The Seven Ages of Oil Part 1: Boom and Bust, War and Peace, Growth and Decline

The Seven Ages of Oil Part 1: Boom and Bust, War and Peace, Growth and Decline

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January 30, 2015

Dateline January 2015: The Perilous Plummet

The week of January 26, 2015, saw the price of a barrel of oil drop below $45. It has been a perilous plummet from a high of $100.52 just six months ago. If you ask a Goldman Sachs trader, they may tell you the price will probably continue to decline to as low as $30. If you ask an Iranian oil minister, he may tell you the industry might endure a further slump toward $25. Funny thing – if you had asked a trader at Goldman Sachs or an Iranian oil minister the same question 17 years ago in 1998, they may have had the same negative sentiment: “The price of oil is going down, and it is going to stay that way for a while. So just you tighten your belt!”

Boom Goes the Machine-Drilled Well

If we pinpoint the beginning of the commercial oil industry as Edwin Drake’s 1859 machine-drilled well near Titusville, Pennsylvania, then we can say with confidence that oil prices have always known dramatic growth and decline. Mr. Drake did indeed touch off the first major boom, soon to be followed by the first major shock a few years later due to the US Civil War. Indeed, technical innovation, commercial interests, geo-politics, and war have always driven the booms and busts of the oil industry.

The Seven Ages

For clarity, we will define the “Seven Ages of Oil” as those periods in time that saw oil price growth followed by periods of accumulated average price decline of greater than 30% (all prices adjusted for inflation to 2014 dollars). These price climbs and subsequent descents can be extremely dramatic in the short term, as demonstrated by the current 55% drop over the past six months. Or, it can be more gradual as with the multi-year decline from a high of $110 in 1979 to less than $25 in 1994. Similarly, oil prices reached an astonishing near all-time low in 1998 at just over $17 before reaching an all-time high of $140 in June 2008, only to fall once again below $40 by the end of the year. Clearly, oil trading is a high stakes endeavor not fit for the faint of heart. Let us then describe the Seven Ages of Oil in an attempt to discern some measure of commonality or predictability.

  1. 1859-1870: Illumination Births an Industry
  2. 1870-1911: Rockefeller Creates the Multinational Oil Standard
  3. 1911-1921: A Pax on Arabia
  4. 1921-1973: Texas Oil Boom in the Gusher Age
  5. 1973-1994: The Middle East Shrugs its Shackles
  6. 1994 -2008: Deregulation, Speculation, Manipulation, and Detonation
  7. 2008-2015: All Fracked Up
Figure 1 – US oil price fluctuations throughout the Seven Ages of Oil (1859-2015)

Figure 1 – US oil price fluctuations throughout the Seven Ages of Oil (1859-2015)

Figure 2 – Percentage fluctuations throughout the Seven Ages of Oil (1859-2015)

Figure 2 – Percentage fluctuations throughout the Seven Ages of Oil (1859-2015)

1859-1870: Illumination Births an Industry

When Robert Edwin Dietz produced a modern kerosene lamp in 1853, thousands of whales breathed a short sigh of relief. Illuminants, lubricants, and solvents prior to the commercial introduction of oil were obtained from a variety of natural sources including the much persecuted whale and sometimes exploited plant resources. There was limited production of petroleum or gas from coal, asphalt, coal-tars, and shale. It was another Edwin, not Dietz, but Drake who ushered in the Age of Illumination by oil. Edwin would drill the first commercially owned well in Titusville, Pennsylvania, in the year 1859. The 69-foot (21 m) well was drilled for the Seneca Oil Company.

The first yields of 25 barrels per day fetched a pretty premium at the equivalent of $2,000 per barrel – not so surprising given the expensive process of making oil and the high consumer demand for this new luxury product. Production grew sharply in Pennsylvania, and prices dropped nearly tenfold in a single year. In 1859, two thousand barrels were produced. In 1860, half a million barrels were produced, quadrupling by 1861 to more than two million barrels. Correspondingly, prices dropped into the teens before the US Civil War (1962-1964) and brought on the first oil shock. Subsequently, with a massive surge in demand for all commodities generated by the war effort, constriction in oil supply, blockages of turpentine from the south, and a larger tax on alcohol (then a competing illuminant), prices escalated well north of $120 per barrel the following year.

