Chapter 31: OPEC Imperium

The key to a successful group of entities, be they companies are countries, is some degree of cooperation and consistency. OPEC has always been plagued with challenges from within. Some want higher prices; others want less production to grow demand. Iran was a short-term thinker, Saudi Arabia a long-term thinker. On paper, OPEC is a powerhouse, controlling so much of the world’s oil that they can make or break economies. And they have. OPEC became a major force in the world economy, with the flow of petro-dollars earnings increasing from $23 billion in 1972 to $140 billion by 1977. The international oil order had been turned upside down. OPEC essentially then determined if there would be inflation or recession, and they were the world's new bankers.

During OPEC’s golden age, 1974-1978, they acquired complete control of their own resources, and there was no longer confusion on who owned the oil. When you have much of one thing, regardless how valuable, it can lead to desiring things you do not have. With the wealth and riches, the oil-producing countries acquired the spending trappings of the West — industrialization, infrastructure, subsidies, services, necessities, luxuries, weapons, waste, and corruption. To ensure the security of oil access, weapons sales were used as a way to enhance security and maintain and gain influence. The OPEC shopping spree, through the attempt to buy a modern economy off the rack and build modern military forces, led to the evaporation of the financial surpluses. By 1978, the 1972 surplus in the balance of payment of OPEC of $67 billion had become a deficit of $2 billion.

Had the poor management and strategy of OPEC been confined to the member countries it would be one issue. But the oil price hikes and the “OPEC tax” brought about a deep recession in the industrial countries. For example, the gross national product (GNP) of the US plunged by 6% between 1973 and 1975 and unemployment doubled to 9%. In 1974, Japan's GNP declined for the first time since WWII. The impact of the oil shocks was stagflation (high inflation and unemployment rates; high prices and slow/low economic growth). Thus, the price hikes resulted in inflationary shocks to most economies, especially developing countries without oil. The developing economies around the world struggled with inflation and recession. Their balance of payments bottomed out, which prevented investment and any growth within these developing economies. When the price of oil went up, it caused them to go into debt to cope with the new oil price. Importing countries had to find ways to negotiate with all of the countries, which meant different strategies with different countries.

Iran is a great case study of how a sudden influx of money can destabilize a society. The huge inflow of money to Iran was causing drastic changes in the Iranian society that included chaos, waste, inflation, temptation, corruption, and political and social tensions. We shall see as time passes that this country has become almost the opposite of what it was leading up to the riches of the Middle East oil industry boom.

As we discussed in Lesson 9, there has always been tension between concessions and participation, and the nationalization of oil. The exporting countries had always found the concessions degrading and a symbol of colonial power. Iraq had also completed the nationalization of the Iraq Petroleum Company (IPC) in 1972. That left the only remaining major ones not yet nationalized as Kuwait, Venezuela, and Saudi Arabia. Kuwait decided to nationalize the remaining 40% of Kuwait Oil Company of BP and Gulf in December 1975.

Through a number of laws passed in 1971 and 1972, Venezuela took control over oil, effectively achieving the objectives of nationalization without actually nationalizing. It eventually led to the state holding company, Petroleos de Venezuela (PDVSA). A number of operating companies each fully integrated were also formed to ensure quasi-competition. The Venezuelan nationalization eventually took place on the first day of 1976.

That left Saudi Arabia with the mother of all concessions. This led Saudi Arabia to find a model that was not full nationalization but gave them more control. Under the agreement, Saudi Arabia took over ownership of the assets and oil rights. The companies now became like contractors providing “services” involving the operation and all the things they previously did. Thus, the oil companies were now simply buyers & refiners (“contractors”) and not producers in those countries. Instead, they provided “services” by exploring, producing, refining, and marketing oil. Hence the global oil industry took on a new form after the OPEC golden ages and the nationalization when the state-owned companies moved downstream, beyond production, into the international oil business outside their own boundaries.