Foreign Relations of the United States, 1969–1976, Volume XXXVII, Energy Crisis, 1974–1980

160. Paper Prepared in the Department of State¹

Washington, undated.

Strategy Toward December OPEC Price Decision

Issue

The OPEC Ministers will meet on December 16 in Abu Dhabi to decide the price of the market crude from January 1979. We must decide on our objective with regard to the price issue and our tactical approach over the next several weeks.²

Background

Most producers last increased oil prices in January 1977 by ten percent, based on a marker price of $12.70. Saudi Arabia and UAE raised their prices by five percent then and by a further five percent in July 1977. At the Caracas meeting last December, Saudi Arabia and Iran effectively blocked any price increase for 1978, citing world economic and oil market conditions, and have maintained that the freeze applies for the full year.

The small and middle producers only reluctantly acquiesced in the price freeze and have sought unsuccessfully to overturn it through the year. Rising revenue needs, declining purchasing power of oil earnings, and the approaching end of the agreed price freeze period have contributed to strong pressures within OPEC for a price increase at the next meeting. No member currently espouses a continuation of the freeze. The Shah has gently signalled that an increase is desired; and while Saudi Arabia has not indicated it would support an increase, it has clearly not ruled one out and is not working for a continued price freeze as it did prior to the meeting last December. Saudi Oil Minister Yamani has continued to comment publicly on the desirability of small but frequent price increases as an alternative to a sudden, large market-induced increase at some point in the future.

The second issue likely to come up at Abu Dhabi is a proposal for adoption of a mechanism to adjust oil prices for exchange rate changes. Several OPEC countries have sought oil price adjustments to compensate for loss of purchasing power caused by dollar depreciation. This effort has been resisted by Saudi Arabia, and Iran and Venezuela are not supporting it. For the moment it appears unlikely that such a mechanism will be adopted. However, continued rapid depreciation of the dollar against the yen, mark, and Swiss franc could intensify pressures for an exchange rate adjustment mechanism.

Relevant Factors

In making price decisions, OPEC members take a number of factors into account. OPEC’s perception of these factors also affects the influence we can have on the Abu Dhabi decision.

1. Current and expected demand for oil. The rate of growth of oil consumption by the major oil-importing countries has declined since 1976, and non-OPEC oil production increased by 7 percent during the first half of 1978 over the same period of 1977. As a result, demand for OPEC oil has remained roughly level during the period 1976–78 at about 31 million b/d. The market will tighten through the remainder of 1978 as a result of seasonal inventory accumulation and anticipatory buying in advance of an expected price increase. Based on assumed constant real prices, demand for OPEC oil in 1979 will continue at about this same level, as rising global consumption is largely met by increased production from the North Sea and Mexico.

Saudi production policies introduce an element of some uncertainty in the market outlook for the next 15 months. The Saudis have imposed a limit on production of light Arabian crude, on an annual basis, to 65 percent of total liftings, compared with the traditional portion of about 75 percent. Misunderstandings involving how the limit would be calculated caused Aramco to overproduce light crude earlier this year, and reductions necessary to meet the limit will further tighten the oil market during the remainder of 1978. It is possible that the Saudis could tighten the heavy/light limitation further in 1979 by, for example, reducing the allowable proportion of light crude production to 50 percent (roughly in line with the proportion of light oil in Saudi reserves).

Over the longer term OPEC has no significant fear that demand for their oil will decline as a result of short-term price increases, nor are the revenue surplus members persuaded that oil in the ground will be less valuable than financial assets accumulated now. This expectation lends force to the demands of Venezuela, Kuwait, and others that the price of oil should be adjusted at least to maintain constant purchasing power.

U.S. demand for imported oil is an important element in OPEC’s perception of future demand because of the sheer size of U.S. demand and the U.S. potential for developing alternative conventional and non-conventional energy sources. Saudi Arabia in particular asserts that it cannot be expected to pursue the pricing and production policies we desire if our demand for oil goes unchecked. Enactment of the four pending parts of the U.S. energy plan³ will be helpful in influencing the upcoming price decision and should bolster our case for price moderation over the longer term.

