Economides, Michael & Oligney, Ronald. The Color of Oil: The History, the Money and the Politics of the World's Biggest Business. Katy, Texas: Round Oak Publishing Company, 2000.

Date: 26 July 2003

Economides provides modest remarks from which I gleaned the impetus to reconcile a certain inconsistency that has bothered me for some years; namely the quality gap between known research methods and the simplistic methods often employed by decision-makers in business. To this point, Economides writes…

"… the oil industry is under-researched and not nearly as high-tech as we claim. Then it occurred to me. The strength of the oil industry is not research or technology per se; it is that we innovate - relentlessly - on the basis of technological advances, no matter where the advances come from."

He is stating that industry's technological advances are not deliberate. Then it occurred to ME, the research deficiency in support of corporate leadership is an expected result of corporate incentives in the private sector (and in my opinion provides justification for public investment in various analytical fields). That is, most forms of research might be categorized in economic terms as a sort of "public goods" (those that provide net gains to the industry as a whole, but are too expensive for investment by individual corporations). I say a "sort" of public good, because the direct costs for decision-science resources are not prohibitively high, but they are inconsistent with the timeframe and perceived organizational constraints facing the management and boards of many public companies.

In my own limited experience in both the public and private sectors, I find that government employees and contractors give a great deal of respect to their private industry counterparts under the assumption that the private-sector must work intensely and excel in the decision sciences. True, industry does tend to respond eagerly to changes in the workplace, but claims by private-sector companies and consultants of powerful proprietary decision-support methods are generally overstated... usually to the extent of being false. Most analytical methods employed in the private sector fall short of those taught in classrooms of universities… much less those employed by government agencies and contractors.

The public sector is far superior in identifying, designing, building and using analystical tools, and gives too much credit to the private sector. However, the private sector often surpasses the public sector in responding in the quickest and lowest-cost fashion to market changes and business crises (see quote below from "Green" chapter), even those crises created by its own short-sightedness. This is not to say that the private sector is more long-run efficient (not by a long shot), but it is surely more short-run efficient. So each sector often surpasses the other, but in different areas. Economides alludes to this distinction with respect to the oil industry while depicting the current research methods to be outdated. He describes the point at which he reconciled the lack of advancement in research methods by noting that the industry "innovates" instead.

He alludes to basic economic principles whereby individuals and firms in the industry are not incented to invest in long-term research, but they rather view challenges as short-run in nature, and therefore devise short-term incremental innovations. This is consistent with my own observations. The primary issue here is incentive structure. Few corporate managers with promotion aspirations, transfer opportunities, and a foreseeable retirement horizon are incented to invest in research that might add value 10 to 20 to 30 years (or often even 3 years) down the road. Therefore, they usually don't. Neither can we expect boards or investors to correct for under-investment. The incentives are similar in all public companies, so no one addresses their industry's and market's long-term investment needs. Economides almost implies that substantial leaps in the technology and methods employed by firms will only arise through public investment in research.

Although a staunch reductionist with respect to many forms of federal spending, I agree with this conclusion for two primary reasons. First, I have little doubt that there is a vast litany of citacions in the public-sector economics literature to describe the economic forces that have driven R&D investment out of certain industries... but the fact of it is clear enough to me. Second, I have a continuously renewed respect for the depth, breath, and intensity of the public-sector research community.

Summary

This book analyzes the oil industry, but is also a commentary and memoir. Each chapter focuses on a different aspect of the industry, but his personal interests create underlying themes that run across chapters (most notably his interest in research investment). I summarize selected chapters below.

Economides begins with his chapter entitled "Green" by summarizing the socio-economic impacts of the oil industry in the U.S. and the world since the 1800s. He provides informative statistics, but makes some flawed statements about economic relationships. For example, he states that the "demand for energy does not result from wealth, but instead, promotes wealth. Obviously, it does neither; energy (as a viable input) contributes to output... the use of it generates wealth. He does (however) offer an insightful instance of a principal that has become evident in my own career…

"The ability to perform a 10-minute calculation on the back of an envelope, coupled with the capacity to think and understand, often has a literal worth many times that associated with the ability to run the most advanced model or black-box simulator."

Although my education and career has focused almost exclusively on decision science, I fully agree with this statement. Advanced analytics often do NOT provide any incremental value to the decision-maker, but in certain cases they can provide the business manager with at least a slight operational or competitive edge that has a large positive impact on outcome and/or the bottom line. The same is true for policy-makers and military leaders.

