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Managing an oligopoly of would-be sovereigns: the dynamics of joint control and self-control in the international oil industry past, present, and future

  • Theodore H. Moran (a1)

Abstract

The key to the success of the oil oligopoly has been the ability of its members to make commitments to each other credible despite great divisiveness and enormous uncertainties. To accomplish this, the oil companies constructed a regime of suprasovereign constraints to control the pursuit of individual self-interest. When these anti-democratic, anti-autonomous institutions functioned effectively, the corporations met challenges far greater than those OPEC subsequently faced; when they began to disintegrate, the companies' ability to hold price above marginal cost deteriorated. OPEC reinvigorated the oligopoly using the ready-made self-denial and surveillance mechanisms built by the companies, then systematically unravelled them in moving towards a “mature” cartel held together by “mere” common interest, promises, and threats. To reconstruct an oligopoly that has the cohesiveness of the corporate era, OPEC will need not only a more moderate price trajectory, but also a binding structure that gives preponderance to the most conservative members, provides prompt and accurate verification of cheating, and automatically imposes penalties in magnified form for competitive behavior (without the need for direct retaliation). Beyond predictions about the future of the oil industry, these findings have important implications for economic approaches to imperfect competition, for anti-trust analyses of collusion, and for organizational theories of hegemonic leadership.

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1. In economic and legal usage, the distinction between an oligopoly and a cartel lies in how explicit are the rules that govern the behavior of the members and how overt are the efforts at collusion. In the oil industry, as we shall see, there has been a rich mixture of explicit and tacit, overt and covert attempts to regulate the activities of the participants. For a discussion of price behavior for an industry with an exhaustible resource, see note 46.

2. The prospects for cartel success were favored by concentration of production, inelastic demand, operating-cost advantages, and few short-term substitutes. When all of these conditions were met, however, the average cartel life was four to five years. Eckbo, Paul Leo, The Future of World Oil (Cambridge, Mass.: Ballinger, 1976).

3. Bain, Joe S., Barriers to New Competition (Cambridge: Harvard University Press, 1956); Scherer, F. M., Industrial Market Structure and Economic Performance (Chicago: Rand McNally, 1980). For recent approaches which emphasize the role of enforcement, see notes 9 and 31.

4. For the debate about measures of industry concentration and the presumption of tacit collusion, see note 61.

5. Standard Oil Company of New Jersey v. United States, 221 U.S. 1 (1911). Sampson, Anthony, The Seven Sisters (London: Hodder & Stoughton, 1975).

6. Kindleberger, Charles P., The World in Depression, 1929–1939 (Berkeley: University of California Press, 1973), and Dominance and Leadership in the International Economy,” International Studies Quarterly 25 (06 1981). See also note 63. Unlike most other studies of hegemony, this examination of the oil industry does not have the hidden motive of applauding or lamenting the decline of American preeminence in the international system.

7. An optimal price trajectory combines elasticities of supply and demand, prospects for substitution, discount rates (which indicate relative need for current revenues), and reserve bases (which suggest relative concern about spoiling future markets) to generate the maximum return from producing oil. See Pindyck, Robert, “Gains to Producers from the Cartelteation of Exhaustible Resources,” Review of Economics and Statistics 60 (05 1978). On the difficulty of using this unitary actor, rational monopolist model for OPEC, see Moran, Theodore H., ”Modeling OPEC Behavior: Economic and Political Alternatives,” International Organization 35 (Spring 1981).

8. Schelling, Thomas C., The Strategy of Conflict (New York: Oxford University Press, 1963).

9. Economic analysis (subsequent to Schelling) on making commitments by “tieing one's hands” has centered on making dedicated investments to preempt entry by other firms. Eaton, B. Curtis and Lipsey, Richard G., “Capital, Commitment, and Entry Equilibrium,” Bell Journal of Economics 12 (Autumn 1981); Dixit, Avinash, “Recent Developments in Oligopoly Theory,” American Economic Review Proceedings 72 (05 1982). For a broader view of credible commitments, see Oliver E. Williamson, note 31. In the political economy literature, Kenneth A. Oye highlights the question of how actors “bind” themselves to mutually advantageous courses of action. Cooperation Under Anarchy (Princeton, N.J.: Princeton University Press, 1986).

