The Energy Question Volume One: The World: An International Failure of Policy 9781487595029

Table of contents :
Contents
Introduction
The world oil market
Part One: The Actors
Oil in the Middle East and North Africa
Political and financial aspects of the oil game
The Soviet Union in world energy markets
China and Japan in the world energy economy
Petroleum and natural gas in sub-Saharan Africa
The Latin American petroleum industry
Western Europe's energy policies
Multinational corporations and national economic policy
Multinational corporations in world politics
Part Two: Energy and the Environment
Energy consumption and environmental quality
Mankind as a factor in climate change
The Faustian bargain
The devil's advocates
Part Three: Policy
Energy, resources, and growth
Oil diplomacy
Oil and the US balance of payments
Part Four: Energy System Modeling
A world energy model
The limits of The Limits to Growth
Contributors
Contents of volume 2

Citation preview

The Energy Question The so-called energy crisis that burst upon the world in 1973 was not easily understood by many people. I t was neithe r 'th e beginnin g of the end' nor the first encounter b y modern ma n wit h th e natura l resul t o f his prodigality . Thes e papers, collecte d in two volumes, from energ y economist s i n the Unite d States , Canada, and Britai n all indicate that the 'crisis ' was and is a short-run problem caused by government action or inaction. The problem may be complex, but it was mishandled, particularly by the United States, in terms o f government policy. The ris e i n the pric e of , an d th e embarg o on , oil came int o being because of a successfu l producers ' carte l outsid e Nort h America ; oi l buyers - nation s an d companies - di d no t respon d i n kin d bu t scurrie d aroun d th e worl d i n separate planes in order t o ensure supplies fo r themselves a t any price . That price became many time s th e cost-of-productio n price , despit e th e fac t tha t coo l analysi s reveals a n increas e i n both productio n an d reserve s i n most area s o f the world . The shortage s of refined oi l products fo r consumers ar e attributabl e partly to th e embargo, bu t als o t o a shortag e o f refineries an d bottleneck s i n transportation some of which hav e been induced by government uncertaintie s ove r recent years . Proper governmen t policie s are now required. The thirty-six papers in the two books trea t a multitude of topics related to the question of energy a s seen from th e stance of the economist. All source s of energy are considered, a s ar e th e market s i n major area s of the world ; pas t policies ar e analysed, an d future policies recommended . It i s hoped tha t the volumes , giving the backgroun d t o the energ y problem s of the immediat e futur e an d a menu o f prescriptions fo r their solution, will interes t businessmen, marke t analysts, an d policy-makers as wel l a s economists , teachin g or learning, in many parts o f the world . Volume 2 is titled North America. edward w. erickson is associate professor of economics at North Carolina State

University leonard waverman is associate professor of economics at the University of

Toronto and reasearch associate at the university’s Institute for the Quantitative Analysis of Social and Economic Policy.

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E D I T E D B Y E D W A R D W . E R I C K S ON AND LEONAR D WAVERMA N

The energy question An international failure of policy VOLUME 1

TH E W O R L D

U N I V E R S I T Y O F TORONT O PRES S

© Universit y o f Toronto Press 197 4 Toronto and Buffal o Volume 1 ISBN 0-8020-2134- 4 (cloth ) ISBN 0-8020-6238- 5 (paper ) Volume 2 ISBN 0-8020-2140- 9 (cloth ) ISBN 0-8020-6240- 7 (paper) LC 73-91565 Printed i n the Unite d State s o f Americ a

Contents

EDWARD W . ERICKSON AN D LEONAR D WAVERMA N

Introduction vi i M.A. ADELMA N

The world oil market 5

Part One: The Actors 4 1 MAUREEN S . CRANDALL

Oil in the Middl e East an d North Afric a 4 3 ROBERT MABR O

Political an d financia l aspect s of the oi l game 7 3 ARTHUR W . WRIGHT

The Sovie t Unio n i n world energy markets 8 5 THOMAS G . RAWSK I

China and Japan i n the worl d energ y economy 10 1 SCOTT R . PEARSO N

Petroleum an d natural gas in sub-Saharan Africa 12 1 HENRY STEEL E

The Latin America n petroleum industr y 14 7

Contents M.V. POSNER Western Europe's energ y policies 18 1 EMILIO G.COLLAD O

Multinational corporations and national economic polic y 19 5

J.s. NYE Multinational corporations i n world politic s 21 1 Part Two: Energ y and the Environment 22 3 DONALD N . DEWEE S

Energy consumptio n an d environmental quality 22 5 WILLIAM W . KELLOG G

Mankind a s a factor in climate chang e 24 1 ALLEN V . KNEES E

The Faustia n bargain 25 9 A. CARNESALE AN D T.S . ELLEMA N

The devil's advocates 26 7 Part Three: Policy 27 3 HAROLD J . BARNET T

Energy, resources, and growth 27 7 ROLAND S . HOME T

Oil diplomacy 30 1 THOMAS J . GRENNE S AN D HERBER T S . WINOKUR, JR

Oil and the u s balanc e of payments 31 1

Part Four: Energy System Modelin g 33 5 RJ. DEA M

A world energy model 33 7 MARC J . ROBERT S

The limits of The Limits to Growth 35 1 CONTRIBUTORS 37

7

CONTENTS OF VOLUME 2 37

vi

8

E D W A R D W . E R I C K S O N AN D LEONAR D W A V E R M A N

Introduction

SCENARIO O F TH E CRISI S

Table 1 shows data on worl d oi l production, exports , an d import s fo r 1972 . The us produce d 2 1 per cent o f world oi l and consumed 3 0 per cent. Western Europe consumed 2 7 pe r cent o f oil produced, Japa n 11 . Middle East oi l was shipped primarily to Western Europe (4 7 per cent) and Japan (2 1 per cent), and the us too k only a small percentage o f Mid East productio n ( 5 per cent). 1 Venezuelan oi l goes mainly t o Nort h Americ a (6 5 pe r cent) and Europe (12) . It is clear from thes e figures that th e u s i s central to an y discussion o f energy, since 3 0 per cen t o f world productio n an d consumptio n an d 2 0 pe r cent o f world oi l trade involves the us . Moreover , of the eigh t major international petroleum companie s (Exxon , Texaco, Standard Oi l of California, Mobil, Gulf, British Petroleum, Shell , an d Compagnie Frangais e de Petroles (CFP)), five are American-based . It i s equally clea r from Tabl e 1 that, if the u s become s self-sufficien t i n oil, a significant portio n o f th e worl d marke t wil l be lost t o presen t oi l producers an d exporters, primaril y Venezuela an d the Middle East; currently, the us marke t takes some eigh t millio n barrel s per day o r thre e billio n barrels per year. Eigh t years ago, us import s o f oil were only 2.5 million barrels per day, while Europ e and Japan together importe d 1 0 million barrels per day. The rapi d growth i n international trad e i n petroleum product s i s then a product o f two trends - th e rapi d rate of growth i n the industrial west wit h it s related growt h i n energy consumption - an d the increasing reliance of the us o n imported petroleu m products . vii

TABLE 1 World oil 197 2 (1965 ) '00 0 bd Production

1972 196 United State s Western Europ e Canada Mexico Caribbean3 South America Middle Eas t Saudi Arabia Iran Kuwait Abu Daba i Other North Afric a Sub-Saharan Afric a South Eas t Asi a USSR Eastern Hemispher e (excl. USSR) TOTALS

5

11 ,180 9,01

435 44 1,835 92 500 38 3,650 3,81 825 47

5 0 5 5 0 5

5,735 2,02 5 ,050 1,90 3,000 2,17 1,050 3 3 ,140 2,21 3,745 1,89 2 ,085 31 1,295 60 7 ,890 4,80

5 5 0 0 0 5 5 0 0

1,510 61 52,925 31,70

0 0

a Venezuela , Columbia, an d Trinida d b Processin g gain excluded fro m domesti c demand c Japanes e import s ar e 4.8 Mbd

Consumption

Imports

1972

1965

1972

15,980b 14,205 1,665 610 1,195 1,495 1,145

11,300 7,730 1,150 360) 720) 920 660

4,740 14,060 915

2,465 7,725 555

225 325 1,085

185 165 325

1,170

195

3,620

3,250

880 120

480 25

100 16,950

60 7,610

130

400

950

680

1965

7,460

3,030

6,420C

7,990

4,500

380

52,695

31,050

29,575

Exports

d

1972

5,390e

2,140

3,000

1,130

460

265

1,260

900

15,110

30,085d

d Doe s not equat e because of minor unrecorded shipments e Nort h Africa n export s are 3.5 Mbd

SOURCE: B P Statistical Review of th e World Oi l Industry, 1972 , 1965 .

1965

15,110

Introduction Japan an d Europe have imported fa r larger percentages of their energ y needs than has the us. Ye t it is American government official s - not Japanes e o r European - wh o in seeing oil imports grow from zer o to 1 0 per cent o f requirements, a level that official s i n other countrie s dream fondl y of , began to fea r a n energy shortage. The energy question i s a complex one . Ther e ar e many divers e actors - con suming nations wh o act independently o f each other; producing nations; multinational producin g companies; smalle r independent companies , divers e substitutes, etc. The energy question mus t b e analyzed agains t the backdrop o f growing awareness in underdeveloped nations of the powe r o f taxes, heightened Ara b nationalism, ta x polic y i n consuming countries , wester n industria l national policie s for indigenou s energ y sources. There i s no simple answer. T o look for a scapegoat o r simplisti c solution t o a complex proble m is psychologically appealin g but irrelevant . To understand the natur e of today's problem s an d possible solu tions, let us consider some o f the individua l events which togethe r make up th e energy question o f the 1970s . ACTION The world petroleum marke t has recently bee n in turmoil; long-standing relationships have been changin g rapidly , and a t a time whe n many othe r aspects o f th e energy economy ar e also under stress. For example : The delivery and installation of nuclear power plant s have not bee n a s prompt a s scheduled. Once installed, nuclear power plants have not, i n general, had th e reliabilit y that was anticipated. Growth in electricity demand, together wit h th e tw o factor s above, has caused power companie s to prolon g the lif e o f aging (on averag e less dependable) equip ment, to us e older equipmen t more intensivel y tha n normall y woul d hav e bee n the case , and to expan d effectiv e capacit y with fuel-intensiv e internal combustion turbines . Artificially lo w ceiling prices for natura l gas in the Unite d States have create d a regulation-induced shortag e of natural gas reserves and production . Environmental considerations have delayed th e constructio n o f the trans-Alask a pipeline, the availabilit y of oil from that source , and drilling on the Alaska n Nort h Slope t o discove r the approximat e magnitud e of the oi l and gas reserves there. The maneuvering surrounding the issu e o f the trans-Alask a pipeline i n tur n clouded discussion s o f the Mackenzi e Valley pipeline through Canad a and delayed intensiv e exploratory drillin g in the Canadia n Arctic.

IX

Edward W. Erickson an d Leonar d Waverman Serious environmenta l problems cause d drilling programs t o b e curtaile d i n a number o f world locations . Oil producers i n the Unite d State s were made ver y nervou s by th e deliberation s of th e Cabine t Task Force o n Oi l Import Contro l an d wer e left i n a state o f uncertainty concernin g when an d how th e mandator y impor t contro l progra m would b e relaxed , the prospect s for th e stat e conservatio n regulation syste m under which the y were accustomed t o operate , and th e landed price, source, and volume o f foreign oil against which they woul d hav e to compete . Price control s i n the Unite d State s distorte d norma l economi c incentive s wit h regard t o th e produc t mi x of refiner y output , kept th e pric e o f crude oi l belo w the marke t clearin g level, and evolved int o a two-tier price syste m fo r 'old ' and 'new' crude oil with variou s categories of exemptions an d incentives. Uncertainty abou t th e futur e cours e o f the Unite d State s oi l import progra m an d refinery-siting problem s caused a hiatus in us refiner y construction a t a time when substantia l new refining capacity neede d t o b e initiated . Power plan t emission s controls , land reclamatio n standards , an d mine safet y laws simultaneously affecte d th e deman d an d suppl y condition s for coal . Non-price rationing and end-use priority control s t o allocat e th e shortag e of natural gas, together wit h restriction s on th e productio n an d us e of coal , shifte d fuel demand s t o low-sulfu r fue l oil s at the sam e time tha t refinin g capacit y ha s been becomin g more an d more pinched . Automobile emissio n controls cause d a decrease in gasoline mileage and a n increase i n gasoline demand . Challenges to th e u s Burea u of Lan d Managemen t postponed leas e sales and delayed th e discover y an d developmen t o f new oil and gas reserves in the Gul f o f Mexico. Alarmists marching to th e beat o f an imaginary drummer - i n the fac e of new oil and gas strikes in Indonesia, China, Russia , Nigeria, South America, th e Nort h Sea, Australia, Alaska, Canada, and elsewhere - proclaime d tha t th e world was in imminent dange r of 'runnin g out' of fossi l fuels. As a result of al l of th e abov e factors but th e last , the Unite d State s became a significant an d unexpecte d sourc e o f temporary incrementa l deman d i n world refined-product an d low-sulfur crude oi l markets. The United State s and othe r consuming countries adopte d th e rol e o f supplicants in dealing with th e oi l merchants o f the Persia n Gulf. European countrie s acte d i n independent self-interes t to attemp t t o 'ti e up' long-term contracts with Persia n Gulf producers . Japan an d France activel y supported th e policie s of som e producin g countrie s t o en d con cession right s to existin g firm s an d re-offe r thes e right s t o ne w firms which happened t o hav e Japanese o r French interests .

X

Introduction European nuclea r strateg y coul d no t b e developed. Countrie s could no t (an d still have not ) decide d o n option s whic h includ e developin g new breeder capacity , adopting or modifying the Canadia n heavy wate r reactor, or adopting th e enriched u s nuclea r capacity. Eve n in adopting enriched reactors , Europe i s divided on th e appropriat e enrichin g process, France an d Britai n moving in separate directions. Becaus e of thes e problems , delays in nuclear investment have been experienced, with th e sam e effect s a s described abov e in the us . When 'wolf i s cried often enough , eve n the wol f believes it. Producers coul d not le t consumers , who believe d in shortages, enjo y low prices. Prices bega n t o march u p in 1970 . I t i s important t o note that much of the earl y price increases were du e t o action s i n Venezuela an d i n Nigeria. Nigeria di d not joi n OPE C until late 1971 . As the pric e continued t o rise , governments in consuming countries ha d tw o rational policie s available: 1 le t domesti c price s rise to limi t consumption , limit demand , thus limiting imports an d s o Persian Gul f productio n 2 ban d togethe r t o fac e th e cartel . Instead, most consumin g countries , expectin g even higher prices for oil , scrambled fo r short - an d long-ter m contracts wit h pro ducing countries , increasing the deman d fo r oi l as the pric e rose . The oi l market began to sho w dee p signs of disequilibriu m as perverse action prevailed . The Arab-Israeli war of Octobe r 197 3 precipitate d a complete embarg o of nation s friendly wit h Israel , a 25 per cen t reductio n i n production an d hefty pric e increases by Persian Gulf producers. It i s important t o distinguis h th e political from th e economic actions of the Arabs . To embargo the us an d Holland was political, althoug h suc h actio n coul d hav e little impac t o n thes e countries ' for eign policies. No r could th e embarg o have a major impac t o n the us , which , depending on which number s you read , imports fro m 6 to 1 0 per cent o f its energy requirements from th e Middl e East. Increasing the pric e to frien d an d fo e alike is not a political move, but i s clearly economic. N o votes are gained by charging India a n extra $15 0 million per year. Th e embargo, the politica l actions , will soon end. Th e economic actions will continue . A QUESTIO N O F CRISI S OR A

CRISI S O F QUESTIO N

The net resul t of the abov e factors (and probabl y othe r factor s which hav e been overlooked) i s what i s called th e 'energ y crisis. ' Most of the contributin g circumstances cited abov e involve dimensions of energy policy i n the Unite d State s and Europe, primaril y the us . Th e emphasis on the United State s in these volume s is

XI

Edward W. Erickson an d Leonar d Waverman not just a result of the ethnocentricit y o f one of the editors . Th e United State s is simultaneously th e biggest consumer and the bigges t producer of energy in the world. When supply an d demand ge t out o f balance in the Unite d States , th e effects ar e felt throughou t th e world ; as an old aphoris m proclaims, when th e United State s sneezes, the world catches pneumonia . Th e recent an d continuin g convulsions in the worl d energy markets are evidence that thi s sam e rule applies there. Moreover, care must b e exercised tha t th e cur e for the u s doe s not kil l the world. What the n o f the energ y crisis? The energy crisis is policy-induced. The consensus of the contributor s t o thi s volume is that th e crisi s does no t represen t some abrup t change in the fundamenta l relationships between man an d nature . The worl d is not o n the verg e of runnin g out o f fossi l fuels . Relativ e costs an d prices are changing. But the price change s are initially more related to th e effect s of policy inconsistencie s and polic y failure s than the y ar e to change s in real resource costs on a world basis. After a period o f adjustment, the margina l real resource costs o f some fuel s fro m som e source s will rise to mee t prices . Nevertheless, on a worldwide basis, policy-created price changes will have led cost changes . The abrupt price change s do not reflec t discontinuity i n the incrementa l cost o f incremental world supplies of fossi l fuels . The touchston e o f modern economic analysi s is Alfred Marshall' s Principles o f Economics, first published in 1890 . Marshall thought he was writing a primer on economic analysi s for businessmen. Instea d he wrote th e basi c text fo r nearl y a half a century of graduate education i n microeconomics. Indeed , much o f Marshall's analytica l framework is still the appropriat e context withi n which t o examine contemporary economic problems . Perhaps no singl e line of Marshall' s text i s more relevan t to th e problem s addresse d in these volumes than th e epigraph. That inscription is : natura non facit saltum. The approximate translatio n is, 'nature does not procee d b y leaps.' In early 1971 , crude oil was in excess supply , especially in Europe, an d prices fell. Sinc e nature does no t procee d b y leaps, since growth in world oil consumption coul d not i n two years outpace supply, especially sinc e Saud i Arabia alone increased production nearl y 40 per cent in two years, how did today's shortage s occur. More importantly, how di d the pric e rise and what is the outlook fo r th e future? Just a s we now live in the citie s o f the twenty-firs t century , so we are now operating in the energ y economy o f th e twenty-firs t century . This i s basically a fossil-fuel economy . I f the energ y crisis is policy-induced, then fo r th e foresee able futur e th e critica l polic y response s ar e going to be thos e abou t fossi l fuels , and oi l and natura l gas are the premie r fossil fuel s i n this regard. xn

Introduction The basic question s and root cause s of the energ y crisis necessitate tha t w e delineate energ y policy option s an d choose amon g them. To facilitate this, most countries are in the proces s of establishing a national Energ y Administration t o coordinate and administe r energy policy. I n this context, a legitimate question is the exten t t o which th e energ y crisis overall or even for any individual countr y is simply a result of uncoordinated policie s - a case where either policy X o r policy Y i n isolation migh t be appropriate , but wher e th e combine d effect s o f policies X an d Y togethe r ar e undesirable. Alternatively, we must identif y and rectify fundamentall y inappropriate policies , each wit h separat e effect s unam biguously detrimenta l t o smoothl y functionin g energy economies, an d with combined effect s whic h ca n only exacerbat e imbalance in the system . I n the curren t state o f affairs , creatio n o f singl e national energy agencies and reorganizatio n of executive departments and administrative agencies is unlikely by itsel f to bring order out o f chaos. Som e o f th e policies which ar e important determinant s of the energ y crisis lie outside th e feasibl e jurisdiction o f a national energy administration. Moreover, coordination o n a national basis alone i s unlikely t o b e suffi cient t o remed y the curren t ills. In addition, fundamental review is required. Coordination an d revie w must b e a continuing process with wel l established feed back an d consistent principle s of coordinatio n an d bases for review. In th e sens e that i t will require continuing polic y decisions , the energ y crisis is apt t o be with us for a long time. Thi s i s because one definitio n of a crisis is a change i n relative costs and prices . As they hav e in the past , relative costs and price s can be expected t o continu e t o chang e in the future. What should b e the principle s for coordination an d the base s for review? Economists would almos t universall y recommend tha t th e principle s should b e those of supply and demand, and that th e basic s should b e accommodatio n t o th e market mechanism . THE BASI C LAWS : SUPPLY , DEMAND, PRICE , AN D PROFIT S

