Concepts to Consider for the Lesson

In this Lesson, we see the birth of the modern oil industry. I say “modern” because fossil fuels and hydrocarbons have been in use for thousands of years. We learned that what defines this new era was driven by several factors- the growth of the “business” aspect, the advent of new technologies and efficiencies, and the shift to “rock oil” or oil recovered by drilling as compared to finding seeps and skimming off the surface. In other words, we started digging for it rather than stumbling onto it. Another fact defining the “modern” oil industry was the incredible diversification in uses. We tend to think of fossil fuels as mainly for heating and transportation, but those uses are relatively recent arrivals to the story. The early years were focused on oil as a source of lighting, as a lubricant, and to an extent, for medicinal purposes. In regard to efficiencies, the rapid evolution from horse-drawn carriages carrying barrels to railroads to seafaring tankers completely altered the dynamics and economics of the business.

The textbook frames these aspects as themes- oil as the rise of modern capitalism; oil as a commodity important enough to impact politics and national strategies, and as something that permeates society so thoroughly that we are in what the book calls the age of “Hydrocarbon Man.” This short half-century from the mid to late 1800s saw this industry go from its birth to unseating coal as “king,” and making itself one of the world’s most important commodities even to this day. As we will see as we go further into the textbook, many of the characteristics of the industry back then still exist and occur today. We will also see how we got to be where we are today.

However, the focus of the first few chapters actually highlights another effect altogether of the oil industry and that is how it shaped and molded the business world as a whole and helped define the era of the giants of the industry. The oil industry taught us many things about the general aspects of being successful in business. We learned that it takes an immense risk, confidence in convictions, patience, and tolerance for failure or at best, long delays between successes. Without this mindset, the giants of their day, most exemplified by Rockefeller, would not have been able to create what they did. Unlike typical manufacturing, in the oil industry, you need to go to where it is. You also need to move it great distances to get it from where it is to where it is needed, with the intermediate elements of processing and refining. It is truly amazing then that it was the oil industry and not typical manufacturing, that was the early pioneer of fully integrated and multinational giants.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to the history and development of the oil industry in America and throughout the world
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications

What is due for Lesson 1?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

The Prize, Chapter 1 Overview

Even in the earliest days of the business, the pioneers experienced market booms and busts with wild price fluctuations. Some areas that were prolific producing regions quickly dried up. The early days were characterized by an essentially uncontrolled frenzy to find and produce as much as possible. This quickly proved unsustainable, and our oil industry today is much more tempered and organized. Some may see today’s discipline as counter to the entrepreneurial spirit, but in reality, it is necessary to ensure long-term stability.

An interesting point about the early days of the oil industry is the important role that Pennsylvania played. Pennsylvania essentially was the US oil industry. It would only come later, as we shall see in subsequent chapters, that the focus moved to Texas and Oklahoma. And by the time we get to today, the first places people think about in regard to the US oil industry are Texas, Alaska, Oklahoma, Louisiana, and Wyoming. The recent reemergence of Pennsylvania, and the entry of the Dakotas, as oil hubs is due to the advent of hydraulic fracturing, another “necessity driven innovation”.

The Prize, Chapter 2 Overview

What is even more interesting from a business perspective is how the oil industry created changes and approaches that we see today in nearly all business sectors, for example, the concept of multinational monopolies and the pushback to these monopolies. We also learned about the concept of the integrated company, which contains many or all aspects of the business. We are used to this now with industry, but the idea evolved from the early oil days when they realized being limited to only a few aspects of the lifecycle led to uncertainty, risk, and vulnerability. Rockefeller’s vision was to control all aspects. Ironically, he didn’t go at it from start to finish in terms of the process. Instead, he focused at first on the middle, the refining, and only later added exploration and production, and then marketing. Not surprising in that the highest risk and uncertainty was in the exploration and production, as compared to refining the product once already in hand.

Rockefeller and Standard Oil also catalyzed the concepts of “cash on hand”, leveraging economy of scale, and reducing, or even eliminating competition. We see all of these aspects today. I am sure many of you can see Rockefeller’s Standard Oil in today’s Walmart or Ford Motor Company. The concept of shareholders and trusts that Rockefeller leveraged to maintain his empire effectively are now common in the business world.

Although a keen, and at times ruthless businessman, Rockefeller was also part of the age of philanthropists that gave us Carnegie, DuPont, and others. They came from a mindset of being successful, providing a service to society, and giving back to do good.

The Prize, Chapter 3 Overview

With Chapter 3, we see the beginning of true globalization. This doesn’t mean that the rest of the world didn’t use oil, but what happened in the late 1800’s was the connection between countries by way of multinational business approaches. As the industry was essentially private sector and not bound by national borders and government jurisdictions, it was possible for single entities to see the entire world as a marketplace and source of oil. But with this expansionist view, we also now saw the arrival of new competitors. Whereas Standard Oil may have had a monopoly in the US, they encountered formidable challengers on the world stage. They also encountered significantly more challenging conditions. For those who thought exploring for oil in rural Pennsylvania was challenging, it was a rude awakening to encounter the conditions in Southeast Asia and Russia. The topography was challenging, and the distances were truly vast. Moving oil tens or hundreds of miles paled in comparison to moving it thousands of miles and across waterways and over mountains.

Lesson 1 Connection Video

Review the video titled "The Rise of American Oil and the Competitive International Industry" (3:36)

Concepts to Consider for the Lesson

In the short time passage covered from Lesson 1 to Lesson 2 we see the inevitable consequences of the appearance of a new industry sector. Recall in Lesson 1 the diversification of uses for oil, and the meteoric growth of Standard Oil. We saw in Lesson 1 that with this rapid growth came great success. But brewing underneath that success was the focus of the competition and others' suspicion of ulterior motives.

As with Lesson 1, the readings teach us two stories in parallel. The evolution of the oil industry itself, and the oil industry as an example of the evolution of capitalism as a whole. For example, the appearance of competitors, the obsession with “cutting Standard Oil down to size,” and the expansion of markets. There are two ways to succeed in business- get a bigger piece of the pie, but also see what you can do to make the pie bigger! Consider what you read about the early days of the oil industry to what you see today with electronics, social media, and the entertainment industry.

Another significant takeaway from the readings in Lesson 2 is that what may seem like a solid business that will last forever rarely does. In a short time, the oil industry almost disappeared simply because of the invention of electric lighting. It was only by sheer luck that the automobile came along at the same time and innovation found a way to utilize oil products for that market. The key was the ability of the oil industry to see what was happening and find a way to adapt. The oil industry never stopped innovating since then, and today, the uses of crude oil products are staggering. A common misconception by society is that if we can eliminate the automobile, there will no longer be a need to drill for oil and gas. Many people will be quite disappointed if they knew how many day-to-day household necessities come from crude oil products. So even if phased out of transportation or power generation, there will be a lot more innovation needed to phase out its other uses entirely.

With Lesson 2 we will discuss the loss of oil markets with the invention of electric light and the almost simultaneous regaining of new markets with the development of the automobile. It also discusses the decline in the dominance of Standard Oil with the discovery of oil in other parts of America and the subsequent emergence of competitors. But at the same time we will also discuss the growing public hatred against big oil, and the cry for the Federal government to break up Standard Oil as a way of overcoming its monopoly. Concurrent with the desire to break up the monopoly that was Standard Oil, the concept of the major international oil company was born. The rise of Royal Dutch/Shell as a major international oil company and the fall of the Russian oil industry will also be discussed.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to the Standard Oil Trust and to the “Oil Wars”
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications

What is due for Lesson 2?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

The Prize, Chapter 4 Overview

The chapter is characterized by additional themes. We see the rapid, and fortuitous transition of the industry from primarily supplying fuel for lighting to now supplying fuel for transportation- mainly for the newly commercially mass-produced automobile. And not a moment too soon because the invention of the electric light completely decimated the oil for lighting business. To this day, fossil fuels are fundamental to transportation of all types. From cars to airplanes to ships, they move because of fossil fuels. The time period also saw the oil industry keep up with rapid industrialization of the economy, with the growing use of fuel oil to power boilers in factories.

This chapter also highlights that the oil sector was growing, and it was no longer all about Standard Oil. We see the birth of new companies and new producing areas. No longer was Pennsylvania the center of action. During this period Texas and California came online as substantive producing areas. Unlike Pennsylvania, which has faded a bit, places like Texas and California still dominate as major US producing regions. The famous Spindletop in Texas occurred in this period. Spindletop exemplified that despite many lessons learned over time, certain things were done the “old way,” resulting in the same problems. The same issues of over-drilling and uncontrolled production that crashed the industry in Pennsylvania also hurt Spindletop. Unfortunately, those drilling at Spindletop did not learn that production rates must be controlled to maintain reservoir pressure and price stability. An interesting development as the California oil sector evolved in 1900-1911 was the use of science, specifically geology, to be more logical and accurate in searching for oil. The days of finding oil by chance gave way to using science. Geology helped explain how oil forms and where to look for it. Eventually, the “petroleum geologist” became its own profession.

As to competition, we saw the birth of many new companies that have since become iconic household names today. Shell, Gulf, Sun, and Texaco all came of age during the late 1800’s and early 1900’s. We also saw the establishment of the “integrated company” where a single entity controlled everything from getting oil out of the ground all the way through to refining and distribution.

The Prize, Chapter 5 Overview

All was not ideal as far as the general public was concerned. Rapid industrialization spawned big monopolies and giant companies. Society felt threatened and suspicious and called on the government to institute controls. Reminds us of today and big tech companies, does it not? That fear of “big oil” combined with a growth of progressivism set the government and Standard Oil on a collision course that would change the face of the industry forever. This fight was as much about socialism versus capitalism as it was about oil. Ida Tarbell’s mission to dismantle Standard Oil aligned with President Roosevelt’s belief that government need not destroy these monopolies and trusts, but should control them.

Standard Oil established a holding company, but that was not enough to insulate the company, and by 1906, the government filed a lawsuit, and in 1909, the dissolution was ordered. Interestingly, the dissolution of Standard Oil was the end of an era, and Rockefeller retired, but it also triggered a new movement. Out of the dissolution came forth a number of new smaller companies who today are great in their own right. But as we see today, over a century later, the market is still adjusting. At one time, Exxon and Mobil were powerhouses competing with each other, but now we know them as ExxonMobil. Some companies that came from Standard Oil have since disappeared.

The early 1900s was jampacked with new technology, new areas of development, new uses for the product, and a new relationship between government and big business. This dynamic relationship between government and big business exists to this day; and we see it with telecommunications, banking, technology, and others. Think of Twitter, Facebook and others.

The Dissolution of Standard Oil (SO)

Click for a text description of The Dissolution of Standard Oil.

Some of the companies that came out of the Original Standard Oil Company were: ExxonMobil, Chevron, Amoco, BP, and Conoco. The table shows a timeline of events.

Table of events relevant to the dissolution of Standard Oil.

Year	Event
1880	SO Controlled 90% of US oil
1882	SO 1st trust formed
1892	Ohio Courts ruled against SO in an Anti-Monopoly suit
1897	Rockefeller unofficially retired, President of SO in name only
1899	SO of NJ formed a holding company
1901	Roosevelt became President
1902-1904	Ida Tarbell's Articles were published
1906	Roosevelt started the US Gov't's "Good Sweating" of SO
1909	US Federal Court ruled Dissolution of SO
1911	US Supreme Court supported the Federal court ruling
1913	Value SO stock Doubled

image credit: The Dissolution of Standard Oil by K. Jensen © Penn State is licensed under CC BY-NC-SA 4.0 

The Prize, Chapter 6 Overview

One tried and true rule of business success, and which is clearly demonstrated in what we see in Chapter 6, is that if you invest in one part of the business, you must invest in other parts to maintain a balance. A supply with no market or way to get the product to market is not very valuable. Similarly, a market with no product quickly collapses. This “supply chain” concept became a household term recently during the COVID and immediate post-COVID period.

The birth of Royal Dutch-Shell, one of today’s largest and most iconic oil giants, illustrates this concept well. As you will read in the chapter, the evolution of Royal Dutch-Shell was a series of mergers, deals, market manipulations, and conflicts. The goal to integrate all aspects of the business as a way to make it most resilient meant pulling together oil supply, transportation options, and outlets to markets. As you read about the journey from separate Royal Dutch and Shell, through iterations of British Dutch and Asiatic, you will see how things had to adapt in order to bring in the necessary pieces. Shell is a great example of a company at death’s door being reborn as a success story by adapting to new business models and accepting reality. But the Royal Dutch-Shell story also taught us another frustrating reality in that companies continued to be undisciplined in developing fields, and as quickly as areas grew, the reservoirs lost pressure and reserves, and prices crashed due to overproduction.

In Lesson 1, we focused on the US market in the story of Standard Oil. But covering approximately at the same time period, Lesson 2 tells the story of Royal Dutch-Shell and describes the story of the Russian, European, and Far East oil markets. We must remember that we not only have huge oil reserves in the US, but also in many other parts of the world. Those regions had to go through the evolutionary process, but unlike the US markets, those markets had the added challenge of social unrest, regional wars, and extremely difficult conditions. Russia best exemplifies how social and political unrest and chaos can affect the private sector, global industry. Just because you are not government-run does not mean you are insulated from government conditions.

One final additional element we learn in Lesson 2, and something we will see continue throughout the rest of the history of the oil industry, is that multinationals were moving more widely among markets. Until now, the US market was dominated by Standard Oil and the Europe/Far East markets was by Royal Dutch-Shell. Standard Oil was known for intruding into other parts of the world, but in Lesson 2 we see Royal Dutch-Shell coming to the US, especially in California and Oklahoma.

Concepts to Consider for the Lesson

We are used to hearing about important oil producing areas around the world. But they did not all come online at the same time. Oil exploration evolved over time, with certain periods of history focusing on specific geographies. In Lesson 2, we studied the development of the markets in Russia, Europe, and the Far East. In Lesson 3, we start to see the expansion into what we now know as the Middle East oil region, one of the most important, and prolific, oil markets in the world. We will discuss the beginnings of oil discovery in the Middle East, specifically in Persia, the clash of British and Persian cultures, and the emergence of Anglo-Persian Oil Company.

This lesson also covers the changes in the markets as well. Recall changes in Lesson 1 when more uses for oil products were being developed. Then in Lesson 2 was the automobile. Lesson 3 will introduce us to the role of the internal combustion engine and the need for gasoline. It was not that long before where gasoline as a by-product was seen almost as a nuisance, and now it is evolving into its own product in demand.

Lesson 3 also reminds that even as new concepts crystallize; some old habits die hard. We still see the up and down aspects of the market with companies oscillating between doing quite well and experiencing imminent collapse. We also still see squabbling among companies, distrust, and cutthroat competition, punctuated with moments of cooperation for the greater good. But we must realize that the “greater good” in many cases meant to ensure their own survival.

As important as all of that is, one of the most impactful elements of Lesson 3 content is the emergence of oil as a strategic commodity- becoming central to global crisis and military positioning. The uptake of the internal combustion engine and its use of gasoline, combined with the transition from coal to oil, completely changed the face of military readiness and national security. As you will read, it is safe to say that the use and availability of oil drove the progress, and ultimate outcome, of World War I. The transitioning of the Navy from coal to oil is one thing but imagine the rest of the military equipment if they didn’t run on oil and had to use coal!

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to Asian oil development and World War I
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications
• Produce an evaluative statement that justifies your answer to a posed homework question

What is due for Lesson 3?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

The Prize, Chapter 7 Overview

In the early days of the oil industry, we saw the emergence of powerful companies- Standard Oil in America, Royal-Dutch Shell in Europe, and the Far East, and in this chapter, we are introduced to Anglo Persian Oil Company. Anglo Persian was born from a syndicate of other companies, an arrangement necessary to deal with the logistical challenges of this new area, as well as managing competing interests from nearby countries, not the least of which was Russia. There was little to no transportation network in Persia at the time of initial oil exploration. Among the many challenges were difficult terrain and weather (workers' quarters could get to 120 degrees), hostile culture towards the outside world, lack of technical skills, and feuds between tribes.

What makes the oil picture in this part of the world so volatile is that the history of the area is volatile. During the days covered in this chapter we speak of Persia, in 1935 it became what we know today as Iran. We all know from the news that Iran is not only a challenge politically, it is also gifted with incredible amounts of oil reserves. Control of these oil reserves would be pivotal in geopolitics from then to the present. We shall see in future chapters that this marriage of political turmoil and oil riches are characteristic of many of these Middle East countries.

