A Brave New Energy World

By Christopher Byron

Lower oil prices cause unexpected difficulties for Government and industry

For nearly a decade, escalating energy prices have sapped the economies of industrialized countries, spurred long and steep inflation, and sent hundreds of billions of dollars flowing into the treasuries of a handful of oil producers. Now the combined effects of recession and conservation have sharply curbed demand for oil and forced the most serious price break since the Organization of Petroleum Exporting Countries quintupled the cost of crude between 1973 and 1975.

The new world of lower energy prices, though, is presenting new and different challenges to both Government and industry. Cheaper oil could undermine the incentives to save and conserve that have led to the drop in prices. Moreover, it might reduce the willingness of oilmen to take large financial risks to search for new oil supplies. Gyrating prices might also play havoc with the ability of businessmen to plan their investments or even know what their operating costs will be from one day to the next.

Over the short term, the softening price of oil has certainly been good news for hard-pressed consumers. Every $1 per bbl. drop in petroleum prices gives them $5.5 billion to $6 billion in increased purchasing power. That is because oil is by far the most important and widely used energy resource in the economy, going into everything from automotive fuel to farm fertilizers, plastics and paints.

From January 1979 to January 1981, oil prices shot up approximately 150%, and the rise sent American consumer prices leaping at an annual rate of more than 12%, the steepest peacetime increase in more than 30 years. Since April of last year, though, petroleum prices, which had briefly gone to more than $41 per bbl. for high-quality crude, have declined slightly to approximately $33 per bbl. Moreover, in recent months prices have actually begun to slip somewhat on the unregulated spot market, where crude was last week selling for as little as $30 per bbl. As a result, consumer prices have ceased spiraling upward, and in February they climbed at an annual rate of only 2.4%. Last week the Labor Department reported that wholesale, or producer, prices fell at an annual 1.7% rate during March, matching an equal decline in February, for the first such two-month drop in the index since 1976.

There is also, however, an unwelcome side to the drop in oil prices for Reagan Administration policymakers. Michael Evans, a private Washington-based economist, forecasts that a $10 per bbl. drop in the price of oil would cost the Treasury as much as $40 billion in lost revenues from the windfall-profits tax that President Jimmy Carter levied on the oil industry two years ago. Prices so far have dropped $4 per bbl. Those losses would add billions of dollars more to the 1983 deficit, which congressional economists now expect to top $120 billion.

As a result of the sliding price of crude and the rising deficit, the White House is actively considering a variety of tax proposals that would both raise revenue and keep consumption from jumping up again. Proposals under consideration include a $5 or $10 per bbl. surcharge on imported oil and an increase of 50 in the federal excise tax on gasoline. President Reagan has yet to indicate his position on these staff proposals.

Though some businesses, such as commercial aviation and the petrochemicals industry, will benefit directly from lower petroleum costs, others may see their business plans disrupted. Key among them, ironically, is the long-troubled American auto industry. The industry is now in the midst of an $80 billion retooling program to switch over to the production of smaller, more fuel-efficient cars, but could have trouble selling them if fuel prices continue to drop. Says Philip E. Benton Jr., vice president for sales at Ford: "As an industry, we are so heavily committed to small cars that it cannot be reversed." Summed up Chrysler Corp. Chairman Lee lacocca, when questioned at a recent press conference about sagging gasoline prices: "If the price goes to $1 per gal., I am going to go out, buy a gun and shoot myself."

Automen are having nightmares that drivers will return to big cars just as they did in 1976, when a temporary glut led many people to think the energy crisis was over. Americans do not seem interested in small cars whenever long lines at gasoline pumps have vanished and fuel is plentiful and cheaper. Though overall domestic auto industry sales for the first three months of the year were down 19.2% from depressed 1981 levels, larger cars have been moving relatively briskly. Sales of the full-size Mercury Marquis rose 27% during the first quarter, and Ford's assembly plant in St. Louis has added an overtime shift to meet demand. Sales have perked up as well for Chrysler's New Yorker sedan, and an extra shift has been added at the company's Windsor, Ont., plant. Meanwhile, sales have fallen flat for the firm's fuel-efficient line of Omni and Horizon subcompacts.

