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

166. Paper Prepared in the Department of State¹

Washington, undated.

Iranian Oil Production

Summary

The situation in Iran’s oilfields and loading facilities is subject to rapid change, but as of November 3 reports indicated a curtailment of Iran’s exports on the order of 4 million b/d (over 10 percent of OPEC exports). The interruption comes at a time when demand for OPEC oil has been rising sharply, substantially reducing the amount of excess capacity available earlier in the year.²

The upward trend in spot market prices has already been accelerated by this situation, but spot sales represent a small portion of oil moving in international trade and are notoriously subject to speculative pressures. If the strikers go back to work within the next week or so, the situation would give only limited encouragement to OPEC price hawks. It is likely that by some increase in liftings elsewhere, a draw-down of stocks, and the adjustment of shipping schedules, the oil companies could accommodate the loss of exports while Iran’s production is being built back to normal levels.

If the strike is prolonged by several weeks, and holds production down to the current level, it is unlikely that sufficient capacity will be available to make up fully the loss of Iranian oil. Much of OPEC’s excess capacity is already committed to production for the fourth quarter; it would require a politically difficult reversal of conservation policies—particularly in Saudi Arabia, Kuwait and the UAE—and a period of months to reach maximum sustainable capacity. Even with the addition of surge capacity in producers outside OPEC (including Canada and the U.S.), there would probably not be enough oil available to avoid a tight market situation and substantial OPEC price increases in December, or possibly earlier, which reflect it.

Among the most dependent on Iran as a source of oil are the Netherlands (36% of imports); Spain (23%); and Japan, Canada and the U.K. (about 16% each). Italy’s dependence is 13% and West Germany’s 11%. The U.S. obtains 9% of its imports from Iran, which represents about 4% of consumption. Normal oil company practice to prorate supplies among their customers, however, would help to even out the impact of diminished Iranian exports.

Israel and South Africa, which are heavily dependent on Iranian oil and have few alternatives, have large stockpiles. Nevertheless, Israel is entitled to call upon the U.S. to fulfill its commitment to make oil available if Israel is unable to locate sufficient supplies.

If the shortfall in oil supplies is perceived as likely to be deep and prolonged, any of the members of the IEA whose traditional dependence on Iran’s oil exceeds 7 percent of normal consumption would be entitled to request the activation of the IEA’s emergency sharing system.³ While the actual size and distribution of the shortfall would depend on the supply and marketing response, the historic figures suggest that if the IEA sharing system were activated, the U.S. would have an obligation to make oil available to other IEA members by foregoing some imports. Operation of the scheme, however, would be likely to reduce the potential for strained relations among the Western allies, and help dampen speculative bidding on spot markets.

The Department of Energy’s “Interim Response Plan for Petroleum Contingencies”⁴ provides for a number of domestic measures to allocate supplies and restrain demand. Our primary emergency management measures would be the standby crude oil and product allocation programs and price controls, as only relatively small savings can be expected from voluntary measures.

Consideration might be given to additional actions to enhance supplies if the Iranian strike continues, including (a) suspension of oil purchases for our strategic reserves and use of the 50 million barrels already purchased; (b) an approach to Canada to liberalize oil and gas exports; and (c) approaches as necessary to Saudi Arabia, the UAE and Kuwait to persuade them to move to full capacity production. Such approaches would have to be considered in light of their likely effect on perceptions in Iran and the Middle East of our continuing confidence in and support for the Shah.

A. Consequences for Supply and Price of Oil

The world oil market was tightening even before the strikes led to the interruption in Iranian supply. World demand for OPEC oil was fairly slack early in the year, averaging only about 29 mmb/d during the first six months, but it stepped up to 30.5 mmb/d in the third quarter and is estimated to reach 31–33 mmb/d during the fourth quarter. Normal seasonal swings produce a year-end jump in oil demand, but this fall’s increase also reflects purchases for the U.S. and Japanese government stockpile programs and speculative stockpiling in anticipation of an OPEC price increase in January.

Iran supplied an average of 5.0 mmb/d to the world oil market during the first nine months of 1978, or about 10 percent of free world production and one-sixth of OPEC’s exports. Since the inception of the severe strikes in the oil fields, Iran’s production has fallen sharply, reportedly providing enough for domestic consumption (0.6 mmb/d) and up to 2.0 mmb/d of exports. Actual exports have not exceeded 1.5 mmb/d in recent days. (Iranian exports of refined petroleum products amount to less than 400,000 b/d, mainly residual fuel oil surplus to domestic needs. Domestic refineries will receive priority access to Iranian crude and in any case a drop in Iranian exports of refined products would not have a significant effect on world markets.)

