The present calamity of the oil or energy crisis has become widely accepted as an article of the popular faith. Everybody talks about the crisis as if it were the implacable nemesis from which no man can escape, and if everybody says so (not only the major oil companies, but also the environmentalists, the U.S. government, and the citizen unable to heat his house), then it must be true. What other misfortune could possibly explain the higher prices for gasoline and the sudden shortage of winter fuel? Does not the United States possess vast natural resources and an incomparable genius for capital formation and technological invention? If so, how else could it have been ensnared in the present crisis unless through the machinations of sly and resentful Arabs?
For the past few years, the major oil companies have spent considerable sums of money advertising a vision of the apocalypse. The October war between some Arabs and all Israelis seemed to testify to the truth of this vision. The embargoes placed on Arab oil shipments to the United States and the Netherlands, together with unilateral price raises and threats of reduced production, provoked a further outpouring of oil industry bulletins announcing the approach of an energy crisis akin to the millennial scourge of Huns from the Asiatic steppes. The bulletins have been confirmed by the proper authorities in Washington, and they have been amplified in the hollow echo chamber of the national press.
The official broadcasts resolve into variations of what might be called the Arabian fantasy. The editorial writers--unchallenged but not encouraged by company spokesmen--explain that the Arab states (principally Saudi Arabia, Kuwait, Libya, Iraq, and Iran*), control the bulk of the world's proven oil reserves, and that they
have become rich beyond all reason or understanding. The demagogues among them entertain radical and dangerous political ideas about the sanctity of Western economic interests, and they refuse to recover their oil in ways convenient to the major international oil companies. In their more ominous moments they threaten to shut down the flow of oil unless the Western nations accede to their demands against Israel. The Western nations must prepare for the worst, and the worst undoubtedly will be expensive. Thus, the need for rationing and higher costs to the consumer.
What energy crisis?
Although sufficient to its melodramatic purpose, the prevailing rhetoric fails to answer a number of awkward questions, especially now that the October war has come and gone. Few people point out that in the past year the major oil companies have reported enormous profits, or that they have enjoyed a policy of generous forbearance on the part of the Nixon Administration,* or that they appear to get along quite successfully with even the most radical of Arab governments. Worse,
virtually nobody explains that the energy crisis is a crisis taking place in time future rather than time present.
Even October's war was not the vengeful uprising against the West that the American information media represented it to be. When the war broke out, the Arabs stopped virtually all criticism of American action or policy. Arab officials did not claim that American troops or pilots participated in the war; Beirut newspapers, even while publishing photographs of bombed-out buildings in Damascus, quoted the Lebanese premier to the effect that America had informed him that it would make the necessary efforts to ensure Lebanese security against Israel. King Faisal of Saudi Arabia had already upped Aramco's production by a million barrels a day during the hot months of July and August, thus allowing him to reduce production when the war began and still retain normal supply levels for the year. The war has created a few problems with the logistics of oil supply, but these have aggravated the American public more than they have inconvenienced American oil companies. For the time being, the world's supply of oil far exceeds the world's demand, and so the crisis must be discerned in a network of theoretical lines converging at imaginary points in time future. The oil companies therefore project a rate of increasing demand for oil, and then they project a rate of declining supply.** When these two lines intersect, presumably in the early 1980s, the actual crisis (as opposed to the abstract or hypothetical crisis) will be unloosed upon an
innocent and law-abiding world.
