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• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP87T01127R000100070005-5
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 13
• Document Creation Date: January 12, 2017
• Document Release Date: April 21, 2011
• Sequence Number: 5
• Publication Date: June 1, 1985
• Content Type: REPORT

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Intelligence
Softening Oil Market
OPEC: Narrowing Options in a
An Intelligence Assessment
PROJECT NUMBER
WMJK
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"7
TOTAL NU BER OF COPIES
DISSEM DATE CS '-& o1
EXTRA COPIES ~`I I y ~c
RF7OORD CQVTER -
JOB NUMBER
GI 85-10165
June 1985
413
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j j Inaciugence .
OPEC: Narrowing Options in a
Softening Oil Market
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Comments and queries are welcom
e and may be
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directed to the Chief, Strategic Resources Division,
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OGI,
Secret
GI 85-10165
June 1985
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3ecrer
OPEC: Narrowing Options in a
Softening Oil Market 25X1
Key Judgments Overproduction and low demand continue to put intense downward
Information available pressure on oil prices. OPEC's lack of discipline to restrain production in
as of 13 June 1985 the face of low demand could cause a price decline before OPEC's
was used in this report.
ministerial meeting on 5 July. Saudi Arabia's willingness to cut back
production over the past two years to prop up OPEC's price structure has
prevented a major price break, but with Saudi output at an 18-year low,
Riyadh no longer appears able or willing to carry the burden alone.
This means that, with little or no prospect for a near-term increase in oil
demand, market weakness will continue and downward price pressure is
unlikely to abate. Strict adherence to production guidelines by OPEC
could avert a price cut at this time, but the intense financial pressures on
several members make voluntary restraint unlikely. Without production
discipline, prices could fall-perhaps sharply-particularly if Saudi Arabia
makes good on its recent threat to retaliate against quota violators by
lowering prices and sharply increasing exports. A unilateral price break by
the Saudis, which cannot be ruled out, could precipitate a dissolution of
OPEC.
Recent market developments have created problems for Saudi Arabia.
Riyadh will need OPEC's other members to share the burden of stabilizing
the market. Financial and political constraints are narrowing Saudi options
to cope with the weakening market. Saudi oil earnings this year will not
match 1984 levels under any realistic price and production scenario. At the
same time, the Saudis face further deep cuts in their ability to sustain
wide-ranging domestic and foreign financial assistance programs-or a
drawdown in foreign reserves-if they continue to absorb market slack.
OPEC's options to forestall a price break are extremely limited, particular-
ly if members do not equally shoulder the burden of supporting prices. An
oil price decline would have mixed effects on the world economy. Although
lower oil prices would help efforts to keep inflation in consuming countries
under control and give impetus to economic expansion, a precipitate drop
would create severe financial problems for oil-producing nations with
heavy debt burdens, and place serious strains on the international banking
community.
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GI 85-10165
June 1985
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Scope Note This assessment examines the events leading up to the current oil price 25X1
crisis facing OPEC and sets the stage for the organization's semiannual
ministerial meeting previously scheduled for 22 July. The meeting has been
rescheduled for 5 July in Vienna and will deal with the risk of another price
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OPEC: Narrowing Options in a
Softening Oil Market
Introduction
Pressures are mounting for another fall in oil prices.
The oil market continues to weaken, and spot prices
for major crudes are edging downward. High produc-
tion levels by the Organization of Petroleum Export-
ing Countries (OPEC) t since the first of the year
continue to reinforce industry skepticism that OPEC
can and will hold prices by adjusting supply to meet
lackluster demand. More ominous from OPEC's view,
however, is the prospect that Saudi Arabia-faced
with mounting financial and budgetary constraints-
may decide not to cut back output further to support
the organization's official price structure. Without
renewed production restraint within OPEC, a new
round of price cuts is likely, perhaps before OPEC's
ministerial meeting, now scheduled for 5 July in
Vienna
The Market Backdrop
According to preliminary data, non-Communist oil
consumption in the first quarter of 1985 was 1 percent
below that for the same period last year, or more than
500,000 barrels per day (b/d) less than many oil
companies had expected. Preliminary data also show
sales in the United States in April were 3 percent
lower than for the same period in 1984. Slower
economic growth in the United States, the end to the
British coal miners' strike, and continued gains in
conservation and substitution-in part because of the
strong dollar-contributed to the drop in oil use in the
industrialized countries.
