THE OIL MARKET: IMPACT OF THE OPEC AGREEMENT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83B00231R000100230001-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 16
• Document Creation Date: December 21, 2016
• Document Release Date: December 18, 2007
• Sequence Number: 1
• Publication Date: April 1, 1982
• Content Type: REPORT

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Intelligence
The Oil Market:
Impact of the
OPEC Agreement
Secret
GI 82-10082
April 1982
Copy" 4 6 l
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Directorate of Secret
Intelligence
The Oil Market:
Impact of the
OPEC Agreement
An Intelligence Assessment
Information available as of 12 April 1982
has been used in the preparation of this report.
This assessment was prepared b f
the Office of Global Issues and
Office of Current Production and Analytic
Support. Comments and queries are welcome and may
be directed to the Chief, Energy Markets Branch,
OGI,
Secret
GI 82-10082
April 1982
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The Oil Market:
Impact of the
OPEC Agreement
quota system to combat the price slide.
Key Judgments Continued sluggish economic activity in the OECD countries has caused
oil consumption to decline more rapidly than had been anticipated. As a re-
sult, oil use by non-Communist countries for 1982 will probably be under
45 million b/d-more than 1 million b/d below our original forecast in
January. The drop in consumption has also placed considerable downward
pressure on oil prices and forced OPEC members to adopt a production
OPEC success in defending nominal prices will depend on several factors:
On the demand side
? The duration of the present drawdown in excess inventories could keep
demand for OPEC crude oil depressed at or below the quota of 17.5
million b/d for three to six months. Once the drawdown is complete,
demand for OPEC oil should rebound by as much as 3-4 million b/d. Fi-
nancially strained countries, including Nigeria, Indonesia, Venezuela,
and Libya, should be able to increase sales to near-desired levels if at that
time Saudi Arabia is willing to hold output at relatively low levels.
? The rapid decline in oil consumption may continue if economic recovery
is delayed and conservation continues at a high level. Such developments
would slow the inventory adjustment process.
On the supply side
? The willingness of OPEC members to adhere to production quotas,
despite temptations to cheat because of domestic economic and political
pressures, will speed the inventory adjustment process.
? The willingness of the Saudis to follow through on their oft-stated
intention to cut output further if necessary will weigh heavily on
preventing a price collapse.
Because all OPEC members know that it is in their collective interest to
hold the line on prices, we believe the cartel will take the necessary steps to
prevent a price collapse unless the decline in demand for OPEC oil is much
more severe and prolonged than expected. This would not preclude some
countries like Nigeria from cutting prices to increase sales.
iii Secret
GI 82-10082
April 1982
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Even if OPEC is largely successful in defending prices in 1982, an end to
the Iran-Iraq war and the expected slow growth in oil consumption could
increase downward price pressures on the oil market in 1983 and 1984. De-
mand for OPEC oil will probably increase to only 23-24 million b/d during
this period even with strong economic growth. In that event, a new OPEC
agreement to limit production may become necessary, particularly if Iran
and Iraq attempt to raise output sharply
A substantial excess of productive capacity within the OPEC countries and
surplus oil inventories in OECD countries will protect the market from all
but a major supply disruption over the next year or two. Beyond then, the
market could once again return to a period of vulnerability caused by oil
supply disruptions:
? Oil-supply disruptions could occur rather frequently, as they have in the
past.
? Oil-consuming countries remain highly dependent. on oil supplies from
the volatile Persian Gulf region.
? The liquidation of inventories in 1982 will remove the stock cushion that
would help ease market pressures in the event of another supply cutoff.
? The decline in oil prices at least in real terms could spur oil consumption
during the mid-1980s and erode surplus productive capacity.
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The Oil Market:
Impact of the
OPEC Agreement
Recent Developments
The oil market has continued to weaken in recent
months. Oil consumption has declined at a much
faster pace than most forecasters expected, in part
due to reduced economic activity. Consequently, oil
company inventories remain far above desired levels.
