The Oil Revolution
 

1. Oil Market Changes – 1960’s

2.  Strategic changes in the Gulf

3.  1973 embargo and price hikes

4.  Middle East Consequences of the Oil Revolution

Having looked at the 1973 Arab-Israeli war, we now examine in more detail one of the most important, if not the most important for the world as a whole, consequences of that event -- the oil revolution.  The Saudi embargo did not so much cause the oil crisis, as it was the spark that ignited it.  Changes in the world oil market, in the relationship between producer countries and the oil companies, and in the strategic picture in the Persian Gulf all combined to set the stage for the dramatic price increases of 1974.  It was the 1973 war, the production cuts made by Arab producers, and finally the Saudi embargo on the US that focused the attention of the markets on these changed circumstances and pointed up both the fragility of the supply of oil and the new level of oil dependence in the industrial countries.

To get to the roots of the 1973-74 oil crisis, we have to go back to the late 1950's.  The world oil market (in the non-Communist world) was controlled by seven major multinational oil companies (Exxon, Mobil, Socal, Texaco, Gulf, BP, Royal Dutch Shell).  In response to new competitive pressures (generated in part by the entrance of the Soviet Union into the export market), in 1959 the companies decided unilaterally to reduce the taxes they paid to the producing countries.  They did this by reducing the posted prices for crude oil -- the price which determined the level of payments to governments.  Understandably upset that such a decision was taken without consulting them, the producer country governments decided to organize, in hopes of preventing such cavalier treatment in the future.  In 1960 Saudi Arabia, Venezuela, Kuwait, Iran and Iraq joined together to found OPEC (joined shortly thereafter by Qatar, Indonesia and Libya, and then even later by other oil producers -- Nigeria, UAE, etc.).  OPEC still provides the forum for producer country cooperation right up to the present.

OPEC's founding was a major milestone in the history of the oil market.  It established an institution within which the producer countries could get to know one another's needs and policies, and to develop habits of cooperation which would become increasingly important by the end of the 1960's.  However, at the time OPEC had little if any impact on the world oil market.  The conditions of supply and demand were not yet favorable for the producer countries.  World oil supply still exceeded demand by a relatively large margin, keeping prices low.  The real price of oil, adjusted for inflation, dropped slowly but steadily throughout the 1960's.  At such low prices, each producer government was interested in maximum production to maximize revenues.  The companies could easily shift production to other countries if a particular government were giving them trouble.

We saw this pattern in the Iranian crisis of 1951-53.  The major oil companies organized a successful boycott of Iranian oil and made up the shortfall by increasing production elsewhere.  A similar situation occurred in the early 1960's in Iraq, where the Qasim government tried unsuccessfully to pressure the IPC into increasing production and royalty payments.  Even as late as 1967, during the 6 Day Arab-Israeli War, efforts by Arab oil producers to enforce an embargo on Britain and the US were a failure.  The major oil companies merely rerouted supplies and increased production elsewhere.  Given this structural weakness in the market, the producer states' own need for revenue, the short duration of the war and the hostility of many Arab producers toward Nasir (Saudis, Kuwaitis), the embargo lasted just a few weeks and had no effect on either the politics or the economics of the target countries. [some evidence of cheating even during] 

However, during the 1960's major changes in the world oil market -- in the structure of supply and demand -- were occurring.  During this decade world demand for oil more than doubled; the Middle East share of production increased from 24% to 31%; the OPEC share of world production increased from 42% to 52%.  In the equally important category of proven oil reserves, the Middle East during the 1960's surged ahead of every other region in the world. In 1970 the reserves of the Middle East and North African states accounted for over 75% of the non-Communist world oil reserves.  Meanwhile, the United States had moved from being an exporter of oil in 1960 to the world's largest oil importer by early 1973 -- a reflection both of increased US demand and decreasing US production.  In effect, the difference between world oil supply and world oil demand, which had allowed the oil companies so much flexibility in shifting production and keeping prices low in the preceding decades, had narrowed to the point that supply disruptions could not be made up quickly by surplus production elsewhere.  In this new situation, the producer states had increasing leverage on the market, a leverage they quickly realized and quickly exploited. [production cuts mean higher prices, not loss of market share, thus making cutting strategy realistic]

