Oil Industry: Background and History

¶ … Oil Industry: Background and History

In historical terms the oil industry began more than five thousand years ago. In the Middle East oil was used in"... waterproofing boats and baskets, in paints, lighting and even for medication" (History of the oil industry). Oil and oil usage is evident in human society even in ancient times where the use of oil was used for medical, domestic and building purposes and not seen as a fuel as it is today. For example, the Bible refers to pitch being used for building purposes in the cementing of the walls of Babylon. (History of Oil Use) Even as late as the 1800s, oil was seen as "...a disinfectant, a vermin killer, hair oil, boot grease, and a cure for kidney stones" (History of Oil). In the 4th century the Chinese drilled for oil and natural gas. ("Oil Industry")

However when whale oil became less abundant there was a search for news ways to obtain oil. The first modern oil well was dug by Edwin Drake in Titusville, Pa, which began the first oil rush. This was to lead to the construction of the first oil refinery in 1861. ("Oil Industry") Subsequently, in the 19th century many of the larger oil companies were founded. During the Civil War, John D. Rockefeller was to invest in oil and Standard Oil as created in 1870. This company "...refined about 95% of the United States' oil in 1880" ("Oil Industry"). However Standard Oil was split into more the thirty companies in 1911 due to the fact that it was declared an illegal monopoly. Among these new companies were Esso or Exxon, Mobil, Chevron, Atlantic Richfield (later ARCO), and Amoco. Shell (1907) and British Petroleum (1909) were also established in this period. ("Oil Industry")

The increase in the production of automobiles and their common use also influenced the oil industry and spurred its growth. "In 1900, worldwide crude oil production stood at nearly 150 million barrels. Illuminants served as the primary product of the oil industry, but new inventions such as the automobile and the airplane used petroleum as fuel..." (Petroleum Industry).

This also increased the need for new oil resources and the large Texas oil fields were exploited in the 1930's. Furthermore, Chevron, Texaco, Exxon, and Mobil expanded their oil reserves by "...purchasing the rights to the extensive Saudi Arabian oil fields for only $50,000 from the king in 1946 oil replaced coal as the world's most popular energy source" ("Oil Industry"). In a more contemporary sense the oil industry as we know it today began in the early 1900s; and escalated with the advent of World War Two; while before had been an oversupply of oil before the war, the advent of World War Two "...taught government the importance of having a safe supply of oil" (History of Oil).

An extremely important part of the history of the oil industry is the formation of Organization of Petroleum Exporting Countries (OPEC) in 1960. OPEC as the dominant force in the oil market, "...required that the major oil companies provide them with a larger percentage of the profits from their fields." ("Oil Industry"). This was to result in an oil embargo in 1973 and the increase of OPEC oil prices in 1981. This also led to an international energy crisis which illustrates the extent to which many counties in the world had become dependent on oil as an integral part of their economies. " the resulting energy crisis forced many developing countries to pay more for energy, negatively affecting Third World debt; industrialized countries implemented new measures to conserve and develop new sources of energy" ("Oil Industry").

Countries like the United States begin searching for new sources of oil and this research extended to the exploration of the Alaskan oil fields, as well as the oil fields in the North Sea. Subsequently, with these additional resources, the price of oil declined and evened out until 1999. In that year OPEC again reduced production in order to increase worldwide prices.

Therefore it is evident from even a brief glimpse at the convoluted history of oil that the impact of oil production, as well as other economic factors relating to the industry, was to have far - reaching implications for the world economy. One example was the collapse of oil prices in the 1980s, which was to ruin a large number of independent oil refineries and led to a recession in many areas of the world.

Another issue that has impacted the oil industry and which will also be discussed in later sections of this paper are the environmental issues related to the industry and which have a secondary but equally complex and important impact on the world economy. For instance, the oil spill from the Exxon Valdez tanker in 1989 caused extensive damage to ecosystems and alerted environmental authorities to the danger that the oil industry could pose to the environment and, by extension, to the economies of those countries affected.

Today many oil companies have diversified their activities into area such as chemical production. Since the 1990s there has been increased consolidation of oil companies. For example, the largest U.S. oil company, Exxon, has merged with Mobil, creating the ExxonMobil giant. Other mergers included Texaco as ChevronTexaco, British Petroleum with Amoco and ARCO as BP, and Conoco with Phillips Petroleum as ConocoPhillips. ("Oil Industry")

The situation in more recent times has been influenced by political factors such as the end of the Cold War and the demise of the Soviet Union. This has had a negative effect on oil production in the developing countries, mainly due to the fact the loss of material support from the Soviet Union and Communist countries. The decline in the world economy as well as the move towards sources of energy other then oil has consequently resulted in a decline of oil production. ("Oil Industry")

Another factor is the tendency towards privatization in the industry. This is due to the view that, "...state ownership has been labelled a failure and private ownership touted as the only way forward" ("Oil Industry"). All of these factors have meant that there has been a change in the power balance between the large oil companies and the developing or Third World countries, in favor of the oil companies.

