MALCOLM AND HILLCART was a real estate agency in the town of Fort William, on the west coast of Scotland, seventy-five miles north of Glasgow. It dealt in the rental of estates for hunting and fishing; and in anticipation of the summer season of 1928, it had prepared the “particulars” for a property called Achnacarry Castle, which was located a dozen or so miles away, in Inverness-shire. Like real estate agents around the world, Malcolm and Hillcart spared no adjectives. “The Castle is beautifully situated on the banks of the River Arkaig and is one of the most interesting historical spots in the Scottish Highlands,” it said. “The surrounding scenery is probably unsurpassed in Scotland.” The shooting—over fifty thousand acres—and fishing were excellent; one might anticipate as many as 90 stags, 160 brace of grouse, and 2,000 fish. The main house itself—built at the beginning of the nineteenth century “in the Scottish baronial style,” though modernized with electricity, hot water, and central heating—had nine bedrooms, plus additional rooms with beds, and another four bedrooms were attached to the garage. For all of August 1928, the estate was available for three thousand pounds; though, to be sure, the renter had to bring his own servants, except for the head housemaid, who would be provided.
What better place could there be to spend some time in a relaxed setting with old friends? Henri Deterding took the property for the month. One old friend who joined him was Walter Teagle, the head of Standard Oil of New Jersey. There was nothing surprising in that; after all, the two men had made it a point to go hunting together on occasion over the years. But this time, the list of old friends was longer; there was Heinrich Riedemann, Jersey’s chief man in Germany; Sir John Cadman of Anglo-Persian; William Mellon of Gulf; and Colonel Robert Stewart of Standard of Indiana. Their holiday entourage included secretaries, typists, and advisers, who were housed in a specially secured cottage seven miles away.
Though great effort had gone into keeping the get-together secret, word leaked out and the London press galloped northward, only to be told that the oil men had gathered merely for some grouse shooting and fishing. But then why the great effort at secrecy? “The grouse were to have no warning,” the Daily Express hypothesized. No further word could be extracted, not even from the butler, about what the oil men might be saying as they traipsed across the moors or sat together in the evening, talking over drinks. Uninterested in the sports and bored with the conversation, Deterding’s two teenage nieces—“hellions,” in Teagle’s phrase—poured molasses into Riedemann’s bed and tied his pajamas in knots. The stiff German was furious. As for the shooting, it was lousy, Teagle later said. But that did not matter, for it was not grouse the oil men were after. They were searching for a solution to the dilemmas of overproduction and over-capacity in their troubled industry. More than trying to bring another truce to the oil wars, they were after a formal treaty for Europe and Asia—one that would bring order, divide markets, stabilize the industry, and defend profitability. Achnacarry was a peace conference.1
This was a year before the 1929 stock market crash and the beginnings of the Great Depression—and two years before Dad Joiner’s discovery in East Texas. But already, oil was surging from the United States, Venezuela, Rumania, and the Soviet Union, flooding the world market, weakening prices and threatening “ruinous competition.” The flow of Russian oil, in particular, had carried the oil men directly to Achnacarry. The vicious price war that Deterding had launched against Standard Oil of New York in retaliation for its purchases of Russian oil had spread to many markets around the world. The battle had gotten out of hand and turned into bitter global warfare, prices were collapsing, and none of the oil companies could feel secure in any market.
Achnacarry reflected the temper of the times. Industrial rationalization, efficiency, and the elimination of duplication were the values and objectives of the day in Europe and the United States, celebrated by both businessmen and government officials, as well as by economists and publicists. Mergers, collaboration, cartels, marketing agreements, and associations were the various instruments for achieving those goals, and they constituted the pattern of international business in the 1920s and, even more so, in the 1930s, with the coming of the Depression. Profits would be preserved and costs controlled through the “efficiencies” of collaboration. As in the days of John D. Rockefeller and Henry Flagler, “unbridled competition” was the danger that had to be fought off. But it was no longer possible to seek to eliminate commercial rivalry through total control, a universal monopoly. No one firm was powerful enough to “sweat” the others into submission. Nor would political realities allow it. And so a concordat, rather than conquest, was now the objective of the oil men of Achnacarry.2
The Hand of the British Government
The meeting at Achnacarry was not only the work of the oil companies. Behind the scenes, hidden from most observers, the British government was prodding and pushing the companies toward collaboration in the pursuit of its own economic and political goals.
At the juncture of these various interests stood Sir John Cadman, the successor to Charles Greenway as chairman of Anglo-Persian. By 1928, Cadman was arriving at the peak of his influence, operating on the same plane as Deterding and Teagle, but also with unparalleled credibility in the eyes of the British government. Growing up in a family of mining engineers, Cadman had begun his own career as a coal mine manager. (He won awards for saving miners during underground disasters.) In time, he became professor of mining at Birmingham University, where he had shocked the academic establishment by introducing a new course in “petroleum engineering,” so novel that an academic opponent denounced it as “flagrantly advertised” and “a blind alley” with “a freak title.” By the outbreak of World War I, Cadman was one of the outstanding experts on oil technology. During the war, as head of the Petroleum Executive, he demonstrated considerable skills both at politics and in managing people. In 1921, he became technical adviser to Anglo-Persian; six years later, the government’s candidate, he became its chairman.
By that time, petroleum production was growing throughout the world, and the total output of Cadman’s own company, from Persia as well as Iraq, was poised to increase fourfold. “It was essential that new markets should be found,” Cadman said flatly. Anglo-Persian had two choices: Fight its way into those new markets, with the consequent large investment and unavoidable competition, or set up joint ventures with established companies and so divide the markets with them.
Cadman chose the second path, making an arrangement to pool markets and facilities in India with Shell as well as with Burmah, which happened to be Anglo-Persian’s second-largest shareholder after the British government. The next target was Africa, where Anglo-Persian and Royal Dutch/Shell proposed to form an “alliance,” under which they would split markets fifty-fifty. But, in order to proceed with this new venture, Anglo-Persian sought in early 1928 the permission of its majority stockholder, the British government. And the government was not at all sure that it should approve. The Admiralty expressed its customary fear that Anglo-Persian might be absorbed by Shell, which would go against the most basic tenets of government policy. The Foreign Office and the Treasury were anxious about alienating the United States. They worried that such a combination might lead the United States—“in the present state of irritability of American public opinion”—to charge that the two companies were making “‘war’ on American interests represented by the Standard Oil Company.” That indictment could easily be extended to the British government, owing to its majority ownership in Anglo-Persian, and that would have most unfortunate political consequences. Moreover, the resulting tensions might lead—so the reasoning went—to pressure on the government to sell its holdings in Anglo-Persian, which would be a catastrophe for the Royal Navy and not very good at all for the Exchequer, which was most attached to its attractive dividends.