This new situation not only changed the balance between consumers and producers in the oil world, but also between the producer governments and the oil companies themselves.  Whereas before the companies were worried about managing surplus, they now had to concern themselves with maximum access to production -- placing them more at the mercy of the producer governments.  As early as 1968 OPEC, at the instigation of Saudi Arabia, set as one of its policy aims the right for producer governments to fully manage their hydrocarbon resources -- that is to say, transferring the right to determine price and production levels from the oil companies to the governments.  The first actual break in the pattern of company dominance over producer governments -- the turning point in the history of the world oil market -- occurred in Libya in 1970.  The new Libyan leader, Muammar al-Qaddafi, was both a fierce anti-imperialist and an ambitious politician.  He saw oil company control of Libya's resources as a remnant of imperialism, and saw the possibility of a revenue bonanza if he could get more control over the companies' operations.

Libya in 1970 was in an ideal bargaining position vis a vis the companies.  We have already seen in general how the balance of power in the oil market was shifting toward the producers.  Libya enjoyed some special advantages over and above this general change.  The Suez Canal had been closed in 1967, but the supertankers that took up much of the slack in oil transport [Cape route] had not yet come into regular service.  The TAPline, connecting Saudi fields with the Mediterranean, had been shut down by Syria in a dispute over transit fees.  Therefore, Libyan oil was at a premium for the European market.  Moreover, much of the production in Libya was done not by the larger companies, but by a smaller independent company, Occidental Petroleum (owned by the swashbuckling entrepreneur Armand Hammar).  Unlike the majors, Occidental had few if any alternative sources of supply to which to turn for fulfilling their contracts -- without Libyan oil, it would default.  So Qaddafi really had the upper hand when he started squeezing the independents in June 1970.  He demanded an increase in the tax rate from 50% to 55%, and an increase in the posted price of oil by $0.30.  Armand Hammer tried to organize the majors to support him in resisting these demands (by agreeing to make up his shortfall), but they refused (grudges about the independents of long-standing).  Occidental gave into Qaddafi's demands.

The other OPEC members, appreciating their increased strength in the market, took the Libya victory as a signal to do as well or better.  Rather than undercutting Libya by pushing for increases in their own production, OPEC ministers meeting in December 1970 declared that 55% would be the minimum tax in all member countries.  In February 1971, after a mega-negotiation in Teheran between 23 oil companies and the producer states of the Persian Gulf, the companies agreed to a 55% tax rate, an across the board $0.30 increase in posted prices, and successive further increases spread out over the next four years.  As a result, the average government revenue per barrel of oil rose from $0.87 in 1970 to $1.25 in 1971 -- a 50% increase.  Far from settling the market situation, this agreement opened the door to new demands.  Libya immediately demanded a $1 premium on its crude, ostensibly because of its low sulfur content and Libya's proximity to European markets.  Similar mark-ups were obtained by Saudi Arabia and Iraq for their oil sold via Mediterranean pipelines, and by Algeria and Nigeria.  Shortly thereafter Algeria nationalized 51% of its French oil concessions; Libya nationalized 50% of BP's operations there; and Saudi Arabia announced its intention to increase "participation" in the ARAMCO oil concessions -- nationalization on the installment plan.  In September 1971 OPEC ministers demanded a revision of the Teheran Agreement, gaining an increase in the posted price of oil by 8.5%.  Further negotiations led to increases in the posted price from $2.18 in 1971, $2.48 in 1972, and $2.90 in June of 1973.

The balance of power in the world market had clearly shifted.  Once the Libyan independents had agreed to Qaddafi's original demands, the majors had little choice but to fall in line -- otherwise they risked losing their concessions to the independents, who were willing to give the producer states better deals.  When it became clear that increased oil prices would not affect world demand (which continued to increase through 1973), the companies had no real interest in fighting price increases, which they could merely pass along to consumers.  The importance of continued supply to the companies, in a market where both demand and price were going up, gave the producer states even more bargaining leverage on the question of control.  Control was no longer vital to the companies -- supply was.

