THE PRICE OF OIL was balanced precariously in the mid-1980s. So much was at stake that all eyes fastened on its every twitch and twinge. As the president of Esso Europe said in 1984, “Today, the price of oil is the chief variable in our equation and the greatest single source of uncertainty about the future.”
Would the price begin to go up again, would it languish, or would it plummet? As the months marched on, “How low can it go?” became a refrain heard more and more around the world, not only in energy companies but also in financial institutions and the corridors of government, and everywhere for good reason. The answer would have a profound impact on the oil companies, of course. But, beyond that, it would determine the future vigor of “oil power” in world politics and would mightily affect global economic prospects and the shifting balance of world economic and political strength. High prices would favor the oil exporters, from Saudi Arabia to Libya to Mexico to the Soviet Union. The USSR depended on oil, along with natural gas, for most of the hard currency that it used to purchase the Western technology it desperately needed for economic modernization. Low prices would favor the oil-importing countries, including the two economic powerhouses, Germany and Japan. In between and uncertain was the United States. It had interests on both sides of the divide. It was the world’s largest importer and consumer of oil, and yet it was also the world’s second-largest producer of oil, and a good part of its financial system had cast its fate with high oil prices. If push came to shove, on which side would the United States line up?
Despite its becoming even more restrictive in 1984, OPEC’s new quota system was not working. Non-OPEC production continued to grow; coal, nuclear power, and natural gas were still taking markets away from oil; and conservation was still shrinking demand. Inevitably, as the various OPEC exporters watched their revenues dwindle, quota cheating among them became more obvious. If they could not attain their revenue ambition on price, then they would discount and try to make it on volume. In an act of self-exasperation, OPEC retained an international accounting firm to police the quota. The accountants were promised access to every invoice, every account, every bill of lading. They did not get such access; in fact, they had great difficulty even in gaining entrée to some OPEC countries and were completely denied entrance to key facilities. Meanwhile, various of the exporters, to get around their quotas and the languishing oil trade, turned to barter and countertrade—exchanging oil directly for weapons, planes, and industrial goods—which had the effect of increasing the oversupply of petroleum on the world market.
High or Low?
The force of the market could not easily be resisted. In establishing the state-owned British National Oil Company in the 1970s, Britain’s Labour government not only made it the repository for the government’s share of oil and gas reserves in the North Sea, but also gave it a specific trading function; it would buy up to 1.3 million barrels per day of output from North Sea producers and then turn around and sell it to refiners. Thus, BNOC had an important price-setting role in the world oil market, for it announced the prices at which it would buy and sell oil. But, with the weakening oil price, BNOC found itself in the uncomfortable position of buying over a million barrels per day of oil at one price from North Sea operators and selling those same barrels at a lower price! The result was a significant loss for BNOC, and for the British Treasury. As one of the mandarins from Whitehall soulfully explained: “It is obviously very painful to the Treasury to have a body in the public sector buying oil at $28.65 and selling at a lower price; it gives us very, very great pain, be assured of that!” No one was more critical than Margaret Thatcher herself. On principle, she did not like state companies—if anything, she was even more attached to “free markets” and against government intervention than Ronald Reagan; and privatization of state enterprises was a basic plank in her political platform. She saw no security reason to maintain BNOC, and in the spring of 1985 she simply abolished it. With that action, the British government exited from direct participation in the oil business. The elimination of BNOC removed one more important prop from the OPEC price; it was another victory for the market.
In the oil industry, the general view was that, while the price might sink a few dollars, it would recover and start to go up again toward the end of the 1980s or the beginning of the 1990s. Yet weak demand, plus growing supply capacity, plus the shift to the commodity market all pointed much more strongly in one direction, and that was down. But how far?
OPEC’s Deepening Dilemma
By the middle 1980s, OPEC was faced with a critical choice. It could cut price; but where would a falling price stop? Or it could continue to prop up the price. But if it did that, it would be holding up an umbrella under which non-OPEC oil, competing energy sources, and conservation would all flourish, guaranteeing itself a shrinking market share. To make matters worse, more oil would be coming out of the OPEC countries themselves. Even as the Iran-Iraq War dragged on, exports from both belligerents were recovering. Nigeria, too, upped its output and, hungry for revenues, adopted for a time a “Nigeria first” policy, aimed at maximizing exports.
As was often the case, much depended on the Saudis. In 1983 Saudi Arabia had explicitly taken on the job of swing producer, varying its output to support the OPEC price. But by 1985, the costs, relative to those of other producers, were becoming disproportionately high. Defending price meant a huge drop in output and a vast loss of market share and a huge fall in revenues. The high point of earnings for Saudi Arabia was $119 billion in 1981. By 1984, its revenues had fallen to $36 billion, and they would fall further, to $26 billion, in 1985. Meanwhile, like the other exporters, Saudi Arabia had embarked on a great spending and development program, which now had to be cut back dramatically. The country started to run a large budget deficit, and foreign reserves were being drawn down. So unsettling was the situation that the promulgation of the national budget was indefinitely postponed.
The loss of market had another consequence; it was reducing Saudi Arabia to a more marginal role on the world stage. The rapid fall-away in political influence and significance, and the likelihood of further erosion, ran counter to the fundamental precepts of the kingdom’s security policy, at a time when the Iran-Iraq War was threatening the region and the Ayatollah Khomeini continued to pursue his vendetta against Saudi Arabia. The dramatic market loss also reduced Saudi influence on Middle Eastern politics and the Arab-Israeli dispute, and on the Western industrial countries. Oil power was losing its meaning. “In principle, we must draw a line between economics and politics,” Yamani said on Saudi television. “In other words political decisions should not affect economic facts and laws. But crude oil is a political power and no one can deny that Arab political power in 1973 was based on oil and that its influence reached its peak in the Western world in 1979 because of oil. At present we are suffering because of the weakness of Arab political power based on oil. These are elementary facts which are known even to the man in the street.”
The Saudis sent out warning after warning to the other OPEC countries and to the non-OPEC producers. It would not continue to accept the loss of market share; it would not indefinitely tolerate and underwrite quota violations by other OPEC countries and increased production by the non-OPEC nations; it could not be counted on to be the swing producer. If need be, Saudi Arabia would flood the market. Did these warnings add up to a serious threat, a clear indication of intention? Or were they only a bluff, intended to frighten? Yet, if the Saudis did not make some change, then, logically, they might expect their production to fall to a million barrels per day or less, as export markets disappeared altogether. Under such circumstances and insofar as oil in a fundamental sense defined the country’s identity and influence, Saudi Arabia would on the world stage almost cease being Saudi Arabia.1
In the first days of June 1985, OPEC ministers congregated at Taif in Saudi Arabia. Yamani read them a letter from King Fahd, who sharply criticized the cheating and discounting by other OPEC countries that had led “to a loss of markets for Saudi Arabia.” Saudi Arabia would not abide such a situation forever. “If Member countries feel they have a free hand to act,” said the King, “then all should enjoy this situation and Saudi Arabia would certainly secure its own interests.”
At the conclusion of the King’s message, the Nigerian oil minister said that he hoped “this wise message had sunk in.” But in the following weeks there was no particular evidence that it had. And Saudi oil production sagged to as low as 2.2 million barrels per day, half of its quota level and little more than a fifth of what that nation had been producing half a decade earlier. Exports to the United States, which had been as high as 1.4 million barrels per day in 1979, slumped to a mere 26,000 barrels per day in June 1985, which was essentially nothing.
At times, in the summer of 1985, Saudi oil output fell below that of the British sector of the North Sea. Here was the last outrage. To the Saudis, it meant that they were propping up the price so that the British could produce more, while Prime Minister Thatcher continued to celebrate her attachment to free markets and to advertise her indifference to whether oil prices were high or low. An even greater threat was closer to home. The Iraqis were reconstructing their export capacity, expanding and adding new pipelines, some of them passing through Saudi Arabia. Whatever else happened, large additional volumes of Iraqi oil would soon be pushing their way into the already congested market. The situation was untenable. Something had to give, and again, as in the 1970s, it would be price, but in the opposite direction. Still, how low would it go?
