10

Going Fifty-Fifty

ALTHOUGH THE SAUDIS’ RENEGOTIATION OF THE TERMS OF ARAMCO’S concession had sparked a race to claim the Rub al-Khali, that was nothing compared to the further change they then agreed with the company at the end of 1950, which was to have far greater implications for the British, not just in southeastern Arabia but all over the Middle East.

Money, as ever, was the issue for the cash-strapped Ibn Saud, whose family now numbered about a thousand. Although, through the revised agreement of April 1948, the king had managed to increase his royalty by half, to thirty-three cents a barrel, he soon had reason to regret this deal. After Aramco—under pressure from the State Department to give independent American oil companies a slice of Middle Eastern business—had surrendered its share of the exploration rights to the neutral zone between Saudi Arabia and Kuwait, at the start of 1949 the Saudis managed to resell this lease to another U.S. company that was willing to pay a royalty equivalent to fifty-five cents a barrel. The sale left Ibn Saud wishing that he had screwed Aramco for more.

Aramco training its Saudi employees to tell the time, Dhahran, c. 1955.

Saudi disgruntlement only grew when Aramco then cut back its output. After global oil production caught up with demand in 1949, the Marshall Plan’s administrators put pressure on the company to cut its prices, and demand then fell back when that year’s sterling crisis led the British government to bring in measures that discriminated against American producers by discouraging oil importers buying oil priced in dollars. Assailed by both these pressures, Aramco scaled back its production and postponed expansion plans. Since the concession agreement tied royalties to output, lower production meant less revenue for the Saudis: the State Department reckoned that the combined effect of these moves by Aramco might slash Saudi Arabia’s income by $25 million, or a quarter.

This calamitous drop in revenue hit Ibn Saud just at the moment when his main Iraqi rivals—whose own sterling-denominated oil sales were growing unabated—appeared to be dusting off their Greater Syria plan again and the British were dismissing his own claim to the Buraimi oasis. Convinced that this was no coincidence and that the British were trying to encircle him, the increasingly paranoid king asked Aramco if he could borrow $6 million, and then promptly relent the money to Syria in January 1950, hoping to kill off a union with Iraq. The first signs of another Saudi financial crisis came days later when the finance minister asked for an advance against a royalty payment he was due to receive toward the end of February. The same day that Aramco deposited the cash, one of the king’s sons sent an emissary to ask when his master might expect his share while the cashiers were still counting out the money.

To avoid friction with the Saudis, Aramco agreed to each demand. But the company’s executives were outraged at the use to which Ibn Saud had put the $6 million loan, and the uncertainty surrounding the concession meant they could not shell out money indefinitely. Early in 1950 they asked the U.S. government for help, initially over a relatively unusual matter. National Geographic was about to reissue its map of Africa and the Middle East, which currently gave Qatar, the Trucial Sheikhdoms, and Oman boundaries that marched some way into the Rub al-Khali. As the cartographer had refused to give in to the company’s pressure, Aramco asked the State Department if it could ensure that “these disputed areas be left uncoloured.” The March 1950 edition of the map provides enduring proof that the State Department agreed to help. Although, following Thesiger’s expeditions, it shows more details of the topography of the Empty Quarter, the dotted lines indicating the frontiers, which were present in the previous edition, had vanished.¹

The Truman administration was reluctant to get more involved. Its diplomats in Jeddah were very skeptical of the Saudis’ claim to Buraimi, not least because the king’s governor, Ibn Jiluwi, himself privately admitted it was groundless. The administration saw the frontier dispute as a distraction from its main priority: to persuade the Saudis to renew the Dhahran base agreement, which had expired during 1949. But in exchange—and no doubt to put pressure on the British—Ibn Saud wanted a formal, military alliance. Washington did not wish to give this because it knew that it would struggle to push it through Congress in the face of general suspicion of “entangling alliances” and the likely opposition of the Israel lobby. But equally Washington did not want Aramco to lose its concession.

