Petroleum, Oil, and Natural Gas

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PETROLEUM, OIL, AND NATURAL GAS

naturally occurring hydrocarbon compounds.

The petroleum industry in the Middle East dates to 3000 b.c.e., when Mesopotamians exploited asphaltic bitumen obtained from seepages and rock asphalt mining to produce construction mortar, mosaic cement, road surfacing, and waterproofing materials. This form of petroleum, called pitch, is the residue left after natural gas and volatile liquid fractions have evaporated from crude oil. Ancient Bahrainis coated pottery and baskets with pitch, and in the biblical story of Noah it is used to caulk the ark. An industry distilling lamp fuel from crude oil began in Alexandria about the second century c.e. About five hundred years later, Byzantine armies began to use "Greek fire," a napalmlike substance distilled from crude oil that was poured or sprayed on enemy troops and ships, and then set afire.

The Modern Oil Industry

The modern oil industry is far more complex and integrated, a continuous process that pivots on the extraction, or production, of petroleum and natural gas from the earth. Upstream from production are exploration (the search for oil-bearing lands), and development (the construction of production infrastructure such as oil wells and natural gas separators in oil fields). Downstream from production are transportation (including pipelines, tankers, trucks, and railroads), refining (turning crude oil into usable products), and marketing (gasoline stations and other outlets). Petroleum and natural gas are both fuel sources as well as the raw material from which petrochemicals, such as fertilizers and the building blocks of plastics, are manufactured.

Looking at the oil industry as a global system lets us identify its choke points, the stages where a powerful firm or government can exert political and economic leverage on the entire process. One potential choke point concerns petroleum reserves and production. In the nations of the Middle East, as in most other nations, mineral rights belong to the state. Firms must negotiate with governments for concessions, or rights, to extract hydrocarbons on their territories. In exchange, they offer lump-sum payments, rents, taxes, and/or royalties (payments per unit of oil or gas produced).

The One Company/One Country Pattern

Before World War II, Middle Eastern countries competed for investment from international oil companies (IOCs). The largest IOCs were more fearful of an oil glut, which would depress prices, than of shortages, which would inconvenience consumers. Under the 1928 Red Line Agreement, the partners in the Iraq Petroleum Company agreed that none of them would explore for or develop new oil in the former Ottoman Empire unless every partner consented to each new project. Countries inside the Red Line had difficulty getting the IOCs to find or develop the oil that could have increased their national incomes because the largest—and richest—Red Line companies were reluctant to add to already excessive oil production capacity.

Oil partnerships and concession patterns also limited the leverage of Middle Eastern governments. Instead of one government hosting several firms that operated on various parts of its territory, the initial pattern of oil industry development in the region was to have a single operating company, often a joint venture or partnership, as the only oil producer in each country. Joint ventures are common in the oil industry because of its capital intensity and high risk. Individual parent companies like Gulf (now part of Chevron) and the Anglo-Persian Oil Company (later Anglo-Iranian Oil Company, then British Petroleum, and now BP Amoco), set up jointly owned operating companies such as the Kuwait Oil Company (KOC) to pool financial resources and risk. Although two separate parents invested in and profited from Kuwait's oil, their business in Kuwait was conducted by a single company, KOC. Such partnerships also offered the IOCs some control over total world oil supplies. They made sharing production information easier (especially for U.S. companies, which were constrained by antitrust laws), dampened competition among partners, and provided a protected environment in which the large IOCs could coordinate their global operations.

Kuwait's ability to choose a concession partner was limited by treaties between its ruler and the British government, which gave Britain the final authority to approve concession agreements. Britain would not allow Kuwait to contract with a non-British company, although Kuwait eventually persuaded Britain to accept a non-British firm as a partner in KOC. The concession further limited Kuwait's autonomy by giving KOC exclusive rights for ninety years to find and produce oil over the entire land area of Kuwait. Had Kuwait sought better terms from another company during that time, that company would have faced legal challenges from KOC's parents, preventing it from selling Kuwaiti oil in the international market.

