Those Who Forget the 1970s Are Doomed to Repeat Them
Let's review. This will be long, please bear with me. You might care: it's about the history of oil prices. Let's start with an overview graph, inflation-adjusted to 2007 prices, from an extraordinarily good technical overview of the topic by James L. Williams, his 2007 "History and Analysis - Crude Oil Prices."
For all the right reasons, Williams' graph starts in 1947. Why 1947? Because in 1947, the USA inherited a really freaky bit of luck: we had very nearly the only oil refineries in the world that hadn't been bombed to smithereens. This meant that if anybody in the world wanted to buy gasoline, diesel fuel, jet fuel, kerosene, plastics, petrochemical fertilizers, or any other product derived from oil, there was only one place they could buy it: American companies. What's more, those companies were themselves busily converting back from war-material production to civilian production, so for quite a long time the demand was much higher than the refineries and chemical plants could supply, so forget competition. American companies could set the prices for petroleum products however high they wanted, and did. Furthermore, oil-exporting countries desperately needed to continue exporting oil in order to pay for food, and only the Americans were buying. So long as the Americans were paying even a few pennies more than it cost to pump the oil out of the ground, even if it meant they were paying no local taxes, no local mineral rights costs, and slave-labor wages to the oil workers, it was still worth more sold to the Americans than left in the ground.
Unsurprisingly, Americans remember the 25 years after that as a golden age of American purchasing power, and we set our national expectations as to how we can afford to live by that baseline. But a whole lot happened over that period of 25 years. The most important is that Europe and Asia rebuilt their bombed-out oil refineries. Another is that the American manufacturing sector got lazy and sloppy. But also importantly, the US spent the last several years of that time period, under both Democratic President Johnson and Republican President Nixon, engaged in a long, expensive, and futile land war in Asia, the Vietnam War, and by bipartisan consensus, neither one of them asked the American people to pay higher wartime taxes or even to buy war bonds to finance that war; they instead simply "ran the printing presses," inflating the national debt at a rate unheard of since the Revolutionary War, and thereby running the US dollar into the ground. And worse: they also lost the war those deficits financed, and lost it in a way that wrecked our military so badly it took us another 10 years to rebuild it.
A world-wide economic cartel of oil-exporting countries, OPEC, had been trying to gin up oil prices to the point where they could at least pay their people starvation-level wages since the mid 60s. With the 1973 collapse of the Vietnam War, they realized that the time was right, because they could do anything they wanted to the US and there wasn't a single thing the US could do about it. Nor did they even have to go without selling oil to do so, since once they broke their contracts with American firms, there were plenty of newly rebuilt European and Asian customers eager to buy that oil for their refineries. And the US's limited defense of Israel from unprovoked aggressive invasions by Egypt, Jordan, and Syria gave them the political cover they needed to do what they'd always wanted to do: raise the price of oil at the well-head from roughly $2-$3 up to $12-$15. US inflation, already troubling, went ballistic, reaching double-digit levels, and priced in US dollars, the prices kept going up way, way past the original $15 target price, up to $50 and more.
Economists and petroleum experts assured us that no end was in sight; the era of cheap oil was over. Pessimists insisted that the real reason for the price spike was that we were going to run out of oil completely, world-wide, by the end of the 20th century, but even the optimists were saying that $50 to $100 per barrel oil was a reality we were just going to have to get used to. But there were people to whom that was good news, after a fashion: American oil companies, their suppliers, and the financial institutions that desperately wanted to lend money to them. To explain why, I have to explain something about oil.
