THE OIL MARKET OUTLOOK THROUGH 1985

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00283R000700040009-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 22
• Document Creation Date: December 21, 2016
• Document Release Date: February 6, 2009
• Sequence Number: 9
• Publication Date: February 1, 1984
• Content Type: REPORT

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Figure 3
Oil Price Trends, 1982-January 1984?
Official price
- Spot price
1982 1983
29 1 29
for OPEC oil will approximate 20-21 million b/d.'
Under this demand scenario, we expect supplies to be
ample to keep a soft-to-stable market and OPEC to
have to continue to restrain output, with few, if any,
countries able to produce at desired levels. If demand
for OPEC oil is below our baseline scenario and if
OPEC fails to experience an upturn in market share,
the cartel could have a difficult time maintaining the
price structure. Indeed, some economists are now
predicting an economic downturn in 1985 that could
depress demand for OPEC oil. A failure to realize any
substantial growth in market share in 1985 would be
'Assumptions underlying this forecast include: OECD real GNP
growth of 2.7 percent; a continued slight decline in the energy-to-
GNP ratio; constant nominal oil prices; and an increase of about I
million b/d in nonoil energy demand in OECD countries. F_
very demoralizing for the cartel, because several
members have already suffered financial problems for
the past two to three years.
Iraq and Iran-Increased Production Possible
Constraints imposed by the continuing war will limit
the likelihood of any major increase in production
from Iran and Iraq in 1984. On the basis of recent
initiatives by the Iraqis to expand export outlets,
however, we believe developments in Iraq and Iran
will play a crucial role in determining market condi-
tions in 1985:
? If the war continues and Iraq and Iran maintain
exports at or near current levels, other OPEC
members will be able to share any increase in oil
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Key factors to observe over the coming months that
might portend a decline in oil prices are:
? Levels of OPEC production well in excess of the
cartel's 17.5 million b/d quota, with Saudi output
in excess of 5.0 million b/d a key factor.
? Absence of a sustained rebound in oil consumption.
? Falling spot crude prices that dip $2 to $4 below
official prices.
? Competition between the United Kingdom and Ni-
geria for market share.
? Exodus of buyers for North Sea crudes, forcing
BNOC to step up spot market sales substantially.
? Saudi Arabia's hints that it is no longer willing to
defend the benchmark.
? Additional price discounting, barter deals, or con-
cessional credit terms in countries such as Libya,
Iran, and Nigeria.
demand among themselves and avoid the conten-
tious issue of higher production quotas for the
belligerents.
? Iraq's current attempts to increase oil export capaci-
ty and revenues could place Baghdad in a position to
boost production and demand a higher quota.' A
proposal to link to the Saudi oil pipeline to the Red
Sea appears to afford Iraq an opportunity to in-
crease exports by 500,000 b/d in 1985. Should Iran
match any increase in Iraqi oil exports-as Tehran
has threatened-an additional 1 million b/d of
exports would offset the expected increase in de-
mand and keep the oil market soft.
? An end to the hostilities could allow Iraq to increase
its export capacity by 2 million b/d or more by
reinstalling offshore loading facilities in the Persian
Gulf and building a new pipeline link. If Iran also
raises its exports by nearly 1 million b/d, substantial
cuts by other producers would be needed just to
maintain price stability.
Table 6
OPEC Desired Crude Oil
Production, 1984 a
22.8
0.8
Gabon
0.2
Indonesia
1.7
Iran
2.6
Saudi Arabia b
7.6
United Arab Emirates
1.2
Venezuela
2.1
a Crude oil production needed to maintain financial assets at
yearend 1983 levels.
b Neutral Zone production divided between Saudi Arabia and
Kuwait.
In our judgment, OPEC countries such as Nigeria,
Venezuela, and Indonesia probably would be unwill-
ing to lower output to offset higher production from
Iraq and Iran. Indeed, these countries-especially
Nigeria-are eager to increase production and reve-
nues. Even if these and other OPEC members were to
agree to limit output to current quotas for 1985, an
additional 3 million b/d of oil from Iraq and Iran
could only be accommodated by lowering Saudi pro-
duction to less than 4 million b/d. Because of their
own internal needs, we believe such an outcome would
give the Saudis pause and increase the risk of an oil
price slide.
