Global Resources

Conflict and Cooperation

R. Dannreuther, W. Ostrowski, R. Dannreuther, W. Ostrowski

• Publisher: Palgrave Macmillan
• Year: 2013
• Print ISBN: 9781349347827, 9780230360501
• eBook ISBN: 9781137349149
• Topic: Economics
• Subtopic: Environmental Economics
• Index: Economics

This EU-funded projectexamines the dynamics of conflict, collaboration and competition in relation to access to oil, gas and minerals.It involves 12 different institutions from across the EU andexamines oil, gas and other minerals - spanninggeology, technology studies, sociology, economics and political science.

Part I

Historical Legacies

1

History of the International Oil Industry

Paul Stevens

The purpose of this chapter is threefold. The first is to provide a narrative of events relating to the oil industry, both at local, regional and international level. To achieve this, six historical periods have been identified largely defined by oil market events. These set the scene for the narrative that runs throughout the chapter derived from the three cycles, described below, which have dominated the history of the international oil industry. It cannot be stressed enough how important it is that the history is understood if the present and future is to be comprehensible.¹ The second is, in each of these periods, to identify a spectrum of relations between the various players (governments – producing and consuming; companies – Majors, independents and national) ranging from conflict to tension to competition to collaboration. Finally, an attempt has been made to identify the various major transmission mechanisms between these periods. Overall, this links into the overarching theme of the book that concerns the role of state capitalism and how it influences the behaviour and motivation of the various players.

The underlying theme of the chapter is that much of these relations, be they conflictual or collaborative, derive from the agreement between the owner of the (potential) oil-in-place (outside of the US, the state) and the operator. In turn, these relationships influence the way in which the various players, that is, governments and various types of companies interact between themselves. Such relations occur and develop in the context of three cycles which characterize the industry (Stevens 2008a): the political cycle which refers to the attitude to state intervention in the allocation of economic resources in an economy; the resource nationalist cycle which relates to the attitude to allowing foreign company involvement in the sector; and finally, the obsolescing bargain cycle which concerns the willingness and ability of the state to revise the fiscal terms inherent in the agreement. A common theme that links these three cycles and runs throughout this book concerns the role of state capitalism and the nature of the regimes.

Birth of the industry: The nineteenth century

Oil in the nineteenth century was dominated by what was happening in the US (Sampson 1975; Yergin 1991). Conventionally, the history of the industry begins in 1859 when Edwin Drake drilled the first well in Titusville, Pennsylvania.² The early days of the industry in the US were dominated by intense competition and rivalry. This arose in large part because of the problem of property rights where the commodity in question (i.e. oil) flows in three-dimensional space and is therefore no respecter of land boundaries (Bradley 1996). Thus the Law of Capture introduced to solve this property rights problem encouraged producers to produce from their own pools as quickly as possible before their neighbours drained the reserves. The result was extreme price volatility as larger finds disrupted markets and also caused serious damage to the recovery factor of the fields. This intense rivalry was greatly aggravated by ‘robber baron corporations’ in what was an incredibly corrupt political environment that allowed them to behave without restraint.

Gradually however, the Standard Oil Trust of J. D. Rockefeller between 1873 and 1882 effectively consolidated the industry suppressing competition. This was driven predominantly by control over pipelines and refining. It was in effect a collaborative solution but one imposed invariably using methods that could hardly be described as pristine and often involving violence. By 1904, the Trust controlled over 85 per cent of the throughput of US refineries. This whole system was effectively destroyed in 1911 when the US Supreme Court, invoking the Sherman Anti Trust Laws of 1904, broke up the Standard Oil Trust creating a large number of what were supposed to be competing companies. However, some stability was restored to crude supply with the introduction of pro-rationing by the federal government, operating at a state level, which was intended to limit production to prevent field damage and to limit price volatility from oversupply. In effect, as will be developed below, this was the precursor to Organisation of Petroleum Exporting Countries (OPEC).

In this period the US dominated the international markets for oil. In the 1860s over half of US kerosene production was exported and by the 1880s oil products represented the fourth largest US export (Penrose 1968). As for the rest of the world in this period, other countries were beginning to produce oil. The main players in Europe were the Nobel Brothers and a group of private Russian companies. However, oil markets were largely a localized regional phenomenon given the relatively high cost of transporting oil. Thus, there was relatively little competition within these regional markets and many were effectively monopoly markets. However, oil consumption was low and dominated by the use of kerosene for lighting purposes, which had effectively pushed whale oil out of the primary energy mix. For example, in the UK, arguably the most industrialized of the countries in 1900, less than 1 per cent of primary energy consumption was petroleum (Fouquet and Pearson 1998).

The rise of oil: 1901 to the Second World War

In 1901, the Persian government awarded an oil concession to William D’Arcy. The subsequent discovery of oil at Masjid-i-Sulaiman in 1908 effectively signalled the start of a new era whose main characteristic was the availability of cheap oil outside of the US, much of it from the Middle East (Stocking 1970). A peculiar mixture of conflict and collaboration characterized this era.