10. As will become evident, this analysis takes a “tough” approach to distinguishing between regimes, emphasizing surveillance procedures, mechanisms for imposing discipline, and real penalties for deviation, rather than the “softer” idea of shared norms, principles, and expectations. It tries simultaneously, however, to avoid the danger of reification. In the final analysis, the regime of the corporate period, like that of OPEC, depended upon consent, not coercion. Krasner, Stephen D., ed., International Organization 36 (Spring 1982).

11. Rockefeller, John D., Random Reminiscences of Men and Events (New York: Arno Press, 1973; reprint of 1909 edition). For the natural monopoly point of view, see also Frankel, Paul H., Essentials of Petroleum (London: Chapman & Hall, 1946).

12. The principle that the relationship between fixed-costs and variable-costs can render a corporation extremely vulnerable to external suppliers played a key role in two subsequent periods: 1971 and 1979. For the railroads to cave in to Rockefeller was as predictable as for Occidental to cave in to Qadafi, or for Japanese refiners to chase spot prices five times above contract prices after the fall of the Shah. See infra, p. 597 and note 57.

13. Chandler, Alfred H. Jr, “Divestiture in Perspective: History of Corporate Power and Structure,” presentation at Johns Hopkins School of Advanced International Studies, Washington, D.C., 27 05 1976. See Loescher, Samuel M., “A Sherman Act Precedent for the Application of Antitrust Legislation to Conglomerate Mergers: Standard Oil, 1911,” in Markham, Jesse W. and Papanek, Gustav F., eds., Industrial Organization and Economic Development (Boston: Houghton Mifflin, 1970).

14. Oral Argument on Behalf of Appellants before the Supreme Court, Standard Oil Company of New Jersey v. United States., 221 U.S. 1 (1911), p. 59, cited in Loescher, , “A Sherman Act Precedent,” p. 204.

15. Rockefeller, John D., Randon Reminiscences, p. 5.

16. Following Edith Penrose and M. A. Adelman, I shall use the more familiar modern names of the oil companies unless a prior name is needed for historical clarity. For an estimate of the relative sizes of the eight companies, see the chart on p. 585.

17. Control over the transportation stage, à la Rockefeller, was never a realistic option for the international oil companies. World tanker capacity was too diffusely held. At the end of World War II, the Seven Sisters had 35% of dead weight capacity; in 1953, 29%; in 1972, 19%. Jacoby, Neil H., Multinational Oil: A Study in Industrial Dynamics (New York: Macmillan, 1974), Table 5.3, p. 78.

Strictly speaking, if the constraint on production were absolute, there would be no requirement for further constraints downstream. As will become evident, the oil industry needed multiple layers of joint control, surveillance, discipline, and compensation.

18. Mikesell, Raymond F. and Chenery, Hollis B., Arabian Oil: American's Stake in the Middle East (Chapel Hill: University of North Carolina Press, 1949), p. 45.

19. After satisfying American demand, U.S. companies accounted for 58% of all foreign oil requirements in 1921. Exxon alone provided over 50% of the United Kingdom's needs. Clearly, executives within Exxon discussed the possibility of threatening to withdraw from the British market (letter from E. F. Powell to F. D. Asche, 14 May 1920), but it is not certain that they ever made the threat. The International Petroleum Cartel, staff report to the Federal Trade Commission, submitted to Subcommittee on Monopoly of the Select Committee on Small Business, U.S. Senate, 22 08 1952 (Washington, D.C.: GPO, 1952), p. 53.

20. For the details of IPC negotiations, among themselves and with the authorities in Baghdad, , see The International Petroleum Cartel; and United States v. Standard Oil Company (New Jersey) et al., United States District-Court, Southern District of New York, Civil Action No. 86027, 12 06 1961, reproduced in The International Petroleum Cartel, the Iranian Consortium and U.S. National Security (Washington, D.C.: Subcommittee on Multinational Corporations, Committee on Foreign Relations, United States Senate, 21 02 1974); and Stivers, William, ”A Note on the Red Line Agreement,” Diplomatic History 7 (Winter 1983). The quotation from Deterding's, Sir Henri letter is found in The International Petroleum Cartel, p. 59. The Iraq Petroleum Corporation was called the Turkish Petroleum Corporation until 1929. A further motivation to settlement may have been the Exxon/Royal Dutch-Shell price war of 1927. See the next section on the Achnacarry Agreement.