The Prize, Chapter 8 Overview

Chapter 8 is best characterized by the statement “oil is an instrument of national policy, a strategic commodity”. The British Royal Navy pioneered the connection between oil and military advantage. Prior to this period, the Royal Navy was powered by coal, as most other Navy’s were, including Germany’s. But the Royal Navy had the foresight to switch from coal to oil. The advantages were obvious, both logistically as well as tactically. The Navy would be more mobile, maneuverable, and reliable. And it would operate without having to cart around tons and tons of bulky coal. But with this decision came the negative aspect of needing to ensure a reliable supply. For Britain, access to coal was not a problem, they had an incredible amount within their national borders. Oil on the other hand, was for the most part, sourced from elsewhere. Resolving that conflict took some time and persuasion, but eventually the Navy pivoted to oil. With this decision, the support and pressure from the government, and specifically the military, fell on the oil industry to produce.

It was clear that the government was not effective or positioned to manage their own oil operations, they had to look to and actually depend on what the big private companies were doing. But being passive observers was not prudent, and we see the beginnings of these public-private partnerships between government and the private sector.

As mentioned before in prior lessons, similarities between the early days of the oil industry, and the situation today are remarkably similar. And it makes you wonder if we learn anything from history. The concept of needing to be energy independent and reducing dependency on outside sources that one cannot always control was the leading issue of the day. And pressure to control and ensure supply led to the rapid development of these new reserves in Persia, in spite of the logistical challenges.

Another similarity is the conflict between the government’s military spending and social spending. Social unrest in the early 1900s characterized the conflict between sharing limited budgets between the military and the people. But a great global conflict of a scale not seen since the oil industry started to take off in the mid 1800s was just around the corner- a world war was coming. Eleven days after Churchill's bill, on June 28th, 1914, Archduke Franz Ferdinand of Austria was assassinated at Sarajevo. Russia mobilized its forces on July 30th and on August 1st, 1914, Germany declared war on Russia. Churchill flashed the order to the entire British fleet to "Commence hostilities against Germany" starting the First World War!

The Prize, Chapter 9  and The Quest, Chapter 2 Overview

Overview, The Prize - Chapter 9: The Blood of Victory

While previous wars depended on men and horses, WWI depended on men and machines powered by oil intensifying the extent of damage and destruction. It is interesting that in wars with horses, planning required one horse for every three men and 10 times the food of each man for every horse! WWI was characterized by oil and the internal combustion engine. And to have the oil required rapid development and exploitation of Persia, and as we shall see, what is now Iraq.

For a period of more than two years, the battle lines hardly moved more than 10 miles in either direction until the British turned to technology to break the stalemate by designing, developing and building a new vehicle funded by Churchill’s Navy under the codename “tank”. With the tanks and motorized transport, suddenly speed and mobility became possible as the tanks moved on traction, impervious to machine guns and barbed wires, and amplified the devastation. Towards the end of the war, the British had 56,000 trucks, 23,000 motorcars and 34,000 motorcycles. The US entered the war in 1917 with another 50,000 vehicles to France—all powered by gasoline! Eventually more than 13 million died during World War I, and victory of the truck over the locomotive was demonstrated.

Aviation technology also advanced during the war and provided strategic importance and advantages of the air with a bird’s eye view of the battlefield (reconnaissance and observation) and the ability to bomb enemy positions and airplanes. The planes powered by oil as fuel provided another reason to maintain access to petroleum products. The advanced aviation technology yielded fighter planes that had greater lethality and were much faster. The Germans actually took the lead in strategic bombing with the use of Zeppelins and Strategic Bombers. The war constantly pushed innovation for larger numbers, faster, and better planes. In fact, by 1915, all machines that had been in the air at the beginning of the war were obsolete. The war proved Churchill and Fisher right in their conversion of the British fleet to oil as it provided advantages over the German fleet powered by coal--greater range and speed and faster refueling. Oil also proved useful not only for transportation fuel to power all of these new pieces of equipment, but as a new, better source of toluene- needed to make TNT.

The more things change, the more they stay the same. During this period we see more inter-company squabbling and the desire by companies to be more integrated, leading Anglo Persian to acquire British Petroleum.

Many military aspects of WWI are actually rooted in oil. The German U-boat attacks were meant in large part to disrupt the access to oil for the allies. In return, many battles were fought with the intent to disrupt oil fields and transportation routes. Dealing with this supply challenge led to the entry of the United States into the fray, and it was the lack of a secure oil supply that eventually led Germany to surrender. By October 1918, the situation of Germany with respect to oil was desperate as Germany was anticipating a crisis in the coming winter and spring, and within a month a worn-down Germany surrendered. The Armistice or Peace treaty was signed at 5 AM on Nov 11, 1918, and went into effect 6 hours later, ending the war. The impact of oil in the war is eloquently summed up by Lord Curzon of Britain, “The Allied cause had floated to victory upon a wave of oil,” and by Senator Bérenger of France, “Oil-the blood of the earth was the blood of victory. Germany had boasted too much of its superiority in iron and coal, but it had not taken sufficient account of our superiority in oil. As oil had been the blood of war, so it would be the blood of the peace.”

It must be noted that while it was the governments who wanted this secure supply, it was the private companies that made it happen. It was a mutually beneficial engagement- the companies had a secure demand, and the government was able to leverage the reach and know-how of the oil giants.

The supply shortage and high demand resulted in rapid increases in the price of oil. The price changes clearly had no negative effect on the demand as the demand remained strong even with the increasing prices. Thus, the demand for oil had become relatively inelastic, or oil was exhibiting inelastic demand in economic terms.

The Quest - Chapter 2: The Caspian Derby

Fast forward to the end of the Cold War and we see a somewhat similar scenario to pre-WWI. Like the fall of the Ottoman Empire into many smaller new nations looking for a foothold in the world order, the dissolution of the Soviet Union also led to new nations. And like with the Ottoman Empire-derived new countries, the post-Soviet Era countries had a wealth of oil; they only needed to find a way to play in the global marketplace. Hence the Caspian oil region was born, and these new places were now dealing with the likes of Russia, Great Britain, the United States, Turkey, Iran, and at one point China.

The new opening up of the Caspian region would bring up recurring rivals, most notably Russia and Britain, and continual competition and striving for control and influence. But the situation would take on new characteristics in the 20th Century, revolving around oil transportation. The oil in Baku was essentially landlocked. The advances in tanker technology would do nothing for transporting this oil. It would require a network of pipelines to get the crude from the drill point to the consumer. The many countries surrounding the Baku Oil Region would all want their piece of the pie. Each country would want to negotiate individual terms for oil to travel through a pipeline over their land.

The Prize, Chapter 10 Overview

Chapter 10 highlights the breakup of the Ottoman Empire, and the entry of what is now Iraq into the world oil market. We also see in this chapter various arrangements such as the Sykes-Picot Agreement. The growing complexity of who was in charge of what required some degree of collaboration and to an extent, “sacrifice” for the greater good. The British, German, and Royal Dutch/Shell common goal was to get as much access as possible to the speculated petroleum. Under the agreement, the Turkish Petroleum Company (TPC) became the only entity with access to concessions in the area within the Ottoman Empire, and all oil production had to be done jointly as all parties had to agree to the "self-denying clause." This clause required all parties included in the agreement to work together or not at all. The investment would be shared, and the profits would be shared. The only areas of the Ottoman Empire exempted from the clause were Egypt, Kuwait, and territories on the Turco-Persian border.

America, fearing the exhaustion of petroleum under their own land and the return of "Gasolineless Sundays" sought access to the brightest prospects – the Middle East. To add to the fears, demand for oil in America increased by 90% from 1911-1918 and the number of registered cars went from 1.8 to 9.2 million from 1914-1920. George Otis Smith, the director of the U.S. Geological Survey, warned that the known American reserves would be gone in exactly nine years and three months-which would have been before 1930. This influenced the price of oil to increase and encouraged the government to support the oil companies in their quest for foreign supplies. Thus, the fear of shortage and competition helped to push American companies to now explore for oil wherever they could find it with support of the US government - and that meant the Middle East.

Britain had much economic and strategic collaboration with the US and was not willing to jeopardize its relationship with America and reconsidered. Besides, they also realized that entry of American capital and technology would accelerate the development, and the presence of America would also improve the political climate and strengthen the position of the companies in any political conflict. In the words of the Permanent Undersecretary of the British Foreign Office, according to the Prize, "it would be better to have the Americans inside than outside competing and challenging the concessions."

In the ultimate irony when viewed against the early days of trust busting and the downfall of Standard Oil, Herbert Hoover, the Secretary of Commerce, suggested that a syndicate of companies should be formed to operate in Mesopotamia. It felt remarkably like the dragon that had been slain by the Supreme Court was back to life… and Standard Oil of NJ sat at the top! A few years back, the group would have been a target of the government for antitrust and restraint of trade, but now they were being cheered on as the champions for promoting the Open Door policy!

The US constantly refused to recognize the 1914 granting of concessions to the TPC. Eventually, however, a new concession agreement was signed on March 14, 1925, between the TPC and the Iraqi government that satisfied the Open Door policy after lengthy and contentious negotiations. Despite all the controversy between the oil companies, ethnic groups, and the British appointed king, a joint geological expedition in Iraq started drilling in April 1927. Six months later in October 1927 at Baba Gurgur, six miles northwest of Kirkuk, oil was gushing 50 feet above the derrick into the air. The oil flowed until capped at 95,000 BPD.

With the availability of oil in the area proved, the final settlement of the negotiations that was to bring the American companies into the TPC had to be completed with urgency. This happened on July 31, 1928, with Royal Dutch/Shell, Anglo-Persian, the CFP (French), and the Near East Development Company (which held the interests of the American companies) each receiving 23.75% with the remaining 5% going to Gulbenkian.

The "self-denying" clause still remained, and at one of the negotiation meetings a red line was drawn around the old Ottoman (Turkish) Empire on a map, and the "self-denying" clause became known as the "Red Line Agreement." Within the Red Line that included the entire Middle East, except Kuwait and Persia, the group was bound to operate together. As expected, the Red Line Agreement continued to be a focus of tension and bitter conflicts for many years to come, as it constrained exploration and development by requiring all the partners to work together in all oil production.

Note that the events in this chapter were between the two world wars, when countries had found out in WWI that access to oil was of critical strategic importance to national security and strategies. Also, note that Kuwait and Iran were the only parts of the Middle East not included within the Red Line.

The Quest, Chapter 13 The Security of Energy

The story from The Prize chapter 7-10 is a cautionary tale that we face even today. Nmely, that there are dimensions to energy security. Simply finding oil is not enough. In this part of The Quest, we learn about the other dimensions. An argument can be made that some current policy decisions are not being true to the importance of these principles. It is important to note that we as a country are not anywhere near a position to halt fossil fuel production and still remain functional and secure. Therefore, for the time being, we will be dependent on oil from other places, as we will surely need it for the foreseeable future, regardless of green energy policies. It is simply the practical nature of where we are.

If we relate to the present-day argument for no fossil fuels to the early 1900s situation, you see how pivotal the US being a potential exporter actually was. We also see the dire straits Britain found itself in as they had no oil of their own, but sorely needed it for their national security. And it was not just military needs, the shortages meant no transportation or heat for the general public. Are we learning from history in setting modern day energy policy?

The dimensions of energy are:

• Physical Security: Infrastructure, supply chains, trade routes - an example of this would be the Oil Tanker making its way to Britain from Russia - 6000 miles. How is it protected? Can this route be disrupted? Thus, the supply is then not where it is relied upon to be.
• Access to Supplies: Physically, contractually, commercially - remember Reynold’s “Beer and Skittles” challenges in Persia? He struggled with everything from actually finding the oil to negotiations with local Persians to basic infrastructure to transport it to the Oil Tanker.
• Energy Security: This refers to the challenges with the many Government Policies, Non-Governmental Organizations (NGOs) - for example Greenpeace, the Red Cross, International Government Organizations examples - for example United Nations (UN), World Trade Organization (WTO) European Union (EU). Coordination between these many organizations impacts the security of the oil supply. The teamwork between these organizations is illustrated in how they respond to the disruption of emergencies in supplies. These organizations also partner with many International Oil companies to ensure our house is warm and gas is available for travel so each of us can have what are now considered necessities every day.

Many non-oil related situations can impact this teamwork and thus impact the supply of oil. A non-oil related situation could be a religious difference between two countries that want to have a pipeline connection. What happens when that religious difference becomes more important than the oil profit or oil-related products? A disruption in the oil supply.

Concepts to Consider for the Lesson

The more things change, the more they stay the same; a recurring theme as we work our way through the textbook. In this lesson we will cover the impact of different cultures on the industry, and how the industry changed the American culture. You will be introduced to the sudden rise in oil demand in the United States and the proliferation of gasoline stations as a result of the increase in mobility/transportation. The Teapot Dome and associated kickback scandals and their impact on individuals, industry, and government will be discussed.

The emergence of nationalism in Persia and Mexico and the Mexican expropriation that sent chills through the oil industry will be discussed, including some discussions on the tensions over stability and sovereignty that led in some cases to revolutions and political unrest and how they impacted investments and oil development. This will highlight the challenges that the oil industry has in being a civilian and military commodity.

In addition, we will learn about the discovery of East Texas oil, how overproduction and hot oil led to the fall in crude prices, and the actions taken by the states of Texas and Oklahoma to stabilize the market. We will also discuss how the federal government had to step in and work with the states to regulate production via unitization and pro-rationing.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to oil development in the Middle East and the rise of automobiles and gasoline
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications

What is due for Lesson 4?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

The Prize, Chapter 11 Overview

With Chapter 11, we enter “The Age of Gasoline”, arguably an age we are still in it to this day. The demand for gasoline increased and still continues to increase. In 1919, the U.S. used 1.03 million barrels per day; ten years later, demand had increased 2.5 times to 2.58 million barrels per day. The demand of oil for light had transferred to the demand for oil used for mobility. The increase in demand was driven primarily by the increase in the number of automobiles. In 1916, the U.S. had 3.4 million registered vehicles, and by the end of the decade, the number had jumped to 23.1 million, with cars being driven farther and farther. By 1929, nearly 80% of the world’s automobiles were in America, and oil’s share of total energy consumption had gone from 10 to 25% in the decade 1919 -1929, with gasoline and fuel oil accounting for 85% of the total oil consumption.

The graph shows national trends in population and automobile registrations in the United States from 1907 through 2000. Both have risen since 1907, but at different rates. Since approximately 1945, automobile registrations have outpaced population growth.

Click Here for Text Description of the Automobile registrations graph

The graph shows national trends in population and automobile registrations in the United States from 1907 through 2000. Both have risen at different rates. The population increased steadily from about 84 million people in 1905 to about 281 million in 2000. Automobile registrations increased from 0 in 1905 to about 20 million in 1920. The number of registrations stayed fairly steady until 1945 when it increased at a steady pace until around 1990 when it peaked at about 120 million registrations. From 1945 – 2000, the number of automobile registrations outpaced population growth.

Credit: Miller, John S.. "The Uncertainty of Forecasts." U.S. Dept. of Transportation. Public Roads 68, no. 2 (2004)

Although we are so used to it that we hardly notice it, a new culture emerged around gasoline, the emergence of the gasoline station. Before 1920, most gasoline was sold by storekeepers, who kept it dangerously in cans in the store. The Automobile Gasoline Company is credited with the first drive-in gas station in St. Louis in 1907. However, the proliferation of gas stations did not catch on until the 1920s. But selling a commodity such as gasoline is tricky. In general, gasoline is gasoline so why would you buy from one instead of another? Price is one way to ensure market share, however you can only reduce price so far before you are losing money. So the oil companies developed trademarks to distinguish themselves and promote competition. The filling/service stations added features that would help their customers with their vehicles by checking/selling tires, batteries, and accessories. Today, we see gas stations and “convenience stores” that sell gasoline. The appearance of the gas station revolutionized how gasoline was marketed.

