Internal State Department Memoranda--Analysis of Middle Eastern Oil Concessions and Their Implications for US. Foreign Policy by Richard Funkhouser, 3 July 1953

SOURCE: United States Congress, Senate Committee on Foreign Relations, Hearings, Multinational Corporations and United States Foreign Policy (Washington, D. C., 1975), pp. 135-39.

To: Ne-Mr. Hart.
From: NE-Mr. Funkhouser.
Subject: Middle East oil policy considerations.

July 3, 1953 (revised September 10, 1953).

1. The history of agreements on Middle East oil is not encouraging. Past agreements have been either restrictive, counter-productive or ineffective:

(a) The Sam Remo agreement arbitrarily divided Middle East oil between the British and French. The United States Government spent several years breaking up this "duopoly," only to replace it by what even oil men consider an undesirable "oligopoly," e.g. IPC.

(b) The State Department's "Open Door Policy" negotiations with the British Government in the 1920's were officially interpreted as a landmark in improving the competitive aspects of Middle East oil development and in establishing U.S. oil companies in the Middle East. C. S. Gulbenkian, however, calls the "O.D.P." "eyewash," and writes in his memoirs that "never was the open door so hermetically sealed." "If the U.S. companies had not been allowed into the British French Mesopotamian concessions they would have broken in," because of the tenuous and controversial grounds on which the British-French concession was based. Gulbenkian argues that this action established a most effective cartel in which maximum prices and profits were realized.

(c) The intercompany Red Line Agreement of 1926 prevented the major oil companies from competing against each other for concessions or oil purchases in the Middle East. This helped retard production in Iraq, Kuwait, Saudi Arabia, Qatar and the Neutral Zone for ten to twenty years. It contributed heavily to public mistrust of the international oil business which is haunting the oil industry today in the area.

(d) The Anglo-American Oil Agreement of 1946 was abortive. The United States Government with its companies controlling only 5% of Middle East production wanted to remove British restrictions to competition. The United Kingdom Government wanted an agreement which would maintain the status quo and guarantee respect for concession contracts. The eviscerated compromise was meaningless but even that caused domestic producers in the United States to fear that they might be subjected to some international control. The agreement was pocketed by Senator Connolly. Meanwhile, American companies by their own competitive efforts and without such an agreement have gained control of 66% of Middle East production. (This might be 90% if United States companies wished to deal with Iran.)

(e) United States Government efforts (1946-1948 and later) to spell out an oil policy have been abortive. The Department of State has not been able to agree on oil policy within its own walls, let alone develop substantive agreement between other agencies. Probably the major impasse comes down to whether the principles of the Sherman Anti-Trust Act are good or not good for the world and oil.

2. There are other reasons for this dilemma regarding agreement on oil. One is that there are few outside the oil industry who are well in-formed on oil; company officials by their nature cannot be completely disinterested and objective. Secondly, two realistic and resourceful oil executives when put together traditionally retreat to caution and conformity. These qualities are not helpful in accommodating the dynamic oil industry to the rapidly changing conditions in the Middle East. Thirdly, the Departments of the United States Government, as well as oil companies, seem to find it difficult to agree formally to the difficult courses of action always required. Formal discussions and agreements on oil turn out to be defensive and try to insulate the oil industry from trends abroad in the world. Nationalism as applied to the oil industry and interpreted by the industry becomes a scheme of local radicals who "wish to kill the goose that lays the golden eggs." Consequently, oil policy discussions tend towards the restrictive, the unrealistic and the unimaginative. Lastly, oil agreements seem always to be between parties that have the oil and consequently cannot take into account adequately the interests which cause the trouble. The result is that agreements on oil are suspect in the public mind and "agreements" become in themselves self-defeating. This would certainly apply to any U.S.-U.K. agreement on Middle East oil at either the company or the government level.

3. It is thus more than possible that the results of United States and United Kingdom oil company collusion or cooperation, as HMG is recommending, would produce something bad rather than good. United States oil history and legislation would support this suggestion. The facts and findings of the FTC report, notwithstanding its highly slanted and non-objective approach, are pertinent in this respect. It should be remembered that the NSC and individual departments of government did not attempt to evaluate the substance of the report or its validity but only objected to its publication. Critical problems raised by real or alleged collusion among oil companies remain to be settled.

