A Brief History of Oil

1859-1911: A New Industry

The modern oil industry began as a result of a scarcity of whales. Artificial light, through all the ages of civilization, has served as the tool man has used to free himself from his dependency on daylight. Until 1859, most people obtained light by burning animal fats in the form of beeswax candles or whale oil. Whale oil shed the purest light of all available fuels, and became a luxury product. Overfishing led to a decline in the whale population and a sharp increase in whale oil prices.

People have used oil obtained from the ground since at least 4,000 BC. In the Middle East, crude oil that seeped to the surface was used to waterproof boats and as an adhesive in the construction of buildings and roads. Crude oil was also refined in minor quantities for lamp and heating oil in China around 1,000 BC, though this technology never made it directly to modern times. By 600 AD, the Byzantines used crude oil to produce a flame-throwing weapon known as Greek fire.

In the 1840s, a Pennsylvanian salt mine owner named Samuel Kier noticed his works were becoming fouled on the surface with an oily substance. Later, after noticing local Seneca Indians using the oil as liniment for skin ailments, Kier decided to commercially market this waste product as medicinal Seneca Oil, or Rock Oil.

In 1854, George Bissell and his business partners sent a sample of crude oil skimmed from a surface pool in northwestern Pennsylvania to Professor Benjamin Silliman of Yale University for analysis. Bissell hoped that the crude oil could be distilled into a lamp fuel so that they could profit from high whale oil prices. Silliman confirmed that the sample could indeed be distilled to produce kerosene.

Silliman's analysis was used to raise capital for the formation of the Pennsylvania Rock Oil Company in 1855. The company hired a railroad conductor named Colonel Edwin Drake to carry out the drilling. Drake was never in the military - his title was created by the Rock Oil Company so that he would impress locals. After a nervous few weeks in rural Pennsylvania, Drake struck oil on August 27, 1859. The first well was on a salt dome rock formation, 69 feet deep, yielding 15 barrels a day.

The price of a barrel of crude oil in January 1860 sold for $18 in the money of the time. By the end of 1861, however, a barrel collapsed to just 10 cents per barrel due to rampant overproduction. The new industry was gradually consolidated and monopolized by John D. Rockefeller and his Standard Oil Company. Rockefeller formed Standard Oil in 1870 and by 1890 controlled 90% of the US oil market. The Sherman Antitrust Act was used in 1911 to split Standard Oil into 34 competing firms, including what became ExxonMobil, Chevron, and ConocoPhillips.

Although whiskey and wine barrels were only briefly used to transport oil, the barrel remained the default volume measure. Standard Oil standardized the volume to be a Standard Oil Blue Barrel, or bbl, which is 42 US gallons. The extra 2 gallons (over the standard 40-gallon whiskey barrel) allowed for evaporation and leaks during shipment.

Early 20th Century: Boats, Planes, Trains and Automobiles

Following the initial discovery in Pennsylvania, additional small discoveries were made in Texas, Oklahoma, and California. So little oil was produced that Henry Ford initially designed the Model T to run on ethanol. Then came Spindletop.

Spindletop, discovered in 1901 just south of Beaumont, Texas, produced over 50,000 barrels per day - a gigantic amount at the time. This individual well produced 20% of daily US production. Spindletop and subsequent discoveries created the cheap, abundant supply needed to launch the automotive age.

Up until World War I, oil was not of much strategic significance. This changed when Winston Churchill decided to replace slow coal-powered British Navy vessels with rapid response oil-powered military ships. The high energy density of oil was also essential to powered flight - a gasoline engine powered the Wright Flyer in 1903.

By 1950, crude oil had completely transitioned from a source of lamp oil to a transportation fuel, with gasoline, diesel, residual fuel oil, and jet fuel accounting for about two-thirds of crude oil consumption.

Mid to Late 20th Century: Managing Excess Capacity

In 1928, the heads of the most powerful oil companies attended a grouse shoot at Achnacarry Castle in Scotland. The result was the As-Is Agreement: the oilmen agreed not to compete against each other outside of the US. The agreement failed as participants did not hold sufficient market share to control prices.

The need to stabilize prices was satisfied by the US government. In 1930, a wildcatter named Dad Joiner discovered a massive oil field in East Texas. The Texas Railroad Commission (TRC) was given authority to impose production restrictions. TRC control of spare capacity made it the arbiter of global prices from 1931 through 1971.