Chapter 11 discusses the increasing trend we saw in Lesson 3 of oil becoming a key element of national policy and national security. Oil was becoming more of a factor in economic stability and the resilience of the military. As you would expect, with this growing role, also comes controversy and challenges. The Teapot Dome scandal illustrates this aspect in the sense of collusion between private sector companies and government, criminal kickbacks, and political favors. And Teapot Dome itself illustrates another emerging idea, an organized, government-supported reserve to be used for the military. The idea being that the US Navy would have a reliable source of fuel regardless of what was happening geopolitically, and whether imported supplies were threatened.

Today, we are seeing a different challenge associated with such reserves. We have the Strategic Petroleum Reserve created by the government to hold a supply of fuel to be used in times of national emergency. As we will see in this course, when you depend on other countries for oil supply, you tend to be at their mercy in terms of volume, prices, and stability. There has been current controversy around releases from the SPR, including claims that releases are for political reasons- to stabilize fuel prices. Some argue this is not the intended use of the SPR, and is putting national security at risk.

We remember from prior lessons the idea of “Rule of Capture.” A nice way of saying “grab all you can get as fast as you can”. This mentality compromised the efficiency of oil fields, resulting in lost reserves and price volatility. The industry was realizing that this approach clearly does not work in the long run. Enter the concept of “unitization” where producers work together in developing a field to ensure that it is managed as efficiently as possible. A good analogy is a children’s Easter egg hunt. There are two ways to do it- you let all the children run out in the field and grab as much as they can (Rule of Capture), or you establish some rules such as a maximum number of eggs allowed per child, sperate areas for age groups, and so on (Unitization). As you can imagine, and as the companies learned, unitization makes sense if those involved agree to cooperate.

New discoveries were few in the years 1917-1920, resulting in pessimism about production and increased prices. For example, Oklahoma crude that sold for $1.20 a barrel in 1916 was selling for $3.36 in 1920. In the 1920s, technology for finding oil improved as geophysicists led the way in developing tools for oil exploration. So, in spite of the shortage fear, the new innovations helped in the discovery of several major fields including the Signal Hill and others which made California the number one oil-producing state in 1923; the Greater Seminole field in Oklahoma in 1926 (flowed at 527,000 barrels per day (BPD) on July 30, 1927) and the Yates field in West Texas and New Mexico.

In addition to innovations in exploration and production, innovations in crude processing/refining such as cracking enabled more and superior gasoline with better anti-knock properties to be extracted out of a barrel of crude, reducing the demand for more crude. With demand decreasing and the many producers each maximizing their production, the flush production led to oversupply and devastating consequences on the price of oil. With the glut and low prices, the opinion of the oil industry began to lean toward an approach of conservation and production control. This time, not based on shortage but as a means to prevent the flood and its catastrophic effect on pricing. Still, opposition to direct government regulation or involvement was extremely strong.

Restructuring and the Deep Depression

Rockefeller actually set the example of confronting imbalances in supply and demand through consolidation and integration within Standard Oil and the oil industry years before. Consolidation – implies the acquisition of competitors and complementary companies, and Integration – implies the fusing of the upstream (exploration and production) and the downstream (refining, transportation, sales, and distribution) under one company working for the same goal.

The oil industry realized that the strategy of restructuring via consolidation and integration has its advantages and would form the foundation for our modern American oil industry. There were now many big companies and several independents by the 1920s, as by 1927 45% of the refined products were controlled by the various “Standard companies” compared to the 80% two decades earlier.

The stock market plunged in October 1929 ushering in the Great Depression that led to many people losing their jobs, savings, and standard of living. There was massive unemployment, poverty, and hardship throughout the nation, ending the constant growth in demand for oil. Just when the country was realizing in autumn 1930 that the stock market crash was not a simple correction but a true economic disaster, as luck would have it, the largest oil field in the lower 48 states, the Black Giant in East Texas, was discovered. Now, there would be a flood of available petroleum with a consequent drop in prices.

The Stock Market Crash, just like the COVID outbreak in recent years are what is call a “Black Swan Event.” Such events are surprises and unexpected, but when viewed in hindsight, should have been expected. The idea is that a black swan is very rare, but genetically it can happen and should be expected to occur at some point. Regardless, Black Swan events are very disruptive to even the best laid plans.

The Prize, Chapter 12 Overview

Chapter 12 is characterized by the introduction of the national oil company, and the challenges of dealing with other countries, especially those with different cultures and where unrest is imminent. As you read the sections of Chapter 12, pay particular attention to the differences between Mexico, Venezuela, Persia (Iran), and Russia. Very different places, very different situations, but similar outcomes. The outcomes being challenges and risks for the oil companies, and potential disruption of supplies. Chapter 12 is a cautionary tale of why energy independence is so important for economic and national security.

Interactions with these countries illustrate the necessary love/hate relationship between the country and the oil companies. The companies would rather not deal with the governments due to the very high risks, but they must in order to have access to the supplies. The countries would rather not deal with the private companies who they did not trust, but they also realize the companies are necessary to develop the fields and market the oil. Sitting on large fields is of no value if there is no one to develop it. The battle between government and oil companies boiled down to two issues:

1. stability of agreements for the oil companies, and
2. the question of sovereignty and ownwership for the producing countries.

And the companies realized that although they were competitors, and did not always trust each other, they had to join forces to operate in this changing, and challenging world. Recall the saying “the enemy of my enemy is my friend.”

The Quest, Chapter 5 Overview

We include a short reading in The Quest to provide more insight into the impacts to a country that is an exporter of energy vs one that imports. And you can then imagine how disruptive it is for a country to switch back and forth. In recent years, the USA went from importer, to exporter, to importer again. That can’t be good for economic stability, let alone risks in regard to energy security. And we sometimes hear the terms net exporter or net importer, which means a country can be an importer and exporter at the same time. The “net” then is based on which dominates at any given time. A country can be one for gas and the other for oil. Finally, if you are a net exporting country, it makes a profound difference to the stability of your economy if it depends primarily on that export or if the oil and gas is one of many exports. Countries like the USA are less impacted than a country like Venezuela because we have many exports compared to Venezuela. But do not be fooled, having many types of exports does not make us immune to risks associated with being a net energy importer.

The Prize, Chapter 13 Overview

As you look back on history, one can point to pivotal events that change things for the long haul. The discovery of the East Texas oil field was one of those. It came at a time when there was concern of dwindling domestic reserves. This brought some confidence and stability to the markets. But it also brought back our old friend overproduction. And again, we had oversupply and collapsing prices. This time, government and industry self-imposed controls were tried. But this created a new problem, “hot oil,” or what we would call today “black market oil.”

Finally, there was stability brought about by the regulatory system in place for the oil industry, and it had taken East Texas oil at about 10 cents a barrel to get the industry and producing states to move in that direction. Other factors that contributed to making it happen were the advances in petroleum engineering, the Great Depression, and President Franklin D. Roosevelt’s New Deal. Two compelling assumptions were central to the regulatory system: 1). Demand for oil is not responsive to price (i.e., demand at 10 cents a barrel would not be much different from demand at $1 a barrel, especially in the Depression) and 2). Each state had its “natural” share of the market.

The Prize, Chapter 14 Overview

During that period, industrial rationalization, efficiency and elimination of duplication were the values and objectives promoted by the companies as they explored mergers, collaboration cartels, marketing arrangements, and associations to address the excess supply problem. These and other developments were what contributed to the "As-Is" Agreement, also called Pool Association that was agreed to, but not signed. Under the agreement, each company was allocated a quota in various markets, but the agreement excluded the domestic US market to avoid violating US antitrust laws. In addition to the quotas, the companies agreed to drive down costs, share facilities, and be cautious in building new refineries and other facilities. A few months later, the industry leaders agreed to control production as well. Thus, by the agreement, an international oil cartel was in essence being formed!

Cartels typically control or fix prices, markets, and production. However, the agreement fell apart as the companies resumed attacking each other's markets. Eventually, 17 American companies formed the Export Petroleum Association, under the Webb-Pomerene Act of 1918 that allowed US companies to do abroad what the antitrust law would not allow them to do in the US. Disagreements on the allocation of output between the American and European companies led to the failure of the attempt to "cartelize" US oil exports, further undermining the "As-Is" agreement. Besides, there was too much production outside the "As Is" framework for it to be effective, and the agreement and the attempt to "cartelize" international oil production failed.

The Big Three (SO of New Jersey, Shell, & Anglo-Persian) tried to reformulate an alliance in 1930 dealing with the European Markets. They attempted to make local arrangements, dividing market shares with "outsiders." Again, the system proved ineffective due to the rising volumes of American, Russian, and Romanian oil. In December 1932, the companies came up with an updated "As-Is" understanding: "The Heads of Agreement for Distribution." The initial adherents were Royal Dutch/Shell, Jersey, Anglo-Persian, Socony, Gulf, Atlantic, Texas, and Sinclair. There were, however, many contentious points in the new agreement including chronic cheating and new markets. The companies, being fierce competitors, always plotted new attacks against each other even while they sought cooperation. In addition, there were constant conflicts with implementing agreements or even "agreeing to what had been agreed to."

In a way, the "As-Is" agreement in addition to being a tool to defend against overproduction and the Depression, was also intended to defend against the emergence of political forces in Europe and the producing countries. During the 1930s, political pressure on the oil companies took many forms. Governments imposed import quotas, set prices, and placed restrictions on foreign exchange and also, as a result of the Depression, autocracy and bilateralism were the order of the day. The oil companies sought to insulate and protect themselves from government intervention in the second half of the 1930s after the worst of the Depression was over. Political and economic nationalism had also intensified throughout the world, and, as one oil observer then noted, "Operations in the oil business are 90% political and 10% Oil."

Concepts to Consider for the Lesson

Here we will explore oil discovery in the area that was not supposed to have oil, Arabia (Bahrain, Kuwait, and Saudi), and the problems posed by the troublesome Red Line agreement. The reasons for the economic hardships of the area that made concessions possible in these areas will be discussed. The different objectives of the American and British companies that made it possible for America to beat the British in Arabian oil dominance will also be explored.

Followed by the rise of nationalism and military expansionism in Japan in the 1930s, and the deadly paradox/dilemma Japan faced in choosing food to be a synthetic fuel instead of feeding their citizens. This will lead Japan into the Pearl Harbor attack, its key success elements, objectives, impacts, and the miscalculations of both sides. We will then discuss the innovations in chemistry that helped with synthetic oil production in Germany, and how synthetic oil shaped Hitler’s WWII plans and strategy in Europe. Finally, we conclude with a ponderable comparison to the Iraq War of 2003.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to Boom and Bust Cycles
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications
• Produce an evaluative statement that justifies your answer to a posed homework question

What is due for Lesson 5?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

The Prize, Chapter 15 Overview

In chapter 15 we encounter much wheeling and dealing in Arabia. In today’s global oil market, not only is the Middle East a key player, but it is also actually influential enough to direct prices, supplies, and overall market responses. But it wasn’t always like that, and in the early days, people were not even sure this area had potential. But like many of the other areas we have explored, an intrepid entrepreneur pursues a rumor or a seep, and the rest is history.

Finding oil is as much about science as it is about agreements and politics. The Red Line Agreement we read about before ended up causing headaches for some companies, while it allowed others to take advantage. The contrasting story of Gulf and Socal demonstrates how such agreements can keep someone out of a market. Ironically, Gulf pivoted and moved to an area where they could work, and it turned out to be quite the strategic maneuver. In addition to the complexities introduced by agreements, there is the issue of nations having to deal with other powers. The interaction of American and British interests, and how they were perceived in this newly evolving oil market was the early manifestations of the conflicts that we face still today. That being the conflict of Western and Eastern cultures that play out on the battlefield of today’s oil markets.

It is interesting that, as we saw in other parts of the world, discoveries of large oil reserves sometimes soften the contempt one country can feel for another, and a greater effort is made to “close the deal.” We see that in this chapter, in regard to how these new oil-rich countries acted with America and Britain, and with each other. Kuwait is a classic example of this, as well as the old adage, “the enemy of my enemy is my friend.” With economic conditions causing problems, Kuwait needed money, but it was sitting on quite a bit of oil. Playing America and Britain off of each other by way of Gulf and Anglo-Persian proved a useful strategy. Conversely, the two companies teaming up also proved to be strategic and prudent.

Having a great agreement means nothing if the oil is uneconomic to develop or if demand is low. This means you have to improvise or temporarily adapt. The Texaco and Socal part of the story, and the birth of CalTex illustrates this well. But in the 1930s, oil was discovered in Kuwait and Saudi Arabia in commercial quantities, and so began the prominence of this area in the global oil market.

Change was once again coming in the form of another war. And like in World War I, although it wasn’t because of oil that the war started, oil did end up playing a major role.

The Prize, Chapter 16 Overview

In chapter 16, we return to Asia and learn about Japan’s incentive to engage in a war. Several reasons accounted for this shift in military expansionism: vulnerability due to its lack of natural resources, economic hardship from the Great Depression and the collapse of world trade, dwindling access to international markets, extreme nationalism, moral distress, arrogance, and the mystical belief in the superiority of Japanese culture as well as “The Imperial Way” (Asia under Japanese control).

When Prime Minister Osachi Hamaguchi won a large election victory in February 1930 and favored cooperation with Britain and the United States, he was assassinated by a youth, and that killed any spirit of cooperation. Ultra-nationalism took hold thereafter. After being reprimanded for its actions by the League of Nations (United Nations), Japan left the League, rejected liberalism, capitalism, and democracy as engines of weakness, and embarked on its own destructive course. The Emperor sought to establish a “national defense state” in which all resources, especially oil, were targeted for war based on Germany's failure/defeat in WWI from lack of resources (oil).

Japan was a good example of the desperation that comes from lack of energy security and independence. By the late 1930s, Japan produced only 7% of the oil it consumed. It imported the rest, with 80% coming from the U.S., and 10% from the Dutch East Indies. Japan sought to dominate the oil industry to serve its needs. Up to that time, 60% of its internal market was held by two Western companies (Rising Sun & Stanvac). Rising Sun was the Japanese affiliate of Royal Dutch/Shell, and Stanvac was a joint venture between Standard Oil of New Jersey and Standard Oil of New York. In other words, even in cases driven by national interests, the global companies are ever-present.

As with the Middle East experience we saw in Chapter 15, sometimes national feelings toward another country or culture clashes with the reality of dependence, especially with oil. With Japan’s actions, the United States emerged as Japan’s antagonist in the Pacific, as the U.S. had an “open door” policy which was counter to Japan’s strategy. With the U.S. as Japan’s major oil supplier and likely antagonist, the question was where was Japan going to get its oil in case of war? To help address this, the military won passage in 1934 of the Petroleum Industry Law, which gave the government the power to control imports, set quotas, fix prices, and make compulsory purchases. The underlining objectives of the law were to build up refining industry, reduce the role of foreign companies, and prepare for war. The oil companies, U.S., and Britain all recognized and disapproved of the “squeeze and restrictive oil” policies of Japan.

Japan didn’t want any disruption of its oil supply and passed the Synthetic Oil Industry Law which provided a 7-year plan to produce synthetic fuels from coal by 1943. Japan began to establish industrial self-sufficiency and to break its dependence on the U.S. in anticipation of an oil embargo. But in the meantime, it needed to ensure supply and ironically kept buying gasoline from America. This rings of the current paradox we see with Russian oil and the European countries.

With the increased escalation and tension, an embargo was virtually the only way left, and on July 25, 1941, the U.S. ordered all Japanese financial assets in the U.S. frozen. While it was not an embargo, a lack of assets to buy oil virtually turned it indirectly into an embargo. On July 28, Japan, as expected, invaded Indochina, taking another step towards war. Effectively, by August 1, 1941, there were no more oil exports to Japan from the U.S. Japan’s oil situation was so serious that there were some last-minute diplomatic efforts to avoid the confrontation in addition to intense discussions between the Emperor and his top military generals.

With the Pearl Harbor attack, even though it was not the only reason for the war, Japan, however, made one grave mistake – not sending a third wave to attack the oil supplies and repair facilities on the island of Oahu. All oil on the island had been transported from the mainland. Thus, the destruction of the oil reserves and tanks holding them at Oahu would have immobilized every ship of the U.S. Pacific Fleet not just those destroyed, accomplishing exactly what the Japanese original intention had been. The sparing of the aircraft carriers, the oil, and repair facilities ended up being the only good fortune of the U.S. on that day. “Oil had been central to Japan’s decision to go to war. Yet the Japanese forgot about oil when it came to planning Operation Hawaii.”

