Sunday, August 9, 2009

Oil, mother of all troubles (part 2)

During early 1970's, Arab nations among oil producing countries decided to impose an oil embargo against western nations for their support of Israel in the war against Arabs. This decision came a day after OPEC decided to increase the oil price by 17% for partial matching with the high prices of manufactured goods which were imported from those nations and nullify the effect of unjustified inflation rates in those countries on oil producing nations.

In those years, I used to work in NIPC (National Iranian Petrochemical Company) which was a young organization created and operated by Iranian government to enter the nation into this amazing industrial field. The place that I used to work at, was an industrial complex which was constructed by American manufacturers under an agreement that was signed with Du Pont industries in mid 1960's but it cost about 80% more than predicted budget when it was finished about 4 years later because of the wild increase in the prices of the parts which were being purchased from different western nations. This was just a minor example of how westerners transferred their economic problems to others while always objecting to slightest price increase on oil or other materials that they imported from other countries.

Mr. Ardeshir Zahedi who was Iranian ambassador to US in mid 1970's, participated in a TV interview program to provide the views of Iranian government on the issue of oil price which had sparked a lot of resentments among western people as unjust and unfair action by irresponsible oil producing nations (including Iran). In this interview, Mr. Zahedi drew a clear picture on the source of the problem which was in western nations reckless economy that was driven by greed, unfair competitions and self centered mentality. Here is part of that interview:

Q: Mr. Ambassador, is there to be no end to these oil-price increase? Do Iran and other producers intend to push the cost higher and higher?

A: That depends on a number of things, but most important of all is the problem of worldwide inflation. If that continues at the present rate, then Iran and other in OPEC [Organization of Petroleum Exporting Countries] must demand higher prices for their oil. How else can we afford to buy things we need?

Here is Great Britain with an inflation rate of around 26 percent. In Israel, it is 39 percent. In West Germany - from whom Iran buys many things – it is about 6 percent. Here in the United States of America, you have between 17 and 18 percent
Q: Sir, the U.S. inflation rate peaked at 12.2 percent in December 1974 and at latest report was 7.3 percent.

A: Be that as it may, we know in Iran what we have had to pay for many commodities that we buy from you and others to whom we sell our oil.

I have figures on raw sugar. In 1966 it was at $55 a ton. It is now around $935 to $1000 a ton, and three month ago we had to pay $1650. Here is paper – in 1966 at 234.64 a ton, and 1974 up to $499. And here you have vegetable oil, increasing from $275 a ton to $732.

Here is Du Pont, a very famous company in the United States. Thirteen month ago we made an agreement with them involving 250 million dollars. Now they are asking us 450 million dollars-an increase of 200 million.

The Japanese, 11 month ago, made a contract with us involving 1 billion dollars. Today, they are asking 1.9 billion.

To add something interesting to above information, when we started producing sulphur (one of the products in the complex) in our newly established petrochemical plants, the universal sulphur prices dropped to the point that Iranian newly established company was bankrupt even before it started the production! Why? Because price of sulphur was controled by Americans in their trade markets and we could not do anything about it at that time. This is while our sulphur production was mostly for internal use in other units of our industrial complex which started working shortly afterwards, and we did not buy (did not even need) any sulphur of that amount from other countries!

Historical data for inflation in the two nations of United States and United Kingdom indicate that economies of those countries have been very much dependent on the cheap oil as a good source of wealth gathering and progress while inflation was increasing steadily at slower rate until the issue of oil price was taken over by the oil cartel of oil producing nations. OPEC was formed in 1960 from the founding nations of Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. It is interesting to know the price of oil in June 1960 was $2.85/barrel which was only $0.07 more than its price in the ending months of 1947! Oil price was set at $3.00 in August 1960 and remained the same until 1965 which was increased by $0.10 and then $0.05 every year until 1969. this means an increase of 0.016% on average per year compared to average inflation of about 2% in US and about 4% in UK for the same period of time! WTRG which is an American research group based in Texas, in their report in year 2008 wrote:

"Crude Oil prices ranged between $2.50 and $3.00 from 1948 through the end of the 1960s. The price oil rose from $2.50 in 1948 to about $3.00 in 1957. When viewed in 2006 dollars an entirely different story emerges with crude oil prices fluctuating between $17 - $18 during the same period. The apparent 20% price increase just kept up with inflation.

