On Wednesday, March 2nd, 2011, Dr Wilf Wilde, a former oil analyst and trader in the City of London, talked about “The Price of Oil”- in political and human, as well as financial terms.
When last summer we planned tonight’s Debate we could not fully anticipate how close to the cutting edge of contemporary debate the Price of Oil would become again.
Now as everyone who watches the news can see what I call the ‘Elusive Revolutions’ of the Middle East unfold, we are reminded that the oil price is closely linked to global geopolitics. As a young student in 1978 I chose to follow oil as I sat watching the Iranian revolution on my TV, whilst at the same time British North Sea oil first came on stream. This led me to work in the oil industry for what is now Exxon, then work as an oil analyst in the City – where one of my jobs was to predict the oil price.
When I first wrote this talk it was already noticeable that the oil price which had fallen back to as low as $40 at the start of the recession year of 2009 (averaging 60$ in 2009) was moving back to between $80-90. Then as the Egyptian up-rising of January took place – some are calling it the January 25 Revolution – we moved to $100. Now with Libya dominating the news we have been up to $115 for North Sea crude prices. This is almost treble the low point of two years ago and double the 2009 average of $60. You may have seen some folk doing my old job talking in the last few days of a doubling again to $220 as one possibility.
I would like to make 2 analytical points in this talk. As the teacher says, if you forget everything else, try and remember these two. First the oil price has been driven, is driven and will be driven by what I call global geopolitics. If you wish to understand British and US foreign policy, the wars in Iraq and Afghanistan, and even Blair or Cameron’s recent comments on Iran, you need to start by understanding what one US writer calls the Prize. This is the attempt to control the flow of oil – and increasingly gas and energy production – which lies at the heart of the global capitalist economy. To use a more economistic term – it is the long run supply of oil from places like the Middle East, Africa, Asia – which will determine the price of oil. Working at Ofgem as I did last year to try and effect some of our British energy policy in a pragmatic way, this puts me at variance with government policy of late – which for public consumption has rather focused more on our demand – that is getting ‘our’ demand down. I would argue that although understandable as a means of reducing our energy insecurity, this policy is ultimately flawed. It fails to take on the energy beasts that dominate the global production of oil – rather like failing to take on the banks. The other famous book on the history of the oil industry I would recommend is called ‘The Seven Sisters.’(*) Huge multinational oil companies like BP, Shell and Exxon once dominated what I call in my book the Empire of Oil. Now there are also Chinese, Iranian, Venezuelan and Russian oil and gas giant companies.
(*) by Anthony Sampson- “The Seven Sisters: the great Oil Companies and the World they Shaped”, published by Viking press, 1975
OIL INDUCED RECESSION?
The second point is that the biggest danger faced by the global economy in 2011 is for the US and the EU to go back into a recession, partly fuelled by rapidly rising energy prices. This in turn has a knock-on effect to other prices – especially food. When riots and uprisings appear in the Middle East and elsewhere, it is these two, coupled with rising youth unemployment and authoritarian dictatorships, which often are the final trigger for trouble. And a vicious cycle of rising prices and rising unrest can set in. If you study Venezuela – another important place for oil and US foreign policy – its first riots, way before Chavez came to power in 1998, were known as La Caracazo – the protests started on bus fares – as far back as 1989. This is the demand side of the equation as we think through the economics. And we shall return to the problems for the UK government of trying to control demand when in 2009-11 this was driven by China and India.
THE MAGICAL STATE – RENTS
My third major point is an analytical one to help explain how the oil industry works. If you were ever mad enough to read the textbooks you will come across the idea of the oil price containing what is often called a large element of rent. This rent arises partly because the costs of producing oil vary sharply from place to place and, partly because of this difference, governments are able to raise substantial taxes to take advantage of a crude oil price that is set globally not nationally. This is very important in the oil producing countries, for it provides massive revenues for the State – in say Saudi Arabia. In Venezuela they call it the Magical State because it feels like the money just rains down from heaven, when in fact of course it comes from control of the resource under the earth. Politics in these countries centres around who controls the State and therefore the oil revenues, as we can see in Libya at the moment.
