The Oil Crisis

Article from Foreign Affairs, April 1973

Link: http://www.foreignaffairs.com/articles/24416/james-e-akins/the-oil-crisis-this-time-the-wolf-is-here?page=show

I:

• Predictions of oil shortages, prices, etc.
• Nixon: Task Force on Oil Imports
  • Modest price rises
  • 1980 demand: 18.5 million barrels, 5 million barrels imported (rest from Western hemisphere)
  • elimination of quota system, replacement with tariffs
  • limit imports from Eastern Hemisphere to 10% of national oil consumption
  • raise barriers if 10% exceeded to "forestall such excess imports"
• Projections spectacularly wrong
  • 1973: imports = 6 million barrels
  • imports from Eastern hemisphere = 15% (1972), 20% (1973)
  • total consumption = 17 million barrels
• Reason for incorrect projections:
  • uncritical acceptance of oil companies' estimates of domestic production and capacity
  • neglect of decline of natural gas supply and its affect on oil demand
• Estimates from State Department (1970)
  • 1970 - converted natural gas shortfalls to oil equivalents and added to projected oil demand
  • 1980 - estimated 24 million barrels of consumption per day
  • domestic production would cover 1/2 of this
  • 2/3 of imports (35% of total consumption) imported from Eastern hemisphere
  • estimated that oil prices in Persian Gulf (less than $2.00 per barrel) would rise by 1980 to level equal to alternate sources of energy ($4.50-$5.00 per barrel)
• "Have the Department and others been crying wolf unnecessarily, or is the "oil crisis" a reality? If it is, what can the United States and other countries do to live bearably with it?"

II:

• Place to start: with oil reserves
• Proven, probable, and secondary
• Figures: understated (for tax purposes) by oil companies, used by governments for political purposes
• "Positive" picture:
  • Proven reserves, non-communist countries: 500 billion barrels (300 billion in Arab countries, Middle East and North Africa)
  • World demand (excl. Soviet Russia and China): rise by 1980 to 85 million bpd, compared to 39 million bpd in 1970
  • 1970-1980: 200 billion barrels
  • 1980-1990: 300 billion barrels (at 1980 consumption level)
• More importantly:
  • Most of world's probable reserves are in Middle East
  • 95% of exploration activity outside of Middle East
  • Indonesia, Alaska, North Sea reserves all too small to meet demand longer than a few years
• Oil reserve picture:
  • Oil in Middle East not distributed evenly
  • Jordan, Lebanon, Tunisia, Morocco, Yemen have almost none
  • Egypt has little
  • Algeria, Libya have somewhat more
  • Giant reserves concentrated in Fed. of Arab Amirates, Kuwait, Iran, Iraq, Saudi Arabia
  • S. Ar. reserves: 150 billion barrels, could be twice that
• ignoring coal, shale, tar sands, heavy oil

III:

• Political tension between US and Middle East

"Even King Faisal of Saudi Arabia, who has said repeatedly that he wishes to be a friend of the United States and who believes that communism is a mortal danger to the Arabs, insists to every visitor that U.S. policy in the Middle East, which he characterizes as pro- Israeli, will ultimately drive all Arabs into the Communist camp, and that this policy will bring disaster on all America's remaining Arab friends, as earlier Anglo-American policies did to Nuri Said of Iraq."

• http://en.wikipedia.org/wiki/File:Oil_Prices_1861_2007.svg
• King Faisal: Arabs should not let oil be used as political weapon
• 1972 - 15 threats by other Arabs to use oil as weapon against "enemies" (almost all U.S.)
• total cut-off of oil supply would be impossible for some Arab gov.s to survive
• usual Arab threat is to block supply to enemies (U.S.) and supply to friends (many of our allies), providing continued income
• last boycott: 1967 Six Day war, 1 mo., no effect b/c importing < 500,000 bpd
• 1973 picture: very different
• 1980 picture: importing 8-11 million bpd
• if Middle East imposed boycott for political or economic reasons...
  • what would be our response?
  • choices are difficult and limited
  • military means
  • accede to wishes of oil suppliers
  • accept the economic damage/consequences
  • European/Japanese response?
• availability of oil surplus diminishing; within few years, production of any seven (Saudi Arabia, Iran, Iraq, Federation of Arab Amirates, Kuwait, Libya, Venezuela) will be larger than combined spare capacity of rest of world
• loss of production of any of these countries could lead to world oil shortage (temporary)
• loss of two could cause crisis, consumer panic
• threat of oil as a weapon has to be taken seriously due to U.S. vulnerability