It should be noted that wars are expensive, resource-hungry endeavors. In the 1850s, US federal expenditures were $1 million a week. By the start of the war it had reached $1.5 million a day. By the end of the war it had rocketed to $3.5 million a day. The United States was the first country to spend $1 billion in a single year. To finance the war, the North and the South each taxed its citizens, borrowed money, and printed new dollars. The result was hyper-inflation of up to 9,000% by the end of the war. The North was more effective in its financing, which may have helped them win the war and recover faster in the post-war period. The oil price curve mimics that of inflation during this time.

While the war and the shock may have been relatively short lived, many things were firmly established in those early years:

  1. Oil production is technically driven
  2. Oil is big business
  3. Oil helps win wars
  4. Oil and fiscal policy are closely tied
  5. Oil has no borders
  6. Oil pricing is volatile
  7. Oil can change the shape of the world

Naturally, once the North won the war, tensions settled, markets regained their composure, and the floor on oil prices dropped away before they started to climb again. In that brief decade, the fledgling industry witnessed the two largest boom and bust cycles the industry would ever face, but also primed the energy industry for what would be ongoing, highly dramatized, and world-changing cycles. The first age was over, and Rockefeller was set to make an entrance on the world stage.

1870-1911: Rockefeller Creates the Multinational Oil Standard

Born July 8, 1939, John D. Rockefeller is arguably the most notorious business magnate and philanthropist the world has ever known. The first American billionaire, at the pinnacle of his power he controlled 90% of all US oil. In 1865, Rockefeller bought out Clark & Company at auction for $72,500 to establish the firm of Rockefeller & Andrews. He thereafter quickly manoeuvered to take advantage of the post-war posterity and followed the trains westward to build a national oil business. The next five years saw an expansion in scope as he built business ties and alliances as quickly as he built his oil business. Pivotally, in June of 1870, Rockefeller formed Standard Oil of Ohio. Standard Oil became essentially the one and only oil standard taking over Ohio and then the nation. In the age of cartels and unrestricted monopolies, the oil men and the railroad men (a.k.a. the Robber Barons) became the richest and most powerful people in the world. Rockefeller ate up his competition until, by the end of the 1870s, Standard Oil was refining more than 90% of US oil. As the price setter, Rockefeller would even sell at a loss to gain market share. And for the most part, prices were in decline for the greater part of the Age of Standard Oil.

Notably, Rockefeller was not the architect behind the doubling of oil prices in 1875, but rather it was the US Government. In what would be the oft-called “peak oil” cry of the wolf (as the regulator warned of the wolf amongst the flock, the sky falling, the end being nigh), John Strong Newberry, the chief geologist of the state of Ohio, declared that oil supplies would soon dry up. Obviously, this was no truer in 1875 than it was in 1973 when the Nixon declared the Oil Crisis, or in 1979 when Jimmy Carter implemented subsidies to derive fuel from corn, or in 2005 when George W. Bush’s Energy Policy was developed to combat growing energy concerns (partially arising from the war on Iraq) with tax incentives for alternative energy, or during the Obama Administration when he dithered in his policies on energy independence, $800 billion for clean energy investment, and the ever-pending approval of the Keystone Pipeline.

Following Newberry’s ominous predictions, two major technological advancements would impact oil prices into the turn of the twentieth century. In 1878, the pivotal pioneer of the electric industry, Thomas Edison, would invent the light bulb and essentially eliminate demand for kerosene as an illuminant, sending the oil industry into a brief recession. However, automotive pioneers on either side of the Atlantic would soon help them out of this recession. In 1886, Karl Benz and Wilhelm Daimler introduced gasoline-powered automobiles to Europe and fueled them with California oil. Following in the tracks of the German’s, Henry Ford and his Ford Motor Company began producing the Model T (Tin Lizzie) in 1908. The oil industry would thereafter ride the coattails of automotive industrialists and their fuel-ravenous consumers. Before the automobile, gasoline was simply a solvent produced from kerosene distillation; in other words, it was a cheap way to strip paint.