From 1958 to 1970 prices were stable at about $3.00 per barrel, but in real terms the price of crude oil declined from above $17 to below $14 per barrel. The decline in the price of crude when adjusted for inflation was amplified for the international producer in 1971 and 1972 by the weakness of the US dollar. "

It is important to note that except for a short period of time in 1957 that oil prices went up to $3.00, the price was always bellow $3.00 and sometimes even bellow $2.00 and by 1960, it still remained bellow $3.00 at $2.85. Based on this, in fact the 20% price increase which is mentioned in the paragraph quoted from WTRG was just a glitch that lasted only for a very short period of time while the inflation in western nations steadily increased at a much higher rate. In another part of same report from WTRG we read:

"Throughout the post war period exporting countries found increasing demand for their crude oil but a 40% decline in the purchasing power of a barrel of oil. In March 1971, the balance of power shifted. That month the Texas Railroad Commission set proration at 100 percent for the first time. This meant that Texas producers were no longer limited in the amount of oil that they could produce. More importantly, it meant that the power to control crude oil prices shifted from the United States (Texas, Oklahoma and Louisiana) to OPEC. Another way to say it is that there was no more spare capacity and therefore no tool to put an upper limit on prices. A little over two years later OPEC would, through the unintended consequence of war, get a glimpse at the extent of its power to influence prices."

This raises an important question that if oil price increase kept up with inflation then how did oil producing countries experienced "40% decline in purchasing power" for their crude oil? In an article about "Oil: A Driving Force in the U.S. Economy" in Swift Energy Company website we read:"

By 1973, U.S. oil production entered into an irreversible decline and virtually all of the world’s spare production capacity was in the Middle East. Emboldened by this shift in power, the Organization of Petroleum Exporting Countries (OPEC) sought to control oil prices by restricting its oil production. Later in the year, the Arab Oil Embargo was enacted. Oil prices soared, creating a ripple effect throughout the U.S. economy. Inflation rose and the stock market plummeted 48% from 1972 to 1974 in inflation-adjusted terms. A similar situation occurred in 1979 when the Shah of Iran was ousted, with the resulting high oil prices causing inflation to soar again."
As a side note, it is interesting to know that this company started its activities in 1979 right after Shah's government was ousted in Iran. This calls for a closer look at statistics of inflation in US and UK as two major parties in oil related issues all over the world but before that let's take a look at some other parts of Mr. Zahedi's interview with American media:

"Q: The report shows that a barrel of oil sold by OPEC now buys nearly three times as much in terms of commodities and more than four times in manufactured goods than in the base year of 1955. That is quite an advantage-

A: You do not have to buy the oil. Neither do the Europeans or Japanese. If you do not like the price, why do you not use other resources of energy? The answer, of courser, is that other sources such as coal and nuclear power are going to cost far more than the price of oil.

You are a free country. Your people should go out and invest their money in developing these other sources if you believe the price of our oil is too high. None of these other energy sources, we think, is going to cost less than a comparable price of $12 to $14 a barrel for oil.

Once our oil resources are exhausted, how much will you charge us for your oil or liquefied coal? Will you ask us what we think is a fair price?

Q: Is Iran prepared to reduce its oil production if that becomes necessary to maintain the current price of around %11.50 a barrel at the Persian Gulf?

A: There has been a drop in OPEC production, but that does not worry us too much. We would be happy to see the United States become self-sufficient in oil and other energy fuels. Iran is a leader among those who say that we must not continue to use up the world’s oil at such a rapid rate.

