IMPLICATIONS OF AN OIL PRICE DECLINE

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP87T00573R000100130003-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 26
• Document Creation Date: December 22, 2016
• Document Release Date: June 21, 2011
• Sequence Number: 3
• Publication Date: August 1, 1985
• Content Type: SNIE

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Director of
Central
Intelligence
Implications of
an Oil Price Decline
Special National Intelligence Estimate
Seems
SNIE 3-85
August 1985
?y 426
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STAT
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S N I E 3-85
IMPLICATIONS OF
AN OIL PRICE DECLINE
Information available as of 9 August 1985 was used in the
preparation of this Estimate, which was approved by the
National Foreign Intelligence Board on that date.
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THIS ESTIMATE IS ISSUED BY THE DIRECTOR OF CENTRAL
INTELLIGENCE.
THE NATIONAL FOREIGN INTELLIGENCE BOARD CONCURS.
The following intelligence organizations participated in the preparation of the
Estimate:
The Central Intelligence Agency, the Defense Intelligence Agency, the National Security
Agency, and the intelligence organizations of the Departments of State, the Treasury,
and Energy.
Also Participating:
The Assistant Chief of Staff for Intelligence, Department of the Army
The Director of Naval Intelligence, Department of the Navy
The Assistant Chief of Staff, Intelligence, Department of the Air Force
The Director of Intelligence, Headquarters, Marine Corps
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CONTENTS
Page
SCOPE NOTE ...................................................................................... 1
KEY JUDGMENTS .............................................................................. 3
DISCUSSION ........................................................................................ 7
Market Trends and Uncertainties ................................................ 7
Impacts and Reactions .................................................................. 7
Beneficial to Most Industrial Countries .............................. 7
Likely OECD Policy Responses ........................................... 10
Exchange Rate Movements .................................................. 10
Generally Positive Effects for Oil-Importing LDCs .......... 12
Mixed Effects for OECD Oil/Gas Exporters ..................... 13
Clear Harm to LDC Oil Exporters ..................................... 13
Difficult Choices for the Soviet Union ................................ 16
Ramifications for US Interests ..................................................... 17
West European Energy Security ......................................... 18
Long-Run Oil Market Impacts ............................................ 18
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SCOPE NOTE
Stagnant oil demand in non-Communist nations and rising non-
OPEC supplies have created softness in the world oil market un-
matched since the 1960s. Prices have already declined by about $6 to $7
per barrel since 1981, and continued pressures that could produce
marked price declines seem likely for the next couple of years. The pur-
pose of this Special National Intelligence Estimate is not to predict
whether such declines will occur but to examine the effects of such
declines, should they take place, on: (a) global economic performance,
(b) international financial linkages, and (c) the political situations in
some affected countries. In addition to quantifying the benefits of a
decline, the Estimate looks at the midterm impact-that is, through
about 1990-on. US interests in the Middle East, Western Europe,
Japan, and the less developed countries
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KEY JUDGMENTS
If oil prices fall markedly over the next few years-say to $20 per
barrel-most of the world, including the United States, will benefit
substantially. However, certain oil exporters and other countries could
suffer economic setbacks and political repercussions-in some cases
sufficiently serious to affect US strategic interests adversely.
On the positive side, most developed countries and oil-importing
LDCs would receive substantial direct economic benefits and also
would obtain added policy flexibility to enhance these benefits and deal
with current economic problems:
- Overall growth in member countries of the Organization for
Economic Cooperation and Development (OECD) would in-
crease by about 0.3 percent per year over the rest of the decade,
inflation would subside further, and unemployment in Western
Europe would decline. Even Canada and the United Kingdom
would be likely to benefit from a decline in oil prices, despite
being net energy exporters.
- Although Western governments could accentuate the growth
benefits from an oil price decline by adopting more stimulative
economic policies, we believe most would simply let the benefits
go directly to consumers. Japan and, perhaps, Italy might raise
energy taxes to avoid increases in oil imports and reduce
government deficits
As for the oil-importing LDCs, a reduction in oil prices to the $20
per barrel range would reduce energy import costs and raise exports to
the developed countries:
- Brazil and South Korea, for example, each would save more
than $5 billion in oil import payments between now and 1990,
and could add roughly $2 billion to their exports to the OECD
over the same period.
- As with the developed countries, most oil-importing LDCs
would pass on the full price reduction to their domestic
economies, although some, including Brazil and the Philippines,
might raise taxes on oil to reduce budget deficits and protect do-
mestic energy investments
In contrast to the benefits of lower oil prices for most oil-importing
LDCs, a few countries, dependent on aid or remittances from OPEC
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countries, are likely to be hurt as the OPEC countries cut their aid flows
and employment levels in response to declining income.
Lower prices would create serious problems for some oil exporters.
In Mexico, Nigeria, and Egypt, lower oil prices would stall economic re-
covery, increase the potential for social unrest, and bring calls for higher
levels of US aid or other types of assistance. In Iran and Iraq, the loss in
revenues would increase the burden of continuing the war while trying
to meet domestic needs. Libya, which uses its oil revenues to support
terrorism and other activities inimical to US interests, also would be hit
financially, but not enough to end its support of these activities.
Those oil exporters with larger reserve bases and financial assets
and smaller populations-notably Saudi Arabia, Kuwait, and UAE-
would also suffer, but we believe they could ride out the stresses in the
near term. Riyadh, in addition to drawing down its assets, has to date
coped with lower oil revenues by putting development projects on hold,
paying bills late, and reducing foreign aid. Kuwait and UAE have even
managed to keep their current accounts in surplus.
Even in these countries, however, stresses would be brought on by
lower oil prices. In Saudi Arabia, foreign liquid assets-now under $80
billion and declining by $1-1.5 billion per month-are approaching
psychologically and politically important thresholds. As a result, Riyadh
is for the first time making serious efforts to cut expenditures in areas
that will be felt by the typical Saudi. Lower oil prices would aggravate
these problems.
We believe that in the Soviet Union a fall in oil prices would have a
net unfavorable impact in the near term. If oil prices fell to $20 per bar-
rel, hard currency earnings from oil exports would drop by $10-12
billion over the rest of the decade, and natural gas earnings-given the
link of Soviet gas prices with world oil prices-would slide sharply as
well. Such declines would force Moscow to make difficult choices:
selling off assets, increasing Western borrowing, shifting energy exports
from Eastern to Western Europe, or reducing imports. On the basis of
Moscow's past conservative financial policies and the already con-
strained levels of its East European energy sales, we believe a cut in
hard currency imports would be necessary if oil prices fell dramatically.
