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January 7, 1977
F i ve- P ercen t S ol u ti on
The OPEC nations imposed another
price increase last week-endwhich is not exactly news, especially in view of the fact that the price
of oil at the Persian/Arabian Gulf
had already increased eight-fold
since the beginning of the decade.
What is news is that the cartel split
over the size of the increase, with
two nations refusing to go along
with the plans of the other members to raise prices by 10 percent
now and by 5 percent more at
midyear. Instead, Saudia Arabia
(along with the United Arab Emirates) posted only a 5-percent increase, and suggested that it might
try to enforce its price decision by
raising its production ceiling, which
is now 3.3 million barrels/day below full capacity of 11.8 million
barrels/day. Since Saudi Arabia accounts for almost one-third of
OPEC's total capacity, its 5-percent
solution carries considerable
weight in the world's oil market.
On the sidelines stood the Western
oil-consuming nations, waiting to
see how much strain this latest price
increase would place on their stillfragile recovery from the 1973-75
recession-a recession brought
about in part by the OPEC-caused
1973-74 oil crisis. They might gain
some insight into the market's future behavior if they studied the
background to that historical
turning-point, as described in a
number of recent studies, notably
the analysis by Harvard University's
Raymond Vernon in the Fall 1975
issue of Daedalus.
The crisis was signaled by the emergence of a group of unindustrialized oil-producing countries with
both the aspirations and the power
to control the international oil market. Their bid for power could perhaps have been foreseen in Mexico's nationalization of foreignowned oil companies in 1938, in
Venezuela's role in organizing
OPEC in 1960 after it had failed to
gain preferential access to the U.S.
market-and perhaps also in the
abortive efforts by the major oil
companies to gain some sort of
stabilization agreement from the
exporting nations in'the 1970-71
period. Even so, few observers actually foresaw the sudden cutback in
supply and the sharp escalation in
price which occurred during the
1973-74 crisis-or the ability of the
cartel to make its price decisions
stick.
Supply/demand shifts
Yee the supply and demand conditions which evolved during the period after World War II placed petroleum in a somewhat special category. As people's incomes grew
throughout the world, the demand
for most sources of energy (coal,
hydro, nuclear, oil and gas) grew as
well. But demand grew faster for oil
than for any of those other sources,
primarily because oil was much
cheaper to obtain than practically
(continued on page 2)
anything else. When oil could be
produced at 10-20 cents a barrelas in large parts of the Middle
East-no other energy source could
come close to competing.
Of course} the sales price of the
world's oil reflected much more
than low Middle Eastern production costs. Producing countries
caused prices to rise by imposing
taxes on the oil companies; in the
Middle Ease these taxes jumped
from about 90 cents a barrel in 1969
to about $10 a barrel in 1974. For a
while} importing countries also
caused prices to rise by imposing
tariffs and import quotas on foreign
oil} primarily to protect domestic
coal and oil producers. But despite
all their efforts} Europe's high-cost
coal industry and America's highcost oil industry gradually lost their
position in world markets. The situation didn't register at first on the
public mind} especially in view of
the U.S. oil industry's ability to
bring underused capacity into play
during the Suez crisis of 1956 and
the Six Day War of 1967.
By the early 1970's} however} the
monopoly potential of J\;liddle Eastern oil was heightened by the sharp
worldwide increase in demand for
energy in general and for oil in
particular. Energy demand soared
as a massive boom swept the major
industrial countries of the world.
Petroleum demand soared for that
same reason} but also because of
various restrictions affecting the
energy industry-such
as (in the
U.S.) delays in developing nuclear
2
power} price ceilings on natural gas}
controls on auto emissions: and delays in exploiting Alaskan and offshore oil sources.
DlnldepelnlCients
Another key element in the developing crisis was the rise of the
((independent" oil companies that
stood outside the long-dominant
group of major firms-the ((Seven
Sisters" of Exxon, Gulf, Texaco, Mobil) Socal, British Petroleum and
Shell. The independents originally
had been compelled to build their
refinery and distribution business
on the basis of relatively expensive
crude oil-oil
acquired sometimes
from high-cost U.S. sources and
sometimes from the majors themselves. But the independents inevitably cast their eyes on the extraordinarily cheap tv1iddle Eastern
oil. Eventually they were able to
break into that market, beginning
(with U.S. government help) with
their inclusion in the Iranian oil
consortium of 1954.
