357. Paper Prepared in the Office of Economic Research, Central Intelligence Agency1

The Buyback Issue

Background

1.
Increasing producer government ownership of Western oil company operations within their borders has injected a high degree of instability into the world oil market. Arbitrary demands (unrelated to market forces) by the producer governments regarding prices for government-owned oil sold back to the companies—buyback oil—have caused prices to rise even higher than expected this year.
2.
The buyback price of government oil is not an issue in most OPEC countries. Differing types of arrangements such as the production-sharing pacts in Indonesia and nationalizations in Algeria and Iraq obviate the need for buyback price discussion in those countries. Venezuela presently has no participation in the companies operations and therefore no buyback oil. These countries are affected, however, by buyback agreements in other countries because the buyback prices are taken into consideration when Algeria, Indonesia and Iraq set their sales prices and in Venezuela’s case when it sets its tax reference values.
3.
Iran is a special case. Tehran achieved full operational control over its industry in March 1973 and sells most of its oil back to the Consortium on a 20 year contract. Iran’s price is adjustable through a “balancing margin” designed to give Tehran financial equivalency with the per barrel revenues of other Persian Gulf countries. The balancing margin was recently adjusted retroactive to 1 January 1974 to take into account the Qatar agreement for 60% government participation and a buyback price of 93% of the posted price.
4.
Buyback price negotiations have been settled in Libya, Nigeria and Qatar. Libya agreed to a buyback price equivalent to 85% of the posted price for May through September 1974. Nigeria sold most of its participation oil back to the companies at 90% of the posted price during the second quarter this year. Libyan and Nigerian posted prices are substantially higher than postings in Persian Gulf countries because of [Page 1014]higher quality oil in the two countries and their transportation advantages to the major oil markets of the United States and Western Europe. The lower percentage buyback prices agreed to in Libya and Nigeria still yield per barrel oil revenues much higher than the equivalent of 93% of Persian Gulf posted prices and probably reflects posted prices that were too high in the current soft market.
5.
Qatar is the only Persian Gulf country known to have a firm buyback price for 1974. The companies agreed to a buyback price of 93% of the posted price for the first half of this year subject to review quarterly.
6.
Buyback prices remain unsettled in Kuwait, Saudi Arabia and Abu Dhabi.

Status of Current Negotiations

7.
Kuwait has demanded that Gulf and British Petroleum pay 94% of the posted price for government oil lifted in January–May and 94.8% for June. We believe the Kuwaitis recognize their demands cannot be supported by the market but seek the high prices in large measure for domestic reasons and to a much lesser extent for international reasons. The companies have refused to meet Kuwait demands but recently, Gulf has indicated it has little choice but to accept. Acceptance of Kuwait’s demands would probably lead to a re-opening of buyback negotiations in other countries and would almost certainly escalate producer demands for the remainder of 1974.
8.
The companies have exhibited no compelling urgency to settle with Kuwait. Negotiations over the buyback prices have dragged on for months, leading in part to Kuwait’s decision to place its total available participation oil, 1.25 million b/d, on the auction market for the second half of this year. BP and Gulf, who jointly purchase some 1 million b/d of equity oil in Kuwait, did not bid on the auction oil, apparently deciding to forego the oil rather than meet Kuwait’s price. BP has indicated it is prepared to await the results of the auction, the deadline for bids was 30 June, before resuming buyback negotiations.
9.
Negotiations are underway in Abu Dhabi but they appear to be concentrating on the percentage of participation ownership by the government. Abu Dhabi is likely to follow the lead of Kuwait and Saudi Arabia on buyback prices.

The Auction: A Complicating Factor

10.
If Kuwait’s auction is successful—the bids closed on Sunday 30 June—it would make the question of providing compensation oil to the companies moot. Presumably the purchasers of the Kuwait auction oil would largely be former Gulf/BP customers—chiefly Japan—or other oil companies who would supply those customers. Gulf/BP would lose part of their share of the market.
11.
On the other hand, should the auction fail partially or completely we believe Kuwait might well cut production by the amount of oil they are unable to sell at their asking price. With world oil supply currently outpacing demand by 1.5 to 2 million b/d we believe it unlikely that even a full cutback of 1.25 million b/d would lead to shortages although it would firm up spot and auction prices.

How Could the Companies be Compensated?

12.
If Gulf and BP lose access to Kuwait buyback oil they are unlikely to be able to increase their production in other countries. Other than in Kuwait, the bulk of the world’s unused oil productive capacity is controlled by the governments of Libya (1 million b/d), Iraq (500,000 b/d) and Saudi Arabia (1,700,000 b/d); the official excess capacity is 700,000 b/d. We believe that Libya and Iraq probably would be willing to sell the companies additional oil but at a price as high or higher than that demanded by Kuwait.
13.
The proposed Saudi auction could make additional oil available to the companies. If part of the auction oil is supplied by new oil production it could offset all or part of the Kuwaiti reduction. We see no reason why Gulf and BP could not bid on Saudi auction oil if they wished and probably at a price of 93% or less of the posted price.

Conclusions

14.
We see no compelling reason for Gulf and BP to cave in to Kuwait’s current demand for an increase in the price of buyback oil. They could drag out negotiations and the expected weakening of market prices could take the force out of Kuwait’s demands.
15.
Moreover, the companies have already decided in effect that they could do without buyback oil by not bidding for Kuwait’s auction oil which is after all the buyback oil the companies have been selling.
16.
Even if Kuwait cuts production by the full 1.25 million b/d up for auction there will be sufficient oil production elsewhere because supply is outrunning demand by between 1.5 and 2 million b/d.
17.
Gulf and BP may lose part of their market share because they have little or no excess capacity available to them elsewhere. If the companies attempt to maintain their share of the market by buying oil from Iraq or Libya it will be high priced. The companies presumably can also bid for oil in the Saudi auction to be held later this month. The Saudi price probably will be no higher than 93% of posted prices and it could be lower.
18.
In view of the above, there would seem to be no need for a consumer government scheme to replace Kuwaiti buyback oil no longer available to Gulf or BP. Moreover, such a scheme could be counterproductive. It would raise the buyback negotiations from an economic [Page 1016]issue to a political one. We believe that any such effort of backing the companies, which could not be kept secret, would be viewed as a confrontation by the producing countries. Even Yamani (and King Faisal) who are working to lower crude prices would object to such a consumer scheme and almost certainly would support an OPEC action to counteract it.
  1. Source: Central Intelligence Agency, Office of Economic Research, Job 80–T01315A, Box 41. Confidential. An attached July 1 memorandum from Walter J. McDonald, Chief, Industrial Nations Division, Office of Economic Research, to Thomas Enders, Assistant Secretary of State-Designate for Economic and Business Affairs, notes that this analysis had been prepared for Treasury Secretary Simon as Enders had requested. (Ibid.)