Although the United States would derive largely positive economic
benefits from lower oil prices, we see four sets of possibly adverse
political and strategic effects on US interests:
- If the economic problems created in oil-exporting countries,
such as Mexico, Egypt, Nigeria, and the Persian Gulf states,
were sufficiently great to cause political instability in those
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countries, the United States could be called on to react. These
responses could range from the protection of US citizens and
property against domestic unrest to attempts to moderate the
effects on these countries and on the international financial
system of the deteriorated debt situation of some of the
countries.
-A drop in oil prices could further the continuing shift in the
Middle Eastern power balance away from moderate states that
use oil money as a lever of power, particularly Saudi Arabia.
- In the area of West European energy security, unless substantial
progress is achieved in the development of indigenous resources
over the next few years, the Soviet-supplied proportion of West
European gas consumption could rise sharply, perhaps to about
one-third of the total by 2000. We believe there is a possibility
that lower oil prices would push the outcome in this direction.
Because of the high cost of developing new West European gas,
including taxes, development of indigenous gas is at best a risky
proposition. If natural gas prices fall with those of oil, then a
drop in oil prices could well eliminate many incentives for
further development. In time, Moscow could take advantage of
the opportunity presented by a decline in West European gas
development by taking only a few extra steps of its own. All of
the primary Soviet-West European pipeline will be in place by
late 1986; all that would be necessary would be building the
Trans-Czech pipeline, a task that could be done in eight months.
- Finally, a drop in oil prices, without compensatory policy
adjustments, could stimulate consumption and reduce explora-
tion, development, and maintenance of capacity, thereby in-
creasing dependence on Persian Gulf supplies and raising the
potential for an oil supply shortfall and a runup in oil prices. We
believe, however, that, given present capacity excesses, this
problem is unlikely to occur in this decade.
While we believe even a sharp fall in prices-in contrast to the more
gradual slide we feel is more likely-would be favorable for most of the
world economy, there would be some added risks. There would be some
risk that banks with heavy energy or LDC loan exposure would fail and
there would be the potential for political backlash in LDC oil exporters as
sudden income declines forced rapid reductions in living standards.
Because of its precarious economic situation and proximity to the United
States, we are most concerned about the effects on Mexico
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DISCUSSION
Market Trends and Uncertainties
1. Since early 1981, when the average official oil
price of the Organization of Petroleum Exporting
Countries (OPEC) reached almost $35 a barrel, surplus
productive capacity has caused steady downward
pressure on official prices. Several factors have played
a role in this reversal of the trends of the previous
decade (see figure 1):
- Conservation, set in train by the first oil price
shock of the mid-1970s and accelerated by the
1979-81 increases, continued to reduce the ener-
gy intensity-the ratio of energy use to economic
activity-of the world economy. Between 1980
and 1983 the amount of energy used per unit of
real GNP in the member countries of the Organi-
zation for Economic Cooperation and Develop-
ment (OECD) declined by almost 10 percent.
- Substitution of other forms of energy further
reduced the demand for oil. The 1980-83 period
brought a reduction in oil's share of non-Com-
munist primary energy production from 50 per-
cent to 47 percent.
- Widespread economic recession also reduced oil
demand; between 1980 and 1983, world real
output rose only 4 percent, according to the
World Bank.
- Additional supplies of oil, stimulated by the price
rises of the 1970s, continued to expand. Despite
falling demand, the quantity of oil supplied by
non-OPEC countries, including net Communist
exports, rose from 21.5 million b/d in 1980. to
24.7 million b/d in 1983.
- The strength of the US dollar kept European
prices, measured in nominal national currencies,
from falling and further reduced the quantity of
oil demanded.
These factors combined to put severe downward
pressures on global oil prices and forced OPEC to
lower its benchmark price in 1983, in 1984, and again
in 1985. As a result, the average official OPEC price
now stands at about $27 a barrel-$8 a barrel below
the 1981 peak]
2. Despite the drop in world oil prices, the oil
market remains in considerable surplus. Even with the
rebound in global economic activity, oil demand has
remained stagnant, with non-Communist oil consump-
tion no higher now than it was in 1982 despite the
lower prices and an 8-percent gain in world GNP.
Continued increases in non-OPEC supplies also have
contributed to oversupply in the market. As a result,
oil prices are again softening, and most observers
believe that, without a major disruption, the excess
capacity will exist for several years.
3. This SNIE examines the economic effects of an
assumed drop in oil prices to $20 per barrel (see figure
2). The $20 price was chosen because:
- It is large enough to have a major impact on the
world economy; a drop to $25, while more likely,
would have less effect.
- It is the price most often mentioned in discussing
where oil prices could go in the next two years.
- It has some precedent in that OPEC, under
pressure from Saudi Arabia, cut nominal prices
in 1983 by more than $4 a barrel; a fall to $20 a
barrel would be a cut of about the same magni-
tude.
Impacts and Reactions
4. An orderly decline in the price of oil to the $20
per barrel range-that is, a drop that occurred in
discrete increments over the next two to three years-
would of itself affect the world economy in a number
of ways. At the same time it would create opportuni-
ties for governments to offset or magnify these effects.
Beneficial to Most Industrial Countries
5. Most OECD countries would receive economic
benefits from such an oil price cut. A sustained,
orderly drop in world oil prices to $20 a barrel would
increase overall OECD real GNP by a total of 1.5 to 2
percent by the late 1980s, adding about 0.3 percentage
point to annual growth rates over the rest of the
decade, and creating some 1 million jobs (see table 2).
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Figure 1
Oil Market Trends
OECD Energy-GNP Ratio
Index 1973=100
75
OECD: Oil as a Share of Energy Consumption OECD Real GNP
Percent Index 1973=100
105
I I I I I I I 1
15 1973 74 75 76 77 78 79 80 81 82 83 84
20
10
0 1973 74 75 76 77 78 79 80 81 82 83 84
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6. Lower oil prices would improve OECD growth
in several ways:
- A gradual drop to $20 a barrel would leave a
cumulative $270 billion in the hands of OECD
consumers and businesses between now and
1990. Present spending patterns indicate that
most of this would be spent on OECD-produced
goods and services.
Given the current level of surplus production capaci-
ty in OPEC and the financial problems in many OPEC
countries, a number of factors could cause oil prices to
decline substantially over the next couple of years.
