Birth of the Global Oil and Gas Industry and OPEC

In August 1859, former railway conductor Edwin Drake struck oil at 69 feet after piecing together the world’s first oil well drilling rig – powered by a steam engine – in Titusville, Pennsylvania, USA - population 125. Within fifteen months, 75 wells were producing there and when these original reserves ran out, exploration shifted to other sources in the hills of northwestern Pennsylvania by more than 16,000 drillers over the next decade.

With uneven success in these early days, the price of oil fluctuated wildly between 50 cents and $10 a barrel. Since the major oil product in those days was kerosene, used for lighting lamps, a tug-of-war between drillers and refineries began, where drillers kept oil supplies and prices in flux due to the uncertain nature of exploration, but the manufacturing operations of refineries benefited from a steady flow of low-priced crude.

John D. Rockefeller, a trader from Cleveland, started in oil refining when a rail line linked his Ohio hometown with western Pennsylvania. By the late 1860s, the industry was in a glut, with far more oil and perhaps three times as much refining capacity as the market needed. Rockefeller came up with a legal plan to restore order by uniting the entire American refining industry at a time when there was an abundance of local competitors in the United States, making anti-trust laws unnecessary.

He started Standard Oil and persuaded many rivals to contribute their refineries in exchange for a stake in the publicly traded company. Holdouts found themselves facing brutal competition in their regional markets, often from firms that appeared to be independent but actually belonged to Standard, and few rebels survived. As its muscle strengthened, Standard secretly negotiated lower freight rates with the railways and, in a brazen demonstration of monopoly power, charged them a kickback fee for every barrel of crude shipped by its competitors. 

Crude oil was initially shipped in whiskey barrels, which became the industry’s standard measure of volume. At times, a wooden barrel cost more than the oil it contained.

In a desperate move to break the Standard stranglehold on refining and transportation, petroleum producers united behind a daring scheme to construct a long distance pipeline in 1879, but Rockefeller swiftly outdid them by building his own pipelines. It was the last domestic challenge to Standard’s dominance in the American and Canadian markets. In 1880, sixteen Ontario refiners had united as Imperial Oil, which would remain Canada’s largest petroleum company, but the province’s oil production base was weak and in 1896 Standard bought control of Imperial. In the late 1880s, as Pennsylvania’s reserves dwindled, an oil rush began in Ohio and Indiana and the price of oil plummeted to 15 cents a barrel. In response to the glut, Rockefeller decided Standard should acquire its own oil fields and soon controlled reserves that fed his expanding network of refineries. As the twentieth century began, what was previously almost worthless gasoline, a by-product of kerosene production, started to beat out electricity and steam as fuel for the newly invented automobile.

In 1892, Ida Tarbell, the daughter of a Titusville oilfield equipment manufacturer, wrote a 24-part expose for McClure’s magazine, outlining Standard’s dealings that included espionage against competitors and systemic bribes to politicians. Her anti-monopoly advocacy impressed President Theodore Roosevelt, who was elected in 1901 and utilized the 1890 Sherman Act to launch 45 actions against railways, tobacco, beef, steel, and other industries. Roosevelt said the directors of Standard were criminals and a government lawsuit that lasted from 1906 to 1911 found Standard guilty of restraining trade, ordering the company to dissolve. Standard was carved up into 38 companies, divided along geographical lines, including Standard Oil (later renamed Exxon) in New Jersey, which became the largest oil company in the world, Socal (Standard Oil of California), Standard of New York (Mobil), Gulf Oil (Texas) and Texaco (Texas). The five majors faced two foreign rivals of their stature: Royal Dutch/Shell and British Petroleum.

As gasoline-powered automobiles proliferated the globe, especially North America, these majors – who became known as the Seven Sisters – sought to control the largest possible portion of the cash flow. The corporate ideal within the oil patch became ownership of the entire chain of petroleum operations from wellhead to gas pump, of a vertically integrated system run by self-capitalizing firms. Exxon and Shell, though strongest in the retail market, were weakest at producing crude and therefore expanded overseas into countries such as Saudi Arabia and Venezuela, becoming the first multinational corporations.

As a result, the world’s first oil cartel took shape in the Middle East. In the 1920s, Shell, BP, Exxon, and Mobil divided up Iraq and in 1934 Gulf and BP signed an exclusive production deal with Kuwait, a tiny country whose largest economic asset was a small wooden fishing fleet. That same year, the additional Sisters from the United States moved into Saudi Arabia, a country of which its entire treasury could then fit into a camel’s saddlebag, and King Ibn Saud was desperate for cash to keep his two-year-old country together. An alliance of Socal and Texaco came up with a short-term payment of USD $275,000 in gold plus USD $25,000 per year in exchange for 60-year leases of lands which proved more prolific than the entire United States. To ensure access to markets, the first two Sisters later cut Exxon and Mobil into the Saudi deal.

