Notes from Thursday's Lecture on OPEC

The End of the Cycle of Empires

  • The world is changing.
  • End of the cycle of empires.
  • Rise of the nation state (from 1648).
  • Balance of power.
  • World market/competition.
  • Democracy/sustained economic growth.
  • Hegemony.
    • Nation states should provide opportunities for economic growth to satisfy the needs of their people.

Broader Context of OPEC's Power

  • Explain the broader international context for understanding why OPEC is important and why OPEC exists.
  • Rise of the nation state.
  • The need for sustained economic growth to satisfy the needs of the people within those borders.
  • Nation states invest to create opportunities.
  • OPEC is important for understanding the growth strategies of oil-producing states.

Lead Up to the Founding of OPEC

  • Oil markets are not competitive, they are Oligopolistic.
  • Oligopolistic market structure starting with the monopoly of Rockefeller.
  • Rockefeller's monopoly was broken up.
  • In the 1930s, a group of oil producers, at the urging of the Texas Railroad Commission, set market quotas.
    • The Texas Railroad Commission set market quotas for oil production in Texas, Oklahoma and Ohio.
  • Historically, there hasn't been a competitive market system in the oil industry.

Five Developments Leading to the Rise of OPEC

  • Rise of Arab nationalism.
    • Examples: Nasser (Egypt), Mosaddeq.
    • Suez Canal crisis (1956).
  • Global consumption and production.
    • By the 1960s and 1970s, the U.S. started needing more energy than it produced.
    • The U.S. could produce enough oil for itself and Europe until the 1960s.
    • Consumption went up in the 1960s and 70s.
    • Production of petroleum exponentially increased in the Middle East (10 times more than in the U.S.).
    • Countries in the Middle East became the new dominant producers and sellers of petroleum in the 1960s.
  • Challenge to the dominant market producers in petroleum (the Seven Sisters).
    • Seven Sisters: the original oligopoly.
      • Exxon, Volvo, Mexico, Chevron, Volvo.
    • They operated by providing simple fees and taxes, and settling on a percentage of the profits (initially around 10%, 15%, 17%, 20%, and sometimes up to 35%).
    • The companies determined profit levels, and the oil nation states (e.g., Kuwait, Saudi Arabia) weren't sophisticated financially and took their word for it.
    • The terms of trade between the oil nation states and the major oil companies (Seven Sisters) were skewed, with the oil-producing companies having the power.
    • The oil companies could threaten to go to other countries (e.g., Kuwait instead of Saudi Arabia) and stop production in local markets.
  • Mexico nationalized its oil industry in 1938.
    • Mexico got tired of the games being played and took over the oil facilities.
    • FDR decided not to invade Mexico because he saw what was coming around the corner (Great Depression, competitive valuations, global-wide debt, Hitler in Europe, crazy Japanese in the West).
  • Venezuela demanded a 50/50 split on the profits in 1943.
    • The oil companies bought in because Venezuela was sitting on a pile of petroleum.
    • All long-term contracts became suspect and questioned.
    • The Venezuelans bragged to the Middle Easterners about their 50/50 split.

Getty's Game-Changing Move

  • Getty offered the Saudis 9.59.5 million plus 11 million per year to explore the desert in Saudi Arabia, whether he found oil or not, plus 55% of the profits.
  • This set the oil world on fire because the other companies were only getting 35%, 30%, 15%, 12%, etc.
  • Getty found the biggest oil find in the history of petroleum finds in Saudi Arabia, making him the richest man in the world and putting Saudi Arabia on a trajectory that Saudi Arabia never anticipated.
  • By 1955, the Saudis started demanding Venezuelan-like contracts with everybody.
  • This started a trend that broke up the Seven Sisters.

Soviet Union's Impact

  • The Soviets started to sell petroleum because they needed dollars to purchase gadgets they saw in the West.
  • They sold petroleum in the world market at a lower price than what all the other world producers were selling.
  • The Soviet need for dollars led them to flood the oil markets through the 1940s, 1950s, and even through the 1960s.
  • This destabilized the oil markets.