Once again Winston Churchill, now Chancellor of the Exchequer, was to play a pivotal role. At first, he had many doubts about the proposed African combination. “The moment when Sir Henri Deterding is at ‘war’ with the Standard,” he said, “seems a singularly inopportune one for the British government to be drawn into the quarrel.” But as Churchill reflected further on the matter, he came to the conclusion that combination was the best policy. It was also the cheapest. “The alternative to the proposed working arrangement was for the Anglo-Persian Oil Company to fight for the market in Africa,” he told the Committee on Imperial Defense. That would require a great deal more money, and would mean that he—on behalf of His Majesty’s government, the largest shareholder—would have to approach Parliament for it. He had done so once before, in 1914, when he had convinced the government to buy shares in Anglo-Persian; and he did not want to go through a similar episode again, especially when it was likely to prove much more controversial. The direct interests of the British government in oil matters were best kept out of sight.
The government, thus, gave its firm support to Cadman’s efforts to form his African “alliance” with Shell. Its overall position was laid out in a joint memorandum from the Treasury and the Admiralty in February 1928. “Such a policy will in the long run be more in the interest of the consumer than cutthroat competition.” The arrangement could have additional benefits, the memorandum went on to say; it might promote “similar alliances elsewhere”—especially with Standard Oil of New Jersey.
That last provision, aside from approval of the African arrangement itself, was the most important thing to come out of the government deliberations. The government had given Anglo-Persian a mandate to talk with Standard Oil and to seek out similar market arrangements with the Americans in order “to allay their jealousies and show that we are not out to quarrel.” For, unhindered by the American tradition of antitrust, the British government was partial to combination. As one British official wrote at the time, “Our experience has broadly been that the amalgamation of oil interests has not resulted in the consumer suffering.”
Cadman, now representing government policy as well as Anglo-Persian, pursued a concordat with the American companies. Once the African deal with Shell was done, he wrote to Teagle of Jersey to propose “a small ‘clearing-house’ for matters of the very highest policy” for their respective companies, plus Royal Dutch/Shell. These various developments were among the major influences leading to Deterding’s invitation to Teagle, Cadman, and the others to join him, in August of 1928, for a little shooting and fishing at Achnacarry Castle in the Scottish Highlands.3
“The Problem of the Oil Industry”
The two weeks of discussion that ensued on the banks of the River Arkaig resulted in a seventeen-page document, agreed to but not signed, that was called the “Pool Association.” It became better known as the Achnacarry or “As-Is” Agreement. The document summarized the “problem of the oil industry”—overproduction, the effect of which “has been destructive rather than constructive competition, resulting in much higher operating costs. … Recognizing this, economies must be effected, waste must be eliminated, the expensive duplication of facilities curtailed.”
But the heart of the document was the “As-Is” understanding: each company was allocated a quota in various markets—a percentage share of the total sales, based upon its share in 1928. A company could only increase its actual volumes insofar as the total demand grew, but it would always keep to the same percentage share. Beyond this, the companies would seek to drive down costs, agreeing to share facilities and to be cautious in building new refineries and other facilities. In order to increase efficiency, markets would be supplied from the nearest geographical source. That would mean extra profits, since the sales price would still be based upon the traditional formula—American Gulf Coast price plus the going freight rate from that coast to the market—even if the oil was coming from a closer location. That provision was central, for it established a uniform selling price, and adherents to the “As-Is” Agreement did not have to worry about price competition—and price wars—from other adherents.
A few months later, the industry leaders agreed to control production as well. Participants in the Achnacarry system could increase their output above the volumes indicated by their market quotas, but only so long as they sold this extra production to other pool members. In order to implement the agreement, an “Association,” managed by one representative from each company, was set up to carry out the necessary statistical analysis of demand and transportation and to allocate the actual quotas.
An important participant in the European oil trade was, however, noticeable by its absence from the agreement—the Soviet Union. Clearly, the Soviets had to be brought into the “As-Is” system if it was to have any chance of success. For, by 1928, a Soviet company, Russian Oil Products, was the fourth-largest importer into the United Kingdom. The Soviets had regained prewar production levels, and oil had become the Soviet Union’s largest single source of hard currency earnings. Remarkably enough, considering Deterding’s and Teagle’s distaste for doing business with the Soviet Union, the major companies reached an understanding with the Russians in February 1929, which gave the Soviet Union a guaranteed share of the British market. With Russia apparently roped in, at least in part, there was only one major exception to this amicable division of the world’s oil markets. But it was a very large one: The agreement explicitly excluded the domestic U.S. market, in order to avoid violating American antitrust laws.4
The Achnacarry Agreement, crafted in the isolated beauty of the Scottish Highlands, harked back to the turn of the century, when Rockefeller and Arch-bold, Deterding and Samuel, the Nobels and the Rothschilds all strenuously sought a grand concord in the world oil market, but failed in the attempt. This time around, the oil companies were no more successful in implementing their new agreement than they had been in keeping their meeting at Achnacarry secret in the first place. While the companies involved in the “As-Is” Agreement were by far the dominant firms, there were enough “fringe” players who did not belong and who did not hesitate to nibble away at the market share of the major companies. In fact, nonmembers of the “As-Is” Agreement found it to their liking. They could price just a bit beneath the large companies and win market share. Even if the members did respond with tough price competition, forcing the nibblers out of one market, these smaller companies could move on to another.
In particular, it was critical to win control over American oil exports, which amounted to about a third of all oil consumed outside the United States. And immediately upon Teagle’s return from Achnacarry, a number of American companies, seventeen in all, combined to form the Export Petroleum Association, which would jointly manage their oil exports and allocate quotas among them. They were acting under an American law called the Webb-Pomerene Act of 1918, which allowed U.S. companies to do abroad what the antitrust laws did not permit them to do at home—come together in a combination—so long as the combination’s activities took place exclusively outside the United States. But the association’s negotiations with the “European Group” fell apart over the question of how to allocate output between the American and European companies. Moreover, the association never attained the critical mass—at the most, it controlled only 45 percent of American exports—while seventeen companies were simply too many to come to satisfactory agreement on prices and quotas. The failure of this attempt to cartelize U.S. oil exports further undermined the determined efforts at Achnacarry.