These rents are different from what the media lazily talks of the oil price being set by government tax – because they only think of the fuel duty. There are 2 types of rent: those set on the production side – in the UK this is largely about the Petroleum Revenue Tax – and on the other side a consumption tax – which is the fuel duty. Let’s put some numbers on it so you can see how it works. A very old producing field in Venezuela or Saudi Arabia may have production costs as low as $5 a barrel. (Remember only 20 years ago the oil price was barely above $10). The price of petrol in Venezuela was only 3p a litre – for there is no other consumption tax. In Venezuela it is cheaper in some places to produce a new barrel of oil than to provide a barrel of clean water and/or take away dirty water. In the old North Sea production cost maybe $15 – so at low prices it was barely profitable. Now the companies are saying that to bring in new oil – say offshore in the Gulf of Mexico or off Brazil or Africa or the North Sea again it will cost around $70. For the Arctic in deep waters, or in the Canadian tar sands it might cost $100 – hence OPEC have talked of being comfortable with $90. But notice for a $5 producer, over $100 today is available in profit and tax. For the North Sea there may only be $30 rent – and so on. After the OPEC-driven price rises in the 70s consumer governments like ours learnt that as oil prices fell they could make up the difference and even add some more. On the pretext of raising prices to cut demand they could also raise a lot of tax.
When BP was struggling with oil spills in the Gulf of Louisiana, it still published its yearly bible of statistics on world energy. Hidden away in the middle pages is a chart that tells us a great deal about the importance of the price of oil to global politics and economics. It shows the huge impact on oil prices that stems, in my opinion, from the geo-politics of oil over the last 50 years. Even an oil company labelling the chart uses geo-political finds and wars plus the economy to describe the trends: from Russian and Venezuelan oil exports to the Suez crisis and the Iranian revolution; from fears of shortages in the USA in the 1920s to the Asian financial crisis of the 1990s.
Apart from an initially high first finding price, which saw prices touch over $100/barrel in the 1860s when its main use was for the kerosene used for lighting, the oil price for the next 100 years remained very low in absolute terms (around $2/barrel was the benchmark). When global oil production came on stream – with its earliest examples being in Russia and Mexico – the price after 1900, allowing for inflation, remained fairly low (from a peak of $35 in 1895 to a low of $10 in 1914).
In the brief commodity boom at the end of the Great War, there were worries about US oil shortages and serious exploration began in Venezuela. Production from Mexico filled the gap, rising to 38 percent of world output in 1921 at 524 thousand barrels a day. By 1938 when the Mexican industry was nationalised (being the first after Russia in 1918) the Mexican oil industry was a shadow of its old self. Revolutionary Mexico was not appealing to the oil companies but Venezuela’s dictatorship was. Mexican output fell to 107 tbd as Venezuelan output took its place (rising to 515 tbd by 1938). Unlike the usual free market mythology, Mexican production declined first. Nationalisation was an attempt to address the problem – not its cause.
In this era until the 1970s it was the Seven Sisters that not only controlled output but the decisions as to where to locate incremental exploration and development. Politics as well as geology entered into this choice. One of the reasons State oil companies appeared was to take more control of this process for the nation state. The oil companies might choose to develop the cheapest incremental resource – this might be good for Saudi Arabia – but it might not suit, say, a Trinidad which depended on the industry and had potential resources. Although new production or exploration might be economic in one country, it was not as profitable for the companies as in another.
Having peaked in 1920 the inflation-adjusted price goes into decline. The line running along a chart of oil prices so low that the actual price is hard to make out – but from then until the 1970s it is quite clear that the inflation-adjusted price was below $20/barrel in 2009 money. Here is part of the reason which helped fuel the long economic booms of the 1920s in the USA, and globally in the 1950s and 1990s. Notice that low oil prices are not the only answer – in the 1930s inflation-adjusted prices were reasonable, dropping to a low of $10 in 1931– but of itself this did not cause an economic recovery. In 1986 the absolute price fell as low as $13 from a 1980 peak of $35, but the world economy did not comfortably come out of recession until after the first Gulf war (there was a small rise in absolute prices in 1990 to $20 again).
THE MIDDLE EAST: RESERVES AND HEGEMONY
From as early as 1914 events in the Middle East have had the potential to affect long run developments in the energy industry and the oil price as a part of this. This is partly because the world’s cheapest and largest reserves are in that area. 57 percent of the world’s oil reserves were in the Middle East at the end of 2009. Three countries accounted for nearly 30 percent: Saudi Arabia with 20 percent, Iran with 10 and Iraq with 9. Unlike the USA, which still produces 3 times the level of Iraqi production and has only 11 years of declared proven reserves, Saudi Arabia, Iran and Iraq have around 100 years or more; Russia may only have 20 years. One can see why it likes to influence Kazakhstan which has 65 years.
