Foreign Relations of the United States, 1952–1954, The Near and Middle East, Volume IX, Part 1

880.2553/12–1752: Despatch

No. 273
The Petroleum Attaché in the United Kingdom (Moline) to the Department of State

confidential
No. 2872

London, December 17, 1952.

Subject:

• Middle East Pipeline Conventions

Introduction:

The question of payments to governments of countries crossed by oil pipelines has recently become active in the Middle East with Lebanon’s refusal to ratify its May 1952 agreement with the Iraq Petroleum Company and with Lebanon and Syria both indicating the belief that they are entitled to higher pipeline payments than they would get from agreements of the most recent type. Their requests variously put and variously interpreted appear to be aimed at obtaining a share of the “profits” from the pipeline equal to the share obtained by IPC.

The fact that “profits” are undefined and exceedingly difficult to define has not hindered the requests. Neither have demands for some sort of 50–50 division been precluded by the fact that agreements with Tapline have been recently concluded on a different basis and that Lebanon concluded an agreement, still unratified, only last May, with IPC on a fixed fee basis. On the contrary, both Syria and Lebanon indicate their intention to denouce the Tapline agreements.

Tapline has said it will not countenance a reopening of its recently concluded pipeline agreements. IPC too has firmly resisted Syrian demands for pipeline payments on a 50–50 profit sharing basis. The IPC has contended for reasons indicated below that the 50–50 principle for pipelines is unsound, unworkable and unjustified.

Originally the company believed that it could with a show of firmness settle with Syria on the same basis as Tapline had done, making due allowance for the greater IPC mileage in Syria and the loading port at Banias. One senior IPC official has recently said that no agreement on a fixed fee basis can be reached. Other sources say that IPC is already considering some alternative approach, apparently based on the pipeline tariff approach with taxation of profits on a nondiscriminatory rate.

Whether or not the present negotiation can be settled on the fixed fee basis, which has hitherto applied in the Middle East, it does not seem likely to hold for long unless the fee can be given status as an equitable one or contracts establishing such fees can be given a sanctity which oil contracts have not enjoyed recently in the Middle East. Eventually, if not in the present negotiations, some new approach to transit payments seems likely to be needed. The United States and United Kingdom Governments must concern themselves with the problem in order to insure, if possible, equitable arrangements conducive to stability in the area and meriting governmental support which they should have.

What are the alternatives? They seem to be the fixed fee, the 50–50 sharing of profits however calculated and the pipeline tariff approach.

Objectives:

In trying to decide on the appropriate course in the event that the present discussions become deadlocked or future controversy develops, the guide lines for reaching the decision should be the objectives we seek to attain in the Middle East.

The basic objective is the promotion of stability in the Middle East, based on its economic well being, which will guarantee both the security of Western oil interests and the furtherance of Western security objectives in the region.

In the narrow sphere of petroleum developments, we should be seeking agreement among the interested parties on rules for oil operations in the area which will be generally regarded as equitable. Such rules and the financial interpretation of them should result in less controversy and more local income. Also, they should provide both standards for judging disputes which may arise and a basis for world understanding of the Western position if any major disagreement should develop. To further the economic well-being of the area and the stability and security we seek, it would be desirable for income from oil operations in the Middle East to be spread as widely as can be reasonably and economically justified. If by application of different standards or a change in practice, or the choice of one course rather than another, more of the profitability of oil production and sale can be attached to transport, refining and distribution and less to production, it would seem desirable that such a course be followed. Particularly is this so when the costs of tankers, pipelines, storage, refineries, etc., seem certain to be far greater for handling additional increments of Middle East oil than the costs of bringing such increments to the well head.

Pros and Cons of Various Alternatives:

It should be clear at the outset that the IPC is not trying to be niggardly in its fixed fee approach. It is apparently prepared to make fairly substantial payments. It is probably also true that governments which talk 50–50 are more interested in the money than in the principle.

Fixed Fee: The chief argument for the fixed fee is that agreements on this line are not only usual in the Middle East, but they have also been concluded very recently on such lines. To move to a new system would almost certainly unsettle the Tapline agreements with the various countries through which Tapline passes and would therefore still further undermine the much abused sanctity of contract principle.