But getting back to Rockefeller, we can observe that nothing lasts forever: not monopolies, not civil wars, not world wars, not cold wars, not empires, not political regimes, and not the national or geopolitical status quo. Rockefeller’s use of market power to bust railroads and undermine competition finally led to charges of monopolizing the oil trade in 1879. The scale had tipped as the business practices of Standard Oil became a national talking point and a source of shame. It took another 22 years, but eventually in 1911 the US Supreme Court found Standard Oil to be in violation of the Sherman Antitrust Act. Standard Oil was broken up into 34 separate new companies. It has been more than 100 years, but many of these companies remain, although often transformed. Continental Oil became Conoco / ConocoPhillips. Amoco became part of BP. Esso became Exxon and is now part of ExxonMobil. Mobil is now part of ExxonMobil. Pennzoil and Chevron have remained largely the same.

There were other important developments in the Age of Standard Oil. Rockefeller actually quintupled his wealth, as the assets broken up were worth significantly more than under the monopoly. He essentially traded his monopoly power for wealth. Although 85% of global oil production was coming from Pennsylvania in the 1880s, Russia and Asia notably joined the fray during the 1880s, introducing pipelines and tankers to the technology mix. Further, the Rothschilds of Paris were providing the financing. It was the age of power and dominium on a global scale. As Mark Twain so aptly put it, it was the “Gilded Age.” Everything was shiny, new, and exciting on the outside; however, on the inside, greed was insidious, ruthless speculators abounded, scandal was rampant, and politicians were easily corrupted. Thus the 1880s saw the irrevocable and enduring connection among energy (oil and electricity), geopolitics, and finance. The stage was unknowingly set for the conflicts that would define the twentieth century as the Age of the Pax and World Wars.

1911-1921 – A Pax on You

Exiting the Gilded Age – of the Robber Baron, of larger than life magnates, of industrialists and financiers – we approach the staging for world war. Eventually, the culmination of World War I would end the European pastime of Empire building and put in place hegemonic practice of Pax. Prior to the war, there was very little separation between building political influence, empire building, and the building of personal wealth. Financiers and businessmen in Europe and America were constantly conniving to establish their power, national empires, and personal wealth by any means. Just because one oil magnate’s monopoly and aspirations were corralled, it did not mean that the rest of the world was neutered.

While history may rightly denote the assassination of the Archduke Francis Ferdinand, the heir to the Habsburg throne, on June 28, 1914, as the spark that set the world aflame, the predisposition to war was already well established. Similarly, the sinking of the Lusitania on May 7, 1915, may have been used as a ruse to draw the United States into the war formally. However, the United States was already financially invested through deals between the financial houses of the French Rothschild’s and the American Morgan’s as well as myriad other overseas industrialist ventures. As noted, the ties among war, commodities, finance, politics, and social change were well established. But it is important to note that, by the turn of twentieth century, London remained the undisputed financier of the world. But soon, British industrial excellence would succumb to the natural resource strength of America and, more importantly, Imperial Germany (unified in 1871). During its brief 47 years, Imperial Germany was an industrial and technological force, achieving more Nobel Prizes in science than their soon-to-be adversaries in war (Britain, France, Russia, and the United States) combined. The envy and fear of German might was palpable. Germany had to be controlled at any cost!

Of course, one must keep in mind that oil and industry are inseparable. Germany needed resources and German industrialists and financiers made it so. Indeed, it was Deutsche Bank that financed the Berlin-to-Baghdad railway project. Yes, long before the United States stepped into what would later become Iraq, Germany had laid claim to the oil their geologists had discovered in Mosul, Kirkuk, and Basra. Britain, however, was under the assumption that Persian oil had been conceded to them. Churchill had converted the English naval fleet to oil from coal and was desperate for fuel. He thus formed secret alliances with France and Russia to encircle Germany in order to restrict its movements and incite political unrest throughout Imperial Germany. Who really started World War I is immaterial; blame Serbia, blame Austria-Hungary, blame Russia, blame Germany, and blame Britain. And if you decide not to blame any country, you could certainly blame any number of financiers or industrialists. Because, in the end, the war was about access to commodities. Although World War I was epic, the resolution for ultimate global control would not be resolved at the war’s end, nor even in the sequel in 1939.