You see, it turns out that there are very few places on Earth where there isn't any oil. Wherever you're sitting now, if you were to dig down far enough, odds are that you'd hit oil. Some places, it's very near the surface, under a thin layer of dirt, or a shallow swamp, or even a thin layer of sand. Other places you might have to go down through hundreds of feet of solid granite rock. Nor are is the oil evenly distributed. The oil pocket under your feet might only be a couple of feet deep; other places might have a vast underground ocean of the stuff. Nor is oil always at the same temperature. Some places are atop thin spots in the earth's crust, closer to the molten magma, and therefore warmed to nearly the boiling point and under high pressure; others, not so much, leaving the oil cold, and sluggish. Nor is it all chemically identical; some oil is more glue-like, stickier, more sluggish even at the same temperature and pressure. All of which makes a difference.
So, imagine two extremes. Oil well #1 is in a place where there's a vast ocean of oil underneath it. The oil in question is thin, runny, and smooth. The earth's crust is thin underneath the oil, so it's hot and under high pressure. The soil on top of the oil is a thin layer of sand, maybe a couple of feet thick. Oh, and to make life even better: it's in a dirt-poor part of the world, the people around the oil well work for pennies an hour. Now imagine that oil well #2 is in a place where there's not so much oil at the bottom of that well. The oil that there is, is gluey, thick, and sluggish. Worse, it's cold. Worse than that, oil well #2 has to go very, very deep, through hundreds of feet of solid granite. And as if that weren't enough, oil well #2 is in a place where there's a comfortable middle class economy, with good jobs, so the owner of oil well #2 has to pay his workers a decent living wage, and because of how hard it is to get the oil out from under his land, he needs more of them, too. I take it you can see how it might cost even 100 times as much for oil well #2 to pump a barrel of oil as oil well #1?
If there's more demand than both of them can supply, them and everybody else, that's one thing. In olden days, wars would have been fought to get exclusive rights to oil well #1's output for your country, so you could produce oil products cheaper. Nowadays, with more open markets, what ends up happening is that the price gets set at about what it costs the guy who owns well #2 to get his oil out of the ground, and the guy who owns well #1 makes out like a bandit. But ... what happens to the guy who owns oil well #2, which happens to be in Texas in 1980, if supply goes up or demand goes down, and suddenly oil well #1, which happens to be in the Middle East, can supply all the oil the world needs? This isn't a theoretical question. It happened.
In 1979, the Iranian people overthrew their government. Neighboring Iraq, sensing a power vacuum (and assured of quiet US assistance) set out to conquer Iran. This turned out to be rather harder than they thought it would be; instead of the couple-day march to victory that Saddam Hussein had promised his people, the Iranian people fought tooth and nail for every inch of their new revolutionary state. Further, Saddam failed to anticipate that his own sizable Shiite Muslim population, emboldened by the Shiite revolution in Iran, might take their Shiite brethren's side over their own country's, and he and his army suffered terrible betrayals, including one very credible assassination attempt. So as the war slogged on for year after year, both Iran and Iraq said to heck with their OPEC quotas, to heck with supporting high oil prices by limiting supply, they needed the money to fund their war. (Which, I mention in passing, shows that both Saddam Hussein and the Ayatollah Khomeini were smarter than Lyndon Johnson, Richard Nixon, and George W. Bush combined.) Worse luck for Americans invested in domestic oil production, they did this just when the US was starting to get its inflation rate under control. Oil prices plummeted through $30 a barrel, and further down to $15 a barrel, and briefly even flirted with the $12 mark.
Good news? You wish.
