Exam 2 - Energy Economics & Policy

10. What fundamental shifts in the structure and commerce in the world oil markets took place largely as a result of the nationalization/participation agreements reached in the Middle East during the 1970s? What was the nature of the new relationship between the host countries and the international oil companies still operating within their countries? What fundamental shift took place in the length of the contracts transacting in the world crude oil markets after the mid-1970s?

"The Old Order": -- The international majors had been fully vertically integrated. -- They did not compete much with one another to acquire oil. They competed downstream, primarily at retail. -- To the extent that crude was traded, it was traded almost entirely under longer-term multi-year contracts. The spot market in crude oil was relatively illiquid. "The New Order": -- The international majors had to acquire a sizeable portion of their crude oil stocks from the new national oil companies. -- They competed heavily against one another and would switch suppliers for small differences in prices. -- The market shifted markedly and quickly to much larger volumes transacting in spot markets.

8. When the Saudis eventually increased their participation in Aramco to 100%, did this mean that the international oil company partners in Aramco were simply summarily dismissed from any further association with the Aramco operations in Saudi Arabia? What was the nature of their continuing involvement with Aramco (at least for a time)?

(*uncertain answer*) If the oil companies could be obligated to purchase the country's equity oil share, the country no longer had to worry about disposing of the oil downstream?

15. What basic characteristics of petroleum and natural gas make them so valuable and virtually assure their continued dominance as the "king" and "queen" of primary energy sources over the next several decades? In other words, what basic characteristics make them so economically special?

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12. Following the adoption of the Mandatory Oil Import Program (MOIP), did the TRC (and the other state demand-prorationers) largely lose its ability to support the world price? Briefly explain the basic economics of your response to this last question? When approximately was the MOIP terminated?

*Attach ppt image of "Equilibrium with an Import Quota* Over time, special provisions and exemptions proliferated and the MOIP became more and more complex to implement. By 1971, the world oil market was rapidly tightening and prices began rising toward U.S. domestic levels. The case for protecting domestic oil producers from cheaper oil imports was rapidly disappearing. Furthermore, excess domestic production capacity was disappearing threatening to increase domestic prices. Political pressure was increasing from oil-consuming states to allow more imports. In 1973, Nixon ended the MOIP.

*Early Developments in the World Oil Market (roughly up to WWI)* 1. What area of Russia was the location where tremendous amounts of oil were first found and still remains a key oil-producing region today (although no longer part of Russia or the Soviet Union)? What two famous European families were heavily involved in the early development of Russian oil in this area prior to WWI? What special innovations and investments did each undertake that helped unlock Russian oil from this relatively land-locked region?

*Baku, Russia (today known as Azerbaijian)* Found because of its surface oil shows. Initially the Russian oil industry was a state-run monopoly and technologically stagnant. In 1870 became privatized and quickly blossomed. The two famous European families that were heavily involved in the early developments of oil in this area: - the Nobel brothers in the 1870's who found a better way to make kerosene(which made it so Rockefeller couldn't compete), created the first well-to-refinery pipeline in Baku and the first cistern ship(oil tanker) in the world that transported oil and refined products up into Russia towards St. Petersburg - The Rothschild Banking family by forming the Caspian and Black sea Petroleum Company(Bnito). They also built a railway connecting Baku and Batlim. Also built a refinery in Fiume which allowed to Russia to break from its landlocked status and ship oil worldwide.

4. What is meant by a "cap rock" and an "oil trap"?

*Cap rock* - impermeable rock layer, usually shales or salts *Oil trap* - several kinds including anticline trap, salt dome and fault trap which are reservoirs of oil - It is estimated that only about 10% of all oil manages to get trapped in economic oil traps *Extra notes of what happens to the rest of the oil*: 1) Doesn't get out of the source rock (too "tight") 2) Gets trapped in small uneconomic traps during migration toward the surface 3) Seeps to the surface and evaporates - Most, but not all, oil traps also contain some amount of natural gas and water - The water is almost always beneath the oil & gas and usually provides some amount of upward pressure in the reservoir - The gas (so-called "associated gas" may either be on top of the oil ("unsaturated") or dissolved within the oil ("saturated") - Although almost all oil is found with gas, some reservoirs contain only gas (called "unassociated gas")

14. What is the basic distinction between "conventional" and "unconventional" sources of petroleum? Give a few examples of "unconventional" sources of petroleum.

*Conventional oil* or gas comes from formations that are "normal" or straightforward to extract product from. Extracting fossil fuels from these geological formations can be done with standard methods that can be used to economically remove the fuel from the deposit. *Unconventional oil* or gas resources are much more difficult to extract. Some of these resources are trapped in reservoirs with poor permeability and porosity, meaning that it is extremely difficult or impossible for oil or natural gas to flow through the pores and into a standard well. To be able to produce from these difficult reservoirs, specialized techniques and tools are used. Ex. oil shales, oil sands, extra-heavy oil, gas-to-liquids and coal-to-liquids

*Physical Aspects of Oil and Gas Formation and Refining: What Is It? Where Does It Come From? How Do We Transform It?* 1. What is the predominantly accepted theory of the basic original source of geologic deposits of hydrocarbons? What is the alternative "abiogenic theory" of their origins? Why, in general, are most scientists skeptical about the abiogenic theory of the origin of geologic hydrocarbon deposits? As a practical matter, what difference does it make which theory is correct?

*Predominantly accepted theory*: bioaccumulation of sediment at the bottom of lakes led to degradation and release of co2, methane and hydrogen-sulfide. Then it was put through extreme pressure and formed into source rock. *Abiogenic theory*: The inorganic Origin of Petroleum - petroleum and natural gas are formed by non-biological processes deep within the Earth's crust and mantle. The very large and therefore very under appreciated "deep biosphere" feeds on these rising molecules and contaminates them with the biomarkers we find in crude oil. This theory is more popular in Russia than in the U.S.

11. The contractual "business model" adopted after the 1970s for international oil companies operating in foreign countries was the "Production Sharing Agreement" (PSA). What are the basic elements of a PSA contract?

*Production Sharing Agreement*: 1) A foreign company is invited into a country to engage in exploration and production (E&P) activities. 2) The host country retains full ownership of the underground in situ oil and gas reserves. 3) The company assumes all investment risks. 4) If the company successfully finds oil, they generally receive the full economic benefits of the oil until they recover their past and ongoing E&P costs. This oil is frequently called "cost oil". 5) All revenues in excess of what is needed to recover past and current ongoing costs is shared between the company and the country—usually about 80% to the host government and 20% to the oil company. -- In the beginning, there were concessions during which the oil companies owned the oil in the ground -- The company is being brought in to do business, but under very strict terms set by the host country -- They keep all the proceeds until they have fully recovered all the input costs/investment costs -- When you find more oil, we will get 80% of the net proceeds, you get 20% -- This is the current risk/reward structure

*Early Developments in the U.S. Oil Markets (roughly up to 1911)* 1. The early history of the U.S. oil market is primarily the history of John D. Rockefeller's Standard Oil Company. Explain in broad terms what general strategies and tactics Rockefeller used to assemble his Standard Oil refining monopoly.

*Simple answer: Risk-taking, luck, leverage, hard work, and ruthless business tactics *Positive side:* -Increased efficiencies and cost reductions -Achieving larger economies of scale by merger and expansion -Getting preferential railroad shipping rates due to his size -Through his operating efficiencies, he achieved huge decreases in the retail price of kerosene: from 58 cents in 1865 to 26 cents in 1870 *Negative side:* -Using unethical methods to force mergers •E.g., Temporarily selling below cost to drive out competition ("predatory pricing") -Secret rebates from the railroads for shipping his oil versus rivals' oil -Buying political influence •In less than four months in 1872, Rockefeller absorbed 22 of his 26 competitors in Cleveland.

13. In general, petroleum refining can vary from being very simple to very complex. What basic capabilities define this range of refining complexity? In other words, in general, what do the more sophisticated refineries do that the simpler refineries cannot do?

*Simple refineries* are designed to distil crude oil into a limited range and yield and products. They are referred to as topping or hydroskimming plants. Topping is the most basic distillation process. Hydroskimming involves distillation in the presence of hydrogen. *Complex refineries* involve a combination of interrelated processes to produce a broader range of refined products. They commonly utilise thermal and catalytic cracking that enables deeper conversion of the crude oil feedstock into higher yields of more valuable and marketable products.

*State Regulation of Petroleum "Conservation" and the Evolution of "Demand Prorationing" in the U.S.* 1. What is meant by "the rule of capture" in English common law and why was it important in the early days of petroleum development in the U.S.? What specific analogy from the English common law was applied to underground petroleum? What is the legal doctrine of "implied covenants" and how did this principle interact with the "rule of capture" to aggravate and intensify the anti-social effects of "the rule of capture" in the early days of the U.S. petroleum industry?