It is worthwhile, then, t o revie w what thes e ideas entail. Demand i s the valuatio n of benefits from consumption . Suppl y i s the valuatio n of the cost s of production . The underlying assumption i s that individua l consuming and producin g units are their ow n best judges of the benefits to the m o f additiona l consumptio n o r production a t going and expected marke t prices . Supply an d demand determin e price. On the basi s of price, there i s decentralized evaluation of costs an d benefits by those bes t abl e to mak e th e judgments. To the extent that policy formulation and administration prevent this proces s from working , queues and surpluses

Xlll

Edward W. Erickson an d Leonar d Waverman develop which mus t ultimatel y b e resolved by discontinuou s jumps in marke t variables. It i s these discontinuitie s which creat e a crisis atmosphere . To economists , profi t is not a dirty word . Profit realization and th e potentia l it indicate s ar e the signal s which caus e resources t o flo w in a responsive marke t system. I t i s crucial to distinguis h between th e proces s and the resul t o f behavior motivated b y th e attemp t t o maximiz e profits . Profit maximizatio n require s cost minimization fo r any rat e o f output. Cos t minimizatio n i s required for th e con servation o f real resources. Profit maximization als o require s a balance to b e struck between productio n an d use now an d productio n an d use in the future . Thus, profit maximization i s consistent wit h the conservatio n o f energy resources. The market system , however, cannot alway s be relied upon t o produc e sociall y optimal results . Two situation s which ar e important i n this regar d are: (a ) th e existence o f market powe r in less than competitiv e markets ; and (b) th e presenc e of externalities in production an d use . The externalities proble m is central t o th e consideratio n o f th e environmenta l consequences of energy suppl y an d demand. The textboo k exampl e o f a n externality i s the cas e of a papermill which impose s cost s o n downstrea m water user s as a result of effluen t discharge s into a stream which i s treated a s a free wast e sink b y th e papermill . These downstrea m cost s have often no t bee n include d i n the accounting o f the cost s of producing paper and are thus 'external ' t o th e decisions of the papermil l operators an d the consumer s of paper. In the lis t of policy factor s which hav e contributed t o th e energ y crisis presented a t th e beginnin g of this introduction , a number of policies associated wit h environmental protectio n wer e included. This wa s not becaus e we feel that environmental protectio n i s a fundamental cause of th e energ y crisis. (Neither d o we feel tha t al l environmental protectio n policie s ar e necessarily optimal.) Environ mental protectio n policie s have aggravated energy supply an d demand adjustmen t processes; however, thes e environmenta l policie s ar e at best second - o r perhap s third-order factors in the energ y crisis . The consensu s of th e contributor s t o these volume s is that it is possible t o have enhanced environmenta l protection at some cos t - withou t immediat e and drastic changes in either th e level or rate of growth o f real income. (I n fact , the kin d o f flexibilit y and iterative adaptatio n that seem s t o b e developing in the environmenta l policy are a might serv e as a model fo r energy policy.) Bigness is often mistake n fo r monopoly. A t the presen t time , this misconception i s nowhere mor e apparen t tha n wit h regar d to th e petroleu m industry . Monopoly is in the eyes of the beholder The structure o f the petroleu m industr y is consistent wit h an effectively competi tive industry . The individua l firms ar e very large, but s o is the industry . Exxon xiv

Introduction occupies abou t th e sam e relative position i n the petroleu m industr y a s Burlington Industrie s does in the u s textile s industry. Definitions of what i s a 'major ' petroleum compan y vary . The us Federa l Trade Commissio n pinpoint s eight major petroleu m companie s in its Investigation o f th e Petroleum Industry.^ Other definition s list twenty-od d majo r companies. Eithe r figur e i s revealing, but conside r th e twenty-od d companies . Most industrial-organization economist s consider twent y firm s t o b e a sufficient numbe r fo r competitiv e results . Moreover, there ar e substantial numbers o f intermediat e and stil l smalle r sized companies which are active and successfu l on a worldwide basis. If th e mor e restric tive definition o f eight 'majors ' i s used, then th e competitiv e 'fringe ' correspond ingly expand s t o includ e suc h significan t and activ e companies as BP, Amerada Hess, Phillips, Continental, Union Oi l of California , Su n Oil, etc. I n addition , national petroleu m companie s operat e i n both producing an d consuming coun tries. On a structural basis, the petroleu m industr y is probably effectivel y compe titive. Many individual s and agencie s allege that th e conduc t o f the petroleu m industry i s cooperative rather tha n competitive . I t i s also allege d that ther e ar e barriers to entr y fo r non-integrated, independent refiners . The combination o f thes e circumstances i s alleged to affec t competitio n adversely . As an example, consider , as does th e FTC , gasoline marketing in the Unite d States . Betwee n 195 5 an d th e latter half o f 1973 , th e rea l price of gasoline and th e marke t shar e in gasoline sales of the major s fell. A t this same time , a s a result of both growth i n demand because of higher rea l incomes an d th e changin g structure of transportatio n demand du e t o suburbanization , it is likely that gasolin e demand became mor e price inelastic . In suc h a situation, th e profit-maximizin g response o f a n effec tively cooperativ e industry would b e to rais e real prices - no t lowe r them . One explanation o f fallin g rea l prices is that th e industry , rather tha n bein g charac terized by cooperativ e conduct , actuall y behaves competitively. Another ex planation i s that there ar e not unsurmountabl e barrier s to entr y i n refining and marketing. These explanation s ar e not mutuall y exclusive. We believe that both are probably correct . The profit s of the companie s i n th e petroleu m industr y set al l time record s in 1973. Tw o major sources of 197 3 profitabilit y for the petroleu m industr y were extraordinary events . These wer e th e exten t o f th e devaluatio n of th e dolla r and the Ara b oil embargo. Exchang e rate s will continue t o fluctuat e and may becom e more generall y flexible, but i t i s questionable whethe r foreig n exchang e earnings from adroi t mone y managemen t wil l soon agai n be a s prominent a part o f th e petroleum industr y earnings as they wer e in 1973 . By forcing up price s to ratio n scarce supplie s among competing users, the Ara b oil embargo created substantia l profits o n inventories and improve d operatin g margins. But onc e th e syste m is xv

Edward W.Erickson and Leonar d Waverman fully adjuste d t o th e ne w level of world prices, these profit s will be dissipated . But i t is important tha t the y b e allowed t o b e earned while they endure. This is because the profits are indicative of temporary shortages , and the wa y t o cur e shortages is to allocat e mor e resource s to th e activity in question - i n this case, almost th e whol e spectru m o f petroleum industr y activity . I n general (despit e grandiose talk o f national petroleum companies in the Unite d State s and Canada and th e existenc e of suc h companie s elsewhere), the agent s of societ y fo r resource allocation decision s are private business firms. Thes e firm s ar e attracted by hig h profits, even if they kno w tha t suc h profit s are transitory. Thus , t o eliminat e quickly an d effectivel y th e shortage s which ar e symptomatic o f the energ y crisis, it is essential that hig h profit s are allowed t o b e realized in order that the y serve as incentives for speed y resourc e allocation adjustments. The 1973-7 4 profitability of firms in the u s petroleu m industry is a short-run measure of th e performanc e of the industry . Current profits reflect th e effec t of the policy-induce d energ y crisis. A more relevan t measure for evaluatin g the com petitiveness of the industr y is its record of long-run profit performance. Over th e period o f more tha n tw o decade s from 195 1 throug h 1971 , th e eight leadin g major firm s in the industr y were not exceptionall y profitable . Th e eight a s a group averaged slightl y highe r returns on stockholders ' equit y tha n a n index o f all manufacturing. Bu t i n any give n year, several of the larges t eight major s always earned less than the al l manufacturing average. Over the whol e 1951-7 1 period, approximately half of th e eigh t largest majors on averag e earned less than th e inde x fo r all manufacturing. In Table 2, the profi t rates of fiv e o f th e eigh t majo r internationals is detailed, along with the averag e rate of retur n for manufacturin g as a whole. I t i s difficul t to evaluat e these figure s sinc e the industrie s are so diverse in many respects , particularly risk. Moreover, accounting profits on book capita l are not measure s of economic profits . There i s also th e problem o f how t o evaluate the depreciatio n offset whic h th e oi l companies, but no t manufacturin g firms, receive . Before calculating net incom e fo r tax purposes , these oi l firms ca n deduct 2 2 pe r cen t of th e valu e of crude oi l sales. A simple example wil l indicate the effect s o f th e depletion allowanc e on the accountin g rate of return. Assume the compan y ha d sales of $1000 , with a n invested capital of $1000. (This is below th e industr y average of sale s per dolla r of invested capital.) Also assume that al l sales were of crude oil , and the corporat e profi t tax rat e is 50 pe r cent. After deductin g th e depletion allowance , the company ha s net incom e afte r taxe s o f $100; i t earns 10 per cent o n invested capital - belo w th e manufacturing average. But depletio n allowance (at 2 0 per cent) is $200. Therefore, afte r ta x profi t gross of depletio n is $200, the rat e of retur n is 20 pe r cent! Thi s i s but on e adjustmen t which ca n be made to thes e accountin g data. Another would be to us e the marke t valu e of

xvi

TABLE 2 The fiv e to p America n oi l firm s World sale s ($ billions )

1964

1965 1966 1967 1968 1969 1970 1971 1972 *1973

USA manufacturing net return on equity

World return on investe d capital , after ta x an d depletion'

Exxon

Mobil

Texaco

Gulf

SoCal

Exxon

Mobil

Texaco

Gulf

10.8 11.5 12.2 13.3 14.1 14.9 16.6 18.7 20.3 28.5

4.5 4.9 5.3 5.8 6.2 6.6 7.3 8.2 9.2 12.7

3.6 3.8 4.4 5.1 5.5 5.9 6.3 7.5 8.7 11.8

3.2 3.4 3.8 4.2 4.6 5.0 5.4 5.9 6.2 na

2.3 2.5 2.7 2.9 3.2 3.5 3.7 4.1 4.5 6.5

12.2% 11.5 11.6 11.9 11.8 10.9 10.8 11.5 10.9 14.0

8.3% 8.7 9.3 9.4 9.8 9.6 9.5 9.7 9.6 11.7

14.4% 14.8 14.9 14.2 13.4 10.9 10.9 11.0 10.2 12.1

10.5% 11.1% 11.8 10.7 11.5 11.0 10.4 11.7 11.3 10.3 10.4 9.7 9.2 8.9 8.3 9.7 6.6 9.6 na 11.4

SoCal

Average

11.6% 13.0 13.4 11.7 12.1 11.5 9.3 9.7 na na

* Estimat e f Ne t income/investe d capital , annual average, except fo r 197 3 wher e measure is for firs t nin e months . Net income : incom e afte r taxes , before extraordinary items; Invested capital : su m of long-term debt, minority interest, preferre d stock, deferre d taxes an d investmen t tax credit , an d commo n equity, average for year , na no t availabl e SOURCE: Business Week, 1 Feb. 1974 , p. 51. USA manufacturing average dat a fro m Federa l Trade Commission, Investigation o f th e Petroleum Industry, Committe e Print, Permanent Subcommittee o n Investigatio n o f the Committe e o n Government Operations, US Senate (Washington : GPO 1973 )

Edward W . Erickson an d Leonar d Waverman assets, an adjustment whic h woul d relativel y increase the rat e of retur n o f manu facturing firms . The companie s presente d i n Table 2 do not mak e al l their profit s fro m crud e oil sales. Actually , sinc e they ar e fully integrate d fro m crud e production t o gaso line marketing , i t is impossible t o tel l wher e thei r profit s are. Transfer pricin g between subsidiarie s does no t provid e a guide t o interna l profits . Som e hav e argue d that al l these profits ar e in crude production, t o minimiz e profit s i n refining and marketing s o as to preven t entry . Other s hav e argue d that th e profit s ar e in refining to show producin g countrie s the lo w rent available . Whatever the case , th e numbers in Table 2 do understate th e tru e profits i n the industry . Even assumin g that th e tru e profit s are 20 pe r cent highe r tha n a s depicted, th e us industr y does not sho w grea t profitability . Actually, except fo r 1973 , profit s in the 1960 s were not muc h above profits in manufacturing and were declining . Also, th e 1950 s were more profitabl e tha n the 1960 s and the earl y 1960 s were more profitabl e tha n th e late 1960s . Another tes t i s to compar e th e averag e profitabilit y of th e eigh t larges t major s to th e profitabilit y of firms generally regarde d to hav e som e marke t power . O n average, the eigh t larges t majors are only abou t hal f a s profitable as , for example , such firm s a s International Busines s Machines, General Motors, and th e prescrip tion dru g companies . The profitability o f the petroleu m industry , a s measured b y th e profit s o f th e eight majo r oil companies, i s approximately wha t on e would expec t fro m a structurally competitiv e industr y with som e barrier s to entr y an d generally increasin g competitive conduct . On average, the eigh t companie s ear n o n shareholders ' equit y a return probabl y abou t equa l to th e cos t o f equity capital . And despite thei r impressive recent profi t performance , knowledgeable peopl e in the financia l com munity hav e no t bi d u p the pric e o f the majors ' commo n share s in expectatio n that thes e transitor y profit s indicat e a permanent increas e in earnings capacity . THE CAUSE : TH E UNITE D STATE S

The competitiveness o f the petroleu m industr y i s of more importanc e tha n simply idl e curiosity t o a few academic economists. I t i s a well known propositio n in economics tha t th e efficienc y o f resourc e allocatio n i s not necessaril y improve d by removin g a constraint tha t prevent s prices fro m equallin g long-run marginal costs unles s all other price s in the econom y ar e also equa l to margina l costs. Ap parently thi s principle has also bee n incorporate d int o politica l wisdo m a s well. One of the principa l genera l causes of a divergence between pric e an d long-ru n marginal cos t i s the existenc e o f market powe r - o r non-competitiveness. I n a non-competitive situation , pric e exceeds long-ru n marginal cost. On e of th e prinxviii

Introduction cipal cause s of th e worl d energ y crisis is the regulation-induce d shortag e o f nat ural gas in the Unite d States . The effec t o f the shortag e of natural gas has been to shif t natura l ga s demands t o fue l oils . Becaus e of th e effectiv e price ceiling, wellhead price s fo r natura l gas are below long-run marginal costs of discovering and developin g market clearin g quantities of new natura l gas reserves. This is well recognized. But one of the reason s why the u s Congres s has faile d t o deregulate the fiel d marke t fo r natura l gas is the erroneou s belief tha t th e supplier s of natural gas in particular, and th e petroleu m industr y i n general, are non-competitive and have monopoly marke t power . If one accepts th e thesi s that imbalance s in us energ y suppl y an d deman d tem porarily tightene d u p th e worl d marke t fo r oil and made th e consumin g countrie s vulnerable t o th e suppl y interruption s an d unilateral price increases which have characterized th e recen t situation , the n what policie s ar e most responsible ? The chief responsibilit y lie s on three: failure t o deregulat e the wellhea d pric e o f natural gas; price control s whic h imped e both flexibl e use of refining capacit y an d petroleu m exploration (b y creatin g artificial shortage s o f drill pipe, etc.) an d preven t the u s oil market fro m clearing ; and the failur e t o rationaliz e u s oi l import polic y resultin g in costly uncertaint y an d delays in planning and implementing addition s to u s refiner y an d crud e oil capacity. A discussion of th e general price controls policie s of Nixon's phase s i , II , in, and i v ar e beyond th e scop e o f energy policy alone , but a brief comment i s appropriate. If all but a few prices in an economic syste m ar e more o r les s effec tively controlled , the n the brun t o f any adjustments must be borne b y thos e prices which ar e relatively mor e fre e t o move . A not insignifican t shar e o f th e impetus fo r world spo t marke t price s of $3 0 pe r to n fo r coal i n the Unite d State s and $ 17 per barrel of oi l in the Persia n Gulf an d Nigeri a lies in the pric e contro l system. Thi s was aggravated by a n administrative mechanism whic h allowed high prices for imported oi l to b e passed on to u s consumers , but whic h hel d u s crud e oil prices at controlle d levels . The effect s o f wellhea d ceilin g prices on natura l gas to shif t deman d t o oi l have alread y been discussed . The failur e t o rationaliz e us oi l import polic y i s more difficul t t o assess . In th e late 1960 s at the then prevailin g prices for us crud e oil , it was apparent tha t u s production o f crude oil from conventiona l sources would no t kee p pace with th e expected growt h i n us demand . Import s of crude oil were tie d t o u s productio n through the mandator y oi l import quot a which ha d bee n instituted i n 195 9 o n grounds o f nationa l security . As a result of various provisions in the quot a system, tota l oi l imports approximate d abou t 2 5 per cent o f us crud e oil productio n and 20 pe r cen t o f u s consumption . A s a result of the operatio n o f th e impor t

xix

Edward W . Erickson an d Leonar d Waverman control program , the u s pric e of crude oil exceeded th e worl d marke t pric e for crude oil landed i n us port s by approximately 5 0 per cent - o r about on e dollar per barrel. Because of this situation, because of the impendin g imbalance i n u s supply an d demand a t th e existin g price level, and because the the n existin g quota arrangemen t was not sufficientl y flexibl e t o dea l with th e problem , th e Cabinet Tas k Forc e o n Oi l Import Contro l wa s convened an d a fundamental policy revie w undertaken. (The quit e complicate d detail s of th e oi l import con trol program , as it existed i n 196 9 an d had develope d prior to then , ar e discussed in Th e Oil Import Question, the repor t o f the Cabine t Task Force. 3) The majority of the Cabine t Task Forc e recommende d replacin g the quot a sys tem with a flexible tarif f intende d t o be used t o help minimize u s energ y cost s while a t th e sam e time achievin g national security objectives. The recommenda tion wa s not accepted . The general quota syste m was kept i n place an d n o fundamental polic y decisio n was made, but th e basic s of the situatio n continued t o develop. Th e resul t was uncertainty abou t wha t would b e done an d when, a virtual cessatio n o f new refiner y construction i n the Unite d States , absorptio n o f excess us domesti c crude oil producing capacity, an increased u s deman d fo r imports of refine d products , an d a general tightening of world markets . All this was accompanied b y som e unusua l us diplomac y wit h th e Organizatio n of Petroleum Exportin g Countries . This diplomac y consiste d o f crying shortage; refus ing to allo w Venezuela most-favored-nation status under the us' s Lati n America n 'Good Neighbor' policy; and suggestin g that th e pric e increase s agreed t o a t OPEC' S Teheran-Tripoli meetin g were in consuming countries ' interests . If a little ta x is good, a bigger tax must b e better . Even with th e advantag e of hindsight, it is impossible to sa y what woul d hav e occurred i n the worl d petroleum marke t i f all the recommendation s o f th e ma jority o f the Cabinet Task Forc e an d their corollarie s had been adopte d - tha t is to say , had th e Unite d State s adopted a vigorous national energy polic y o f operating at home and abroa d t o minimiz e energy costs . I n thi s regar d it is useful t o distinguish among th e economics , th e politics , an d th e theatr e o f events. The economics o f the situatio n were clearly consistent wit h th e vie w that i t was advantageous fo r the Unite d State s t o tak e greate r advantage of lower-cost world oi l supplies. But a s the failur e t o mov e i n that directio n reveals, this was politically unacceptable. Th e failur e t o tak e decisiv e action se t the stag e for the dramati c pric e increases associated wit h th e theatr e o f the Tehera n an d Tripol i conference s and the porou s Ara b oil embargo. I t is possible that a policy approac h whic h wa s an alternative t o inactio n might hav e averte d some o f thes e events . A plausible counter-argument i s that adoptio n o f the Cabine t Task Forc e majority recom mendations woul d have made thing s wors e today tha n the y now are . That is possible, but probabl y the y would no t b e much worse .

