 Pump power
Blame OPEC for rising oil prices and forget the real
problem in the Middle East. Wrong!
Hashem Farhang
December 16, 2004
iranian.com
I have been a Petroleum Engineer for more than
forty five years. The misconceptions
about the organization and the routine attack on OPEC and its
members; have prompted me to write this little note for all and
especially
Iranian and Iranian-Americans. What I write may ruffle some feathers
but I hope criticism will be based on facts not general declarations
or personal opinions.
OPEC is an international organization of eleven developing countries
which rely heavily on oil revenues as their main source of
income. Membership is open to any country which is a substantial
net exporter of oil and which shares the ideals of the Organization.
The current Members are Algeria, Indonesia, Iran, Iraq, Kuwait,
Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and
Venezuela. OPEC's eleven members collectively supply
about 35 per cent of the world's oil output, and possess
more than three-quarters of the world's total proven crude
oil reserves.
Since oil revenues are so vital for the economic development
of these nations, they aim to bring stability and harmony to the
oil market by adjusting their oil output to help ensure a balance
between supply and demand. Twice a year, or more frequently if
required, the Oil and Energy Ministers of the OPEC Members meet
to decide on the Organization's output level, and consider
whether any action to adjust output is necessary in the light of
current and anticipated oil market developments.
OPEC was formed at a meeting held on September 14, 1960 in Baghdad,
Iraq, by five Founder Members: Iran, Iraq, Kuwait, Saudi Arabia
and Venezuela. OPEC was registered with the United Nations Secretariat
on November 6, 1962. The present day estimate of total reserve
of just over 811 Billion Barrels (last estimated in 1999) represent
about 77% of world oil reserves.
Provided the question of Politics and trust are resolved OPEC
can provide an increasing amount of oil to meet the expected growth
of global oil demand. OPEC currently produces about 35 per cent
of the world's crude oil; but that is forecast to grow to more
than 50 per cent in the next quarter of a century. The 40% production
(35% export), however, represents 55% of crude oil trade.
History
To understand the establishment of OPEC, one has to pay a little
attention to the history of oil industry in the founding countries
and the relationship of the international oil companies with their
own as well as the host governments. Initially the most active
international oil companies in the Middle East were those of Europe,
namely the British Petroleum and the Royal Dutch Shell. These two
companies had much in common with their Governments, almost one
and the same for a long time (The British Government owned 51%
of BP and a small interest in shell; while the Dutch Government
independently and through Queen Juliana of Holland owned majority
interest in Shell).
Because of these inseparable entities and interests; the then
Imperial British government treated any little demand on these
two companies as an attack on the British Empire and the then uniquely
commanding Royal Navy would respond by sending war ships to the
vicinity of the victim country (Gun Boat Diplomacy). This close
relationship between the oil companies and their Governments, of
course, proved very useful during the WWII; the companies enjoyed
military protection with enormous income at high prices and unquestioned
support from the home governments. The government, in return, enjoyed
hundred percent supply cooperation. The case with American companies
was much different in that while they provided the U.S. Government
the supply she needed, they had no special relationship that would
necessarily be to the detriment of other producing regions or their
own general consumers; the competition was in control; as we shall
see later.
With the exception of Saudi Arabia where Aramco (a consortium
of major American oil companies) was operating; the rest of the
Middle East, starting from Iran in 1908, Iraq in 1927, Kuwait and
Bahrain in 1932 were mainly the domain of the two European oil
companies. After the war, Shell sold its interests in Kuwait to
Mobile (a sale that Shell regretted for ever and never forgave
itself), and as time went by and America became the dominant power,
the subsequent discoveries like those in what is now known as the
United Arab Emirates after 1960s were mostly by Americans. The
American concessions, Initially because of a famous American philanthropist,
was based on a genuine 50/50 arrangement. This arrangement was
far more equitable than those offered by the European Imperialistic
oil companies.
In Iran the 1906 agreement provided a mere 12.5% Royalty (7 to
1 in favor of the oil companies - remember the 1 to 1 ratio of
the Aramco) and this after deductions of cooked up costs and books.
Additionally the company enjoyed unrestricted imports and exports,
all free of Duty and Custom charges. In 1936, with a lot of
propaganda and hoopla, the split was improved a little to 16%.
Things were going badly for the original producing country and
the oil industry in Iran was in turmoil. In 1952 the country, in
retaliation against the injustices of the Anglo Iranian Oil company,
the precursor of the British Petroleum, nationalized its oil industry.
Initially America aware of the unfair arrangements (remember Aramco
was from the start a 50/50 arrangement) supported Iran in its struggle.
This caused enormous problems for Britain and after a couple
of years, for the first time, the American administration of the
time, under the undue influence of the two paranoid Dulles brothers,
who in turn were themselves misguided by the cunning British Prime
Minister, Churchill, sided with the oil companies of Europe and
toppled the democratically elected government of Iran and the American
oil companies came to Iran for the first time.
The change of international politics and the unstoppable aspirations
of the people everywhere that were mostly encouraged by a rivalry
between the Soviets and the West, championed by America, plus the
natural American tendency of fair game and the public interest
at large, forced the American government to gradually move away
from blatant support of the oil companies and assumed a less biased
policy.
