Saudi Arabia yesterday began a substantial increase in oil production, informed sources said, in a dramatic break with the rest of the oil cartel that is expected to force another sharp drop in world prices.
By Oct. 1, the additional Saudi production will reach 1 million barrels a day, raising its output to 3.5 million barrels daily, the sources said. The Saudis' action is seen by energy analysts in this country as an unprecedented attempt to force other members of the Organization of Petroleum Exporting Countries to honor OPEC oil pricing agreements, now widely violated by discount sales.
If it succeeds, the strategy could push oil prices down by $2 to $4 a barrel by next spring, depending on the demand for heating oil over the coming winter, oil company officials said. That would be comparable to a reduction of 5 to 10 cents a gallon in gasoline and fuel oil prices. The current market price is about $26 a barrel.
There is an outside chance, however, that other OPEC producers will attempt to match the Saudi production increase, triggering an escalating price war that could cause world oil prices to plunge by $8 to $10 a barrel. A sudden drop of that magnitude could have dire consequences for some heavily indebted U.S. oil companies, for Third World oil producers such as Mexico, Venezuela and Nigeria, for the U.S. and European banks that have billions of dollars in loans outstanding to these countries -- and to the fragile military balance in the Persian Gulf itself.
The change in Saudi policy, rumored in the oil industry since the third week in August, surfaced last Friday and over the weekend, following remarks by Saudi oil minister Sheik Ahmed Zaki Yamani to a private, high-level meeting of energy officials at Oxford, England. After second-hand versions of Yamani's comments leaked out, the OPEC news agency said Saturday he had warned the seminar of the dangers of a price war that could push prices down to $15 to $18 a barrel after the winter "if non-OPEC producers do not cooperate with the organization and we in OPEC do not discipline ourselves."
"The conventional wisdom is that the Saudis are bluffing and the markets are disregarding what Yamani is saying," said John C. Sawhill, a partner with the consulting firm McKinsey & Co. and former deputy secretary of the Department of Energy. "My view is that the Saudis are really serious this time. . . . They're tired of being the bagman for the rest of OPEC."
"What he Yamani is saying is, if the OPEC members who are cheating on established prices don't stop and don't develop a sense of discipline, Saudi Arabia has the vehicle to increase its oil production and go head-to-head with anyone in a price war," said Peter C. Beutel, an industry analyst with Rudolf Wolff Futures Inc. in New York. "I don't think the odds of that happening are very great."
But the Saudis' action risks an escalation of strife in the Persian Gulf, Beutel said. Iraq is expected to begin shipping 500,000 barrels a day of oil through its new spur of the Trans Saudi pipeline next month, adding to the increased production from the Saudis and bringing additional pressure on Iran, another major Gulf oil producer with which Iraq is at war. Iran, like Iraq, needs oil revenue to finance the conflict.
Sources confirmed yesterday that the bulk of the additional 1 million barrels of Saudi production will be sold to four American companies -- Exxon Corp., Mobil Corp., Texaco Inc. and Shell Oil Co. -- although none of the companies would comment on the reports. The Saudis reportedly have negotiated "netback" contracts with the oil companies in which the price the Saudis will receive for their crude oil is determined by the market prices for gasoline, heating oil and other products made from the crude.
Because so much crude oil now is being sold at discount prices below the OPEC targets, market prices for petroleum products reflect the discounting. The Saudis' decision to peg crude oil prices to the market prices of oil petroleum products could result in a decline of up to $3 in the average price of Saudi crude oil, some industry analysts speculate.
That won't happen immediately, analysts added, because at the moment, the demand for oil products has picked up, boosting prices.
The immediate outlook for energy prices is made more uncertain by the unpredictibility of the demand for heating oil this winter.
Stocks of heating oil have dropped sharply over the past three years because of declining production and last week were more than 20 percent below the national average for the past three years. In the East Coast, the decline has been even sharper, leaving stocks 31 percent below the three-year average. Inventories are also low in Europe, Beutel said.
A severe, sustained cold spell in this country could cause a rapid jump in fuel oil prices, Beutel said.
"I think it's kind of hard to predict where the price is going at this stage," said B. M. Thompson, vice president of Phillips Petroleum Co. for corporate planning and development. "We need to adopt a wait-and-see attitude until the OPEC meeting." The OPEC oil ministers are meeting in Vienna Oct. 3. "I think you'll see an increase in demand, which should absorb this increase in production," Thompson said.
"Certainly we don't see the bottom falling out of the crude oil market. OPEC will get their house in order before it reaches that point," he added.
The direction of oil prices is critical for Phillips, in particular, following its successful battle to thwart a takeover attempt by Carl C. Icahn last March. Phillips' defense left the company deep in debt, and it is committed to selling $2 billion in assets and diverting surplus cash from its operations into retiring that debt.
A drop in oil prices compounds Phillips' difficulties in reducing its debt, but Thompson said the problem is manageable at $25 a barrel. Even a drop to $20 a barrel would not cripple the company's ability to handle its debt, Phillips has said.
An immediate drop below $20 would create severe problems for Phillips and Unocal Corp., which also went deep into debt in a takeover defense struggle this year, said Barry Good, an oil industry analyst with Morgan Stanley & Co. But he doesn't expect that either.
"Over a period of time, there is more likely to be a ratcheting downward of price . . . and after three or four years, you do wind up in the $18 to $20 range. I put a probability on that of 45 percent."
He puts the odds of a price war in the next few months at less than 25 percent. "I think anybody that deals with price assumptions is in the realm of speculation. . . . Hypothetically, if one country starts undercutting, there is leapfrogging, and a price war, and you get to $18. That's basically suicidal. The oil ministers are aware of that," he said.