xx

Introduction A PRIME R O N EXPROPRIATION

4

A nation quit e naturall y wishes to contro l it s own industries, the petroleu m industry bein g one o f many. I n most countries , however , this control ha s been difficult, sinc e each stag e in this industry requires large capital outlays, with explo ratory ventures being particularly costl y an d risky . Oil occurs predominantly i n underdeveloped countrie s which hav e a shortage of capita l and which canno t afford t o financ e their ow n industrie s adequately fro m thei r own resources . Over the years, a recognizable pattern ha s evolved, with man y o f the development s having been pioneere d i n Venezuela. Initially , with little bein g known concernin g th e geology o f a region, risks are high an d government s must offer relativel y high rewards and liberal terms i n concessions i n order t o induc e exploration an d development b y competen t operators . Onc e larg e discoveries are made, potential investors tend t o regar d exploratory risk s as being reduced , and new concessions will still fin d taker s even with les s attractive terms . As a profitable industry i s established i n a country, two factor s change th e relative bargaining advantages of company versu s country. First , th e regulator y authorities require detailed report s an d ar e thus able to apprais e the promis e o f explored area s and th e profitabilit y of current operations. Second, th e concessio n operator invest s increasing sums in the countr y and thu s becomes les s flexibl e with regar d to alternativ e sources of supply - it s fixed asset s are economic hos tages. A basis is thus create d which permit s the producin g country t o appropriat e an increasin g share o f the profit s of oil operations. U p t o a point, thi s approac h i s certainly consisten t wit h th e economi c theor y o f fre e enterpris e under competi tive conditions , in that th e economi c 'rents ' of high profits , whic h accru e to th e exploitation o f a low-cost resourc e (i.e., prolifi c oi l fields) can be appropriate d in ful l b y the owner of that resourc e without affecting the rat e of production fro m that resource . Unfortunately, however, the politic s of industry control ar e not a s self-regulating a s the economic s o f competition. Change s in world marke t conditions, suc h a s relative production an d transportatio n costs , ca n reduce the com petitive advantage of a given oil field an d thu s diminish th e profitabilit y of it s exploitation. Th e governments o f producing countries hav e shown greate r awareness, in general, of th e opportunitie s for increasin g taxes, rentals , and royalties , than o f the nee d for thei r reduction when marke t condition s a t least temporaril y deteriorate. It may becom e les s costly fo r a company t o reduc e outpu t o r even temporarily ceas e productio n i n a given are a rather tha n persis t in operating under advers e regulations. It i s in such instances that th e threa t o f expropriatio n arises. The structure o f th e internationa l oil industry is such, however, tha t i n the pas t there wer e practical considerations whic h usuall y tempered a country's urg e to

xxi

Edward W. Erickson an d Leonar d Waverman nationalize th e facilitie s o f it s oil companies. First , th e larges t petroleum deposit s are usually far removed from th e majo r consuming centers , so that transportatio n of oil across nationa l border s i s necessary. Thus, thos e wh o gover n the producer s do not gover n the consumers. Second , th e majo r international oi l companies ar e fully integrated , from productio n throug h marketing . Third, sinc e th e lat e 1940 s there ha s been a potential surplu s of oi l supply ove r oil demand a t prevailing market prices . Thus a country whic h expropriate d a major concessionaire migh t hav e a hard tim e marketin g its oil, unless it were willing to sel l at a rather low price which i n turn would ten d t o undermin e worl d oil prices still further. Fourth, until 197 0 th e producin g country cartel , OPEC, was not abl e to ac t in concert t o force oi l prices up towar d th e monopol y level . But afte r solidarit y was achieved in 1970 , price s were forced up by concerte d actio n t o keep outpu t an d produc tion capacity expanding a s rapidly a s demand. This increased th e threa t o f expropriation b y reducing the penaltie s likel y t o b e experienced b y the producin g country. Henc e th e countrie s fel t increasingl y fre e t o experimen t wit h more one rous regulatio n and taxation, an d the compan y respons e was frequently reduce d simply t o makin g th e bes t o f a deteriorating situation. I n a sense, fo r countrie s with establishe d exportin g industries , cartelization has become a substitute fo r nationalization, an d the private companies, rathe r than bein g expropriated, have become ta x collectin g agent s and service contractors b y function , while retaining the forma l status of independent companies . This applie s t o countrie s with establishe d exportin g industries . Countries whic h have not ye t attaine d tha t statu s stil l offe r concession s an d other inducement s t o outside investors . Afte r all , a country mus t firs t obtai n a petroleum industr y be fore i t can control it . A D E LM A N

The most encyclopedi c analysi s to dat e o f the basic s of the proble m i s that by M.A. Adelman i n his book, The World Petroleum Market.5 Adelma n argue s that even at the worl d pric e levels prevailing in 197 0 prio r to th e recen t massiv e price increases, ther e existe d a potential excess suppl y o f world petroleum . Becaus e o f this, Adelman has been subjec t t o substantia l criticism. Exces s suppl y trigger s price decreases . Prices have actuall y risen . Bu t one has to distinguis h betwee n th e weak an d strong Adelma n hypotheses. Th e strong hypotheses involv e specific behavior by specifi c actors i n the worl d petroleu m market . A s with an y point estimates, the y ar e likely t o b e wrong in detail. Because of the mas s of specifi c detail in Adelman's analysis , it is tempting t o focu s on th e stron g hypotheses. The weak hypotheses ar e of more interes t an d are apt t o b e of longer-run policy significance. Th e weak hypotheses focu s on structura l relationships, involvin g the xxii

Introduction fundamentals o f excess supply and th e difficultie s o f maintaining a stable international cartel . The action s of the participant s in the Ara b oil embargo ar e evidence o f how quickl y thes e effect s ca n operate, even in the bes t of times . If Adelman is correct about costs , and i f excess supply wa s a potential proble m a t 197 0 prices, then it is an even greater potential problem a t present prices. Tw o previou s Adelman predictions are of interest here. On the basi s of cos t an d deman d data , he predicte d a secular decline in the rea i price of worl d oi l in the 1960s . On th e basis of the realignment s that occurre d at Tehera n an d Tripoli, he i n 197 1 predicted substantia l increases in the worl d price of oil. Both times he was correct. What if Adelman i s correct again ? What if there i s a surplus of oil ? One o f th e most seriou s sources of potentia l friction i n international policy, and discor d in domestic policy withi n som e countries , could be the machination s require d t o prop u p a n institutionalized world oil price that i s far above the long-ru n marginal cos t o f finding and developin g new reserve s and i s under serious pressure from incrementa l supplies. One suggestion for dealin g with thi s problem is some form o f internationa l commodity agreement for oil. The history o f international commodity agreement s is not particularl y encouraging. There ar e a number of scenarios through whic h th e worl d might agai n arrive at a situation analogou s to that whic h existed in the late 1960s - a decline in the rea l price of oil . Should such a circumstance come t o pass - an d until we see empirically supporte d analytical work which contradict s Adelma n and i s confirmed by supplie r behavior, we believe such a circumstance is more probabl e tha n not - i t is likely tha t the world will again fail to lear n from its history. Wit h appropriate changes of costume, casting, and choreography , th e sho w wil l go on. OUT O N A N OIL Y LIM B

It i s our tentativ e judgment that , fo r the foreseeabl e future, dislocation rather than stabilit y will characterize th e world oil market. Rather tha n reflectin g th e inexorable pressure of deman d upo n supply , the sourc e of instability i s apt t o be relentless pressure of suppl y upon demand. Th e historical variations will be the action s of supplier nations to kee p th e logica l effects o f that pressure from being realized, and the response s o f consuming nations to thos e actions . The seasoning will be adde d by thos e nations who cannot decid e whether the y are suppliers or consumers. The variations are unpredictable. The furthe r on e tries to se e into th e future , the mor e unpredictable th e variations become. Changes in underlying source and use patterns will surely be reflecte d in energy supply and demand . Bu t prediction o f any specifi c changes will be in error. It was less than on e hundred years ago that the firs t commercia l electri c generating station bega n supplyin g power . xxiii

Edward W. Erickson an d Leonar d Waverman When the Standar d Oil Trust wa s broken up i n 1911 , the principal use of the out put o f its refineries was for illuminating oil . An index o f the likelihoo d o f con tinued long-ru n technological change , modification in energy sources and uses , shifts i n supply an d demand , an d pressur e on real costs and price s is the fac t tha t roughly 9 5 pe r cen t o f the scientist s and engineers who eve r lived are alive today. Extrapolation o f exponential growt h trends is a very unsatisfactory business. But if one is to extrapolat e an y trends , technological chang e must b e included. The world is ultimately finite. The laws of thermodynamic s ar e relevant. Economi c activity does accelerate the rat e at which entrop y increases . The principles developed by Nicholas Georgescu-Roegen in The Entropy La w an d the Economic Process6 must b e given more consideratio n by practica l economists. An d i t is true that n o perfect mechanism exist s whic h allow s future generations to vote i n the market plac e of today' s resourc e allocation decisions. But rathe r tha n arbitrarily abstaining from curren t consumption t o preserv e some o f today's limited resources for futur e consumption , a n alternative is to continu e investin g in technological change t o mak e ne w and greater resources more availabl e tomorrow fo r ourselves and our successors . Subjec t t o th e inevitabl e death o f the sun , Adam Smith's invisible hand ma y also work intergenerationally. Standing on an oily limb, months befor e publication, is not a very safe plac e t o be. We feel tha t presen t world price s (e.g., Venezuelan tax referenc e prices of $14.50) are not i n the long-ru n profit-maximizing interests of the oi l exporters . We believe the suppl y o f oi l to b e relatively price-elastic . At decontrolle d well head price s in the us , tertiar y recover y alone will add some 2 5 billion barrels to us domesti c oi l potential. Drilling activity in North Americ a has reached th e levels of the mid-1960s . Much new oi l will be foun d inside North America and outside it - China , Sub-saharan Africa, Indonesia , Latin America , etc. Sinc e the 'crisis' began in October 1973 , Britai n has foun d sufficien t reserve s of coa l an d oil to make tha t countr y a n exporter by 1980 . A n embargo held muc h longer , a price of oi l at it s present level will set irreversible forces into play. These force s will be t o fin d othe r source s of energy which ar e cheaper tha n $14.00 per barrel. Once nation s have committed themselve s to secur e oil costing $10.0 0 per barrel, Middle East oi l costing $.20 pe r barrel will be driven out o f the markets . Everyone will lose. Nations will become committe d t o domesti c oi l shale (us), costl y domestic pipeline s (Canada), Russian LNG (Japan), and oil bought wit h armaments (Britain and France). Existin g oil producers sitting on th e cheapes t energy imaginable will find few buyers. An «th best solution . The eighteen paper s presented in this book provide an encyclopedic wealt h o f information o n past an d futur e trend s in exploration, production , an d government policy . I f they are read with care , these experts ' opinions will convince th e xxiv

Introduction reader of the tru e nature of the energ y question of the 1970 s and 1980s-a n international failur e o f policy, not a physical shortag e of energy. To end this introduction , w e can do no better tha n t o quot e th e Economist o f 10 November 1973 , p . 13 , 'Most assumption s that th e Arab s can go on holdin g the worl d to ranso m are based o n the commones t delusio n o f third-class political economy: th e delusio n that yesterday's attitudes , yesterday's market projections , yesterday's condition s o f supply an d substitution, yesterday's politica l trendinesses can be presumed t o hol d goo d fo r tomorrow, eve n if today's action s base d on these delusion s will by themselve s change ever y one of them. But befor e thes e realisations strike home, while blackmail makes its headway agains t unnecessary panic, foolis h mistake s ca n and will become embedde d i n official policie s and popular thinkin g alike. ' NOTES 1 Exac t figures ar e difficult t o devis e since crude oil is refined an d reshippe d as products. Th e U S percentage o f Mi d East production coul d be 1 0 to 1 5 pe r cent, at thi s time , withou t a n embargo. 2 Federa l Trade Commission, Investigation o f th e Petroleum Industry, Committe e Report o f th e Permanen t Subcommittee on Investigations of th e Committe e on Government Operation s (Washington: Government Printing Office, 1973 ) 3 Cabine t Task Forc e o n Oi l Import Control , Th e Oi l Import Question (Washington: Governmen t Printing Office, 1970 ) 4 Thi s primer o n expropriation ha s been borrowe d fro m a draft fro m Henr y Steele. No compensation is intended. 5 (Baltimore : Johns Hopkins , 1972 ) 6 (Cambridge , Mass.: Harvard University Press, 1971 )

XXV

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The energy question

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M. A . A D E L M A N

The fundamental s of Professo r Adel man's poin t of view are very straightforward. First , increase s i n the worl d price o f oi l are not a result o f increase s in the rea l resource cos t o f oi l in th e Persian Gulf . Second, th e curren t rea l resource cos t o f production o f Persian Gulf oi l is only a negligible fractio n of the curren t pric e o f oil. Third , eve n with zer o ne w discoveries, potentia l reserve developmen t i n the Persia n Gulf a t approximatel y constant rea l resource cost woul d provid e sufficien t new oi l to mee t incrementa l worl d demand fo r th e foreseeabl e future. Fourth , the curren t energ y crisi s does not repre sent a fundamental change in the basi c relationship betwee n ma n and nature, but i s policy-induced. Fifth, thi s i s not the firs t tim e tha t oi l policy (national , multinational, world) has created mor e problems than i t has solved. Sixth , th e major ingredien t of th e worl d pric e of oil is monopoly rent . Seventh , the mo -

nopoly ren t primaril y accrues to th e cartel of major oil exporting countries , not th e international oi l companies. Eighth, althoug h it is not ver y produc tive to ran t an d rail abou t th e evil s of the internationa l oi l companies, on e must understan d thei r positio n in and contributio n t o - th e situation which w e now cal l 'th e energy crisis' in order t o evaluat e alternative polic y proposals. Ninth , the dynamic s of cartels makes them inherentl y unstable , but som e cartels are more stabl e tha n others. Tenth, som e peopl e loo k a t potential cartel instability wit h favo r an d some wit h horror , an d all of th e latte r are neither citizen s of producing countries nor executive s of international oi l companies. The tw o mos t centra l pillars of th e Adelman analysi s ar e the cos t estimate s for th e Persia n Gulf which lea d t o his prediction o f oversuppl y an d hi s discussion o f potentia l carte l behavior in

the fac e o f oversupply . Al l of th e polic y discussion flow s fro m thes e tw o points . We know o f no on e wh o seriousl y dis putes th e orde r o f magnitude of th e Adelman real resource cos t estimate s for Persia n Gul f incremental supply . Many people , however, explicitly o r implicitly, challeng e his interpretatio n of past, present , and possibl e futur e events in the contex t o f cartel behavio r with various producing-country, consuming-country, and multinationalcompany actors . W e happen t o believe that Adelma n is correct, at leas t wit h regard t o th e past an d present. But that doe s not solv e th e dilemm a of choosing and successfully implementing a policy fo r th e future . If Adelma n is right abou t cost s and reserves, and i f experience fro m th e international oi l market an d othe r mar kets is relevant, there coul d b e considerable downside risk in world oi l prices in the latte r par t o f this decade and in the 1980s . Is this good o r bad? Multinational governmen t policy coul d encourage price erosion, or it coul d shor e up th e market . Peopl e wh o shudde r when the y rea d Adelman's policy analysis ask, 'Bu t wha t about th e instability whic h woul d result fro m chao tic (i.e., declining prices) oil marketing conditions?' In reply, Adelma n might respond, 'But wha t abou t th e instability tha t i s apt t o resul t if we don't eliminate some o f th e monopol y rent s by inducing lower prices?' One way t o handle instability, a s Adelman acknowledges, is through a n international com modity agreemen t fo r oil . However,

were the worl d to adop t suc h a n arrangement, it woul d b e confirmation o f th e Adelman hypothesis withou t acceptin g the Adelma n policy prognosis . Afte r all , an international commodit y agreemen t is simply a means to administe r a potential surplus at some approximatio n o f the monopol y price . Professor Adelman' s contribution t o these volumes should b e especially com pared t o th e chapters by Collado, Nye, Hornet, and Grenne s and Winokur . Moreover, this chapter i s important back ground fo r all the othe r chapter s in thi s volume. In addition, Professor Adelman provides significant perspective for th e Kellogg, Roberts, and Barnet t chapters , among others.

M. A . A D E L M A N

The world oil market

For oil-importin g countries, the tw o main components o f the lande d pric e of crude oi l are transport servic e and th e FO B price at th e por t o f shipment . Th e two markets coul d hardly b e more different , and there i s much t o be learned in the contrast . T R A N S PO RT

Tanker operatio n i s a purely competitiv e industry. 1 Shipowners an d operator s are many an d th e eigh t larges t oil companies accoun t fo r only 2 0 pe r cen t o f th e world (non-us) fleet. During any given year, roughly one-fourth t o one-thir d o f the flee t i s available for charterin g at long or shor t ter m throug h a highly organized worldwide market wit h n o protected enclave s (outside th e United States , which w e need t o ignore) . Ther e ar e no stron g economies o f scale in ship operation. Many owners have only on e ship - a n oddity unti l one realizes that man y firms perform service s incidental to tanke r shippin g and take advantag e of som e particular opportunit y t o bu y on e or a very few ships. Bu t although th e industr y is purely competitiv e it i s imperfectly competitiv e becaus e massive innovation, incompletely foreseen , has given large profits to th e more alert , skilful, and lucky. Forecasting i s difficult becaus e since 196 3 ther e has been a chronic shortag e of tankers. Shipbuildin g capacity has tripled an d i s still expanding; shipyards have raised wages and scratche d fo r labor. Ship price s have risen considerably. But tanke r rate s kept o n declinin g through 1967 , becaus e new ships were so much large r and more efficient . Sinc e May 196 7 th e marke t has been throug h

M.A. Adelman violent turmoil. I f we define equilibrium a s a long-term rat e equal t o th e short term rate, the tw o hav e never been s o far apart fo r s o long. The long-term charte r rate is appropriate for an investment decisio n i n production a t one end an d refin ing at th e other . Mor e precisely, we need to identif y th e margina l ship fo r th e run fro m th e Persian Gulf (or Africa) to th e United State s east coast , assuming time enough t o buil d the prope r unloading facilities. (The u s eas t coas t will be used a s a point o f reference, but th e argumen t applies to othe r market s as well.) I define th e margina l ship as the smalles t highest-cost vesse l to b e used regularly on a given run, one whose stoc k i s being expanded by enoug h ne w orders to preclude scrapping. The neighborhood o f the marginal shi p was pretty clearl y defined i n 1969 , whe n nothing at al l was ordered in the rang e of 150,000-200,00 0 deadweight tons . Belo w 150,00 0 tons, ship s are destined fo r specialize d services, in relatively small ports. For lon g trunk line service, ships over 200,000 tons are required, the VLCC S (very large crude carrier). 2 Since th e ru n to th e eas t coas t fro m th e Persian Gulf is farther tha n t o eithe r Northwest Europ e o r Japan, th e margina l tanker will have a capacity o f abou t 250,000 tons, assuming the necessary investment i n unloading ports. Indeed, new orders for ship s in the 250,000-300,000 ton class , nil in July 1969 , i n the next twenty-fou r months exceede d order s for the 200,000-250,00 0 class. There are , of course, much large r tankers i n operation today , an d ship s are actually being built o f about 480,000 tons. Moreover, the Dutch governmen t has in effect pu t som e money o n a wager that th e optima l siz e to serv e the por t of Rotterdam wil l be in that range. If so, it would probabl y als o be true o f th e us eas t coast. Nevertheless, it seem s prudent to tak e actua l commitments i n the recent pas t a s a practical or working maximum, an d to assum e that th e growt h in ship sizes has come permanentl y t o a halt. At least we know the directio n of error. The recent ris e in long-term rates was both cause and effec t o f about a 50 pe r cent ris e in VLC C prices. But thes e reflecte d only short-ru n marginal costs. Th e yards were and are crammed with orders ; they ar e working at top capacit y on new designs and ar e chronically shor t o f labor. Japan i s speeding ahead i n this field, despite th e fea r o f eventual excess. The shipbuilding industry appear s to b e competitive, although th e evidenc e is not a s clear as for ship operation . I f the governments o f the shipbuildin g countries were able to carteliz e the shipbuildin g industry - the y hav e tried but not succeeded thus fa r - an d raise prices, integration of shipping with shipbuilding , either by merge r or by long-ter m contract, woul d probably follo w and the resul t would be higher profits for vertically integrated groups at the expense o f the non-integrated . Tanker rates would stil l be determined by investmen t cost a t th e margi n plus operating costs. Henc e a rough estimate of a dollar per barrel long-run charter rea l transport cost s fro m the Per-