Combined sales of key oil products in six major
developed countries in January fell by more than 10
percent from year-earlier levels. US oil consumption
fell 13 percent in January and dropped 5 percent in
both February and March. France recorded the
sharpest decline in oil sales, down 23 percent in
January and 11 percent in February. In January,
West Germany registered a 14-percent decline, Japa-
nese consumption fell 10 percent, while Italy and the
United Kingdom registered declines of 4 percent and
1 percent, respectively. The International Energy
Agency estimates that oil consumption in the non-
Communist world during the first quarter was 5 to 6
percent below year-earlier levels.
In addition to the recession and higher OPEC crude
oil prices, several other factors have added to the
decline in oil consumption in recent years:
? Rapid appreciation of the dollar versus other cur-
rencies in 1980 and 1981 has pushed oil costs up in
foreign countries faster than energy prices (figure 1).
Since October, dollar appreciation has raised the
market cost of crude by the equivalent of $4 for
France and Italy, almost $2 for Japan, and $1 for
West Germany. (Crude oil prices are denominated
in dollars.)
Loosening of controls on product oil prices in some
foreign countries and decontrol of crude and prod-
uct prices in the United States.
Several foreign countries have raised the tax on key
petroleum products
mained at about 22.5 million b/d.
Lower oil consumption has continued to force reduc-
tions in production. Total OPEC oil production, in-
cluding 1 million b/d of natural gas liquids, fell from
more than 22 million b/d during January to an
estimated 20 million b/d in March. Non-OPEC pro-
duction, including net Communist imports, has re-
We tentatively estimate that inventories, including
floating storage, declined by about 3 million b/d 25X1
during the first quarter, approximating the normal
seasonal rate. As a result, total non-Communist in-
ventories at the end of the first quarter remained 300-
500 million barrels above normal despite oil company
efforts to pare excess stocks because of high carrying
costs and prospects of falling real oil prices.
Downward Price Pressures
Market conditions have put downward pressure on
prices in recent months. Spot market prices have
fallen sharply since mid-January. Spot prices for Arab
Light crude declined from about $34.50 to $28 to $29 25X1
per barrel by mid-March. African Light crudes have
declined $7 to $8 per barrel since early January on the
spot market, while heavy crudes declined by $4 to $5
per barrel.
Since the last round of price revisions at the beginning
of 1982, the slump in spot prices and sluggish oil
demand caused several producers to lower official
prices:
? Iran cut prices three times in February, reducing its
official sales price to $4 per barrel below the OPEC
benchmark. So far, this has been the only serious
departure from the agreed OPEC price structure.
? Venezuela dropped the price of its heavy crudes-
those with an API gravity of 19 degrees or less-by
$2.50 per barrel.
? Mexico cut its average official price by $2 per
barrel.
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Real Oil and Energy Price Trends in Selected Foreign Countries
L
Final Energy
Price
? British North Sea crude prices have been cut a total
of $5.50 per barrel and are now priced as much as
$4.50 below comparable African OPEC crudes.
? Norway has cut prices by as much as $5.75 per
barrel, matching the British reductions.
? Egypt has cut the price of Suez Blend by $2 per
barrel since the beginning of the year. Lower quality
crudes have been cut by as much as $2.85.
? The USSR reportedly has reduced prices by as
much as $4 per barrel.
agree on a first-ever production-sharing mechanism.
The OPEC Vienna Agreement
The pronounced decline in oil prices in recent weeks
and the continued slump in demand forced OPEC
members to call an emergency meeting in March to
prevent a collapse of their nominal price structure.
Two weeks prior to the Vienna meeting, behind-the-
scenes negotiations by several oil ministers laid the
framework for a production-sharing scheme that
would limit OPEC crude output to 18.5 million b/d.
