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: