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.

Oil Bites Back

A generation had passed since the oil companies brokered their first Middle East oil deals. World oil consumption had exploded during the immediate post-war years and the Middle East was the source of much of that growth. None of this was lost on a new set of leaders in the Middle East who resented the carve-up of their region by the colonial powers and the cut-price concessions the major oil companies had negotiated. In a world dependent on hydrocarbons, the Middle East could and should get a greater share of the profits, the producing nations reasoned. The time had come to challenge the majors.

The catalyst for this challenge came not from some cavalier Lawrence of Arabia figure or even from Soviet meddling. It came from Venezuela where, in 1948, a populist government had passed a new petroleum law. It ensured Venezuela would now share all “rents” – the market share profits plus extra fees that took into account various costs of production – in a 50/50 split with the major oil companies. The companies, realizing that the US government wasn’t going to back them up and fearful that they might lose everything if Venezuela nationalized its oil business, agreed to the new deal.

Word of the Venezuelan deal spread and by 1949, Saudi Arabia was demanding the same terms. Aramco might have rebuffed the Saudi government had it not been for a new group of independent oil men, epitomized by Oklahoma millionaire J Paul Getty who offered far higher terms for Saudi concessions. If this American was prepared to pay so much, then obviously the majors were taking the Saudi government for a ride. Soon, Kuwait and Iraq had also cut their own 50/50 deals.

Iran also tried to get BP, the sole operator in the Anglo Iranian Petroleum Company, to agree to such a deal, but its chairman, William Frasier rejected it outright. It would prove disastrous for BP. In 1951, the new prime minister of Iran, Mohammed Mossadegh  called for the nationalization of Iranian oil and the seizure of BP’s oil fields. BP retaliated by organizing a boycott of Iranian oil effectively depriving Iran of its primary source of income.

Mossadegh’s revolt was a direct affront to Western interests in the Middle East. If BP could be thrown out of Iran, what would that mean for the other majors in the region? The US and Britain may have been concerned about the Soviet threat in the region but they were more worried about their companies losing their sweetheart deals. So, in a move that continues to affect Iranian attitudes to the West today, the CIA, at Britain’s prompting, staged a coup and forced Mossadegh out of office. In his place they put the young Shah Reza Pahlevi on the Peacock throne. The West, it was clear, would let no one interfere with its control of Middle East oil.

Mossadegh’s message of resistance was carried on by Egyptian dictator Colonel Gamal Abdel Nasser. He was not just a nationalist and anti-colonialist, he also sought to unite the Arab world in a campaign for the dissolution of Israel. Nasser was perfectly candid about the role oil played in his revolutionary thinking, calling it “the vital nerve of civilization” and vowing to use oil as a weapon to overcome imperialism.

The only problem for Nasser was that Egypt didn’t have any oil. But it did have the Suez canal which carried the majority of Middle East oil shipments to Europe even though stewardship of the canal was still controlled by Britain and France. In just a few months in 1955 Nasser successfully scared the hell out of US and Western Europe by turning to the Soviet bloc in search of weapons and raising the prospect that the canal might fall under Communist control.

Britain and France, fearing an economic catastrophe and also furious at the latest demonstration that their colonial power had crumbled, took an aggressive step – they decided to invade the Suez to protect the canal. Israel, already smarting for a fight to topple Nasser, volunteered to come along for the ride. The only ally they neglected to tell was the US who could only look aghast, not so much at the attempt to overthrow Nasser, but at the damage caused to Arab diplomacy by Western paratroops fighting together with Israeli troops.

The Suez drop was a huge embarrassment for the Europeans. Arab oil nations promptly banned all oil shipments to Britain and France and the US also declined to bail them out. The Europeans immediately retreated and with them disappeared their influence in Middle East affairs.

Three years later, Nasser again unsettled the West when he helped engineer a military coup against the British backed Hashemite royal family in Iraq. The new Arabist regime put pressure on the major oil companies and in 1960 it revoked 99.5 percent of the concession granted to the Iraq Petroleum Company, leaving the Seven Sister companies with only the three fields it was then producing. The Arab nations were beginning to flex their muscles. Oil they realized could give them great power if they worked together.