In the United States, you thought you had about 75 to 80 years of reserves. Now I have been told by geologists in your country that there is not more than 20 to 50 years of supply left. It is the same elsewhere. In Iran, we are producing nearly 5 million barrel a day, and our reserves are65 to 70 billion barrels. At that rate we have 30 years supply left. Even in Saudi Arabia, if production is increased to 10 million barrels a day, reserves would run out in 45 to 50 years.

We in Iran think that oil is too valuable to be burned up only as fuel. Here is a product from which you can make 70,000 different products-from which even greater revenues than current price of oil can be derived. Iran would like to see conserved for these uses through petrochemical production."

In the last question the interviewer is probably asking about $11.50 a barrel oil price (which was the price around the time of interview) otherwise it does not make sense. The claims made by interviewer in above portion is obviously in contradiction with confirmed facts which indicate substantial decline in purchasing power of the oil. In the next question, Mr. Zahedi addresses the relation of oil price and world inflation:

"Q: Does it worry you that the high cost of oil, a factor in present worldwide inflation, could possibly bankrupt some industrialized nations, which are your best customer?

A: I am grateful for that question. I will explain the realities of your inflation, which your politicians have led the public to believe is the fault of oil prices.

About one half of 1 percent of the inflation in the United States is caused by the increase in cost of petroleum. That is the figure that your economists have published. In the world, only 1.5 to 2 percent of inflation has been caused by higher oil prices, according to the figures published by some of your own leading economists as well as OPEC and international organizations.

Yet you Americans and the Europeans and Japanese want to blame it all on us. We are blamed because inflation has got out of hand. But look, you in the United States have devalued the dollar twice. Do you realize what that has done to our investments in your bank? In England, wage increases to the labor unions are enormous. These are some of the reasons why your economies are threatened.

Actually, you get our oil at reasonable prices, but you charge your people more than they should pay based on the cost of crude petroleum. Let’s say you pay 50 cents a gallon for gasoline just to take a round figure, though it is more. There are 42 gallons in a barrel of oil. Multiply that by 50 cents and you find American consumers are paying at least $21 per barrel, while we are charging your oil companies only $11.5 a barrel."

Information is available from the links which will come at the end but not neccessary for the purpose of this article but for now and before moving on to political aspects of this issue, I like to mention a short comment from "" about how the inflation is created:

"Price inflation is a result of "monetary inflation".

Or "monetary inflation" is the cause of "price inflation".

So what is "monetary inflation" and where does it come from?

"Monetary inflation" is basically the government figuratively cranking up the printing presses and increasing the money supply.

In the old days that was how we got inflation. The government would actually print more dollars. But today the government has much more advanced methods of increasing the money supply. Remember, "monetary inflation" is the "increase in the amount of currency in circulation". "

Same statistical resources indicate continuous rise in inflation (sometimes in a very rapid manner) in UK and US until 1979-1980 which then inflation moves in a downward fashion to the point the currently we have around 3% inflation in US and around 4% in UK.

Here is a link to an Interesting chart from WTRG which indicates how oil prices have been in constant decline based on 2006 US dollar value:

Here is another chart on relations between oil prices and different events from 2001-2005 calculated based on 2006 US dollar value

Some of the sources which have been used for this article:

Oil, mother of all troubles (part 1)

After the production of oil as a cheaper and commercial source for producing light started by drilling wells in North America during 1800’s, oil quickly grew to become one of the most important issues in the internal affairs of most nations as well as international relations. Later, discovery of electric power to produce light in United States forced the oil industry to look for other areas of consumption while drive for finding new oil resources had taken over the whole nation. Invention of gas burning engine to run a vehicle solved the most important problem which oil industry was facing in its toddler years and made it possible for this industry to continue growing in more rapid manner and generate more profit for the owners. This meant heavy competition

As newer inventions and discoveries were introduced, oil gradually turned into the most important source of energy for all needs of societies. From producers of electricity to transportation and aviation, farming and other industries, all needed oil. Transportation industry grew immensely based on the needs and in parallel to the oil industries and this matter expanded relations between the nations to a great degree. Industrial growth in pioneer nations of the west went into full gear and need for new markets and resources created intense competitions. Control of the sources of energy in the world became a vital interest for those nations which saw that as an essential component to their progress and prosperity and also to become a dominant global power.