Impact on Price

The reduction of Iranian exports and uncertainty about future production have intensified upward price pressures in spot markets for crude oil and products. This market is heavily influenced by marginal and speculative trading, and prices could soar if the strike continues for many weeks. At the moment, however, spot crude cargoes are not available at the prices offered. Prices in spot markets influence the climate for OPEC price increases, but are not an accurate reflection of the prevailing price for oil, which overwhelmingly moves under long-term contracts. If the strike continues, within a month or so pressures in spot markets would spread to the premiums charged among oil companies for the crude they sell to one another. At the same time, some OPEC members, including Algeria, Libya, Nigeria, and Venezuela would be tempted to break ranks by raising unilaterally the price differentials applied to their oil in order to capture the benefits of a rising market. Such market pressures in advance of the December 16 OPEC meeting would powerfully strengthen the hands of members pressing for larger and more frequent increases in the general level of oil prices.

It is impossible to predict what general level oil prices could reach in the event of a shortfall prolonged for several months. This would depend not only on the amount of the supply shortfall remaining after offsetting supply increases elsewhere, but also on perceptions about the duration of the crisis. In addition, national and international measures to restrain consumption and utilize existing stocks could help curb demand.

For the sake of illustration, assuming a shortfall of 2 mmb/d after the above measures were taken and a short-term price elasticity of 0.1, it would require a 37 percent oil price increase to balance supply and demand. However, the inflationary impact on domestic prices and the recessionary effect of additional income transfer to OPEC would create new economic conditions in oil-importing countries; each 5 percent increase in the oil price raises the global cost of oil imports by over $6.0 billion, and the U.S. cost of oil imports by about $2.0 billion. Depending on the fiscal and monetary policy responses to these conditions, demand for oil might be further reduced through income effects.

Supply Vulnerability

International Energy Agency (IEA) members most dependent upon Iran for their petroleum imports are the Netherlands (36%), Spain (23%), and Japan, Canada, and the U.K. (each about 16%). The dependence of other industrialized consumers is Italy (13%), West Germany (11%), and the U.S. (9%). The Netherlands and Italy are refining centers, and some of the Iranian crude they import actually is reexported to other European consumers. France—not an IEA member—depends upon Iran for about 8 percent of its oil imports. A prolonged reduction in Iranian exports is not likely to affect all consuming nations in proportion to their dependence on Iranian oil, however, because oil companies can be expected to manage stocks and adjust sourcing and destination of crude flows to spread out the effect of the reduced supply among their own affiliates and long-term customers.

The two countries with the greatest dependence upon Iran as an oil supplier—South Africa and Israel—have limited alternatives. In anticipation, both have large oil stocks. South Africa’s oil stockpile may be sufficient to provide up to three years’ consumption. Israel, with about seven months’ supply, might nevertheless call upon the U.S. to make good on our commitment to make oil available to cover its normal domestic requirements if it is unable to find replacement supplies on the world market, since that commitment is independent of the extent of Israel’s stocks.

Impact on Gas Supply

Pipeline natural gas exports to the USSR have also been suspended as a consequence of the Iranian strikes. The USSR normally receives approximately one billion cubic feet of natural gas per day from Iran, which represents about 3 percent of total Soviet consumption of 32 billion cubic feet per day. However, the Iranian gas is consumed primarily in the North Caucasus area where it is a more important component of regional consumption of about 2 bcf/d. While the USSR is a substantial gas exporter (1.7 bcf/d to Eastern Europe, 1.9 bcf/d to Western Europe), it is unlikely that Iranian-related shortages in the North Caucasus could be relieved in the short run by diverting supplies destined for other markets, export or domestic, to that area. There would be technical problems in reversing the direction of flow in the gas pipelines which are currently set up for south-to-north deliveries, and the Soviets would probably be reluctant to jeopardize their reputation as a dependable supplier.

B. Supply Response

Oil companies are assessing the contribution which stocks could make to current supply. Free world oil stockpiles at the end of the third quarter—some 3.8 billion barrels—represented 74 days of normal consumption but they are unequally distributed among countries. About half of these could be drawn down, but the rest are working stocks needed to keep the distribution system running smoothly. Oil being transported at sea amounts to more than a 30 day supply. Stocks and oil enroute are likely to provide only limited flexibility, however, as companies will be reluctant to liquidate stocks if future supplies are uncertain.