President Truman tried to assuage the Saudis and buy time by commissioning an exhaustive survey of the country’s military requirements. Realizing that the king was putting pressure on Aramco because he feared British designs, his administration also passed on a promise from London that the British government would use its influence to prevent the “use of force by one Middle Eastern country against another.” But this fell far short of what Ibn Saud was after. “The British were a people of ‘but’,” he once declared, “They made statements and gave you assurances but always at the end ‘but’.” In February 1950 the Saudis made another onerous demand of Aramco: that the company foot the bill for the protection of the nearly completed Tapline. Given that the pipeline ran parallel with the Iraqi frontier, the American ambassador immediately saw what the Saudis were trying to do: “transfer to Aramco the entire cost of protecting Saudi Arabia’s northern marches from the exaggerated Hashemite menace on their flanks.”²

Unable to give the Saudis what they wanted, the State Department decided some personal diplomacy was in order. Midway through March, the assistant secretary of state responsible for the Middle East, George McGhee, set out to meet Ibn Saud in Riyadh, bearing a personal letter from Truman to the king in which the president said he hoped strong “ties of friendship” would continue. Though only thirty-eight years old, McGhee knew the subject and the stakes perfectly. A geologist by training, he had made such a fortune in the oil business that he could now afford to work pro bono for the State Department. His father-in-law was Everette DeGolyer, the leading oil geologist of his generation and the first man to appreciate just how vast Saudi Arabia’s oil reserves might be.³

“My main hope,” McGhee would later recollect, “was to lay a sound basis for US-Saudi relations, in order to assist Aramco in maintaining its position as the sole developer of Saudi oil.” In preliminary talks with Ibn Saud’s advisers on his arrival in Riyadh, he dodged an invitation to get involved in the Rub al-Khali frontier dispute and made sympathetic noises about their fears of the Hashemites. Three days later he dined with Ibn Saud, who entertained him with an account of his seizure of Riyadh with forty followers in 1902.⁴

It was only after the old king had retired to bed that the haggling with his advisers began. McGhee was adamant that his government could not enter an alliance. Instead, he proposed a treaty of friendship and sugared that underwhelming offer with the offer of a loan and technical expertise under the Point Four aid program that Truman had unveiled the year before. He wisely tied the prospect of weapons—which was what Ibn Saud really wanted—to Saudi renewal of the base agreement.

McGhee left Riyadh under the impression that he had royal agreement for his proposals, but he did not significantly ease the pressure on Aramco, for the company’s tax affairs had meanwhile come under close scrutiny from the man in charge of Ibn Saud’s treasury in Mecca, Abdullah Suleiman, once memorably described by a British diplomat as “the only finance minister I ever met who drank methylated spirit.”⁵

Suleiman had been trying to understand the effect of an arcane change to Aramco’s commercial relationship with its shareholders, which had made the oil company significantly more profitable and thus liable to pay more taxes in the United States where it was domiciled. This investigation now revealed a fact so startling that it must have had the finance minister reaching for the bottle to refill his glass: in 1949 Aramco had coughed up more to the American government in taxes than it paid out in royalties to Riyadh.⁶

A recent innovation in Venezuela showed the Saudis the way forward. The South American government had enacted a law that subjected all oil company profits to a 50 percent levy. Had Saudi Arabia applied the same fifty-fifty law to Aramco in 1949, it could have wrung another $33 million from the company.

The prospect of imposing such a tax became even more appealing after an expert on U.S. tax, hired by the Saudis, cleared up the one uncertainty that the fifty-fifty tax left. This man was able to confirm to Abdullah Suleiman that the tax hike would not harm Aramco’s ability to invest in its Saudi operations since, under existing U.S. law, the company could offset this new foreign tax bill against its domestic tax liability. So long as the Saudis taxed Aramco no more than what the company owed the U.S. government, it was the U.S. taxpayer, and not they or the company, who would suffer. In May 1950 Suleiman told Bill Eddy, formerly the U.S. minister to Jeddah and now working for Aramco, that his government intended “to obtain a larger share in Aramco’s profits.”⁷

