A Breif History of Oil...

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History of Oil

Oil booms and busts have come and gone.

In our report on the history of oil, we'll cover what's affected the price of oil since World War II through the Gulf War, to draw some conclusions about this most precious of commodities today.

The story seems to repeat itself over and over... Boom and bust. Opportunity found, and opportunity literally stolen away. Oversupply and shortage. Optimism and despair.

Let's take a quick look over history, to see if any patterns emerge...

Oil Before WWII: "A Cure for Kidney Stones"

Oil has been around for a while... But the true importance of oil worldwide wasn't understood until World War II. For example: Oil in the 1860s, you may be surprised to learn, wasn't for fuels. As William Fowler wrote, oil in the 1860s was hailed as "a disinfectant, a vermin killer, hair oil, boot grease, and a cure for kidney stones."

Before World War II, the issue was too much supply... We'd discovered oil in Texas in the 1930s, and the major companies were colluding to keep the price up. World War II then taught government the importance of having a safe supply of oil.

In 1933, Americans paid $275,000 to Saudi Arabia's King Ibn Saud for an oil concession. He thought he'd sold the Americans sand, as the Brits didn't think there was oil there. After five years of disappointment, the Americans struck oil in Saudi Arabia. One expert at the time described Saudi Arabia's oil as "the single greatest prize in all history."

At the same time (March 1938) on the other side of the world, the Mexican government expropriated the assets of the U.S. and U.K. oil companies in Mexico. This woke big oil up to the real risks of doing business in undeveloped countries. Until the end of the 1940s, the U.S. and Latin America provided Europe's oil.

Starting after World War II, it was clear that the world was going to need a lot of oil... more than Socal and Texaco in Saudi Arabia could provide.

The Government Steps In... People Get Rich

The U.S. government gave every incentive for more companies to enter the Saudi fray, and Exxon, Chevron and Mobil (actually Socony-Vacuum at the time) joined in.

Saudi Arabia was going to be rich. Washington promoted a new deal - a 50/50 split of oil profits between the companies doing the work and the countries where the oil was.

To match the American assets in Saudi Arabia, the Brits developed a vast oil industry in Iran. At that time in history, it was the biggest single foreign asset of Britain.

The Brits were slow to come around to the 50/50 deal. It really hurt them... In 1951, the Iranians simply took the oil industry from the Brits, nationalizing its oil industry. Nationalism was rising in the Middle East, and the balance of oil power was just beginning to shift.

OPEC: The Shift of Power to the Middle East

OPEC was formed in 1960. A Venezuelan and a Saudi got together over a soda in 1959, and thought of collusion. August 1960 was the last straw for the Middle Eastern countries, as the major Western oil companies lowered oil prices yet again. OPEC acted unilaterally to raise prices for the first time in 1963.

In what gets to be an old story, Libya was then discovered to have vast oil reserves. A U.S. company built the infrastructure. Then the terms were changed drastically by the Libyans. Libya became the first producing country to dictate the terms to the West. This change was huge... The heyday of the U.S. majors was over. Now the Middle East held all the cards.

The major oil companies had basically controlled oil prices from the end of World War II until 1973. Their day was done.

Nixon, the Shah and the 1970s "Oil Shocks"

For more than a century, the British had policed the Gulf states. But in 1971, the British withdrew from the Middle East, leaving the Arab states to police themselves. Nixon chose the Shah of Iran to fill the policing vacuum.

The Arab Israeli War (the Yom Kippur War) broke out in 1973. The U.S. flubbed its attempt to secretly fly planes into Israel at night to help the Israelis fight. Instead, the U.S. planes arrived in the morning light, filmed by TV cameras.

The "oil weapon" was then used by the Arabs to squeeze the States - the Arab oil embargo caused a panic in the West, as oil soared and subsequently so did gas prices.




  • [ ]
Oil prices are driven by politics in the short run and by economics (supply and demand) in the long run, a quick glance over history suggests.


