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

259. Paper Prepared in the Department of State¹

Washington, February 8, 1980.

SUBJECT

• International Energy Strategy

In deciding on an international strategy we should bear in mind the medium-term outlook (1985–1990) as much as, or even more than, the 1980–81 outlook. The two perspectives raise different problems.

In the short run, emphasis necessarily is on measures to mitigate the costs of a tight or tightening market through restraining the scramble for supplies and equitably sharing the burden of cutting consumption quickly through painful internal measures—price or otherwise. Establishing import ceilings, consultations on pricing, and coordinating stock policies are means of accomplishing these objectives. If the ceilings are tight, they amount to an international allocation of scarce supplies.

Over the medium-term, with more time for adjustment, we can seek to improve the underlying market situation through measures to restrain demand and increase supply of primary fuels on a gradual basis. For 1985, primary reliance for adjustment must still rest on demand restraint measures. For 1990, supply side actions take on much greater importance. The economic justification for new measures in advance of a crisis is that they are less costly than relying wholly on price jumps imposed by OPEC and on reduced economic growth to adjust OECD demand to reduced oil supplies. In addition, reduced dependence on oil imports may well be essential to achieve political and strategic objectives. Since lead times are long, decisions on these measures have to be taken early if the results are to be worthwhile.

What are the likely oil market constraints over the next ten years with which energy and economic policy will have to contend?

I. The World Market Outlook:

A lot of work has been done on the 1980–81 outlook; a reasonable amount on 1985, and very little on 1990. This is what we have so far:

1980:

—OPEC production is likely to be down by 2 mmbd from 1979 levels. This assumes a return to baseline production in Saudi Arabia and Kuwait after the first quarter 1980, and moderate reductions in a few other countries.

—This reduction in supply could be offset by:

1) a reduction of 6 mmbd in consumption (resulting from higher prices and the assumption of zero OECD growth);

2) an increase in non-OPEC supply of .3 mmbd (assuming a further decline in net communist exports);

3) the absence of additional stock building, which amounted to 1.1 million barrels per day in 1979. Stocks are now at record levels.

—While these calculations suggest greater precision than is warranted, it is likely, new political disruptions aside, that much of the steam will be taken out of the spot market during most of 1980. On the other hand, downward pressure on contract prices can virtually be ruled out because of the ease with which OPEC production can be further reduced. At the least, contract prices should increase during 1980 by enough to offset inflation; if OECD economic growth is somewhat higher than zero, prices could significantly increase in real terms.

—IEA import demand should also be down by 1.5–2 mmbd from the import targets set for 1980 (which were based on OPEC supplies in 1979). The “surplus” will be unevenly spread among the IEA countries, but only Japan may have difficulty in undershooting its ceiling.

—The December communiqué² said that the ministers would meet in the first quarter of 1980 to review the need to adjust 1980 targets in light of the market situation. If both OPEC supplies and net import demand go down by roughly equivalent amounts and if spot prices continue to soften, those opposing adjustment of 1980 targets will hold strongly to their position—even though the underlying market balance is narrow.

1981:

Assuming significant economic recovery (3% OECD economic growth), oil consumption may still increase only moderately, principally because of additional use of coal, nuclear capacity, and gas. Even so, significant pressure on prices could reemerge, because OPEC supplies are not expected to increase and in any event are subject to major uncertainties—as are the projections for expanded use of alternative energy fuels (coal, nuclear and gas). The IEA Secretariat believes that the market could tighten in mid-1981, but clearly the margin for error is so small and the uncertainties so substantial that price pressures could develop earlier.

1985:

Present projections suggest that oil supplies available for OECD net imports could range from 19 mmbd to 22 mmbd. Saudi production is the major variable. Present estimates suggest that for both economic and internal political reasons, Saudi production is not likely to exceed 8.5 mmbd and it may be less.

This is a much more pessimistic outlook than OECD has assumed up to now. It rests on a growing belief that OPEC production will be more heavily influenced by conservationist policies (made feasible by high and rising real oil prices), that declining Soviet production will increase demand on the world market by 1.5 mmbd between now and 1985, and that OPEC oil consumption will grow by more than 1 mmbd, thus further reducing the amount of OPEC production available for export.

