RISKS OF AN OIL PRICE DECLINE
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CIA-RDP85T00287R001101170001-2
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S
Document Page Count:
11
Document Creation Date:
December 22, 2016
Document Release Date:
August 20, 2010
Sequence Number:
1
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Publication Date:
January 23, 1984
Content Type:
MEMO
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Central Intelligence Agency
2 3 ,lRf~ ~Q
Washington, D. C.20505
DIRECTORATE OF INTELLIGENCE
MEMORANDUM FOR: E. Allan Wendt
Deputy Assistant Secretary for
International Energy Policy
Department of State
Director of Global Issues
SUBJECT: Risks of an Oil Price Decline
I would like to raise to your attention the attached report
prepared by members of my staff concerning the issue of oil price
stability over the next several months. In our view the risk of
an oil price decline will increase during the months ahead as
seasonal demand for oil slackens and some financially troubled
countries, like Nigeria, attempt to increase their market
share. While we would not specifically forecast a sharp price
decline or unravelling in the market, it remains a possibility 25X1
that you should be aware of. If you or members of your staff
have questions concerning the report, please call.
Attachment:
Risks of an Oil Price Decline
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SUBJEC?i': Risks of an Oil Price Decline
OGI/SRD/EIB/~
E. Allan Wendt, State
The Honorable Allen Wallis, State
The Honorable Kenneth W. Dam, State
The Honorable Richard T. McCormack, State
The Honorable Donald P. Hodel, DOE
The Honorable R. T. McNamar, Treasury
The Honorable Lionel H. Olmer, Commerce
The Honorable Martin S. Feldstein, NSC
Roger Robinson, NSC
Bill Martin, NSC
Dr. H. A. Merklein, DOE
B. Bonk, NSC
F. Gerlach, State
K. Glozer, OMB
C. Boykin, DOE
J. Brodman, DOE
C. Kilgore, DOE
D. Tarbell, DOE
SA/DDC I
ExDir
DDI
DDI/PES
NIO/Econ
CPAS/ILS
OGI/PS
DD/OGI, D/OGI
Ch/SRD
(23 Jan 84)
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Central Intelligence Agency
Washington, D. C.20505
DIRECTORATE OF INTELLIGENCE
20 January 1984
Risks of an Oil Price Decline
Summary
Overproduction, Zorn demand and raeak spot prices have kept
downward pressure on oil prices and reeentZzJ forced a number of
producers to Zoraer prices. Eroding diseipZine among OPEC
countries and prospects of a seasonal cutback in oil demand this
spring could place additional strong pressures on the current
price structure. Nigeria, OPEC's raeakest Zink and possessor of a
new government, in particular continues to suffer economic
problems that might prompt Lagos to announce a unilateral price
cut. If Nigeria and others move to increase their market-share
to help address financial problems, a doranraard oil price spiral
could ensue. The central factor raorking against such an
eventuaZitrg would once again be Saudi raiZZingness to cut their
production. At this point, Saudi Arabia appears raiZling to
defend the current benchmark price but onZz~ as Zong as other
producers adhere eZoseZz~ to`their production quotas. The
poZitica2 situation in the Middle East remains unsettled and
market,eonditions cou d tighten if Iran or Iraq disrupt oil floras
T tis memoran um raas prepared b;
IEnergzJ Issues Branch,
~~~ZCe o G o a Issues. The information contained herein is
updated to 20 Januarrg 1984. Comments mark be
Chief, Strategic Resources Division.,
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Risks of an Oil Price Decline
Current Situation
Overproduction and weak consumption have put downward
pressure on prices in recent months. OPEC crude production in
the fourth quarter averaged about 19 million b/d, some 1.5
million b/d above the cartel's production ceiling. We estimate
non-Communist oil consumption in the fourth quarter .rose by about
1 percent, considerably less than most companies had
anticipated. Consequently, oil inventories at yearend remained
in excess of company needs and spot prices for most crudes have
declined to about 51 below official prices.
The potential for a replay of last year's oil price drop is
mounting even though underlying market conditions are working in
favor of price maintenance.
o Unlike the sharp 6 percent decline in fourth quarter
oil use in 1982, oil consumption actually increased in
the same period in 1983.
o ~Jeather conditions in North America are decidedly
colder than last year, boosting consumption of fuel oil
and other heating fuels.
o The level of excess inventories is less than that of a
year ago. Oil stocks at yearend stood at 90 days of
consumption compared to 96 days at yearend 1982.
o OPEC crude production of 18.7 million b/d in December
was about 500,000 b/d below year earlier levels.
o Spot oil prices have weakened but the decline is not as
sharp as last year. Spot prices for most crudes are
now about $1 below official prices compared to a $3 to
54 spread early last year.
