The Secret History of Oil and Money - Part 1

The mastermind behind OPEC was not an Arab sheikh, but an austere and fastidious Venezuelan lawyer named Juan Pablo Perez Alfonso. Oil had been discovered in Venezuela in 1922, and provided the bulk of the government's revenues. The problem was that it was so cheap that the country made very little money off it.

Perez Alfonso was what we might call today "Peak Oil Aware." He knew that oil was a finite resource that would someday run out, and that oil was a one-time gift that would help Venezuela modernize and become a wealthy country. But the low prices of this one-time gift were undercutting this ability. Furthermore, the low prices encouraged wastefulness instead of conservation.

Instead, his idea was to find a way to preserve the resource, and raise the revenue gained from it at the same time.

In 1948 the military dictatorship of Perez Jimenez took over in Venezuela and Perez Alfonso went into exile, first in the U.S. and then in Mexico. While in exile, he became acquainted with what would become the guiding inspiration for OPEC. But you won't find it in the writings of Karl Marx. No, the inspiration came straight out of good old red-white-and-blue American corporate socialism: the Texas Railroad Commission.

The Texas Railroad Commission, as the name implies, was first set up to regulate the railroads. When oil drilling came along, instead of creating a new regulatory body, Texas gave the railroad commission the authority to regulate oil production.

At the time, the problem was that because so much oil was being pumped, many of the smaller independent oil drillers had trouble making enough profit because they did not have access to distribution networks, refineries and gas stations like the Big Guys. Because the land rights above did not always line up with where the oil flowed underneath the earth's crust, the independent drillers felt they were being cheated. These independent drillers were still worth millions of dollars despite not making "enough" profit, so they did what rugged individualists in Texas always do - they went running to government and threw their money around to get special rules passed. The Railroad Commission introduced limits on oil drilling--how much oil could be produced. In order to keep oil from outside the United States from undercutting this price, they regulated the amount of oil let into the United States by constructing an "invisible dike:"

The Texas Railroad Commission did not set a price for oil, but it determined what could be produced. The early appointments to its board developed a reputation for fairness, from the point of view of the producers. When the demand dropped, the Texas Railroad Commission gathered the industry and polled it as to what the real demand might be. It then set an allowable rate of production, so many days per month, that oil could be produced. Thus conservation produced a mechanism for stabilizing the market.

If the price of oil started to sag, the Texas Railroad Commission would reduce the number of days per month that oil could be produced. "It became the policy of the Commission," Fortune wrote in 1959, "to keep oil prices high enough for the 'little man'—the marginal Texas producer—to make money. This of course was a wonderful arrangement for the nonmarginal (i.e., the major) U.S. producers. It enabled them to clear as much as 50 per cent per annum. And it was even more wonderful for the major companies overseas."

It was wonderful for the companies overseas because the Texas price was the American price...[a]nd the Texas price became the world price, so oil was leaving the other Gulf, the Persian Gulf, in the tankers of Exxon and Gulf, at $1.80 a barrel—the Texas price— when it cost only 10 cents a barrel.

The trouble was that so much oil was being found in the world that the "Gulf" price, out of Texas, wasn't always sticking. Somebody was always trying to cut the price. The Texas Railroad Commission could keep the American price up by ordering a cutback in production, but oil could still land in the United States from abroad, and move cheaply. The American oil companies then limited imports, by voluntary agreement, which later became mandatory by order of the U.S. government. They constructed, said the British economist Paul Frankel, "an invisible dike against the outside world."

pp.148-149

By 1959 the military junta had fled the country, the reformer Romulo Betancourt was president, and Perez Alfonso was named the oil minister.

Perez Alfonso's idea was to use the Texas Railroad Commission model for the oil producing countries to cut back production, thus conserving the resource by increasing the price. The increases would send money into the coffers of the oil-producing nations and allow them to develop. He started talking to people in Austin.