OECD growth, already expected to slow, could drop
more than expected and, in combination with continu-
ing substitution and conservation trends, could reduce
oil demand. A second potential source of a drop in oil
prices could be more rapid increases in the quantity of
oil supplied by non-OPEC producers. Oil price declines
also could stem from a further breakdown in OPEC
production discipline. Saudi Arabia, for example, could
make good its threats to increase production in the face
of widespread cheating on quotas; the increase in
production planned by Iraq could also trigger price
declines
Should oil prices fall, there is the matter of how far
and how fast. From the standpoint of how far, world oil
prices presently are well above levels required to cover
competitive long- and short-run costs, even in very
expensive fields, where total costs are no more than $15
to $20 a barrel and operating costs are $10 per barrel or
less. We believe, however, it is unlikely that oil prices
would fall to this range. OPEC members recognize that
a "price war" would be financially disasterous; thus we
believe a price this low to be unlikely.
Should those OPEC members with large reserve-to-
production ratios, such as Saudi Arabia and Kuwait,
decide to cut prices in a measured way in order to
protect their long-term interests, several factors argue
against a cut below the $20 per barrel range:
- The Saudis previously have been extremely cau-
tious in cutting prices-and have done so only
while simultaneously reducing production in order
to defend the new price level. At present, howev-
er, Saudi Arabia is producing at under 3 million
b/d, severely limiting its ability to cut production
further. We believe the Saudis would attempt to
gain agreement within the organization for a
consolidated approach, and because almost all
other OPEC members oppose further reductions
in nominal oil prices, such a cut would probably
be relatively moderate.
- A price drop of this size could add marginally to
price stability because some analysts argue that at
$22 to $25 per barrel, some high-cost secondary
and tertiary oil production-in the United States,
for example-could become uneconomic.
All in all, it is our view that further $1 to $2 per year
declines in oil prices over the next year or two are
likely. According to some industry estimates, even with
OECD growth of 3 percent, non-Communist oil de-
mand is expected to increase only 0.5 to 1.0 percent a
year through 1990 (see table 1). Meanwhile, non-OPEC
supplies will continue to rise, at least for the next year
or two. With OPEC countries already producing well
below capacity, it seems likely they will find it difficult
to prevent further declines in prices.
A sudden, large fall in oil prices cannot be ruled out.
A major recession in the OECD countries akin to that
which occurred in 1982-83 would cause demand for oil
to decline below the already stagnant baseline by an
additional 1-2 million b/d. This outcome could force
OPEC to cut production further in order to avoid a
large surplus of oil. If OPEC discipline broke down,
spot prices would fall and OPEC would eventually be
forced to cut official prices. This scenario could play out
in a matter of months.
Another possible cause of suddenly lower oil prices
would be an end to the Iran-Iraq war, with Iraq and
Iran rapidly boosting oil production and aggressively
marketing the increment. Our estimates indicate that
within six months after the end of hostilities, the two
countries combined would have the physical capability
to place an additional 1-2 million b/d on the market. As
with the OECD recession scenario, we do not believe
Saudi Arabia would be willing to offset this increase in
supply and a sharp price drop could occur.
Table 1
Projected Oil Market Trends, 1986-90
Change in non-Communist real GNP (percent) 15
Change in non-Communist energy demand (percent) 5
Change in non-Communist oil demand (million b/d) 2
Change in non-OPEC supply (million b/d) 1
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- The favorable impact on inflation-which we
estimate at about a half percentage point a year
for the entire OECD-would further increase
real purchasing power, as declines in wage rate
increases lagged the falloff in inflation.
- Lower inflation rates also would help reduce
nominal interest rates, increase investment, and
add an additional increment to growth.
Set against these favorable impacts would be lowered
purchases by oil-exporting countries. We are not sure
how great these cuts would be, but, given the difficult
financial position of most oil exporters, import cuts
could be almost as great as revenue declines. This
offset, however, would by no means undo the favor-
able impacts on growth.'
7. Among the larger OECD countries, the United
States, Japan, and Canada would receive the largest
benefits to growth from a drop in oil prices to $20 per
barrel. Canada, while losing from lower oil revenues,
would receive more-than-offsetting benefits from the
impact of lower oil prices on the US economy and
improved prospects for Canada's nonoil sectors. Japan
would receive the largest improvement in its current
account-a rise of some $35 billion. The United States'
current account balance would improve at first,. but
eventually higher imports fueled by higher GNP
would lead to a worsening balance. The major West
European countries-which are more dependent on
exports to OPEC-would gain less than the United
States and Japan, but would still register improved
growth. Turkey and Greece would benefit less than
other OECD countries because their exports depend
especially heavily on sales to the Middle East.
Likely OECD Policy Responses
8. Because the increased strength of the dollar has
largely offset the decline in the price of oil since early
1983 in national currency terms for OECD. economies
other than the United States, we believe most govern-
ments-with the possible exceptions of those in Japan,
Italy, and France among the major countries-would
welcome the opportunity to pass on to consumers a
decline in the price of oil. We believe, however, that
because of continuing problems with inflation and
budget deficits, few, if any, OECD governments
' The quantitiative estimates of the OECD impacts of a drop in
oil prices are based on CIA's Model of the
world economy. In utilizing this model, the effects of a drop in oil
would respond to lower oil prices by adopting more
expansionary policies, despite the need to reduce
unemployment.
9. The Japanese Government is considering action
to keep retail oil prices from falling. US Embassy
reporting indicates Tokyo thinks the current softness
in oil prices will last only a few years, and producers
will regain control of the oil market by the late 1980s.
Consequently, if the market continues to weaken this
year, Tokyo probably would raise oil taxes to maintain
current retail prices and avoid an increase in oil
dependence. Moreover, this would help Prime Minis-
ter Nakasone reduce the government deficit-still an
important goal for the government.
10. Italy has yet to formulate a policy to deal with a
drop in oil prices. Initially, Rome would probably raise
oil taxes in order to help limit a growing budget
deficit-now around 15 percent of GDP-but concern
with high unemployment, which averaged 10 percent
last year, would limit the extent of an oil tax increase.
The Christian Democratic Party probably would rec-
ommend a tax increase, with the funds used to
maintain employment through public works projects.
Some of the smaller coalition partners, however,
would probably prefer a more market-oriented ap-
proach. As a result, the final policy will probably be a
compromise solution, including some tax increases.
11. West Germany's market-oriented government
probably would allow domestic oil prices to decline as
the market price of oil goes down; the potential
reaction in France, on the other hand, is less clear. A
passthrough of lower oil prices would be appealing as
the Socialist Party tries to improve its prospects in next
year's National Assembly elections. On the other hand,
the French Government has promised additional in-
come tax cuts for 1986 and, if the price of oil falls,
compensating increases in domestic oil taxes might be
a convenient way to make up the revenue shortfall.