In trend-setting California, the number of miles logged by motorists in February showed a slight 3.5% increase over the same period a year before. But energy experts do not yet detect any signs that Americans are returning to their old driving habits. Says Dan Lundberg, publisher of a leading gasoline-industry newsletter: "People have imposed upon themselves new strictures of driving that they will be reluctant to modify for even another 20-c- per gal. drop in the price of gasoline."

The oil industry has also been thrown off balance by falling petroleum prices. During 1981, three of the nation's top six oil giants--Texaco, Mobil and Standard Oil of California--alone racked up a total of $7 billion in profits. This year they are not expected to do so well, and that is one reason that the stock prices of the major oil companies have lost about half their value since reaching a peak two years ago. Meanwhile, oil companies have begun scaling back capital investment programs. Says Charles Kittrell, executive vice president of Phillips Petroleum: "We are having to cut back in investments all across the board. I am not asking for any get-well cards, but I do not think we will be able to provide as well as we might have for the country's energy needs under these circumstances."

Among the first of the industry's cutbacks have been construction plans for a number of highly capital-intensive synthetic-fuel plants to produce gasoline and other petroleum products from coal, tar sands and shale rock. Occidental Petroleum and Tenneco Inc. have already shelved joint plans to exploit Colorado shale oil, and Exxon has postponed construction of a $4 billion East Texas plant to make gas from lignite. Says Exxon Chairman Clifton C. Garvin Jr.: "We'd rather gamble on the price of oil in our explorations than in synfuels."

Exploration plans are also being sharply pared. As recently as last December, the industry was planning to invest about $40 billion on such projects, an increase of 15% over 1981 levels. Many of those projects are now on the shelf. Says Industry Analyst Barry Good of the Morgan Stanley investment banking firm: "If you polled those same companies today, you would come up with a rate of increased investment probably half as large as anticipated last autumn, and in two months' time, planned investment might actually be below the 1981 figure." Mobil has already pruned this year's drilling program back from $5.9 billion to $4.1 billion, and Standard of California has trimmed projected outlays almost as much, from an estimated $5.9 billion to $5.3 billion.

Hardest hit of all have been the independent wildcatters who do exploratory drilling under contract for the oil majors. The wildcatters, many with no more than $2 million to $3 million in working capital, or about the cost of three exploratory drilling operations in the Intermountain West, are finding it increasingly hard to come up with the financial backing to go out and search for crude. Says Thomas Petrie, an industry analyst for the First Boston Corp. investment firm: "Investors see no point in backing high-risk drilling operations that can cost $12 or more per bbl. Instead, they can in effect acquire proven reserves for less risk, at, say, $3 to $5 per bbl., on Wall Street simply by investing in the depressed stock of financially sound oil giants."

With world oil consumption currently running at nearly 6 million bbl. a day below the level of just three years ago, the immediate supply outlook is reassuring. Nonetheless, American crude oil imports, which have declined a dramatic 36% during the past year, still account for approximately 25% of all U.S. needs. As long as one of every four barrels of oil consumed in the U.S. is supplied by foreign producers, there remains the constant peril of exorbitant new price increases and economically disruptive supply interruptions.

This is all the more a problem because Western oil supplies come largely from the volatile Middle East. Some unpredictable event there could quickly turn the present abundance into scarcity and send petroleum prices rocketing upward on markets around the world. The current fortuitous situation of declining oil prices provides an ideal opportunity to press ahead with greater efforts at conservation and the development of non-OPEC energy supplies. It was just such efforts in the past three years that helped bring about the present break in oil cartel prices.

--By Christopher Byron.

-- Reported by Gary Lee/Washington and Frederick Ungeheuer/New York

With reporting by Gary Lee, Frederick Ungeheuer

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