The Age of Energy

The war in Europe had only been over for a few months when first President Roosevelt traveled to meet a world leader he might not have given the time of day to just a few years before - Saudi King Ibn Saud. There is no official record of what Roosevelt and the Saudi king discussed, but a number of accounts assert the US president promised to guarantee Saudi national security (not least from Great Britain whose imperial traits Ibn Saud had a particular dislike for) in return for continued and preferential access to Saudi oil. The potential prize was huge – in 1939, Standard Oil of California along with Texaco had struck Saudi oil. The companies had agreed a 60 year concession with Ibn Saud covering 440,000 miles, one sixth of the continental US. Now, geologists at the newly formed Saudi-American Oil Compnay, Aramco, confirmed there was more oil underneath the Saudi sands than in the whole of the United States.

The US and Saudi Arabia had good reason to be concerned. The world was divided into two camps and Middle East oil was caught in a superpower struggle between the US and the Soviet Union. As Daniel Yergin describes in The Prize, his sweeping history of the oil industry, the US believed that “The Middle Eastern oil fields had to be preserved and protected on the Western side of the Iron Curtain to assure the economic survival of the entire Western world.”

In 1940, America had accounted for two thirds of all global oil production. But the immediate post-war years saw an enormous growth in world oil demand and, while the US could still meet most of its own domestic demand, Saudi oil soon became an important part of the Marshall Plan to bail out Western Europe. US president Harry S. Truman wrote to the Ibn Saud in 1948, “No threat to your Kingdom could occur that would not be a matter of immediate concern to the United States.”

Socal and Texaco had won the right to develop Saudi Arabia’s oil industry but they quickly realized that the task was so immense that they needed outside help.  The companies that Socal and Texaco reached out to were Exxon and Mobil.

The entry of Exxon and Mobil into Saudi Aramco signaled the end of the Red Line Agreement but it also allowed all the US and European majors to put aside their rivalries and protect their mutual interests in the Middle East. United, they could shut out other oil companies from lucrative contracts and also control Middle East oil output. So successful were they in this strategy that they earned themselves the enmity of other independent companies. They also picked up a sardonic nickname to describe their cozy realtionship, the Seven Sisters. Through the multi-decade sweetheart deals signed in Iraq, Iran and Saudi Arabia the Sisters (Exxon, Mobil, Shell, BP, Texaco, Socal and Gulf) would transform themselves into the greatest multinationals in the world. For a time, they would be more powerful than the countries whose oil fields they were drilling.

The US government let the four Aramco members act as de facto US ambassadors to Saudi Arabia, not least because the US government was a strong supporter of the new state of Israel, a position the anti-Zionist Saudi King abhorred. Despite their disagreements over Israel, both the US and Saudi found common cause in a greater concern: the Soviet Union’s own territorial ambitions in the region. And this wedded US foreign policy even more closely to the business needs of the major oil companies. So while back in the states, the companies were fighting tooth and nail against the government over new antitrust and price fixing charges, abroad they were America’s eyes and ears in what was becoming the most influential region of the world.  This blurring of business and diplomacy suited both parties: the oil companies had been negotiating deals in the Middle East since the 1920s and they understood the workings of the region better than the US state department. The companies’ close ties to the US government also enhanced their standing with Middle East governments. Before long though, the perception that the majors were doing Washington’s bidding would come back to haunt them.

The Rise of Big Oil

The lessons of the First World War were all too obvious – the Great Powers needed oil to survive. And while new finds were being made in the US and Mexico, one region of the world was attracting more interest than any other – the Middle East. Pre-war the US had been content to develop its domestic reserves and leave foreign prospecting to the Europeans. Now, it was adamant that Britain and France should not carve up the Middle East alone.

Britain and France had agreed to divide up responsibility for the Arab lands of the Ottoman Empire, which had been allied with Germany during the war, but had now disintegrated.  Central to their ambitions was Mesopotamia, which Britain quickly renamed Iraq, and specifically the region around Baghdad and Mosul that were believed to hold huge oil reserves. Iraq’s potential had first been identified by a savvy Armenian oil prospector, Calouste Gulbenkian. In 1914 he put together the Turkish Petroleum Company, a syndicate involving Anglo Iranian, Shell, Deutsche Bank and himself, holding five percent of the concern.

After the war, Britain and France agreed to let the US companies, Standard of New Jersey (Exxon), Socony (Mobil) and five other US companies take Deutsche Bank’s stake in what was now called the Iraq Petroleum Company.  With Britain overseeing Iraq, the local puppet rulers rubberstamped a very favorable concession for the foreign companies - exclusive drilling rights in Iraq until the year 2000.

