The Changing Structure of the World Oil Industry

David Hawdon

• Publisher: Taylor & Francis
• Year: 2017
• eBook ISBN: 9781351388535
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Originally published in 1985 by a group of international experts and oil industry officials, this book surveys the dramatic changes which took place in the oil industry in the second half of the twentieth century. It discusses the role of OPEC and the long term impact its decisions had for both producers and oil consumers and examines possible future trends in the oil industry structure and stability, together with the possible consequences for North Sea oil and gas development.

1 THE OIL INDUSTRY. SOME PERSONAL RECOLLECTIONS AND OPINIONS

Lord Kearton

INTRODUCTION

I must say that it does seem odd that someone who retired a few years ago should be making the opening remarks at this conference on the changing structure of the world oil industry. Especially as that someone, me, was never employed in any of the major or even minor companies of the industry, and is not an economist, not a business historian or an analyst or a planner. I did, it is true, intermittently come into contact with the world of oil over a period of about 50 years and what I propose to do is to give you a sort of worm’s eye reaction. And I have lately, been a member of an energy sub-committee of a select committee of the House of Lords; so I am not a complete innocent, although far-removed from the distinguished experts who will be offering the meat of this conference. And for that matter, the distinguished participants in the conference. But the meat provided by the experts will be spiced with the insight of a minister, I am very pleased to see, an ex-Secretary of State.

Well, I had better start off by saying I regard the oil industry with admiration. And I have also had occasion to view it with some suspicion. Admiration for its boldness, its risk-taking and the ever-growing technical ingenuity and engineering expertise which it exercises. Suspicion because of the industry’s very bigness and capacity to have undue influence on governments and their decisions and even to over-awe governments. The industry has had its share of ups and downs. In its up periods it has often acted very independently and self-sufficiently with little regard to any interests but its own. When in difficulties, it has been very adept at enlisting government support for restrictive practices. Up or down, it has always favoured and mostly operated in managed markets. Competition has been within in a carapace of cartelisation.

Obviously the structure of the industry has evolved and changed as oil became the single most important commodity in the world economy. Nevertheless it is my feeling that the instincts and behaviour which have characterised the industry for more than a century still remain, although modified by the experiences of the past decade. Will it be that beyond the convolutions of today, we shall find it a case of “plus, ca change, plus c’est la même chose”?

INDUSTRY BEGINNINGS

Rockefeller in the early days of the industry set the pattern. He of course was a book-keeper. We call them accountants nowadays. He was the founding father of the big oil company ethos. That is quite straight forwardly, control the supply of the raw material, control the markets for the finished products, control prices, and cartelise. His Standard Oil Trust through its operations was the main begetter of the anti-trust laws in the United States. Yet his big oil was tiny in comparison with today’s operations. The main outlets for oil in his day were for lighting and for cooking. The takeover by oil of the energy and transportation markets was fifty years into the future. But oil as a comfort and convenience commodity was so important at the turn of the century that government intervention to establish a freer market was inevitable. Governments have sparred with oil companies ever since. It has not been a love hate relationship so much as a need hate relationship, like a stormy marriage with peaceful intervals.

The government-inspired fragmentation of the old Standard Oil was, ironically, helpful to the industry itself. Opportunities for growth were so great that they outran the capacity of Standard’s monolithic organisation. The rump of the diversement directives, Standard Oil of New Jersey, now Exxon, today takes turn and turn about with General Motors to be the largest business enterprise – in terms of turnover – in the Western World. The offshoots themselves became giants. And Texas grew two of its own – Gulf and Texaco.

America was where the oil industry began and the big oil company was born. Finds in Russia and the Dutch East Indies led to the founding of Shell and Royal Dutch at the turn of the century, at first in competition with Standard in Europe and with each other, and led by entrepreneurs as ruthless as Rockefeller. Shell and Royal Dutch amalgamated in the early years of the century. And also before the First World War, the discovery of oil in Persia led to the growth of a company which ultimately became BP, another world-class enterprise. For nearly fifty years, a handful of large companies developed and controlled oil fields all over the globe. The companies of this handful were rivals, but also collaborators. Together, they had more economic power and influence than all but the largest of the nation states. They shaped and changed our lives.