6

The world oil market sian Gulf to an y destination appear s to be not inconsisten t wit h wha t ca n be discerned i n the shipbuildin g market. When supertankers are combined with superports, a barrel of oil anywhere in the worl d is a barrel everywhere. [Editors ' note : For a detailed discussio n of the worl d tanker market , see Chapter iv o f The World Petroleum Market, ] CRUDE OI L -SUPPL Y AN D DEMAN D

Our problem with crude oil is the exac t contrar y of that in transport. The market is not sufficientl y competitive t o b e a good sensin g mechanism, i.e . price does no t register cost. We must measur e it directly. In the lat e 1960s , the investmen t needed to establis h a n additional daily barrel of capacity i n the fou r big Persian Gulf concessions was about $110 . Some of the smalle r sheikdoms ma y involv e even lower cost. A price of just under six cents pe r barrel, if paid for th e expecte d outpu t o f one initial barrel daily, declining at on e pe r cent, over the next 2 5 years, and discounted a t 2 0 pe r cent i n view of low geological ris k but hig h political risk , would have a present value of $ 110. Then si x cents per barrel was the suppl y pric e or cost o f capital. Operating costs in Iran in 197 0 wer e 2.7 cents ; there an d als o in Saudi Arabia and Kuwait labor requirements per unit o f output hav e decreased greatly. However, we assume them to be 4 cents; total developmen t cos t wa s then about 10 ^ per barrel. This was the current long-run marginal cost i n the recen t past . In order to estimate future long-ru n marginal cost, we first nee d t o estimate th e volume of futur e output. Fo r purposes of bounding the calculations reported here, we assume no natural gas or nuclear power, an d the disappearanc e of two-thirds of non-us coal by the year 1980 ; i t is further assume d that all of the 1969-8 0 increment t o th e consumption i n the world market (i.e . outsid e Nort h America ) goes to th e Persian Gulf. These assumption s throw th e maximu m likely weight on to tha t area . In order tha t th e Persia n Gulf be the suppl y source for incremental world consump tion, two conditions mus t be met. First , the oil-producing countries there mus t be willing to produc e a t the implie d rates . Second, th e price s in the Persian Gulf must be sufficientl y lo w to forestal l development o f incremental capacity elsewhere (for example, Indonesia, th e America n and Canadian Arctic and Eas t Coast oute r continenta l shelf , the Nort h Sea , etc.). If we assume that on e or both of these condition s i s not met , higher Persian Gulf prices and a lower rate of increase of Persian Gul f output, the calculate d Persian Gulf cost wil l be lower. Under our assumptions, Persian Gulf production increase s not b y th e recen t 1 1 per cent bu t b y 13. 5 pe r cent pe r year over the next te n years, after whic h i t drops back t o th e worldwide energ y growth rat e of 4.5 pe r cent. Recent expe rience suggests these rate s may be too high . To the extent tha t thi s is true, the 7

M.A. Adelman TABLE 1 Persian Gulf reserves and output, 1969-8 4 (i n billions of barrels) (in billions of barrels) Persian Gul f output Year Pe

r year

1969 4. 1979 16. 1984 20.

5 0 0

Persian Gulf reserves, end-1969 plus additions in known field s less cumulative production, 1970-8 4 inclusiv e Persian Gul f reserves , end-1984 Reserve-production ratio, end-198 4 Annual growth rate: net reserve s (per cent )

Cumulative

80.4 87.5 167.9 333 +222 -168 387 19.6 1.016

long-run marginal costs reporte d belo w ar e also too high. But under thes e extreme assumptions , ove r the 1 5 years beginning with 197 0 w e would hav e expected th e following : Under thi s scenario , end-of-1984 Persian Gulf reserve s would be nearly 2 0 times production. Bu t with assume d zer o new discoveries thi s increase in reserves impounded fro m the muc h large r total o f oil-in-place canno t b e assumed available at constan t cost . The increasing decline rat e and the lower output pe r well both increase capital cost . Moreover, since we assume that there wil l be not onl y ex tension o f old reservoirs but als o new pools found i n the ol d fields, we mak e allowance by includin g expenditures for geological-geophysical work an d explo ratory drilling , which wer e excluded fro m development costs . When conservative adjustments ar e made i n these figure s t o reflec t changes in capital an d operatin g costs, th e 198 5 rea l long-run marginal cost o f new oil is in round number s about 20^ per barrel, double th e experienc e o f the recen t past . No allowance is made for ne w discoveries or fo r improved technolog y i n oil development. [Editors ' note: Fo r a unified theory o f oil operating-developing-finding costs and mor e detail o n th e Persia n Gul f and elsewhere, se e Chapters i and n o f Th e World Petroleum Market. ] Obviously thi s is not a n estimate o f the mos t likel y futur e cost but rathe r an overestimate, approximately wha t i t would have cost i n 1962- 8 to produc e fro m the big Persian Gul f fields had the y bee n depleted t o th e point where th e reserve-

8

The world oi l market production rati o was down to abou t 20 . In 1971 , Persian Gulf production was six billion barrels and reserve s were 367 billio n barrels. The deliberat e bias in the procedur e is seen by considerin g the correspondin g estimates in an earlier publication.3 A testable element of th e projectio n was th e assumed growth o f Persian Gulf production at 10. 4 pe r cen t per year an d assumed growth of proved reserves at abou t 1. 4 per cent pe r year. Actually, production has grown somewhat mor e slowly , while reserves have grown at a rate of 11. 5 per cen t per year. This support s our 196 6 treatmen t o f the cos t increas e as high rather tha n probable. I n fact, between 196 0 an d 1970 , th e investmen t needed per unit of new crude oi l capacity fel l b y ove r 50 per cent , despit e a rising general price level. The basic theory i s that developmen t cost swallow s up operating cost o n th e one sid e and findin g cos t o n th e other. The total increase in cost, in this case IQi per barrel , is called the Maximum Economic Findin g Cost. In theory, sinc e oil operators fac e a constant trade-of f between higher development cost o n th e on e side and discovery cost o n the other , these should b e equated a t the margin . Hence MEFC shoul d b e an indirect measure or proxy fo r finding cost. Perhaps this is to carry a valid idea too far , suggesting a precision that does not ye t exist . MEFC, th e rise in development cost , remain s merely a plausible limit, the penalt y fo r doing nothing to fin d ne w oil. Severe as are the limitations of the method , i t suffice s t o show tha t th e fears o f long-run physical scarcity ar e unfounded, a t leas t fo r 1 5 years ahead. To look farthe r ahea d i s at best a n exercise in method, a t wors t a vain presumption. Th e differenc e between a long-run physical shortag e evidenced by sharpl y risin g real resource costs an d a n economic shortag e cause d by a combination of poo r plannin g and effective carte l action is significant in terms of longrun polic y formation , but indiscernibl e in terms of short-run financial effects upon consumin g countries. At th e cente r of our theor y w e put th e investmen t process of creation o f a ready shel f inventory, proved reserves, out o f a much larger resource, oil-in-place. 4 This much larger but imperfectl y known stock i s replenished irregularly by discoveries. But over a long enough time horizon t o wher e th e presen t value of a good o r bad guess is nearly zero, oil production cost s ar e development costs , determined by a n orthodox investmen t process. We see now that th e traditional theory o f 'exhaustible resources,' wherein, for example, a rise in interest rate s makes futur e revenues less attractive, speeds up th e rat e of output, and lowers prices, covers only a very special case. In the minera l industries , greater scarcity of capital inhi bits development investment, reduces output, an d raises prices. If this reasoning is sound i t shuts th e door o n th e irrelevant features of the pro blem. Over past years, since the en d o f th e firs t Sue z crisis in 1957 , many have predicted tha t growin g consumption woul d dr y out th e 'surplus ' and naturally 9

M.A. Adelma n restore prices from bargain-basemen t to norma l a s a result of the pressur e of demand upo n costs . This remain s th e officia l trut h i n the capitalist , Communist , and Third Worlds , but i t is a mistake. I n a competitive situation , highe r outpu t tends to pu t u p prices only b y raisin g incremental cost , but eve n our generous or excessive allowanc e for increased cos t i s negligible in relation t o price s (to b e discussed below). Outside the United States , there has been no 'surplus, ' in that current producin g capacit y wa s in good clos e relatio n to output . I f by 'surplus ' is meant th e abilit y t o expan d outpu t by drilling and connecting more well s at costs far below current prices, there has indeed been a surplus, but i t will no t disappear for many years to come . Cost i n the Persian Gul f explain s onl y a minor, almost negligible , fraction of price. Above all, it explains none o f th e recent explosiv e increases in price. CRUDE OI L -MONOPOL Y ELEMENT S

How sharp a contrast ther e i s between th e tanke r market an d th e crud e oil market. I n tankers, th e price o f the servic e reflects the cost , but th e cost is itself subject t o great change and uncertainty, and the problem i s to separat e th e transitor y from th e permanent . I n crude oil, the cos t i s quite stable an d even great percentage error would no t hav e much importance , bu t competitiv e suppl y an d demand , i.e. long-ru n incremental cost, have explained ver y little. A massive block to com petition i s registered by the price-cos t gap. Of the approximatel y $1.70- $ 1.80 per barrel i n th e fal l o f 1971 , the Persia n Gulf government s already got abou t $1.50 . Hence if we had been abl e to se t to zer o the monopol y elemen t amon g the companies (assum e tha t ther e ar e 10 0 or 100 0 equal-sized competitors), th e pric e would be decreased by onl y 1 0 to 2 0 cents per barrel. In the contex t o f the 1971 example, however, if we removed the governmenta l element, th e decreas e is nearly $1.50. Today, of course, the compariso n i s even more dramatic . But picking a benchmark pric e in the curren t unsettled marke t i s more difficult . Private oligopoly i n world oil is no longer important; were it no t fo r th e rol e of the companie s a s government agent s it would b e negligible. The main obstacl e t o competitive evolution is the per-barre l tax o f the producin g countries . Over th e near term i t acts like a cost. No oil company wil l commit itsel f to inves t an d deliver for anythin g les s than th e su m of costs plus taxes plus a n allowance fo r contingencies. Hence, not onl y i s the ta x a floor t o price , it i s even effective a t a distance. A price forecast fo r the 1970 s has nothing t o d o with supply an d demand o r the rea l scarcity value of crude oil. Hardly anything matter s but th e taxe s levied by the producin g countries . I n late 1970 , a plausible forecast was that they woul d in time shad e taxe s to permi t the companie s to shad e prices. I consider this as still 10

The world oi l market the long-ru n prospect fo r an unrestrained market , bu t th e long run i s now further away in calendar time, price erosion would star t fro m a much highe r leve l of prices and the likelihoo d o f a market unrestrained by forma l price maintenance agreements between producing and consuming nations i s much less . The force s acting for and agains t long-run pric e erosion ca n be briefly set forth, befor e look ing at th e dramati c changes in 197 3 whic h wer e wrought b y fundamenta l changes in circumstances in January-February 1971 . The producing nations had alread y shade d taxe s i n isolated an d peripheral instances. To maintain the pric e they must mak e an d then enforc e an agreement t o limit outpu t an d allocate markets. There i s no othe r wa y to remov e the inducement t o cu t per-barre l tax t o permi t a lower price to increas e sales and tota l ta x revenues. One possibility would b e a worldwide commodity agreemen t unde r th e aegis of the Unite d Nations Conference on Trade and Development (UNCTAD) . World public opinion seem s favorable to th e ple a of many less-developed countries that price ratios are 'unfair': th e develope d world is paying too littl e and charging too much . Suc h perennia l opponents a s the Unite d State s an d Franc e have been favorabl e to commodit y agreements , and although I would no t dar e give odds on the chance s of one in oil, they are not negligible . The likelihood o f a commodity agreemen t increases as it becomes mor e desirabl e for producin g countries to extrac t a formal ratification or guarantee of existing and expecte d prices from the governments o f consuming countries . The producing countries are making a successful output-sharing carte l more difficult an d unlikely. They hav e brought i n as many new concession operator s as they ca n to tak e u p new acreage, or acreage relinquished by othe r operators . They hav e set up national oil companies to compet e wit h private ones, and acquired participatio n with th e oi l companies in the reserve s of th e establishe d con cessions. As a result, the numbe r of competitors i s increasing. The national companies have only cos t a s a price floor, without tax . Moreover, national prestige may becom e involved , and even where ther e i s no profi t in making a sale, it is possible that th e nationa l companies will still try t o mak e it . National prestige, however, can cut both ways and may be a partial explanation o f the exportin g countries', particularl y OAPEC'S, ability to see m to han g together versus the developed world . But it is difficult to sor t ou t an y such effec t fro m th e effect s of vulnerability caused by poor polic y plannin g - particularl y in the United States . Furthermore, th e various governments have different attitudes abou t th e tim e value of money. A small barren country ca n do little productiv e investmen t at home. Afte r payin g out som e protection mone y i n loans to othe r governments and in subsidies to nationalist movements, it invests in the Europea n mone y mar ket. All things considered then , a future dolla r o f tax revenue s must be discounte d at no more tha n 6 or 8 per cent because that is all it can earn, net, in the interim . 11

M.A. Adelman Matters are very different in a country lik e Iran, which has a considerable popu lation, arable land, and water. Its rate o f growth has been seve n per cent pe r year in the pas t decad e and more recentl y has speeded u p t o 1 0 per cent. The present value of a dollar of future ta x revenu e must b e discounted at well over 20 pe r cent per year which i t could ear n if invested i n public or private enterprise. Although adroi t and opportunistic behavio r on the par t of the producin g countries has been th e proximat e caus e of the recent surge in the worl d pric e of oil, the ultimate obstacl e to th e competitiv e evolution o f prices lies in the governments of the consumin g countries. Among the develope d nations, onl y th e Scandinavians (now excluding Norway) seem uncommitted t o higher prices , while Japan appear s careful t o kee p its options ope n i n both directions. Lower prices for oi l products have been assailed , especially i n Europe, a s ruthless economic warfare b y America n companies whose 'vas t financia l resources ' allow them t o ruin thei r rival s in any one spot - the whole bell-book-and-candl e recited here against 'conglomerates' and big business generally. As high-cost Europea n coal is eased ou t i t i s being replaced, especially i n Britain, by high-cost nuclea r energy needing protection fro m oil . Various nations have direct producing interest in oil or gas, and ar e moving to acquir e more. Solicitud e for a n independent local refining industr y lead s to protectio n o f local product prices and indirectl y of crude prices. There i s a self-fulfilling prophec y a t work . Because they expect increasin g oil prices, and canno t imagin e the possibilit y of competition i n world oil, governments make o r subsidiz e investments which wil l be see n a s grossly uneconomic if oil prices decline or fai l t o rise . Governments cannot los e face ; the mor e the y inves t an d make oi l cheap, the mor e the y will hold i t dear. Waste of resources invested in high cos t oil , coal, and nuclear power leads to eve n more waste . RECENT EVENT S AN D CURREN T PROSPECT S

Over th e decad e o f the 1960s , the ne t resul t of increased competition amon g the increased number of international oil companies was a very slow price decline, which I expected t o continue . Bu t in 1970-1 , the producin g nation s twic e raised taxes, totalling about 5 0 cents per barrel, with another 1 0 cents for 1971-5 ; the companies immediately raised prices by tha t amoun t 'an d a bit more, ' a s some of the companie s stated, in order t o improv e pric e margins. By the en d of 1973 , the 'average' price for Persian Gulf crude oil (in an unspecified mixture o f ol d and new, short- and long-term contracts) wa s moving toward $4.0 0 per barrel, and one spo t market transactio n was reported a t a price in excess o f $17.00 . The question is : why th e abrup t and massive reversal of trend? I t had happene d 20 years earlier: in the 1950 s world-market prices persistently ros e followin g irre 12

The world oi l market levant increase s in the Unite d States , t o th e accompanimen t o f European fear s about a n 'energy gap.' Now also, there are many statement s tha t prices are up because demand exceed s supply, turning the marke t around , etc. As Adam Smit h said o f another protectionis t argument : 'They who preache d i t were by n o means such fool s a s they who believed it.' The irrelevance of supply-demand ha s alread y been pointed out , an d the argumen t lost eve n its appearance of validity i n late 1971 a s consumption growt h slowe d dow n t o nearly zero, but th e fe w sellers held crud e oi l prices firm. Th e ta x increas e had bee n th e signa l which al l sellers could follo w i n raising prices without an y collusion , an d a few sellers can hol d the pric e s o long as everyone waits for everyone else to mak e th e firs t reduction . But th e pric e increase over and above the ta x boost wa s quite smal l an d will probably be eroded. What is much mor e importan t i s that th e producin g nations contrived th e ta x increas e with th e cooperatio n o f the companie s an d of th e United States government, which convene d a special meeting o f the OEC D nations , accounting fo r nearly al l world-market consumption, t o ge t advance assurance that consuming countries would foo t th e bil l an d take n o counter-measures. The United State s had som e soli d reason s for wanting the settlement , which per mitted highe r compan y profits , benefiting our GN P and balance of payments . Whether o n balance this intervention wa s a good ide a need no t b e discussed here. The companies and th e Stat e Department spok e o f th e 'assurances ' of a five yea r 'stability' in taxes and hence prices . How much o f it they believe d we canno t say . As Johnson tol d Boswell , such foolis h tal k a s calling yourself a man's mos t hum ble servan t was harmless, merely a form of speech , 'bu t you mus t no t think fool ishly.' I do not suppos e th e oi l companies thin k foolishly , thoug h a s late as June 1971 on e still heard tal k about 'valuabl e assurances' of tax-price stability. The new demands and the embarg o are sufficient commen t o n these assurances . Pretexts ar e unimportant. Ream s of paper will be consumed in spelling out 'more. ' The 'agreements ' of 1970- 1 marked a n irreversible change. Th e producing nations fo r the firs t tim e knew what previousl y was a likely bu t no t sur e bet: tha t the consumin g countrie s were so divided and confused tha t the y woul d yiel d t o the threa t o f a concerted shutdow n o f output. The threats were forthcoming after th e OEC D meeting , and consumate d in 1973 . The producin g nations are now limite d onl y b y th e elasticit y o f demand fo r oil products, which i s very low at current and prospective prices . Even at current prices , taxes could probabl y be raised muc h mor e withou t muc h immediat e effec t o n th e amoun t demande d (either i n total, o r fro m th e Persian Gulf) , and raise d they will be . Hence th e crud e oil price level in the latte r part of thi s decade wil l probably exceed recen t levels . It is less likely that th e 1980 s level will. [Editors ' note : The first draf t o f this paper was written in 1971 . At that time , Professor Adelma n correctly predicte d that 197 5 price s would excee d 197 1 prices. ] Fo r th e higher 13

M.A. Adelman prices above taxes will further stimulat e discoveries, the highe r taxe s will widen the margin , tempting governments to shade . I n addition, the development of incremental supplies elsewhere in the worl d may resul t in different countrie s sharing unequally in world market growth. In short, in the absenc e of an international commodity agreemen t for oil , or some othe r relatively stable vehicle throug h which consumin g countries ' preference s for higher prices can be administered, nothing has happened t o chang e the analysi s sketched above . The new factor , the cooperation o f the producin g nations, has had a large impact. But th e Arab oil embargo has not bee n a n unblemished tapestry o f unity of action. An d th e longer-run consequence s of the pric e increases which ar e the frui t o f that coop eration may no t al l be in one direction . To understand the recen t event s in the world oil market, one must understan d the role s of the multinational companie s and the leading position o f the United States. To that tas k we now turn. THE MULTINATIONA L OI L COMPANIE S AS AGENT S O F TH E PRODUCE R COUNTR Y MONOPOL Y

The multinational oil companies have become, i n the words of the boar d chairman of British Petroleum, the 'tax collecting agency' of the producin g nations. In 1972 , th e companie s operated th e greates t monopoly in history an d transferred abou t $1 5 billion fro m the consumin g countries to thei r principals. If th e arrangement continues , a conservative estimate for 198 0 collectio n i s over $5 5 billion per year. Much of that wealth will be available to disrup t the worl d monetary syste m an d promote arme d conflict. Oil supply i s now muc h more inse cure. Monopoly, the power t o overcharge , is the power to withhold supply . Among nations, an embargo is an act o f war, and a n oil embargo ushered i n th e active phase of th e Organizatio n of Petroleum Exporting Countries (OPEC) cartel. The oil companies are now th e agent s of a foreign power . They wil l be blamed for impairin g the sovereignt y of the consumin g countries, and quite unjustly . They onl y di d the will of the OPE C nations an d o f the consumin g countrie s themselves, notably the Unite d States. The consumers' 'strange and self-abuse ' is the key t o how th e event s of 1970- 1 turned a slowly retreating into a rapidly advancing monopoly. The most importan t playe r in the gam e is the America n State Department. This agency is deplorably poorly informe d i n mineral resource economics, th e oil industry, the histor y o f oil crises and the participatio n therein of th e Arab s with whom i t i s obsessed; in fact, State cannot eve n give a n accurate account o f its own recent doings , us polic y canno t b e justified by increased scarcity .