The main source of conflict was the battle to secure exploration acreage in a world where the industry was dominated by eight international companies: the Majors³ – BP (British), Shell (Anglo-Dutch), CFP (French), and Chevron, Exxon, Gulf, Mobil and Texaco (American). The story revolved around their machinations and those of their home governments – Britain, France and the US (Keating 2006). This conflict was aggravated by several factors. The First World War had identified the strategic importance of oil to fuel the machines of war.⁴ In addition, oil consumption began to rise, a situation given a major boost by the development of the mass-produced car – the first Model T Ford appeared in 1912. By 1925, in the US, liquid fuels accounted for 19 per cent of total primary energy consumption (Darmstadter et al. 1971). Another factor aggravating conflict was the fact that the aftermath of the Treaty of Versailles and the creation of the League of Nations gave Britain and France very significant mandate powers over the oil-producing regions of the Middle East. The result was fierce competition by these governments (and increasingly the US) to secure concessions for their oil companies (Keating 2006).⁵ The result of these interactions was the creation of the major concessions that dominated the international industry until the early 1970s.⁶ The ultimate winners were reflected in the nationalities of the Majors – US, Britain and France. Prior to the First World War, Germany also played a part in this scramble for resources but subsequently was effectively pushed out of the game. Some have indeed argued that the Second World War was in part an attempt by Germany to secure access to oil reserves faced with being frozen out of the process after 1918 (Yergin 1991).⁷

Another source of conflict early in this period was the growing competition between the Majors for market share. Thus a series of price wars⁸ broke out in various regional markets (Penrose 1968) culminating in a major conflict between Shell and Exxon in India during 1927 and 1928. Such price wars were the inevitable outcome of an industry characterized by an oligopolistic structure and a tendency to carry excess capacity because of the discovery of relatively large fields whose production attracted significant economic rent to produce oil.⁹ Furthermore it was (and still is) an industry with a cost structure characterized by very low short-run marginal cost which meant marginal revenue always exceeded marginal costs encouraging greater production (Stevens 2008b). In short it was an industry, if left to itself, which would suffer from chronic overproduction leading to intense price competition to ensure market outlets.

However, all of this conflict between the Majors was taking a serious toll on their profitability and effectively encouraged them to seek a collaborative solution. The main sources of collaboration first emerged in 1928. In that year, the heads of Exxon, BP and Shell met at Achnacarry Castle in Scotland where they effectively carved up the international oil market based upon the ‘As-Is Agreement’. This agreement, which quickly included the other Majors, remained secret until 1952. In essence it agreed, as the name implied, to maintain existing market shares and, above all, not to compete on the basis of price. To this end the Gulf Basing Point System was introduced (Penrose 1968). Thus irrespective of geographic location, oil products were priced on a cost insurance freight (c.i.f) basis as though they had originated on the Gulf of Mexico that is, based on the US domestic price and the landed price equalized by means of a ‘phantom freight rate’. In 1944, following complaints by their respective navies to the US and British governments, a second basing point was introduced at the Abadan Refinery in the Persian Gulf. This effectively opened up world oil markets to low-cost Middle East oil without threatening the price structure. This was one of the most important decisions for oil in the twentieth century since it allowed cheap oil to fuel the post-Second World War economic boom. Another example of the growing collaboration between the Majors in this period was the Red Line Agreement, also signed in1928. This was an agreement between the co-owners of the IPC (that effectively included five of the eight Majors) to not compete for exploration acreage in the region roughly coinciding with the old Ottoman Empire.

A post-imperial world: 1945–70

The relationship between the major oil-consumer governments – the states in the Organisation for Economic Cooperation and Development (OECD) – and the oil companies in this period was one of collaboration. The Majors were able to supply the ever-increasing demand for oil, which was fuelling the ‘OECD economic miracle’, and to do so with falling real prices. The result was that the US and British governments were content to leave oil issues to the Majors and the civil service was specifically instructed to let the Majors get on with the business of fuelling post-war reconstruction and eventual boom in the 1960s. As will be seen in the next period, this changed dramatically with the oil shocks of the 1970s but one of the reasons the ‘shocks’ were shocks was because having left oil to the Majors, no one in government – politicians or bureaucrats – had the first idea over what was going on in the industry in the 1970s as international prices quadrupled in the first oil shock of 1973–4 and quadrupled again in the second oil shock of 1978–81.

In terms of the relationship between the Majors and producer governments, the period was characterized by conflict. The key source of this conflict was the division of the rent from oil. This is based upon the agreement between the owner of the resource (normally the state represented by the government) and the operator (frequently a multinational corporation). The agreement defines property rights, roles and responsibilities. As outlined at the start of the chapter such agreements emerged and operated post-Second World War in the context of three interconnected cycles: the political cycle, the resource nationalist cycle and the obsolescing bargain cycle. As will be explained, it is the interactions of these cycles that determined the extent to which the various relations were closer to conflict or collaboration.