About half a century after oil became preferred source of energy to produce light, security and progress of United States and many European nations had become heavily dependent on it. The need for new resources dragged American companies and government with their immense financial power into the areas which were part of old colonialist’s domains that reluctantly conceded to share its region of influence with greater power. Other western nations like France and Germany were left behind in the race for oil while the need for more energy resources was becoming a matter of great concern to Germans for inevitable competition with growing economy of British Empire. In fact, in both WWI and WWII, oil became the biggest advantage point of allied nations against Germany which was desperate for new energy resources to accommodate its progress.

Western nations which were involved in colonizing non-European territories during previous decades and centuries, were in fact the initial beneficiaries of expansion in the business of oil throughout the world. During this period, many concessions for exploration activities to find oil were obtained from governments in Asian, African and South American continents. In some cases, investments seemed very risky in the beginning but later, they brought huge fortunes for the hasty investors to make them greedier even further. Serious drive for finding new oil fields as a source of energy for the world and as good source for gaining vast and fast wealth for some, and heavy competition between rival companies sometimes caused conflicts over territories of influence. This matter was later resolved with an “informal” agreement between the oil companies which was observed by all very closely in order to respect each other’s boundary and avoid disputes. This agreement was known to oil companies with the name of “As-Is” which helped them to regulate everything related to oil industry, from pricing to rate of production and establishment of new plants, for a long time.

While exploration activities were continuing and the amount of proven oil reserves were increasing every day, oil production was also bringing unexpected wealth to some of the poorest nations in the world including those in the Middle East and Persian Gulf region to make their economy totally dependent on it. This wealth of course was never comparable to enormous gains that oil companies were making of these sources of oil which were in the territories of other nations. The monopoly over the market and transportation of oil provided oil companies with enormous gains and gave them a huge leverage against governments of oil producing nations which had previously signed unfair concessions in desperate situations.

From the beginning, oil related issues and unjust relation between providers of oil industry’s technology and oil transportation from one side and oil producing nations from another side, had become a major contributor to many open or hidden conflicts between people, governments, and corporations. A new trend in relations between nations and oil companies started after strike and revolt of Russian oil workers in early 1900’s which resulted in destruction of large areas of oil production and refining facilities under leadership of Stalin and eventually ejecting Rothschild out of Russia after losing a great portion of his investment. This issue raised a lot of concerns among private investors and they started looking for guarantees for their investments from their own governments after that. This matter dragged some western governments practically into business of oil as active partners with wealthy investors. Confrontation between British and France over Iraq’s oil after WWI in which they were allied against Germany and Ottoman Empire, was an indication that oil had become a very serious issue for all western governments.

Another revolution and nationalization oil industries in Mexico a couple of decades after Russian revolution, made it clear that a clash between interests of consumers with producer nations was inevitable. At the same time oil had turned into the lifeline for security of progressive nations while, in some cases, the resources in their own territories had decreased greatly as a result of overconsumption or had become too expensive to exploit compared to cheaper oil which was available in abundance from overseas.

Discovery of vast oil resources in the countries around Persian Gulf by American capitalists which had received generous concessions from rulers in Bahrain, Kuwait and Saudi Arabia turned this region into an important center for production of oil that was desperately needed by western world. From the time that oil started flowing from Iran in 1911 to this day which over 25% of energy needs of the world is supplied from Persian Gulf area, this region has seen many political turbulences in which, oil has always played an important role.

For decades before discovery of oil, British Empire had tried to use Iran and Persian Gulf as a base for protecting their interests in Indian subcontinent against Russians who considered reaching the Persian Gulf waters an historical mission for themselves to fulfill the wishes of their king Peter I. Communist Revolution changed the expansionist attitude of Russians for a short period of time when British took the opportunity to expand their influence in the region but Russians came back soon and this time they had a revolution with a lot of beautiful slogans to export.