21. The four other American companies were Socony, Gulf, Atlantic Refining, and Pan American Petroleum. In 1930, Exxon and Socony bought out Atlantic Refining and Pan American Petroleum. In 1931, Socony merged with Vacuum Oil to become Socony-Vacuum, later Mobil.

22. Skliros, J., managing director, cited in The International Petroleum Cartel, p. 65.

23. Each “major group” could appoint two directors. Resolutions at IPC board meetings could pass only if three major groups voted favorably. Since one director from the American group always came from Exxon, the company could block proposals by the other U.S. participants.

24. For details of the Achnacarry Agreement and the subsequent modification of the As Is system, see United States v. Standard Oil Company (New Jersey) el al.; and The International Petroleum Cartel.

25. Rules for the treatment of under-traders and over-traders were first formulated in 1930, but the arrangement did not last long. The 1934 “Draft Memorandum of Principles” empowered the London committee to “in general do all things necessary toward the proper functioning of this arrangement” (clause 231). Specifically, if interested members could not resolve a dispute, the decision of the committee was to be binding on all participants. International Petroleum Cartel, p. 265.

26. For initial reserve estimates, see Mikesell and Chenery, Arabian Oil. For current (and more sophisticated) reserve estimates, see Nehring, Richard, Giant Oil Fields and World Oil Resources (Santa Monica, Calif.: Rand, 06 1978) and The Petroleum Resources of the Middle East (Washington, D.C.: Energy Information Administration, 1981).

27. Following Adelman, who argues that the U.S. market was not open to imports in the postwar period, this table excludes U.S. (as well as U.S.S.R.) production and reserves. In fact, in 1947, U.S. oil production and consumption were approximately in balance.

28. United States v. Standard Oil Company (New Jersey) et al., p. 152.

29. Ibid., p. 155.

30. For details, see The International Petroleum Cartel, chap. 6.

31. Oliver E. Williamson examines the use of hostages to make commitments more credible. His analysis focuses on the “posting” of a hostage by one side, or the demand of a hostage as an ”entry fee” by the other side. My assessment is closer to Schelling's idea of an exchange of hostages within a structure of mutual assured destruction. Williamson, Oliver E., “Credible Commitments: Using Hostages to Support Exchange,” The American Economic Review 73 (09 1983); and The Economic Institutions of Capitalism (New York: Free Press, 1985), chaps. 7, 8, 14, and 15.

32. For details, see The International Petroleum Cartel, chap. 5. See also Anderson, Irvine H., Aramco, United States, and Saudi Arabia: A Study of the Dynamics of Foreign Oil Policy, 1922–1950 (Princeton, N.J.: Princeton University Press, 1981).

33. Ibid., p. 124.

34. J. E. Hartshorn and Penrose agree that a penalty for overlifting existed, but do not state the amount. I assume that it began as the 15ø per barrel indicated in Article IV of the off-take agreement. Hartshorn, J. E., Oil Companies and Governments (London: Faber & Faber, 1967), pp. 181–82; Penrose, Edith T., The Large International Firm in Developing Countries: The International Petroleum Industry (Westport, Conn.: Greenwood Press, 1968), p. 159.

35. “Memorandum for the Secretary [of State], November 26, 1952,” in The International Petroleum Cartel, The Iranian Consortium, and U.S. National Security, pp. 26–28. For an excellent overview, see Painter, David S., Oil and the American Century: The Political Economy of U.S. Foreign Oil Policy, 1941–1954 (Baltimore: Johns Hopkins University Press, 1986).

36. Ibid.

37. Ibid., and “Incoming Telegram,” London to Secretary of State, 30 March 1954, pp. 82–83.

38. It is a mistake to conceive of the U.S. corporations or the U.S. government as interjecting a mercantilistic American presence into the affairs of European rivals. On the contrary, these moves with regard to Iranian production (like the earlier IPC in Iraq) are better understood, to paraphrase one interpretation of the dynamics of imperialism, as an effort to use the New World to help redress the balance of the Old.

