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Overview
Oil in the 1950’s was characterized by a rapidly growing production capacity that far outstripped demand. Not only where more oil wells discovered and put into production, but more players entered the market. In the non-US market from 1953, one estimate puts the number of players who entered or expanded their participation in the oil industry at 350. In the Middle East alone, the number of companies rose from nine in 1946 to 19 by 1956.
During this period, Middle East producers, for the most part, kept the pressure on oil companies operating within their territories to increase production, not prices, to increase their revenues. This was egged-on by new players, many of them independent oil companies.
The independents, as new entrants, aggressively assaulted the established positions of the major oil players by offering better terms for the source country in order to acquire new concessions. And unlike the majors who have other significant concessions or supply sources to protect or rely on, the independents have not much reason to hold back production, and they as aggressively explored, lifted and marketed their Middle East oil and engaged everyone else in cutthroat competition.
To make the supply glut worse, the Soviet oil industry recovered quickly after the war with the Volga-Urals oil bonanza, so that by 1955, they resumed oil exports to the West, eager to reassume Russia’s role as its traditional supplier.
By the end of the 1950s, the Soviet Union was already the second biggest producer of oil in the world, next only to the US, its output equal to about three-fifths of the entire Middle East production at that time.
In those cold war years, it was hard for the West to take the so-called Soviet offensive in purely economic terms. In Western national security circles, the flood of cheap Soviet oil has gained some form of an economic warfare directed against NATO’s unity and the established Western oil position in the Middle East. As a result, oil price cuts have acquired the added character of a political counter measure, a response dictated by the demands of national security and the integrity of the Western alliance.
In 1959, a reluctant President Dwight Eisenhower, under intense pressure from the politically powerful independent domestic oil producers who were facing ruinous competition from imported oil, mandatorily imposed import quotas in the US. Pursuant to law, the US President was empowered to restrict oil imports when he determines that there is a threat to the national security or economic well-being of the US, severely limiting outside access to the biggest oil market in the world.
With so much oil seeking a constricting market, oil companies inevitably responded by offering discounts on the selling price of their Middle East oil. This eventually led to a bitter confrontation with oil producers.
Oil was being sold at a “posted” or official price, which was used as a basis in computing the royalties and taxes due the producing countries, in short, their income or share in oil sale revenues of the oil company. The prevailing sharing arrangement at that time was 50:50. The posted price is set to match the actual market price, but with more and more companies compelled to give bigger and bigger discounts, a gap appeared, and widened, with the actual prices falling and the posted price more difficult to change because of the negative economic and political repercussions on the producing state.
Initially, the oil companies absorbed the effects of the price cuts. Producing countries in effect got more than their 50% of the profits based on the posted price, at the expense of the share of the oil companies. But with more and more oil flooding the market and with oil company profits going down as prices continue to plummet, it was only a matter of time.
British Petroleum was the first to act, reducing the posted price by 10% in early 1959. Over a year later, in August 1960, Standard Oil of New Jersey followed with a 7% cut.
The announcement of the first cut in the posted price of oil by British Petroleum, by sheer coincidence, came on the eve of the Arab Oil Congress in Cairo in April of 1959. Four hundred delegates attended the meeting of supposedly “Arab Oil Experts.”
Present at that time was Abdullah Tariki, head of the newly created Directorate of Oil and Mining Affairs of Saudi Arabia. Tariki studied mining and chemistry at the University of Texas, and trained as a geologist in Texaco. When it came to oil policy, he was the most important man in the Kingdom, and because of the dominant position of Saudi Arabia, he was an important personality in Middle East oil business.
Tariki was 35 when he took his job in the Directorate of Oil and Mining Affairs in 1955. Critical of Western oil companies and their concessions, he would raise the idea of nationalizing ARAMCO itself. He believed that a fully integrated Saudi oil company, from extraction, refining, to marketing and retailing even in the consuming countries is the way to raise revenues. In short, he wanted to create Saudi oil major. But with the sudden and unilateral cut in the posted price of oil, he had a change of mind. It dawned on him that control over oil price and production was more important.
Also present at that time was Juan Pablo Perez Alfonzo, Venezuela’s Minister of Mines and Hydrocarbons. Venezuela was in the Arab Oil Congress as an observer. The Eisenhower quotas on all imported oil coming to the US hit Venezuela the hardest. It was exporting 40% of its oil to the US.
To salvage the situation for his country, Perez Alfonzo rushed to Washington with a proposal to create a Western hemisphere system run by governments, not by oil companies, which shall allocate quotas that will guarantee each oil-producing country in that region, Venezuela included, a share in the US market. Clearly, it was a foreshadowing of OPEC. He never got an answer in Washington, instead brought his idea to Cairo.
Perez Alfonzo and Tariki met at the Cairo Hilton, in the room of Wanda Jablonski, an influential female oil journalist at that time. In that meeting, which Jablonski arranged, the two agreed to invite other representatives of major oil exporting countries present in the Arab Oil Congress to a secret meeting.
The secret meeting was held in a Yacht Club in the Cairo suburbs. Present, other than Tariki and Perez Alfonzo, were representatives from Kuwait, Iran, and Iraq. The Iraq representative came as an officer of the Arab League since Iraq was boycotting the Cairo meeting because of differences with Nasser. Since none of those present had as yet authority to represent, much less bind their governments, they ended up signing a “Gentleman’s Agreement” merely containing recommendations to their respective governments. But at that time, that was all Perez Alfonzo needed.
The contents of the Agreement contained much of Perez Alfonzo’s strongly-held ideas and that of Tariki’s as well. It recommended that their governments establish an “Oil Consultative Commission,” that they defend the price of oil, and that they establish fully integrated national oil companies that will control production, refining and marketing. The Agreement also called for ending the fifty-fifty profit sharing arrangement with oil companies in favor of a larger share for the producing country. (Daniel Yegin, “Prize,” 1991, p. 518). |