WORKING FOR ICI IN OIL

Turning from such wide vistas to personal experience, I had my own introduction to the oil scene in the 1930s. I joined ICI to work on their project to make oil, particularly petrol, from coal. In the 1920s, oil production was but 5 per cent or less of today’s production. Nevertheless, some shortages had developed and interest had been aroused in processes to convert coal into oil. One route, developed by the German chemist, Bergius, proceeded by hydrogenation and high pressure. Shell and Standard had worked on similar processes. Bergius was backed by the vast German chemical concern, I.G. Faben-Industrie. The formation, in 1926, of ICI from an amalgamation of four long-established British chemical companies was partly, even mainly, inspired by the wish to participate in the new process. In other words, the thought in the mid-20s was that making petrol from coal was going to be the great growth area for the big chemical companies. International Hydrogenation Patents was formed with Shell, Esso, I.G. and ICI as partners, pooling their respective expertise.

Neither of the oil majors in the event went ahead with actual hydrogenation plants. More oil was being found, shortages were turning into glut. And now much more important to the oil companies, Shell and Esso had with BP arrived at the secret Achnacarry Agreement in 1928. This divided the world into an international cartel. The three oil companies eschewed competition and agreed on market shares. It was envisaged that new capacity would be brought on to the market in an orderly way. They had merely to maintain a watching brief on oil from coal, and the activities of the chemical companies they once feared.

ICI built its coal-oil plant in 1933/34 in a mood of hope and desperation. With desperation, because the slump of that time had left them with lots of spare hydrogen making capacity which they wanted to use. Hope, that an oil shortage would again develop. Germany went ahead because it wanted oil self-sufficiency in the event of war.

Fifty years ago I worked on various aspects of the ICI project and became the Manager of the refinery section. It was also one of my jobs to watch the general supply-demand situation. Now, at the time, two things struck me. In America, production in the 1930s was strictly controlled to protect prices. The rationing was carried out by an authority of that most free-wheeling and individualistic of States, Texas. The State brought order into the market and protected the producers. Moreover, import of cheap oil into the USA was strictly controlled, to protect the home producers.

In the United Kingdom I, from my refinery, supplied petrol to identical specification to both Shell and Esso. It was a time when rival advertising between Shell and Esso was very fierce, very extensive. The consumer was given the impression that these two famous names were fighting for his custom, that the petrols offered were different. They were not different. They were exactly the same. And the market was being shared out anyway.

In the late 1930s with the threat of war looming, the British government became concerned with the security of aviation fuel supply for the RAF. I was one of the ICI team seconded to come up with proposals. It was decided to provide a petrol base by hydrogenating gas oil and to bring this up to the grade required by the aviation engines by blending with Iso-octane and adding lots of tetraethyl lead. ICI pioneered the production of the Iso-octane from Iso-butane, a by-product of the hydrogenation process. The process was licenced from the consultants Universal Oil Products of Chicago, who had operated a small pilot plant. I was put in charge of ICI’s Iso-octane operations, through design to start-up. I also served as a technical manager in the tripartite team from Shell, Trinidad Leaseholds, and ICI which designed the large-scale aviation fuel plant which was built at Heysham. It was the largest single war-time project, incidentally, in which ICI was engaged. Trinidad supplied the gas oil and some of the general management. The major technical input by far was from ICI and this was true even for the distillation columns of the plant where one might have expected Shell to score.

In 1939, to widen my background, I was given the opportunity to visit plants of Esso, Shell, Gulf and others in the United States covering both refining and reforming and chemicals production. In passing, I also saw numerous oil fields, all of the nodding donkey type. At this time, Esso was by far the most impressive oil company in the technical sense. I was at Baton Rouge, and saw the early days of fluidised bed development and of catalytic cracking.

The most disconcerting thing to me about the tour was the monumental indifference of the American oil men to the outcome of any possible war in Europe. You must remember that this was 1939 and we had had the crisis at Munich and war did seem a possibility. The American oil men were extremely indifferent to any outcome and, if anything, Germany was favoured.