Other Market Pressures
We expect several factors to grow in significance over
producers to prevent an oil price decline
the next few years, making it even more difficult for
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the spot oil market has become
increasingly active in recent years. While accurate
measurement of the volume of oil traded on the spot
market is difficult,
the spot market now constitutes 20 to 25 percent
of total non-Communist oil trade, compared with 5 to
10 percent in the 1970s. Increasing spot market sales
and the introduction of crude oil futures contracts
have increased market responsiveness, buyer flexibili-
ty, and price transparency, while reducing the volume
of oil sold on a traditional contract basis. As a result,
to boost oil sales, some producers are modifying
contract terms to make deals more attractive. For
example, some OPEC countries are:
? Offering buyers term contracts with prices set at the
prevailing spot price at time of lifting.
? Reducing the length of the contract.
? Extending buyer credit terms-effectively discount-
ing prices.
? Reducing or eliminating restrictions on the destina-
tion or resale of crude oil purchases.
Price discounting by OPEC members on contract
sales adds to price weakness in soft market periods
and increases pressure on OPEC's official price struc-
ture (figure 4). Indeed, even without official action by
OPEC, the growing volume of oil traded as spot sales
effectively reduces average world crude oil prices
when the market is soft.
Oil producers are expanding downstream operations.
Refinery capacity within OPEC increased by more
than 1 million b/d from 1979 to 1981, and, according
to the International Energy Agency (IEA), OPEC will
add another 2-3 million b/d to capacity over the next
several years. About half of this increase is expected
to occur in the Persian Gulf. Projects under construc-
tion in Saudi Arabia alone are expected to add as
much as 1 million b/d to capacity in the next few
years. Product export capacity in OPEC could ap-
proximate 3.5 million b/d in 1985 or 1986, roughly 20
percent of expected total OPEC oil exports (table 7).
Purchases of existing European capacity by OPEC
members, primarily Kuwait, will also increase
OPEC's role in downstream operations. Kuwait re-
cently purchased both refining and marketing opera-
tions in Denmark, the Netherlands, and Italy and is
reportedly seeking additional facilities in the United
Kingdom. OPEC oil producers in recent years have
purchased or are partners in about 350,000 b/d of
Table 7 Thousand b/d
OPEC: Product Export Capacity
Refining
Capacity
Product
Export
Capacity
Refining
Capacity
Product
Export
Capacity b
Saudi Arabia
570
-100
1,900
1,000
Kuwait
594
333
720
950
Venezuela
1,400
490
1,600
500
Indonesia
471
85
940
350
Algeria
300
136
450
250
Libya
130
32
360
200
Others
1,205
98
1,870
150
a Projections based on IEA data.
b Exportable product capacity calculated based on 90 percent
utilization less domestic consumption. Excludes natural gas liquids.
refining capacity in Western Europe, and, according
to press reports, purchases by private Saudi compa-
nies reportedly total an additional 170,000 b/d
(table 8).
OPEC countries' growing role in product markets,
initially planned in order to capture the profits in this
sector, may cause additional problems for the organi-
zation as it struggles to maintain control of oil prices
and production in the next few years. Oil product
prices are not included in the cartel's official price
structure, and OPEC currently has little recourse if
producers choose to discount product prices, despite
the fact that such discounts tend to erode crude oil
prices. Furthermore, because product sales are more
difficult to monitor than crude sales, producers want-
ing to increase market share may be better able to
disguise overproduction.
We believe increasing OPEC penetration into product
markets may also be cause for increasing tension
between these countries and consuming countries in
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Figure 4
Oil Production and Price Trends, 1972-83
Oil Production 40
Million b/d
Oil Price Trends
US S per barrel
OPEC production
accord a
OPEC available
production capacity b
Benchmark official price c
Spot priced
a Benchmark price falls five dollars per barrel.
b Reflects government production ceilings.
c Actual contract sales prices for Arabian Light.
d Annual average.
