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The origins of last week's oil slide reach back to midsummer. Buyers started balking at official prices at a time of continuing glut. The Saudis helped restore temporary calm by keeping their production low. As an added measure, Sheik Ahmed Zaki Yamani, the Saudi Arabian Oil Minister, jetted around the globe to such non-OPEC countries as Egypt, Malaysia and Mexico, urging those governments to restrain from giving discounts or increasing production.
Britain decided to cut prices on long-term contracts last week because its own "oil and similar varieties like Nigeria's Bonny Light were selling for discounts of at least $2 on the spot market, where prices float according to market conditions. As a result, producers were having trouble signing up steady customers. Said a Japanese buyer in the Persian Gulf: "We prefer reliable, long-term contracts to buying on spot, but the price difference is too big for us to pass up." In July the Japanese bought 25% of their oil on the spot market, compared with 9% in 1982.
An ironic reason for the slack demand for so-called sweet crude like Britain's Brent light is that its quality is too high. Traditionally, refiners were willing to pay a premium for light, low-sulfur crude, which is used primarily to make gasoline. But refiners in the past year have improved their technology so that they use more of the less expensive, heavy crude. Thus the so-called sour oil is getting a larger share of the market, and its price has been holding firmer. In the past few weeks Saudi Arabia has boosted its exports of heavy crude, which it sells for as little as $26 per bbl.
The pricing problems between light and heavy crude come at a time when the oil industry is just recovering from two years of massive oversupply, caused largely by conservation measures and the global economic slump. Total oil consumption is expected to increase about 3% this year over 1983, thanks partly to strong growth in the U.S. and Japan. But that pace is too slow to satisfy OPEC members, which are currently producing slightly less than their self-imposed quota of 17.5 million bbl. per day, only half their capacity. As a result, OPEC countries such as Libya and Iran have been quietly undercutting official prices to keep sales steady. "They're showing an inability to handle a moderately growing pie," says Arnold Safer, president of the Energy Futures Group consulting firm. "When there are a few more goodies to share, they fall apart."
When OPEC ministers meet in Geneva, they will have four basic choices: cut production, cut prices, adjust prices between light and heavy crude, or do nothing while hoping demand will pick up soon. It will be extremely difficult for them to decide which members should cut back output and by how much. All the countries want to keep production up in order to keep money flowing in. Iran and Iraq have a four-year-long war to finance. Venezuela and Nigeria owe large debts to Western bankers. Reducing the official price from $29 to compete with Britain could start an all-out skirmish with non-OPEC producers. "The system is so inherently unstable," says William Randol, an industry analyst for the First Boston investment firm, "that the slightest slip can lead to another crisis."