*The Rule of Capture:* Under English Common Law landowners had the right to shoot wild game that wandered onto their property. -Early on, the Pennsylvania Supreme Court ruled by analogy that fugitive underground oil was subject to the same "rule of capture". *The Doctrine of "Implied Covenants* -The legal doctrine of "implied covenants" merely exacerbated the "rule of capture". -An oil developer with a mineral lease on another party's property had an implied obligation to protect the lessor's interest in the lease by proceeding quickly and diligently with oil production. •The initial major oil strike in Pennsylvania, Oklahoma, and Texas were all followed by "overproduction" and severe collapses in oil prices. •Physical conditions at the core of the problem: -The fluid and migratory nature of underground oil pools -Multiple surface landowners, all with the right to "the rule of capture" -Reservoir pressure dependent on pumping rates -Ultimate economic recovery amounts dependent of pumping patterns •Obvious manifestations of the problems: -Dense drilling, especially along property lines -All-out frenzied production -Rapid dissipation of reservoir pressure -Lower ultimate recovery amounts -Discrimination by affiliated downstream buyers, transporters, and pipelines

*Fundamental Recurring Political-Economic Themes in the Dynamics of the International Oil Industry* 1. What is meant by the "Trilateral Oligopoly" that has characterized the evolution, functioning, and performance of the international oil industry over many years? Who are the three groups of players who constitute this trilateral oligopoly? Briefly discuss the nature of the conflicting interests between the three groups? By what general means does each of the three groups typically try to get a bigger piece of the "oil pie" (i.e., the economic "surplus" generated by the oil markets)? Discuss the nature of the conflicts within each group?

*Trilateral Oligopoly: Participants in the World Struggle for Oil's "Rents" *Producing Countries*: all the major countries where oil is produced within their geographic boundaries. International Oil companies: early days, they were the only players in this story in the western, developing world. Oil companies will start to arise domestically in Russia and U.S., eventually these countries will venture into the less developed world. They will start doing business with smaller countries. Early 1950s: seven sisters (really 8 of them). Eventually will be followed by independent oil companies *Consumers & Their Country Gov't*: the interest of consumers of oil. There is both conflict & cooperation at the nodes among these players. *Not one of these parties can withdraw from the triangle. They are all key players.

7. Some oil producers advocated oil field "unitization". What is meant by "unitization" of an oil field? When "unitization" was applied to an individual field was it mainly directed at controlling "physical waste" or "economic waste" as those terms were used at the time? When oil field unitization was applied to an individual oil field, what basic broad objective did it seek to accomplish at that field? If and when unitization was adopted, what category of laws were the participants in unitization explicitly exempted from so that they could legally participate in unitization?

*Unitization*: "Unitization" refers to the practice of jointly operating a reservoir as if it were a single unit under one management. (This generally requires that the state legislature grant a limited exemption to its antitrust laws for this purpose.) Even in some states not practicing full-blown unitization, small tracts of land were frequently aggregated into larger "drilling units" for the purpose of joint regulation.

12. Because crude oil comes in such diverse quality, there is no single price of crude oil. Nonetheless, people want a "quick and dirty" indicator of whether the prices of crude are going up or going down, and market participants want a specific commodity to hedge. Therefore, at least two leading "marker" or "benchmark" crudes are commonly quoted in the financial press: WTI, and Brent crude. What does each specifically refer to? Which one is higher quality? Which one is more heavily traded in financial derivatives markets in the U.S. and, therefore, more commonly regarded in U.S. markets as "the" price of crude oil?

*WTI* = West Texas Intermediate - grade of crude oil used as a benchmark for oil pricing. *Brent* = 15 different oil fields in the north sea used in the price gaging

6. Who were the "Seven Sisters"? What eighth large integrated oil company should probably have been included within the designation of this group?

*a.k.a. : "Sette Sorelle"* · Anglo-Persian (British Petroleum) · Royal Dutch/Shell (Shell) · Standard Oil of New Jersey (Exxon) · Socony-Vacuum (Mobil) · Standard Oil of California (Chevron) · Texaco · Gulf *French CFP* should have been included, but Otto sorelle doesn't rhyme

2. The early history of the world oil market is basically one of competitive duopoly (with an annoying competitive fringe). For a brief time, there essentially were duopolies in both the European and Far Eastern markets? Who were the two main national players in the international duopoly in the European market in the late 1800s? What is the best statistical evidence that this duopoly may have had a formal agreement among the players (although no documentation of a formal oligopoly has ever been found)? There is solid evidence that the key members of this oligopoly met in Paris in 1893 to solidify and extend this oligopoly, although they appear to have been unsuccessful in holding the duopoly together. Who were the key players who met in Paris in 1893? Why did their efforts fail; what source of competition was most responsible for eventually eroding this duopoly near the end of the 1800s?

- 1890's, there were three big oil rivals: Standard Oil, the Nobles and the Rothschild/Samuels - the initial emergence of the U.S- Russian Duopoly - With Robert Nobel's invention of a way to refine the Baku oil into a high-quality kerosene, the Branobel oil was quickly able to under-price Rockefeller's Standard Oil and push it out of the Russian market. - The data suggests that Nobel and Rockefeller may have reached a market-sharing accommodation for several years (consistent shares in percentage from 1880-1892), but, if so, it soon fell apart after the Paris meeting - Attendants of the Paris meeting Rothschild, Rockefellor, & Nobles) - Competition from the independents (i.e. not one of the main big players) eroded the duopoly near the end of the 1800s

*The 1970s World Oil Crisis* 1. "The Great Transition" refers to the many economic and political trends and events that laid a fertile foundation for the massive restructuring of the oil concessions in the international oil industry in the early and mid 1970s. List and very briefly identify as many of these major trends and events as you can.

- acceleration of the growth of world demand energy - steady increase in petroleum's share of energy - simultaneous economic booms in US, Japan and Europe US environmental initiatives encouraged fuel switching from coal to fuel oil in power plants (not a good idea) firming the world oil prices leading up to the eventual elimination of the US mandatory oil import program (Us is more vulnerable to world oil prices) Rising importance of Persian Gulf and North African oil in total world oil supplies Disappearance of excess oil production capacity outside of OPEC and inability of the U.S. to continue serving as "the supplier of last resort"; Prorationing MDFs were increased to 100% in March 1972. Environmental initiatives discouraging oil drilling and development in certain environmentally sensitive areas Santa Barbara oil spill in 1968 leads to ban on offshore drilling on California coast Delays in building the Trans-Alaskan Pipeline from Prudhoe Bay to Valdez U.S. hit "peak oil" production in 1970 (at least for the moment) International political developments encourage more aggressive actions by host governments -- Continued retreat of both Britain and France as world colonial powers -- U.S. gets bogged down in Vietnam War (domestic politics would not have supported any military action in the middle east at this time)

3. Most states very quickly adopted statutes regulating local "gathering" pipelines for oil and gas as "common carriers". What legal obligation does a "common carrier" pipeline have? Describe the anti-competitive conduct that the imposition of common carrier obligations on gas and oil gathering pipelines was intended to control or eliminate? Why was this anticompetitive conduct especially abusive within the context of a common-pool resource like petroleum?

- common carriers are responsible for the transportation of of the goods, and are responsible for any loss/damage of goods - the anti-competitive conduct - discrimination by affiliated pipelines and refineries - by not transporting some oil for people, having it sit in the ground, other drillers can suck up that oil (your partners)

5. Most oil-producing states have "conservation" laws regulating the development and production of oil and gas. In the absence of "conservation" regulation, what specific "anti-social" behaviors are individual oil and gas developers likely to engage in as a result of the "rule of capture"? Name three specific dimensions of regulations that were directed at controlling these specific anti-social behaviors (i.e., what very specific actions did they seek to modify or constrain)?

- pollution issues - the exercise of market power by vertically integrated oil companies operating oil-gathering pipelines; - open access expolitation - uneconomically dense drilling - Full current production regardless of future price expectations -Insufficient incentive to take individual actions to maintain reservoir pressure - Loss of ultimate recovery due to uncoordinated development efforts

11. What economic factors led to the adoption of the Mandatory Oil Import Program by the U.S.? How did the failure of state demand-prorationing to support the interests of domestic oil producers lead to the Mandatory Oil Import Program (MOIP)? Approximately when was it adopted, approximately how large was the quota? How, in general, was the MOIP implemented and what were its basic economic effects? (Be sure to mention its effects on both world oil prices and domestic oil prices, what domestic constituencies benefitted and lost from the program and why, describe the exact nature of any deadweight loss effects, etc.)

-From the early 1950s to the late 1960s, there was a large amount of "excess" capacity in the Middle East that was not producing at full production. Driving down oil price. - The American MOIP, although supporting the domestic price of oil, placed additional downward pressure on the world price of oil. The wellhead price of oil gradually declined from 1950 to 1970 -In 1955, Congress had passed legislation authorizing the President to intervene to limit imports by Presidential Proclamation if they posed a threat to national security. -Faced with mounting tensions in the domestic oil industry aggravated by the 1958 recession, Eisenhower imposed the Mandatory Oil Import Program in March 1959. -The quota was initially set at 9% but then increased to 12.2% in 1962. The MOIP stayed in place until it was rescinded by Nixon in 1973. -Without this program, imports would have been as high as 20% -Under the MOIP, quota "tickets" (essentially, "permission slips" to import oil) were issued and allocated for free to all refineries on a "grandfathered" basis—i.e., in approximate proportion to their recent actual imports. -Economic punch line: The MOIP supported domestic producers by driving a wedge between the world price of oil and the domestic price of oil.

8. What new players tended to erode the economic power of the "Seven Sister" oil companies in the Middle East during this period (1945-1970)? Who specifically were some of these players?

