Crude-oil prices dropped below $10 a barrel in commodity trading yesterday, hitting an eight-year low, but then rebounded after Vice President George Bush suggested the oil price collapse has gone too far.
Bush's comments at a press conference echoed similar signals by Energy Secretary John Herrington over the past two days directed at Saudi Arabia.
Bush, who will travel to Saudi Arabia yesterday, said, "We're not going there on a price-setting mission." But, he added, "I think it is essential that we talk about stability [of oil prices] and that we not just have a continued free fall, like a parachutist jumping out without a parachute."
Herrington said yesterday that Bush would tell the Saudis "they need to beware of the dire straits" confronting the U.S. oil industry because of the steep price decline.
The Saudis' decision to boost oil production sharply last fall triggered the fall in crude prices from the $31-a-barrel level in late November. The Saudis remain intent on forcing other oil-producing nations to join them in a new agreement to stabilize prices at lower levels. The Saudis say this would assure them and their allies of their "fair share" of world oil shipments. But a sharply divided Organization of Petroleum Exporting Countries failed to reach agreement on production quotas last month and has scheduled another meeting for April 15.
Bush's press conference comments helped boost the price of oil from a low of $9.75 a barrel to $11.27 yesterday on the New York Mercantile Exchange, where futures contracts to buy and sell oil are traded.
Although Bush said he wasn't expressing new administration policy on oil prices, some economists and oil industry officials believe a change may have occurred.
The White House "has been doing a rain dance" for lower oil prices, said one top oil industry executive. Now administration officials realize there is "too much rain. We're washing out the bloody crops," the executive said.
As oil prices fell from $27 a barrel to $20, the overall effect on the economy was very positive, said Roger Brinner, chief economist of Data Resources Inc., a Massachusetts-based consulting group. The gains from lower fuel prices offset losses for the energy industry.
Retail gasoline prices have dropped to a nationwide average of 95.76 cents a gallon, down more than 25 cents since Jan. 1, according to the latest Lundberg Survey of gasoline retailers. Utility customers, transportation companies and the petrochemical industry all stand to gain substantially, as well.
The drop in oil prices is making a major contribution to the decline in inflation, and, indirectly, helping pave the way for lower interest rates. "It's like a $400 billion tax cut for the free world," said Philip K. Verleger Jr., an energy analyst with Charles River Associates.
A combination of lower oil prices, a lower dollar and declining interest rates caused the International Monetary Fund to raise its estimates for worldwide economic growth, the Dow Jones news service said yesterday. The IMF now projects a growth rate of 3 percent this year for all industrial countries, after accounting for inflation, up from an earlier 2.8 percent forecast. The new estimate was based on $20-a-barrel oil.
But Brinner said the gains and losses may offset one another as prices hit $15 a barrel. The average price for oil paid by U.S. refiners is now below $15, according to Sanford Margoshes, an energy analyst with Shearson Lehman Bros. Inc.
"As you go from $15 to $10 . . . I wouldn't be surprised to find the world economy is worse off," Brinner added.
DRI estimates that each $1 drop in the price of a barrel of oil caused the oil industry to reduce its capital spending on drilling and production by $1.5 billion annually. At $10 a barrel, the impact of the severe cutbacks in the energy sector, coupled with serious pressures on banks in energy states, overcome the benefits, Brinner said. "It becomes a bad phenomenon," he asserted.
The losses in Texas, Louisiana, Oklahoma and Alaska threaten to overwhelm the gains elsewhere from lower oil prices, the industry official said. Those four oil and gas states account for 10 percent of U.S. employment and 11 percent of retail sales.
A drop in oil prices below $20 a barrel also raises the risk that Mexico, the United States' chief foreign oil supplier, may default on its loan obligations to U.S. and other major foreign banks.
The Saudis still hold the key to where oil prices go, several analysts noted.
The Saudis and other Persian Gulf producers are trying to push oil prices down as part of a long-term strategy to restore their political and economic leverage in the world oil trade, Margoshes said.
OPEC's decisions in the 1970s to raise oil prices above $30 a barrel made it economical to extract oil in new, higher-cost regions in Alaska, the North Sea, Brazil, India, China and elsewhere.
Moreover, while the Saudis lived up to oil production agreements, other OPEC producers violated the quotas by selling as much oil as possible. As a result, the Saudis' share of world oil shipments has steadily declined. The current Saudi strategy aims at reversing that trend by cutting prices to the bone, leading to a larger share for OPEC in the 1990s. The Saudis also hope that lower prices will cause an increase in overall demand for oil, as consumers switch to petroleum from other fuels.
"They clearly dominate the market. They're calling the tune," Margoshes said.
Margoshes' best estimate is that Saudi pressure will force other OPEC nations, and some of the non-OPEC producers to agree to production quotas at the April 15 meeting that will stabilize oil prices at about $18 a barrel. But that remains to be seen, he said. "We're clearly in uncharted waters," Margoshes said.
But the Saudis will not win support from Britain, a major North Sea oil producer, Margoshes and other analysts believe. The British government sees Britain as a trading nation, not an oil exporter, and appears set against any cooperation with the oil cartel.
If there is no agreement on oil production this month, "It will be because the Saudis won't be able to transcend their feud with Britain," Margoshes said.
"If the Saudis had their druthers, they would probably settle for around $18 a barrel, and would take their time getting there, making sure everyone learned a lesson," Margoshes said. "But they're under a lot of pressures" -- including those generated by the war between two key OPEC members, Iran and Iraq, he added. The prospect of a victory by the hostile Iranian side could encourage the Saudis to calm the tensions within OPEC through a settlement of the quarrel over production quotas, Margoshes said.
It may have become clear to the Reagan administration and the Saudis that the poorer Middle East oil-producing countries can't tolerate an oil price of $10 a barrel, said the U.S. oil industry official, adding, "Their economies don't work on $10 oil."
But the hostility between Iran and Iraq is so pervasive, it may be impossible to get them to sign a new OPEC agreement, and OPEC's rules require unanimous consent, the official noted.
Verleger said he believes it is too late for the Reagan administration to attempt to pressure the Saudis to stabilize oil prices through a production agreement. "They're suffering a substantially lower income" because of increased competition from within and outside of OPEC, he said. "They wouldn't gain anything by caving in to the United States and bringing prices back up."
The difference between long-term prices of $15 and $20 a barrel is critical for the U.S. oil industry, analysts said.
Chevron Corp. has estimated that if prices settle in the $10-to-$15-a-barrel range, U.S. oil production will fall by as much as 15 percent by 1988, the International Herald Tribune newspaper reported.
The early indication of that trend is the sharp decline in drilling in this country, measured by the number of active drilling rigs. The American Petroleum Institute yesterday reported that exploratory drilling in the United States dropped sharply in 1985, before the current plunge in prices. Drilling activity is believed to be at, or near, all-time lows since rig-activity surveys began in the 1950s, according to API.
The most immediate impact on production will involve the more than 450,000 so-called "stripper" wells in Texas and other oil states that produce less than 10 barrels of oil a day. These wells account for about 12 percent of U.S. production, but a deep price cut would make tens of thousands of stripper wells uneconomical, forcing producers to cap them permanently.
Those downward pressures on oil production could be eased somewhat because lower energy prices will stimulate a greater demand for gasoline and fuel oil.
But in sum, U.S. oil output, now at 8.9 million barrels a day, should fall by up to 1 million barrels a day within two years, with comparable declines elsewhere in high-cost oil-producing regions, said Townsend-Greenspan & Co., an economic forecasting firm.