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

208. Paper Prepared by the National Security Council Staff¹

Washington, October 5, 1973.

OIL SUPPLY ARRANGEMENTS: ALTERNATIVE APPROACHES TO THE MAJOR PRODUCER AND CONSUMER STATES

Section I. Introduction

Several factors would support an expanded U.S. government role in international oil markets in the future: (1) the rapid growth of U.S. and allied demand for Middle Eastern oil, which could lead to competition by the major importers to tie down supplies; (2) the companies’ diminishing control over oil, caused by the expansion of participation agreements; (3) the asymmetry of the current negotiating process in which companies deal directly with sovereign producer governments having a unilateral power to legislate; (4) the recent rapid increase in oil prices; and, (5) the growing power of the producer states that will accompany their strengthened financial position. These same factors support the need for rethinking our strategy for dealing with both the major producer and major consumer states.

The purpose of this paper is to examine in some detail alternative USG roles and associated approaches to the major Middle Eastern producer governments and to the major consumer states.

Section II presents background data and discusses the broad issues for decision. Sections III and IV, respectively, discuss multilateral and bilateral aspects of possible approaches. Section V discusses alternative strategies which combine elements of both the bilateral and multilateral approaches.

Section II. General Discussion

Saudi Arabia and Iran are the two key producer nations. Together they possess about 35 percent of the world’s proven oil reserves and, based on current forecasts, will account for between 50 and 90 percent of the projected increases in world oil production between now and 1980.

Of the two, Saudi Arabia is more important since it alone has sufficient spare productive capacity to expand to meet the rapid growth in world demand. Based on mid-range demand projections, a four-fold increase in Saudi Arabian production and a doubling of Iranian production will be needed to meet world needs in 1985. However, Saudi willingness to allow sufficient production is in doubt for both economic and political reasons.

Since Saudi Arabia is key, any consideration of alternative strategies must focus on this country. However, our strategy cannot focus solely on Saudi Arabia at the expense of the other producers, particularly Iran. Indeed, it might be easier and safer to focus our efforts on Iran—rather than Saudi Arabia in order to meet U.S. needs. Nonetheless, Saudi Arabia would still occupy the central position in terms of meeting the world’s oil demands and thus our overall strategy must be designed to encourage adequate Saudi production, if not primarily for us then for our allies.

Our approach should be developed in the total context of interrelations between all the Persian Gulf producer countries. For example, within the area itself, complicating factors such as the following deep-seated conflicts must be taken into account: Iran versus Iraq; Iraq versus Kuwait; Saudi Arabia versus Abu Dhabi; Libya versus the traditional Arab states; and the Arab-Israeli conflict. We will especially need to take into account the likely effects on the Saudi-Iran relationship, on which we are counting to insure stability in the Gulf.²

Primary Objectives

Our primary objectives in developing and implementing a strategy for dealing with the producer nations would be to:

(1) Ensure production is expanded to meet U.S. and allied needs.

(2) Enhance the reliability of future supplies.

(3) Keep oil prices as low as possible by reducing competition for participation oil as it comes increasingly under the marketing control of producer governments.

(4) Soften the strain on balance of payments accompanying the inevitable growth in U.S. oil imports.

(5) To use energy to the U.S. advantage in relations with other consumers and, insofar as possible, make it a source of leverage in U.S. diplomatic policy.

(6) Contain the divisive potential for disrupting our relations with Western Europe and Japan which could result from the future uncoordinated development of the world oil market.

(7) Develop policies for managing the rapidly growing foreign exchange of producing countries.

The Broad Elements of a Strategy

U.S. approaches to the oil supply problems are proceeding on three tracks, and our future strategy will result from decisions on the relative emphasis we will place on each:

(1) We could develop further a number of multilateral measures. These would aim at coordinating policies of the various consumer nations and presenting as united a front as possible to the OPEC cartel.

(2) We could focus on establishing some bilateral agreements with the producer nations. The principal target would be Saudi Arabia and, although U.S. needs would be our primary concern, allied needs must also be part of such an approach.