The Prize, Chapter 17 Overview

Let’s move now back to Europe and examine Germany’s motivations. In chapter 17 we again see how necessity drives innovation. Germany was the world leader in chemistry. One of its scientists, Friedrich Bergius, had, in 1913, invented the hydrogenation method to produce high-grade liquid fuel from coal which Farben patented the rights to in 1926. The hydrogenation process involved heating large amounts of hydrogen with coal at high temperatures and pressure in the presence of a catalyst. The competing technology was the Fischer-Tropsch process. It involved steam reforming of coal to produce Syn-gas (a mixture of hydrogen and carbon monoxide) that was subsequently converted to synthetic oil, but wasn’t as successful. Hydrogenation could also produce aviation fuel, while the Fischer-Tropsch method could not.

The argument was that synthetic fuels from coal could cut Germany’s dependence on foreign oil and also reduce the pressures on foreign exchange. The German government commenced in building the Nazi war machine (bombers, fighter planes, tanks, trucks) that all depended on oil. Thus, an independent oil supply was vital, and the synthetic fuels would become an important strategic source.

Standard Oil of New Jersey (SO of NJ), which had unsuccessfully been exploring alternatives to crude oil as early as 1921 and had acquired acres of shale oil in Colorado with the hope of extracting oil out of the shale, showed interest in the technology. SO of NJ saw the technology as a clear threat to its business. They had no need to produce synthetic fuels because of the oversupply of crude oil, but wanted to ensure that each stayed out of the other’s main fields of activity. SO of NJ would also rather use hydrogenation to increase the gasoline yield and boost octane out of crude oil.

We learn in Chapter 17 that regardless of why one enters war, the access and management of oil can make or break the outcome. Hitler had been convinced that there was absolutely no way Germany could win the war without access to the Russian oil. The grand strategy was to have one attack through southern Russia and another from the southwest via North Africa. The grand strategy failed due to a number of reasons including Allied attacks on German fuel supply lines, the fierce Russian resistance, and Allied code breakers. Clearly, the bitter lesson learned by Rommel is illustrated by his statement, “The bravest men can do nothing without guns, the guns nothing without plenty of ammunition, and neither guns nor ammunition are of much use in mobile warfare unless there are vehicles with sufficient petrol to haul them around.” The Allies, led by General Carl Spaatz, set a new priority target – the German synthetic fuels industry and began bombing oil factories all over Germany. The goal was to deny oil to the enemy armed forces.

The Quest, Chapter 7 Overview

The section from the Quest reviews the reasons behind the war the United States engaged with Iraq post 9-11. This allows us to compare the road to war in Japan and Germany, and in the United States, years apart. Some similarities and some differences, but an undeniable fact is that the oil industry was impacted by both. Some could argue that oil caused both wars, some others could argue that both wars highlighted the value of oil. The actual answer is somewhere in the middle, and that any time war occurred since World War I - oil was included in the consideration.

World War II was a delayed reaction to the end of World War I. Similar to how the Iraq War of 2003 could be considered a delayed reaction to the Gulf War of 1991, Japan of WWII underestimated the United States' reaction. Similarly Iraq and Saddam Hussein were only focused on the regional blustering and did not have the United States in focus. The threat of an armed opponent was a guiding fear factor. The attack on 9-11 has been compared to the attack on Pearl Harbor. However, after 9-11, there was not a clear adversary for the United States. Iraq and Afghanistan were ways to prevent war, but was not as clear as when Japan attacked Pearl Harbor.

So, what do these have to do with oil? - WWII, Japan was seeking more oil sources. The United States has a fear of losing oil supplies. But did the individual attacks, Japan on Pearl Harbor and the United States on Iraq, actually increase access to oil? Japan still had to seek out new oil supplies in the East Indies, and the United States had to stabilize and rebuild the oil industry in Iraq. Neither direction increased access to oil quickly, and neither was a stable and secure option.

Instability does not encourage foreign investment. The oil companies wanted to know how the political system would work and impact their investment. They wanted to know about the economic system and contracts. What would guarantee security to their investment? Then and only then would the oil companies invest. But the United States Government could not guarantee any security of the investment or the knowledgeability to build a stable investment environment. Thus, was the war really all focused on the oil industry? The goal of the US Government would be to keep the oil available on the world market in general. The loss of any percentage of oil production is not just a shortage for one country, but a decreased amount of oil available for everyone.

Then, enter the other view that the oil companies were pushing for oil access. Oil companies do have an increased demand for oil resources to fuel the engaged militaries. Would this be a case of application of the “Rule of Capture” - sell as much oil as possible while the war happens? Or would the oil companies have learned from how this principle impacted the industry? Steady gains more profit than quick.

Iraq had been operating under a nationalized oil industry. We know the challenges and corruption that comes with the Petro State. Yet, we can also see the citizens from a nationalized industry receiving the profits and being able to ideally receive benefits from the natural resources they live on. Iraq had long term goals in the 1970s for 6 million barrels a day. This long-term goal was stopped by the Iran/Iraq war of the 1980s, then the Gulf War of the 1990s. Their continual participation in wars have hurt the Iraqis' ability to develop and advance their oil industry.

Upon review of the Iraqi oil industry and infrastructure - the country had stopped developing in the industry approximately 50 years earlier. Any technological advances were not from government coordinated production development, but the individual skill and innovation of the Iraqi oil engineers. We remember when the USSR fell, and the state of the Baku oil fields; well, this is much of the same. These countries did not develop or advance their oil industry but instead relied on the consistent Petro income to finance the rest of the government, leaving the state of the industry a shadow of what once was.

With Saddam removed from power, the focus of the United States military was finally security. This is what the oil companies were focused on from the start, but the military was focused on changing the regime. Look at this way- thinking that the oil companies could speculate the vast income from the Iraq War is like Rockefeller allowing Standard Oil to be split up so he could multiply his wealth, or Japan attacking Pearl Harbor to increase their Gross Domestic Product (GDP).

Concepts to Consider for the Lesson

In Lesson 6 you might get the impression this is in part a history class on World War II. But the underlying message is that oil plays a key role in global conflicts. It may not be the cause of the conflict, but it surely can influence it. We shall cover the war in the Atlantic and in Europe and the role oil played in the war as well as how oil impacted American society because of the war.

It was after World War II that the world saw the establishment of the Middle East as an oil powerhouse. We will find out how America, and not Britain, became the major power in Middle East oil and politics. We will learn when and how America became a net importer of oil and discuss how the Red Line Agreement was finally abandoned, paving the way for major American involvement in Middle East Oil. Lesson 6 highlights how over history, the issue of energy independence and being a net exporter vs. importer has notable implications for national security.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to Oil Strategy and World War II
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications

What is due for Lesson 6?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

The Prize, Chapter 18 Overview

The high/low rollercoaster relationship Japan had with oil characterizes their fortunes and misfortunes in World War II. Concerns over supply was a big driver to get them into war, but they quickly secured access and quantity and were riding high and feeling victory was imminent. We may not typically think of Asia as an oil source today, but we see how important that region’s reserves were for Japan. And when Japan brought America into the war, the first thing we thought to do was secure our supplies and interrupt theirs.

With the ever-tightening blockade on Japan by the submarines, “The shortage of liquid fuel was Japan’s Achilles' Heel.” Oil imports that had risen to their peak in the first quarter of 1943 had decreased by about half at the same time in 1944 and had completely disappeared/dried up by the same time in 1945. Desperate, Japan tried many forms of improvisations as the oil situation worsened. Industrial oil was made from soybeans, peanuts, coconuts, and castor beans. Potatoes, sugar, rice, and sake were even converted to alcohol to be used as fuel. By 1944, civilian gasoline consumption was down to 257,000 gallons, just 4% of the 1940 figure. Japan revived its 1937 synthetic fuel attempts, and in 1943, Japan’s synthetic fuel production amounted to 1 million barrels – only 8% of the target amount. Over half of this value was in Manchuria, which was useless in late 1944 and 1945 due to the blockade. Besides, synthetic fuel was a drain on resources, manpower, and management and was more of a liability than an asset.

The overall consequence of the oil shortage caused the naval strength of the Japanese fleet to be divided when it truly needed to be combined. Part of the fleet was based in Japan waiting for new aircraft and pilots, and the heavy battleships were stationed near Singapore closer to the East Indies supply. The shortage worsened in 1945, and navigation training for flight pilots was eliminated. Unfortunately, another solution for aviation fuel shortage was the introduction of the kamikaze pilots- as they only needed half the fuel of a normal mission!

While Japan’s condition continued to worsen, the Americans had an abundant fuel supply in the Pacific with huge floating bases made up of fuel barges, repair ships, tenders, tugs, floating docks, salvage ships, lighters, and store ships that gave the U.S. Navy long legs across the Pacific. This is indeed ironic in that the Pacific is home to Japan but incredibly far away for Americans!

The Prize, Chapter 19 Overview

In 1937, before the outbreak of war and in anticipation of war, a special committee was formed to examine the possibility of Britain adopting an “oil from coal” synthetic fuels strategy similar to what Germany had done in WWI. The strategy was rejected, as importing through many ports was deemed less vulnerable than easily bombed hydrogenation plants. Besides, it would have been more costly compared to the cheaper and readily available oil. Also, 85% of Britain’s domestic refining marketing was in the hands of three western/friendly companies, Shell, Anglo-Iranian, and Standard Oil of New Jersey’s (SONJ) British subsidiary, and two of these had their home in Britain. The British government also decided in 1938 that in case of war the entire British oil industry would be run under one organization and not through three separate competing companies.

Fears of oil shortage led to rationing being imposed on recreational vehicles in Britain, which led to a big boom in bicycling. Under the threat of German invasion, 17,000 gasoline stations in England were shut down, leaving 2,000 stations that could at least be defended.

The two critical questions of importance to Britain for war with the Germans were whether oil would be available and if they could pay for it. The United States was responsible for two-thirds of total world production and, therefore, the answer to whether oil would be available was yes. To help Britain overcome the question of payment, on March 1941, the Lend-Lease was instituted. This removed the problem of finance as a constraint on American supply to Britain, since, with the Lend-Lease, American oil could now be lent and repaid later. The neutrality legislation which had placed restrictions on the shipment of supplies was also gradually lifted to help loosen restrictions on shipment of supplies to Britain. Thus, by spring 1941, all the important steps had been taken to ensure an adequate flow of oil from America to Britain.

We have learned so far this semester that having access to oil reserves is not helpful if you cannot get to it and move it around. Vulnerability of supply lines could result in shortages even if there is plenty of oil. The vulnerability issue became a key element of World War II, and we think of it as the German U-Boat crisis.

An alternative to tanker shipment came into being when pipeline construction (dubbed Big Inch) from Texas to the East Coast, was initiated in August 1942. Within a year and a half of construction, Big Inch was carrying one-half of all crude moving East through its 1,254 miles by the end of 1943. Little Inch, which was 1,475 miles, was built between April 1943 and March 1944 to carry gasoline and other refined products also from the Southwest to the East Coast. By the end of 1944, about 42% of all oil was transported to the east coast through pipelines, compared to just 4% at the beginning of 1942. We see as history unfolds that pipelines revolutionize the oil industry, even in peacetime.

Coordinating unity among the many competing US forces (Congress, the Administration, the companies, the press, etc.) in the US was very difficult. To address this challenge, an effective government-industry partnership was gradually established and sought antitrust exemption from the Justice Department. Although there were temporary shortages, there was never a serious oil supply crisis in the US. The overall production record in the US was quite good. Meanwhile, between December 1941 and August 1945, the Allies consumed 7 billion barrels of oil, 6 billion of which came from the United States. It is also interesting to note that the wartime oil output was more than 25% of all oil produced in the US from the time of Colonel Drake to 1941!

To accommodate the war oil output, consumption/rationing was considered. Efforts were made to get industrial users to switch from oil to coal, and President Roosevelt took strong interest in the potential of America’s largely underutilized natural gas resources. However, gasoline was still the focus of contention. America, which had rejected voluntary conservation, now accepted enforced rationing because there was a war.

Oil clearly was demonstrated to be essential in WWII as it played a significant role for the Army. Before WWII, the Army did not even keep records of its oil use. While WWI had been a static, more relatively stationary war, WWII was a war of motion, and, at the peaks, the American forces in Europe used one hundred times more gasoline in WWII than in WWI. A number of innovations were also created to facilitate the use and flow of petroleum. A simple innovation that had a profound effect on the conduct of the war was the 5-gallon gasoline can. This was based on an improved design on captured German cans that led to the common nicknames “jerrycan” and “blitz can.” Other innovations included the all-purpose motor fuel and all-purpose diesel fuel and the development of the 100-octane fuel, through catalytic cracking, for better aircraft performance. The 100-octane fuel provided greater bursts of speed, more power, quicker takeoff, longer range, and greater maneuverability.

The Prize, Chapter 20 Overview

We will learn in chapter 20 that the general belief was that the center of gravity of world oil production would shift from the Gulf-Caribbean area to the Middle East. In 1940, for example, the Arabian Peninsula produced less than 5% of world oil, and the U.S. produced 63%. The report coming from a man with great respect in oil exploration clearly predicted the end of oil domination by the US that had produced nearly 90% of the oil of the used by Allies in WWII.

The British sphere of influence in the Arabian Peninsula was huge relative to the US. However, the US knew there were enormous potential oil reserves in the area, and the American orientation to Saudi Arabia and the Middle East was changing.

America’s entry into the war in 1942 and 1943 caused a whole new outlook to be placed upon Middle Eastern oil. Oil was recognized as a critical strategic commodity that was essential for national power and international predominance. The single resource that shaped military strategy and could cause defeat was oil. The U.S. single-handedly fueled the Allies during WWII, which significantly drained its oil reserves. Fear of shortage began to grow, and the explosive growth with discoveries in the 1920s and 1930s had fallen off sharply, resulting in additions becoming more difficult, expensive, and limited (i.e., the law of diminishing returns was in effect). These assessments led to the conclusion that the U.S. was destined to become a net importer of oil, with potentially grave security implications. This gave rise to the “conservation theory,” which suggested that the U.S. government had to control and develop foreign oil reserves to reduce the drain on domestic supplies and conserve them for the future and guarantee America’s security. And the foreign reserves had to be the Middle East. In essence, American policymakers had arrived at the same standpoint that Britain had held since WWI, the centrality of the Middle East.

The focus shift to the Middle East introduced a whole new suite of issues, many rooted in the mutual distrust between America and Britain.

Socal & Texaco were the only private companies involved in Saudi Arabia, and they knew the size of the Saudi Arabian oil reserves. They were afraid the British, through the financing of Ibn Saud, would help get them kicked out of the country. Besides, Saudi Arabia was only 20 years old, and they were unsure if the Kingdom and oil concession would survive the King himself. They also realized that it was one thing to throw out private companies and another to take on the most powerful power in the world. Thus, the policy of solidification, or direct involvement by the American government in Saudi Arabia, was an easy argument since it would help reduce the risk of expropriation as happened in Mexico. The implementation of the Lend-Lease approach was a mechanism to assure access.

Once again, we see the risk of overproduction and price crashes. If the U.S. was not going into the oil business, there was still another avenue to consider: British Partnership in managing the world oil market. Both the British and Americans saw a coming postwar glut from the Middle East and potential for all-out competition. Also, many in the U.S. feared the exhaustion of US reserves and wanted a fundamental transformation in supply arrangements whereby Europe could be supplied primarily from the Middle East and not from the U.S. reserves. The British campaigned hard on negotiations on the Middle East oil. Both sides recognized that after the war, the Middle East countries that depended on the oil royalties were going to put incredible pressure on the companies to increase production to increase their royalty revenue. This, in turn, was going to lead to a glut and intense competition, as failure to meet the demands of the countries would result in vulnerability of the oil concessions. Thus, the U.S. government explored partnerships with Britain to manage the world oil market ahead of the problem.

The U.S. was soon finding that it could not sustain itself on its production alone, as it was on its way from being a net exporter to being a net importer. Everything that wartime negotiators sought to prevent was soon found to be coming true: competition, chaos, and instability. In the absence of an International Petroleum Agreement, oil companies moved quickly to work out their own salvation in the Middle East for the postwar world.