Jack Radcliffe's Unilateral Move

  • Jack Radcliffe, CEO of Standard Oil, unilaterally cut the posted price.
  • He cut the price down to 0.450.45 when the posted price used to be 0.550.55 a gallon.
  • This cut out the revenue/income for every single country.
  • All the major oil producers followed suit.
  • This happened on August 9, right before the Baghdad Conference, in September 15, 1960.
  • Wrap-up: Radcliffe struck a nerve with the oil industry and the oil companies.
  • He said this was a fatal move and that you can't just be guided by market forces in an industry so essential to various governments.
  • He said that free market doesn't exist (back in 1960).
  • All of this began to undermine the power of the Seven Sisters.

Founding of OPEC

  • OPEC is an oligopoly (a big club, but none of you are in it).
  • A group of oil producers who come together and say, okay, we can't just set the price unilaterally, but together, we can do it as a collaborative.
  • They cooperate on the price of petroleum.
  • They followed a non-market pattern that we saw earlier.
  • John D. Rockefeller monopolized petroleum markets.
  • The Texas Railroad Commission assigned quotas to who could produce what and who would get to send their petroleum on the railways going through Texas.
  • Juan Pablo Diaz from Venezuela proposed effectively propose to the United States OPEC before OPEC is formed, but was rejected.
  • Abdullah Tariqi from Saudi Arabia, met with Juan Pablo Perez and together they created OPEC.

Baghdad Conference

  • OPEC was founded in 1960 at the Baghdad Conference after Jack Rafale reduced unilaterally the posted price on petroleum.
  • Founding members: Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela.

OPEC's Weakness in 1960s

  • OPEC's primary weakness in the 1960s was that they didn't control anything.
  • The U.S. dominated the market because it can still meet all its needs and supply to Europe.
  • OPEC was primarily a Gentleman's Club at this time.

Volatile Years: 1960s and 1970s

  • Geopolitical environment: Cold War, Vietnam War, civil rights movement, great society.
  • Libya became a giant and found the new elephant of the oil industry in 1966.
  • Omar Gaddafi seized power in 1969.
  • Six-Day War in 1967.
  • Lynden joined OPEC.
  • Arab-Israeli War in 1973.
  • The Arabs were trying to get support from the U.S., but the U.S. said no.
  • OPEC restricted the supply of petroleum around the world.
  • Price of petroleum went through the roof.
  • Everyone figured out what a swing producer is.
    • Saudi Arabia has so much petroleum that they can literally turn on the stimulus and flood the market with so much petroleum that they can collapse the price of petroleum.
  • After 1973, inflation went through the roof because OPEC shut off the spigot for petroleum.
  • Inflation rates in the 1970s were as high as 14%.
  • Imagine purchasing a house in 1979 with interest rates of 20-25%.

Impact of OPEC on World Politics and International Relations

  • Petroleum is a big player in our modern world.
  • International relations are extensive, not just military.
  • Military option is inefficient in the modern world.
  • Collective security, complex interdependence.

Generations War in Conflict.

  • 1979: Iranian Revolution.
    • The Iranians overthrew the Shah of Iran.
    • The CIA imposed the Shah of Iran in 1953.
    • The Ayatollah has come to power in 1979.
  • 1979: Hostage situation.
  • 1980-1988: War between Iran and Iraq.
    • The U.S. backed Iraq because Saddam Hussein could stare down the Iranians.
    • The U.S. arranged loans through allies, gave credits, and money so that they could beat each other up for eight years.
    • Iran and Iraq were undercutting the price set by OPEC.
      Reagan didn't slain inflation, the war between Iran and Iraq decreased the inflation.

Under cutting the price of petroleum, helps reduce inflation.

Gulf Wars

  • During the Iran-Iraq war, Saddam needed money from the world to pay his debt for war supplies.
  • Saddam Hussein goes to Kuwait and Saudi Arabia and said, I need money. I'm keeping these Ayatollahs off of your back. You need to give me money.
  • If he can't pay his bills, then you need to give me better terms, and they don't.
  • 1990 Invasion of Kuwait.
    • The reason was Saddam Hussein try to get more advantages with oil and gas companies to produce and grow gas prices, so he can get profits and in that way pay his debts.
    • This the first Gulf War happened when US troops stationed in Saudi Arabia to maintain control through the OPEC countries. Which annoyed Osama Bin Laden and because of that, the war US and Al Qaeda started, better known as Nine Eleven.
  • Second Gulf War (Afghanistan and Iraq).
  • The United States ended up in another prolonged war.