Before the arrival of the Russians, petroleum extraction was very primitive. For centuries indigenous petroleum traders had to extract the petroleum with rags and buckets. By using hand labor they were able to increase the depth of some of the pits but it was all quite unsophisticated. When the Russians came, they were able to improve the technology somewhat and production increased accordingly. In 1848 a Russian, A. F. Semenov, drilled the first relatively deep well, but even then the well was only sixty to ninety feet deep.5
In 1821, after their reconquest of the area, the Russians set up a special franchising system for those who wanted to produce and sell petroleum. Given how few hours of light there are in St. Petersburg during the winter, by 1862 there was a good market in the north for kerosene made from Baku’s petroleum.6 The rights to drill and pump petroleum on a specific site were extended on a monopoly basis by the state for four-year periods.7 However, the lease could be revoked at the end of that time and there were no options for renewal. This deterred some investors and precluded more serious exploration and drilling activity, causing the leaseholders to extract as much as they could during the four years of their lease with little or no thought about maximizing the long-run output of the area. This system prevailed until January 1873 when a more efficient public auction system was introduced.8 As Table Intro.1 indicates, the changes facilitated a sharp increase in production. Although it was small to begin with, production doubled that year. The discovery of Baku’s first gusher in June 1873 facilitated this growth.9
COMPETITION FOR MARKETS
These developments in turn attracted other prospectors, especially foreigners like the Swede Robert Nobel. Nobel arrived in Baku in March 1873 and soon came to exercise enormous influence in the area, not only as a producer but also as a refiner and marketer.10 By 1883 production exceeded 1 million tons; by 1887 it exceeded 2 million tons (50 million tons equals approximately 1 million barrels a day). Equally significant, in 1877 and again in 1882, 1885, and 1891, strong and increasingly effective tariffs were passed that helped to curb Russian imports of American kerosene.11
However, it took more than tariffs to stem the flow. Russia had become an early battleground for oil producers seeking to carve out exclusive markets for themselves. John D. Rockefeller and his Standard Oil of the United States, as the world’s largest producer, had taken over a dominant share of the Russian market. Eventually high tariffs on imported oil made it less attractive to import, but before Standard Oil and its U.S. petroleum could be pushed out of the Russian market, the Nobels—Robert and his brother Ludwig— had to find some way to facilitate the shipment of their petroleum and kerosene from Baku to the urban centers of Moscow and St. Petersburg. Just as during the Crimean War it was easier to move troops from Paris and London to the Crimea than from St. Petersburg and Moscow, so it was easier to move kerosene from the United States to St. Petersburg than it was from Baku. Seeking a way to facilitate the flow of Russian oil to the north, in 1878 Ludwig, designed a pipeline to carry crude oil from the well to their refinery and then on to the Caspian Sea. To carry large enough quantities across the Caspian Sea to make the venture profitable, he also conceived of and constructed the first oil tanker, the Zoroaster.12 His tankers docked at Astrakhan, where the oil was transferred to barges that then moved up the Volga. A storage depot was established in Tsaritsyn (later to become Stalingrad and now Volgograd) where by 1881 the petroleum could be reloaded onto railroad cars, a convenience that was particularly important in the winter when the Upper Volga was frozen. One result of Nobel’s innovation and the government’s higher tariffs was the all but complete halt of kerosene imports from the United States. Imports, which were 4,400 tons in 1884, fell to 1,130 tons in 1885 and to an almost unnoticeable 22 tons in 189613—one loss (temporarily) for the Rockefellers.
The cultivation of domestic markets was followed by an effort to expand foreign markets. For obvious geographical reasons, Persia had always been a major consumer of Baku’s oil. For equally obvious geographical reasons—that is, Baku’s location on the essentially landlocked Caspian Sea—it was difficult to supply other regions of the world, including St. Petersburg. Since this was before Stalin came along to build his canal network, the challenge at the time was to break through the barrier of the Caucasus Mountains to gain access to the Black and Mediterranean Seas and thus to the ocean routes beyond.
Only in 1878 when the Russians pushed the Turks out of Batumi on the Black Sea did a new route became a realistic possibility. Shortly thereafter, led by A. A. Bunge and S. S. Palashkovsky, a group of Russian oil producers in the Baku region obtained a franchise to build a railroad over the mountains from Baku through Tbilisi to Batumi. Since they were short of funds, they sought the help of the Nobels. Initially, the Nobels refused, fearing that their dominance of the Baku trade, especially their St. Petersburg markets, would be jeopardized by the additional competition. Not to be denied, Bunge and Palashkovsky turned instead to the French house of Rothschild. Having recently backed a refinery on the Adriatic, the Rothschilds were anxiously searching for a source of crude oil to free themselves from dependence on Rockefeller’s Standard Oil.14 The cork on Russian exports was pulled when that trans-Caucasian railroad was completed in 1883–1884. Table Intro.1 indicates how overall exports increased. Exports from Batumi, which totaled 3,300 tons in 1882, increased to 24,500 tons in 1883 and 65,000 tons in 1884, an amount equal to previous total exports from all Russian ports.15 The flow soon became even greater when a forty-two-mile pipeline replaced the most rugged portion of the railroad route in 1889.16
RUSSIA AS AN OIL EXPORTER
The increased flow of Rothschild’s petroleum from Batumi and Nobel oil via the Volga put competitive pressure on Standard Oil’s markets in England. The era was one of oil abundance, and sellers vied to under-price their competitors. Angry over the threat presented by Russian oil to his English and European markets, Rockefeller and Standard Oil retaliated in what was to become a familiar pattern by cutting prices. For a time this tactic succeeded, but ultimately the Russian producers prevailed and carved out a share of the market for themselves. Whereas the combined Rothschild-Nobel share of the British market amounted to only 2 percent in 1884, by 1888 it had expanded to 30 percent.17 Overall, however, compared to worldwide American exports, Russian exports were relatively more important only in Asia. Thus in 1897, 75 percent of American exports went to Europe and 16 percent to Asia, whereas only 59 percent of Russian exports went to Europe but 38 percent went to Asia.18 The pattern was much the same in 1913.
