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Directorate of Intelligence
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OPEC: Iraqi Intimidation and Implications
for Oil Prices
Sunmary
Largely with the help of Iraqi intimidation, OPEC's neu agreement represents potentially its strongest accord since oil prices collapsed Each member seems touota that it can livepolitically andthe time being. Most members have already given solid commitments to honor the agreement and severalincluding Kuwait and Saudialready begun to cut production. Horeovor, current oil market conditions suggest that oil prices will likely rise toward the cartel's price targeter barrel by ye&rend, as long as OPEC holds down production* Another factor likely to help prop up prices in the months ahead is the bullish market psychology
that has emerged in recent
More ominous tor Western oil consumers is thecontinued Iraqi pressure on OPEC to raise oil Largelyesult ot BaghdadrsOPEC has shifted its emphasis from expansionshare to oneother
Gulf Arab have
difficult time resisting further efforts to raise oil prices over tho next year or so, short of assisting Baghdad financially.
Energy Resources Division, Office of Resources/ Trade, Technology. Information available as of0 was used in its preparation. Comments or questions mav behief, Energy Resources Division
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RocAnt Developments
Iraq's need for substantially higher revenues to financespending requirements for military and economicprobably the primary motivation behind Iraq's recentmilitary action against Kuwait and the United Arab Low oil prices earlier this year seriouslyefforts to increase revenue. Above-quotayear by Kuwait and the-^BBm
B-helpcd weaken oil prices, which byby'itTor*^tnaner barrel from the January levelper barrel. By early July, Gulf producers werecommitment to production restraint thus reducingturning prices around significantly in coming months. has no mechanism to enforce production quotas, Iraqinto its own hands by threatening Kuwait and the UAE. XiMTiG time, it: demanded that OPEC raiseer barreler barrel
Iraq's efforts were largely successful, as OPEC appears to have come up with potentially its strongest accord on production quotas and target prices since oil prices collapsedn the production issue, if members adhere to the new quota5, OPEC output could fallrom first0 levels. The UAE, for example, will reduce output^frono its quota level;
orth^fTrst time in five years, eachmemoeruota it can^live with for the timepolitically
enforcementthreat of Iraqicompliance from Kuwait and the UAE for the timethe price issue, OPEC raised its reference priceerevel that will enable membersIraqi and Iranianthatunlikely to have much short-term imjjacl^wi oil demandpriority of the other Gulf
The Oil Market Setting
Industry
supply conditions for the remainder of this year suggest that OPEC will likely approach its price target, as long as production remains close to the new ceiling. Indeed, an upturn in demand during the second halfombined with only minimal
increases in supplies outside of OPEC, suggests prices will rise the new target as long as OPEC restrains its own output.
ding to|
market economies wil half
oil consumption in tne9uring the second illionover 2year-earlier levels.' OECD countries are expected to account for about half the increase, rising more8:
consumption is expected to recover in the second half, rising4bove second-half
Japanese consumption should riseercentn the strength oX high economic growth,
o Western European oil use should reach, up8ccording to several estimates.
LDC oil consumption should riseo1, with most of the increase coming from the Far East, f
Little Increase in non-OPEC Supplies. 0 non-OPEC oil supplies are likely to increaserom year-earlier_levels7. ecline in US
prcductior.-kBbVLili^LIVHbiH B'lt: rop
Soviet exportsill be offsetumber of small
increases elsewhere:
o OECD suppliers will likely increase output by a
ith most of the increase coming from the United Kingdom, Canada, and Horway.
ey to Market Psychology. Oil inventories in the market economics arc at normal levels, but heightened concerns about Iraqi threats and expectations of higher prices could lead oil companies to increase oil stocks in the months ahead.. Such behavior would contribute to upward price pressure.
