223. Memorandum Prepared in the Office of Economic Research, Central Intelligence Agency1
A. The Oil Weapon and Its Effects
On 17 October the Organization of Arab Petroleum Exporting Countries (OAPEC) decided to cut oil production.
- —Production will be reduced by not less than 5% a month until an Israeli withdrawal from occupied territories is completed and the “legal rights” of the Palestinians are restored;
- —The Arab countries also promised to maintain oil deliveries to “friendly” countries that give Arabs “effective material help”; and
- —Threatened a total embargo of countries that used their armed forces to aid Israel.
Many parts of the statement were left deliberately vague in order to allow each Arab country a degree of freedom to act according to its own best interests. This ambiguity—similar to that of OPEC decisions in the past—is intended to give the OAPEC agreement greater durability by giving each country greater flexibility. All of the states are obliged to cut production by 5% a month, but the way is open for some [Page 621] to make larger cuts. The Arabs did not define those “friendly” countries that will continue to receive normal imports from the Arab World. They probably will cut back shipments to neutral states such as the United Kingdom and Japan and may cut back shipments to such states as France and Italy that are “tilting” their neutrality toward the Arabs. In any event, the final interpretation of the definition is left to the individual producing country.
At least in the first months, the Arab monthly production cutback will probably be between 5% and 10%, but closer to the 5% rate. Saudi Arabia has reportedly already cut current production by 10%. Some other countries—such as Iraq, which is unable to export most of its production because of the closure of eastern Mediterranean ports—may make a virtue of necessity and make very large initial cuts. An all-Arab cutback of between 5% and 10% would represent a loss of between one million and two million barrels per day (b/d).
Several countries, including Libya, Abu Dhabi, Kuwait, and Saudi Arabia, have either announced or threatened a total embargo against the United States. However, the United States receives only about 1.6 million b/d of Arab oil (including products refined in Europe and the Caribbean). Thus, even if the embargo were effective, the effect on the United States would be relatively small, and, after the first month, the brunt of the cutback would fall on Europe and Japan. Moreover, the US companies that produce most Middle East oil might be able to shift supplies among themselves to avoid the embargo. The companies would, of course, hesitate to do this for fear of jeopardizing their relations with the producing countries as well as with Western Europe and Japan.
It seems inevitable that Western Europe and Japan will bear the brunt of the progressive cutbacks. Western Europe is dependent on Arab oil for 70% of its consumption, and Japan depends on the Arabs for 40% of its supply. The producer states recognize that it is “unjust” to punish Europe and Japan more severely than the United States, but see no other alternative. The Saudis have informed representatives of the major West European nations that they will be expected to pressure the United States. They have also suggested to the Japanese that they make a statement before the UN General Assembly to the effect that Japan desires an early settlement to the war and that it supports the Arab position.
From the point of view of United States vulnerability, it is perhaps fortunate that this particular crisis occurred now rather than a few years hence. It had been predicted that we would be importing nearly 5 million barrels per day of Arab oil or 21%–22% of our consumption by 1980. With this level of exports an Arab cutoff would severely affect our economy. Even now there are domestic as well as foreign pressures for policy changes as a result of the current cutoff. In any event, the [Page 622] rapid increase in the price of imported oil should dampen our consumption and make other domestic energy sources more attractive, for example oil from Colorado shales and coal gasification.
Although the West European countries are attempting to form a common position regarding the oil cutback, divisive tendencies may prove too strong. Joint contingency plans exist, but, because of the different countries’ different views of their own advantage, the plans may not be used efectively. Individual countries also have developed plans for dealing with a crisis on a national basis. Some reportedly are updating rationing systems worked out during earlier crises and have stocks of rationing books ready for distribution. At the same time, a few European countries, notably France, still entertain hopes that the Arab oil production cutback will not apply to them.
The immediate impact from war damage and production cutbacks will vary considerably among EC members. The shutdown of three eastern Mediterranean pipelines already has dropped Italy’s oil imports by some 24% and France’s by 14%, while affecting other members’ imports only moderately or not at all. Because of the large difference in shipping distances, those nations such as West Germany that depend most heavily on North African oil will feel the pinch of a production cutback much sooner than those such as the Benelux countries that depend on Persian Gulf supplies (see the table). Italy already has imposed an embargo on refined oil exports outside the EC—a move detrimental to US supplies that may be emulated by other Community members if the supply situation worsens.
