PROPOSED OIL CONSUMPTION TAXES WORRY PRODUCERS IN MIDDLE EAST

Proposed levies on oil consumption in the U.S. and Europe cause furrowed brows among Middle East oil producers, who fret over huge capital needs to add productive capacity.

Producers say the tax plans threaten the still hazy goal of producer-consumer cooperation.

Their concerns surfaced last week in Dubai at the Middle East Petroleum and Gas Conference.

Fereidun Fesharaki, director of the East-West Center's program on resources and chairman of the conference, said the meeting was the first of what will be an annual event.

About 310 persons attended.

In addition to tax proposals in the consuming world, conference topics covered strategies for dealing with oil price volatility and the global ramifications of U.S. environmental regulations.

WHO GETS THE RENT?

Herman Franssen, economic adviser to Oman's minister of petroleum and minerals, renewed a call heard often in recent years for cooperation between oil producers and consumers.

He said, "The key issue between producers and consumers is: "Who gets the rent?" He used "rent" as the term economists give to profits in excess of costs for the most expensive unit of production.

Taxes in consuming nations take much of the economic rent from crude oil sales, he said. European Community members receive an average $10/ bbl of oil consumed, Japan $5.40/bbl, and the U.S. $2/bbl. By contrast, members of the Organization of Exporting Countries earn about $5/bbl of crude exported, Franssen said.

Acknowledging the difficulties of making producer-consumer cooperation work, Franssen said nothing should prevent governments from discussing "major policy actions with the other side." And he had a specific policy action in mind: a carbon tax as proposed in the EC and discussed in the U. S.

"All these discussions have taken place in a vacuum," Franssen complained.

OPEC CAPACITY BUILDUP

Henry T. Azzam, chief economist for National Commercial Bank of Saudi Arabia, jeddah, said the urge of consuming nation governments to tax oil consumption clashes with the needs of producing countries to add productive capacity.

He said OPEC will have to add about 13 million b/d of productive capacity during the 1990s to meet the call he projects on the group's oil with a 15% cushion of spare capacity.

Azzam said Saudi Arabia is on target with plans to boost maximum sustainable capacity to 10 million b/d by 1995 from 8.7 million b/d in 1991 at a capital cost of $16 billion. The kingdom could push capacity to 12 million b/d by 2000, he said.

Kuwait is rebuilding capacity after the Iraqi occupation and oil field sabotage. Capacity reached 1.4 million b/d in 1992 and will average 2 million b/d in 1993, stepping up to 2.15 million b/ d in the fourth quarter. The country plans to raise capacity to 2.7 million b/ d in 1995 and 3 million b/d in 2000 at a capital cost of $6.8 billion.

Capacity in the U.A.E. is to rise to 2.9 million b/d by 1995, with gains to 2.4 million b/d from 2.1 million b/d in Abu Dhabi and 500,000 b/d from 425,000 b/d in Dubai.

Outside the Middle East Venezuela will push capacity to 3.25 million b/d from 2.6 million b/d, Nigeria to 2.5 million b/d from 2.1 million b/d, and Qatar to 600,000 b/d from 450,000 b/d, according to plans cited by Azzam.

He said Iran plans to spend $5 billion to hike productive capacity to 5 million b/d from 3.6 million b/d-$3 billion offshore and $2 billion onshore - if it can raise the capital.

The market needs a cushion of spare capacity, such as the one that replaced lost Iraqi exports after its expulsion from Kuwait, but OPEC members worry that their investments in new capacity will be spoiled by deliberate effort; to raise consumption taxes and reduce demand in the EC and U.S.

"We have difficulty in this part of the world understanding that (trend toward higher taxes)," Azzam said.

U.S.TAX, IMPORTS

John H. Lichtblau, chairman of the Petroleum Industry Research Foundation Inc., New York, said a U.S. gasoline tax increase is more likely to emerge from the incoming Clinton administration than an oil import fee. He cited an apparent new policy objective of reducing oil imports and questioned the motivations behind it.

The country doesn't need to replace gasoline with alternative fuels to reduce vehicle emissions or improve fuel use efficiency, Lichtblau said. Except for pollution in Los Angeles, trends toward cleaner air and vehicle efficiency are strong.

Lichtblau challenged the pursuit of lower oil imports "for its own sake" under arguments about oil's real costs being higher than market prices.

One such argument, which focuses on "security externalties," says oil prices should reflect the money spent on military defense capability that might be used to protect overseas oil suppliers.

Lichtblau sees no evidence that military expenditures are higher than they would be if oil import dependency were half its current level.

A long term goal of reducing oil imports by the government would hurt not only exporters but much more so the U.S. refining industry, Lichtblau said.

Robert W. Walsh, president of Chevron International Oil Co. Inc., said U.S. budget deficit problems make up the driving force behind possible new oil taxes. Like Lichtblau, he thinks a gasoline tax, for which the public will blame oil companies and not the government, is most likely.