Price Developments
Nonetheless, in addition to weak spot prices and growing
financial pressures in several oil producing countries, several
other signals indicate a repeat of last year's oil price slide
may be developing.
o The Soviet Union reduced its price by Sl per barrel
late last year and Egypt lowered its contract prices by
5.25 to 5.50 per barrel effective 1 January. In
addition, Cairo announced it would review oil prices
monthly. Roth countries are now undercutting
comparable OPEC crudes by about 51 per barrel.
GI M 84-10010
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o Statoil, the Norwegian oil company, .reduced the price
of its Statfjord crude by 5.20 per barrel in early
January.
o The British National Oil Corporation (BNOC) proposed
freezing contract prices for first quarter 1984 at
current levels, but still faces some buyer resistance
to its proposal.
o In late November, Qatar reportedly offered a 100,000
b/d one-year contract to a US firm at a discount of
5.90 per barrel off the official price.
of (Indonesia's Pertamina
is marketing crude o'il under arrangements that
effectively discount its oil by 51 to 52 per barrel in
an effort to boost crude export volumes.
o Ecuador lowered its crude oil price by 5.70 per barrel
in January.
o Iran recently signed crude contracts for
million b/d with several major customers
pegged to spot prices,
Tehran also reported y eased
prices
restrictions and will allow customers to swap crude to
third parties.
o Oman effectively lowered the selling price of its crude
45 cents per barrel to Japanese and British buyers by
extending the payment period, according to press
reports.
o Libya is'offering at least one producing company a 25X1
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Near Term Demand Outlook
The near term demand outlook will depend mainly on the pace
of the economic recovery in OECD countries, inventory patterns
and seasonal weather conditions. Based on available information,
we expect a modest increase in oil consumption in early 1984 in
response to the continued economic recovery, further erosion in
real oil prices and projected weather patterns. As a result, we
expect non-Communist consumption to record about a 2 percent
increase in first half 1984 over year earlier levels. We
estimate first-quarter consumption at about 46 million b/d with
an expected seasonal decline in consumption to 43 million b/d in
the second-quarter. Our consumption forecast is in agreement
with most recent industry projections.
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If consumption predictions hold, inventory decisions will
play the key role in determining the level of oii demand at least
through first-half 1984. Oil companies still have leeway to
reduce inventories because of overproduction and unexpectedly
weak consumption in the fourth-quarter. Prospects of continued
price weakness will also likely cause stockholders to run down
excess inventories in early 1984. We have assumed in our base
case that most excess inventories--estimated at about 200 million
barrels--are drawn down during first-half 1984. As a result, we
anticipate that the inventory drawdown through March will
approximate 2.5 million b/d, followed by little or no seasonal
stockbuild during the second-quarter.
Under our base case conditions, demand for OPEC oil,
including 1 million b/d of natural gas-liquids, will approximate
18.5 million b/d in first-half 1984, or some 1.5 million b/d
below fourth quarter levels. Should the rebound in total oil
consumption fail to materialize, demand for OPEC oil in first
half 1984 could fall one million b/d or more below the group's
current production ceiling. Unless OPEC producers cut production
Price Pressures in the Months Ahead
The key to the near term price outlook under these
circumstances will be producer cooperation. While OPEC
reaffirmed its nine-month old production accord in early
December, this action did little to improve compliance and the
cartel is not scheduled to formally consider changes until July
1984. Given the growing financial pressures in several producing
countries and the political animosity between some members, OPEC
could be hard pressed to maintain an effective production sharing
agreement in the months ahead. Competition between the United
Kingdom and Nigeria for market share over the next few months
could trigger price cuts byeeither country and set off a downward
United Kingdom
In the absence of more discipline from OPEC countries,
official oil prices of some non-OPEC producers--especially the
United Kingdom--could again come under pressure. Because London
has no mechanism to shut in oil production, prices are generally
set in line with market conditions. We expect London to attempt
to hold prices through the first quarter, but a reduction in US
domestic oil prices or a further weakening in spot prices that
causes a major buyer exodus could force a British price
reduction. Rapid acceptance of BNOC's price. proposal by the
major oil companies operating in the UK indicates that these
companies at least have little desire to see prices fall.
