The Humbling of OPEC

By Charles P. Alexander

Those 13 member nations cannot control each other, much less world oil

In the glittery lobby of Geneva's Hotel Intercontinental last week, reporters waited anxiously outside the grand ballroom as delegates from the 13-member Organization of Petroleum Exporting Countries deliberated behind closed doors. For the second time in the past five weeks, OPEC's contentious band of oil ministers were debating what to do about a continuing worldwide petroleum glut that has put intense downward pressure on prices. Their main goal: to reach agreement on production quotas that would keep the cost of crude at $34 per bbl., the "official" level for the past 16 months. Suddenly, the ballroom door burst open and out strode the dapper, but obviously weary Saudi Oil Minister, Sheik Ahmed Zaki Yamani. As cameras flashed and video recorders whirred, OPEC's most powerful leader curtly announced: "The meeting has ended. There has been complete failure."

That simple pronouncement could hardly have been loaded with more significance. The mighty organization that once seemed able to bend the world to its will was sinking deeper into its worst crisis. OPEC was badly split, if not permanently shattered. Concluded Harvard Economics Professor Otto Eckstein: "The cartel is on the verge of falling apart. If Saudi Arabia cannot impose some production and price discipline on the other members, then OPEC is finished."

To be technical, OPEC never existed as a true cartel, by definition a group that controls price by controlling production. The organization thrived as long as there was a sellers' market, but until recently it has never had to prove that its members could operate in a buyers' market and abide by agreements to limit production. The collapse of the talks in Geneva demonstrated that such discipline may be beyond them. As a result, the world may be in for the first sharp break in oil prices since OPEC quadrupled the cost of crude almost a decade ago.

After the meeting broke up, the oil producers began a tense waiting game to see which one would be the first to slash prices. At a press conference, Yamani predicted that Britain, a non-OPEC producer, would take the lead within a few days by trimming $2 or $3 off its $33.50 charge for North Sea oil. He said that Nigeria, an OPEC member that has had particular trouble selling oil recently, might then feel forced to follow Britain's lead. If that happened, Yamani hinted, the Saudis might themselves shave a few dollars off their $34-per-bbl. price.

Word of a possible Saudi price cut had an immediate impact. In spot markets, where shipments of oil that are not part of long-term contracts are traded, the cost of crude dropped to about $30. Some experts believe that the price will eventually drop below this level, but even if $30 became the new OPEC price, it would represent a 12% decline. Any reduction, in fact, would be like a huge tax cut for the world economy, which could help end its worst downturn since the 1930s.

The tidings about OPEC's troubles, however, have generated fears as well as cheers. Cheaper oil will be a boon to millions upon millions of motorists, homeowners, landlords and businessmen: anyone who pays an energy bill. It will be a salvation for scores of nations that have run up mammoth deficits to buy oil. But it will also hurt every country that sells oil, every company that drills for, pumps or markets crude and, potentially, every bank that has given big loans to these countries and companies. Billions of dollars have been borrowed, invested and spent on the assumption that energy prices would keep rising. Falling prices could rewrite the list of winners and losers. They could even bolster some governments and topple others.

The prospect of much cheaper energy produced a brief period of panic on the New York Stock Exchange, which got the news about the OPEC breakdown just as it was opening on Monday of last week. The value of many oil-company stocks dipped sharply, sparking a general sell-off that sent the Dow Jones industrial average down 39 points, to 1013, before it recovered some of that ground to finish the day at 1030.17. The market rebounded sharply later in the week as fears about the impact of a big break in oil prices eased.

Still, more than a few bankers are worried that the OPEC split will trigger an all-out oil price war. If that happens, some industry experts believe, the price of crude could spiral down as low as $20 per bbl. Mexico, Venezuela and other oil producers that are deeply in debt to banks in the industrial countries might go into default. At the same time, the rich Persian Gulf states might have to draw down their deposits at those banks. Thus squeezed on two sides, some institutions could fail, creating a ripple that would threaten the stability of the entire international financial system. Says Joseph Story, an international economist with Wharton Econometrics in Philadelphia: "Every producer and every banker in the world is scared to death."