Almost all other OECD governments would let domes-
tic oil prices go down in line with a world oil price
decline. Those with major deficit problems-Greece,
Portugal, and Iceland-probably would consider rais-
ing oil taxes, however.
Exchange Rate Movements
12. The distribution of the impacts would be affect-
ed if the lower prices caused adjustment of exchange
rates, particularly of the dollar in relation to other
currencies. During the first major oil price rise in
1974-75, the dollar was somewhat favored by the
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Figure 2
Declining Oil Prices: Alternative Scenarios
I I I I I 1
15 1985 86 87 88 89 90 91
Table 2
OECD: Estimated Impacts of Gradual Declines
in Oil Prices, 1986-90
Impacts on Average
Annual Real Growth
(percentage points)
Impacts on Average
Annual Inflation
(percentage points)
Total Impact on Un-
employment Rate
(percentage points)
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Cumulative Impact
on Current Account
Balances
(billion US $)
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perception that the United States would be less
harmed than Japan or Europe by oil price rises. By the
same reasoning, a fall in oil prices could supply
downward pressure on the dollar if Japan and Europe
(excluding the United Kingdom) where perceived to
enjoy disproportionate gains from an oil price decline.
If such an outcome did occur, the benefits of lower
dollar oil prices to Western Europe and Japan would
be followed by a further drop in their national
currency oil prices. Over the long run, the lower dollar
would provide an additional benefit to the United
States in the form of enhanced trade competitiveness
relative to Europe and Japan. It should be noted,
however, that the downward movement in oil prices
over the past several months has been interpreted in
the market as favorable to the dollar.
including those from LDCs, although LDCs that sell
substantial amounts of goods to oil-exporting coun-
tries-notably Pakistan, Jordan, India, and Sudan-
would find markets in these countries diminishing
following an oil price decline. The diverse composition
of LDC exports makes it difficult to assess which
countries would benefit most from OECD growth, but
export-oriented countries, such as South Korea and
Brazil, would be in the best position to benefit from
increased demand from the OECD
15. If these price declines result in lower interest
rates, oil-importing LDCs would derive even more
benefit. Each 1-point decline in rates saves oil-import-
ing LDCs $2 billion annually. LDC oil importers with
large debts-including Brazil, Argentina, and the Phil-
ippines-would receive the largest impact from this
Generally Positive Effects for Oil-Importing LDCs
13. Oil-importing LDCs also would benefit from
falling oil prices; those with debt problems and large
oil imports would receive the greatest benefit. Brazil
and South Korea, because they are large oil importers,
would receive the greatest direct benefit; a drop in oil
prices to $20 a barrel would mean each would realize
import savings exceeding $5 billion in the 1986-90
period at current consumption levels (see table 3). The
Philippines would achieve savings of $2 billion.
14. So-called second-order effects also would bene-
fit oil-importing LDCs. In particular, the greater
growth in OECD countries generated by oil price
drops would lead to greater demand for imports,
Table 3
Key LDC Oil Importers:
Estimated Impact of Gradual Decline in Oil Prices, 1986-90
Direct Impact of Reduced Oil
Import Payments
Total Savings a
a Based on oil import volumes for 1984.
b Assumes a 1:1 relationship between changes in OECD real
GNP and LDC exports.
c Assumes that, as a result of low oil prices, floating rate interest
charges paid by LDCs average I percentage point lower.
second-order effect
16. The LDC governments, like those in OECD
countries, would also face policy decisions:
- Lower oil prices would allow governments to
raise revenues relatively painlessly by imposing
new energy taxes or tariffs. Domestic oil product
prices would be maintained, thus not disturbing
investment projects and energy consumption pat-
terns that depend on an oil price of roughly $30
per barrel. Governments especially in need of
funds, such as Brazil, could find this tax policy
attractive.
- Alternatively, some countries could choose sim-
ply to pass the full oil price reduction on to their
Indirect Impact on Exports Indirect Impact on Interest
Total Additions b Payments
Total Savings c
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domestic economies, allowing greater imports of
other goods. At the same time, the oil price
decline would also encourage a greater volume of
oil imports, especially after an adjustment period
of several years.
We believe most LDC governments, given the already
severe retrenchment of their economies, would opt to
use the savings from lower oil prices in a stimulative
manner, either by passing the lower oil prices on to
their private sectors or by restoring government pro-
grams recently cut.
17. Some oil-importing LDCs would be hit with
significant negative effects from lower oil prices. Non-
Arab African countries probably would receive less aid
from Saudi Arabia and other Persian Gulf states. Saudi
aid to moderate regional regimes-such as Morocco,
Jordan, and Pakistan-is likely to continue, although
possibly in slightly reduced amounts and more of it in
the form of free oil. Also, countries that have supplied
workers to the Persian Gulf region would see a drop in
worker remittance receipts and a return home of
workers, in most cases, to already surplus labor mar-
kets. Oil importers likely to be hit hardest by this
effect include Pakistan and the Philippines.
Mixed Effects for OECD Oil/Gas Exporters
18. We believe that for the United Kingdom a
decline in oil prices will produce a net benefit, but it
will also have unwelcome short-term effects on gov-
ernment oil revenues and perhaps create pressure on
the pound, particularly vis-a-vis other European cur-
rencies. As oil prices fell between 1981 and 1984, for
example, British Government oil-generated revenues
barely increased and the pound's trade-weighted value
declined by some 20 percent. Higher losses in the
energy industries could eventually be offset by gains in
other sectors of the economy, particularly in the nonoil
export sector, where the cheaper pound would make
goods and services more attractive. London, which has
recently taken action to remove government involve-
ment in pricing by abolishing the British National Oil
Company, probably would pass any decline in world
oil prices on to consumers
19. In the event lower prices did push the pound
sharply downward, Prime Minister Margaret Thatcher
probably would act quickly to avoid a repeat of the
pound crisis that occurred earlier this year. London
could raise interest rates-as it did in January-but
this would be costly for the Thatcher government,
both economically and politically; indeed, the govern-
ment recently has encouraged rates to fall following
signs of a weakening in economic growth. New interest
rate hikes would cut growth and further increase
unemployment-one of the UK's major economic
problems. Given the domestic constraints on shoring
up the pound, Thatcher might ask for coordinated
intervention in the foreign exchange market to support
the pound temporarily, but probably would get little
response.
20. In Canada, Ottawa recently announced that it
would stop regulating domestic oil prices and would
henceforth allow market forces to set prices. In addi-
tion, the new Conservative government eliminated
several major federal taxes on energy. We believe the
government, given this policy stance, would resist
pressure from either private-sector energy firms or the
governments of the oil-producing provinces to take
action, unless prices fall'well below $20 a barrel.C
21. Among the OECD countries, Norway would be
the biggest loser from an oil price decline because oil
and gas now account for about one-third of exports
and provide almost one-fifth of government revenue.
