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All the owner concerns have 'trading companies" whose sole purpose is to buy from Aramco at the posted price and sell, at a discount, at the market price. One such trading company, it was learned, has accumulated losses totaling $2 billion in this manner.
The owner companies of Aramco more than offset such "losses," however, with the "dividends" received from Aramco.
Typically, a transaction between Aramco and an owner company works like this:
The owner company takes one million barrels of Aramco crude, paying Aramco $11.65 a barrel cash, or a total of $11,650,000. The owner company sells the oil for perhaps as much as $10 a barrel, giving it a "loss" of $1,650,000.
Aramco, meanwhile, has paid the Saudi government $7 million (at $7 a barrel) and has operating costs totaling $150,000 for the million barrels. It therefore has netted a "profit" of $4.5 million, or $4.50 a barrel.
But Aramco then declares a "dividend"-perhaps equal to $3.50 a barrel after retaining something for capital expansion--giving the owner company $3.5 million on the million barrels. Subtracting its earlier "loss" of $1,650,000 on the transaction, the owner company has come out with a profit of $1,850,000.
[From the Indianapolis Star, Sunday, March 24, 1974) DEPENDENCE ON FOREIGN OIL TRACED TO IRS "TAX" RULING
(By Richard E. Meyer) Americans will live in jeopardy of oil shortages long after the first tanker of unembargoed Arab oil arrives because U.S. oil companies ignored more than a decade of warnings that Middle East oil was a trap.
Cheap oil, huge profits and tax privileges offered by the United States government to companies operating abroad led the American oil industry into a tangle that will place serious constraints on the availability of petroleum for years,
During this period, the government joined the industry in efforts to keep the tangle from tightening-ultimately to little avail.
Government and private studies, interviews with oilmen and a review of congressional testimony by industry and government officials show that U.S. oil companies abroad have become virtual hostages of the nations where they drill their wells.
Government and industry officials alike say the end of the embargo last week is no guarantee that millions of barrels of Middle East oil will not be held for ransom again.
The Arab embargo helped to demonstrate painfully to Americans that they consume far more oil (17 to 19 million barrels a day) than they produce (nine million barrels a day).
What the embargo didn't demonstrate was how U.S. consumers ended up in this predicament.
An examination shows :
Major U.S. oil companies pursued overseas oil for profit in the face of repeated signs that they were losing control of their foreign holdings. Some companies have increased domestic exploration, but the reliance on foreign oil goes on because the oil industry says it will take 10 to 15 years to develop self-sufficiency in the United States.
The oil companies obtained from the U.S. government tax privileges that permitted them to write off huge portions of the
cost of their overseas ventures. By the beginning of the embargo, they had used up most of the write-offs. Now the industry says foreign oil costs must be passed along to U.S. consumers.
Middle East oil-totaling 58 percent of all the world's proven petroleum reserves—always has been what oilmen call "easy oil."
Most of it was shallow, says Prof. Charles Issawi, an oil economist at New York's Columbia University-generally 5,000 to 6,000 feet below the sand. It was close to the coast. Rock formations were porous. And natural gas was readily available to force it to the top.
Yield per well was high-6,500 barrels a day in 1971 and still that good. And production costs, says T. M. Powell, vice-president of Standard of California, were the lowest anywhere in the world-less than 15 cents a barrel since the early '50s.
In the United States, by contrast, where the U.S. Geological Survey says there are still 440 billion barrels of producible and undiscovered oil (enough to meet America's needs well into the next century), most crude oil has cost $1 a barrel or more to take from the ground for the past 25 years. And much of it is under unleased Federal land.
U.S. oil companies gained a foothold in the Middle East in 1928. By the end of World War II, several American companies held large concessions-among them Standard of California (SOCAL). SOCAL found more oil in Saudi Arabia than it could market, and it brought in other companies. The California-Arab Standard Oil Company was formed-and it became the Arabian American Oil Company (ARAMCO), one of two huge oil consortia that dominate Middle East oil today.
ARAMCO holds concessionary rights to oil worth an estimated $1 trilliongiving it a face value of more than the combined assets of the top 500 corporations rated by Fortune magazine.
It is owned by Exxon, Texaco, Mobil, Standard of California and the Saudi government. Together with Gulf, British Petroleum and Royal Dutch Shell, these giant American multinational corporations are known as the "seven sisters.” All are fully integrated, which means they control their petroleum from the gleam in the geologist's eye to the gasoline pump at the service station.