Today the top 234 private international oil companies hold only about 5% of the world's crude oil reserves of 1,000 billion barrels. The situation is similar with regard to natural gas, which is widely agreed to be the hydrocarbon fuel of the future because it is less polluting than oil.

Tanzer)

2. Key issues that are related to international economy.

The oil or petroleum industry is related to the petroleum market internationally. In understanding the key issues in international economics and oil one has firstly to understand the importance of oil as an energy source. Oil drives the economies of the world and is related to almost every industry and economic activity. This does not only refer to the need for fuel for transport in modern economies but also to the myriad ways in which oil usage and consumption impacts on particular countries and economies. If one takes into account the contemporary reality of globalization, then the impact of oil becomes more evident.

With increased communications technologies and forms of transport, the era of the isolated economy or country are a thing of the past. On a simplistic level, globalization means that every economy or country is affected by the global economic situation, which is intimately connected to oil. The effect of an increase in the oil price is therefore widespread and invasive and impacts on every country in relation to that countries dependence on oil. This is an aspect that will be discussed in the following sections and it is a cardinal and fundamental factor that needs to be taken into account in terms of the way that the oil industry impacts on the global economy. The importance of oil lies in the fact that it is a vital component of almost all other industries. In fact some commentators claim that it is a vital part of industrialized civilization itself.

The importance of oil for the international economy and industry can be seen for the following figures. In terms of world production oil averaged about 83.02 million barrels per day in 2004 compared to about 74 million barrels per day in 2002. (Some interesting oil industry statistics) This aspect is cardinal in the understanding of the relationship between oil production and contemporary economic factors. This refers essentially to the fact that, "...Consumption is increasing at a faster rate than the increase in production. And at the end of 2005, world demand... exceeded world refinery capacity for the first time - demand of 84 million barrels per day vs. 83.5 million barrels per day refinery capacity" (Some interesting oil industry statistics). This has a number of economic implications internationally.

One commentator compares the modern oil industry to a river with various countries along its banks vying for the resource. While oil is a valuable resource,

Like... The river it is also a curse. Its flow is inconstant. In drought years, the supply of water falls; in other years, floods can take their toll, leaving death and destruction in their wake. It can become polluted, causing both health and economic problems for its users.

Davis J.)

The above analogy highlights some of the essential features of the modern oil industry and the way that it affects world economies. Oil is essentially a limited commodity as well as being a vital resource for the international economy. As such it is also affected by a range of different variables; including politics, international affairs, fluctuating market prices, environmental concerns and other factors that all combine to form of complex picture of the industry in relation to the international community.

One of the central features of the contemporary oil industry is the problem of environmental pollution. This problem is summarized by the fact that; "Oil is a Fossil fuel. Burnt fossil fuels release Carbon dioxide (CO2) into the Earth's atmosphere and thus contribute to Global warming." (Petroleum industry) This is one of the central challenges facing the industry and will be discussed in section four.

Another feature that is also a challenge to the future of the industry is the fact that oil is a non-renewable resource; which means that the industry has to face the fact that the oil supply will eventually diminish. Linked to this is the issue of world politics, which is also inextricably intertwined with the way that oil impacts on economies. This subject would take a few books to analyze comprehensively.

One example serves to illustrate the impact of politics on oil production and world economics. Oil was used by the oil-rich Arab countries after the Arab Israeli War of 1973. "The "oil weapon" was "... used by the Arabs to squeeze the States - the Arab oil embargo caused a panic in the West, as oil soared and subsequently so did gas prices" (History of Oil). There is a common saying that Oil prices are driven by politics in the short run and by economics in the long-term. (History of Oil) Politics plays a considerable role in determining the supply and demand of oil and therefore has an extensive effect on the world economy. The war in Iraq and the political volatility of the region is also a security issue for the oil industry and international economy, as will be discussed in section four of this paper. As one article states "The Iraq War raises important questions about the shifting distribution of economic and financial power around the world" (Restructuring World Economic Power Relations through High Oil Prices)

3. The oil industry's impact on the international economy.

There are many variables and complexities that have to be taken into account in understanding the way that oil production and supply functions in terms of the variables in this process, and the way that these affect global economies. The following is a brief overview of the main elements of this process.