American independents began to erode the seven sisters in the middle east: 1947 Ashland, Sinclair and Phillips formed the American Independent Oil Company and won a Kuwait concession 1948, Getty won a Saudi concession (these two eventually teamed up) the Middle east was also becoming more developed - Foreign independents also entered into the offshore Persian Gulf: - ---Japan Petroleum Trading Company - --- Enrico Mattei of ENI entered into a partnership with the National Iranian Oil Company that shocked the oil industry. -Mattei offered Iran 50% of gross profits plus 50% of net profits—essentially a 75-25 profit sharing arrangement in favor of Iran. - Between 1948 and 1973, Russian production moved east to the Volga-Urals fields and Russia became a net exporter of oil. Even though the U.S. warned the Europeans against becoming too dependent on Russian oil, Italy, Germany, Austria, France, and Sweden all became major buyers of Russian oil.

*The Structure of International Oil Concession Contracts* 1. In general, what types of provisions were typical features in the international oil concessions signed before WWII?

An exclusive right to a defined area for a specified period. Temporary acquisition of mineral title. Company bears all the commercial development risks. Company payments to the host government, typically consisting of most or all of the following: - Upfront payment - Annual lease payments (likely per square mile) - "Royalties" per unit (e.g., barrel, ton) of crude oil sold - Share of the net revenues (profit sharing)

3. In the early 1900s in the Eastern Hemisphere, what diverse national oil interests combined to form the main collusive entity controlling this Eastern market, and what was the name of the joint-venture market-sharing company that they formed? Roughly how long did it last as an effective organization? What forces eventually led to the erosion of this Eastern Hemisphere oil duopoly in the second half of the second decade of the 1900s? What large contemporary oil company traces its origin to the merger of two of the key companies involved in this joint venture market-sharing agreement in the Eastern market?

Asiatic Petroleum Company (1902-1914), had monopolistic power in the Eastern market. formed from a market sharing agreement between Royal Dutch, Shell, and Bnito (each with ⅓ share) Rothschild worked out an agreement among three of the largest producers in Baku to consign their oil for marketing in the Eastern market to Bnito. These Russian "independents" agreed not to sell in competition with Asiatic Petroleum in the Eastern market. Bnito had to "police" the Russian independents; if they sold in the eastern market, Bnito's share was reduced equally. *forces that lead to the erosion of the Eastern hemisphere oil duopoly include:* - Completion of the Panama Canal in 1914 (ability for oil to get to Eastern markets, more american competition) - The turmoil of World War I and its aftermath (russian revolution decreased amount of oil coming from that area) - Major expansion of U.S. oil exports with the development of the oil fields in Oklahoma and Texas - The most enduring result of the Asiatic Petroleum Company was the merger of Royal Dutch and Shell in 1911 (To preserve the national identity of both countries, the company merged in a holding company structure, with Royal Dutch taking 60% of the equity and earnings, and Shell taking 40%)

6. Under nationalization and participation, what general financial/accounting valuation "theory/method " was initially suggested by the host countries for calculating the compensation payments owed to the integrated oil companies for their ownership interests in their Middle East oil concessions? From an economic theory perspective, in what way was this initial financial/accounting basis for paying compensation woefully paltry? What economic indicators/comparisons clearly illustrate how paltry it was? On what basis would conventional economic/financial theory seem to suggest they should have been compensated for the takeover of their businesses? In general, how far apart from one another would these two wildly different valuation methods have been? As negotiations finally turned out, approximately how much more liberal were the participation payments made by the host countries compared to the countries' initial "going-in" negotiating positions.

At its 24th Conference in 1971, OPEC laid out its Recommendations for Participation: -- Level of Participation: at least 51% -- Compensation: net book value -- Company commitment to buyback crude: for an interim transitional period ---The buyback crude basically just says that the oil companies need to play a role in running the downstream operations -- Nationalization vs. participation became a distinction without a difference. ---If the oil companies could be obligated to purchase the country's equity oil share, the country no longer had to worry about disposing of the oil downstream. The starting points for negotiations on valuation were the following: -- Host countries: "net book value" = original investments costs minus accumulated depreciation -- Oil companies: discounted present value of all future net cash flows For the six largest producing countries (Abu Dhabi, Iran, Iraq, Qatar, Kuwait, and Saudi Arabia), net book value would have been about $1.3 billion for 100% participation. This paltry amount of payments would have been equal to just: -- 23 cents per barrel of a single year's production ! -- One year's worth of oil company profits ! -- ½ cent per barrel of proven reserves !!! In the final outcome of the initial negotiations, an "updated net book value" was derived by adjusting net book value by several "fudge factors" resulting in a multiplier of about 3. Saudi Arabia $ 500 million Kuwait $ 150 million Iraq $ 68 million Qatar $ 71 million Abu Dhabi $ 162 million Total $ 951 million for 25% participation (equivalent to paying $3.8 billion for 100%) And Libya, Algeria and Iraq got away with paying something closer to book value.

*World Oil Developments: 1945-1970* 1. What major worldwide factors and trends drove the tremendous increase in world oil consumption between 1945 and 1970? Name as many as you can.

Between 1949 and 1972, the world's energy consumption more than triples, oil consumption increased by a factor of 5 US automobile and suburbanization continued shift worldwide from coal to petroleum post-war reconstruction of Europe and Japan (under the Marshall Plan) - US had to get oil into Europe to secure Allies spectacular emergence and growth of the new petrochemicals industries (plastic)

2. Why did America become rapidly refocused on the issue of energy security—especially oil security—in the years following WWII? What fundamental geographic shift was taking place in world oil supplies? In approximately what year did the U.S. cross the line and become a net importer of petroleum and petroleum products? Did the U.S. shift to becoming a net exporter because U.S. production declined? Roughly when did U.S. oil production actually peak?

Between 1950 and 1973, there was a shift in world oil supplies to the Persian gulf states, and the production was extremely cheap Production was also increasing in the US, but in 1948 the US became a net importer of oil indefinitely, however, the US remained a top producer for a while During the second world war, between 1942 and 1945, the US supplied about 85% of all oil consumed by the Allied nations and their militaries, by the end of the war, the US became concerned about long-term oil security Under Roosevelt, Harold Ickes proclaimed "We are running out of oil, if there's a World War 3, it would have to be fought with someone else's petroleum..."

3. In what various ways did WWI demonstrate the strategic importance of petroleum? What was the Allies main source of petroleum during WWI? What hostile German activity in the Atlantic Ocean involving this petroleum dimension of the war contributed more than anything to eventually drawing the U.S. into WWI late in the war?

British-German national rivalry raises British concerns about the future supremacy of the British Navy. Winston Churchill becomes a strong advocate for military preparedness. The British government decides to contribute financial assistance directly to the struggling Anglo-Persian Oil Company in exchange for taking a controlling interest of the company and a long-term contract to supply oil to the British Navy at favorable prices. WWI establishes the strategic importance of oil (and the internal combustion engine). 80% of the oil used by the Allies was supplied from U.S. continental oil production. During the course of WWI, Anglo-Persian becomes a vertically integrated international oil company.

4. Even though we frequently speak of "monopoly power" being exerted in the oil markets, there really never has ever been literally a single supplier of oil. Instead, at any point in time, there has generally been one of more very large supplier and a lot of much smaller suppliers. An import mental-reference model for visualizing and understanding what is likely to happen in such a situation is the model of a single very large "monopolist" making production choices in the presence of a "competitive fringe". Using simple diagrams, briefly explain this "monopolist with a competitive fringe" model. Be sure to explain in the diagram—and in coherent words—how the monopolist goes about choosing its output level, i.e., what does he/she consider?

Check out this graph!

5. Why, when faced with the prospect of fabulous success in Bahrain and Saudi Arabia, did Chevron choose to share its new venture with a partner? What partner did it choose and why?

Chevron was concentrated upstream in oil production (into finding oil and brining it up)—not downstream in oil refining and marketing. It was having a hard time disposing of even the small amount of oil it had found in Bahrain. Texaco was a Texas-based oil company faced with the opposite problem: it was concentrated in the downstream and needed crude oil. In 1936, Texaco dropped out of the TPC and Chevron and Texaco pooled their assets "East of the Suez" and pursue a 50-50 joint venture for producing and marketing the Bahrain and Saudi oil. This joint venture was named the California Arabian Standard Oil Company. In 1944, it was renamed the Arabian American Oil Company (Aramco)

4. While U.S. consumers enjoyed lower oil prices as a result of the oil price collapse of 1986, the U.S. government had several reasons for feeling at least somewhat ambivalent about these radically lower oil prices. What were these reasons? Name as many as you can.

Destruction of U.S domestic production, Economic recession in the Southwest, Threat to world financial markets, Undermining of domestic energy investments and a return to oil dependence, jeopardy to U.S arms sales, A threat to "veiled" U.S. foreign aid

2. What two broad formats for dispute resolution were generally contained in international oil concession contracts and why?