A shade from the past was rising again—John D. Rockefeller and the prospect of an all-out price war. In the late nineteenth and early twentieth centuries, Rockefeller and his colleagues had often instituted a “good sweating” against their competitors by flooding the market and cutting the price. Competitors were forced to make a truce according to the rules of Standard Oil, or, lacking the staying power of Standard Oil, they would be driven out of business or taken over. Circumstances were, of course, wholly different in the mid-1980s; yet they were not so different, after all. Once again, a “good sweating” was at hand.
The Saudis moved from a defense of price to a defense of volume—their own desired level of output—and chose an ingenious weapon: netback deals with the Aramco partners and with other oil companies strategically located in key markets. Under such deals, Saudi Arabia would not charge a fixed price to the refiner. Rather, it would be paid on the basis of what the refined products earned in the marketplace. The refiner, however, would be guaranteed a predetermined profit off the top—say $2 a barrel. No matter whether the final selling price of the products was $29 or $19 or $9, he would get his $2 and the Saudis would get the rest (minus various costs). The refiner’s profit would be locked in. So he would not have any particular compulsion to strive for a higher rather than a lower price at the point of sale; he would simply want to move as much product as he could. He knew that each additional barrel meant an additional $2 of profit, no matter what the price. But increasing volume and reduced concern about the selling price would add up to a perfect recipe for falling prices. The Saudis, for their part, hoped that what they lost because of lower prices they would make up, and then some, with the higher volumes. But the Saudis were also careful not to be too confrontational; their aim was to regain their quota level, and no more, and they put a cap on the volume that would be covered by their new netback deals. In so doing, they were aiming their new policy as much at other OPEC members, which had been cheating and thus taking away their market share, as at the non-OPEC countries.
In the summer of 1985, a senior executive of one of the Aramco partners received a phone call from Yamani. The oil minister observed that the executive had earlier said that he would be interested in increasing purchases from Saudi Arabia if the pricing was competitive, and, explained Yamani, that was now the case. The executive flew to London in August to discuss the netback terms. “It sounds like it’s competitive,” the executive said, and he signed forthwith. A number of other companies, Aramco and non-Aramco alike, agreed to similar contracts.
The netback contracts obviously meant that there was no longer an official Saudi price. The price would be whatever oil fetched in the market. And that meant there would no longer be an OPEC oil price. As word circulated around the global marketplace in late September and early October of 1985 about the Saudi netback deals, nervousness and anxiety rose. Yet once the Saudis had committed themselves to a market share strategy, other exporters started to follow suit out of pure competitive self-defense. Netback deals began to proliferate. For the long-suffering downstream part of the oil industry, it was a godsend, an opportunity at last to make money in refining, which had seemed almost beyond human ingenuity since the early 1970s.
Was the price now posed for a great fall? Most of the exporters thought so, but they expected no more than a drop to $18 or $20 a barrel, below which, they thought, production in the North Sea would not be economical. On that, they were mistaken. The tax rates on the North Sea were so high that, for instance, in one field, called Ninian, a drop in the oil price from $20 to $10 would cost the companies only 85 cents. The big loser would be the British Treasury, which was taking most of the rents. Actual operating costs in Ninian—the cash costs to extract oil—were only $6 per barrel, so there would be no reason to shut-in production at any price above that. Furthermore, it was so costly and complicated to close down operations temporarily that there would be reluctance to do so even if the price dropped below $6. As George Keller, chairman of Chevron, said at the time, “There is not much of a price floor.” But then few thought matters would be pressed anywhere near that far. It wouldn’t be rational.
From the beginning of November 1985, with the approach of winter, the price for bellwether West Texas Intermediate on the futures market continued to climb, reaching what was until then the highest point ever recorded on the Nymex—$31.75—on November 20, 1985, belying the threat of a price collapse. Surely, many thought, the Saudis really did not mean what they were saying. It was merely an elaborate warning designed to scare the other OPEC countries and restore discipline.
A week and a half after the November high, OPEC met yet again. By its actions, Saudi Arabia had already, in effect, declared a war for market share against the other OPEC countries. Now OPEC as a group, including Saudi Arabia, announced its intention to battle non-OPEC to regain lost markets. The communiqué from the conference contained the new formula: OPEC was no longer protecting price; now its objective was to “secure and defend for OPEC a fair share in the world oil market consistent with the necessary income for member countries’ development.”
Yet how significant, really, were these words? When, on December 9, the text of the communiqué was carried into a room where senior planners of an OPEC country were meeting to talk about the future, one of them said dismissively, “Oh, it’s just another OPEC winter communiqué.”
Then the price began to collapse.2
The Third Oil Shock
What ensued was no less turbulent and dramatic than the crises of 1973–74 and 1979–81. West Texas Intermediate plummeted by 70 percent over the next few months—from its peak of $31.75 a barrel at the end of November 1985, to $10. Some Persian Gulf cargoes sold for around $6 a barrel. In the two previous shocks, marginal losses and disruptions of supply had been enough to send prices shooting up. Here, too, the actual variation in volume was also marginal. OPEC’s output in the first four months of 1986 averaged about 17.8 million barrels per day—only about 9 percent higher than 1985 production, and in fact, at about the same level as the 1983 quota. Overall, the additional production meant not much more than a 3 percent increase in total free world oil supply! Yet that, combined with the commitment to market share, was enough to drive prices down to levels so low as to have been virtually unimaginable only months earlier.
It was, indeed, the Third Oil Shock, but all the consequences ran in the opposite direction. Now, the exporters were scrambling for markets, rather than buyers for supplies. And buyers rather than sellers were playing leapfrog, each jumping over the other in pursuit of the lowest price. This unfamiliar situation once again threw up the question of security, but in new dimensions. One was security of demand for the oil exporters—that is, guaranteed access to markets. That concern may have seemed new. But in truth it was the same issue that had made the exporting countries such intense competitors in the 1950s and 1960s, and had led Juan Pablo Pérez Alfonzo to seek a guaranteed market in the United States, before he left for Cairo and the first step on the road to OPEC. For consumers, it seemed that all the concerns of the 1970s about security of supply were being made irrelevant in the battle for market share. But what of the future? Would cheap imported oil undermine the energy security so laboriously rebuilt over the preceding thirteen years?
It was not merely that prices were collapsing; they were also out of control. For the first time in memory, there was no price-setting structure. There was not even an official OPEC price. The market was victorious, at least for the time being. Price would be set not through an arduous negotiation among OPEC countries, but through thousands and thousands of individual transactions. Netback deals, spot deals, “spotback deals,” barter deals, processing deals, “topping off” deals, this deal and that deal—there seemed to be no end to the variations and twists adopted as exporters fought to hold on to and regain markets. Not only was OPEC struggling with non-OPEC, but, the December 1985 communiqué notwithstanding, the individual OPEC countries were battling with each other over customers. And, in the fiercely competitive environment, the matter came down to offering discount after discount to assure markets. “Everybody gets tired of endless negotiations for each cargo or each quarter,” said the head of the Iraq State Marketing Commission in mid-1986. “In the end, the lazy negotiator for the crude exporter simply gives across-the-board discounts in order to ensure he undercuts all other OPEC barrels.” It was not the specific kind of deal—netbacks or whatever—that caused the price collapse, but rather the fundamental facts that more oil was seeking markets than there were markets for oil, and that the hand of a regulator, in this case OPEC and in particular Saudi Arabia, was removed.
