Oil

by Tom Bower

  The new, unfocused group confronting the Western cartel remained ineffectual until the Six-Day War in 1967. Resentment against America and Britain sparked the declaration by Saudi Arabia of an oil embargo, but this show of bravado descended into farce when the Seven Sisters efficiently organized increased supplies from Iran and Venezuela, and Saudi Arabia’s income plummeted. The fiasco emboldened Muammar Gaddafi after his coup in Libya in 1969. “My country has survived 5,000 years without oil,” he told Peter Walters, BP’s managing director, during their first tense meeting in 1970, “and unless we get more money we will stop supplies.” A huge spurt in demand had prompted Exxon to forecast for the first time a world shortage of oil, and the fear of scarcity, plus America’s increase in imports to 28 percent of its consumption, served the interests of OPEC. The Seven Sisters, OPEC knew, could only control prices so long as there was a surplus of oil. Armand Hammer, the chairman of Occidental, was the first to capitulate, reducing production and increasing his payments to Gaddafi in May 1970. Gaddafi’s success encouraged the Shah of Iran, and then the governments of Venezuela and Saudi Arabia, to demand price hikes. The oil companies feared losing their power to threaten the producers with a boycott if they rejected the prices they stipulated. Meeting in New York on January 11, 1971, 23 oil companies agreed, with the American government’s permission, to breach the antitrust laws, and confront Libya and OPEC. Their unity was short-lived. During negotiations in Tehran and Tripoli in March 1971, the companies’ agreement disintegrated, and prices were increased beyond their limits. “We’ll never recover,” Walters lamented. “There is no doubt that the buyer’s market for oil is over,” admitted David Barran, Shell’s chairman. The Arabs, he noted, felt betrayed by the West. Sensing weakness, the Libyan and Iraqi governments began partial nationalization of Western oil interests in 1972. The United States, said Gaddafi, deserved “a good hard slap on its cool and insolent face.” The Shah agreed. He nationalized 51 percent of the oil majors’ Iranian interests and increased prices again. Peter Walters was meeting OPEC representatives in Vienna on October 6, 1973, when he heard that Egypt and Syria had invaded Israel during Yom Kippur, the most holy day in the Jewish calendar. The relationship between the OPEC producers and the Seven Sisters had changed unalterably. The public and the politicians blamed the oil companies for creating chaos and making excessive profits. In the vacuum of considered energy policies, Western governments were accused of perpetuating a “fool’s paradise” by relying on arrogant oil executives to supply civilization’s lifeblood. Eric Drake, BP’s chairman, admitted to Andy Hall and other graduates recruited during that epic year that oil would probably rise from $2.90 to the unprecedented price of $10 a barrel. Prices actually rose to $12, provoking the Seven Sisters’ disintegration and the industry’s transformation. Oil was no longer a concession or a product for refining, but became a tradable commodity attractive to cowboys.

  Until 1973, oil traders hardly existed except for a fringe group who, to the irritation of BP and Shell, shipped crude from Russia to Rotterdam to supply West Germany and Switzerland. After the Seven Sisters were disabled, BP and Shell no longer felt obliged to protect the Arabs’ monopoly. Whenever the corporations had a surplus of crude, they traded it for instant delivery in Rotterdam, one of the world’s largest oil-storage areas. Anro, a subsidiary of BP managed by Yorkshireman Chris Houseman, began speculating in oil and refined products based on “spot” prices quoted in Rotterdam, and Shell established Petra, a rival trader in the port. Gradually the two companies replaced the fixed-price contracts agreed upon with OPEC with contracts based on prices quoted among traders on the day of delivery in Rotterdam. Oil became a traded commodity in an unregulated market, subject only to finance from banks and counterparty risk.

