Glut and Cut
By the early 1960s, there was far more oil available on the world market than even the multiplying demand for automobiles and passenger jets could sustain. Compounding this glut, the Soviet Union had restored its oil fields to near full production and was aggressively selling on the world market. The major companies were forced to discount the price at which they sold their Mid-East oil, but they still had to pay the producing nations the official price for crude oil they’d set under the 50/50 agreements. This meant the companies had to discount their oil at the pump and were only receiving 40 or even 30 percent of the profits. They were, however, still making a handsome profit thanks to a clandestine scam worked out with the US state department that allowed the companies to deduct the extra money they paid the producing nations as losses on their US corporate tax bill.
Still, they were not prepared to absorb the depressed oil prices alone. In 1959, BP unilaterally cut the posted price of oil by 10 percent outraging the oil exporters. Two men in particular – Juan Pablo Perez Alfonso of Venezuela and Saudi oil minister Abdullah Tariki - began planning a new oil producers cartel that would stand up to the Seven Sisters. Then, in 1960, Exxon cut the posted price of oil once again, forcing all the other majors to follow suit. This cut into the national economies of the oil producing nations all of whom depended on their oil profits for the bulk of national revenue. Within a month, Alfonso and Tariki convened the major exporting countries – Saudi Arabia, Venezuela, Kuwait, Iran, and Iraq – and they agreed to establish a new organization to protect their interests. It would be called the Organization of Petroleum Exporting Countries, OPEC for short, and it would maintain the price that the producing nations wanted on the global market.
The oil companies realized they’d made a big mistake but it was still hard for them to believe that this new organization could have any real clout. For the next decade, the seven major companies paid lip service to OPEC while also undermining it by cutting deals with individual member nations.
Still, OPEC’s potential and the West’s growing dependence on Middle East oil worried the Western powers. Global demand for oil was finally catching up with supply and by 1970, the production glut was over. Unfortunately for the US, this rise in demand came just as US domestic production peaked reached 11.3 million barrels a day. Never again would it be so productive, and the nation that had come to take cheap oil for granted would from this point on be dependent on foreign oil to meet its needs. The US could no longer count on the security surplus of oil it had maintained for over 50 years. Though it didn’t know it yet, America had discovered its Achilles heel.
By the start of the 1970s, the oil producing powers could see it was their oil, not that of the United States, that mattered most to the world economy. There had been a 21 million barrel increase in demand for oil in the non-Soviet world since 1960 and two thirds of that demand was being met by the Middle East.
Just as the world’s oil consumers were dependent on Middle East oil, so were the major oil companies. And that gave OPEC great power whenever it chose to use it.
OPEC’s first thrust was spearheaded by Libya. Under the aggressive tack of a new dictator, Colonel Muammar Qadaffi, threatened to nationalize all of its oil fields unless foreign companies improved upon the 50/50 split. Libyan oil was crucial to the economies of Western Europe – it was easily refined into gasoline and had cheaper transportation costs than Persian Gulf oil - and the companies took his threats very seriously. As soon as Qadaffi upped the old 50/50 deal to 55 percent in Libya’s favor, Iran demanded a similar deal. Knowing they’d have to offer the same deal to the other Gulf states, the companies agreed to a 55/45 split in the exporters favor in 1971 along with a 35 cents increase in the posted price of crude oil to be renewed annually.
It didn’t last. Within two months, Libya had strong-armed the companies into another price increase and the new agreement would be whittled away by the exporting nations over the next two years.
By 1973, the market price for crude oil had doubled from its 1970 level. But if the Mid-East producers were making more money, so were the oil companies. OPEC had intended to reduce the companies’ take and redress the balance towards the producing nations, not increase it. Now in October 1973, OPEC announced its intention to set new prices without consulting with Big Oil. The new prices would reflect the desires of the Middle East, not America, Japan or Europe. As Saudi oil minister Sheik Ahmed Yamani declared in the fall of 1973, “The moment has come. We are masters of our own commodity.”
Triple Shock
Just as OPEC ministers were convening to discuss new prices, Egypt and Syria, supported by the Soviet Union, launched a surprise attack on Israel, the start of the Yom Kippur War. Israel, in danger of being overwhelmed, called on the US for help. And when the US military first flew in supplies to its ally (albeit reluctantly) and then okayed a $2.2. billion military aid package for Israel, the Arab nations reacted with indignation.
First, OPEC raised the posted price of oil by 70 percent, bringing it up to $5.11 a barrel, the same price it was currently trading on a now very jittery spot market. Then Saudi Arabia announced its intention to cut off all oil exports to any nation that supported Israel. The other Arab states all did the same.
In the past, the US might have shrugged off this oil blackmail, confident that its powerful Texas, Oklahoma and California oil fields would simply ramp up production to meet the fall in supply. But those days were over. Saudi Arabia was now the only nation with enough excess producing capacity to act as the “swing” producer – upping production to match a shortfall elsewhere in the world. And Saudi Arabia was the one causing the shortfall.
The embargo, combined with OPEC’s price hike, caused panic around the world. By November, oil prices had jumped from $5 to $16 a barrel. At the time, the Nixon administration was so distraught over the embargo that it drew up plans to send troops to the Middle East to seize oil fields in Saudi Arabia, Kuwait and Oman. According to British intelligence documents, the US contemplated holding onto the oil fields for up to 10 years in order to maintain its energy security.
In the end, the Arab states lifted the embargo on Western Europe after those countries pledged their support for the Arab position but waited until the spring of 1974 to resume shipments to the US. OPEC had shown that the Arab states now controlled oil prices and now the main Middle East members began nationalizing their oil industries. The Seven Sisters found themselves frozen out of Saudi Arabia, Iraq and, with the 1978 overthrow of the Shah, Iran as well.
The Ford administration took immediate action. In 1975, it established the Strategic Petroleum Reserve, an emergency stockpile of up to 1 billion barrels of oil that would be stored in empty salt caverns underneath the Texas and Louisiana coast and could be accessed in times of an energy emergency. Today the reserve holds nearly 700 million barrels of oil – just over one month’s supply of America’s total daily oil consumption. The same year, Congress passed the Energy Policy and Conservation Act establishing the first ever fuel economy standards for US cars and trucks.
In 1978, western consumers suffered a second oil shock when the Shah of Iran was toppled by the Islamic revolution of Ayatollah Khomeini. In the process, the US embassy in Tehran was stormed, 50 hostages taken and all foreign oil companies were thrown out of Iran. This time, Saudi Arabia upped its own production to meet the shortfall but panic once again gripped the world oil markets. Crude oil prices shot up to over $30 a barrel.
Just when it looked like things couldn’t get worse, the Iraq regime of Saddam Hussein invaded Iran in 1980, sparking a war involving two of the world’s most important oil producers and triggering the third oil shock. Crude prices went over $30 a barrel once again.