Here, the author discusses the Russian and Persian oil industries at the turn of the century (which were largely developed by European firms) and the increased mechanization and role of petroleum in WWI. He also reveals the strategic role of oil in WWII… Germany's campaign to capture Russia's Caspian oil fields in the Caucasus, and Japan's target of Euro-American controlled oil fields in Indonesia (noting that Japan was oil starved by 1945). He describes U.S. strategic policy in the later half of the 20^th century, which is summarized by his following statements…

"Access to petroleum and unhindered movement of the commodity are crucial elements to both the welfare of the U.S. and the E.U., and to the health of the international economy."

… and …

"Disturbing or threatening to disturb petroleum supplies and trading would not be tolerated."

Economides provides anecdotes to claim the industry is under-researched and not as high-tech as claimed, but once problems arise, the industry implements small innovative changes to correct and avoid problems in the future. He discusses capital investment, links industry stability to interest rates, and describes the dominance of U.S. firms, which can borrow cheaper than foreign entities. He describes the industry's dependence on technology, reveals that the industry's research spending (less that 1% of sales) is the lowest of all major industries, and explains this apparent contradiction. He notes technology for finding new reserves as the dominant R&D focus and points to deep water drilling as a major new-reserves opportunity in the future.

Economides discusses nationalistic and economic impacts on the industry. For example, he discusses the factors surrounding the Arab Oil Embargo of the 1970s, and how this spawned U.S. research in order to lessen our dependence on foreign oil… a topic that has resurged in recent years. He describes a demise of industrialization and manufacturing as a source of wealth in lieu of energy and technology sectors. He again asserts energy consumption as a source for national wealth, and concludes that increasing energy consumption might give China and the Pacific Rim a monopsonistic influence in energy (which will antagonize the Middle-Eastern exporters); I'm not sure this conclusion makes sense.

He again returns to the technology paradox, noting that "the industry may use vast amounts of technology, but it can coast with existing methods." He quite accurately concludes that technology will advance only as current reserves mature to the point that new technology is required.

He analyzes the role of culture in oil producing nations, noting the incentive structure in these nations limits their ability to capture many types of gains from oil production. Local labor often does not have real promotion opportunity, therefore workers have no technological knowledge have no incentive to absorb such knowledge. He also describes the role of elitism in corporate and local cultures. Ultimately, he declares that oil producing governments and corporation need to better embrace longer-term strategies regarding research, training, and incentive-structure, and states…

"Technical management should be exactly that. Knowledge and technology should be considered assets to be acquired. As with oil development itself, investments are needed to allow full exploitation of the technology."

Economides provides an historical account of the government's impacts in the industry, beginning with the federal government's WWI effective formation of a national oil cartel. After the 1911 bust-up of Standard Oil, the government imposed oil restrictions to raise and stabilize oil prices resulting in oil bootlegging (which is similar to the result of cheating by OPEC members). He describes how the IRS used excise taxes to support independent suppliers and used import tariffs obviously supported domestic producers (but not consumers… just as obviously). He attributes the protectionist 1959 import limit quotas under the Mandatory Oil Import Program (MOIP) as the impetus for the 1960 formation of OPEC, and he summarizes taxes, models, and price controls under Carter, and de-regulation under Reagan. He ultimately expresses a positive outlook for the oil and energy industries and markets, but he criticizes the current level of investment on long-term research, technology, and information efforts, and prescribes a two-part role for the government. After suggesting a regulatory role to preserve a level playing field, he returns to the issue of research and development, suggesting greater federal investment in oil and gas technology and infrastructure.

New Green: Economides gives a scathing description of modern day environmentalism, using such adjectives as dishonest, elitist, zealous, and sinister. He disputes several environmental arguments in detail and describes impacts on developing countries.

Economides summarizes the current status and market share of the various energy industries and speculates regarding their future development and usage. He predicts a surge in the use of natural gas, but estimates that current oil reserves will provide energy for a longer timespan (about three centuries) than natural gas. He is pessimistic for the future of wind and solar sources of energy, but hopeful for nuclear fission and fusion, gas extracted from coal, and hydrogen (derived from hydrocarbons in the short run and non-hydrocarbons in the long run). He warns, however, that feasible hydrogen-based energy sources will require the most demanding quantum leaps in technological innovation in history.

He notes that the information revelation that is transforming the world will allow entrepreneurial entrance by developing countries into many industries including the technology side of the energy sector.

Finally, Economides states he is "bullish on energy", by which he means that the energy sector will ultimately satisfy the great need to change and grow in order to meet the world's energy needs.

J. Sprigg