Shock was the universal reaction throughout the oil world. Would OPEC do anything? Could it? The organization was bitterly divided. Iran, Algeria, and Libya wanted OPEC to adopt a new and much lower quota and thus to restore price to $29 a barrel. The high-volume countries, principally Saudi Arabia and Kuwait, remained committed to regaining market share, though, almost plaintively, Yamani felt compelled to blame things on the buyers, telling an executive of one of the major companies, “I never sold a barrel someone didn’t want.” Meanwhile, Iran and Iraq, two of the key OPEC members, were still locked in a death struggle, and Iran’s hostility to the Arab exporters was unmitigated.
The non-OPEC countries were suffering no less in their lost revenues. Belatedly, they took OPEC’s warnings more seriously and started a “dialogue.” Mexico, Egypt, Oman, Malaysia, and Angola attended an OPEC meeting as observers in the spring of 1986. Norway’s conservative government initially declared that it was a member of the West, and it would not negotiate with OPEC. However, oil supplied about 20 percent of government revenues, and the government could not meet its budget. The ruling party fell and was replaced by its labor opposition. The new prime minister immediately announced that Norway would take steps to help stabilize the oil price. The oil minister of the new government boarded Zaki Yamani’s yacht in Venice for a cruise and a discussion of oil prices. Yet in total, the dialogue between OPEC and non-OPEC did not yield much of substance. Thus, with little meeting of minds both within OPEC and between OPEC and non-OPEC, the “good sweating” continued through the spring of 1986.
“A Little Action”
Many oil companies were unprepared for this latest crisis, their executives having been convinced that “they”—OPEC—would not do something so silly as to eradicate a large part of their own revenues. A few had thought otherwise. Planners at Shell in London, reading the fundamentals carefully, had geared up an “OCS”—an Oil Collapse Scenario. The company had insisted that its senior managers take it seriously even if they thought it was improbable, discuss what their responses would be, and start taking prophylactic action. Thus, when the collapse struck, in contrast to the shock observed in many other oil companies, there was an eerie calm and orderliness at Shell Centre on the south bank of the Thames. Managers there, as well as in the field, went about their jobs as though carrying out a civil defense emergency operation for which they had already practiced.
In general, once the industry had assimilated the reality of the shock, it responded with quick and massive cuts in expenditures. Particularly hard hit was exploration and production in the United States. The country was one of the highest-cost oil provinces and had proved to be one of the most disappointing. Who could forget Mukluk, the $2 billion dry hole off Alaska? And companies had the most flexibility to respond in the United States; they did not have to worry about jeopardizing long-negotiated arrangements with national governments, as they did throughout the developing world.
Consumers were, of course, jubilant. All their fears about a permanent oil shortage were now laid to rest. Their standard of living and lifestyles were no longer at risk. After the years of huffing and puffing, oil was cheap again. The prophecies of doom had been a mirage, it seemed, and oil power was a harmless and empty threat. The “gas wars” at the corner filling stations, which had supposedly disappeared with the 1950s and 1960s, were now back, but writ large as a global oil war. And how low could prices really go? The irreducible minimum was indubitably established at Billy Jack Mason’s Exxon station on the north side of Austin, Texas, on a one-day promotion in early April 1986, sponsored by a local country music station. Billy Jack’s price for unleaded that day was zero cents a gallon. Free. It was a deal that could not be beat, and the result was a stampede. By nine o’clock in the morning, the line of cars waiting for their fillup stretched for six miles; some people had driven from as far away as Waco. “The thing you gotta do is create a little action,” explained Billy Jack. And when his opinion as an oil expert was sought on the future of prices, Billy Jack declared, “That’s overseas. Nothing we can do about that until the Arabs get the prices right.”
Another Texan, an adopted one, agreed with Billy Jack Mason that it was up to the Arabs, at least to a large degree. He was the Vice-President of the United States, George H. W. Bush, and while Billy Jack was selling his gasoline for zero cents a gallon, Bush was preparing to leave on an overseas mission to the Middle East to discuss oil, among other things. A visit to Saudi Arabia and the Gulf states had been on his schedule for several months, predating the collapse. But now he was going at a time when the domestic American oil and gas industry, the oil exporters, consumers, America’s allies—all were asking the same question. Was the United States government going to do anything about the price collapse? By timing and position, and by his own history, Bush became the point man for the dilemmas of the Reagan Administration and U.S. policy at this very delicate moment in international relations.3
George H. W. Bush
A few years later, on the eve of his own inauguration as President in 1989, Bush would say, “I put it this way. They got a President of the United States that came out of the oil and gas industry, that knows it and knows it well.” He knew, in particular, the risk-taking, deal-making world of the independent oil men, who were the backbone of exploration in the United States and who were the ones knocked flat on their backs by the price collapse. That had been the world in which he had spent his formative years. On graduating from Yale in 1948, Bush had passed up the obvious jobs on Wall Street for someone of his background; after all, his father had been a partner in Brown Brothers, Harriman, before becoming Senator from Connecticut. Then, having failed to be called back after a job interview with Procter and Gamble, he packed up his red 1947 Studebaker and set off for Texas, first Odessa, then its neighbor Midland, which would soon be calling itself the “oil capital of West Texas.” He began at the bottom, as a trainee charged with painting pumping equipment, and then graduated to itinerant salesman, driving from rig to rig, inquiring of the customer what size drill bit he needed and what kind of rock he was drilling through, and then asking for the order.
Bush was an Easterner, with what some would have called a patrician background, but he was not entirely atypical. There was a noble tradition of Easterners coming to seek their fortunes in Texas oil, beginning with the Mellons and the Pews at Spindletop, and continuing through what Fortune magazine once called the “swarm of young Ivy Leaguers” who, Bush among them, in the post–World War II years had “descended on an isolated west Texas oil town”—Midland—“and created a most unlikely outpost of the working rich” as well as “a union between the cactus and the Ivy.” It was not coincidental that the best men’s store in Midland, Albert S. Kelley’s, dressed its customers almost exactly the way that Brooks Brothers did.
Soon enough in this little world, as Bush later said, he “caught the fever” and formed an independent oil company in partnership with other ambitious young men no less eager to make money. “Somebody had a rig, knew of a deal, and we were all looking for funds,” one of his partners said. “Oil was the thing in Midland.” They wanted a name that would be memorable; another partner suggested that it should start either with an A or Z so it would be first or last in the phone book—but not get lost in the middle. The filmViva Zapata!, with Marlon Brando in the role of the Mexican revolutionary, was playing in Midland, so they called their company Zapata.
Bush quickly mastered the skills of the independent oil man, flying off to North Dakota in atrocious weather to try to buy royalty interests from suspicious farmers, combing courthouse records to find out who owned the mineral rights adjacent to new discoveries, arranging for a good drilling rig crew as quickly and as cheaply as possible—and, of course, making the pilgrimage back East to round up money from investors. On a brisk morning in the mid-1950s, near Union Station in Washington, D.C., he even closed a deal with Eugene Meyer, the august publisher of the Washington Post, in the back seat of Meyer’s limousine. For good measure, Meyer also committed his son-in-law to the deal. Meyer remained one of Bush’s investors over the years. And did the name Zapata help Bush and his partners in their new venture? “It rubbed both ways,” said Hugh Liedtke, a Bush partner. “The shareholders that got in early and had a profitable investment, well, they thought Zapata was a patriot. But those that got in at one of the top swings in the market, and then the market fell, they thought Zapata was a bandit.”
Eventually, the partners amicably split Zapata in two, and Bush took the offshore oil services side of the business, making it one of the pioneers and leaders in the dynamic development of offshore drilling and production in the Gulf of Mexico and around the world. Even today, crusty institutional stockbrokers in New York still recall that, when they phoned Zapata’s offices in Houston to find out how the next quarter’s results might turn out, they got not the Texas drawl of some good ol’ boy at the other end of the line, but rather the modified Yankee twang of George Bush. For in addition to CEO, he was part-time investor relations officer. He lived through the erratic cycles of the postwar domestic oil industry. He could see how sensitive industry activity was to the price of oil, as well as how vulnerable it could be to unbridled foreign competition in those years of the great buildup in Middle Eastern oil—at least until Eisenhower imposed quotas in 1959. He also did well. The Bush family was about the first to put in a swimming pool in their neighborhood in Midland.