The self-absorption of oil men was illustrated to me again in 1940 when Holland was overrun and a number of Shell technical men from the Hague escaped to this country and were temporarily housed by ICI. It was one of my jobs to look after them. The minutest points of procedure about office amenities and fittings seemed of far more importance than anything else that was going on in Europe.

At the end of 1940 I got moved on to atomic work and stayed on atomic work for nearly all the war except for a brief period when I was brought back to work on a project called “Victane” which, believe it or not, produced aviation fuel with a specification of 125 octane number and enabled the Tempest air plane to overtake and overturn the flying bombs.

POSTWAR CONTACTS WITH THE INDUSTRY, TO 1960

Post war I joined Courtaulds and again took part in sundry dialogues with various of the major oil companies. The activities included operation of a pilot plant in Houston with Esso, prior to a joint project which in the event did not materialise. It also extended to discussion of various collaborative proposals with Shell, again none of which were pursued. The impression left on me was that these very powerful companies, Shell and Esso, could not adjust their thinking to collaboration on a basis of equality with a weaker partner. I think that in the 1950s the OPEC countries, where the stakes were so vastly greater, must have felt the same way.

In the oil production world resentment had of course started earlier. Mexico reacted angrily against what it regarded as exploitation and nationalised its oil industry in 1938. It was boycotted and it took over 30 years to make the State Company, Pemex, efficient. I had the opportunity of seeing Pemex in the late 70s and it seemed to me to be a good operation. I see their results for 1983 show a five billion dollar profit. To come back to my theme, Iran nationalised BP in 1951 and then found its oil boycotted by agreement amongst the major oil companies. It was 1954 before a new agreement was reached which allowed bulk exports again from Iran. This agreement, reached with American help, ended BP’s monopoly of Iranian oil. Marketing was put in the hands of a new consortium made up besides BP of American and French interests with BP retaining a 40 per cent share. Iran was left owning the oil, but output, distribution and pricing were firmly in the hands of the oil companies.

It was in 1960 that Exxon provided the trigger which led to the formation of OPEC. It unilaterally cut the price of Venezuelan crude for the second time in quick succession. And this had repercussions, not only on Venezuela, but on Iraq and the whole Middle East and caused great anger.

Now Exxon’s price reduction was actually sparked off by cuts in the price of Russian oil, especially to Signor Mattei in Italy. I knew something of Mattei because in the 50s I represented my then company Courtaulds in various Italian interests, and one of them was in fact a buyer of natural gas from Mattei. He was a folk hero in Italy in those days. His Agip petrol stations, with their logo of the six-legged running dog with flames coming out of its mouth, really made the whole Po Valley look very colourful. Mattei was very anti big oil. I believe he was the man who coined the phrase “the Seven Sisters”.

I had a personal reason to be interested. From the mid-50s, I had worked hard to open up UK trade with Russia. I sold them fibres, fibre manufacturing plants, and fabrics and with some success. I might mention that trade has continued and we recently celebrated in my old company 30 years of trade with Russia. And the total trade over the 30 years has amounted in today’s money to about 1.6 billion pounds. So we started something quite useful in the 50s. But the Russians at the time were short of hard currency. I looked for further ways of increasing trade, and discussed with the Russian authorities the idea of importing their oil and oil products. They were very keen on the idea. And with the Russians we looked at and worked out various schemes. The initial phase was to be the importation of one million tonnes per year of oil. I was very pleased. We took the proposals to Whitehall for blessing. I got a blank refusal. Not just blank, but passionate blank. I was told categorically that no circumstances could be envisaged in which approval could be given. My arguments that the oil would be cheaper and broaden the supply base were peremptorily dismissed. The then permanent Secretary concerned told me that any such imports would be over his dead body. You must forgive me for seeing the hands of the major oil companies in his attitude.

Well, perhaps it was just as well for my company Courtaulds that I was turned down. It would have been a formidable task to have taken on the oil majors, even if modestly. And the venture would have been far away from our main line of business. It was conceived as an exercise in diversification, then a fashionable concept.