While these changes in the market were taking place, equally important strategic changes in the Persian Gulf were occurring.  In 1968, Great Britain announced that by 1971 it would unilaterally abrogate its protectorate arrangements with the Arab shaykhdoms of the Gulf, and withdraw the bulk of its military and naval forces from the area.  The United States, preoccupied with the Vietnam War, was in no position to replace the British as the dominant military/naval power in the Gulf.  Thus, in 1971 the shaykhdoms of Qatar, Bahrain and the UAE became independent states, ending any formal role Britain had in determining their foreign and economic policies (including oil policy).  At the same time, the states of the region took over for themselves the task of filling the strategic void left by the British withdrawal.  The United States encouraged Iran, and to a lesser extent Saudi Arabia, to fill this gap with their own military efforts.  So, at the same time that the balance of power in the world oil market was shifting to the producer states, the leading Western consumers unilaterally gave up their position of strategic dominance in the major oil producing region in the world.

It is hard to draw any direct relationship between this strategic withdrawal and the subsequent revolution in the world oil markets.  However, it is certainly true that the departure of Western military units from the Gulf removed any direct threat of outside interference in the claims of the Gulf states to control the oil industry.  No longer either reliant upon Western forces for strategic control of the Gulf, or threatened by those forces should they take independent measures, the Gulf states were freer to act on their interests in oil matters.

This was the setting in the oil market in October 1973, when the fifth Arab-Israeli war broke out.  On the third day of the war, OPEC's ministerial committee (consisting of the Gulf producers) held a previously scheduled meeting with company representatives.  At this meeting, the committee demanded an increase in the posted price of oil to $5.12, over $2 more than the current price.  The companies refused.  On October 16, as the war was continuing, the OPEC ministers met in Kuwait and announced a unilateral increase to $5.12.  The next day, five Arab oil ministers separately announced a set of production cuts -- 25% immediately and then 5% for every month until Israel evacuated the occupied territories.  On October 20, as we know from our previous lecture, Saudi Arabia added to the pressure by declaring an embargo on oil shipments to the United States.  Clearly the demand for price increases was not related to the War; it had been in the planning stages before the war began.  However, the combination of the war and the companies' refusal to agree to the price increases led to the production cut decisions, and the Saudi embargo on the US was wholly related to the politics of the war.  Thus economic and political circumstances came together to link the world oil market to the Arab-Israeli conflict in an unprecedented way.

Despite the moves taken by the Arab oil producers to reduce world supply, the world market was not as seriously affected as it might have been.  The major oil companies made a largely successful effort to reroute supplies from other sources to the embargoed countries.  Non-Arab producers such as Iran and Nigeria, and even Arab producer Iraq, increased production to make up some of the shortfall.  However, price was driven at this time as much by consumer panic as it was by the actual supply-demand situation.  Iran held an oil auction in December 1973, at which the price of oil was set at $11.65 per barrel [some bids as high as $17.00].  OPEC ministers meeting in January 1974 confirmed this as the official OPEC price.  Thus was accomplished the oil revolution in the world political economy.  There were various negotiations, within OPEC, among consumer nations, and even between consumers and producers about the price situation, but the world economy adjusted to it (at great cost both to industrialized countries and to non-oil LDC's) and for the rest of the 1970's oil prices remained relatively stable, when adjusted for inflation.  Saudi Arabia, as the state with the largest oil reserves and the largest excess capacity (production capability v. need) came to play the crucial role in the pricing decisions within OPEC, and thus assumed a new leadership role on the world stage.

The consequences of the 1973-74 oil revolution were enormous on a number of levels, including that of the world political economy.  Recessions throughout the Western world and the 3rd world debt crisis can be directly traced to the quadrupling of oil prices during this period.  For our purposes, lets look at the effects in our four areas of interest for Middle East international relations.  In the Arab-Israeli arena, the oil revolution had the immediate impact of strengthening the bargaining position of the Arab states, as can be seen from US post-war diplomacy.  In giving US policy a new focus within the Middle East, it contributed to the change from the pre-1973 policy of almost complete support for Israel.  In a larger sense, the new Arab oil wealth made possible the strengthening of the Arab side both militarily and politically.  The realization of that new potential, of course, depended upon the uses it was put to by the oil producers themselves and by the state of inter-Arab politics.  But, at a minimum, Israel had to confront the possibility that its adversaries would be a much more serious threat to it. [new states in conflict, arms and money transfers to front-line states]