39. “Memorandum for the Secretary (of State), November 26, 1952,” “Memo to the Files from Stanley N. Barnes, Assistant Attorney General for Antitrust,” 23 September 1953, and ”Incoming Telegram, London to Secretary of State, March 30, 1954” in The International Petroleum Cartel, the Iranian Consortium, and U.S. National Security. Another player in this decision was Sen. Lyndon Johnson, who warned Secretary of State John Foster Dulles that Texas oilmen were afraid of being flooded with cheap Iranian crude. Dulles reassured him. Hearings before the Subcommittee on Multinational Corporations of the Committee on Foreign Relations, United States Senate, August 1974, part 8.

40. Article 28, Participants’ Agreement, The International Petroleum Cartel, the Iranian Consortium and U.S. National Security, p. 110.

41. Ibid., “Preface.” See also Kaufman, Burton J., The Oil Cartel Case: A Documentary Study of Antitrust Activity in the Cold War Era (Westport, Conn.: Greenwood, 1978).

42. Ibid.

43. The International Petroleum Cartel, chap. 8.

44. The production figures, after 1947, are from Adelman, M. A., The World Petroleum Market (Baltimore: Johns Hopkins University Press for Resources for the Future, 1972), pp. 8081. Adelman excludes the U.S. market, arguing that it was not open to imports during this period. The 1947 production calculation is from Chenery and Mikesell, Arabian Oil. The reserve estimates are subject to a large margin of imprecision. For the 1947 estimate, I have used a calculation by the engineering firm of De Golyer, cited in Arabian Oil. For later periods, I have used calculations for individual oil fields given by the Energy Information Administration, and by Richard Nehring in Giant Oil Fields, with the assumption that 60% of the subsequently known reserves were proven in the first five years after discovery, 80% in the first ten years, and 90% in the first fifteen years. For the large Persian Gulf fields, this procedure may be too conservative. The resulting estimates are not meant to be exact; whatever methodology one adopts, however, it is clear that the smaller members of the corporate oligopoly accumulated very large proven reserves quite quickly.

45. To be sure, it is logically impossible, in absolute terms, to separate competitive behavior in the final marketplace from competitive behavior at the production level: a barrel used to expand one's market share must always come from somewhere, and, assuming a positive elasticity of demand, it must always be one barrel more than what would be required to clear the market at the slightly higher price. Still, the contrast in behavior at the production and the sales end is striking.

For disputes about the relationship between concentration and competition, see note 61.

46. Prices and production costs are for Saudi Arabia. Calculations for Kuwait, Iraq, and Iran are within the same range. From Adelman, World Petroleum Market. Data are not complete for each year. This analysis is consistent with Neil Jacoby's finding that the profitability of the international oil companies was converging with the average return on capital for American industry in the 1960s. Neil H. Jacoby, Multinational Oil.

It can be argued that, for an exhaustible resource, prices will be higher than marginal costs even under competitive conditions. But the massive expansion of reserves with stable or declining production costs demonstrate that the “Hotelling approach” to exhaustible resources was not the appropriate framework during this period. See Hotelling, Harold, “The Economics of Exhaustible Resources,” Journal of Political Economy 39 (04 1931); and Moran, Theodore H., ”Modeling OPEC Behavior: Economic and Political Alternatives,” International Organization 35 (Spring 1981).

47. Adelman, , World Petroleum Market, and Suzuki, M., “Competition and Monopoly in the World Oil Markets,” 02 1968, cited in Adelman, Appendix V-A.

48. Adelman, World Petroleum Market. Adelman hypothesizes that the American major oil companies observed “voluntary” import quotas at least a decade before the mandatory quotas of 1959 to avoid the wrath of oil-state senators who knew what would happen to small, local producers if low-cost foreign oil poured into the United States.

49. Penrose, The Large International Firm.

50. Adelman, M. A., “Is the Oil Shortage Real?Foreign Policy 9 (Winter 19721973). For a counter-argument, see Akins, James E., “The Oil Crisis: This Time the Wolf is Here,” Foreign Affairs 51 (04 1973).

51. Adelman, ibid.

52. The revolution in the oil industry was not demand-driven. In 1969–70, the demand for oil was rising less rapidly than it had been during the mid-1960s, when prices were falling; in 1971–72, it was rising less rapidly still. The location of spare capacity, however, was changing. By the time of the 1973 oil crisis, spare capacity in the United States was down to about 10%, compared to a 25% level during the unsuccessful Arab embargoes of 1956–57 and 1967.