Moreover, should oil prices decline to $20 a barrel,
Norway would lose the opportunity to develop the
high cost offshore gas in the Troll field. The Nether-
lands' trade balance would benefit from falling oil
prices, as lower oil import costs would offset smaller
declines in the earnings of gas exports. On the other
hand, the falling gas prices would reduce government
revenues and frustrate government attempts to reduce
the budget deficit.
Clear Harm to LDC Oil Exporters
22. While lower oil prices would impact negatively
on all LDC oil exporters, those with high per capita
incomes, including Saudi Arabia, Kuwait, and UAE,
are in the best position to handle a decline. While oil
earnings make up most of the foreign exchange earn-
ings of these countries, each has significant levels of
foreign assets to draw on to continue spending at
current levels:
- Saudi Arabia has official liquid foreign assets of
about $80 billion, equivalent to two years of
imports, giving it time to make adjustments by
continuing to draw down assets.
- Kuwait and UAE are in even stronger positions.
High foreign investment income and reductions
in imports and spending have allowed these
countries to continue to increase foreign assets,
albeit at a slower rate.)
23. Despite its strong asset bases, a decline in oil
prices would force Saudi Arabia to make some diffi-
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cult choices. Officials in Riyadh have to date coped
with lower oil revenues by putting some major devel-
opment projects on hold, delaying payments, and
reducing foreign aid, in addition to drawing down
assets (see table 4). Most of the impact has fallen on
foreign construction firms and workers.
24. Reductions in liquid official foreign assets, how-
ever, are now approaching psychologically and politi-
cally important levels and further cuts may be more
difficult. To stem the asset drawdown, Riyadh has
formulated a balanced budget for the current fiscal
year. Even though this goal will not be achieved, Saudi
officials are, for the first time, making serious efforts
to cut expenditures in areas that will be felt by the
typical Saudi. For example, overtime payments to civil
servants are to be severely restricted, and those who
live in government-provided housing will now have to
pay rent.
Continued Downward Pressure:
The Implications for OPEC's Survival
Although a breakup of OPEC would almost inevita-
bly bring about lower oil prices, it is less apparent that
lower oil prices would necessarily bring about the
dissolution of OPEC. The true test of OPEC's market
power has been its ability to limit the fall in the oil
prices over the last four years-Saudi Light, the official
benchmark crude, dropped only $6 per barrel, or 18
percent, from its peak in 1982-despite enormous
downward pressure from energy conservation, fuel
substitution, and economic recession. The cost to the
organization, however, has been significant, in that
current OPEC output is now under half the 31-million-
b/d production level attained in 1979. The resulting
drop in sales and revenue has forced members to
explore new marketing strategies, many of which are at
odds with OPEC's price and production guidelines,
although in past times of crisis individual members
generally have acted collectively to defend the official
25. Saudi Arabia, however, does have options that
are unavailable to most other oil exporters. It has
sufficient excess capacity that, should Riyadh choose
to give up its attempts to uphold OPEC price stability,
it could sell significantly more oil. Although this would
accelerate the oil price slide, by capturing larger
market shares, Saudi Arabia could probably increase
its revenues.
26. An economic decline caused by reduced oil
prices will erode further the monarchy's popular
Table 4
Saudi Arabia:
Reactions to Soft Oil Market, 1982-84
1981
1984
1984 vs. 1981
Absolute
Change
Percent
Change
Price of its oil
($ per barrel)
31.58
26.91
-4.67
-14.8
Oil exports
(million b/d)
9.5
3.9
-5.6
-58.9
Export earnings
(billion US $)
109.9
39.5
-70.4
-64.1
Import expenditures
(billion US $)
34.0
35.0
1.0
2.9
Grant aid
(billion US $)
5.7
2.0
-3.7
-64.9
Current account
balance
(billion US $)
49.7
-14.1
-63.8
NC a
Official liquid assets
(billion US $)
127
92
-35
-27.6
price structure.
The value of continued membership in OPEC is now
being seriously questioned by some members. OPEC
members realize that even concerted action in coming
months will not alter the gloomy demand outlook for its
oil over the next two to three years. Production disci-
pline is no longer viewed as a short-term sacrifice
guaranteeing a brighter future, but as a long-term
headache with no relief in sight. With OPEC providing
neither effective leadership to halt the slide in prices
nor innovative solutions to its problems, the organiza-
tion's utility to its members is decreasing, and each
successive price drop will further loosen the bonds that
hold the members together.
In our view, Saudi Arabia is key to OPEC's future.
While all OPEC countries could undertake unilateral
actions, and a number already have, none except the
Saudis have the excess capacity to drop prices so
dramatically as to render OPEC completely ineffective
as an organization. While we believe Riyadh would be
reluctant to cause OPEC's demise, the pressure of
holding it together is beginning to tell. At OPEC's last
meeting in July, Riyadh informed the other members
that if they continued their efforts to raise revenues by
boosting production above their agreed quotas then
Saudi Arabia would do the same. How willing the
Saudis are to follow through is uncertain, but continued
lack of discipline among other OPEC members at the
expense of the Saudis raises the probability of unilateral
support but is not sufficient, by itself, to pose a near-
term threat to the continued rule of the Saudi royal
family. Most politically significant segments of Saudi
society have direct and close ties to the royal family
and will maintain a vested interest in the current
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regime. If public dissatisfaction with the government's
handling of the economy became worrisome, King
Fahd almost certainly would identify scapegoats. He
would probably begin to blame publicly the private
sector for not undertaking its proper role in economic
development. Fahd also probably would try to exploit
the situation to make changes in his favor in the
Council of Ministers, possibly replacing key techno-
crats.
