When the Going Gets Tough

By John Haldane

Spring's in the air. Wall Street's on a romp again and American motorists happily turn their thoughts to a summer's idyll of cheap petroleum. But J.R. Ewing isn't smiling much these days. Neither are the laid off workers on his oil rigs.

The precipitous fall in world oil prices is wreaking havoc in Texas, Oklahoma, Louisiana and Alaska. Unless the U.S. government puts its energies quickly into tackling the domestic oil crisis, some parts of the American economy will fall on lean days reminiscent of the Great Depression. What makes the current crisis in the oil sector so dangerous is that it comes on top of crises in agriculture and banking. The U.S. farm sector has been under terrible strain for some time now: an estimated $210 billion in accumulated farm debt, more than enough to keep American bankers reaching for the aspirin. U.S. bankers have been concerned for some time that Mexico, their biggest debtor, would be unable to repay its huge outstanding loans. Now the Mexicans, hurt hard by the drop in oil prices, are going to need even more money to stay afloat: $9 billion of extra credits this year, instead of the $4 billion forecast before oil prices fell.

Each time oil industry executives and analysts open their copies of the Oil & Gas Journal and the Petroleum Economist, they find new portents of gloom. The Oil & Gas Journal did not mince words in its March 17 editorial blasting "the faulty premises underlying most elements of what can only loosely be called energy policy in the U.S."

"These policy mistakes," it warned, "are as bad for the industry and national energy security as plummeting crude oil prices. And 1986, when energy prices are falling, is the time for Congress and the administration to correct them. If they do not, the harm from poor policy will far outlive that from an industry wrecking price crash."

Even staid, generally calm Business Week sounded the alarm: "The rest of the world may be cheering, but the recent break in oil prices is reverberating like a death rattle throughout major segments of the industry. The price drop has demolished the economics of new drilling and hastened the dismantling of an elaborate energy finding industry hurriedly assembled in the 1970's and leveraged to the hilt."

Are things really as bad as they seem? Yes. The combination of weakening farm and oil sectors means that the economy will be facing major financial and employment problems that will have serious political repercussions during an election year and could adversely affect the national security of the United States.

The Southwest Sings the Oil Blues

The fortunes of the energy producing states are fading as quickly as they bloomed in the 1970's. Texas, Oklahoma and Louisiana already are in financial trouble and, up in Alaska, economic conditions are beginning to look dismal.

Texas loses about $100 million in production taxes and $3 billion in gross state product for each dollar decline in crude oil prices. The unemployment rate in Texas, our leading energy producing state, rose to 8.4 percent in February, an unheard of 2 percent leap from the previous month. Governor White is loudly complaining that Texas is "the first casualty report from the energy battlefront." He warns that "If the federal government does not take immediate action to protect a domestic industry so essential to our national security interest, then the list of economic casualties can only grow as more and more Americans find themselves out of work." William Fisher, director of the University of Texas Bureau of Economic Geology, predicts that $15 a barrel oil will result in the loss of at least 3.1 million barrels a day of American production, or about one third of current capacity, by 1990. The parts of the Texan economy being hit first and hardest are oil extraction and oil field equipment manufacturing, industries already suffering because of the decline in real oil prices that began back in 1981. Six major Texas banks, suffering from falling oil prices and declining real estate price values, were placed on a special "watch list" recently by Standard & Poor's Corporation.

Oklahoma's dependence on oil is second only to its dependence on farming a small consolation to the Sooners these days. The state relies upon energy taxes for about 25 percent of its annual revenues. Louisiana's oil producers all but stopped sinking new wells back in 1982; by 1984, the state had 6 percent fewer wells in production than in 1980. A revenue shortfall similar to that in Oklahoma is expected, since taxes on oil and gas producers traditionally yield a sizeable amount of state income.

Alaska, where the cost of production is cheap but the cost of getting it down to the "lower 48" is dear, is facing the tightest squeeze of all. Nearly 90 percent of Alaska's revenue comes from oil, mainly in the form of taxes and royalties. The state has lost an estimated $1 billion in projected revenues since oil prices began plummeting. Atlantic Richfield Corporation, which builds drilling and pumping modules for use in Alaskan oil exploration and production and floats them north, has announced that it will halt production with the completion of 1986 contracts. This action will lay off 5,000 workers in Washington and Oregon.

(Expect no help from those off shore California wells, by the way. Below $20 a barrel, oil experts say, oil from those wells becomes uneconomic.)

