Crude oil prices are falling around the world, opening the possibility of a dramatic lowering of inflation in the United States that in turn could help bring recovery from the recession.
The evidence is everywhere. Self-service gasoline prices have dropped nearly 10 cents a gallon in the last year. Home heating oil, more than $1.10 a gallon on New York spot markets a year ago, was available last week in a commodity futures contract for about 74 cents. And the most recent declines in crude prices are still to be felt at the retail level.
A $5 per barrel drop in the average price of crude oil, if fully passed through to consumers, could cut a full percentage point off the inflation rate. At the same time, because individuals and businesses would not need to spend so much for fuel, they would have more left over to buy other things, which would help recovery.
Therefore the oil glut is good news--except for the oil business. From oilmen suddenly there is talk that perhaps the government should impose an import fee on foreign oil. Advocates say proceeds from such a fee, which might go as high as $5 to $10 a barrel, could help reduce the large impending federal budget deficits and encourage continued energy conservation and synthetic fuels production. In addition, of course, a fee would slide a floor under domestic crude oil prices.
As talk of a fee emerges here, the Organization of Petroleum Exporting Countries will meet Friday in Vienna in an effort to reach agreement on cutting production to prop up crude oil prices.
More than any other factor, oil price shocks were responsible for the simultaneous high inflation and depressed economic activity that afflicted the nation throughout the 1970s. The quadrupling of oil prices in 1973 and the near tripling between 1978 and 1981 were much like excise tax increases, driving up prices while at the same time leaving oil users with less money to spend on other things. Three presidents were bedeviled by these price increases, just as a fourth now is benefiting from the decline.
In a way the increases helped produce the decline. The high oil prices spurred major conservation efforts in many consuming nations and oil demand has tumbled. Now recessions in many industrial nations are helping cut oil use even further, particularly by hardhit heavy industries.
At the same time, high interest rates, particularly in the United States, are reducing oil demand in two ways. First, the high rates have boosted the value of the dollar--which OPEC uses to set oil prices--so that oil has become ever more costly in other importing countries such as West Germany. Second, high interest rates make it extremely costly to hold oil inventories.
The combination of all these factors is driving down consumption, production, prices, and--for the United States in particular--the level of oil imports.
Gasoline use fell more than 11 percent between 1978 and 1981, and now is running nearly 5 percent below last year's level. The use of both light and heavy fuel oil--more sensitive than gasoline to the state of the economy--dropped 21 percent and 47 percent respectively over the three years.
Net oil imports, which hit 8.6 million barrels a day in 1977, were down to 5.3 million barrels daily last year and 270,000 of those went into the Strategic Petroleum Reserve. In the four weeks ended March 5, net imports were only 3.8 million barrels a day.
The most potent force in the market today is a huge overhang of oil stocks--estimated by some experts to be at least 300 million barrels and perhaps as much as 600 million or 700 million worldwide. Oil companies are trying desperately to reduce their stocks, but many of them, such as Standard Oil of California, have not succeeded so far. In the United States generally, inventories have not been falling as much as is normal for this time of year--meaning that the excess still may be growing.
In the face of such a double slump in demand--from lower consumption and the need to reduce inventories--OPEC nations are trying to reach an agreement to cut production to prop up prices. But most analysts said the cuts of about 1.5 million barrels a day, to which OPEC reportedly may agree at the Vienna meeting, will not be enough to halt the price slide.
Spot market prices for crude now are more than $5 a barrel lower than most official OPEC prices. In addition, both Iraq and Iran are offering "The question is not whether the Saudis can hold the price at $34 or $32, but whether they can hold it anywhere. That means they have to operate on supply, not price."--Milton Russell, energy economist at Resources for the Future. oil for far less than the official $34 a barrel for Arab light, which OPEC uses as a price reference. Meanwhile, the United Kingdom and Norway, neither an OPEC member, are selling high grade North Sea oil for about $5 less than Arab light, once quality and transportation differences are taken into account.