The main point is that even the optimistic estimate of OPEC supply would require that net OECD imports be 4 mmbd below the present, and recently reduced, IEA targets for 1985. OECD oil production is likely to decline by 1 mmbd because the continued fall in US production will not be fully offset by increased North Sea oil (in part because UK and Norwegian politics could also turn more conservationist). Thus, OECD oil consumption in 1985 may have to be on the order of 12% less than it was in 1979. If this reduced availability of oil is not offset by supplies of non-oil primary fuels above the amounts now foreseen, and by non-price conservation measures, the prospect for the next five years is for further large increases in real oil prices and low economic growth.

1990:

We are only at the beginning of this forecasting exercise. If CIA’s first rough oil availability numbers are to be taken seriously, the world will come to the end. We will soon have new figures, representing the results of further analysis. I doubt that the 1990 outlook will be more promising than 1985 (assuming present policy trends), and it is very likely to be worse.

II. Policy Implications:

1. The 1980 supply situation may provide some breathing room to get away from the present preoccupation with short-term emergency measures to deal with immediate shortages. The danger is that it will be used as an excuse for doing nothing. This would be a serious mistake. If we do not begin now to accelerate measures to restrain demand and increase supply, the macro-economic adjustments to a steadily tightening oil market in the future will be that much more severe and costly.

2. Going directly to setting 1981 targets as a way station to a program of sustained demand restraint through 1985 might now be the best way to proceed. There seems to be considerable support among the major countries for concentrating on 1981, although by no means a willingness to face the need for sustained demand restraint to cope at less cost with the certainty of long pull problems. To be realistic, we would have to face the probability that in a 1981 target setting exercise, most other IEA countries would insist on starting from actual consumption (e.g., 1979–1980 average) adjusted for growth, rather than from 1980 targets. This would greatly reduce, if not eliminate, the present margin in the US target, but it would require taking into full account the oil consumption requirements for US economic recovery in 1981, which would be of advantage to the US.

3. On the other hand, if we insist on achieving reductions in the 1980 targets in the present market situation, we are likely to get nowhere. At most, by shedding a great deal of blood, we might get a reduction of 1 mmbd for the IEA as a whole, of which considerably more than half probably would be from the US target. At worst, we could end up in disagreement and disarray. In any event, because the collective IEA target is 1.5–2 mmbd above actual demand for consumption, any reductions that might be negotiated would not result in tight targets and would not be likely to stimulate new demand restraint measures.

4. This suggests that at the March Ministerial meeting, we should try to concentrate minds on the bleak 1985 outlook, on setting 1981 targets consistent with this worsening supply outlook and, most importantly, on putting into place new measures that could improve the economic fundaments of future markets. The Germans and the British have been saying we should concentrate on measures; we could take their statements at face value. The objective would be to have each country adopt new measures in 1980 that would restrain oil consumption in 1981 and beyond, bearing in mind the need to accelerate energy conservation and production to deal with the medium-term outlook. We would have to agree on price and non-price measures that were meaningful and could be quantified, so that rough equality of effort would exist, be perceived, and could be monitored. Setting tight import targets for 1981 would be the first step in this program.

5. If we pursue this approach, the March IEA Meeting, illustratively, could shape up as follows:

—The ministers would announce that as a result of reduced economic growth and energy conservation measures, net IEA imports in 1980 were likely to be 1–2 mmbd below the collective IEA target and that each country would at least meet its ceiling.

—They would express their concern about the medium term oil market outlook and announce a reduction of 4 mmbd in the collective IEA target for 1985, as required by that outlook. Individual country targets for 1985 would be approved and country programs for achieving these targets would be reviewed, at a November meeting. These programs would subsequently be monitored on a regular basis.

—The ministers would announce that net import targets for 1981 would be reduced by 1.5–2 mmbd from the 1980 target level. This would require that oil consumption be 3%–4% lower than in 1979. Ministers would meet in November to agree on how the reduction in targets would apply to each country and to approve the measures proposed by each country to achieve its target.

—If supplies proved to be higher than the collective 1981 target, the ministers would agree that their countries would absorb the additional amount into stocks so as to maintain stability in the market. If supplies proved to be lower than anticipated, the targets for 1981 would be reduced on a pro-rata and semi-automatic basis to share the burdens equitably.

—We might also seek to build up an informal system of close consultations among major consumers (a hot line) to stiffen resistance to leapfrogging prices when the market is comparatively slack and stocks are high, as at present. This probably would require informal understandings providing partially compensating import rights to countries that might suffer reduced supplies as a result of resistance to price increases. It also would require understandings with the moderate OPEC exporters as being part of a joint program to avoid disorder and disruption in the market. Arrangements of this type, however, should not be part of the formal IEA system.