14

The world oi l market Prediction i s unavoidable but risky . In 196 3 I thought that , abstracting from inflation, a price of $ 1 per barre l at th e Persia n Gulf was not unlikel y fairl y soon . In term s of 196 3 dollar s it did go to 92 cent s by earl y 1970 . A s predicted, suppl y remained excessive, and the companies coul d not contro l th e market. Bu t on th e political side , the predictio n went al l wrong in 1970-1 . Although I had warne d that th e producin g countries might threate n a cut-off of supply, an d urged insurance against it, I was mistaken t o cal l it an unlikely event. Nor di d I expec t the consumin g countries, especially the United States , t o cooperat e s o zealously.5 I may b e equall y wrong to expec t that consumin g countries will continue this way for mos t o r all of the 1970s . The unanimous opinio n issuin g from companie s and governments in th e capitalist, Communist, an d Third World s is that the pric e reversal of 197 0 an d 197 1 resulted fro m a surge in demand, o r change fro m surplu s to scarcity , from a buyers ' to a sellers' market . Th e story ha s no resemblance to th e facts . The 197 0 increas e in consumption ove r 196 9 wa s somewhat belo w th e 1960-7 0 averag e i n all areas. The increase in 197 1 over 1970 , i n Western Europ e an d Japan, was about hal f th e decade average . In the firs t quarte r of 1972 , Wester n European consumptio n wa s only 1 .5 per cent above the previou s year. By mid-1972, excess producing capacity, a rarity in world oi l (i.e. outsid e Nort h America) , was almost universa l and had le d to drasti c government action , especiall y in Venezuela and Iraq. The industry wa s 'suffering fro m having provided the facilitie s for a n increase in trad e which di d not materialize. ' A drastic unforeseen slowdown i n growth an d unused capacit y woul d mak e price s fall, not rise , in any competitive market . Some powerfu l force has overridden demand an d supply . This force di d no t enter befor e th e middle o f 1970 , a t the earliest. Up to that tim e the tren d of prices had bee n downward , and long-term contracts had bee n a t lower price s than short-term , indicatin g that th e industr y expected stil l lower prices in the future, eve n as far a s 1 0 years ahead.6 If demand exceed s suppl y a t current prices , sellers and buyers acting individually make new bargains at higher prices . When supply exceed s demand ye t price s are raised, the conclaves , joint actions , an d 'justifications ' ar e strong evidence of collusion, no t scarcity . More precisely: i n a competitive market , a surge in demand o r shrinkage in supply raise s price because i t puts a strain o n the productiv e apparatus . T o produce additiona l outpu t require s higher costs ; unless compensated b y higher prices , the additiona l outpu t wil l not b e supplied . If there wer e increasing long-run scarcity a t the Persia n Gulf, discoveries falling behind consumption , th e reservoir s would be exploited mor e intensivel y to offse t decline, and to maintain an d expand production . Th e world 'energ y crisis' or

15

M.A. Adelman 'energy shortage' is a fiction. Bu t belief in the fictio n i s a fact. It make s peopl e accept higher oi l prices as imposed b y nature , when the y ar e really fixed by col lusion. An d seller s of all fuels, whateve r their conflicts , can stand i n harmony o n the platfor m o f high oil prices. Twenty year s ago, the Paley Commission mad e the classi c statement o f th e problem: 'Exhaustio n i s not wakin g up t o fin d th e cupboard i s bare but th e nee d to devot e constantl y increasin g efforts to acquirin g each poun d o f materials fro m natural resource s which ar e dwindling both in quality an d quantity .. . The essence of th e material s problem is costs.' Depletion of reserve s at th e Persia n Gulf is only abou t 1. 5 per cen t a year. It is uneconomic t o tur n over an inventory so slowly. But Persian Gulf operators have not bee n fre e t o expan d outpu t an d displace higher cos t productio n fro m othe r areas because thi s would wrec k th e worl d price structure. Therefore, it i s meaningless to averag e production-reserv e ratios for th e whol e world , as is too ofte n done. A barrel of reserves found an d develope d elsewhere in the worl d i s fro m five t o seve n time s a s important i n terms of productiv e capacity a s a barrel at th e Persian Gulf . In other words , one could displac e production fro m th e entir e Persian Gulf with reserves from one-fift h t o one-sevent h a s large. And thi s is perhaps the onl y constructive aspect o f th e curren t driv e for self-sufficienc y i n oil. Thi s zero-discoveries model yields a much highe r production-reserve s per cent, hence a substantial increas e in investment requirement s and curren t operating costs pe r barrel. Today a t th e Persian Gulf, capital and operatin g costs are each abou t 5 cents per barrel; under our extreme assumptions, the y are roughly double . The difference betwee n 1 0 and 20 cent s measures th e valu e of discovering new fields: it take s the strai n off the old . No basis for fears of physical scarcity The zero-discoveries model onl y estimates the worst tha t coul d happen ; i t is not a prediction o f what wil l happen. Whe n the procedur e wa s applied i n 1965 , current an d projected cost s were higher tha n the y ar e now; since many ne w discoveries have freshene d the mix , not t o spea k of improvements in technology. There i s no mor e basi s for fear s o f acut e oi l scarcity i n the nex t 1 5 years tha n there was 15 years ago - an d the fears were stron g i n 1957 . Th e myth that rising imports (of the Unite d States ) will 'turn the market around ' is only th e lates t version of the myt h tha t risin g imports of Europe an d Japan woul d 'dr y out th e surplus in 1957-70.' 7 More generally: suppl y and deman d ar e registered in incremental cost , which is and long will be a negligible fraction o f the curren t crud e oil price of abou t $1.90 pe r barrel. Hence supply an d demand ar e irrelevant to th e curren t and

16

The world oi l market expected pric e of crude oil. Al l that matters is whether th e monopol y will flourish or fade . In Europe an d Japan, ther e was a mild an d temporar y shortage of refinin g capacity i n early 1970 . A t the sam e time , a tanker shortag e pu t rate s at th e highest level since shortl y afte r th e closin g of the Sue z Canal, and raised product prices . In May 197 0 th e trans-Arabia n pipeline was blocked by Syri a to obtai n highe r payments for the transi t rights , while the Libya n governmen t began to impos e production cutbacks on most o f the companie s operating there, to forc e them t o agree to highe r taxes. Although th e direc t effec t o f the cutbac k an d closure was small, the effec t o n tanker rate s was spectacular, and produc t price s and profits shot up . The companies producing in Libya speedil y agreed to a tax increase . The Persian Gulf producing countries then demande d an d receive d th e sam e increase , whereupon Liby a demande d a further increase and the Persia n Gulf countries followe d suit. Finally, agreements were signed in Tehran i n February 1971 , increasing tax and royalt y payment s at the Persian Gulf as of June 197 1 by abou t 4 7 cent s per barrel, and risin g to abou t 6 6 cents in 1975 . Nort h Africa n an d Nigerian increases were larger. In Venezuela th e previou s 196 6 agreemen t was disregarded and higher taxes were simply legislated. These taxe s are in form incom e taxes , in fact excis e taxes, in cents per barrel. Like an y othe r excis e tax the y ar e treated a s a cost and become a floor to price . No oil company ca n commit fo r less than th e su m of taxplus-cost pe r barrel. 8 Harmony between producing-country governments and multinational companies The multinational companie s producing oil were amenable to thes e tax increases because as was openly sai d on the morro w o f Tehran, they used the occasio n t o increase their margin s and return on investmen t i n both crude and products . I n Great Britai n the objec t wa s stated: t o cove r the tax increas e 'and leave some over,' and the Februar y 197 1 tax increas e was matched b y a product pric e increase perhaps half agai n as great. The best summar y o f the result s was by a wellknown financia l analyst, Kenneth E . Hill, who called the agreement s 'truly an unexpected boon fo r the worldwide industry.' Mr Hill rightly emphasize d produc t pric e increases, but arm' s length crud e prices also increased by more tha n the ta x increases . When the producin g coun tries made fresh demands later in 1971 , an American investment advisor y service (United Busines s Services) remarked that ta x increase s were actually favorabl e t o oil company profits . And 197 1 wa s easily the bes t yea r fo r company profit s since 1963, althoug h ther e was a profit slid e off later i n the year , as competition i n products, though not ye t i n crude, again reasserted itself . 17

M.A. Adelman The price pattern is set for the 1970s . From tim e t o time , either i n pursuance or in violation of the Tehran-Tripol i 'agreements,' and enforced by embarg o whe n convenient, the ta x i s increased, whereupon prices increase as much o r more , bu t then ten d t o erod e as the companie s compete very slowly at th e crud e level and less slowly at th e product s level . Thus price s increase in steps, yet a t an y given moment ther e is usually a buyer's market, i.e. more is available than i s demanded at th e price , which i s under downward pressure. The companies' margin will therefore wax and wane, but the y benefit by th e new order. They cannot , eve n if they would , mediate between producin g an d consuming nations. As individual competitors, the y ar e vulnerable to producingnation threat s t o hit the m on e a t a time. A s a group, they ca n profit by a higher tax throug h raisin g prices in concert, for the highe r ta x i s that clea r signal to which the y respon d withou t communication . Th e Secretar y General of OPEC , Dr Nadim Pachachi, sai d truly tha t ther e i s no basic conflict betwee n companie s and producing nations. The then head o f Shell , Si r David Barran, spoke o f a 'marriage' of companie s and producin g governments. Most precise of all was Sir Eric Drake, the chairma n of BP, who calle d the companie s a 'tax collecting agency, ' for bot h producing and consuming country governments . There is , however, a difference i n kind between servin g a government in its own country t o collec t revenue from its own citizens, an d serving a government to collec t revenu e from other countries . LEADING ROL E O F TH E UNITE D STATE S

Without activ e support fro m th e Unite d States , OPEC might neve r have achieved much. When the firs t Libya n cutback s wer e decreed, in May 1970, the Unite d States coul d have easily convened the oi l companies to wor k out a n insurance scheme whereb y an y single company force d t o shu t dow n would have crud e oil supplied b y the other s at tax-plus-cost fro m anothe r source. (The stable was possibly locked a year afte r th e horse wa s stolen.) Had that been done , al l companies might have been shut down , an d the Libya n governmen t would have los t al l production income. It would have been helpful but no t necessar y to freez e it s deposits abroad . Th e OPE C nations wer e unprepared for conflict . Thei r unit y woul d have been severel y tested an d probably destroyed . Th e revenue losses o f Liby a would hav e been gain s to al l other producin g nations, and al l would have realized the dange r of trying to pressur e the consumin g countries . An y Libya n divisio n or brigade commander coul d conside r how he an d friend s migh t gai n several billions of dollar s a year, and othe r billions deposited abroad , by issuin g the righ t marching orders. 18

The world oi l marke t Failure t o oppose does not necessarily imply that the United States favored th e result. Bu t there wa s unambiguous actio n shortl y thereafter . A month afte r th e November agreement s with Libya , a special OPEC meetin g in Caracas first resolved on 'concret e and simultaneous action,' but thi s had not bee n explaine d o r translated int o a threat o f cutoff even as late as 1 3 January, nor b y 1 6 January 1971 , when th e companies submitted thei r proposal s for higher and escalating taxes. 9 Then cam e th e turnin g point: th e Unite d State s convened a meeting in Paris of the OEC D nations (who accoun t for most oi l consumption) o n 2 0 January 1971 . There i s no public record of the meeting, but - a s will become clea r below - ther e is no doub t tha t th e America n representatives and the oi l companies assure d th e other governments that if they offere d n o resistance to higher oil prices they could a t least count o n fiv e years ' secure supply a t stable or onl y slightl y rising prices. The OEC D meetin g could hav e kept silent , thereby keepin g the OPE C nation s guessing, and moderating their demand s for fea r o f counteraction . O r the y migh t have tol d the pres s the y were sur e th e OPE C nations were to o matur e an d states manlike t o d o anythin g drastic, because afte r al l the OEC D nation s had som e dras tic option s ope n t o the m to o .. . but wh y inflame opinio n b y talkin g about thos e things? Instea d an OEC D spokesma n praise d the companies ' offer , an d decline d to estimat e its cost to th e consuming countries . He stated that the meeting had not discusse d 'contingency arrangements fo r coping with an oil shortage.' This was an advance capitulation. Th e OPE C nations now ha d a signal to g o ful l spee d ahead becaus e there woul d be no resistance. Before 2 0 January 197 1 a n open threa t b y the OPE C nations would no t hav e been credible , in view of th e previou s failure o f even mild attempt s a t productio n regulation in 196 5 an d 1966 . Bu t after th e capitulation , threat s were credibl e and were made often . (This i s clear fro m a careful readin g of th e pres s in January an d February 1971. ) They culminate d i n a resolution passed on 7 February 197 1 b y nine OPE C members , including Venezuela but no t Indonesia , providing for a n embargo afte r tw o week s if their demand s were not met . Th e Irania n finance minister, chief of the producing nations ' team, said: 'There is no question of negotiations or resuming negotiations. It' s just th e acceptanc e o f our terms.' The companies wer e resigned to this , but wante d assurance s that wha t the y accepte d would no t b e change d fo r fiv e years . The United States had bee n active in the meantime . Our Under Secretary of State arrived i n Tehran 1 7 January 1971 , publicly stating hi s government's interest in 'stable an d predictable' prices, which i n context mean t highe r prices. He told th e Sha h o f Iran the damag e tha t woul d be done t o Europ e and Japan i f oil supplies were cut off . Perhaps thi s is why th e Sha h soo n thereafte r mad e the firs t 19

M.A. Adelman threat o f a cutoff o f supply. I t i s hard t o imagin e a more effectiv e incitement t o extreme action than to hear that this will d o one's opponents great damage . Resistance t o th e OPE C demands would have shattered th e nascen t cartel . As late as 24 January 1971 , th e Sha h tol d th e press : 'If th e oi l producing countries suffer eve n th e slightes t defeat , it would b e the death-knel l fo r OPEC , and fro m then o n th e countrie s would n o longer have the courag e to get together.' When the Tehra n agreemen t wa s announced, anothe r Stat e Departmen t specia l press conference hailed it, referring many time s to 'stability ' and 'durability.' They 'expecte d th e previously turbulen t internationa l oil situation t o cal m dow n following th e ne w agreements.' They must reall y have believed this! Otherwis e they would no t hav e claimed credit fo r M r Irwin o r fo r Secretar y Rogers , or induced President Nixon' s offic e t o announce tha t h e too was pleased. They mus t have said this in Paris in January an d agai n at a n OEC D meeting in May. We now live with th e consequences . State Department representativ e James Akin s told a senate committe e i n Feb ruary 1972 : 'Th e approac h we made in the Persia n Gulf [was ] primaril y because of the threa t t o cu t of f oi l production .. . We informed th e countrie s that we were disturbed b y thei r threats , and thes e wer e withdrawn very shortl y afte r ou r trip.' The public record outline d above show s that the threat s of embargo bega n afte r the Unde r Secretary's arrival , culminated in OPEC Resolutio n xxii.13 1 on 7 Feb ruary 1971 , and were never withdrawn. Scraps of paper The oil companies knew better tha n t o tak e th e 'agreements ' seriously; they ha d been ther e before . To be sure, one could cit e many a statement by a n oil executive about th e 'valuabl e assurances of stability, ' but thi s was ritual. The Londo n Economist, always in close touch wit h th e industry , expected an y agreements to last onl y a few months, give n th e 'persisten t ba d faith. ' Th e bes t summar y was made by Petroleum Intelligence Weekly: 'I f suc h agreement s were worth anythin g the present crisi s wouldn't exist. ' This was borne ou t i n August o f 1971 . Devaluation of the dollar , the occasio n for ne w demands, was of course a n incident in the worldwid e price inflation t o which th e Tehra n an d Tripoli agreement s had adjuste d by providin g for periodi c escalation. Moreover , Persian Gulf revenues were mostly no t payabl e in dollars. The new element i n the situatio n wa s not th e increased dollar cos t o f imports t o the producing countries, but th e fac t tha t prices i n dollars increased, especiall y in Germany an d Japan. Thi s was another windfal l gai n to th e companies , just as in early 1970 . Agai n the producing countries were able to tak e mos t o f tha t gai n in the consumin g countrie s because the multinationa l companies were th e pro ducers of oi l as well as sellers of refine d products . 20

The world oi l marke t The 'oil companie s had hailed th e agreement s as guaranteeing a semblance o f stability i n oil prices ... they woul d see k t o pas s on th e impac t o f any ne w cos t [tax] increase. ' The new demands, said the chairma n of Jersey Standard (Esso , now Exxon), were a violation of th e Tehra n agreements , but 'th e industry will solve these problem s just a s our difference s wit h the m wer e reconciled earlie r this year and before,' i.e . higher taxe s and higher prices . This was precisely correct both as to substanc e an d as to ritual . The OPE C governments made thei r demands. The companie s mad e an offer . Th e government s refused i t an d brok e of f the talks . The companies made a better offer , taxe s were raised again, and crude oil prices with them . Even before this deal , the producin g nations had alread y made a n additional demand, fo r so-called 'participation.' The companie s said they wer e distresse d that the agreements 'have not le d to th e long peace .. . that the y ha d anticipated. ' They woul d resis t the demand s as a violation of th e agreements . Whereupon th e governments 'announced that they woul d tak e par t i n a "combined action" if they didn' t receiv e "satisfaction,"' an d the companie s agreed to negotiate . I n March, the Aramc o companies , whic h accoun t fo r nearly all output i n Saudi Arabia, conceded participatio n 'in principle.' 'Participation,' recentl y negotiate d b y companie s an d variou s host governments, is a misnomer. 'Pseudo-participation ' would be more apt . 'Participation' does no t mea n tha t th e governmen t actually produces or sell s oil, or transfer s it downstream fo r refinin g and sale . As we shall se e later, selling oil is what Saud i Arabia wisely aims to avoid . 'Participation' is simply a n ingenious way o f furthe r increasing the ta x pe r barrel without touchin g eithe r poste d price s or nominal ta x rates, thus apparently respectin g the Tehra n agreements. Once the ta x increas e is decided, everything can be cut t o fit . The sam e oi l is still sold or transferre d by the sam e companies. O n the term s discussed early in 1972 , 'participation ' meant about 9 cents more ta x pe r barrel. 10 Those who a t the tim e believed that this assured supply , stable prices , and a solution t o th e balanc e of payment s proble m would hav e believed anything . There has been unparallele d turbulence sinc e the Stat e Departmen t specia l conference. Venezuela dispensed with th e elaborat e sophistry of 'agreements,' and legislated: a n additional tax increas e in 197 1 an d agai n in early 1972 , wit h anothe r expected i n early 1973 ; nationalizatio n o f natural gas; the requiremen t that com panies deposit increasin g sums of money les t they permi t propertie s to ru n dow n before th e nationa l take-over in 1984 ; an d the extensio n o f this 'reversion' to all facilities rathe r than onl y producin g facilities. Confronte d with declining production because it was cheaper for the companie s t o lif t additiona l output fro m th e Persian Gulf, Venezuela se t minimum productio n rates, with fine s for insufficient output. 21

M.A. Adelman In Libya , the governmen t followed th e Persia n Gulf countrie s in demanding and gettin g an increase on th e sam e pretext o f monetary adjustment ; and als o in demanding participation, whether 'participation ' or the rea l thing i s not ye t clear . In December 1971 , when Ira n seized two island s near the mout h o f th e Persia n Gulf, Liby a seized th e propertie s o f Britis h Petroleum i n 'retaliation'; any stic k is good enoug h t o beat a dog. The Algerian government took two-thirds of the outpu t o f the Frenc h compa nies, who were 'compensated' with wha t littl e remained afte r deductin g newl y calculated taxes . In Iraq, the operating Ira q Petroleum Compan y cu t back outpu t sharpl y durin g 1972 fo r th e sam e reaso n as everywhere else in the Mediterranea n (where th e main field delivers via pipeline) - cost s plus taxes were lower at the Persian Gulf, where capacity wa s being quickly an d cheaply expanded . Ira q demanded tha t production b e restored, and that IP C make a long-term commitment t o expan d out put b y 1 0 per cen t pe r year. The IP C counter-offer not bein g acceptable, Iraq made headlines b y seizin g the Kirku k fiel d 1 June 1972 , the n offere d forthwit h to sel l at 'reduce d and competitiv e prices,' for spot deliver y or long-term contracts . This threat wa s aimed at the mos t sensitiv e point o f the world oi l industry: th e permanent potential oversuppl y which i n Iraq (and othe r countries ) had alread y been mad e actual . Price-cutting is intolerable i n a cartel; to avoi d it , a flurry o f complex negotiation s began . A loan wa s soon mad e by othe r Ara b OPE C members . 'Behind th e Ara b nations' actio n .. . lies an offer b y Ira q to sel l its newly national ized oi l at a cut rate , which woul d have driven down th e revenue s received by th e other countrie s fo r their oil. ' This may also explain the gentlemanlik e behavio r of the expropriate d IPC , which di d not attemp t t o blacklist Ira q oil to b e sold in non-Communist markets . Onward and upward with taxes and prices The genie was out o f the bottle . The OPE C nations had a great success with th e threat o f embargo. They appea r to be having even more succes s with th e actuality . The turbulence will continue a s taxes an d prices are raised again and again . The producing nations ar e sure of oil company cooperatio n an d consuming-countr y nonresistance. This i s a necessary condition . There ar e two purel y economic rea sons why the situatio n canno t be stable . A s the detaile d outlin e of events illustrates, the difficultie s i n the worl d petroleu m market have been brewing for a long time and the stag e in the curren t ac t of the crisi s was set in 197 0 an d 1971 . The Arab-Israeli war was merely a pretext whic h perhap s at mos t determine d th e form o f the mos t recen t turn of the screw. The crude oi l price can go much higher before i t reaches the monopol y equili brium o r point of greatest profit .

