Demand Shock; Closing the Open Door with a Thin Red Line

(The American Energy Society) – The historical characterization of the United States in the 1920’s as “roaring” and worry-free is almost but not perfectly accurate. It is true that seemingly overnight the Great War’s unprecedented carnage and destruction and Woodrow Wilson’s straight-laced, reform-minded, two-term presidency gave way to a decade of flappers, jazz, homeruns, the radio, refrigerators, instant cameras…. But none of these could compete with America’s truest new love – the car.

In a stunning demonstration of the fruitful marriage of innovative technologies to mass markets, the effective price of an automobile fell steeply from the century’s opening onward. A car that cost the average worker the equivalent of nearly two years’ wages before the First World War could be purchased for about three months’ earnings by the late 1920s. This low-price high-volume marketing strategy was among the miracles of mass production – or “Fordism,” as it was sometimes called in honor of its most famous pioneer, who perfected the means to manufacture a working automobile in four hours. The Great War probably delayed mass-adoption – the market for cars started quickly, when the first Model T rolled off of Henry Ford’s assembly line in 1913 through to 1916 when Americans purchased about five million cars that year. Then with the arrival of world war auto sales came to a screeching halt – in 1918 the eight primary manufacturers produced only about 800,000[1], with a significant percentage going unsold and many more being shipped to the front-lines.  But then, the peace that led to prosperity led to a surge. In the immediate post-War years, Americans purchased about five million cars every year. By 1928, there were more than 50 million automobiles in the US, or about 1 for every five people, a ratio never matched again. The introduction of consumer credit, or “installment buying,” pioneered by General Motors, had fueled a domestic market to such an extent that it seemed like almost everyone could afford to buy a car.  And it wasn’t just the total number of cars that was overwhelming. Every car was driven farther, too: in 1919, each car was driven an average of 4,500 miles per year; in 1929 it was 7,500 miles per year. The de facto historian of the 1920s, Frederick Lewis Allen, described the arrival of the automobile in American life as an “invasion.”

The embrace of this new mode of transportation seemed limitless, but the fabulously successful automobile market did have its limits. Mass production of cars made mass consumption of gasoline inevitable; the process of turning hydrocarbons into gasoline could not keep pace. In a stunning demonstration of a market out of balance, consumption of gasoline jumped 90% from the end of fighting in 1919 to the arrival of President Harding in 1921, which drove up the price of crude 50%, from $2 to $3 per barrel. Domestic supplies could not catch up: oil reservoirs in Oklahoma and Texas provided a reprieve, but at nowhere near a rate that could keep pace with demand. Early oil discoveries in New Mexico held promise but proved woefully inadequate, which briefly made Los Angeles the de facto number one producing oil region in the world. Part of the problem, the technologies for finding oil focused on the “surface geology” of the visible landscape.  But even new innovations, many of which had been developed and tested during World War I, had limited benefit, too.  For instance, the torsion balance, an instrument that measured changes in gravity from point to point on the surface, or the magnetometer, which measured changes in the Earth’s magnetic field, only hinted at the prospect of shallow-subsurface reserves.  These desperate technological advances did virtually nothing to offset the under-supply. The fear of imminent depletion of gasoline gripped all those who had purchased a car, worried that they might not be able to drive it. The implementation of “Gasolineless Sundays” was just one reminder of war-time austerity that no one wanted to relive.

The gasoline shortage

Experts in engineering and scientific geology gave an authoritative voice to the gasoline shortage. A worried administration official wrote to outgoing President Wilson that lack of oil was the most serious problem facing the US, to which President Wilson concurred: “I agree – there [is] no method by which we can assure ourselves of a necessary supply.” The director of the US Bureau of Mines projected that by 1925 the oil fields of the US would “reach their maximum production, and from that time on [would] face ever-increasing decline.” George Otis Smith, the director of the US Geological Survey, went further when he warned of a possible “gasoline famine” – the government should “give moral support to every effort of American business to expand its circle of activity in oil production throughout the world.” And they had to do so quickly because by his calculations, American oil reserves would be exhausted in exactly nine years and three months. Here were among the first recognitions that the youthful industry of automobile manufacturing would desperately need foreign sources of oil.

