Volume 6, Number 14, Page 1

Trade Dispute in Crude Oil: Mexico, Venezuela, Saudi Arabia and Iraq

By George Baker

For the first time in U.S. history, international commerce in crude oil is the subject of a dumping complain. The two petitions submitted on June 29, 1999 to the U.S. Department of Commerce (DOC) and the U.S. International Trade Commission (USITC) raise far-reaching questions about the nature of the world economy and the role of regulation in the world oil market.

This discussion seeks to raise questions on three orders of ideas: One, the attitude of the Executive Branch of the U.S. Government toward this petition. Two, the adequacy and fairness of the petition process itself. Three, the validity of the petition itself in the terms in which it was presented.

Attitude of the U.S. Government

The U.S. Government has known about the intention of several groups of independent producers to file this petition for over a year. The groups have argued that domestic upstream oil operations need protection against international imports; implicitly, the request is either for direct or indirect subsidies (e.g., tax credits) or import duties against competitor supplies. Recalling that in the past efforts to tax oil imports have come to nothing, officials in the Commerce and Energy Departments may have had a basis for believing that independent producers would not fund the estimated $1 million to file a petition, and, for this reason, the matter could be ignored.

Still, when interviewed by the Mexico City press, Secretary of Energy Bill Richardson was reported to have said, not that “this is a serious matter that could affect not only the bilateral energy relationships between the U.S. and its key partners but the course of oil prices in the short term;9” instead, he was reported as having said that these are “serious allegations,” suggesting that the Government was going to treat the claims against Mexico as ones deserving full investigation.

It may have been the hostile attitude expressed in the Secretary’s remarks that led his Mexican counterpart, Luis Téllez, to call a press conference and withdraw the Government’s earlier commitment to eliminate its controversial import duty on natural gas on July 1, 1999.

The Petition Process

Regarding the petition process itself, it is probably the case that all countries construct procedures and standards of evidence that favor domestic producers over international competitors. An example is the matter of production costs. The U.S. producer can offer “constructed” costs of an international competitor based on “like products” in comparable markets. The U.S. producer is not required to obtain actual production costs; it is the responsibility of the international producer to provide not only cost data themselves but an accounting framework that is accepted by the U.S. authorities. If the accounting framework fails to meet unspecified tests of the investigators, then the “best available information” may turn out the data-by-analogy introduced by the petitioners.

Petition

Regarding the petition itself, the analysis finds that the framing of the issues is narrowly conceived and that the negative economic impact on oil markets, inflation and national revenues would far outweigh benefits that could be achieved through granting relief to the petitioners.

The petitions are sponsored by a number of trade associations representing operators of small and marginal fields located mainly in the region from North Dakota to Louisiana. The petitions allege that a number of international producers are wrongfully damaging regional U.S. oil producers by exporting crude oil to the U.S. at prices below their fair market value. The petitioners seek relief by invoking mechanisms that would impose tariff penalties on such producers. The producers are accused of dumping oil on the U.S. market; their governments are accused of subsidizing their respective state oil companies. A hearing is scheduled for July 20, 1999 at the USITC office in Washington, DC at which time arguments for and against will be presented (see www.usitc.gov/notices).

The petitioners argue that U.S. trade policy in the past has protected domestic producers from unfair competition abroad. The public record shows that diverse industries could be cited in this connection: steel, farm products, cattle, brooms, tuna and cement.

The allegation is based on a theory that low export prices of those countries constitute commercial dumping, which, in turn, is made possible by government subsidies on production. To compensate for the alleged subsidies, petitioners seek a countervailing duty of $6.18/bbl for exports from the four countries that were eventually named in the petition: Venezuela, Saudi Arabia, Iraq and Mexico. In addition, the petitioners seek a duty penalty for dumping that ranges from 33% for Mexico to 177% for Venezuela.

Economic Theory

Before considering specific issues related to dumping or subsidies, several general questions deserve mention:

1) Is there a world oil market?

