Seven Elements That Have Changed the World (11 page)

The oligarchs had become more successful and more powerful. Over time, they wanted to protect their own wealth both from the reach of the
government, which could apply the law to its advantage, and from simple theft. In this way they were like the nineteenth-century American robber barons. They used their political influence to keep as much power as possible for as long as possible. In history, the development of oil tends to concentrate power and wealth in the hands of only a few. Even after the ‘dragon’ that was Standard Oil had been slain in 1911, the power of oil continued to remain in the hands of a few.
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For the first half of the twentieth century the so-called Seven Sisters, consisting of the largest fragments of Standard Oil, along with rival US companies Texaco and Gulf and European companies British Petroleum and Royal Dutch Shell, controlled production from the majority of the world’s oil reserves.
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Working as a cartel, they respected each other’s markets and were able to eliminate other competitors, much as Rockefeller had done in the US.

The Seven Sisters also received support from their domestic governments. In 1914, Winston Churchill, then the First Lord of the Admiralty, purchased a controlling stake in the Anglo-Iranian Oil Company for the British government to ensure a secure oil supply for her navy. Similarly, the US government asked its oil companies to participate in arrangements in the Middle East that were contrary to the same laws which had been used to break up Standard Oil.

The initial success of British Petroleum and Royal Dutch Shell depended on their oil discoveries in the British and Dutch empires. Although these empires were gradually dissolved after the Second World War, colonial attitudes remained and the Seven Sisters continued to exert considerable power over oil-exporting countries until the 1940s.

The balance of power began to shift from the oil-consuming countries to the oil-producing countries when Venezuela negotiated the first ‘fifty-fifty’ deal in 1943. Under the new petroleum law, government oil revenues would equal the profits after taxes and royalties in Venezuela of any oil company operating there. The fifty-fifty principle soon spread to the Middle East and became standard practice across much of the global oil
industry. Many oil-exporting countries wanted more: the oil belonged to them and so, they believed, they should receive the lion’s share of profits.

The ‘fifty-fifty’ principle was eventually broken in 1957 when Enrico Mattei, president of ENI, the Italian multinational oil and gas company, conceded to an unprecedented 25:75 split between ENI and Iran. Italy wanted a share in the new giant Middle Eastern oilfields, known as ‘elephants’, that were discovered in the 1950s. Mattei was derisive about the close ties between large international oil companies and wanted to weaken their stronghold on the world’s oil supplies. In his aggressive pursuit for reserves, he struck a deal that no other oil company was prepared to agree.

The weakening of the Seven Sisters along with the sudden discovery of vast new oil reserves provided opportunities for new oil companies to get involved in the game. The growth of new reserves also resulted in a surplus of oil. Unable to compete with low Soviet oil prices, oil companies began to cut the price they were prepared to pay for their oil (the ‘posted price’), but this also cut the national revenue of oil-exporting countries.

In response, in September 1960 five major oil-producing nations formed OPEC. In doing so they hoped to take control over the setting of the international oil price. However, supplies were abundant and oil companies, which controlled the market outlets, treated the oil-exporting countries with disdain. Rivalries inside OPEC made price setting even harder and so the price of oil fell throughout the decade.
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Not only had OPEC failed to raise the price, they had failed even to defend it.

In the 1970s demand caught up with supply. Realising the power they now held, in 1973 OPEC unleashed the ‘oil weapon’.

On 6 October 1973 a coalition of Arab states led by Egypt and Syria launched a surprise attack on Israel, starting the Yom Kippur War, known as such for commencing on the Israeli holy day of Yom Kippur. By choosing for the attack a day of religious fasting and rest, the Arab forces hoped to catch Israel when it was least prepared. Although Israeli armed forces were strong, they had miscalculated how long their supplies would last. As
they ran out of equipment against the Soviet-supported Arab forces, Israel asked for help from the US, who then provided it.