Spot prices for most OPEC crudes are more than $1
per barrel below official levels (figure 1). Non-OPEC
supply continues to rise and in the first quarter
averaged 500,000 b/d above year-earlier levels. Non-
OPEC producers such as Egypt and the USSR low-
ered official prices in recent weeks, and Mexico-
under intense pressure from customers-reportedly is
Figure 1
Spot Versus Official Prices
for Arab Light- Crude Off, 1985
US $ per barrel
26
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25
Jan
Feb
Mar
Apr
May
a Formerly OPEC benchmark crude.
b Price at end of month.
Continued OPEC Overproduction
The market situation has been exacerbated by contin-
ued high levels of OPEC oil production. Through the
first four months of 1985, OPEC's output was consis-
tently above the 16 million b/d revised ceiling estab-
lished last October (table). In recent months, 12 of the
13 members have produced at or above their individ-
ual quotas, with Nigeria at times exceeding its alloca-
tion by more than 300,000 b/d, according to US
Embassy reporting
Saudi cutbacks in April were quickly offset by in-
creased Iranian production as Tehran pushed to in-
crease oil sales. In May OPEC output finally fell
considering a $1-per-barrel price cut. British oil
prices, now more closely linked to movements in snot
oil prices, were reduced by $1.25 per barrel.
'OPEC members are Saudi Arabia, Iran, Kuwait, Iraq, Venezuela,
Qatar, Libya, Indonesia, the United Arab Emirates, Algeria,
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OPEC: Crude Oil Production Million b/d
Oct 1984 1985
Quota
First
Qtr Mar
Apr
May
Total
16.00
16.5
17.0
16.7
15.3
Algeria
0.66
0.7
0.7
0.7
0.7
Ecuador
0.18
0.3
0.3
0.3
0.3
Indonesia
1.19
1.3
1.2
1.3
1.2
Iran
2.30
2.2
2.5
2.7
2.6
1.20
1.2
1.3
1.3
1.3
Kuwait
0.90
1.2
1.1
1.0
1.0
(Less share of
Neutral Zone)
(0.9)
(0.9)
(0.8)
(0.8)
0.99
1.0
1.0
1.0
1.0
1.30
1.6
1.7
1.6
1.5
0.28
0.3
0.3
0.3
0.3
Saudi Arabia
4.35
3.9
4.0
3.6
2.7
(Less share of
Neutral Zone)
a
(3.6)
(3.8)
(3.4)
(2.5)
UAE
0.95
1.2
1.2
1.2
1.2
Venezuela
1.56
1.6
1.6
1.6
1.6
a Neutral Zone has no production quota; output is divided
between Saudi Arabia and Kuwait and included in their country
quotas.
below its ceiling, paced by an almost 1-million-b/d
drop in Saudi oil production from April levels. The
production decline was market induced, primarily
because buyers delayed lifting crude in expectation
that OPEC's prices will fall.
Iran Abandons Production Restraints
Until recently, Iran had been willing to restrain
output to support high oil prices. The persistent weak
oil market and Iraqi attacks on tankers, however,
continue to play havoc with Iran's oil earnings.
Monthly revenues from August 1984 through March
1985 averaged 30 percent less than during the previ-
ous year and a half. Economic retrenchment-the
major result of declining oil revenues-led to growing
public discontent. In April the Iranian Parliament
reportedly ordered the national oil company to signifi-
cantly boost oil sales. Iran's oil minister also autho-
rized price discounts to market the oil, effectively
abandoning Tehran's de facto support of OPEC's
official price structure.
As part of its sales drive-and to reduce high insur-
ance costs to its customers-Iran began to shuttle
crude away from its vulnerable oil export facility at
Jazireh-ye Khark to tankers anchored offshore at
Jazireh-ye Sirri in the southern Persian Gulf for
the shuttle operation
began in early e ruary. Initially besieged with tech-
nical and operational problems, Iran improved its
efficiency, and by April oil exports through the shuttle
operation surpassed direct exports from Khark. From
a low production rate of 1.8 million b/d in January,
Iran managed to increase output by about 500,000
b/d in February and another 200,000 b/d in both
we estimate that Iran's output reached an
estimated 2.7 million b/d in April-its highest level in
a year-before falling slightly in May.
