The Impact of the Tehran-Tripoli Agreements on U. S. Oil Policy and Prices

Abstract

The current price of Persian Gulf crude oil is unrelated to competitive supply and demand, hence projections are irrelevant. The producing-nation cartel will keep raising prices further despite "agreements"; what's more, the cartel will last for years. Those high prices will make discovery and development very profitable indeed. prices will make discovery and development very profitable indeed. Introduction Stocks of mineral resources, including petroleum, are renewable and replaceable by discovery and development. The incremental cost of renewal is equated in a competitive market to price the register of scarcity, measuring the pressure of demand on supply. Greater or less scarcity means a higher or lower cost of renewing and expanding capacity. Therefore projections of rising consumption alone, even if correct, projections of rising consumption alone, even if correct, say nothing whatever about scarcity or price. They are the sound of one band clapping. In an earlier paper I suggested that a long-run price forecast must be in four steps: "(1) determine price forecast must be in four steps: "determine what the price would be under purely competitive supply and demand;project the price into the future;look at interference with supply and demand, most especially the role of governments; andtry to predict the future of this influence. Needless to say, the reliability of the forecast declines at each step." My forecast was that (Steps 1 and 2) even assuming high consumption growth and zero new-field discoveries, the rise in cost at the margin would be negligible relative to any likely price, that (Step 3) the companies were no longer in command, and that the influence of governments had been and (Step 4) would be insufficient to stem a slow continuance of the price decline of the previous 12 years or so. The forecast was right on the first three points, all wrong on the fourth. We shall review developments at each stage. The Irrelevance of Scarcity Crude oil outside the U. S. has become increasingly plentiful. Investment requirements at the Persian plentiful. Investment requirements at the Persian Gulf are down by more than 50 percent in the 1960's. When discoveries fail to keep up with consumption, the remaining reservoirs must be ever more intensively developed, at higher cost. This is a fact in the U. S. not elsewhere. About 35 to 40 Persian Gulf rigs operated in 1960 and in 1970, yet they supplied about three times the increment to capacity. The 1970 labor force was much smaller. New-field discoveries in the 1960's must have considerably exceeded discoveries in the 1950's, and they already supply 29 percent of total production. More important, the real resource cost of Persian Gulf crude oil in the big concessions, who could supply much more, is about 10 cents/bbl. On the extreme assumptions of continued growth at historical rates and zero new-field discovery, cost would double by 1985, to about 20 cents. If Persian Gulf crude became 10 times as scarce, cost would still be less than the market price. Within those wide limits, supply and demand have nothing to do with the world price of oil. Recent history confirms this. In 1970-72, consumption growth was the smallest in many years. In much of 1972 there was even short-run excess capacity, a rarity in world oil, in the Mediterranean and the Caribbean. Excess capacity led directly to the seizure in Iraq, when the Iraq Petroleum Co. refused to restore production cuts and expand. In a competitive market, the price would have declined in those 2 years. In reality, it soared. P. 1255