Remember what I said about runaway inflation in the US, a few paragraphs back? Imagine that you're someone with a few thousand dollars (or more) in savings in the mid 1970s, when inflation is running around 10%, and the best interest rate you can get out of any bank account, or any form of investment at all, is around 6%. Unless you can find an investment that pays better than 10%, your money is dwindling away steadily every day, like water running out of a leaky bucket. That's the trap that every bank, every savings and loan, every brokerage firm, every pension fund, every bond underwriting firm, and every financial services firm found themselves in: they had nothing they could offer people that would pay an interest rate that was even half as high as the inflation rate. So how do you think they reacted when every expert told them that the optimistic estimate for the future was that even if everything else went right, there was no way in hell that oil could ever drop below $50 a barrel? What's so magical about that $50 (in 1976 dollars) price point? That was what it would cost to pump more oil out of Texas. So with $50 to $75 oil in the present, and every expert assuring them that the price of oil would never drop below $50 and might well be on the far side of $100 in a couple of years, everybody in America sank their money, all at once, into Texas oil exploration. Houston office real estate became more precious than gold, as company after company was funded to buy up mineral rights, or to scientifically survey for good places to drill, or to drill exploratory wells, or to build oil well machinery, or to service oil well machinery in place. Among those companies was a tiny little firm named Arbusto Energy Services. Its founder and CEO was the son of a US Senator and largely unsuccessful Republican Presidential candidate, happy to take his father's campaign contributors' money and eager to take advantage of the fact that oil would never be priced less than $50/bbl to earn his own "independent" fortune, to prove that he was more of a man than his father. That man was, of course, George Walker Bush, and when oil hit $15/bbl, he went completely bankrupt.
How does a guy forget his own multi-million-dollar bankruptcy?
But here's why this is weighing on me right now: for the last couple of weeks of the presidential campaign, every politician in America has been eager to take a stand on the subject of off-shore oil exploration and mining, particularly on the outer continental shelf just over the horizon from both the east coast and the west coast of the continental US. And it's taken me pretty nearly that whole time, up until a couple of days ago, to find the number that I wanted most to hear: how much is it going to cost to mine that oil? What is the cost per barrel that oil will have to be at, or above, for those companies to not go bankrupt? I finally got that number, or range of numbers actually, last Tuesday from Jacob Liebenluft's article on Slate.com, "What's the deal with offshore drilling? Will it do any good at all?" I say "range of prices" because the oil companies haven't decided yet just how much technology to throw at the problem. If they throw in the minimum investment, they can get a little bit of that oil, enough to reduce oil prices by about maybe 1% world-wide, and it will cost them $50/bbl to get that much oil. What they want to do is throw some higher-tech pumping solutions at it, get enough oil to make it "really worthwhile." In this context, "really worthwhile" means enough to lower the cost of oil by maybe 3%, reducing, say, gasoline from $3.50/gal to $3.40/gal. But the higher-tech pumping solutions mean that it will cost us $80 to $115 per barrel for that oil.
And there are a lot of American investors really, really eager to fund those offshore oil platforms. Inflation is edging up; by honest numbers, as opposed to the cooked books we've been getting out of every executive branch since the Reagan administration, it's already in the 10% to 12% range. The government is intervening to keep interest rates low, officially to "stimulate the economy" but even more than that in a desperate attempt to keep the interest payments on the national debt even close to manageable. (More on that in a later journal entry.) The collapses of the tech-stock bubble and of the securitized-mortgage bubble have left investors with no reliable way to earn more than the inflation rate, so everybody in America is watching the value of their savings, their pensions, and so forth dribble away. But fortunately, as long as the price of oil stays above $100 or $115 a barrel, there is a lot of oil we can mine right here in America, and with prices "only going up, from now on," there's a lot of money to be made in lending the oil companies the money to build those oil wells.
It's disturbing how many people don't remember that we have been told this before. Nor is there any more reason, this time, to doubt that by the time those offshore oil platforms become functional, oil could easily be back down to $30/bbl. And where will we be, if we invest every penny in every bank and in every pension fund in offshore drilling, when oil prices drop below what it costs to pay off the loans on those oil rigs? Rejoicing that our oil and gasoline prices have gone down? You wish; no, where we'll be is flat broke, as a nation, again.
Didn't they tell you better than this as a kid? "The Itsy Bitsy Spider went up the water-spout. Down came the rain, and washed the spider out. Out came the sun, and dried up all the rain. And the Itsy Bitsy Spider ..."? Well, you remember the rest. I hope. You do if you're smarter than George Bush. Or John McCain.