HUGE INCREASES IN OIL COSTS' AND 'SHOCK FOR THE THIRD WORLD,' THE PETROLEUM ECONOMIST, FEBRUARY 1974

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP79-01194A000100800001-7
• Release Decision: RIPPUB
• Original Classification: K
• Document Page Count: 7
• Document Creation Date: November 11, 2016
• Document Release Date: August 8, 1998
• Sequence Number: 1
• Publication Date: February 15, 1974
• Content Type: OPEN

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German, Arabic and Japanese. '
In the circumstances of artificial scarcify created by the Arabs, crude oil is being traded at an
extraordinarily tii~ide range of prices; even those closely related to tax-paid cost are four or
five times tfte level of a year ago. if host governments persist in their present attitudes, the
demand for oil will be drastically curtailed.
~c~ ease in ail ~~~~~
The world is faced with an unprecedented iucmasc in oil costs, with payments to producing.
countries in 1971 possibly totalliua over seven times the amount paid in ]972 for the same
quantity of oil.
s
' The developing Third World is now fu1{y aware of the fact that the high cost of oil will strike
' a swage blow at its economic welfare. With no exemption from the unprecedented increase
r
' in prices, most countries in Asia and Africa trill not be able to affurd the. quantities of oil needed
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t~ ~ ~~~r~~~e in ~l ~~sts
UNE of the main reasons for the unilateral escalation.
of posted prices by the Organization of Petroleum Furtieip~rtion
Exporting Countries (OPEC), to the point where the
international pricing system previously maintained by In spite of these take-overs in Iran and Iraq and
the major oiT companies has virtually broken down, production-sharing agreements elsewhere, the main
has been the high prices obtained by 11'fiddIc East impact on prices in 1973 came as a result of partici-
producers for the marginal amounts of oil sold on the potion agreements with four of the major Arab
open market. This oil has become available to the producers in the Persian Gulf; a fifth, Kuwait, has
state companies largely as a result of various agree- made, but not yet ratified, an agreement far a 60
ments made in 1973 -participation by Saudi Arabia, per cent share, instead of the 2~ per cent equity
Abu Dhabi, Qatar and Uman, and nationalization in provided under the original agreement, rising to
Iraq and Iran -and the still disputed 51 per cent 51 'per cent by 1982 (see also page 72).
nationalization by Libya. Such is the present state of flux in the Middle East
But it should be stressed that these amounts of oil that agreements, however solemnly allirmed at the
are still very small corripared with. the great bulk of time, are scarcely worth the paper on which they are
supplies moved by the major companies -probably written. The recent unilateral actions of OPEC in
li tle more than 5 per cent of total production. It is setting posted prices without reference to the com-
the attempt to arrive at a so-called market price, parries have negated. the Teheran and Geneva
based on marginal sales, that threatens the world. pricing formulas, reached at various intervals between
with monetary chaos. 1970 and 1973; even the countries which ratified the
Under most of the original concession agreements, participation agreements have indicated that the
the producing countries were entitled to take up to terms are no longer acceptable; and Iran is thou~ahi
12.5 per cent of production in kind to sell themselves, to be seeking a revision of the 20-year pact with the
in lieu of the cash royalty payment. This was usually Consortium to provide its state company with larger
less advantageous financially since, until the present amounts of oil for direct sale. The situation is even
situation arose, the government could not obtain full more complicated by the actions of Libya and the
posted prices for- the royalty oil, and received a higher lack of agreement with some of tl~e companies whose
revenue when it was sold by the companies. There rights have been. expropriated; this has led to an
were occasions, how~~e~?er, usually during a dispute of extraordinary dual pricing system, by which the
some kind, ~i~hen this. option was taken up. Thus in Libyans are charging 820 a barrel for uridisputed a~Zd
the mid-i960s, whe~~ the Shah of lran was pressint 816 a barrel for disputed oil.
