Let’s talk about oil (Part II)
J.D. Rockefeller, the founder of Standard Oil, became the world’s first billionaire in 1916. It wasn’t Andrew Carnegie, the steel magnate, or Cornelius Vanderbilt, the transportation mogul, or J.P. Morgan, the legendary banker. It was Rockefeller. And this was even considering the fact that oil had largely been used only for machinery, medicine, and lighting up to that point, and transportation only came into the mix in the early 1900s.
Oil has since become the most important commodity, ever. In fact, almost every major geopolitical event in the past century can be tied to oil.
How did oil get to be so important?
A strategic military resource
Oil became a strategic commodity with WWI. In 1913, Churchill decided to shift the country’s military to oil instead of coal. The decision was highly controversial because Britain had lots of coal, but no oil. And yet, the decision enabled the British Royal Navy to travel a much greater range, and helped ground forces to utilize the tank (ending trench warfare). The Allies won WWI due in no small part to oil.
But this decision made the British dependent on access to an energy source thousands of miles away. This made the oil-rich lands in the Middle East of immense strategic importance, and laid the grounds for future conflict.
By WWII, oil influenced most military strategy. Pearl Harbor, for example, happened because the U.S. embargoed oil sales to Japan, and Japan was afraid that the U.S. might try to disrupt its access to the oil-rich East Indies. Germany also invaded the Soviet Union to capture the Baku oil fields, culminating in the Battle of the Caucasus (Hitler even refused to divert troops stationed in the Caucasus to help in the Battle of Stalingrad, saying “Unless we get the Baku oil, the war is lost.” Incidentally, Germany lost both battles).
After the war, the U.S. had massively depleted its resources, and didn’t have enough reserves back home to fight another long-lasting war. This became of increasing relevance as tensions between the Soviet Union and the U.S. grew. Thus, the U.S. also came to focus on the Middle East. The U.S. government (from Eisenhower to Kennedy) even had detailed plans (called the “oil denial policy”) to bomb and destroy all of the oil resources in Saudi Arabia, Iran, Iraq, Lebanon, Egypt, and Kuwait, if the Soviet Union were to ever take control of the region.
This reliance on the Middle East made the U.S. especially vulnerable to Middle East policy. When in 1973, the Middle East embargoed oil exports to the U.S. (due to U.S. support of Israel in the Yom Kippur War), the U.S. economy was devastated. The price of oil quadrupled from $3 to $12 a gallon, and resulted in the 1973–1974 stock market crash.
The rise of the petrodollar
The U.S. decided to try to neutralize oil as an economic weapon by becoming close allies with the Middle East. Nixon struck a deal with Saudi Arabia to standardize the price of oil in U.S. dollars (called the petrodollar system) — from then on, all of Saudi Arabia’s oil was to be sold in USD, in exchange for U.S. military protection. Eventually, all countries in OPEC followed suit with similar deals, and by 1975, all OPEC oil was standardized with the USD. This meant that almost every country looking to buy oil had to first exchange to the USD.
This event had far-reaching consequences into the 21st century— because oil was the most valuable commodity in the world, and because OPEC controlled most of the oil in the world, the dollar became the world’s most valuable currency. And with a growing supply of oil in the world, it increased liquidity in U.S. financial markets (since there were more dollars in circulation), and this kept interest rates low (by increasing global demand of the USD).
The rise of the petrodollar is ironic, because in trying to neutralize oil, the U.S. and the state of the U.S. economy instead became heavily reliant on oil. It’s even believed that the U.S. invaded Iraq in 2003 because Saddam Hussein had shifted Iraqi oil to trade in the EU’s Euro. (Side note: It will be interesting to see what happens now that China recently announced its intention to sell their oil using the Chinese yuan. China, as the world’s biggest importer of crude oil, will be challenging the supremacy of the USD.)
This dependence on oil was evidenced during the Iranian Revolution in 1979, when another oil shortage tripled the cost of oil and resulted in another U.S. recession. Many countries this time finally learned their lessons and made themselves less vulnerable to oil by investing in alternative fuels (it was at this time that countries like France and Japan came to develop a large nuclear energy infrastructure). The price spike also allowed smaller oil producing countries to finally enter the market, like Mexico, China, and Brazil. When the Middle East stabilized a few years later, the influx of oil created during this decade caused the market to be flooded with low-price oil. This devastated energy producing countries, and even ultimately contributed to the collapse of the Soviet Union and led to Hugo Chávez’s Bolivarian Revolution (and another recession in the U.S. in the early 1980s).
