Prospect of slipping prices has Big Oil shifting gears
As a result of OPEC's inability to agree on a pricing structure, the oil industry is preparing to make some significant changes.
* Oil companies now plan to buy more crude oil on the world spot markets instead of rounding up supplies by means of long-term contracts.
* Exploration for new supplies of oil will be reexamined using a new factor: cost. If the price of oil continues to fall, drilling on many marginal prospects will be scrubbed.
* Marketing of oil will continue to be aggressive, which may have some ramifications as to who stays in the refining business.
These are some of the major trends oil industry executives and analysts see developing in the wake of the recent inconclusive meeting held in Geneva by the Organization of Petroleum Exporting Countries. Although some of the trends were already in effect, they will now be reinforced.
For example, oil companies had already been buying more crude on the spot markets. But from interviews with company executives, most of whom prefer not to be identified, it is clear they now intend to buy less oil through term contracts. One executive at a major company explained, ''As the contracts come due, we will renew them for less crude than we were taking and purchase whatever else we need on the spot market.''
About 5 percent of all oil buying now takes place in the spot market. The executives indicate, however, that they would not be surprised to see that swell to 10 to 15 percent in the months ahead. Currently, the spot markets are quiet. One executive said this was the result of the uncertainties hanging over the markets. ''People are willing to draw down inventories,'' he commented, ''and wait to see what happens.''
There are ramifications of increased purchases on the spot market. Aivars Krasts, vice-president for coordination and planning at the Stamford, Conn.-based Conoco, says more use of the spot market may result in increased volatility and wider swings in price. ''In the past, the price of oil has moved stepwise,'' he commented.''Now it may be in a more sawtooth pattern.''
Prices will react much more sharply to supply and demand, another executive said. This will make planning - an important function at oil companies - more difficult. The price swings will apparently be most beneficial to companies that are agile traders and can most quickly take advantage of price differentials.
Without exception, oil company analysts expect to see the price drift lower. Exactly how much is the subject of some debate. One major company said it was planning to pay $26 to $28 a barrel for Saudi Arabian light crude over the next six months. Another said the consensus in his company was that the price would fall at least $2 a barrel, indicating a $28-a-barrel level.
Another executive, whose job is planning when to buy oil for a major oil company, said this erosion was good for the industry. ''Oil priced at $34 per barrel was too high,'' he commented, ''and demand went away too fast. My own view is that if OPEC had held together and tried to maintain too high a crude price, it could have led to chaos.'' Specifically, he feels oil will slip to $20 a barrel before moving back to $26 later in the year. ''The reality is, they couldn't have held $34 per barrel even if they all agreed to it,'' he said.
In large part, notes Barry Good, an oil analyst with Morgan Stanley & Co., the pressure on oil prices has come because of a major structural change that has taken place in the industry. Because the companies no longer have as much control over the producing part of the business, they are now constantly looking for the best deal they can get on crude oil. ''For any refinery,'' Mr. Good said , ''the critical cost is how much you are paying for crude. Thus, an acute adversarial relationship has developed between buyer and seller.''
Reinforcing that change has been a shift in tax rates, Good noted. For example, oil companies now pay a tax rate of 80 to 90 percent of their revenues on oil pumped from the North Sea. And, with the windfall profits tax in the United States, their tax rate is about 80 percent. In the refining end of the business, however, it's 40 or 50 percent. Thus, the companies have been upgrading their refineries, because they can achieve higher aftertax returns in refining.
Oil companies react to a falling price of oil faster than consumers do. Thus, the executives expect that the exploration part of the business will suffer first. Exploration and drilling costs come directly out of cash flow. When oil prices fall, cash flow falls.
John Bookout, president of Shell Oil, once noted, ''We generally spend what we have. We can't spend what we don't have.'' Oil companies don't borrow for exploration purposes. Thus, one executive at a major company commented that, ''no doubt about it, we'll take a close look at marginal drilling prospects. We probably should have done it all along.''
The fallng price of oil will make developing large and expensive new oil fields a difficult proposition. Mr. Good notes that a gyrating price of oil ''puts a premium on being able to guess the price when a big project comes on stream.''
For example, Atlantic Richfield, at a cost of $8 billion, is developing a huge new Alaska source, called the Kuparuk Field, which should be producing 250, 000 barrels of oil per day by 1986 or '87. It will cost $8 billion. ''You can't go ahead with this project if the price is $20 per barrel,'' Mr. Good said, adding, ''If the price is flipping between $15 and $30 per barrel, I wouldn't want the job of deciding if it should be developed.''
Another ramification of falling oil prices is that governments around the world will see their incomes dwindle, since oil taxes are now a significant component of the price consumers pay. In fact, taxation should shield the oil companies from much of the brunt of any price drop. If a government receives 80 percent of an oil company's revenues from sales, it is the government that feels the price drop the most. And, as Mr. Good says, ''OPEC is quite aware of the fact that if it cuts the price of oil to stimulate demand, the consumer won't notice it, because his taxes will be raised. . . . Cutting prices is a thin reed as far as stimulating demand.''
Despite the current oversupply of oil, the industry still believes there will be shortages in the future. A lot depends on government reactions. If oil prices drop but taxes rise, Mr. Krasts of Conoco concludes that ''we will head for a government-induced shortage around the turn of the decade'' as drilling shrinks.