the Consortium companies to increase production, The first pace-setting sale of participation crude
Iran took sizeable amotults of royalty oil for Long- was by Saudi Arabia in May last year. The amount
Term barter deals ~~ ith Eastern 1/uropcan countries. involved in 1973 was only 69 million barrels, or about
When the new Iranian agreement was concluded in 2.5 per cent of Aramco's total anticipated pro-
May last year, by which lean had about 200 000 duction of 2 760 million barrels (the 25 per cent
barrels daily, or 4 per cent of the Consortium's equity share minus 90 per cent for "bridging" aid
production, available for direct sale in 1973, some "phase-in" volumes which the state was committed
f0 000 b;'d was carn~ar}.ed for these deals. to sell back to-the companies). Similar amounts were
Another country which in the Late 1960s made sold for delivery in 1974 and 1975, when the per-
similar baricr deals ~ti~ith the Soviet Union and Eastern tentage available to the state would rise to 5 per
European countries, though for rather different cent and 6.25 per cent. The pace set was 93 per cent
reasons, was Iraq. [n return for Equipment, technical of the posted price, which at that time was X2.742 a
co-operation and cash loans,. crude was to he barrel for Arabian Light (now the benchmarl; for
supplied from the nationalized North Rumaila Gulf prices), thus realizing 52.550 a barrel. At that
field. This came into production in 1472 at an initial time the government take from Ararnco's production
rate of 100000 E~/d, scheduled to rise to some was 51.607 and the bridging price which Aramco
360 000 b/d in 1974; most of this was earmarked for had to pay for most of the remaining equity share
.the Soviet bloc. But by March 1973, agreement had was 82.39. Aramco's~tax paid cost was 81.707 a
been reached with the IPC operating companies on barrel. Thus, already a small amount of oil ~~s~as
the complete nationalization of the Iraqi oilfields, beginning to enter the world market at about 84
with the exception of the Basrah fields in the south, centsJliarrel more than Aramco's tax-paid costs and
giving the Iraq state oil company over 1.5 million 16-centsJbarrel more ifian the bridging price.
b/ out of a total production of some 2 million brd- Further participation sales by Abu Dhabi and an
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increase in the buy-back price for Libyan crude to
54.90 a barrel, following Libya's acts of nationaliz-
ation which arerstilt in dispute, accelerated this trend.
Apart fi-om the agreed increases in posted prices to
offset the decline in the dollar under the Geneva
formula, they encow-aged. OPEC to make a 70 per
cent rise in posted prices on 16th October, lifting the
postitjg for Arabian Light for instance from 53.011
to 55.119 a barrel.., Finally, after even higher prices
were obtained for sales in Nigeria, Venezuela, Libya,
Algeria and Indonesia, arecord-breaking 517.34 was
offered for some of the direct-deal and joint-venture
crude auctioned by the National Iranian Oil
Company in mid-December. It was that price and
others of the same order which stimulated OPEC to
make the mast massive increase of all in posted prices
as from 1st January, raising the government take
by some 130 per cent to around ~7 a barrel, based on
a posted price of 511.651 for Arabian Light com-
pared with #5.036 the previous month.
Price Increases
It was largely the fear of shortages last year -
when supplies were tight because of a high world
demand, especially in the USA, to ?meet industrial
expansion -that spurred many independents and
consumer governments to bid up the price of
participation and nationalized crude. The shortage
has, of course, been made immeasurably worse by the
cutbacks in Arab production for political reasons.
With "consuming" governments attempting to put a
ceiling on product prices to control inflation, and in
any case limited by a Lack of foreign currency in their
ability to pay for the oil, it is probable that some of
the independent buyers, including a number of
speculators who had never been involved in the oil
business before; may have burned their fingers.
Even some governments such as the Indian, which
sought to by-pass th.e oil companies which were
their regular suppliers b}~ purchasing supplies direct,
may now have cause to re`Tret their decision.. For
example, although the tax-paid cost to Aramco for
most of its production is now just over S7 barrel,
for the original purchasers of Saudi participation oil
the cost has escalated to over 510 (93 per cent of the
posted price).
Oil is now entering the world market at such a host
of different prices that it is impossible to predict
accurately the cost of imports to the consuming
countries in 1974. A major uncertainty is the level of
government participation that may be reached this
year as a result of re-neeotiation of previous agree-
ments. Whether a 60 per cent or a 100 per cent equity
share is achieved by the Arab governments, a major
determinant of prices will he the proportion sold
baA~4~~~1~E~~l~ ~~~e'4e1 I~
frozen until 1st April) the following is an example of
the cost of a representative 1 million barrels Saudi
Arabian Light crude under the terms of the original
participation agreement.
