Organization of Petroleum Exporting Countries ; Petroleum industry and trade ; Power resources - Prices

Yvonne Levy

English

Research Papers in Economics

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January 11, 1980 
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OPEC: $27? $30? 
The OPEC nations, all acting individually, 
last month sent a collective message to the 
industrial world that 1980, like 1979, would 
mean another year of inflationary price 
increases. To reinforce the point, most 
members-with the notable exception 
of Saudi Arabia-followed up their 
December price hikes with further increases 
in early January. Even ifofficial prices remain 
stable for the remainder of 1980, the increase 
in average prices wi  II exceed the 44-percent 
jumpof  1979, which of  course was exceeded 
only by the 1973-74 price upsurge. And if  the 
world oil market is hit by another production 
cutback comparable to the 1979 Iranian 
cutback, the year-to-year gain could 
be double the 1979 increase. 
The one bright spot in this otherwise dark 
outlook is the possibility that the worst 
already has happened. Barring a complete 
cutoff of  all Iranian exports to the world 
market, sluggish world-wide demand 
resulting from brim-full inventories and 
a U.S. business slowdown could mean few 
(if  any) further price increases over the course 
of  the year. In that case, the overall increase 
in OPEC prices between the fourth quarter 
of 1979 and the fourth quarter of  1980  wou  Id 
probably range from about 13 to 28 percent, 
compared with the 82-percent increase that 
occurred between the fourth quarters of 1978 
and 1979. 
Historic event 
Last year's upsurge in prices began with the 
shutdown associated with the Iranian 
Revolution -an  event outweighed 
in magnitude only by the Arab oil embargo 
and price upsurge of 1973-74. For several 
months, Iran's normal supply of 5.5 million 
barrels a day (bid) was completely lost to the 
world market without output elsewhere fully 
compensating for that decline in production. 
Even when Iran began producing again, 
it marketed only about half of its previous 
exports. Those supply pressures, plus the 
O? 
frantic demand pressures exerted 
by refineries rebuilding their depleted 
inventories, culminated in a sharp increase 
in the average OPEC contract selling price, 
which had risen only from $11.06 to $12.93 
a barrel between 1974 and 1978 (see chart). 
At OPEC's June 1979 meeting, the producers 
set a new ceiling price at $23.50 a barrel, and 
even the "moderate" Saudis pushed their 
official sales price to $18.00 a barrel. 
Moreover, the price leapfrogging continued, 
climaxed in December by a new round of 
price hikes. First, Saudi Arabia raised its price 
for light marker  crude by one-third, to $24.00 
a barrel, retroactive to November 1. 
By narrowing the differential between its 
price and the higher contract prices then 
bei  ng  charged by the more mil  itant producers 
(the "hawks"), the Saudis hoped to establish 
the basis for a more unified price structure 
at the forthcoming December 17 OPEC 
conference in Caracas. Other moderates'-
Venezuela, Qatar, and the United Arab 
Emirates-quickly supported that effort 
by moving into line with the Saudi marker 
price. 
That unification effort failed, however, as Iran 
and Libya independently raised their official 
prices atthe Caracas meeting, and then again 
on January 1, to new highs of  about $35.00 
a barrel. With Saudi Arabia still at $24.00, 
and other producers strung out in between, 
the average contract price for the first quarter 
of 1980 has reached $27.00-more than 
double the late 1978 pre-Iranian Revolution 
average price-and it will rise even more 
if Saudi Arabia decides again to narrow the 
differential between itself and other 
producers. 
Wanted: real increase 
The desired strategy of  the OPEC producers 
in 1980-at  least the strategy of  the hawks-
will be to reduce production sufficiently 