OPEC Availabilities

Oil companies are also seeking additional supplies from OPEC producers. Producer government output ceilings and other policies hold total OPEC available capacity below the maximum sustainable production capacity. Some output ceilings are applied on an annual average basis, however, and reduced liftings earlier this year mean that in some countries output theoretically could rise to maximum sustainable levels for the fourth quarter without exceeding the ceilings. Much of this nominal slack capacity, however, was already committed to meet higher demand expected in the fourth quarter before Iranian output fell. While additional amounts of oil might be available over time, this would depend upon producer governments relaxing a number of important constraints outlined below. Many of these constraints are based upon resource management considerations and have broad political support in the host countries. Therefore, we cannot assume willingness of producer governments to suspend these policies even temporarily; oil companies have already been turned down by Kuwait, Iraq and Abu Dhabi when they sought permission to lift greater than scheduled amounts of oil to help offset the Iranian shortfall.

Before the strikes affecting Iran’s petroleum sector, maximum sustainable crude productive capacity in OPEC was estimated to be approximately 36.9 million b/d, including 6.5 million b/d in Iran. With OPEC production, excluding Iran, close to 25.6 million b/d in September 1978, under-utilized productive capacity outside Iran then stood at about 4.8 million b/d.

Much of this capacity already was committed to production in the fourth quarter. For a variety of reasons—political, technical and economic—most of the remainder located in Saudi Arabia, Kuwait, and Abu Dhabi will not be immediately available as a substitute for Iranian oil. If these countries were willing to lift existing restraints on oil production to balance market demand as a result of shortfalls from Iran, two months or so might be required to bring a large share of this additional capacity on line.

Saudi Arabia—Aramco estimates its sustainable capacity in Saudi Arabia at 10.4 million b/d, and an additional 0.3 mmb/d is the Saudi share of the Neutral Zone production. The company is operating under a set of production rules, some of which will limit fourth quarter 1978 production to a level substantially below capacity. These rules include:

—A prohibition against producing more than 65 percent Arab Light crude on an average annual basis. This limitation would restrict fourth quarter output to approximately 8.7–9.0 million b/d. Production above the 65 percent ratio in the first nine months of 1978 means that Arab Light output will have to be held to 62 percent of the total in the fourth quarter. Current sustainable capacity in other crudes is only about 3.3 million b/d.

—Individual ceilings imposed on several major oil fields. These ceilings would cumulatively restrict output below 8.7 million b/d.

—An 8.5 million b/d annual production ceiling. Since Aramco production in the first nine months of 1978 averaged only 7.5 million b/d, it will be able to produce to the level of sustainable capacity for the rest of the year.

As of late September, one Aramco shareholder company projected fourth quarter production in the range of 8.8–9.0 million b/d. The decision by the oil companies to lift larger volumes of crude in the fourth quarter was made before the strikes in Iran. If this decision is approved by the Saudi Petroleum Minister and higher Saudi authorities, much of the additional crude would go toward meeting both normal winter market requirements and liftings in advance of an OPEC price increase.

Kuwait—Sustainable crude productive capacity in Kuwait is estimated at 3 million b/d, excluding the Neutral Zone, but the government maintains an annual ceiling of 2.0 million b/d on production. Several oil companies have already asked Kuwait to provide an increase in their fourth quarter 1978 liftings because of the supply dislocation in Iran. But Kuwait has thus far refused.

The Kuwaitis, arguing that the international oil companies have taken advantage of liftings in advance of OPEC price increases to garner windfall profits, have advocated control over this practice. Thus, the Kuwaiti oil minister indicated in October that additional volumes of crude could only be obtained if the companies were willing to sign contracts of 3 years or more. Moreover, Kuwait probably would prefer a tighter oil market, at least temporarily, to strengthen its demands for a higher price increase when OPEC convenes in Abu Dhabi in December.

United Arab Emirates—Abu Dhabi has maintained stringent production ceilings on the producing oil companies because of concern for reserve depletion and proper oil reservoir maintenance. Although the Emirate has estimated sustainable capacity of almost 2.0 million b/d, it is limiting average 1978 production to less than 1.5 million b/d. The government has cut back fourth quarter entitlements for companies that exceeded their limits earlier. A political decision would now be required to reverse existing policy temporarily. The other Emirates together have only about 400,000 b/d of productive capacity, almost all of which would be produced in the fourth quarter under normal market conditions.