This is what the oil companies tell the public, not what they themselves know to be the case. In the Middle East they play the part of middlemen rather than principals, and in their various dealings, both with the Arabs and with each other, they display the devious cunning that characterizes the dealings of middlemen in any trade. The instability of Arab politics once frightened them (so much money invested in such unsafe places, etc.), but after the Arab-Israeli war of 1967 and the closing of the Suez Canal they began to understand this instability as a chronic condition much less harmful than it seemed. They found that they could bear the cost of shipping oil around Africa instead of through the Suez Canal; and the construction of supertankers, as well as the hurried discovery of new reserves in the North Sea and Prudhoe Bay, Alaska, obliged them to become more indepen. dent of the Arabs. As a result of their efforts, the inventory of the world's available fuel has been increasing rather than diminishing, even when measured against the annual rise in the rate of the world's consumption. The inventory has become so extensive that it has become a luxury, or at best a waste of time, for most people to worry about it. ***
The oil companies obviously worry about it, but their worries have to do not so much with the supply of oil as with the cost at which they can trade it. It is the disparity between these two concerns that gives rise to the convenient misperception of the oil crisis. Anybody who hopes to make sense of the present confusion must bear in mind three primary facts:
(1) There is a tremendous volume of oil in the world. (The oil companies publish deceptively conservative figures on this subject; as an example, British Petroleum in 1971 estimated the proven world reserves at about 641 billion barrels; figuring on an annual consumption rate of 18 billion barrels, this leaves enough for at least thirty years.)
(2) There is a tremendous difference between the cost of producing oil and the price at which it sells.
(3) The inhibitions against vengeful political acts on the part of the suppliers depend not so much on fear of military reprisals as they do on the implications of facts 1 and 2.
The fact of volume is the easiest to establish. The largest reservoirs of oil in the world are those in Saudi Arabia (at least 160 billion barrels) and those in Iran (at least 100 billion barrels). Between them these two nations possess the bulk of the oil in the Middle East, and dominate the entire subject of Middle Eastern oil. They lie opposite one another across about half the length of the Persian Gulf, but they have little in common except a mutual distrust. The majority of people in Iran speak Persian or Turkish; they know Arabic only as a sacred language, and they have virtually no relations of any kind with the Arab world. The oil reserves in both countries have been developed and exploited by two combinations of Western oil companies, the combination in Iran being known as "the Consortium," and the one in Saudi Arabia as "Aramco." The seven major oil companies (British Petroleum, Royal Dutch Shell, Texaco, Mobil, Exxon, Standard Oil of California, and Gulf) take part in both combinations, and it's because of these partnerships that they dominate the international oil trade.*
* Each of the five American companies owned a 7 percent share in Iran's Consortium. Although Iran "nationalized" its oil production in 1973, the same companies draw the same volume of oil from the same fields. With the exception of Gulf, the same companies also own the major shares of Aramco, currently pro. ducing about 7.5 million barrels of oil a day. As a consolation of sorts, Gulf owns three.eighths of the Kuwait Oil Company.
Although both Saudi Arabia and Iran contribute a huge volume of oil to the market, the oil companies choose to give much more publicity to the reserves in Saudi Arabia. They imply that if only they could be assured of access to the Saudi Arabian fields, then they would feel far more secure about the reserves elsewhere in the world. As a measure of the quantity of Saudi Arabian oil, consider, for example, the Ghawar field; roughly 155 miles long and in some places 22 miles wide, this field still contains as much oil as has ever been consumed in the United States.
The Iranian fields contain comparable amounts of oil, but the oil companies prefer to underestimate their volume. The various spokes. men usually explain that Iranian production has been declining, that it has passed its maturity, that it never will exceed 8 million barrels a day. This may be true of the smaller fields that have been onstream since the 1930s, but there are other fields yet to achieve full production and a number of enormous fields, discovered in the past decade or so, that have yet to be tapped. The largest mature fields are those of Agha Jan and Gach Saran, which, although immense, have no more than about forty-five wells, spaced much farther apart than wells in American fields; many of these wells have the capacity to produce 100,000 barrels a day. Other enormous fields recently have been brought onstream at Marun, Ahvaz, Binak, Karanj, and Bibi Hakimeh--each one of them as large as any field in the United States. Equally large fields remain "on hold" at Mansuri, Kilur Karim, Golkhari, Ab Teymur, and Susangerd.