An underappreciated outcome of World War I was the subsequent Arab Revolt (1916-1918). Sherif Hussein bin Ali incited revolt to gain independence for the various Arab states from the ruling Ottoman Turks. The desire was to create a single, unified Arab state from Syria to Yemen. At the time, the British controlled the Turkish Petroleum Company and thus held some concessionary rights to oil. As far as Britain was concerned, it and France would divide up the Arab land and control the Middle East – the so called Sykes-Picot Agreement. And here we have it, the Age of the Pax – peace through might. By 1923, Britain had leveraged Iraq’s fear of invasion by the Turks to force the complete concession of all rights in the Iraq Petroleum Company (the former Turkish Petroleum Company) for 75 years, despite national sentiments opposing absolute concession. For the balance of the century, the western hegemony would prevail with primarily Britain and the United States neck-deep in Arab Oil in their quest for global dominance. The friction and uncertainty around oil supply post war continued to push prices upwards; but oil prices basically stabilized for almost half a century, until conflict in the Middle East started to come to head and Pax began to unravel.

1921-1973 – Texas Oil Boom in the Gusher Age

In the meantime, the Texas cowboys would have their day. It is not unfair to say that the oil industry matured in Texas. Indeed, Texas, and specifically Houston, would grow to become the energy capital of the world. As the state grew in wealth, so did its stature and influence. The power and might of the United States, as well as its global aims, developed alongside the oil industry. In fact, the United States would later produce father and son US presidents who called Texas their home state and who would take the United States back into Iraq. Gradually, the Pax Britainica would succumb to Pax Americana until the falsely perpetrated Iraq War (a.k.a. the War on Terror).

In 1894, in Navarro County near Corsicana in East Texas, the American Well and Prospecting Company discovered oil by accident while looking for water. By 1898, the Corsicana oilfield was in production. The pivotal event, though, was the Spindletop strike in 1901. At that time, it was the world’s most productive well. Texas and the world were never the same again. The Wild West was quickly transformed, as the advent of Texas oil pushed the United States ahead of the Russian Empire as the world’s largest oil producer. The state came fully into its own by 1940 as the undeniable leader in the global oil economy – just in time for World War II.

Actually, oil prices rode out the Great Depression and WWII with considerably less drama than in any other period. That said, there was a momentary squeeze on oil in 1933 during the Great Depression. With growing Texas supply and a decline in prices, the price per barrel reached a low of around $12. Globally, other nations were upset with the United States, blaming them for overproduction and illegal production. Although there was not the monopolistic Standard Oil of old, the Standard Oil of post-1911 did exist within an oligarchic regime. Takeovers and acquisitions were rampant, locally and globally. It was a period of global unrest, and the Middle East was still in significant turmoil as they tried to throw off their western oppressors and establish independence.

The Shaw in Persia abruptly cancelled Britain’s prized Anglo-Persian oil concessions in November 1932. He rightly wanted a share of the profits to support building his country’s infrastructure. Although Britain toyed with the idea of war, a compromise was reached after the president of Anglo-Persia threatened to abandon the negotiations. Perhaps even more staggering was Saudi Arabia’s King Abdulaziz’ bargain basement sale of oil rights for an upfront payment of $250,000 by Standard Oil and a royalty of about $1.60 per barrel. The Middle East would never truly find its footing, fighting amongst each other over borders and rights, trying to manage the baffling effects of Pax.