All over the world, there were too many producers and too much production outside the “As-Is” framework. “The figures we had before us,” J. B. Kessler, a Royal Dutch/Shell director, wrote to Teagle, “showed that, of the potential world production, a large part is controlled by companies which are not controlled either by you or us or any of the few other large oil companies. From this followed that the present balance in the world’s oil production cannot possibly be maintained by you and we only.” It did not take long for the accuracy of Kessler’s prediction to be confirmed. Discoveries and output in the United States were building up to the great crescendo of East Texas. Oil was also coming onto the world market from other sources, such as Rumania. In the surge of uncontrollable production, the Achnacarry Agreement was washed away. And the oil companies once again began attacking one another’s markets.5
Discord Within “Private Walls”
The Big Three—Jersey, Shell, and Anglo-Persian—tried to reformulate an alliance in 1930, but this time in a less grandiose manner. They revised the “As-Is” understanding in the form of a new Memorandum for European Markets. Instead of seeking a global arrangement, their operating companies in the various European markets would try to make “local arrangements,” dividing market shares, with “Outsiders.” Yet once again, the system proved rather ineffective in the face of the still-rising volumes of American, Russian, and Rumanian oil. The Soviets, in particular, never hesitated to cut prices when they saw the opportunity to earn more revenues. Normal commercial considerations did not apply for them; the Russian trading organizations were charged by the Kremlin with earning as much foreign currency as possible, in whatever way they could, in order to pay for the machinery that Russia needed for its industrialization drive. Despite the continuing efforts, the companies found it impossible to fashion an “orderly” and durable marketing arrangement with the Russians.
By 1931, Jersey, for one, had grown disenchanted with unworkable global alliances. “In view of the collapse of the Export Association, our as-is arrangement with the Royal Dutch should be abrogated,” E. J. Sadler, Jersey’s head of production, told his colleagues. “Jersey at present makes a great sacrifice in protecting other companies in uneconomical movements or situations.” He advocated that Jersey junk the whole effort at cooperation and instead make war on the Shell group. “Now is the best time to fight the Royal Dutch, as they are most vulnerable in the Far East. … In this region we have never made any profit, and a price war would cost us almost nothing.” In a grim meeting in March 1932, Deterding and other senior executives of Royal Dutch/Shell made the bleakness of the worldwide situation abundantly clear to M. Weill, who oversaw the Rothschilds’ large interest in Royal Dutch/Shell. Sales volumes had plummeted, Weill reported afterward to Baron Rothschild. “Prices are bad everywhere, and except for a few rare places, money is not being made.”
In November 1932, Sir John Cadman addressed the American Petroleum Institute. He devoted his speech to extolling the merits of “cooperation”—“strictly, of course, within the laws of every country.” His remarks clearly belied the widespread view that the “As-Is” arrangements were a secret conspiracy, unknown to the larger world. After all, here was John Cadman, chairman of Anglo-Persian, standing up before the entire membership of the American Petroleum Institute to declare that “the principle of ‘As-Is’” has “become the keystone of cooperation in international petroleum trading outside the United States.”
Cadman went on to warn the delegates, “It is still raining outside,” and with catastrophe looming at the very depths of the Depression, the companies could not give up the effort to seek shelter from the storm and stabilize the industry. They came up with a new version of the “As-Is” understanding: the Heads of Agreement for Distribution, of December 1932, which “should be used as a guide to representatives in the field for drawing up rules for local cartels or local Agreements.” The initial adherents to the Heads included Royal Dutch/Shell, Jersey, Anglo-Persian, Socony, Gulf, Atlantic, Texas, and Sinclair. The new arrangement was managed by two “As-Is” committees, one in New York, oriented to supply, and one in London, oriented to distribution. A central “As-Is” secretariat was established in London to carry out the statistical and coordinating tasks under the agreements. Internal “As-Is” departments were also established in at least some of the companies. But there were many points of friction in the new arrangement, including chronic cheating and the problem of what to do about “virginal markets,” that is, markets in which participants had not previously traded but were now seeking to enter.6
As the Great Depression progressed, so did the problems in the oil industry, and the companies tried yet again to improve the “As-Is” system, this time devising the 1934 Draft Memorandum of Principles, which provided for looser cooperation agreements. So severe was the Depression’s pinch that the new memorandum called for “economy in competitive expenditure.” Money was to be saved, and competitive differences among companies reduced, by cutting back on advertising budgets. The number of road signs and billboards was to be reduced; newspaper advertising “to be restrained within reasonable limits”; and “premiums to racing drivers” to be cut or eliminated. The little promotional gifts so dear to motorists, such as cigarette lighters, pens, and calendars, were to be sharply limited or done away with altogether. Nothing was left unscrutinized; even the number and type of signs in gas stations were “to be standardized to reduce unnecessary expenditure.”
Such agreements, whatever their scale or actual effectiveness, were inevitably controversial, arousing passionate and pervasive criticism on one side and self-righteous defense on the other. Many looked at them and found only proof of a giant conspiracy directed against the interests of consumers. There was great apprehension about international cartels in any industry and, especially, any show of camaraderie among the giants of oil. Yet these arrangements, outside the United States, did not run counter to the laws of various countries. On the contrary, both the temper of the time and the pressure of government policies, in addition to the business environment, pushed toward some form of collaboration and cartelization.