The political cycle had two dimensions – international relations and economic. The international relations dimension concerns the rise and pursuit of the Cold War between the US and the Soviet Union. Thus the world became divided into spheres of influence based upon client–patron relation-ships. As will be seen, this division began to seriously affect relations between some producer governments (individually and collectively within OPEC) as representatives of the ‘Third World’ and the Majors as ‘representatives’ of Western capitalism.

A major driver of this cold war conflict was the rapidly increasing demand for oil. The 1960s saw the ‘OECD economic miracle’. The US, Western Europe and Japan grew at an unprecedented rate. With an income elasticity of demand for oil of one, this meant very strong demand growth for oil met largely by imports. Between 1958 and 1972 world oil demand (excluding communist areas) grew from 16.5 to 46.3 million b/d, an annual average growth rate of 6.3 per cent while between 1965 and 1970, the annual average was 8.1 per cent growth. In the same period, non-OPEC production grew at only 6.8 per cent thus greatly increasing OPEC’s share of the market and its market power. By 1973, OPEC produced 53 per cent of world production outside of the Soviet Union. This raised the strategic importance of the Middle East to the West. Thus the region became one of the main battlefields of the Cold War with the US and the Soviet Union carving up the region to secure their own client states and trying to subvert the client states of the other. As will be seen below, it also inevitably increased the bargaining power of producer governments in the Middle East.

The economic dimension of the political cycle refers to the view – usually driven by a mixture of ideology and economic crises – as to the role of government in the allocation of economic resources within an economy. Thus if it is believed that markets do not work efficiently because of market failure, governments should intervene. This period was one in which, outside of the US, the generally accepted view was for government intervention although the degree of such intervention was debated (Stevens 2008b). However, as has already been explained, the relationship between OECD-consuming governments and Majors was based upon a view of the political cycle which suggested the Majors were doing ‘a good job’ and the industry should be left to work things out in the context of markets without undue government interference.

The story of relations between producer government and companies was very different. Here the other two cycles – resource nationalism and the obsolescing bargain become crucial. As defined in the introduction, the resource nationalist cycle refers to the desire of the government to assert control over its natural resources together with its attitudes to foreign companies. Thus the peak of the cycle would be a strong desire for control with xenophobic dimensions. This cycle tended to be driven by the magnitude of and need for oil revenues, which to a large extent was determined by oil prices. The obsolescing bargain cycle refers to the idea that the terms of the agreement are determined initially by the relative bargaining power of the parties at the time of negotiation. However, after the operator has made the necessary investments, the bargaining power swings strongly to the government leading them to seek renegotiation of terms. This cycle is driven in part by the resource nationalist cycle, the size of the eventual oil discovery and the price of oil.

This period, the post-imperial world, was characterized by several elements. First, it was obviously a postcolonial world where all forms of nationalism were in the ascendancy as newly independent nations tried to assert their sovereignty. This was in a context where state intervention in the economy was increasingly regarded as the norm. This was especially true for oil, which was seen as a key ‘commanding heights’ sector by the producing governments. In this period, the influence of the Soviet Union and its command economy approach to resource allocation was especially powerful in developing countries who were seeking to break out of their circle of poverty.

Second, there was the rise of the concept of ‘permanent sovereignty over natural resources’. The United Nations passed its first resolution on this issue in 1952. In 1962, a resolution recognized the rights of a country to dispose of its natural wealth in accordance with its national interests. In 1966, resolution 2158 was even more explicit and host countries were advised to secure maximum exploitation of natural resources by the accelerated acquisition of full control over production operations, management and marketing. This effectively legitimized the concept of the obsolescing bargain.

Third, there was growing dissatisfaction with the oil concessions signed in the previous period, especially in the Middle East. Four issues dominated. First was the very long life of the original concessions. In Iran, Iraq, Kuwait and Saudi Arabia the average life was 82 years. Second, the areas covered by the agreements were huge. In the four main countries, 88 per cent of the national area was covered including all of Iraq and Kuwait. Furthermore there were no relinquishment clauses. The Majors could simply sit on acreage, including commercial discoveries, and do absolutely nothing. Third, there was growing dissatisfaction with the fiscal terms. This first surfaced in Venezuela in 1948 when the government insisted (successfully) on a profits tax in addition to the lump sum royalty. This idea rapidly spread to the Middle East and by 1952 all the major countries in the region had switched to a syst...

Table of contents

• Cover
• Title Page
• Copyright
• Contents
• List of Figures and Tables
• Acknowledgements
• List of Abbreviations
• Notes on Contributors
• Introduction: The Dynamics of Conflict and Cooperation
• Part I: Historical Legacies
• Part II: Theoretical Frameworks
• Part III: Companies, Contracts and Communities
• Part IV: Scarcity, Technology and Future Supply
• Conclusion: Reconceptualizing the Dynamics of Conflict and Cooperation
• Bibliography
• Index