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.
By the end of this lesson, you should be able to:
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.
Activity | Location | Submitting Your Work |
---|---|---|
Read | The Prize: Chapters 11, 12, 13, & 14 (select sections) The Quest: Chapter 5 (select sections) |
No Submission |
Discuss | Participate in the Yellowdig discussion | Canvas |
Complete | Complete Quiz 2 | Canvas |
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.
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.
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.
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.
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:
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.”
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.
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.
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."