Negotiations were expected to be difficult, and many
observers believed that OPEC would be unable to
OPEC members not only succeeded in reaching an
accord on production quotas in Vienna but also agreed
on an even larger production cut than had been
anticipated. The members agreed to limit collective
crude output to 18 million b/d, including 7.5 million
b/d from Saudi Arabia. Riyadh, in keeping with its
longstanding policy that production decisions are the
exclusive right of each country, made a separate
announcement of an additional 500,000-b/d produc-
tion cut. The new OPEC crude oil ceiling of 17.5
million b/d will lower the recent production level by
about 1.6 million b/d if strictly enforced To
this end, the conference appointed a monitoring com-
mittee to make inspections and to report any viola-
tions to the scheduled ministerial meeting in May.
The committee was also empowered to call an ex-
traordinary meeting if the situation warrants.
The agreement also allows the producers to cut prices
for their higher quality crudes by up to $1.50 per
barrel. The action still leaves African crudes about
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$4.50 per barrel higher than similar quality North
Sea crudes. OPEC plans to send representatives to
some non-OPEC producers to discuss the results of
the meeting and encourage these exporters to main-
tain prices. At the new April production ceilings and
given recent price cuts, the OPEC average official
sales price will fall to about $33.60 per barrel from
$34.29 per barrel in January
Impact of the Agreement
The immediate impact of the agreement likely will be
the prevention of a further slide in oil prices. Because
the OPEC action took most market observers by
surprise, the market is likely to stabilize for the next
month or so. Still, several factors suggest prices may
come under more downward pressure later in the
spring:
? There is no end in sight to the present sluggishness
in economic growth.
? Conservation and substitution practices have be-
come ingrained.
? Inventories remain well above desired levels, and
company attempts to pare stocks rapidly could bring
added pressure on prices or keep demand for OPEC
crude depressed at 17.5 million b/d well beyond
midyear.
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Non-Communist Oil Supply and Demand Base Case a
Supply 45.3 43.4
Non-OPEC 21.8 22.4
OPEC d 23.5 21.0
a Assumes 1-percent OECD economic growth in 1982.
b Estimated.
c Normal inventory pattern from second quarter-fourth quarter
including 100,000-b/d increase in government-owned stocks.
d Including natural gas liquids.
? The longer demand remains depressed, the greater
is the likelihood that some members will cheat on
the agreement. Non-OPEC producers have at least
300,000 b/d in surplus capacity at this time and
have been aggressive in cutting prices.
44.9 45.7 45.4 44.7
22.5 22.7 22.7 22.5
22.4 23.0 22.7 22.2
roughly 800,000 b/d below the base case.
1982 oil consumption. To accommodate the possibility
of growing repercussions from US recessionary pres-
sures, the high interest rates? and the continued high
rates of conservation due to structural changes in
energy use, we have also considered a low case where
non-Communist consumption is about 44 million b/d,
In our base case, a sharp decline in OECD consump-
tion is only partly offset by increases in LDC oil use.
The bulk of the growth in LDC oil consumption
occurs in OPEC and other oil-producing states like
Consumption Outlook
Sluggish economic growth and continued conservation
and substitution is expected to hold non-Communist
oil consumption in 1982 to under 45 million b/d,
about 3 percent below year-earlier levels (table 2).
Although the 1982 economic outlook continues to be
clouded by uncertainty, the downturn in the US
economy and high interest rates have led a number of
forecasters to lower their projections of 1982 OECD
economic growth to 1 percent. This lower growth
forecast was the primary factor causing a reduction of
more than 1 million b/d from our January estimate of
Mexico.
