Created: 3/12/1986

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Statomont of David Cohen

Director, Office of Global issues

Central Intelligence Agency

Before the Committoe on Energy and Natural Resources

United States Senate



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Statement of David Cohan Director, office of Global Iasue3 Central Intelligence Agency Before the Com it tee on Energy and Natural Resources United States senate6

Mr. Chairman and distinguished members of theelcome this opportunity to present the Central Intelligence Agency's views on the world oil market situation and its implications. We believe weak market conditions will keep downward pressure on oil prices this year. The major factor propelling the market downward is OPEC's move,

to defend market share rather than prices. At this time, no other producer aeems willing to cut production voluntarily

Furthermore, thedecline in demand could intensify downward pressure ifmembers try to

maintain output at current levels.

Current market weakness is dueumber of factors which came aboutesult of higher oil prices in. As the chart illustratesi

o 95 non-Communist oil consumption felln rosponse to conservation and substitution away from oil. in spite of economic growth, consumption fellercent last year to.

o At the same time, non-OPEC production

9 Ample supplies, falling demand and prospects of lower

oil prices, in turn, caused non-Communist oil

inventories on land to fall byil Hon barrels

o esult. OPEC oil production dropped by about 15

rorcont95 and o Average OPEC prices felleak0 per

barrel1er barrel last year. Paced with an eroding market share, OPEC countries decided late last year to defend market share even if it meant lower oil prices.

As the second

chart illustrates, spot crude prices have plummented over the last three months. These lower spot prices are now pulling official prices downward. Wo estimate the average world oil price in late February fell toer barrel compared to year.

OPEC producers have adopted flexible marketing arrangements in an attempt to recapture market share. OPEC February output, including natural gas liquids, climbed to about,bove last year's averago.

The increase has comeime when commercial oil stocks in the West are probably already above planned levels and just as the seasonal decline in consumption is about to begin. OPEC has been able to increase production because its Timbers

have so far been more aggressive than some of their non-OPEC competitors in marketing their oil. How producers respond to lower seasonal demand this spring will determine near-term price movementr..

The market outlook for the remainder6 offers little relief for producers. Given our estimates for consumption, inventory behavior, and non-OPEC supplies, demand for OPEC oil6 will approximate, or about the same as last year. Demand for OPEC oil will vary seasonally over the year, and will probably fallow of abouturing the spring and summer months,ercent below current levels.

This expected seasonal decline In oil demand will put severe downward pressure on prices during the next several months, unless producers are willing to cut output from current levels. O The first bar of this chart shows estimated oil demand for the first quarter6 and the breakdown between OPEC and non-OPEC supply. OPEC countries supply about, and non-OPEC countries produce roughly.

O The second bar shows how demand will fall in the spring and stay low over the summer months and illustrates the problem that producers are facing. Someone will have to cut production by as muchillion barrels per

In our judgment, non-OPEC producing countries aro unlikely to voluntarily cut output significantly, despite continuing pressure from OPEC countries, for several reasons:

o Non-OPEC producersarge group with disparate

elatively small share of world oil trade, and no mechanism for communication or coordination. As the next chart shows, although these countries produce over, theyarge portion of their output. Net exports, represented by the smaller bar, approximate only, and would have to be slashed by more than one-third, an unacceptably large reduction, for OPEC to maintain current output without further price declines, o Voluntary cutbacks, moreover, are risky. Non-OPEC

producers realize they might have to restrict output for an indeterminate period in order to prop up prices. In addition, they cannot be assured that other producers, including OPEC members, wouldn't immediately boost output toigher share of the market. nability to adhere to past quotas has undermined confidence that any kindofcoordinated output-reduction

Many individual country governments have voiced their opposition to market intervention to bolster prices. In some cases, however, producers may be willing to offer token cutbacks or will attempt to score political points by portraying output reductions

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madeesult of marketing or other problems,ign of solidarity with OPEC.

Norway, so far, is sticking by its long-standing policy of non-intervention. Projections of lower oil revenues, however, are sparking domestic political debate and the government appears to be searching for some flexibility to deal with future marketIf prices fall so low that capital

Oman has said that agree to cut

LOC's are also unlikely to bow to OPEC pressure to reduce output. Many countries are striving for energy self-sufficiency or need the foreign exchange earnings that oil exports generate.

it will reduce Its output it ail pr production as partorld producer accord.

Both the Soviet union and China have voiced support for worldwide production cuts. Any production cutback by the Soviet

Despite an intensive campaign to push the blame for falling oil prices on non-OPEC producers, it appears that if OPEC

countries want prices to stabilize near current levels, they will

Some of the poorer OPEC countries, particularly those with little excess production capacity, have been surprised by both the pace and extent of the recent price decline, and are feeling the pinch of lower revenues. The blame for the deteriorating


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In sura, producer intentions and market forces pointontinued decline in oil prices.

A decline in oil prices is generally good news for the global economy. Lower oil prices will give impetus to economic growth and employment, helo keep Inflation under control and for many LDC energy Importing debtors such as Brazil, reduce the financial drain on their economies. On the other hand, many LDC oil exporters, especially those already debt-troubled, will encounter financial problems with sharply lower oil prices. In some countries these problems could be severe, and may prompt political unrest or major policy shifts. As this next chart shows, at an oil price ofer barrel, for example.

believe that the governments of Algeria and Indonesia will be able to effectively manage any protests over economic conditions.

Finally, let me briefly address some implications for the long-term oil market. Lower oil prices will tend to raise demand, slow supply development andeturnight market situation. No one knows precisely the magnitude of the consumption or supply response to lower oil prices. Some argue that oil consumption will rise fairly quickly, especially at extremely low prices because of faster economic growth and substitution back to oil. Others believe structural changes and prospects of higher oil prices In the future will moderate increases in oil consumption. Economic models based on historical trends will likely be ooor predictors of the impact of lower prices.

Despite tho uncertainties, we believe lower oil prices will slow exploration and development. In addition, they will tend to

dampen conservation and substitution, boost oil demand andreturn to tight market conditions. Under theseon Middle East oil supplies will likely increasebecause most of the non-Communist oil reserves are in As this chart shows, about two-thirds of knownoil reserves are in the Middle East, and aboutare located in Saudi Arabia. Given the longto develop new supplies and the current excessthe Middle East, these producers would eventuallyshare If lower prices persisted for several years.leave the market more vulnerable to supply disruptions



Although substantial surplus production capacity currently provides the oil market considerable flexibility, the unstable situation in the Middle East couldurnaround in the oil market. Surplus available production capacity averages about, butf this lies outside the Gulf region. Persian Gulf countries still provide about one-fourth of total non-Communist oil supplies and most of the oil still flows through the strait of Hormuz. Continued Iraqi attacks against the Khark Island oil export terminal increase the risk that Tehran may move to disrupt oil flows from the Persian Gulf. Recent Iraqi military setbacks could cause Baghdad to step up

Secret "CrGnfi

Crude Oil Reserves

(Billions of


Otheraudither OPEC

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