[ ]

Oil prices could fall from here, as war and supply tensions fall.



OPEC had the pricing power now. So Western companies started a hunt for oil outside the Middle East. Soon more oil was being produced from the North Sea than from many OPEC countries.

The Shah fell in the Iranian Revolution in 1979, and Western influence over Mid-East oil shrank even further. Two weeks after the fall of the Shah, the anti-western Ayatollah Khomeni came to power, and the Second Oil Shock hit the West, this time in 1979.

In the Second Oil Shock, of 1979, there was a panic... But in reality there was no shortage of oil. Oil touched $40 a barrel, and OPEC felt it could raise oil prices at will. In hindsight, it was the height of OPEC.

In the 1979 demise of the Shah, Saddam Hussein saw opportunity... he set out to either take control of Iran's oil or destroy it. The Iran-Iraq War ran for eight years, until both sides threw in the towel.

OPEC's Importance Shrinks and Market Forces Take Hold

Oil was discovered in Alaska and, by the early 1980s, a quarter of U.S. production was coming from Alaska. By 1983, four years after the Second Oil Shock, it was clear there was plenty of supply and no increase in demand, so OPEC had to cuts its prices. OPEC was forced to institute production quotas to limit production and keep prices up.

In 1986, oil prices fell from $29 to $10 a barrel. Market forces now ruled, as oil prices were set in the futures markets in New York (that started in 1983). OPEC was no longer in the driver's seat. With prices falling, oil companies had to shrink.

Saddam Hussein had run up $75 billion-plus in debts in his attempt to take Iran's oil, and he asked his Middle Eastern neighbors for debt forgiveness. Kuwait refused. Saddam was desperate for cash... and Kuwait was a convenient target, next door, with tons of oil. He invaded Kuwait in 1991 and was swiftly defeated by Americans.

The price of oil swiftly rose above $40 a barrel during the war, and then it fell back down.

From 1971 to 1991, the Middle East was left to police itself. It failed. After the Gulf War, the U.S. picked up where the British left off in 1971, policing the Middle East.

Oil and War

Another interesting fact from history is that oil prices don't necessarily rise when U.S. national security is threatened. When national security is threatened, history suggests that oil prices only rise if the opponent poses a threat to the world supply of oil.

A few examples:

  • [ ]During the Korean War, oil prices didn't rise.
    [ ]During the year of the Cuban Missile Crisis, oil prices didn't rise.
    [ ]And as we steadily became more involved in Vietnam, oil prices fell from 1965 to 1972, adjusted for inflation.
In these situations, the oil supply was not at risk. So if the world supply of oil is not at risk, the price of oil is not at risk.

However, if the world oil supply is perceived to be at risk, oil prices will rise. During the Yom Kippur War, the Iran-Iraq War, the Gulf War, etc., prices spiked, but subsided dramatically over the following years, crashing a few years later (in the mid- to late 1980s and the mid-1990s, in those two examples).

So, based on limited evidence, it seems clear that oil prices rise when the supply of oil is threatened, not our national security.

Where To From Here?

Our brief view over the modern history of oil would lead us to believe that oil prices are driven by politics in the short run and by economics (supply and demand) in the long run.

So the questions that need to be answered right now are:

A. What are the economics of oil right now?
What are the fundamentals, as the fundamentals are what matter in the long run? Is there plenty of supply? If there is, then prices should come down, eventually.
 
 
 

B. Will the War on Terrorism affect the world's supply of oil as badly as the current price of oil suggests?
That's the important question regarding oil. At first glance, it appears that the price of oil is pricing in a great deal of disruption. It may be priced for fear right now, not reality. But who knows?
 
 
 

Our brief look over history suggests that fears over supply and war do eventually subside, and oil prices then return back to earth.

A fall in the price of oil may be coming. But with the price of oil near multi-year highs, we're not there yet...

 
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