Gulbenkian, wary of being squeezed out by the major oil companies, was insistent on one condition in the contract: no member of the Iraq Petroleum Company would undertake operations anywhere else within the Middle East lands of the former Ottoman Empire without the joint cooperation of the other members. There was just one problem – no one was really sure just how far the Ottoman lands extended. So when the new members of the company came together to finalize the deal, Gulbenkian took a red pencil and drew a rough line on a map around what he understood to be the Ottoman lands. Inside the line lay all of Iraq and Saudi Arabia. Gulbenkian’s guess had fortuitously pinpointed the greatest oil fields in the world and it put them in the hands of Western oil companies. In establishing a de facto non-compete agreement between Shell, BP, Exxon and Mobil, Gulbenkian’s Red Line agreement, as it became known, created a cartel out of the world’s pre-eminent oil companies. As for Gulbenkian, he got to keep his original stake in the company. He would forever be known as Mr. Five Percent.

The Second Great Oil War

Twenty years after the end of World War I, Europe once again found itself facing war. This time, all the powers knew that oil would make the difference between victory and defeat. The US once again used its plentiful oil fields to supply its own war needs and those of Great Britain. But Germany, just as in the First World War, was forced to undertake a risky strategy to capture foreign oil supplies.

Germany believed that its key to victory was a series of short overwhelming mechanized attacks – the blitzkrieg – and at first it was very successful. One reason for the blitzkrieg was that Hitler knew he didn’t have enough oil to compete in long drawn-out battles. To counter this weakness, Germany had two goals in mind – its Panzer tank divisions would punch through Russia and snatch the Baku oil fields before continuing on to secure the grand prize of Iraq and Iran. But Operation Blau, as this grand oil grab was called, faltered before it could ever reach Baku. The German army had to travel thousands of miles to reach the Caucuses and the speedy Nazi tanks outran their own fuel supply lines. Short of gas, and caught in the heavily defended Caucasus mountains, the armored divisions had to be refueled by camel trains as their own trucks had run out of gas. In its desperation to capture Baku, Germany left its sixth army stranded and short of fuel outside Stalingrad. Surrounded by Soviet forces after a six-month siege, the Germans needed only to fight for 30 miles to escape. But their tanks only had 20 miles of fuel in them. The decision to strand the sixth army by refusing to divert the Baku-bound forces was taken by Hitler himself. “Unless we get the Baku oil, the war is lost,” he told his commander of the forces in the Caucasus.

Fuel shortages would continue to bedevil both sides as the war went on. General Erwin Rommel, father of the Afrika Korps, the most mobile and effective tank division Germany possessed was undone in North Africa when the allies destroyed his refueling lines of supply while the hard-charging American General George Patton and his rampant Third Army was prevented from what could have been an early and decisive invasion of Germany in 1944 by a lack of fuel. “My men can eat their belts” he said, “but my tanks have gotta have gas.”

The United States may never have entered the war were it not for Japan’s desperation to capture the oil fields of Indochina. As early as the mid-1930s, Japanese economic planners had come to the conclusion that Japan’s plans for the aggressive colonization of Southeast Asia would fail unless it controlled its own oil destiny. That meant invading the oil fields of the Dutch East Indies but this strategy risked an attack by the US, who already wary of Japan’s imperial ambitions, had recently moved the American fleet from California to Pearl Harbor in Hawaii. Faced with Japan’s invasion of Southern Indochina and its new alliance with Germany and Italy the US had frozen all Japanese financial assets cutting off its ability to purchase US oil.

It was at this point that Japan took its own fateful plunge – the pre-emptive attack on Pearl Harbor in an attempt to destroy US influence in the Pacific. To a degree they were successful. The December 7, 1941 assault decimated many ships in the fleet. But the Japanese also made a big mistake. They failed to hit the four and a half million barrels of oil stored at Pearl Harbor. If they had destroyed America’s Pacific oil reserves the whole fleet would have been immobilized.

Over the next four year, Japan would be methodically expelled by Allied forces from the Pacific islands and Southeast Asia. And with each defeat, it saw its access to oil dwindle. By the time the first atomic bomb was dropped on Hiroshima in August 1945, Japan was already a spent force. The US navy was sinking every Japanese oil tanker before it could return home from the Dutch East Indies and the Japanese Navy didn’t have enough fuel to leave its home base. The shock of the atomic attacks ended the war, but it was a lack of oil that defeated Japan.