Oil

by Tom Bower

  Over the following months, Radley and other BP employees relaxed, convinced that there would be no recrimination. Despite the widespread knowledge of their ruse, the CFTC’s officials appeared to have ignored the coverage in the trade newspapers. Seemingly convinced of his immunity, Radley used a PowerPoint presentation to explain BP’s tactics and losses to his superiors at a conference in Britain. Only a year later, after a victim did complain, was a CFTC investigation launched. BP’s position was hopeless. All the traders’ conversations had been recorded, including an exchange in 2003 between Cody Claborn and Dennis Abbott, his superior.

  ABBOTT: How does it feel taking on the whole market, man?

  CLABORN: Whew, it’s pretty big, man.

  ABBOTT: Dude, you’re the entire [expletive deleted] propane market.

  BP argued that the recorded conversations should not be taken at face value, as testosterone-fueled traders habitually speak with bravado. No trader ever loses money on his own — it’s always someone else’s fault. The CFTC’s investigators were unpersuaded. Besides the tape recordings, they had seized incriminating notes and obtained signed confessions. But proving manipulation as opposed to speculation is difficult. The prosecutor needed to prove that the price was artificial; that BP intended to create that artificial price; that BP had the power to dominate the market; and that there was evidence of intention to manipulate. Unusually, in this case all those points were covered by the evidence handed over by BP to the CFTC. Patently, BP’s traders knew their squeeze was illegal. On June 28, 2006, the regulator charged BP with violating the Commodity Exchange Act. The corporation had already agreed to pay $303 million in fines and restitution and submit itself to three years’ supervision. Many propane traders left BP, complaining that the compliance regulations imposed by the CFTC would limit their earnings.

  BP was wounded and embarrassed, but only briefly. Its oil traders remained unaffected. Shortly after the propane settlement, they received advance warning that two major American refineries processing WTI crude — BP’s at Whiting in Indiana and Valero’s at McKee in Texas — were malfunctioning. Once the market heard the news, the demand for WTI from Cushing would fall, bringing down prices. According to Platts, using that unique intelligence BP’s traders had within minutes sold huge stocks of WTI and bought Mars, the sour crude from the Gulf of Mexico that would be refined to compensate for the lack of WTI. “BP made a big killing,” noticed a Platts reporter. BP would deny that scenario. Under its new code, the corporation resiled from profiting from its own misfortunes. An unannounced change occurred. Under permanent US government supervision, BP’s traders had become markedly less aggressive, while Shell’s traders, Platts and Argus reporters noticed, capitalizing on their company’s refineries, were reincarnated as belligerent hawks. Reprimands were swift. Unusually, a Shell trader in London was warned to stop simultaneously trading for Shell and himself on the Platts window. The admonitions had limited effect. Undeterred, Shell’s and BP’s traders and managers hoped to earn a bounty from rising oil prices.

  During 2007, shortages rather than speculation were blamed for the rising prices. In his State of the Union message in January 2007, President Bush urged that Americans should cut gasoline consumption by 20 percent over the next 10 years. His “20/10” message, combined with subsidies to build an additional 70 ethanol factories to promote the switch from gasoline to biofuels, gave credibility to A Crude Awakening: The Oil Crash, an apocalyptic peak-oil documentary film predicting the end of civilization because mankind had used half of the world’s oil reserves.

  To Colin Campbell, the leading “oil peakist,” Bush’s fears were confirmation of his beliefs. His latest prediction for the peak was 2011. Thereafter production, he foretold, would decline steeply, leading to a “world without oil.” Optimists, said Campbell, were being deliberately misled by the oil majors. “Truth is not their game,” he said, referring to BP’s reassurances about sufficient oil for 40 years’ consumption at the current rate. His warnings were supported by recent events. Global warming had previously been disparaged by oil executives, and there had been silence for two years after North Sea oil peaked in 1999. Now, said Campbell, no one admitted the probability of a global recession if oil remained above $100 a barrel. Campbell’s credibility had been reinforced over the previous 18 months by the conversion of some senior oil executives to the oil peakists’ camp.