Kuwaiti autonomy also was limited by the threat of direct intervention by one or both home governments of KOC's parents, Britain and the United States. In the early 1950s, Iran found itself in exactly this situation. In 1951, the Iranian government under Prime Minister Mohammad Mossadegh nationalized the operations of Iran's oil company following a conflict with its managers. The owner of the oldest oil production facilities in the Middle East, Iran's operating company had only one parent, the Anglo-Iranian Oil Company (AIOC). AIOC obtained court orders enjoining other companies from buying Iranian oil.

Afraid of the example that a successful nationalization might provide to other Middle Eastern governments, the British and American governments worked to destabilize and eventually to overthrow the Mossadegh regime. The restoration of the shah, Mohammad Reza Pahlavi, in 1953, following a brief period of ouster, also reinstated foreign oil companies as managers of the nationalized Iranian oil company. Rather than restoring AIOC to its former position as sole owner, however, the Iranian government sought a "Kuwait solution" and invited non-British participation in the National Iranian Oil Company (NIOC). When NIOC was reorganized, American companies and the French national oil company received 60 percent of the shares, leaving AIOC with only 40 percent.

The one company/one country concession pattern allowed oil companies to treat one or more Middle Eastern host countries as marginal suppliers of oil to the international market despite the cost advantages of their oil over what could be obtained from most other sources. This balancing act was possible because all the major companies whose production holdings stretched across the Middle East were partners in two or more concessions. The way the Iranian crisis was resolved in the 1950s made the management of crude oil supply by the IOCs even easier. The reorganized NIOC was the first operating consortium in the Middle East to include all of the Seven Sisters—the IOCs dominating the industry from the end of World War II until the oil revolution. Once these companies had estimated the amount of oil needed to balance market demand, they could regulate production by increasing or decreasing offtake in countries whose governments could not retaliate easily.

The End of the One Company/One Country Pattern

The one company/one country pattern in the Middle East unraveled in the 1950s. Following the reorganization of the Iranian concession, which incorporated several independent companies, independents began to compete more vigorously against the majors to win new concessions. When the government of Libya opened bidding for concessions in 1955, it divided its territory into independent parcels, eventually awarding rights covering 55 percent of its land area to fifteen operating companies whose owners included independents from France, Germany, and the United States. At about the same time, older producers with unallocated offshore properties began to auction them off. The independents were innovative bidders for all these properties, offering terms that included higher-than-average lump-sum payments and royalties along with equity shares for host governments. Better terms for new concessions encouraged host governments to demand that prior concession holders relinquish un-exploited territories. The new concessions that were signed for relinquished properties included sunset provisions allowing the contracts to lapse if the companies failed to develop promising properties after a predetermined period of time. As more and more independents won concessions and then found oil, markets became glutted and prices weakened.

In what was perhaps the last straw for the IOCs, the U.S. government imposed a quota on U.S. oil imports in 1959. The U.S. market, the largest in the world, was doubly lucrative because the high cost of domestically produced oil gave sellers of lower-cost foreign oil the potential to reap high profits by selling at or slightly under high U.S. product prices. U.S.-based IOCs had long been encouraged by their government to find oil overseas, and access to the protected U.S. domestic market reinforced other incentives to invest abroad. When profits from their international operations were squeezed by higher concession costs and competition from independents, IOCs with marketing outlets in the United States looked toward U.S. oil sales as a source of deliverance. However, cheap imports threatened the domestic price structure, and firms that owned only U.S. production facilities fought oil imports, especially from the low-cost Middle East.

The U.S. government asked oil companies to limit imports voluntarily, but hard-pressed firms were unwilling to forgo profits from crude sales in the United States. Domestic producers, citing national security and the risk of becoming dependent on foreign imports, soon demanded real protection. In 1959, the voluntary quotas became mandatory. Meanwhile, the major companies had begun to consider reducing per-barrel prices paid to host governments as a way to improve their deteriorating finances. In February 1959, after consulting one another (but not their hosts), the IOCs unilaterally reduced the posted prices of crude oil used to calculate operating-company tax obligations to host countries. Despite the outcry that followed, the IOCs lowered posted prices again in August 1960. In September, Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela formed the Organization of Petroleum Exporting Countries (OPEC).