Saudi Options Narrow
With Iran abandoning its position of production re-
straint and de facto partnership with the Saudis in
supporting prices, Riyadh's options for coping with
the weakening market are narrowing. Output in May,
excluding Saudi Neutral Zone production, averaged
an estimated 2.5 million b/d-down about 900,000
b/d from April levels-indicating that the Saudis for
the moment are continuing their role as OPEC's
swing producer. But a statement issued by King Fahd
and delivered by Saudi Oil Minister Yamani at
OPEC's Ministerial Executive Council meeting in
Taif warned that Riyadh would stop supporting the
current price if members continue to violate price and
production guidelines.
Recent public statements by Yamani on the current
low levels of Saudi output and the possibility of
lowering prices of heavier crude oils appear designed
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to inform the market and OPEC's other ministers that
Riyadh has begun to devote its full attention to the
organization's upcoming semiannual ministerial meet-
ing. Although Yamani did not quantify the potential
price drop for heavy crudes, industry analysts suggest
that a 50-cents-to-$i-per-barrel cut is possible. Ri-
yadh realizes that, without production restraint by
other OPEC members before the meeting, it is unlike-
ly that continued Saudi output at the 2.5 million b/d
level will be enough to narrow the widening gap
between official and spot oil prices.
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Riyadh may believe that the only way to spur demand
for its crude in the longer term is to cut oil prices now.
Yamani's recent public statements about lowering
heavy oil prices and Fahd's admonition against over-
production could be designed to facilitate a price cut
while shifting the blame for not holding the line to
other producers. sever-
al months ago Yamani foresaw Saudi production
falling to a low of about 2 million b/d by this summer
(figure 3). as early as
February, amain predicted a price cut of several
dollars this spring. If the Saudis intend to maintain
their price management role, they may advocate a $2-
to-$3-per-barrel price cut that would bring OPEC's
price structure more in line with spot market levels.
Technically, Riyadh still can maneuver and reduce
output to the "zero-export" level, which we estimate is
around 1.5 million b/d. This production level provides
enough oil to meet domestic consumption needs, while
gas requirements can be met from a combination of
the associated gas from 1.5 million b/d of oil produc-
tion, nonassociated gas, and some switching to liquid
fuels. Removal of the additional 1 million b/d of
supply from the market-coupled with firm agree-
ment by OPEC's other members to keep production at
current rates-probably would be enough to buoy
prices. It would, however, deprive Riyadh of all oil
revenue for at least several months-an outcome we
believe the Saudis would find unacceptable. Nor can
the Saudis expect relief from a step-up in demand.
Most industry analysts now call for little, if any,
increase in demand for OPEC oil until winter needs
spur seasonal demand.
For several economic and political reasons, however,
we believe that the Saudis are no longer in a position
to reduce oil production much below current levels.
Relatively liquid international financial assets held by
Riyadh are currently $95 billion-down roughly a
third from the peak recorded three years ago-and
will make the Saudis extremely reluctant to reduce oil
production. We believe that the Saudis do not want to
finance a government deficit much larger than $10
billion because they do not want to make a further
sharp reduction in their international assets. A further
decline in oil revenues would add to Riyadh's deficit.
If, for example, oil production during the current
fiscal year averaged 2 million b/d and nominal prices
remain unchanged, government revenues would total
roughly $30 billion. This would leave Riyadh with a
deficit of about $20 billion, if no additional spending
cuts were implemented. Saudi officials have already
made cutbacks that, for the first time, are targeted
towards Saudis, and they will be wary of making
additional steep cuts. One Saudi official has told US
Embassy officers that domestic benefits can be re-
duced only with great care and that Riyadh is aware
of problems in Morocco, Tunisia, and Sudan resulting
from reductions in consumer subsidies
Political imperatives also constrain Riyadh's ability to
further cut back production. Not only are the Saudis
directly subsidizing the Iraqi war effort by selling a
large portion of their share of Neutral Zone oil
production to Iraq's customers and giving Baghdad
the revenue, but by lowering production to hold up
prices Riyadh also indirectly provides Tehran the
market share needed for increased sales and financing
necessary to continue the fight. In our view, the
Saudis are unlikely to allow the situation to persist
much longer, particularly if they see Iran displace
them as OPEC's largest producer. Moreover, al-
though fiscal austerity does not yet seriously threaten
the stability of the Al Saud regime, a further down-
turn in the economy probably would erode the monar-
chy's popular support and could fuel antiregime
sentiment.