Either the commercial laws of the host country (if developed), or a "choice-of-law clause"(can designated the law of a third country that will government the interpretation of the contract) or an "arbitration clause"

6. What major forces external to OPEC likely contributed to the collapse of oil prices in 1986?

Extraction from the North Sea was cheap,

9. What role did the Texas Railroad Commission (and the other state regulators implementing demand-prorationing) allegedly play in supporting world oil prices during the immediate post-WWII period? What oil market developments caused the ability and the motivation of the TRC (and other states' prorationers) to support world oil prices to gradually erode in the decade following WWII? What is the most striking evidence of the inability of state demand-prorationing to support the world oil price in a manner consistent with the interests of the U.S. domestic oil companies? What broad categories of U.S. oil companies were hurt, and which were helped, by the continuing attempts to support the world price of oil by demand-prorationing U.S. domestic production?

From 1948 onward, U.S. net imports continued to steadily rise. By 1954 to 1957, net imports rose from 15% to 19% of domestic production. Domestic oil prices were "soft" in the U.S. during the 1950s causing unrest among domestic independents. In 1949 and 1950, there were various proposals for import tariffs, but these all failed. The "majors" tried to keep peace in the industry by voluntarily restraining their imports in 1953 and 1954. However, the relative power of the "majors" was declining as American independents flocked overseas to develop additional oil resources. In 1956, the the American oil industry invested more overseas than in the U.S. State petroleum regulators throttled way back on Market Demand Factor "allowables" (MDFs) during the 1950s: Texas 76 → 33% Oklahoma 30 → 23% Louisiana 90 → 33% New Mexico 74 → 49%

3. What is meant in general by the term "hysteresis"? In economics, hysteresis effects are frequently encountered when long-lived sunk investments play an important role in determining the "short-run" equilibrium in an industry. Long-lived sunk investments can be especially important in the energy area. Using the examples of (1) sunk investment in new energy supply development, and (2) sunk investments by consumers in more energy-efficient capital stocks (more efficient cars, better insulated homes, etc), explain how these two different categories of sunk investments can cause significant hysteresis effects in the energy markets. In doing so, make explicit use of simple supply-demand curves.

Hysteresis: things don't operate in reverse when you have sunk investments. *System not only depends on current state but also its past.

4. Why was Gulf Oil forced to sell its Bahrain concession? Who was it sold to? Why was Gulf Oil not forced to dispose of its Kuwaiti concession as well for the same reason? Why did Gulf Oil agree to partner with Anglo-Persian and form the Kuwait Oil Company to develop its Kuwaiti concession? How did Gulf's partnership with Anglo-Persian in the Kuwaiti Oil Company essentially bring it into indirect and loose cooperation with the other partners in the TPC and, therefore, virtually into the Red Line Agreement.

In 1926, Holmes' oil company was so strapped for capital that it sought to sell itself to a larger oil company. Both Anglo-Persian and Standard Oil were skeptical of oil in Saudi Arabia or Bahrain and declined the overtures from Holmes. (This was before they signed the Red Line Agreement.) In 1927, Gulf agreed to assist Holmes by providing financing to develop the Bahrain concession. In 1928, after Gulf signed the Red Line Agreement, Gulf could not proceed with either Saudi Arabia or Bahrain except within the TPC. Gulf found an American buyer for its Bahrain concession, Standard Oil of California (SoCal, later called Chevron). In 1931, almost immediately after beginning to drill in Bahrain, Chevron struck oil. after Chevron discovered oil in Bahrain in 1932, Anglo-Persian (BP) suddenly became very interested in Kuwait. They pushed through British-American diplomatic channels to establish a joint venture with Gulf in Kuwait. This 50-50 joint venture in late 1933 became known as the Kuwait Oil Company. As part of their joint-venture agreement, Gulf and Anglo-Persian agreed not to injure the marketing position of one another "at any time or place".

2. How did Muammar Qaddafi of Libya tactically proceed in putting pressure on the oil companies in Libya? What did this have to do with Armand Hammer, the head of Occidental Petroleum? What did Armand Hammer ask the other American oil companies (and Exxon, in particular) to do in order to reduce pressure on Occidental? Did they comply with Hammer's request? Do you think this was a strategic mistake by the other oil companies? Briefly explain.

In 1940, libya demanded a 20% increase on the posted price of oil oil and was countered with a mer 4 cent Exxon and Occidental rebuttal Libya put pressure on Occidental by ordering them to reduce it crude production unless they met libya's demands ---> Occidental then pleaded with Exxon to supply them with the replacement crude in order to outlast Quaddafis demands Exxon refused to help, probably because they didnt think it would do any good in the long run SO, Hammer agreed to increase the posted price to 30 cents, and a profit sharing increase from 50% to 55%, shortly after, other "independents" in Libya agreed Eventually the majors ( Chevron, Texaco, Shell, BP) also agreed Throughout this episode, the U.S. State Department appeared to take the attitude that it had very little leverage it could exert over Libya and that higher oil prices would not be all that bad. If higher oil prices meant more revenues to the Middle Eastern countries, then perhaps this was a more politically acceptable substitute compared to officially increasing foreign aid directly.

3. What was the "As-Is Agreement" (or Achnacarry Agreement)? Who joined in this agreement and what, in broad terms, did they agree to? How successful was this agreement in achieving its objectives and why was its effectiveness so short-lived; what major disruptive event hit the world oil industry in the early 1930s?

In August 1928, Henri Deterding of Royal Dutch/Shell rented a hunting lodge by the name of Achnacarry Castle in the Scottish Highlands and invited high level executives from Standard Oil of New Jersey, Anglo-Persian, Gulf Oil, and Standard Oil of Indiana to join him for several weeks of hunting. The true agenda of this secret meeting was not hunting. Instead, it was to work out an agreement among the oil companies regarding how to "stabilize" the oil market in Europe and Asia. By 1928, even before the economic collapse of industrial production during the 1930s, there was a growing "surplus" of oil production. New oil supplies were surging out of the United States, Venezuela, Rumania, and the Soviet Union, flooding the markets, weakening prices, and threatening ruinous competition among the majors. Achnacarry eventually led to a 17-page document titled simply "Pool Association". It became better known as "the As-Is Agreement". The key provision of the As-Is Agreement was a provision that called for all the participants to hold fixed at their 1928 levels the relative shares of final petroleum products sold at retail in various geographic markets. Beyond this key market-sharing provision, the signatories also agreed to share facilities in order to avoid duplication and drive down costs, be cautious about undertaking investments in new refineries, and supply oil from the closest geographical source by swapping oil among themselves in order to minimize transportation costs. The agreement also provided for the creation of an "Association" consisting of one representative from each company to oversee and coordinate the conduct of company activities in accordance with the agreement. In order to avoid violating the American antitrust laws, the domestic U.S. market was explicitly excluded from the market-sharing agreement. (The American antitrust laws are generally written in such a manner as to protect American consumers, not to preclude American business activity that might adversely affect foreign consumers.) one gaping flaw: it did not include all the relevant suppliers. American "independent" oil companies supplied about one-third of the oil consumed outside the U.S. Given the aggregate size of the American independents, it was critical to the success of the As-Is Agreement that these companies also be somehow "organized" into the As-Is Agreement. Moreover, the 17 American companies only controlled about 45 percent of the American exports.

9. What was meant by "hot oil", and what kind of regulation was imposed under the Connally Hot Oil Act? Why did this federal law seem to be necessary and even get support from "states' rights" advocates at the time?

In February 1932, martial law was lifted in Texas and the Texas Railroad Commission was able to resume control over the East Texas oil field. However, many oil companies continued to produce oil in violation of the TRC's orders. This illegally-produced became known as "hot oil". By March 1933, the number of wells in East Texas was approaching 10,000 and the "hot oil" situation was running out of hand. Hot oil production was estimated at 125,000-150,000 bpd. Control of hot oil production became the next focus of public policy. As explained further below, the ultimate resolution of the "hot oil" problem required federal assistance to stem the tide of hot oil going into in interstate commerce. When the National Industrial Act was being adopted, Senator Tom Connally of Texas added the so-called Connally Amendment requiring the Department of Interior to police the transportation of "hot oil" across state lines, a measure designed to plug the main leakage in states' enforcement of their prorationing statutes. When the Supreme Court invalidated the entire NIRA petroleum code in 1935, Congress immediately passed the Connally Hot Oil Act of 1935 in order to preserve the federal policing of interstate commerce in "hot oil" and thereby provide necessary assistance to states in enforcing their own prorationing codes

2. When the newly formed Anglo-Persian Oil Company was looking for a partner to contribute needed capital so that it could quickly develop it's oil concession in Persia, why did the British government take such a keen interest in trying to assure that a British national company would be its partner? What objective of pre-WWI British military strategy did the Anglo-Persian Oil Company become an essential part of? What unusual step did Winston Churchill eventually spearhead to assure that the British government would control the development of oil in Persia/Iran?

In view of its growing rivalry with Germany in the early 1900s, the British government was keenly interested in converting the British Navy from coal to fuel oil and diesel fuel. D'Arcy quickly realized he needed more resources and sent out "feelers" to Rockefeller and the Rothschilds. The British government was interested in keeping D'Arcy's Persian concession entirely a British venture. In 1904, a small company called Burmah Oil had secured a tentative agreement to provide oil to the British Navy, but lacked enough oil resources. The British government recruited Burmah Oil to join with D'Arcy's venture. •The British government reached the momentous decision that the only way to preserve Anglo-Persian as a British enterprise was for the government itself to take a financial stake in the company. - Winston Churchill championed the cause, and succeeded in convincing Parliament to pass a bill investing 2.2 million British pounds in Anglo-Persian. -In return, the British government was given 51% controlling share of Anglo-Persian and a secret "sweetheart" 20-year contract to get fuel oil at below-market prices. -This partnership also gave the Royal Navy an important source of off-budget financing so that it did not have to seek its full budget from Parliament.