2. World economic conditions. Except for maverick Iraq and Libya, all OPEC members and particularly the leading ones, have been responsive to some degree to the impact of oil price increases on the world economy. While economic growth in the oil-importing countries can hardly look robust to OPEC, it is also unlikely that OPEC currently believes that any oil price increase at all would necessarily endanger current levels of economic activity world-wide. Nevertheless, the impact of oil price increases is significant and may act as a restraining factor in OPEC’s decision as to the amount of an increase. Further analysis is underway to obtain an agreed view on the impact of price increases which can be used in our tactical approaches. However, preliminary analysis indicates that a five percent price increase for oil for 1979 could raise inflation in the Big Seven OECD countries by 0.4 percent and reduce OECD growth by 0.25 percent, thus intensifying the problems of fiscal and monetary management of those OECD economies. The trade balances of the OECD countries in 1979, even taking into account increased exports to OPEC, would deteriorate by almost $4 billion, with the U.S. bearing about 40 percent of that total.

The oil-importing developing countries would be hit even harder. A 5 percent price increase would raise their oil bills by $700 million in 1979 and would add $450 million to the cost of their non-oil imports. Their export revenues would also decline because of slowed economic growth by developed countries. The net result is estimated to be a deterioration of $1.2 billion in the trade accounts of oil-importing developing countries.

3. OPEC Purchasing Power and Revenue Needs. The strongest argument made within OPEC for a substantial price increase for 1979 is based on the effect of dollar depreciation and inflation on the purchasing power of OPEC revenues, particularly in the markets of Europe and Japan. DOE has calculated that OPEC purchasing power for oil revenues (on a trade-weighted basis) has declined to about 80–90 percent of its value in 1974 depending on the country involved, with about 7 percent of the decline in the last quarter alone. OPEC’s desire to recoup the loss through an oil price increase is restrained to some degree by the fear of leading producers, particularly Saudi Arabia, that a price rise could precipitate a further dollar depreciation and by their hope that the dollar will stabilize and strengthen.

This loss of purchasing power and the stagnant demand for OPEC oil has had a direct adverse effect on the ability of OPEC members to finance growing public expenditures. For members such as Venezuela, Indonesia, and Nigeria, immediate revenue needs will tend to outweigh concern over depressing effects of a price increase on global oil demand. The Saudis are not immune to this concern and have cut back production in the past year in part to assist the sales of other OPEC members.

4. Political and security. The political and security stake of individual OPEC members in cooperative relations with the West may not dictate the outcome of OPEC’s decision, but at a minimum it will affect the receptivity of approaches we make on price. Here the priority Saudi concern will be the post Camp David-Summit implications for the Middle East, while Iran’s first concern will be internal stability. These factors can conceivably strengthen our influence on the price decision. Conversely, the amount of influence we must concentrate on gaining continued Saudi support for our Mid-East peace strategy will determine how much we can press the Saudis on the short-term price issue.

5. Attitude of other oil-importing countries. The convictions and approaches of other governments will reinforce or weaken the arguments and approaches we make. Several industrialized countries are unlikely to take a strong position against any price increase in 1979. German and Japanese credibility is undercut by appreciation of their currencies which has resulted in major declines in the mark and yen price of oil. They will be more disposed to counsel unspecific price moderation, stressing the threat to financial and economic stability of a large price increase. The British now have a stake in high oil prices,⁴ and they are unlikely to oppose a 5–10 percent price increase. Most oil-importing developing countries would hope that a price increase could be avoided but are unwilling to oppose it actively.

Options for U.S.

1. Seek a price freeze

Since no one in OPEC is espousing a freeze, it is extremely difficult to expect this can be achieved. To carry it would require a Saudi lead, probably the backing of Iran, and some neutralization of Venezuela and others pressing for a price increase. If we decide to support this option, we would have to try to convince other major consuming countries to adopt a parallel and consistent posture. We would have to act quickly with high-level démarches to the Saudis, Iran, Venezuela and others. Publicly we would make clear that the onus of a price hike would rest squarely with OPEC, that market conditions do not justify an increase, that we want to avoid not only an increased burden on our own shoulders but a heavier burden for the non-OPEC LDC’s.

Pro

—Tactically, it is a clear U.S. position which cannot be misunderstood, which OPEC has come to expect and which might act as a restraining factor on the eventual amount of any increase; and

—It accords with public and Congressional perception that the OPEC price is already unjustifiably high.

—Achievement of the objective would be the best outcome for the world economy and for the dollar.