Rapid increase in consumption of oil to support newer generations of transportation vehicles and war machines, which ran faster and better, made Persian Gulf region and other oil rich areas in the world a matter of greater interest for all powerful nations. After WW I, when Winston Churchill ordered all British Navy to switch from burning solid fuel to oil based fuel, in fact he linked the security of his nation to the oil which was produced far away from home by Anglo-Iranian oil company.

By mid 1930’s economic growth of all nations was heavily dependent on oil for fueling their modern industries and mobility to distribute their goods throughout the world with faster speed. Great Britain and USA, which had vast resources of cheap oil in their reach, had huge advantages over others like France and Germany that needed to buy it from them. Production of fuel from other sources through synthetic process would cost much more and put a big burden on any nation’s economy to make competition a lot harder. Once again, trouble was brewing in Europe but this time oil had played a big role in it on the side of need for newer markets to support the economic growth.

During WW II, oil proved to be of the highest strategic value to both sides and when it ended, new measures were taken by both British and American governments in order to deal with the most important issue facing western nations: OIL. A lot of work needed to be done after deliberate destruction of oil wells and production facilities in Persian Gulf region and Indochina which were carried in order to deny access to Germans and Japanese in case if they got there. On top of that, new agreements were to be reached between the oil companies and also between British and US governments in order to impose their control over production and pricing of this valuable commodity to avoid loss of profit while maintaining control over the access to energy sources. A new era had started in the world affairs and the race for domination of energy resources became a high priority in the agendas of superpowers in order to impose their authority over the world.

Start of cold war immediately after WW II was ended, brought the importance of oil as main source of world’s energy into spot light. British government was already involved in the oil business directly through Anglo-Iranian Oil company, which later changed to British Petroleum. US government was restricted by laws and could not enter any business directly but threw its full support behind the oil companies against British and others to ensure the security of their own share of resources.

In fact, US government had become a counselor for American oil companies and acted as their protector in international disputes for decades to come. US government documents show that, during 1960’s and 1970’s, very deep issues had arisen between American and Iranian governments resulting in exchange of threats over the oil dispute between Iran and Oil Consortium in which seven American companies had a big share. This was while American government denied having any control over oil companies and at the same time encouraging Iranian government to yield to the demands by Oil Consortium and settle for what they offered in order to avoid bitterness in relations with US and British governments.

During 1980’s, a war between Iran and Iraq broke out which dragged the superpowers into the region. During that war, American government provided indirect intelligence assistance and sold weapons to both sides while reluctantly raising US flags over Kuwaiti oil ships for their protection. In fact, US government did not respond to Kuwaiti government’s requests until they raised USSR flags over three of their ships so that Iranian and Iraqi forces do not target them.

Later on, in 1990’s Iraq attacked Kuwait and destroyed almost all their oil production facilities which provided oil companies with new opportunities and imposed incredible damages on Kuwaitis. The attack by Iraqis on Kuwait happened shortly after James Baker, the secretary of state during G. Bush sr., stated that Kuwait did not have a defense pact with United States. About a month earlier, American Ambassador to Iraq told a reporter that US government did not have any issue with Iraq if they tried to resolve their border disputes with Kuwait. This was while more than a hundred thousand of Iraqi forces were positioned near Kuwaiti borders according to the news reports of that time.

Later on, under UN mandate, US forces led a military operation to rid Kuwait of Iraqi forces and impose heavy damages on Iraqis. Saddam never expected that Americans who had helped him from the beginning of his career as an assassin and CIA agent, turn on him. Saddam fell and a new government with greater influence from Iraqi Shiite sect with close ties with Islamic government of Iran replaced him. As a consequence of all these events, American government could establish a permanent base in the region to enforce the security of flow of oil to the free world. At the same time, the three oil rich nations of UAE, Kuwait and Saudi purchased total worth of one third of all conventional military products of the whole world during 8 years from the attack of Iraqis on Kuwait. And the story goes on…