[OPE-L:6230] oil pricing

From: Rakesh Bhandari (rakeshb@stanford.edu)
Date: Wed Nov 28 2001 - 13:05:31 EST


this website (date unknown) gives a concise (and hopefully fairly 
accurate) description of the regime of administered pricing that, 
according to Cyrus Bina's theory, broke down with the globalization 
of the oil industry.


Pricing of Oil

A study of the pricing of oil in world markets may shed some light on 
the analysis of Petrodollars.

Pricing of oil as far back as the 1920's was established on the 
basing point system. The United States and Mexico were the two main 
exporters of oil at that
time. Therefore, it was natural that the price of oil in world trade 
was mainly influenced by the price of oil from the Gulf of Mexico. 
The basing point was
simply calculated on the basis of the price of crude oil quoted in 
the Gulf of Mexico plus transportation costs, irrespective of the 
point of origin, from the Gulf of Mexico to the point of delivery. 
For example, if oil is shipped from Abadan in Iran to Calcutta in 
India, the buyer will have to pay the price of the Gulf of Mexico in 
addition to the cost of transportation from the Gulf of Mexico all 
the way to Calcutta. Even with the emergence of Venezuela as one of 
the major exporters of oil in the late twenties, this basing point 
system was not disturbed.

However, during WWII and with the emergence of the Middle Eastern 
countries as important suppliers of crude oil to the West, England 
became extremely
concerned with the phantom freight rate being charged. In 1945 a new 
basing point system was established in which buyers in the Arabian 
Gulf would still
pay the posted price of oil from the Gulf of Mexico in addition to a 
freight rate from the nearest supply source. Therefore, it was 
feasible for Middle Eastern oil to compete geographically with U.S., 
Mexican or Venezuelan oil in nearby markets.

As the United States became concerned over the depletion of its own 
oil resources, the growing demand for fuel in Europe led to a 
substantial increase in the Middle East oil production.

Some writers concluded that in order to direct the oil market towards 
the Middle East and to ensure conservation of the United States oil 
resources in
particular, Ait was necessary that the relative price of Middle 
Eastern crude oil should fall so as to enable it to compete with 
Western Hemisphere oil in
Western Europe. Hence in 1945-47 Gulf of Mexico prices of crude were 
raised by $1.32 per barrel (to $2.68 for crude oil of 34 degrees API) 
[Arabian] Gulf
prices were raised only by $1.17 (to $2.18). By March, 1948, all 
major Middle Eastern producers had established a uniform [Arabian] 
Gulf Price of $2.18
per barrel (341), at which price existing freight rates equalized 
Middle Eastern and Gulf of Mexico based prices in London. In May 
1948, [Arabian] Gulf
prices were reduced to $2.03. This was intended to make Middle 
Eastern oil competitive with Venezuelan oil in Western Europe. Since 
Venezuelan prices
continued to equal Gulf of Mexico prices (minus the above mentioned 
import duty into the United States), while Venezuela-western Europe 
freight rates were
some 154 per barrel lower than United States-Western Europe rates, it 
was necessary to bring the price of Middle Eastern oil slightly below 
that of Venezuela.

Observing oil price movements since 1948, we find that the gap 
between the price of the Middle Eastern oil and that of the Gulf of 
Mexico has widened. Not
only was Middle Eastern oil priced cheaply, but it was also 
abundantly produced. Fluctuations in tanker freight rates after WWII 
created new markets for
Middle Eastern oil in the Far East, particularly Japan.

Reviewing the pricing of oil in world trade one can easily deduce the 
following facts:

1. Pricing of oil in world trade was not determined by the 
competitive forces of supply and demand, but was actually 
administered, controlled and manipulated
by the international oil companies, mainly by the so-called seven 
sisters: Standard Oil of New Jersey (Exxon), Standard Oil of 
California (Socal), Standard Oil of New York (Mobil), Gulf Oil, 
Texaco, Anglo-Persian Oil (British Petroleum) and Royal Dutch Shell. 
In my view that those companies having owned most
of the oil in the world through oil concessions, pursued an 
oligopolistic policy to maximize their profits. By keeping the price 
of oil low, they paid less
royalties as they were usually a percentage of the posted price. 
Furthermore, they marketed their cheap oil to their parent companies, 
to their own refineries
and/or to their own down stream operations, thus widening the gap 
between the cost of the main input, namely crude oil, and the 
revenues from the sale of the
final products.