Con

—Governments of some important oil-importing nations might not be willing to press for a freeze under present circumstances.

—To have a chance of acceptance probably requires extremely favorable linkage or costly actions on political and security matters of concern to leading producers.

—Would damage our domestic and international credibility if the objective were publicly announced and failed.

2. Try to hold increase below ten percent⁵

Recognizing that some increase is highly probable, we would try to minimize severely the amount of the increase. We would indicate privately to the Saudis that while any price increase can compound global economic problems, we could consider an increase of, say, five percent for the full year to be at the outer limits of that which the world economy could absorb without serious damage and that which would not jeopardize our efforts to strengthen the dollar.

We could at the same time raise the issue of capacity expansion, pointing out the favorable impact that a firm Saudi decision to increase investment in capacity would have on the U.S., thus mitigating somewhat the adverse reaction to a price increase. We would make parallel approaches on the price question to Iran, Venezuela, and others. In any public statements we would avoid giving any specific number as to the price increase we would be prepared to accept but would stress that any increase would have some impact on the world economy and that OPEC governments have a direct responsibility for the health of the world economy. We should make our own efforts on inflation, domestic energy policy and the balance of payments a central feature of our overall approach to the oil price increase.

Pro

—Other major oil-importing countries would probably adopt a similar posture.

—If the dollar does not decline further, our objectives may be achievable within the limits of U.S. influence and without concessions on other questions.

—Achievement of an understanding would minimize the extent of potential damage to the world economy and could settle foreign exchange and oil markets if a small increase is understood to be the probable outcome of the OPEC meeting.

Con

—There is no strong justification for a price increase in oil market conditions.

—Position could be misconstrued by OPEC as acquiescence in a larger increase or future price increases.

—Is subject to criticism from segments of U.S. public and Congressional opinion.

Tactics

Regardless of the option decided upon, many of the tactics which can be employed will be the same. These include public pronouncements, letters to key OPEC governments from the Secretaries of State and/or Treasury and the President, démarches by our Embassies to OPEC governments, consultations with key oil-importing countries, inclusion into agendas during meetings with key OPEC officials, coordination of importing country positions via IEA and possibly other forums. In this regard, we should take advantage of the Bank/Fund meetings in Washington and the UNGA later this month and the opportunities for contact with key OPEC ministers.

Our approaches should cover the elements analyzed in this paper, including the state of the oil market, the impact of oil price issues on the world economy, and the relationship between OPEC’s decision on oil prices and the success of our efforts to control inflation and improve our trade deficit as fundamental to a strengthening of the dollar.

1. Source: Carter Library, National Security Affairs, Staff Material, Middle East File, Box 66, Subject File, Middle East Oil, 12/77–12/78. Confidential. The paper is attached to a September 19 memorandum from Bosworth to the National Security Council, Department of Energy, Department of the Treasury, and the White House, explaining that the NSC Staff had asked that he distribute the paper to principals for use at the September 21 NSC-chaired meeting on short-term OPEC price strategy.

2. While the report of the Interagency Task Force on Long Term Strategy toward OPEC prices has not yet been reviewed by the PRC, its conclusion is that gradual increases by OPEC in the real price of oil are not preferable to a later, sharp oil price increase by the mid-1980’s. The report recommended that the U.S.:

   —Reaffirm the policy of seeking to keep OPEC price increases as small and infrequent as possible within the limits of U.S. influence and advisable tradeoffs with other objectives.

   —Establish the longer-term strategic goal of seeking to expand world productive capacity as a major foreign policy objective.

   —Review periodically U.S. posture and tactics with respect to OPEC in the light of market developments and past success in moderating price and expanding capacity. [Footnote in the original. For the terms of reference for the task force, see Document 150.]

3. See footnote 3, Document 153.
4. As a result of oil development in the North Sea.
5. In a September 20 memorandum to Brzezinski attached to this paper, John Renner of the NSC Staff recommended that Brzezinski favor this option because: “a. It is in line with the decision the OPEC countries are likely to make; b. It would appear to the Saudis as the more reasonable position and would enable us to use our influence to try to persuade the Saudis to support the Camp David agreements; c. It would put us in a better position to argue for increased investment in production capacity, which is essential to avoid supply problems in the late 1980s.” Renner also noted that Henry Owen agreed with his recommendation.