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

181. Memorandum From Secretary of Energy Schlesinger to President Carter ¹

Washington, January 4, 1979.

SUBJECT

• Iranian Oil Situation

Summary

The shortages that are currently projected to result from the cessation of Iranian oil production are manageable in the short-term. Continuation of the curtailments through the summer of 1979, however, could lead to actual supply shortages during next winter’s peak demand period.

The elimination of Iranian exports since Christmas² is now being offset by increases in production in other producing countries. On balance, world oil markets have lost 5.0 to 5.5 million b/d of Iranian oil exports. Increased production elsewhere, the largest portion of which is from Saudi Arabia, is adding almost 3.5 million barrels a day. The current worldwide shortfall is, therefore, approximately 1.5 to 2.0 million barrels of oil a day.

In the short-term, this shortfall can be managed by stock drawdowns. This, however, requires the consuming nations to borrow against future supplies. Before the onset of winter, petroleum stocks are normally high so they can be drawn down to meet high winter demand. If higher than normal drawdowns occur this winter to compensate for Iranian shortfalls, and if Iranian exports are not resumed in the next month or two, the normal build-up of stocks that occurs in the spring in preparation for summer demand peaks could be jeopardized. If Iranian production remains at substantially curtailed levels beyond the summer of 1979, it is clear that supplies will be inadequate to build-up inventories for next winter’s peak demand, even if we experience no actual supply shortages this summer.

In the very near-term, minor product shortages and rising prices for small volumes of spot purchases could trigger hoarding by private citi-zens and businesses, thereby creating a more serious, psychologically-induced shortage. This possibility makes it critically important that the Administration reassure the public that the current situation is manageable while urging prudent, voluntary conservation efforts as a hedge against possible longer-range curtailments.

During the duration of any Iranian production curtailment, the world’s oil supply system will have virtually no reserve capacity should some other crises develop. With a major portion of the Iranian shortfall being made up by increased production in Saudi Arabia, the ability and willingness of the Saudis to maintain such levels of production also becomes critical. If the Saudis continue to produce at full capacity for several more months, the reservoir problems that were an important factor in the Saudi decision to restrict the volume of production to 8.5 MBD last year could reappear. If these problems become serious, the Saudis will be under increasing pressure to once again order production cutbacks.

The technical concerns over the Saudi fields have not disappeared, and each day output stays above the 8.5 million barrel per day ceiling, some of the reservoir pressure improvements made in 1978 are lost. It will be up to the Saudi leadership to decide at what point the technical damage that results from sustaining production is greater than the political damage that would be sustained by lowering output.

Another major variable during the duration of any continued Iranian curtailment is the weather. The warmer-than-average winter being experienced in the United States reduces the level of required stock drawdowns and improves the chances for successfully rebuilding stocks for the next peak demand period. The colder-than-average winter now being experienced in Europe places increased demands on an already oil-short world market. Even if supplies prove sufficient for the duration of any curtailment, the price effects of the demand for oil that will be needed to rebuild stocks may well have a serious inflationary impact on U.S. prices.

We will be monitoring all of these world oil market factors closely, and have developed a set of domestic contingency plans which could be activated quickly, if necessary.

World Oil Production

Until strikes began in late October, Iranian oil production was averaging about 6 million b/d. As a result of intermittent strikes and slowdowns, production during November and December averaged less than 3 million b/d. Since Christmas, production has averaged less than .4 million b/d, sufficient to meet less than half of Iranian domestic consumption, and all exports have ceased. Expatriate supervisory personnel of the Iranian oil consortium companies are being evacuated.

The prospects for increased production and resumption of exports are uncertain:

• Under current conditions, production is not likely to be restored beyond the level necessary to meet domestic demand (.8 million b/d).

• If the political/security situation improves, but expatriate personnel do not return, restoration of production to even 3 million b/d could take up to 90 days.

• If political stability and security are reestablished and foreign personnel return promptly, production could be restored to a level of 4–4.5 million b/d within 60 days.

In the most pessimistic case, world oil markets will have to accommodate the loss of 5.0 to 5.5 million b/d from Iran for a prolonged period. Increases in production elsewhere of up to a maximum of 3.5 million b/d have reduced the net shortfall to a range of 1.5 to 2.0 million b/d, with Saudi Arabia representing the single largest source of this additional production.

General Worldwide Impacts

Thus far the impact of the Iranian oil cutbacks on world oil markets has been limited by transportation lags, the rapid availability of alternative supplies and the high level of world oil stocks. World oil stocks, including oil currently at sea, are sufficient to cover the net shortfall resulting from a complete loss of Iranian exports for at least 2 to 3 months. Based on the experience of 1973–74, the international oil companies will probably redistribute world supplies to spread the shortfall relatively evenly among the various consuming regions.

Next Several Months

Over the next three months, however, some problems can be anticipated:

• Prices. As the oil market continues to tighten, spot prices for both crude oil and refined products will rise rapidly. Isolated bids of $20/barrel have already been reported.

• Distribution. While worldwide stocks in the aggregate are adequate to make up the shortfall for 2–3 months, there is the possibility that certain countries or regions will be more severely impacted than others. If redistribution efforts by the international oil companies prove insufficient, one or more of the seriously affected member countries might seek to activate the International Energy Agency’s emergency sharing system, which goes into effect when any country experiences a 7% reduction of normal supply. Based on discussions with the governments of the Netherlands, Japan, the UK, and other IEA governments which are heavily dependent on Iranian supplies, it appears unlikely that the IEA emergency sharing system will be triggered in the near future.