27. Other DC oil-exporters are in a much weaker
position to weather a price decline (see table 5). A
price decline would be a major blow to Mexico's
efforts to promote economic recovery after a period of
economic decline and would complicate the govern-
ment's political problems. A decline in oil prices to $20
per barrel would deprive Mexico of some $3-4 billion
in foreign exchange earnings, more than offsetting the
favorable effects of faster US growth and any interest
rate declines that might follow oil price drops. Mexico
City would. attempt to stave off the most severe
consequences of an annual $2 a barrel fall in oil prices
by drawing down foreign exchange reserves, seeking
new debt rescheduling, and devaluing the currency
more rapidly. Even with such measures, however, the
economy would stagnate, and unemployment and
underemployment would riseF_~
28. Under these circumstances, we believe Mexico
City would be likely to turn once again to the United
Table 5
LDC Oil Exporters:
Dependence on Oil and Foreign
Reserve Position in 1984
Oil Exports Ratios of Reserves
as Share of to Imports
Exports (months)
(percent)
States for financial assistance, including emergency
loans and credits for basic imports. Additionally, Mexi-
co would increase efforts to gain unilateral trade
concessions for Mexican goods. At the same time, US
leverage with Mexico over issues important to Wash-
ington would increase, although Mexico City would
resist any domestic appearance of being a lackey to US
interests. In particular, the government would contin-
ue to emphasize statist policies rather than turn to the
private sector
29. Egypt is another area of potential policy con-
cern. The country's economic difficulties are already
being exacerbated by lower oil prices. Moreover, while
Cairo has been able to obtain credits easily in the past,
some bankers are expressing concern about Egypt's
financial situation. Additional oil price drops would
compound these difficulties-oil income accounts for
60 percent of goods exports and over 20 percent of
goods and services exports.
30. Lower oil prices would adversely affect Egypt
in several ways:
- They would directly lower export earnings.
- They would reduce remittances and cause Egyp-
tian workers in the Persian Gulf countries and
Libya to return home in large numbers; the 1
million Egyptian workers in the Gulf area pres-
ently remit more than $2 billion annually
through official channels.
- They could interrupt Egyptian oil exploration
efforts, reducing present inflows of capital and
hindering future growth of oil production
31. President Mubarak would undoubtedly try to
insulate Egyptian citizens from the adverse fallout of
Egypt's more precarious international economic posi-
tion. Despite progress, incomes-at about $700 per
person-remain low, the population is growing rapid-
ly, and most of the urban population is concentrated in
Cairo and Alexandria. To mitigate or delay the impact
of lower oil prices, Mubarak almost certainly would
turn to Washington with requests for even more
assistance. He already is using his financial difficulties
as leverage to try to obtain better terms on loans and
forgiveness for Egypt's Foreign Military Sales debt to
the United States.
32. While of less importance to US interests, other
oil-exporting debtor LDCs would also be adversely
affected and require US attention. Lower oil prices
will pose particularly difficult economic and political
problems for whatever government rules in Nigeria,
which depends on oil sales for 96 percent of its
export earnings. General Buhari's regime has been
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unable to fulfill promises made upon seizing power in
late 1983 to improve living standards and end the
worst economic recession since the 1967-70 civil war.
Lagos now faces even greater challenges because of its
refusal to accept a politically risky agreement with the
International Monetary Fund and its inability to sell
sufficient oil to cover rising debt service payments that
will consume at least 45 percent of Lagos's estimated
$10 billion oil earnings for 1985. These debt obliga-
tions-which peak in 1987-will remain high through-
out the decade, and declining oil revenues would force
Lagos to cut back even further on imports and to fall
behind on debt payments without rescheduling or
recourse to the IMF. In this event, perceptions of
mismanagement and of worsening economic condi-
tions will increase chances for a coup by disadvan-
taged ethnic groups or more radical officers that could
set off regional violence or an anti-Western backlash.
revenue
35. The United States could potentially derive ben-
efit from the impact of lower oil prices on oil export-
ers, such as Libya, that use oil earnings for arms
purchases, to fund terrorism, and for other activities
inimical to US interests. Libya-whose international
reserves have fallen by $10 billion in the last three
years-would be seriously harmed by lower oil prices;
a drop in price to $20 a barrel would reduce Tripoli's
annual revenues by over $2 billion. We believe Tripoli
would react primarily by cutting back imports. On the
other hand, Quadhafi would not reduce its support of
terrorist groups and anti-American governments. Re-
cent examples of Libyan aid to anti-American govern-
ments in Nicaragua and Ethiopia suggest that even
tighter financial conditions would not cause Qadhafi
to forgo these activities.
33. We expect that, despite ample foreign reserves
of almost $13 billion, lower oil prices would give
Venezuela some difficulties; in particular, we believe
Caracas would experience greater difficulty in finaliz-
ing its rescheduling agreement and obtaining new
money from creditors. Venezuela has not borrowed
externally in two years, while private investment has
stagnated. Caracas needs new investment funds to
stimulate the economy out of an austerity-induced
recession. Venezuela would probably react with a
combination of continued austerity and a reserves
drawdown. The administration of President Jaime
Lusinchi, however, will likely keep unrest under con-
trol by balancing mild stimulus with price and wage
controls. Because of a sound underlying financial
position and a strong government, Indonesia should be
able to cope with a loss in revenue. Even there,
however, the loss of an accumulated $2.5-3 billion in
export revenue by 1988 from a slide in oil prices to
$20 a barrel would force the government to take
strong action to bring the current account deficit down
to levels that could be financed.
34. Sliding oil prices would impose considerable
economic cost on Iran and Iraq. They derive most of
their foreign earnings from oil sales and, because of the
cost of their war, both are in precarious economic
shape, both domestically and internationally. Baghdad
probably hopes to increase exports by 500,000 b/d
when its new pipeline through Saudi Arabia opens later
this year and will continue to push for new outlets
outside the Gulf. However, Bagdhad has already prom-
ised to repay some of its commercial creditors with
funds generated from the added sales. For its part,
Tehran probably would try to use some of its
Difficult Choices for the Soviet Union
36. A gradual slide in oil prices probably will pose
more problems than opportunities for the Soviet Union
in the near to medium term, given the importance of
Moscow's energy exports as a source of hard currency
(see table 6). Directly, the sliding prices will reduce oil
revenues by an average of some $2-3 billion annually
for the 1986-90 period. Moreover, because their natu-
ral gas prices are tied to world oil prices, revenues
from this source would also fall by just under $1 billion
annually.
37. In a world of declining oil prices, Moscow
would face difficult choices with regard to hard
currency expenditures, use of oil in its own economy,
and provision of oil to Eastern Europe, but would have
time to make nondisruptive adjustments. Moscow
could respond to a drop in energy prices initially by
cutting less essential imports,. stepping up its borrow-
ing, and increasing gold sales.
Table 6
Soviet Union:
Importance of Energy Exports
1970
1975
1980
1984
Hard currency exports
2.8
9.8
27.8
31.6
0.4
3.4
12.3
15.8
2.4
6.2
12.8
11.9
-0.2
-4.8
1.7
4.4
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38. The financial adjustments could be taken im-
mediately. The Kremlin has used these tools before to
overcome short-term hard currency payment prob-
lems and is in a good position to apply them now:
- It enjoys a highly favorable credit rating among
Western lenders who are willing to make loans
available at relatively low rates of interest.