Suleiman’s alcoholism meant that Aramco’s officials were never quite sure how seriously to take him, and initially they offered to defer repayments of the $6 million Syria loan, which the Saudis had been due to start making that August. When it turned out the finance minister was not bluffing, they realized they had very little leverage. Even if the company wrote off every debt owed it by the Saudis, the sum was half what the Saudis stood to gain each year if they applied the Venezuelan law. In June Abdullah Suleiman presented Aramco with an ultimatum, calling on the company to contribute at least $10 million annually to a welfare fund, shoulder the cost of new infrastructure, and accept deferred payment of all invoices until January the following year. Since none of these costs could be offset against the U.S. corporation tax, the aim of this demand was to make the fifty-fifty alternative appealing. In July Aramco’s president told the American ambassador to Saudi Arabia that he could go no further: to make more concessions “would not only invite additional demands by the Saudi Government but would be financially unwise.” The following month Aramco’s board authorized its officers to renegotiate the 1933 agreement along fifty-fifty lines. In doing so, it was effectively volunteering American taxpayers to subsidize the lifestyle of the Saudi royal family.⁸

While this was bad news for the U.S. taxpayer, it was good news for McGhee. Although the president had turned down McGhee’s request, earlier that year, for a billion pounds in aid to help the countries of the Middle East and South Asia, for which he was responsible, Saudi Arabia’s strategic importance was growing. The outbreak of the Korean War at the end of June made a war with Soviet Russia seem more likely. In that scenario, Dhahran assumed a huge importance because it was the only air base that put U.S. bombers within striking range of industrial southern Russia. What amounted to a disguised subsidy of the Saudis was the order of the day.

There was another reason why McGhee was happy with this outcome. He felt it would oblige the British, who were resisting similar pressure from the Iranian government to improve the royalties their Anglo-Iranian Oil Company was paying, to come up with a matching offer. State Department officials were by now worrying about the vulnerability of Middle Eastern states to communism and feared the consequences of the disruption that would follow if Aramco lost or abandoned the Saudi concession. But another way the Saudis might be exposed to communism was if neighboring Iran succumbed to Soviet influence—a risk that British stubbornness increased, in Washington’s opinion. “As soon as it became clear that Aramco was going to make substantial concessions to Saudi Arabia,” McGhee recalled later, “I knew that we must warn the British so the AIOC would have an opportunity to improve their offer to Iran.”⁹

BY NOW THE Anglo-Iranian Oil Company, the biggest of the oil companies operating in the Middle East, dwarfed Aramco. Yet, when it was established thirty years earlier, the company had been the green newcomer to a market dominated by well-established rivals, and it needed more customers and capital. Its breakthrough came in 1914 when Winston Churchill, then first lord of the admiralty, announced that His Majesty’s government would supply both, through a £2 million investment and a twenty-year contract to supply the admiralty with cut-price fuel. Urged by the former First Sea Lord to “do our damnedest to get control… and to keep it for all times an absolutely British company,” the British government purchased the majority of Anglo-Iranian’s stock and took two seats on the board. The result defied easy description. Anglo-Iranian was, as Ernest Bevin admitted, “really a state company” but one over which he felt he had “no power or influence… to do anything at all.”¹⁰

Churchill once described Anglo-Iranian’s concession as “a prize from fairyland far beyond our brightest hopes.” Even when the Iranians reached the same conclusion and forced a renegotiation of the deal in 1933, the outcome was, if anything, even better for the company, since it prolonged its rights for sixty years and carved in stone the tax rates that the Iranians could levy on the company until 1963. Reopening that agreement was “the very last thing the company desires,” the company’s forbidding Glaswegian chairman, Sir William Fraser, remarked in 1948, “as no new concession could ever be as favourable… as the one now in existence.” And so it was a deeply unwelcome development when the passage of Venezuela’s fifty-fifty law dragged him back to the negotiating table the following year.¹¹

For both Anglo-Iranian and the British government, the stakes the 1949 negotiation involved were huge because the war had turned the business into a massive enterprise. While Aramco produced half a million barrels of oil a day, Anglo-Iranian churned out almost half as much again. Nearly three-quarters of this output was processed at the refinery at Abadan on the Shatt-al-Arab waterway. Following massive expansion during wartime, the plant was now the largest refinery in the world and Britain’s “most important single overseas investment”; one young Iranian described it as “awe-inspiring.” A “vast, smoking, spitting complex” of holding tanks, pipes and tall thin chimneys, which seemed to wobble in the mirage, it had quadruple the capacity of its Aramco-owned rival down the Gulf at Ras Tanura. Reeking of sulphur and kerosene, it distilled crude oil into British power.¹²