While the effects of past price increases continue to
spur conservation, we assume in our base case that
efficiency gains will slow du:ring the remainder of the
year because of the erosion in real and even nominal
oil prices. Moreover, the expected recovery in indus-
trial output later in the year may spur utilization of
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this is the first drop in two decades. Between January announcing plans to increase gasoline taxes.
and March, prices in the United States have declined
Retail oil product prices are beginning to reflect the 13 cents per gallon while declines in foreign countries
fall in crude prices. Retail gasoline prices, for exam- ranged from 3 cents in France to 22 cents per gallon
ple, have fallen in all major countries since January in West Germany. Italy and the United Kingdom have
in response to the soft oil market. In some countries taken advantage of declining retail prices by recently
Major Developed Countries:
Gasoline Price Trends
1981 June
1982 January
generation. the amount considered surplus. 25X1
energy and coal meet increased needs in electricity deal of uncertainty about current oil stock levels and
France West Italy United United Japan
Germany Kingdom States
231
233
256
209
132
254
227
284
230
129
135
106
170
118
14
135
105
171
127
14
older and less efficient equipment and encourage The Inventory Overhang
rebuilding in industrial oil stocks. Nonoil energy Non-Communist Oil Stocks. A one- to two-quarter
supplies are expected to continue to rise as nuclear time lag in reporting of inventory data causes a great 25X1
the fourth quarter.
Because of the expected economic recovery and a
slowdown in efficiency gains, we assume under our
base case that the rate of decline in oil consumption
will moderate during the remaining three quarters.
Under our alternative low-consumption case, the rate
of decline in oil use will continue at recent rates over
the next two quarters before moderating slightly in
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We estimate primary stocks' on land totaled about
4.3-4.4 billion barrels at end of 1981-about 93 days
of forward consumption (table 4). In addition, an
estimated 800 million barrels were in tankers offshore
or en route to consuming countries. These stock
estimates do not include oil held at the wholesale and
retail level.
Reliable data on secondary and tertiary stock levels 2
are not available. A recent study estimates US storage
capacity of gasoline and distillate fuel oil at 500
million barrels. If the estimate is accurate and is
representative of secondary and tertiary stock levels
elsewhere, the total capacity of non-Communist coun-
tries is probably on the order of 2.5-3 billion barrels.
Market watchers speculate that secondary and terti-
ary destockings were partly responsible for the sharp
consumption declines last year. If this is the case,
remaining surplus stocks at this level are probably
small. Indeed, the recession has probably led this
sector to pare excess stocks to perhaps even below
normal levels.
' Primary stocks include crude oil products and unfinished oils held
in refinery tanks, bulk terminals, pipeline tankages, barges, Intra-
coastal tankers in ports, inland ship bunkers, and large consumer
inventories as required by law or otherwise controlled by govern-
ment.
tion
Most oil stocks are working inventories needed to
ensure the smooth operation of the distribution sys-
tem. Based on consumption trends and working inven-
tory requirements, some 300-500 million barrels of
yearend 1981 stocks were considered excess'-an
amount equal to six to 11 days of forward consump-
Because of seasonal fluctuations in the level of oil
consumption, non-Communist primary oil stocks are
normally accumulated during the spring and summer
months (figure 2). The buildup is usually about 1.5
million b/d during the second quarter and approxi-
mately 2.5 million b/d during the third quarter. These
stocks are then depleted during the fall and winter to
meet peak consumption needs. The drawdown is
normally about 1.0 million b/d during the fourth
quarter and about 3.0 million during the first quarter.
Stock Depletion. Oil companies will attempt to un-
load excess stocks for several reasons:
? Companies generally view the market as weak with
flat or declining prices over the next few months.
? Inventory carrying costs are high at current interest
rates. Interest costs alone for storing a barrel of
crude oil for a year are about $5 to $6. Given the
projected size of the excess, total finance costs
amount to $1.5-2.5 billion annually.
? Cash flow problems in some companies and de-
pressed profits in the refining sector dictate a move
to liquidate excess inventoriies.
? Because several OPEC members are producing
below desired levels, inventory managers view this
surplus capacity as a cushion to be tapped for future
supply needs.