Although the strategic control of the Middle East by the Empire of Capital extends to more than just the oil industry and price, the Empire of Oil has lain at the heart of the struggle for hegemony in the area. Just to show the laughable language on the ‘private’ and ‘public’ sectors misunderstands how today’s State capitalism works (and yesterday’s imperial oil), it was the UK which was the first country to nationalise an oil company. Churchill – not a socialist by general agreement – nationalised Anglo Iranian in early 1914. Did he anticipate something? The company became BP.
In terms of its impact on oil prices the struggle for hegemony in the Middle East only became noticeable in the 1970s. Both the overthrow of Mossadeq’s nationalist regime in Iran in 1953, and then the Suez Crisis were big clues to the future. The oil barons and the political strategists had known this before – plentiful supplies now came from the Middle East, especially from Saudi Arabia. Kuwait’s output also rose to 1620 tbd by 1960, while Saudi production increased 10-fold from 50 tbd in 1940 to 547 tbd by 1950 and then doubled again to 1240 tbd by 1960. All this extra output helped keep prices low in the 50s and 60s.
In 1914, Britain (and Russia, and eventually Germany and Turkey too) invaded Iran. The irony – not lost on the Iranians – is that, like Belgium, Iran declared itself neutral. In 1940, we invaded again; in 1938 Iranian production had been 210 tbd – 4 times larger than that of Saudi Arabia before the war. Iran was the second largest exporter and the fourth largest producer in the world; there was no way either Britain or Russia were going to allow Germany to get her hands on Iranian oil. It was also worth fighting for both Iraq and Egypt in the 1940s. They were not only on the route to India, but also both vital oil producers for the war effort (Iraq with 90 tbd in 1938 and Egypt with 24 tbd in 1945).
The world’s largest exporter at the outbreak of war was Venezuela (50% of world exports and 90% of US imports), and there had been unrest throughout the Caribbean in 1935-38: general strikes in Venezuela and a rebellion against colonial rule in Trinidad (another significant producer). Venezuelan output was also vital and was one reason why way before Chavez Venezuela formed a leading role in OPEC’s early efforts. Venezuelan output was still more significant in absolute terms than Saudi Arabia in the immediate post war era – rising to 1485 tbd by 1950 (from 540 in 1940). Venezuela produced nearly 3 mbd in 1960 – still nearly 3 times the Saudi level. It took until 1970 for Saudi’s authoritarian monarchy to reach the same output level as Venezuela, which by this time had become a democracy.
STATE CAPITALIST OIL
OPEC was a major element of the politics culminating in 1973-4 which changed the oil world forever. The key periods here are from 1973 to 74 when the price rose from $3 to $10, and from 1978 to 79. During the heat of the Iranian Revolution oil prices rose from $13 to $30. Yet the rise of OPEC interestingly goes un-remarked on BP’s chart. OPEC could be presented as the first example of ‘developmentalism’: third world socialist and nationalising governments attempting to take on the capitalist order.
The reality, for all the talk of Arabs versus Israel too, was – and is – more prosaic. Here were a variety of governments – some exceedingly pro-capitalist – attempting to fight with the major oil companies and the major imperial powers over who controlled the massive rents that were beginning to accrue from the taxing of oil to fund governments. The price of extraction – especially in the Middle East from 1950-70 – was just too tempting, against the final prices that could be realised from the use of oil products and the knock-on uses in plastics, petro-chemicals and synthetic textiles. A whole life-style of mobility (roads and petrol stations) and new products followed from the era of global boom and cheap oil.
Like the old excise taxes on alcohol and tobacco, it is worth remembering that when we pay for our oil there is huge amount of tax in the price. This is a rent extracted both by producing and consuming governments. Even without the geo-politics, the oil industry – and thereby the energy/electricity industry too (which increasingly depends on gas produced by the same companies) will now always be political. To think there is some real competitive free market in operation in the energy industry is an illusion. There are forms of competition between Capitals and between governments – I would argue that it is in a world that is now obviously dominated not by a mythical free market but a variety of forms of State Capitalism.
The oil industry set the global trend at the beginning of the twentieth century by leading the world in a global search for resources controlled increasingly by vertically integrated companies. At the beginning of the twenty-first it reveals the trends again – as a variety of State oil companies (China, Iran, Russian, Saudi and Venezuelan to name but a few) bestride the world like the old (now much depleted) Seven Sisters. State Capitalism rules today – and nowhere is this better shown than in the history and politics of the price of oil.