Post-1970s World Energy Events and Trends 1. In what sense was the Iran-Iraq War from 1980 to 1988 at least partially about oil?

Iraq's invasion of Kuwait in August 1990 and the subsequent conduct of "Operation Desert Shield" by Coalition forces in early 1991 may have been the first war fought blatantly over the control of oil--the first true "oil war". OPEC members were overproducing their quotas of 24 mad by about 2 mad, and 80% of this overproduction was coming from Kuwait and the UAE. Sadam Hussein launched a campaign accusing Kuwait of conspiring with the US to keep oil prices low in order to keep Iraq weak. Furthermore, Sadam accused Kuwait of stealing Iraq's oil by pumping more than their fair share (common pool resource issue)

5. What presumably happens to upwardly migrating underground oil and gas if it never hits a cap rock?

It reaches the surface and evaporates

4. What famous Russian leader was a labor organizer during the early days of social unrest in the Russian oil fields? What broad course was traveled by the Russian oil industry between 1900 and the eve of WWII? Why was the main Russian oil resource (as well as the oil resources in Romania) of such great strategic importance during WWII?

Joseph Stalin was a labor agitator in Batum and Baku around 1903 - 1907 Oil production in Baku was very dependent on the continued infusion of Western capital. The pre-WWI civil unrest in the Baku region frightened off foreign investment. 1902, production started to decline The Bolshevik revolutionists occupied Baku in 1918 and soon nationalized the oil companies. •In March 1921, Lenin issued his "New Economic Policy"(for general industry, not just oil) allowing limited capitalism and requesting the return of foreigners to restore oil production. A wide variety of Western companies re-entered the Russia oil market at this time. •After a few years, Lenin reneged on the deal and systematically revoked all foreigners' concessions. By 1930, most of the foreigners had been expelled. Russian oil in WW2: by mid-1930's, russian oil was revved and passing past peaks (supplied roughly 17% of Western Europeans oil) supplied oil to Hitler during WW2 under the Molotov-Ribbentrop Pact of 1939 1940, the British and French undertook an unsuccessful oil bombing campaign against the Baku oil fields called "operation pike" Hitler tried to take the Baku oil fields but was also unsuccessful

7. While recognizing that the answer to the following question calls for some intelligent speculation, why does it seem that the home governments of the integrated oil companies (Britain, France and the U.S.) did not intervene with some diplomatic muscle and/or "sabre rattling" on behalf of their home oil companies when it came to the issue of "fair compensation"?

Legal ambiguities and uncertainties: Formal legal action would have taken a long time to resolve and it would not necessarily have gone in the companies' favor. The host countries had the legal right to nationalize a company as long as "just compensation" was paid. The illusion of company control was an anachronistic illusion. There was no actual reality to be rescued. The companies' home governments wanted physical access to oil. Greater confrontation might have jeopardized physical access. U.S. domestic politics would not have supported "gunboat diplomacy". The U.S. was in the midst of the Vietnam War. Another war—and a war "over oil"—was unthinkable. The Middle East was too important a source of oil in the long run to risk alienating and agitating the host countries. The U.S. government was beginning more and more to see low oil prices as a problem. Meaningful consumer conservation required higher prices. The West needed strong allied governments in the Middle East to counteract Soviet influence in the area. Higher oil prices were essentially foreign aid, and most of this bill would be paid by the other western countries—not especially by the U.S. Domestic politics severely constrained the more moderate Middle East countries from acting "more reasonably".

3. When the oil companies came under increasing political pressure to increase their payments to the host country governments during the years 1969-1973, why didn't the companies and their home countries more vigorously resist the strong-arm tactics of the host countries? Why did the home countries of oil companies not give them more support? List as many plausible and likely reasons as you can.

Legal ambiguities and uncertainties: formal legal action would have taken a long time to resolve and it would not have necessarily gone in the company's favor ( the host countries had the legal right to nationalize a company as long as "just compensation" was paid) The illusion of company control was an anachronistic illusion. There was no actual reality to be rescued The companies host governments wanted physical access to oil. Confrontation might have jeopardized physical access, they are only interested in natural security and physical oil. US domestic policy would not have supported "gunboat diplomacy" The middle east was too important a source of oil in the long run to risk alienating and agitating the host countries The US government was beginning to gradually see low oil prices as a problem. Meaningful consumer conservation required higher prices. The west needed strong allied governments in the middle east to counteract the Soviet influence in the region. Higher oil prices were essentially foreign aid, and most of this bill would be paid by the other western countries - esp. By the US Domestic politics severely constrained the more moderate middle east countries from acting "more reasonably"

10. What was the Interstate Oil Compact Commission? What did its original advocates hope that it would do? That is, how far did they want it to go in terms of oil conservation regulation and coordinating such regulation? In the end, what lesser role was the IOCC given? That is, what in general was it authorized to do? What role did it play in the implementation and facilitation of individual state market-demand prorationg?

Main official objective of the IOCC is to prevent physical waste, and expressly not to fix prices. The IOCC is to study and recommend methods to prevent waste and the compacting states are to adopt laws preventing certain kinds of waste. The IOCC is precluded from setting an overall production quota for the state - Following the legal demise of the National Industrial Recovery Act, attention again shifted to seeking federal authorization of an interstate compact. The governor of Oklahoma had taken the initiative to convene a meeting of governors in late 1934 to reconsider the formation of an interstate compact. As discussions proceeded into 1935, the main bone of contention concerned the issue of whether prorationing should adjust supply to meet market demand with the objective of sustaining prices. The governor of Oklahoma and most of the eight other governors favored this objective. However, the governor of Texas was adamantly opposed. Moreover, he was also opposed to any mechanism that would establish state quotas or shares of the national domestic market. Although seemingly an ideologically driven position, it might also be that the governor of Texas was concerned that any sharing formula among states might be based on historical production levels that would overly restrict the future expansion of Texas production which was rapidly growing at the time. Thus, as initially authorized, the authorities granted to the IOCC avoided resolving the central controversy over market-demand prorationing. Stronger regulations were blocked by: (1) an antipathy toward granting too much authority to the federal governemnt, (2) the unwillingness of Texas to relinquish state authority or go along with market-demand prorationing and the prevention of "economic" waste, and (3) an inability of the states to agree on a market-sharing arrangement. Despite these shortcomings, it seems likely that the prevailing feeling was that it was better to get started with some form of interstate cooperation rather than once more lose the initiative to the shifting winds of politics. In any case, the terms of the compact have remained unchanged from its original formation. Authorized functions are limited to collecting and disseminating information to the member states, making recommendations on certain issues, and serving as a forum for the discussion of common problems. The IOCC exerts absolutely no coercive power over the actions of individual states.

2. Who were the major partners in the Turkish Petroleum Company immediately following WWI? What did these partners agree to in signing the "Self-Denying Clause", or so-called "Red Line Agreement", as part of their TPC partnership? How did the American oil companies manage to "shoot their way" into the TPC?

Major Players (American): Standard oil of New Jersey, Socony-Vacuum (mobil), Texaco, Gulf, Standard oil of Indiana, Atlantic and Sinclair(dropped out) -- 1928 only 5 were admitted - In restructuring the TPC in 1928, the new partners all agreed to "the Self-Denying Clause" (better known as "the Red-Line Agreement") in which they contractually committed that their companies would pursue oil development within the red-lined boundaries only through their participation in the Turkish Petroleum Company. - As a compromise to please the British, the American State Department agreed that the U.S. companies would not seek separate concessions but instead would be allowed to buy into the Turkish Petroleum Company. (monopsony power)

4. Why was the nationalization of the Anglo-Iranian Oil Company in 1951 a dismal failure? How did the resolution of this crisis situation in 1953 fundamentally change the partnership structure and the business structure of the oil concession arrangements in Iran going forward from 1953? Thereafter, who actually owned the in situ oil reserves in the ground? What cautionary lessons would other host governments in the Middle East likely have learned from the Iranian nationalization experience in 1953?