The economic situation is bad now, but worse is yet to come. Most major American oil companies have started reducing their exploration budgets: Atlantic Richfield by 50 percent, Standard Oil by 30 percent, Texaco and Amoco by 10 percent. Less exploratory drilling, of course, means less American oil in the future. Also, less employment in the oil fields, equipment manufacturing and related operations. All this further deprives the states and the national government of revenues. Whereas the poor farmers seem to have no one to speak up for them in Washington, D.C., the oil companies do. Expect a sudden and large flurry of attention in Congress, led by the Senators and Representatives from the oil states. The real need for emergency funds for the domestic oil sector and the drop in federal revenues may well force Congress to take a hard took at the huge amounts of aid being dispensed to a number of foreign countries.

What Is To Be Done?

Aside from domestic efforts to ease the immediate unemployment and financial problems, what else can be done? Two ideas come to mind in the international area.

President Reagan could send Secretary of State Shultz to London to confer with the British on the world wide consequences of the sharp drop in crude oil prices. Shultz, in his low key manner, could point out to the British that they are hurting their own economy by refusing to discuss oil production and pricing with Saudi Arabia, After all, the recent budget proposal presented to the House of Commons by the Chancellor of the Exchequer was a pretty sad document. Despite earlier rosy predictions, the tax reduction section totaled only $1.5 billion, significantly less than what the government had hoped to be able to provide before the fall in world oil prices cut projected revenues practically in half. Shultz could mention that Britain, where output had already peaked last year, is exploiting its oil at a pace which will deplete known reserves in a couple of decades: North Sea output accounts for 20 percent of British GNP and about 36 percent of exports. Younger Englishmen of voting age might agree with the idea that husbanding oil reserves at a time of low world prices might be good for the country in the longer run.

Prime Minister Thatcher, at least publicly, vows to keep North Sea production going at full blast. She flatly rejected a March Saudi Arabian plea to cooperate with OPEC in its efforts to reverse the dangerous decline in world oil prices. A recent news item from London, however, indicates Mrs. Thatcher may not be as stiff upper lipped as she pretends. Forbes reported that "publicly Prime Minister Thatcher won't negotiate, but there's talk in London of an 'unexpected' need for output cutting maintenance work in midwinter on North Sea oil rigs." So perhaps Shultz and Thatcher might have something to talk about after all.

The second proposal is that Secretary Schutz proceed from London to Riyadh and have a talk with Sheikh Yamani and other high Saudi officials. He needn't bring up the poor state of the American oil sector. On his recent visit to Riyadh Vice President Bush drilled that fact into the Saudis. Rather, Schulz should emphasize U.S. concern over the adverse effect the current oil crisis is having on world economic stability and the damage it's doing to some of the poorest Third World countries. He should praise the Saudis for their past efforts to stabilize oil prices and empathize with their frustration at not being able to inject some order into the OPEC/non OPEC oil chaos. Unsaid would be American awareness that, as Forbes put it: "The Saudis, threatened by Iranian fundamentalists and Libyan crazies, know there are limits to how far they can push world markets."

Such talks, no matter what inconclusive public communiques are issued subsequently, would make clear the United States' concern about what is probably the most important economic problem facing the world today. Mexico, our largest oil supplier, certainly would take note and be grateful. And even Congress, for a change, could rise in bipartisan approbation of such a bold diplomatic effort. It certainly would give hope to U.S. oil producers that world oil prices might settle at a point where their oil fields could be revived and everyone could get back to work.

If no far sighted Administration initiative is taken, the domestic oil crisis will worsen. A continued hands off attitude by the President means attrition of the American oil industry, just at a time when it is becoming painfully clear that there are no non OPEC easy solutions to U.S. oil import needs. Bruce Lazier, an oil analyst at Prescott Ball & Turben Inc., said recently: "We won't have the easy fixes of the 1970's. We will have no new North Sea or new Prudhoe Bay, no new Soviet Union and the only Mexico we've got is Mexico." Saudi Arabia and the Gulf states are still sitting on the world's largest oil reserves. Friendly discussions now with the Saudis conceivably could spell relief to the American oil sector in the short run and rebound in our favor in the future when imports from that area of the world will be vital to our own national security.

John Haldane is a specialist in Middle East affairs who has served as a foreign service officer in Baghdad, Beirut and Cairo, and as an international economist in the Departments of Commerce and Treasury.