Arameo share
barrels
75 % at tax-paid cost of $7.108 abarrel
- 750
000
- $5 331
000
State share
12.5% bridging crude at 58.436 abarrel
- ]25
000
- $i 054
SOb
7.5 % phase-in crude at 57.458 abarrel
- 75
000
- $559
350
5 % direct sale at $10.835 abarrel
- 50
000
- $541
750
Total
- $7 486
600
This gives an average price of 57.487 a barrel
which; if multiplied by a possible ] 974 production of
3 000 million barrels and taking into account the
fractionally Lower prices for other Saudi Arabian
crudes, would give Saudi Arabia a revenue of some
X21 billion, compared. with just over 53 billion in
1972. But in fact, the producing countries have been
demanding higher buy-back prices which will raise
revenues even further. ?here are obvious uncertain-
ties depending on the exact levels of bridging, phase-
in and direct sale crudes, and at the prices being
obtained Saudi Arabia and othet-s mieht wish to take
some of the 12.5 per cent royalty oil to increase their
direct sales. Another imponderable is any revision in
the level of participation. Should Saudi Arabia
achieve a 60 per cent equity, for instance, and with
corresponding increases in the three types of crude
available, the average price {at present levels) would
increase to about 58.550 a barrel, giving an income of
525 billion on a similar production. "This difTerence
alone is more than Saudi Arabia's total revenues in
1972.
On a world basis, including all the non-communist
oil exporting countries and- assuming similar price
levels, host government revenues under the present
participation agreements would total around SlI6
billion at 1973 production levels, compared with
about 515 billion in 1972 and probably around 535
billion in 1973. Should participation be increased to
the 60 per cent Level with higher buy-back prices,
revenues on the same output could rise to around
5125 billion. And when freight charges and a
minimum level of company profits are added, the
consuming countries could be faced with a staggering
bill of over 5160 billion. But at such costs demand
must, in fact, fall since many of the importing
countries simply do not have the foreign exchange
to buy the same amount of oil.
Such price levels are unprecedented, not only far
oil but for any commodity, considering that the
actual cost of production averages only from 10 to
30 cents a barrel in most of the countries concerned.
It has been estimated by the World Bank that by
1980 the five main Gaif producers alone, after
allowing for maximum internal development pro-
grammes, could accumulate some 5280 billion, well
~~~~2b~e~lA- ~'9~0?~'It~~-4~0''4d~~0~@PD=serves. That
figure compares ~lth net foreign assets of SS billion
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m an ,, I Ion as year. ome o e
producers, and Saudi Arabia in particular, see the
need for a lowering of prices. Iran, on the other hand,
has taken the lead in pressing far even higher prices,
although it was only in June Last year that the Shah
of Iran expressed his opposition to increasing prices
on the grounds that it would force Western exporters
to raise their prices for the heavy industrial equip-
ment which Iran needed to import.
~~RGHT
~~ock for the Third. World
T'HE developing Third World is now fully aware of
the fact that the high cost of oil will strike a savage
blow at its economic welfare. With na exemption from
the unprecedented increase iu prices, most countries
in Asia and Africa will not be able to afford the
quantities of oil needed far continued development.
Worse still, agricultural output can be expected
to stagnate or decline - at a time when expansion
is urgently, needed -because less petroleum-based
fertilizers will be available. This raises the spectre
of ~r~despread famine.
The tenor of radio and press commentaries in
Asia and Africa has become one of growing concern
about the explosive rise in crude oil prices, which
will affect national trade and payments so adversely.
It is increasingly realized that declining industrial
activity and deterioration in the balances of pay-
. - - _ ---
ments will cause the advanced countries to import
less from the Third World and export their manu-
factured goods at higher prices. There is also the
clear danger that industrialized nations might have
to cut down on their aid programmes for developing
countries. International tourism, an increasingly im-
portant foreign exchange earner in the Third World,
is facing a slump.
Several of the worst hit Asian countries have
appealed directly to Arab producers for supplies at
concessionary prices on a direct government-to-
government basis, thus bypassing the American and
British oil companies that are their traditional sup-
pliers. The special committee of the Organization of
African. Unity, formed to study the effects of the oil
crisis on the economies of African countries, has also
appealed for preferential prices or, alternatively, for
a system of long-term credits to pay for oil.
Although OPEC is studying special schemes to
help the "friendly" developing nations gut of the
financial difficulties it has created for them, no
immediate steps have been taken to supply oil at the
old prices - a move which could have firmly nailed
African and. Asian colours to the Arab mast. Instead,
there is now talk in Asia and Africa about economic
rettlpalitik by the oil-producing countries; and the
#Sq million loan to be placed in the new Arab Bank
for industrial and agricultural development in Africa
was seen as "coming back in part as a tip for services
re;,dered" by Renya's "Daily Na?ior.".