He had admired the Texas Railroad Commission, he said, for its conservation practices, and he wanted OPEC to be a club that would give oil its proper value and extend its life. It was intended to wrest the power from the great oil companies, and to show the industrial nations how they wasted resources. "The nations of OPEC," he said, "should be an example to the rest of the world in the way they live."

At the time, the price of oil was not controlled by the producers themselves, but by the oil companies, in particular the International Oil Cartel comprised of the "Seven Sisters:"

The [International Oil Cartel] had been formed in September 1928, when Sir Henri Deterding, the chairman of Royal Dutch/Shell, invited the heads of Exxon (then Standard Oil of New Jersey) and British Petroleum to his estate in Achnacarry, Scotland, ostensibly for some grouse shooting. What the grouse shooters did, however, was to agree on an unsigned document that specified principles for eliminating "destructive competition." The three original members later admitted Texaco, Gulf, Mobil, and Socal—Standard of California—to make up what Enrico Mattei, the Italian oil man who could not break their grip, called the "Seven Sisters."

pp150-151

Which just proves the original Adam Smith's famous dictum:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”
Chapter X, Part II, p. 152.

The oil cartel set the amount of production, and hence the price, regardless of the needs of the country in which the oil was located. "The oil companies took our oil at a dollar a barrel...BP and Gulf would come and say, 'You can pump a million barrels a day; that's all we will sell.'"  (p.226) The low prices decreased the revenues of the oil producing countries, keeping them poor while making the oil companies rich. Perez Alfonso passed a number of new laws in Venezuela based on conservation, but it was to little avail as long as the oil cartel controlled the international market. If Venezuela cut back production, the oil companies would just get it from somewhere else in their vast empire. And Venezuela only had 7 percent of the world's oil reserves, while the Middle East had 70 percent. "Venezuela could cut back until it was blue in the face and it wouldn't matter; it would be like Pennsylvania starting the Texas Railroad Commission." p150; 152,153

At a meeting of oil producing countries in Cairo in 1959, Juan Pablo Perez Alfonso met a Saudi oil minister named Abdullah Tariki. He explained his proposal:

It would be an international Texas Railroad Commission without the Texans! A Texas Railroad Commission for the whole world! If the price of oil started to go down, all the members would hold back their production until the price went up again. And together, united, the producers of the oil--by which Perez Alfonso meant the countries in which the oil was located--together could stand up to the great industrial nations with their great oil companies. p152

Tariki had studied at the University of Texas and worked briefly for Texaco. He was the director of the Office of Petroleum Affairs for Saudi Arabia. At the time, Saudi Oil was controlled by Aramco - the partnership of Exxon, Mobil, Socal and Texaco. Rather than being dictated to by Western oil companies, Tariki wanted Saudi Arabia to have its own integrated oil company. Tariki, like Perez Alfonso, was not at all pleased with the status quo:

Tariki was fuming because the oil companies had just reduced their prices. Saudi Arabia did not have very sophisticated management, to say the least. King Saud married at least 125 times, and each wife got a house and an allowance. When the king needed money, a courtier would call up Aramco and ask for an advance. Saudi Arabia was perilously close to being out of cash, and Tariki was getting the phone calls, and the oil companies were cutting their prices, which was going to cost Saudi Arabia $34 million.
p. 153

He listened intently to Juan Pablo Perez Alfonso's message and was sold. "Conserve and cut back, unite and control. If you want more money, do not sell more oil; sell less." Now with an ally in the Middle East, Perez Alfonso would spread the idea to whoever would listen:

Tariki went through the Arab states, and Perez Alfonso went to Iran, where he held a press conference even before he got to see the Shah. Later he went even to Moscow. The Russians were as hostile as the major oil companies. Perez Alfonso had to explain that OPEC was not a front for the oil cartel.