This is seen in a battle between state capitalists about who controls the rents, and thereby the price of oil. But it was also a game of the politics of controlling the oil rent – both externally and internally. In Venezuela the oil resource supplied what they call the ‘magical State’ – this label could be applied to most of the major oil producers. Controlling the State becomes the magical route to its riches. Venezuela’s ‘twenty-first century socialism’ would not be possible without the oil rents.
THE LESSONS OF PEAK OIL – GERMANY AND JAPAN
The global economy too has never been the same since the price hikes of the 1970s. Not only did the oil price hike signal the end of the long 15-year boom after the Korean War, it finally killed off the global capitalist economy’s growth, which had been spluttering in any case after the spring-time of 1968. We forget now that the oil price not only aided the recession in the ‘North’ – which started us on the path to neo-liberal myth making, Thatcherism and Reaganism – but caused an economic and currency crisis in today’s ‘Brics’ (Brazil, Russia, India and China)– especially in Brazil and India. As after 2008, the State, whose military industrial complex had helped fuel the boom (ask Japan or Thailand about the useful economic affects of the Vietnam war) could be blamed. Yet in turn the same welfare States now needed to intervene even more (from the late 60s) to pick up the casualties from the manufacturing fall out – for a recession actually caused by the contradictions of Capital’s own impossible search for endless accumulation, power and expanding profit.
This magical rent game is also one that the consuming governments well learnt from OPEC without honestly telling their own people. As the OPEC-induced global spot price came down in the 1980s, most world consumers did not feel the benefit. Consuming governments put on more taxes at their end to keep the final price up much higher than it would otherwise have been. This was done in the name of conservation, which may be partially true – German and Japanese oil demand first peaked in 1979 as their economies had to change from their oil dependence. This did not happen as much in the USA or in the UK.
Japanese oil demand had shot up in the 1960s – increasing 5-fold (from 600 tbd to 4 million between 1960-70). It then hit around 5.5 mbd in 1979 and never exceeded this level of demand again throughout its own continuing boom in the 1980s. With the exceptionally low prices of the end of the 1990s, Japan added about another 300 tbd to its peak demand year of 1996. From then Japanese oil demand fell slowly back to 5 mbd by 2007. In Germany after 1979 the reaction was even sharper. Total demand was about the same as Japan’s in 1960 (but obviously higher per capita). But its total demand never exceeded 3 million bd around 1979. From here, even more than Japan, its demand fell back to less than 2.5 mbd by 2007.
In contrast – with lower consumption taxes – US oil demand kept on booming. Having first peaked at around 18 mbd in 1979, like Japan it went back to its old level by 1996 in the booming 90s. Demand kept on rising to reach a new high of 20.6 mbd in 2007. Part of the problem is that the US still thinks of itself as an oil producer – it is – and its own Big Oil companies lobby ferociously for tax breaks. Until the 1950s, the US produced more than half the world’s oil – at around 6mbd. It remained the world’s largest producer until 1978 (around 10 mbd). Since 1990, when output started to fall from 10 – 7 mbd the still growing US oil demand until 2007 was fed by imports of 13 mbd.
Interestingly, given the decline in its manufacturing sector, UK oil demand peaked in 1973 – at around 2.3 mbd. Now driven largely on gasoline consumption it has remained remarkably stable at around 1.7 mbd for 1990-2007. With the North Sea covering its own demand comfortably from the early 1980s, it was a net exporter of oil until 2003. For the first time in the UK oil output failed to meet demand in 2006.
IRAQ, IRAN AND $250 A BARREL?
The game of who controls the oil rents had been largely won by the consuming governments in both the recessionary 80s and the booming 90s. The oil price reached a new absolute low of $12 in 1998. What a wonderful inheritance for New Labour. Only by 2006 was it in import deficit on the oil front, and as early as 2004 in gas. By then ‘security of supply’ – now at much higher prices – began to hit its consciousness. It was still struggling to come to terms with the implications under Ed Miliband when it left power.
In the USA after 9/11 the labelling of potential enemies took them handily and strategically straight back to the Middle East (Iraq) and the ‘cockpit of the world’ – Central Asia (Afghanistan). The oil price started its steady rise to be nearly 3 times higher between 1998-2004 (the year after the invasion of Iraq) at $34, and then nearly trebled again from 2003-8.
The war in Iraq improved the profits of all the major oil companies and at the same time rather handily made any future increase in Iraq oil output even more valuable. The US elite must have been well aware of this potential affect. (They may have hoped a big increase in Iraqi oil production might bring down the long run price).
