A short review of the oil market history takes us from Rockefeller’s Standard Oil to the shift from posted prices towards the spot market, which is dominated by the forces of demand and supply.
The world of oil started back in 1859 in Pennsylvania as a free world where the forces of demand and supply ruled. This kind of market didn’t last for long. John D. Rockefeller entered the business of oil and changed the rules of the game. Rockefeller went to church once a week, and the rest of his time was devoted to the destruction of his competitors. He was extremely successful. He soon ruled the world of oil in America via his company Standard Oil.
Clearly, the government didn’t want a single company to control about 90 percent of any market, so a legal battle followed and ended with the breakup of Standard Oil. Standard Oil gave birth to new companies: Exxon, Mobil, Chevron, Amoco and Conoco.
Texaco emerged as another big player, one of the few that were not an offspring of Standard Oil. Meanwhile, a British company called Shell distributed oil for Rothschild, who ruled the other oil region of the world, Russia. Royal Dutch found oil in Sumatra in 1890 and formed together with Shell what is today known as Royal Dutch Shell.
British Petroleum, known as BP, started back in 1908 as Anglo-Persian as it had discovered oil in Iran.
Those companies entered the oil rich countries like predators. While there was some regulation and government control in the US, the Middle East proved to be a fertile hunting area for Big Oil. They developed the market and they divided the markets. BP ruled Iran, the Americans had Saudi Arabia.
Some of them even made a treaty to ensure that everything went smoothly. They met in the Scottish castle of Achnacarry in order to control the downstream market. The dominating companies became later known as the “Seven Sisters”; some call them Big Oil.
The rule of the Sisters wasn’t so bad; they really cared about keeping the market supplied. If one company faced a problem, another was ready to help out. They controlled production, distribution, production reserves, the prices and the downstream markets.
The governments of oil producing countries were more like children receiving some money for their piggy bank and less like political forces controlling the country. Big Oil told them how much oil was produced and how much money the government received as Big Oil controlled the price of crude oil.
This worked for some time, but states, especially in the Middle East, simply didn’t kick out their colonial rulers just to be ruled economically by an accountant of BP instead of a commander of the British armed forces.
The clash between governments and Big Oil was inevitable. The states demanded higher prices and a greater share of the money Big Oil received for selling its crude.
Big Oil fought a battle to slow down this pressure and succeeded in delaying the shift of power between governments and companies. Out of frustration, Saudi Arabia and Venezuela initiated the foundation of OPEC, the Organization of Petroleum Exporting Countries, in 1960.
This new organization only managed to note down some collective demands; public relations was the only tangible success of OPEC during the first decade of its existence. The great breakthrough for crude exporters came with the revolution of a young colonel.
In 1969, a young Arab colonel drove his German Beetle car towards the palace of his king to start a revolution that changed Libya. His name was Muammar al-Gaddafi.
As a young and ambitious leader, Gaddafi wanted to change things, and he wasn’t very patient. Once again, the game of “we want more money” against “we will see” began. But this time it was different. He didn’t negotiate with a united front of foreign companies, but chose Occidental, a smaller one, and pressured them into a new agreement.
His next target was Shell. Shell proved to be a tougher target. Shell was more willing to play the delay game.
Some people say Gaddafi is a madman. I am not here to judge his mental state. But he may well be one of the toughest negotiators on earth. Shell refused his offer, so Gaddafi gave orders to close all oil wells operated by Shell in Libya. He added that Libyans had lived for 5.000 years without oil, so they would make it some more years without it.
Was he mad or a genius? Shell didn’t want to find it out, not surprisingly; Shell now thought the Libyan offer was just right as the alternative was a total loss of its investment in Libya.
Gaddafi had shown his colleagues what was possible, others followed to put more pressure on Big Oil. The Seven Sisters started to lose the game as assets were nationalized and national oil companies started to take charge of operations.
The real decisive change came rather unnoticed as an unknown metals trader started to enter the world of oil. Marc Rich, formerly Marcel Reich, started to buy oil from the exporting countries in order to sell it in the spot market, which comprised just five percent of the overall oil market at this time. Most of the oil was traded via long-term agreements (about two years) and fixed prices.
Rich had an advantage: Spot prices were at this time higher than the fixed long-term prices. Oil exporting countries watched the difference and greed succeeded. More and more oil was diverted from long-term trades towards the more promising spot market. The exporters only realized years later that they had practically submitted their business to the market forces of supply and demand.