4. Oil companies are now insisting that the anti-trust law suit is the root of all their Middle East troubles. This point should be most carefully evaluated. White it is obvious that ME officials will take advantage of every available weapon in their negotiations, it is unrealistic to equate oil company difficulties in the area to the law suit alone. Oil companies were under greater pressure in the two-year period preceding the FTC report and lawsuit than they have been in the succeeding period, e. g. AIOC concession was cancelled in 1951; Aramco told the Department that American lives were endangered by Saudi Arabs in 1950, IPC narrowly escaped nationalization in 1949. A reflection of the deepseated problems discussed in the FPC [sic] report could be found in these serious crises, but neither the report itself nor the lawsuit played any role in these difficulties since they were unborn. Similarly, it was easy to predict, as both Department and oil company officials did on repeated occasions, that the pipeline and pricing policies of ME companies were most vulnerable to local attack on grounds of precedents elsewhere. Industry representatives recognized this situation, and current Aramco action squarely faces these facts. The antitrust action has of course contributed to local suspicion of companies in the area, but this is neither particularly new nor is it certain that it is one of the basic contributing factors to instability in Middle East oil. Solutions aimed at removing what may be marginal factors in this equation may be either counter-productive domestically and abroad or dangerously tangential during a critical period when the real sources of trouble must be analyzed and corrected.

5. It is possible to be equally skeptical about constructive results from collusion or cooperation between Arab states on oil. Their self-interest lies not only in increased control of the industry with the attendant hazards to the West, but specifically in increased prices which could adversely affect the viability of all oil consuming states, particularly our European allies. Such repercussions would hardly cause concern among Arab Governments which feel the West has taken too much profit from Arab oil to [sic] long.

6. Collusion or cooperation between Arab states and oil companies together might well compound the disadvantages of paragraphs three and four. There might be a pronounced mutuality of interest in higher prices, supported by controlled or restricted production. Direct repercussions could increasingly with time affect the American consumer. With the center of gravity of the world's oil moving from the United States to the Middle East, matters of price and supply may eventually be determined in the Arab world and the unpleasant day may come when Arab states can double oil prices and get away with it.

7. Collusion or cooperation between oil companies, Arab states and HMG might further compound the problem. As British Embassy representatives have suggested. HMG's Treasury might welcome higher priced Middle East oil. A case could be made that the consumer would find himself up against a formidable "super-cartel." Competition in the international oil industry could under the circumstances suffer a serious blow. It is possible that big companies would get bigger, small companies smaller, fewer would control more, until the point of serious conflict with the rest of the world, the result of which could cause world repercussions much greater than anything now faced.

8. Mr. Duce believes that such a group, however, could get together for constructive purposes. He refers to the operations of the Texas Railway Commission which endeavors to conserve dwindling reserves and to avoid unsound production practices. It should be remembered, however, that the Commission was developed within the narrow limits of one area which had experience in producing oil in vast quantities for fifty years. The problem in the Middle East seems to be quite different. The Arabs are not interested in conservation. Their complaint is that their oil has been conserved too long. Their production has been restricted during a most lucrative half of the twentieth century and now they may well wish to spread their oil all over the world. Arab states may eventually be more concerned with competition from other sources of power than with depletion of their 70 billion barrels of proved resources which probably cannot be over.produced in the foreseeable future.

9. One of the tested solutions to oil problems has been, on the other hand, the development of conditions under which competitive forces are encouraged to operate more freely on each other. Some oil executives and economists, for example, believe that AIOC might never have been nationalized if they had had competitors in Iran. There is a certain safety in numbers; it has worked in the United States and in Venezuela. If Jersey, Socony or Shell and several independent groups of whatever nationality had been producing oil in Iran the following might have developed; (a) there would have been no monopoly, which is ideally easy to nationalize, (b) AIOC would have been kept on its toes and been abreast of changing conditions in the world, (c) Iran would have profited from greater production, greater activity and greater revenues, (d) AIOC would not have been blamed for everything that went wrong in Iran. The Department has in the past, as have individual oil company officials, urged IPC and Aramco to relinquish greater parts of their 400,000 square mile concessions in the Middle East, for this reason. The Department has been partially successful with IPC and a strong case can be made that the action has been helpful in reducing tensions in the area. AIOC, of course, helped save itself from expropriation in 1933 by giving back 400,000 of its 500,000 square miles monopoly, but then unfortunately did everything in its considerable power to keep out competitors. Aramco by its own admission could have avoided jumping to the 50-50 profit-sharing agreement if they had given up a large part of their concession in 1950, as asked by the Saudis and generally supported by the Department. This issue may be difficult for the company to sidetrack indefinitely.