The Quest, Chapter 14 Overview

This is a review of the development of the oil industry in the Middle East. Throughout the lessons, this can get confusing and lack big picture coherence. So, this one page of review brings the Middle East pre-World War II development back. Now, we just had our lesson about when the realization of the oil opportunities in the Middle East are truly coming to light. Just to see the foundation for the Middle East Oil Industry as the greatest Prize.

Concepts to Consider for the Lesson

With Lesson 7, we are now entering the post-WWII period. This introduces new drivers for the evolution of the oil industry. No longer are we focused on battlefield concerns but now it’s more about national security and economic development. The post-war era also introduces us to what is relatively common in today’s day-the international nature of the oil industry. Company goals and priorities and market stability seem more impactful than national borders when it comes to strategic decision-making. That said, the situation in key oil-producing countries is critical to understand and must be integrated into deals.

We also learn of the focus on the Middle East, a focus prominent to this very day. The lesson discusses the three big deals made in the immediate post-war era. As these relationships mature, we see the evolution of how payments are made. The development and execution of these deals is a fascinating study in reconciling global capitalism drivers with national interests. The story of Iran is a great example of how this played out.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to the Post-War order
• Demonstrate an understanding of the role of oil in relation to pivotal events in history 
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications
• Create an original infographic to synthesize a course topic and an external source of your choosing

What is due for Lesson 7?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

The Prize, Chapter 21 Overview

Gasoline rationing was lifted in August 1945 in the U.S. within 24 hours of Japan’s defeat, and the operative phrase for most motorists at the gas station was “Fill ‘er up!” By 1950, oil was meeting more of America’s total energy needs than coal. While demand was increasing, supply was not decreasing as expected, due to new discoveries in the U.S. and even Canada, near Edmonton in the province of Alberta. Eventually, however, there was a shortage of available oil in 1947-48. Consumption rose with unexpected rapidity, and as it took time, money, and materials to redesign refineries to turn out products consumers wanted, supply could not catch up fast enough. But in 1948, imports of crude oil and products together had exceeded exports for the first time, creating an ominous new phrase, “foreign oil.” The figure below shows the stark difference in trends of domestic production and import. This divergence, especially with imports outpacing domestic production, is a red flag for energy independence, security, and flexibility. To this day, we see the challenges of depending on others for our oil needs.

    

U.S. oil production, imports and exports (black line) between 1920 and 2005. Illustrates how foreign oil became “here to stay”.

Click here for a text description of the figure

U.S. production increased fairly steadily between 1920 and 1970. Increasing from around 1.2 million barrels/day in 1920 to 9.5 million barrels of oil/day. Production then decreased and flatlined at 9 million barrels/day between 1975 and 1985. Production then decreased steadily until only 5 million barrels were produced per day in 2005.

U.S. imports were between 0 and 500,000 barrels a day until ~1942 when it increased steadily to 1.2 million barrels/day in 1980. Imports then spiked to around 6.5 million barrels/day in 1980, dropped to ~3.2 million barrels/day in 1983. Then imports rose again to 10 million barrels/day in 2005. Imports surpassed production around 1994.

Exports remained fairly low, between 1 million barrels/day to no barrels a day. In 1950, exports decreased to almost nothing, and the graph shows exports being too small to graph around 1988.

Credit: U.S. Oil Production and Imports 1920 to 2005 by David Moe from Wikimedia Commons is licensed under CC BY-SA 3.0

Hence, energy security was a big issue for the Western Powers. Oil became the convergence point for foreign policy, international economics, national security, and corporate interests, and both Britain and the U.S. were intent on ensuring access to oil based on the lessons learned from WWII, the growing economic significance of oil, and the magnitude of Middle Eastern resources. Taking into consideration all the risks, Socal realized it would be best to pursue a policy of “solidification” and bring in new partners to gain market access & spread the risk.

Here the delicate dance began for American oil companies to have access to the oil of Saudi Arabia. Saudi Arabia had much oil, but it needed the partnership and agreements to leverage that resource. But it was a very volatile area. Clearly, enlarging the participation to more American companies only furthered the fundamental goals of American strategy to increase Middle East production, ensure that the Saudi concessions remained in U.S. hands, and conserve America’s own resources. Even though it is obvious now, as early as the late 40s, the US saw the strategic importance of the Middle East for oil. All of this led to the setting up of three landmark deals that will change the face of the global oil market for the future. Each of these deals involved a specific Middle East region, and had unique attributes, conditions, and drivers. Not all deals were the same.

The first of these deals involved Saudi Arabia and the expansion of Aramco. This deal was driven by a desire to have only American participation within Aramco. The second deal involved Kuwait and was driven by a need to get Kuwaiti oil into the European marketplace. The third deal involved Iran and was focused on ensuring stability in Iran and protection from the Soviet Union. With the completion of the three huge deals (Aramco, Gulf-Shell, and the Iranian contract) things (mechanisms, capital, and marketing systems) were in place to move vast quantities of Middle Eastern oil into European markets.

The US has experienced its share of energy crises. But in the immediate post-war period, it was Europe that was in dire straits. Throughout Europe, destruction and disorganization were everywhere, and food and raw materials were in desperately short supply after the war. Economic disarray from the longest and coldest winter weather in 1947 and the energy crisis increased the shortage of the dollar that also minimized the ability to import goods and caused a chain reaction that crippled the economy throughout Europe.

We see during the reconstruction period in Europe after the war that although the overall goal was to rebuild the economy, it was rooted in the oil industry. Energy was fundamental to any rebirth. The first issue addressed was the energy crisis. For most of the European countries, oil was the largest single item in their dollar budgets. The Marshall Plan made it possible for the European economy to change from coal-based to one based on imported oil. Without oil, especially Middle East oil, the Marshall plan could not have succeeded. There are periods in

history, where fortuitous alignments of conditions act as a catalyst to enact change. Europe’s needs and Middle East oil production around that time made a powerful and timely combination.

It was also interesting to see how oil markets were so important to some countries, that maintaining that stability forced them to make adjustments contrary to other goals and commitments. As a result, construction of the Tapline continued even during the Arab-Israeli War! So concerned were they to not risk losing the American role in transporting Middle East oil to Europe, that they were against us on one front, but in partnership on another front- at the same time.

Britain’s major sources of oil were Iran, Kuwait, and Iraq, and the U.S. was also becoming an ever more petroleum-based society. Therefore, Soviet expansionism, especially towards the Middle East, brought the area to center stage as the Middle Eastern oil fields had to be preserved and protected on the Western side of the Iron Curtain to assure economic survival of the Western world.

Often, and as we saw in earlier years, crisis breeds innovation. Americans were very much aware of energy dependence on the Middle East and how the security of supplies could be assured in a future conflict, and some argued for importing more oil in peacetime in order to preserve domestic resources for wartime. Many also advocated building a synthetic fuels industry by extracting liquids from the oil shale in the Colorado Mountains and developing natural gas.

With the expensive synthetic fuel route and offshore development, the issue was whether there was another alternative to imported oil. The answer was found in natural gas that was considered a useless, inconvenient by-product of oil production and was burned off or flared. Although not a big percentage of fossil fuel use, natural gas did take some of the stress off by reducing US oil demand. As we see today, natural gas has “saved the day” time and again.

The Prize, Chapter 22 Overview

In the 1940s and 1950s, the countries hosting American oil companies or subsidiaries wanted more from their foreign visitors and continuously argued about the financial terms of their concessions and “rents.” The central objective of their argument was to shift revenues from the oil companies and the tax receipts on oil in the consuming countries to become income for the exporting countries.

In chapter 22 we see the introduction of the concept of economic rent as the amount of profit above and beyond that amount necessary to keep oil in production. Thus, rent represented the difference between the market price and the cost of production plus an allowance for additional costs (transportation, processing, and distribution). It was viewed as a return from nature’s bounty. Viewed in another way, the question was: If through a tenant’s risk-taking efforts, the tenant made a discovery that increased the landlord’s property, should the tenant continue to pay the same rent, or should the rent be raised? The idea of the fifty-fifty model, and the contrast between how Venezuela handled it vs how Mexico handled it is a great story in capitalism and letting the free market work. Unlike Mexico, Venezuela achieved its national objectives without nationalization. And Venezuela’s model prompted Saudi Arabia to follow suit.

Clearly, a new relationship now existed between the tenants and landlords as the oil companies' position now did not just depend upon compliance with laws & payments to governments, but whether the whole concession is perceived as “fair” by the government & public opinion. It was bound to change if it was not perceived as fair. Interestingly and unfortunately, “fairness” and “unfairness” happen to be concepts of emotion and not fixed & measurable economic standards. The 50-50 principle, however, had the right psychological feel of fairness to it.

The Prize, Chapter 23 Overview

Iran was a different story, and one driven by unrest and conflict and the impact it had on the oil industry. Whereas we have seen over the years that companies were not afraid to go into challenging and uncharted areas to explore, Iran’s problems appeared to be almost too much even for the most aggressive companies. Iran presented a mix of almost every type of problem, civil, religious, cultural, and political unrest compounded with challenges setting up agreements with oil companies. Unlike Venezuela, Iran took the nationalization route. And we must not forget the threat of the Soviet takeover of Iran that would seriously destabilize the oil market for Europe. Iran needed bold moves by oil companies, and they were already apprehensive of doing business there, and also had to deal with fears of anit-trust charges. Fortunately, the National Security Council issued a directive that stated: “The enforcement of the Antitrust Laws of the United States against western oil companies operating in the Middle East may be deemed secondary to the national security interest.” With the Iranian consortium, the U.S. was clearly the major player now in the Middle East, with all its oil and volatile politics.

The Prize, Chapter 24 Overview

The Suez Canal is an interesting story in its own right, but it had and has important oil industry implications. Like the Nord Stream and Alaskan pipelines, sometimes efficiencies in moving oil changes the dynamic. So much so that markets become dependent on any “new and easier” way to get oil, and if it becomes threatened, it causes much angst. The canal’s significance was strategic, as it served as a lifeline of the British Empire. When, in 1948, India became independent, the canal lost its traditional rationale of being critical for the defense of India or the empire. It subsequently became a highway of oil and not of empire, as it cut the 11,000 mile journey of Persian Gulf Oil to Europe around the Cape of Good Hope to 6,500 miles through the canal.

In this chapter, you will read about the conflict over the canal, and how it nearly brought America, Britain, and France to blows. The Suez crisis taught the Western powers about the volatility of the Middle East and the need to work to achieve long-term peace and prosperity in the area. As a footnote, in 1970, fourteen years after the Suez crisis, at a dinner at 10 Downing Street in honor of Anthony Eden, then Lord Avon, Eden offered a special prayer for the British people to discover “a lake of oil” under the North Sea. Interestingly, that was exactly what they found shortly after. It would have been interesting what the British would have done in 1956 if they had known or even suspected they were sitting on such a lake. This is important because we will learn in later chapters how North Sea oil changed the global market in Europe’s favor. After struggling for so long to get oil from others, Europe would finally have its own treasure.

The Suez Canal crisis and Syria’s interruption of the oil flow through the Iraq Petroleum Company pipelines showed the vulnerability of oil transportation and opened up discussions on alternatives to the Suez Canal and pipelines. The safer alternative was with supertankers going around the Cape of Good Hope. This provided a lower political risk. The Japanese, with advances in diesel engines, and better steel, started to build supertankers capable of carrying a lot more oil.

The Quest, Chapter 13 Overview

As we step beyond the Suez Crisis, the world that does not produce oil now has a critical need to find ways to guarantee their access to oil. Not only to their citizens, but also guaranteed access for their militaries. If a country was only receiving oil imports from one location, it was vulnerable to disruption. If a country increased supply locations, then if one location was disrupted, that would only disrupt a portion of its supply.

If countries worked together to coordinate a world trade regulation of the oil supply, then countries would be even less vulnerable to one location disruption. This could be further stretched to include a variety of types of petroleum sources, including unconventional sources also.

Not all disruptions of access to oil revolve around war or country disputes; we know how hurricanes can impact drilling rigs and refineries. In 2005, 2900 oil platforms were in the combined paths of Katrina and Rita Hurricanes according to Interior Secretary Gale Norton. “As a result, 90 percent of crude production and 72 percent of natural gas output is paralyzed,” she stated. This natural disaster regarding the oil access was lessened through the coordination of countries to fill the gap left by the tragic weather.

The challenges facing operating systems are but one element to consider in regard to energy security. Pipelines are another piece of the overall transportation of oil. They have been in the news through the discussion about the Keystone Pipeline and Dakota Access Pipeline. This is not to endorse the use of pipelines, but just consider all the pipelines that the United States has

without the controversy. Here are two maps that allow you to visualize the interconnections and vast land coverage.

Where are pipelines located?:

• https://pipeline101.org/topic/where-are-liquid-pipelines-located
• https://www.eia.gov/state/maps.cfm

The Suez Canal also made us more cognizant of the “choke point”. These choke points could be compromised by natural and man-motivated actions. Several points have frequent interactions with pirates, or nonstate actors, trying to seize possession of oil and gain profits from selling it. These points are also no secret; any country could cut off the lanes as a specific way to disrupt the worldwide oil supply. It is in most countries’ best interest to keep these points free from disruption. Several navies add these lanes to their commitment to continual order on the sea.

Concepts to Consider for the Lesson

Lesson 8 pulls together many interesting aspects of the immediate post-war era and the entry into the turbulent 1960s. As we move through history, and we get into more contemporary times, we are starting to see the birth of oil industry aspects we are used to in the present day. This Lesson also introduces us to many cautionary tales which may have fallen on deaf ears, and not learning from them has destined us to be reliving the same issues in today’s world.

For example, in this lesson, we see how unrest and volatility in oil-producing countries can wreak havoc on those countries that depend on those exports. We also once again see the impacts of wild fluctuations in production, causing cycling between shortages and surpluses. These countries are household names now when it comes to global oil markets, but they were only coming into their own in the time period of lesson 8. These countries include Russia, the Middle East, and Africa. Profoundly oil-rich, but politically unstable, places.

OPEC comes into being in this Lesson, a formidable power in the 70s and beyond, but a bit unsure of itself and ineffective in it early days during the 1950s and 60s. OPEC introduced the idea that oil exporting countries had something to gain by working in collaboration, the same lesson the oil companies had learned so many years before, that they could have significant control over the market if they worked together. But the same Catch-22 that plagued the oil companies now faced the exporting countrie; they were producing more oil but getting less for it.

But what is probably the most interesting chapter of this lesson, and probable one of the most telling stories of the entire textbook, is Chapter 27, “Hydrocarbon Man”. After one reads how oil underpinned so many societal changes, it is easier to see why turning away from oil will not occur as easily, or as fast, as is being suggested by the renewable energy and climate change positions.

The reading from The Quest start to introduce us to changes to come, such as the entry of the North Sea oil region and how that impacts the global market. But even before then, Europe and the US domination in the Middle East starts to diminish, and the market is settling into a new profile with shifting influence and new players.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to the Post-war Petroleum Order and Crises
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications

What is due for Lesson 8?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

The Prize, Chapter 25 The Elephants

Overview

A large oil field (reserve) is known as an elephant in the oil industry. Due to the discovery of many elephants, worldwide oil boomed, and oil production in the Middle East in particular grew. Worldwide reserves, the amount of oil technologically and economically recoverable, increased and the reserves of the Middle East- the center of gravity for the oil industry at the time- increased significantly. It should be noted that the amount of oil known to exist that may or may not be technologically and economically recoverable is often referred to as a resource. Thus, resources are greater than reserves and some resources become reserves over time as they become technologically and economically recoverable.

The 1950s not only saw the discovery of big elephants, but also the establishment of the Middle East, and its member countries, into an oil powerhouse. It was not easy considering the competing interests and politics. Iran, Japan, Venezuela, and Egypt become key players. All of this was happening while at the same time market disruptions due to manipulation of posted vs market prices and quotas for imports from specific countries caused more repositioning.

A secret set of meetings launched what is now OPEC. A formidable entity in the 1970s and beyond but which got off to a weak start, as we see in the next chapter.

The Prize, Chapter 26 Overview

In chapter 26, we see the further evolution of OPEC and the impact of Russia coming back into the game. Except Russia’s approach was not to restrict oil, but the opposite, flood the market and impact pricing and market share. Russia wanted to create dependency on their oil by making it almost “too easy” to get. More than one expert has stated that the current challenges in Western Europe today are rooted in over-dependency on Russian oil and gas.