OPEC, formed in 1960, was not at first effective. The 60s saw the oil majors dominating the world oil scene. Together they controlled over 70 per cent of the world trade. Remember, the 60s was a marvellous period for world economic growth. The fields in the Middle East and North Africa seemed easy to find, the wells were extraordinarily prolific, capital costs were modest and actual costs of production almost derisorily low. But cheap as was the delivered price of oil to the West, it could have been even cheaper if a free market had existed. But production was controlled by the various licencees and they had agreements with each other which crossed all national boundaries. If a producing country was difficult it found it harder to get its oil uplifted. Unity within OPEC was poor. The Arab boycott at the time of the 1967 Egypt-Israel six-day war was not effective. Venezuela and Iran quickly made up any shortfall.

Please note the scenario at this time. For years and years, oil consumption had continued to grow between 8 and 10 per cent compound growth per annum. Forecasts by the oil companies at the end of the 60s assumed the curve would continue upwards at this and faster rates throughout the 70s the 80s and so on. The companies were confident the oil would be there. The plateau forecast for Saudi Arabia, its potential, was put at 20 million barrels a day. And it was thought that other large reserves would be found. The oil concessionaires saw as their chief task not the finding of more oil, but the maintenance of an orderly market for the oil already available. They wanted an oil price which gave “reasonable” – their definition – margins over production and all other costs, including payments to host countries. These host countries were becoming increasingly restive. Very much so under this regime. They felt their cut from the margin was too small. They wanted both a higher price and a bigger cut from the increased margin.

Looked at in one way, the non-American countries with indigenous oil were being exploited by the multi-national countries because of their oil. Looked at in another, the exploration, production, marketing and stable pricing policies of these same multi-nationals were vital factors for over 20 years in the extraordinary economic growth of the whole world system.

A feature of oil company structure from earliest days has been vertical integration, right from the days of Rockefeller. Controlling outlets, as I mentioned, was very important. The big companies had their own refineries and distribution systems. They controlled a lot of their own transport. Refineries and their conversion techniques were developed in the home of petroleum technology, America. Initially, some big multi-nationals preferred to keep their refineries away from both producing and importing countries. I remember, long ago, the then Shell chairman arguing in one of his annual reports that the logical place for large multi-product refineries was sites such as the Dutch West Indies. Near enough to take the Venezuelan crude, and big enough to supply a wide variety of export markets with a wide variety of products – including countries such as Britain. But the rapid growth in consumption led of course in the end to the establishment of versatile refineries in most countries which consumed large amounts of oil.

The end of the 60s, this wonderful period, saw major developments. The United States, a protected market for so long, became a net importer of oil and oil products. They could no longer meet their own demands and this was a great turning point. The tidy world of the Seven Sisters was also being disrupted by brash independents, themselves growing into major international oil companies. Then Colonel Gaddafi staged his coup in Libya and this was absolutely one of the seminal events of the whole oil industry development. He showed in essence the Emperor had got no clothes. He showed in essence that the West, when it came to it, would not protect what had been thought to be their vital interests. The restlessness of the OPEC countries began to strain at the reins of the multi-natioal control system. As the 70s opened, the emancipation struggle strengthened. It culminated at the time of the 1973 Yom Kippur war. This saw the OPEC countries finally breaking free, and taking decisive control of the pricing of their oil. The wider consequence was that the vulnerability of the prosperity of the developed world was vividly demonstrated.

The oil multi-nationals, in the event, came to terms with the new situation surprisingly rapidly. They still controlled the markets. It became clear that for many years the OPEC countries would need them just as before. In 1977, I took part in a big meeting at Vienna between the OPEC countries and representatives of all the major oil companies. They had not really met in the open for four years, since 1973. Very wide-ranging discussions and a lo...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Acknowledgements
• Introduction and Summary
• 1 The Oil Industry. Some Personal Recollections and Opinions. Lord Kearton
• 2 A Survey of Structural Change in the International Oil Industry 1945-1984. Paul Stevens
• 3 Standing the Test of Time. Richard Reid
• 4 Government Sellers in a Restructured Crude Oil Market. Jack E Hartshorn
• 5 OPEC and Structural Change. Ian Seymour
• 6 Downstream Implications of Structural Change Edith Penrose
• 7 Structure, Stability and Policy – Panel Discussion. Peter Beck, David Howell, Walid Khadduri, Colin Robinson, John Wiggins
• 8 Survey of Oil Price Expectations David Hawdon