To argue that the export prices of four major oil producers are distorted for one market is to suggest that they are distorted for all exports markets, as the differences in prices between one market and another depends mainly on local price benchmarks. If the 6 million b/d of traded oil by these producers—some 25% of the world market—is at distorted prices, the remaining volume of traded oil must also be distorted, as the prices of the “tainted” oil are used as benchmarks by others. If all traded oil prices are distorted, then the existence of a free market in petroleum products is put in doubt. Does a free oil market in which oil prices respond to supply and demand exist or not?

2) Do existing crude supply contracts, as contracts, have economic value?

The petitioners believe that a producer should shut in production when market prices are below operating costs. One can imagine a market condition in which market prices fell near—or even below—operating costs. International oil exporters with supply contracts in the United States could have to ask themselves: What is the implicit cost/bbl of choosing not to fulfill a contract? In addition to revenue losses, such costs would include penalties as well as damage to the producer’s reputation as a reliable supplier. Mexico, in particular, has made points in the oil marketplace as a non-OPEC, non-Middle East supplier.

Three conclusions suggest themselves: One, considerations of the value of contractual obligations and market presence are likely to figure in an oil exporter’s calculation of the opportunity cost associated with choosing not to fulfill supply contracts in the United States by shutting in production. Two, such considerations could lead the oil producer to continue export shipments even when market prices were below the sum of sunk capital costs and current operating expenses, scaled to production units. Three, such a decision to continue export shipments would be based on sound market reasoning, not any predatory pricing strategy.

3) What counts as operating costs? What affects operating costs?

With the high capital costs associated with exploration and production infrastructure, operators, once production begins, wear trifocal accounting lenses: One lens sees the day-to-day lifting costs (reported as under $1/bbl in Saudi Arabia and $2-3/bbl in Mexico). The second lens sees the capital cost per barrel (seldom reported as such, but estimated at $2-3 in the case of Mexico). The third lens sees the sum of the two categories.

Since the early 1980s technological innovation has driven down finding and production costs, especially offshore. In the petitioner’s home state, Oklahoma, well costs are some $15/bbl to operate. Clearly, if such costs are exclusively lifting costs, these wells cannot compete with Saudi Arabia’s $1/bbl or Mexico’s $2.50/bbl. If the figure of $15/bbl represents the sum of sunk capital costs and lifting expenses, then, shorn of the former, what is the comparable figure for the region represented by the petitioners? A related question would be, how responsive would such costs be to the application of advanced downhole and process technology?

4) What is the national security meaning of self-sufficiency in oil production?

In an electoral season like the present, when conservative Republicans are looking for popular causes, a campaign slogan like “Save domestic oil” has understandable appeal among some voters. These voters may be swayed by arguments that say that a strong upstream oil industry at home means greater national security in the larger international arena.

Such a me-oriented perspective looses sight of the larger truth that the national security of any country depends as much, or more, on the economic well-being of its network of strategic allies than on the strength of any one domestic industry. In the case of the U.S., its network of strategic allies includes—on a short list—Canada, Mexico, Germany, Japan, Israel, Saudi Arabia and Venezuela. Four of these seven countries have been mentioned in the press interviews given by the petitioners as having engaged in commercial dumping of crude oil in U.S. markets.

This way of framing the issue suggests that a judgment on the merits of a national security argument is the responsibility of the highest level of government whose officials are charged with balancing the interests of local constituencies with those related to the formal and informal obligations of members of the country’s strategic international network.

Commercial Dumping

To argue that a country is guilty of commercial dumping means that the country is exporting products at prices lower than those offered in the home country and that the intent is to damage the domestic producers of the other country. In the case Venezuela, crude oil is not sold in the domestic market as such except to affiliated petrochemical companies using it as a feedstock. For that reason, an indirect measure of the underlying price of crude oil must be sought: one measure would be gasoline prices, which, since 1996, have been continuously and substantially higher than comparable U.S. prices. In March of 1999, when U.S. unleaded regular gasoline was under a dollar a gallon, in Mexico it was the equivalent of over $1.40/gal. In Venezuela, it historically has been the case that gasoline prices were below international prices. Venezuela, however, is an island market, and there if such prices were to be considered evidence of dumping, the charge could have been made ten years ago.