to achieve a price increase in real terms, that Opinions expressed in this newsletter do not 
necessarily refleci the views of the managernent 
of the tederal Reserve Rank of San  Francisco, 
nor of the Board of Covernors of the Federal 
Reserve Systern. 
is, relative to the dollar cost of their imports. 
They complain that the real selling price 
of  thei r oi I dropped '19 percent between 1974 
and 1978, despite a 17  -percent increase 
in nominal terms, because inflation in the 
industrialized countries and the decline 
in the exchange value of the dollar raised the 
price of their imports from industrial nations 
by an even greater amount. In terms of real 
purchasing power, their oil price did not 
return to the 197  4 level until the third quarter 
of 1979. 
With this strategy in mind-and assuming 
stable non-Communist world petroleum 
consumption -we  can discern three possible 
price scenarios involving three alternative 
levels of  OPEC crude production. Scenario I 
assumes that the level of OPEC production 
declines by less than 1.0 million bid in 1980, 
wh  ich bri  ngs about a 1  3-percent increase 
in average nominal OPEC prices between the 
fourth quarter of 1979 and the fourth quarter 
of 1980. If OPEC import prices rise 
10 percent, that would result in a real 
increase to the OPEC members of 3 percent. 
Scenario II assumes a greater OPEC 
production cutback of 1.0-1.5 million bid, 
bringing about an average price increase 
of 28 percent in nominal terms, and 
18 percent in terms of  real purchasing power, 
over the same time-span. Scenario III, 
in contrast, assumes a production cutback 
of  around 3.0 million bid of at least several 
months' duration. A production cutback 
of  that magnitude would be similar to that 
which accompanied the Iranian cutback 
of  early 1979, and would probably have 
similarly severe price consequences. 
UI(eiy outcome 
Currently, Scenario II appears to be the most 
likely outcome, with its assumptions of  stable 
worldwide consumption and an OPEC 
production cutback of no more than 
1.5 million bid. A projected decline in U.S. 
2 
oil-import consumption supports the 
no-growth assumption of non-Communist 
world consumption. Moreover, worldwide 
inventories of crude and refined products 
have now reached record levels and are 
straining available storage capacity, making 
unlikely any repetition of last year's massive 
upsurge in refinery inventory demand. 
On the other side of  the equation, Iran's 
production has declined substantially since 
last fall, from 3.8 to 2.9 million bid, primarily 
because of  oil-field maintenance problems. 
However, other hawks apparently have not 
implemented their earlier threatened 
cutbacks, while Saudi Arabia has decided 
to maintain its present production of 
9.5 million bid at least through the first 
quarter of this year. 
If this scenario materializes, the average 
OPEC contract price may rise only modestly 
over the remainder of  the year, from a first-
quarter level of $27.00 to a fourth-quarter 
figure of $30.00 per barrel. This moderate 
scenario gains some support from the recent 
behavior of spot-market prices for crude oil 
sales not under contract. Since November, 
with refinery inventories bulging, spot prices 
for I  ight crudes on the key Rotterdam market 
have dropped from a peak of around $42.00 
to $37.00 a barrel. Those prices could 
weaken further, in view of the present heavy 
inventory situation and consequent sluggish 
worldwide refinery demand, unless OPEC 
producers reduce output sufficiently  . 
to forestall a further buildup of  crude 
inventories. But the OPEC nations could not 
agree on major production cutbacks during 
the 1974-75 recession, and they might not 
be able to discipline themselves enough 
to do so on this occasion either. In any event,. 
a narrowing of the differential between spot 
and contract prices should help reduce the 
upward pressure on the latter, and help 
