OPEC: Less Oil, More Politics, Higher Prices

By John T. Haldane

On December 20, 1986, all members of the Organization of Petroleum Exporting Countries (OPEC) except Iraq agreed to cut production in the first half of 1987 by about 7.1 percent across the board. The daily production limit will be 15.8 million barrels per day (b/d), the lowest ceiling in the cartel's 25-year history.

Under the December agreement, Iraq is assigned a "postulated production ceiling" of something less than 1.47 million b/d. However, Baghdad now is producing more than 1.6 million b/d and hopes to return to a normal production rate of 1.8 million b/d. Iran's quota was set at about 2.3 million b/d, far above its current output estimated at less than 1.6 million b/d. Tehran's low exports have come involuntarily, as a result of the increasing effectiveness of Iraqi air strikes against Iranian oil tankers and terminals.

The price war aimed at increasing OPEC's share of the international oil market, which had been strongly advocated by Sheikh Yamani, was dropped in favor of the fixed price structure long pushed by the price hawks: Iran, Algeria and Libya. Ironically, it was Saudi Arabia, this time represented by a new oil minister, Hisham Nazer, that led the fight for a return to a fixed price plan. Although Nazer now is permanent Minister of Oil, a Smith Barney analyst has remarked: "It's been clear since Sheikh Yamani left that King Fahd is the premier policy maker on oil there."

International oil experts concede that if the OPEC members stand together, the $18 a barrel price has a good chance. "The market has given OPEC enough so that it can go ahead and cut production without losing revenues," said Peter Beutel, assistant director of the energy group at Elders Futures, Inc., New York. Gordon Pye, an oil industry economist for Irving Trust Company, adds: "It seems to me there's a lot of resolve out there on the part of OPEC to live up to this agreement. Having looked down the mouth of the cannon for most of 1986, that fear will stay with them for quite a while."

It is now clear that some political fine-tuning has accompanied the change in Saudi oil policy. Saudi Arabia has decided that its domestic defense interests dictate smoother relations with Iran, lest its tankers and oil facilities come under attack. Some experts consider that the newfound accommodation between the two formerly cool neighbors in the Gulf will set in motion political and economic policy reviews by all of the Arab states. Iran, of course, has seen its prestige soar because of its success in breaching the US arms embargo and in causing immense embarrassment to the Reagan administration.

Iraq's refusal to bow to the majority pressure in the December OPEC meeting may have seemed necessary to Iraqi President Saddam Hussein, since Iraq may continue to pump as much oil as it can without observing OPEC production controls. But experts wonder if Baghdad may not regret its stand a few months from now, as Iran and Saudi Arabia pursue an unspoken agreement not to interfere in each other's internal affairs.

It certainly must have been unpleasant for the Saudis to have to try to bring Iraq into line behind the OPEC production cuts crucial to securing the rise of oil to $18 a barrel, a matter upon which King Fahd has staked his prestige. But the other OPEC members, not unreasonably, made it clear that they consider Iraq a Saudi responsibility. They, after all, were well aware that the Saudis have been heavily subsidizing Iraq's war budgets for quite a number of years.

That the OPEC meeting dragged on for 10 days was almost exclusively a result of lengthy Saudi efforts to persuade Iraq to accept a compromise with the Iranians. King Fahd, a proud man, will not have fond memories of Iraqi Foreign Minister Tariq Aziz bluntly informing him that President Hussein refused to agree to any quota lower than that assigned to Iran.

Iraq cannot ignore the fact that it is dependent upon Saudi Arabia for the flow of Iraqi oil through Petroline, the trans-peninsula pipeline system to Yanbu on the Red Sea. Since November, the Saudis have, for "technical reasons," reduced the flow of Iraqi oil through this system to between 120,000 and 130,000 b/d from the full potential of 500,000 b/d. After the less than fruitful talks between Riyadh and Baghdad, Saudi Arabia reportedly advised Iraq that the restriction would have to remain in force until April 1987.