They were an odd couple, Perez Alfonso and Tariki, but they got along. Here was this precise, brilliant, balding Latin with his horn-rimmed glasses and his pencil mustache, intense, nervous, his bedside pad always ready to receive his thoughts when he could not sleep; and here was his Arab sidekick, somewhat swarthy—he had sometimes been taken for a Mexican in Texas restaurants— with thick hair and a generous nose. Tariki was as careless as Perez Alfonso was precise. He loved speaking to crowds, though he was personally shy; and when he was speaking, he would drum out, "Aramco—is—stealing, Aramco—is —stealing," and then would rattle off statistics. The statistics bore no particular relationship to reality. "They sound good, no?" he said. "So what? The oil is ours." Tariki lived alone in Jidda, in a house with a walled garden that contained gazelles, chickens, turkeys, and various lame animals which he nursed. His Saluki dogs had the run of the house, and the Salukis remained in their chairs even when visitors entered. Tariki was also a violent Arab nationalist. "I am an Arab, not a Saudi," he said...
pp.157-158.

But what I found most fascinating was the fact that the problem with oil in the middle of the Twentieth century was that there was too much of it! No one needed all that oil, no one knew what to do with it, and the producers had a hard time making a profit because it was so abundant. So rather than scarce oil chasing the needs of consumption, we came up with entirely new ways of wasteful consumption to soak up all the oil being produced so that the oil companies could make a profit  (Carbon Democracy makes this point as well). Rather than too little oil, there was too much.

Oil companies did everything they could do to artificially increase the demand for oil, including buying up streetcar lines and having them demolished. The ostensible reason was that everyone was driving anyway, so the public transportation systems were losing money. Might as well just turn the roads over to cars and run gasoline-powered buses instead (which immediately suffered from neglect and budget cuts). Demand was driven by the cheap prices of a resource that would seemingly be cheap forever.

The [Los Angeles Railway] system was sold in 1945 by [railroad tycoon Henry] Huntington's estate to National City Lines, a company that was purchasing transit systems across the country. National City Lines, along with its investors that included Firestone Tire, Standard Oil of California (now Chevron Corporation) and General Motors, were later convicted of conspiring to monopolize the sale of buses and related products to local transit companies controlled by National City Lines and other companies in what became known as the General Motors streetcar conspiracy. National City Lines purchased Key System, which operated streetcars systems in Northern California, the following year.

The company was renamed as Los Angeles Transit Lines. The new company introduced 40 new ACF-Brill trolley buses which had originally been intended for the Key System streetcar system in Oakland which was being converted by National City Lines to buses in late 1948.

Many lines were converted to buses in the late 1940s and early 1950s.

The last remaining lines were taken over by the Los Angeles Metropolitan Transit Authority (a predecessor to the current agency, The Los Angeles County Metropolitan Transportation Authority (Metro)) along with the remains of the Pacific Electric Railway in 1958. The agency removed the remaining five streetcar lines (J, P, R, S and V) and two trolley bus lines (2 and 3), replacing electric service with diesel buses on March 31, 1963. (Wikipedia)

There was endless glut as far as the eye could see. So we invented a happy motoring utopia, building the interstate highway system and repaved local roads, the distant suburbs driven by white flight away from minorities moving north for factory jobs, and ripped up railway and streetcar lines so that people would become utterly dependent upon the motorcar. People bought a new Cadillac every year and headed to the drive-in. James Dean and Marlon Brando rebelled against authority and Americans got their kicks on Route 66. It was the drive-in future covered in chrome with a hood ornament on top; the Golden Age we Americans still pine for today. It was all part of the plan to increase the use of oil because of oversupply, which would seemingly last forever (forever being a decade hence):

In August 1959 Fortune magazine noticed the itinerant preachings of the Odd Couple. Its tone was one of amusement and skepticism, its point of view, as usual, that of big business. To read it is to enter an astonishing time warp.