(3) Finally, whatever we do on the multilateral and bilateral tracks, we will presumably be taking urgent unilateral steps toward U.S. self-sufficiency in energy as early as possible.

This paper discusses how these elements might be combined to produce the maximum incentives or pressures to achieve our objectives.

The unilateral, bilateral, and multilateral elements are not inconsistent with each other. However, they are interrelated. For example, if the USG moved toward developing a direct bilateral deal with the Saudi Arabians, other consumer nations might be stimulated to enlist our cooperation on a multilateral basis or they might instead intensify their efforts to make bilateral deals on their own. On the other hand, effective multilateral or unilateral steps could have a moderating effect on the policies of producing governments.

Our planning must also take into account the fact that although the role of the international oil companies is rapidly changing, they will remain the major source of technical expertise for both oil exploration and production throughout the foreseeable future. They will also be the primary diversified source of international oil and the chief marketing agents for the producer nations. This capability cannot immediately be replaced.

Issues for Decision

This paper assumes that the U.S. will continue urgent efforts to decrease its own dependence on imported energy and insofar as possible coordinate with other consumers. The issues for decision now are:

• —What degree of multilateral coordination should we try to achieve? Is it realistic to try to achieve a formal consumers’ union? Would the prospect of coordination be effective in moderating producers’ policies or would it provoke confrontation? Short of that, should we try to develop new consultative machinery or simply spur our efforts within the OECD?
• —On what additional issues is improved coodination most urgent? Should some of these be raised to a political level to force them toward decision?
• —What kinds of bilateral arrangements might the U.S. now make with Saudi Arabia and perhaps Iran that would improve our own supply situation enough to spur other consumer countries to greater coordination of policy without provoking them to cutthroat pursuit of their own bilateral deals?
• —To what extent are we prepared to introduce political, strategic, and security aspects of our relationships into these bilateral negotiations? To what extent is this feasible unless there is coordination on these subjects among all major consumer governments?

[Omitted here are Section III on Multilateral Consumer Arrangements and Section IV on bilateral arrangements.]

Section V. Strategy Choices

Assuming that the U.S. will continue to urgently develop domestic alternatives to oil imports, our strategic program is to find the right combination of bilateral and multilateral initiatives which will:

(1) Maximize pressures and incentives for the producer countries to produce adequate amounts of oil at reasonable prices, and

(2) Maximize the potential leverage which oil gives to the U.S. in our relations with Europe and Japan. As a minimum, we should seek to reduce the potentially divisive impact on relations between the U.S. and other major consumers.

A strategy emphasizing solely the bilateral arrangements or the multilateral arrangements is conceivable. However, neither strategy is likely to be successful by itself in attaining these objectives. A bilateral strategy alone would run the risk of triggering a scramble for oil supplies that would unnecessarily bid up prices, with no assurance that adequate supplies of oil would be obtained. Moreover, the intensified competition would run the risk of sharply dividing our existing alliances.

A multilateral strategy alone would likely either never attain our goals or take too long in achieving them.

A Combined Strategy

A combined strategy would involve drawing elements from both the bilateral and multilateral approaches in order to reduce the obstacles inherent in each approach and build on the advantages of each.

Currently, our policy has been focused on gaining cooperation between consumers through oil allocation arrangements and cooperation in research and development. We have relied on the major oil companies to deal with the producer countries and—except for interventions such as the current Libyan situation—have not made approaches to the producer nations on a bilateral government-to-government basis in matters of oil.

Since we are already embarked on these low level multilateral initiatives, the key policy decision is:

(1) Whether the USG should, on a bilateral basis, approach the producer nations and establish an agreement that sets oil production and perhaps price levels. It would also include, on the U.S. side, some of the economic and security concessions listed above; or,

(2) Continue on the current multilateral approach and rely on the OECD and other negotiations between consumers to meet our objectives. Alternatively, we could expand our efforts with respect to import sharing, etc., placing them on a higher political level but still not pursuing the bilateral approach.

Our objective in starting the bilateral initiative would be to spur the other consumers towards cooperation. We would bank on our political and economic leverage to demonstrate to the other consumers that cooperation was in their best interest because in all out competition with the U.S. they could not prevail.

