Revenge of the Invisible Hand

How the free market shaped the new geopolitics of the oil industry.

When the Supreme Court ordered the breakup of Standard Oil in 1911, the decision reflected society's distrust of Big Oil -- and a century later, not much has changed. The oil majors' 19th-century legacy makes them an easy target for politicians; portrayed as rich, powerful, secretive, and manipulative, they are an easy scapegoat when gasoline price spikes breed public discontent. But this ritual theater belies the fact that Big Oil has, in fact, long since been tamed. And for all of the U.S. government's shouting, it wasn't politicians, Supreme Court justices, or federal regulators who tamed it -- it was the free market.

John D. Rockefeller, Standard's larger-than-life founder and CEO, was openly contemptuous of the U.S. government. But he was not much friendlier toward the idea of the free market. In Rockefeller's world, oil companies and railroads colluded to guarantee profitability for investors and stability for consumers. Competition, Rockefeller believed, was unnecessary and destructive.

Rockefeller knew his enemy: While it was the Supreme Court that dealt the death blow to Standard Oil, by that point the company's position had already eroded dramatically, not because of government meddling but because of market competition. The Nobels in Azerbaijan and Shell in Indonesia became major oil producers and refused to collude with John D. In 1875, U.S. oil production, dominated by Standard Oil, was over 90 percent of world production. By 1911, U.S. output was closer to 60 percent. With new competitors firmly in place, the company that had controlled 90 percent of U.S. oil refining in 1880 accounted for just 60 to 65 percent of it in 1911.

When the Supreme Court ordered the breakup of Standard Oil in 1911, the decision reflected society’s distrust of Big Oil — and a century later, not much has changed. The oil majors’ 19th-century legacy makes them an easy target for politicians; portrayed as rich, powerful, secretive, and manipulative, they are an easy scapegoat when gasoline price spikes breed public discontent. But this ritual theater belies the fact that Big Oil has, in fact, long since been tamed. And for all of the U.S. government’s shouting, it wasn’t politicians, Supreme Court justices, or federal regulators who tamed it — it was the free market.

John D. Rockefeller, Standard’s larger-than-life founder and CEO, was openly contemptuous of the U.S. government. But he was not much friendlier toward the idea of the free market. In Rockefeller’s world, oil companies and railroads colluded to guarantee profitability for investors and stability for consumers. Competition, Rockefeller believed, was unnecessary and destructive.

Rockefeller knew his enemy: While it was the Supreme Court that dealt the death blow to Standard Oil, by that point the company’s position had already eroded dramatically, not because of government meddling but because of market competition. The Nobels in Azerbaijan and Shell in Indonesia became major oil producers and refused to collude with John D. In 1875, U.S. oil production, dominated by Standard Oil, was over 90 percent of world production. By 1911, U.S. output was closer to 60 percent. With new competitors firmly in place, the company that had controlled 90 percent of U.S. oil refining in 1880 accounted for just 60 to 65 percent of it in 1911.

After the breakup, Standard Oil’s successors were still major players in oil’s global expansion — but that, too, would change with time. The massive oil fields of the Middle East were developed in the early 20th century by cash-rich, technologically advanced oil companies like Exxon, Mobil, Chevron, and BP, which negotiated sweetheart deals with poor, backward regimes living under the thumb of European colonialism. In 1933, for instance, Chevron obtained a 66-year concession from King Abdul Aziz of Saudi Arabia for a one-time payment of about $4 million (in 2011 dollars), plus a $2 per barrel royalty. Today, the Saudis earn $4 million from their oil fields every six minutes.

Big Oil’s dominant position started to crack in the 1950s as governments came to understand the value of their resources and demanded an increasing share of revenues. The Cold War and the demise of European empires shifted the balance of oil power from companies to governments. New independent companies like Occidental and Eni refused to join a common industry front in resisting the demands of oil-producing governments. Big Oil’s control of the industry collapsed completely in the 1970s as most oil-producing countries nationalized their industries, handing control to state-owned oil companies. Big Oil’s profitable oil fields in the Middle East, Latin America, and elsewhere were either taken away altogether or cut back to contracting operations at the behest of local governments. The United States and Canada are now the only countries in the world that permit the private ownership of oil resources. Elsewhere, governments retain exclusive resource ownership, control production and pricing decisions, and keep the lion’s share of revenue for themselves.

