EGEE 120
Oil: International Evolution

The Prize Chapter 38: Epilogue

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Consider the following questions:

  • Why was oil not as important a strategic commodity in the 1990s?
  • What caused oil prices to fall to $10/bbl in the 1990s, and what were the impacts?
  • What were the exciting new things in world economy with oil in the back seat?
  • Was the Afghanistan war justified? How about the Iraq war?
  • What is happening in the Middle East in 2011, and how is it impacting oil prices?
  • What caused the collapse of the Soviet oil industry in the 1990s?
  • What factors led oil prices to rise above $145/bbl in 2008 and why did they drop again?
  • Are we going to keep finding new oil each time we think we are running out?
  • Do you think mankind and our use of fossil fuel is contributing to climate change?
  • Can the hydrocarbon man overcome his addiction to hydrocarbons?
  • What do you envision to be the energy choices in another 100 years?

The Epilogue

Map showing major cities in central and eastern Europe
Map of Central and Eastern Europe, 2007.
Credit: Public Domain Wikipedia

The year 1991 began with Operation Desert Storm in January to remove the threat to the Persian Gulf and ended with the dissolution of the Soviet Union by Mikhail Gorbachev, president of the Soviet Union, in December. The Cold War was over, lifting the nuclear threat and ushering a new era of peace. The focus of the international community shifted to economics, growth, and globalization leading to vast expansion of international trade. Kazakhstan and Azerbaijan were integrated into the global oil industry, and the Baku-Tbilisi-Ceyhan pipeline linked historic Baku on the Caspian Sea to a port on the Mediterranean in Turkey.

For most of the 1990s, oil was not as important 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 global economy. In 1997-1998, however, Asia’s economic miracle/bubble burst (starting in Thailand), resulting in 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 SUV’s and light trucks.

Consequences of Low Oil Prices

When revenues fall from low prices, one of the survival strategies often adopted by companies is to cut their budget. Another way is to get bigger through mergers and acquisitions to reduce cost and improve efficiency. The victims often are the employees that are laid off, and the winners are the shareholders whose stock prices often increase. At the same time, whereas in the 1990s mega projects offshore were defined in terms of hundreds of millions of dollars, in the 2000s to the present, mega projects on the drawing boards were on the order of $5 to $10 billion scale.

The restructuring led to the remaking of the Seven Sisters via takeovers/mergers into super-majors. With Gulf Oil already gone, the remaining sisters changed into super-majors as follows:

  • BP merged with Amoco to form BP Amoco which subsequently merged with ARCO to become a bigger BP
  • Exxon and Mobil became ExxonMobil
  • Chevron and Texaco became initially ChevronTexaco then simply Chevron
  • Conoco and Phillips combined to form ConocoPhillips
  • Total and Elf Aquitaine of France and Petrofina of Belgium formed Total

The sixth sister, Royal Dutch/Shell, which was already a super-major company is the only one that remained the same. Even so, it did away with its old way of maintaining two separate holding companies with offices in Hague and London and became a true unitary company.

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.

The 2000-2010 Decade and the Return of Oil

Picture taken during the 9/11 attacks from the statue of liberty
September 11, 2001 attacks in New York City.
Credit: Public Domain

Three events in the decade 2000-2010 changed the oil view after the 1990s. The first was on September 11, 2001 when, for the first time since Pearl Harbor, the US was attacked, this time by a jihadist group, Al-Qaeda, with over 3,000 loss of life. The Western Allies counterattacked with the “war on terror” in Afghanistan (the base from which Al-Qaeda operated) in autumn 2001 against Al-Qaeda and its ally, the ruling Taliban. Subsequently, and for questionable reasons that continue to be debated to date, the Iraq War or second Gulf War was initiated on March 20, 2003, more than 12 years after the first Gulf War. This time, some allies such as Germany and France opposed the war and did not join. The Afghan and Iraq wars that were supposed to be “lightning victories” continue to this day (2011). The Iraqi oil industry is still struggling to regain production due to lack of technology, skills, security, and a strong political structure and government. Other major changes that have occurred in the Middle East since September 11, 2001 include 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 as Egypt, Lebanon, Syria, Bahrain, Yemen and Saudi Arabia for freedom and democracy in 2011. In some situations, this has led to the peaceful fall of governments (e.g., in Tunisia and Egypt).

The second major event of the decade is globalization. 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 for the oil industry to be disciplined, cautious, and even restrictive in its investment to avoid low stock prices. Geopolitics also contributed in restricting supply. For example, strikes in Venezuela in 2002 and 2003 shut down production, and militia/gang attacks in Nigeria in 2003 cut production by 40%. Production in Mexico also declined. Russia, that at times had even been the world’s largest producer, saw its production decline in the 1990s after the collapse of the Soviet Union but grew by 50% in the first half of the next decade and flattened altogether.

Graph of Russian oil production dropping in the early 90s and then recovering today
Russian oil production.
Credit: US EIA

A New Oil Shock

Iran aggressively launched a nuclear development program that it said was for peaceful purposes (electric power generation). Few in the international community, however, believed this, given statements of the Iranian president to “eliminate this disgraceful stain (Israel) from the Islamic world” and indicating that Israel “must be wiped off the map.” 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.”

Clearly, 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 specific or one event that triggered this new oil shock. 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 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, United Arab Emirates, Qatar, China, India, and USA. Such economic shifts have always had political consequences and resulted in continuing struggles between the importers and exporters over the money and power derived from oil, as seen throughout this course.

The restructuring of the oil industry with the mergers and acquisitions and the evolution of super-majors at the end of the 1990s also led to “huge” state-owned or national oil companies. To put things in perspective, while less than 15% of total world oil is produced by the super-majors, 80% of world reserves are controlled by governments and their state-owned oil companies, and of the 20 largest oil companies in the world, 15 are national oil companies or state-owned, with Saudi Aramco by far as the largest.

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.

Graph showing how oil price changes with various events, for example the Iran/Iraq war or the Gulf War.
Plot of oil price trends since the 70s to the present with associated events of the peaks.
Credit: US EIA

Clearly, a growing world economy, coupled with rising income and population growth can only mean the need of 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 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.

Discussion about Peak Oil and the Environment will continue in Lesson 12 - The Prize Epilogue was not enough.