53. For the evidence on rerouting petroleum to offset the impact of the embargo, see Stobaugh, Robert B., “The Oil Companies in the Crisis,” Daedalus (Fall 1975).

The principal adverse effects on the U.S. economy came not from the selective embargo, but from domestic price controls and from a highly deflationary macroeconomic policy.

54. Moran, Theodore H., “Oil Prices and the Future of OPEC,” Foreign Policy (Winter 19761977).

55. Exxon, , Middle East Oil and Gas (New York: Exxon Background Series, 12 1984).

56. Levy, Brian, “World Oil Marketing in Transition,” International Organization 36 (Winter 1982).

57. Over-aggressive pricing policies are not uncommon among state-owned companies, leading them to become suppliers of last resort. See Moran, Theodore H., Multinational Corporations and the Politics of Dependence: Copper in Chile (Princeton, N.J.: Princeton University Press, 1974), and Shafer, Michael, “Capturing the Mineral Multinationals: Advantage or Disadvantage?International Organization 37 (Winter 1983).

From the demand side, when force majeure was declared first on Iranian contracts in 1978, and subsequently on Saudi contracts in 1979, it put non-integrated refiners in a tight squeeze. With high fixed-costs and the threat of bankruptcy looming, they bid prices in the thin spot market up to a level four to five times the average contract price. Their “panic” was economically rational.

58. The Petroleum Intelligence Weekly was founded in 1961 and (as a measure of consistency in reporting) has been under the same editor ever since. To produce a conservative measure of ”cheating”, disputes about differentials have been excluded. The survey includes the first three stories in each issue. Credit for assistance in preparing this analysis belongs to Roza Pace.

59. The PIW calculation is $19.7 billion, but most of Iraq's decline in production was due to the war with Iran and troubles with Syria, not price competition per se. “Billions at Stake as Output Shares Shifting within OPEC,” Petroleum Intelligence Weekly, 13 December 1982.

60. Morse, Edward L., “After the Fall: The Politics of Oil,” Foreign Affairs 64 (Spring 1986).

61. There is inconclusive controversy about whether an 8-firm concentration ratio above 70% is, by itself, an accurate predictor of tacit collusion. The evidence from the petroleum industry suggests that, in the absence of explicit enforcement mechanisms, it is not. For the fundamentals of the debate see Harold Demsetz, “Two Systems of Belief about Monopoly,”Leonard W. Weiss, “The Concentration-Profits Relationship and Antitrust,” Posner, And Richard A., ”Problems of a Policy of Deconcentration,” in Goldschmid, Harvey J., Mann, H. Michael, and Weston, J. Fred, eds., Industrial Concentration: The New Learning (Boston: Little, Brown, 1974); and Scherer, Industrial Market Structure.

62. Craven, John, ed., Industrial Organization, Antitrust, and Public Policy (Boston: Kluwer-Nijhoff, 1982); Posner, Richard A., “Some Uses and Abuses of Economics in Law,” University of Chicago Law Review 46 (Winter 1979).

63. Robert Keohane emphasizes the importance of institutions put in place, and left in place, to facilitate cooperation as a hierarchical hegemonic system deteriorates. He argues that institutions do not necessarily contradict neorealist premises about self-interested behavior; institutions may play a valuable role in achieving the goals of the individual actors. After Hegemony: Cooperation and Discord in the World Political Economy (Princeton, N.J.: Princeton University Press, 1984).

For the importance of hegemonic coercion, with an insistence on contributions from the smaller members of a given group, however, see Sm'dal, Duncan, “The Limits of Hegemonic Stability Theory,” International Organization 39 (Autumn 1985), and Gilpin, Robert, War and Change in World Politics (Cambridge: Cambridge University Press, 1982).

64. As Thomas Willett notes, policies that have the largest real economic effects with the least cohesion-enhancing appearance of confrontation are most likely to be successful. Willett, Thomas D., “Conflict and Cooperation in OPEC: Some Additional Economic Considerations,” International Organization 33 (Autumn 1979).

65. To be sure, other exporting nations, including Venezuela, Nigeria, Indonesia, and Great Britain, would be less well off with the permanent collapse of the oil oligopoly.

Managing an oligopoly of would-be sovereigns: the dynamics of joint control and self-control in the international oil industry past, present, and future

  • Theodore H. Moran (a1)

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