In 1990, when Iraq invaded Kuwait and seized Kuwait’s oil fields, the U.S. stormed in and drove Iraq out. The Iraqi invasion of Kuwait also marked a turning point in the U.S./Middle East relationship. In 1989, the U.S. had fewer than 700 troops deployed in all of the Middle East. But after the Iraqi invasion, nearly 250,000 troops were stationed in the area. The U.S. relied on oil production in the Middle East, both for its energy and for its underlying currency, and the U.S. couldn’t accept any increase in political instability.
“Let our position be absolutely clear: An attempt by any outside force to gain control of the Persian Gulf region will be regarded as an assault on the vital interests of the United States of America, and such an assault will be repelled by any means necessary, including military force.” – Jimmy Carter, 1980 State of the Union
Then, suddenly, American dependence on the Middle East reversed.
The “Saudi Arabia of Natural Gas”
In the past decade, there were a few key innovations that changed everything. These innovations were in hydraulic fracturing, horizontal drilling, 3D seismic mapping, and liquefaction trains.
These innovations made it feasible to extract and transport large quantities of natural gas from places that were unthinkable just a few years earlier.
Liquefaction trains made transportation of natural gas possible. Previously, natural gas had to be transported in gas form using pipes, which could be damaged or sabotaged. Thus, this network of pipes required huge up-front infrastructure expenses, and contracts typically had to be made for the long term, on the order of 20+ years. However, with the advent of liquefaction trains and liquid natural gas (LNG), transportation became easy. Shale oil also changed the game by lowering initial capital expenditures and the time for development — conventional oil would take decades and hundreds of billions of dollars to develop, while shale oil production would only take months to drill, and only cost a couple million dollars).
But more specifically for the U.S., hydraulic fracturing and horizontal drilling unlocked access to some of the largest natural gas reserves in the world — the Marcellus shale region and the Utica shale region. Thus began the “shale revolution.”
The U.S. quickly became the world’s top producer of natural gas, surpassing Russia’s total petroleum and natural gas production in 2012, and becoming the largest oil producer after beating Saudi Arabia in 2013. The U.S. has now been the world’s top producer of petroleum and natural gas hydrocarbons for 5 straight years.
In truth, despite Obama’s environmentalist reputation, he actually oversaw the biggest oil boom in American history.
“We have a supply of natural gas that can last America nearly 100 years, and my administration will take every possible action to safely develop this energy”
— Barack Obama, 2012 State of the Union
Interestingly enough, the U.S. also seemed to lose much of its interest in the Middle East at around this time as well.
Changing power dynamic
This rising elasticity in oil production loosened the Middle East’s grip on the global oil market, and diminished the power of OPEC.
In order to try and regain control, OPEC tried to flush out competitors by increasing their production in 2014. In 2014, oil was around $100/barrel. By early 2016, oil had plummeted to $28/barrel. Though low prices decimated the global oil industry, financial hardship also affected OPEC members countries and convinced the countries to cut production in early 2017. OPEC embargoes have also historically been difficult to keep, given the hostility between many OPEC members, such as Shi’a Iran and Sunni Saudi Arabia.
The decreasing prominence of Middle Eastern oil counterintuitively destabilizes the world — Saudi Arabia’s strategic value in the past came from its state controlled oil industry, and its ability to actively step in to add or subtract oil to stabilize a destabilizing geopolitical event. U.S. oil however is privately owned, and will only react to price signals. This means that the global geopolitical middleman has lost much of its mediating strength. And though the U.S. itself has become more energy independent, the global market is still heavily dependent on oil prices, and so any effect on the global market will still affect the U.S.
Oil is still king.
As a result, global superpowers are still fighting to gain influence in countries that are large oil suppliers. For one, the U.S. and Russia have been fighting many proxy wars in recent years. In Venezuela (which possesses the largest proven oil reserves in the world), Russia has been providing millions in loans while the U.S. has imposed sanctions for corruption. In the Middle East, Russia supports Iran (with the 4th largest oil reserves), while the U.S. supports Saudi Arabia (with the 2nd largest oil reserves). If we allow tensions in the region to escalate and war to break out, it may even lead to other superpowers with a large reliance on Middle Eastern oil, like China, to enter the region and exert a new stabilizing presence.
The wheels of history
It wouldn’t be a stretch to say that energy alone has moved the wheels of history. Oil has crowned winners of wars, forged unlikely truces and alliances, and determined the economic potential of countries. There is likely no other resource that has so directly influenced so many consequential events in history, and no other commodity that will continue to influence events in the future.
We must keep an eye on global energy resources and learn from our history. Because from a century of experience, one thing is absolutely clear — if you control energy, you control the world.
I’ve written over 35,000 words about 20 topics in energy and environment — check them out if you’re looking to learn about the sector. See my Table of Contents for an index of everything I’ve written about so far.