But conservative Republicans who recaptured the Congress in 1918 and the White House in 1920 had no interest in world affairs. No policy better represented their embrace of laissez-faire than their foreign policy of “Isolationism.” Americans had come to emphatically believe that the Great War was an unalloyed tragedy, an unpardonable costly mistake never to be repeated. But the barricade that this inward-looking policy apparently provided was dangerously inconsistent with American auto manufacturing hell-bent to find oil. The quest posed a huge conundrum that pitted an isolationist foreign policy determined by popular will against an expansive economic interest driven by market principles. The popular desire to “disengage from global politics,” as well as the government’s desire to avoid foreign entanglements, created a tightly confining matrix that restricted oil interests to quietly cast about looking for foreign sources.  And when the sector looked beyond US borders, they saw very few options: Canadian reservoirs were dismissed as insufficient; Mexico was considered an “unreliable” partner; the East Indies were jealously guarded by the Dutch; and the Arctic and North Sea were “impenetrable.”

A solution seemed elusive until geologists identified “Mesopotamia!” – mostly Iraq and Kuwait and parts of Saudi Arabia and Syria – as either an interesting potential strategic reserve or the last port in a storm. With US officials prudently looking away, Standard Oil infiltrated the region with two of its geologists on a determined prospecting mission, but a British civil commissioner caught them and turned them over to the chief of police in Baghdad. In a manner that insanely perpetuated in peacetime the diplomatic processes of alliance-forming that escalated World War I, the British retaliated to the intrusion of the geologists by forming regional alliances that would block encroaching American interests. The alliance, formally known as the San Remo Agreement of 1920, gave the French and Dutch restricted access to the Middle East in exchange for diplomatic support of British oversight of the region. The Harding White House immediately denounced the San Remo Agreement as “old-fashioned imperialism.” Jersey Oil thought that wasn’t enough and demanded that the State Department punish those who had “violated America’s ‘Open Door’ principles,” not caring to note the contradictions inherent in their claim. Congress responded by passing the Mineral Leasing Act of 1920, a petty attempt to deny access to American public land to foreign interests whose governments did not respect the “Open Door” policy.

STALEMATE.

No one wanted conflict, especially between erstwhile allies following a terrible war. But no one wanted an oil shortage either. And no one could ignore the fact that the United States at the time produced and consumed more than half of the world’s oil. Ever receptive to avoiding any conflict whatsoever, President Harding and his administration embraced the seductive idea that perhaps they could remain behind the scenes and simply encourage oil companies in the US to solve the intractable problem of negotiating its way into foreign markets. No sooner had the new administration taken office in mid-1921 then Secretary of State Charles Evan Hughes and Commerce Secretary Herbert Hoover approached Walter Teagle, at the time just 42 but already Director and President of Standard Oil, and asked him to “play the role of Goldilocks” and open the door to new oil supplies with just the right amount of negotiation: “do not attempt to swing the door open on behalf of one company alone,” but instead “for a representative group of American [oil] interests.”  And by all means, do not link the efforts back to the US government.

Born into personal and professional privilege, Teagle was destined for the assignment – grandson of Maurice B. Clark, one of John D. Rockefeller’s former partners in Standard Oil, and son of John Teagle of Scofield, Shurmer and Teagle, Standard Oil’s main competitor in Cleveland. Teagle grew up around other oil families in the heyday of Cleveland Heights, and then attended Cornell University with the class of 1900, but graduated early in 1899 with a B.S. in chemistry. Right about that time, Standard Oil bought the family firm, and as per the acquisition, Teagle effortlessly assumed a position as Vice President for Esso (aka, Standard Oil) and then for more than seven years traveled the world charting the company’s foreign interests in search of possible solutions to the sector’s major problem: “find an adequate crude supply.” Throughout his first professional decade Teagle spent more time touring the Middle East than anywhere else in the world. Almost preternaturally self-confident, Teagle’s concept of leadership consisted of himself.

In July 1922, the US State Department quietly orchestrated a meeting between the world’s oil titans at The Carlton Hotel, in London. To meet with Walter Teague and his associates, the French sent a consortium of oil interests so large they almost filled the hotel themselves; at point for the French was Colonel Ernest Mercier, director of the French Petroleum Company (CFP), the forerunner of the French petroleum conglomerate Total. The British went even further, sending a team to accompany Henry Deterding, the Senior Shell executive in Britain, as well as Sir Charles Greenway, Senior Partner in the law firm of Shaw Wallace & Co and one of the founders of the Anglo-Persian Oil Company. Complicating matters, the British brought as uninvited guests the entire Turkish Petroleum Consortium, a quasi-formal group of businessmen with regional Middle East interests but with no political power or recognizable business authority.