By the mid-1960s, Bush had decided he had made sufficient money; his father had been a Senator for ten years, and he would head in the same direction. He gave up the oil business for politics. The Republican party was just then getting started in Texas. But the Democrats’ perennial lock on the state was not the only political problem to be faced. The would-be reconstituted Republican party was under assault from the right, and at one point Bush had to defend himself against the charge from the John Birch Society that his father-in-law was a communist—on grounds that the gentleman happened to be publisher of the unfortunately named woman’s magazine Redbook.
Bush went from county chairman to Congress. In contrast to Calouste Gulbenkian, he did not find oil friendships slippery; his associates from his Midland days remained among his closest friends thereafter. As a Congressman from Houston, he was supposed to stand up for the oil industry, which he resolutely did. In 1969, when Richard Nixon was considering ending the quota system that restricted petroleum imports, Bush arranged for Treasury Secretary David Kennedy to meet with a group of oil men at Bush’s home in Houston. Afterward, he wrote to Kennedy to thank him for taking time for the discussion. “I was also appreciative of your telling them how I bled and died for the oil industry,” Bush said. “That might kill me off in the Washington Post but it darn sure helps in Houston.” But oil was hardly uppermost on his political agenda once Bush moved on to other jobs—from ambassador to the United Nations and then chairman of the Republican National Committee during Watergate, to United States envoy to the People’s Republic of China, to head of the CIA, and then to four years of campaigning unsuccessfully for the Republican nomination for the Presidency. In 1980, the man who beat him, Ronald Reagan, chose him as running mate, which led him to the Vice-Presidency.
Unlike Jimmy Carter, who made energy the centerpiece of his Administration, Ronald Reagan was determined to make it a footnote. The energy crisis resulted mainly, he maintained, from regulation and the misguided policies of the United States government. The solution was to get the government out of energy and return to “free markets.” Anyway, Reagan had said during the campaign, there was more oil in Alaska than in Saudi Arabia. One of the very first acts of the Reagan Administration was to speed up the decontrol of oil prices that the Carter Administration had started. In its shift to a policy of “benign neglect” toward energy, the new Administration, to be sure, was helped by what was happening to the world oil market. Jimmy Carter’s misfortune, rising oil prices, had been transmuted into Ronald Reagan’s good fortune, for just around the time that he moved into the White House in 1981, half a decade before the price collapse, the inflation-adjusted price of oil actually started its long slide in the face of rising non-OPEC supply and falling demand. Not only did the decline in the real price remove energy as a dominant issue, it also served as a major stimulus to renewed economic growth and to the decline in inflation, two key features of the Reagan boom. Of course, the “free market” approach rested upon a contradiction; after all, a cartel, OPEC, was preventing a big fall in the price of oil, thus providing the incentives for conservation and energy development in the United States and elsewhere. But this contradiction remained latent and untroubling until the price collapse of 1986.
What was unleashed that year, in the words of the Acting Secretary General of OPEC Fadhil al-Chalabi, was nothing less than “absolute competition.” And the results were devastating to the American oil industry. Pink slips were flying out at an awesome rate; drilling rigs were stacking up throughout the oil patch; and the financial infrastructure of the Southwest was quaking, as the region headed into an economic depression. Moreover, if prices stayed down, United States oil demand would shoot up, domestic production would plummet, and imports would start flooding in again, as they had in the 1970s. Perhaps, when it came to “market forces,” there could be too much of a good thing. Still, there was not much that the United States government could do, even if so moved, in the face of those powerful forces of supply and demand. One possibility was to slap on a tariff, and so protect domestic energy production and continue to provide an incentive for conservation. While there were many calls in 1986 for a tariff, none of them came from the Reagan Administration. Another option was to try to jawbone OPEC into getting its act together again. Thus did George Bush’s long official inattention to oil abruptly come to an end. Who else in the Reagan Administration could better talk, out of his own long experience, to the Saudis about oil?4
“I Know I’m Correct”
In its early planning, the main objective of Bush’s trip to the Persian Gulf, amid the apparently interminable Iran-Iraq War, had been to underline United States support for the moderate Arab states in the region. But one could hardly be expected to go to Saudi Arabia and not discuss oil, especially when its price had fallen below ten dollars a barrel. Had the tables turned? In the 1970s, senior American officials had trooped to Riyadh to ask the Saudis to help keep prices down. Now, in 1986, would the Vice-President of the United States go to Saudi Arabia to ask them to push the price up?
Certainly, Bush felt that enough was enough. Conditions were as bad or worse in Texas and in the industry than any he had seen during his own days as an oil man. Moreover, the clamor and criticism from his political base in the Southwest, particularly Texas, was suddenly very intense. Nor was Bush alone with his concerns in the Reagan Administration; Energy Secretary John Herrington was warning that the fall in oil prices had reached the point of threatening national security. But the two belonged to a minority in the Administration.
In early April 1986, on the eve of his trip, Bush said that he would “be selling very hard” to persuade the Saudis “of our own domestic interest and thus the interest of national security…. I think it is essential that we talk about stability and that we not just have a continued free fall like a parachutist jumping out without a parachute.” He ritualistically acknowledged the central free market precept of the Reagan Administration. “Our answer is market, market—let the market forces work,” he incanted. But, he added, “I happen to believe, and always have, that a strong domestic U.S. industry is in the national security interests, vital interests of this country.” Bush was clearly saying that market forces had gone too far. And he was quickly and embarrassingly disavowed by the Reagan White House, whose spokesman declared, “The way to address price stability is to let the free market work.” The White House pointedly said that Bush would stress to King Fahd that market forces, not politicians, should determine price levels.
Bush’s first stop was in Riyadh, where he dedicated the new United States embassy building. At a dinner with several ministers, including Yamani, the talk, of course, dealt in part with oil, and Bush commented that, if prices remained too low, pressure would build in the United States Congress for a tariff, and it would become increasingly difficult to resist that pressure. The Saudis took his remark very seriously. The Vice-President stopped next in Dhahran, in the eastern provinces, where the King was temporarily in residence. The American party was entertained at a banquet in the King’s Eastern Palace, served by waiters who wore swords and pistols on their belts and had cartridges strapped across their chests. Their rifles, to the relief of the American Secret Service, were parked along the wall.
A private meeting with the King had been scheduled for the following day, but the Americans were told after the banquet that it had been moved up in the aftermath of an Iranian attack on a Saudi tanker. Bush was summoned into a late-night session with the King, which went on until well after 2:00 A.M. and, altogether, lasted more than two and a half hours. The Saudis were jittery about Iran’s military advances and threats, and the prime subject of the meeting, as of the entire Bush mission, was Persian Gulf security and United States weapons supplies. Oil was mentioned only glancingly, but according to American officials, Fahd did express his hope for “stability in the market.” The officials added that the King “felt Saudi Arabia was, in non-royal language, being given a bum rap in stories about its role in the oil market.”
Though courting criticism at home, the Vice-President stuck to his position on oil prices. “I know I’m correct,” he said after his visit with the King. “Some things you’re sure of. This I’m absolutely sure of”—that low prices would cripple the domestic American energy industries, with serious consequences for the nation. At a breakfast with American businessmen in Dhahran a day later, Bush declared, “There is some point at which the national security interest of the United States says, ‘Hey, we must have a strong, viable domestic industry.’ I’ve felt that way all my political life and I’m not going to start changing that at this juncture. I feel it, and I know the President of the United States feels it.”
Bush prided himself on loyalty, and he had proved over the previous five years to be a very loyal Vice-President. Never before had he departed from the White House line. But now he apparently had, and the adverse reaction became more explicit. “Poor George,” was the way a senior White House official disparagingly talked about him, adding that Bush’s position was “not Administration policy.” But Bush refused to retreat—much. “I don’t know that I’m defending the [U.S. oil] industry. What I’m doing is defending a position that I feel very, very strongly…Whether that’s a help politically or whether it proves a detriment politically I couldn’t care less.”
