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Oil: That Sinking Feeling

January 23, 1986

Seven years ago oil was selling for just under $13 a barrel, and its producers were counting their blessings. Then the Iranian revolution and panic buying led to a near-tripling of oil prices, and producing countries went on a borrowing spree to finance ambitious development projects. For collateral they had oil reserves that both they and their creditors knew could only increase in value. But now the oil glut that has been building for years has brought sudden new chaos to the market, pushing prices down to $20 a barrel and less. Many will benefit from this fall, even as some pay dearly.

Mexico will be one of the biggest losers. This year the scheduled interest payments alone on its $97-billion foreign debt come to $11 billion. That is an obligation beyond Mexico's capacity. Its currency reserves have shrunk drastically, and concern is mounting that some interest payments will be missed. Mexico needs billions in new loans. A U.S.-led bail-out effort is almost inevitable, but how soon that will come and how effective it might be are uncertain.

What is misfortune for Mexico is manna for Brazil, Latin America's largest oil importer and biggest debtor. Every $1 drop in the price of oil saves Brazil $150 million a year. There are other big winners--among them the airlines, which can expect to save $110 million annually for each 1-cent-a-gallon drop in the cost of aviation fuel.

The severe run-up in oil prices in the 1970s staggered economies in both the developed world and the Third World. What was lost then may now be at least partly regained. The major industrialized nations seem poised to add tens of billions of dollars to their output this year because of cheaper oil. Energy-intensive industries will gain as production costs fall, and consumers should have more to spend on other things as fuel costs go down. These anti-inflationary gains could lead to lower interest rates and greater economic expansion.

Cheaper prices have so far added little to oil demand. Structural changes that have yielded more efficient energy use in factories, transportation and homes give hope that future growth in oil demand will be both moderate and gradual. To compensate for lower prices, some oil producers almost certainly will increase output, creating further downward pressures on prices. Saudi Arabia and the rich smaller producers on its borders claim that they can wait out the price falls without harm to their economies. Heavily indebted countries like Mexico, Nigeria, Indonesia and Venezuela don't have that cushion.

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