Within the walls of each company that was a party to the agreements, the senior management would refer to the management of other companies as “friends”: “Friends in London say …” or “Friends not yet made up mind.” But it was not friendship that was at work, not a “brotherhood of oil.” Rather it was a sense of desperation in a depressed world economy and in the face of stagnant demand that really brought the oil companies together. They were aggressive competitors, and they never forgot that. The efforts at collaboration were paralleled by pervasive distrust, wariness, and deep-seated rivalry. Even as they were talking cooperation, they were plotting new attacks. Just a few months after Achnacarry, Shell entered the East Coast market in the United States and proceeded to expand its business very rapidly. Jersey was infuriated; one of its executives denounced the Shell move as “warranted only by ambition.” Then, in 1936, Henri Deterding learned that Jersey was discussing the sale of its entire Mexican operation to William Davis, an independent oil man with interests both in the United States and in Europe. Davis was one of those “fringe” players who made enforcement of the “As-Is” agreements so difficult. “We are engaged together in resistance to Davis’ activities,” Deterding angrily wrote to Jersey, “and surely it is hopelessly inconsistent with sound warfare to sell the enemy a complete set of much needed munitions with which more effectively to conduct the war with us.” In fact, all during the 1930s, as Jersey discussed cooperation with Shell, it was continually giving serious consideration to merging its foreign business with Socony so that it could better take on Shell.
Moreover, conflict constantly erupted over implementing what was agreed to, or even agreeing as to what had been agreed to. The 1934 Draft Memorandum of Principles contained the provision that outside auditors would review the various adherents’ trade numbers. A senior executive of Standard-Vacuum, the joint venture of Jersey and Socony in Asia, was outraged. He and his colleagues “are unanimously opposed to this,” he said in December 1934. “Not only is the thought of having outside auditors go over our books objectionable for obvious reasons, but it seems to us that the As-Is would be on a very weak foundation if the parties concerned cannot trust each other to the extent of giving correct information on the volume of trade.” He added, “We should by all means keep the operation of the As-Is within the private walls of those interested.” But things did not go easily even inside those private walls. In December 1934, Shell director Frederick Godber was in the Far East, where he reported, “Figures trade clearly show Texas Co. unnecessarily aggressive and will end year with larger share of trade than that to which they are entitled.” He added that the other companies would have to apply “sterner measures” against the errant Texas Company. Agreements notwithstanding, the impulse to compete could not be completely checked.
And how successful was the allocation process itself? The results for the United Kingdom, for instance, showed considerable unevenness. Shell and Anglo-Persian formed a combined marketing system in Britain, Shell-Mex/BP. The ratio of sales between that group and Jersey’s affiliate, with some notable exceptions, remained relatively constant. But the two groups’combined share of the total market fluctuated considerably as oil entered Britain from a variety of sources.
As unstable as they were, the “As-Is” agreements became much more effective with the Draft Memorandum, from 1934 onward. Three factors contributed to its comparative success. In the United States, Federal and state authorities, led by Harold Ickes, finally brought production under control. In the Soviet Union, the quickening pace of industrialization stimulated domestic oil demand, constricting the amount of oil available for export. And the large companies finally succeeded in getting some control imposed on Rumanian output. Even so, there were not very many years of respite. In early 1938, Jersey gave verbal notice of termination of the “As-Is” agreements. And, in large part, any surviving “As-Is” activities came to an end in September 1939, with the outbreak of World War II.7
The “As-Is” agreements did not take place in a vacuum. They were meant to defend not only against the glut of oil and then the Depression, but also against the emergence of powerful political forces in Europe and elsewhere. “Throughout the European continent, government policies confronted those of private foreign oil companies—and the scope of the confrontation was unprecedented,” one historian has written. “It is little wonder that in a defensive manner they discussed among themselves means of coping with the abnormal conditions of trade.”
During the 1930s, the forms of political pressure on the oil companies were many. Governments imposed import quotas, set prices, and placed restrictions on foreign exchange. They forced companies to blend alcohol made from surplus crops into motor fuel, and to use other petroleum substitutes. They levied a multitude of new taxes and intervened to control the direction of the export and import trade in oil to match bilateral trade agreements and larger political links. They blocked profit remittances, forcing investment in domestic facilities that lacked economic justification, and insisted that companies maintain extra inventories. As a result of the Depression, autarchy and bilateralism were the order of the day in the 1930s, with consequent pressure to circumscribe the major oil companies. For, warned the President of the Board of Trade in London, there was now a “general tendency in all foreign countries to-day to force or encourage the establishment in their own lands of national companies in the place of non-national subsidiaries.”
It became standard practice for European governments to compel foreign companies to participate in national cartels and to divide the market between foreign and local companies. In country after country, the government insisted that the foreign companies help build up local refining capacity. The French government, operating under the 1928 legislation, allocated specific shares in the market to each company. In France, said a Jersey executive, “failure to cooperate with a national commercial endeavor—whatever the sacrifice in dollars or in principles—invariably provoked retaliatory legislation which was more costly to private interests than the original government proposals.” In Nazi Germany, regulations and manipulation of all kinds were mounting, as that government geared up for war. Overall, in the second half of the 1930s, with the worst years of the Depression behind, the most important objective for the major oil companies became to insulate and protect themselves against government intervention. “We are now confronted with nationalistic policies in almost all foreign countries, as well as decidedly socialistic tendencies in many,” said Orville Harden, a vice-president of Jersey, in 1935. “These problems are between the Government, on the one hand, and industry as a unit, on the other. They are becoming continually more serious, and a very large part of management’s time is devoted to efforts at their solution.”
That same year, an observer of the oil industry, noting the intensification of political and economic nationalism in Europe, summed it all up very simply: Operations in the oil business in Europe, he said, “are 90 percent political and 10 percent oil.” The same seemed to be true in the rest of the world.8
The Shah’s New Terms
At the very bottom of the Depression, Shah Reza Pahlavi of Persia became infuriated at discovering that, as an observer put it, “oil is not gold in these days.” The Shah’s country had become an oil state; petroleum royalties from Anglo-Persian provided two-thirds of its export earnings and a substantial part of government revenues. But, with the Depression, the royalties from Anglo-Persian had plummeted to the lowest level since 1917. Appalled and outraged, the Shah blamed the company, and he decided to take matters into his own hands. At a Cabinet meeting on November 16, 1932, to the surprise of his ministers, he abruptly announced that he was unilaterally canceling Anglo-Persian’s concession. It was the thunderbolt that no one had really believed that the Shah would dare deliver. His action threatened the very existence of Anglo-Persian.