Specifically, the strategy would be designed to:

(1) Create an incentive towards cooperation between consumers that goes beyond the cooperative arrangements currently under consideration on the basis that they are not, in themselves, sufficient to avoid divisiveness and create the needed level of confidence between consumers.

(2) Based on this incentive, we would strive to get agreement between consumer nations on critical issues such as (a) ways to support the international oil companies in their dealings with producer countries, (b) agreement to avoid bidding for participation oil, and (c) ways to develop economic and political incentives on a multilateral basis in order to get adequate production levels.

(3) At the same time, we would be hedging against a shortfall in production and break out of competition by casting a bilateral relationship that would ensure U.S. needs are met first and that U.S. leverage is maximized with respect to the other consumer nations. Emergency sharing arrangements would also provide a hedge.

A combined strategy could thus involve the following steps:

(1) As a first step in the multilateral area and to build confidence among the consumers, we would continue with our efforts to negotiate a strong emergency sharing arrangement. We might agree to an arrangement which favors the allies rather than the U.S. in exchange for an agreement regarding handling of participation oil or ways of backing the oil companies on a coordinated basis. The issue is at what political level should this be carried out.

(2) We would combine this with broader high level discussion and negotiations with the other consumers regarding several critical issues such as:

(a) common objectives we share in relations with the producer nations;

(b) control of price competition for participation oil;

(c) definition of acceptable bilateral arrangements;

(d) possibilities for producer country economic diversification;

(e) the government role in oil company negotiations; and,

(f) the broad parameters which governments could set to govern company negotiations.

To make these more palatable to countries like Japan, these multilateral initiatives could include a heavy emphasis on cooperation with the producer countries as well. For example, they could concentrate on ways of contributing, on a multilateral basis, to producer country economic diversification and other economic needs.

(3) To spur such agreement—we would proceed on a bilateral basis to pursue economic talks with Saudi Arabia (and perhaps Iran) aimed at broadening the base of our relations with these two countries in the national security and economic spheres. We could emphasize more heavily the tie between the incentives we offer to the meeting of U.S. oil needs. We could continue to develop a package of tariff and other economic concessions and perhaps work out arrangements in which U.S. oil imports were perhaps tied to the export of food and other commodities to the producer countries. Although we would not seek to make these moves public, we would soften our public stance against bilateral arrangements as a signal of our changed attitude.

(4) Based on the results of the bilateral and multilateral talks, a framework agreement—assuring adequate oil supplies at reasonable prices—could be negotiated bilaterally (e.g., U.S. with Saudi Arabia; France with Iraq)—or it could be negotiated on a multilateral basis by the major consumers as a group direct with the major producers (or OPEC). The international oil companies are predominately American and make a positive contribution to our balance of payments and the agreements should, therefore, preserve as much of their role as possible. This argues for fairly broad multilateral framework agreements rather than detailed export-import arrangements with individual country quotas.

(5) If no such framework agreement is worked out, we would, as a minimum, seek tighter coordination among the consumers. Assuming adequate confidence and proper framework agreements had been achieved, this could eventually lead to creation of a solid united front for any further negotiations with the major producers.

Next Steps

The required next steps for development of a combined strategy would include further definition of the various bilateral and multilateral components.

On-going analysis will cover the development of a policy covering emergency sharing. Work also should be continued on the specified economic components of bilateral elements including incentives the U.S. might be willing to provide. Finally, we should address more fully the legal implications of a greater government role in oil company negotiations.

1. Source: National Archives, Nixon Presidential Materials, NSC Files, NSC Institutional Files (H-Files), Box H–197, National Security Study Memoranda, NSSM 174 (Response). Secret. Sent to Kissinger, Schlesinger, Shultz, Colby, and Moorer under a covering October 5 memorandum. A copy was sent to Flanigan and Love. The paper was to be discussed at the Senior Review Group meeting scheduled for October 12. That meeting was not held.
2. It is beyond the scope of this paper, however, to address in detail all the relevant political considerations in the total context of Middle East relationships. [Footnote in the original.]