The waters of the Persian Gulf also conceal at least one immense accumulation of oil, in what is known as the Fereydoon-Marjan field. The Iranians and the Saudis share the field, but potential production in only the Iranian half of it, at Fereydoon, has been estimated at 1 million barrels a day.* A number of people in the oil
* The concession to Fereydoon does not belong to the Consortium. It is shared by the Iranian govern. ment and an "independent," Standard Oil Company of Indiana. To wonder why Standard of Indiana and Aramco, on the other side of the gulf, have chosen not to draw oil from the field is to raise the possibility of a deal. It is conceivable that the Aramco partners could be supplying Standard of Indiana with crude oil at cut-rate prices in return for Standard's willingness to forestall operations in Iran.
business assess the reserves of the entire field at about 30 billion barrels.
The oil companies do not like talk about increasing production in Iran because it is more expensive than increasing production in Saudi Arabia. Before the Tehran and Tripoli price agreements in late 1970 and early 1971, the companies figured the per barrel profit on Saudi Arabian oil at between 50 and 53 cents a barrel; in Iran the comparable figure was between 43 and 45 cents a barrel for crude oil of the same specific gravity. The oil pumped out of the ground in Saudi Arabia is the cheapest in the world for its volume. It costs 4.6 cents a barrel, or one-tenth of a cent a gallon, to load into a tanker. Although Iranian wells individually produce twice as much oil a day, it costs roughly 12 cents a barrel to load into a tanker. The Iranian wells are more distant from water than those in Saudi Arabia; the pipelines cross mountain ranges rather than flat sand, and the "drive" provided by the water latent under the oil reservoirs is generally not as great in Iran as it is in Saudi Arabia.
Which probably explains why the oil companies prefer to turn the conversation to the wonders of Saudi Arabia. They say that only in Saudi Arabia can production be raised to 20 million barrels a day, and then they go on to develop the terrible fantasy about King Faisal suddenly deciding to quit the business if he doesn't find his customers congenial.
But Faisal continues to raise production whenever he can do so, and the fantasy omits a simple calculation in arithmetic. If, for instance, the oil companies hold their offtake in Iran to 8 million barrels a day and at the same time increase their offtake in Saudi Arabia to 20 million barrels a day, they will save about 8 cents a barrel on every barrel produced in Saudi Arabia instead of in Iran. Divided by two for tax purposes, and multiplied by 12 million barrels a day by 365 days in the year, the oil companies achieve an annual saving of $165 million. This is precisely what they are in business to do.
A question of profits
It is this kind of calculation that illuminates the difference between the oil-company
definition of a crisis and the connotations ordinarily attributed to the same
word by people who buy gas or heating fuel. The companies define crisis not
in terms of available resources but, rather, in terms of when those resources
can be delivered, in what quantities, and at what cost. The illusion of crisis
helps them to exact further concessions from alarmed politicians in Washington.
If the crisis can be presented as a national emergency, then how can the patriotic
Senator refuse to grant hurried permits for drilling off the Atlantic coast,
for alleviating pollution controls, for whatever might hasten the delivery of
energy to a suffering electorate?
By the early 1950s, the oil companies and the oil-producing nations had established
a protected market that has now begun to collapse. Twenty-five years ago the
oil companies clearly understood that their dealings with the volatile rulers
of the Middle East (or, indeed, with the rulers of any oil-producing state,
such as Mexico or Venezuela) could easily deteriorate into bitter disputes.
They accepted the Middle East's traditional aversion to the West, and they assumed
that Arabs could be extremely difficult people with whom to bargain; they further
assumed that this unpleasantness sooner or later was bound to make itself manifest,
no matter what the pretext. The companies, therefore, hoped to limit all negotiations
to matters having nothing to do with politics. They chose to wall themselves
off from the communities in which they operated, and they kept themselves aloof
from the social or political concerns that threatened to provoke unseemly incidents.
With this strategy in mind, the oil companies confined their discussions to
relatively small fiscal points within a narrowly legalistic context. Oil negotiation
in the Middle East over the past twenty years thus became a continuous debate
over such points as royalty expensing, acceleration of tax payments, gravity
allowances, rates of depreciation, port and customs duties, marketing allowances,
and allowances for the devaluation of foreign currencies. An entire chapter
of the recent history could be written on the question as to whether forty-degree
Zakum oil should be taxed at the same rate as thirty-seven-degree Umm Shaif
oil. These questions often involved millions of dollars, but they rarely touched
on social or political events taking place beyond the compounds of the oil installations.