In response to US support for Israel, Arab members of OPEC cut production by 5 per cent from the September level. They then announced a further 5 per cent cut each month so as to increase pressure on the US. With gradually diminishing oil supplies, the US economy was being stifled.

The war continued and, later in October, President Nixon announced a $2.2 billion military aid package for Israel. Saudi Arabia, the world’s largest oil exporter at the time, retaliated by announcing a complete embargo of oil shipments to the US. Other Arab states soon followed suit.

Prices rocketed to over $50 a barrel of oil in today’s money, the highest since the wildcat days of the oil industry at the end of the nineteenth century. The price increases were worsened by OPEC’s announcement in the previous week that it was taking complete authority over the setting of the posted global oil price, raising it by 70 per cent. These events marked the beginning of our modern anxiety over oil supplies.

At the time I was living in New York and working on Alaskan oil developments. On OPEC’s announcement, the city was thrown into a state of turmoil. Queues for gasoline stations ran for blocks down the street. People would drive from station to station searching for fuel. Even with their tank nearly full, they would wait for hours for a top-up; who knew if there would be any gasoline tomorrow? The embargo galvanised America into action: in January 1974, we received the long-awaited authorisation to build the Trans-Alaska Pipeline to run between our super-giant oil field in Prudhoe Bay in the north of Alaska and the Valdez terminal in the south.
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It would eventually start production in 1976 and at its peak in 1988 supply over two million barrels of oil per day, equivalent to almost 12 per cent of the US’s demand for crude oil.
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The oil crisis of 1973 marked a new relationship between those who produced oil and those who consumed it. No longer was oil a plentiful resource, the supply of which could always be assured. It was now a political weapon, a vital strategic interest and the cause of frequent crises in the global economy. The next of these crises was to emerge in the Iranian Revolution of 1978. Iran then provided 20 per cent of the world’s oil, and so the global supply was disrupted and the price again rose.

Iran’s rich oil reserves were a cause of the Iran-Iraq war of the 1980s and also Iraq’s invasion of Kuwait in 1990. Wary of neighbouring Iran’s great oil wealth, Saddam Hussein wanted to increase Iraq’s power, and one way of doing that was to increase his oil reserves. As Iraq invaded Kuwait in August 1990, oil wells were abandoned, disrupting global oil supply once again. Several months later, Iraqi forces fled following a US-led military attack, but not before they had set Kuwait’s oil wells alight, stopping production for months afterwards. We all vividly remember images of the thick black smoke rising from Kuwait’s burning oil wells. BP had developed the Kuwait oilfields and so, being the then sole possessor of information on the fields, cooperated in the clean-up operations.
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Later that year, I visited Kuwait and was shown around the fields. The fires had only just been put out and all that remained was a mass of twisted, molten equipment. The entire desert was black; it looked as though it had been asphalted.

Unstable politics, increasing demand and OPEC’s tightening grip on oil supplies led to high prices through the 1970s. However, high prices also stimulate greater investment in exploration and production. This is just what happened and by the middle of the 1980s new oil supplies, combined with an economic downturn, caused the price of oil to slump to very low levels, which persisted through the 1990s. This presented oil companies with a new challenge altogether.

To survive with the low oil prices of the 1990s there was a need for consolidation in the industry so as to benefit from economies of scale. BP was too small. If BP did not acquire another company it would surely have been taken over by another. I began discussions with Larry Fuller, chairman and CEO of Amoco, and on in August 1998 I announced that BP would merge with Amoco, triggering a wave of mergers across the industry: Exxon merged with Mobil, Chevron with Texaco, Conoco with Phillips and Total with Fina and Elf.
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Between 1998 and 2002 the industry went through the most significant reshaping since 1911 and the break-up of the Standard Oil Trust. The biggest deal, the merger of Exxon and Mobil, brought together the two largest companies to have emerged from its 1911 dissolution. Scale brought efficiency, security and clout, enabling these newly created super-majors to compete with states and governments and take on bigger challenges of greater technological complexity. The risks of
oil extraction could be spread over a greater number of barrels of oil.