0hole. Free World oil consumption is likely to4, the highest level ever recorded, surpassing the historical high reached
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Civcn Che expected demand and non-OPEC supply levels, the market probably could absorb OPEC production ofnd support pricos near its new target. Those lovols are consistent with OPEC's new crude oil quota5lus the groupsroduction of natural gas liquids (NGLs).
outlook for Production Restraint
Commitment to the new accord is likely to be strong overseveral months.. Judging Iron production plans by
Iraqi pressure on Kuw^it^oPEc^rooTict^nduring the second half0 indeed will likely5f crude oilf NGLs. Among the Persianproducers:
o Iran, Iraq, and Qatar have quotas near their oil production capacity levels, leaving little possibility of much' overproduction.
August by nearl
Saudi Arabia plans to cuto
ie new accor
B to demonstrate its support tor iselow its quota.
Finally, a
conciliatory oilas
lone; am the threat of military aqgressTonreBalns.
il production has already begun to
fall.
Close adherence to the new agreement is also likely among mombors outside the Persian Gulf. Host of these producers were producing at or below their quotas prior to the meeting, primarily because they are already producing at near full capacity. Only Libya and Venezuela have more than marginal amounts of surplus capacity. Libyarice hawk and was the most outspoken supporter for Iraq's demand for substantially higher prices at the recent mooting, according to press reporting. Tripoli almost certainly hopes toowerful hawkish alliance with Iran, Iraq, and Algeria at future OPEC meetings to push prices higher. For its part, Venezuela hopes toummit of OPEC heads of state in the near futui
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p jications
With close adherence to the OPEC agreement, prices are ikely to0 per barrel during the rest of the year. Demand and supply factors suggest that prices will hover near the lower or middle part of the range during the third quarter, although market psychology has become more bullish and could give prices an added boost. In any event, prices should be at or above the upper end of theranqe during the fourth quarter, when demand will be stronger. MB
If ongoing negotiations between Kuwait and Iraq turned sour and Baghdad attacked Kuwaiti oil facilities, oil prices would rise sharplyer barrel. The upward price spike, however, probably would not last for moreewin the worst caseutoff of all Kuwaiti oillong as Saudi Arabia and the UAE offset the' lost Kuwaiti supplies.
o Saudi Arabia and the UAEombined surplus capacity of, more than enough to offset Kuwaiti output.
o Moref surplus capacity exists outside the Persian Gulf, mainly in Venezuela and Libya, although Tripoli might not increase its output in the eventisruption in Kuwait.
Nevertheless, the market would be significantly tighter under these conditions and subject to upward pressures that cou' prices weller barrel for an extended period.
Looking Prospects for Saudi-Iraqi Tensions
OPEC almost certainly will increasingly divide into two
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Because of its recent successes, Baghdad almost certainly believes it willuch larger say in future OPEC decisions and may periodically resort to military threats to extort concessions from the other Gulf Arab producers* Higher prices and increased production restraint by others will buy Iraq time to invest more heavily in expanding its own oilosition itself to demand hiaher auotas in the future
indicate that Saudi Arabia 1
oil prices mucher barrel over the next several
the fundamental lesson ofor key moderate Arab producers was that inordinate price increases ultimately undermine world oil demand. Consequently,Saudi Arabia, Kuwait, the UAE and Venezuelalikely remain concerned that substantially higher prices vill:
o Choke off demand for OPEC oil by stimulating non-OPEC oil production andiffusion of technologies in consuming countries to increase energy efficiency and alternatives to oil.
o Lower future oil revenue prospects, make it more difficult to work out future production-sharing arrangements in OPEC, and increase tensions in the region.
o Renew public concern about energy security in the
industrialized countries and increase sympathyarbon tax and other environmental policies that would further weaken oil demand.
Providing Iraq large sums of money in the form of grants or aid in return for Iraqi flexibility on oil policy issues, especially if demand growth slows with higher prices. While expensive, it would at least allow the Gulf producers to sustain oil market conditions that are favorable to their long-term interests.
o Accelerating the moderate expansion of their oil productionin Saudi Arabia and theensure they retain some economic leverage over Iraq. This would be the most risky option but might remind Iraq ofwn vulnerabilities and encourage some moderation.
Original document.
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