  The treatment of oil as a commodity akin to sugar, rice, coal and particularly metal ores caught the attention of Marc Rich, a secretive trader employed by Philipp Brothers, the world’s largest supplier of raw materials, based in New York. Ambitious for wealth, Rich would achieve notoriety in 2000 when, in the last moments of the Clinton administration, the president granted him a pardon on charges of tax evasion. Rich’s journey had begun in the late 1960s. Accustomed to playing both sides in order to control the market for any mineral buried in the earth, he and his partner Pincus “Pinky” Green had realized that the Seven Sisters’ control of the oil surplus would eventually be challenged and replaced by the producers’ governments. Like the handful of rival traders in London, Rich understood both the complications and the simplicity of oil. After sophisticated technology had found a reservoir, basic project management would efficiently pipe the crude to a tanker for delivery to a refinery. To earn a real fortune from trading oil, Rich knew, required understanding of refining — heating crude oil to boiling point and separating the parts: naphtha for chemicals and the distillates to make gasoline, jet fuel, heating oil, kerosene and diesel. Making a profit from the manufacture of those fuels depended on understanding the constraints of the 600 refineries in the world, each calibrated to process a particular crude from roughly 120 different types. If a refinery calibrated for Iranian crude was denied supplies, the adjustment to process the alternative heavy, “sour” sulphur crude from Saudi Arabia or the lighter “sweet” crude from Iraq was expensive and time-consuming. Profiting from oil, Rich knew, depended on anticipating the circumstances that could cause a disruption of the market or spotting a potential shortage, and securing alternative supplies.

  The biggest profits were earned by breaking embargoes, of which none was more high-profile than that against the apartheid regime in South Africa. A company called Sigmoil, loosely connected to Philipp Brothers, dispatched laden tankers from New York to South Africa. In the middle of the Atlantic, the ships’ names were changed by rapid repainting, successfully confusing the hostile intelligence services in South Africa. In that atmosphere, Rich was looking for his own niche.

  In early 1973, Rich heard rumors about a forthcoming Arab invasion of Israel. That war, he believed, would lead to an oil embargo and soaring prices. Rich was focused on Iranian oil, which in the event of war would be withheld. If he could accumulate and store Iranian oil, its value would rocket after the crisis erupted. Rich was able to find Iranian officials close to the Shah, the pro-Western dictator imposed on the country after a CIA coup in 1953, who were prepared to break their government’s agreement to supply oil exclusively to the Seven Sisters. Working in the shadows, Rich flew to inhospitable locations to supervise the loading of crude onto tankers destined for refineries in Spain and Israel and, more importantly, storage in Rotterdam. In exchange for selling the oil below the world price to Philipp Bros., but unbeknownst to the company’s directors, the Iranian officials, it is alleged, received “chocolates” in their Swiss bank accounts. Even the corrupt, Rich always acknowledged, were clever. In New York, however, Philipp’s directors disbelieved Rich’s information about an imminent war. Fearful of the financial risks of purchasing and storing Iranian crude, they ordered the stocks to be sold. Philipp Bros. position has always been that it had no idea what Rich was up to.

  After the October invasion, as Israel fought for survival, the oil producers met and agreed to increase prices; to prevent any supplies of weapons reaching Israel, they also imposed an embargo on Holland and the USA. In the face of queues and rationing of gasoline, there was fear throughout the West of economic devastation. Richard Nixon, fighting to retain his presidency in the midst of the Watergate scandal, supported Israel against what Henry Kissinger, his secretary of state, called OPEC’s “political blackmail.” In retaliation after Israel’s victory, the Shah, hosting a conference of OPEC producers in Tehran in December 1973, urged even higher prices than $12 a barrel. Privately, Nixon protested about the potential “catastrophic problems” that would be caused by the “destabilizing impact” of the price increase. Iran, the Shah replied, needed to realize the maximum from its resources, which “might be finished in 30 years.” Whether the Shah believed his proph
ecy was uncertain, but OPEC’s new power was indisputable.