Crushing Burdens
One nation which will have to bear a particularly
crushing burden arising from the higher crude oil
prices is India, which has just drafted its Fifth
Five-Year Plan envisaging an annual growth rate
of 5.5 per cent. On our reckoning, India would have
to pay same US ~ 1 240 million to cover her imported
crude oil needs during 1974, which is around 40 per
cent of her potential export earnings and twice her
existing foreign exchange reserves (see table). This
assumes a landed cost of X10 a barrel (based on an
average tax-paid cost of X7.5 a barrel in the Gulf)
- over four times the average paid a year before.
India's oil imports come chiefly from Iran, Iraq
and Saudi Arabia. Clearly, without concessionary
crude oil prices, special barter deals involving steel
and jute fvr ail, ar cash aid from these exporting
countries, India would have to halve crude oil
imports and face a harsh economic depression be-
cause it does not have the foreign exchange to pay
for so much oil at today's prices. However, it is
highly unlikely that any OPEC, scheme could rescue
India's Fifth Plan, which will also be affected by the
international economic repercussions arising from
the higher crude prices.
SELECTED DEVELOPING COUNTRIES: IMPACT OF HIGH CRUDE OIL
COSTS
R4illion US dollars
Oil a) Foreign Trade b)
Foreign
?
Estimated Exports
Cos[
lmports
Iiatance
Exchange
Resen~es c}
India ... ...
1972
-
Z
372
2 198
{-226)
G61
1973
-
2
934
Z ??i
163
b29
r
.
1974
1
241
Paltistan .. ".
1972
?-
7S4
644
140
103
983
92$
55
254
1974
266 ,
?
Philippines ..
1972
1
009
1354
(-345)
309
1973
1
494
1 243
251
606
197a
693
-
..-
Thsiland ..
1972
-
1
194
1411
(-317)
S36
7973
-
1
382
1 662
(-280)
7
107
1974
657
-
Tanzania ?. ,,
1972
-
307
390
(-83)
n a
1973
399
3G3
3G
n a
Si
L
1974
1972'
b2
152
erra
eone
...
1973
-
145
125
125
27
20
35
36
1974
29
Sudan .. .
..
1972
-+
355
356
(-1)
38
1973
--
401
376
25
28
974
"
127
Ethiopia ..
:.
1972
-
183
203
(-20)
53
1974
51
285
180 ~
]OS
i}4
a) Assuming normal requirements ad'd nn average landed cost o! 510 a barrel.
D) Annual rates based on first quarter statistics,
S) End of first quarter 19?3.
Source: International Monetary Fund, except oil estimates.
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~nnrnvarl Fnr Ralaaca ~ aaainain~ ~in_Rr1P7Q_n~ ~ aannnn~ nnttnnnn~ _~
Pakistan will find the bill for imported oil this year,
estimated at 5266 million, only slightlytless crushing.
For it would be drained of its current foreign
exchange reserves in the year, rather than within six
months. The oil import bill would be 27 per cent of
Pakistan's potential export earnings, using. first.
quarter 1973 figures which reflect a booming world
economy not yet shaken by OPEC.
The impact of high crude oil prices on Southeast
Asian nations is similarly disturbing. Here, only two
countries -Indonesia and Malaysia -can escape the
consequences of reduced supplies and higher prices
by virtue of having their own oil production, res-
spectively 1.4 million b/d and 97 000 b/d. This they
export at premium prices to Japan and the USA, as
internal demand is no more than 170 000 b/d and
84 000 b/d respectively. Appeals from fellow South-
east Asian nations to Indonesia and Malaysia for
emergency supplies to plug supply cuts ranging from
20-30 per cent have met with limited response from
Indonesia which will supply 5000 b/d of gasoline to
ASEAN countries, 5 000 b/d of fuel oil to Thailand
and 8 000 b/d of crude to Burma. CYlina was also
able to offer 'L'h.ailand supplies - 50 000 -tons of
diesel oil with first deliveries starting in January. An
acute shortage of this product_.since late November
has seriously disrupted nationwide road transportand
caused a major drop in tin mining, Thailand's third
biggest export earner.