Due to the fact that oil is an essential energy source, the way that countries and industries perform is largely dependent on the oil price and the factors that accompany changes in this price. The way that oil production and consumption affects the world economy is a macroeconomic sense can best be gauged from the events and situations that result from an increase in the oil price. This is a phenomenon that we have recently experienced in this country and elsewhere in the world. This view provide an outline of the way that oil functions in relation to the larger economy and also shows the importance of this commodity or resource in the global economy.

In reality an increase in the oil price affects the performance of world economies in different ways. In general however an increase in the oil price leads to a transfer of income from the countries that import the oil to exporting countries. The extent of the effect of an increase in the price of oil depends on a number of factors; these include; the share of the cost of oil in national income, the degree of dependence on imported oil and the ability of end users to reduce their consumption and switch away from oil. (Analysis of the Impact of High Oil Prices on the Global Economy) Other concomitants factors include the following: "...the extent to which gas prices rise in response to an oil-price increase, the gas-intensity of the economy and the impact of higher prices on other forms of energy that compete with or, in the case of electricity, are generated from oil and gas..." (Analysis of the Impact of High Oil Prices on the Global Economy)

Therefore a change in the balance of supply and an increase in the cost of oil have enormous repercussion not only for the industry itself but also for the multitude of interrelated and dependent aspects of the economies of various countries; and these effects have a cumulative and ripple effect on the global economy. It therefore stands to reason that, "...the bigger the oil-price increase and the longer higher prices are sustained, the bigger the macroeconomic impact" (Analysis of the Impact of High Oil Prices on the Global Economy).

An important factor to consider in the way that oil impacts on global economies is that the impact of an oil increase and price fluctuation is also related to the status of a country as an oil importer or exporter. This again refers to the political dimension and adds to the complex picture of oil as a determining factor in global economies. Therefore for oil - exporting counties a price increase will of course increase national income via the higher export earnings. However this increase in income is also offset by losses from lower demand for exports, generally due to the economic problems and possible recession suffered by trading partners in other countries. (Analysis of the Impact of High Oil Prices on the Global Economy)

The effects of a higher oil prices have numerous repercussions in general. These include inflation, increased input costs, reduced non-oil demand and lower investment in net oil-importing countries. This can also result in a reduction in tax revenues and an increase in the budget deficit, as well as an increase in interest rates.

There is also pressure on the standard or normative wage levels in a country as a result of the various facets that result from an increase in the oil price. This in turn can also lead a rise in the level of unemployment - which would of course have a negative effect on less developed countries where unemployment is very high. There is also the fact that these aspects affect consumer confidence which further impacts particularly on world economics.

Because of resistance to real declines in wages, an oil price increase typically leads to upward pressure on nominal wage levels. Wage pressures together with reduced demand tend to lead to higher unemployment, at least in the short-term. These effects are greater the more sudden and the more pronounced the price increase and are magnified by the impact of higher prices on consumer and business confidence.

Analysis of the Impact of High Oil Prices on the Global Economy) significant aspect is the way that oil impacts on the economic relationship between countries. An increase in the price of oil can alter the balance of trade between counties and also affects exchange rates. This refers to the scenario in which the oil-importing countries experience a decline in their balance of payments. This exerts a negative pressure on exchange rates and results in the increase in the price of imports and a reduction in the value of exports. This in turn leads to a decline in the national income of that country. All of these facets have a long-term impact on the economy of countries. "The economic and energy-policy response to a combination of higher inflation, higher unemployment, lower exchange rates and lower real output also affects the overall impact on the economy over the longer term" (Analysis of the Impact of High Oil Prices on the Global Economy)

An actual historical example of the points mentioned above can be seen in terms of the macroeconomic damage in the price collapse of the economies of oil - importing countries in 1986. When the price of oil was increased in 1973 and in1979/1980, there was a sharp reduction in the economic growth of those countries in the world that imported oil. (Analysis of the Impact of High Oil Prices on the Global Economy) This phenomenon can also be clearly seen in the economic history of the United States as well as in Europe during this period. "...most of the major economic downturns in the United States, Europe and the Pacific since the 1970s have been preceded by sudden increases in the price of crude oil, although other factors were more important in some cases." (Analysis of the Impact of High Oil Prices on the Global Economy)

As this quotation points out one should also be careful not to ascribe all micro and macroeconomic events to the price and supply of oil. However it is certainly true that oil and the oil industry play a very large and significant part in the way that international economies function. Therefore it can be stated that the oil industry plays a major role in world economies and that the world economy "... has always fallen sharply in the wake of each major run up in oil..." (Analysis of the Impact of High Oil Prices on the Global Economy) This is largely due to the fact that; the propensity to consume of net importing countries that lose from higher prices is generally higher than that of the exporting countries. Demand in the latter countries tends to rise only gradually in response to higher prices and export earnings, so that net global demand tends to fall in the short-term.