A 1952 investigation by the U.S. Federal Trade Commission found that the "Seven Sisters" (Exxon, Mobil, Chevron, Gulf, Texaco, Shell, and BP) held nearly two-thirds of the free world’s oil reserves and operated 55 percent of world oil production and refining capacity. In 2010, the Seven Sisters — now merged into four companies (ExxonMobil, Chevron, Shell, and BP) — held about 2.5 percent of world oil reserves, primarily under contract with governments, and accounted for only 10 percent of world oil production and 15 percent of global refining. State-owned national oil companies (NOCs) have displaced Big Oil as the major reserve holders and oil producers. The NOCs of Saudi Arabia, Iran, Kuwait, Abu Dhabi, Iraq, and Venezuela control 60 percent of world oil reserves, and most of this oil is off-limits to private investors.

If Big Oil’s omnipresence is overstated, so is its impact on the cost of oil; consumers’ ire over high gas prices would be better aimed at governments than oil companies. The majors are certainly profitable businesses — the 2010 earnings of today’s Four Sisters (excluding BP’s oil spill costs) totaled just over $100 billion. But that amounts to just 2 percent of the $4 trillion in petroleum products sold worldwide in 2010 — the rest went to operating costs and government taxes. And that money didn’t just go to OPEC and other producing countries — oil-consuming countries alone extracted about $700 billion in excise and sales taxes from consumers, nearly seven times the take of all the oil majors combined.

But Big Oil’s early detractors were certainly right about one thing, at least: A smaller, humbler oil industry is better for consumers. Although Standard Oil’s heirs no longer dominate the industry, they remain successful and capable enterprises, maintaining Rockefeller’s culture of detailed analysis, precision, hard work, and a focus on shareholder value. What they have lost along the way is the ambition to control the world’s oil supply and price and to maintain a hold on every oil-producing corner of the world. The privately held parts of the global oil industry — transportation, refining, distributing, and retailing — are now intensely competitive. The successor of Rockefeller’s cartel is OPEC, not ExxonMobil.

The new geopolitics of oil have also changed the nature of the work that Big Oil does. With 90 percent of the world’s petroleum off-limits to them, the majors have been forced to think creatively. ExxonMobil may no longer be able to produce cheap oil in the deserts of Saudi Arabia, but there are lots of hydrocarbons that require the technological know-how and capabilities that only the major oil companies have. Big Oil is increasingly focused on the most difficult and challenging resource plays: deep-water and Arctic drilling, oil sands production, and liquefied natural gas. These projects are high risk, high tech, expensive, and beyond the abilities of the national oil companies, and are likely to remain so for years to come.

At the same time, the oil majors are likely to pull back from the refining and marketing of oil — think Shell-brand gas stations — that was once their bread and butter. More recent entrants into the gas station retail market such as Walmart, Lukoil, 7-Eleven, and Safeway have put severe pressure on retail profit margins; refining, the original core of Rockefeller’s empire, has been a disappointing business for a very long time. Over the last five years, the Four Sisters have invested $372 billion in exploration and production but only $71 billion in refining and marketing, much of it just to meet new government regulations.

Meanwhile, barring some unforeseen technological breakthrough, renewable energy sources like wind and solar will remain a footnote on Big Oil’s balance sheet. With the possible exception of biofuels, the major oil companies have little to offer in this business: Why would ExxonMobil want to compete with General Electric in producing wind turbines? ExxonMobil’s efforts at diversification in the 1970s, including computers and Montgomery Ward department stores, were disasters. BP and Shell have thrown a little money at alternative energy for its public relations value, but Big Oil’s shareholders want returns on their investments, not glowing reports from the Sierra Club.

Today’s big oil companies are commercial entities competing for scarce capital and consumer dollars in a competitive global economy. For many decades now, Big Oil’s profits have reflected the hard day-to-day work of painstaking investment decisions and efficient operations, not John D.’s collusion and manipulation. Big Oil’s shareholders are now mostly pensions and mutual funds held by schoolteachers and retirees, not Rockefellers. It’s now the 21st century — well past time to declare victory in the war against 19th-century tycoons and move on to more important things.

Bruce Everett is a retired ExxonMobil executive currently teaching energy economics at the Fletcher School at Tufts University and at Georgetown University's School of Foreign Service.

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