As the American oil industry shifted overseas, it took along its practice of setting its crude oil prices on the basis of U.S. rates in the Gulf of Mexico. But these prices were much higher than costs in the Middle East.
In the late '40s, the Federal Trade Commission says, the oil companies paid only 40 cents a barrel for oil in Saudi Arabia and 25 cents in Bahrain, including both production costs and royalties to Middle East governments.
Prof. Issawi, in his book, "Oil, the Middle East and the World,” says the royalties come to only 20-25 cents a barrel, Christopher Rand, a Middle East specialist, once employed by SOCAL, says they were even lower: 12–18 cents a barrel.
The American oil companies turned around, the FTC says, and charged $1.05 a barrel and up.
"Profits were enormous," says oil writer Christopher Tugendhat.
Americans had begun developing oil in Venezuela, too. And remarkably, it was in South America, not in the Middle East, where American oil companies got their first warning that their shift to overseas production could bring grief.
Venezuelans saw the tremendous wealth of the U.S. oil companies-based, it seemed, on oil which belonged to them. When World War II gave the allies a desperate need for oil, the Venezuelan government increased its oil prices 80 percent. And in 1948, it enacted an income tax law that guaranteed Venezuela 50 percent of all profits U.S. oil companies made on Venezuelan oil.
Now the Middle East wanted more profits, too.
The U.S. Government, under President Harry S. Truman, quietly proposed to Middle East nations that they call the increase a "tax" instead of a royalty. And the companies obtained a ruling from the Internal Revenue Service—by private letter, says Thomas Field, a former adviser to the Treasury Department's legislative counsel-that the IRS would accept the "tax" designation.
That meant the companies could use the increase as a foreign tax credit. "The whole dollar," says Field, "would come out of the U.S. Treasury."
It therefore was agreed, Tugendhat says, "that although the companies should continue to make royalty payments on each ton of oil they produced, the main increase should come in the form of taxes."
Because the Middle East oil nations had no tax structure, the companies agreed to set an export price-now known as the posted price."
"It then became a comparatively simple matter to subtract the cost of production and the royalty payment," Tugendhat says, "and to divide the remaining profit equally between the two sides."
In 1950, Saudi Arabia became the first Middle East nation to use the new system, and by 1952 all other important producing countries in the area except Iran had matched Venezuela's profit split.
"The American taxpayers," says Sen. Abraham Ribicoff (D-Conn.) "ended up subsidizing American oil companies to develop abroad.”
"The tax situation." counters Annon M. Card, senior vice-president of Texaco, “has nothing to do with where we make our investments."
But Prof. Issawi says output “shot up” in Saudi Arabia and Kuwait after the war.
The Nixon administration has denounced the staff report.
"The FTC report is biased against the largest integrated companies," says William E. Simon, the President's energy policy administrator.
But the effects of the foreign tax credit on the U.S. Treasury were immediate and dramatic. In 1950, ARAMCO paid $50 million in U.S. taxes. In 1951, it paid only $6 million.
ARAMCO payments to Saudi Arabia, on the other hand, jumped by that precise difference: From $66 million in 1950 to $110 million in 1951. And by 1963, the five largest U.S. oil companies had amassed such huge foreign tax credits because of their payments to the Arabs that they no longer had to pay any U.S. taxes at all on the profits they earned overseas.
The second warning to the U.S. oil industry that overseas investment might be harmful came from Iran.
It had granted its oil concessions to Britain's Anglo-Iranian Company and now, in 1950, oppostion deputies in the National Assembly led by Dr. Mohammed Mossadegh invoked Iranian nationalism and forced the government to renounce its Anglo-Iranian agreement. Mossadegh said the company was plundering Iran, and he suggested nationalizing it.
Prime Minister Ali Razmara was assassinated. And when the assembly agreed to Mossadegh's proposal for nationalization, Reza Shab Pahlavi was forced to assent. He appointed Mossadegh prime minister, and a state-owned National Iranian Oil Company was formed. Mossadegh insisted that the Anglo-Iranian staff either work for it or leave. Britain chose to withdraw its people. And oil operations in Iran halted abruptly.
"To their horror,” Tugendhat says "the Iranians discovered that they had been cut off from their markets.” Mossadegh refused to compromise and Iran's economy fell into chaos.