In inter-Arab and regional politics, the effects were enormous.  Saudi Arabia emerged for the first time in Arab politics as a major power, one whose support was curried and whose counsels were carefully considered.  From this position the Saudis attempted to maintain the united Arab front that fought the 1973 war.  However, the Saudis' failure to prevent Sadat from going his own way is an object lesson in the limits of power backed only by financial resources.  The Saudis also used their new oil wealth to promote their own interpretation of Sunni Islam throughout the Muslim world, helping to set the stage not just for the resurgence of Islamist politics more generally, but also to encourage the development of the salafi interpretation of Islam that would help spawn al-Qaeda.  The new oil wealth also increased the relative power potential within Arab circles of oil producers like Libya, Iraq and even the smaller shaykhdoms.  On the social level, this explosion in wealth in the underpopulated Arab oil states led to large-scale population movements across Arab borders, as workers from non-oil countries like Egypt, Jordan, Yemen and from the Palestinian community migrated to the oil countries to find work.  Most of these workers stayed only for a few years, returning home with their new wealth, to be replaced by other of their countrymen.  It also occasioned large-scale capital transfers from the oil to the non-oil states, in the forms of direct grants and capital investment.  We will speculate in a later lecture about the long-term consequences of this "new Arab social order", as it has been called, for politics in the region.

On the regional level, the combination of British withdrawal from the Gulf in 1971 and the price increases of 1973-74 made of the Gulf a new area of strategic interaction and conflict.  The stakes were much higher, and the absence of a superpower "policeman" allowed the local states, with their new oil wealth, to indulge in their own pretensions to regional dominance.  The dynamic here was for the most part Iran vs. Iraq, a dynamic which spiralled into war in 1980.  Saudi Arabia played a nervous second-fiddle to the Shah on the "pro-Western" side.  All the states spent billions of dollars on armaments.

In terms of international politics, the oil crisis focused US thinking on the Gulf as an important strategic area much more than had been the case before.  Given the political realities of the immediate post-Vietnam era, that focus expressed itself in very close military/political/economic relations with Iran and Saudi Arabia, not in direct US involvement.  But it was the oil crisis that set the stage for a more active, direct US role in the Gulf after the Iranian Revolution and the Soviet invasion of Afghanistan -- Carter Doctrine, Rapid Deployment Force, access agreements, the naval deployment of 1987-88, and finally the Gulf War.  In essence, the events of 1973-74 elevated the importance of the Gulf as an area of strategic interest to the United States.  As a by-product of this change, US Middle East policy was now focused much less exclusively upon the Arab-Israeli conflict.  Through the role played by oil producers like Saudi Arabia in both arenas (Gulf and Arab-Israeli), the US now found it harder to separate its policies toward the two areas.  The Gulf remained much less important from the strategic side to the Soviet Union, but because the US was there and because of its land border with Iran and Afghanistan, Moscow did invest some of its strategic assets in the area.

Finally, in terms of domestic politics, the oil revolution wrought changes of enormous magnitude on the producer countries of the region, and had a spill-over effect in non-producing countries.  Oil wealth was both a blessing and a curse:  a blessing in the sense that it provided support for all the regimes that controlled it.  They could provide benefits to their citizens unimaginable just a few years earlier.  However, the social changes that oil wealth would bring to the producer societies could also have a dislocative and destabilizing effect, as was the case with Iran.

Even with all these changes in the regional, domestic and international environments, politics went on during the mid-1970's, and the focus of Middle Eastern politics in terms of issues did not change.  The Arab-Israeli conflict still held center stage, though now in terms of negotiations, not in terms of war.  The Gulf area remained stable, as the tenuous partnership of Iran and Saudi Arabia, supported by the US, checked any Iraqi desires to exert a greater role.  Inter-Arab politics revolved largely around the issue of negotiations with Israel, and in our next lecture we will examine the political process that led to the Camp David agreements and Egyptian-Israeli peace.