OPEC threatens oil-price war to protect market share. Cuts should lower inflation, interest rates, raise GNP

December 10, 1985

It's more perception than reality at the moment, but get ready for lower oil prices. At service stations, on Wall Street, in the economy overall, that should bring smiles. At midday Monday, the stock market was up strongly, largely due to the salutary effects lower energy prices would have on airline and transportation stocks. The futures price of oil was down sharply on the New York Mercantile Exchange, although it later recovered. Gold and silver prices fell.

These were among the initial reactions to news that the Organization of Petroleum Exporting Countries (OPEC) is taking actions that almost certainly will cause oil prices to fall. Whether or not the stock market continues to surge, the prospect of lower oil prices is a good one -- unless you work for, or own shares in, an oil company. Or unless live in Mexico, Saudi Arabia, or another oil-producing nation.

OPEC oil ministers, who ended their meeting in Geneva yesterday, said they are prepared to abandon their policy of keeping oil at $28 a barrel. They will do whatever is necessary -- including cutting prices and boosting production -- to protect their share of the world oil market.

``The conference decided to secure and defend for OPEC a fair share in the world oil market,'' an OPEC statement said.

That share has shrunk from two-thirds in 1980 to about one-third today. OPEC is producing 18 million barrels a day, some 2 million above its official quota. If production increases, or simply stays at this level when winter demand for oil falls off, prices could fall rapidly.

This raises questions about the continued existence of the 13-nation cartel, which appears to be abandoning its central tenent -- price and production controls -- in order to halt further increases in the market share of noncartel oil nations. As in the past, however, it is difficult to tell what exactly the oil ministers of OPEC agreed to do in their closed-door meetings in Geneva last weekend.

OPEC may actually be issuing a veiled threat to non-OPEC nations, especially Britain and Norway.

Most OPEC nations have very low oil production costs. It costs Saudi Arabia, for instance, as little as $1 a barrel to pump oil out of the ground. But many of the North Sea wells have production costs in the high teens. Those wells would be uneconomical if prices fall very far. If OPEC can bully nations outside the cartel into curbing their output, it might keep prices relatively secure.

But this is a dangerous game, notes G. Henry M. Schuler, head of the energy security program at Georgetown University's Center for Strategic and International Studies. Mr. Schuler points out that OPEC risks causing an immediate reaction on world oil markets.

Oil buyers will decrease demand, hoping to benefit from much lower prices in the coming months, he says. Oil sellers, worried about lower prices in the future, will speed up production to try to benefit from the current prices. More supply and less demand could cause prices to plummet that must faster. ``It's a very high-risk strategy,'' Schuler says.

Whether or not it is an OPEC gambit, it seems reasonable to expect lower oil prices by next spring.

How low? Conservative estimates see a $2- to $3-a-barrel drop from the current free-market price of $26-27 a barrel. The moderate view is prices at $20-23. Some see a price war that hits the low teens.

``Any way you look at it, it's good news,'' says Robert Gough, senior vice-president and economist at Data Resources Inc., the Lexington, Mass., consulting firm.

Mr. Gough estimates that $23 a barrel oil would yield inflation at 3.5 percent and gross national product growth at 3.5 percent in the US next year. But Gough says $20 a barrel is more likely, yielding 22/3 percent inflation and 4 percent GNP growth.

Although he has not yet analyzed the effects of $20-23 a barrel oil on third-world debtor nations, Gough says ``an orderly reduction won't cause a problem.'' Brazil and Argentina, which owe $100 billion and $48 billion respectively, will benefit greatly. Mexico, which owes $96 billion, would be worse off since it relies on oil revenue to service its debt.

A lower inflation forecast would help interest rates decline. A better GNP and lower interest rates would benefit the stock market -- with the exception of oil companies themselves. Many of these firms are heavily in debt and lower oil prices could worsen their conditions.

``The real test is not today,'' notes veteran oil analyst Sanford Margoshes of Shearson Lehman Brothers. It is next spring, when Saudi Arabia and Nigeria have to decide whether to scale back to prevent a collapse. Mr. Margoshes, who foresees only a $2 to $2.50 a barrel decline, thinks that despite the ``game of chicken'' OPEC will not get into a price war.