"the Price War Is Here"

By Stephen Koepp

When petroleum prices were doubling and redoubling during the 1970s, oil buyers wondered whether the increases would ever hit a ceiling. Last week the problem was reversed: as global prices continued to plummet, traders despaired about the lack of a firm floor. "The market is in a careening tailspin," said one Manhattan oil-futures analyst. Warned another: "Put on your hard hat. The sky is falling." The price for next month's delivery of West Texas Intermediate, a major U.S. crude, plunged $3.39 on Monday and Tuesday to $15.44 per bbl., its lowest point since 1979 and a nearly 50% decline from just three months ago. Only toward the end of the week did the markets calm down a bit, and the price recovered part of its losses, to finish at $17.68.

The steep slide early in the week occurred when members of the Organization of Petroleum Exporting Countries confirmed that the group has in effect abandoned any effort to curb its production, thus ensuring a worsening global glut. Meeting in Vienna under dark snow clouds, a committee of oil ministers from five OPEC nations--Venezuela, Indonesia, Iraq, Kuwait and the United Arab Emirates--declined to propose any new output limit for the 13- member group. Their decision goes along with the strategy being pursued by Saudi Arabia, Kuwait and other wealthy oil producers, who are flooding the market with excess petroleum. These countries aim to push prices excruciatingly low so that non-OPEC oil countries, notably Britain and Norway, will be persuaded to help reverse the glut by cutting output.

So far, though, most oil countries have kept right on pumping. OPEC, meanwhile, is currently producing at least 17.5 million bbl. a day, even though demand for its oil is only at 15 million bbl. As a result, prices are plunging while the countries wait to see which one will be the first to blink. The standoff could bring months or even years of rock-bottom energy bills. Says Mani Said al-Oteiba, Oil Minister of the United Arab Emirates: "The price war is here." Adds Constantine Fliakos, senior petroleum analyst at Merrill Lynch: "It's a case of everyone for himself."

The energy giveaway, which could bring inflation-free economic growth to oil-consuming countries, sent spasms of optimism through the U.S. stock market. The Dow Jones industrial average rose 42.43 points and broke through the 1600 milestone for the first time, closing the week at a record 1613.42. But the rally stalled occasionally, partly because many investors were nervous about the effect that falling oil prices could have on Mexico, Nigeria and other debt-ridden oil producers and on the banks that have lent them money.

How did OPEC go from a strategy of one-for-all to a free-for-all? The cartel's disintegration began in 1981, when prices started sliding because of worldwide overproduction, partly caused by consumption cutbacks in many oil- dependent nations. To sop up the surplus, OPEC imposed output limits on its members. But that only provided a chance for such new producers as Mexico and Britain to steal business from OPEC countries, whose market share consequently dropped from 63% in 1979 to 38% currently.

Saudi Arabia tried for years to set an example of self-restraint in OPEC. The country slashed its production from a peak 10.3 million bbl. a day in 1981 to a low of 2 million bbl. a day last June. But gradually the Saudis began to feel that they were being played for a sucker by other OPEC members like Colonel Muammar Gaddafi's Libya, which has exceeded its quotas, and by some non-OPEC countries, which were producing at peak capacity. Finally fed up, the Saudis quietly began opening their spigots last autumn, when a seasonal increase in demand temporarily camouflaged the additional supply. By now the kingdom has more than doubled its output, to nearly 4.5 million bbl. a day.

Several other well-off producers, including Kuwait and the United Arab Emirates, have endorsed Saudi Arabia's strategy. Observes Peter Beutel, an energy specialist at New York City's Rudolf Wolff Futures: "They're out to prove to Britain and anybody else, 'If you're not going to cooperate, you're going to be destroyed.' " The Saudis and their allies have hinted that they might break off the battle if non-OPEC producers can agree collectively to cut production by 1.5 million bbl. a day, or about 6%. That kind of agreement would create, in effect, an expanded version of the old OPEC.

The Saudi challenge is no empty bluff. In a protracted price war, Saudi Arabia could outlast everyone else. The country sits on reserves of about 170 billion bbl., more than any other producer, and it costs the Saudis less than $3 per bbl. to extract its oil, compared with $4 to $9 in the North Sea and $5 to $7 in Mexico. The Saudis could be raking in profits at prices so low that other producers could not afford to turn on their pumps.