Regional conflicts will work against an oil import fee, he said, while the coal lobby will resist a carbon tax.

PRICE VOLATILITY

Several speakers cited strategies that producers-OPEC members, non-OPEC Middle East producers, and private oil companies-can use to deal with oil price volatility.

Pedro Haas, general director of Petroleos Mexicanos International, a unit of Mexico's state owned oil company, described how his organization boosts profits through trading.

Managers of oil companies, state owned and private alike, resist trading because they associate it with speculation. But trading isn't speculative if conducted by skilled traders, he suggested.

He distinguished between price ranges, which he said are determined by producers and consumers, and "the tick to tick price."

A state company has the responsibility to "participate in the market and capture as much value as we can" from the latter type of price movements, Haas said.

Philip Lynch, chairman of the International Petroleum Exchange (IPE), showed how Brent blend can serve as a vehicle for hedging a variety of crudes. In a basic hedge, a crude oil owner protects against price declines by selling enough futures contracts to cover physical volumes in hand.

A futures contract for Brent blend crude trades on IPE.

Lynch estimated the 1992 price risks of Dubai, Saudi Arabia, Iran, Oman, and Egypt at $1.31[bbl or a total of nearly $6 billion for the year. And it was a year in which price volatility was less than usual.

If the countries could have covered all their crude exports with Brent futures contracts, Lynch said, they would have reduced their total price risk by almost $4 million.

Philip Verleger of the Institute of International Economics, Washington,

D.C., urged producers, including governments, to seek income stability rather than price stability. Because of financial mechanisms such as futures contracts, forward trading, swaps (exchanges of cash flows that amount to a series of forward contracts), and options, "The search for price stability is no longer relevant," he declared.

The mechanisms separate physical sales from price determination in time and thus stabilize income flows. Newly able to diversify their cash flow sources, producers can disengage transactions from unpredictable spot prices.

Thus, Verleger said, there no longer is a single oil price. Moreover, he asserted, financial transactions are "a zero sum game," and producers who sell only at the spot price subsidize producers who diversify with the other financial instruments now available.

"There is a risk in not hedging and not using these long term instruments," he said.

Verleger further said the random nature of prices means increased use of hedging will tend to reduce prices overall. As prices rise to levels justifying additions to productive capacity, hedging will increase with the rising sales of futures contracts weakening general price levels.

Verleger also said markets are large enough to accommodate use of the new mechanisms by producing nations to stabilize incomes.

Efforts to stabilize the market with production adjustments will fail, he said, "often with disastrous consequences for producers."

And, he said, it's "no longer necessary, either, given the new instruments."

SYNTHETIC OIL FIELDS

Giacomo Luciani, deputy director for international affairs at Italy's Ente Nazionale Idrocarburi SpA, carried Verleger's recommendations a step further. He urged producing nations to develop futures or forward contracts with terms of perhaps 10 years and create "synthetic oil fields."

Underexploitation of low cost Persian Gulf reserves, manifest in the comparatively high reserves lives of most producers in the region, is "fundamentally irrational from an economic point of view," he said.

The best strategy for Persian Gulf producers is to discourage international majors from exploring and developing reserves in high cost areas, Luciani said.

In addition to developing a standard long term, synthetic oil field contract, gulf producers should press integration into downstream operations and allow private oil companies to own producing assets in their countries.

Producers need downstream assets because, "From a portfolio management point of view, it's not rational for producing countries to hold just one asset: oil in the ground." But downstream integration of national oil companies probably won't move as fast as production increases, partly because refinery owners won't sell assets as readily as they would if equity interests in production were available.

"Vertical integration will take place at a satisfactory rate only if it is allowed to be a two way process," he said.

U.S. ENVIRONMENTAL RULES

Paul Chellgren, president and chief operating officer of Ashland Oil Inc., reviewed requirements of the U.S. Clean Air Act amendments of 1990 and warned that the pressures they put on U.S. refiners will affect world markets.

Ashland estimates investments required by the amendments will force shutdown of 1-2 million b/d of U.S. refining capacity and 500,000 b/d of that is already closed.

A typical 100,000 b/d refinery will have to invest at least $81 million by 2000 to produce ultralow sulfur diesel fuel and reformulated gasoline, Chellgren said. Other new environmental rules will add $140 million to such a refinery's costs by the end of the 1990S.

The industry may need to invest $45 million for each 100,000 b/d of capacity for methyl tertiary butyl ether production outside refineries,

Refiners outside the U.S. will face similarly stricter environmental regulations and associated costs. Chellgren cited a Purvin & Gertz study estimating that the non-U.S. industry will have to spend $124 billion in the next 20 years to deal with rising consumption, tougher fuel specifications, and crude quality changes.

The higher costs to consumers might moderate expected demand, Chellgren added.

Trends point to a widening spread between sweet and sour crude prices to reflect the high cost of sulfur removal, changing export markets as producing nations leave markets not conforming to their crude quality, and strengthening demand for natural gas, coal, and other energy sources as petroleum product prices rise.