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Table 8
Major OPEC Downstream
European Acquisitions,
as of February 1984
Refining
Capacity
(barrels
per day)
Retail
Outlets
Kuwait-Kuwait Petroleum
Corporation (KPC)
Netherlands/Belgium/Luxembourg
(February 1983)
75,000
750
Sweden/Denmark (March 1983)
85,000
825
Italy (January 1984)
80,000
1,500
Total to date a
240,000
3,075
Saudi Arabia-First Arabian Corp-
oration and Arabian Sea First
Italy/Switzerland (April 1983)
170,000
NA
Venezuela-Petroven
West Germany (December 1983)
105,000
NA
Market Vulnerability-The Iran-Iraq Risk
Although we expect the market to remain weak over
the next year or so, the volatile situation in the Middle
East could cause a rapid turnabout in the market.
Iraq's deterioriating economic situation and its grow-
ing frustration over the protracted war with Iran
could prompt Baghdad to initiate attacks in the
coming weeks against oil shipping in the Persian Gulf
in an effort to bring an end to the conflict. Such
action might induce Iran to carry out its oft-repeated
threat to close the Gulf to shipping or to strike out
against the oil facilities of Iraq and its Persian Gulf
allies.'
Under these conditions, the world oil market could
tighten quickly and cause at least a temporary runup
in spot prices for several reasons:
? Uncertainty regarding the extent of damage to the
a KPC has expressed interest in purchasing additional downstream oil industry in the Gulf and the length of any supply
facilities in the United Kingdom consisting of a 100,000 b/d disruption, including the possibility of further at-
refinery and 400 retail outlets. tacks on oil facilities, probably would encourage
b Purchased by private Saudi buyers.
c Fifty-fifty joint venture in a 210,000 b/d refinery with the West increased spot market purchases.
German company Veba.
Europe. Reduced oil consumption has created a
worldwide surplus of refining capacity, and many
OECD refineries have been shut down, particularly in
Western Europe. Much of the adjustment, however,
will be offset by OPEC's increased capacity. Accord-
ing to the IEA, total OECD capacity declined by
more than 5 million b/d from 1979 to 1982, and
additional cutbacks are required. Moves to further
reduce European capacity probably will be difficult
and slow, however, and West European countries may
decide to impose import fees on oil products to protect
the domestic industry and jobs, according to one
industry source. Thus far, OPEC has no strategy for
coping with these problems, but, given their access to
low-cost crude feedstocks, cartel members are in a
position to embark on a ruinous price war to force
additional refinery closures and increase OPEC's
market share.
? A minimum of available surplus capacity in non-
Communist countries is outside the Gulf; only about
3 million b/d of the current surplus of 8 million b/d
is located outside the region.
? Commercial stocks have been drawn down to near
normal levels, and there is little surplus to offset a
disruption; government-held stockpiles might not be
used initially to prevent price runups.
While sizable runups in oil prices are likely during a
major disruption of Persian Gulf oil supplies, we
cannot predict how high prices would rise or how long
such increases might be sustained. We believe the key
factors under any circumstances are industry and
public perceptions of the disruption and the timing of
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such an event. A price runup of any nature or
duration could impact on economic growth, inflation,
financial markets, and political stability
Because of the many economic variables that come
into play, the precise impacts of future supply disrup-
tions are difficult to gauge. Using the CIA-linked
econometric model and allowing for the 2 million b/d
of excess capacity that the industry believes is needed
to maintain market equilibrium, we have attempted to
measure the order of magnitude of economic impacts
from a supply disruption. Our analysis indicates that
for each 1 million b/d net supply shortfall, real oil
prices would rise by about $10 per barrel and OECD
GNP growth would decline by about 0.5 percentage
point. In the event of a major price increase, heavily
indebted oil-importing LDCs would be hard pressed
to finance higher oil import bills given the reluctance
of commercial creditors to further increase their
exposure. We estimate that a $10 price increase
would add another $5 billion in foreign exchange
requirements for the five largest LDC commercial
debtors-Brazil South Korea Chile the Philippines,
and Morocco
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