Not only did Anglo-Iranian’s Abadan refinery supply the United Kingdom with the means to fight another war, it generated a much-needed £100 million a year in foreign exchange from sales of oil in sterling and paid the British government colossal sums in taxes and dividends. At a cost of about five shillings a ton, the plant turned Iranian crude oil into a commodity that sold for twenty times as much in Europe. The British government then taxed Anglo-Iranian’s profits, earned a dividend as the owner of the majority stake, and taxed the dividends the company paid out to its other British shareholders. In the three years from 1948 to 1950, the British government received about £116 million.¹³

That colossal sum did not even include the tax the British government received on the profits of over fifty Anglo-Iranian subsidiaries. These the Board of Trade excused Anglo-Iranian from having to consolidate into its own annual report on the grounds—the company’s directors insisted—that to do so would be “misleading.”¹⁴

Revealing would have been a more accurate word, for the subsidiaries were involved in distribution and marketing of “downstream” activities that, then as now, were by far the most lucrative part of an oil company’s operations. What the British government was actually doing by allowing Anglo-Iranian to split off its subsidiaries’ financial results was to collude in a cover-up. The company was reinvesting most of the money it made from extracting Iranian crude oil and refining it at Abadan in subsidiary marketing businesses that made profits on which the Iranians had no claim. As the British minister of fuel and power privately admitted, the “Persians are not getting anything like as much out of this as we.”¹⁵

The “Persians” already had an inkling this was the case. Before they reopened the terms of the deal, they had hired a French law professor, Gilbert Gidel, to review the existing concession agreement and take a closer look at Anglo-Iranian’s operations. Gidel not only found that the basis for the current deal was flawed and that there was a vast and growing gulf between what the British and the Iranian governments each earned from the arrangement, but he also revealed the profitability of Anglo-Iranian’s subsidiaries—the secret that the company, with Whitehall’s connivance, had done its utmost to hide.

The Iranian finance minister used Gidel’s report to argue that his country deserved a royalty of one pound per ton. But his arguments ricocheted off Anglo-Iranian’s redoubtable chairman, Fraser, whose final offer of twelve shillings and sixpence was less than two-thirds the finance minister’s demand. Fraser argued, brazenly, that the very reason why Iran could not follow Venezuela and claim half his company’s profits was because Anglo-Iranian’s subsidiaries operated outside the country. The Iranians pointed out that, without their oil, the subsidiaries would have nothing to sell.

It took the Iranian ruler, the shah, to break the deadlock. After he had instructed his unhappy ministers to accept Fraser’s offer, the Supplemental Agreement, as the company had dubbed the deal, was signed on July 17, 1949. The company’s executives hoped that the shah could railroad the arrangement through the Iranian parliament, the Majlis, before it was dissolved at the end of the month.

But ratification never happened. The Supplemental Agreement was not the fifty-fifty deal the Iranians had asked for, nor did it touch their demand that they should receive a cut of the Anglo-Iranian subsidiaries’ profits. When at the same time the company ineptly announced an all-time record profit, the finance minister was, understandably, unimpressed. To sabotage the deal’s chances in parliament, he made Gidel’s report public. Hostile deputies in the Majlis then filibustered to stop the agreement’s ratification before the end of the parliamentary session.

The British spent liberally to ensure the election of a sympathetic new Majlis in early 1950. But if they believed that its pro-British majority would swiftly endorse the Supplemental Agreement, they were wrong. At the election, a new coalition calling itself the National Front, which opposed the Anglo-Iranian agreement, also won eight seats. Led by a former finance minister named Mohammed Mosaddeq, the Front blamed foreign interference for Iran’s many problems and promised fundamental change. Mosaddeq and his colleagues succeeded in forcing the Majlis to refer the Supplemental Agreement to a parliamentary committee for further scrutiny, and then managed to secure six out of the eighteen seats on the panel. Mosaddeq became its chairman.

The shah fired his prime minister and finance minister and appointed a lean, overconfident general, Ali Razmara, as the new premier. Razmara felt sure that he could push the Supplementary Agreement through the Majlis if only Anglo-Iranian made some concessions. With American encouragement, he demanded greater transparency from the company and for the Iranians to be treated as well as Anglo-Iranian’s most favored customer, the Royal Navy.