For almost twenty years the petroleum flowed so readily in the Baku region that there seemed to be no reason to develop new fields or exercise much care in pumping existing fields. The waste was enormous, not to mention hazardous. In what was to become a standard reaction in the years to come, visitors were appalled by the inefficiency, sloppiness, and lack of care exercised by Russian petroleum operators.19
Still, little changed as long as the oil kept flowing. Moreover, the per capita consumption of oil—or more appropriately, petroleum products— was much lower in Russia than it was in other advanced countries in the world. This was due in large part to the lower standard of living at the time in Russia. In the late nineteenth century, for instance, Russian consumption of kerosene per capita was one-half of that in Germany.20 And since domestic productive capacity exceeded domestic petroleum needs, petroleum producers generally sought to divert a portion of their output to foreign markets. For example, during the good production years of 1903 and 1904, the Russian-based producers exported 16 percent of their total production (see Table Intro.1). In 1904 absolute petroleum exports reached their peak of 1.8 million tons. However, because domestic consumption by that time had increased, the relative share of petroleum exports earlier in 1890 and 1892 was actually higher; then 22 percent of all petroleum produced was exported.
Not surprisingly, therefore, Russian petroleum exports often exceeded those of the United States during the late 1890s and the early
twentieth century. And if they were not the largest exporter, the Russians were certainly the second largest. It is difficult to tell precisely which years the Russians out-exported the Americans because the data are incomplete. When export-import data for crude oil are available for comparison, the United States statistics on imports and exports of petroleum products begin only in 1920.21 Net American exports of refined products were high, but oddly enough, American imports of crude oil from 1920 to 1924 were even higher.
Nevertheless, as Table Intro.1 indicates, Russian production exceeded American production from 1898 to 1902, and virtually all of it came from the wells around Baku. In that four-year window, Russia was the largest producer of petroleum in the world. The Middle East was viewed as a barren desert then, and it was not until 1938 that the ARAMCO Consortium discovered oil in Saudi Arabia. The only other oil-producing areas of note at the turn of the century were in the Dutch East Indies and Mexico. Even with that, in 1897 Russia and the United States accounted for about 95 percent of the world’s production.22
PRODUCTION STAGNATION
The high point for Russia was in 1901, when Russian production reached a pre-revolutionary peak of 11.987 million tons. The comparable figure for the United States was 9.468 million tons (see Table Intro.1). But while American production of crude oil reached 12 million tons the following year and continued to climb every year but one until 1924, Russian production did not exceed the 1901 level until 1929. Why did Russian production decline after 1901?
Initially there were rumors that the fields of Baku were running dry. Such rumors were not easily dispelled. Indeed, one early effort to set the record straight was by the noted Russian scientist Dmitry Mendeleyev, who wrote a paper entitled “The supposed exhaustion of the Baku oilfields.”23 Output did decline but not in the country as a whole. The Russians sought to cope with the drop in output in existing wells in a variety of ways. First, as production fell in some of the older Baku fields, prospectors drilled new fields nearby. Second, new deposits outside the Baku region were discovered. Whereas Baku accounted for 96 percent of all Russian production in 1897, by 1910 it made up 85 percent and by 1913 even less.24 New fields that opened up at Grozny in Chechnia, at Emba (300 miles to the north on the northern shore of the Caspian Sea), and at Maikop, only fifty miles from the Black Sea, accounted for most of the difference.