- Its net hard currency debt totals only about $10
billion, with a gross debt of $20.5 billion offset by
about $10 billion in hard currency asset holdings.
- Soviet gold reserves are now valued at around
$28 billion.
needed to reduce key bottlenecks in the Soviet econo-
my. Imports of machinery and equipment, turnkey
plants, and high-technology items-which receive
high priority under the new 12th Five Year Plan
(1986-90) and part of the push to modernize and
revitalize the Soviet economy-also would not be cut
drastically. In all cases, Moscow would ensure that
needed import cuts did not impact on military re-
quirements.
42. The Soviets would have limited success in com-
pensating for losses in hard currency earnings due to
lower energy prices by increasing oil or gas exports.
Energy exports would be constrained by several
factors:
17 percent
39. Moscow would probably view any significant
decline in its foreign asset holdings as unacceptable,
however. Because these assets serve Moscow in a
variety of economic and political ways, it would
probably dispose of them only as a last resort. During
past periods of heavy hard currency borrowing, the
Soviets have tried to leave their foreign asset holdings
intact as much as possible and would be likely to do
the same at this time.)
40. The Kremlin also probably would not let its
hard currency debt grow rapidly. Moscow has been
very cautious in its financial dealings with the West,
carefully keeping its own debt under control. It has
been critical of the rapid growth of the hard currency
debt of some of its partners in the Council for Mutual
Economic Assistance, asserting that they have become
vulnerable to Western pressures and influence. As the
perceived duration of the loss of earnings from a fall in
energy prices lengthened, however, Moscow would
need to reassess its conservative financial policies. The
Soviets would most likely increase their long-term
hard currency borrowing, being careful not to let the
debt service ratio rise to an economically and political-
ly unacceptable level
41. In addition, Moscow would increasingly have to
rely on adjustments in its hard currency imports to
compensate, although significant reductions in any one
area would be limited. Given Soviet emphasis on the
food program and consumer welfare in general and
the ever-present possibility for poor grain crops, we
believe that Moscow would be very reluctant to curtail
greatly imports of agricultural commodities such as
grain and meat. The Soviets would also hesitate to cut
imports of industrial materials such as metals, raw
materials, and chemicals very much, as these are
- Soviet oil production is likely to remain stagnant
or decline into the 1990s.
- Substantial quantities of oil could not be quickly
diverted from Eastern Europe without causing
possibly serious economic damage there.
- Evidence does suggest that the Soviets are trying
to conserve oil and substitute gas for oil, but these
changes require time and are not likely to do
more than stabilize domestic consumption over
the short term.
43. The Soviets would also suffer in the global arms
market, which is a substantial source of hard currency
for Moscow. With oil prices depressed, its main arms
customers-Iraq, Syria, Libya, and Algeria-would be
financially strapped and less able to pay in hard
currency. Indeed, they might well find it necessary to
curtail their arms import programs; Iraq and Libya
already have to pay for past purchases in oil rather
than hard currency
44. Although the Soviets could step up gold sales,
the gold market is now weaker than it has been in past
years and, should the price of oil fall, would probably
become weaker still. Soviet efforts to compensate for
hard currency losses by selling gold could depress the
price further. For these reasons, we believe that the
Soviets would be reluctant to compensate for a large
share of these losses through gold sales unless the only
alternatives involved a sharp rise in the debt service
ratio or a large reduction in foreign asset holdings.
Ramifications for US Interests
45. While OECD and US economic interests are
best served by competitive oil prices, the current
situation of artificially high prices serves some strate-
gic interests. It creates private-sector opportunities and
incentives to develop relatively high-cost gas in West-
ern Europe; these resources could limit expansion of
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Soviet gas sales in that market. Also, high prices limit
reliance on Persian Gulf exports by promoting conser-
vation, non-OPEC energy exploration and develop-
ment and further gains in energy productivity.
Additional Disruptions of a Sharp Plunge in Prices
A drop in oil prices, however it occurs, will increase
the purchasing power of those economic units that are
net purchasers of oil or oil-based products. In this sense,
the same potential gains exist for a rapid as for a
gradual decline; moreover, the benefits would come
sooner. Nonetheless, a sudden drop would create selec-
tive disruptions that could offset some of these positive
economic effects for many key sectors of the world
economy:
- One potential problem area in a rapid price
decline would be in industrial-country oil and
other energy industries. Should prices decline
rapidly, say to $20 a barrel by the end of this year,
we believe this decline could sharply and adverse-
ly affect the energy industry. However, the overall
impact on oil-importing economies would be fa-
vorable on balance because of the benefits of
lower prices on nonenergy sectors.
- Similarly, in the event of a sharp decline in oil
prices, we would be concerned about international
financial problems stemming from the impact of
lower oil prices on banks with large proportions of
energy-related loans in their portfolios. Banks with
extensive exposure in oil-producing LDCs also
could be adversely affected as these countries'
overall foreign exchange earnings fall.
Finally, and most important, we are concerned about
the implications for political stability in a number of
countries of a sudden plunge in oil prices. A sudden
plunge in prices would create problems not present in a
gradual decline, chiefly by forcing all the negative
effects into a single year and eliminating the ability to
adjust gradually. Such an outcome would exacerbate
policy dilemmas in a number of countries, notably
Mexico, Egypt, Nigeria, Iran, and Iraq.
One of our greatest concerns would be for the impact
on and'reactions of Mexico. There, where a gradual
decline in oil prices would cause the economy to
stagnate for the next few years, an immediate drop in
oil prices would plunge h it economy into severe
recession. model of Mexico, for
example, suggests a decline in oil prices of $2 a year for
1985-88, even accompanied by government action to
offset some of the most severe results, would reduce
growth to an average of 1 percent or so a year. On the
other hand a sudden drop to $20 a barrel without
significant government policy response would bring
Mexico's real growth to a complete halt for several
years, with some years of actual recession.
West European Energy Security
46. For years the Soviet Union has emphasized
energy exports to the West-chiefly Western Eu-
rope-as a means of obtaining hard currency. Histori-
cally, oil has been the major earner, but, with the
completion of the Soviet-West European pipeline,
natural gas will become increasingly important. In-
deed, unless substantial progress is achieved in the
development of indigenous resources over the next few
years, Soviet inroads into West European gas con-
sumption could rise to as high as one-third of supplies
by 2000 (see table 7). We believe there is a good
possibility lower oil prices will push the outcome in
this direction. Because of the high cost of developing
West European gas-inclusive of taxes-development
of indigenous gas would become less attractive. If
natural gas prices fall with those of oil-historically
they have moved together-then a drop in oil prices
could well postpone further development.