The OPEC Era

Through OPEC, major oil exporting countries had the same opportunities to coordinate their oil policies that the IOCs had long enjoyed. They used the companies' refusal to engage in joint negotiations with an OPEC representative to ratchet oil prices up in successive negotiations, each taking the best deal made by any other member as its floor for the next round, a tactic called leapfrogging. Following a failed Arab oil embargo imposed after the 1967 Arab–Israel War, OPEC militancy in relation to the IOCs grew. In 1970, the Libyan government used its superior structural position to induce leapfrogging among its own concessionaires, enforcing production cuts on the most vulnerable to make them agree to price increases and then imposing those increases on the rest.

In 1971, OPEC moved toward participation, a concept referring to gradual nationalization, which had originated with Saudi Arabia's oil minister, Ahmad Zaki Yamani. Members that reached participation agreements with their operating companies in the early 1970s later accelerated the timetable to achieve full nationalization more rapidly. Even so, the process allowed each OPEC member to develop a strategic plan for assuming control of its oil industry. After nationalization, most national oil companies (NOCs) managed their new responsibilities far better than predicted, some with the assistance of former concession owners. A few acquired overseas holdings and most added to their hydro-carbon reserves and expanded operations, such as refining, that added value to their exports. Excessive political interference and infrastructure deterioration did not become major problems for most OPEC NOCs until after world oil prices collapsed in the mid-1980s.

As more than one energy analyst has observed, the stone age did not end because the world ran out of stones and the oil age will not end because the world runs out of oil. Middle Eastern oil and gas operations are undergoing a transition. Natural gas has become a highly desirable fuel. New resources have been discovered, including the giant Northern field in Qatar. New technologies allow natural gas to be shipped long distances and off-loaded safely, right at the time when governments in developed countries are tightening antipollution requirements and encouraging consumers to shift to cleaner fuels such as gas. Where air and water quality are high priorities, gas is the hydrocarbon fuel of choice for electrical power generation as well as for direct consumption. Countries with large gas reserves may be better placed economically than those that rely primarily on crude oil sales.

For oil exporters, the future is more ambiguous. Even if oil remains a dominant fuel for some years, supplies are increasing outside the Middle East and competition will keep prices and revenues down. As domestic industries age, new exploration and development will have to be financed out of earnings against which domestic claims are increasing or, as seems increasingly to be the case, foreign investment will make up the difference between what oil exporters can afford to pay and what they need to invest. Strategic investment in overseas oil and gas operations, recreating to varying degrees the multinational vertical integration that had underpinned the old oil regime, has been helpful. Ownership of downstream operations enables OPEC members to guarantee a minimum level of production and sales through their own refining and marketing networks, and also helps them stabilize oil profits because of the inverse relationship between price movements in crude and products—when one falls, the other generally rises.

Overall, however, strategic investment of oil revenues outside of the oil and gas industry is a more pressing need, whether this includes research on alternative energy sources or concentrates on identifying and supporting domestic industries vibrant enough to employ rising generations and satisfy key local needs. A quarter of a century ago, the economist Walter J. Levy deplored "the years that the locust hath eaten," the resources consumed rather than invested to achieve long-term, post–oil age economic security. Since then, the locusts have consumed many more resources, while Middle Eastern governments and populations remain acutely dependent on oil revenues for basic needs. Wisdom suggests anticipating the end of the oil age by adopting new investment policies, but the combination of expediency and their strong positions in hydro-carbons offer more tempting and far easier alternatives to Middle Eastern countries making choices about how to use their petroleum and natural gas resources.

see also anglo–iranian oil company; iraq petroleum company (ipc); mossadegh, mohammad; oil embargo (1973–1974); organization of petroleum exporting countries (opec); petroleum reserves and production; red line agreement; yamani, ahmad zaki.