235. Memorandum From the Under Secretary of State for Economic Affairs (Casey) to Secretary of State Kissinger 1
This memorandum with my current thoughts, judgments, and assessments on the oil situation, may be useful in preparation for your talks next week.2
The Current Situation
The assessment of the damage inflicted by the embargo grows more serious. Two weeks ago the estimate was that a cutoff of Arab oil supplies would take away 10 to 12 percent of our total consumption. The latest estimate from the Love office is 15.5 percent, and the oil companies and Defense are putting it at closer to 18 percent. This latest jump comes from the inclusion of 300 thousand barrels a day of bonded military jet fuel stored offshore and higher estimates of winter needs and products imports coming indirectly from Arab countries through Caribbean, South American, and European refineries. The increase in impact estimates also comes from the Saudis’ unexpected diligence and efficiency in pulling the noose tight on indirect U.S. use of their crude through imports of petroleum products from third countries. The savings from the options currently being presented to the President are estimated to be good for 2 million barrels a day. The prospect of the shortfall running to 3 million barrels a day requires forcing further consumption cuts by a consumer rationing. This will take 60 days to put in place, and that process is to some extent in motion. Because of quirks in the distribution system and time lags these expectancies are not likely to be fully achieved so that we will see considerable confusion and hardship if the embargo continues for another 2 or 3 months.
The Strategic Alternative
I am signing through to you today the new study (Tab A) of alternative strategies dealing with the international oil problem which you have requested. It looks at four basic strategies:
- Control the companies.
- Use of diplomatic, security and other leverages on the producing countries.
- Reorganize the market through consumer cartels or a system of consumer country import controls or through a supply and price commodity agreement between consumer and producer countries.
- Rely primarily on building self-sufficiency.
These strategies are not mutually exclusive and all four of them could be utilized.
My own judgment is that a strong drive to self-sufficiency is fundamental and paramount and that diplomatic initiative is necessary to buy time and to cope with the financial imbalances already inherent in the present situation. I have very little confidence in controlling the companies or organizing the market. It is my judgment that these approaches would turn out to be counter-productive.
The Price Impact
I think it is important to recognize that the increase in price which has already taken place will turn out to be more important than the embargo. The embargo will not last forever but the price increases will generate wide financial disruption and, more important, remove the incentive of the Arabs to lift their production to the levels they had planned and on which the consumer countries have been counting.
Counter Economic Warfare
In looking at options to deal with embargo I had INR pull together a picture of what might be accomplished by economic counter measures. As you will see from the paper at Tab B there does not seem to be much leverage there.
Fundamental Long-Term Approach to the Arabs
During the summer I felt the same dissatisfaction you have expressed in the options being developed for cooperation of a bilateral and multilateral character to meet the energy challenge. I felt that any approach to the Arabs would be ineffective unless (a) put in perspective of actual steps already in motion on our part to achieve self-sufficiency and (b) related to their self-interest in beginning now to adapt to a world in which their only real asset—liquid oil in the ground—will have lost much of its importance. It seems to me that we have to show them that by going wild on prices they will accelerate this process. It also seemed to me that the only way to enlist their financial cooperation is to offer them a way of participating in the future world energy system in which liquid hydrocarbon must play a smaller role. I would urge you to read the speech I made in September in which I began to spell out this perspective. It is at Tab C and I have marked off the most important paragraphs.
They must come to understand that we can manage without their oil. Cutting our consumption back by 20 percent will be rough but only [Page 667] for a few years. I am attaching at Tab D a preliminary on a study we have been working on with Interior which shows how more severe but still feasible steps than those set out in the President’s energy messages could relieve us of dependence on Arab imports in 1975, all oil imports by 1980 and all gas imports by 1985. The Arabs must also perceive that once we make the immense effort and investment to start in this direction their market for oil may be permanently impaired.
You are uniquely in a position to begin a process of engaging the Saudis in a continuing exploration of where their real interest lies in this period of transition to a world in which liquid hydrocarbons will inevitably share the world energy market with increasing proportions of hard hydrocarbons in the form of coal, shale and tar sands and new technologies based on the atom, hydrogen, and the sun. Children in Saudi Arabia today can see a day when their oil may not be enough to sustain them, and wise leaders would use their growing financial reserves to get a stake in that world.
We should also be exploring what a $10 barrel of oil will do to the prices of all the other commodities in the world. We should be studying together the implications of $5 a bushel wheat and $6 a barrel oil for their inflationary investment and monetary implications along with our mutual political and security concerns which I don’t have to develop for you.
Addressing the Embargo
The most promising approach at this time, is the effort you are embarking upon to convince Sadat and Faisal that, if we are to play successfully the role in the Arab-Israeli territorial settlements they need, this oil pressure is counter-productive. They cannot expect you to sustain the domestic and other support you will require to accomplish this by tightening the screws every few days.