  By then, Marc Rich and Pinky Green had quit Philipp Bros. in fury to create a rival organization. Registered in Zug, Switzerland, Rich’s new company used Philipp’s secrets and key staff to establish a network that spanned the globe, although the paper trail ended either in a shredder in his New York headquarters or in Zug, beyond the jurisdiction of America’s police and regulators. There was good reason for destroying the evidence. Rich’s growing empire was profiting by exploiting regulations introduced by President Nixon in 1973 to mitigate increasing oil prices and to encourage American companies to search for new oil. The regulations priced “old” oil higher than “new” oil. In common with many American oil traders, Rich relabeled “old” oil as “new.” Unscrupulous traders, it was officially estimated, made about $2 billion from such practices between 1974 and 1978. Rich would claim that he, like his rivals, had exploited a loophole in badly drafted regulations. However, he had set himself apart from other traders by ostensibly operating from Switzerland, in order to evade American taxes. That might have been ignored if he had not planned to profit by exploiting a crisis in Iran, where oil workers were striking to topple the Shah, disrupting supplies. Oil prices in Rotterdam rose by 150 percent, the harbinger of what would be called the second oil shock. Anticipating the shortage, Rich had again purchased oil for storage from corrupt Iranian officials. Among his customers was BP, the former owner of the Iranian oilfields, which was anxious to keep its refineries operating. BP’s reliance on Rich increased after the Shah was ousted from Tehran in January 1979 and replaced by the Islamic fundamentalist Ayatollah Khomeini. Fears of an oil embargo pushed prices further up.

  On BP’s trading floor in London, Andy Hall watched Chris Moorhouse, the lead trader, regularly run up a flight of stairs to ask Bryan Sanderson, the director responsible for the supply department, to approve contracts to buy oil at increasingly higher prices. Over those weeks Rich resold oil that had cost between $1 and $2 a barrel for around $30. Resentful traders haphazardly tried to compete, and enviously asserted that Rich had paid for the oil with weapons. More seriously, Rich’s oil was occasionally exposed as substandard.

  Refineries across the world relied on Iranian inspectors to certify the quality of the oil. Few realized how easy it was for Rich to disguise a tanker of low-quality crude. One tanker dispatched by Rich’s company to supply Uganda’s solitary power station carried, despite the inspector’s certificate, unusable “layered” oil. After a day’s use the power station broke down, and the country’s electricity supply was cut off until another tanker arrived. Rich was aware that he was breaking the US embargo, but his profits were soaring. His good fortune was not welcomed by those queuing for gasoline across America and Europe. Big Oil was accused of profiteering from rationing supplies, and Rich was in the firing line after the seizure on November 4, 1979, of 52 American diplomats in Tehran. His profiteering from America’s humiliation sparked a federal investigation into suspected tax evasion.

  Rich’s success also aroused the interest of two independent oil traders: Oscar Wyatt, an American famous for running over anyone who got in his way, and John Deuss, alias “the Alligator,” a scarred buccaneer based in Bermuda, born 200 years too late. The son of a Ford plant manager in Amsterdam, Deuss’s early career as a car dealer had ended in bankruptcy. His next occupation was bartering oil between opportunistic producers and South Africa and Israel, both of which were excluded from normal trade by embargoes. From the profits he bought a refinery and 1,000 gasoline stations on America’s East Coast. Compared to Marc Rich, Deuss and Wyatt were minnows. Rich’s skill, as they both appreciated, was obtaining oil by any means possible, brilliantly mastering the markets and insuring himself against losses by asking Andy Hall to legitimately hedge his daily trade against price fluctuations.

  In 1980, Hall arrived in New York to run BP’s nascent trading operation. After BP’s expulsion from Iran and from Nigeria in 1979 for illegally trading with apartheid South Africa (exposed, according to BP’s executives, by Shell, which was eager to remove a rival), the company was seeking new sources of income. BP’s directors had noticed that as OPEC’s control over prices crumbled, BP could trade just for profit — buying and selling oil from other suppliers, and not just for its own use. After the discovery of oil in Nigeria in the mid-1950s and in the North Sea in 1969, the governments in London and Washington encouraged the oil companies to flood the market in order to undermine OPEC’s cartel. Hall, a novice trader, was given a short lesson on the art by Jeremy Brennan, the trader whom he was replacing. “To find out market prices,” explained Brennan, “just tell them you want to buy when you want to sell, and that you want to sell when you want to buy. Keep good relations with the other majors and don’t squeeze.” Hall decided to ignore the advice.

