204. Information Memorandum From the Assistant Secretary of State for Economic and Business Affairs (Armstrong) to Acting Secretary of State Rush1

Middle East Oil Nationalization Trends, Their Context and USG Responses

The Problem

An acceleration is underway in the trend toward producer governments’ control of their oil production levels and sales. This threatens to shatter the hopes of the international oil companies and of oil consuming countries that such majority control would be assumed in a gradual and orderly manner. In addition, the crude oil price arrangements, negotiated between OPEC and the companies in Tehran in 1971,2 will be reopened this year rather than in 1975 as originally scheduled. Finally the prospect grows that Saudi Arabia will not expand its output at the rates called for by the world’s demand curves.

The recent Libyan seizures of 51 percent of the production of foreign (mostly U.S.) companies operating in its territory, while being discounted somewhat by the resistance of the major companies, are leading the trend to greater producer country control. The more moderate producers in the Persian Gulf become very uncomfortable when the radical Libyans get out in front of them, especially when they feel that the tight supply situation will allow the Libyans to succeed.

It is Kuwait, however, that can upset the Persian Gulf participation accords most quickly. Its National Assembly, an important political force in this rare city-state, was unenthusiastic about the 25 percent participation agreement negotiated last year by Yamani, the Saudi Petroleum Minister.3 Ateegi, the Kuwaiti Minister of Finance and Oil, told our Ambassador last week that Kuwait will ask Gulf and BP for 100 percent control of production in return for compensation at net book value, guaranteed supplies to present customers and crude at discounted [Page 556]prices to the two companies. We had understood that these companies and Yamani were interpreting Kuwait’s desires as 51 percent control and some cosmetic Kuwaitization of the agreement respectively. The reasoning behind the Kuwaiti move appears to be that operation of Kuwait’s fields, unlike Saudi Arabia’s, is relatively simple and there is likewise no requirement for investment in exploration and expansion since production is being held constant at 3 million barrels per day (b/d). So Kuwait should be able to go now to the Iranian complete control formula with Gulf and BP becoming service contractors in production and marketing. Gulf tells us that it is as vulnerable and dependent as the independents were in Libya—i.e., its one-half share of Kuwait production, 1.5 million b/d, represents 60 percent of its 2.5 million b/d total oil output worldwide. Should Kuwait gain 51 to 100 percent control, there will undoubtedly be matching changes in the participation agreements of Saudi Arabia, the smaller Gulf states, Libya and Nigeria. A discussion today with Gulf’s President reveals that talks between the companies and Ateegi have been underway since late July, with the latter holding out for 100 percent, etc., as indicated above. Ateegi has said that January 1 is his deadline, with a first company proposal to be on the bargaining table by November 1. Gulf is giving serious consideration to the implications of going to the recent Iranian type settlement—i.e., 100 percent production ownership to Kuwait in return for long-term crude purchase arrangements.4

There are two related developments that compound the problem faced by the oil companies and their customers alike. Yamani told our Embassy recently that the Tehran agreement is “either dead or dying” and must be revised to (1) include a sizeable increase in posted prices and a mechanism to keep these above realized (market) prices and (2) provide for a more realistic inflation rate factor. He is dissatisfied with the fact that he can sell the small portion of his 25 percent share of production that he markets directly at between 50 and 60 cents a barrel more than ARAMCO pays in buying back the majority of his share under terms of the participation agreement. Renegotiation of this is already underway. The OPEC meetings of September 15 and 16 focused on getting underway renegotiation of the current 2.5 percent inflation [Page 557]escalator to bring it close to the actual annual rate of inflation of 8 percent. Of more concern to the U.S. and other consumers, however, is the grim prospect that Saudi Arabia’s own political-economic national interests and not the demands of world consumers may increasingly govern the rate of growth of Saudi oil production. While a decision appears several months away, the matter is of current central concern to King Faisal and his government.

The Context

Before considering our responses to the problem, it would be well to focus on the context in which the problem arises. This is necessary if we are to have the right perspective and the degree of realism required to judge our alternatives.

The developments described above are not new; they are very much connected with a past that reaches back to the Mossadegh nationalization effort. Throughout the 1950s and 1960s the oil producer governments (in the Middle East and elsewhere—e.g., Venezuela) harbored the desire to control their prime, and often only, foreign exchange earning resource. But, the buyer’s market that prevailed over those two decades effectively prevented achievement of these national desires. It even stymied OPEC, which had been created at the beginning of the 60s to reverse the decline in crude oil prices. With the advent of the 70s, this situation has been quickly reversed by the peaking out and decline of U.S. domestic production and the consequent strong addition of our large and growing demand, to likewise burgeoning world demand, on a limited number of oil exporters, without surplus supplies but with ample financial reserves. It is on the basis of an all pervasive seller’s market that these exporter governments are now making their national desires effective.