A strong argument can be made also that the transit rates granted to a country are only rental fees for use of a small amount of land which in most instances is of limited value for other purposes. Since the line does not take anything from the resources of the country in the same manner as the export of a country’s oil, there is no justification for the 50% sharing of profits comparable to the case of the producing country whose natural wealth is being permanently removed. Moreover, construction of the line will have contributed employment opportunities to the country during the building and frequently some employment opportunities in connection with pumping stations when the line is complete.

Another significant advantage of the fixed fee is that there is only one main item about which to argue with a country—namely, the size of the fixed fee. In the other alternatives several elements of the necessary formula can be subject to the kind of attack levied against the single item in the fixed fee arrangement whenever any excuse is wanted for reopening negotiations.

On the other hand, there are evident disadvantages with the fixed fee. They are almost exactly the reverse of the arguments for it.

The most important disadvantage is that there is no evident equity in a fixed fee, however fair it may be. There is no obvious reason why one particular fee per ton is any more just or reasonable than any other fee. Consequently, the fee is subject to challenge each time there is pressure for more income. There is no limit to the sum which might be demanded.

Insistence on a fixed fee settlement seems likely to lead to prolonged controversy, perhaps resulting in a stoppage of oil to the major disadvantage of Western interests in Iraq and elsewhere.

A 50–50 Formula: Of the three alternatives mentioned herein, this one has the greatest initial appeal to the countries. Without being sure of what it is they are talking about, the concept of 50–50 seems to have fired the local imagination subject, of course, to the qualification that 50–50 is understood to mean a fairly substantial return. That this principle has some degree of acceptance is evidenced by the request for settlement on these lines.

It should be possible also to devise a formula based on Tapline and the alternative tanker transport which would have a superficial appearance at least of reasonableness and which should not be markedly out of line with the present scale of payments if the charges for amortization are substantial.

This type of formula should not penalize the producing countries of Saudi Arabia and Iraq unduly since both countries have a substantial amount of pipeline mileage within their borders on which they would presumably be getting a 50–50 division.

Already there is some precedent for a 50–50 division of rates on pipeline operation in the Middle East in that the value of Iraq crude for the purposes of a 50–50 division of profits is calculated at the Syrian border on the basis of a formula which related the prices of oil in the Persian Gulf and the Mediterranean to the mileage of a theoretical pipeline between the two points. Though it was not intended to regard this Iraq-Syrian border price as a distinct price from that on oil at the well head, still it is an easy calculation to push the price back to well head by reference to the same figure per mile used in the calculation of the border price. As a matter of fact, the establisment of the border price appears to have overlooked the fact of the rapid amortization of the investment in Iraq pipelines and to have given Iraq a very much larger return on the transport element in Iraq oil at the border than would have derived from the more conservative calculations which would seem to be justified.

The questions of a different price at the first main gathering station and at the Saudi Arab-Jordan border is still unresolved. If agreement is reached on two different values at these points, further support would be given to the thesis that value is being assigned by virtue of transport, and that profits accruing in such a transaction are in fact being divided on a 50–50 basis.

The disadvantages of the 50–50 principle are two in particular. First of all, no one knows what 50–50 means for pipelines. The calculation of a formula would almost certainly be an artificial though rationalized one in which all of the elements would be subject to debate and only the posted prices in the Persian Gulf and the Eastern Mediterranean would have any degree of acceptability. It is possible, moreover, to foresee a situation in which oil from the Persian Gulf and the Eastern Mediterranean would have any degree of acceptability. It is possible, moreover, to foresee a situation in which oil from the Persian Gulf moving by tanker will go entirely east of Suez in a region where competition from other crude oil will be exceedingly limited and where its price may not have to reflect to the same degree as in the regional west of Suez the pressure of other crude oil supplies. In this situation the Persian Gulf price for east of Suez destinations might in theory be equal to or greater than prices in the Eastern Mediterranean for European destinations. In the present price relationships it is said to be 21 cents per barrel cheaper to move oil by tanker from the Persian Gulf to the Eastern Mediterranean than by Tapline, charging 66 cents per barrel. What in these circumstances is the profit on Tapline? And in any circumstances, is it not likely that oil companies will turn to use of tankers where possible if in the alternative case profits must be shared on a 50–50 basis?