Falling prices will put financial pressure on such producers as the Soviet Union and Britain. Every 10% drop in oil prices costs Britain about $1 billion in tax revenue, and the decline could prevent Prime Minister Margaret Thatcher from coming through with a promised $4.2 billion tax cut. Yet Britain has stoutly refused to join any kind of cartel arrangement, however informal. And declining prices are likely to inspire the Soviets to sell more rather than less. The country relies on exports of oil and natural gas for much of the Western currency it needs for buying machinery and high technology.

The Saudis and their allies have aimed most of their verbal assaults at Britain, apparently because it is the only significant producer outside OPEC that could theoretically afford to cut its output. Yet Britain's share of the free-world market, at about 4%, is still so small that many experts think the Saudi wrath is insincere. Instead, they believe that Britain is serving as a scapegoat for the Saudis, who want to distract attention from the fact that they are waging a fierce price war against struggling OPEC brethren, notably Libya, Algeria and Iran. Plunging revenue could also pose a dire financial threat to OPEC member Nigeria, where the six-month-old government of President Ibrahim Babangida is staggering under a foreign debt of $24 billion.

The Saudi scheme has already created a rift between the poor producers and the rich ones. In Iran, Ayatullah Khomeini's government last week condemned the Saudi plan as "an imperialist conspiracy." Meanwhile, the oil ministers of Mexico and Venezuela teamed up for a road show to promote peace among the petropowers. One stop was Egypt, which has reportedly taken a step toward cooperation by quietly lowering its production by 23%, to 670,000 bbl. a day.

Besides bashing their competitors, the Saudis have long-term reasons for opening the floodgates. By lowering prices they hope to boost worldwide consumption, which energy-saving measures have forced down by about 18% since 1977. The Saudis also want to transform some of their huge oil reserves into cash or other assets that can earn interest instead of just sitting in the ground.

The biggest casualty of dropping prices will be Mexico, which owes foreign creditors $96 billion and earns about 70% of its export income from oil. Mexican financial officials told creditor banks only last December that the country would need to borrow an additional $4 billion to stay abreast of its payments during 1986. But declining oil prices changed that estimate almost overnight. When Mexican government officials met again with bankers last week in New York, their projected borrowing needs had increased to $9 billion.

The country's citizens have grown increasingly restive about the austerity measures that were imposed by the government of President Miguel de la Madrid to meet debt payments. About 35,000 people joined a protest march last week in Mexico City. Said one banner: MORATORIUM ON THE DEBT. THE PEOPLE HAVE HAD ENOUGH. By comparison, Venezuela's President Jamie Lusinchi should experience less trauma because his country's debt, at $35 billion, is smaller.

Cheap oil is of course a boon for the U.S., Western Europe, Japan, Brazil and other heavy consumers. Lower energy costs can boost economic growth, reduce interest rates and inflation, and create more jobs. Unemployment in the U.S., for example, is declining significantly. The Labor Department reported last week that the jobless rate fell from 6.9% in December to 6.7% last month.

Low-cost oil could help the Federal Government deal with its debilitating budget deficit. As long as crude prices are falling, increased energy taxes would be a relatively painless way of raising money. In the Senate, New Jersey Democrat Bill Bradley has proposed tripling the current 9 cents-per-gal. gasoline tax, a move that he estimates would bring the Government an extra $15 billion a year. President Reagan conceded for the first time last week that he would listen to proposals for an energy tax, but only if it would be used for reducing other levies rather than purely for cutting the budget deficit.

In the meantime, U.S. consumers should expect a break in their energy bills. But retail prices take about 45 days to respond to crude-oil declines because the fuel currently on sale was made with more expensive crude. The average U.S. price for regular unleaded gasoline is now $1.15 per gal., already down from a peak of $1.41 in 1981. While most filling stations have made no dramatic cuts yet, some experts think that the price could fall to 90 cents by late spring.

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With reporting by Robert Ball/Vienna and Raji Samghabadi/New York, with other bureaus