The Carlton Hotel, London

In the company of such privilege and power Walter Teagle could almost hold his own, except that also in attendance was Calouste Gulbenkian. Gulbenkian was an odd adversary. While Teagle was an imposing figure at six foot five inches and more than 300 pounds, he could disarm people with warmth and charm. Gulbenkian, on the other hand, was the mirror opposite of Teagle; at barely five foot six inches, Gulbenkian had long before severed any and all ties to nation or people in order to protect his own self-interests. As a child of British nationality and Armenian origin, Gulbenkian grew up handed between family members in cities around the world including London, Paris, Lisbon, and a primary residence in Constantinople.  When he was 15 his father sent him off to be educated at King’s College London, where he took just three years to complete his first-class degree in petroleum engineering and his practicum with the Russian oil industry at Baku. Unlike Teagle, who took very seriously the collection of friends and allies, Gulbenkian would make a show of his independence, manifesting at times as unbearable personal qualities, sometimes just to make those around him uncomfortable. Of his many awful tendencies, the most upsetting was certainly his conspicuous preference for young teenage girls, but his business colleagues didn’t particularly like working with him either; even his business partners found him “totally and completely untrusting.”

Calouste Gulbenkian

Walter Teagle

His offenses may not have won him many friends, but it did win him extraordinary advantages as a negotiator in business. Indeed, from 1912 onward, European governments consistently granted the Armenian a 5% “beneficiary interest” in all oil transactions he facilitated – meaning, he was never granted rights, but enjoyed all the financial benefits as a shareholder – in exchange for his help negotiating passage through confusing local customs and incessant foreign government regulations. Whenever asked about his methods of mediating large oil transactions, Gulbenkian would simply quote his preferred Arab proverb: “the hand you dare not bite, kiss it.”

But despite many contrasts as people and as negotiators, Teagle and Gulbenkian did share one thing in common – vast experience and interest in oil markets, which helped neutralize their differences and made the two men stand above all others, especially among those in attendance at the 1922 Carlton Oil Conference.

At the opening of the meeting, Teagle took immediate control and confidently laid out in extraordinary detail a plan to develop an elaborate system of exploration and production throughout Mesopotamia that was capable of satisfying all Western gasoline markets and even maintain a global oil reserve. Teagle also implied that since his proposal was a “public good,” all oil would be sold at cost without any profits for anyone. To him, the lessons of undersupply were clear: “with a limitless supply of oil, you don’t have to worry if or whether government or markets will provide a solution.”

Teagle’s impassioned pleas fell on deaf ears. The British suggested that they might be willing to agree if the US were willing to pay British taxes on all oil extracted from British territory. None of the French could agree with anyone or each other on the amount of oil to be divided.  Though not allowed at the primary negotiation table, Persian interests were also clear:  take the oil, but expect to pay generous royalties on all resources removed from their homeland. Even a side agreement between European interests failed because they disapproved of the common definition for word ‘equitable.’ In fact, there were really only two things that the Western diplomats could agree upon:  one, that they disagreed on everything, including the meaning of “equal division of revenues”; and two, that Gulbenkian’s 5% draw on all oil transactions was categorically unacceptable.

In late November 1922, after about five months of uninterrupted and unproductive negotiations, Teagle finally set aside his distaste for Gulbenkian and reached out to him with a request for a private lunch meeting. After working their way through many courses, Teagle finally got to the point, “Surely, Mr. Gulbenkian, you’re too good an oil merchant not to know that the attendees won’t stand any such rate (5%) as that.”  Gulbenkian exploded in rage: “Young man! Young man!” he shouted. “Don’t you ever call me an oil merchant!  I’m not an oil merchant and I’ll have you distinctly understand that!”

Teagle was taken aback unsure how to address his adversary. So he tried a different approach – he asked Gulbenkian to sacrifice his own self-interests on behalf of the group, or else, “my sage friend, think of the conceivable consequences without an agreement between all parties.” Teagle had miscalculated.  Badly.  Before Teagle could finish Gulbenkian had gotten up and had left the table, and with him the last real chance to reach an agreement on a global oil market. And these fruitless months would stretch into years with no sign of anyone willing to change their opinion or position on any global oil-market agreement.

Egyptian cartoon criticizing policy of the West

Note the date of the publication.