The new OPEC production cutbacks have produced an interesting reaction from a number of non-OPEC producers. "The Group of Five"—Angola, Egypt, Malaysia, Mexico, and Oman—participated in the December OPEC meeting and supposedly agreed to reduce production by up to 10 percent. Malaysia, for example, announced after the meeting that it would follow the OPEC accord and reduce its output of 459,000 b/d by 7.25 percent. While Great Britain remains aloof, Norway, without openly holding discussions with OPEC, has announced a continuation of its 10 percent production cut made on an ad hoc basis last month.

If OPEC sticks to its strategy, the estimated 300 million barrels of excess oil in the world market could be reduced by 2 million b/d, eliminating that surplus in less than six months. That will give OPEC enormous influence over prices, which tumbled 50 percent over the past year, costing the 13-member cartel an estimated $50 billion in revenues. This loss has led to strong political and economic pressures on all OPEC members, but especially on those in the Middle East accustomed to huge oil revenue inflows.

The cautious pattern of Saudi Arabian-Iranian cooperation in OOPEC has been developing since mid-1986. Iran desperately needs higher oil prices to finance its war with Iraq. The Saudis, on their part, see two advantages in pursuing a more friendly relationship with Iran. Riyadh needs increased oil revenues to meet domestic budget requirements. It also needs some assurance that Saudi and Gulf state tankers and oil facilities will not be attacked by Iranian military forces.

The new Saudi fiscal year 1987 budget, equivalent to $45.3 billion, contains a 15 percent cut in budgeted spending and a deficit of $14.05 billion to be offset by the nation's reserves. This is the first time that the Kingdom has admitted that it will have to tap its petrodollar reserves, estimated at about $90 billion, to meet a budget deficit, one that is twice as large as had been anticipated.

The Saudi Ministry of Finance and National Economy has conceded that oil revenue was expected to reach $41.1 billion under the old budget, but actually totaled only $16.3 billion. The Ministry stated that the latter figure represented an 80 percent decline from six years earlier, when oil accounted for 88 percent of total revenue. In 1987, oil will provide only an estimated 56 percent of total revenue, the smallest contribution ever by oil to government revenues.

Although the Gulf states did cooperate with Iran on quota and pricing policies at the December OPEC meeting, the political results of Tehran's overtures to Iraq's Arab allies are unclear. Another such overture is the audience granted on December 27 of last year by Foreign Minister Ali Akbar Velayati to the leader of a Saudi-backed Afghan resistance group. This meeting, foreign diplomats in Tehran say, shows that Iran is ready to collaborate with the Saudis in unifying all Afghan resistance groups. In the past, Iran has only supported Afghan guerrillas loyal to the Ayatollah Khomeini.

If the newfound economic cooperation between Saudi Arabia and Iran continues and a number of non-OPEC members begin to support production cutbacks, what does this mean for the United States? Robert J. Samuelson, a noted American economist, states: "We remain dependent on imported oil, whose supply is unavoidably insecure. As long as the Persian Gulf contains two-thirds of the non-communist world's oil reserves, oil's free flow remains vulnerable to political events over which we have little control. Our interest lies in defusing this ongoing danger. It promises to be as great in 1997 as in 1987."

The Petroleum Economist, in a late November 1986 article on the US oil sector, stated: "In the meantime, oil companies have been adapting to this year's price slump by vigorous cost-cutting; immediate reductions in exploration expenditures; some reorientation of investment programming away from the US to areas where the return is more favorable; and attempts to explore new methods of financing involving less dependence on current earnings."

With the US domestic oil industry in shambles, the Reagan Administration's amateurish approach to Middle East developments indicates that it still fails to understand that what now is occurring in the Middle East could have significant consequences throughout the US economy within the next 10 years. Last year, Americans used 4.9 million b/d of imported oil. That has now jumped close to 6 million b/d and is expected to go much higher by mid-1987. When that occurs, imports will represent more than one-third of the US oil supply.

John T. Haldane is a specialist in Middle East affairs who has served as a Foreign Service Officer in Baghdad, Cairo, and Beirut, and as an international economist with the Departments of Commerce and Treasury.