Oil booms and oil busts are both ‘crises’ that disrupt market stability and create confusion in economic, political and industrial circles. And because oil is a basic commodity linked to nearly all of our activities, oil market volatility is quickly transferred to other sectors of society as well. What is considered an ‘oil boom’ for the industry is actually an ‘oil shock’ for consumers. High oil prices, if maintained too long, encourage a shifting away from oil, thus hurting the oil industry; on the other hand, drastic falls in prices, although temporarily advantageous for consumers, are ‘market crashes’ for the industry, limiting its capability to invest in new exploration and to meet the rising oil demand (rising partly because of low oil prices). Oil market stability, therefore, provides an optimum functionality for investors, producers, planners, governments, and consumers.
Predicting oil prices and crises is a great game in today’s economy and geopolitics, but everyone agrees that it is a hard game too. Perhaps the history of oil booms and busts offers a realistic perspective on the forces determining oil prices and crises.
The Pennsylvania Years: 1859–1867
The modern oil industry began in 1859 in Pennsylvania, or so the story goes. In this simplified narrative, Edwin Drake drilled a well close to an oil seep in Titusville to extract oil; his persistence and hard work paid off, and that discovery well ushered in the new hydrocarbon age (see The Birth of the Modern Oil Industry). But why did Drake decide to drill an oil well? The answer is the old adage “necessity is the mother of invention”. In other words, technological advances are rooted in market demands. This was, is and will be true for oil everywhere.
In 1853, when Robert Edwin Dietz in New York began producing kerosene lamps, he created a huge market for oil. Drake’s drill was in response to that demand. Therefore, right from its beginning, the oil industry was closely related to the availability of markets. That is why, in 1859 as soon as oil came out of wells, it was sold, on average, at $16 a barrel – equivalent to $442 a barrel at today’s price! This created a craze for oil drilling; production increased from 2,000 barrels in 1859 to 0.5 MMbo in 1860 and 2 MMbo in 1861. As a result, supply far exceeded demand and the price dropped to merely $0.49 (= $13) in 1861. Indeed, the oil market crash of 1861 was so severe that oil producers in Pennsylvania founded the Oil Creek Association to limit oil production. Within the first two years of its birth, the oil industry had experienced its first boom and its first bust. Hence the law of supply and demand set the pattern for oil prices.
Cheap prices motivated huge consumption of oil. The American Civil War of 1862–1864 further increased oil prices as the war cut parts of the supply, showing the importance of oil for war and life, and the impact of supply cuts on oil prices. At the end of the Civil War oil was traded at about $10 (= $146) a barrel. During 1864–65, oil enjoyed a boom, partly because of hyper-inflation as both North and South printed huge amounts of money to finance the war. A new factor – inflation or, in other words, how much money is worth – was superimposed on the law of supply and demand, and is still valid; when the US dollar, in which oil is traded, is weak in the international market, oil prices go up. The 1865 boom did not last long, and within two years oil prices were back to $2.40 (= $41) because of overproduction; another cycle of boom and bust, within a fairly short period of time.
Enter Rockefeller: 1870s–1900s
By 1867, within a decade of the start of the industry in North America, almost all the key factors influencing oil prices had been recognized and tested; these were later incorporated into the global economy and geopolitics. In the 1860s, even though the US exported oil to Europe, oil was not a major product on the global market. Therefore, the oil booms and busts of this early era affected economies locally rather than globally. However, local economy was important to local people, particularly to a businessman as shrewd as John D. Rockefeller. He had made a fortune during the American Civil War and had founded a refinery in 1863 in Cleveland, Ohio, which became the nucleus of Standard Oil of Ohio in 1870, followed by the Standard Oil Trust in 1882. During the 1870s–1880s, Rockefeller’s company dominated American oil business, partly through forcing out his rivals by sometimes unethical practices. Eventually Standard Oil was split into 33 separate companies by the order of the US Supreme Court in 1911. (For more on J. D. Rockefeller and the rise and fall of Standard Oil, see 'Further Reading' below.)
Despite many criticisms of Rockefeller and Standard Oil, they brought some stability and lower prices (compared to the 1860s) to the North American oil market as they reduced the mushrooming number of oil producers and refiners in the region. Nevertheless, the period 1870–1900 had its own bumps too, with a boom when oil prices rose to $4.34 (= $82.30) in 1871 followed by a bust in 1874 ($1.17 = $23.60). In 1876 they rose to $2.56 (= $55.10) mainly because Jon Strong Newberry, Ohio’s Chief Geologist, declared that the US was running out of oil – the first ‘peak oil’ prediction. This boom was short-lived and oil prices fell back to $0.86 ($19.20) in 1881. Indeed, from the 1870s up to World War I, oil prices remained less than $1 a barrel except for two brief periods.
During the 1880s–1890s, two factors, other than Standard Oil, contributed to lower oil prices. First, Edison’s invention of electric bulbs in 1885 diminished the prospect of kerosene lamps as a major source of illumination, while wood, rather than natural gas, remained the main source of heating. Secondly, as oil production and trading became an international enterprise, the first ‘oil wars’ were launched among the oil traders, including Standard Oil, Czarist Russia (represented by the French Rothschild family and the Swedish Nobel family), Royal Dutch Petroleum of the Netherlands, and the Shell Company of the British Samuel brothers.
