Years of Upheaval

by Henry Kissinger

  In October 1969 the Shah again came to the United States, this time on an official visit, and pursued the subject of American oil purchases directly with Nixon. The Shah considered that he was short $155 million in his development program — a sum oil producers would now consider a pittance. Nixon promised that he would do his utmost to increase oil purchases from Iran. This event merely served to teach Nixon how negligible was the influence of the President of the United States over oil import allocations. While the US government set the import quotas, the basic decisions as to where to purchase and produce were made by a consortium of the seven largest oil companies — the so-called majors. The quota established a ceiling but did not require that the ceiling actually be met; for actual sales each country had to deal with the majors.

  The companies operated under concessions in the various producing countries, owning the production facilities as well as the refineries and paying the host countries an agreed sum per barrel. The majors — not governments — made the basic pricing, production, and marketing decisions. They had had trouble enough finding a new share of the market for Libya, where oil had been discovered in the late Fifties, without complicating their problem by increasing Iran’s share.III When Nixon’s request was put before them, the American partners of the consortium refused to cooperate even with shifting some Defense Department purchases to Iran because the American share of the Iranian output was much smaller than in, say, Saudi Arabia. As Flanigan pointed out in a memorandum to me of January 10, 1970, “a substantial portion of the profits from these purchases would go to non-American companies if Iranian oil were sought.” On July 30, 1970 — nine months after having made a promise to be helpful on oil purchases — Nixon was obliged to write to the Shah in effect that he could not deliver.

  Nothing illustrates better the misperceptions that can precede a great upheaval. The industrial democracies, the companies, and the producing countries alike were blinded by a kaleidoscope of illusions: by the supposed surplus capacity in the United States, by the fear of a glut of oil that might lead to a massive break in prices, by the apparent eagerness of the various producing countries to increase their output, and by an assumption that individual producers would always be willing to undercut prices to increase their revenues at the expense of the rest — all notions that were exactly the opposite of the reality that was gradually emerging. Its full impact was obscured for a while because the oil companies had effectively made all pricing and marketing decisions for over a generation; the United States government was by habit reluctant to interfere with the operation of a market that seemed both efficient and consonant with our long-term interests.

  The Gathering Storm: 1970–1973

  AS the new decade began, all this began to change. World conditions of supply and demand shifted inexorably against the consumers. Demand grew, most of all in the United States. Soon we no longer possessed surplus capacity. In early 1972 the Texas Railroad Commission for the first time took off all restrictions on American production; by the end of the year the United States was producing at full capacity — with no further margin for discretionary expansion. It was a fateful turn of events. Domestic and world demand continued to grow, as the global economy headed for the end of its third decade of nearly uninterrupted boom. For America, oil imports turned from a convenience into a necessity: In 1947, the United States imported 8.1 percent of its oil consumption; in 1973, 36.1 percent.3 No longer able to dampen the world price by spurring our own production further or even to protect ourselves against supply cutoffs, we rapidly lost leverage. The balance of power on energy was shifting from the Texas Gulf to the Persian Gulf. The OPEC producers were moving into the driver’s seat. It was only a matter of time before they took advantage of it.

  The dimensions of the change were not immediately apparent. Because for a while longer prices were still established through negotiations between the private oil companies and the host countries, the illusion persisted that one was watching commercial bargaining and not a revolutionary upheaval. And because the symptoms, the price increases in the early 1970s, were extremely modest, no issue even of domestic economic policy — not to speak of national security — seemed to be involved.

  The proximate cause was the overthrow in September 1969 of the pro-Western King Idris of Libya by the radical Colonel Muammar Qaddafi. (It must be stressed that the price explosion was not a personal decision; one way or another, market conditions would have produced a price explosion, though perhaps over a longer period of time.) Until then the dominant role among the oil-producing countries was played by essentially conservative governments whose interest in increasing their oil revenues was balanced by their dependence on the industrial democracies for protection against external (and perhaps even internal) threats. Qaddafi was free of such inhibitions. An avowed radical, he set out to extirpate Western influence. He did not care if in the process he weakened the global economy. The working level of our government, especially in the State Department, operated on the romantic view that Third World radicalism was really frustrated Western liberalism. Third World leaders, they believed, had become extremist because the West had backed conservative regimes, because we did not understand their reformist aspirations, because their societies were backward and eager for change4 — for every reason, in fact, other than the most likely: ideological commitment to the implacable anti-Western doctrines they were espousing.

