Week/Lecture 9: Oil and Global Politics

Introduction

• Petroleum's importance as fuel for economies/military makes it a subject of politics.
• Since 1900, companies and countries tried to manage petroleum supply and demand.
• During Bretton Woods, a few multinational companies, mostly U.S.-based, dominated the oil industry.
• In the interdependence period, oil-exporting developing countries controlled the international oil system to increase prices, but lacked the leverage to change their economies.
• Globalization brought changes, including the entry of formerly communist countries as buyers and sellers, Russia becoming a key player.
• Newly independent Caspian region countries (Azerbaijan, Kazakhstan, Turkmenistan, Uzbekistan) developed oil/gas deposits but needed pipelines and financing partners.
  • Pipeline routes varied (through Russia, Iran, China/Pakistan via Afghanistan), making Central Eurasia an area of geopolitical interest.
• Supply fluctuated due to wars from the 1990s, causing temporary price changes.
  • U.S. involvement in the Gulf War (1991) and Iraq invasion (2003) was partly motivated by oil control in the Middle East.
• The 2000s saw rapid consumption growth in China/India, increasing global demand and oil prices (2005-2008).
• Oil politics was significant in all three periods, but no actual global governance existed.

Corporate Oligopoly

• The international oil system was controlled by an oligopoly of international oil companies known as the Seven Sisters (Exxon, Mobil, Gulf, Socal, Texaco, Shell, and British Petroleum (BP)).
  • These companies dominated markets through vertical integration: controlling supply, transportation, refining, marketing, and technology.
• In the late 19th century, oil companies expanded abroad, gaining control of foreign supplies on favorable terms.
  • After World War I, they formed joint ventures, dividing supply sources by explicit agreements in the 1920s to control markets/prices and discriminate against outsiders.
• During the Great Depression, oil prices fell despite efforts to stabilize markets.
  • The U.S. was the largest producer and exporter, but the Seven Sisters couldn't regulate production.
  • The Texas Railroad Commission became significant in the international oil industry.
• Post-World War II, inexpensive imported oil became a primary energy source.
  • Western Europe and Japan became major oil importers.
  • In 1950, the U.S. became a net oil importer.
• The Seven Sisters, or majors, dominated the system by controlling almost all oil production outside the communist world.
• Inelastic oil demand allowed price management. Higher prices meant high profits without losing sales.
• The U.S. supported higher prices to protect its domestic industry.
• The Seven Sisters' dominance was supported by political intervention.

Decline of the Oligopoly

• Changes in the oil industry, producing states, and consuming countries undermined the Seven Sisters.
• Competition increased as new players explored/produced oil in regions like Algeria, Libya, and Nigeria.
  • Oil-producing governments such as Libya and Saudi Arabia increased earnings and reserves.
• Producer governments began to cooperate due to price cuts in 1959 and 1960.
  • Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela formed OPEC in 1960 to protect oil prices and revenues.
  • OPEC expanded to thirteen members, accounting for 85% of world exports: Qatar (1961), Indonesia (1962), Libya (1962), the United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973), Gabon (1975) and Angola (2007).
• In 1972, 80% of Western European and Japanese oil imports came from the Middle East and North Africa.
  • By 1972, the U.S. relied on the Middle East and North Africa for 15% of its oil imports.

The OPEC System

• In the 1970s, OPEC controlled oil prices and ownership of oil investments.
• Libya triggered the OPEC revolution when Muammar al-Qaddafi demanded higher prices and taxes in 1969.
• In December 1970, OPEC called for higher prices and income taxes on oil, soon followed by a request to nationalize production facilities.
• A December 1972 agreement with Saudi Arabia, Qatar, Abu Dhabi provided for government ownership starting at 25% and rising to 51% by 1982.
• Inflation in the West and dollar devaluation lowered the value of oil earnings.
• Rapidly rising demand and supply shortages made developed economies vulnerable.
• Negotiations between OPEC and oil companies began on October 8, 1973, with producers demanding higher prices, leading to an unresolved adjournment.

The First Oil Crisis: Unilateral Power

• Political and economic conditions enhanced the power of Arab oil producers.
• The Yom Kippur War (October 6) unified Arab OPEC members, who increased crude oil prices to $5.12$.
• On December 23, OPEC unilaterally raised the price of Persian Gulf oil to $11.65$.
• After 1973, oil prices were controlled by OPEC.
• With the decline of the Seven Sisters, consumer governments disagreed on a standard policy.
  • The International Energy Agency (IEA) was established to develop an emergency oil-sharing scheme and alternative energy sources.
• The U.S. pressed for consumer unity, while Europeans sought special arrangements with oil producers.

Stable OPEC Management and The Second Oil Crisis

• From 1973-1978, OPEC, led by Saudi Arabia, managed the oil system.
  • Saudi Arabia controlled a large share of production, reserves, and finances.
• By 1978, the environment became unstable, diminishing Saudi control.
• The 1978 Iranian revolution caused a world oil shortage.
  • OPEC increased prices above inflation rates, the first real increase in five years.
• In March 1979, OPEC announced a 14.5% price increase and allowed surcharges, showing even OPEC couldn't control prices.
  • In July 1979, OPEC raised prices again.
• By mid-1980, high Saudi production and stable consumption eased markets.
  • Saudi Arabia and other OPEC members sought to regain price control and develop a long-term strategy for gradual increases tied to inflation and growth.