2. As a result of an administered pricing of oil, there was a 
disparity of prices, particularly between oil originating from the 
Gulf of Mexico and that originating from the Middle East. From 1948 
to 1973, the gap between these two sets of prices was widening over 
time. Thus terms of trade of Middle Eastern exporting deteriorated 
more rapidly than those of Venezuela.

3. A complicated structure of oil pricing emerged as a result of 
diversified terms of international oil concessions and historical 
developments of oil ownership. There is, of course, a market price 
which reflects the actual price paid for every transaction and which 
is usually less than the posted price of oil. International oil 
companies came up with the notion of posted price which is a 
reference figure used to compute taxes and royalties paid to the 
Governments or rulers wherever oil was pumped. Then there is a 
buy-back price which emerged with the implementation of OPEC=s 
Resolution XVI,90 which stressed the necessity of oil-exporting 
countries to participate in the ownership of concession-holding 
companies. The buy-back price is what an oil company pays to the 
country from where oil is exploited for the percentage of oil 
produced which represents the governments ownership share in the 
company. In 1974, for example, the ownership of share of Saudi Arabia 
in the Arabian-American Oil Company (Aramco) represented sixty 
percent of the total production. A buy-back price is
that price Aramco pays the government of Saudi Arabia on sixty 
percent of the oil produced.

Needless to say, this type of pricing does not exist in countries 
which have reacquired the full ownership of their oil production. In 
other countries which still share oil production with international 
oil companies, the buy-back price also is less than the posted price. 
With the current fluid situation of oil issue, I do not think that 
the multiple and complicated system of oil prices can continue.

4. The Middle East oil was cheaply sold in world markets The 
following table shows the series of posted price of Saudi Arabian 
oil, 341, F.O.B. Ras Tanura
since 1947. In money terms, in which figures are not adjusted for 
inflationary component, we find that the posted price declined from 
$2.18 in 1947 to $1.80
in 1970, a monetary decline of seventeen percent during this period. 
In order to adjust the posted price of oil, I used the United States 
Wholesale Price Index
of all commodities and an average Gross National Product Price Index 
of seventeen European countries as two reasonable yardsticks to 
remove the
inflationary component of the price series. When these posted prices 
were deflated by the US Wholesale Price Index, the price of oil fell 
from $2.18 in 1947 to $1.25 in 1970, a decline of forty three percent 
in real terms. The decline was even sharper - sixty eight percent - 
when posted prices were deflated by an average price index of 
seventeen European countries. Thus Saudi Arabian oil as an example 
for other Middle Eastern countries bought less and less in real 
commodity exchange markets. This also means that the terms of trade 
of Middle Eastern oil-exporting were deteriorating over time. 
Furthermore, if we allow for the fact that the posted price is 
usually above market prices due to price discounts - which were 
sometimes substantial - one can easily conclude that oil exploitation 
of Middle Eastern oil was only suited to serve the economic interests 
of oil importing countries at the expense of oil-exporting nations. 
Further decline in the price of oil in 1959 triggered the anguish of 
oil-exporting countries. Therefore based on meetings of Iraq, Iran, 
Kuwait, Saudi Arabia and Venezuela, the Organization of Petroleum 
Exporting Countries (OPEC) was formed in September 1960 of which its 
current member countries are thirteen. The intention was to form a 
unified front as a means of collective bargaining with an extremely 
powerful group of buyers which had dictated an oil policy, in pricing 
as well as in production, along its own terms.

[data removed--see website address above]

  From the above data , it is evident that economic exploitation of 
Middle Eastern oil-exporting countries in particular had extended 
over a long period of time. This does not suggest, however, that an 
unmanageable increase in the price of oil is to be enforced all of a 
sudden to rectify past injustices.

This archive was generated by hypermail 2b30 : Sun Dec 02 2001 - 00:00:06 EST