Sharing the Burden
OPEC's options to forestall a price break at this time
are extremely limited, particularly because the Saudis
apparently have decided not to shoulder the burden of
supporting OPEC's prices alone. Should the Saudis
receive firm assurance from OPEC's other members
of strict compliance with production quotas, Riyadh
probably would be willing once again to do its part as
OPEC's swing producer. In our judgment, the Saudis
still do not want to keep production much under 3.5
million b/d-excluding output from the Neutral
Zone-for more than a few months to restore stability
to the market.
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OCCI CL
Figure 3
Saudi Arabia: Share of OPEC Crude Oil Productions
Although this production level might be enough to
hold prices near present levels if other OPEC produc-
ers cut back to the agreed quotas, there are several
reasons why voluntary restraint from some of OPEC's
other members is unlikely. Social, political, and eco-
nomic pressures mounting in several member states
are at the root of the problem as they work to
encourage overproduction counter to Saudi Arabia's
goal of stable output and prices. In particular, Nige-
ria, Indonesia, Venezuela, and Ecuador have stated
the need to sell more oil to stave off social unrest. Iran
and Iraq-locked into the fifth year of war-have
vowed to maximize oil revenues to boost their falter-
ing economies and to support the war effort. Nigeria,
OPEC's most financially strapped member, has a
large population and limited options outside of over-
production to reverse its declining economy. The
Saudis probably are hoping that further progress by
an independent auditor in monitoring production will
lead to greater discipline and eliminate the need for
Riyadh to adjust output lower than 3.5 million b/d.
Any effort by the Saudis to ensure this level of output,
however, could be quickly thwarted from within
First Quarter 1985
Total OPEC: 16.5
OPEC. Indeed, Ecuador, Nigeria, and Iraq probably
will demand increases in individual quotas when
OPEC meets early next month, according to US
Embassy reporting, further aggravating the difficulty
of getting Saudi output above its present depressed
level without precipitating a price break.
The Coming Battle Within OPEC
With less willingness on its part to prop up the market
by further decreasing output, we believe that Saudi
Arabia appears ready to mobilize OPEC for a new
round of talks on production restraint, lower output
quotas, and smaller price differentials. The US Em-
bassy in Riyadh reports that OPEC may reduce its
output ceiling to 15.5 million b/d;
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Arabia would like a production quota of 3.5 million
b/d, according to the US Embassy. Reaching agree-
ment on a lower output ceiling would be difficult to
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achieve because it would require major sacrifices by
OPEC to prorate quota cuts and, at the same time,
allow the Saudis to produce at their preferred level.
Nonetheless, OPEC consensus and compliance with
any agreement will be critical if a price decline is to
be avoided this year. The gap between spot and
official prices is growing, and it now looks like prompt
action to lower production is OPEC's best bet to hold
the current pricing structure intact.
We believe that Riyadh also is well aware of the need
to act quickly. At the same time the Saudis know the
difficulty of soliciting support from all of OPEC's
members. The recent Taif conference provided a
forum for discussing OPEC's current problems and,
more important for the Saudis, allowed members to
review the latest auditor's report on exports and
production levels that should lend credibility to Ya-
mani's claim that Saudi Arabia alone has made
sacrifices to hold prices. The conference also provided
the ministers with a barometer of how to judge the
Saudis' view of the current market situation and what
actions Riyadh feels OPEC should take.
According to US Embassy reporting, Riyadh has
decided that it is time for OPEC members to be held
accountable for their collective decisions. Yamani
understands that all members face revenue problems
that are increasingly intractable and that few are
willing to rein in production. He has, nonetheless,
warned of retaliation against OPEC members who
continue to violate the organization's guidelines, using
the threat of a unilateral price cut and production
increase. Yamani has used this tactic successfully in
the past to get members to cooperate at the bargain-
ing table
We believe that the Saudis are hesitant to take any
unilateral measures that could lead to a disintegration
of OPEC and would probably do so only if declining
revenues reach a point where the regime's domestic
political support or revenue base is seriously threat-
ened. Although financial pressures are now far short
of this level, should Saudi oil production fall below
current levels for more than a few months, mounting
budget deficits could lead to more serious problems
after a year or so.