The problem, Fortune said, is the Glut. Too much oil. Furthermore, said Fortune, "the glut is certain to last a long time." The reason: "too much oil underground too easy to get at, ready to flow at very little additional expense." The ratio of reserves to consumption had formerly been twenty to one; that is, for every barrel shipped there were twenty barrels underground. Now it was forty to one; in the Middle East it was one hundred to one. Even if nobody ever drilled another well, there was so much oil that the ratio of reserves to consumption wouldn't go back to twenty to one for another decade. 

"The international oil companies do not propose to take a beating lying down," said Fortune. "They are redoubling their efforts to increase the use of petroleum products." General Motors and Socal had already bought the Los Angeles mass transit rail system and shut it down. Exxon promised a tiger in a tank. Everywhere there were campaigns to increase driving and heating. "Glut without end?" read the Fortune subhead. "Today, for the first time in years, the companies are cracking down on salaries, expense accounts and office overhead." The Highway Trust Fund helped by building the interstate highway system. Farther out, suburbs were springing up, requiring more driving. 

pp. 145-155

In 1960 there was a epic oil glut and the price of oil collapsed: "...that summer of 1960 was the glut. The Russians were selling oil; the Italians were selling oil; odd tankers everywhere were dumping the stuff for whatever it would bring." (p. 158). Exxon cut the price of oil without any consultation with the major oil producing nations, whose budgets were dependent on that price. There was widespread anger and fury, not so much from the cut itself as from the fact that the oil companies did not so much as consult any of the oil producing nations before doing it. The Shah of Iran was furious, as were others. "The budgets of Middle eastern countries went out the windows, with a clamor from those countries. ...The price cut was serious for Iran, with its growing population, and for Saudi Arabia, which was planning a major program of social services....The Odd Couple's preachings were recalled. Tariki called a meeting in Baghdad for September 9, 1960." (p.158)

It turned out to be the straw that broke the metaphorical camel's back. At that meeting OPEC was formed, an "exclusive club" of oil-producing nations with "similar interests." How did one become a member of that club? Canada and the Soviet Union were not admitted, but Gabon and the sheikdom of Qatar were, despite not being substantial net exporters. "OPEC's rules were that an applicant had to be accepted by three-quarters of the Full Members, but a blackball by any Founding Member would keep him out." (p.161). Three of the five Founding Members--those with the charter privilege of blackball--were Arab states,as were, eventually, seven of the twelve full members." Thus it really developed as a club of "third-world" oil producers, chiefly Arab states, that is, countries not explicitly aligned with the United States or the Soviet Union. And what did "fundamentally similar interests" mean? In reality, it meant countries that would not sell to Israel.

It turns out, though, that it didn't work. Oil was just so damn cheap, and we had other things on our mind, so we continued Happy Motoring  all throughout the 1960's:

But the price of oil did not go up; in fact, it declined, all through the 1960s. The "posted price" of $1.80 a barrel in the Persian Gulf was for tax purposes; sometimes the oil was discounted to as low as $1 a barrel. Behind the "invisible dike," in Texas, oil sold, at the end of the decade, for $3.45 a barrel.

A contributing factor to the declining price of Middle Eastern oil was the improved ways of carrying it. The tankers in the middle 1950s had been perhaps 20,000 tons. Japanese shipyards then developed the jumbo tanker, and then the VLCC supertanker, 250,000 tons, which sharply reduced the cost of oil as it landed at the refineries.

All during the 1960s, OPEC and the seven great oil companies squabbled over a few cents a barrel. The Shah developed a major spending program and needed more revenue to support it. The Saudis eyed his program nervously. During the Six Day War, in 1967, the Arabs set up a boycott, and the Suez Canal was closed. The boycott was relatively ineffective. The end of the Six Day War left OPEC standing, but in tatters; the Iranians and the Venezuelans had increased their exports at the expense of the Arabs. 

In the United States, in the early 1960s, the rate of inflation was about 1 percent a year. 

p.163-164

So OPEC had formed, but it didn't matter. There was still plenty of oil everywhere, and always people willing to sell it for less to get the money. Oil producing nations were divided. The balance of power was with they buyers, not the sellers--they needed us more than we needed them.