In the meantime the oil companies enjoying enormous powers
by proxy; were controlling the prices at the well as well as the
pump. The price at the well which they had to share with the producing
countries were kept low which meant that they had a policy
of arbitrarily fixing Persian Gulf crude oil prices at a level
that they could get away with.
At the Pump, however, the consumers
paid little attention to the price of gas; since they were under
the impression (substantially correct) that the normal competition
in the market place took care of that. And if anytime people complained
of excess prices, there were always the greedy rulers of the Middle
East and the taxes at home to blame. The greedy producers and the
local taxes at the pump were always identified as the culprits
for any complaint against higher prices.
In a sense the tax portion of
the complaint was true as the Governments in the consuming countries
of Europe were having a larger income in taxes alone as compared
with the total income of the Governments of the producing countries.
Although the Greedy Rulers of these countries were being blamed;
few people were aware or much cared that the same rulers were nothing
but the puppets of their own governments.
The companies meanwhile used the same consumer complaints at
home to lower the price of crude in the Persian Gulf, a few pennies
at a time, and thus adding more to their already enormous profits.
The consumers were then advised to wait for the price to take effect
that was in the pipeline. However, as we all know; seldom the price
of gas reflected the price of crude, at least not when the price
of crude is on downward trend. The lower the price at the wellhead
the less they had to pay the host countries and the more their
profit margins.
To further manipulate these forced pricing structures, they invented
a number of artificial pricing mechanisms with ambiguous names
like Persian Gulf prices, Posted prices, Rotterdam & London
prices and finally wellhead and Texas Sweet crude prices in America.
The posted prices were cleverly calculated as the price of wellhead
prices in the United States less the "handling and transport" costs
to deliver the oil transported from the Persian Gulf to Texas.
In those days of course there were only the oil company themselves
that had the major tanker fleets. Also since, prior to 1971, United
States was a net exporter of crude oil, there was no real figure
of transport costs to the United States and any imports of crude
from the Persian Gulf was simply a swap arrangement anyway; meaning
that the nonexistent oil transport cost to the United States was
simply a ploy to subtract a fiction cost from the price of
crude at the production source - Persian Gulf.
The Governments of producing countries, under enormous pressures
of their people, gradually were forced to get together and do something
about the oil prices on which the income sharing was based. These
governments finding the general atmosphere in the consuming countries
a little less belligerent; started talking among themselves to
join in an association to speak more or less with one voice against
the united International Oil Companies.
Much to their delight and
encouragement they found that the host governments of these giant
oil companies were not uncooperative (in the meantime the British
Government had sold its interests in BP). Further the producing
countries solicited (and were solicited by) the representatives
of the thousands of independent oil companies throughout America;
to see what an organization of the less powerful producers could
do to combat the monopoly control of the giant oil companies. After
all the Independent Oil Companies of America were having an enormously
difficult time, competing with Persian Gulf prices arbitrarily
set by the giants, the so called Seven Sisters.
Without an adjustment of world crude oil prices, the entire domestic
oil production in America was in jeopardy.
On the other hand, for security reasons, the Governments in consuming
countries, particularly in America, were encouraging multi source
availability of crude oil resources. However, at the posted prices
of the Persian Gulf, no exploration, development and production
could take place unless the prices reflected the real costs of
oil discoveries elsewhere in the world. Additionally the possibility
of the Persian Gulf oilfields falling into the Soviet sphere of
influence had to be considered.
For all these reasons - viability of Independent Oil companies,
encouragement of explorations elsewhere (deep seas and oceans,
Alaska and North Sea etc. - the establishment of an association
along the general lines of present day OPEC was thought desirable.
If the prices did gradually increase to truly reflect international
producing prices; it would have the effect, on the one hand, to
increase the income of the producing countries, which in itself
would more easily combat the Communist propaganda and at the same
time satisfy the nationalistic aspirations of the local people,
which had been so badly and unwisely put down by the likes of the
CIA arranged Iranian Coup and on the other hand, a gradual increase
in the price of crude would make exploration elsewhere in the world
a definite possibility. This was because they no longer had to
compete with the ridiculously cheap oil of the Middle East.
It was in fact the direct result of the OPEC, several years later,
that oilfields like those of the North Sea and Alaska became an
economic possibility. There was no way that crude oil price of
$1.78 per barrel of the early Sixties, would allow Production of
oil in offshore and deep sea places. With better prices, many undesirable
and environmentally difficult parts of the world could have their
oil discovered and thus alleviate local poverties and at the same
time combat Communist propaganda.
So gradually the oil prices were allowed to move up and once
the governments of the producing countries saw the benefit of higher
oil prices economically, they employed it as a local political
tool to boost their standing with their own population. As a result
there was a competition between the countries of the Persian Gulf,
each to claim as the champion for bringing about OPEC.
Yamani on
behalf of the Saudis, Iranian Oil Ministers on behalf of the
Shah of Iran; Iraqi Generals on behalf of Saddam and all the other
lesser
powers of the regions individually claimed complete credit for
the creation of OPEC. In reality none had anything to do with it.