  Leading that group were the senior executives of Total. French mathematical geologists had become adamant adherents of peak oil. With the state providing generous subsidies for biofuels, the country’s oil executives, tainted by suggestions of chicanery, understood the financial advantages of embracing peak oil. Thierry Desmarest, Total’s chairman, had said in 2006, “The opinion of our geologists is we can go a bit beyond 100 million but not to 120 million.” One year later, he sharply retreated. Oil production, he forecast, would peak in 2020: “This is the great secret everyone knows about and governments are too terrified to discuss because they don’t know what to do and oil companies don’t want to frighten their shareholders.” Christophe de Margerie, Total’s chief executive, spread similar anxiety by preaching that among those who “like to speak clearly, honestly and not… just to please people,” even 100 million barrels a day was falsely “optimistic about geology. Not in terms of reserves, but in terms of how to develop those reserves: how much time it takes, how much realistically do you need.” His opinion was shared by James Mulva, head of ConocoPhillips. “I don’t think we’re going to see the supply going over 100 million barrels a day… where is all that oil going to come from?” Mulva committed his corporation to far higher investment than other oil companies. All three executives, contradicting the IEA’s forecast that production would reach 116 million barrels a day by 2030, dismissed technology’s capacity to produce even an additional 20 million barrels every day. The national oil companies, they believed, were unwilling and unable to allow greater extraction. Rex Tillerson’s criticism of President Nazarbayev for causing delays at Kashagan endorsed their argument. “We’ve invested $17 billion,” said Tillerson, “and haven’t got a drop of oil yet.” He blamed the Kazakh government for having — like the governments of Venezuela, Mexico and Russia — a lack of interest in reinvesting its income in oil production, preferring to spend billions building Astana, a new capital on the barren steppe, employing the British architect Norman Foster to design edifices glorifying Nazarbayev for winning elections with never less than 95 percent of the vote. The oil peakists’ pessimism was welcomed by the anti-American oil producers. In the month of October 2007 oil had passed first $80 and then $90 a barrel. Convinced that the rising prices would be permanent, Colonel Gaddafi of Libya threatened to reduce production, while Hugo Chávez, with Iran’s support, declared open warfare on the oil majors.

  One year earlier, after government agents raided ExxonMobil’s offices in San Ignacio Towers, Caracas, Chávez had ordered the corporation to submit its assets to Venezuelan control by May 1, 2007. ExxonMobil’s development of the Orinoco’s heavy oil was halted. The confiscation was not entirely unexpected. Venezuela’s oil exports to America had been dramatically reduced, not least because the country’s oil production had fallen since Chávez took power in 1999. To aggravate ExxonMobil, Chávez pledged to sell Venezuela’s oil to China, even though the Chinese, having pledged $450 million to Venezuela, would need to build refineries to process Venezuela’s high-sulphur crude. Nevertheless, the combination of the seizure and the threat to switch sales to China, Rex Tillerson knew, was a defining moment. If Chávez was successful, national oil companies in Kazakhstan, Nigeria and other South American countries would also consider partial nationalization. ExxonMobil and ConocoPhillips refused to hand over control of their assets to the confiscatory socialist. “If Chávez wants it,” said an ExxonMobil executive in Caracas, “he’ll have to pay market value and in cash.” ExxonMobil’s assets were worth about $2 billion, and ConocoPhillips’s about $7 billion.

  Disunity among
the oil majors weakened Tillerson’s position. Shell and Chevron, despite the confiscation, agreed to cooperate with Chávez, while the Italian corporation ENI, another victim of confiscation, agreed to develop the Orinoco and other projects confiscated from ExxonMobil, despite lacking the necessary expertise. ExxonMobil appeared wounded after Total agreed to consider taking over its investments in Venezuela. Considering his corporation’s refusal to help others, Tillerson could not complain about disloyalty. Isolated but defiant, ExxonMobil’s lawyers sought court orders to freeze Venezuela’s assets in America, Britain, Holland and the Dutch Antilles. In early 2008, a judge in New York maintained the order over $315 million of Venezuela’s assets, but in London a court ruled that ExxonMobil had failed to overcome legal hurdles, and unfroze Venezuela’s $12 billion worth of assets in Britain.

  “Petro-nationalism” was not new, nor was Chávez’s grandstanding populism in summoning South America’s leaders to an energy summit, but the prospect of a global oil crisis aggravated the dispute. Relishing their power to make more money by producing less, the national oil companies celebrated each cent added to the oil price, calculating the additional billions of dollars deposited in their treasuries. For the Gulf states, where production of a barrel of crude cost $2 in Saudi Arabia and at most $5 elsewhere, the daily windfall was enormous. Since oil had risen above $20, at least an additional $3 trillion had passed from consumers to the producers. The enhancement of the sovereign wealth funds was matched by the decline of the oil majors, although Tillerson’s gesture at the company’s staff Christmas party disguised any hint of shrinkage. The ground floor of the headquarters in Irving was covered with artificial snow, imported reindeer were tethered along the drive and the hospitality was uncommonly generous, reflecting record profits from high prices. Although the corporation’s oil production in the first quarter of 2008 would fall by 5.6 percent, it accumulated $40.9 billion in cash during 2007, after spending $28 billion to buy back shares and distributing $1.9 billion in dividends.

  In Tillerson’s opinion, investment would be more profitable when oil prices inevitably fell. To a lesser degree, his rivals agreed. The oil majors were divided in their response to dictators, but had been united since 1998 about cutting investment. BP had spent $27 billion in 2005 and 2006 buying back shares, Chevron allocated $15 billion in 2007 to buy back shares over the following three years, and Shell, whose production fell by 6 percent in 2007 and was predicted by the company to continue to fall until 2011, spent $8.2 billion buying back shares in 2006. Only ConocoPhillips invested heavily in buying companies to replenish its reserves in compensation for poor discoveries, making itself vulnerable to a takeover if oil prices fell, a scenario Mulva dismissed. The end of 2007 was a brief calm before the storm.

