190. Memorandum From the Director of the Office of Fuels and Energy (Oliver) to the Assistant Secretary of State for Economic Affairs (Solomon)1
SUBJECT
- Significance of Recent OPEC Resolutions
The Eleventh Session of the OPEC adopted two resolutions indicating new moves by the member countries to increase their revenues from oil and ultimately to raise prices at which crude oil is sold by concessionnaire companies.
Resolution 71 recommends that each member country take steps toward the complete elimination of [Page 347] the tax free discount off of posted prices permitted the companies. The discount was granted in the OPEC settlement of 1964 as a quid pro quo to the companies for their agreeing to treat royalty payments to governments as an operating expense instead of as a part of the total tax liability to governments as was the case under the original 50–50 profit sharing formula. The net effect of the tax free discount under the 1964 settlement was to offset in part the amount governments would receive by treating the standard 12.5 percent royalty payment as an operating expense. By the terms of the 1964 agreement, negotiations are to take place this year on the amount of the tax free discount for 1967 and future years. The companies are committed to reduce the discount if market conditions justify a reduction below the 6.5 percent rate in effect for 1966.
If the OPEC membership were to succeed in forcing an immediate elimination of the discount beginning in 1967, total payments to governments would be increased significantly. For Kuwait for example, discontinuance of the discount would result in an increase in payments to the GOK of about $0.05 per barrel of production, or $40 million per year.
The producing companies are certain to resist any move by governments to terminate the discount, and the probability is that the best the governments will obtain will be agreement to eliminate the discount gradually over a period of years, at a rate of decrease of perhaps 1 percent per year over five years.
The important point in respect of this resolution is that altering the percentage discount will require protracted negotiations with the companies. Therefore Resolution 71 should not have an immediate impact upon either government revenues or the cost of crude oil to the companies.
Resolution 72 recommends that member countries apply posted or “reference” prices for the purpose of determining the tax liabilities of the oil companies operating in their territories; and that no petroleum rights be granted or contracts entered into concerning exploration or exploitation of new areas unless royalty payments and income tax liabilities are calculated on the basis of posted or reference prices, or unless the share to be obtained by the government is not less favorable than that obtained under existing arrangements based on posted or reference prices.
This resolution derives from a resolution taken at the Tenth OPEC conference in December 1965 directing the Economic Commission of the OPEC to study the “implications” of applying posted prices for tax purposes. Of significance is the fact that the December 1965 resolution was taken “in pursuance of” a September 1960 resolution which said member countries would require oil companies to maintain stable prices, try to reestablish posted prices at levels prevailing before these were cut (in 1958–1959), and assure that oil companies enter into consultations with governments to explain any circumstances they felt required any future price modifications.
A posted price system does not now apply in all OPEC member countries. Venezuela and Indonesia compute income liabilities on prices realized on crude sales. In Saudi Arabia, ARAMCO sales to non-affiliated [Page 348] companies are taxed at realized prices. The OPEC countries have apparently concluded that so long as crude production in some countries is taxed on actual sales realizations the way is open for some companies to grant “excessive” sales discounts off of posted prices which depress the price of crude oil on world markets. If posted prices were the uniform rule in the OPEC membership this would have the desirable effect of steadying and stabilizing world crude oil prices.
We believe that this resolution will not prove too difficult for the OPEC countries to bring into effect. Venezuela is already considering an offer by the oil companies to compute future taxes on a “reference price” basis. Saudi Arabia has raised with ARAMCO the idea of calculating income from third party sales on posted prices applying to transfers to affiliated companies. Our assessment is influenced by the conviction that most “major” international companies are accustomed to a posted price system and can see some advantage in placing Venezuela and Indonesia on the same basis in that tax disputes and claims for additional tax payments by those countries might be avoided in the future. There is a further attraction to the old line majors to posted prices; it could affect the capability of the “newcomers” internationally to compete with them in major markets. The latter companies do not have anything like the integrated marketing structure of the major companies. The newcomer’s ability to sell at discounted prices and be taxed on those prices has assisted their effort to find markets for their production. To the extent that the range of discounts those companies can offer is narrowed by having to compute taxes on posted prices, particularly when posted prices are out of line with market realities, the newcomers will be able to compete less favorably with the majors in the principal international markets.
Once a posted price system is in effect throughout OPEC, a logical subsequent move by the OPEC countries would be to demand some increase in actual prices posted. Such a move would support the objective stated in the 1960 resolution to obtain a return of posted prices to 1958–1959 levels.
Resolutions 71 and 72 have implications for consumer countries. Each amounts to an increase in real costs of crude oil to the companies which will be reflected in prices offered consumers. The range of discounts off of posted prices companies are willing to absorb as a cost of doing business is narrowed in either case, and increases of the real costs of crude to the producer will be passed on to the buyer.
The Eleventh Conference also adopted a non-specific resolution on future production programming within the OPEC membership, although at a prior meeting this year OPEC had announced that a decision had been made to “go into the second period of the joint production program.” The resolution refers to “unsatisfactory” rate of [Page 349] production increase in “certain” member countries, and attributes this condition to “manipulation” of production by companies. It warns that all members will give full support of efforts by those countries “to safeguard their legitimate natural national interests” should their “rates of growth not be improved to satisfactory levels during the year 1966.”
This last resolution probably is another case of producer countries using the OPEC as the “bogey man” so to speak in pressuring companies to meet their demands. Nevertheless it is an indication of the concern some members have with the levels of production, and is an important resolution to keep in mind when discussing proposals such as DOD’s to return a substantial part of foreign procurement of products to the United States.
- Source: Department of State, E Files: Lot 70 D 54, PET 3 Organizations and Conferences 1966. OPEC. Limited Official Use.↩