The Shah’s announcement, though unexpected, was the culmination of four years of negotiation and tension between Persia and the Anglo-Persian Oil Company. In 1928, John Cadman had observed “that concessionaries can regard their future as safeguarded against the rising tide of economic nationalism in proportion to the extent in which the national interests and their own approach identity.” But Cadman had found it most difficult to create that identity. Indeed, the Persians charged that William Knox D’Arcy’s 1901 concession violated national sovereignty; they also wanted more money out of the concession, much more. In 1929, Cadman thought he had worked out a deal with the Shah’s Minister of Court, Abdul Husayn Timurtash, whereby the Persian government would not only have obtained much higher payments; it would also have acquired 25 percent of the company’s shares along, possibly, with board representation and a share of the company’s overall global profits. But the proposed deal could never be closed. There were recriminations and accusations on both sides. The discussions continued, but every time an agreement seemed to be at hand, the Persians would submit new amendments and revisions and would ask for still more.
The prime reason for the inability to come to final agreement lay in the character of the highly personal autocracy in Persia and the huge man who stood at the top. Reza Khan had used his command of the Cossack Brigade to make himself the unchallenged and unchallengeable leader of the country. He was a tough, domineering, brutal, and blunt man, who, said a British minister to Tehran, “does not waste time in exchanging the delicately phrased but perfectly futile compliments so dear to the Persian heart.” Reza Khan had become War Minister in 1921 and then Prime Minister in 1923. He dallied with the notion of making himself President, but then decided otherwise, and instead in 1925 crowned himself Reza Shah Pahlavi, founder of the new Pahlavi dynasty. Thereafter he set out to modernize his country, but in an erratic and chaotic fashion. The Shah’s greatest fault, said Timurtash, was “his suspicion of everybody and everyone. There was really nobody in the whole country whom His Majesty trusted and this was very much resented by those who had always stood faithfully by him.”
The Shah was contemptuous of his subjects; he told one visitor that the Persian people were “bigoted and ignorant.” He was also bent on consolidating the fractious country and centralizing control in his own hands, which meant reducing all other competing centers of power. He began with the clerics, the mullahs who led the traditionalists and religious fundamentalists strongly opposed to his efforts to create a modern, secular nation. In their eyes, the Shah was guilty of many sins; he had, after all, abolished the compulsory wearing of the veil by women. He was spending money on public health services and was widening educational opportunities. But he would not be stayed. He once even personally beat an ayatollah who had questioned the appropriateness of the dress of female members of his family as they entered a shrine. The mullahs as a group were beaten down into a sullen but still rebellious submission. “It has often been said,” observed a visitor, “that the Shah’s greatest achievement is his victory over the Mullahs.”
In the Shah’s opinion, Anglo-Persian was like the mullahs—an independent power center, and he was intent on reducing its power and influence as well. But he also relied on its royalty payments to fulfill his ambitions. With the drastic fall in oil revenues for Persia, the local press and politicians, responding to the dictates of the Shah, intensified their attacks on the company, criticizing and challenging everything from the validity of D’Arcy’s original concession to the fact that there was refrigeration of food at the refinery site at Abadan, which was considered irreligious.
Moreover, the Shah had become angry with Anglo-Persian’s majority stockholder, the British government, about other issues. He was trying to assert Persian sovereignty over Bahrain, while Britain insisted on maintaining its protectorate over the island sheikhdom. And he was furious at the British for their diplomatic recognition of Iraq, which he regarded as an invention of British imperialism. The management of Anglo-Persian could endlessly repeat that the company operated as a commercial entity, independent of the government, but no Persian would ever believe such an assertion. Hearing such statements, they “could only imagine that duplicity was being compounded with complicity.”
Matters came to a head in November 1932, with the Shah’s unilateral cancellation of the Anglo-Persian concession. His action was a direct challenge to the British government, whose military security had been tied by Churchill in 1914 to Persian oil. Britain could not passively accept the Shah’s action. But what to do? The issue was sent to the League of Nations. With consent of all concerned, the League put the matter into abeyance, to give the contending parties time to try to work out a new arrangement. Five months later, in April 1933, Cadman himself went to Tehran to try to salvage the situation. After meeting with the Shah, he noted, “There is no doubt that H.M. [His Majesty] is after money.” By the third week of April, negotiations were again deadlocked; and Cadman, frustrated and exasperated, returned to the Palace for yet another discussion with the Shah. To emphasize that a breakdown was at hand, that his own patience was at an end, and that he was ready to depart, Cadman instructed his pilot to carry out a trial flight and taxi the plane in such a way that it would be visible from the windows of the Shah’s palace during the course of the meeting.
The point was not lost on Reza Shah, who now retreated. Persian demands were moderated. By the end of April 1933, a new agreement was finally forged. The concession area was reduced by three-quarters. Persia was guaranteed a fixed royalty of four shillings per ton, which protected it against fluctuations in oil prices. At the same time, it would receive 20 percent of the company’s worldwide profits that were actually distributed to shareholders above a certain minimum sum. In addition, a minimum annual payment of £750,000, irrespective of other developments, was guaranteed. The royalties for 1931 and 1932 were to be recalculated on the new basis, and the “Persianization” of the workforce was to be accelerated. Meanwhile, the duration of the concession was extended from 1961 to 1993. “I felt that we had been pretty well plucked,” noted Cadman afterward. But the essential position of Anglo-Persian had been preserved.9
The Mexican Battle
Of all the nationalistic challenges to the oil companies, the greatest came in the Western Hemisphere. There, in one of the world’s most important petroleum-producing countries, the companies were caught up in a bitter battle against the full force of fervent nationalism, which challenged the very legitimacy of their activities. The setting was Mexico, and the focal point of dispute was paragraph 4 of Article 27 of the Mexican Constitution of 1917, the clause that declared that underground resources—the “subsoil,” as it was called—belonged not to those who owned the property above, but to the Mexican state.
To the companies, of course, that was dangerous dogma. In the years immediately after the adoption of the 1917 constitution, they fought hard against implementation of Article 27, invoking support of the American and British governments along the way. They maintained that the property rights that they had acquired before the revolution, and in which they had invested so heavily, could not retroactively be seized by the state. Mexico insisted that it had owned the subsoil all along, and what the companies possessed did not constitute company property, but only concessions, granted by the fiat of the state. The result was a standoff—in effect, an agreement to disagree.