Mossadegh affair of 1953 the forced nationalization was a big deal for the British, mainly because oil wealth was a considerable financial importance to the British treasury, as well as the access to physical access to oil -- lead the British to want to invade Iran, but the Americans convinced them not to do it in order to not give Russians an excuse to invade British launched an international boycott of Iranian oil, which plummeted from 240 million barrels in 1950 to 10 million in 1952 ( other arab oil producing nations quickly filled the void with their oil) Mossadegh could not back down and was corned by his political base and his own personal hatred for the British--- he went on to declare martial law this led to the British led Operation Ajax, which led the Iranian military to arrest the Shah (this incident tarnished the American credibility in the Middle East) •Although the Shah was re-instated to power, he was politically constrained from simply inviting the return of the hated British as the controlling interest in Anglo-Iranian. •The U.S. took the lead in putting together a new consortium of companies to operate the Iranian concessions. •The National Iranian Oil Company established by Mossadegh would own Iran's reserves (a major change from the past), but the actual operations would be conducted by Iranian Oil Participants Ltd. Under a 50-50 profit sharing arrangement under the following ownership: Exxon 8% BP 40% Mobil 8% Shell 14% Texaco 8% Total 6% Gulf 8% European 60% Chevron 8% U.S. 40%

3. What basic new policy did OPEC initiate within its ranks in 1982 in order to try to maintain "pricing unity" and a high world price of oil? Was this mechanism successful? What special role was played by Saudi Arabia within this OPEC scheme in the early 1980s? What action did Saudi Arabia eventually take in late 1985 and early 1986 and why? What effect did this Saudi action have on world oil prices?Ope

OPEC adopted its very first total production ceiling along with individual production quotas for each OPEC member. The total quota was set at 17.5 mbd. Saudi Arabia agreed to reduce its production immediately to 7mbd and to adjust its production. It failed because the agreement as a temporary stop gap, and did not include any agreement as to how quotas would be adjusted over the long term. Secondly Iran never formally agreed to its 1.2 mad quota and very quickly pursued an output level of 2.5 mbd by order to maintaining a price $30 instead of the agreed upon price. Third, in order to maintain its allocated production quota, Nigeria was forced to lower its price because of competition in the North Sea, Fourth, within two months Libya, and Venezuela pushed their production levels far above their quotas by reducing their prices. Eventually Saudia Arabia was to "act as the swing producer" *********

5. As initially conceived and pursued, what was the major difference between "participation" and "nationalization"? Why did Sheikh Yamani of Saudi Arabia strongly favor participation over nationalization? What was he apparently most concerned about? What were the three major issues in the negotiation of participation agreements? In the end, why did there prove not to be much difference between participation and nationalization?

Political Spin: Nationalization has such negative connotations bordering on simple "theft". But what reasonable person could possibly object to host country "participation"? Nationalization would require each individual country to operate its oil company and dispose of its oil. They had very little experience in doing either. Moreover, nationalization would pit each country against the other in selling its oil. Nationalization also might frighten off foreign investment of all sorts. The host countries might succeed in capturing the asset, but then lose any existing market power the companies now had downstream in selling the oil. To the extent that oil companies had market power, they would simply exercise this market power downstream. In the end, the host countries could be worse off.

4. What three very broad categories of "anti-social behavior" in the oil patch were addressed by various types of regulations that were adopted in the early days of the oil industry?

See question 5

9. What were the major economic and political effects of the 1973 Arab Oil Embargo? Did the "selective" aspect of the embargo succeed? Why or why not?

Shockingly large run-up in oil prices -- Oil prices shot from about $2.80 to $17.05 (a comparable percentage increase today would send prices to $500 per barrel) Relatively small reductions in overall oil supply -- Arab oil production fell by about 20% within months, but Iran filled a good portion of this deficit. Overall reductions were about 10% of total world oil exports but only about 5.5% of world oil consumption. Abject failure of the selective embargo (the oil will get rerouted and the oil will flow to the highest bidders) -- Oil is a fungible commodity and selective embargoes just don't work. Erosion of support for Israel -- In mid-November, the European Community passed a resolution supportive of the Arab position in the conflict. Japan did the same and was reclassified as "friendly". Resolve by developed oil consumer countries(OECD) to formulate a collective security response (large western oil countries) -- Formation of the International Energy Agency to counteract any future selective embargoes

2. One of the major themes in the history of the performance of the oil industry are periodically recurring market "cycles" involving levels of competition, wide swings in oil prices, etc. Describe the typical and market tensions and dynamics that seem to play out over the course of these periodic cycles. Do so in such a manner as to include as many of the salient market changes and dynamics that tend to occur as the cycle makes its full circle.

Simplified market cycle: (1) Entry of New Suppliers → (2) Competition; low prices → (3) Producer cooperation → (4) High Prices & Profitability

6. What is meant by "reservoir rock"? What is meant by the "porosity" and permeability" of source rock? What is meant by "tight" reservoir rock and "tight" oil or gas formations?

Source Rock: refers to rocks from which hydrocarbons have been generated or are capable of being generated *Reservoir Rock*: A place that oil migrates to and is held underground. A sandstone has plenty of room inside itself to trap oil, just like a sponge has room inside of itself to soak up spills in your kitchen. It is for this reason that sandstones are the most common reservoir rocks. Porosity: % of the rock volume not occupied by solid material (0-5% is too "tight"; 15-20% is good; >20% is excellent) Permeability: ability of fluid to flow through the rock (usually measured in cm/sec—a "Darcy") It is estimated that only about 10% of all oil manages to get trapped in economic oil traps. The rest doesn't get out of the source rock (too "tight"). Oil-Bearing Shale:Shale reservoir rock containing mature crude oil. Usually a "tight" formation that requires fracturing

2. What is the meant by "source rock" or "kerogen"? Why is the density of hydrocarbons in source rock important?

Source rock contains up to 10% organic material, but usually 1-2% is more typical. *IMPORTANCE?*

*Oil Developments in the Middle East in the Early 1900s* 1. Briefly explain the early years of the development of the Anglo-Persian Oil Company. What two world powers were vying for influence in Persia and environs in the late 1800s and early 1900s? What famous phrase did Rudyard Kipling coin to describe this international contest? What were the main interests of these two countries in exerting influence over Persia and the neighboring area?

The Russians wanted to build a pipeline through Persia from Baku to the Persian Gulf and the British were interested in blocking Russia and developing oil themselves. The Persian monarchy was profligate, corrupt, and looking for money, and the British government was willing to accommodate them With the cooperation of the British government, William D'Arcy, an Australian millionaire and adventurer sought and was granted a 60-year exclusive oil concession covering about 75% of the Persian empire (the 5 northern provinces were excluded in deference to Russian concerns). D'Arcy agreed to pay: 1.40,000 British pounds upfront 2.16% of any net profits 3.A royalty of four shillings per ton of oil the British wanted to keep the company completely British, so the government recruited Burmah Oil to join the D'Arcy venture in 1908 struck oil (first significant oil find in the middle east)

10. What in general was President Eisenhower's view of limiting oil imports by either a tariff or quota on imported oil in order to promote national energy security? What alternative policy did Eisenhower favor in order to promote national energy security?

The U.S. Congress was inclined toward protectionist import policies based on the influence of influential Senators from the oil and coal-producing states (e.g., Lyndon Johnson, Sam Rayburn, Robert Kerr, Robert Byrd, etc.) Several proposals for protectionist import tariffs or quotas were "dressed up" as national security policies. Eisenhower understood the game and saw protectionist tariffs and quotas as really "anti-security" policies—i.e., "drain America first". Eisenhower preferred free trade and building a strategic petroleum reserve. Eisenhower tried to placate the protectionists through a "voluntary" import limitation program. This policy, of course, failed.

4. It appears that the U.S. government, especially the State Department, may not have been all that concerned about higher oil prices (within reason) during the early 1970s? Why might that have been the case? How might the Cold War and the relationship between the U.S. and the Saudis and the U.S. and the Shah of Iran have factored into this U.S. government viewpoint? What was clearly the U.S. government's overriding main concern during this period of international oil tensions?

The main reason the U.S. Government was not necessarily concerned about higher oil prices was due to the fact that higher oil prices provided a way for the US to be supporting Middle Eastern economies without having to give direct aid Petro dollars supported the economies that the US was already spending thousands of dollars supporting through foreign aid The U.S. government was beginning more and more to see low oil prices as a problem. Meaningful consumer conservation required higher prices. The West needed strong allied governments in the Middle East to counteract Soviet influence in the area. Higher oil prices were essentially foreign aid, and most of this bill would be paid by the other western countries—not especially by the U.S.

7. What, in general, were the nature of the "off-take agreements" and "special supply arrangement" among the large international oil companies engaged in the various joint ventures in the Middle East? What broad role did these arrangements play in aligning the interests of the joint-venture oil companies? Explain how they tended to better align the mutual interests of the companies?

The oil companies exercised some loose "organization" through their system of "off-take agreements" and "special supply agreements'. "Off-Take Agreements": Generally gave each partner in a joint venture a share of the oil equal to its equity share in the joint venture. "Special Supply Arrangements": Because the partners were not equally capable of disposing of their equity-shares of the oil, these arrangements would provide for "crude-long" companies to sell to "crude-short" companies. The special supply arrangements essentially helped the companies stay on the same page regarding the pros and cons of total production. The crude-short companies could get their oil from the crude-long companies without lobbying for increased total production from the joint ventures. Agreements among the oil companies as to what every oil company is going to get for every share of oil, and how they will share it with each other to maximize each company's advantages/capabilities Without the special supply arrangements, the vertical integration of specific companies would encourage them produce more or less than their given share You could either dispose of oil through your own single company, where there is complete vertical integration, or through long-term contracts between companies

3. In the formation of oil and gas, what role is played by natural "thermal cracking" in the "oil window"? What is meant by each of these terms? What will happen if the source rock does not spend sufficient time in the oil window? What will happen if the source rock spends too much time below the oil window under greater heat and pressure?

The oil window is the period of time that's just right for oil, you don't want it to be heated for too long or it all turns to methane

8. Were oil producers all immediately and unambiguously in favor of market-demand prorationing? What broad category of producers tended to opposed this type of prorationing and why? What major events and economic forces eventually caused many of these opponents to change their minds?