In return for this convenience, the Middle Eastern governments received munificent royalties, also known as "economic rents," computed on the basis of the difference between the cost of producing oil and the price at which it could be sold. The companies could afford to pay these rents because, by paying large sums of money to Middle Eastern governments, they could run their operations in Europe and the United States at a low rate of profit, or even at an apparent loss. They could also avoid paying taxes to the United States government. The companies insisted on only one condition: that the Middle Eastern countries refer to these payments as "taxes" rather than as "royalties." Before World War II, and in most places until about 1950 or 1951, the Middle Eastern governments earned a royalty of from 12 to 18 cents a barrel. The rulers were content with this arrangement until they discovered that their oil sold for at least six times that price on the world market. By the middle l950s, various political figures in the Arab world began to understand that oil-company executives were easily frightened, and so they began talking, or, preferably, screaming about the shabby terms of their concessions. They raised public and impassioned complaints whenever possible, and by so doing they threatened to wreck the industry policy of nonengagement. Their harangues gradually induced the companies to pay higher rates of royalty, and they became the beneficiaries of one of the weirdest practices in the annals of international commerce.
This practice accounts for the inflated and fictitious price at which Middle Eastern oil sells on the world market. The fictitious price has been in effect since before World War II, when the center of gravity in the petroleum export trade was to be found in the Gulf of Mexico rather than in the Persian Gulf. The trade shifted eastward in the late l940s with the first development of prolific fields in Kuwait, Saudi Arabia, and southern Iraq. In those days, the major exporting companies controlled even more of the trade than they do now, and they sold almost exclusively to themselves and to each other, in both Europe and the United States. They could set the price largely as they pleased, but for reasons of convenience they agreed to set it on the basis of the old rates that had prevailed in the Gulf of Mexico. This was done even though the new and abundant oil in the Persian Gulf cost far less than the fixed price at which the companies agreed to trade it to each other. The barrel of oil shipped from Saudi Arabia might cost 4.6 cents to load into a tanker at Ras Tanura, but it would be priced in Europe as if it were the most expensive barrel of the same kind of oil delivered from Texas. Other "costs" (depletion, depreciation, and amortization) would be added to the company's actual expenses of 4.6 cents to provide further tax deductions.
The posted price was considered extravagant in 1950, but by 1960 it had become so remote from market conditions that the companies with interests in the Persian Gulf tried to lower it. This decision proved calamitous. By trying to bring the price of oil into line with what it would bring from a customer willing to buy it (an American fuel-oil dealer, for instance, or the government of Ceylon, or an Italian petrochemical firm), the oil companies set off the enraged outcries of their necessary partners in the Mid. dle East. The Arabs and the Iranians had been receiving revenue calculated on the basis of the posted price, and they refused to let it drop. In their rage and anxiety they formed the Organization of Petroleum Exporting Countries, and this combination has since become the bane of the oil companies. The first agreements within OPEC stopped the downward trend in prices and thereby introduced a principle that has yet to be publicly questioned by any of the major oil companies: the tax-reference price on Persian Gulf oil (or on any other oil produced by the members of OPEC) can never drop. The corollary to that principle states that revenues paid to the governments in the Middle East can only rise.
It was the weakness of the oil companies that brought about the organization of OPEC. First the companies tried to lower the old price; then they couldn't agree on a line of bargaining with the Arabs. And yet it is precisely these people who attribute an almost godlike omnipotence to OPEC. The oil companies at least share similar political interests, and they have far more in common with one another than do the several factions within OPEC. The assignment of magical force to OPEC also presents a major contradiction within the structure of the Arabian fantasy so widely proclaimed in the American press. The emotional aspect of that fantasy portrays the Arabs as childish, petulant, and treacherous, but the analytical aspect of the fantasy shows them as idealistic, fearless, and beyond corruption. The historical evidence suggests that OPEC will collapse for the same reason that the oil-company front collapsed.
