Oil opportunity needs careful handling

Press, 17 March 1982, Page 26

Oil opportunity needs careful handling

From “The Economist.’’ London

The world might soon face its third oil shock in a decade, but this time a big price fall. The. British have had to reduce their North Sea oil prices by 15 per cent in four weeks, which may be only a start. That should be good news for almost everybody, but it would be typical though dotty if the disasters suffered when oil prices went up are remuddled into new disasters as oil prices come down. When the Arabs in 1973 tried to raise oil by $B-9 a barrel as an afterthough in a brief antiIsraeli war, no computer foretold that the consequences would include the creation of 28M unemployed among the top industrial countries' 350 M workers, a doubling, or trebling of inflation across the free world, a similar but repressed and therefore much more damaging inflation in the communist countries (hence the longer queues, socials unrest, Lech Walesa), the unlikely response to oil riches in Iran (a populist uprising in favour of an ascetic monk) which then raised oil by another $lB-19 in 1978-80, the Afghan invasion. . Ronald Reagan and a greater danger of nuclear war. As the nine years’ wonder of rising oil prices at last looks like toppling over, the world may again be at a stage where the sort of guesses based on computer models will fade far behind the power of great events.

Still the most interesting thing- now being said by the O.E.C.D.'s computer is that by early 1983 oil consumption in the 24 largest free industrial countries may be 15 per cent lower than in 1979. although their combined gross national products should be almost 7 per cent higher. For oil producers this does not look like merely a temporary glut entirely caused by world recession; witness the nearly 40 per cent savings in oil use per unit of output since 1973 in booming Japan. Nor is the reason simply lower inventories at today's high interest rate, in-

ventories have usually been kept too high by the belief that oil will always be an appreicating asset, whether in the ground or in the tank, and very many things could change very abruptly if that belief disappears. With O.R.E.C. oil prodcuction already down from 1979’s 31M barrels a day to 20M barrels a day now, the official cartel price of $34 a barrel is being, steadily undercut on the Rotterdam spot market. If Iran and Iraq ever slop their war. which already seems a quite pointless one anyway, expect an uncartelised ’ upsurge of their supplies. Unless there is a coup, in Saudi Arabia or some-where-a coup which could then be increasingly to the interest of the Soviet Union and other oil producers—prices could fall by more than the one third or over $ll a barrel. This would be equivalent to passing about 1 per cent of gross world product (G.W.P.) back from oil producers to oil consumers. The 1973-74 dnd 1978-80 price increases caused crises because the first sought to move just over, and the second just under. 2 per cent of G.W.P. out of Westerners’ spending into Arab’s saving potential, thus intensifying worldwide de-mand-deflation and price-infla-tion and balance-of-payments disequilibria all at the same time.

Any economist can prescribe the right remedy: (a) prepare to shift two lots of 2 per cent of G.W.P. (before 1973 under half of one year's growth) to rectifying the balance of payments’. yet (b) hurry to pass through to consumers more than the whole price rise in the cartelised product so that you can hope that price elasticities will crack the infant cartel.

Something like this "highly theoretical" approach was early adopted by highly theoretical Japan. In 1973-76 Japan made a 3 3 <i-6 times bigger increase in real energy prices to its final consumers than was dared by any other of the big five democracies, all of whom

were hampered .by practical politicians' precisely opposite policies (price freezes, failures to raise petrol tax ad valorem, windfall profits tapes) which made the lign macro-economic effects of the 1973 O.P.E.C. hoist far longer and worse than they ever need have been. The Western response to the 1978-80 price rises has been less lunatic than to the 1973 ones, which is why even mature O.P.E.C. may be half-cracking now. If 1 per cent G.W.P. is about to be returned to consumers’ demand in a way that reduces prices, this should do automatically what is most needed during a slumpflation. The dangers are. first that demand for oil products might shoot up again if oil prices to consumers fall (already some loss-making airlines are talking of ndt commissioning Boeing 757 s and 767 s because "their only advantages are fuel economy"); and. second that various chickens might return to roost. Suring the oil spasm, the worst planners have been the planned socialist economies plus two. great capitalist institutions (Western banks and oil companies) who seem so to have handled themselves through the bad times that the return of better times could drive them bust.