Although there is some reason to believe that the existence and even early production at some of these sites as at Grozny predated the arrival of the Nobels, many of the more important fields were subsequently developed by foreigners like the Nobels, especially with English capital.25 Western assistance also helped improve the technology. Learning how to drill deeper produced the quickest results. The commonly used Russian drilling methods, which often relied on wooden, not metal, tools, made it difficult to go deeper than 300 feet. By the end of the nineteenth century, Nobel and some of the other foreign companies were drilling wells more than 1,800 feet deep. With the help of the American-produced rotary drilling system, by 1909 the wells went as deep as 2,400 feet.26
Yet ultimately the Russians could not prevent a sharp decline in their production and exports. The drop was partly due to the failure of Russian companies to import the necessary technology. In what will turn out to be a recurring pattern, few Russian companies bothered to keep up with the rapidly changing refining and drilling techniques. Russian oil companies also conformed to the period’s dominant international trend: ruthless corporate scheming and bitter rivalries. Inevitably, the jockeying for market share around the world by companies such as Standard Oil and Shell had some impact. Price cutting was a common tactic. As a result, many producers cut back on their operations and occasionally went bankrupt. Recurring depressions had the same winnowing impact. Russian markets were not immune to such rivalry. In 1911 Shell became a major player in the Russian market when it purchased the Rothschild family’s petroleum holdings. Shell entities then produced 20 percent of Russia’s petroleum output, second only to that pumped by the Nobels. Since the revolution and expropriation were only six years away, it was probably one of the smartest sales the Rothschilds ever made. But most deal making of this sort involved financial juggling, not technological innovation, and thus added little to the country’s productive capabilities.
Also hurtful to Russian production was the Czarist government’s decision in 1896 to change the concession system that had governed Russian oil production.27 In an effort to collect more revenue, the government instituted a combined auction royalty system. (It presaged the system that Middle Eastern states would come to use in the 1950s and 1960s.) At the time, however, the royalties demanded by the Czarist government seemed exorbitant, sometimes reaching as high as 40 percent. With the wisdom of hindsight, today that older Russian system looks like a bargain for a foreign investor. But considering that it was roughly seventy-five years before anyone else imposed such seemingly confiscatory terms, concession holders within Russia opposed the change and reduced output.
Most damaging, however, was the growing labor and civil unrest that hit the Batumi and Baku areas. Led in part by Stalin, strikes occurred in the Batumi area as early as 1901–1902.28 They were followed in July 1903 by an oil worker strike in Baku. Interspersed between almost annual strikes in 1904, 1905, and 1907 were the activities of the reactionary Black Hundreds, supporters of the Czar who often resorted to mob action. What the strikers did not pillage or burn, the Black Hundreds did. Nor did the complex racial mix of Tatars, Armenians, Jews, Russians, and Muslim Turks and Persians add to the tranquility of the region once tensions erupted. The climax came during the 1905 Russian Revolution. Two-thirds of all the oil wells were destroyed. As a result, overall production fell by more than 3 million tons and exports were cut in half.29 Whereas Russia produced 31 percent of the world’s petroleum output in 1904, by 1913, due to the labor unrest, Russia’s share had fallen to 9 percent.30 Neither production nor exports were to recover significantly until long after the 1917 Revolution.31
The rather disappointing years of production and export in the decade before the Revolution should not obscure the fact that the petroleum industry in pre-revolutionary Russia had an important role to play (see Table Intro 1). Not only did Russia produce more petroleum than any other country for a short period of time but there were also periods when petroleum contributed in a fairly important way to the country’s export earnings. True, petroleum exports never came close to matching grain export earnings, which accounted for 50 to 70 percent of the country’s export earnings from 1895 to 1914.32 But except for timber, petroleum was often the largest nonagricultural export. In the peak years of 1900 and 1901, petroleum generated 7 percent of Russia’s export earnings, a foretaste of the much greater role petroleum would play after the revolution.
THE REVOLUTION
The 1917 Bolshevik Revolution had an immediate impact on oil production. The unrest caused by the workers’ demands for more control over managerial decision making caused output to fall from 10.8 million tons in 1916 to 8.8 million tons in 1917. In some cases, workers’ committees were formed to superintend management. Naturally this interrupted production. The Bolsheviks declared formal confiscation the following year, on June 6, 1918, officially nationalizing the fields.33 Then production fell to 4.1 million tons.
The path of recovery was erratic because the revolution was followed by a counterrevolution that was supported by various foreign companies. As we saw, one of the more notable aspects of the prerevolutionary period of Russian oil development was the important role played by foreigners. Swedish, French, British, and even American investors and operators devoted large sums of money in an effort to gain control and increase production. With the exception of the Rothschilds who sold out earlier to Shell, the revolution meant a loss for most of them. The decade that followed was marked by the efforts and intrigue of many of the former foreign operators to out-maneuver the newly empowered Bolshevik rulers to regain or repatriate some of their money. Even with the help of for
eign military intervention, most failed, but oil men have always been more venturesome and bigger risk takers than most of us.
The Turkish occupation of Baku in September 1918 provided the opening the old investors had been waiting for. Aware that the Bolsheviks were distracted by unrest in the north, the British sent in an expeditionary military force. It was tasked with helping Azerbaijan prop up its independence, which it had declared in March 1918, and later with insuring that Turkey remove its troops once the Armistice to World War I was declared in November 1918. This was not solely an anti-Bolshevik gesture, but also an anti-Russian step to protect Persia and block Russian access to British India. Much the same type of maneuvering took place after the Second World War, only in the late 1940s the Soviets attempted to reverse the process and extend their influence from Azerbaijan into the northern part of Persia/Iran.
Petrostate:Putin, Power, and the New Russia Page 4