Those who opposed Mrkt demand prorationing: *Local independents* (wildcatters) b/c its their ideology/culture to distribute locally. They feared self-interest of large oil company. Rise of lawlessness & chaos in oil fields changed their minds in favor of prorationing.

13. What was the institution of the "posted price"? What did it have to do with administering 50-50 profit-sharing arrangements? Why did the "posted price" seem to be needed and seem to make sense when it was originally adopted? In what way did it rather quickly become a problem for the oil companies with the passage of time? What very important instrumental role did it play in the formation of OPEC?

When oil companies agreed to 50-50 profit sharing, they had to come up with a credible way to determine the "transfer" price(internal) of oil within their vertically integrated corporate structure. They came up with a concept called "the posted price" of oil. "The posted price" was simply a price at which they agreed to sell oil to anyone—including unassociated third parties. Thus, it was a price that they would have no motivation to understate. This posted price would then be used to calculate the revenues used for determining profits in the profit-sharing formulas.

2. What major worldwide economic events and trends were working against OPEC as it tried unsuccessfully to maintain high oil prices in the first half of the 1980s?

Worldwide recession, Fuel switching, Public Policies, Market-driven conservation, Development of alternative sources of energy, increase in Non-Opec Supplies of oil, structural changes in oil

14. To the extent that there is validity to the notion that international oil companies exploited their host countries in the developing world, what are the best substantive arguments supporting this viewpoint? In other words, in broad terms, what were the alleged avenues and vehicles by which the international oil companies accomplished this alleged exploitation?

YES: They discouraged competition from the independents in order to maintain their "monopsony" status for as long as possible; They retarded the ability of the countries to run their oil industries by not training local technicians; From time to time they solicited their home government's diplomatic efforts and interference in the host countries; and They controlled the downstream oil distribution channels for disposing of the oil.

11. Briefly identify and explain the main significance of the following (a few sentences will be sufficient): a. The Standard Oil Trust b. Standard Oil Co. of New Jersey v. United States c. State regulation of local oil pipelines as "common carriers" d. The Hepburn Act e. The common law doctrine of "the rule of capture" f. The legal doctrine of "correlative rights" g. Market-Demand Prorationing vs. MER Prorationing h. Oil Field "Unitization" i. "Hot Oil" j. The Connally Hot Oil Act k. Interstate Oil Compact Commission (This question is very redundant with several of the previous questions. It simply illustrates how the question might instead be posed on the exam.)

a. The Rockefeller oil empire. b. *Standard Oil Co. of New Jersey v. United States*: The Supreme court ordered the break-up of the Standard Oil Trust. c. Common Carriers - oil pipelines have to carry *everyone's* oil d. *The Hepburn Act (1906):* extended federal regulation to interstate oil pipelines e. *Rule of Capture* - Penn. Supreme court ruled that "fugitive" underground oil was subject to same law as wild game found on one's property. f. *Correlative rights:* replaced the rule of capture in 1890 from *Ohio oil co. v. State of Indiana,* Intended for a "just distribution" of common oil pool. Established legal doctrine for further state regulation. g. *Market-Demand vs. MER Prorationing:* Managing Econ waste vs. Physical waste h. Oil field *Unitization:* jointly operating a reservoir that is owned by many entities as if it were a single unit under 1 manager. i. *Hot oil:* oil companies producing oil in violation of TRC. j. *Connally Hot Oil Act:* required. Dept. of Interior to police the transportation of hot oil across interstate lines. Meant to provide assistance to states in enforcing pro-rationing codes. k. *Interstate Oil compact Commission*

5. How did Eisenhower use "the oil weapon" to end the 1956 Suez Canal Crisis and compel Britain and France to withdraw their troops from Egypt? In what sense did Eisenhower have Britain and France "over a barrel", so to speak?

in 1869, the Suez Canal was completed with a joint venture between the Egyptian government and a french company, and in 1875, the Egyptian gov sold it to the British after a military coup in 1952, Gamal Abdel Nasser became the dictator in 1954 (he wanted to create an Arab state with populist ideals) in 1955, in placate Nassar, the British and the US began discussing loaning Egypt money for the Aswan dam, however, after backing out, Nassar seized control of the Canal in 1956, despite the lease ending in 1968 what followed was an attack by the British, French and Israel Eisenhower was unaware of the above plan and after the Israeli invasion, Eisenhower sought UN endorsement of economic sanctions against Israel until they withdrew On October 30, Britain and France(Allies) vetoed the U.S.-proposed resolution in the U.N. Security Council and launched an air raid on Egypt under the guise of "protecting the Canal" and wiped out the Egyptian air force. However, especially with the Canal blocked, Eisenhower recognized he had the upper hand in determining the final outcome because substantial oil shipments were now cut off and Britain and France would need U.S. cooperation in supplying them oil until the Canal could be re-opened. Eisenhower also threatened the British that, if they did not agree to quickly withdraw their troops, he would sell massive amounts of British bonds held by the IMF as part of European Reconstruction on the open market thereby pushing Britain into a devaluation of the pound.

Oil Developments in the Middle East Between the Two World Wars 1. What were "mandatories" or "mandates" under the Treaty of Versailles (and the League of Nations) following WWI? What eventually important oil areas in the Middle East were made British "mandates" after WWI? What mandates were assigned to France and what did France do to better assure that it would be able to participate in any post-WWI oil development in the Middle East? What was the nature and source of the tensions between America and Britain that arose regarding these British mandates very quickly after WWI? In general, how was this tension resolved; Specifically, what accommodations did Britain make?

mandates: allocated former colonies or land to allied rule: England got Palestine, Mesopotamia (Iraq) France got Syria, Lebanon Following WWI, the Allied Supreme Council met at the Paris Peace Conference and sliced up the Ottoman Empire into various "mandates" to be administered by Britain and France with the stated objective of eventually establishing *democratic home rule in these areas.* As part of the partitioning of mandates, the French were concerned that oil would eventually be found in Iraq and that it's development would be dominated by "the Anglo-Saxon Trusts". Therefore, in the San Remo Agreement in 1920, the French insisted that Deutsche Bank's share in the Turkish Petroleum Company be handed over to Compagnie Fancais des Petroles (CFP)—today named "Total". *American Interest in Iraq:* Beginning around 1920 (with the USGS Report), the U.S. government was becoming concerned that the U.S. oil reserves were being rapidly depleted. Wanting to go into Middle East because that looks like oil future. American oil firms were also looking more and more at the prospects for developing oil internationally. Traditionally, in their Middle East "protectorates" the British had enforced a "British Nationality Clause"—foreigners could invest, but they would have to be minority partners in a British enterprise( they will have 51% say.(not Paris peace conference stuff) Following the Paris Peace Convention, the British were supposed to follow an "Open Door" Policy to foreign investments in their Middle Eastern mandates. Britain was also stretched financially and needed development capital in the Middle East; it also wanted to preserve the British-American Alliance.

11. What is meant by "the petrochemicals industry"? Give some examples of various petrochemical final products.

non - energy products Lubricants Detergents Solvents and cleaners Adhesives Synthetic rubber Plastics Polyvinyl Chloride (PVC) Cosmetics

15. What economic forces and events led to the formation of OPEC? What were the early officially adopted objectives of OPEC? How successful was OPEC in achieving these objectives prior to 1970? What internal and external factors tended to limit the effectiveness of OPEC during its first decade of existence? What were the most important achievements of OPEC during this first decade?

oil company reductions in the posted price result in the formation of OPEC British Petroleum was the first company to say "UNCLE" and reduced its posted price by 18 cents (about 10%) in early 1959. By happenstance, the First Arab Petroleum Congress was scheduled to meet shortly in April 1959. ---The conferees (which included Venezuela as an observer) issued the Mehdi Pact calling for: 1.An increase in payments to host countries 2.Prior consultation on any reductions in the posted price 3.Establishment of an institution to coordinate production In August 1960, without any consultation, a new "tone deaf" Exxon management team announced a unilateral reduction of 14 cents (about 7%) in the posted price. All the majors followed suit. Meeting in Baghdad in September 1960, Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela formed OPEC. the beginning of OPEC was timid and Venezuela took the most radical position they began with 3 moderate resolutions: 1. roll back the posted price reductions 2. study ways to stabilize world oil prices 3. establish a permanent OPEC organization with a permanent secretariat what they accomplished: 1.to begin to form bonds of solidarity and commonality among its members; and 2.To provide a forum for the host countries to develop and share their own knowledge and expertise about the oil industry.