to moderate any further increases in contract 
prices over the remainder of 1980. i:fiect on U.S. inflation 
The behavior of  OPEC prices will have 
a significant impact on the outlook for U.S. 
inflation. Rising world oil prices will directly 
affect the cost of both the 3.0 million bid 
of imported oil and the 0.6 million bid 
of uncontrolled domestic oil whose price 
moves in accordance with the OPEC price. 
The ultimate impact will involve both the 
direct effect of rising crude-oil prices and the 
indirect price effect on substitute fuels and 
products requiring fuel inputs. Congressional 
Budget Office analysts use a price multiplier 
of 1.3 to take accou nt  of  these i  nd i  rect effects. 
Dollars 
40 
OPEC  Average 
30  Contract  Price 
20 
10 
o 
1973  1975 
3 
The sharp upsurge in OPEC prices over the 
course of 1979 added about 2.0 percentage 
points to the rate of domestic inflation-
measured by the GNP price index 
(deflator) -compared with the rate that 
otherwise would have prevailed with stable 
world oil prices. With the assumptions 
of Scenario II, rising world oil prices during 
1980 could contribute 1.2 percentage points 
to the U.S. inflation rate. In the worse-case 
scenario-a repetition of the 1979 OPEC 
production cutback and price run-up-
the domestic inflationary impact could 
be just as bad (if not worse) than we 
experienced last year. 
Yvonne levy 
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT 
(Dollar amounts in millions) 
Selected Assets and Liabilities 
Large Comrnerdal Banks 
Loans (gross, adjusted) and investments* 
Loans (gross, adjusted) - total# 
Commercial and industrial 
Real estate 
Loans to individuals 
Securities loans 
U.s. Treasury securities* 
Other securities* 
Demand deposits - total# 
Demand deposits - adjusted 
Savings deposits - total 
Time deposits - total# 
Individuals, part. & corp. 
(Large negotiable CD's) 
Weekly Averages 
of Daily Figures 
Member Bank Reserve Position 
Excess Reserves (+  )/Deficiency (-) 
Borrowings 
Net free reserves (+  )/Net borrowed( - ) 
Federal Funds - Seven Large Ban~ 
Net interbank transactions 
[Purchases (+  )/Sales (-)] 
Net, U.S. Securities dealer transactions 
[Loans (+  )/Borrowings (-)] 
...  Excludes trading account securities. 
#  Includes items not shown separately. 
Amount 
Outstanding 
12/26/79 
137,875 
115,051 
32,372 
43,123 
24,420 
1,623 
7,249 
15,575 
46,147 
33,718 
28,398 
58,855 
50,061 
21,841 
Weekended 
12/26/79 
36 
64 
28 
+1,784 
21 
Change 
from 
12/19/79 
+1,397 
+1,482 
+  617 
+  3 
+  191 
- 34 
+  5 
90 
+1,015 
+  1,971 
- 134 
- 33 
- 41 
- 186 
Change from 
yearago@ 
Dollar  Percent 
+  16,847  +  13.92 
+  16,697  +  16.98 
+  3,925  +  13.80 
+  8,727  +  25.37 
NA  NA 
NA  NA 
- 932  - 11.39 
+  1,082  +  7.47 
+  3,107  +  7.22 
+  3,178  +  10.41 
- 1,811  - 5.99 
+  7,940  +  15.59 
+  8,592  +  20.72 
+  1,626  +  8.04 
Weekended  Comparable 
12/19/79  year-ago period 
30  15 
208  108 
- 239  - 123 
+ 1,811  +  694 
79  +  369 
@ Historical data are not strictly comparable due to changes in the reporting panel; however, adjustments 
have been applied to 1978 data to remove as much as possible the effects of the changes in coverage. In 
addition, for some items, historical data are'not available due to definitional changes. 
Editorial comments may be addressed to the editor (William Burke) or to the author ....  Free copies of 
this and other Federal Reserve publications can be obtained by calling or writing the Public Information 
Section, Federal  Reserve  Dank of San  Francisco, P.O.  Box  7702,  San  Francisco 94120. Phone (415) 
544-2184. 

OPEC: $27? $30? $40?

http://www.frbsf.org/publications/economics/letter/1980/el80-02.pdf

OPEC: $27?$ 30? $40?

Abstract

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Research Papers in Economics

OPEC: 27?27? 27?30? $40?

Abstract

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Research Papers in Economics

OPEC: $27?$ 30? $40?