As the BP chart plainly shows the oil price in 2009 money needed to reach $100 to be at the same relative level as during the Iranian Revolution (the key shift of power in the Middle East since 1956). When it looked at one point that Bush II would go out in a blaze of glory by attacking Iran, as Wikileaks confirms, the oil market promptly began to reflect the risk. It was at this point that the teenage oil scribblers in the City started to talk of $250 a barrel oil. If the USA does attack Iran then I agree – this is where the oil price will go.
Even without this extra political risk, what is most worrying for today is that since the global recession of 2008, the oil price did come down to around $60 in 2009, but has still been around $85 for most of 2010. The oil price has traded in the range $70-90 in 2010, and is around $85 this week. This is barely down from its 2009 peak, while for some of the light low sulphur crudes (most desirable for making gasoline and low sulphur diesel) the price reached $100.
The oil companies argue that the new development needs $70 oil – though even in the difficult North Sea they managed on less than $15 for much of 1986-99. At these higher prices, even US output rose again – by 7% to 7.2 mbd in 2009 – but as with gas too much could be made of this. It means US oil production is back at the level of 2004 and no more. At the $70 price it is noticeable that the oil companies continue their offshore searches – off Brazil and the West coast of Africa, where it will be easier than offshore USA or in Alaska. The African drill map, where the companies had barely looked, is now beginning to fill in – with important discoveries in Ghana and Uganda on top of Sudan becoming a major producer. There has been and will be a new scramble for African resources – of coal as well as oil and gas. African output increased from 7 mbd in 1990 to nearly 10 mbd in 2009. As Russian output made it the world’s largest national producer again in 2009 – with production back over 10 mbd – the new production geo-politics looks set.
OIL DEMAND: FROM CHINA TO THE USA AND 2007-9
The key other side to the equation is of course the level of demand. Global oil is still dominated by US demand. At its peak in 2007, the USA consumed nearly 21 mbd – 25% of entire world demand (of around 85 mbd).
But as often reported, China is now catching up. China is now the world’s second largest consumer of oil (it comfortably takes most of the world’s coal). China’s demand in 2009 was 9 mbd – more than double now than that of the EU. China does have her own production – of around 3.8 mbd; but she now imports more than the entire EU.
Given that the oil price peak of 1979/80 and the consequent global recession led to major changes in the geo-politics of oil, it is worth seeing the signs from the demand side of the equation between 2007-9. At first sight the year on year numbers could be seen as encouraging – the first prospects of a lower carbon economy caused by higher prices. Japan’s demand for oil fell by nearly 11% in 2009 and Germany’s by 5%. German demand is now lower than it was in 1970.
German oil and gas demand is rather like the UK’s – that is it has moved within a relatively small range (between around 2.3 and 2.9 mbd for 40 years) – driven largely by the demand for petrol and diesel; just as gas demand is driven by a relatively flat weather-dependent demand for heating. The move away from energy intensive manufacturing on these numbers looks to have flattened out; all the easy cuts have been taken.
The story gets worse. Alongside a minor rise in production, US demand has at last fallen – by 5% in 2009 – to below the 20 mbd mark. Imports as a consequence have fallen too (from nearly 14 mbd to 11m). But despite the recession – and it will be interesting to see what the first signs of recovery in 2010 reveal – US demand can be presented in two ways. It is the lowest for 13 years, but it is still higher than at the start of the global boom in the 90s. Import requirements are still higher than in 1998. Demand is still higher than the last major crisis time – in 1978 (although lower per capita). The two year recession has not rid the US of its fixation on oil. This explains a little bit why oil prices remain high.
If one starts to look again at India and China then the data explains even more why oil prices are holding firm. Indian demand only passed the UK when Blair came to power in 1997. Since then its demand has virtually doubled (from 1.7 mbd to 3.2 mbd in 2009). There is no evidence of a recession in the new Indian desire for oil. With a small amount of its own production (0.7 mbd), India now imports more than Germany consumes. India’s increasing demand in the last two years – around 400 tbd would be sufficient take the entire output of a new African producer like the Sudan.
China is similar. Its demand has increased 1million bd in the last two years. The entire increase of African output in the last decade would be consumed by China’s incremental demand in a relatively slow growth period – 2007-9. In four years China’s incremental demand is akin to the whole of the UK’s demand. Yet by definition its per capita demand is 15 times lower. The great game of oil geo-politics is set to continue – whatever happens at Cancun.