That fright has created one of history's great ironies. For years, politicians, the press and the public have raged against OPEC'S price hikes. Now more and more people are praying that the organization will regroup and somehow keep the oil price from diving. Says Richard O'Brien, chief economist of the American Express Bank in London: "The only thing worse than OPEC managing the price of oil is nobody managing it."

In a sense, OPEC'S crisis began at the peak of its power in 1979. During the Iranian revolution, an upheaval that disrupted world oil supplies by shutting off Iran's exports, the remaining OPEC members watched greedily as customers bid up the cost of crude to previously unimaginable heights. Taking advantage of this panic buying, OPEC jacked up its bench-mark price from about $13 per bbl. to $34 by the fall of 1981. At times, the more aggressive members of the group peddled shipments on spot markets for $40 or more.

This oil shock helped send the world economy into a deep slump. As assembly lines came to a halt and unemployment grew, the use of energy fell. High prices spawned vigorous conservation efforts that cut energy consumption still more. Since 1979, oil demand in the non-Communist world has dropped from 52.4 million bbl. per day to an estimated 45.5 million, creating a sea of excess supply.

At the same time, the new value of black gold spurred swift development of non-OPEC oil sources, including fields in the North Sea, Alaska and Mexico. Because of this increased competition and sagging oil demand, OPEC'S sales started to slide. Last year, for the first time in nearly two decades, it produced less than half the non-Communist world's oil supply. OPEC'S share of the total now stands at 46%, down from 68% in 1976.

In the meantime, OPEC members had conjured up grand visions of what they could do with their present and future petrodollars, and some countries began spending lavishly. When the oil market softened, OPEC'S revenues no longer grew faster than its burgeoning expenses. The 13 countries' surplus in their trade of goods and services with the rest of the world dwindled rapidly from a peak of $109 billion in 1980. American Express Bank estimates that last year OPEC suffered a deficit of some $18 billion.

Inevitably, the cash drain generated ill will between countries such as Iran and Nigeria, with their teeming populations and immense development needs, and the rich, scantly populated desert states like Saudi Arabia and Kuwait, which have healthy trade surpluses. As always, the Middle East was torn by centuries-old religious conflicts and political rivalries. Since 1980, two of OPEC'S members, Iran and Iraq, have been at war. On the eve of last week's meeting, Iraqi jets struck Kharg Island, Iran's principal oil shipping center.

Throughout all the turmoil, Saudi Arabia, OPEC'S largest producer and its anchor, has tried to hold things together. To prop up prices, the Saudis slashed their production from 10 million bbl. per day in late 1979 to fewer than 8 million at the beginning of last year. But still the oil glut persisted. At a meeting last March, the ministers decided to adopt an overall production ceiling of 18 million bbl. per day, and each member agreed to a quota.

That pact proved to be a sham. Algeria, Nigeria, Libya, Venezuela and Iran all exceeded their ceilings. Desperate to boost output and revenues, they started cheating on price as well, offering discounts of $2 or more on as much as 70% of all crude on the market. Iran, in particular, was anxious to raise money for its war with Iraq and to restore its prerevolution status as a premier power in OPEC. Iran's price dipped at times to $28, well below the $34 bench mark. To keep oil supplies from swelling, the Saudis eventually dropped production to their current level of about 5 million bbl. per day, much less than their 7.5 million quota, and reluctantly gave up a part of their market share. While output by Saudi Arabia and its two closest allies, Kuwait and the United Arab Emirates, has dropped over the past year from 10.5 million bbl. per day to 6.5 million, production by the rest of OPEC has surged from about 10 million bbl. per day to almost 12 million.

Stormy meetings of the oil ministers last May and again in December failed to resolve the problems of quota cheating and price discounting. Pressure on the Saudis reached a peak last month. Their four main oil-company customers--Exxon, Mobil, Texaco and Standard Oil of California--threatened to turn to other suppliers if the Saudis did not lower their price. At conferences in London and Geneva, Yamani huddled with top executives from the four firms, who brought confidential figures to show the oil minister how much they were losing by staying with Saudi crude.