It is an interesting approach, and a characteristic of the oil industry, in that providing too much oil can almost be as destabilizing as restricting it. This is why at time embargoes are put in place, but at other times, it is more about quotas. The quota issue is discussed in the context of Middle East oil vs Canada, Venezuela, and Mexico.

This chapter discusses the development of OPEC and the ill-fated approach that the oil companies and importing countries took by discounting and ignoring them. In later chapters, we will learn how OPEC single-handedly drove the energy crisis of the 70s. Although the OPEC countries were influential, during this period, Africa also comes into the picture. North Africa, especially Libya, and other countries such as Nigeria and Algeria become major producers.

On a larger scale, things were surely changing. The powerful consortium of oil companies was losing some of its influence as the exporting countries flexed some muscle. Iran was becoming a force to be reckoned with in its own right, but further compounded by appearances that it may align with Russia. And there was an overall growing dislike and distaste for the West. Ironically, the Persian Gulf area, typically seen as the volatile area, became the “stabilizer” of supply to dampen the effect of problems that were popping up elsewhere.

In their own way, countries and companies were realizing that the oil market was a complex thing that needed care and innovation to work properly. And simple cutthroat competition drives down profits and hurts everyone. They continued to look for ways to work as an integrated machine, while recognizing the differing priorities, cultures, and drivers between countries and regions. Sometimes, this meant setting quotas, which generally aggravated the impacted producing countries.

The conflicts in the Middle East and Africa spawned the growing discussion in the US about energy security and making sure we have enough for ourselves, while at the same encouraging and supporting global trade. The idea of a stockpile came up. Unfortunately, even to this day in the 2020s, balancing energy national energy security with participation in global commerce has proven challenging.

The Prize, Chapter 27 Overview

The trend in the rapid increase in the consumption of oil continued in a straight line after WWII. For example, both world and US energy consumption tripled between 1948/49 and 1972. The post-WWII oil use explosion was due to a number of factors including economic and income growth, increased standard of living, huge increases in automobiles, increased use of plastics, decreasing oil prices, and exporting countries demanding more and more production to increase their revenue. Thus, production, reserves, and consumption all pointed in one direction-UP, and the saying “bigger is better” engulfed the consumer and oil industry.

Top Petroleum Consuming Countries, 1960-2008.

Click Here for Text Description of the Automobile registrations graph

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Credit: EIA petroleum consumption of selected nations 1960-2008 by U.S. DOE Energy Information Administration from Wikimedia Commons

You will see in this chapter how oil is the foundation upon which so many things changed in society. At the surface, you may not think they are related- fast food restaurants, suburbs, motels, drive in movies, the interstate highway system, and more are all are rooted in the growth of the automobile and increased mobility of the average consumer. And this only happened because oil was the catalyst behind the growth of the automobile industry. One can debate the wisdom of this dependency, but the fact is that societies became fully integrated with oil.

This integration of oil was so prevalent that it actually began to unseat “king coal” which had dominated the energy market for over century before. Oil was cleaner (avoiding the “killer fogs”), easier to process, and more efficient than coal so even in cases where coal may have been cheaper overall, oil still won. But coal eventually even lost the cost advantage. The new lifestyle of society would not work with coal as the dominant source of energy and transition was inevitable. This transition was happening not only in the US, but Europe and Japan as well, although for slightly different reasons. Competition shifted from oil vs coal to oil vs oil, as more companies came into the game. And this led to jockeying for position of who has the “best oil.” Enter the additives and special gasolines. When you go to a gas station, note how many variations there are; and think about the early days when it was simply “gasoline”.

Who would have thought that one of the most popular television programs of the time was about the oil industry? In 1962, the number one TV show was the Beverly Hillbillies, with a theme song:

“Come and listen to a story ‘bout a man named Jed, A poor mountaineer, barely kept his family fed, Then one day he was shooting at some food, When up from the ground come a ‘bub-a-lin’ crude, − oil that is, black gold, Texas tea. (The Ballad of Jed Clampett)”

And it did not end there, as we will see later in the 1980s a number of oil industry -based television shows. One of the most famous of the 70s was “Dallas” with the fictional Ewing Oil company.

But there were dark clouds on the horizon when conflict broke out in several places, almost at the same time. The Arab-Israeli conflict and conflict in Nigeria threatened to cause major disruption of the global oil market. However, with a little bit more work than during previous energy crises, the Organization for Economic Cooperation and Development (OECD) approved a relief plan that involved the deployment of supertankers. Under American and international coordination, petroleum from non-Arab countries was sent to embargoed countries, and Arab oil was sent to non-embargoed countries.

The system of redistributing supplies by the international oil companies themselves where they were needed worked so well that the emergency joint operations were not even utilized. There was simply plenty of excess production capacity to overcome the oil weapon. Thus, it was clear by then that the embargo had failed, with the major losers being the Arab oil-producing countries, and by September, the embargo on the US, Britain, and Germany had been lifted.

The two lessons the US drew out of the embargo were the importance of diversifying sources of supply and of maintaining a flexible tanker fleet. The worldwide surge after the six-day war, as expected, caused supplies to exceed, at least in the short term, demand, with no worry of availability. Unfortunately, now that the war had demonstrated the importance of security of supply, the hydrocarbon man took oil for granted again and embarked on his old lifestyle, knowing that oil was abundantly available and cheap. This will prove to be a costly mistake.

The Quest, Chapter 12 Overview

After reviewing the origins and early years of OPEC, we see the control and worldwide impact this new organization can bring to the oil industry. This portion adds some balance to the swing for oil control. The North Sea adds unconventional petroleum to the world market and counters the percentage control with OPEC. This also highlights the advantages of continuing to advance technology for recovering oil. The North Sea deep oil drilling has its own challenges of cold and harsh weather conditions. This offshore drilling is more expensive than drilling in the Middle East and even more than drilling in Venezuela. Yet, in response to the rise in the price of a barrel of oil, it would cover this increased cost of drilling in the North Sea.

Just as we see today with the increase of hydraulic fracking (HF). HF is more expensive than conventional drilling, but as the price per barrel goes up, so can the investment in unconventional drilling process and recovery. The challenge is to make the recovery of the oil economically profitable. There is a price threshold below which the recovery of this unconventional oil is no longer profitable. The companies can continue drilling at a loss or stop drilling until the price rebounds. There is no point in drilling oil that costs more to produce than the price for which it can be sold.

The Quest, Chapter 15 Overview

From The Prize, we saw that the replacement of coal is explained though the general use of petroleum and nuclear energy options. The Quest reading focuses more specifically on the Liquid Natural Gas (LNG) used to replace coal. Here we learn that technology to change it from a gas to a liquid and back again is key to it replacing coal.

The next challenge is the economic considerations of being able to make that transfer economically profitable. The high cost to make natural gas into a liquid, then transport it, then transfer it back adds to the overall cost of the product. The long-term view of the Natural Gas (NG) industry saw the need to lengthen the contracts to guarantee an ability to spread the costs over a longer time frame and have a long-term customer. At the beginning of these long-term contracts, there were limited sources for the NG, mainly being in Louisiana and Algeria. Once

there was an increase in the number of producers around the world, the price of transporting NG dropped.

This section jumps ahead and gives you a glimpse of yet another oil crisis in 1973. We will not go into details about it yet. Beyond that, it spurred the development of more expensive options as a response. This new abundant product, LNG, added stability to the world market by giving a balance to the resources controlled by OPEC, thus reducing their overall influence on the market. Even though LNG is a different product than petroleum, the price was indexed to the oil prices - meaning they were attached, but not the same per barrel. As the price of oil went up, the price of LNG went up the same amount. If the price of a barrel of oil dropped, so did the price of LNG. Hence, this new expensive product was added to the overall world market of petroleum.

Concepts to Consider for the Lesson

Lesson 9 brings us out of the late 1960s to the early 1970s. And with that decadal change, we see significant shifts in the oil industry. We will see changes in who is producing oil, how conflict influences oil as compared to WWII where oil influenced conflict, and how the business relationship between oil exporters, oil importers, national governments, and countries changed. Of significant note in this Lesson is the onset of the Age of Shortage. No longer are we basking in a global surplus, but instead becoming increasingly vulnerable to cutoffs and shortages.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to OPEC and the Hydrocarbon Age
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications
• Develop a proposal for the Unessay Project

What is due for Lesson 9?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

During the years covered in Chapter 28, we see a power shift so to speak in the Middle East. The British leave which creates a power vacuum, quickly filled by Iran, while the Russians arm Iraq. This period also saw the birth of the United Arab Emirates. Libya comes on strong and shifts the balance of power. The countries themselves started flexing their muscle, pressuring the companies into price and production ultimatums. OPEC was finally having the influence they had always hoped for, but they had to deal with rogue nations- Libya and Venezuela. On a global scale however, there were other challenges- mainly demand was catching up with supply and the surpluses and buffers that existed for a while were rapidly dwindling.

Dependency on foreign oil increased, and there was an alarming decrease in the margin of error. Any glitch in the supply chain, even if the supply of oil was sufficient, could cause shortages and stresses. It was more than finding recoverable oil, it also needed reliable transportation, refining, and distribution systems to be working optimally.

Helping the supply/demand issue was the discovery of North Sea oil fields and the incredible find on the North Slope of Alaska. These two areas would become two of the most productive oil regions in the world for many decades to come. And not being in the Middle East or in areas of political instability provided a supply line less threatened by conflict. Not all was hunky-dory though as these areas were very challenging technologically to develop, and the environmental movement was introducing roadblocks and barriers. Companies who were extremely competitive saw that “the enemy of my enemy is my friend,” and decided to work together to push back against the governments of the oil producing countries to avoid being completely overrun. Both countries and companies realized that joint “participation” in development was better than nationalizing the oil industry. Countries didn’t want to become de facto oil companies and the existing companies wanted to participate in the producing regions and get the oil to global markets. It was just smarter to work together in a more productive fashion, than take adversarial roles that would not help anyone. Unfortunately, oil consuming and importing countries, especially the US, didn’t seem to notice the writing on the wall and downplayed the growing threats to reliable and secure oil supplies from abroad. As we will learn, that proved to be a fatal error, and one that we seem to be repeating again in the 2020s.

The 1970s introduce the new term that exist still today- “energy crisis.” During the early 70s, the crisis was largely due to the growing fragility of the marketplace combined with conflict. In WWII, we learned how oil supply influenced the war by impacting how the countries fought. But in the 1970s, we learned how a local war could have global impact through the role of oil. The greatest conflicts of that time were the Arab-Israeli engagements.  

Because the US was seen as an ally to Israel, it got caught up in the conflict. Oil was now, itself, a weapon, used to drive policy and get concessions. A friend of Israel was an enemy to the Arab states and therefore vulnerable to attack. The most effective use of the weapon was production cutbacks more so than embargos. A country can get around an embargo by moving oil from countries that aren’t embargoed to those that are. But the producing countries realized that it was more effective to simply reduce production so there is not enough oil to move around.  

This period saw the end of 12-year surplus and a shift from the 30-year post-war way of doing business to this new world where the power was seated with the producing countries, and they knew it! Unfortunately for the US, the Watergate scandal introduced doubt in the minds of other countries about American leadership, and this further emboldened the producing countries. It also did not help that we ignored the warning signs leading up to the early 1970s, and we found ourselves vulnerable in terms of reliable supply of foreign oil, and not enough production in the US. The two diagrams below show the great shift from restricting foreign oil to support domestic producers, to importing as much as possible to have enough.  

Quotas Illustrated

Credit: Quotas Illustrated by K. Jensen © Penn State is licensed under CC BY-NC-SA 4.0(link is external)

Importing Oil into the United States 

Credit: Importing Oil into the United States by K. Jensen © Penn State is licensed under CC BY-NC-SA 4.0

The embargo and cutbacks by OPEC and the Arabs continued and caused more havoc. American gas prices rose by 40%, and suddenly the age of oil shortage was leading to lost economic growth, recession, and inflation, and the US was on the defensive and being humiliated by a few small nations. The effect of the embargo on the psyche of the US, Western Europe, and Japan was dramatic. Up until October 1973, the US public did not even know the US imported oil. The most visible symbol of the embargo in the US was the gas lines, as US motorists, who were used to driving until their gas gauge read “empty,” now filled the tank constantly, afraid that oil would run out. This created long lines and up to TWO HOUR waits at gas stations. Ironically, drivers waiting in long lines with their engines running and tempers rising seemed to burn even more gas than they were able to buy. Of course, panic buying meant extra demand in the market and higher prices!

The public blamed the oil companies and Nixon for the embargo, shortages, and price hikes. Misinformation, mistrust, confusion, and fear were the order of the day. Congress was engrossed in Watergate, and any presidential energy action lost out in news coverage to Watergate. Nixon tried a national conservation movement to save energy and we saw growing interest in using oil revenues to invest in new technologies and energy sources to reduce the risk of dependency on others for oil.

With the global agitation, anger, suspicion and suffering, the issue was how the available oil was going to be distributed/rationed/allocated. The Arabs masterfully managed to split and put a wedge between the industrial countries. Japan, without any local energy sources, was the most vulnerable, and interestingly, Britain was placed in the “friendly nations” category. OPEC was able to cut production and maintain a profit due to the high prices. Thus, they could sell less and earn more!

At the start of the embargo, the European allies, led by France, distanced themselves from the US, as they thought the US was too confrontational. The US, on the other hand, thought Europe was too soft on OPEC. Thus, the embargo divided the consuming countries based on the Middle East labels placed on each country (i.e., friendly - supported Arab states and got a lot of oil; neutral - did not support either side and got less oil; unfriendly - supported Israel and the US and got no oil).

The companies were caught in the middle. For example, how would it look to see an American company implementing an embargo against the US? The companies decided to use “equal suffering” and “equal misery”- production cutbacks would be applied equally among all countries, with Arab oil going to Arab friendly countries and non-Arab oil going to the US and other countries under the embargo.

There are many lessons learned from this period which seem lost on our current society. We have again let energy independence slide away and have become dependent on others for our energy security. We have also again learned the risks and impacts of fragile supply chains and how quickly even the perception of a problem can trigger panic, which in turn exacerbates the problem.

This Oil War is not as literal as the October War, yet it illustrates when a financial crisis spurs a similar but different shock to the world oil market. Earlier in the lesson, it was noted that Saudi Arabia became the Swing Producer; this carries through into our current time. Saudi Arabia frequently has struggles with other OPEC nations that do not stick to the agreed upon production. When these rebel OPEC members increase their production, the profit comes out of Saudi Arabia’s pocket more often than any other OPEC member.

We learned how even under an embargo; OPEC members still pushed the outer limits of production. They were sure to keep the US out of the share, but that meant the whole world market shrank, and thus OPEC countries were all losing income. In this section, Venezuela chooses to ignore the OPEC quotas and disregards the impact of world financial crisis. This makes each exporting country’s market share shrink, and so this rebellion by Venezuela hurts all the oil producers, OPEC and non-OPEC alike.

Chapter 8 - The Tightest Market

This section of The Quest Chapter compares the 1973 embargo to the more recent disruptions in the world oil market in 1996, 2003, 2005 - the world lacking a security cushion or the ability of the United States to raise production again as they did in response to the 1956 Suez Crisis and the 1967 oil embargo. There was no safety net - the market responded with higher prices to shrink the demand and signal for restraint in the market. These times were not planned as the oil embargoes were to modify the behavior of another country. There were different challenges that brought on these disruptions. So many times, the oil companies strive to find the balance in supply and demand, yet oil has broader implications beyond the basic supply and demand concept. War, weather, financial crisis, revolution, shift in political affiliations, religion, and technology are only a few non-oil related situations that also impact the oil supply and demand.

This section explains more details on the Jakarta Syndrome and how it applies to the oil industry. OPEC is striving to balance the market by controlling their production, which is the opposite goal of their oil embargoes when they were striving to give their customers an old-fashioned Rockefeller “good sweating” until they changed their actions. Here, OPEC is being proactive and trying to keep a balance in the world markets.

However, the future was not as the OPEC members anticipated - There was now too much oil! This could be compared to when, in the United States, there was fear of running out of oil, and the Black Giant struck and flooded the market. The price drops, and the oil exporting countries learn another valuable lesson about increasing production. The lessons continued to encourage efficiency and using technology to the best advantage by merging companies.