Indeed, recent press reports indicate that these companies may
voluntarily limit oil output in coming months to reduce price
pressures. The companies are aware that a British cut could
trigger price cuts by other producers, especially Nigeria, since
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Lagos produces oil that competes directly with North Sea
crudes: If some price reduction does become necessary, BNOC
probably first will attempt to adjust prices of crudes other than
Brent--now priced the same as Nigeria's Bonny Light--in an
attempt to technically leave British and Nigerian prices at
parity. Any unilateral reduction in oil prices by the Nigerians,
however, probably would be quickly matched by the United
Kingdom.
Nigeria
Pressing revenue needs in the face of weak demand for
Nigerian crudes could force the new Buhari regime to lower nr_ir_es
in an attempt to boost oil sales.
Most equity producers in Nigeria view Buhari as experienced
in oil matters, having served as chairman of the NNPC in the
1970s. We believe this experience will sensitize Buhari to the
advantages of moving slowly on any pricing decision because he is
fully aware of the impact of a price war on Nigeria's economy.
Indeed, General Buhari has stated publicly his intention to
remain in OPEC and that any change in its OPEC membership would
come only after consultation with other cartel members. Given
Buhari's oil experience, he may eventually use the threat of a
price cut and production increase to seek financial assistance
from other OPEC members.
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Other OPEC Members
Several other OPEC countries faced with financial problems
are under pressure to increase export earnings. We would expect
that most of these producers would match any sizable Nigerian
price cut.
o Iran probably will continue tying crude oil export
prices to the prevailing spot market price. Iran's new
pricing arrangement could encourage other OPEC members
who produce comparable quality crudes to negotiate
similar deals rather than risk losing market shares.
o Libya was unable to sell much of its December
production, and Libyan oil officials reportedly fear
continued weak demand could precipitate a further
reduction in liftings.
Saudi Arabia -- the Key Player
Saudi Arabia will play the key role in determining oil price
developments from the producer side, in our view. Although the
Saudis may believe OPEC oil is still overpriced, Riyadh is
mindful of the dangers of a"n uncontrolled round of price cuts and
the damage it could do to itself. Unlike last year, the Saudis
have not issued public threats to reduce the price of oil and
have, in fact, stated their support for the current price. As a
result, we feel the Saudis currently view defense of OPEC's $29
per barrel marker price as the best option available. Indeed,
Saudi production has fallen gradually from its September 1983
peak of 6.2 million b/d to 5.6 million b/d in December and we
expect January's output will approximate 5.2 million b/d. If
demand weakens during first half 1984 as we now expect, Riyadh
probably will be willing to cut output below 5 million b/d--
perhaps as low as 4 million b/d--to defend. prices.. If, however,
other OPEC countries do not adhere closely to their production
ceilings and force Saudi output even lower, Riyadh may reconsider
its options and the-risk of a price collapse would be
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The Iran-Iraq Risk
Although we expect the market to remain weak over the coming
months, the volatile situation in the- Middle East could cause a
rapid turnabout in the market. Iraq's deterioriating economic
situation, coupled with the recent acquisition of French Super
Etendard aircraft with Exocet missiles, could prompt Baghdad to
initiate attacks against oil shipping in the Persian Gulf in an
effort to bring an end to the conflict with Iran. Such action
might induce Iran to carry out its oft repeated threat to
retaliate by closing the Gulf to shipping or to strike out
against the oil facilities of Iraq and its Persian Gulf allies.
Any major disruption to oil flows in the region could quickly
i
t
ghten supplies and reverse market psychology.
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Oil Price Indicators
Key factors to observe over the coming weeks that might
portend a decline in oil price are:
o Levels of OPEC production well in excess of the
cartel's 17.5 million b/d quota with Saudi output in
excess of 5.5 million b/d being a key factor.
o Absence of a sustained rebound in oil consumption.
o Falling spot crude prices that dip $2-4 below official
prices.
o Exodus of buyers for North Sea crudes, forcing BNOC to
step up spot market sales.
o A sharp decline in Nigerian production to well below 1
million b/d.
o Saudi hints that it is no longer willing to defend the
benchmark.
o Increases in price discounts such as barter deals,
credit terms or linkages with spot price deals in
countries such as Libya, Iran, and Nigeria.
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