The Second Oil Crisis

• The plan was disrupted by the Iraq-Iran War in September 1980.
  • Oil exports from both countries halted, reducing world supplies by 3.5 million barrels per day (10% of exports), increasing spot market pressure.
  • Spot prices reached $41$ a barrel in December 1980.
• Unstable conditions and political uncertainty led to predictions of shortages.
• High demand and lack of oil stockpiles contributed to OPEC's success in the 1970s.
• Cartel survival depends on managing prices to avoid substitutes and controlling supply from other producers.

OPEC in Decline

• In the 1980s, OPEC faced problems common to producer cartels.
  • Higher prices led to substitution with coal, natural gas, and nuclear energy.
  • Conservation efforts increased, especially in Europe and Japan.
  • Noncommunist developed countries reduced imported oil demand by 40%, decreasing reliance from two-thirds in 1979 to less than half in 1983.
• Shifting supply/demand depressed oil prices.
  • Spot prices fell from $40$ per barrel in 1980 to $30$ at the end of 1982.
  • New sources diminished OPEC's advantage.
• OPEC became a victim of cheating, with members undercutting prices in the 1980s.
• In 1984, OPEC lowered the price to $28$ per barrel, but spot market prices fell to $10$ in July 1986 and $14$ by late 1988.
• The 1980s led to a major change in OPEC's price-setting power.
• New oil reservoirs in developed countries became operational in the 1990s.
  • The North Sea made Norway and Britain players.

Era of Globalization

• In the 1990s, oil remained central but unmanageable by any single entity (OPEC, companies, consumers).
• Oil played a role in Northern foreign policy.
• The U.S. protected interests in the Middle East, maintaining ties with Saudi Arabia.
• The 1991 Gulf War showed OPEC's inability to manage the system and the importance of Middle Eastern oil.
• Concern over the Iraqi invasion's impact on oil markets motivated the strong reaction from the U.S., Saudi Arabia, and allies.
• The Iraqi invasion led to a spike to nearly $40$ per barrel by October 1990.
• On January 16, 1991, military action liberated Kuwait, causing a short-term price drop from $33$ to under $18$ per barrel, followed by sanctions and the U.S.-led invasion of Iraq.

Oil in the Caspian Region

• In the 1990s, oil and gas deposits were found in former Soviet states in the Caspian region (Azerbaijan, Kazakhstan, and Turkmenistan).
• Russia and Iran bordered the Caspian Sea, with all five countries claiming seabed deposits.
• Pipelines were needed to transport Caspian oil to markets.
  • Alternatives were the Baku-Tbilisi-Ceyhan (BTC), Baku-Tbilisi-Supsa (BTS), and Baku-Novorosiisk (BN) pipelines.
• Western countries aimed for multiple routes to prevent any country from blocking exports or using transportation for political leverage.
• Plans were developed to connect Caspian oil fields to Pakistan (via Afghanistan), Iran, and China.
• The new Great Game involves control over energy between Russia and the U.S.

Changing Economics of Oil at the End of the Twentieth Century

• The Gulf War showed OPEC could no longer manage the oil system.
• Divergent interests made price/production management difficult.
• Oil markets resembled other commodities: volatile and subject to supply/demand swings, but influenced by producers.
• Offshore drilling advances reduced costs.
  • North Sea oil costs decreased by 80% in the 1990s, to around $3$ per barrel, making it similar to Middle Eastern oil.
• China's growth increased fossil fuel demand.
  • China became the third largest consumer and a net importer in 1993.
• Saudi Arabia's ability as a swing producer was weakened by non-OPEC production and OPEC conflicts.
  • In the 1990s, Saudi finances were also a factor.

Oil in the Twenty-First Century

• The early 21st century set the stage for rising prices due to emerging markets like China and India.
• In 2003, prices began to climb, accelerating in 2007.
  • Prices exceeded $100$ per barrel in March 2008, rising to over $140$ before dropping to around $80$ in October. The market looked stable at around 50-$60 during the 2010s.
• Steady supply and growing demand were the causes, with a possible role for alternative energy.
• Higher prices had political effects.
  • Russia emerged as the largest energy producer, becoming more assertive.
• Western economies were vulnerable to supply disruptions due to reliance on imports.
  • Russia disrupted flows to Europe via Ukraine and Belarus in 2005 and 2006.

The War in Iraq and Looking Ahead

• Access to oil influenced issues of war and peace.
• Oil wasn't the sole cause of the 2003 Iraq invasion but was important for peace/stability and affected the oil market.
• Post 9/11, concern grew about Iraq's weapons programs and ties to Al-Qaeda.
• False intelligence suggested sanctions had failed and the 9/11 terrorists had consulted with Iraqi officials.
• Despite U.S. protection, Iraqi oil production declined.
• Future demand depends on addressing climate change and reducing fossil fuel (oil and coal) consumption.
• Burning fossil fuels contributes to greenhouse gases and global warming.
• International agreements to reduce greenhouse gases will be important.
• Geopolitical forces like instability, war, and terrorism will affect the oil economy.