Dance of the Oil Dervishes

OPEC's sharp price increase will hurt the U.S. economy

If Jimmy Carter tried to describe one of his worst nightmares, he might report that he had imagined seeing a group of Arab oil ministers waving AK-47 Soviet rifles above their heads and dancing like dervishes on the tennis court of the Hilton Hotel in Abu Dhabi. The reason for their jubilation, in this nightmare, was that they had just engineered a huge increase in the price of crude oil. Unfortunately, this was no Arabian Nights fantasy but sobering reality last week. Several Arab ministers really did take part in a "Dance of the Rifles" to celebrate the sixth price boost by the Organization of Petroleum Exporting Countries since 1973, and potentially one of the most devastating.

While the Carter Administration had optimistically expected a modest increase of between 5% and 10%, the 13 OPEC nations agreed on a 14.5% hike to be imposed in stages at three-month intervals in 1979. The timing could hardly have been worse. Carter must cope with an intolerably high rate of inflation, expected to be 9.5% for 1978, and the prospects of a recession next year; the OPEC decision significantly augments both problems and makes them that much harder to deal with. Reflecting the difficulties ahead, the dollar fell an average of 2.25% against major European currencies last week until it was temporarily rescued by large-scale intervention from central banks. The Dow Jones dropped 17.84, to 787.51 before rallying at week's end.

The bad news broke at a time when the President was trying to finish the difficult budget for fiscal 1980 (and suffering from a flare-up of hemorrhoids that forced him to cancel all appointments on Thursday). Administration economists immediately tried to calculate what the damage from the OPEC price hike would be for 1979. They estimated that the cost of petroleum products, ranging from heating oil to gasoline, would rise 3-c- to 5-c- a gallon. The inflation rate, now projected at 7.5% for next year, would rise by another .3%. The rate of economic growth, they estimated, would be trimmed by .15% to 2.5%, a performance sluggish enough to lead to a recession, though the Administration continued to insist that there would be no recession. Unemployment, currently at 5.8%, could go to 6.5%.

The effects of the OPEC move will be felt throughout the nation--and indeed the world--but some areas of the U.S. will be harder hit than others. New England is in particular jeopardy because 85% of its energy comes from oil, 65% of it imported. Though the region contains only 5.8% of the U.S. population, it consumes 25% of the nation's crude oil, which is used mainly for heating. Massachusetts officials estimate that heating-oil bills will rise by about $75 a month by the end of 1979, bringing the average annual cost to $1,000 for homeowners. Confronted with still another boost to inflation, the President seemed as determined as ever to resist any increases in the $30 billion deficit planned for his $532 billion budget for fiscal 1980. He made that plain in a meeting last week with a group of the nation's Governors and mayors. While the Governors were relatively sympathetic, the mayors were dismayed. Carter's projected reductions in federal spending could cost them $ 15 billion in aid at a time when their own costs are rising. Complained Atlanta Mayor Maynard Jackson: "Not only are we cutting to the bone, but we are threatening to cut to the marrow." Irritated Newark Mayor Kenneth Gibson told Carter that he had already started laying off hundreds of public employees even though his city has the highest unemployment rate in the country.

Among the anticipated cuts: more than a third from the budget for the $11 billion Comprehensive Employment Training Act, meaning the loss of some 60,000 jobs; $1 billion from the waste-water-treatment construction program; $150 million from urban-transit aid; $150 million from new urban parks; $400 million from the urban-development-action grant program--a favorite of the mayors since it provides seed money for private development projects. Carter listened politely but stonily to protests against these cuts. "He did not give us any final answers," said Syracuse Mayor Lee Alexander. "I believe there is a low threshold of patience in the cities. We may have to go to Congress."