Over the next few months, the impact of reduced oil imports will be partly mitigated by reserve stocks maintained by the EC nations. All have about a two-month supply on hand, and France reportedly has a 90-day reserve. Arab oil, however, accounts for between 63% and 78% of EC members’ oil imports and a similar share of their total consumption. As a result, a 5%–10% cumulative monthly reduction in production by the Arab states, together with already interrupted pipeline deliveries, would soon force EC nations to draw heavily on reserve stocks. If current consumption levels were maintained, these reserves might be depleted within six months, and total available supplies could be reduced to one-half of normal. Conservation measures could delay the depletion of reserves by at most another few months.
[Omitted here are a table on EC dependence on Arab oil and material on the effects of a 5 percent cutback, including 5 graphs.]
B. The Impact of Increased Oil Prices
The increase in oil prices will be felt primarily in the United States, Japan, and Western Europe. The oil import bills of the United States and Japan will each increase by about $3 billion, while the additional [Page 623] cost to Western Europe will approach $8 billion. This assumes that deliveries from the Gulf will continue as scheduled prior to the announcement of production limitations.
- —The oil price rise will turn an expected $1 billion or so 1974 US trade surplus into a roughly $2 billion deficit
- —The Canadian trade balance will be virtually unaffected because Canadian oil imports are roughly equal to exports
- —Japan, which imports about 43% of its oil from the Arab countries, will have a 1974 surplus of about $3 billion, compared with a previous estimate of $6 billion.
- —The West Germans will pay an additional cost of about $1.8 billion—the highest in Europe—but they will feel the least hardship because their 1974 trade surplus will be on the order of $8 billion.
- —Petroleum imports will push the UK trade deficit from about $3.5 billion to almost $5 billion.
- —The OPEC action will add $1.5 billion to the oil import bill of both France and Italy. The price increases will reduce the French surplus to near zero. Italy’s small deficit in 1973 was expected to narrow further but should now be in the $1.5 billion–$2 billion range.
Some of the impact of higher oil prices in the consuming countries will be offset by greater repatriation of oil company profits and larger exports to the producers, generated by their greater export income. Only part of the worldwide producer revenue increases of $15 billion will be spent, however. The 1974 oil revenues of Saudi Arabia, Abu Dhabi, Qatar, and Kuwait will approach the amounts recently estimated for 1980. These countries have only limited absorptive capacities.
Although the trade balances of the oil importers will deteriorate sharply, the impact on their domestic economies will probably be slight. Oil imports do not compete with domestic production so there should be no initial offsetting loss in jobs. The consuming countries’ non-petroleum trade and production will essentially be the same as before the oil price increase. Moreover, the sharp rise in crude oil prices should not significantly increase the price of finished goods.
The use to which the oil producers put their reserves could have an appreciable impact on the international exchange rate system and, through the exchange system, ultimately on the volume of exports and imports. If, for example, the producers decide to hold most of their increased receipts in dollars, the dollar will strengthen in exchange markets. A dollar appreciation means more expensive—and therefore reduced—US exports. In effect, the oil producers will be converting their trade surpluses with other consumers into trade surpluses with the United States; or, in another view, the US trade account with Japan, Canada, and Western Europe will deteriorate by the amount of the increase in their oil import bills.
As the oil producers’ reserves increase, their threat to exchange markets will also increase. The Arab oil states already have enough [Page 624] liquid foreign assets—around $5–$7 billion—to temporarily disrupt currency markets. Although there is no evidence of any substantial dollar sales during the current crisis, and an attack on the dollar would result in the depreciation of the Arabs’ own reserve holding, it is not inconceivable that—if the political and military situation becomes increasingly unacceptable to them—the Arab leadership would move against the dollar. On Thursday,2 Libya publicly called for concerted Arab dollar sales and withdrawal of deposits from US banks.