Preparatory to stepping in, the four "sisters" in ARAMCO obtained from the U.S. government under President Dwight D. Eisenhower what Senator Frank Church (D-Idaho) says were secret exemptions from antitrust laws permitting them to form the second consortium in the Middle East—this time along with the other three "sisters," Gulf, BP and Royal Dutch Shell.
A coup swept Mossadegh from office. "It is frequently alleged that the American and British secret services financed the uprising," says Tugendhat, "and it is perhaps significant that in his memoirs the shah leaves the question open." The Wall Street Journal says flatly that the Central Intelligence Agency helped in the overthrow.
Senator HARTKE. This article reveals that over the last decade the international oil companies formulated a premeditated policy of limiting oil supplies to keep the price up.
This policy contributed to today's critical shortages.
This conclusion comes from secret U.S. Government documents on activities of the oil companies and from the files of Standard Oil Co. of California.
I would like to place this in the record. Senator TALMADGE. Without objection. [The article follows:)
[From the Wall Street Journal, Mar. 27, 1974) A DIFFERENT STORY—Nor LONG AGO, It Was Too Much PETROLEUM THAT UPSET
(By Jerry Landauer) WASHINGTON.-Among oilmen nowadays, the task is all of shortages. And the industry's publicity broadsides tell again and again how shortages might have been prevented.
“The fuel industry has been warning . . . for the past decade," a Gulf Oil Corp. newspaper ad says, "that if government regulations continued to keep oil and natural gas prices at levels too low and generate capital needed to find more oil and gas, our nation would eventually, run short.”
During most of the past decade, however, some oilmen were actually worrying in private not about impending shortages but about oil surpluses that could depress prices and profits. And some international operators were considering or taking action to head off such surpluses-action that may have con
tributed to today's shortages. Evidence for this conclusion comes from secret C.S. government reports on activities of various oil companies and from the files of Standard Oil Co. of California, know as Socal.
"The overhang of surplus crude avails" (shorthand for "availabilities") "is very large,” according to a forecast prepared by Socal's economics department in December 1968. The document projected a "large potential surplus" through 1973, and it predicted even more troublesome excesses through 1978, when the expected flow of Arctic oil, on top of imminent new production in Australia and strong growth in Indonesia, would be "extending and magnifying surplus supply problems."
SLASHES IN OUTPUT With such a dire future in mind, the company's economists proposed strong measures to prevent an oversupply-though Socal contends this was only a paper exercise. At a time when oil-producing countries were demanding everbigger output to lift their national incomes, the Socal men urged cutbacks in most of the foreign lands where U.S. companies operate.
The company economists proposed slashing total 1969 output from the level of "indicated availability” in Egypt, Nigeria, Libya, Latin America and Indonesia ; such reduction, they figured, would permit "politically palatable" growth of production in Saudi Arabia and Iran, where Socal and some sister companies are most heavily invested. "Pressures will exist to continue to produce in many areas in excess of market requirements,” they warned.
[The oil economists also assumed that all the major international monopoly companies would act concurrently to hold production down rather than see prices drop. And their prediction of industry production behavior in 1969 was remarkably prescient.] Though they missed wildly in a couple of countries, their error for the Eastern Hemisphere and for the entire non-Communist world was roughly 1%.
"NO COLLECTIVE DETERMINATIONS" James E. O'Brien, Socal's vice president for legal affairs, warns against drawing conclusions. He says the forecast of supply and demand was merely a “think piece" lacking much significance and unrelated to management decisions.
"This was only one assessment by one company,” Mr. O'Brien says. “There were no collective determinations. ... There is no international oil cartel. So it would be a big mistake to salivate too much over this piece of paper. Dammit, we think we've done a darn good job of bringing oil to the American people."
Still, the company's persistent worry about oversupply ("The worry was no different than it had been for five or 10 years," says C. J. Carlton, manager of Socal's economics department, who signed the 1968 forecast) could explain a basic development: The major international companies have permitted spare production capacity to shrink in recent years.
In the early 1960s, this idle capacity available to meet unexpected demand in the non-Communist world stood at roughly six million barrels a day. Oilmen then saw this standby reserve as permitting them to negotiate in a hard-nosed way with demanding governments of the producing states; as an Exxon vice president, George T. Piercy, says, “We had alternatives, and when you have alternatives you have strength.”