But the Mexican government did not want to push too far in the late 1920s. It needed the companies to develop and market petroleum. It also, more generally, sought foreign investment to promote the country’s “reconstruction;” and driving out the oil companies would hardly have been good advertising. Thus, the Mexican government devised a loose, face-saving formula that kept the companies working but preserved its claim to ownership of the subsoil. This modus vivendi was hardly easy; it was punctuated by periods of sharp acrimony and bitter rhetoric. The tension rose so high in 1927 that a rupture between the Mexican and American governments appeared imminent, with the possibility of another U.S. military intervention, as had occurred when Woodrow Wilson dispatched troops to Mexico during the revolution. The risk seemed real enough to President Plutarco Elías Calles that he ordered General Lázaro Cárdenas, the military commander in the oil zone, to prepare to set the oil fields on fire in the event of a U.S. invasion.
Yet, from 1927 onward, a greater stability and a calming emerged in relations between the oil companies and the Mexican government, and between the two governments themselves. But, by the mid-1930s, that new détente was coming undone. One reason was the economic condition of the industry. Mexico was losing its ability to compete in the world oil market, particularly against Venezuela, because of higher production costs, increasing taxation, and the exhaustion of existing fields. Venezuelan oil was even being landed in Mexico for refining at Tampico because it was cheaper than Mexican oil! The largest foreign oil company was Cowdray’s old Mexican Eagle, now partly owned and more or less completely managed by Royal Dutch/Shell. This group was responsible for about 65 percent of Mexico’s total production. American companies produced another 30 percent, led by Standard Oil of New Jersey, Sinclair, Cities Service, and Gulf. Rather than risk new investments in the face of the unsettled conditions in the country, most of the companies were simply trying to maintain what they had. As a result, the country’s production fell dramatically. In the early 1920s, Mexico had been the world’s second-largest producer. A decade later, production had fallen from 499,000 barrels per day to 104,000 barrels per day, a drop of 80 percent. That was a sore disappointment to a Mexican government that had been counting on a buoyant oil industry to deliver higher revenues. It blamed the foreign companies exclusively, rather than acknowledging the effects of a depressed international market and of domestic conditions that were decidedly inhospitable to foreign investment.10
The political environment was also changing in Mexico. Revolutionary fervor and nationalism were surging again, and syndicalist trade unions were rapidly growing in membership and power. These changes were personified in the figure of General Lázaro Cárdenas, the former War Minister who became President at the end of 1934. A man of striking appearance, he had, said the British minister, “the long, mask-like face and inscrutable, obsidian eyes of the Indian.” The son of an herbalist, Cárdenas had been able to attend school only to the age of eleven, though he remained for the rest of his life a voracious reader of everything from poetry to geography, but especially of history, and more especially the history of the French Revolution and of Mexico. At the age of eighteen, having already worked as a tax collector, a printer’s devil, and a jailkeeper, he enlisted in the Mexican Revolution. Recognized for his valor, his self-contained modesty, and his leadership, he was a general by the age of twenty-five and became a protégé of Plutarco Calles, the jefe máximo, the “maximum chief” of the revolution. In the 1920s, while other of the new military leaders moved to the right, Cárdenas stayed on the left. As Governor of his home state of Michoacán, he devoted much energy to promoting education and to breaking up large estates in order to give the lands to the Indians. He was sober and puritanical in his own way of life, a supporter of prohibition and an opponent of casinos.
When Cárdenas was elected president, he packed his old mentor General Calles into exile and demonstrated that he was his own man and not a puppet. Adept at playing one group off against another and asserting his own supremacy, he went on to create the political system that would dominate Mexico until the end of the 1980s. Oil and nationalism would prove central to that system. Cárdenas was, in fact, the most radical of any of the Mexican Presidents. “His leftist inclinations make him the bugbear of capitalism,” the British minister said of him in 1938, “but all things considered it is to be regretted that there are not more men of his calibre in Mexican life.” Cárdenas aggressively pushed land reform, education, and an expensive program of public works. Labor unions became far more powerful during his presidency. He publicly identified himself with the masses and incessantly toured the country, often arriving unannounced to listen to the complaints of the peasants.
To Cárdenas, a fervent nationalist as well as a political radical, the foreign oil industry in Mexico was a painful and sore presence. As military commander in the oil region in the late 1920s, he had developed a considerable dislike for the foreign companies. He resented what he saw as their arrogant attitude and the way that they treated Mexico as “conquered territory”—at least so he was to write in his diary in 1938. And once he assumed the presidency, a shift to radicalism was inevitable. In early 1935, a few months after Cárdenas’s inauguration, one of Cowdray’s lieutenants in Mexican Eagle complained that “politically the country is quite Red.” The oil companies had known how to do business in pre-Cárdenas Mexico, a world of blackmail, bribery, and payoffs, but they were ill-equipped to handle the new realities.
Mexican Eagle itself was caught in a crossfire between its local management, trying to adjust to the new spirit of radicalism in the country, and Royal Dutch/Shell, which had overall managerial control, though only a minority of the stock. Henri Deterding, said the resident manager, “was incapable of conceiving of Mexico as anything but a Colonial Government to which you simply dictated orders.” He tried to “disillusion” Deterding. Not only did he fail, but Deterding, in turn, accused him of being “half a Bolshevik.” The manager could only fulminate. “The sooner,” he said, “that these big international companies learn that in the world of to-day, if they want the oil they have got to pay the price demanded, however unreasonable, the better it will be for them and their shareholders.”
Standard Oil of New Jersey was also in no mood to accommodate to the new political realities. Everette DeGolyer, the prominent American geologist who just before World War I had made the huge discovery that was the basis for the “Golden Lane” and the growth of the Mexican oil industry, had maintained his Mexican contacts. Now he was worried by the implacable stance of the American companies. He privately urged Eugene Holman, head of Jersey’s production department, to “work out a partnership deal with the Mexican Government which would satisfy their national aspirations and leave the Jersey in a position where it could ultimately retire its capital and, meanwhile, earn a reasonable return upon it.” Holman adamantly rejected the idea. “The matter was so important as a precedent in other areas,” he told DeGolyer, “that the company would prefer to lose everything that it had in Mexico rather than acquiesce in a partnership which might be regarded as a partial expropriation.”
