Today's international petroleum industry is radically different from what it was in the 1970s. Yet it remains as highly politicized as it was in the heyday of resource nationalism two decades ago, when oil occupied the attention of Western governments and the press. Those concerned about oil have dwindled in number, save for the oil exporters who recently had to bear an extraordinary burden of adjustment when petroleum prices collapsed after January 1997. Even so, petroleum issues remain significant in a wider political setting. Less than a decade ago, the United Nations, under U.S. leadership, fought a modern war over petroleum after Iraq seized Kuwait and its oil resources. More recently, the United States has been brandishing the oil weapon through its sanctions policy, conducting the very policy that it fought against a quarter of a century ago.
Since the collapse of the Soviet Union and the end of the Cold War, a new political economy of oil has been evolving. It is characterized by open access to resources not only in the Persian Gulf, where most of the world's oil is located, but elsewhere in the world as well--especially the Caspian Sea basin. This new era is also marked by dramatically improved technology and a shift from government control to government and industry cooperation. Despite the differences between oil politics today and those of yesteryear, however, there remain important continuities between the two eras. This essay will examine the foundations of this new political economy of oil and the forces that will shape a new paradigm for the next century.
THE STRUCTURE OF THE OIL INDUSTRY
Petroleum has proven to be the most versatile fuel source ever discovered, situated at the core of the modern industrial economy.(1) It is the most widely used source of energy, constituting 45 percent of all energy use in the last five years.(2) Despite competition from gas and nuclear energy, it has maintained its prominence largely because it is the only energy source that can be used across the board--in space heating, as an industrial fuel supply and as a means to generate electricity--and because it continues to be unrivaled in the transportation sector. Petroleum remains abundant, inexpensive and more readily and cheaply transported across long distances than any of its competitors.
The industry is divided into two sectors: the upstream and the downstream.(3) The upstream sector involves the marshaling of capital and technology in the search for and development of new supplies. When crude oil is perceived to be in short supply, a great deal of capital is dedicated to exploration and production, almost inevitably resulting in the development of large new oil fields. These fields have very low operating costs in comparison to the price of finding and developing them. For example, a field that costs $10 per barrel to find and develop can be operated and depleted for only $2 to $5 a barrel once the original capital requirements for platforms and other infrastructure have been met. Yet unless a mechanism is found to control this new supply, the market becomes glutted with oil and prices fall, threatening the profitability of the upstream activities that made the discovery possible. This drives out capital and eventually supply, until tightened market conditions restore prices and renew the process.
The other main sector, the downstream, refers to the refining of crude oil into a variety of different products, which are then marketed and distributed to consumers. Like the upstream, the downstream sector is highly capital-intensive. It is costly to build a refinery, but, once it exists, the refining costs are fairly low, with the main cost being the price of crude oil. In other words, once a refinery is operating, the cost of refining an additional barrel amounts to little more than the cost of the crude oil itself. Thus there is a temptation to maximize operational cash flows by driving down incremental costs. …