But it was not only the Arabs who were feeling slighted. Germany also felt the weight of oppression. Found guilty alongside Austria-Hungary for World War I, the wrath of the victors imposed on them crippling financial sanctions and a disembodied empire. Germany was totally demilitarized. It was not enough that they were faced with insurmountable debt, but when the stock market collapsed on Wall Street on October 29, 1929, it sent financial markets worldwide into a tailspin with disastrous effects. With huge debt, American loans coming due, and the market for exports shrivelling, Germany was in desperate straits. With people out of work, banks failing, savings evaporated, and subsequent hyperinflation, the German people were cast into ruin. The Germans were not alone, and many people across the world turned to Fascism to save their economies. As history has shown, when times are tough and changes need to be made, societies go to war. It seemed that Hitler was the man for the job. He seized the opportunity, appealed to his disenfranchised countrymen, and built a massive armed force.

Much of the 1930s saw war and strife in Europe: the Spanish Civil War, the annexation of Austria, and the invasion of Czechoslovakia. However, it was the German invasion of Poland on September 1, 1939, that set the world to full-scale war once again. On September 3, Britain and France declared war on Germany but left their ally Poland to fall.
But of course, this is the story of oil. Germany’s heavy reliance on oil to power its immense war machine was identified before the conflict. The British RAF and American USAAF conducted a strategic bombing campaign to target facilities supplying oil – no target in any enemy country was spared. No oil, no war. At the close of World War II, with Hitler defeated and Japan staggering from two atomic blasts, three things were firmly established: he who controls the energy controls the world, an atomic age had been ushered in, and America was undoubtedly the world’s superpower.

Going back to Texas, despite the war raging on, by the 1940s, the Texas Railroad Commission had taken regulatory control of the Texas oil industry and managed to stabilize oil production thus eliminating most of the wild price swings that were common during the earlier years of the Texas boom. This basically meant that, from an oil standpoint, the United States entered the war in a composed state. Pivotally, the Great Depression led US President Franklin D. Roosevelt to develop the New Deal. The New Deal was a series of domestic programs enacted between 1933 and 1938 designed to extract the United States from depression through “relief, recovery, and reform.” He changed fiscal policy and reformed banking; but critically, he literally energized the nation by building massive electricity plants and put people to work building physical facilities as well as in the war effort.

The United States exited the war liberalized and empowered, entering a period of fabulous growth. It was the post-war golden age of capitalism that would end in crisis in the 1970s. This extended period of time was also called the “long boom.” Until 1973, the hegemonic control by the United States of most of the world’s oil continued largely unabated. Both the State and the major integrated oil companies were in charge. In July 1944, the Bretton Woods System was put in place to manage the financial relations amongst the first-world nations and established the gold standard, due to requirements to tie currency values to gold.

The United States was engaged in a cold war almost before World War II was over. The Cold War was largely bloodless, save for excursions into Korea and Vietnam starting from 1950. The Cold War served to bolster the US industrial complex and war machine. The armaments and nuclear bombs served as a deterrent to another World War, but came at a heavy economic cost. The benefits, though, were highly attractive. Being a central player in global markets gave the United States ultimate freedom in deployment and foreign relations. The United States was the go-to trade partner for all commodities. The United States intervened where it wanted, when it wanted, with virtual impunity. Pax Americana was at its height prior to the 1970s.

As previously mentioned, nothing lasts forever. The Bretton Woods system collapsed in 1971 when Nixon unilaterally severed the agreement, leaving the world to flounder. The Nixon shock sent the world into a tailspin and was to be followed soon by the OPEC shock. Nixon disconnected the link between the dollar and gold, making the US dollar a fully floating fiat currency. Nixon was prepared to print as much money as necessary to cover the costs of the Cold War. Still, he worried about the long-term strength of the US dollar. Brilliantly, recognizing the world was more hungry for oil now than ever (remember the cries of wolf about oil supply), he simply swapped gold for black gold. Recognizing that Saudi Arabia would love to have the United States as its ready market for oil, Nixon derived an agreement whereby Saudi oil could only be purchased in US dollars. Problem solved – everyone wanted US dollars. But let’s not celebrate too soon…

To be continued.

In part two, we will discuss the three remaining ages of oil, draw some conclusions, and consider the future of oil.

 Effective Date: January 30, 2015

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