  During the last months of the year, banks in New York, London, Zürich and Frankfurt were reporting difficulties. Terms like “sub-prime” and “credit crunch” were entering the popular lexicon. Most assumed that after the boom, minor banking problems would restrict economic growth, but daily events suggested something worse. Increasing fuel prices, the national producers were warned by the governments in Washington and London, could tip the world into a recession. Since similar warnings had been issued by economists as oil neared the $50 and $100 benchmarks, the message was ignored. A greater fear was that the world would be endangered by disappearing oil supplies. The news that Abu Dhabi, Dubai and Oman were building coal-fired power stations because local natural gas was too expensive and coal was cheaper than crude confirmed the crisis.

  The pessimistic scenario offered by Thierry Desmarest and Christophe de Margerie had been contradicted in September 2007 by Shell’s chairman Jeroen van der Veer. “There’s a lot of psychology in the price,” said van der Veer, finding no real reason for the high prices. Peter Davies, BP’s economist, agreed: “An imminent peak in production has been repeatedly and wrongly predicted… It’s not a resource issue, it’s an investment issue.” Globally in 2007, demand had increased by one million barrels a day, and was predicted to grow by a further 1.4 million barrels a day in 2008. Rex Tillerson, joining the chorus, urged calm: “Sufficient hydrocarbon resources exist to play their role in meeting this growing global demand, if industry is allowed access to them.” At the end of 2007, the oil price fell back to $87, suggesting that the threat of a recession in America had ended the speculative boom.

  In that fractious atmosphere, the Saudi oil minister Ali al-Naimi sought to rebut the predictions of gloom uttered by Total’s executives. “Their skepticism is doing a lot of damage to the stability of the market,” he said. “Only the speculators are being helped.” Saudi Arabia, he insisted, could produce 11.3 million barrels a day, but was only producing nine million. “The demand is not there,” he explained. Over four billion barrels of oil were in storage, more than was exported by the Middle East in six months. Nevertheless, to prove OPEC’s sincerity, the Kingdom had invested $80 billion to increase output by 2009 to 12.5 million barrels a day. Other OPEC countries had also committed $40 billion to expand production. The unmentioned impediment was the bottlenecks among the world’s refineries, constrained by new environmental regulations, which impeded their ability to process Saudi sour crude, especially to manufacture diesel. Underlying al-Naimi’s exhortation was the truism that in the long term, OPEC and the oil producers were more dependent on consumers than the opposite. If OPEC restricted oil production, the West would find alternative sources of energy — nuclear, renewables and coal — and use it more efficiently. History had shown that the oil weapon was a blunt instrument with a limited life. Political manipulation of oil markets by producers and consumers had endured only for a short term.

  Ali al-Naimi was not believed. Although Saudi Arabia refused to join Chávez in sabotaging America’s economy, the IEA warned about an imminent “supply crunch.” In the marketplace, anxieties about Saudi Arabia’s restricted production were translated into an inevitable crisis. OPEC’s supplies were stagnating, and output in Iraq and Venezuela was falling. Suspicions caused by OPEC’s lack of transparency further excited volatility. In Congress, politicians urged the US administration to prosecute the OPEC countries for membership in a price-fixing cartel; legislation had been passed to remove those countries’ sovereign immunity. Bush had opposed that law, a toothless piece of showboating, but could not ignore the new warning of Jeroen van der Veer. At the beginning of 2008, Shell’s chairman somersaulted. Nations, he conceded to his staff, would “scramble” to secure oil and gas once demand outstripped supply by 2015. Predictions of shortages inspired Bush to telephone King Abdullah, asking for more supplies and price cuts. He was rebuffed. The king told him there was no shortage of sour crude. “We are idling at around nine million barrels,” said al-Naimi. There would be no increase once capacity hit 12.5 million barrels in 2009. By May, prices had reached $130 a barrel. “We’re running out of oil,” claimed the oil peakists. The chorus of disaster delighted the traders and refiners. Expecting prices to rise further, the traders bet long, while refiners like Valero, with inventories at a nine-year high, bought extra storage capacity, betting on uncertainty and the churn of contracts in the markets. Few believed a BP spokesman’s comment that speculators were not dictating price movements but had “just jumped on for the ride.”

  The mood ignored the facts. As the oil price rose, consumption in the Western world was falling. The fundamentals of supply and demand could not permanently support record high prices, and if the price increases were remorseless, the cost of processing “unconventional” tar sands into gasoline became realistic, undermining the peak oil case. High crude prices, however, were hitting profits. Refineries were earning less from their products, the cost of rigs and personnel was rising, and the taxes demanded by the producer nations soared. Rex Tillerson tried to talk prices down. “One trillion barrels of oil have been produced,” he said, “and over 15 trillion barrels of energy remains.” More conservatively, the energy consulting group CERA estimated that four trillion barrels
of proven reserves existed; by including oil shale, tar sands and bitumen, that figure was increased to at least seven trillion barrels. A new CERA study by Peter Jackson of 811 oilfields, producing 19 billion barrels a year out of the world’s total of 32 billion, showed that the 4.5 percent depletion was just half the rate previously assumed by the industry. “There is no technical evidence that Ghawar is about to decline,” Jackson asserted. By 2017, global production could easily reach 100 million barrels a day, agreed Peter Davies of BP. Demand rather than supply would peak.