This can be brought even closer to our current time with the historical collapse in the price of oil from $140 per barrel in 2008 to a drop to around $50 per barrel in 2009, also brought on by a flood of oil in the world market. The price of oil continually fluctuates, but not usually this drastic of a change.

Concepts to Consider for the Lesson

Lesson 10 covered the golden age of OPEC, and also saw significant conflict and upheaval in the Middle East, especially with Iran and Iraq. As noted in the previous lesson, there continued to be shifting from concessions to nationalization in the producing countries. These conditions led to adjustments in the consuming nations to the new realities of oil supplies and markets. 

All of this helps usher in a second oil shock with the usual panic, price increases, leapfrogging and scrambling. Gas lines and the Iran hostage crisis helped bring down a presidential administration. During the oil price increases, all other outputs that required oil also increased in price. This, as expected, led to inflation, high interest rates, and a world-wide recession that led to declining oil demand. But the greed of OPEC in increasing prices (despite the war), the declining demand for oil because of inflation, the surge in non-OPEC production, and the great inventory dump all led eventually to further declining prices. 

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to OPEC
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications

What is due for Lesson 10?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

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.

How things change with time. While in the 1950s and 60s, inexpensive oil had fueled economic growth, in the 70s, oil seemed expensive and insecure. Also, before the 70s, it was oil exporters who complained that their sovereignty was being impaired by oil, but in the 70s, it was the industrial countries that found their sovereignty, security, and foreign policies threatened by oil. Since the hydrocarbon man was unwilling to surrender his newfound love of petroleum, adjustments to the new realities had to be made.

Countries sought to secure their own energy sources after the embargo. While the mix for various countries may have been different, the elements were virtually the same and included alternative fuels, diversified sources of oil, and conservation. The French, for example, rapidly developed nuclear power, returned to coal, and emphasized conservation.

The threat to oil companies now came from the importing countries, not the exporting countries. Gas allowances and foreign tax credit were rescinded as the companies became increasingly unpopular. Some people insinuated that the oil companies had planned the crisis to raise their profits, and the government even threatened “divestiture”- breaking up the oil companies' integrated structure so that each stage was a different business. Oil companies had become the enemy of the people.

Already by mid-decade, profits dropped back down in 1975 due to weakened demand, increased royalty taxes, and the removal of tax exemptions at home. Profits increased slightly over the next few years but remained constant with inflation. Between government policy attempts to control prices, and companies adapting to changing acceptance by culture, domestic oil policy in the 1970s was somewhat marked by divisive, angry, bitter, confused debate on price controls and company practices and policies.

Ironically compared to today’s sentiment, coal was seen as a possible solution to the oil crunch. Actions during the 70s included the Trans-Alaskan pipeline (TAPS), an increase in 1975 of automobile fuel efficiency standards, and the establishment of a strategic petroleum reserve that was part of the fuel efficiency bill. This reserve is the same one that President Biden has tapped in an attempt to stabilize oil prices.

With the exit of the Nixon Administration and arrival of the Carter Administration, there was an attempt to remove the price controls on oil and natural gas, as well as put greater emphasis on the use of coal. Their top priority was to remove the oil subsidy and let domestic oil that was under price control rise to the world market price. It also sought to encourage the development of alternative sources of energy (e.g., solar) and to improve competition in the electricity sector.

The public that had gotten accustomed to the hydrocarbon lifestyle, however, did not think there was a crisis, and there was significant push-back on the new policy. As a reaction to the embargo, price hikes, and expectation of increases, a frantic search for new oil ensued, and the cost for everything related to drilling doubled relative to its value in 1973. Companies were determined to avoid nationalization at all costs and redirected their exploration and production to the industrial and “friendly” nations of the Western world (US, Canada, British Isles and Norway). The 70s saw rapid expansion of Alaska, the North Sea, and even Mexico was making a comeback.

The companies also embarked on “diversification” in non-oil businesses. As examples, Mobil bought Montgomery Ward (a now defunct department store), Exxon went into office automation, ARCO went into copper, and Gulf bid for the Ringling Brothers and Barnum & Bailey Circus.

The enormous amount of money flowing into Iran caused inflation, waste, and corruption, which generated economic hardship and social and political tensions in Iran. Much of Iran, therefore, began to resent modernization, and instead preferred the traditional Islamic teachings. This was the onset of the collapse of the “westernized” version of Iran. But because they were such a key player in the oil market, “what happened in Iran didn’t stay in Iran.”

This Iran issue helped lead to another oil shock. With Iranian oil off the market, other sources increased their production, but an actual shortage existed, and this helped to create the Second Oil Shock. For example, oil prices went from $13 to $34 a barrel, resulting in huge changes in the world economy and global politics. Panic ensued. The panic resulted from a number of reasons: the growth of oil consumption and its impact on the market, disruptions of contractual agreements and breaking of the industry vertical integration and creating new buyers, the inconsistent and contradictory policies of the industrial nations, the oil exporters taking advantage of any opportunity to increase rents, and the power of pure emotions (uncertainty, anxiety, confusion, fear, and pessimism). The buyers, for fear of a repeat of the oil shock in 1973, worsened the shortage by buying and storing the oil even though it was expensive to hold the oil in inventories as insurance against price and shortage. This, obviously, led to further increases in the price of oil.

Nuclear had become a major alternative source of power to many industrial countries after the Suez Crisis and the first oil shock. Unfortunately, in late March 1979, part of the Three Mile Island nuclear plant near Harrisburg, Pennsylvania malfunctioned from a pump and valve failure. The accident limited the public interest in the nuclear option, and the cost and uncertainty of alternative energy also increased and contributed to the gloom, pessimism, and fatalism in the Western world. While, previously, the industrial countries had been able to obtain both low-priced oil and guaranteed secure supplies, now these two objectives had become contradictory, and governments ended up pursuing the latter.

Gasoline lines, the nightmare of 1973, re-emerged in the US during the Second Oil Shock. The US was caught in a gasoline shortage, and ineffective US policy made matters worse. Price controls limited conservation, and the gas lines essentially led to rationing and created more gas lines. The blame fell on President Carter, and his approval rating fell to as low as 25%. Oil companies once again became public enemy #1.

The gas lines and the Iran hostage crisis helped to bring down Jimmy Carter - and could be a cautionary tale for the Biden Administration in the current geopolitical energy landscape, mainly with the conflict in Eastern Europe. In April 1979, Carter announced decontrol of oil prices (which angered liberals who blamed oil companies). He also imposed a “windfall profits tax” on “excess” oil earnings (which angered conservatives who blamed government regulation and intervention). Thus, the new policy only intensified the barrage. Carter made a series of other mistakes that alienated people on both sides of the aisle as well as the general public. His actions also caused doubt and uncertainty in other countries about the stability and practicality of US policy.

With Iranian oil cut off from the US, redistribution was necessary. Prices soared because of this. The Saudis were the only OPEC nation to advocate lowering prices. They felt that if the price of oil became too high, consuming nations might try to develop alternatives. Also, rising prices could cause recession, depression, or even ruin of the global economy. What mattered most to Saudi Arabia and most nations were the rates: interest, exchange, inflation, and growth rates. The Saudis' objective was to use their significant weight in excess supply to push prices down. The producers had lost sight of the market reality, which would later come back to bite them.

On September 22nd, 1980, the heads of OPEC met in Vienna. At the very same time, Iraq, with a third of the population of Iran, began to launch airstrikes against Iran. The war removed 15% of total OPEC output and 8% of world demand. Thus, the oil supply was cut back sharply as a result of the war, but consumer nations were prepared this time. The International Energy Agency seemed to do a better job (relative to the second oil shock in 1979) of urging companies not to buy in fear or scramble for supplies to drive up prices, but, instead, to draw down their inventories and conserve the oil they had. But, with the war underway, panic buying began again.

A huge inventory build during 1979-1980 made sense when prices were increasing and there was an actual risk of a shortage. However, when demand started to plummet and supply from other non-OPEC sources surged, OPEC had no choice but to unify and bring prices down to Saudi’s $34/ bbl. The prices for “OPEC hawks” began to drop, and October 1981 saw the last OPEC price increase for at least another 10 years.

Concepts to Consider for the Lesson

More oil shocks, more conflict in the Middle East, and more price volatility characterize the period covered by this lesson. We also see major restructuring of companies with many mergers, some quite significant. Permeating this period, and in truth, most of the oil industry’s history, is the fear of running out of oil. The fear of our running out of oil or our having peaked in oil production has always occurred after major oil events such as World War I, World War II, the oil crises in the 1970s, and the new oil shock of 2003-2008. Interestingly, each time, more oil was found in new areas using new technologies, and a new surplus evolved after the 2008-2009 recession. All the data suggests there are sufficient oil resources underground. However, there are a number of constraints and challenges in getting them out. The first is the above-ground risks that can deter development and lead to supply and demand imbalance. Such risks may involve geopolitics, costs, government and company decisions, and restrictions on access and investment. The second is the increase in nontraditional or unconventional oil from ultra-deep offshore waters, oil/tar sands, shale oil, and natural gas liquids (NGL). Third, is the frightening sheer size of the potential demand of China and India and the challenges posed in meeting that potential demand.

As we wrap up our journey through The Prize, we learn that the rush for oil has not stopped since Pennsylvania in 1859. Since then, oil has had the ability to make and break nations, whether in war or in peace. It has also brought the best and worst out of society and produced booms and busts. Oil’s central and strategic role in national politics, economy and strategies, geographical distribution, and recurrent patterns of crisis continue to make it a problematic commodity. Oil powers our daily life, gives us our daily bread, and fuels our global struggles and economy. The fierce search for oil and its riches and power will continue as long as the hydrocarbon man is addicted to it. That power, however, comes with a heavy price.

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to Supply Disruptions, Price Shocks & Oil Market Trading
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications
• Analyze your own perceptions, values, beliefs, goals, histories, or self-concepts for the Course Reflection Activity

What is due for Lesson 11?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

Still within the same decade of the 70s, we see another oil shock. The Second Oil Shock saw oil prices skyrocket to $34 a barrel, and the price of everything connected to oil also shot up - drilling land, real estate in oil cities, graduates of oil-related disciplines such as geology and petroleum engineering, among other things. Although large sums of money were being exchanged, oil companies began to invest in the development of other fossil fuels, including shale oil technology. This diversion to other fossil fuels was short-lived as prices dropped again. Short-lived for now, in that we shall see later the investment in shale gas that transformed the US’s role in the global market.

As the price of oil increased, so did the price of outputs that required oil as an input. This, as we know, causes inflation. The combined effect of the reduced spending power and the tight monetary policy (high interest rates brought on by high inflation), both caused by the high oil prices, led to a deep global recession. America actually hit the “Double Dip” recession in the early 1980s, with the two bottoms being in 1980 and 1982.

Developing countries were debt-laden and, with the markets for their goods hit hard by the recession, went into economic decline, reducing their demand for oil. Thus, the recession halted the increasing demand for oil. The increasing oil prices also forced a change in the dependence on oil through increased demand for coal, nuclear, and liquefied natural gas (LNG) in electricity production. Increased energy efficiency and conservation further reduced the demand for oil. While demand was weakening, new technology and production sites were increasing the supply of oil available outside OPEC. There was major new production in Mexico, Alaska, the North Sea, Egypt, Malaysia, Angola, and China. Clearly, not only was the share of the energy pie declining, but the pie itself, oil consumption, was also getting smaller from the efficiency/conservation improvements and the recession. OPEC learned the hard way that they were no more immune to the whims of the marketplace than anyone else. Reduced demand, other sources of oil and gas, and general economic woes force OPEC into a corner. Even with attempts to cut production, set quotas, and alter prices, OPEC oil was still overabundant and overpriced.

There had clearly been a major transformation of the oil industry as the oil industry’s domination by large, integrated oil companies had broken. It was at this time that oil became “just another commodity.” Where the industry had been dominated by large integrated suppliers before, traders or ‘commercial people’ now ruled the market. With nationalization, and countries assuming ownership of the oil resources, the links that tied reserves to particular companies, refineries, and overseas markets were severed, and the oil companies, having lost their integration, became buyers and traders, just as commodity-style traders.

In March 1983, crude oil futures were traded on the New York Mercantile Exchange (NYMEX) for the first time. A future contract gives you the right to buy or sell a set amount of a good at a set price and date in the future. It was to minimize the risk from the volatility and uncertainty in the spot market, as it allowed one to lock in a price or buy at some month in the future at a specified known price. While decades earlier, the benchmark price was set with Arab Light as the marker crude, now West Texas Intermediate was used to set the benchmark price.

Oil was completely deregulated in the US in 1981. Deregulation, as expected, removed protection and increased competition, resulting in consolidation, spin-offs, takeovers, and other corporate changes. Overcapacity and decreasing prices also promoted consolidation, shrinking, greater efficiency, and greater profits. Companies started to evaluate the value gap, the difference between a company’s stock and the value of its oil and gas reserves of other companies, which gave a measure of whether the company was under or overvalued. With oil heavily traded in futures markets, many firms attempted to increase their stock by buying out other, undervalued oil companies.

Many smaller oil companies were bought out by larger ones, as it cost more to add a barrel by exploration than to buy the assets of an existing operation. Thus, it was cheaper to “explore for oil on the floor of the NY Stock Exchange” than to do so from the topsoil of Texas or under the seabed of the Gulf of Mexico.

The downturn in the industry and the near bankruptcy of Mexico clearly demonstrated the interdependence of oil and global finance. It should be pointed out that the downturn did not only affect nations but also jeopardized the integrity of the interconnected banking system, especially in the US, leading to the huge 1984 $13.5 billion Federal bailout of Continental Illinois, the largest bank in the Mid-West and the 7th largest in the US.

As we enter the early and mid-1980s there is a massive restructuring of the industry in terms of companies with mergers everywhere! The companies had to reposition to adjust to the fact that exploration was just too costly and risky, and there were options of buying ready-made reserves. At the national government level, at the May 1985 G7 meeting in Bonn, the main themes were free-market politics, deregulation, and privatization. Instead of inflation and recession, there was now a booming/vibrant economy and the bull market that was not being fueled by increased demand in oil.

This lesson goes into some complex oil investment concepts, expands on the way that oil became more of a commodity. Some might find this to be a review, but all need to have an understanding of how they apply to the oil industry.

Historically, the United States has led the oil industry, thus the price of oil has been tied to the US dollar. As the price of the dollar went down, the price of oil went up; enter inflation. This would be caused by the value of the dollar going down, but the value of oil remains consistent, so the price of oil would have to go up to accommodate this currency value change. Oil has a lasting long-term value and can be used for stability for investment and ultimately gaining profit. Thus, investors can assume oil will maintain relative value over the long term. This makes it a good commodity to hedge higher risk investments. The demand for oil will continue to grow, as oil does not have a strong or consistent competitor through alternative energy options. The power of the oil industry will continue until an economically viable alternative gains a significant market share.

The Quest goes into extended focus on the 1970s - 1980s oil trading, beyond the daily trading. Going into the 1970s, oil companies were integrated, following the example of Rockefeller as he built Standard Oil. Taking all the parts of the process under one large company allows for the company to absorb higher costs with higher profits along the process. The nationalization of oil companies in many oil-exporting countries contributed to the breakup and new approach to the flow of oil. The oil-exporting countries did not want the challenge of finding the individual consumer, but instead to pass on the risk to international oil companies, who were already equipped with gas stations all over the world.

The separation of the process allowed for companies to sell off the higher-risk areas and potentially make more profit while allowing for new speculators to enter the Wonderful World of Oil.

With oil now a commodity in the 1980s and prices spiraling downward compared to the surge in the 1970s, the question was, “How low can it go?” The answer to that had huge implications on the oil companies, the future of “oil power,” global economy, and the shifting balance in world economic and political strength. Clearly, high prices favored exporting nations (OPEC and non-OPEC), and low prices favored the oil-importing nations (Germany, Japan, and the many developing nations). The U.S. had interests on both sides, as it was the world’s second-largest producer and the world’s largest importer and consumer. OPEC was not helping its own situation with failing quotas and member cheating.

