OPEC should heed lessons from Achnacarry Agreement

Group’s effort to stabilise oil market fails

John Kemp is a Reuters market analyst. The views expressed are his own. — Editor

OPEC members are struggling to protect their revenues in the face of renewed competition from US shale producers and other suppliers outside the organisation.

OPEC’s revenues from petroleum exports have fallen to just $446 billion in 2016 from $1.2 trillion in 2012.

But past experience strongly suggests OPEC’s effort to stabilise oil inventories and prices while protecting its market share will fail.

Since the beginning of the modern petroleum industry, periods of high prices and concern about supplies running out have alternated with episodes of low prices and oversupply.

High prices and concerns about availability normally trigger an exploration boom and rapid innovations in drilling and production technology as well as efforts to use oil more efficiently.

The resulting increase in production and a slowdown in consumption growth creates conditions for a subsequent slump.

The basic narrative has not changed since the first oil well was drilled in 1859, with periods of oversupply (1900s, 1930s, 1950s and 1990s) alternating with panics about shortages (1910s, 1970s, 2000s).

The current oversupply and slump in prices has its roots in the panic about peak oil and soaring prices in the middle of the last decade.

High prices between 2004 and 2014 spurred an exploration boom around the world as well as the widespread deployment of horizontal drilling and hydraulic fracturing techniques in the United States.

At the same time, the cost of oil led to renewed interest among governments, businesses and consumers in greater oil efficiency and alternative energy technologies including renewables and electric vehicles.

The slump which followed was inevitable as were the subsequent calls for more coordination among producers to cut output, reduce excess stocks and boost prices.

Every slump prompts calls for more coordination, restrictions on production and the stabilisation of market shares .

The most notorious was the secret agreement reached between Standard Oil of New Jersey (forerunner of Exxon), Royal Dutch-Shell and the AngloPersian Oil Company (forerunner of BP) in September 1928.

Walter Teagle, president of Standard Oil, John Cadman, chairman of AngloPersian, and Henri Deterding, managing director of Royal Dutch-Shell, met at Deterding’s rented castle in the Highlands of Scotland.

Afterwards, all Teagle would say was that “Sir John Cadman ... and myself were guests of Sir Henri Deterding and Lady Deterding at Achnacarry for the grouse shooting, and while the game was a primary object of the visit, the problem of the world’s petroleum industry naturally came in for a great deal of discussion.”

In fact the three men had reached a secret deal under which they would accept their current share of the oil market and not seek to increase it at the expense of the others.

A draft, which seems to have been adopted without alterations, is reproduced in the official history of BP (“The History of the British Petroleum Company”, Volume 2, Bamberg, 1994).

The Achnacarry Agreement, also called the “As-Is” agreement because its attempted to stabilise the status quo, is worth studying because of the close parallels with the current situation in the oil market.

Fears about shortages during the World War One and subsequent worries about the depletion of US oilfields in the post-war period had caused real oil prices to more than double from $15 per barrel in 1915 to $37 in 1920.

The result was an exploration boom and a subsequent slump in prices, which had fallen to just $19 by 1923, and remained depressed through the rest of the decade, even before the onset of the Great Depression after 1929.

“Since its inception the oil industry has looked forward with apprehension to the gradual depletion and final exhaustion of its supplies of crude oil,” the preamble to the Achnacarry Agreement explained.

“The temporary shortage of supplies that existed in certain countries during the great war further accentuated this fear and caused vast sums of good money to be expended to locate and develop reserves in all parts of the world where petroleum potentialities appeared, as well as accumulating large reserve stocks above ground.”

“Now the situation has changed. An adequate supply for a long time to come is assured. This is the result of the application of science to the petroleum industry.”

“On the other hand, more effective methods of handling crude have been developed so that the yield of gasoline from a given amount of crude has been enormously increased.”

“Methods of consumption are being made more economical; high compression motors are being developed; diesel engines and fuel oil is being is being utilized more efficiently and economically.”

“All these developments will have a marked tendency to slow down the rate of increase in consumption,” the agreement warned.

“Excessive competition” had resulted in tremendous overproduction, as each oil company “has tried to take care of its own over-production and tried to increase its sales at the expense of someone else”.

The result was “destructive rather than constructive competition”. No company could hope to cure its overproduction by increasing its market share when all the others were attempting to do the same.

The rational solution was a marketsharing agreement in which all three companies agreed to accept their share of the current market and a proportionate share of any future growth in oil demand.

As-Is specifically excluded oil production and imports into the United States because any attempt to cartelize the US market was prohibited by US antitrust law.

Standard Oil nonetheless organised the Standard Oil Export Corporation and the US Export Petroleum Association in a bid to control US exports of crude and refined fuels to the rest of the world.

And the three companies sought to formulate guidelines for competition in other countries with the Memorandum for European Markets signed in 1930 and the Heads of Agreement for Distribution signed in 1932.

Ultimately, however, the Achnacarry Agreement was a failure. Part of the reason was the Great Depression, which resulted in a slump in oil demand, just as the oil companies were trying to restrict supply.

But the discovery of the super-giant East Texas field in 1930 sparked an uncontrolled drilling race and a flood of oil onto US domestic markets and into exports.