Throughout the twentieth century, international oil and the Middle East have been inexorably linked. The region, as an increasingly important oil producer and exporter, played and still plays a major role in influencing developments in the international oil industry. Equally, since the first oil was exported, the oil revenues and the oil operations have had a profound impact on the economic, social and political situation in both the Arab countries and the wider region.
The Development of the Oil Industry
The development of the oil industry began with concession agreements. In all the countries of the region (Middle East and which includes Iran), as for the rest of the world outside of the USA, sub-soil minerals such as oil are the property of the state. In the early days of the industry, no country in the region had the technical or managerial ability to develop these oil resources. Foreign companies were required to provide the skill, capital and markets for their development. Britain and France company involvement was part of tools and aims of hegemony power, whatever the historical reality, within the region, the oil companies are seen as the extension of the colonial power.
In the early decades of the twentieth century, there were only a small number of such companies, the so-called ‘seven sisters’. To use their modern names these were BP, Chevron, Exxon, Gulf, Mobil, Shell and Texaco. Conventionally, the French company CFP is also added to make the ‘eighth sister’. Collectively they became known as the majors. They operated in the region under the terms of the various concession agreements between themselves and the governments.
After the 1950s, for reasons to be explained, the nature of these agreements changed, moving towards joint ventures and other forms of production sharing and service contracts as newer companies entered the arena.
It was these old-style concession agreements which set the context for subsequent developments. While the details of the agreements differed, there were four common features, which can be identified. First, the agreements were for very long periods of time. The four concessions in Iran, Iraq, Kuwait and Saudi Arabia had an average life of 82 years. Second, the agreements covered very large tracts of territory. In the case of Iraq and Kuwait the agreements covered the whole of the country. Furthermore, unlike later agreements, these early agreements had no provision for relinquishing acreage. In effect the companies could sit on the acreage for a long time, do nothing themselves and at the same time prevent the government from doing anything. A third common feature was the financial terms. In the concessions these were a fixed royalty paid per ton of production. The final feature was the huge amount of managerial control ceded to the oil companies in the development of their concession areas.
Apart from requirements of ‘good oil field practice’ which some but not all the agreements contained, the companies had complete discretion and freedom to decide on the extent of exploration, whether discovered reserves should be developed, the level of production and how the oil should be disposed of. In effect they became a state within a state with total control over what was to become in most cases the key resource of the country. The importance of oil and oil exports flowing from these agreements grew both for the world oil markets and the countries of the region.
The key to this growing role of the region’s oil supplies lay in changes to the pricing mechanisms for oil. Prior to 1928, the international oil industry had been characterized by intense and vicious price wars between the majors. In 1928, tired of the negative consequences of such competition, the majors negotiated the ‘as-is’ agreement which was intended to end price wars. A key ingredient was the ‘Gulf basing point system’. Thus oil products imported anywhere in the world had a landed price as though they had been bought and shipped from the US Gulf of Mexico. This ‘uniformity’ was achieved by the addition of a ‘phantom freight rate’ which the majors then pocketed. In 1944, the British and American navies complained to their governments of this practice. The outcome was that the Iranian Abadan Refinery at the head of the Persian Gulf became a second basing point. This crucial decision effectively opened up world oil markets to lower-cost Middle East crude whose natural market was now determined by real freight costs. In 1945, the western limit of this market was the east coast of Italy. By 1949, it had extended to the east coast of the USA. The introduction of this dual basing point system began the era in which Middle East oil exports dominated world oil trade.
While these concession agreements started the process of producing and exporting oil, they also triggered a series of growing concerns from the governments of the region which were to have a profound effect on the development of the oil industry in the Middle East and the wider world.
There were two broad areas of criticism which emerged through the 1950s. The first criticism was the rigidity of the agreements. Quite simply, there was no option to renegotiate terms despite their long life and the fact they covered so much of the available acreage. The second criticism was the issue of managerial control.
The relinquishment issue received a boost when, in 1960, Iraq implemented Law 80. This was a unilateral taking of all of the company’s acreage except existing producing fields. This prompted others in the region to relinquish acreage to pre-empt a repeat performance. The consequent availability of acreage enabled newer oil companies to enter the region. These included the national oil companies of the consuming countries such as ENI, Hispanoil, Deminex and the Japanese National Oil Company and the smaller American ‘independents’ such as Occidental, Philips, and Amoco etc. The fact these new entrants were willing to offer not only better terms but also a much greater role for the governments, put the older-style concession agreements under ever greater pressure.
The disputes over the financial terms of the concessions rumbled on. At the start of the 1950s, following the lead set by Venezuela, the region’s oil producers moved to a system of profits tax as well as royalties, based upon the setting of posted prices. The next twenty years saw a succession of disputes and negotiations over the precise terms of the fiscal take ranging from the treatment of royalties to various other accounting issues, not least the percentage of profits tax. However, the result was a growing volume of oil revenues feeding into the countries of the region.
However, such renegotiated changes, although important, failed to address the second area of criticism, the managerial freedom available to the companies. The result was that host governments continually put pressure on the companies to secure greater control over decision making. This desire for control by governments was driven by three factors.
First, they wanted to determine the rate at which the oil was developed and produced. After 1960, the posted prices (which determined tax-take) were effectively fixed following the creation of OPEC. This creation had been in response to companies’ effort to lower these prices unilaterally. Thus the only mechanism to increase government revenue was to increase production. As the governments became progressively more dependent on oil revenues, this imperative grew.
Second, there was a growing view that the oil sector should play a more integrated role in the economic development of the countries, especially as a spur to industrialization, which was seen as the obvious means of progress. This is discussed in more detail later. It was perceived this could be achieved more easily if governments had greater control over procurement for the industry. A related issue of control was the flaring of associated gas by the oil companies which was seen by the governments as a waste of national resources.
Finally, there was the politics. The majors were seen as tools of the former imperial powers – Britain and France or tools of the imperial power in waiting – the USA. As such, they were seen as a serious threat to sovereignty. This was at a time when the United Nations Organization among others was pushing the concept of ‘permanent sovereignty over natural resources’. This argued that governments should control these resources rather than companies. Such ideas fell on very fertile soil in the countries of the region.
Thus the 1960s saw the start of a growing battle for control between the governments of the region and the majors. In an effort to move towards greater managerial control, the governments began to create their own national oil companies. This began in Iran in 1951 with the creation of the National Iranian Oil Company. By the early 1970s, every oil producing country had its own national oil company.