The general view was that Bush was making not merely a blooper, but an enormous blunder, one that could in itself damage his political ambition and that pointed to a tendency to self-destruct. His gleeful opponents for the Republican nomination for the Presidency could not wait to use clips of the Bush statements in the critical primary state—and resolutely non-oil state—of New Hampshire. Columnists denounced him for cuddling up to OPEC and solemnly intoned that this could be the fatal act of suicide for his upcoming Presidential bid. Of course, within the oil states he was much commended for what he said. But outside the oil patch, it seemed that just about the only voice that had anything good to say about Bush’s position was none other than the editorial page of theWashington Post, the newspaper he had once feared would kill him off for expressing pro–oil industry sentiments. On the contrary, the Post now said that the Vice-President was on to a very important point in his warning of how low prices would undermine the domestic energy industry, even if no one wanted to admit it. “Mr. Bush is struggling with a real question,” the Post commented. “A steadily increasing dependence on imported oil is, as the man suggests, not a happy prospect.” In short, said thePost, Bush was right.
But what, in fact, had Bush really said about an oil tariff to the Saudi ministers? Were they merely remarks made in passing, or something stronger than that? Whatever was said or heard—and there is often a big difference between the two in diplomacy—some Saudis thereafter insisted that Bush had explicitly issued a warning that the United States would impose a tariff if prices remained down, even if a tariff was absolutely contrary to the Reagan Administration line. And the Japanese had indicated that if the United States slapped a tariff on imported oil, they would follow suit, in order to protect their own program of energy diversification and to pick up some extra revenues for the Ministry of Finance. Few things could more quickly arouse the exporters to outrage than the prospect of a tariff in the oil-importing countries, for such a levy would transfer revenues from their own treasuries back to the treasuries of the consumers.
But the tariff was only part of a larger consideration. The Saudis, along with the other exporters, were worried about the huge financial losses from a continuing price collapse. Moreover, they were most unhappy with all the external criticism and political pressures that were converging on them because of the collapse. The Bush trip came as an additional incentive to restore some stability to prices. Some of the Vice-President’s own advisers may have thought that his remarks about oil were intended only as a placebo for the American oil patch, but that was not how they were interpreted by the Saudis. What they heard was the Vice-President of the United States of America saying that the price collapse was destabilizing and threatened the security of the United States: American petroleum imports would rise substantially, and the United States would be weakened militarily and strategically vis-à-vis the Soviet Union. The Saudis looked to the United States for their own security; surely, they thought in the aftermath of the Bush visit, they would have to be attentive to the security needs of the United States. They had thought about security concerns in 1979, when they had pushed up production. And they thought about security again in the spring of 1986. They were feeling pressure from many countries, including Egypt and battle-strained Iraq. They were very worried about the Iran-Iraq War and its possible outcome. The Bush mission, on top of the turmoil and the other difficulties, provided reason for the Saudis to reconsider the fierce battle for market share that had sent prices into a tailspin—and to look for a way out. Moreover, the other exporters had finally learned that cheating had a cost.5
“Hara-Kiri” and $18 a Barrel
Yet no one really had any idea of how to behave in a competitive environment, nor indeed any experience. One OPEC veteran, Alirio Parra, a senior official of Petróleos de Venezuela, struggled to find some historical context. He had begun his career as an assistant to Juan Pablo Pérez Alfonzo during the formation of OPEC and, in fact, had been sitting with Pérez Alfonzo when the invitation to the founding meeting had arrived in 1960. Now the dissolution of OPEC seemed at hand. Searching his mind for some starting point, Parra recollected a book he had read many years earlier, The United States Oil Policy, published in 1926 by John Ise, a professor of economics at the University of Kansas. Parra finally found a battered copy in Caracas and brought it with him to London where he read it carefully.
“The unfortunate features of the oil history of Pennsylvania have been repeated in the later history of almost every other producing region,” Ise had written then. “There has been the same instability in the industry, the same recurrent or chronic over-production, the same wide fluctuations in prices, with consequent curtailment agreements, the same waste of oil, capital, and of energy.” Ise described one episode in the 1920s as a “spectacle of a vast overproduction of this limited natural resource, growing stocks, overflowing tanks, and declining prices, frantic efforts to stimulate more low and unimportant uses, or to sell for next to nothing…. It was a case of ‘being choked, and strangled, and gagged, by the very thing people most wanted—oil.’” Ise added, “Oil producers were committing ‘hara-kiri’ by producing so much oil. All saw the remedy, but would not adopt it. The remedy was, of course, a reduction in the production.” Although Ise had written the book sixty years ago, the language and the diagnosis sounded all too familiar to Parra. He made notes.
Thereafter, Parra was one of the handful from the exporting countries who began trying to work out a new pricing system that took into account the fact that oil and energy markets were, after all, competitive. Consumers had choices. That led him and the others to focus on a new price range of $17 to $19—and, more specifically, $18 a barrel—$11 less than what had been the official price of $29 a few months earlier. Somehow, this seemed to be the “right” price. Parra and a couple of others spent a week in May holed up in the Kuwaiti embassy in Vienna discussing the rationale for the new price. Correcting for inflation, it took oil prices back to where they had been in the mid-1970s, on the eve of the Second Oil Shock. Now, $18 seemed to be the point at which oil was again competitive with other energy sources and with conservation. It appeared to be the highest level that the exporters could attain and still achieve their goals of stimulating economic growth in the rest of the world and thus energy demand. It would reignite demand for oil and cap or perhaps even reverse the seemingly un-stoppable non-OPEC production. Eighteen dollars “is inconvenient for my country,” one senior OPEC official said to a friend, “but don’t you think it’s the best we can do?”
In the last week of May 1986, six oil ministers met in Taif in Saudi Arabia. One of the ministers commented that some of the others were predicting that oil prices would fall as low as $5 a barrel. “None of those present wants to give oil away to the consumer or to give the consumer a present,” noted the Kuwaiti oil minister. But, he added, the old $29 a barrel had done OPEC “more harm than good.”
Yamani categorically stated Saudi Arabia’s position: “We want to see a correction in the trends in the market. Once we regain control of the market by increasing our share, we will be able to act accordingly. We want to regain our market power.”
The ministers in attendance all confirmed their support for $17 to $19 a barrel and agreed on the need for a new quota system to go with it. What would have seemed heresy a few months earlier was now becoming the accepted wisdom. For, amid all the confusion and disarray of this latest oil crisis, a new consensus in favor of $18 a barrel was very definitely emerging out of the wreckage of the old. “It was a process of osmosis,” said Alirio Parra. And not only producers, but consumers liked it, too. The Japanese, as importers of more than 99 percent of their oil, might have been expected to prefer the lowest possible price. That was not the case. Two problems would result if prices were too low. First, this would undercut the large and expensive commitment they had made to alternative energy sources, leading, they were sure, back to higher oil dependence and eventually to renewed vulnerability, and setting the stage for another crisis. Second, since oil constituted a substantial part of Japan’s imports, very low prices would enormously swell Japan’s already-huge trade surplus, further accentuating the severe conflicts with American and Western European trading partners. Thus, one found throughout the Japanese oil industry and government a belief in “reasonable prices,” which happened to come out to about $18 a barrel.
The new consensus was evident in the United States, as well—in the government, on Wall Street, in banks, among economic forecasters. The gains from falling oil prices (higher growth and lower inflation) would outweigh the losses (the problems of the energy industries and the Southwest). But that was true only up to a point, at least according to the new view. At some level, the pain and the dislocation in the financial system, along with the discomfort to politicians, would start canceling the benefits, and that point, by general consent, fell somewhere between $15 and $18. The Reagan Administration was rooting for the efforts to reestablish the price around $18. Such a price would give a strong boost to economic growth, while helping to restrain inflation, but it was also a price at which the domestic oil industry could scrape by and would thus greatly reduce the pressure for a tariff. As a result, the Administration could maintain its commitment to “free markets” and would not have to take any action. When all things were considered in these circumstances, the most desirable thing to do was nothing.