10. However, oil company management, like HMG, too often appears to think time is on their side and with notable exceptions may take required action too late. Concession contracts like the British Empire will continue to undergo "surprising" attacks and "crises" and, like the British Empire, probably cannot be protected by guns or governments but only by enlightened thought, understanding and compromise. Enlightened oil company policies, knowledge and application of public relations, government relations, labor relations practices proven effective elsewhere in the world, forthrightness (such as has not been overdone to date in the recent Aramco price and the IPC pipeline negotiations), education and other specific lines of action spelled out in the Department's draft Middle East Policy paper dated September 10, 1950 would seem to provide companies with the best possibility of riding out these crises and changing with change.

11. However, with oil company policies as they have occassionally been in the past, with the Arab coming into his own with a vengeance, with the historic precedents for colonies to go through the nationalistic stage before arriving at the international approach required for Mr. Duce's Oil Plan [sic}. IPC and Aramco local producing operations may well be nationalized or at least "reversed" in time. The equation may be that the nationalization date equals X (time for present generation to develop Arab oil "experts"), plus Y (completion of the large investments and installations needed to produce in quantity), plus Z (a hardheaded bargaining position on the part of oil company management). Z is dangerous variable, Y is probably here, and X is moving along fast. Irresponsible Arab nationalism and distrust of Western governments and oil companies appear to be "constants" in this equation. General Smith told Mr. Duce virtually the same thing when he said "natural resources invite nationalization."

12. In this regard it may be a false conclusion to consider that the Iranian catastrophe will deter others from following suit. On the contrary, it might be argued that other Middle East states (a) strongly sympathize with what they consider a courageous defiance of the West, (b) now more clearly recognize the extent to which oil companies and Western governments can and will penalize the oil state by boycott and (c) will consequently move more carefully but more relentlessly towards breaking this "foreign control" of their countries and their resources. To think that the Arab masses will learn a lesson from the Iranian debacle may be unrealistic.

13. Oil companies and/or Western governments might consequently be making useful plans at this moment to handle such a situation should it develop despite all efforts to the contrary, i.e., how to carry on trade in the Middle East in a situation in which producing "concessions" are drastically altered. General Smith's "management contracts" proposals might well be given secret study by industry and/or government, but it is difficult to have' confidence that such planning for the worst can be successfully undertaken, particularly en masse as Mr. Duce suggests.

14. Perhaps serious study would indicate that nationalization or "reversal" of all Middle East producing properties might not ipso facto mean doom as oil companies claim. It is possible that the same oil might be available to the same consumers and to the same oil companies in the same quantities. There would appear to be no real alternate sources of consumers or companies. A case might even be made that there would be fewer tensions in our relations with the Middle East and a more profitable and stable international oil industry if the companies worked through the reverse type of concession, i.e., the management contract advanced by General Smith and advocated by such successful oil executives as Mr. Brantly of ECA and Texas. What are needed are oil men with the vision to be able to accommodate their thinking to changing oil conditions in unorthodox times and in an unorthodox area. (I am convinced the industry not government must lead in this.) That ability to accommodate is best developed under an environment of free competition rather than from efforts to "hold the line," which seldom succeed. The "hold the line," "big stick," "force," "British," "Kennan" school has however many supports in and out of industry; its adherents increase with frustration, exasperation and crisis in the area. I can't believe it is the answer or that it will work in 1953 in Asia. Its record, as illustrated best by past AIOC-U.K. policy in the Middle East, is unenviable in terms of end results. Its contribution to the difficulties now found in the area seems large. Such a policy even appears commercially unsound, judging by the profitability of the American company approach to Middle East oil problems. Furthermore, the identification of foreign companies with their foreign governments has not helped British company stability in the area, while a case can be made that Aramco's independence of the U.S. Government was not only responsible for the granting of the Aramco concession in the first place but has been a carefully nurtured concept of the company in its present highly successful operations. U.K.-AIOC singleness of purpose only served to close both minds to the realities of the Iranian situation and resulted in the wrong answer. Such a policy has also helped convince Iranians that soverign [sic] control of their own country is meaningless in the face of foreign government involved in commercial affairs.