IloPes Dashed
Faced with an estimated bill of 5657 million for
oil imports during 1974, the Thai government has
raised the excise duty on gasoline and diesel oil by
about 12 per cent in a move to curb demand. The
prospect of a permanently adverse trade balance and
a total drain of its foreign exchange reserves, have
also led the government to announce that it is rush-
ing through plans to invite international bidding
from oil companies for rights to develop an oil-shale
deposit in Tak Province. These were estimated by
a recent UN survey to contain about 670 million tons
of low-sulphur oil, which compares with a current
internal demand of around 9 million tons of oil a
year. `
The Philippines sees its hopes for a continued
economic recovery, begun in early 1973, dashed now
that she would have to pay an estimated 5693
million for normal oil. imports this year. This
estimate, also based on S10 a barrel landed cost, is
conservative compared with 510.80 fob for crudes
produced in neighbouring Indonesia, reflecting prob-
ably more precisely the cost of alternative Middle
East crudes in the Southeast Asia area. Again, the
estimated oil import bill is more than the country
can expect to earn net from its trade and more than
.its foreign exchange reserves. The government has
already introduced. gasoline and diesel rationing. It
is seeking to barter Iranian oil for cement and
sugar, while it has also started negotiations for
petroleum products supplies from China.
The cost of Black Africa's oil imports -despite its
solidarity with the Arab cause -will also be high.
The total is estimated by OAU's oil crisis committee
at ~l 000 million during 1974, 5600 million. more
than the 1973 oil imports bill. The new-found
solidarity between Black Africa and the Arabs,
which for historical reasons must be considered
fragile at best, is showing strains now that the Arab
oil weapon hangs over the delicate national econo-
mies (see table}. Diplomatic pressures on the Arabs
for concessionary oil prices and special loan or barter
deals to safeguard economic viability have been
intense, without significant results so far.
In our calculation of the impact on selected African
countries, ~ 10 a barrel has again been used, although
the landed cost will tend to be lower in Northeast
and East Africa which are closer to the Gulf. It
shows that the cost of oil to the Sudan, closely
allied to the Arab world, would be particularly severe
to its trading and foreign exchange positions.
Fertilizers and Cl~e~nicals Affected
Apart from the crushing burden on the export
earnings and currency reserves of developing natioris,
high-priced oil in short supply threatens to dislocate
agricultural production - in developing and ad-
vanced countries alike -because petroleum (oil or
gas) is used not only for the manufacture of ferti-
lizers, but also for powering irrigation pumps,
tractors and drying equipment.
The Japanese Fertilizer Association has indicated
that the country's output of urea and ammonium
sulphate would have to be reduced by 24 and 18 per
cent respectively, resulting in delivery cuts of fertili-
zers to India and other developing countries in
Asia. Even in the American Midwest, farmers are
clamouring for fertilizers now that a worldwide
supply shortage has become severer because of th
oil crisis, with prices skyrocketing beyond the purse
of the poor. (New York t'ob price of ammonia las
year rose from 1.30 US cents per lb to 3.95 cents.)
India is expected to have to make do with 2.
million .tons of chemical fertilizers this year, com
paned with 3.5 million tons in 1.973 - a shortfal
which will cause an estimated reduction of some 1
" million tons in India's potential grain harvest. Th
. fertilizer shortage in America is expected to be mor
-than 1 million tons this year, resulting in a reduce
9utput from land which increasingly needs chemica
fertilizers to provide food for peoples whose con
tinned expansion presses relentlessly on the limits o
arable land acid agricultural technology. The supp]
?and pricing of oil have now aggravated an alread
difficult worldwide food problem. And experts se
no end to the worldwide shortage of chemica
pprove or a ease
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fertilizers because of the huge capital requirements
for new plant anal the large amount of energy
needed to make fertilizers. (One ton of oiI makes one
ton of ammonia which converts to 2-3 tons of
fertilizers, depending on the type.)
Reports from Asia also indicate that Japanese
supplies of chemical raw materials for the manu-
facture of plastics and synthetic textiles have dropped
severely, leading to a reduction of manufacturing
operations in many Asian countries. Insufficient
supply of bunker fuels is expected to result in a
sharp decrease in the volume of trade between Japan
and the rest of Asia, which will also affect iron and
steel deliveries. Increasing shortages and rising prices
of Japanese exports will force many Asian countries
into changing their economic development directions.
The recent Tidewater Conference of aid-giving
nations found that the developing countries whichdo
not possess oil will be affected to a greater extent
than the industrialized nations by the oil crisis. The
Shah of Iran in announcing the extortionate prices
fixed for 1st January spoke of a "new equilibrium"
between rich and poor..But the quadrupling in
twelve months of the price of so vital a commodit}~
to rich and poor nations alike is hardly the way to
close the poverty gap.
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