  Conditions in America had changed. Although the country was the world’s largest energy producer if its oil, gas and coal were combined, the regulations introduced by Nixon in 1971 to encourage more exploration and keep oil prices down had proven unsuccessful. The fall of the Shah had prompted a new search for more oil and other energy sources, including nuclear power and natural gas, and energy efficiency. President Jimmy Carter encouraged the purchase of fuel-efficient cars, especially diesel engines, which used 25 percent less gasoline, and greater energy conservation. His initiative was floundering when, on September 22, 1980, Iraq invaded Iran, starting an eight-year war. Overnight, both countries ceased supplying oil, and in anticipation of shortages, inflation and a recession, oil prices soared. The government in Saudi Arabia increased oil production to stem the emergency, and the crisis was short-lived. In 1981 Ronald Reagan, the new president, abolished price controls, and America was promised as much cheap oil as it needed. No one anticipated the turmoil this would cause. America’s oil industry was booming, and the supply gap from Iraq and Iran was filled from the North Sea and Alaska. Then, just as Saudi Arabia increased production, oil demand in the West fell. Prices tumbled, and OPEC members cheated on quotas to earn sufficient income. In retaliation against its OPEC partners Saudi Arabia flooded the market, and prices fell to $10 a barrel, undercutting oil produced in America. To save jobs in Texas, Vice President George Bush toured the Middle East, urging producers to cut production. His task was hopeless. Oil was no longer a state utility but was becoming a private business. Speculators and traders, not least Andy Hall and BP, rather than politicians and the OPEC cartel, were gradually determining prices.

  The major oil companies had lost their way. The nationalization of their assets in Iran, Saudi Arabia, Libya and Nigeria had shaken their self-confidence. Relying for supplies from dictatorships, Peter Walters of BP decided, had proven to be a mistake. Irate shareholders were demanding better profits. The oil companies began searching in the shallows of the Gulf of Mexico and in the North Sea, but refused to stray into the unknown. An offer to Walters in 1974 from the Soviet ambassador of exclusive rights to explore for oil in western Siberia had been rejected as too risky. Without experience in exploration, Walters did not understand the limitations of his strategy. The new world was unstable, and the future was unpredictable. Oil had become a cyclical business. Fearful of a financial squeeze, the American majors diversified into non-petroleum industries that would eventually include coal mining, mobile phones, high-street retailers, nuclear power, chemicals, button manufacturing and minerals. Exxon invested in Reliance Electric; Occidental bought Iowa Beef Processors; Gulf considered buying Barnum & Bailey circus; BP bought a dog-food factory. Astute trading was another solution to compensate for low prices and the loss of oilfields.

  To exploit the political uncertainty, Andy Hall was urged to trade aggressively. In the era before computers and screens, the market was inefficient. Traders were constantly scrambling to identify the last trade in the market and the latest price paid by rivals. In 1981, ascertaining future prices was difficult. At the beginning of the Iran crisis, experts had predicted that oil would rise beyond $4
0 a barrel, but instead it had remained at around $30, and sometimes lower. Politicians and OPEC’s leaders blamed London’s traders and the Rotterdam spot market. The oil companies, having bought massive quantities of oil to cover every eventuality, were dumping their stocks. The volatility of prices caused OPEC and most of the major oil companies concern, but BP seemed well placed to profit from the new uncertainty. Unlike other traders, Hall noticed that besides the increasing amounts of oil being imported by the USA and the simplicity of trading tankers of crude oil on the daily Rotterdam spot market, there was an opportunity to speculate about future prices by using schemes devised in the financial markets. The rapid changes in prices made those profits potentially lucrative. The second oil shock had hastened the development of speculation.