Like any failed agreement, many of the participants contributed to its failure.  Part of the problem was the persistent arrogance of the West to negotiate with each other, and their categorical assumption that they could make claims on foreign oil. Indeed, local interests were furious that they were usually excluded from break-out sessions, and never felt as if they were taken seriously. The British seemed to sympathize with the Persians, except that Churchill had chosen the out-of-work and unappreciated Faisal I bin Hussein bin Ali al-Hashemi as head negotiator for all Persian interests. Summoned from exile, Faisal had been the King of Syria until he was deposed, and then in time for the conference was hastily crowned King of Iraq; Faisal’s brother, Abdullah, was also granted the title “Amirate of Transjordan,” which he used throughout the conference, too. Of course, Teagle shares some responsibility –  the first rule of thumb of all negotiations is simple: know your adversary. The attempt to appeal to Gulbenkian’s better nature had no chance of succeeding, and he knew it: Teagle himself had once said that Gulbenkian was “most difficult in difficult situations.”  No doubt Gulbenkian also contributed to the breakdown of negotiations. His deep distrust of everyone, especially Westerners, created a toxic social climate. But his stubbornness was mortal – he was never going to give up his 5% commission rate and fought back every attempt by the West to renege on it.  But the single most important reason why negotiations failed – more significant than the clash of personalities or the arrogance of the West –  no one knew for certain if Mesopotamia actually had oil reserves in commercial quantities!   How was it possible to fairly divide an unknown? Since it was all pure speculation, was it reasonable to assume that the parties could in fact reach an agreement on a workable template for sharing an imagined global oil reserve?

STALEMATE BROKEN

In 1927, a joint geological expedition of Anglo, Persian, Royal Dutch and most of the major American companies, set off for another prospecting mission in Mesopotamia, particularly Baba Gurgur, six miles south of Kirkuk, Iraq. There, for thousands of years, two dozen holes in the ground had been venting natural gas, which was always alight. These vents were thought to be the “burning furnace” into which Nebuchadneszzar, King of Babylon, had cast the infidels. It was there, according to Plutarch, that the locals set fire to the gas flairs in order to impress Alexander the Great.

And it was there, at 3:00 a.m. on October 15, 1927, from the well called “Baba Gurgur Number 1,” when a drill bit that had barely passed fifteen hundred feet led to a great roar that reverberated across the desert. The sudden explosion was followed by a powerful gusher that reached fifty feet above the derrick, carrying in it rocks from the bottom of the hole. The countryside was drenched with oil. Expeditionary forces quickly recruited seven hundred local tribesmen to build dikes and walls to contain the flood of oil. Finally, after eight and a half days, the well was brought under control.

Baba Gurgur Number 1

The leading question that had vexed the negotiators in London three years prior had been answered. There was in fact petroleum in Iraq – so bountiful and obvious that Walter Teagle and Sir Henry Dettering and Colonel Ernest Mercier and even Calouste Gulbenkian could see that unrelenting haggling of details was pointless.  There was more than enough for everyone.

On July 31, 1928, nine months after the initial discovery and almost six years to the day since the initial negotiations had begun, Teagle and the rest of the participants returned to London one last time to finalize the negotiations and reach an agreement. First, they agreed on a “self-denying” clause: participation in the negotiations and the final agreement would be restricted to all those who had participated in the original negotiations six years prior.  The next issue was also easily solved – each of the four Western interests could claim 23.75 percent of all the oil extracted from the region: Royal Dutch/Shell, Anglo-Persian (British), the French, and the East Development Company (on behalf of all American companies).  The next issue was just as straightforward:  Gulbenkian would be allowed to keep his full 5% “commission,” and he could sell his share of petroleum at any price. There was just one more issue to settle: to what region did this agreement apply to?  Participants hesitated, and the pause brought back fear of another stalemate. Everyone knew this was a contentious issue – the original negotiations had essentially excluded local interests and no one seemed bent on inclusiveness in the current talks, either. Then Gulbenkian broke the silence.  He called for a large map of Middle East. He pointed at the now-defunct Turkish empire, and then he declared: “That was the old Ottoman Empire which I knew in 1914.  I ought to know.  I was born in it, lived in it, and served in it.” And then he drew a big red circle around the outer-most boundary of the former Ottoman Empire. This Red-Line Agreement identified the region that the participants would divide – ultimately, all of the major oil-producing fields of the Middle East.[2]

 

Calouste Gulbenkian’s inspired “Red-Line”

***

Eric J. Vettel, Ph.D. is the President of the American Energy Society.

Sources:

The Prize, by Daniel Yergin

Freedom From Fear, by David Kennedy

Only Yesterday: An Informal History of the 1920s, by Frederick Lewis Allen

Titan: The Life of John D. Rockefeller, Sr., by Ron Chernow

Energy: A Human History, by Richard Rhodes

Energy and Civilization: A History, by Vaclav Smil

The Red Line:  https://history.state.gov/milestones/1921-1936/red-line

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