The world's largest, oil-pro-ducing country, the Soviet Union (with oil’output stagnating at 12M barrels a day has shown that its economic system is too inflexible to handle any disturbance, like even a massive temporary improvement in its terms of trade, but its stronger gold holdings encouraged Western banks to lend to its satellites who were still themselves in mounting trade deficit. When money thus sloshes into communist economies, it mainly increases distortions and queues. Last year Russia was back in trade deficit, together with perhaps half of other oil-producing countries.

The absurd consequence is that a great economic opportunity could be turned into some sort of financial crash

because communists and other shaky customers have borrowed too much capitalist money. When some sheikh starts .to draw (cheques on the odd billions he has deposited, some banks might have to explain that his money has been lent under State guarantee to a Mr Gierek whose successors will not repay since they are carting him off to jail. Many of the newly deficitrunning oil producers’ have also ordered imports too lavishly, and banks have lent heavily to some of their suppliers who now may not be paid. The Russians' will try to bridge their gap and buy their grain by dumping gold, but during the oil spasm hanks have lent to speculators who bought gold on the assumption that its price would always go up. The big oil companies had a large part of their businesses virtually expropriated a decade ago. but have made huge inventory profits as oil prices rose. They should have returned those profits to shareholders and started closing a lot of their now excessive downstream facilities. Instead they maintained those facilities and invested the profits in diversifications (metal mines, trendy office equipment businesses, etc.) at which they are unskilled. If the period of huge inventory gains is replaced by one of large inventory losses some oil companies will be left crying all the way to the unlistening bank.

When oil prices soared it was generally agreed that the worst blow would fall on the world’s most energy-naked big manufacturing country, and a fall in the oil price now should restore international equilibrium by reducing what should logically be its large external deficit. Embarrassingly, however, this energy-naked country is Japan, Which even without an oil-price fall was recently forecast by Britain's national economic research institute to be heading for a $33 billion current external surplus in 1983. The additional surplus that would accrue to Japan with any oil price fall should presumably drive up the exchange rate of the yen. but Japan might resist, thus catching the Dutch disease through its non-petrocurrency status.

Japan is the only one of the five biggest industrial countries that has increased its share of the O.P.E.C. market since 1972-73 (to over 19 per cent by the first half of 1981). America, France. West Germany and Britain all saw their shares decline. If the O.P.E.C. market fades. Japan might start to shift its export effort to some European and American markets which have not realised that they have been attracting less Japanese attention for a while.

As one country which thought it should benefit from petrocurrency status, Britain had until 1973 got its oil from

cheap taps in the deserts which partlv belonged to itself. After 1973 'it had to turn to digging oil out of the stormy North Sea at about a hundred times Arabian oils' pre-1973 marginal cost. Politicians in Britain argued how to spend this “North Sea bonanza" which, compared with J973,'was actually a considerable increase in real national expense. And now?

The auguries- do not seem good that governments will handle the great oil opportunity less clumsily than they handled the great oil crisis. The right economic ' policies will meet objections from all the industrial pressure groups (motorists, energy-intensive industries, the oil and gas industrv). Thev are;, push gasoline arid other oil‘product taxes higher as oil prices fall so as to break the 0.P.E.C.. cartel more completely, return the bonus to consumers through lower general taxation, keep the new incentives to fuel economy in place but push other incentives back to the ones that were giving tolerably healthy noninflationary growth before the oil spasm began — the O.E.C.D. averages in 1964-73 were 5 per cent annual growth at under 4‘s per cent inflation. The political problem is that, to 'seize the opportunity of striking free from O.P.E.C.'s grip, it will be necessary to accompany a period of falling real oil prices to producers by a period in wnich consumer prices for oil are still kept steadily rising, so that the recent progress in conservation is not undone. The political prize from getting back to O.P.EC’.-free growth could be that of seeing the Soviet empire at last collapse under its internal absurdities. The political danger of vacillating in fear of motorists’ votes is that the West's continued dependence on an increasingly unstable Gulf will provide a growing temptation for the Russians to try to exploit conflagrations in the Middle East, especially while Mr Menachem Begin keeps the powder so dry