  For reasons I have explained earlier, I did not in Nixon’s first term take an initiating role in Middle Eastern policy. There were desultory discussions in the Washington Special Actions Group (WSAG) on what attitude to take toward the new Libyan regime. In a meeting of November 24, 1969, I raised the question whether to have the 40 CommitteeIV canvass the possibility of covert action. A study was prepared of economic and political pressure points on Libya; but the agencies did not have their heart in it. All options involving action were rejected, causing me to exclaim that I was averse to submitting to the President a paper that left us with the proposition that we could do nothing. My reluctance did not change a consensus along precisely those lines. According to the dominant view, the real danger of radicalization resided in our opposition to Qaddafi. The huge Wheelus Air Base — which Qaddafi asked us to vacate — was alleged to be of marginal significance. We would protect our oil interests best, it was said, by separating them from military matters. As perceived by the interagency paper prepared for the WSAG meeting, energy supplies were in jeopardy only if we did something to antagonize the new Libyan revolutionary regime:

  We see no immediate threat to these [oil] interests, although such could result if the regime is threatened, or becomes increasingly unstable, or if there were a real confrontation over Wheelus, or in the event of renewed hostilities in the Middle East.

  According to the bureaucratic consensus, it followed necessarily that our only choice was to try to get along with Qaddafi:

  Our present strategy is to seek to establish satisfactory relations with the new regime. The return to our balance of payments and the security of U.S. investments in oil are considered our primary interests. We seek to retain our military facilities, but not at the expense of threatening our economic return. We also wish to protect European dependence on Libyan oil; it is literally the only “irreplaceable” oil in the world, from the point of view both of quality and geographic location.

  Whereas America was deciding on passivity, Western Europe chose actively to curry favor with Libya’s radical ruler. Europe had, of course, made itself far more dependent on imported oil, much of it Libyan. In 1950, 75 percent of Europe’s energy needs had been met by coal. By 1970, faith in permanently cheap and plentiful oil, backed up by government incentives, had produced a 60 percent dependence on oil — almost all of it imported. And 25 percent of Europe’s energy requirements was supplied by Libya. The result was that within four months of Qaddafi’s coming to power, France had negotiated the sale of 100 advanced jet aircraft to Libya. France assuaged its conscience with
an inherently absurd and unenforceable Libyan promise that the planes would not be transferred to the states bordering Israel. Since Libya had few pilots trained for jet aircraft, the only possible purpose could be to make the planes available, one way or the other, to brother Arab states. Other European countries followed the same policy of conciliation; an especially friendly relationship developed between Libya and the Federal Republic of Germany.

  As is often the case, decisions that seemed prudent and restrained when they were made have come to appear reckless to posterity. In the cause of short-term economic prudence the West accepted Qaddafi’s revolution — and this, as it turned out, was bound to affect also the West’s political relations with the conservative oil producers. Libya taught these rulers a fateful lesson: The industrial democracies would not protect friendly governments so long as their radical, avowedly hostile successors did not challenge the democracies’ access to oil. Hence, there was no point in seeking to buy Western goodwill by restraint on oil prices or anything else. For a year or two, the occasion to apply this insight did not arise. But as market conditions changed, it subtly affected the attitudes of even the moderate governments.

  Thus did the political balance also shift, just as market conditions were transforming the economic equilibrium. Radical Libya then triggered a process by which the host governments gradually discovered, and began to exercise, their dominant power over the world oil market. There were three discernible stages in the revolution about to unfold: first, a creeping increase in prices; then the host governments’ gradual, de facto takeover of ownership and operational control from the oil companies; and finally the resulting ability of the producer governments to link the sale of oil to political conditions, especially the Arab-Israeli conflict.

  At the beginning of 1970, Libya demanded larger oil revenues from the companies operating on its soil. It had a special bargaining advantage in that the majors did not have the stranglehold on Libyan production that they enjoyed in the Persian Gulf. Because of Libya’s relatively late entry into the ranks of oil producers, and because of the majors’ reluctance to shift their purchases from traditional suppliers, the “independents” came to assume a special prominence in Libya. And they were much more vulnerable than their larger competitors. They could not substitute increased production in the Persian Gulf for cutbacks in Libyan oil or hold out against Libyan threats to shut down their facilities. On January 29, 1970, matters came to a head when the Libyan government demanded an increase of 40 cents a barrel — or 20 percent — in the price of its oil. While tiny in terms of later oil price rises, this represented the largest single jump in the history of oil negotiations. The companies initially resisted the increase and the Libyans thereupon resorted to unprecedented methods of intimidation.

  Libya picked on the most vulnerable link in the chain, the independent company Occidental Petroleum, and imposed production cutbacks on it more severe than those on its competitors. On June 12, 1970, Occidental’s production was slashed from 800,000 barrels a day to 500,000 and on August 19 it was cut again to 440,000, thus lowering Occidental’s output by 45 percent. It was the first time a producing country had implemented what amounted to an embargo. The majors in turn demonstrated their short sightedness by letting an inconvenient competitor twist slowly, slowly in the wind, to use a phrase of a later era, rejecting any measures of support to compensate Occidental for the costs of the cutback. Isolated and vulnerable, Occidental yielded to Libyan blackmail on September 4, 1970, agreeing to an immediate increase of 30 cents a barrel, rising to 40 cents over five years. The other companies soon followed suit.5