22

The world oi l market The averag e price in Europe o f a barrel of oi l products i n 1969-7 0 was about $ 13 per barrel. It i s higher today . If the ne w tax rate s were substantially increased at the Persia n Gulf , a straight pass-throug h int o product price s would b e a much smaller percentag e increase . It i s doubtful tha t suc h a n increase would hav e an y noticeable effec t o n th e absolut e leve l of oil consumption. Moreover , about hal f of the Europea n pric e consists o f taxe s levied by th e variou s consuming-country governments. The producing nations have long insisted tha t in justice the y ought to receiv e some o r most o f this amount. B e that as it may, most o r all of this ta x can be transferred from consumin g t o producin g nations, with help fro m consum ing country governments who dislik e unpopularit y throug h higher fue l prices . Th e Italian government collaborated earl y in 1971. 11 The curren t price of oil , however fa r abov e the competitiv e level , is still muc h less than alternatives . The producin g nations are not a whit displease d b y big expensive projects to produc e oi l or gas from coal o r shale o r tar sands , which ar e a constant reminde r o f what a bargain crude is, even at higher prices . Particularly outside th e Unite d States , nuclea r power set s a high ceiling , coal a much highe r ceiling. The pric e of Britis h coal ha s long an d wel l serve d sellers of fue l oi l in Britain, who price d a t o r slightly belo w coal-equivalent . Small wonder tha t th e head o f Shell appeale d in October 197 1 for th e maintenanc e of a British coal industry. There has therefore been muc h discussion , mostly oral , of th e goa l for the Persian Gulf nations being the u s price ; or $ 5 per barrel, etc. Thes e ar e attainable goals, and we must therefor e expec t attempt s t o reac h them. The producing nations canno t fi x prices without usin g the multinationa l com panies. Al l price-fixing cartels must eithe r contro l outpu t o r detect an d preven t individual price reductions, which would erod e th e price down towar d th e competitive level . The OPE C tax syste m accomplishe s thi s simply an d efficiently . Every importan t OPE C nation publishe s its taxes pe r barrel; they ar e a public record, impossible t o falsif y much . Outright suppressio n would b e a confessio n of cheating. Onc e th e taxe s ar e set by concerte d company-governmen t action , the pric e floo r o f taxes-plus-cos t is safe, an d th e floo r can be jacked u p fro m tim e to time , as in early 1971 , or early 1972 , o r by 'participation. ' It i s essential for th e carte l that th e oi l companies continu e a s crude oi l marketers, paying the excis e ta x before sellin g the crud e or refining to sel l it a s products . Were the producin g nations th e seller s of crude, paying the companie s i n cash or oil for thei r services, the carte l would crumble . The floo r to pric e would the n be not th e tax-plus-cost, but onl y bare cost. The producing nations woul d nee d to se t and obey productio n quotas . Otherwise , the y would inevitabl y chisel an d bring prices down b y sellin g incremental amount s a t discount prices . Each seller nation would be forced t o chise l to retain markets because i t could no longer be 23

M.A. Adelman assured o f th e collaboratio n o f al l the othe r sellers . Every cartel has in time bee n destroyed b y one , the n som e members , chiselin g and cheating; without th e instrument o f the multinationa l companie s and the cooperatio n o f the consumin g countries, OPEC would b e a n ordinary cartel . An d nationa l companie s have always been an d still are price cutters. 12 Chiseling will accelerate if national companies go 'downstream' into refinin g and marketing . One can transfer oi l to downstrea m subsidiarie s or partners at high fo b prices, but wit h fictitiou s lo w tanker rate s or generous delivery credits. The producing nation ca n put u p most o f th e money o r tak e a minority participation, o r lend a t less than market interes t rates . One can arrange buy-back deals, barter deals, and exchanges o f crude i n one par t o f th e worl d fo r availabilit y elsewhere. Th e world oi l cartel in the 1930 s was eroded b y thi s kind o f piecemeal competition, an d s o will the ne w cartel of th e 1970 s if the individua l producing nations become th e seller s of oil . The arrangemen t between Ira n an d Ashlan d Oil may be th e firs t ste p in this long, slow process . The Saud i Arabian petroleum minister, Sheik Yamani , who designe d 'participa tion,' warned in 196 8 against nationalizing the oi l companies, an d making them 'buyers and brokers' o f crude oil. This would, he argue d truly, lead to 'collapse ' of oil prices and benefit only the consumin g countries. Th e expert s retained by OPEC also warned in 197 1 that 'participation ' must no t interfer e wit h marketing of the oi l through th e companies . More recently, in 1971 , Sheik Yaman i warned that 'participation' had to provid e the righ t kin d o f 'marketing operations.' In 1972 he added : 'W e are concerned tha t price s in world markets do not fal l down. ' OPEC has come no t t o expe l bu t t o exploit . An d if the exces s crud e oi l supply were no t permanent , Sheik Yaman i would have n o caus e fo r th e 'concern ' he rightly feels . We may therefor e conclude: th e producin g countries can raise prices and revenues further b y jacking up th e excis e ta x floor , in concert. Conversely , if and when th e consumin g countries want to b e rid of the cartel , they can take their companies ou t o f crude oi l marketing. To avoid taxation , they can decommissio n the ta x collectin g agents who ar e their ow n creation. Bu t this i s not a step whic h any singl e country can unilaterally accomplish. So far, the consumin g countrie s have gone in precisely th e opposit e direction . As they develo p high cos t substitutes , and strive to ge t thei r respective compa nies, public or 'private, ' into crud e oil production an d marketing, they wil l rivet the ta x collectio n agency more firml y o n their necks . It i s time t o as k why the y do this, and whether th e polic y ma y change . One can only gues s at th e unstate d reason s why th e Unite d States has put OPE C in the driver' s seat. First , American companies have a large producing interest i n the world market . I n 1971 , American companie s produced abou t 6. 5 billion bar24

The world oi l market rels outside th e Unite d States . For ever y cent o f increase in prices above tha t in tax, ther e i s an additional $6 5 million i n profit. 13 Second, th e highe r energ y costs will now be imposed o n competitor s i n world markets ; and in petrochemicals , higher raw material costs as well. Third, the Unite d State s has a large domesti c oil-producing industry. The less the differenc e between domesti c an d world prices, the less the tensio n betwee n producing and consumin g regions . Fourth, the United State s desired t o appeas e the producing nations, buying popularity wit h someon e else' s mone y an d trying to mitigat e the tensio n cause d by th e Arab-Israe l strife, which , however, is irrelevant to oil . If the Arab-Israeli dispute were settled tomorrow , th e producing nation s would no t slo w dow n fo r one minute their drive for ever higher prices and taxes . The acknowledged leade r of the Persia n Gulf nations i n early 197 1 was Iran, which ha s in one importan t respect - th e Trans-Israel Pipe Line - actuall y cooperated with Israe l more tha n the United States , which i n 195 7 an d 196 8 discourage d the pipeline. 14 The potential for a changing American interest First, securit y has been greatl y impaired for all importing countries by th e cohe sion o f th e OPE C nations which mad e a n embargo feasible. Second, th e balance of payments impac t wil l soon becom e unfavorable to us , as it is to al l other importers. 15 The fac t will slowly be recognize d that nearly al l of the oi l deficit coul d b e abo lished by gettin g American companies ou t o f crud e oil marketing, to produc e o n contract fo r the producin g countries, who coul d the n compet e th e pric e way down. The companies' profit s (and contributio n t o th e balanc e o f payments ) would not b e much less , and in th e long ru n they might b e greater, as the expe rience in Venezuela proves: th e companie s producing there ar e at o r over the los s line. Larger America n imports will, if anything, tend to pu t th e worl d pric e down . The process was seen o n a small scale after 1966 , whe n quota s o n (heavy ) residual fuel import s wer e lifted. Imports increased considerably , an d th e pric e decreased . Moreover, concern over air pollution wa s growing rapidly, and alar m was fel t ove r possible los s of markets for residual fuel oil . Hence th e Venezuela n governmen t made agreement s with Ess o and Shel l grantin g them lower taxe s on productio n of low-sulfur fue l oil . This bit o f history wa s too rapidl y forgotten. 16 The declinin g price of fue l oi l in the fac e o f greate r demand woul d b e inex plicable in a competitive market , but i s to b e expected whe n th e pric e i s far above cost. It is exactly wha t happene d i n Europe t o embarras s coal. The hope of greater profits o n increase d sales, and the knowledg e tha t larg e buyers have now a n incentive to roa m th e marke t an d look for every chance o f a better deal , means tha t one must reduc e the pric e before one' s rivals tie up th e goo d customers . As

25

M.A. Adelma n American quotas are relaxed, refiner s who hav e a crude defici t wil l become exactly th e kin d o f large-scale buyer whom Shei k Yaman i rightl y fears . The prospect o f world price s rising because of large-scale American imports ha s alarmed Europ e an d Asia , and the Unite d State s governmen t ha s gladly fanned those fears . Bu t the y hav e no basi s in theory o r experience . May th e reade r excuse our sayin g again what need s t o b e said often: large r consumption onl y raise s price i n a competitive market , by raisin g marginal cost. In so awesomely noncompetitive a market, cost i s not relevan t because price is 10 to 2 0 times cost. Suppl y an d demand have nothing t o d o with th e world price of oil: onl y th e strengt h of the carte l matters . OTHER CONSUMIN G COUNTRIE S

Consuming government s ar e stayin g i n th e sam e groov e tha t serve d the m badl y between 195 7 an d 1970 , an d wors e afterward . Prices had rise n i n th e 1950 s because th e oi l companie s wer e abl e t o ac t i n concer t withou t over t collusion : they responde d t o a signa l fro m th e Unite d States . Price s the n jumpe d fo r a time whe n th e Sue z Cana l wa s cut . Th e reactio n wa s fea r o f shortage . On e heard i n 195 7 wha t on e hears no w - 'True , reserve s are ample , bu t i n 1 5 years, say b y 1972 , the y wil l mostly be gone! We must guar d against th e shortage , obtain concession s o f our own , protect domesti c energ y industries agains t futur e scarcity, etc.' Thereby th e consuming countrie s committe d themselve s t o hig h oil prices. The consumin g countries were all the mor e read y to fea r thes e imaginar y demons because they ha d investe d heavily in coal. The decline i n fuel oi l prices after 195 7 wa s greeted with disbelie f and resentment . Prices of oi l assumed in government energy plans and forecast s were always much highe r than actua l market. I n 196 2 (an d 1964 ) th e EE C energ y experts made a long-term forecast of heavy fue l oi l at $1 8 per metric ton, whe n i t was about $13 . The y were bitterly denounced fo r s o low a forecast. Yet eve n in mid-1972, fue l oi l in Western Europe wa s only $14.50 , i.e., in 196 2 price s $10.75 per ton . Seldo m ha s s o costly a mistake been s o long and stubbornly maintained . Nationalized industries - and others which coul d be influenced or pressured - wer e and still are reserved to coal. Worse yet, th e artificia l Europea n coal price s became a cost standar d fo r building nuclear power plants; in Great Britain they are wildly uneconomic . The costly insistenc e on self-sufficienc y wa s mostly uninforme d fea r o f th e multinational oi l companies. Th e more th e companie s los t contro l o f th e market an d competed dow n the pric e of fuel oil , losing profits thereby, th e mor e resentment a t their 'ruthless economic warfare. ' A s late as 1972 , a British econo mist wrote of the oil company 'design' to drive out coal. Fear of the multinationa l 26

The world oi l market firms leads consuming countries not onl y t o protec t coa l but t o see k 'their own' oil through government-owne d or sponsored companies. Thereby th e consumingcountry governmen t acquires a vested interest in high oi l prices. Low oi l prices, or the possibilit y thereof, become not a n opportunity bu t a scandal, to b e ignored as far a s possible. The fear o f shortage in the 1970 s a s in the 1950 s leads to attempt s t o obtai n oil concessions. It ma y mak e sense to ru n risk s in new area s where governments will keep taxe s low. There i s much oi l which i s profitable t o fin d an d develo p at today's prices , even at cost s 2 5 time s that i n the Persian Gulf. A non-Japanese can hardly objec t whe n Japan propose s to spen d som e $ 3 billion i n the near future-to fin d an d develo p new oi l resources. If spent i n new area s it will certainly add t o th e wealt h of the world, and, perhaps, not b e a loss to Japan . Bu t ther e is nothing gaine d in seeking new concession s in the ol d areas, or buying into old concessions. Suc h a policy doe s not ad d an y resources . The price paid fo r con cession share s will discount th e profits, which ma y no t continu e long . Perhap s worst o f all, in committing itsel f to tak e oi l from 'its ' concessions, th e consum ing country lose s all independence in buying, and i s exploited wors e than i t coul d ever be by th e multinationa l companies. The French experience The policy o f seeking 'independence' has been carrie d farthest i n France. I n 1962 , agreements were reached wit h newly independent Algeria , inaugurating a 'new type' of relationship, fre e fro m the burde n of colonialism, etc. (One hears similar language today i n Japan.) In early 1971 , M. Fontaine describe d in LeMonde the drear y succession of broken promises, seizures , spoliation, an d the like . Yet no more tha n th e Frenc h governmen t could h e or his newspaper bring themselves to discar d th e policy; there were supposed politica l advantages, such as lessening Soviet influenc e in the Western Mediterranean. The logical result wa s the two thirds confiscation in 197 2 o f what they ha d fondl y thought t o be 'their own' oil . The head o f ERAP , the wholl y state-owne d French compan y (a s distinguished from Compagni e Francaise des Petroles, only 3 5 per cent state-owned) , summed up 1 0 years' experience an d loss of the Algeria n oil as 'une operatio n blanche. ' Had the fund s bee n invested at a steady rate and draw n a 7 per cen t return , private or social (hospitals, schools , highways, etc.), it would have been wort h one third more i n 1972 . But that i s only a small part o f the rea l social cost . There has been substantia l French ai d to th e Algeria n economy an d French oi l prices have been amon g the highest i n Europe. Bu t the Frenc h insis t o n rose-colored glasses . A break-even operation i s viewed as economic. Hig h oil prices are aid to Algeria, loading French industr y with heavy cost s an d taxes that reduc e it s export capability, ar e viewed as a help to th e balanc e of payments . 27

M.A. Adelman Four months after Algeri a was written off , Iraq approache d Franc e a s soon as they seize d the Kirku k fiel d fro m Ira q Petroleum Company . Thei r experienc e ha d taught the m wh o wa s an easy mark. I n 1961 , they had seize d th e whol e IP C con cession outsid e o f field s actuall y producing, but althoug h th e expropriate d are a included th e great undeveloped Nort h Rumail a field nobody leased it. Then in 1967, afte r th e Six-Da y War, France obtaine d a large concessio n i n Ira q for ERAP , 'ratified wit h grea t pomp i n Baghdad (and haile d throughou t th e Middl e East) as a great victory over Anglo-America n imperialism.' The usually sober LeMonde was thrilled. Someone wa s needed 'wh o would no t flinch ' whe n IP C 'showe d thei r teeth,' someone 'capabl e o f braving the ange r of th e member s of IPC. ' Becaus e of France, the 'Anglo-American s [lose ] an y chance o f expansion int o th e hitherto unexplored part s of the country.' They hav e been outmaneuvered ; they canno t block Franc e fro m ' a plac e in the untouche d zone s of Ira q without provokin g a grave politica l crisis.' This is their just rewar d because 'on the morro w of th e las t war the y woul d no t le t Franc e int o the gam e in this region.' Having used North Rumail a a's bait t o tak e i n the French , Ira q dangled it before others, then decided t o develo p the field itself, with Russia n assistance. There wa s great annoyanc e in France, where doub t wa s expressed tha t Iraq wa s capable of developing the field . Bu t i n April 1972 , shipment s bega n i n the presenc e o f Mr Kosygin, exclaiming 'Arab oil to th e Arabs! ' By early 1971 , ERA P had foun d three field s wort h developing , whereupon Ira q demande d higher payments tha n in the contract . ERAP was willing to giv e more, but no t a s much a s demanded, and negotiation s dragged on. Predictably, the Frenc h blame d th e deadloc k o n th e machinations o f IPC , trying to bloc k thei r intrusion into wha t Le Monde calle d 'the private hunting preserve of the Anglo-Saxons. ' In June 1972 , whe n Ira q seized the Kirku k fiel d an d threatened price cutting, they 'preserve d Frenc h interest s in Iraq.' Surely, the y told newsmen, th e French ought t o be no more scrupulou s in Iraq tha n th e Americans , who had offere d t o do business with Algeri a after th e confiscatio n of French interest s there. France , said Le Monde, feare d a rejection of th e Ira q offer 'woul d harm it s prestige in th e Near Eas t and woul d b e take n a s a break with Gaullis t policy i n the region' ; while acceptance would allo w France t o 'serv e a s a bridge between th e Wes t and th e lef t wing regimes of th e Ara b world, a role whereb y she , alone , can hope t o counter balance the growin g Soviet influence. ' (Doe s th e Gaullis t policy hel p i n oil matters, or does Franc e accep t higher oi l cost s in order to keep the polic y going ? One wishes for somethin g intelligible. ) A few days later came a Soviet-Iraq agreemen t on economic cooperation . Thi s was no break in policy; th e Baghda d regime had lifted it s ban o n Communist politica l activity, and accepte d two Communist s in the government. But , of course, the greate r the Sovie t influence , the greate r the 28