In 1928, Exxon, Shell, and BP had held secret meetings to deal with the threat posed to their European markets by cheap crude from Communist Russia and this private volume and price fixing soon expanded worldwide. For decades, the Sisters agreed to sell oil to countries overseas at a price competitive with the cost of Texas crude if it were shipped into that market. The arrangement meant lavish profit margins for majors producing in the Middle East, since oil there was much cheaper to pump and transport to Europe and Asia.

By negotiating with each other, the Sisters determined which countries would produce how much oil at what price for consumers. Major industrial powers in Europe and Asia, provided with oil at a price that permitted excellent rates of economic expansion, did not interfere. The United States accepted the practice, which ensured that domestic production was not affected by a flood of cheaper oil from Venezuela and the Middle East. American governments realized that oil was a strategic commodity and that security of supply was more important than low prices. Inevitably, the producing countries resented the lavish profits earned by the companies, despite themselves not having the technological ability and market power.

This frustration came to a head in 1938, when Mexican workers went on strike and the Mexican government ordered the employers to meet their demands. When they refused, President Lazaro Cardenas nationalized the industry. American, British, and Dutch companies boycotted the new state-owned company, Petroleos Mexicanos, shutting its production out of their refineries and markets. Although some Mexican oil found its way to market after the Second World War began, it was no match for the flood the majors were pumping out of Venezuela, which, by 1946, was the world’s largest producer aside from the United States.

Venezuela, aware that its reserves were limited compared to the Middle East, took advantage of its temporary pre-eminence in production. In 1948, the country successfully insisted that petroleum profits be split 50-50 between producing companies and the government. Within two years, Saudi Arabia won the same deal. When BP refused to compromise in Iran, Prime Minister Mohammed Mossadeq nationalized the country’s oil fields in 1951. Iranian oil then vanished from the market and reappeared without a ripple in oil prices since the world was still awash in crude.

Advocates from producing states, who wanted higher oil prices and a larger percentage of oil revenue, realized that the Seven Sisters were financing their empires of refineries, pipelines, and tankers entirely from huge internal profits. They saw the opportunity to exploit the geographical concentration of the world’s oil exports from Venezuela, Saudi Arabia, Iran, Iraq, and Kuwait, which accounted for 80 percent of the world’s oil exports by the end of the 1950s. Venezuela urged the others to create a producer cartel to mirror that of the Sisters, arguing they could achieve higher revenues by using quotas to match their oil output to world demand.

In 1960, Exxon, followed by the other majors, unilaterally imposed a stiff oil price-cut without consulting exporting nations. Infuriated, the five largest producers formed the Organization of Petroleum Exporting Nations (OPEC) in response, which initially had little impact due to the ongoing surplus of crude oil.

Aside from Communist nations, total oil consumption tripled from 15 million barrels a day in 1955 to 45 million by the end of 1973. Oil and natural gas rose from 38 percent of total world energy consumption in 1950 to about two-thirds in the 1970s, replacing coal. American petroleum production peaked and then entered an irreversible decline by 1970, though still demand grew.

The Seven Sisters lost their grip over the world market starting with Libya. Oil began flowing in the country in the early 1960s, accounting for 25 percent of western Europe’s supply by 1969 – the year corrupt King Idris was replaced by Colonel Muammar al-Qaddafi through as military coup. The Libyans had been careful to ensure that half of their oil was produced by independents rather than the majors. In 1970, the new dictator’s regime threatened to bankrupt Occidental, an independent, by curbing its allowable production. Desperate for oil, Occidental founder Armand Hammer agreed to higher prices and a more generous share of oil revenue for the Libyan government. Other producers in Libya, including the majors, subsequently caved in to the new financial terms as well, at which point the Middle Eastern countries demanded and obtained better contacts that included higher oil prices. Libya in turn demanded even more, and these tactics succeeded because the demand for oil had outstripped supply. Even Texas, which was North America’s primary source, could no longer supply allies so even the United States became dependent on OPEC crude. OPEC’s producers, including Libya, Algeria, and Iraq, began nationalizing their oilfields and Saudi Arabia acquired majority ownership in Aramco, the Sister’s producing consortium in the country.

Then the Egyptian and Syrian armies launched a surprise attack against Israel on October 6, 1973 – the Jewish holy day of Yom Kippur. Anti-American sentiment grew when the United States provided resupply of war materiel to Israel to counter the Soviets doing the same for its Egyptian and Syrian allies. The new OPEC cartel seized control of world oil pricing from western companies to bring pressure against Israel. Arab producers choked the flow of oil to industrialized nations and petroleum prices skyrocketed. Though Egypt and Israel stopped fighting after three weeks, the Arab oil embargo lasted until March 1974.

Source: Alberta in the Twentieth Century, Volume Eleven, Lougheed and the War with Ottawa; CanMedia Inc.