Outside the US, exploration was dominated by the Seven Sisters - through mergers, now four: ExxonMobil, Chevron, BP, and Royal Dutch Shell. They operated via concessions with producing nations, typically on a 50/50 profit-sharing basis.

OPEC was formed in 1960 in Baghdad by five founding members: Saudi Arabia, Kuwait, Iran, Iraq, and Venezuela. During the 1960s, OPEC had little power - western Majors controlled production and the TRC controlled global pricing. This changed in 1970 when US oil production peaked and began to decline.

The Oil Shocks

On October 16, 1973, Arab OPEC members imposed an oil embargo against the US and the Netherlands. The embargo cut world supply by 5-10% overnight. The price of crude increased almost fourfold between October 1973 and January 1974. This was the first and only time the Arab oil weapon has been used.

The first oil shock of 1973-74 was followed by the second oil shock of 1978-81. The Iranian revolution, the overthrow of the Shah, the Iran hostage crisis, and the Iran-Iraq war pushed crude to over $38 per barrel in 1980 (over $90 in today's terms). US oil spending climbed to over 8% of GDP.

The nationalization of oil resources accelerated during the 1970s. The IEA was formed in 1974. President Gerald Ford established the Strategic Petroleum Reserve in 1975. Contrary to popular perception, there was no global shortage of oil - government price controls in individual countries created artificial localized shortages.

1980-1990: Bust, Transparency, and Formula Pricing

Saudi Arabia cut production from 10.5 million bpd to 2 million bpd to support OPEC quotas, but other members cheated. In August 1985, the Saudis began linking their crude price to open market finished product prices and increased production to 5 million bpd. Within a year, oil prices collapsed more than 70%. The mid-1980s drop effectively bankrupted the Soviet Union and nearly bankrupted the US oil industry.

Oil began trading on futures exchanges in the late 1970s. Heating oil futures first traded on NYMEX in 1978, followed by gasoline in 1981, and crude oil in 1983. This created price transparency between producers and consumers never witnessed before.

1990-2009: Excess Capacity Disappears

Iraq's invasion of Kuwait in 1990 caused crude prices to more than double in days. Apart from a brief period in the mid-1990s, prices remained subdued for most of the decade. By 2005, demand finally caught up with OPEC's 35 years of managing excess capacity. For the first time since 1859, there was effectively no buffer against unexpected supply outages.

"In 1930, we found 10 billion new barrels of oil in the world, and we used 1.5 billion. We reached a peak in 1964, when we found 48 billion barrels and used approximately 12 billion. In 1988, we found 23 billion barrels and used 23 billion barrels. In 2007, we found perhaps 6-7 billion, and we used 31 billion." - Charley Maxwell

2nd Edition Update: 2009 to Today

The following sections are new to the 2nd edition, covering the transformative events since the original publication.

Since the first edition of Oil 101 was published in 2009, the oil industry has undergone its most dramatic transformation in half a century. The US shale revolution, powered by horizontal drilling and hydraulic fracturing, turned the world's largest oil importer into its largest producer. US crude output surged from 5 million bpd in 2008 to over 13 million bpd by 2024, reshaping global trade flows and geopolitical relationships.

OPEC was forced to adapt. In 2016, OPEC partnered with Russia and nine other non-member producers to form OPEC+, the broadest supply management agreement in oil market history. The alliance has managed production cuts and increases through multiple crises, including the 2020 pandemic demand collapse.

On April 20, 2020, the front-month WTI futures contract settled at negative $37.63 per barrel - an event previously considered impossible. The convergence of a pandemic demand collapse with a Saudi-Russia price war created a storage crisis that overwhelmed the physical delivery system at Cushing, Oklahoma. This event is explored in detail in Chapter 23.

The energy transition debate has intensified. Electric vehicle adoption has accelerated, particularly in China and Europe. Yet global oil demand has continued to grow, exceeding 100 million barrels per day for the first time in 2023. The question is no longer whether oil demand will peak, but when, and how steep the subsequent decline will be.

The forward curve above shows today's WTI futures prices extending years into the future. Its shape - whether in contango (upward sloping) or backwardation (downward sloping) - reflects the market's current assessment of supply and demand balance. This is explored in detail in Chapter 18.