' We calculated normal inventories using an equation derived from
the historical (1973-78) relationship among oil stocks, oil consump-
tion, and oil prices. Our model indicates stocks stood at some 300
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Figure 2
Rate of Adjustment for Non-Communist Primary Oil Stocksa
Million b/d
I I I I I I I I I I I I I I I I I I I I I I C I
I II III IV I II III IV 1 II 111 IV I II III IV I II III IV I II III IV 1 II III IV I II III IV I II III IV
1973 74 75 76 77 78 79 80 81b
alncludes changes in government-owned stockpiles,
b Estimated.
Non-Communist Primary Oil Stocks
on Land, End of Period a
a Estimates include government-owned stocks in Japan and the
United States that have increased from 18 million barrels in first-
quarter 1978 to 299 million barrels at the end of fourth-quarter
198 1. The increase amounts to about six days of forward
consumption.
b Estimated.
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Despite sharp production cuts, lower-than-expected
consumption levels have undercut oil industry efforts
to trim excess inventories. Companies made some
progress in reducing stocks during the third quarter of
last year. The decline in consumption accelerated
again during fourth-quarter 1981 and first-quarter
1982, hampering company efforts to destock. As a
result, stocks are still some 300-500 million barrels
above normal levels. The prospect of falling prices
may cause buyers to allow stocks to fall below normal
historical levels, particularly if stockholders underesti-
mate near-term oil consumption.
Implications for the Demand
for OPEC Crude Oil
The expected inventory adjustment process during the
remainder of this year will play a key role in deter-
mining near-term market conditions. The pace and
duration of this process is uncertain. Given estimated
consumption levels, maintenance of the production
quotas agreed to at the OPEC meeting would allow
for a rapid rate of destocking, perhaps resulting in a
net drawdown of 3-4 million b/d. At this rate, excess
stocks would be depleted within three to six months
(table 5). Once this destocking is over and inventory
patterns return to normal, demand for OPEC crude
oil could rebound by as much as 3-4 million b/d, to
about 20.5-21.5 million b/d or 21.5-22.5 million b/d,
including natural gas liquids production. As oil de-
mand rises, the recent adjustments to price differen-
tials should allow countries facing financial strains,
such as Nigeria, Indonesia, and Libya, to increase
OPEC: Impact of Inventory Adjustment
on Production a
Normal stock charge
Non-OPEC supplies
Base-Case Consumption
300-million-barrel adjustment
Stock charge
Demand for OPEC oil
500-million-barrel adjustment
Stock charge
-2.3
1.1
- 1.1
Demand for OPEC oil
18.5
21.4
22.7
Low Consumption
42.3
42.0
45.5
300-million-barrel adjustment
Stock charge
-1.3
2.3
-1.1
Demand for OPEC oil
18.5
21.6
21.7
500-million-barrel adjustment
Stock charge
-1.3
0.1
- 1.1
Demand for OPEC oil
18.5
19.4
21.7
a Assumes OPEC production, including natural gas liquids of I
million b/d, remains at Vienna quotas until inventory adjustment is
completed.
sales.
Companies may opt for a faster drawdown rate. This,
in turn, would force OPEC crude output below the
17.5 million b/d agreed on in Vienna. In this case,
however, the demand for OPEC oil would rebound
sooner.
Nigeria is already experiencing financial difficulties
and is under pressure to cut prices. Nigerian output
has fallen sharply since the Vienna meeting, reflecting
in part some companies' attempts to work off excess
inventories. Moreover, a substantial share of Nigerian
sales are third-party sales. These purchasers have no
renege on short notice
equity interest in Nigeria and have been able to
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Oil consumption will probably increase only moder-
ately, perhaps by 1-2 million b/d or so from 1982 to
1984 4 even with strong economic growth. Improved
energy efficiency and growing coal use will offset
some of the expected increase in demand for oil
resulting from strong economic growth. Oil is a swing
fuel, however, and demand could rise faster than we
expect. In any case, with relatively stable non-OPEC
supplies in 1983 and 1984, demand for OPEC oil will
probably increase to only about 23-24 million b/d in
1984
At this relatively low level of demand, some OPEC
members will be under pressure to increase revenues.