Iraq—Iraq has an estimated 3.0 million b/d sustainable crude productive capacity and produced close to this level in September 1978. Damage to the Iraq–Turkey 500,000 b/d pipeline resulted in some curtailment of production in October, but the pipeline returned to service in early November. Normal market demand (excluding the Iranian supply problem) will lead Iraq to produce between 2.7–3.0 million b/d in the fourth quarter. Hence, Iraq probably will not be in a position to measurably add supplies this year to compensate for shortfalls in Iran.

Venezuela—Estimated sustainable productive capacity in Venezuela totals 2.6 million b/d and the government normally maintains a production ceiling of 2.3 million b/d. With Venezuelan output expected to reach 2.4 million b/d or more in the last two months of 1978, primarily to meet U.S. winter demand for heavy fuel oil, only an additional 100,000 b/d could be made readily available to meet extraordinary demand requirements.

Other OPEC —The seven remaining OPEC countries—Libya, Indonesia, Nigeria, Algeria, Qatar, Gabon and Ecuador—have a combined crude productive capacity of about 8.4 million b/d. In September 1978, their cumulative output totaled more than 7.7 million b/d, leaving less than 700,000 b/d in under-utilized productive capacity. Much of this spare capacity would have been brought into production in any case during the fourth quarter; the volume available to compensate for Iranian supply shortages will be small.

Non-OPEC Producers

Non-OPEC oil exporters, such as the U.K., Norway, the USSR, Mexico and Trinidad, tend to produce as much as they can, and are unlikely to be able to export significant additional quantities of oil on short notice. Canada has about 400,000 b/d of capacity shut in to slow its long-term production decline, which would be available if the Canadian Government should decide to authorize further exports or exchanges with the U.S. Lesser amounts of capacity might be found in the U.S., with up to 200,000 b/d available from stripper or marginal wells and other shut in capacity. Alaska’s North Slope is now producing at the 1.2 mmb/d capacity of the pipeline, and the Naval Petroleum Reserves are producing at their maximum efficient rate of 132,000 b/d, given current facilities.

C. Contingency Plans

IEA Sharing System

The IEA provides a system for member countries (most developed countries but not France) to allocate oil equitably in an emergency to prevent a scramble which could be costly both economically and politically. The IEA emergency sharing system may be triggered whenever the group, or any member, sustains or can reasonably be expected to sustain a reduction in daily oil supplies (production plus net imports) of 7% or more when compared to Base Period Final Consumption (the current base period is July 1977–June 1978). Because of economic growth since the base period, seasonal factors, and anticipatory lifting, a stoppage of Iranian production would not reduce available oil to the IEA group trigger level.

However, Italy, the Netherlands, Spain, Japan, and the UK depended on Iran for over 14% of their oil supplies in 1977. One of them could seek to activate the selective trigger if normal rearrangements of supply and trading among oil companies did not go far enough in evening out the shortfall among countries.

Procedurally, such a country would have to supply to the IEA Secretariat detailed national oil supply data indicating a prospective shortfall of at least 7% below its base period consumption. The Secretariat would verify the data and submit a report to the Governing Board, which would have to decide whether the conditions for emergency action are fulfilled. To decide not to implement emergency measures when the conditions for such action are found to exist requires a “special majority” consisting of 3/4 of member countries and 60% of weighted votes. (The U.S. has about 1/3 of the weighted votes.)

If the IEA’s sharing system is activated, the Governing Board is to decide whether the situation warrants a partial or full application of the allocation procedures. Full implementation of the system on the basis of a selective trigger would require those countries receiving oil to make up the first 7% reduction in their supplies through demand restraint measures or draw down of stockpiles.

Since the U.S. depends on Iran for a comparatively small part of its consumption, a triggering of the IEA system based on the Iranian crisis would likely obligate the U.S. to make oil available to other IEA members, an obligation which would be fulfilled by foregoing some of our imports.

U.S. Domestic Contingency Plan

The Department of Energy’s “Interim Response Plan for Petroleum Contingencies” provides overall guidance for managing supply interruptions. As in 1973–74, our primary emergency management measures would be the standby crude oil and product allocation programs and price controls, as only relatively small savings can be expected from voluntary measures. The crude oil allocation program is designed to mesh with the IEA allocation system internationally and to allocate available crude oil supply equitably to all refiners. Product allocation programs would result in distribution of available products to domestic consumers.

Revisions of the emergency standby crude oil allocation, refinery yield control, product allocation, and price control regulations are underway; DOE is accelerating this process in view of the Iranian situation. DOE is also readying emergency data acquisition systems necessary to support the IEA allocation system and domestic allocation programs. Agencies involved have accelerated preparation of antitrust clearances which would enable U.S. oil companies to participate in the IEA emergency allocation system if it is triggered.