Cheap oil would drive the major social events of the sixties - the Great Migration of Blacks to the North, White Flight to the suburbs, busing, the rise of suburbs and the movement of the population out of the Industrial Heartland to the Sunbelt (aided by air conditioning - a rarity before the War).

This expansion made a lot of people fabulously rich. Not just the automobile companies, but all the ancillary industries, which included everything from muffler shops, to auto parts stores, to drive-in movie theaters and hamburger joints, to the boys who filled tanks at gas stations (back when they did that), to ambulance-chasing lawyers and insurance companies dealing with all the injuries and accidents. Automobile dealers became the richest and most prominent "big wheels" in small communities across the nation, funding all sorts of advertising and charity events.

The buildout of suburbs for the "nuclear family" generated wealth for the homebuilders and the road builders. It also generated a lot of wealth for the banks. Between the auto loans and the home mortgages, finance became a part of everyday life for everyone thanks to cheap oil. Cities like Phoenix and Los Angeles ripped out streetcars and elevated bike paths and built sprawling metropolises centered totally around the car. Phoenix, with the population of Manhattan, spread out over 200 square miles of parched desert.

 The critical environmental damage done by cars is not caused by the fuel that they themselves consume, although they do plenty of that. (Direct fuel use by cars accounts for roughly a third of U.S. fossil-fuel use and carbon output.) The critical damage is caused by all the other consumption that driving fosters—consumption that would not occur on the same scale if drivers couldn't move around as easily as they do. Before cars, most people had to live close to other people and to the places where they worked and shopped, even if their homes were in small, isolated towns, far from other communities. Cars permanently changed that, by transforming the way their owners arrange themselves in relation to one another. 

The major carbon-spewing energy drain in a sprawling American suburb isn't the car in the driveway; it's the driveway. That is, it's everything the car makes both possible and necessary: the oversized house, the three bay garage, the manicured yard, the unused swimming pool, the miles of connecting asphalt, the redundant utilities, the schools, the hospitals, the shopping malls, and all the other accoutrements of inefficient suburban living—none of which would exist on anything like the same scale if residents were less able to move around at will. Cars are consumption amplifiers; driving is the pump that enlarges the sprawl balloon. And countries with rapidly modernizing economies, like China and India, are now following the American mobility example at extraordinary speed, by acquiring new cars and building new roads at a pace seldom matched even in the United States. It will be a while before those countries overtake Americans in impact per capita, but in absolute numbers they nave already begun to make us look demure. And, as with us, the main driving-related environmental impacts will always be the indirect ones. 

David Owen; The Conundrum, pp. 65-67

We don't realize it now, but until this time oil had been a relatively minor energy source, even though Henry Ford's assembly line started up in 1914. The age of oil began in 1859, but it took one hundred years for oil to become the world's predominant energy source. One hundred years from the Drake Well in 1859 was 1959, coincidentally the year that Perez Alfonso met Abdullah Tariki in Cairo.

The change in energy habits was from coal to oil, and no wonder. Coal was bulky, hard to transport, and left irritants in the atmosphere when burned. Mining it was an unpleasant and hazardous task, whether in Pennsylvania or Wales or Lorraine, and there was always trouble with the miners. The automobile population of the world was increasing geometrically, as if the idea of bigger families had also spread to vehicles.

In 1940 coal accounted for two-thirds of the world's energy. In 1970 it provided less than a third. In the United States coal as a percentage of total energy consumption dropped from 47.2 percent to 18.6 percent in the same period.

p. 163

The good times were rolling during the "Golden Age of Capitalism." But it was not to last. As we approached 1970, all that was about to change in a big, big way. "It took two wars, a gradual change in energy habits, and a French bulldozer to bring about the control first envisioned by Perez Alfonzo." (p. ) That's what we'll cover next time.

UP NEXT: The balance tips.