In the 1990s, oil prices were low and national oil companies (NOCs) lacked the confidence to compete. The size of the super-majors, combined with their expertise, made them valuable partners for producer states. But today the growing size of NOCs combined with high oil prices has once again shifted the balance of power back towards producer states. Around the world, producer states have reduced the share of rents given to the super-majors. In Bolivia, the government has seized oilfields outright; in Venezuela the government has rewritten contracts to give the national oil company control; and, most recently, in Argentina a controlling stake in the former state-owned energy company YPF was seized from Spain’s Repsol.

The relationship between the super-majors and oil-producing nations is often tenuous: one side answers to its shareholders, the other to its citizens. Both sides want to extract as much natural wealth as possible; the question of who gets what remains one of power.

It was 1999 and I arrived at Claridge’s hotel in London where I was to meet Hugo Chávez for the first time since he had become president of Venezuela the previous December. I was hopeful. Chávez had not given details about his plans for his country’s oil industry, but he had said that he regarded continued foreign investment to be of vital importance.

Since 1993, under the presidential leadership of Carlos Andres Perez and later Rafael Caldera, international oil companies were being invited back into the country as part of the opening of the economy,
la apertura.
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The new head of the state oil company Petróleos de Venezuela SA (PDVSA), Luis Giusti, played a central role in this, as, indeed, had BP’s general manger on the ground, Peter Hill. During the years of ‘la apertura’, there was a constant flow of international talent and capital into the country. Billions of dollars had poured in; production from Venezuela’s declining oilfields was being increased. There was a great sense of possibility within PDVSA and international oil companies alike.

Facing Chávez in the hotel room, it soon became clear to me that this
was all about to change. A few minutes into the meeting he started on a speech about the ‘evils of foreign oil companies.’
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To Chávez we were the new face of those who had, for centuries, pillaged the natural riches of South America; to rest of the world, Chávez was the new face of resource nationalism.

The conflict between private oil companies and oil-producing states centres on the problem of rents, an idea first formulated by David Ricardo at the beginning of the nineteen century.
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Ricardo’s Law of Rent assigns a value to land based purely on its intrinsic ‘natural bounty’. Venezuela was traditionally an agricultural nation, dependent on the production of cocoa, coffee and sugar. The low value of these goods could only support a small and poor population; the land had little intrinsic value. The discovery of oil in the early twentieth century created a sudden shift in the Venezuelan economy. The price of oil was high enough so that, after all costs of production and a reasonable return to investors, a surplus was left. This surplus is defined as rent, the inherent value of the land.

Who should receive this rent and how much should they receive? Is it the oil companies that extract the oil, or the state that owns the land? Both hold a claim. Oil companies take great risks in exploring and developing production in foreign countries – in Alaska, for example, BP nearly walked away with huge losses following a fruitless ten-year search. On the other hand, the land and its ‘natural bounty’ are the property of the state. Any state will want to get as big a share as possible. Companies are invited in to find and develop reserves and, in a perfect world, the rules under which they operate would remain unchanged. However, experience shows that, when oil starts flowing, the state squeezes. The investment is sunk and oil companies are defenceless. But there are only a limited number of times the state can get away with these tactics before investment is frightened away. Eventually, companies leave, taking their highly trained people, expertise and investment with them.

The progressive oil industry reforms implemented by Giusti and Pérez in the early 1990s were beginning to reverse the economic decline of the 1980s, but Chávez’s revolution put an abrupt stop to this.
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When Chávez came to power in 1998 he quickly denounced Giusti as ‘the devil who had sold the soul of Venezuela to the imperialists’. Now the state wanted all
the rent. PDVSA quickly became ‘the cash box’ of the state. With financial control of the company in the hands of the central government, the state could now do what it wanted. Following a strike against his presidency in 2002, Chávez fired almost half the workforce. Many of his allies, largely military personnel, were put in power at PDVSA.