By the 1900s, new trends were in place. Henry Ford began manufacturing convenient models of gasoline-powered automobiles which, over the years, became popular. In 1907, the first drive-in gasoline station opened in St. Louis. The successful aircraft flight of the Wright Brothers in 1903 ushered in a new age of aerial warfare and transportation. In 1907 Royal Dutch and Shell merged; the group is still one of the world’s oil giants. The naval powers, including Britain’s Royal Admiralty in 1911–1912, made the strategic decision to convert their coal-powered fleets to faster oil-powered warships. These trends were the seeds of rising oil prices. New oil discoveries, however, intensified the globalization of the oil industry, while finds in Texas, Oklahoma, Louisiana, Kansas and California during the 1900s extended the American oil industry far and wide beyond its north-eastern corner. The discovery of oil in Iran (Persia) in 1908 put the Middle East on the world’s oil map; the following year the Anglo-Persian Oil Company, owned largely by the British government, was formed. In 1910, the Golden Lane oil field in Mexico and Miri in Borneo were discovered.
World War I and its Aftermath: 1910s–1930s
Lord Curzon, Britain’s Secretary of State for Foreign Affairs, famously remarked that in World War I (1914–1918) Great Britain and the Allies “floated to victory on a sea wave of oil”. A fifth of Great Britain’s oil came from the ‘cheap’ Persian fields. Indeed, the war established oil as a strategic commodity for the industrial powers and triggered a century of oil colonialism around the world. The world after the war was different: Russia became the Soviet Union following the Bolshevik Revolution of 1917; the Ottoman Empire, a German ally defeated in the war, spilt into modern Turkey and a number of new Arab nations in the Middle East; and a new oil player, the Turkish (Iraqi) Petroleum Company, began competing with the Anglo- Persian in the Middle East.
World War I pushed oil prices from $0.81 (= $19.40) in 1914 to $3.07 ($36.80) a barrel in 1920, a direct response to rising oil demand as more cars, ships and air planes were on the move. The US Bureau of Mines and the US Chief Geologist David White expressed concerns about peak production in the country, thus encouraging American oil companies to explore for oil worldwide, which they did, but in 1921 oil prices crashed to $1.73 (= $23.20) a barrel. Indeed, from the 1920s–60s the average annual oil prices were $2 a barrel or less (averaging $1.50). This long price stability coincided with the golden age of oil in terms of growth, employment, exploration and discoveries. Oil increasingly replaced coal as a more efficient, high-density energy source. What were the forces behind the long market stability of the 1920s–60s?
For one thing, advances in science and technology, including rotary drilling, seismic surveying, well logging and subsurface geological mapping, made oil exploration and discoveries more successful. Moreover, global exploration for oil was strategically supported by the American, British, French and other Western governments. Major Western oil companies were members of oil consortia in the Middle East, South East Asia and Latin America. Enrico Mattei, who desired his Italian company to be part of this international oil club, called them the ‘Sette Sorrelle’ – the Seven Sisters: British Petroleum, Royal Dutch Shell, Exxon, Mobil, Texaco, Chevron, and Gulf Oil. (He had left out the French oil company in order to demonize the Anglo-American companies.)
The Seven (or eight) Sisters had in their hands 80% of the world’s oil reserves outside the USA, and they coordinated to regulate production and minimize downstream competition. This started in 1928 when Sir John Cadman of BP invited the managers of the Seven Sisters to Achnacarry Castle in Scotland for a weekend negotiation to prevent disorder in their global oil business. The secret Achnacarry Agreement was exposed in 1952 by John Blair (who later wrote, The Control of Oil).
Oil market stability was also regulated in the US. Indeed, oil exploration and production between the two world wars had proved to be too successful, and the real challenge was maintaining a balance between supply and demand even by force. In his recent book, Crude Volatility, Robert McNally recounts how state governments imposed military law on two oil fields (in Oklahoma and East Texas) in 1931 and sent armed troops to shut down the producing wells and thus reduce overproduction or so-called ‘physical waste’!
Overproduction coupled with the Great Depression were major factors in low oil prices in the early 1930s. In 1932 US President Hoover set a tariff of $0.21 per barrel on imported crude (about 23% of the domestic crude price). Eventually, the Texas Railroad Commission took over the task of regulating oil production in Texas and neighboring states to prevent lower oil prices – a task which they strictly performed from 1935 through the 1960s.
World War II and its Aftermath: 1940s–1950s
Although the period 1920s–60s experienced a relatively stable oil market, it did have several episodes of price fluctuation. World War II (1939–45) increased demand for warfare oil. After the war oil consumption increased even more drastically because of the reconstruction of Europe, improved life standards, and population growth. Nevertheless, major Western oil companies with the blessings of their governments were able to increase their reserves and production as needed. The Suez Canal crisis of 1956–57 was the first post-war political oil shock; but the price increases were short lived.
In the mid-1950s, with the coming of Russian oil to the global market, oil prices fell. The independent oil producers in the US were alarmed that the import of cheap foreign oil by major American companies to the US could have destroyed their businesses. Under pressure from these companies, President Eisenhower created the Mandatory Oil Import Quota Program in 1959, according to which US import of foreign crude oil could not exceed 12% of domestic production. The import quota was lifted by President Richard Nixon in 1973 when the US needed to import huge amounts of oil – further instances of government intervention in stabilizing the US oil market.