But consensus was one thing. Putting together a new deal was quite another. And the efforts in that direction were failing, even though the loss of revenue was becoming excruciating for many oil exporters. The Arab Gulf states, which greatly increased the volumes they sold, were the least hurt. Kuwait’s revenues were down only 4 percent, Saudi Arabia’s 11 percent. The price hawks, which happened to be the countries most belligerent and hostile toward their customers in the West, were the ones hit hardest. Iran’s and Libya’s oil earnings in the first half of 1986 were down 42 percent from the same period in 1985. Algeria’s were down even more. For more than economic reasoning. Iran was the country most disadvantaged. Even as its revenues were plummeting, it was having to finance the war with Iraq, which had entered a new, more intense phase. The Iraqi air war against tankers and facilities was taking a rising toll on Iranian export capabilities. How could Iran continue to fight the Ayatollah Khomeini’s holy war against Iraq and Saddam Hussein without money?
Something would have to be done soon. Saudi Arabia had been maintaining its output at its old quota level, but now indicated that it would start pushing its production to higher levels. Even more oil would be coming onto the market. In July 1986, Persian Gulf crudes were going for $7 a barrel or less. Enough was enough, and the leaders of Saudi Arabia and Kuwait were anxious to bring the “good sweating” to an end. They, too, were worrying about prospects for revenues. Moreover, the volatility and uncertainty were too unsettling, too likely to increase broader political risks around the world. Virtually all OPEC decision makers had concluded that the market share strategy was, at least in the short term, a failure. But how to get out of it without sinking back into the bind that had precipitated it in the first place? The only way out was new quotas. But who would get what? Some of the exporters insisted that Saudi Arabia resume its swing role, to which Yamani replied, “Not on your life. We all swing together or not at all. On this point, I am as stubborn as Mrs. Thatcher.”
By July, OPEC experts had worked out on paper a detailed rationale for the new pricing: a range of $17 to $19 a barrel would lead to an improved world economic outlook, stimulating oil demand: “It could be an effective instrument for slowing and arresting the pace of fuel substitution” and “will definitely discourage future developments of high cost oil.” But, if prices were any lower, the exporters would run a grave risk: “strong protectionist measures in the major consuming countries of the industrialized world,” including “the imposition of an oil imports tariff in both the U.S. and Japan.” They remembered Eisenhower’s import restrictions much better than most Americans.
But still there was the matter of quotas, which would require renewed cooperation among the fractious OPEC exporters, and there appeared to be little hope that anything could be worked out when OPEC next met in Geneva, at the end of July and the beginning of August 1986. Iran, in particular, had signaled its opposition to new quotas. But in the course of the meeting, the Iranian oil minister, Gholam Reza Aghazadeh, appeared in Yamani’s suite for a private discussion. He spoke through an interpreter. Yamani was so startled by the message that he insisted that the interpreter translate it again. It was reiterated. Iran, said the minister, was now willing to accept the temporary, voluntary quotas pushed by Yamani and others. Iran had, in fact, backed down. Its oil policy was more pragmatic than its foreign policy.
The market share strategy was over. But in announcing the restoration of quotas, OPEC insisted that it would not carry the burden itself; non-OPEC would have to cooperate. And agreements were subsequently worked out in which various non-OPEC countries indicated that they would do their part. Mexico would cut its output. Norway promised not to cut back but rather to reduce the growth in its output. At least that was something. The Soviet Union had stood aside from most of the discussions. In May 1986 a senior Soviet energy official had derided the notion that the Soviet Union would ever formally cooperate with OPEC. The Soviet Union was not a Third World country, he insisted. “We are not a producer of bananas.” It was true in a way; one could not find bananas in Moscow. But, bananas or not, Soviet officials could read their balance of trade accounts, and the loss in terms of hard currency earnings from oil and gas, if continued, could be devastating for the plans to reform and revive the stagnant Soviet economy that were just beginning to be formulated under Mikhail Gorbachev. The Soviet Union promised to contribute a 100,000-barrelper-day cutback to OPEC’s efforts. The pledge was vague enough and the job of tracking Soviet exports sufficiently difficult that the OPEC countries could never be sure that the Russians were really as good as their word. But in the immediate turmoil, the symbolism was important. The next step to cool off the good sweating was for OPEC to formalize quotas and do something about price. But there was an interlude.6
Playing It by Ear
In September 1986 Harvard University was celebrating its 350th anniversary. Planning for this grand event had been going on for several years; it would demonstrate Harvard’s place in American life and its contribution to global learning. Nothing had been spared for the “350th,” from the corralling of illustrious Nobel Prize–winning names to the minting of specially designed commemorative chocolates. To cap the celebration, Harvard had chosen, from among the planet’s five billion citizens, two people to give major speeches. One was Prince Charles, heir to the British throne; after all, it was from England that John Harvard had emigrated to Massachusetts, where eventually in 1636 he had bequeathed his personal collection of three hundred books to the small college that was later renamed in his honor. The other speaker was the Saudi oil minister, Ahmed Zaki Yamani, who had studied for a year at the Harvard Law School and was now a large donor to the university’s Islamic collection. A delegation from Harvard even flew to Geneva to personally extend the invitation, which Yamani accepted.
The debonair Prince Charles delivered a lively and entertaining speech, delighting all in attendance. For his part, however, Yamani chose to deliver a very substantive, dense discourse, filled with numbers that went out to the second decimal place. The text was passed out in advance as the members of the audience seated themselves in the crowded ARCO Forum at the Kennedy School of Government. That way they could read along. It was meant to be a speech suitable to the occasion, putting into perspective the tumultuous, globe-shaking events of 1986, which had changed every economic indicator. It was also an explication and a justification. Reading in a soft murmur, only occasionally allowing himself a little half smile or small deviation from the text, Yamani recalled his battles over price with the oil companies in the early 1970s and with his OPEC brethren in the late 1970s and early 1980s. He called for stability and the recognition that oil was a “special commodity.” And he held out the hope of a return to that kind of stability: oil priced at fifteen dollars per barrel with a gradual rise in both price and OPEC output. It was a vision of a very orderly world. Did he really believe it?
At the end of his discourse, Yamani agreed to accept questions. For the last question, a tall, thoughtful professor stood up to observe how hard and contentious it was to make energy policy in the United States: the Congress fought with the President, the Senate with the House, various agencies with one another, everybody fought with everybody else. Was it any less contentious in Saudi Arabia? Would Yamani, he asked, describe the process by which oil policy was made inside Saudi Arabia?
Smoothly and without even a moment’s hesitation, the oil minister replied, “We play it by ear.”
The audience roared with laughter. It was an amusing answer, which captured the truth of improvisation in policymaking, whatever the government. Still, it was a little odd, coming from the self-proclaimed disciple of long-term thinking, who had been at the center of world oil decision making for a quarter of a century. Unbeknownst at the time to those in the audience, those words would be among the last of Yamani’s official utterances.
A month later, in October, Yamani was at a meeting in Geneva for the next stage in the reconstruction of OPEC. He followed his role as he was instructed; the kingdom wanted not only to protect its quota and assure its volumes, but also to receive a higher price—the consensus eighteen dollars, which was quite different from the fifteen dollars that Yamani had talked about at Harvard. Yamani went so far as to suggest, semipublicly, that it was contradictory to try to pursue higher volume and higher price at the same time, which seemed to go explicitly against the policy the King had enunciated. Nevertheless, Yamani would do the best he could, and further progress was, in fact, made in reconstructing the quota system. Then, one evening, a week after the meeting, Yamani was back in Riyadh at dinner with friends when he received a phone call advising him to turn on the television news. An item at the end of the broadcast reported tersely and without any adornment that Ahmed Zaki Yamani had been “relieved” of his post as oil minister. That was the way he learned he had been fired. Yamani had been in the job twenty-four years, a good, long run in any position anywhere. Still, it was an abrupt, embarrassing, and disconcerting end to a quarter-century career.