David Willmer, manager of Socal's economics department, said oil companies have been losing about $4 on every barrel of that $34 oil they buy. "Refining and marketing margins really are going to pieces," he said, "and that is one reason spot market prices are so low." Even if the inventory overhang is worked off by summer or fall, Willmer continued, "I don't see it making the crude supply tight."
Each $1 a barrel drop trims the United States' total bill for imported and domestic crude oil by about $6 billion a year. A general $5 a barrel reduction, which many oil industry officials think is in the cards, would be large enough to cut a full percentage point off the nation's inflation rate.
Since growth of the U.S. economy is being restrained by a tight monetary policy, such an anti-inflation bonus could be translated almost directly into more rapid real economic growth, economists said. "It's the equivalent of an excise tax cut," noted Charles L. Schultze, former chairman of the Council of Economic Advisers.
Of course, lower oil prices are not everyone's piece of cake. About two-thirds of the oil used in the United States is produced here, and lower prices mean less income for the owners of that oil, for both federal and state governments, and in some cases even local governments. Each $1 drop in price cuts federal and state tax takes by about 70 cents. One part of that is the windfall profits tax on some domestic crude, which falls about $1.4 billion a year for each $1 drop in price.
Domestic crude prices already have been reduced by $2 or more a barrel since the first of the year, with some, such as that from Alaska's North Slope, falling even more. A weighted average of world crude prices has dropped from $34.38 Jan. 1 to $33.62 early this month, according to the Department of Energy.
The oil industry, of course, has a huge stake in the future course of prices. The declines that already have occurred are causing some companies to reduce their exploration and production budgets, and suppliers of a wide range of drilling equipment and services are seeing their booming markets erode.
Last week, for example, Armco Inc. announced it would defer a $671 million expansion of its facilities that produce pipe for the oil and gas drilling industry partly because of a slump in demand.
Meanwhile, some Reagan administration officials, particularly at the State Department, are said to be concerned that falling oil prices could again put consumption on a rapidly rising track, making the United States more vulnerable to an oil supply disruption related to some upheaval in the Middle East. "The great suspicion here is that people at State are looking for ways to hold up the price of oil," a free market advocate elsewhere in the administration said.
A large, rapid drop in oil prices, should it occur, certainly would cause distress for individuals and companies that made investments keyed to ever higher prices. But a drop would provide some welcome relief for other parts of the economy. "The idea that these oil prices going down is bad for us is perverse," declares Milton Russell, an energy economist at Resources for the Future.
No one can predict how far prices will fall. Most oil analysts believe Saudi Arabia, which has just cut its official production ceiling from 8.5 million to 7.5 million barrels a day, could slash its output far enough to stabilize world markets. But Saudi intentions, as always, are hard to read, and so far they have avoided the sort of "preemptive strike"--a huge reduction--that could tighten markets overnight.
One well informed Saudi observer said the Saudis themselves may not have agreed on what they would like to see happen. There are indications, he said, that the Saudis think the current official OPEC price is too high and that a lower price--in the $28 to $32 range--might provide a better, more profitable market for OPEC oil in the long run. "It's the equivalent of an excise tax cut."--Charles L. Schultze, former chairman of the Council of Economic Advisers.
On the other hand, the Saudi specialist said, cutting official prices would place great new economic and political strains on some hard pressed OPEC countries such as Nigeria, and would run counter to a Saudi desire to provide political leadership both in the Middle East and within the oil cartel. Most of all, he added, the Saudis would prefer not to be seen as the agent causing an abrupt tightening of the market. Any agreement to cut production probably will have to be a joint action by all OPEC members, he said.
The key OPEC problem is that oil consumption, so unaffected by price increases in the short run, is not likely to be changed significantly right away even by a $5 price cut, economist Russell said. "The question is not whether the Saudis can hold the price at $34 or $32, but whether they can hold it anywhere. That means they have to operate on supply, not price," he explained.
For the longer term, Socal's Willmer said, his company's forecasts indicate oil prices will do no more than rise in line with inflation during most of the 1980's but begin to rise more rapidly in the 1990's. Alternate sources of fuel, such as oil shale, are not likely to be economic until sometime after the turn of the century, if this forecast is correct, he said.