The third oil shock was as dramatic as the crisis of 1973-74 (first oil shock) and 1979-81 (second oil shock) except that the consequences this time were in the opposite direction as noted in the figure below. West Texas: crude that had sold at $31.75 per barrel in November 1985 had fallen to $10 per barrel (70% drop in a few months). Not only were prices falling, but they were out of control, and, for the first time, there was no price-setting system or structure - no official OPEC price.

Of course, consumers were ecstatic as their standard of living and improved lifestyles were no longer in jeopardy. If the prices continued to stay low, there was fear that consumption/demand would rise, domestic production would decline, and imports would again flood the U.S. market.

The issue with price cut goes back to the question of: how low can it go? or where would the price fall stop? Cuts in production would make non-OPEC oil, alternative energy sources, and conservation flourish in addition to the huge revenue loss.

Ironically, whereas in the past it was high prices and limited supply that was considered a national security risk, now the risk was too low prices and overabundant supply. Eventually, it was determined by all concerned parties that $18 per barrel, $11 less than the official OPEC price of $29, was the “right” price of oil. This was the equivalent of the mid-1970s price after correcting for inflation. This was felt to be the price that would achieve all the competing objectives: make oil competitive with other sources and conservation, stimulate worldwide economic growth and demand for energy, and cap or reverse the non-OPEC production. With the consensus within OPEC, the U.S., and other non-OPEC countries for $18 per barrel, and the good faith effort of all parties, the market stabilized, and the “good sweating” eased.

Lessons learned during the Oil Shocks included the importance of stability of demand & supply and the fact that price stability and ample supplies were necessary to ensure this. As we exit the 1980s, conflict is brewing again in the Middle East.

1989 was the miracle year in which the East-West confrontation, or the Cold War, was over. The communist Eastern Europe regimes and the Berlin Wall had all collapsed, and the Soviet Union was in a historic transformation from political and economic changes as well as ethnic nationalisms. German reunification was solidly on course, with Germany poised to be the dominant power in Europe. Japan was viewed as the global financial powerhouse, and future confrontations were expected to be based on money, markets, and economic growth.

Oil, except for its environmental concerns, had become unimportant and just another commodity. There were no concerns in the U.S. about supplies, as proven reserves had increased from 670 billion barrels in 1984 to 1.0 trillion barrels in 1990. It should be noted, however, that the world reserves were still concentrated in five major oil producing countries in the Persian Gulf plus Venezuela. Demand was growing, American production was declining, U.S. imports of oil were climbing, and at its highest point, conservation was slowing, efforts to develop alternatives had become anemic, the security margin (the difference between demand and production) was shrinking, low prices and low security of supplies were the order of the day, and the world was moving to heavy dependence on Middle East oil again! Even with the conflict and tension between energy and the environment unresolved, energy issues seemed like a footnote and a thing of the past.

In July 1990, Saddam Hussein, under the pretext of serving as the enforcer of OPEC’s new quota system and threatening Kuwait and the United Arab Emirates if they cheated, amassed 100,000 troops on the border with Kuwait. Interestingly, the only OPEC country that was cheating by mid July 1990 was Iraq! He promised Egypt and Jordan that he had no plans or intention of hostile action but was only there to serve as a deterrent for cheating. On August 2, 1990, however, Iraq invaded and annexed Kuwait, claiming that Kuwait belonged to Iraq and that the Western imperialists (the British) were the ones who had arbitrarily partitioned the two countries to deny Iraq of its oil.

After the invasion, there was Iraqi plundering of Kuwait. On the basis of oil, but not cheap oil, as a critical element in global balance of power and stability, the world, led by the U.S., had to act, and the U.S. helped to put up an unprecedented international coalition to face up to Iraq. With the embargo, 4 million barrels of oil were lost from world supplies, similar to 1973 and 1979, and, as expected, uncertainty, fear, and anxiety caused a sharp rise in prices and the fall of financial markets.

Shortly after the start of the Gulf War, the invasion of Kuwait by Iraq, oil went from $30 to $40 a barrel, but within hours it had plunged to $20 a barrel, well below what it was even before the war. The Strategic Petroleum Reserve (SPR) was used, and besides, demand for oil was falling with the passing of winter. With the extreme success of the initial attacks and the use of the SPR, fear was removed, and supply and demand pushed the price down.

Iraq’s withdrawal from Kuwait led to an oil-related environmental disaster, and it was intentional. Iraq withdrew from Kuwait with vengeance and vindictiveness by initiating the largest oil spill in history (still is), setting Kuwait and its oilfields on fire, and destroying them if it could not have them. More than 600 oil wells were set ablaze creating a huge environmental damage/catastrophe.

The war showed the effectiveness of the energy security system built around the International Energy Agency (IEA) and the Strategic Petroleum Reserve (SPR). IEA provides a framework for the coordinated response and exchange of timely and accurate information among nations. SPR also demonstrated that given time, markets will self-correct, adjust, and allocate. All six major oil price disruptions from 1950 -1991 had shown that logistics and supply systems can adapt to minimize the impact of shortages. For example, in the 1970s, the issue was not one of real shortage but the disruption of the supply system and the confusion of who owned the oil. Also, in the 1970s, the U.S. political system was paralyzed and in disarray, with no rational and coherent policy. And, of course, Watergate was a major part of the problem.

The industrial world faced a resurgent wave of the environmental movement. The first wave that came in the 1960s and early 1970s focused on clean air and water and accelerated the switch from coal to fuel oil for heating and power generation. The second was concentrated on slowing or stopping further development of nuclear power. The third wave that started in the 1980s was in reaction to climate change/global warming and its devastating effect on forests, weather changes, and natural disasters. Among the most significant energy related environmental disasters or events since the 1980s are the Chernobyl nuclear accident in 1986, the Exxon Valdez oil spill accident in 1989, and the 2010 BP Deepwater Horizon oil spill in the Gulf of Mexico. It is clear that the drive for energy security will coexist with the third and future waves of environmentalism as we develop sustainable energy policies.

The Epilogue allows for some closing thoughts on the story told within The Prize. For most of the 1990s, oil was not as important as a strategic issue or commodity, as it was abundantly available and at a low price. Most of the attention was shifted to the emergence of China as a powerhouse in the global economy. In 1997-1998, however, Asia’s economic miracle/bubble burst (starting in Thailand), resulting in a financial panic, bankruptcies, defaults, and a deep economic downturn in most of Asia as well as other emerging markets that included Russia and Brazil. With oil supplies increasing and demand falling from the drop in Gross Domestic Product (GDP), inventories overflowed, and prices dropped to $10 a barrel, just as in 1986. Russia, just as in Mexico earlier, went virtually into default and bankruptcy. For the oil-importing countries, the fall in oil prices was like a big "tax cut" again or a package that stimulated economic growth. It helped to put the lid on inflation, pushed gas prices down at the gasoline pump, and sparked America’s passion for fuel-efficient SUVs and light trucks.

With issues on oil (security and price) taking the back seat in the 1990s, the exciting “new” thing was the Internet that revolutionized the world economy and communication. The Internet made distance suddenly disappear and the world interconnected 24/7. Suddenly, the new generation was not interested in jobs in the “old” oil industry.

Three events in the decade 2000-2010 changed the oil view after the 1990s. The first was on September 11, 2001. Major changes that have occurred in the Middle East since September 11, 2001, including the renunciation of nuclear weapons by Libya in December 2003, the emergence of Abu Dhabi, Qatar, and Dubai as global energy players and economic centers, and the protests that started in Tunisia and propagated to other states like Egypt, Lebanon, Syria, Bahrain, Yemen and Saudi Arabia for freedom and democracy in 2011. The Iraqi oil industry is still struggling to regain production due to a lack of technology, skills, security, and a strong political structure and government.

The second major event of the decade is globalization. The world economy tripled in size between 1990 and 2009, and by 2009, a major fraction of the world’s GDP was generated by developing countries as opposed to the countries of North America, Europe, and Japan. The years 2003-2007 saw the best global economic growth in a generation, and the growth implied strong demand for oil, especially in China and India to power industry, generate electricity, and fuel the many cars, trucks, and planes.

The third major feature is the surge in oil demand that caught the oil industry itself by surprise and resulted in the industry playing catch up as a result of low investments in new oil and gas supplies in the previous decade. During that decade, Wall Street actually demanded the oil industry to be disciplined, cautious, and even restrictive in its investment to avoid low stock prices. Geopolitics also contributed to restricting supply, as illustrated below using Russia as an example.

Hence the Third Oil Shock was upon us. The concern over confrontation with Iran and the fear of its impact on oil flow through the Strait of Hormuz, the “Iranian Premium,” caused an increase in oil prices. Also, the shortages of skilled labor, equipment, and engineering skills, coupled with the high cost of steel for offshore platforms and other equipment, led to high costs in developing new fields, that doubled between 2004 and 2008. This, together with the heavy investment of investors in oil as assets alternative to stocks, bonds, and real estate that could yield high returns, further drove the price of oil higher. The weakness of the dollar relative to the euro and yen further increased the price of oil, as investors hedged against the dollar’s decline. People expected demand for oil in China and India to go off the chart, resulting in oil shortage and higher prices. All the above factors, supply and demand, geopolitics, costs, financial markets, expectations, and speculations combined to push prices from $30/bbl around March 2003 to over $145/bbl in 2008. “By that point, expectations had created a bubble in which the price was increasingly divorced from the fundamentals. For as prices went up demand had inevitably begun to weaken.”

While the oil shock in 1973 was triggered by the Yom Kippur War and the one in 1978-79 by the Iranian Islamic revolution, there was no single specific event that triggered this new oil shock. The wild price fluctuations noted in the figure below align with seminal events triggering the jumps. In the US, the situation was worsened by the credit crises that hit the mortgage and financial sectors. Only when demand growth slowed markedly, in response to high prices, and the financial crises (the worst since the Great Depression) and a worldwide recession occurred did the price of oil come down dramatically. The rise in oil prices certainly led to the transfer of huge sums of money from consumers to exporters, and the drop led to less transfer of income from importers to exporters such as Venezuela, Russia, the United Arab Emirates, Qatar, China, India, and the USA.

Clearly, a growing world economy, coupled with rising income and population growth can only mean the need for more oil. Thus, for decades or even centuries to come, oil will continue to be a factor in national policies and strategies relating to politics and the global economy. It will continue to play a role in how people live. Coal politics, oil security and cost, fuel efficiency standards, alternatives, nuclear waste, and security of infrastructure (e.g., pipelines) will all continue to be questions and choices we will face moving forward.

Concepts to Consider for the Lesson

With this closing lesson for the course, we will take a slightly different tack. We do have readings from The Quest now that we are done with The Prize. However, for the most part, these readings are short sections sprinkled throughout the book, a smorgasbord of topics that are paramount as we enter the “current” phase of the oil industry. Rather than do a chapter-by-chapter approach, we will look at several themes integrated in the reading.  

Learning Objectives

By the end of this lesson, you should be able to:

• Recall course concepts relating to Unconventional Applications and Climate Change
• Demonstrate an understanding of the role of oil in relation to pivotal events in history
• Discuss the role of oil in business applications, global markets, conflicts, energy security, and various unconventional applications
• Construct and deliver your Unessay presentation

What is due for Lesson 12?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

Each week an announcement is sent out in which you will have the opportunity to contribute questions about the topics you are learning about in this course. You are encouraged to engage in these discussions. The more we talk about these ideas and share our thoughts, the more we can learn from each other.

As we see in Chapter 11 (selected sections), the oil industry has had a history of “Chicken Little” or “Boy Who Cried Wolf” periods, where there was fear and concern over the fact that we have peaked in identifying reserves, and the current rates, we would run out of oil in some imminent time frame. We learned each time that the amount of available oil is a moving target because the market forces and technological advances constantly move the goal posts. Recall that reserves represent oil that can be recovered technologically and at a cost that is practical based on the prices of oil. Clearly, when technology advances, costs go down, and/or prices go up, the amount of available oil changes. We have learned over history that in each case of concern, we either find more oil, find cheaper ways to produce, or have a demand/price situation that makes it economic to recover. Could we eventually run out of oil? Sure, but so far history has taught us that it is more likely we will make it through the scare. And with the advent of increased efficiency and new non-oil energy sources, the timeline before we run out is even longer than was ever imagined before.

This is a very interesting chapter that describes a number of unconventional sources of oil that have come into play over the years. There are only two required reading sections, but I encourage you to read as much of the chapter as you can in that it is interesting.

We chose two specific examples because they are fundamental to some recent issues in the news. First is the section on the Canadian Oil Sands. The chapter section provides an excellent overview of how this oil is recovered, especially the unique dual nature of recovery- open pit mining and subsurface steam flooding. The interesting aspect of the Canadian Oil Sands is that they play a key role in the controversy over the Keystone XL Pipeline. It is oil from this area that will constitute the bulk of the oil that was to move through the pipeline from Alberta, Canada to the Texas refineries.

It has been claimed that the challenge to the pipeline was not so much that it was a pipeline, we have hundreds and hundreds of miles of pipelines already in those areas; but that it would encourage development of this oil resource. The truth of the matter is that this region plays a critically important role in Canadian economy and that oil will be recovered with or without the pipeline. It is only a matter of it comes into the US anyway by rail and truck, or it goes west to the British Columbia ports to be shipped on to Asia.

Second, the section on tight oil discusses a technology that was used early on for oil, but more recently for natural gas (Chapter 16)- an approach we will learn about later called hydraulic fracturing. The demise of this approach occurred early because of the price drop in the 1980s which made this technology uneconomic.

We sometimes tend to group oil and gas together as if they are the same. In reality, although they are both fossil fuels, they are quite different. They are formed in slightly different ways (although obviously related), one can occur without the other, they both have different carbon footprint and environmental impacts, and have quite different economics. This distinction became a major element of the natural gas revolution. Whereas oil was a challenge, natural gas was a preferred alternative in the transition from a coal and oil-based sector to a non-fossil fuel sector. How can this be? It is based on all the aspects we have learned about over the semester. The same way oil is cleaner and easier to get than coal, natural gas is easier than oil. Most importantly as we shall see in chapter 21, it has a lower carbon footprint.

This is a great story in itself, but it is further enhanced by the fact that the same fracturing technology used for tight oil in prior years, can be applied to shales containing natural gas. The development of the natural gas market could not have come at a better time. It not only addressed cost and climate impact concerns compared to oil, but it allowed the US to become energy independent, and actually, an energy exporter.

Being in control of such a natural gas bounty was critical considering the power that Russia wielded over Europe with its natural gas resource. US production of natural gas offered a counterbalance to the leverage Russia had with its reserves. The assigned sections of the chapter discuss Gazprom, the Ukraine-Russia love/hate relationship over gas reserves and transmission, and the reason the Nord Stream pipeline is so prominent in the news today.

This chapter and the assigned sections introduce the prominent role climate change began to play in energy policy and the oil industry. The conflict was clearly defined- a global economy driven by fossil fuels that emit carbon vs. a movement to eliminate fossil fuel use to reduce carbon emissions.

Chapter 22 is an overview of the emergence of climate change concerns and carbon emissions trying to play a role in global policy and markets. The intent was to use international treaties to manage and control emissions. Whereas this is a noble cause- it proved to be unrealistic and impractical. On the policy side, requiring emission reductions but exempting high emissions countries undermine the intent. Also, depending on regulatory command and control is the lowest common denominator approach that is inefficient.

Fortunately, in the chapter we learn that market innovation provided a very workable solution. By developing a cap and trade system, the free-market mechanism and economics can be used to drive innovation. We learned that this business model, originally started for acid rain concerns, led to better reductions than the regulatory model would have, at a more affordable cost. Trading markets incentivize emitters to reduce, which proved to be more effective than forcing them through regulation. The success of the market mechanisms, especially when compared to the less-than-ideal outcome of the Kyoto Protocols, proved to be a positive harbinger of the approach needed for carbon.

Chapter 25 describes the experience of the Kyoto Protocol and the evolution of the carbon trading market. Since the publication of The Quest, future global climate meetings have not been able to “crack the nut” of coming up with effective policy mechanisms to enact wholesale change. Key emitting countries are still exempted, much focus is put on trying to move funding to developing countries, and compliance even by those countries who sign the treaties is spotty. Ironically, the US was one of the few countries to meet the goals set by the Kyoto Protocol- even though we never ratified the treaty! In parallel, the carbon trading and offset market has come into its own with millions of tons of carbon removed from emissions (either by capture, reduction, or offset via sequestration) in the past few years.