The confluence and convergence of so many factors plus the
common interests of so many divergent entities as was just explained
above, was the real cause of OPEC establishment. The puppet governments
of the Middle East were in no position to establish an organization
that would seemingly oppose the interests of the International
Oil companies and their sympathetic (to say the least) host
governments.
This development suited all. The oil companies found a perfect
villain to blame for any public outrage of price increases at the
pumps. For years and years there has been absolutely no relationship
between the price of crude and the gas at the pump. Remember when
the price of crude was $1.78; that of gas at the pump was about
25 Cents per gallon. Applying the same relationship, as they disingenuously
and incorrectly sometimes do, the price of gas at $20 per barrel,
would have had to have a corresponding price of gas at the pump
of $2.80 Cents per gallon, at $40 per barrel the corresponding
gas at the pump would have to be $5.60 and at present $50 dollar
oil the gas price would have to be $7.00 per gallon.
But as we have learned to observe, the relationship of crude
oil vs. gas has been confusing at best and the direct relationship
has always been obscure. The reason we enjoyed, and to a large
extent still do, a relatively low price of gas at the pump has
been because the oil pricing for the first time was out of the
control of the giants and more or less at the control of the market.
Unfortunately, however, the market is a little handicapped by
the policy of having barely just enough refining capacity to
have a
gas price that would truly reflect crude oil price. Market, for
all sorts of reasons, is not allowed to function as it should.
How many times have we witnessed the price of gas going up a
lot more than the corresponding increase of the price of crude
on the
way up and how slowly and disproportionately the price of gas
has come down when the price of crude has collapsed.
So OPEC is now a multipurpose organization and certainly a useful
institution:
1- In America, without OPEC, we would have had no domestic oil
exploration and production industry. The industry would have been
just one of consumption.
2- In America, without OPEC, we would have had no domestic Independent
Oil companies that still generate the biggest employment in the
industry.
3- Without OPEC we would have not been able to have the benefit
of deep sea drillings and oil fields the like of Alaska, difficult
jungles and terrains of Africa and Asia, North Sea and other offshore
deep waters.
On the unwelcome side OPEC has been used for Policies and Politics.
If you want to develop the Alaskan oil; why not use OPEC as a villain
to counter opposition for the environmentally unsound projects.
Whether the Alaskan oil in any meaningful way affects the supply/demand
equation, or reduces our dependence on Middle East oil, does not
matter; the public is likely to fall for it.
On pure politics; why not use Arab and other Middle East people
synonymously with OPEC, and get away literally with murder, like
the politics of the region. Blame OPEC as a cartel for the price
hike and forget the real problem in the Middle East causing the
price hike. Meanwhile forget our own speculators to say nothing
of the clever control and designed limitations of the refineries
and their capacities.
3- The OPEC villain can be used as scapegoat for any shortcoming
of the domestic oil industry or the governments and the lobby that
supports the industry keeps the OPEC oil question on the front
pages.
 Conclusion
Let us look at some
facts for reflection:
Present world production is just over 82 million barrels/day
of which only about a third is allocated to OPEC.
Price of coal quietly went up from $34/ton to over 60 in the
past year. What industries politicians do you think benefit from
the double ram of oil and coal price hikes
Energy consumption in America is hardly the result of a robust
economy but the fictitious and non-productive consumptions in inefficient
cars particularly small trucks marketed as SUVs.
Efficiency, much more than alternative sources of energy, perhaps
with the exception of Nuclear Power, is the answer.
Thus the security of oil supplies relies upon the security of
oil demand. Oil producers - and oil consumers - need to work together
to ensure that the security of oil supply and demand are preserved
But in order to expand output, development is essential. Oil
producers invest billions of dollars in exploration and infrastructure
(drilling and pumping, pipelines, docks, storage, refining, staff,
etc) and a new oil field can take 3-10 years to locate and develop.
If oil producers are not helped and encouraged to invest enough
money and do it far enough in advance, then the world could face
a shortage of oil supplies in future.
Reflection: Why is it that owners of 85% of crude oil reserves
are allowed to produce only 35% of consumption?
Is it not silly to suggest and assume that OPEC behaves irresponsibly?
Are they not, necessarily, more concerned about issues that undermine
the prosperity of the oil industry, than they are given credit
for? Is it not well to remember that oil is all the rulers of the
Middle East have to feed their population and furnish their lavish
life styles? They would never wish to disrupt or threaten
the security of world oil supplies and thereby their own personal
safety and security. These rulers have a lot to answer for; but
a culprit of oil problems is not among them.
 OPEC, disingenuously and of course self-servingly, complain about
oil taxations as the cause of inflated gas prices; and in this
they have the consuming countries' population on their side. But
taxation, in my opinion, is one of the more effective ways to discourage
waste; and the revenue should be spent on roads and energy efficiency
related matters. However, taxation has to be fair and evenly distributed.
Presently some countries with high oil taxes actually subsidize
domestic coal production, yet coal produces more carbon dioxide
(the villain of the greenhouse gases which are believed to contribute
to global warming.
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