As authorized by the Energy Policy and Conservation Act of 1975, DOE has developed mandatory energy conservation contingency plans and a standby gasoline rationing plan. The mandatory demand restraint proposals now ready for transmittal to Congress would, if fully effective, curtail demand by about 600,000 barrels per day. The plans cover: restrictions on energy use for commercial, industrial, and public buildings; commuter parking management and carpooling incentives; weekend restrictions on sale of gasoline and diesel fuel; emergency boiler combustion efficiency standards; and restrictions on illuminated advertising. The proposed standby gasoline rationing plan would require a number of steps, including Congressional action, before it could be made ready for implementation.

D. Additional Measures

For the next several days, the situation bears watching as the GOI strives to restore control and production in its oil facilities and while oil companies push their production systems worldwide and probe producer governments for access to offsetting supplies. We will then have a better idea of the technical and political flexibility of supply and a sharper picture of industry patterns of sharing supplies among consuming countries. The stock position in consuming countries and the supply of crude on the high seas give us at least some time to assess next steps. If, however, production in Iran is not restored soon and price pressures continue to build, we may have to consider additional measures to affect supply and demand. The possibilities discussed below are not exhaustive and will require further analysis.

U.S. Supply Actions—We could suspend crude oil purchases for the Strategic Petroleum Reserve, expected to average 330,000 b/d in November and December, in order to remove that much non-commercial demand from the world market, provided that the contracts made by DOD allow such flexibility. There might, however, be an additional budgetary cost in reordering these amounts of crude at a later date. In addition, although SPR holdings are not large (currently 50 million barrels) we might at some point wish to consider using these to help maintain oil supplies to the U.S. economy. Presumably we would first wish to explore the imposition of stringent conservation measures to restrain total oil demand.

Approaches to producers—If market forces and company approaches to producer governments fail to bring forth all the technically feasible alternative oil supplies to offset the Iranian shortfall, we should consider making official approaches to Saudi Arabia, the UAE and Kuwait to relax constraints on producing at full physical capacity, recognizing that the time required to reach full capacity is different for each country. We could also explore the possibility of short-term availability of increased exports of crude oil and natural gas from Canada.

Before we make approaches to OPEC governments it would be prudent to examine carefully a number of significant political considerations. The Saudis and their small Gulf neighbors are acutely sensitive to any sign of lack of constancy in our support for the Shah. They might draw undesired conclusions with respect to their own future relations with us if we appear to be premature in showing a lack of confidence in him. It would also be desirable to consult with the Shah before taking such action.⁵

1. Source: Carter Library, National Security Affairs, Brzezinski Material, Country File, Box 29, Iran, 11/78. Secret. The paper was forwarded to Brzezinski on November 3 under cover of an undated memorandum from Tarnoff indicating that it was done in response to a request from Brzezinski on November 1.
2. Strikes began in Iran on September 9 when workers left a Tehran oil refinery to demand higher wages and protest martial law. With strikes in southern Iran continuing into October, National Iranian Oil Company Chairman Hushang Ansary reported to Sullivan on October 30 that production had fallen “about a million barrels a day for each of the past three days and was now down to slightly over one million barrels.” (Telegram 10560 from Tehran, October 30; National Archives, RG 59, Central Foreign Policy Files, D780446–1068) The CIA produced a study entitled “Iranian Strikes: Impact on World Oil Market” on November 1; a copy is in Carter Library, National Security Affairs, Staff Material, Middle East File, Box 28, Country Files, Iran, 11/1–21/78.
3. Lantzke convened the energy officers of the OECD’s permanent delegations on November 8 to present the IEA’s views on the “drastic” decrease in Iranian oil exports. According to the Embassy in Paris, “Lantzke believed ‘crisis,’ should it come, was months away, even though other producers would not be able to fully compensate for 4–4.5 million b/d drop in Iranian liftings.” He concluded that “there might be a shortfall, but certainly less than the seven percent reduction in supplies to the IEA area needed to trigger emergency sharing program,” adding that “no major supply problem” would occur until “well into the first quarter of 1979, after discounting from present demand hoarding in expectation of an OPEC price increase.” (Telegram 37123 from Paris, November 9; National Archives, RG 59, Central Foreign Policy Files, D780463–0684)
4. Not found.
5. On November 10, Schlesinger sent a memorandum to the President updating him on the “Iranian oil situation,” including its background, the available alternative supplies, and the impact on the international oil market. (Carter Library, National Security Affairs, Brzezinski Material, Country Files, Box 29, Iran, 11/78)