  At this stage, the economic impact of these settlements was less significant than the political implications. Heretofore the oil companies, bargaining as a unit, had imposed a unified price. Now the united front of the companies had been split, shattering one of the buffers between the producing and consuming countries. This set up a “leapfrogging” system between the Mediterranean suppliers and those of the Persian Gulf. Libya justified its higher price on the basis that the transportation costs from Libya were lower than those from the Gulf, that its oil was of a higher quality, and that it was dealing with independents. The Persian Gulf producers did not accept a theory that gave a larger income to a competitor and insisted on receiving matching increases. As soon as they prevailed, Libya would then invoke the loss of its premium to make new demands, triggering additional requests in the Persian Gulf, starting the cycle all over again. No true stopping point emerged; the international petroleum market structure of a generation was collapsing.

  It was a clear warning that something was wrong but it was not so perceived. The price increases, while substantial in percentage terms, started from a very low base. The price remained under $3.00 a barrel, which was still below the American domestic price. The increases did not seem to affect the basic premise of cheap and plentiful oil on which the economies of the industrial democracies were based. And therefore Western governments stayed out of the leapfrog negotiations between the producing governments and the oil companies. When Nixon on his European trip stopped at Chequers on October 3, 1970, British Foreign Secretary Sir Alec Douglas-Home informed Secretary of State William Rogers that the British companies in Libya had been told to be guided by “their commercial judgment” — in other words, since no security interests were involved, they would be left to their own devices.

  In December 1970 OPEC, emulating the Libyan precedent, convened in Caracas and formally requested new price negotiations between the majors and all the petroleum-exporting nations. In effect, the oil producers were beginning to take full control of their oil. Too late the companies bestirred themselves. In January 1971 they agreed to what they had failed to do four months earlier: to bargain collectively and to resist selective blackmail by sharing oil. Ironically, to prevent leapfrogging tactics they also demanded that OPEC negotiate as a unit. In time OPEC accepted the proposal with a vengeance, forging an efficient cartel willing to reduce its production contrary to the historical practice of almost all its members.

  At last the United States government began to take an interest. It was urged on by the oil companies, which followed their time-honored pattern of asking for assistance only at the last moment, and then only ad hoc, not for a long-term strategy — which they feared would lead to government control. They asked for, and received, dispensation from the Department of Justice so that a united front of the companies would not be treated as a violation of antitrust laws. At the urgent request of the companies, Under Secretary of State John N. Irwin II was dispatched to the Mideast on January 16, 1971, to urge moderation on the oil-producing nations.

  Unfortunately, our government would have been hard put to define what it meant by “moderation.” The tactical need to meet the deadlines imposed by OPEC for new negotiations obscured the necessity for a more fundamental review. On January 14 my able staff members C. Fred Bergsten and Harold Saunders, monitoring the fast-moving company negotiations, had recommended a more serious study of the advantages and disadvantages of United States government involvement. They presented several arguments in favor of staying out of the dispute between the producers and the companies: The rise in the price of energy would affect primarily Europe and Japan and probably improve America’s competitive position. To sustain a confrontation would require us to be prepared to ration oil at home to support the European economies — a difficult enterprise in a country racked by Vietnam. To improve their bargaining position with the oil producers the oil companies might bring pressure on the government to intervene in the Arab-Israeli conflict, which was contrary to our strategy of demonstrating the limits of Soviet influence. Confrontation, it was also suggested, could weaken America’s relations with the Arab world.

  My staff also put the arguments in favor of deeper government involvement, not the least of which was the need to head off a cycle of escalating producer demands shading into the political field. There was also the danger of supply disruptions that would
seriously affect our own security as well as that of our allies. Though I leaned to the arguments for a more active governmental role, I concluded that I was in no position to make a recommendation. Therefore I took the official’s time-honored way out: On January 15, 1971, I ordered a study of the national security implications of the problem.

  Well before the study was fairly launched, the arguments for nonintervention carried the day in keeping with long-established national policy. The United States government did not as a general practice involve itself in commercial disputes. We would step in to resist the expropriation of American companies when there was no fair compensation; we had not to my knowledge engaged ourselves in price negotiations.

  On January 18, while Irwin was in the Middle East, I sent Nixon a memorandum (drafted with the help of Bergsten and Saunders) summing up the status of the negotiations between OPEC and the oil companies. If we were going to encourage the companies to stand up to the producers, I argued, six questions would have to be answered:

  Will the companies stick together and hold the line against the Libyan demands? . . . Will Libya stick to its extreme demands and stop the flow of Libyan oil if they are not met? . . . Will the other Arabs then stick with Libya and shut down their production as well? . . . Will the European governments panic at the potential shortages and attempt to strike their own government-to-government deals with Libya, circumventing the companies? . . . Or will the Europeans join forces to staunchly resist the Arabs? . . . Will we then ration oil domestically to help the Europeans withstand the Arabs, and/or bring new pressures on Israel to buy off the Arabs politically?