Subsidies

The petitioners take the case of Venezuela and point out that there is a significant difference between the lower production costs of PDVSA and the higher costs of private operators. According to the petitioners, this difference serves as a proxy for the amount that a private operator would be willing to pay PDVSA as a signature bonus in order to be allowed to operate in best areas. The difference is estimated at $6/bbl.

By extension, the petitioners reason that this amount applies equally to the other countries named in the petition, for which reason they ask for a countervailing duty of $6.18/bbl from all four countries.

In Mexico’s case, in Articles 27 and 28 of the Constitution, Pemex’s legal foundation as a public monopoly is established. As such, Pemex is the state agency legally and solely responsible for the exploration and production of hydrocarbons. Pemex in 1997-98 paid some 60% of its revenue—not its after-tax profit, but its revenue—to the Government in a variety of taxes, including a tax on production itself. Pemex does not, however, pay a tax to the Government at the point of beginning a project of exploration.

Here, it could turn out that an investigation by the US ITS could “disallow” the accounting system and procedures of Pemex, and permit, for purposes of assessing a subsidy, the constructed data of the petitioners.

One might have thought that an argument could be made that U.S. producers have to pay high regulatory and environmental costs, and that lower costs for these categories in other countries could be thought of as a subsidy. In Pemex’s case, there are very high regulatory costs, as Pemex officials have to testify routinely to a half-dozen ministries plus the Energy Commission of the Mexican Congress.

Potential consequences on the World Oil Market

The practical consequences of the petition process have a sharply negative potential. If the petitioners are able to convince the USITC that, by one measure or another, they represent at least 25% of the “regional industry,” they gain “standing,” meaning that their claims may be admitted pending an investigation. Supposing that, for example, the petition for relief of $6.18/bbl were granted. In that case, this amount would have to be put into an escrow account pending the final determination of the case, which could be a matter of 12-18 months. Given an export level of 1.3 million b/d in Mexico’s case alone, some $2.9 billion dollars would have to be deposited in a given year.

In the extreme case, the effect on world oil prices could lead to a third Oil Shock. Imagine that on Monday the average, weighted export price of the four countries named in the petition were $15/bbl and on Tuesday, owing to a subsidy penalty and a countervailing duty charge the price were $25/bbl. Two outcomes would be likely: either these countries would shut in production and choose not to sell to the U.S. market at all; in this case, prices would rise on account of shortages caused by the lack of supply. The second possible outcome would that other suppliers in the North Sea and Africa would raise their prices to match the penalty price being paid for crude oil from Saudi Arabia, Iraq, Venezuela and Mexico.

There is no spare capacity elsewhere in the world to meet such a supply shortfall, particularly if the affected countries decided to shut production in rather than export it to countries that cannot absorb it. In any case, the heavy oil supplies from Mexico, Venezuela and Saudi Arabia (about 70% of U.S. imports of this grade of crude oil), could not be found elsewhere, as Canada is the only other country that produces large volumes of heavy crude. In any case neither U.S. domestic producers of light oil nor Canadian producers of heavy oil would be able to ramp up to meet a 6 million b/d shortfall.

It would also be certain that the turmoil caused in world oil markets would result in inflationary pressures and supply and political disruptions.

Conclusion

In view of the puzzling indifference shown by the U.S. Executive Branch and the low profile maintained to date by the major oil companies, there is a is a definite and non-negligible risk that this petition may succeed. Given the enormous economic consequences associated with such an outcome, any non-negligible risk is too high.

One can only hope that the distortions and biases here illustrated that are presently built into the existing procedures for filing anti-dumping complaints will lead the U.S. Congress to review and rewrite legislation on this matter. But it may already be too late for the oil industry. n

George Baker is Managing Director of Baker & Associates, a consulting firm with offices in Houston and Mexico City.