Pressure continued to build against the foreign companies. Indeed, developments in Mexico were but the sharpest expression of a growing confrontation throughout much of Latin America between foreign oil companies and rising nationalism. In 1937, the shaky new military government of Bolivia, anxious to win public support, accused Standard Oil’s local subsidiary of tax fraud and confiscated its properties. The action won great applause in Bolivia and attracted much attention throughout Latin America. Meanwhile in Mexico, by 1937 wages had supplanted the chronic debates over taxes, royalties, and the legal status of the oil concessions as the number-one point of contention. The oil workers’ union went out on strike in May 1937, with the other unions planning to undertake a general strike in support. Cárdenas was spending much of his time away from Mexico City—in the Yucatán, supervising land distribution to the Indians, and in the small port of Acapulco, where he was overseeing the development of a hotel and bathing beach. But now, with wholesale turmoil threatening, he intervened; the industry could not be closed down, nor a general strike tolerated. Instead, the President set up a commission to review the companies’ books and activities.11
There was little basis for dialogue. Professor Jesús Silva Herzog, the key member of the review commission, described company officials as “men without respect who were unaccustomed to speaking the truth.” The dislike was mutual. To the British ambassador, Silva Herzog was “a notorious but sincere communist.” Silva Herzog’s commission declared that the oil companies had been making lucrative profits while raping the Mexican economy and had contributed nothing to the country’s broader economic development. It not only recommended much higher wages, pegged at a total annual bill of 26 million pesos, but also called for a host of new benefits: a forty-hour week, up to six weeks’ vacation, retirement pensions equivalent to 85 percent of wages at age fifty. Thecommission also said that all foreign technicians should be replaced by Mexicans within two years.
The companies retorted that the commission had woefully misinterpreted their books and misrepresented their profitability. The total average combined profit of all the companies during the years 1935–37, they claimed, was no more than 23 million pesos, compared to the 26 million pesos in additional wages that were now being demanded. The companies also said that if they were forced to comply with the commission’s recommendations, they would have to close down. They were, of course, gambling that the government would not take that chance; they believed that Mexico lacked the personnel, the skills, the transportation facilities, the markets, and the access to capital that would be required in the event of a government takeover.
The companies appealed the commission’s recommendations. The government not only confirmed them but also added retroactive penalties. In anticipation of what might happen next, Mexican Eagle evacuated the wives and children of employees. As the charges and countercharges flew, the stakes grew ever higher. The companies feared the establishment of a precedent and model that could threaten their activities around the world. From the beginning, Cárdenas had intended to extend government control over the oil industry. But now, his own personal prestige and power were increasingly engaged. He could not afford to be seen as retreating before the foreign companies; nor could he allow himself to be outflanked by the militant unions on his left. He had to remain in command of an explosive situation. But he was also pulled along by events and circumstances. At one point, he complained to a friend that he was “in the hands of advisers and officials who never tell him the whole truth and rarely give full effect to his instructions.” He added that “it was only when he went into things himself that he could ever get at the facts.”
Though Mexican Eagle, a British company, was by far the largest producer, much of the agitation against the oil companies was based upon the strong anti–United States sentiment that seemed to unite the country. “The one respect in which I have found Mexicans of all classes completely unanimous,” observed an English diplomat, “is their conviction that it is a fixed principle of American policy to prevent the economic development and political consolidation of their country.” Yet, ironically, the diplomatic support that the American companies had previously counted on was now a thing of the past. The Roosevelt Administration had adopted a “Good Neighbor” policy toward Latin America, and the New Deal viewed the Mexican government’s stance with some empathy. From a foreign policy point of view, Washington was keen to avoid alienating Mexico at a time when concern for hemispheric defense and fear of an impending war were both beginning to mount. Thus, there was little pressure from the North to counterbalance the unions’ radical demands.
The crisis deepened when the Mexican Supreme Court upheld the judgment against the companies. The companies, in turn, upped their wage offers twice, but still not high enough for the union leadership or the Mexican government. On March 8, 1938, Cárdenas met privately with oil company representatives. The result was a further stalemate on the wage issue. Later that same night, Cárdenas, by himself, made up his mind to expropriate—if need be. On March 16, the oil companies were officially declared to be “in rebellion.” Even so, Cárdenas continued to negotiate; the two sides were getting closer. The companies finally accepted the 26 million peso wage hike. But they would not budge in their opposition to transferring management decision making and administrative control to the unions.
On the night of March 18, 1938, Cárdenas met with his Cabinet. He told them that he intended to take over the oil industry. It was better to destroy the oil fields, he said, than let them be an obstacle to national development. At 9:45 P.M., he signed the expropriation order, and then broadcast the momentous news to the nation from the Yellow Room in the presidential palace. His words were greeted with a six-hour parade through Mexico City. The ensuing struggle was to be fierce and drawn out. For Mexico, what had occurred was a great symbolic and passionate act of resistance to foreign control, which would be central to the spirit of nationalism that tied the country together. To the companies, the expropriation was absolutely illegitimate, a violation of clear agreements and formal commitments, a denial of what they had created by risking their capital and energies.12
The expropriated companies joined in a united front and tried to negotiate—not about compensation, in which they had no confidence, but to get their properties back. Their efforts were to no avail. But beyond the specifics of Mexico, there was a much graver concern. If the expropriation was seen as succeeding, said one Shell director, “a precedent is established throughout the world, particularly in Latin America, which would jeopardize the whole structure of international trade and the security of foreign investment.” Therefore, it was imperative for the companies to respond as vigorously as possible, and they indeed sought to organize embargoes against Mexican oil around the world, charging that such exports were stolen goods. The company that had the most to lose was Mexican Eagle; in addition to being controlled by the Royal Dutch/Shell Group, its stockholders were largely British. The British government took a very strong stand against Mexico. It insisted to the Mexicans that the properties be returned. Instead of replying, Mexico severed diplomatic relations.
A similar break with the United States was only barely averted in the immediate aftermath of the expropriation. Over the next couple of years, Washington tried to exert pressure, primarily economic, on Mexico, but these efforts were half-hearted. In fact, the American companies felt that they were far from getting the support that was appropriate. In the era of Roosevelt’s Good Neighbor Policy, and in light of the New Deal’s criticism of “economic royalists” and, specifically in the late 1930s, of the oil industry, the American government could hardly act harshly against Mexico or oppose the sovereign right of expropriation so long as what Roosevelt called “fair compensation” was offered. Moreover, with the rapidly deteriorating international situation at the center of his concerns, Roosevelt did not want to further aggravate relations with Mexico, or any other country in the hemisphere, with consequences that could benefit the Axis powers. Cárdenas had judged the balance of world politics correctly.