Before long, the Saudis made a last-ditch effort to seal the cracks in OPEC'S unity. At a meeting in Bahrain of seven of the organization's members, Yamani offered to lower the Saudis' production quota if the others would accept new ceilings and stick to them. The ministers reached a tentative agreement and decided to convene a full OPEC meeting in Geneva.

On Saturday, Jan. 22, the limousines of the 13 oil ministers pulled up in front of Geneva's 15-story Hotel Intercontinental. As is usual, security was strict. Everyone entering the hotel had to wear a badge and pass through metal detectors. In the lobby, guards herded tourists and reporters behind barriers so that the ministers could move freely, like royalty.

As the talks continued through the weekend, the delegates became increasingly confident that a deal was imminent. The Iranians were surprisingly content to hold their production to present levels. The Venezuelans, who pleaded for a higher quota, agreed to accept a slight cut instead. On Sunday night Venezuela's Calderon Berti suddenly emerged and disclosed that the participants had hammered out new quotas designed to hold the oil price at $34. Iran's Mohammed Gharazi was jubilant. "This is the greatest victory for OPEC," he proclaimed.

But such pronouncements proved to be premature. Without advance warning, the Saudis had tossed on the bargaining table an additional demand that remained to be resolved on Monday morning. They would curb production, said Yamani, only if the African states would charge a premium price for their oil that fully reflected its higher-than-average quality. Nigeria, Algeria and Libya produce so-called sweet crude, which yields a particularly desirable mix of products after refining. Moreover, because these countries are relatively close geographically to their European customers, the cost of transporting the crude is lower. For these reasons, the OPEC members have tacitly agreed in the past that African oil should sell for a few dollars more per barrel than the $34 price for Saudi light crude. But what the exact differential should be has been a matter of dispute.

In recent months, the Africans have not been charging a high enough premium to satisfy the Saudis. At the Geneva meeting, Yamani demanded that the Africans raise their prices in order to keep the Saudis from being noncompetitive when they try to sell their less desirable crude. The Africans balked at boosting prices at a time of sluggish demand, and the meeting disintegrated into a raucous round of name-calling. At one point, Yamani reportedly shouted: "I am a man of the desert, and nobody is going to laugh at my beard." That was the Arab equivalent of saying, "Nobody is going to take advantage of me."

Abandoning hopes for a settlement, Yamani walked out and declared the talks at an end. Post-meeting rhetoric was as bitter as ever. Said Gharazi: "The Saudis thought they could enforce their wishes on others. Saudi Arabia has lost its major role in OPEC."

Several ministers later complained that Yamani must have wanted the meeting to fall apart and that he had lured the other delegates into an elaborate trap. They charged that the Saudis were anxious to cut the price of oil, but hesitated to do so for fear they would be accused of kowtowing to their Western friends in the U.S. and Europe. As a result, the theory goes, the Saudis engineered a deadlock over price differentials so as to break up the meeting and create a situation in which other producers--Britain and Nigeria perhaps--would take the lead in cutting prices.

Many OPEC watchers think that, even if no one else goes first, the Saudis will soon trim their price, perhaps to $30 per bbl. But Yamani has made it clear that he would act to prevent a price collapse. Says he: "Our policy is to ensure stability in the price of oil. We fought against too large a rise. We will fight against collapse." In the short run, the Saudis could theoretically shut down production completely to tighten the market and firm up prices. They could live comfortably on their estimated $160 billion in financial reserves, which earn about $15 billion annually in interest.

The Saudis will not have to do that if OPEC can discipline itself, as Yamani contends it can. Says he: "I don't think this is the end of OPEC. Everybody needs OPEC, including the consumers." Many Western energy experts agree. Says James Tanner, editor of Petroleum Information International: "In a month or two, the ministers will be back to try again. I see no likelihood of a price free fall."

On the other hand, William Brown, the director of energy studies at New York's Hudson Institute, argues that OPEC has never been able to control production or prices. Instead of managing the market, he says, OPEC follows the price dictated by supply and demand. In 1979, for example, prices exploded not by OPEC decree, but because the Iranian revolution cut supplies. Brown, who 2 1/2 years ago accurately predicted the current oil glut and OPEC'S troubles, now forecasts "the complete demise of what is erroneously called the OPEC cartel" and a plunge in prices to $25 or even $20.