IV:

• 90% of oil reserves of oil-producing countries represented by 11-nation OPEC
• OPEC has formidable economic power, has demonstrated willingness to use it
• 1958-1959: international oil companies lowered prices due to surplus
• Venezuela, Iran, Saudi Arabia formed OPEC in 1960 to restore 1958 price levels
• failed due to continued surplus and disunity
• early 1960s: OPEC countries needed money, pushed companies to undercut other OPEC members and increase production, organization did not ultimately follow through - OPEC maintained solidarity in period of buyers' market, at a time when reserves were considered infinite
• 1967 Six Day War: Suez Canal closed, shortage of oil due to transport, Libya increased production to meet European demand
• September 1969: Colonel Qaddafi overthrew King Idris; pro-Arab, anti-Communist, anti-U.S. and anti-Israel
• Strains on transportation: Iraq pipeline closed, Trans-Arabian line cut, European reserves declined; Spring 1970: Libya demanded higher taxes on oil, companies aggreed
• Europe unprepared for oil shortage
• Oil company official urged US to dare Libya to nationalize, would lead to European belt tightening, Libya would succumb due to surplus oil
• Govt: Libya had enough currency reserves ($2 billion) to last 4 years
• Europe: reserves would be cut in half if that happened, European countries wouldn't let that happen
• Europeans would have made deals with Libya anyway, cutting oil companies out of Libya for good
• 1970 Libyan demands: demonstrated new situation, that threat to withhold oil could be used to raise prices
• State Department: involved itself, kept informed of OPEC actions, met with European governments to inform them of OPEC actions, set up companies to replace them
• This led to smooth relations between US oil companies and Europe
• December OPEC resolution: 15-day time limit to accept new demands from every OPEC member, or all oil production would be cut off
• Justice Department: authorized formation of negotiating front (keep from getting picked off one by one)
• Under Secretary John Irwin visited Iran, Saudi Arabia, and Kuwait; told them that cutoff of oil would leave relations with US strained; countries assured him threats were against companies only, that consumers would still have access to oil; Irwin also negotiated extension of timeline
• February 1971: negotiation in Tehran, tax increases equal to half of initial demands (45 cents per barrel in Gulf and 80 cents per barrel in Libya, further increases in 1975)
• No one (still) in any position of immunity to oil boycott
• End price for consumer only increased by 3-5%
• Underdeveloped consuming countries considerably set back; India had to cut petroleum purchases

"This possibility had been foreseen in the negotiations, and the question of a lower or differential tax for sales to underdeveloped nations had been broached with various OPEC countries, specifically Iran, Saudi Arabia, Kuwait and Venezuela. The idea was rejected, on the technical ground that it might lead to circumvention and resale, more broadly on the plea that the producing countries themselves were underdeveloped. If Europe, America or Japan were concerned about the welfare of India or Colombia or Tanzania, it was argued, they had the means to assist them. The issue has lain dormant since; it is sometimes still raised by Asian, African and Latin American states-without response."

V:

• Awareness of lack of profits, exhaustibility of reserves
• "Triumph" of OPEC didn't last long, Arab world castigated OPEC for being too soft/yielding too easily to government and company pressures
• Perspective: important to maximize revenues without exhausting resource
• Participation: defined percentage share in producing operations and assets of international companies
• Came up, with producers claiming participation was implicitly understood outside of Tehran agreements, companies saying it was not allowed by Tehran agreements (Feb 1971)
• Producers: participation would not affect oil prices
• Iran: demand for total ownership/management of oil resources
• Iraq: nationalization of Kirkuk oil fields
• Libya: immediate 50% participation

"In sum, the international companies will probably go on playing an active role in finding, developing and marketing oil for as long as it is used as a fuel or as a raw material. But in this role the companies may increasingly find themselves minority partners of both producer and consumer governments-and they must reconcile themselves to the probability that their role in negotiating with the OPEC countries will in the future be more circumscribed than it has been until now."

• Italiy: first expressed idea that oil companies should be regulated utilities
• Horrifies oil company managers/executives
• Appeals to consuming countries

VI:

• OPEC: reduce position of companies, make bargaining a government-government activity, keep agreements short-term and open to later negotiation
• even after substantial increase in tax per barrel, industrial countries (US) did not reduce consumption
• Rise of oil to a certain price would cause contraction in oil use; price raises without contraction of oil use demonstrate that threshold price has not been reached yet
• Iran: level off production at 8 million bpd
• Kuwait: level off prod. at 3 million bpd
• Iraq: difficulty realizing 5 million
• Others: strain to meet 6 million
• World will need this quantity of oil unless theire is a war or a major recession
• Saudi Arabia: Minister of Petroleum: Ahmad Zaki Yamani, set projected production at 20 million bpd
• Production levels falling short of this would cause significant supply crisis, leading to higher prices
• Projection for 1980 subject to large margin of error

VII:

There have been and still are countries which are richer than any country in OPEC, but there is none which is so small, so inherently weak and which has gained so much for so little activity of its own.