The question of an appropriate tanker rate for comparison with an appropriate range of pipeline charges would also be subject to criticism and debate by the governments of countries through which the pipelines would pass. In the case of IPC in particular there would probably be reluctance on the part of governments to accept the notion of a difference between pipeline and tanker costs setting the measure of the savings to be divided when there was no room for use of a tanker in moving most of Iraqs oil.

Another feature of 50–50 which causes major concern is the fact that the limits of this principle are not foreseen. Is it intended to apply to loading, refining, storage and retail distribution? Should it be applied in reverse to reduce Suez Canal tolls? Even more disturbing is the fact that there has as yet been no United States decision as to whether tax credit can be obtained for foreign tax payments under 50–50 agreements. Should there be a negative decision, the effect on the availability of capital for oil developments abroad could be seriously unfavorable.

Pipeline Tariff: This alternative has not yet been tried in the Middle East. It would seem to have several advantages. The chief one is that it is defensible and possibly saleable on a principle and formula basis. In addition, it is in use elsewhere. In the United States where pipelines are common carriers and where there are examples of lines crossing state and national boundaries, useful illustrations of the principle are exemplified. Even better examples might be found in Venezuela and Colombia.

This principle, once its elements were accepted, i.e., rate of recovery of investment, rate of return on investment, costs of operations, etc., could provide bench marks less open to debate than formulae depending on the price of oil, representativeness of tanker rates and other elements of 50–50. Returns under it should be more stable than under formulae tied to oil and tanker markets.

The principle could, if desired, be given a 50–50 appearance, perhaps under a different name, if it were decided to relate the companies’ return on investment to the countries’ take from a small fixed fee for right of way and a non-discriminatory income tax.

The chief difficulty with the proposal is that the return to governments is probably closer to the fixed fees which have been offered than the sums deriving from their concept of 50–50 “profit” sharing.

Another difficulty is that a proper tariff ought to be on a ton-mile or similar basis. Since Lebanon’s 30 miles of line is as essential to ultimate delivery of the oil as Syria’s 200 or 300 miles, the former may believe that its advantage lies in pushing for a different solution than pipeline tariff.

Conclusion:

In considering the foregoing, it seems that the proper course of action would be to settle for the time being on a fixed fee basis provided agreement can be reached quickly and without bitterness on this basis, and also without prejudice to eventual settlement on a basis more likely to last.

Any time bought in this fashion should be used to refine the argument for a 50–50 profit sharing basis if there is an argument to be made or alternatively to marshal the arguments against it. It should also be used to decide on the appropriate elements of a pipeline tariff approach which seems by far the best one to take.

In any solution there are very real difficulties not the least of which is the proration of the return on any line among the countries through which it passes and among the companies concerned. Whether a solution will be accepted and whether it will hold firm will depend to a large degree on its evident justice and the willingness of the United States and United Kingdom Governments to give it publicity and support.

Considering the importance of the stakes in the Middle East, the United States Government should not hang back from taking an active interest in the problem of stable oil arrangements in the area. If it is to have responsibility for supporting the United States companies in their oil dealings in the Middle East (and it both has and should make evident its acceptance of this responsibility), it has the corollary responsibility of making as certain as possible that it is supporting a justifiable position, which it should therefore seek to influence.

In the present pipeline case it is recommended that agreement be sought with American companies on a pipeline tariff proposal designed to recover a pipeline investment, possibly on a replacement basis, within a reasonably short time and with interest on investment after costs of operation equal to the government’s income from a small fixed fee and a non-discriminatory tax. Thereafter through American companies and the British Government, the agreement of interested British companies should also be sought. Finally, and assuming the necessary company and British Government agreement, the Unites States Government should lend its active support to obtaining the agreement of Middle East Governments to the suggested proposal and to insuring their continued adherence to the agreement within its terms.

It is recognized that no arrangement can be guaranteed as a stable one. Dressing them up as principles doesn’t help at all in the view of the Gulbenkian interests in IPC. Perhaps equal sharing of income will hold only as long as new ways can be found to redefine the agreements to give more and more to Governments. The alternative of working without standards or bench marks seems certain to be unstable. With United States and United Kingdom Government support of positions based on principles they have approved, it may be possible to give them stability. It is worth an intensive try.

Edwin G. Moline