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.

Enter Europe

News of American oil quickly spread to Europe and soon Standard Oil was contracting more and more ships to meet this international surge in demand. In the 1870s and 80s, kerosene exports – most to Europe – accounted for half of all US oil production and provided the fourth largest US export in value. Ninety percent of that kerosene came courtesy of Standard Oil.

Europe also quickly realized that oil was not purely an American gift. For centuries, travelers had talked of flaming pillars that burned in Baku on the Caspian Sea and by 1871, the Russian town of Baku was dotted with oil derricks. Russian oil attracted the Rothschilds, a prominent French banking family, into the European Kerosene industry but it found its path blocked by Standard Oil. Undeterred, the Rothschilds decided to sell oil in Asia where Standard’s grip wasn’t as complete.

The man the Rothschilds found to successfully challenge Standard Oil in Asia was Marcus Samuel, a Jewish merchant from London who, thanks to his father, an import/exporter and trader of handmade seashell gifts, had strong shipping connections throughout the Far East. Samuel knew that to succeed against Rockefeller he would have to outlast Standard’s practice of flooding the market with cheap oil. To do that he would have to sell in all Asian markets at the same time ensuring that Standard couldn’t concentrate just on one market. But that meant Samuel would have to get his Russian oil to the Far East before Standard and its large network of international corporate spies found out.

In fashioning a solution, Samuel invented a new way of transporting oil and established one of oil’s most important companies. Rather than shipping barrels of oil, Samuel commissioned the construction of a new ship – one that carried the kerosene in an enormous tank. Second, he cut the sailing distance of these tankers in half by getting safety clearance from the British government to navigate the new Suez canal (kerosene shipments were banned due to the fear of the vessels exploding in the canal) thereby avoiding the long trip around Africa. In 1892, Samuel’s first tanker, the Murex, named for a type of shell, sailed through the canal. Within a decade, his new company, Shell, controlled 90 percent of the oil passing through the Suez canal.

The prospectors who descended on Pennsylvania’s Western hills in the months following Drake’s 1859 discovery of “rock oil” had no idea of oil’s true potential. They didn’t know that oil would dictate the fortunes of millions of people for the next 150 years. They didn’t know that the pursuit of oil would push great nations into war and they didn’t know that their initial wildcatting would propel the United States to become the most important nation on earth. All that mattered at the time was that there was a fortune to be made. Kerosene lamps were already being celebrated as “the new light” in cities up the Eastern coast and Pennsylvania oil promised a new abundant source.

Thousands of people – many of them Civil War veterans - flocked to stake a claim in the new oil regions. In January 1861, barely a year after Drake’s initial discovery, the price of a barrel of oil hit $10 (Drake had collected the first oil in whiskey barrels and the 42 gallon measure has remained the industry standard ever since). By the end of the year, however, as more and more wells were stuck and prospectors frantically offloaded their oil, the new pioneers came to realize just how fickle their fortune could be. Prices dropped to 10 cents a barrel and the oil industry confronted what would be the first of many gluts in its history.

Yet out of the Oil Regions’ chaos came order and control in the figure of John D. Rockefeller, owner of a small refinery in Cleveland Ohio. Rockefeller observed how the hundreds of Pennsylvania drillers were bidding against each other and so were driving down the cost of oil. Rockefeller realized the essence of making money in this new volatile industry lay not in producing oil but in controlling the transport and sale of oil’s refined products.

Though only 26 years old, Rockefeller bought out his refinery partners and started building up a strong cash position. This liquidity gave him the leverage he needed to buyout competing refineries when the next production glut sent oil prices plummeting and cut revenues for both producers and refiners.

Rockefeller soon began undercutting his rivals by persuading the railroads that carried the oil out of the Oil Regions to give him secret rebates on his shipments based on the volume of his business. By 1870, Rockefeller was able to establish a joint-stock company named the Standard Oil Company. After just seven years in the business, this company controlled one tenth of the US oil industry.

Standard Oil’s business methods were ruthless. The company tried to squeeze many competitors out of business by deliberately cutting its prices in one market, knowing all the time that with its superior cash reserves it could hold out until competitors folded. When Rockefeller bought these companies, he would keep the transactions secret so that his other competitors would not know which companies were owned by Standard and working against them.

By 1883, Standard was laying the foundations for what we now know as the vertically integrated company and the modern multinational. He owned refineries and the new pipelines that were transforming the transportation of oil. He had bought up oil fields. And he was opening up new markets for his products on the East Coast and Europe.

In 1906, following years of investigations and a series of damning newspaper and magazine articles on Standard’s predatory practices, the US government brought a massive lawsuit against the company under the statute of the 1890 Sherman anti-trust act. By now, Standard had recorded over a billion dollars profit since its inception 25 years before. The case dragged on for five years and Standard argued it all the way up the Supreme Court. But in May 1911, Chief Justice Edward White declared Standard Oil a monopoly and ordered that it must divest itself of all its subsidiaries.

By the end of the year, Standard had been split into 34 companies. The break-up destroyed Standard’s singular stranglehold on the oil industry but it didn’t destroy the strength of the Standard brand. On the contrary, Standard’s model was so strong and the US oil industry so vibrant that a number of the new mini-me Standard clones soon emulated Standard’s success. Three in particular, Standard Oil of New Jersey (later to be known as Exxon), Standard Oil of New York (Socony and later Mobil) and Standard Oil of California (Socal, later Chevron) quickly became global powers in their own right.

Big news from South America as new populist president Evo Morales brings all natural gas production under state ownership.

Call it the Chavez effect - national producers all over the world are realizing that their oil and gas supplies are a potent political weapon in these unsettled energy times….and they are adding to the uncertainty with their actions.

Bolivia’s actions follows Russia’s announcement last week that it may not give Western Europe a guaranteed market for its natural gas.

Couple these recent events with Venezuela flexing its petro-muscles, Iran adding it’s own cornered beast threats, and the continued role that China is playing in competing for world oil and you have petropolitics playing out on an unprecedented global scale.

Fascinating and horrifying to watch.

Seems that the frigid cold spell in Russia may be to blame for a shortfall in natural gas deliveries to Italy.

So says the BBC which follows up reports by other news agencies that Russia cut exports to Europe to meet its own winter needs.