NEVER UNLIMITED But in 1968-69 the idle capacity fell below four million barrels a day, and it dropped to zero in 1973 as demand rose. So when Arab states began imposing production limits, the companies lacked capacity elsewhere to compensate in part for the cutbacks or to back their bargaining about prices. “Today, even if there were no political limitations on production, there would still be essentially zero spare capacity world-wide," Mr. Piercy recently told a Senate subcommittee headed by Democrat Frank Church of Idaho.
Indeed, as the Socal document suggests, the Arab states may now be doing to the industrialized West just about what Western oil companies did for decades: limiting production in order to prop prices up. "We can't expect to get unlimited production from the Middle East again," laments Allen E. Murray, vice president of Mobil Oil Corp.
In fact, the big companies' long-time influence over foreign productions is generally being reversed now that there's a seller's market for oil. Not only Arab
regimes but governments from Indonesia to Venezuela are demanding and getting more control over production, more involvement in processing and marketing and a bigger share of the proceeds from each barrel sold.
In the recent past, especially in the Middle East, the situation was far different. For the most part, the story of oil in that region is the story of host governments constantly clamoring for more output in order to increase their revenues and of concession-holding oil companies just as often striving to keep production down, on occasion by trickery.
[In Iraq, according to a secret U.S. government report, a venture of five Western firms known as Iraq Petroleum Co, actually drilled wells to the wrong depths and employed bulldozers to cover up others, all in hopes of hoodwinking the Baghdad government.) "Iraq Petroleum Co. plugged these wells and didn't classify them because the availability of such information would have made the company's bargaining position with Iraq more troublesome,” the report says. (The partners in the Iraq Petroleum Co. were Exxon, Mobil, Royal Dutch Shell, British Petroleum and Compagnie Francaise des Petroles.)
(In Iran, a consortium that includes the so-called seven sisters of international oil (Socal, Texaco, Gulf, Mobil, Exxon, Shell and British Petroleum) frequently resisted the shah's entreaties for more production, entreatise delivered to oilmen even on Swiss ski slopes during royal vacations.] To give the appearance of rising output, the consortium at one point shifted its reporting year from the Christian to the Iranian calendar (March to March). And instead of producing more for Western markets already deemed to be glutted, the consortium agreed to sell oil to the Iranian government-with the understanding that it couldn't be resold to compete with the consortium's oil; thus restricted, the shah bartered with Communist countries.
(The 1954 consortium agreement, disclosed for the first time by Sen, Church's subcommittee last month, permitted any combination of companies oroning at least 30% of the consortium to set its total output at any chosen level-as long as that level was less than the production desired by the remaining consortium members.)
Anxiety about oversupply also accounts for the consortium's cooliness toward a proposed pipeline running from non-Arab Iran through Turkey-a pipeline that could have protected industrialized countries against Arab interruption of oil supplies. Companies belonging to the consortium didn't want the pipeline, apparently because they feared the shah might "force" them to deliver too much oil thereby.
“Major prospective user is contrary,” according to a coded 1967 cable sent to pipeline-building Bechtel Corp. in San Francisco from a company scout in Iran. "Believe real reason is ... that MPU do (sic) not relish being forced to more putthru at expense of member's global interests.” (“Putthru" is jargon for oil to be delivered by way of the proposed pipeline.)
Similar forebodings following the big strike on Alaska's North Slope prompted California Standard's economic department to draw up an illustrative model of "what might occur" to "accommodate" Arctic oil by 1973. The possibilities, as outlined in a paper dated August 1968, included reducing total oil production in California by 70,000 barrels a day and cutting U.S. imports from Canada by 50,000 barrels a day.
A THREAT IN AFRICA The economists warned that "absorbing this production will require many difficult decisions," not only by companies having big stakes on the North Slope but by "all of the industry. However, there is the opportunity and time for the many adjustments to be made...."
Production from Africa, especially Libya, posed a more immediate threat to stable oil prices. According to the Socal forecast of December 1968, production in Libya could rise from 2,591,000 barrels a day in 1968 to an "indicated" 3,555,000 barrels a day in 1969, mostly because smaller U.S. firms had gained a foothold and were pumping without restraint.
“The problem of accommodating a large potential surplus of crude in 1969 and over the five years to 1973 became very apparent when we tabled our estimates, allowing for production in many countries at indicated availability,” the economists advised Socal's management. “If production grew at indicated avail.