The reasons for his firing, and the way it was carried out, became a subject of intense discussion in Saudi Arabia and throughout the world. And the explanations proffered, as might have been expected, were many and somewhat contradictory: He had embarrassed the Royal Family not only by failing to pursue vigorously his instructions in Geneva but also by criticizing the thrust of those instructions; he had made powerful enemies by opposing barter deals; his firing reflected the jettisoning of policies with which he had publicly been associated. It was also said that there was resentment against him in Riyadh because of what was described by some as his arrogance, his patronizing manner, his high profile, and his celebrity status outside the country. Yamani had been King Faisal’s man, but Faisal had been dead for almost a dozen years. Now Fahd was King, and he was the maker of oil policy. By 1986, Yamani had precious few allies, while many of the other ministers and advisers believed that he had usurped their own authority. And, when it came down to it, some said, King Fahd just plain didn’t like Yamani.
Perhaps in the long run, it was the decline and then the precipitous collapse in the price of oil that led to Yamani’s own downfall. But there was the specific matter of the Harvard speech. Before that event, some in Riyadh had the impression that Yamani was merely going to say a few general words, more or less impromptu, not make a major policy statement. But a seventeen-page speech was not everyone’s idea of an impromptu talk. Moreover, the policy it espoused was not exactly identical with the official policy of Saudi Arabia. And the “play it by ear” remark, not a familiar idiom to everyone, was interpreted in Riyadh as a tart criticism of the Saudi government. So Yamani was returned to private life, to manage his fortune, to set up a research institute in London, to try to acquire a Swiss watchmaker, to preside over his perfume factory in Taif, to teach part-time at the Harvard Law School, and not surprisingly, to comment from time to time on world oil.7
The OPEC countries finally brought the “good sweating” to an end with a meeting in Geneva in December 1986. It was the first major OPEC meeting at which the new Saudi oil minister, Hisham Nazer, appeared. He, like Yamani, was among the initial generation of Saudi technocrats. Just two years younger than Yamani, he had been educated at UCLA and had been a deputy to Abdullah Tariki, the Saudis’ first oil minister. Nazer had then served for many years as Minister of Planning, which made him particularly alert to the links between oil and the national economy and to the overall revenue question that was troubling Riyadh. And he carried no responsibility for or commitment to the now-repudiated market share strategy.
The restoration of revenues was the central consideration at Geneva. The exporters agreed to a “reference price” of eighteen dollars, based upon a composite price of several different crude oils. They also agreed to a quota that, they hoped, would support the price. There was just one loophole. No agreement was possible between Iran and Iraq as to what Iraq’s quota should be, in light of the continuing war and Iraq’s expanding exports. So the quota only applied to twelve countries; Iraq was outside it, free to do what it could. It had, once again, as it had done at different times going back to 1961, temporarily seceded from OPEC. Still, a “notional” quota was assigned to Iraq, 1.5 million barrels per day, which brought the total up to 17.3 million barrels per day.
To the surprise of many, the framework of agreement managed, though with considerable reconstruction, to hold up through 1987, 1988, and 1989, though in the face of recurrent and sometimes intense pressure in the marketplace. To be sure, the OPEC price was not eighteen dollars, but rather, for the most part, in a range between fifteen and eighteen dollars. Prices were volatile, and at times appeared ready to plunge again. More than once, the quota system seemed about to fall apart. But the producers, faced with the alternative, rallied. After all, the OPEC countries themselves had felt the full brunt of the “good sweating,” and they had had enough of it.
The new oil prices, reconstituted in a lower range, completely wiped out the increases of the Second Oil Shock of 1979–81. The economic benefits to consumers were enormous. If the two oil price shocks of the 1970s constituted the “OPEC tax,” an immense transfer of wealth from consumers to producers, then the price collapse was the “OPEC tax cut,” a transfer of $50 billion in 1986 alone back to the consuming countries. This tax cut served to stimulate and prolong the economic growth in the industrial world that had begun four years earlier, while at the same time driving down inflation. In economic terms, the long crisis was certainly over.
Iran Versus Iraq: The Tide Turns
Politically and strategically, however, there still remained a great threat—the seemingly endless Iran-Iraq War, which could escalate into a wider conflict that would threaten oil production and supplies throughout the region and the security of the oil states themselves. In its seventh year, in 1987, the war broke through the barriers that had largely restricted it to the two belligerents and for the first time became internationalized, drawing in both the other Arab states of the Gulf and the two superpowers. A year earlier, Iran had captured the Fao Peninsula, the southernmost extreme of Iraq, bordering Kuwait. It looked as though Fao could be the gateway to the conquest of the Iraqi city of Basra, making it the potential key to the dismemberment and disappearance of the unified Iraqi state that Britain had created after World War I. But though the Iranians got to Fao, they could get no further. They bogged down in the marshy sands, blocked by a reinvigorated Iraqi Army. Thereafter, the war turned against them. Iraqi successes in the air and its missile attacks on Iranian shipping in the Gulf—the “tanker war”—led to stepped-up Iranian attacks on third-country tankers. Iran zeroed in on Kuwait, which was assisting Iraq. Khomeini’s forces not only hit shipping going to and from Kuwait, but also launched at least five missile attacks directly on Kuwait itself.
Like the other Arab states, Kuwait had taken seriously the United States campaign against the selling of arms to revolutionary Iran. Thus, it was extremely disconcerted by disclosures that the United States had secretly sold weapons to Iran in an attempt to win freedom for American hostages held in Lebanon and to start, somehow, a dialogue with “moderates” in Tehran, whoever they might be. The disclosures greatly increased the small country’s inherent sense of insecurity. But it was Iran’s attacks that propelled Kuwait, in November of 1986, to ask the United States to protect its shipping (though the American ambassador to Kuwait later insisted that he had relayed such a request in the summer of 1986). Washington was jolted to learn that the Kuwaitis had taken the additional precaution of asking the Russians for protection, and when that information reached the most senior levels in the Reagan Administration, the Kuwaiti request, in the words of one official, “didn’t linger.” The potential significance of the approach to Moscow provided reason for a quick response. For Russian involvement would have expanded Russian influence in the Gulf—something the Americans had sought to prevent for more than four decades, and the British, for no less than 165 years. But, apart from the East-West rivalries, it was deemed imperative to protect the flow of Middle Eastern oil.
President Reagan himself spoke of the need for self-defense in the Gulf but also restated his guarantee that the United States would safeguard the flow of oil. And in March 1987, the Reagan Administration, intent on excluding the Russians, told the Kuwaitis that the United States would take on the whole job of reflagging or nothing at all. It would not go “halvsies” with the Russians. Thus, eleven Kuwaiti tankers were reflagged with the Stars and Stripes, qualifying the ships for American naval escorts. A few months later, U.S. naval vessels were patrolling the Gulf. All that was left to the Russians was to charter some of their own tankers on the run to Kuwait. British and French naval units, along with ships from Italy, Belgium, and the Netherlands, also entered the Gulf to help protect freedom of navigation. The Japanese, forbidden by their constitution from sending ships but highly dependent on oil from the Gulf, chipped in by increasing the funds that they provided to offset the cost of maintaining American forces in Japan and by investing in a precision locator system in the Strait of Hormuz. West Germany shifted some of its naval vessels from the North Sea to the Mediterranean, freeing, it said, United States ships for duty in and around the Gulf. But, with the United States taking the lead, there was now the possibility of a major military confrontation between the U.S. and Iran.
By the spring of 1988, Iraq, making use of chemical weapons, was manifestly winning. And Iran’s ability and will to carry on the war were fading fast. Its economy was in shambles. The defeats were draining support for the Khomeini regime. Volunteers, fervent or otherwise, were no longer forthcoming. War weariness gripped the country; in one month, 140 Iraqi missiles fell on Tehran alone.