47. Moreover, Moscow could take advantage of the
opportunity presented by a decline in West European
gas development with only a few steps of its own,
chiefly building a transit pipeline through Czechoslo-
vakia, a task that would take only eight months. We
believe the Kremlin would be willing to take these
steps and would be able to increase its gas sales to
Western Europe.
Long-Run Oil Market Impacts
48. The other area in which lower oil prices might
create longer run problems is by spurring demand,
reducing supply, and tightening the market. In turn,
susceptibility to rising prices and supply disruptions
and renewed dependence on OPEC would occur
sooner than if prices remained at present levels. Some
analysts believe there is the possibility that dramatical-
Table 7
Soviet-West European Gasline:
Potential Impacts
Total Continental Eur
consumption (billion c
opean gas
ubic meters)
167
190
220
Supplied by Soviet Un
(billion cubic meters)
ion
30
50
70
Soviet share of total (p
ercent)
18
/26
32
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ly lower oil prices would spur consumption in the next
few years and lead to a tight market in this decade.
There are several reasons, however, to believe this will
not be the case:
- One key factor is the momentum of the responses
to the last two price hikes. We believe that, even
if oil prices fall, consumers and businesses will
not undo past conservation measures. Consumers,
for example, seem unlikely to return fully to
large cars and uninsulated homes, even with
lower oil prices. At the same time, there is
continuing momentum to back out residual fuel
oil in stationary applications. Business may
switch to some extent back to oil if its price
declines lead those of other energy sources, but
will be likely to preserve dual capabilities, retain-
ing the ability to reduce demand if supply grows
tight.
- Implementation of new technologies probably
also will minimize any upturn in oil demand.
Many of the newer technologies coming on line,
for example bio processes, are energy saving.
Their implementation, moreover, is not entirely
dependent on oil prices, and we believe many
new technologies will be put in place even at
lower oil prices.
- A final factor that is by no means unimportant is
the change in population and lifestyles. In the
OECD countries, for example, population
growth in general and adult population growth in
particular will be less rapid over the rest of the
century. Moreover, the trends toward compact-
ness-in cars, houses, and appliances-also will
hold down increases in energy demand.
The continued efforts at conservation should also be
aided by the knowledge that, in the past, current
trends and consensus forecasts have frequently been
poor predictors of long-run price trends.
49. There is more uncertainty on the supply side,
however. On the one hand, we believe that $20 a
barrel oil prices will not significantly affect non-OPEC
production between now and 1990, even though the
weak oil market has slowed exploration in other areas
of the non-Communist world. After more than 20
years of annual increases in capital and exploration
spending by the oil industry, expenditures outside
North America declined about 10 percent in 1983
compared to 1982 levels. Preliminary data indicate
that this trend has continued into early 1985. Nonethe-
less, our analysis suggest that production through 1990
can rely on already discovered fields and on develop-
ment projects under way. Consequently, we feel sig-
Growth in Oil Demand:
An Alternative View and Its Implications
In large part, the optimistic conclusion that lower oil
prices would not generate a tight oil market later in this
decade is based on the assumption embodied in the
paper that, with no change in prices, conservation
of/substitution for oil will continue at close to the pace
of the past few years. Specifically, the baseline projec-
tion of the oil market through 1990 assumes the oil
intensity drops at about 2.5 percent a year; since 1980,
the non-Communist world's use of oil for each unit of
real production has fallen at more than 5 percent a
year. In this event, non-Communist oil demand will be
barely 1 million b/d higher in 1990 than it is at present.
Even with no growth in non-OPEC supplies, OPEC
output would remain several million barrels per day
below capacity.F__1
An alternative view is that the recent decline in real
oil and energy prices at the consumer level will reverse,
or at least bring to an end, the declines in the oil
intensity of the world economy. Certainly, energy
prices paid by consumers and businesses, particularly in
the OECD, have fallen since the decline in oil prices got
under way. Since 1982, we estimate final consumer
energy prices for the OECD as a whole have fallen an
average of 6 percent in real terms.
To examine the ramifications of this alternative view
we utilized the energy sector of CIA's Linked Policy
Impact Model, which allows an explicit examination of
the impact of lowered oil prices. According to the
results of that model, there is a possibility that the
declines in real energy prices that have occurred since
1982 and that probably will occur even with constant
oil prices will produce much less of a decline in oil
intensity. Specifically, the model suggests that with
constant nominal oil prices, non-Communist oil intensi-
ty likely will end its decline, and oil consumption will
expand at about the rate of real GNP growth, as it did
when real oil prices were falling in the 1960s. Moreover,
further declines in oil price will produce an even
greater upturn in oil demand.
Should this outcome prove correct, oil market tight-
ness within the next 10 years would be much more
likely to occur substantially earlier. The model results
indicate that, if lower oil and energy prices do have a
strong impact on the use of oil in non-Communist
economies, then demand for OPEC oil could well strain
OPEC available capacities before 1990. In contrast,
continued reduction in oil use would postpone the
timing of market tightness into the 1990s, if it occurred
at all.F___~
nificant reductions in non-OPEC production before
the early 1990s are unlikely, even with $20 per barrel
oil prices.
19
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50. On the other hand, OPEC's decision as to what
it views as optimum available capacity could be
crucial to whether lower oil prices create a tight
market. Over the past several years, OPEC capacity
has eroded by some 5 million b/d, as a result of the
Iranian Revolution, the Iran-Iraq war, financial con-
straints on maintenance, and decisions that available
capacity exceeds needs for the foreseeable future (see
figure 3). If OPEC continues to allow capacity to
erode, then by 1990 rises in demand could reduce
surplus capacity to perilously low levels. If, however,
as OPEC production picks up over the next several
years, OPEC countries hold production capacities near
Figure 3
Non-Communist Oil Market: Supply and Demand
present levels, then the oil market should remain in
substantial surplus into the 1990s.
51. Although the present combination of excess oil
supplies and weak oil demand provides considerable
protection against supply disruptions in the near term,
the dependence of the industrialized countries on oil
from the Persian Gulf could increase by the early
1990s because of rises in consumption and lower oil
production induced by lower prices. If this scenario
comes to pass, the West will again be vulnerable to
supply cutoffs and renewed upward pressure on oil
prices despite the success of policies to conserve
energy, diversify way from oil, and build strategic oil
stockpile
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77
50
:1
4
40
30
20
10
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Non-Communist
Consumption
^ OPEC Surplus
OPEC Production
Non-OPEC Production
1-1 OPEC Capacity
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