6. The Venice Summit could follow up on this approach. If agreement is reached on interim measures at the IEA, the heads of government could agree on:

—An accelerated program to increase supplies of alternative sources of energy by 1990. One way to do this would be establish expanded goals for the use of coal, nuclear energy and synthetic fuels by 1990. In this respect it might be useful to tie in the efforts of the US and Japan to a European Community-wide program, now being formulated by the Commission, which in part might be financed by a new community oil import fee or oil consumption tax. The report of the IETG could help to formulate goals for synthetic fuels. These goals for the expanded production of alternative fuels in 1990 could be presented as a contribution by the industrial countries to the achievement of an orderly transition to a world economy that will have to be less dependent on oil.

—A program to accelerate production of primary energy fuels in the developing countries, both to lessen the damage done to developing country economies by rising oil prices and as a positive means of adjusting to the increasingly difficult world oil balance. In proposing a new program (or an expansion of existing programs), the Summit leaders could invite both OPEC countries and other industrial countries to join in this effort. With the groundwork properly prepared in Saudi Arabia, Venezuela, and Mexico, this initiative could be presented as a Summit response to an OPEC call for joint action to deal with the energy problems of the developing countries.

—Also, if positive responses were received beforehand from moderate producing countries, (see section below on tactics, approach to the Saudis, Venezuela, and Mexico), the Summit leaders might make some forthcoming noises about the need for new understandings between oil producing and oil consuming countries to ensure an orderly world market, for their mutual benefit.

III. Tactics:

1. Lambsdorff. We are now dug in on adjusting targets for 1980 as a means of obtaining demand restraint. We should discuss with Lambsdorff the possibility of passing over target adjustment for 1980 and concentrating directly on 1981 and 1985 targets, and on the necessary demand restraint measures. Without going into specific numbers, we should seek his support for the concept of tight 1981 targets and strong proposals for measures as well as agreement on the general lines of an approach to energy issues at the Summit. We might also broach to Lambsdorff, or leave for the subsequent visit of Schmidt to Washington, the question of a possible US/Japan, European Community approach on alternative energy fuels.

2. Yamani. Secretary Duncan’s talks with Yamani should have ambitious objectives.

—We need to get Saudi understanding and agreement on stock policies—not only for the SPR but also for coordinated IEA stock management policies. Yamani must come to understand that by carrying and cooperately managing large stocks, the industrial countries can make an important contribution to orderly markets and avoid costly disruptions of the world economy. In international commodity agreements, stocks are either financed by producers or jointly financed by producers and consumers. In the case of oil, the importers could be asked to take sole responsibility for financing stocks even though the purpose of carrying stocks would benefit the world economy, including Saudi Arabia and other moderate producers. If we could get Saudi understanding and support for this position, it would immediately be feasible to work out a stronger and coordinated stock policy in the IEA, as well as a rapid building of strategic stocks.

—We should use this visit to explore the feasibility of developing an understanding between producers and consumers on the oil market, including understandings about the future course of prices and, most importantly provisions for standby capacity to underwrite such understandings. The place to begin is Saudi Arabia. Are the Saudis interested in such understandings, and if so, do they believe they should be based on informal discussions, bilateral or multilateral, with a few of the moderate producers, or on a broad agreement between producers and consumers along the lines of full fledged international commodity agreements. (Separate paper on these issues will be prepared.)

—We should obtain Saudi views on their willingness and that of other oil producers to participate in an expanded assistance program to increase LDC energy production.

3. Calderon-Berti. Depending on the talks with Yamani, C-B’s visit to Washington in March provides an opportunity to explore producer-consumer understandings and OPEC participation in an LDC energy assistance program. A clarification of Venezuela’s interest in the involvement of US and other industrial countries in heavy oil investments in Orinoco would also be helpful to action in this area and would be useful in shaping the IETG report for the Summit.

4. Mexico. Secretary Duncan’s visit to Mexico provides another opportunity to explore with a key country (1) producer-consumer understandings; (2) support for an expanded LDC energy program; and (3) stock policies.

1. Source: Carter Library, National Security Affairs, Staff Material, International Economics File, Box 45, Rutherford Poats File, Chron, 2/80. Confidential. There is no drafting information on the paper.
2. See footnote 2, Document 251.