Razmara enjoyed discreet British and American backing and presumably expected a sympathetic response. Had he got one at this point, history might have been different. But Anglo-Iranian’s managers rejected all his proposals: the last thing they wanted was for sunlight to caress the company’s ledgers because then the Iranians might find out how much their marketing subsidiaries were really making. Their stance was supported by the British government, which had seen its majority pared back to single figures in that February’s election; the government stood to lose a lot of revenue if the concession were rewritten in the Iranians’ favor. In talks with the American ambassador in London in August 1950, Bevin defended the Supplemental Agreement as “generous” and refused to give any ground because of the “Iranian propensity to keep opening their mouths wider.”¹⁶

WORRIED OF THE consequences of continued British pigheadedness, that September the assistant secretary of state George McGhee flew to London to try to convince his British counterparts to agree to Razmara’s requests, but he got nowhere. Although by then there were abundant signs that the communist-backed Tudeh Party was gaining ground in Iran, the British thought that American predictions of Iran’s imminent collapse and takeover by Moscow were overblown. Even when McGhee warned them that Aramco was about to make a concession to the Saudis that was “so large… that there would be no chance for Iranian ratification of the… Supplemental Agreement,” the British would not budge. The reaction from the company was no better. “The… Board, in effect, told me that I should mind my own business. They knew more about Iran than we did,” he later recalled. “If you give the Iranians an inch they’ll take a mile,” Anglo-Iranian’s directors told him.¹⁷

So be it, thought McGhee. Having tried to save the British from themselves, he returned home and summoned senior Aramco executives and the American ambassador to Saudi Arabia to see him on November 6, 1950. Two days earlier, the Saudis had upped the ante by bringing in an income tax that targeted Aramco; McGhee told the oilmen that he favored “rolling with the punch.” Aramco’s representatives agreed that they could afford to pay more; a fifty-fifty tax deal attracted them “since it might involve no additional expense to the company.” When McGhee said he could not preempt the Treasury’s response to this arrangement, it became clear that the company had already done its homework. Aramco’s vice president, James Terry Duce, told him that the Treasury officials he had already approached did not seem “particularly concerned” about the issue. That news must have delighted McGhee: he was about to get the disguised subsidy for the Saudis that he had wanted, without the rigmarole of having to gain congressional approval first.¹⁸

Aramco’s negotiation with the Saudi government, which coincided with the opening of the Tapline, took barely a month. Truman had already helped pave the way, by reaffirming that the United States was committed to preserving “the independence and territorial integrity” of Saudi Arabia. On January 10, 1951, Duce took McGhee’s assistant, Richard Funkhouser, through the completed deal. Barraging the young diplomat with the previous year’s figures for gross profits, expenses, and U.S. tax, not forgetting royalties, rents, duties, and the two new rates of Saudi tax, Duce conjured up a figure of $110 million for the Saudi share of the company’s net profit. Once that share of the net profit was divided by an output of 538,000 barrels a day, it produced a very convenient result. Under the new arrangement just negotiated, “Mr Duce calculated that 1950 royalties would come to approximately 56c per barrel”—in other words one cent more than the Saudis had accepted from the Pacific Western Oil Company two years earlier. Whether or not Funkhouser could follow Duce’s working, he got the essential point. “It is equivalent to the highest existing formula and appears basically fair,” he judged, in a telegram summarizing the deal.¹⁹

Funkhouser’s choice of phrase was telling, for appearances were deceptive and in reality the formula was anything but fair. Like Anglo-Iranian, Aramco was massaging its profit. The figure on which the fifty-fifty calculation was founded, Aramco’s gross profit, was low because the company sold oil to its four American owners at a significant discount. The owners then reaped the profit when they sold that oil on to consumers at the going rate. It was not until mid-1953 that the Saudis realized what was going on—and that they had missed out on about $100 million—and pressed Aramco to change the basis for the fifty-fifty calculation. Aramco rolled over, and the Saudis’ royalty then leapt by almost 50 percent, to eighty-three cents per barrel.

All that, in early 1951, still lay in the future. What mattered for the time being was that, with U.S. government support, Aramco had set a generous-looking precedent: one that would have seismic consequences when the Anglo-Iranian Oil Company, backed by its main shareholder the British government, then refused to follow it, until it was too late.