Oil will be cheaper -- but by how much?

February 24, 1983

In a move designed to avert a price-slashing oil war, the Gulf sheikhdoms - the conservative bloc of OPEC - have agreed in principle to reduce their own oil prices.

But, while Western motorists, homeowners, and industrialists can look forward to cheaper fuel, the Gulf's powerful oil ministers are waiting until an OPEC meeting called for next week before deciding how deep the price cuts should be.

What is clear is that the stage is set for yet another potentially stormy showdown between OPEC factions as their oil ministers try to cope with a world awash in crude.

It is widely expected that the OPEC benchmark price of $34 a barrel will be cut at least $5.50 per barrel. However, OPEC faces three key problems in preventing the slide in prices from turning into an avalanche:

* Persuading Nigeria to back off its decision last Saturday to sell its crude at $5.50 per barrel below the OPEC price given for similar high-quality North African oil. This would help the Gulf states avoid having to reduce the price of their own crude even below Nigeria's new low price. Gulf crude is inferior in quality to Nigerian oil.

* Reaching a workable agreement on production quotas that would end price-cheating by OPEC members and help dry up the lingering oil glut.

* Persuading the big oil companies to move back into the market and restock their inventories. Some officials here suggest the US government should join in encouraging American oil companies to help firm up the oil market by increasing imports.

A key to working out a production-sharing agreement will be to determine how much oil will be needed in the world. The Saudis are counting on a quick revival of the industrial nations' economies adding to the demand for OPEC oil, now running at around 16 to 17 million barrels per day (b.p.d.).

Further, they are hoping for a reversing of the sharp decline in oil company inventories in recent months. Foreseeing the weakness in oil prices, the world's oil companies have permitted their oil stocks to decline at a rate equivalent to 2 to 3 million b.p.d. If that was to change to a positive rebuilding of stocks, the swing could be as much as 4 million b.p.d., which is in excess of Saudi Arabia's total current production of under 3.9 million b.p.d.

A high-level Saudi official argues that the US government should encourage major oil companies to ''refill their stocks very quickly.'' But from the American standpoint, this may not work: It would appear to contravene antitrust laws as a conspiracy to maintain a price.

Oil ministers at the impromptu Saudi-led meeting are having to come to grips with what government, diplomatic, and oil-industry sources here characterize as the ''shocking'' and ''mind-boggling'' cut in prices Nigeria made Feb. 19.

A Nigerian price drop had been anticipated, but more on the order of $3 to $3 .50. Such a sizable drop, a diplomat here says, appears not simply as a new, lower price but as the first move in a possible world oil price war.

The Gulf oil ministers at the special OPEC meeting next week (probably in Geneva or Vienna) are expected to appeal to Nigeria to raise its price a little. If Nigeria refuses, it appears the OPEC countries will have to cut the price of Saudi Arabian crude - the OPEC benchmark - at least to the Nigerian level. That, in turn, would force Britain to cut its price again, and the downward spiral would continue.

''The same inelasticity that caused earlier price rises is operating in the opposite direction,'' a diplomat observes.

Thus, even at a new, lower price level, cash-hungry countries such as Nigeria might simply undercut the new level again. With a production-sharing agreement the undercutting might occur unofficially. Without a production-sharing agreement, the undercutting would be out in the open and prices might tumble toward $20 a barrel.

''The Saudis,'' a diplomat says, ''have been saying all along that countries that are starved for cash, like Nigeria, shouldn't fiddle with the oil price because it will simply cause the kind of situation where everybody ends up with lower revenues.''

For consumers, an oil-price war would mean sharply lower costs at gasoline pumps and lower energy costs for home and industry. Secretary of State George Shultz Feb. 22 called the implications ''broadly positive,'' though there would be ''some great difficulties for some countries.''

But the Saudis see a stable world price at around the $28.50 level as being in the interest of the US and other industrial nations. A price war, they note, could put Mexico, Venezuela, and Indonesia in a worse financial situation. This might endanger further their ability to service loans from American and European banks. These debts exceed $60 billion in the case of Mexico.

Though actual production levels are being kept secret, a high-level source hinted that Saudi Arabia is currently pumping less than 3.9 million b.p.d. That is an enormous drop from the more than 10 million b.p.d. in 1981. If so, oil revenues (also now a closely guarded secret) have been more than halved, falling from around $100 billion to perhaps $40 to $50 billion per year.

The impact on this country - dependent on petrodollars to fund a vast development program - is bound to be great. Some Saudis maintain, however, that this sharp drop in oil income can be managed. The kingdom, they note, could cope by slowing its dramatic pace of development, trimming waste, setting more stringent priorities on projects, cutting some public subsidies (such as food and agriculture), and decreasing foreign aid.

But several foreign observers here are less sanguine. ''Slowing down 10 percent, or even 25 percent, would be beneficial to this country over the longer run,'' commented one banker. ''There have been excesses.'' But, he added, a slump of $50 billion in oil revenues is ''an awful lot of money.''

To some degree, the Saudis can cushion any such financial blow by using their massive financial reserves invested conservatively abroad. These are often estimated at $150 billion.