These few major oil exporters see their opportunities in the possession of today’s key energy resource. They want to make the most of it. As a number of their officials have expressed it, the availability of adequate supplies to the consumers must be related (1) to equating the price of oil to the prices of the food and finished goods required by the exporters’ economies and (2) to the relative advantages of acquiring surplus funds for accelerated development at home and investment abroad against allowing more of the oil to appreciate in the ground. There is general concern among them regarding the worldwide price spiral and its depreciating effects on their earnings from oil. Therefore, they all want something more than top prices for their oil—i.e., the technology, organizational knowhow, markets and cooperation that only the developed consumers can provide to rapidly develop their national economies and their assets abroad. All this is enveloped in a feeling that it is only just and right that they get back from those who have exploited their weaknesses over the past years. There are also [Page 558]serious complicating factors, such as past concession agreements with and the producers’ need of the international oil companies and the major foreign relations problem of the Arab producers—i.e., Israel and its relationship with the U.S.

The major consumers of Western Europe and Japan have all along been heavily dependent on oil imports, especially from the Persian Gulf area. The difference these days is the added weight of our demand on the same limited supplies on which they draw. They are less secure than in the previous two decades when they could anticipate our supplies in times of emergency. With the possible exception of the U.K., they are more interested in establishing new energy policies and structures that will mesh with the desires of the producers than with protecting the positions of the international oil companies. Because of concerns over the adverse effects of unrestrained competition for limited amounts of oil, they do desire to cooperate with us in ways that are likely to be constructive and effective.

As for the U.S., two of its major strengths of the past are now gone—i.e., shut-in domestic oil production and a strong, relatively un-challenged international economic position.

Responses

All of the evidence available to us indicates we are witnessing the end of an era during which a few very large international oil companies managed the growth of the oil production, processing and marketing that allowed for the great world economic growth of the post-war years. How our country responds to this will have far reaching consequences that go beyond simply the supply of oil.

It is perhaps easier to indicate how not to respond than vice versa. We can make strong statements with emotional words impugning the motives of the oil exporters. These may have some domestic value, but they produce nothing constructive in our relations with the realists that govern the major importing and exporting countries. We can press for national embargoes against oil purchases from expropriated properties and for the formation of a counteracting organization of oil importing countries, but, given the established fact of a tight seller’s market in the hands of a few well-heeled exporters, such proposals will be considered dangerous and harmful to their interests by our consumer allies. There would be no support from them, or from many here at home, for any military action on our part, which would also undoubtedly result in extensive sabotage cutting the world’s oil supplies drastically for a considerable time period, with consequent significant damage and hardship to the economies and peoples of the world.

In these circumstances, we also find that our strong negative responses to nationalization, dependent as they are on our ability to hold up financing for development, are less than meaningful with governments [Page 559]whose problem is how to usefully dispose of all the money they already have. Also the legal aspects of these oil nationalizations are none too clear. There is considerable doubt in Europe that courts will sustain efforts to block the purchases of hot oil. The complexities of international oil company accounting and marketing and the differences between concessions can raise real questions of interpreting what is prompt, adequate and effective compensation. These limitations do not mean, however, that we should discontinue our practice of protesting uncompensated or otherwise “illegal” nationalizations publicly and by diplomatic note and of supporting through diplomatic representations, as appropriate, the legal efforts of our companies. We should continue to go on record and seek to use our persuasion in ways that will not be counter productive, even though we recognize the limits of their likely effectiveness.

To get at the problem raised by the changing oil situation, it is necessary to search for and achieve meaningful cooperation on the multilateral and bilateral levels with consumers and producers. This is our mandate from the President’s energy policy messages of recent months. And we are currently engaged in activities to further this mandate.

On the consuming country side we are members of a working party of the OECD that is seeking to determine the prospects and limits of an arrangement between Europe, Japan and the U.S. to share oil in times of critical supply conditions. All the governments concerned say they want to see this accomplished. If this can be done prior to a number of these governments determining, perhaps in early 1974, that their national security interests cannot wait and they must make the best bilateral accommodations they can with the producers, then we could establish a basis for orderly accommodation to and resolution of the tight and changing energy situation of the current decade. The working party is at a critical juncture in its work and requires, within the next two to three weeks, an effort on our government’s part to seek a compromise between the U.S. position of sharing based on losses suffered in overseas oil trade and the Japanese approach based on the effects of the oil shortfalls on total energy consumption. The Japanese have told us they want this matter included in bilateral energy talks at the Under Secretary level which they hope will take place soon. Any other effective multilateral and bilateral consumer country cooperation to keep the energy problem from becoming a divisive, disruptive element is dependent on our success in finding an agreed way to equitably share our oil shortages. This has a direct bearing on our efforts to gain some moderating control over the nationalization trend.