The world oi l market need t o counterbalanc e it , hence th e more concession s would b e made to th e Baghdad regim e in oi l affairs . When the stron g man o f the Iraq i cabinet, Vice Premier Saddam Hussein , visited Paris in June, h e had a resounding success . The agreemen t with Franc e gav e CFP (the Frenc h partne r i n IPC ) 'une position privilegiee, ' which come s to this : CFP is obliged t o lif t it s ful l shar e o f Iraq oil for 1 0 years under th e sam e condition s as before th e nationalization : exactl y tha t long-ter m commitment whic h i t rejected a s too expensiv e when i t was a partner in IPC . Smal l wonder that CFP did not wan t thi s 'position privilegiee. ' The reaso n is simple - th e price i s too high ... ' France als o acquired th e 'right' to buy additional crude - whic h Ira q had just offered t o al l the worl d a t reduced prices . But France wil l buy no t a t reduce d bu t at 'commercia l prices,' i.e. higher tha n charge d an y knowledgeabl e arm's lengt h buyer wh o has alternatives. Penally, France wil l extend abou t $8 0 million of long-term credit s to Iraq . This, and futur e credits and grants, is an unacknowledged additio n t o th e price o f the oil . Thus the Frenc h hav e again been had, mos t royally , and by thei r ow n strenuous effort. Ho w are we to understan d this rigi d determinatio n that Franc e have 'its own' oil, whereby Franc e is humiliated an d cheated ? Two elements o f a n explanation ar e worth suggesting , because they ar e no t peculiar t o France . On e is the romanti c politica l aura surrounding oil, whic h let s all manner o f nonsense soun d plausible . 'Whateve r touche s o n oi l is at onc e adorned wit h romance . No other raw material stirs the imaginatio n like this one , nor th e tast e fo r flower y language,' wrote Edga r Faure i n 1938 . Anothe r ke y is to b e found i n such phrase s as 'oil-hungry France' or 'Franc e assure d o f oil needs,' etc. Similarly , in discussing Japan, Professo r Brzezinski speaks repeatedly of 'access to ra w materials' 17 as being so self-evident an d seriou s a problem tha t i t need no t b e explained. Yet th e onl y exampl e o f effective withholding , th e oil embargo of 1973 , ca n actually be viewed as a result o f the scrambl e for access . To pa y fo r 'access,' throug h highe r prices or otherwise, but t o be denied oil , makes n o sense , no matter how on e views the future : 1 Th e price o f crude oil, set by a world monopoly , i s many time s more tha n enough t o mak e i t worthwhile t o expan d output . Therefore , eve n if price declines and especiall y i f it rises , there wil l always be more crud e oil available tha n ca n b e sold, a s there is now an d has alway s been. 2 Assum e the contrary : tha t oi l is becoming increasingly scarce in physical terms , and tha t th e pric e will reac h $5 , $10 , o r whatever. At this price, the marke t is cleared, and just as with a monopolized market , anyone who ca n pay th e pric e gets all he wants . 3 Ther e i s real fear , exploited bu t no t create d b y the u s government , that mas 29

M.A. Adelma n sive American oi l and ga s imports will somehow preclud e buyers from othe r countries, especially if the producin g nations take the advic e to limit output . Let us assume they do so . Then lower-cos t and more profitabl e companies will outbid their rival s for the limite d supply . Japanese iron an d steel companies , for example, ar e obviously much lower-cos t than thei r America n rivals. If so , at exchange rates which overvalu e th e dollar , high oi l prices would have harmed thi s country mor e tha n others . One solution has been to devalu e the dollar. 4 On e often-expresse d fear i s that th e America n multinational companies will divert supplie s to America n customers in preference t o non-American . But if there is some constrain t such tha t bot h groups cannot be full y supplied , then th e price mus t rise . To imagine American companies deliberately holding dow n th e price, in order to precipitat e a shortage, in order t o b e able to discriminate , is fantasy. They woul d no t wis h to d o it, and their masters the producing nations would not allo w it. 5 Th e OPE C nations may wish to den y oi l to som e particula r country. Thi s would be a single country selectiv e embargo differen t fro m th e embarg o o f 197 3 whic h involved a concerted shutdow n with differential stringencie s applied to , fo r example, the American s and the Dutch . Bu t if some o r even most o f them do so, the capacity o f others will be available , and a t most ther e will be a reshuffling o f customers. Ye t let us now assum e that al l OPEC nations unite t o boycott on e country. The y mus t als o prevent diversion of supplies of crude oil and products from othe r consumin g countrie s to th e victim. Yet nobody has suggested why the OPE C nations should join i n this profitless persecution. Moreover, non-OFEC oil is plentiful relative to a single consuming country' s needs. 6 Eve n if all the foregoin g is incorrect, and 'access ' is a real problem, it i s useless to try t o obtai n acces s through a company owne d b y th e consumin g nation, sinc e real power is in the producin g nation . The obsession with a false proble m of 'access to oil ' wastes time an d distracts attention fro m the rea l problem o f security o f supply. The old or new multinational companie s ca n do nothing goo d o r bad fo r security because they have no control o f supply, n o power to cu t of f anybody o r to protec t the m fro m cutoff . Nobody own s oil at th e wellhead o r underground reserves any more excep t th e governments who have th e physica l forc e above ground. A LO O K A H B A D

As evidenced by th e event s of 1973 , oi l supply i s threatened b y on e and onl y on e danger: a concerted shutdown b y th e OPE C nations. N o singl e nation ca n do any harm. The rhetorical questio n 'Woul d you lik e to se e Saudi Arabia supply one third of the oil?' is only marginally relevant. The fewer the sellers and the large r 30

The worl d oi l market their marke t shares , the easie r for the m t o collaborat e an d act a s one. The central question i s their union o r disunion . If a single large selle r breaks away, or a few minor ones , the carte l breaks down i n a stampede for th e exit . Th e cartel i s onl y needed, onl y exists , to thwar t th e basic conditio n o f massive potential exces s capacity - abilit y to expand outpu t a t costs belo w price s - and prevent it fro m becoming actual . Hence lower prices and secur e supply ar e the tw o side s of the sam e coin : ab sence o f monopoly, o r impotence o f disunion . The monopol y ma y still have its finest hours before it, an d prices should ris e well into th e decade . The fewe r the seller s the better , and there wil l presently be fewer Persia n Gulf states. Most of the m hav e to o fe w men, and stuffin g the m ful l of money make s the m wort h occupying . A decade ago , Iraq claimed Kuwait, and was only stoppe d b y the threa t o f force: th e Britis h presence, no w gone. Ira q will be all the mor e read y t o occup y Kuwai t if Iran occupies the Kirku k area , site of the grea t oil field just expropriated . The local peopl e ar e not Arab s but Kurds , Indo-European i n language and Sunnit e Moslem in religion, like th e Iranians . If they behave d themselve s the Irania n army might b e hailed a s liberators fro m th e chronic blood y struggl e with th e Baghda d regime. A new pipeline t o th e Mediterranean coul d g o through Ira n and-Turkey . The importan t consumin g countries even now in 197 4 show n o sig n of understanding thei r plight . Th e situation i s the sam e a s in mid-1972 when th e conven tional wisdo m held tha t 'Europea n nations are believed to b e concerned tha t another stalemat e [o n "participation"] coul d impai r vitally needed oi l supplies ... The companies ar e under considerabl e pressure to reac h an agreement.' 18 Also, the large consumer countrie s have export interest s which wil l benefit b y the higher oi l prices because o f oi l nations' greate r purchasing power. Expor t in dustries ofte n have disproportionat e politica l power, even if the rea l economic benefit t o th e nation , i.e . higher income s t o labo r and capital than fro m th e nex t best alternatives , are piddling compared t o th e outflo w on oil . Europe is rapidly becoming a n important oi l producer. Som e Europea n coun tries will become smal l net importers , some wil l be large net oi l sellers. The hea d of Norsk Hydro oi l operations recentl y noted Norway' s 'economi c interest i n high prices.' He recognized tha t th e OPE C gains 'were forced throug h by threat s of a boycott,' Instead o f maundering about 'politica l stability,' he define d it : 'firs t and foremos t a political syste m under which agreement s an d terms o f licenses are respected eve n if the circumstance s may have change d .. . [an d under which ] every one .. . feels secur e that suppl y wil l be maintained i n all circumstances.' It was an indirect but devastatin g comment o n America n policy . The less-developed nations will suffer th e most , wit h n o offsets . Fo r example , India today consumes about 15 0 million barrels pe r year, and is expected to use 31

M.A. Adelma n TABLE 2 Approximate OPEC revenues , 1972

Area

Estimated 1972 output (Bb)*

Persian Gulf Libya, Algeria Nigeria Venezuela Indonesia

6.50 1.20 0.63 1.10 0.37

Total

Per-barrel revenuest 1.42 2.14 1.85 1.61

1.50

Total revenues ($ billions) 9.2 2.6

1.2 1.8 0.5

15.3

* Outpu t assume d at sam e rate as first quarte r 1972 T Petroleum Intelligence Weekly: Persia n Gulf, 1 4 February 1972 ; Libya, Algeria, 1 5 May 1972; Nigeria, 3 May 1971 , and 3 July 1972 ; Venezuela, 27 December 1971 ; Indonesia, rough guess

about 34 5 i n 1980 . The burden o f monopoly pricin g is direct (payin g highe r prices for imports) an d indirect (bein g force d t o fin d an d produce higher-cos t domestic oil) . I t amount s to a substantial sum per year, an d is increasing rapidly. Yet a t th e 197 2 UNCTA D meeting ther e was no breat h of criticism o f th e oil-pro ducing nations. Solidarity prevailed : things were fel t t o b e going well 'on the oil front,' and , sai d LeMonde, th e same ough t t o happen on other fronts . This favorabl e public attitude also holds i n the develope d countries . A private monopoly which extracte d billion s per year fro m consumers would be denounce d and probably destroyed ; were they American , some executive s woul d be in jail. An intergovernmental monopol y 1 0 times a s big is viewed as a bit o f redres s by the Thir d World. Now one may approve thi s double standard , or deplore it , or laugh t o kee p from crying , but i t is a truth with consequences: n o important resistanc e seems likely i n the nea r term. I n time , attitudes may change . 1 Th e fictitiou s 'worl d energ y crisis' will gradually fade as it di d afte r 1957 , an d the slo w growth o f understanding of oi l prices will resume. This influenc e is minor but no t negligible . 2 I n 1972 , the transfe r fro m consumin g t o th e OPE C nations was about $1 5 billion (see Table 2) . If the tax onl y doubles (and th e pric e i s therefore about $3.35 ) and if output increase s by 8 per cent pe r year, then th e 198 0 transfe r will be over $5 6 billion pe r year. This is a very conservative forecast as compared wit h thos e of th e Departments o f State o r Commerce as cited earlier. It now may be to o low .

32

The world oi l market 3 Som e o f the billion s will be spen t i n ways some consumin g countrie s fin d irksome o r dangerous . Th e large amounts pai d t o Liby a have already cost the NAT O nations additional payments t o Malta, for which M r Mintoff could no t hav e bargained without Libya n help. Payments to th e producing nation s will increase over the years 1973-80 . If these nation s spend, say, three-fourths on goods and service s from abroa d an d save 25 per cent b y buying foreig n assets, the addition s to thei r holdings will be enormous. Th e oi l companies see themselves as the decentl y paid investment managers for this fund; as Schumpeter said , 'This is the way th e bourgeoi s min d works, alway s will work, even in sight o f the hangman' s rope. ' 4 Ther e wil l be monetar y disorder s when larg e holders speculate against a particular currency. Unlike the oil market, where th e producin g countries must ac t in concert o r accomplish nothing, even a single nation wit h big enough foreig n balances can do substantia l damage to th e world monetary system , or try t o bring down a government it dislikes. 5 Securit y o f supply ha s been severel y impaired by th e Paris capitulation an d the great succes s of the embargo . 'Concerted action' has become a reality. Security o f supply - limite d bu t genuine - can be had by stockpiling, combine d with detailed plan s for sever e rationing supplemente d b y high excise taxes , to reduce oi l consumption an d thereb y increas e the effectiv e siz e o f the stockpile . Th e expense wil l be heavy (but ha d th e consumin g countries don e thi s years ago, they would have made large savings). The larger the reserve s piled up by th e OPE C nations , the greate r their power t o withhold oil . Hence th e higher th e price , and the greater the insecurity , th e easie r for th e OPE C nation s to make i t stil l more expensiv e and insecure . The consumin g countries can have cheapness an d security onl y b y a clean break with th e past : ge t the multinationa l oil companies ou t o f crude oil marketing; let the m remai n as producers unde r contract an d as buyers of crud e to transport , refine, an d sel l as products. Th e real owners, the producing nations, must the n assum e the rol e of sellers and they shoul d b e assisted i n competing th e pric e of crude oil down. Th e Yamani prescriptio n wil l be as sound the n as in 1968 , o r 1971 , or 1972 . It i s a simple and elegant maneuver to destro y th e carte l by removin g an essential par t - th e multinational compan y a s crude oil marketers fixing the price o n a firm excise tax floor . But thi s would onl y minimiz e conflict an d confrontation ; it is too lat e to avoi d them . Th e producing countries, like many raw troops, have been welde d by succes s into a real force, and th e huge sums they receiv e and accumulate wil l be both the incentive and the means to fight , by embargo, monetar y disruption, o r even local wars. There wil l be non-negligible damage. To have pu t the power an d the motiv e int o the producers' hand s wa s light-minded foll y by the America n government . 33

M.A. Adelman Moreover, clean breaks with past policy ar e rare. The honest confessio n of error is less likely tha n ange r at the cartel' s local agents , the multinationa l companies , and attempts to restric t and penalize them. Yet thi s misconception i s exactly what has led to pas t mistakes. Bypassing the companie s to make direct deals with producing nations can be helpful onl y whe n th e objectiv e is clearly seen: t o mobilize national buying power, encourage domestic oil buyers to avoi d establishe d channels, and help compet e price s down. Usually such deal s sacrifice al l buying independence in a vain attempt t o ge t a good 'connection, ' or placat e a producing nation, an d only rais e costs . The greatest difficulty i n following the Yaman i formula is the nee d fo r th e leading consuming countries to ac t together. Fo r example , the United States ta x law might recognize , either by statute o r judicial decision , that the 'income ' taxe s paid t o OPE C nations were really excise taxes , hence no t deductibl e from us in come tax . Highe r taxes couple d with the unceasing demands of the OPE C countries might well push one or more of these companie s past patience or profit , and they woul d withdraw to becom e contractor s or buyers, helping to undermine the cartel . Yet toda y othe r larg e consuming countries would scrambl e to get one o f their companies into th e empty slot , and promise anythin g to th e producing nation. Hence it would b e literally worse than useles s for the Unite d States t o tak e th e first steps , without fir m assurance s from a t least France , Germany, Italy, and Japan, that the y would not tr y t o replac e the America n company. Thes e coun tries are still obsessed with vai n notions o f getting 'access' or 'security ' throug h their ow n companies, and the suggestio n that the y refrai n fro m takin g thei r 'jus t share,' and ending their long-resented 'exclusion' from 'th e game,' seems an obvious attempt t o help th e America n companies keep their predominance. It is an old sad story. I f one looks for th e 'rea l motives,' one will never hear what i s being said. CONCLUSIONS A settlement o f quarrels among Arab s or with Israel promises nothing for securit y of supply because there i s no logical relatio n between th e tw o issues . The threa t brought huge profits, an d promises even greater profits; nothing that migh t hap pen in Middle East politics provides the slightes t reason to withdra w the threa t and give up th e presen t or futur e gains . The consuming countries have been meek an d tame because, as pointed ou t earlier , they ar e pulled tw o ways on prices, but the y ar e worried about th e threa t o f short-run physical scarcit y an d scared by th e possibl e need of physical rationing . This will drive them t o stock pile, which i s expensive; a desire to lesse n the burden will make them conside r 34

The world oi l market counteraction. Progres s in this direction wil l be slow, and the nee d t o exclud e th e United State s (and perhap s also Great Britai n and the Netherlands ) fro m thei r councils will make i t eve n slower . Second, a s the producin g nations get directly involve d in the marke t a s sellers, with real cost no t tax-plus-cos t a s the pric e floor, consuming-country govern ments will find i t tempting t o dea l directl y wit h producin g nations a t discriminatory lo w prices. Som e governments ' producing ventures in nuclear energy, oil, gas, etc. may in time tur n ou t s o badly a s to b e past disguising , and they may move to th e simpl e objectiv e of minimizing th e rea l and foreign-exchange cost of energy. If one large country o r a few small ones di d s o during the remainde r of the 1970s , it would dovetai l with th e effor t o f one or more producin g countries to gain more outpu t eve n at lower prices. A lower world pric e would have only a transitory effec t o n the profit s of American companies, who sel l the greater part of world-market oil. Government s have take n nearl y all the oi l production profit s (over an d above th e incompres sible minimum return on investment) ; henceforth i t will fluctuate irregularly . This return is subject t o considerabl e margin for error, and will lead t o disagree able confrontations and perhap s som e expulsions . Pric e reductions will com e from governments ' share , not fro m th e companies' . The predictions mad e thes e days about chea p energ y gone fo r good, higher prices on the way , etc. wil l in my opinion b e a s right an d a s wrong in the 1970 s as in the 1950s . Unless consuming-country government s sponsor a n oil analogue to th e international coffee agreement , we must expec t a n overabundance of oil outside th e United States , and a declining market pric e - eve n though it will be declining fro m a very high level . Governments will resist this strongly, perhaps violently. With strong conflicting forces thus building up, an d exerted mor e tha n ever through politica l bodies, th e resul t becomes too unstabl e to predict . The multinational companie s will probably surviv e the crisis . Yet ther e i s a real danger that the y wil l be force d out o f crude oil production. Thi s would be a grievous waste of resources and coul d precipitat e a genuine shortage o f crud e oil . What happens t o oi l in the 1970 s depends altogether o n the consumin g countries. If they ar e as slow to lear n as they hav e been, then th e projectio n o f $5 5 billion annual tribute pai d th e OPE C nations by 198 0 will be surpassed. But they may als o learn that transferrin g those billion s is not onl y dangerou s but unneces sary. Their energ y economics woul d need t o b e updated a t least t o 1952 , whe n the Paley Commission explained that shortag e means only cost ; they might the n see that th e 'worl d energy shortage' is a myth, that crud e oil continues in oversupply, a s the Venezuelans, the Iraqis , and th e Saud i Arabs have recognized. And the consumin g nations' strategi c thinking would nee d t o be updated a t least t o 1914, when Winston Churchill, who wa s then a young fox, no t a n old lion, ex35

M.A. Adelman plained t o th e Hous e of Commons that acces s to oi l is only a special cas e of monopoly; the power to withhold is the power to overcharge. 19 APPENDIX: FRO M TH E TIM E MACHIN E

[The followin g document wa s retrieved from a trip i n a Time Machine. Unfortunately, th e letterhead an d date ar e missing, and there is no identification o f th e writer or addressee, but the text is almost completel y legible . - The Author] [Editors' note: A version of this document originall y appeare d in M.A. Adelman's book, The World Petroleum Market. W e have edited i t slightly, but th e principles it illustrates ar e unchanged, an d changeless.] As you ar e aware, the u s Federa l Energy Agency has tentatively authorize d increased oi l imports into that countr y i f long-term contracts can be negotiated o n terms that are favorable relativ e to th e cos t o f alternative sources . This coul d mean an increase of 3 million barrels daily ove r and above the curren t rate. Our country an d others have therefore been approache d b y a number of American refiners, who are actively seeking the best term s on which the y coul d bu y very large amounts o f crude oil under long-term contracts. I t is obviously a n attractive prospect, bu t ha s raised a problem which calls for immediate decision . The Alpha Petroleu m Corporation of New York an d Houston ha s put i n a firm bid fo r half a million barrels daily, delivery to begi n on a smaller scal e but esca lating up to tha t figur e ove r 30 months. Ou r own contractor compan y ha s estimated tha t they would nee d t o dril l 50 new wells, half o f them i n sites already chosen, an d the othe r hal f eithe r by close r drilling or in some pools discovered earlier but no t altogethe r delimited . No exploratory drillin g is needed. Since the comprehensive contract revisio n of [illegibl e - probabl y a date] whereby th e concessio n wa s formally changed to a service contract, ou r con tractor has been paid his operating expenses plu s enough to retur n him 20 per cent pe r year on a discounted-cash-flow basis . We have had his estimates audited, and can confirm tha t the per-barre l payment whic h would be due him o n thi s new project would be a relatively small fraction of the weighte d average price of our oi l now being delivered under existing long-term contracts . The cos t estimates are uncertain within limits, depending on som e drillin g estimates which canno t b e altogether precise , but ther e ca n be no doubt tha t a t current price levels costs will be an even smaller fraction of revenue s than pas t experience would indicate . At the curren t long-term contract pric e for the state d grad e of oil, which ha s recently hit a new high in terms of dollars per barrel for new contracts, th e ne t retur n to our national treasur y would be hundreds of millions - perhap s a billion - o f dollars per year. 36