10. What are tar sands? Where do the two largest reserves of tar sands in the world reside?

oil mixed with dirt, very dirty Canada (athabascan) and Venezuela (orinoco)

16. What was OAPEC and how/why did it come into existence? What principled position did it initially adopt toward oil embargos and using oil as a political weapon? Ironically, what action did OAPEC take in October 1973 during the Yom Kippur War?

the 1967 Six Days war brought about OAPEC Nasser's prestige among Arab nationalists was slipping and he didn't want to be "out radicalized" by Syria. So, he: 1. Formed a coalition against Israel with Syria, Jordan, and Iraq 2. Evicted U.N. observers from the Sinai 3. Once again blockaded Israeli shipping in the Gulf of Aqaba Syria began amassing troops along its southern border in the Golan Heights, and other troop preparations were apparent. On the morning of June 5, 1967, the Israelis launched a massive preemptive attack against all of the prospective Arab belligerents. The war was pretty much over in the first 48 hours. By the third day, the Israelis had reached the east bank of the Suez Canal. Ever since this war Israel has occupied the defensive buffer zone of the Sinai and the Golan Heights, and also the West Bank and Jerusalem In response to the Israeli attack, the five Arab oil ministers of Saudi Arabia, Kuwait, Iraq, Libya, and Algeria called for an oil embargo against the U.S. and Britain. The two Arab pipelines to the Mediterranean were completely shut down. The immediate loss of oil was a very significant 6 mbd. This interruption was even larger than during the Suez Crisis. The U.S. launched an emergency program to supply the shortfall and fortunately there was enough U.S. spare capacity to do so (along with its allies Venezuela, Iran, and Indonesia). Afterwards, in early 1968, three of the most conservative Arab countries (at the time)—Saudi Arabia, Kuwait, and Libya—met and disavowed any future use of oil embargoes as a strategic weapon. They formed a new group called the Organization of Arab Petroleum Exporting Countries (OAPEC). --- Ironically, in 1973, it would be OAPEC that declared a second oil embargo.

5. What "conspiracy theory" do some people believe regarding the role played by Saudi Arabia in contributing to the collapse of the Soviet Union?

the Reagan Administration actually pushed the Saudis to induce the oil price collapse in 1986 in order to destabilize the Soviet Union

3. Why did the U.S. government put pressure on Chevron and Texaco to open up their fabulously attractive Aramco partnership to additional partners? What additional oil companies were eventually invited to buy their way into the Chevron-Texaco Aramco partnership? How did these companies manage to join the Aramco partnership without violating their apparent contractual obligations under the Redline Agreement?

the U.S. Marshall Plan quickly reconstructed Europe, aimed at countering further Soviet incursion into Europe during the Cold War would need a large supply of oil. Chevron and Texaco owned the Saudi oil concession but they were relatively small companies at the time and needed additional resources to develop the vast resources that they soon discovered in Saudi Arabia. The best and most economical way to get oil to Europe would be the construction of a very expensive ($100 million), but cost-effective pipeline—the Trans-Arabian Pipeline ("Tapline"). the preponderance of Persian Gulf oil was transported to Europe through the Suez Canal. Chevron and Texaco needed more capital to quickly develop the Saudi fields and the U.S. State Department encouraged Chevron/Texaco to take on more U.S. partners. In 1944, Jersey (Exxon) and Socony (Mobil) began negotiating to participate as partners in Aramco. In 1946, Exxon and Mobil were reminded of the constraints of the Red Line Agreement, and they repudiated it in order to participate in Aramco. Based on the fact that Britain had taken control of the French shares of Turkish Petroleum during the Nazi occupation of France in WWII, Exxon and Mobil lawyers argued that the Red Line Agreement had become null and void under the doctrine of "supervening illegality". In 1948, Chevron and Texaco sold 40% of Aramco to Exxon and Mobil for $470 million. Initially, Exxon and Mobil had planned to split their ownership share in half, but Mobil was concerned about the security of the Saudi government and pared its share back at the last minute. Exxon needed crude oil and was happy to take Mobil's share.

8. Crude oil comes in a wide range of qualities. In distinguishing these qualities, various terms are used to refer to different dimensions of their quality. Briefly and generally, what important dimensions do the following terms refer to: a. "sweet" vs. "sour" crude, b. the "API gravity", and c. the viscosity or "pour point temperature". In what way does each of these dimensions matter? In other words, in terms of each these three characteristic dimensions, what range of each spectrum would indicate a more valuable oil (i.e., sweet vs. sour, light vs, heavy) and why?

•"Sweet" -Sulfur content less than 0.5 % •"Sour" -Sulfur content greater than 2.0 % •Note that the sulfur content of an oil will have serious economic significance because the sulfur is costly to remove making it a higher cost feedstock for making gasoline. For this reason, it is generally more cost-effective to produce higher fractions of gasoline from sweet oil and produce greater fractions of heavy oil, diesel, and fuel oil from sour crude.

2. In 1890, the Supreme Court borrowed the legal concept of "correlative rights" from riparian water law and began applying it to petroleum law. Within the context of a "common pool" of subsurface oil, what was the general meaning and importance of replacing or qualifying the legal doctrine of "the rule of capture" with the legal doctrine of "correlative rights"? What was the legal implication of this Supreme Court ruling for state's authority to impose petroleum "conservation" regulation?

•In 1890, in the case of Ohio Oil Company v. State of Indiana, the Supreme Court transferred the concept of "correlative rights" from riparian water law to petroleum law. -The Court stated that the Rule of Capture applied only to the extent that it did not lead to the "annihilation of the rights of the remainder" to their "just distribution" of the common pool. -Thus, no landowner had the right to take more than its "fair share" of the oil in a common pool. •Obviously, this doctrine presented some serious challenges of practical implementation, but it did establish the legal doctrinal basis for further state regulation to address these issues.

2. What did the Supreme Court do to the Standard Oil Trust in its decision in Standard Oil Co. of New York v. United States? In doing so, under what statutory authority was the Supreme Court acting?

•In 1911, in Standard Oil Co. of New Jersey v. United States, the Supreme court ordered the break-up of the Standard Oil Trust. Original Name Later Names •Std. Oil of New Jersey → Esso, Exxon, ExxonMobil •Std. Oil of New York → Mobil •Std. Oil of California → Unocal, ChevronTexaco, Chevron •Std. Oil of Ohio → Sohio (later acquired by BP) •Std. Oil of Indiana → Amoco (later acquired by BP) •Continental Oil → Conoco •Atlantic → Atlantic, Atlantic Richfield, (later acquired by BP) Note: If Rockefeller's empire was hurt by the break-up, it didn't show. Over the next ten years, the separated companies net worth increased fivefold.

3. What several other factors in the late 1800s and early 1900s contributed to the eventual erosion of the concentration of economic power in the Standard Oil Trust? Briefly explain how each operated to erode the power of Standard Oil.

•Interstate Commerce Act (1887) established railroad regulation •Sherman Antitrust Act (1890) •State laws mandating that oil pipelines be "common carriers" •Hepburn Act (1906) extended federal regulation to interstate oil pipelines •Development of crude oil transport by truck •Opening of crude oil production in Oklahoma and Texas State Regulation of Petroleum "Conservation" and the Evolution of "Demand Prorationing" in the U.S.

9. In the confusing terminology used to refer to shale-related oil, what is the distinction between "oil-bearing shale", "oil shale", and "shale oil"?

•Oil-Bearing Shale: -Shale reservoir rock containing mature crude oil -Usually a "tight" formation that requires fracturing -Example: The Bakken formation in North Dakota •Oil Shale: -Shale containing large amounts of immature organic matter, or "kerogen" (not crude oil itself) -Example: Green River Formation in Colorado, Utah, and Wyoming •Shale Oil -A synthetic crude oil produced by heating oil shale in an anaerobic environment (pyrolysis)

7. In the process of getting crude oil out of the ground, what in general is meant by "primary recovery", "secondary recovery", and "tertiary recovery" techniques?

•Primary Recovery -Reservoir "drive" (internal pressure) comes entirely from natural forces within the reservoir •Pressure from the oil itself, natural gas, and/or water •Enables recovery of about 5-15% of the oil in the reservoir •Secondary recovery -Use of uplift pumps and/or, re-injection of natural gas, or injection of water ("water flooding") •Increases the total recovery rate to about 35-45% of the oil •Tertiary Recovery ("Enhanced Oil Recovery") -Methods that increase the mobility/fluidity of the oil in the reservoir •Typically injection of chemicals, steam, or CO2, or in situ combustion of a portion of the oil in the reservoir •Increases recovery by 5-15%, enabling total recovery of 40-60%

6. What is an MER and what did regulation by MERs—and MERs alone—attempt to achieve as an objective? What is the essential difference between "MER Prorationing" and "Market-Demand Prorationing" (i.e., in what essential way did Market-Demand Prorationing exceed (i.e., be more restrictive than) MER Prorationing)? Which type of prorationing is identified with the elimination of "physical waste" only? Which type is identified with the control of both physical and "economic waste"?

•The political battle over state regulation was almost always framed as a battle between adopting regulations only to prevent "physical" waste or whether to also prevent "economic" waste. •"Physical Waste": In broad terms, the prevention of "physical" waste might be best described as going no further than addressing all the market failures associated with the "rule of capture". For instance, regulating pumping rates to avoid the need to construct massive amounts of above-ground storage tanks, avoiding wanton depletion of reservoir pressure, etc. •"Economic Waste": By comparison, the prevention of "economic" waste might be best described as going one significant step beyond this and explicitly attempting to support a target price for crude. •"MER" Prorationing: -Main objective is avoidance of "physical waste" -A State-employed petroleum engineer establishes an "Maximum Efficient Rate" (MER) of oil production for each well consistent with managing reservoir pressure and "maximizing" ultimate recovery -"Unitization" is the most stark form of this regulation—managing the entire reservoir as if owned by a single entity •A limited exemption to antitrust laws was usually necessary to adopt unitization.