On the producer government side there are also useful responses to be made and work is underway on some of them. For several months now a sub-group of the NSC chaired Committee on the International Aspects of the Energy Problem has been engaged in the paper work for a proposed U.S. economic mission to Saudi Arabia. The purpose of [Page 560]this mission would be to encourage expanded Saudi oil production in exchange for U.S. assistance in economic and industrial development and in foreign investments. An NSC study is underway of possible approaches to cooperation with oil producer countries, following-up on the SRG consideration of NSSM 174—National Security and the U.S. Energy Policy.5 While we need to move forward with more dispatch in the area of bilateral relations with the major exporting producers, especially Saudi Arabia, we must consider the following with care. Neither we nor Israel can escape from the changing circumstances. Any proposals we make must recognize the new realities of producers’ strength in a seller’s market and their national self-interests in decision-making on production and marketing. These proposals must also reckon with likely opposition at home to the exportation of jobs, increased importation of sensitive foreign manufactures and expanded foreign ownership in important areas of our economy that will be inherent in many ideas for the industrial development and foreign investments of oil producer countries. Moreover, we must be aware that offers of special security or economic relations with the U.S. are double-edged swords to the Arabs. Iraq and the Baghdad Pact6 are still part of the memory of Arab leaders.

As for Kuwait, at an appropriate time when we are more sure of the substance of the participation renegotiations between Gulf and BP and the Kuwaiti Government, we could seek to persuade the Kuwaitis, through representations, that their larger national interests require that they take into account the mutual interests of consuming and producing countries in orderly change of the structure of the vital international oil market. We have no particular leverage on the Kuwaitis in terms of close past relations (the British are strongest here) or in the economic and financial spheres. In these circumstances and others described previously, we must exercise care not to take a stand on the private property ownership and compensation aspects of the problem that will be seen by one and all to be untenable.

Although they will not produce meaningful new supplies in less than five years or help us meet ownership and compensation problems such as are in the making in Kuwait, our efforts at consumer and producer cooperation will be greatly strengthened by the degree to which we are able to implement our domestic program for increasing U.S. oil, gas, coal and nuclear energy supplies and for reducing energy demand through conservation and more effective conversion. There would be substantial psychological gains from clear evidence of a sense of purpose and direction on the part of the American people. Therefore, the Department has a great [Page 561]interest in the success of the domestic program and should follow it more closely. This will depend on more open and regular functioning of the Oil Policy Committee than has been the case in past months. With the chairmanship of this committee moving from Treasury to Interior we can seek to return to a larger role in its deliberations.

  1. Source: National Archives, RG 59, Central Files 1970–73, PET 15–2 NEAR E. Secret; Exdis. Drafted by Bennsky and concurred in by NEA/ARP, AF/N, L, EB/OIA, EB/ORF, and S/PC. A copy was sent to Casey. Rush asked for this analysis in a September 12 memorandum to Armstrong. He based his request on the information contained in telegram 3270 from Kuwait, September 10, which he attached. The telegram relayed the views of Atiqi that Kuwait would ask for 100 percent participation and offer compensation at net book value. (Ibid.)
  2. See Document 86.
  3. See Document 141.
  4. In telegram 3371 from Kuwait, September 17, Stoltzfus wrote that Kuwait was mindful of its role in international oil and would “ask for” not “demand” 100 percent participation. (National Archives, Nixon Presidential Materials, NSC Files, Box 620, Country Files, Middle East, Kuwait, Vol. I) Bennsky subsequently noted that reports from Kuwait indicated that Atiqi had pulled back from his “strong demands” because Faisal and Yamani had prevailed on the Sheikh and Atiqi “to not upset the applecart” in the Gulf, “at least not so soon.” (Memorandum of conversation, September 17; ibid., RG 59, Central Files 1970–73, PET 15–2 KUW)
  5. See Document 194.
  6. The Baghdad Pact was formed in 1955, composed of Iraq, Turkey, Pakistan, Iran, and the United Kingdom. The United States joined in 1958, and Iraq withdrew in 1959. After the Iraqi withdrawal, the Baghdad Pact was reformed as CENTO.