The world oi l market The problem is that Alph a is offering a price per barrel that is slightly less than the price s that we know have been contained i n recent contract s executed her e and elsewhere . Alpha allege s that the y have received an offer belo w th e goin g price, for oil of admittedly slightl y highe r quality , fro m [illegible] . The ambassador o f that country has denied an y such offer , an d s o has their ministe r of Petroleum. Ou r problem is whom to believe . In our opinion , Alph a is telling the truth. Their reputatio n i s excellent, while th e ministe r in question ha s not bee n candid with us in the past - you are familiar wit h the matter - an d we consider him hostile to ou r government and nation. The y would like us to let the goo d bids pass by. A s you know , his government still works with a form of the ol d participation syste m where the oil-producin g company stil l sells the oi l and pay s taxes, instead of the mor e modern contrac t syste m i n force here , where title t o the oi l remains in the natio n a t al l times until fina l sale , and the contracto r is paid fo r the servic e of development an d production. Th e differenc e betwee n th e prices we know the y ar e receiving and current tax rat e in their countr y i s such that thei r operatin g company's costs, reckone d o n the sam e basis as ours, cannot possibly b e low enough t o accoun t fo r the discoun t they ar e reported t o b e offer ing. There mus t b e a price shading agreement between their government and th e company; the government has agreed to tak e a lower tax rat e on thi s sale, in order t o permi t th e compan y t o quot e th e lower price. This agrees with th e account which we have obtained fro m ou r usual and hitherto reliable source, whom yo u know. The Alph a bid would brin g us somewhat les s per year than wha t w e would have at th e curren t price. But in seeking the incrementa l revenue associated with getting the price we think we are entitled t o - instea d of Alpha's offer - we seem to be endangering the whol e deal , since it is our judgment that Alph a will get th e offer fro m others . The smal l price reduction does not endange r the revenue s we receive under existing contracts. Furthermore, i f we close the dea l quickly, we may be able t o persuad e Alpha t o increas e the amoun t to a s much a s a million barrels daily, since we have made some rathe r careful estimate s of the requirements of their Europea n and Japanese subsidiaries, and of the patter n o f their production, muc h of it fro m mor e expensive sources. We know that Alpha' s incremental North America n supply i s from oi l shale, tar sand s and syntheti c sources with costs abou t equa l to th e curren t world price (after freigh t netbacks) , but ou r rea l competition fo r this contract is [illegible ] and the discoun t w e believe that they are offering . We therefore recommend: tha t Alph a be asked to pa y onl y fiv e pe r cen t pe r barrel below the goin g market price, and i f they persis t in demanding a ten pe r cent pe r barrel discount to match others ' offers , w e then propos e tha t th e contract b e for 750,000 barrels daily, if need be over a longer buildup period tha n 37

M.A. Adelman 30 months. But if necessary, we should take the origina l terms of 500,000 dail y at a ten pe r cent discount. NOTES Except as stated, this paper draws on M.A . Adelman's Th e World Petroleum Market (Baltimore : Johns Hopkin s for Resource s for th e Future , 1972 ) and M.A. Adelman, 'Is the oi l shortage real ? Oil companies as OPEC tax-collectors,' Foreign Policy, no. 9 , January 1973 , pp. 76-11 4 1 Zeno n S . Zannetos, Th e Theory o f Oi l Tankship Rates (Cambridge : MIT Press, 1966); and Th e World Petroleum Market, chap . IV 2 Th e Sue z Canal is no longe r relevant, since it canno t b e used b y ship s ove r 60,000 tons. This woul d entail to o hig h a cost eve n with th e savin g in time. I t is unlikely tha t th e cana l will ever b e deepene d or widened enough t o tak e VLCCS.

3 M.A . Adelman, 'Oil Production Cost s in Fou r Areas, ' Proceedings o f th e Council on Economics of A.I.M.E. 1966 (Ne w York, AIME , 1966 ) 4 Th e most recen t compariso n wa s for th e en d o f 1961 , when Persian Gul f oilin-place was four times the prove d reserves. P.O. Torrey, C.L . Moore, and G.H . Weber, in Proceedings Sixth World Petroleum Congress, Sec. VIII , Paper 9 . A t that time , there wer e 45 field s identified; by th e en d o f 1969 , 20 more field s were producing, thoug h thei r reserve s are unknown. Oil & Gas Journal, 2 9 December 1969 . Th e estimates mad e above, of th e potentia l fo r more reserve s in known fields , would see m t o b e conservative . 5 M y publications summarize d are: 'Le s Prix Petroliers a Long Terme,' Revu e de 1'Institut Franc.ai s du Petrole, December 1963 ; (trans.) 'Oi l Prices in th e Long Run,' Journal o f Business o f th e University o f Chicago, April 1964 . Price evolution: se e chap. VI, Appendix of Th e World Petroleum Market, Resources for th e Future, 1972 . Supply cut-off: Governmen t Interventio n in the Pric e Mechanism . Hearings before th e Subcommitte e o n Antitrus t an d Monopoly o f th e Committe e o n th e Judiciary , p. 17 . US Senate, 91s t Congress . 1st Session , 1969 . 6 Growt h rates and pric e trends : Th e World Petroleum Market, chap , vill; BP Statistical Revie w o f the Worl d Petroleu m Industry ; Petroleum Press Service, June 1972 , p . 222 . Quotatio n fro m Presentatio n t o a meeting of financial analysts in Tokyo on Friday , 1 2 May 1972 , by F.S . McFadzean , Managin g Director o f Shell . 7 M.A . Adelman, The Present and Future State o f th e World Oi l Industry (Japanese translation) (Petroleu m Association o f Japan, 1965) , pp. 11-33 ,

38

The world oi l market and WPM , chap, n; also National Petroleum Counci l U S Energy Outlook, vol . 1(1971), pp. 41-5 3 8 Ta x i s calculated as follows: output multiplie d by poste d price s equals fictional 'receipts. ' Production cost s ar e subtracted, and however calculated they are very small . The differenc e i s the fictiona l 'profit,' whic h goe s usually 5 5 per cen t t o th e nation . Thus th e ta x pe r barre l is completely independen t of actual receipts, and onl y ver y slightly affecte d b y costs , hence almos t com pletely independen t o f profits. Therefore i t i s an almos t pur e excise tax. 9 Neithe r the New York Times no r th e Wall Street Journal, in their storie s o n the subjec t (14 , 17 , 1 9 January 1971 ) had an y reference to an y retaliation or concerted actio n o n th e proposal . 10 Th e concessio n compan y an d hos t governmen t need t o determin e fou r items : (a) The government owe s the concessionair e a certain sum per year t o cove r the amortize d cost o f th e equit y share , (b) The governmen t loses th e taxe s it formerly receive d on th e shar e it now 'owns. ' (c) The concessionair e owe s the government th e 'price ' of the oi l which th e governmen t owns, and whic h it now 'sells ' to th e company , (d) The concessionaire owe s th e government its prorata share o f th e year' s profit s of th e operatin g company. The subject of the negotiatio n i s by wha t amoun t ( c + d) shall exceed (a + b). Th e 9 cent estimate i s from Petroleu m Pres s Service , April 1972 , p. 118 . 11 D r M.S. Al-Mahdi, chief o f th e Economi c Department of OPEC , in a paper partly summarize d in Middl e Eas t Economic Survey , 14 July 1972 , p. 11 , estimates the 197 0 Western Europe averag e consumer pric e a s $13.14, of which 57. 3 pe r cent wa s tax. Se e also: Direction des Carburants: Rapport Annuel 1969 . Italia n collaboration: Petroleum Intelligence Weekly, 2 4 May 1971. 12 Petroleum Press Service, February 1972 , pp. 5 3 an d 64 , notes tha t Algeria and Liby a have shaved prices to mov e product. 13 Se e The World Petroleum Market, chap , vm, note 32 , fo r th e calculation 14 Wall Street Journal, 2 0 Februar y 195 7 (th e Stat e Departmen t thought a pipeline through Ira q woul d be preferable) and Platt's Oilgram News Service, 22 April 196 8 15 Secretar y o f Commerc e Peterson, i n th e New York Times, 2 0 June 1972 , p . 51, estimate s th e America n balance of payment s deficit o n oi l account a s $26 billion a year in 198 0 i f imports ar e 4.38 billio n barrels. This implies $5.9 4 per barrel delivered, hence probabl y abou t th e sam e $ 5 per barre l fo b a t which Stat e aims . 16 Se e Th e World Petroleum Market, chap . VII 17 Zbignie w Brzezinski, The Fragile Blossom: Crisis and Change in Japan (1972) ,

39

M.A. Adelman pp. 46-7, 71 . Injustice t o Professo r Brzezinski, one should note tha t h e slides quickly fro m 'access ' to 'price ' which is the onl y real problem. 18 A.P . dispatch in International Herald Tribune, 19-2 0 Augus t 1972 19 Se e J.E. Hartshorn, Oil Companies and Governments (196 7 ed.), pp. 255-6 0

40

P A R T ON E

The Actors

The oil-producin g countrie s o f th e Middle East an d Nort h Afric a ar e clearly the key to an y short-run solutio n t o the energ y crisis . First, by raisin g prices through taxe s based on 'poste d prices, ' then b y actuall y cutting supplies t o countries friendly wit h Israel, these procedures have clearl y indicate d a desire t o gathe r monopoly rents , eithe r in pur e dollars or in other ways, from their oi l reserves. Crandall details th e reserve s and pro duction in each o f th e man y countrie s which ar e commonly calle d th e Middle East. Both reserves and production have been increasin g rapidl y unti l ver y re cently. Betwee n th e firs t quarte r o f 1972 an d 197 3 output i n Saudi Arabia, Iran, Ab u Dhabi , an d Duba i rose b y amounts rangin g fro m 2 3 t o 6 7 pe r cent. The tren d i n total oil reserves and production i s strikingly upwards, destroying the myt h of long-term scarcity of energy.

The formatio n o f OPE C is analyzed as is its minor role until 1970 . Th e great succes s of OPE C since 197 0 is laid squarely a t th e fee t o f th e multinationa l oil companies who allowe d themselve s to b e whipsawed into price increases . When th e tim e came for th e oi l company carte l t o hold together , there was little incentive for it t o d o so . Crandall explains why thi s happened. The con cluding remarks suggest that th e divergence o f interest s among Middle East and Nort h Africa n countries , th e na tionalization o f companie s in Libya, and suggeste d action o n th e par t o f consuming countries , largel y th e Unite d States, wil l lead t o decreased price s fo r oil in the lon g run. This pape r should b e read togethe r with th e paper s by Mabro , Pearson, and Steele , all in this volume, and b y Erickson & Spann in the Nort h Ameri can volume. It wa s written i n midOctober 1973 .

MAUREEN S . CRANDAL L

Oil in the Middle East and North Afric a

To most peopl e i n the oil-consumin g countries, the phras e 'energy crisis' evokes dire images of gasoline rationing and of lack of residential and commercia l power . But the phras e brings to min d as well a fear tha t th e majo r petroleum producer s of the Middl e East an d North Afric a ma y well have the economi c an d politica l ability t o den y all oil supplies at will to Western Europe, the Unite d States, and Japan. The United States consume s more tha n one-thir d of the fre e world' s annual output o f petroleum an d is the larges t importer o f oil and oil products. I n 197 2 it importe d more tha n 4. 7 millio n barrels a day (mbd), or close to 3 0 pe r cent of its consumption o f 15. 9 mbd (a barrel contains 4 2 us gallons) . Just unde r half these import s came in the for m o f crude oil, the rest a s products. Currently most us import s come fro m Canada and from other Wester n Hemisphere sources, bu t 15 per cent o f them originate in the Middl e East an d North Africa. Japan use s only 1 0 per cent o f the world' s energy, but i t imports 8 5 per cent o f its demand, and satisfie s 62 pe r cent o f this demand from Middle Eastern and Nort h African sources. Europe is also dependent upon thes e source s for over 80 pe r cen t o f its petroleum needs . The United States has long been an d still is the world' s larges t producer of crude oil . At 9. 5 mb d o f crude oil in 197 2 (an d 1. 7 mbd o f natural gas liquids), its output exceede d tha t o f Saudi Arabia, which ha s the fre e world' s largest reserves and produce d 5. 7 mb d i n 1972 . Prediction s for 197 3 suggest , however, that u s outpu t will fall b y over 2 per cent, 1 while Saud i Arabian production o f crude oi l will rise above 7 mbd, perhaps as high as 8 mbd. Within the nex t fe w

Maureen S . Crandall years, Saudi Arabia is expected t o replac e th e u s a s the world' s larges t petroleum producing nation . Clearly the deman d fo r energy in the developin g countries wil l continue t o rise over the foreseeabl e future. A s less developed countrie s continu e t o gro w and industrialize, their energ y needs, particularly their petroleu m demands , wil l grow at a rate much faste r tha n th e annua l percentage increases in the deman d o f th e developed nations . Al l buyers have been activel y looking fo r additiona l oi l reserves outside th e Middl e East and Nort h Africa , but thos e area s will continu e to be the cente r o f petroleum outpu t an d sales for some tim e t o come . The oi l nations of th e Persia n Gulf and Nort h Afric a ar e a diverse group i n terms o f the relativ e size of their deposits , their populations , thei r politica l align ments, thei r religiou s affiliations, an d thei r state s o f economic development . What they have in common i s oil, and a n interest i n the mos t profitabl e exploitation of those oil resources. It is this latter commonalit y o f interest which wa s the basis for th e foundin g of the Organizatio n of Petroleum Exportin g Countries, generally known a s OPEC (see sectio n 3) . Members of OPEC in North Afric a an d the Middl e East ar e Libya an d Algeri a the major producing countries in North Afric a - an d the Persian Gulf state s of Iran, Iraq, Kuwait, Saudi Arabia, Qatar, and Ab u Dhabi. 2 Originally characterized a s an intergovernmental organization which 'ha s essentially reacted t o changes that have taken plac e .. . [with ] littl e rol e in bringing them about,' 3 the event s of 197 1 and thereafte r have show n OPEC' S abilit y to wi n additional per-barrel ta x payments an d other arrangement s much mor e favorabl e to it s members than ha d been imagine d at its inception i n 1960 . The questio n fo r th e futur e i s what wil l be th e rol e and th e powe r o f OPE C members if the demand s fo r petroleum b y consumin g nation s continu e t o be directed towar d outpu t fro m thi s region. It i s the vie w of thi s author tha t OPE C is indeed a powerful group , but a s production continue s t o expan d i n the Middle East and Nort h Africa , downwar d pressure may be put o n price i f the consumin g countries, particularl y the United States, urge the internationa l oi l companies t o take a strong stance i n future negotiations . 1 TH E M A R K E T FO R OI L

United State s deman d for petroleu m product s an d crud e oil for 197 3 i s expected to b e at least 6 per cent abov e the level of 1972 , an d so to reac h 17. 5 mbd, while domestic u s outpu t i s projected at just ove r 1 1 mbd, o f which 9. 2 mb d wil l be crude oil. 4 Imports of both crude an d refined products wil l make u p th e differ ence, with 197 3 import s of crude oi l rising from 197 2 level s by 31. 5 pe r cen t to 2.9 mbd an d imports o f refined product s up by 28. 9 pe r cent t o 3. 2 mbd. 5 44

Oil in the Middl e East an d Nort h Afric a While imports o f refined products clearl y cove r a variety of goods fro m heav y fuel oil s to gasolines, it should b e noted tha t crud e oils themselves ar e by n o means homogeneous goods . Crud e oils may be distinguished by weigh t a s measured in degrees of gravity, according to th e standar d America n Petroleum Insti tute (API ) scale. This scale , used al l over the world , is linked t o th e specifi c gravity of water, which i s equal t o 1 . For example , a heavy oi l with a specific gravity of 0.904 is defined a s 25° API. In general, light oil s are those with API degree gravities of approximately 34°(specifi c gravity of 0.855) or more, whereas heavy oil s have AP I gravities near 30 ° (specific gravity of 0.876) or lower. Relatively heavy oil s are characterized by a high sulfu r content , wherea s light oil s are generally low i n sulfu r bu t hig h i n wax components. I f delivered prices of both types o f oil were identical i n the United States , ligh t oil s woul d be preferred , since man y user s must compl y wit h air pollution regulation s limit ing the amoun t o f sulfu r conten t i n crude oil. Although th e wa x componen t must als o be removed fro m low-sulfu r oil , thi s proces s is much les s costly tha n the method s use d to desulfuriz e heavy crud e oil in order to mee t th e ai r standards. Predictions sugges t that the presen t 6 mbd level of imports o f both crude oil and product s coul d ris e to 1 2 mbd b y 198 0 an d to 1 7 mbd b y 1985. 6 As recently as 1970 , th e u s Cabine t Task Force 7 estimated total us deman d fo r 198 0 a t 18. 5 mbd; it is now thought tha t thi s deman d wil l be reached b y the end o f 1973 , an d by 198 0 demand wil l be close t o 2 5 mbd. Currentl y the u s i s importing primarily from Canad a and Venezuela (1.1 mbd), bu t 1 5 per cent o f us import s come fro m the Middl e East and Nort h Afric a (0.9 7 mbd). 8 By 1980 o r 198 5 i t i s expected that import s wil l be required to satisf y 5 0 per cent o f total u s deman d an d that as much a s two-thirds o f these ma y com e fro m the Middl e East an d Nort h Africa , with th e remainde r coming fro m th e Western Hemisphere. I f accurate, these fore casts mean tha t th e u s i n 198 0 ma y be demanding about 2 5 mbd with hal f com ing from what i t regard s as 'unstable' supplyin g areas - th e Persian Gul f and North Africa . The gap between th e rat e o f growth i n demand and domesti c suppl y i n th e future i s expected t o b e even greater for Western Europe an d Japan, fo r thes e areas contain ver y small petroleum deposits . Althoug h th e estimates concernin g future annua l growth rate s in demand fo r petroleu m unti l 198 5 o r later vary for both the u s an d other area s of the world , most ar e predicting an annual rate of change in demand o f above 6 or 7 per cent in the next 1 5 years, dropping t o around 6 per cent thereafte r until th e end o f the centur y a s alternative sources of energy, such a s nuclear power, become mor e widespread . North Afric a an d th e Middl e East contain th e largest known world oi l reserves, totalling ove r 405 billio n barrels (Bb) o r about 6 0 per cent o f the world' s proved 45

TABLE 1 Reserves and productio n o f majo r petroleum-producin g countries

Country

Reserves (1/1/73) (Bb)

Abu Dhab i Bahrain Dubai Iran Iraq Kuwait Neutral Zon e Oman Qatar Saudi Arabia

20.8 .375 2.0 65.0 29.0 64.9 16.0 5.0 7.0 138.0

Libya Algeria United State s Canada

Production mbd

Selected forecast s mbd

1971

1972

1973 197

1.05 .072 .130 5.050 1.455 3.000 .565 .280 .485 5.735

1.3

3.845 1.565 2.735 .505 .330 .370 3.550

.935 .075 .125 4.565 1.700 2.925 .545 .285 .430 4.500

3.110 .955

3.320 1.040

2.765 .780

2.210 1.110

9.240 1.310

9.635 1.475

9.465 1.585

9.450 1.835

1968

1969

1970

.500

.600

.695

2.850 1.510 2.420 .425 .235 .340 2.830

3.375 1.525 2.575 .450 .330 .355 2.995

30.4 47.0*

2.600 .915

36.8 10.2

9.095 1.195