The system of fictitious prices worked so well for twenty years that it gave the Middle Eastern governments great, and constantly increasing, sums of money. Contrary to popular misconception, much of this money found its way into the local economy, and wherever it has been present (most notably in Saudi Arabia and Iran) it has strengthened the society. The exorbitant sums of money presented few difficulties as long as the system remained intact. as long as there remained an oligopoly of oil supply.
It was not just an oligopoly of companies but also of system. The companies had no more freedom within the system than did the oil-producing states. They did not dare allow a drop in the posted price (or, to use the preferred euphemism, the tax rate) because they knew that if they did so the Arab states would promptly seize their holdings. The supposedly dreadful consequences of such a doom terrified a generation of oil executives. But now this doom has come to pass, and, lo and behold, it isn't as dreadful as everybody had foretold. The companies have given up larger and larger shares of their concessions, but these proved to be nothing more than pieces of paper assigning them the right to produce the oil that they now can buy from the same producing states under nearly the same conditions as before. The Middle Eastern states have realized the old dream of controlling their own production. In Iran this is called "nationalization"; other countries refer to it as "participation," but, even though the politicians have been satisfied, the oil still must be sold to somebody. The oil companies themselves don't much care where the oil comes from, or who owns it, or at what point along the stream it changes nationality. *
* This is an important aspect of the oil trade, and it explains the reluctance of Standard of Indiana to develop the field at Fereydoon. The lack of owned crude oil may not be a serious liability for a major oil company. Mobil, for instance, has been buying maybe 150,000 barrels a day from Standard of California, one of its partners in Aramco, at what is called "eighth-way price," i.e., a price one-eighth of the way between the tax-paid cost of the oil and its posted price. This represents a markup of perhaps 8 or 9 cents a barrel. Why should Standard of Indiana go the trouble and expense of developing a field like Fereydoon if it can arrange a comparable deal with a partner in Aramco or the Consortium?
The apostles of crisis predict that the Arabs will ignore the laws of free enterprise and choose to sell their oil to nobody. Presumably they will do so because they already have all the money they require, and in the desert countries (Libya, Kuwait, Saudi Arabia) the small population makes no loud demands for social improvements. Thus the rulers can afford to leave the oil in the ground, waiting for a desperate industrialized world to comply with their political demands or to bid the price of oil to the bankrupting levels of $8 a barrel. The rulers then will take advantage of the inflated prices, and in a few years they will destroy the international monetary system and bring about the devaluation of everybody else's currency.
The trouble with this argument, as with most theoretical arguments dependent on imaginary lines converging in abstraction, is that it takes little account of the moderate behavior shown by the Arabs in the aftermath of war. It assumes that the West will do nothing to protect its own interests, that everybody will stand around placidly watching the projections become political realities. Which is, of course, nonsense. Either the oil companies will arrive at a profitable détente with the Middle East (less profitable than in the old days, perhaps, but still satisfactory), or they will suddenly discover that alternate sources of oil and energy were far more accessible than heretofore had been imagined.
The October war reinforces this observation. It does not seem as though the war violated legitimate American aims in the Middle East at all; in fact, it has probably contributed to a détente. An American official sympathetic to the Arab cause but aware of the political power of the Zionist cause in U.S. might shrewdly have confided as follows to a friendly Arab diplomat: if the Arabs threaten Europe with an oil embargo--and thus threaten NATO and American strategic interests--the American government would have no choice but to go before its public and demand a more evenhanded American policy toward the Arabs. American strategic interests would of course be even more jeopardized by Soviet adventurism in the Middle East. The threat of embargo would, at the very least, force the American government to aid in the restitution of Arab lands occupied by the Israelis in 1967. Americans might also feel constrained to do something about the Palestinian diaspora. All in exchange for an Arab-Israeli peace treaty, to be sure. The Zionists would not like it, but they would have little choice but to accept it. After all, they seem to have as few friends left as Taiwan, and the Arabs are getting stronger. The Arab leaders would not like to make peace with Israel, but they could afford to do so if they could show that they had forced America to shift its policy somewhat in their favor: no Arab who might oppose them could say that they had done more than these moderate leaders had done to restore lost Arab honor. And the conservative oil states would brandish the oil weapon just a bit to gain immunity from radical anti-Western Arab opinion.