C. Foreign Reaction
There is very little the West Europeans can do in the near term to get their oil deliveries back to strength. They will, of course, continue to distance themselves from Washington’s present Middle Eastern policy—in speeches, in UN votes, and in the denial of overflight and refueling rights for US military aircraft. But no European leader expects such behavior to cause Washington to rethink its position or entirely to save Europe from the effects of the oil embargo. Indeed, the West Europeans probably are overly conscious of their impotence to influence the present situation; they are more inclined to “keep their heads low” in the hope of warding off still greater threats to their energy supply.
At the moment, the West Europeans are eager to discuss oil problems with the United States, hoping naturally that the United States will agree to share supplies (and shortages). But if such agreements are not forthcoming from Washington—and if oil shortages begin to bite severely—the Europeans would try at least to keep all the oil they can get for themselves by reducing or eliminating their exports of refined oil to the United States. In such a scramble, they would be more likely to act unilaterally than on a joint European-wide basis.
There is some inconsistency between the European desire to minimize association with US political policy in the Middle East crisis and European awareness that some form of cooperation arrangement for coping with oil shortage must necessarily involve US-European conversation. This inconsistency is both real and apparent. The Europeans will try to resolve it insofar as they can, by working for quiet talks within OECD forum on oil matters, while avoiding political initiatives unless and until the time seems ripe for a mediation role that would not alienate the Arabs.
Over the longer run, the present experience will further encourage the West Europeans to decrease their reliance on the major oil [Page 625] companies and to develop instead their own arrangements with oil producing governments. They would focus on offers of government-to-government agreements that would involve European technical assistance in return for supply commitments, and possibly trade preferences for oil producing states. An obvious side effect of such a policy would be lessened European willingness to join in consumer cooperation schemes on terms favorable to the United States or—depending on US-Arab relations in the postwar world—be associated with the United States in oil cooperation schemes on any terms at all.
The Japanese have always sought to avoid taking sides in contentious situations involving Middle East oil. In the last year, the Japanese have refused to join an oil consumers organization, for fear of antagonizing the oil producers in OPEC. There has been an ongoing debate in Japan for some time over the merits of multilateral versus go it alone approaches to assuring oil supplies.
Japan’s policy in regard to the present petroleum supply situation rests almost entirely on the hope that the current Middle East crisis can be defused before severe sanctions are enacted by the Arabs. Tokyo is being urged by the Arab states, with Saudi Arabia taking the lead, to issue an official statement supporting the Arab position in the current conflict. The Arabs have avoided accompanying such requests with threats of a serious disruption in the flow of oil to Japan. Nevertheless, the implied threat of economic blackmail has not been lost on the Japanese. The Japanese are extremely reluctant to abandon their neutral position on the Middle East primarily because of the serious impact such a step would have on relations with the United States, in particular with regard to existing plans for bilateral cooperation in the field of energy-petroleum sharing. Foreign Minister Ohira, on 19 October, sought to sidestep an Arab request for direct political support when he told a group of Arab envoys that Japan favors settlement through the United Nations and noted that Japan supported the 1967 Security Council resolution calling for Israeli withdrawal from occupied Arab territory.
Tokyo’s political tightrope walk will have difficulty surviving an indefinite prolongation or heightening of Arab pressure. If backed to the wall by credible Arab threats of a cut off of oil, the Japanese will probably give in. As a contingency measure, the Japanese Government is already studying drafts of a statement supporting the Arab position that could be used in such a forum as the UN General Assembly. But Japan would first make a last ditch effort to secure assistance from the United States in the form of diversion of some US oil supplies to Japanese needs.
[Omitted here is an Annex of Selected Tables.]
- Source: Central Intelligence Agency, Office of Economic Research, Job 80–T01315A, Box 36. Secret. An October 19 covering memorandum for the record states that the memorandum was prepared October 19 for the WSAG meeting that evening and that Kissinger had requested it for a briefing of the President. An updated itemization of developments, resulting from memoranda of conversation between oil executives and representatives of the Departments of State, Treasury, Interior, Justice, and Defense, the Energy Policy Office, the NSC, and the CIA, is in an October 22 memorandum of conversation. (National Archives, RG 59, Central Files 1970–73, PET 17–1 US)↩
- October 18.↩