The Cartel That Never Was

Saudi Arabia finds in the perceived unity and power of OPEC a convenient illusion
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From its refineries, tankers, and loading platforms, the Seven Sisters cartel had complete knowledge of all facets of the oil market. It also had the power to shut down entire nations that interfered with its concessions: when Mohammed Mossadegh, the prime minister of Iran, nationalized the country's oil industry, in 1951, the cartel denied Iran use of its refineries and tankers for two years, nearly bankrupting the country. Through its network of consortiums, the cartel had absolute control over how much oil was produced and shipped.

The strains that led to the breakup of the Seven Sisters cartel proceeded from a single issue: the division of profits between the international oil companies and the countries from whose territory the oil gushed. Until 1971, the cartel's consortiums gave the countries a set percentage—50 percent in most cases—of an arbitrary price, called the "posted price," that the oil companies paid for each barrel. If an independent oil company attempted to buy oil, it would have to pay a much higher, "third-party" price. It was, of course, in the interest of the oil cartel to keep its posted price as low as possible, and make its profits selling refined oil. In 1970, for example, the posted price was $1.80, as it had been, with minor fluctuations, for twenty years; consumers in Western Europe paid the equivalent of $11 to $13 a barrel for refined oil.

The delicate balance that the cartel had maintained in the world export market for a half-century was irreversibly upset in the late 1960s by the unexpected decline in oil production in the Western Hemisphere. The United States, which had been almost self-sufficient in oil, became a significant importer of Middle Eastern oil. As the scramble for the available supply intensified, it became evident that prices would be forced inexorably upward. With prices for gasoline, heating oil, jet fuel, and other refined products rising in Europe, the countries that produced oil—notably Saudi Arabia, Iraq, Iran, and Libya—were not content with their share of the fixed posted prices; instead, they demanded at least part of the coming windfall.

The first cracks in the cartel's control came in 1970 in Libya—the one major exporter that had granted concessions to independent companies outside the purview of the consortiums. Under the revolutionary leadership of Colonel Qaddafi, Libya threatened to nationalize the independent companies unless they increased Libya's share. Eventually, the largest independent producer, Occidental Petroleum, acquiesced to Qaddafi's demands. Then Saudi Arabia, Iraq, Iran, and other producers in the Persian Gulf demanded that the consortiums grant them the same terms Libya had obtained. When the cartel acceded to these demands, Libya put pressure again on the oil companies, and the cartel found itself caught in a ratchet between Libya and the Persian Gulf producers, both demanding more favorable terms. To solve this problem, the oil companies devised a strategy to force the oil-producing countries to negotiate as a single bloc. Because some of the principal producers were bitter rivals who refused to bargain together, the cartel sought a multinational organization under whose auspices they could assemble for negotiations with the oil companies. In January of 1971, the cartel chose a small Vienna-based group, with a staff of nine, whose very existence it had ignored for the past eleven years—OPEC. A letter signed by the oil companies in the cartel began: "We wish to place before OPEC and its member countries the following proposal. . .

OPEC had originally been established in Baghdad on September 10, 1960, as an intergovernmental group to study posted oil prices. Its five founding members were Saudi Arabia, Venezuela, Iran, Kuwait, and Iraq. During its first six years, which went virtually unnoticed in the press, OPEC based itself in Geneva and opened an "information office," which commissioned occasional studies on crude prices. It also admitted three new members—Qatar, Indonesia, and Libya. After its headquarters moved to Vienna (where the organization was offered diplomatic status for its staff), in 1966, OPEC's main activity became issuing proclamations declaring "solidarity" with the escalating demands of the more rebellious oil producers—notably Libya and Algeria, which joined in 1969. The proposal to serve as a negotiating umbrella for the oil-producing countries was accepted by OPEC, as Henry Kissinger notes in his memoirs, "with a vengeance."

In OPEC, the oil companies found not only a convenient device to bring together feuding states but also a highly visible foe they could blame for the impending rise in oil prices. To negotiate as a single force with this new monolith, the oil companies obtained an antitrust exemption for themselves from the Justice Department. It was not without some irony that OPEC was finally pressed into service by the cartel in Tehran in 1971—a service it had waited eleven years to perform.

Initially, the oil companies' OPEC strategy seemed successful. It produced the Tehran Agreement, in which the producing states, in return for a modest rise in the posted price to $2.18 a barrel and some favorable revisions in the concession terms, accepted a five-year accord that would freeze oil prices. This OPEC agreement lasted only a few months. Each country, ignoring the agreement, insisted that it had sovereignty over its oil concession. The "five-year" Tehran Agreement disintegrated into a free-for-all, and, one by one, the consortiums were nationalized.

Whatever hopes the international oil companies had of reasserting control over the oil-producing nations ended on Yom Kippur of 1973, with the Egyptian invasion of the Sinai. The renewed war in the Middle East caused an oil-buying frenzy in Europe and Japan, as nations fought to build up their reserves of crude oil. Saudi Arabia and other oil producers adopted a policy of charging whatever the freight would bear. Within weeks, the posted price for crude had more than doubled, to $5.60 a barrel. No OPEC control was involved: it was a force majeure that permitted individual nations to raise their prices.

Another price explosion followed the announcement by Saudi Arabia and other Arab states, in October of 1973, that they were cutting back on their oil production and embargoing shipments of oil to the United States and other supporters of Israel. This cutback did not result from any OPEC decision, either. Indeed, many OPEC states—including Iran, Indonesia, Venezuela, Ecuador, and Gabon—actually increased production (and even a few Arab states in OPEC, notably Iraq and Algeria, did not reduce their production). It was almost exclusively an initiative of Saudi Arabia, which was backed vocally, if not materially, by its Arab allies. Moreover, the Saudi decision to shut down 10 percent of the country's oil production was not based entirely on considerations of the plight of the Arabs. The Senate Subcommittee on Multinational Corporations ascertained from testimony of American engineers who were responsible for operating the Saudi fields in 1973 that a 40 percent cutback in the giant Ghawar field—the largest in the world—was required for the installation of water-injection equipment. If it had not made these cutbacks, the entire reservoir of oil would have been jeopardized. Jerome Levinson, the general counsel of the committee, writing under the name Peter Achnacarry, stated: ". . . the embargo saved Saudi Arabia and Aramco [the operating consortium] from the embarrassment of having to explain supply shortages resulting from technical problems." By cloaking the cutback in a political purpose, the Saudis were able to induce other Arab producers, both inside and outside of OPEC, to join them.

In the wild price spiral that followed the Saudi shutdown, the official OPEC price was completely disregarded by other members. Iran and Qatar held auctions to determine how high they could raise prices. At its subsequent meetings, OPEC could do no more than ratify the prices that had already been established by a panicked market.

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