• Hoarding. Rising spot prices and isolated regional shortages could trigger hoarding by individual consumers. If gasoline and heating oil tanks are constantly being topped off, working inventories would be further reduced, leading to more serious spot shortages.

Outlook for 1979

Over the next 6–12 months the outlook varies considerably, depending on the assumed level of Iranian and Saudi Arabian oil production:

• If Iranian production is restored to a level of 4–4.5 million b/d, and the Saudis continue production at a level of approximately 2 million b/d above their ceiling of 8.5 million b/d, market conditions would return to normal. Stocks would be rebuilt in time for next winter and a margin of spare capacity to cope with other supply cutbacks would be restored.

• If Iranian production rises to a level of 2–3 million b/d, the world oil market will remain extremely tight even if the Saudis continue their increased production. Stocks may not be fully rebuilt for next winter and there will be little if any spare capacity to accommodate any additional supply interruptions. Spot prices are likely to stay above OPEC official price levels.

• If Iranian production remains between 0 and 1 million b/d, even with a continuation of increased Saudi production, world oil markets would clearly experience actual supply shortages no later than early next winter. Additionally, spot prices could be substantially above official OPEC prices by late fall, encouraging OPEC to impose another large official price increase in late 1979 or early 1980.

Effect on U.S. Markets and Measures to Reduce Domestic Petroleum Demand

The U.S. share of the net worldwide shortfall of 1.5 to 2.0 million b/d of oil production will be approximately 500,000 b/d. U.S. stock levels are sufficient to accommodate additional drawdowns equal to this rate for approximately 60 days. Because of tankers already at sea, it will be another 30 to 40 days before the shortage is actually felt in reduced tanker deliveries.

Continuation of Iranian curtailments beyond the next several months could turn an already tight gasoline market into one of spot shortages this summer, and may well jeopardize distillate fuel supplies and prices next winter. In an effort to minimize the difficulties of rebuilding stocks whenever production is restored, it will be important to both assure Americans that the current problem is manageable while urging them to undertake voluntary conservation efforts such as observing the 55 mph speed limit, reducing discretionary driving, turning back thermostats, and using natural gas wherever possible as prudent steps in anticipation of any prolonged curtailment. A more detailed description of potential effects on various U.S. markets is attached in Appendix I.³

If the curtailment continues beyond the next several months, a list of initiatives that can save approximately 750,000 barrels of additional oil per day has been prepared. The following table summarizes the oil savings associated with these initiatives:

	Required Action	Oil Savings (MB/D)
Oil to Natural Gas Switching by Utilities and Industrial Operations	Finalization of FERC–DOE rules	up to 300–400*
Oil to Coal Switching	Environmental waivers	35
Transfer of Electricity from Coal or Nuclear Facilities to Oil Dependent Facilities	Coordination of utility wheeling of power	100–150**
Higher Lead and MMT in Gasoline	Temporary suspension of EPA enforcement	45–50
Deferral of Deliveries to the Strategic Petroleum Reserve	Negotiation of time exchanges	300
TOTAL		up to 775–935

A more detailed discussion of these and several other possible measures is attached in Appendix II:

Conclusion

The cutback in Iranian production does not pose substantial problems in the short-term. The measures outlined above should be adequate to deal with a prolonged shortfall caused by virtually no Iranian exports over an extended period of time. The greatest short-term danger, outside of another crisis elsewhere in the world, would be an overreaction by the public,⁴ leading to panic buying and hoarding. I have therefore taken steps to urge the public to conserve where possible as a prudent step in anticipating any longer-term curtailments while offering the assurance that these developments do not currently pose significant oil supply problems for the U.S.⁵

1. Source: Carter Library, National Security Affairs, Staff Material, International Economics File, Box 44, Rutherford Poats File, Chron, 1/1–21/79. Secret.
2. The strikes and ongoing unrest in Iran led to a sharp reduction in oil production, and all exports were stopped by December 27. By the next day, oil production was at a standstill.
3. Appendices I and II are attached but not printed.
4. The variation in the estimate depends upon the severity of the winter weather.
5. The higher figure includes north to south wheeling along the West Coast from the Pacific Northwest.
4. In a January 15 memorandum to the President, Owen argued: “One lesson of events in Iran is that you were right in stressing the need for a national energy policy, which would reduce our dependence on imported oil. We should make more an effort to stress this lesson in public discussion of Iran, in order to: —increase public support for your energy policy; —focus public attention on the future policy implications of events in Iran, instead of merely their past causes; —enhance the Administration’s prestige by reminding people that you weren’t far off in warning about the insecurity of oil supplies.” (Carter Library, National Security Affairs, Brzezinski Material, Country File, Box 29, Iran, 12/78–1/79)
5. In an undated memorandum to the President, Aaron wrote: “Jim Schlesinger’s January 4 assessment of the prospective impact of the Iranian oil situation on US energy supply is generally consistent with CIA, State Department and NSC estimates.” He added that “the likelihood of continued instability in Iran points to a probable tight oil market throughout 1979, with little chance of market forces’ undermining the OPEC price increases,” and concluded: “The policy implications are heightened priority for oil conservation, for accelerating Mexican oil/gas development and exports, for clearing obstacles to investment in pipeline capacity to deliver Alaskan oil and gas to markets, and for substantial expansion of Saudi Arabia’s oil production capacity.” (Ibid., Staff Material, International Economics File, Box 44, Rutherford Poats File, Chron, 1/1–21/79)