15. In several years, events in the area may be recognized as sufficiently serious to require the type of international study and cooperation recommended six years ago by John Loftus. It will be remembered that Mr. Loftus gave his speech in Pittsburgh suggesting that the international oil business might wish that they had an international forum where international order in the industry and international rules to protect their investments might be slowly developed. Mr. Loftus was rash enough to suggest that to be effective such an international instrumentality should give full representation to the consuming as well as producing nations. He was violently attacked by segments of the industry at that time; there are indications, however, that Sir Wffliam Fraser and others may be less violent on the subject now.

16. Meanwhile, the most practicable line of action remains, in my opinion, a full informal exchange of ideas between individual Departmental officials and individual oil company executives. This at least has worked on important occasions in the past.

(a) NEA representations in 1948 to individual officials of Jersey, Socony and the British and French Embassies in Washington successfully brought about the first royalty increase in the Middle East in 1 5 years. A strong case can be made that nationalization of IPC in Iraq was avoided by this "semiofficial" approach.

(b) Informal Department representations to the U.S. companies operating in the area (1947-1949) were instrumental in bringing about the relinquishment of a number of concessions, including, the Kuwait Neutral Zone. A strong case can be made that by this action, stability in Middle East oil as well as competition in Middle East oil was increased.

(c) Informal exchange of views between Department representatives and Middle East oil company executives (1949-1950) played a significant role in the adoption in the Middle East of the Venezuelan profit-sharing agreement as well as other progressive company practices in Venezuela.

(d) Informal exchange of views between Department representatives and individual United States oil officials (1952-1953) played a role in the development of the new "tariff" approach of the United States companies to Middle East pipeline problems.

17. It is meanwhile to be deplored that there seems to be an increasing tendency among modern-day oil executives to seek increased government control, business [sic] and does not reflect the attitude of the aggressive leaders who won the petitive virility and survival powers. This present-day desire to protect the status quo in place of disrupting the status quo would seem to be a sign of old age in business and does not reflect the attitude of the aggressive leaders who won the concessions in the first instance. If this is true, such companies as IPC and Aramco may look forward to the ignominous end of the unversatile dinosaur family that sank in the mud when the weather changed.

18. A strong case can be made that increased government involvement and control is inevitable in international oil. It seems almost certain that Arab Governments will exercise increasing control, and the argument perhaps could be made that in view of this inevitability United States and United Kingdom Governments should get into the act in order to make such control as harmless as possible. However, it is hoped that this unfortunate alternative can be postponed, and that every effort will be made to fight government encroachment into the oil business. This can best be done by increasing the competitive environment in international oil and by forcing oil companies to develop their own biceps by punching each other in the nose occasionally. They are getting along awfully well these days.

19. I would, therefore, reach the conclusion that any study of "proposed solutions" to Middle East oil problems include an evaluation of the following "muscle building techniques" which have produced beneficial results, both commercial and political, in the past:

(a) Aramco and IPC might be completely freed from control of parents and might sell to all comers as producing companies.

(b) Aramco and IPC might relinquish all concession areas not currently in production.

(c) Pipeline companies might be completely freed from control of producing companies and parents and become "common carriers" in competition with tankers.

(d) Middle East governments might be urged to favor bids on new areas by companies without Middle East production.

(e) Every encouragement might be given to independents to move Iranian oil.

(f) These examples of "nose-punching techniques" have each been suggested to me by industry (major company) officials.

20. Lastly, it is of critical importance to the success of any approach that oil men be handled most carefully and diplomatically. Oil officials seem overly sensitive to any indication that the industry isn't perfect. It may be necessary to "agree" with them before attempting to draw criticism of their own operations and possible solutions from them. It is probable that government officials start with two strikes in any objective discussion of oil problems. Emotion, pride, ioyalty, suspicion make it difficult to penetrate to reason. Oil men tend to divide government people as either "for them" or "against them" and the initial adverse impression seems to get around fast and make solutions most difficult to reach.

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