In addition, should the war between Iran and Iraq end
and the countries increase output significantly, pro-
duction rationing problems would continue for OPEC.
As a result, OPEC members could be under even
greater pressures to prevent a nominal price collapse.
Should nominal oil prices fall sharply over the next
two years, oil consumption would rebound more rapid-
ly as conservation, fuel switching, and energy-related
capital investment slow. A price decline to $20 per
barrel, for example, would cut the OECD inflation
rate by about 5 percentage points and add 2.5 per-
centage points to the economic growth rate within a
year. The resulting increase in economic growth
would boost oil consumption sufficiently to tighten the
oil market within two to three years.
Market Vulnerabilities
The present excess in productive capacity will protect
the market from all but a major supply disruption,
such as a shutdown of Saudi production, for the next
Assumptions for 1983 and 1984 include:
? Annual GNP growth of 3.5 percent in the OECD.
? Continued slight decline in the energy-GNP ratio.
? Constant nominal prices in 1983 and 1984.
? Increases in nonoil supplies averaging 1.6 million b/d annually,
mainly coal and natural gas and mostly in the United States and
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Still, OPEC members probably will be successful in
their defense of nominal oil prices. Because all OPEC
members realize that even sizable price reductions are
unlikely to revive overall demand for oil in the near
term, most will continue to try to refrain from cutting
prices. OPEC countries with strong financial reserves
probably can dip into their assets, if necessary, to
preserve the current pricing structure. Some members
have even indicated a willingness to help the more
financially needy producers, such as Nigeria, through
loans. Moreover, Saudi Arabia, Kuwait, and the UAE
have indicated publicly their resolve to cut output
further to defend the $34 benchmark price. As long as
other producers do not cheat excessively on their
present quotas, and price cutting does not become
widespread, further production cuts from the Gulf
producers should be successful in underpinning nomi-
nal prices for the remainder of this year.
Price Collapse Scenario
Under a less likely but not implausible scenario,
cheating on production quotas, combined with contin-
ued sharp declines in consumption and aggressive
attempts by companies to pare excess inventories,
could cause oil prices to tumble. Indeed, cracks could
develop in the production-sharing scheme almost im-
mediately if such countries as Libya, Iran, Iraq, and
Nigeria attempt to boost sales or have difficulty
reaching their quotas. Under these circumstances,
Saudi Arabia could be forced to sharply cut its
production to a level that Riyadh might find
unacceptable, leaving OPEC with no choice but to
lower nominal prices. Should widespread price cutting
break out, we cannot predict where the slide would
stop.
decline.
Beyond 1982
Even with a fairly rapid economic expansion in 1983
and 1984, the oil market will likely remain soft.
Indeed, even if OPEC is successful in preventing a
price slide through the remainder of this year, the
cartel may continually be faced with the task of
allocating production to prevent a nominal price
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year or two. Beyond then, several factors point to a
return toward a period of increased vulnerability to oil
supply disruptions:
? A review of past supply disruptions suggests that
such events occur rather frequently. Since 1950 oil
supplies from major oil-exporting countries have
been interrupted for nonmarket reasons on 13 dif-
ferent occasions.
? Oil-consuming countries still remain highly depend-
ent on imported oil, especially from the politically
volatile and unstable Persian Gulf region.
? As long as the war continues, the supply outlook in
Iran and Iraq remains uncertain and the potential
exists for spreading the supply disruption to other
regions in the Persian Gulf.
? The expected inventory drawdown will remove the
buffer of oil stocks that effectively prohibited a price
runup at the outbreak of the Iran-Iraq war.
? Forecasters have had limited success predicting oil
conservation and consumption trends during the
past few years. Given the likelihood of a decline in
real oil prices, predicting future trends will be
difficult. At a minimum, weak oil prices could slow
conservation and fuel-switching efforts, leading to a
sharper upturn in oil demand during the mid-1980s.
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