Aside from causing bigger budget deficits and higher inflation, the OPEC action jeopardizes the President's energy plans. On the verge of decontrolling oil prices, Carter feels he must now reconsider for fear of adding to inflation. He is expected to make up his mind on decontrol in the first week of January. "It's one of the toughest decisions the President will have over the next two years," says David Rubenstein, deputy assistant to the President for domestic affairs. While Carter ponders, his advisers are split over the issue. James Schlesinger's Energy Department favors decontrol with some kind of tax rebate for low-income people or a windfall tax on oil companies. The Council of Economic Advisers and the Domestic Council want to postpone decontrol, though not beyond 1980 when Carter has promised that U.S. domestic oil prices will rise to world levels. The OPEC decision, says Treasury Secretary Michael Blumenthal, "intensifies the dilemma and the difficulty of the kind of choice the President has to make. The choice is between greater inflation now or a greater energy problem in the future."

The Administration was surprised by the OPEC action because it had been led to believe that a more limited increase was planned. On a swing through four OPEC nations in November, Blumenthal thought he had won an agreement for a 7.5% hike in 1979. The 14.5% increase, staged in regular quarterly installments, indicated that future OPEC boosts might be cynically indexed to U.S. inflation, thus virtually dooming the U.S. to still more inflation.

The main reason for the price hike was clear. OPEC wanted to regain the purchasing power it had lost because of the dollar's decline, 28% since December 1976. Despite huge oil revenues, eight of the OPEC member nations ran deficits in the first half of 1978; as a group, they became the biggest international borrowers, with a total of $5.2 billion in loans and withdrawals. Surprisingly, many American businessmen do not blame OPEC for raising the price as much as it did. "If you take an 18-month time period," says Carlton Jones, manager of energy analysis at Pace Consultants & Engineers in Houston, "the increase is less than U.S. inflation and doesn't cover the dollar devaluation during that time period. The dollar has gone down more than the price increase." Fred Hartley, president of Union Oil in Los Angeles, declares: "It's our fault, not OPEC's. OPEC has behaved as any other group in business would act; it raised its price. Inflation is an international disease in which the U.S. plays the role of having a higher inflation rate than any other industrial nation."

But even with the decline of the dollars they hold in such abundance, OPEC nations might not have agreed to such a large price increase if Iranian production had not been disrupted. When rebellion broke out there in September, output fell from 6 million bbl. a day to less than half a million. Though Saudi Arabia tried to fill the gap with its own surplus, that did not suffice. "The drop in production in Iran was the important factor in the price boost," says a U.S. Treasury official. "The Saudis are able to hold off the price hawks as long as they have excess capacity. They couldn't push any further, though, and had to give in."

Even so, the Administration wonders if its closest friend in OPEC did all it could to moderate the price increase. Saudi Arabia's Oil Minister Sheik Ahmed Zaki Yamani is the unofficial leader of the oil world; his word is powerful. This time, however, he was considerably less argumentative than usual. By the time the first session broke up and the ministers put away their pocket calculators and journeyed in heavily guarded motorcycle caravans to dine at the air-conditioned palace of Abu Dhabi's Sheik Zayed bin Sultan al-Nahayan, the new price had been virtually accepted. "We chewed on those figures a little more," recalled Venezuela's Valentin Hernandez, "but as we reached for the chunks of lamb at Sheik Zayed's dinner, the price was already fixed." Though Sheik Yamani initially asked for a 10% limit on the price increase, he quickly capitulated to the majority view. "I was not happy with it," he noted laconically, "but not so unhappy either."

There were political as well as economic reasons for his behavior. Constantly under fire from the radical Arab states, the Saudis moved closer to their neighbors at the Baghdad conference that was called in October to oppose the Camp David accord. Washington had expected the Saudis to support that accord, even though it slighted the Palestinians and ignored the future status of Jerusalem, but they have not done so. "They are a small country surrounded by people with very different ideas," says James Akins, a former U.S. Ambassador to Saudi Arabia and a top oil expert. "They had to take into account their geographical position."

The U.S. has few options at its disposal in dealing with OPEC since it is more reliant than ever on foreign oil; in the first three quarters of 1978, oil imports from OPEC nations rose 7.7%. The Administration, somewhat optimistically, expects a world oil glut to develop, perhaps by mid-spring if Iranian production returns to normal; then prices may be shaved a bit or scheduled increases deferred. Most experts do not share that view, however. Their consensus: liberation from OPEC's pricing policies will come only when there is significantly greater production and conservation in the U.S.

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