Among those maneuvering for position in post-Khomeini Iran—for the Ayatollah was old and known to be seriously ill—was Ali Akbar Hashemi Rafsanjani, the speaker of the Iranian Parliament and deputy commander of the Army. He was a member of a wealthy family of pistachio growers whose fortune had been augmented by Tehran real estate in the 1970s under the Shah. He himself was a cleric and a Khomeini student and disciple who had begun his opposition to the Shah in 1962. Though deeply involved in the “arms-for-hostages” negotiations with the United States, he had turned aside criticism, and as he navigated his way through the theocratic tangle of Iranian politics, he won himself the nickname of “Kuseh”—the Shark. He was, after Khomeini himself, the top decision maker in the Islamic Republic. And he concluded that it was time to seek an end to the war. Iran no longer had any chance of winning. The costs of the war were enormous, and they had no obvious limit. The Ayatollah’s regime, and his own prospects, could be threatened by continuing losses. Moreover, Iran was diplomatically and politically isolated in the world, while Iraq seemed to be growing stronger.
Then, the American naval presence in the Gulf did, in fact, lead to a major confrontation with Iran, but of an unexpected and tragic kind. In early July 1988, the United States destroyer Vincennes, engaged in an exchange with Iranian warships, mistook an Iranian Airbus, carrying 290 passengers, for a hostile aircraft and shot it down. It was a horrid mistake. To some in the Iranian leadership, however, it was not a mistake, but a sign that the United States was taking off its gloves and preparing to bring its great power to bear in direct military confrontation with Iran in order to destroy the regime in Tehran. Iran, in its weakened state, might not be able to resist. It could no longer afford to go against the United States. Moreover, in trying unsuccessfully in the aftermath of the accident to marshal diplomatic support, Iran discovered just how isolated politically it had become. All of these factors added to the urgency to reconsider Iran’s relentless commitment to the war.
Yet Rafsanjani still had to cope with an implacable force: Ayatollah Khomeini, for whom vengeance, including Saddam Hussein’s head, was the price of peace. But the facts of Iran’s position were evident to the others around Khomeini, and Rafsanjani finally prevailed. On July 17, Iran informed the United Nations of its willingness to countenance a cease-fire. “Taking this decision was more deadly than taking poison,” Khomeini declared. “I submitted myself to God’s will and drank this drink for his satisfaction.” But vengeance was still his ambition. “God willing,” he said, “we will empty our hearts’ anguish at the appropriate time by taking revenge on the Al Saud and America,” he added. The Ayatollah would not live to see such a day; within a year, he would be dead.
After the Iranian message to the United Nations, another four weeks and much negotiation passed before Iraq, too, would accept a cease-fire. It finally went into effect on August 20, 1988, and Iraq immediately began symbolic oil shipments from its Gulf ports, something it had been unable to do for eight years. Iran announced its intention to rebuild the great refinery at Abadan, which had been the starting point for the oil industry in the Middle East at the beginning of the century and had been almost completely destroyed in 1980, in the first days of the war. One month short of eight years after it began, the Iran-Iraq War ended in a stalemate, though one that favored Iraq. As far as Baghdad was concerned, it had won the war, and it now intended to be the dominant political power in the Gulf, and one of the world’s major oil powers. But the significance of the end of the Iran-Iraq War was much more far-reaching. It appeared that the threat to the free flow of Middle Eastern oil had at last been removed; and with the silencing of the guns along the shores of the Persian Gulf, the era of continuing crisis in the world of oil that had begun with the October War fifteen years earlier along the banks of another waterway, the Suez Canal, finally seemed to be at an end.
It was not only the end of the war that pointed to a new era. So did the changing relationship between oil exporting and the consuming countries. The great contentious question of sovereignty had been resolved; the exporters owned the oil. What came to matter for them over the 1980s was sure access to markets. When the producing countries discovered that consumers had more flexibility and wider choices than had been imagined, they came to see that “security of demand” was no less important to them than was “security of supply” to the consumers. Most of the exporters now wanted to establish that they were reliable suppliers and that oil was a secure fuel. With the sovereignty issue settled, with socialism in bad repute, and with the North-South confrontation a fading memory, the exporters could act more on economic than political concerns. In a quest for capital, some were reopening the doors to exploration by private companies within their borders—doors that had been slammed shut in the 1970s.
Others went further, as the logic of integration—so powerful a theme in the history of the industry—reasserted itself, seeking to rejoin the reserves to the markets. The state-owned companies of some of the exporters, following in the historic wake of private companies, went downstream to acquire outlets. Petróleos de Venezuela built up a large refining and marketing system in the United States and Western Europe. Kuwait turned itself into an integrated oil company, with refineries in Western Europe and thousands of gasoline stations in Europe operating under the brand name “Q-8.” Kuwait did not stop there. In 1987, Margaret Thatcher reversed Winston Churchill’s historic decision of 1914 and sold off the government’s 51 percent stake in British Petroleum. In her view, it no longer served any national purpose, and the government would be happy to have the cash. Kuwait thereupon snapped up 22 percent of BP—the very company that, along with Gulf, had developed and owned Kuwait’s oil until 1975. The British government was infuriated and forced Kuwait to reduce its holdings to 10 percent.
At almost exactly the same moment that the Iran-Iraq War ended, Saudi Arabia and Texaco, one of the original Aramco partners, announced a new joint venture. Texaco’s management was preoccupied not only with the company’s immediate problem—a $10 billion judgment that Pennzoil had won against it in a Texas courtroom for the Getty takeover—but also with how to enhance its long-term prospects in a dramatically different world oil industry. Saudi Arabia wanted to ensure that it had access to markets. Under the terms of their new deal, Saudi Arabia acquired a half interest in Texaco’s refineries and gasoline stations in 33 states in the eastern and southern United States. The transaction guaranteed the Saudis, if they wanted it, 600,000 barrels per day of sales in the United States, compared to the trickle of 26,000 barrels per day to which they had fallen in 1985, on the eve of the price collapse. Such “reintegration” represented one effort to put greater long-term stability back into the industry and to manage the risks faced both by producers and consumers.
A few months after the Iran-Iraq cease fire, George Bush, the former oil man, succeeded Ronald Reagan as President of the United States. And with the astonishing disintegration of the barriers, both symbolic and actual, that had long divided the countries of the Soviet bloc from the Western democracies, unprecedented prospects for global peace appeared at hand as the decade of the 1980s gave way to the 1990s. The competition among nations in the years ahead, some predicted, would no longer be ideological but instead primarily economic—a battle to sell their goods and services and manage their capital in a truly international marketplace. If that would, indeed, be the case, oil as a fuel would certainly remain a vital commodity in the economies of both the industrialized and the developing nations of the world. As a bargaining chip among the producers and consumers of oil, it would also remain of paramount importance in the politics of world power.
Yet out of the tumult of the 1970s and 1980s, important lessons had emerged. Consumers had learned that they could not regard oil, the fundament of their lives, so easily as a given. Producers had learned that they could not take their markets and customers for granted. The result was a priority of economics over politics, an emphasis on cooperation over confrontation, or at least so it appeared. But would those critical lessons be recalled as the years passed and those who had been part of the great dramas retired from the scene and new players took their place? After all, the temptation to grasp for great wealth and power has been endemic to human society ever since its beginnings. At a discussion in New York City in the late spring of 1989, the oil minister from one of the major exporting countries, a man who had been at the center of all the battles of the 1970s and 1980s, spoke at length about the new realism of producers and consumers and the lessons learned by both. Afterwards, he was asked how long such lessons would be remembered.
The question took him a bit by surprise, and he thought for a moment. “About three years, without reminding,” he said.
Within a year of that exchange, he himself was no longer minister. And a month later, his country was invaded.8