A delegate to the Taif conference claims that the
ministers took King Fahd's warning to act collectively
in upholding prices very seriously. Should Riyadh
have to make good on its threat, the action could
initiate a series of price cuts and possibly a sharp
decline in oil prices before OPEC can devise new
prices and production guidelines to protect its inter-
ests. In the absence of producer restraint, a much
sharper price drop could ensue. Yamani recently
confided that if a price break comes at this time, it
could be as large as $10 per barrel, according to the
US Embassy in Riyadh.
Outlook
... For the Oil Market. With little or no prospect for
a near-term increase in demand for OPEC oil, down-
ward pressure on prices is unlikely to abate. Low
consumption and rising non-OPEC supplies will con-
tinue to put downward pressure on prices. As OPEC
publicly struggles to deal with overproduction, expec-
tations of additional official price cuts this year will
persist and could further decrease demand for OPEC
oil in the near term. Demand for OPEC oil is likely to
remain at or below the organization's production
ceiling in the coming months and, unless OPEC acts
collectively and reduces output, a further erosion in
prices is likely this year.
... For Saudi Arabia. Oil revenue in 1985 will not
reach last year's level, under any reasonable price and
production scenario. The February 1985 price cut cost
the Saudis about 35 to 40 cents per barrel in revenue,
and export volumes are unlikely to reach the level of
3.7-3.8 million b/d achieved in 1984. Additional price
cuts without a boost in exports would worsen the
revenue situation. Moreover, a unilateral price cut is
unlikely to yield Riyadh any significant gain in
market share, and the resulting drop in world oil
prices probably would not stimulate demand enough
to compensate for the lost revenue per barrel.
Saudi willingness to sacrifice production in the past
enhanced Riyadh's power in OPEC and put the
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Saudis in a good position to impose their will on
OPEC's other members. Nevertheless, Saudi leverage
is weakening. We believe that the Saudis will continue
to be the dominant force in OPEC, but their leader-
ship role may well be challenged this year by Iran,
particularly if Tehran's oil output begins to exceed
Saudi Arabia's for a sustained period. Collapsing oil
prices or sharply reduced oil revenues would aggra-
vate economic, social, and political tensions in the
kingdom and, over time, could threaten the stability
of the Al Saud regime.
... For OPEC. If the organization can discipline itself
and can cut production to reverse the decline in prices
this spring, it will once again prove that OPEC's
power stems from its ability to protect the organiza-
tion's interests in a weak market. This would indicate
that OPEC has learned from past crises and that the
organization probably is still able to close ranks to
avert a major price break. If, on the other hand,
OPEC is unable to effectively grapple with its latest
crisis and if its pricing structure severely weakens,
OPEC will lose much of its credibility. Under these
circumstances, if Saudi Arabia lowers prices unilater-
ally, both OPEC and non-OPEC producers would
quickly follow suit. Unless OPEC members were able
to devise new production and pricing guidelines, the
often predicted demise of the organization would be
likely to ensue.
Implications
... For Third World Debtors. A price decline would
create financial problems for oil producing nations
that are major debtors. Even a small price drop could
reignite financial problems for Nigeria and Egypt
because both heavily depend on oil export earnings.
At the same time, a number of LDC debtors-notably
Brazil, the Philippines, and South Korea-would save
significantly on their oil import bills. The implications
of a precipitate price drop-to perhaps $20 per bar-
rel-would become serious for oil-producing nations
like Mexico, Venezuela, and Indonesia that stand to
lose billions in foreign exchange annually. Moreover,
collapsing oil prices have the potential to undermine
the political stability of several pro-Western govern-
ments in the Third World-oil-producing states and
recipients of OPEC aid.
... For the United States and Other Industrialized
Countries. The prospect of lower world oil prices will
continue to be good news for the US economy,
although a further strengthening of the dollar could
lessen the beneficial impact of lower prices on other
developed economies.' Whereas low oil prices keep
inflation under control and give impetus to economic
expansion, a price collapse would strain moderate
regimes and threaten US strategic interests in several
regions.
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