76. Memorandum From Robert Hormats of the National Security Council Staff to Secretary of State Kissinger1
SUBJECT
- Steps to Prevent or Moderate an Oil Price Increase
There are indications that OPEC will increase oil prices as of October 1 by $1.50–$2 a barrel, but a final decision has not been made. There are a limited number of possibilities for exercising a restraining influence, which are reviewed in this paper.
OPEC’s decision will probably depend on five factors:
—The economic strength of the importing countries. OPEC does not want to cause, or to be perceived as causing, the incipient economic recovery of the industrialized nations to abort. They recognize that their economic fate is linked to the recovery. They also recognize that a price increase in the face of stagnation in the industrialized world would necessitate additional cutbacks in OPEC oil production, in turn [Page 263] pressuring the cartel into the politically difficult process of production allocation which it has heretofore been able to avoid.
—The perceived possibility of a political and psychological reaction in the developed countries which would provoke retaliation through an arms embargo, aid cutoffs or even more severe action.
—Fears of individual members that failure to support action could cause deterioration of bilateral relationships with other producers, provoking attacks from radicals, undermining OPEC solidarity, and depriving producers with payments deficits of the opportunity to increase revenues.
—The possibility of reaction from non-oil producing developing countries, who are beginning to display recognition of the magnitude of the problems which the last price increase has caused them. (OPEC aid has offset less than one-third of recent increases in the LDC import bill.)
—The impact which a price increase could have on the progress which has been made toward a Middle East settlement, resumption of the consumer-producer dialogue, and the new initiatives this involves.
If these are the major criteria in OPEC decision making, it behooves the United States—through Presidential or Cabinet-level statements, through the media, and/or by low-key but firm approaches through diplomatic channels—to make the following points:
—A price increase will have a significant economic impact on the industrial nations whether still in recession, as most are, or moving toward recovery. [CEA estimates that the United States would lose .7–.9 percent of its GNP growth as a direct result of a $1.50–$2 per barrel price increase; after reflows through trade and investment, the figure might drop to .5 percent. Unemployment—already very high—would increase by .2–.3 percent. Tax cuts and monetary stimulus might eventually offset the GNP and unemployment losses, but at a significant cost in terms of inflation. For Western Europe, which is still not in the recovery stage, the GNP decline would probably be on the order of 2 percent; for Japan, more than 3 percent. Furthermore, in these countries there is less room than in the US for reflationary fiscal and monetary actions to moderate this impact, and they will consequently be less able than the US to offset the lower rate of growth.] A message of this sort, articulated by competent economists in the US, Europe, and Japan, might convince OPEC that the market was too weak to sustain large price increases without significant oil production cutbacks.
—The direct impact on developing countries which do not produce oil, exacerbated by the lower level of consumption (and imports) associated with a lower rate of growth in the developed world, would be to further reduce growth, increase unemployment, and worsen payments deficits. On top of this would fall the higher prices of industrial[Page 264]ized country exports associated with increased oil prices and a resurgence of inflation. The total balance of payments impact on the LDC’s would be roughly $1.5 billion; for the MSA’s alone it could be $500 million. The loss in GNP growth could be as much as 5 percent. This message could be conveyed, in a low-key fashion, to Third World and OPEC countries.
—The negative domestic reaction could make it difficult for the United States (and other industrialized countries) to undertake the measures we are planning to improve our economic relationships with the developing world, and with the oil producers in particular. In view of the fact that (according to Treasury) the purchasing power of a barrel of oil as of December 1974 was roughly 4½ times what it was in 1955, in spite of recent inflation caused in part by the last price increase, Americans will see no justification for a new increase. We might be forced by Congressional/public pressure to reduce the level or slow down the pace of our military and economic assistance as well as of activities such as the Joint Commissions, which are designed to encourage closer private sector relationships with the developing and oil producing countries.
—Since the breakup of the consumer/producer preparatory conference, the United States has made a major effort to re-establish a basis for dialogue and cooperation with the developing world, including particularly the oil exporters. We have undertaken a fundamental review of our overall policy toward the developing countries, which has produced the new approach articulated in your speeches in Kansas City and Paris.2 We will make additional proposals at the upcoming Seventh Special Session of the UN. We have made great progress in establishing the conditions and understandings necessary to achieve mutually beneficial cooperation. But this progress could be reversed by an OPEC decision to increase the price of oil. Many in the US would raise questions as to the wisdom of our more forthcoming attitude, arguing for a far less positive or even hostile posture. This would seriously affect bilateral relationships with key oil producers as well as the multilateral dialogue.
It is essential to convey the above message promptly to key OPEC and Third World countries, and to encourage other nations, particularly other consumers, to do the same since the process of analysis leading up to the September 24 OPEC decision has already begun. Moderation becomes increasingly difficult once the momentum for an increase begins to build. The producers are aware in general of our views on a price increase but making a firm approach after agreement is reached [Page 265] to resume the prepcon (along the lines of the attached message to King Khalid which Bob Oakley and I drafted),3 would heighten their awareness. More general communications with other OPEC members and influential Third World countries might also have an impact.
To put it bluntly, it would be simply incredible for the President to have to say after a price increase had taken place that he had not communicated with key OPEC leaders to make them aware of US opposition and the possible backlash effect in no uncertain terms, yet that is the case at present. Moreover, as regards what you and the President said at the 8:15 a.m. Saturday meeting on the economic problems in Europe, a substantial price increase will have an adverse psychological, as well as economic, effect on the consuming countries, demonstrating their helplessness in the face of the oil producers, even under IEA solidarity; it could also, of course, strengthen their efforts to reduce dependence. It would certainly sour US public and Congressional attitudes toward the producing countries, and this could make it more difficult for us to defend and obtain approval of the economic initiatives to the Third World which you have developed. It would also threaten legislation (e.g., foreign assistance) now pending before the Congress, and could generate Congressional pressure for retaliatory action against the producers (e.g., arms embargo, aid cutoff).
Recommendation:
That you call a meeting of your key advisers to determine a strategy for addressing the potential oil price increase or instruct that a scenario be developed along the above lines to be submitted to you for approval by Friday, August 15.
Request meeting be set up
Ask Robinson, Enders, Hormats, Sisco, and Oakley to prepare a scenario4
- Source: Ford Library, National Security Adviser, Presidential Subject File, Box 4, Energy (10). Secret. Sent for action. Brackets are in the original.↩
- See footnote 2, Document 62, and Document 64 and footnote 4 thereto.↩
- Not attached. See footnote 6, Document 79, and Document 80 and footnote 2 thereto.↩
- Kissinger approved this recommendation. No copy of the scenario has been found.↩