IN THE NEWS / Oil Producers' Threats to Flood Market May Force
U.S. Response
Global Intelligence Update
Red Alert
December 2, 1998
On December 1, Brent North Sea crude oil, considered a benchmark
price indicator for oil, opened at a historic low price of $10.44
per barrel for January delivery. It immediately began to slip
even further, closing the day at $10.21 per barrel. Industry
analysts predict that the price per barrel, which had stabilized
briefly, could soon drop into the single digits. The precipitous
decline in oil prices in 1998 has driven private oil producers to
implement sweeping cost cutting measures, including large-scale
layoffs at companies like ARCO and Royal Dutch-Shell, and mega-
mergers such as BP-Amoco and Exxon-Mobil. For countries
dependent on oil export revenues, the year's price drop has been
devastating. While low prices have meant cheaper gasoline for
U.S. consumers, the renewed downturn raises a serious regional
concern for Washington. Latin American producers Venezuela and
Mexico, two of the largest suppliers of oil to the U.S., are
vulnerable to political unrest should this price drop continue or
accelerate. Venezuela, facing an upcoming and already
contentious presidential election, is particularly at risk. And
if Venezuela topples, so likely go the rest of South America's
dominoes, taking with them U.S. investments and outstanding
loans.
The price of oil has steadily declined throughout 1998, and
Mexican Energy Secretary Luis Tellez suggested last week that the
downward trend may not end any time soon. Prior to the OPEC
meeting last week in Vienna, Tellez vowed, should other countries
not comply with production quotas agreed upon earlier this year,
to boost production and exports of oil. In mid-October Kuwaiti
Oil Minister Sheikh Saud al-Sabah also threatened an all-out oil
war to "destroy non-OPEC producers" if they failed to honor the
agreed upon production cuts. Venezuela and Iran, both OPEC
members, have been accused as the worst offenders in busting
quotas.
If the coalition between OPEC and non-OPEC members collapses as
it shows every sign of doing following the unproductive OPEC
meeting in Vienna last week, it could trigger the oil war that
some producers have been threatening. Both Mexico and Venezuela
are poised to open up the taps and pump as much oil as possible
in an attempt to maintain market share and keep money flowing
into state coffers. Whether they can make up in volume for
losses in per barrel price is very much open to question,
particularly as exports rapidly fill up what little available
demand and storage remains in an already saturated market.
This oil crisis comes at a particularly bad time for both Mexico
and Venezuela. Mexico is in the process of approving its budget
for 1999, which has come under fire from various political
elements and private concerns. On December 1, the Mexican daily
Diario de Yucatan reported demonstrations throughout the country
protesting the proposed budget. Incidentally, the current budget
calls for the price of Mexican oil to be at $11.50 per barrel.
Currently the Mexican blend is selling at $7.50 per barrel. Less
dependent on oil revenues than some exporting countries, Mexico
derives 40 percent of its income from oil sales.
Venezuela, whose oil sales account for 80 percent of its income,
is in the midst of a political drama of its own, with the first
act coming to an end this weekend. On December 6 Venezuelans
will elect a new president and, regardless of whether leading
candidate Hugo Chavez wins, the second act will open. The
election results will only determine whether this play is a
tragedy. Chavez is a former colonel who led an unsuccessful coup
in 1992. Although he has worked to moderate his reputation as a
radical, as with any good drama, nobody really seems to know what
Chavez will do if he wins. Perhaps foreshadowing the future, a
sign, in both Spanish and English, outside a Caracas hotel
frequented by international businessmen proclaims "Chavez Now!
Don't Be Afraid!" This is all before the impact of an oil price
war on post-election politics is taken into effect.
Production cuts made earlier in the summer failed to bolster
prices or even to stop the slide. Efforts to secure additional
or even extended production cuts in Vienna failed, and OPEC
members pressing for more cuts will have a harder time than ever
to win over other producers. Options are running out for
producers. At the same time, should oil producers abandon
current quotas and let the oil flow freely, prices will
immediately fall even lower. There is already a glut of oil in
storage, with the supply far outweighing current demand. And
there will be a point at which even increased sales of oil will
not bolster profits as the price continues to fall because of
oversupply. Such an economic development in turn is likely to
trigger domestic political crises in Mexico and Venezuela,
something that the US is reluctant to see happen. Mexico and
Venezuela have spent the last year tightening belts and praying
that oil prices would improve. So far their prayers have gone
unanswered, and at some point both governments will have to deal
with growing public discontent. Inflation and unemployment will
grow as the governments continue to slash budgets, further
increasing public outcry.
This crisis is not limited to Latin America. Even Saudi Arabia,
dependent on oil exports for 75 percent of its revenues, is in
bad shape economically. The region's oil giant was eerily quiet
following the meeting in Vienna last week. The most recent
position of the Saudi government was expounded in the local daily
Al-Jazirah, which said, "The answers lie quite simply in total
respect for production quotas and the agreement recently reached
between OPEC members and non-members." It is unclear how much
longer Saudi Arabia can endure the present situation or what it
will do if the situation does not improve in the near future. If
it joins a production/price war, with its tremendous excess
production capacity, Riyadh could do serious damage to other
producing countries' economies -- of course, dragging itself down
in the process.
If the market does not soon reverse its slide, the U.S. will be
forced to seriously address the problem, as its neighbors and
allies are threatened with economic collapse. At very least,
Washington must turn its attention to Latin America. Latin
America, has been affected by the recent economic crises that
swept Asia and Russia, though it has escaped collapse. However,
if the oil crisis plunges Mexico and Venezuela into chaos, the
rest of Latin America may not be far behind. In recent years the
U.S. has moved to decrease its dependency on oil from the Persian
Gulf, and therefore must ensure that it's two largest suppliers
outside of the Persian Gulf -- Mexico and Venezuela -- survive.
Furthermore, U.S. companies, and by extension the U.S.
government, have significant assets and interests in Mexico,
Venezuela, and throughout Latin America, and therefore must act
to protect them.
What is not clear is what the U.S. can or will do to avoid
turmoil in its backyard. The U.S. cannot condone or participate
in cartelism. Washington cannot economically bail out all oil
producing countries, and a U.S. attempt to subsidize Latin
American producers would not stop Middle Eastern producers from
flooding the market, in turn undermining U.S. efforts in Latin
America. Yet cooperation has failed to stabilize or raise
prices. With oil prices apparently reaching a new inflection
point, the time has come for some producers -- companies and
countries -- to succeed and for some to fail. Unless all oil
exporting countries slide quietly together into recession, some
can produce and some will inevitably be stopped. The U.S. can
stand aside and hope that its preferred suppliers survive, or it
can act.
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