New myths for old
The careful wielding of the oil weapon--specifically, the process of "nationalization"--has gradually shifted the politics of oil negotiation in the Middle East. If the producing nations no longer possess the great threat of expropriation (do what we say, or we will seize your holdings), then they will have lost their most effective advantage. As they become wholesale dealers instead of privileged concessionaires, they will find themselves forced to compete in what will begin to resemble a free market. The oil companies still will own 75 percent of the refineries in the non-Communist markets, as well as most of the port facilities, and so they will continue, albeit less directly, to determine price and regulate production in the international oil trade.
The Middle Eastern countries will also find themselves more concerned about the stability of Western economies. Earlier this year, for instance, Saudi Arabia agreed to buy 25 percent of Aramco for a price of about $1 billion. By so doing, it becomes a major partner in the combination of Western oil companies, and to some extent it will come to share similar interests. As the Middle Eastern governments acquire larger percentages in Western companies, they probably will invest their assets in Western banks and multinational corporations-not because they want to do so, but because they will lack sensible options.
All this will take time to come to pass, but as it does the specter of an oil crisis will gradually diminish and fade. The specter will then be replaced by that of the refinery crisis. Suddenly no one will be talking about the lack of crude oil or the vindictive politics of the Arabs; instead, everybody will be saying that oil is plentiful but means nothing unless it can be refined into useful products, and that the environmental demands placed on these products (low sulphur content, etc.) require a new generation of refineries that will be extremely expensive to construct. This, in turn, will lead to the elaboration of another myth.
The major American oil companies have neglected to build refineries over the past few years because there hasn't as yet been enough profit in the enterprise. In order to justify the expense of building a refinery, the oil companies require the long-term assurance of crude oil supplied at low prices. Refinery construction is expensive: a fair-size plant might cost about $100 million. The big companies have this kind of money. Standard Oil of California, for instance, added $120 million to its cash reserves in 1972, but it allocated none of this money to constructing new refineries in the United States. Until the Nixon Administration relaxed the quotas last spring, the long-term importing of crude oil was restricted, and so the companies had little crude as collateral with which to secure new refinery construction financing. At this moment, it costs well over $2 a barrel to bring Saudi oil into an American port (as opposed to a net production cost of 75 cents for a barrel of American oil), and so the energy crisis continues to be thought of as low crude-oil supplies rather than high oil cost.
When the tax-paid cost of Middle Eastern crude drops, the rush to build refineries in America will be on. As soon as that occurs, the last vestiges of popular illusions about the energy crisis will have disappeared. All the participants in the drama will remain as they were, but in a clearer light.
The independent oil man, the marginal, will be even more threatened and insecure than he has always been and may vanish altogether. The consumer will continue to pay more and more for the services it has always been very much worth the companies' while to provide him with anyway. The consumer had better get busy learning about prices and wondering why the oil companies sell gasoline wholesale at 21 cents a gallon when it costs them only 4 cents a gallon on the average to provide it. He had better start investigating pipeline and production costs, too, and had better find out what it costs the companies to get oil into the top end of the trans. Alaska pipeline and how much they will sell it for at the bottom end when it is finally built. The latest gasoline price hikes are an ominous harbinger of things to come.
The American government will continue to make the same mistake as the consumer:
our Congressmen and Senators will continue to worry about supply and ignore
cost. And the companies? They are not deeply concerned about Saudi Arabia, Iran,
or the Middle East. They know the limitations of the Arab oil weapon, and are
profoundly concerned about protecting their immense assets and safeguarding
the accessibility of these assets. If money in the Middle East no longer comes
easily to the oil companies, they will be happy to keep looking for it elsewhere.
They recognize that it is good enough to have ridden the Arab carousel for more
than
a generation.
Christopher T. Rand is a Middle East specialist who has worked for Standard Oil of California and Occidental Petroleum. He has translated Arabic and Persian materials for the U.S. Department of Commerce, and is now writing a book entitled Oil and the Moslem East.
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