Such a steep decline, some financial experts think, could be catastrophic. Over the past decade, Western banks have received tens of billions of surplus petrodollars from OPEC and recycled them as loans to developing countries. If OPEC has to reclaim those petrodollars, then the banks might no longer be able to carry all those loans. Warns Bernard Lietaer, a Belgian economist and author: "The international banking system is perched on a tenuously constructed financial pyramid that will crash if the price of oil tumbles." Banks are also vulnerable because of loans to companies in the energy business. "In the U.S.," says Walter Levy, a New York City petroleum-industry consultant, "many oil and oil-service companies are heavily in debt, and a significant drop in the price could bankrupt them."

Another fear about falling oil prices is that they could do more damage to the already faltering efforts to develop alternative energy sources. In West Germany, says Economist Liane Launhardt of Commerzbank, research money for vanguard work on solar energy, coal gasification and synthetic fuel may dry up. France is deeply committed to an ambitious nuclear program, which now generates 39% of the country's electricity. The French want to raise that figure to 70% by 1990, but if oil prices slide, the investment could end up being extremely uneconomical.

Conservation efforts might also be undermined. People would suddenly find it less expensive to drive big cars and more attractive to turn up their thermostats. Businesses would think twice about buying costly new energy-efficient equipment. Some economists fear that the industrial nations could once again become dangerously dependent on unstable and unreliable foreign oil supplies. Says William Cline, a fellow at Washington's Institute for International Economics: "We could be on a roller coaster, and if the price drops too low, it could later shoot up again even higher, say to $50 a barrel."

Some have suggested that governments should impose new taxes on oil to keep the cost of energy consumption from falling too far. "Without a tax," says William Quandt, an energy specialist at Washington's Brookings Institution, "you start sending wrong signals to consumers and investors. And we set the stage for returning to more wasteful use of energy." In addition to bolstering conservation, taxes could help several nations -- the U.S. in particular -- to shrink their budget deficits, but the fees would also be a drag on hoped-for world economic recovery.

Despite all the potential pitfalls of a sharp oil-price decline, many energy ex perts feel certain that the benefits would far outweigh the risks. Says John Sawhill, Deputy Secretary of Energy under President Carter: "The soaring OPEC prices were in effect an excise tax on the world economy. A drop would be precisely the reverse -- an enormous shot in the arm." Agrees Walter Heller, chief economic ad viser to President Kennedy: "The eco nomic tonic would be worldwide. If best comes to best, and we see $20 to $25 oil again, we could use part of the economic bonanza to tide over the banks and the Mexicos until economies recover."

Though no one can know exactly how big the bonanza might be, computers are at work printing out projections. American Express Bank esti mates that $25 oil would lift G.N.P. growth in the 24 industrial nations of the Organization for Economic Cooperation and Development from the 1 1/2% currently projected for this year to 2 1/4%. That would result in additional production of goods and services worth $55 billion. At the same time, inflation could slow from the expected 6 3/4% to 5 3/4%, and that would help lower interest rates.

Oil-importing developing nations would gain in many ways. Their energy bills would shrink. Lower interest rates would ease their debt burdens. Their exports of raw materials to the rejuvenated industrial economies would surge. As income in the developing countries increased, they would be able to buy more goods from the developed world, generating a self-sustaining cycle of growth.

On balance, OPEC's crisis bodes well for the future. Most of the fears about falling oil prices center on a precipitous, un controlled drop. While possible, such a plunge is highly unlikely, given the Saudis' desire to prevent it. The best bet is that prices will drift down gradually until demand meets supply.

When OPEC first came on strong a decade ago, the world economy went into a new era of austerity. Over the years, millions of jobs disappeared, and inflation be came a chronic concern. But the hard ships eventually stirred a spirit of defiance and determination in every nation that imports oil. Conservation became a by word, and the search for new energy supplies became a mission of survival. In hindsight, the humbling of OPEC was inevitable. -- Charles P. Alexander. Reported by Jay Branegan/Washington and Lawrence Malkin/ Geneva

With reporting by Jay Branegan/Washington and Lawrence Malkin/ Geneva This file is automatically generated by a robot program, so viewer discretion is required.