\J\/hen entering the Middle Eastern
market} each independent had less
at stake,than any of the majors in
safeguarding the existing series of
agreements with local governments. Thus} each independent
company had little to lose in proposing or accepting an agreement
that would cede a larger share of
revenue to the host government} so
long as Middle Eastern oil remained
cheaper than whatever was available from other sources. Yet once
an independent succeeded in establishing a supply of Middle Eastern crude, that source was likely to
constitute a larger percentage of its
total supply than would have been
the case for one of the majors. So
whenever foreign oil companies
faced a negotiating showdown with
a host government, the independents in the group were most vulnerable to the threat of a shutdown in
supply-and time and again in the
early 1970's, this vulnerability
helped the host governments to
establish their dominance.
Another major reason for OPEC
success was the modernization of
the oil-producing countries themselves, along with their increasingly
profitable involvement in the world
economy. OPEC bargaining
strength grew in line with the increase in the number of companies
bidding for oil, but also in line with
the OPEC countries' own growing
capabilities for dealing with the
market-for
example, their ability
to collect and interpret information
affecting their bargaining position.
Still, the members of the cartel all
had their own diverse interests to
pursue. Their success in the crisis
depended on the willingness of the
dominant producer (Saudi Arabia)
to curtail its own production, thus
creating an umbrella under which
all oil suppliers were able to exploit
their collective position. Saudi
Arabia's production decisions are
of course a major factor in today's
uncertain pricing picture.
3
Vulnerable importers
Another element in the 1973-74
crisis was the inability of the oilimporting countries to deal with
short supplies and escalating prices
in any coherent way. This diversity
of reaction created a serious problem for a world that had become
increasingly interdependent in the
post-World War II period. In Raymond Vernon's words, "With national boundaries open to goods,
money, and enterprise, the rich
countries were also progressively
exposed to crop failures, inflation,
depression, and all the competitive
drives that anyone of them might
generate. The international environment had become one giant
tuning fork." In that environment,
OPEC's blow reverberated around
the world.
All of the factors that helped create
the oil crisis are (to some degree)
still operative, so that we can say
the crisis still exists. The rest of the
world pays the OPEC nations more
than $125 billion a year for oil, with
the u.S. picking up one-fourth of
the tab. Costly diversions of capital
and labor have been required to
build new energy sources at home.
The long-term trend toward lower
energy costs has been at least temporarily reversed-and this mutation of energy costs has drastically
altered the production function of
the world's economy, creating the
possibility of a prolonged period of
reduced economic growth. By
those standards, Saudi Arabia's 5percent solution is only the beginning of a solution.
William Burke
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BANKDNG D ATA- TWl ELfTH flEDERAL RlESERVEDI STRI CT
Selected Assets and liabilities
large Commercial Banks
Amount
Outstanding
12/22176
12/15/76
+
+
Loans (gross, adjusted) and investments*
Loans (gross, adjusted)-total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.S. Treasury securities
Other securities
Deposits (less cash items)-total*
Demand deposits (adjusted)
U.S. Government deposits
Time deposits-total*
States and political subdivisions
Savings deposits
Other time deposits:j:
Large negotiable CD's
93,707
70,315
1,662
22,981
21,415
12,108
10,417
12,975
93,153
26,277
375
64,988
5,733
30,450
26,341
10,596
Weel<ly Averages
of Daily Figures
Week ended
Member BanI< Reserve Position
ExcessReserves (+)/Deficiency H
Borrowings
Net free(+)/Net borrowed H
Federal Funds-Seven large Banks
Interbank Federal fund transactions
Net purchases (+)/Net sales H
Transactions with U.S. security dealers
Net loans (+)/Net borrowings H
Change
from
+
+
+
-
+
+
+
+
+
12/22/76
448
212
44
298
52
89
439
203
619
1,129
390
898
347
189
208
219
Change from
year ago
Dollar
Percent
+
+
+
+
+
+ 4,369
+ 4,345
+ 279
- 468
+ 1,806
+ 1,539
- 173
+ 197
+ 3,871
+ 2,249
+
16
+ 1,893
- 1,638
+ 8,464
- 3,531
- 5,633
Week ended
12/15/76
+
+
+
+
+
+
-
4.89
6.59
20.17
2.00
9.21
14.56
1.63
1.54
4.34
9.36
4.46
3.00
22.22
38.50
11.82
34.71
Comparable
year-ago period
+
138
7
131
+
+
+
613
+
939
+ 1,618
165
+
448
+
45
0
45
+
+
+
109
23
86
573
*Includes items not shown separately. :j:lndividuals, partnerships and corporations.
Editorial comments may be addressed to the editor (William Burl<e) or to the author . . . .
Information on this and other publications can be obtained by calling or writing the Public
Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 544-2184.
@FedFRASER