What will be done with this money will be a matter of crucial importance to the world. The first place for its use must certainly be in their own countries; the second must be the Arab world, which will not, as a whole, be capital-rich. At the Algiers Arab Oil Congress in mid-1972, the proposal was made that the Arabs should solve their "problem" in an inter-Arab agreement whereby the main producer nations would limit their income from oil to the 1972 tax structure. That is, as oil production went up, the increased payments at the 1972 rates would go to the producer governments, but all or at least part of any increases in payments per barrel over 1972 levels would go into an inter-Arab development bank for projects in the entire Arab world. This additional money would be, in a sense, unearned. Moreover, such action would be in perfect consonance with Islamic law practice, which demands twice as much zakat from income derived from lands fed by God-given rain as from lands irrigated by man.

• Purpose of the surplus oil money: important to Arabs, important to U.S.
• A failed American project could lead to loss of confidence and restriction of production

VIII:

• Q: can OPEC hold together? must assume they will
• OPEC understands its importance
• Cannot be compared to other cartels: its product is economically important and cannot be replaced in short term
• OPEC also knows its reserves are finite: reason for leveling off production
• Some predict that OPEC countries' desire to increase their share of the market will lead to decreasing oil prices, but these predictions can lead to deeper determination not to do that

No OPEC country, no matter how great its wealth, is interested in "breaking" world oil prices.

• Saudi Arabia has large enough reserves to destroy OPEC, but this would also destroy Saudi Arabia

It is difficult to see what folly could possess Saudi Arabia to take such action; any consumer government that assumed that Saudi Arabia would (or could) do this without an internal revolution would be guilty of an even greater folly.

• Collapse of OPEC could happen if:
  • vast new reserves discovered
  • breakthrough of new energy sources
• Even these would take long time to drive oil prices down

IX:

• Power of consumers?
• Collective action (has not happened up until now)
• Assistant Secretary of State Philip Trezise (1970): energy problems must be considered in a multilateral context
• U.S. millstones: Israel, and increasing dependence on foreign oil
• OPEC: demonstrated restrictions would apply only to the U.S., splitting U.S. and other oil consuming countries

X:

• Multilateral approach is needed, not just for negotiating with OPEC, but for exploring for new reserves or new energy sources, or build up reserve stocks for bargaining purposes
• Bargaining: it's our short-term reserves vs. their (substantial) financial reserves
• Fuel alternatives:
  • U.S.: substantial coal and shale oil, possibility of geo-thermal, solar, nuclear fission/fusion; but all long-term solutions
  • 300 billion barrels recoverable oil in Athabascan tar sands
  • Capital investment: $5-7 billion per million bpd capacity
  • Lead time: 15 years
• Other possibilities:
  • Canadian oil
  • Venezuelan heavy oil - free entry of this oil in return for investment guarantees to companies developing these oils
  • Increase in domestic energy production
  • More efficient energy use
  • Control of rise in oil demand (e.g. through mass transit systems)

No one action will solve our energy problem, much less that of the entire world. But taken together these steps-collaboration with other nations, the development of alternative energy sources, and controlling our consumption reasonably-could allow us to reduce our imports significantly below those projected in this article. This must surely be our immediate goal.

XI:

• Argument of article: oil crisis is a reality that compels action

Having argued throughout this article that the oil crisis is a reality that compels urgent action, let me end on a note of hope. The current energy problem will not be a long one in human terms. By the end of the century oil will probably lose its predominance as a fuel. The measures we have the capacity to take to protect ourselves by conserving energy and developing alternative sources of energy should enable us, our allies, and the producer nations as well, to get through the next 25 years reasonably smoothly. They might even bring us smiling into the bright new world of nuclear fusion when all energy problems will be solved. This final note would ring less hollow if we did not remember the firm conviction of the late 1940s that the last fossil fuel electricity generating plant would have been built by 1970; and that in this new golden age, the home use of electricity would not even be measured. It would be so cheap, we were told, that the manpower cost of reading meters would be greater than the cost of the energy which the homeowners conceivably could consume. But perhaps in 2000...