Yet, I am inclined to share the doubts stressed by both Ray Cline and John Wilhelm on the ability of Faisal to terminate the embargo before there is tangible evidence of commitments on a settlement. If you decided that is the case, I have some suggestions for a series of specific and not very visible relaxations of the embargo that would relieve our situation and get Faisal moving in the right direction. For example, on the basis that the Arab states as well as all others have an interest in keeping the global air transport and shipping systems going, shipments to refineries to the extent necessary to produce bonded jet and bunker fuel for these purposes could be continued. Another example, Saudi crude goes into refineries in Portland, Maine, which puts it into a bonded pipeline to Montreal. Although Canada is not on the embargo list the Saudis have decreed that the crude necessary to supply their pipeline cannot go to the U.S. refinery. This interpretation might have been the other way. Again, they could be less diligent in [Page 668] shutting off crude to the Caribbean and South American refineries on the basis of products going to the U.S. That they are willing to be flexible in this kind of thing is demonstrated by the Netherlands situation. When they embargoed the Netherlands they did so without cutting back their production to the extent of their shipments to the Netherlands. That means that ARAMCO will get that crude and will be able to send it to European refineries or ports where it can be turned into products that can be applied to meet needs which otherwise would have been met by shipments to Rotterdam. The point here is that both the embargo and the supply situation could be relaxed and a productive process set in motion if it turns out to be impossible to get the embargo called off until the peace settlement shapes up more clearly.
The European Situation
The disarray of the Europeans and the general scramble to appease the Arabs and take care of themselves has made the oil weapon successful more than anything else. This has been generally explained on the basis that the Europeans and Japanese are more dependent on Arab oil than we. The fact is that today we are facing a 15 percent cutback in consumption, Europe a 9 percent cutback in consumption, and Japan a cutback of about 4 percent. The emergency oil sharing scheme which is being studied in the OECD, if implemented today, would increase our imports by 18 percent over the embargo levels if it operated on the basis of sharing imports which is the only basis we have been willing to consider. It would reduce our imports by about 3 percent if operated on the consumption sharing basis which would be the most disadvantageous to us.
When I talk to the British and the Germans on Monday and Tuesday3 I plan on engaging in a mutual assessment of the situation and to see what they are willing to do to remedy it. It is in our common interest to cut back consumption and to force synthetic production. They have to move on that and decide whether they are going to share among themselves in the operation of the European Community before we can [Page 669] even begin to think of anything we might be able to do to help them. In fact because we are losing more than they, we have a grievance as they shut off product shipments to us. They will say that they have to do this in order to keep the Arab crude flowing to them. The only thing that can keep European industry from grinding to a halt and their people from freezing as the Arabs continue their cuts will be the achievement of a settlement, or whatever else it takes to bring about a reverse of the Arabs’ announced policy of steadily curtailed production. The original purpose of Prime Minister Heath’s request for consultation was to discuss what can be done about the huge unilateral price increases which have been imposed. This is particularly damaging to the UK with its acute inflation and balance of payments problems. I want to find out what they propose to do about this and how they assess the feasibility of improving the situation through greater control of the companies and tighter organization of the market. I plan to get their ideas in a general way on the questions indicated in the letter I sent to the Presidents of the oil companies outlining the questions on which we would like to get their reaction when you return from your trip. (Tab D)
As pressing as the current situation is and as urgent as it is to strike out in new directions, we must not let the process of looking for oil be neglected. Nor should we forget that the Arabs carry the risk of significant uncertainties in the demand and supply projections which have undermined the bargaining strength of the producing countries. Continuing large increases in oil prices can be expected to have a dampening effect on its consumption and place in the energy resource mix. Even small changes in the currently projected rates of growth of world energy demand or in the energy resource mix (e.g., more coal) could alter the world oil equation beyond the practical capacity of oil producers to offset. Production projections will probably turn out to be overstated in the case of certain major sources—e.g., Saudi Arabia—while quite possibly understated in a large number of places ranging from the North Sea, Siberia and the Arctic to the offshore continental shelfs around the world to the Amazon jungle.
In short, oil market conditions may well, over the next ten years or so, be conducive to opportunities for advantageous bargaining between producers and consumers on private and public levels. This is the area we should continue to explore, seeking to uncover and even induce new prospects and accelerated exploration. Higher prices will stimulate both exploration and greater production from existing pools and we should be careful about market or contract arrangements which could be counterproductive to this process.
- Source: National Archives, RG 56, Records of Secretary of the Treasury George P. Shultz 1971–74, Box 7, GPS Secretary of State C–1974. No classification marking. All tabs are attached but not printed. Tabs A and B are described in footnote 2, Document 233.↩
- See footnote 4, Document 231.↩
- According to telegram 16053 from Bonn, November 6, Casey met with senior Foreign and Commonwealth Office and DTI officials on November 5. He reported that British policy was to “‘help maintain maximum flow of oil’ by resisting Dutch demands for public manifestation of EC solidarity in order to protect their favored position while quietly preparing for worse and hoping that shock and implications this fourth Arab-Israeli war sufficient help you ‘get politics right in Near East.’” (National Archives, RG 59, Central Foreign Policy Files) On November 6, German officials from the Foreign Office and Ministry of Economics told Casey that they preferred a “very silent” system of cooperation relying on companies to do the necessary shifting of supplies, unless Libya embargoed Germany, which would cause a shortfall of 40 percent of consumption. (Telegram 28915 from USOECD Paris, November 8; ibid.)↩