
And most important, because most powerful, the U.S., Canadian, British and other governments of the industrialized countries, who have come to depend hugely on revenues from several kinds of taxes on high- priced petroleum and who would face even more enormous government deficits if these taxes were not to materialize.
Needless to say, end-use consumers prefer lower prices and would undoubtedly fight against deliberate attempts to keep the price of oil up. But in my judgment, given the array of economic and national security forces arrayed against them, they are unlikely to prevail.
Thus, the question becomes not whether we impose a tax to keep prices up, but where and how much.
One alternative is a flexible tariff wall against lower-priced imported crude. By this means, internal prices for petroleum can be kept at, say, $30-35 per barrel in early 1982 dollars, no matter how much OPEC's prices should fall. This would not only keep windfall profits taxes intact on domestic production, it would provide a brand new revenue source for an increasingly budget-bedeviled U.S. government. The major political problem with that is that it would not only maintain windfall profits taxes for the government, but windfall profits for the domestic oil companies, which would not be popular.
The other way to go is a direct tax on finished fuels, like a 50-cent-a-gallon tax on gasoline, rather than crude. The problem with this is that it does not increase our energy self-sufficiency because it doesn't offer an incentive to the energy companies to exploit our domestic resources. On top of that, the energy-producing states would scream.
Because changing oil prices can redistribute tens of billions of dollars annually in the United States alone, there can be no simple solution to these political problems.
Governments rapidly feel pressures to resist any sharp changes, whether they are rising or falling prices. The turbulence that results from such swings affects overall prosperity and trade negatively on a worldwide basis. Economic prosperity is fostered by stability, not wild swings in either direction.
Yet the outlook is for unstable oil prices for a long time to come. If, as I expect, the soaring oil prices of the 1970s are followed by rapidly declining prices in the 1980s, that decline will probably go too far and set the stage for skyrocketing price rises again.
On each leg of the price oscillation, whether up or down, governments are pressed to take strong measures to resist the change. The consequences of their actions may create as many problems as they solve. At least that conclusion seems warranted from their past behavior.
Still, it's unlikely that we would stand by and do nothing as we watch oil prices collapse, any more than we could stand by and do nothing as they rose.
It is important to keep the price of oil reasonably stable at an appropriate level. Will we have the wisdom to recognize it and respond intelligently?