Washington could already see the unsettling effects from the British-led embargo and the efforts to close off traditional markets to Mexico. Nazi Germany became Mexico’s number-one petroleum customer (and at discount prices or on barter terms), with Fascist Italy next. Japan became a major customer as well. Japanese companies were also exploring for oil in Mexico and were discussing the construction of a pipeline from the oil fields across the country to the Pacific. In the view of the Roosevelt Administration, additional American pressure would, perversely, only enable the Axis powers to strengthen their footholds in Mexico.
The much stiffer British position toward Mexico was also driven more by strategic than by commercial considerations. But the strategic issues were seen through a different lens. As outlined by the Oil Board and the Committee of Imperial Defense in May of 1938, Britain’s problem was this: Just eight countries accounted for 94 percent of world oil production. The neutrality legislation enacted by the Congress and isolationism in the United States could conceivably foreclose American petroleum to Britain in a crisis. Russian exports had fallen to low levels, and might cease altogether in a war. “The Dutch East Indies, Roumania and Iraq, because of their geographical situation, are regarded as doubtful sources of supply in certain eventualities,” said the Oil Board. That left Iran, Venezuela, and Mexico. Yet only a few years earlier, in the clash with Reza Shah, Anglo-Persian had almost lost its treasured Iranian concession.
All of this meant that, in a military crisis, production in the Latin American countries would be essential to Britain, not only “because of their size of production, but because they are favourably placed from a sea transport point of view.” Therefore, every effort had to be made “to ensure that the Mexican policy is not followed by other Latin-American countries.” London was particularly worried about Venezuela, which was supplying upward of 40 percent of Britain’s total petroleum needs. The strategic issues—“defense requirements” and access to oil in wartime—were, the Foreign Office reiterated, “the paramount consideration” driving its entire policy. While the United States was Mexico’s neighbor and had many important interests at stake, when it came to oil, Mexico was far more important to Britain than to the United States.13
“As Dead as Julius Caesar”
After the outbreak of war in Europe in September 1939, the interests of the expropriated American oil companies and of the United States government diverged even more sharply. As far as the Roosevelt Administration was concerned, national security was much more important than restitution for Standard Oil of New Jersey and the other American companies. Washington did not want Nazi submarines refueling in Mexican ports, nor German “geologists” and “oil technicians” wandering over northern Mexico, near the U.S. border, or in the south, in the direction of the Panama Canal. Indeed, the United States was now busy trying to tie Mexico into a hemispheric defense system. Therefore, it was important to get the oil issue out of the way as quickly as possible. Moreover, in the event of American entry into the war, the U.S. government wanted access to Mexican oil supplies, as had been the case during World War I, and it cared increasingly little about who actually owned those supplies. The expropriation was the major obstacle to cooperation with Mexico, U.S. Ambassador Josephus Daniels told Roosevelt in 1941, and there was no sense trying to restore and defend a status “as dead as Julius Caesar.”
The strategic considerations were such that, by the autumn of 1941, shortly before Pearl Harbor, Washington decided to push for a settlement. The crux of the matter by now was certainly not restoration; it was compensation—but how much? Widely differing estimates of the value of the companies’ assets in Mexico were broached—from a Mexican figure of $7 million to a company figure of $408 million. The most critical aspect was the value of the subsoil reserves. A joint U.S.–Mexican commission, appointed by the two governments, was charged with developing a compensation scheme; it found a novel and creative solution. It simply came up with the judgment that 90 percent of all the subsoil reserves owned by the companies had already been produced by the time of expropriation! Under this clever formulation, there was no point in arguing further about who actually owned the subsoil or the value of the reserves, since most of the oil was supposedly gone in any event. On that basis, the commission proposed a compensation settlement of about $30 million, spread out over several years.
The companies reacted with bitter outrage at the compensation figure. They argued that they had gone ahead, in the 1920s, to seek out foreign oil supplies partly at the behest of a U.S. government seriously concerned about future security of supply, and now they were being abandoned and betrayed by that same government. But Secretary of State Cordell Hull finally made it clear that, while the companies were under absolutely no obligation to accept the award, neither should they expect any further assistance or support from Washington. The Administration’s position was, to put the matter bluntly, take it or leave it, and in October 1943, a year and a half after the valuation had been proposed, the American companies took it.
There was also, however, a price for Mexico. A national oil company, Petróleos Mexicanos, was established, owning almost the entire oil industry in Mexico. But the oil business was no longer export-oriented; its focus shifted to the domestic market and to producing cheap oil as the predominant fuel for Mexico’s own economic development. Mexican exports became a small factor in the world’s markets. Moreover, the industry was also hamstrung by shortage of capital and lack of access to technology and skills. The insistence on that large wage hike—the “magic figure” of 26 million pesos—had been the casus belli of the expropriation of the oil fields. But inescapably, nationalism had to make some concessions to economic reality. In the aftermath of the expropriation, not only was the promised wage hike indefinitely postponed, wages were, in fact, cut.
Britain was in no hurry to effect its own settlement, or even to restore diplomatic relations with Mexico. It still feared that compromise with Mexico would, in the words of Alexander Cadogan, the Permanent Undersecretary of the Foreign Office, “put ideas” into the “heads” of Iran and Venezuela. “Of course, when the war is over that question will assume an entirely different aspect.” As it turned out, Mexican Eagle and Shell did not settle with Mexico until 1947, two years after the war’s end. In this instance, patience paid off; even considering the fact that Mexican Eagle was the largest foreign company that had operated in Mexico, it won, proportionately, a far better deal than the Americans—$130 million, to be exact.
Mexican Eagle knew, at least, that it had the British government firmly behind it. The American companies, in contrast, believed that they had been grievously wronged not only by Mexico, but also by their own government. On one thing, however, both the British and American companies could agree; the Mexican expropriation was the biggest trauma that the industry had experienced in many years—since the Bolshevik Revolution, perhaps even since the 1911 dissolution of the Standard Oil Trust. For Mexico, the settlements with the foreign companies confirmed the rightness of its course. The 1938 nationalization was seen as one of the greatest triumphs of the revolution. Mexico was the complete master of its oil industry, and Petróleos Mexicanos—Pemex—would emerge as one of the first and most important of the state-owned oil companies in the world. Mexico had, indeed, established a model for the future.14