Oil embargo and energy crises of 1973 and 1979

• DATE: October 1973, to March 1974, and January to September 1979

The energy crises of 1973 and 1979 produced new energy consciousness, high unemployment and inflation, negative economic growth, and foreign policy shifts within the oil-importing countries of the industrialized world. It also left the major oil-exporting states in the world in control of a global oil industry, which had previously been largely under the control of the major (private) international oil corporations, and of the vast majority of the world’s known petroleum reserves.

Background

The 1973 and 1979 energy crises differed importantly in timing and gravity. The 1973 crisis emerged in a matter of days; the 1979 crisis unfolded over eight months. The 1973 crisis involved the availability and affordability of the essential to the industrialized countries of the Northern Hemisphere. In 1979, the availability of oil was never in doubt, only the ability of the oil importers to pay for it. At their most basic levels, however, the two crises had much in common. Both resulted from sudden, largely unforeseen political events in the Middle East. Both generated periods of global stagflation (high inflation with little or noeconomic growth), and both dramatized the extent to which, by the 1970s, the lifestyle of developed states had come to depend upon an energy resource that they did not control.

The immediate causes of the 1973 oil crisis were the October 1973, war between Israel and Egypt, Jordan, and Syria (the Yom Kippur War), and the U.S. decision to resupply Israel during that war. On October 17, 1973, the Organization of Arab Petroleum Exporting Countries (OAPEC) responded to these events by agreeing to end or reduce oil shipments to countries supporting Israel. OAPEC’s decision set petroleum-importing states bidding against one another for the oil upon which their economies depended. Oil’s spot market price soared from under three dollars per to more than twenty dollars per barrel, and the Organization of Petroleum Exporting Countries (OPEC) successfully exploited the situation to wrest control over the international petroleum market from the cartel of private oil companies that had controlled it for half a century.

On balance, the Yom Kippur War was less responsible for causing the first oil crisis than influencing its timing. By 1973, oil supply and demand trends had combined with political events to make oil-importing states highly dependent on Arab oil producers. Following World War II, industrialized states began doubling their energy use approximately every dozen years. To meet energy needs, Japan and the countries of Europe used ever larger quantities of imported petroleum—the cheapest and most efficient energy source available. Meanwhile, they allowed their indigenous coal industries to decay. Thus, whereas coal had accounted for nearly 78 percent of the energy used in Western Europe and more than 60 percent in Japan in 1950, by 1970, coal was producing less than 25 percent of their energy needs. Conversely, by 1970, imported oil accounted for more than 55 percent of Western Europe’s total energy use and nearly 70 percent of Japan’s. Even in the United States, with its large domestic petroleum industry, imported oil became the postwar means of sustaining the good life. On the eve of the Yom Kippur War, Americans were importing nearly one-third of their petroleum and one-sixth of their total energy needs.

These shifting demand-supply patterns would have been less significant were it not for the political changes that occurred between 1950 and 1970. The primary source of supply of the oil-importing world shifted to the Middle East, where many of the oil-exporting states were shedding pro-Western governments in favor of more radical regimes. These states were at once more likely to cooperate with one another in using the oil weapon against Israel and less willing to accept the prices being paid to them by the seven western oil companies (the “Seven Sisters”), who as late as 1950 still controlled nearly 90 percent of all production outside the United States and the Soviet Union. By 1971, this cartel had already lost its ability to fix the price of oil on the world market.

Against this backdrop, the 1973 oil crisis unfolded as a culmination of events. The higher oil prices began a major shift of wealth toward OPEC states (whose $10-$12 billion surplus on their combined current account in 1973 jumped to a $65 billion surplus in 1974) and ended the 1968-1973 economic boom in the Western industrialized world. The crisis also produced significant diplomatic ruptures within the Western alliance, as Japan and most of the U.S. allies in Europe were forced to break ranks with the United States on Middle East policy in order to avoid having their oil shipments curtailed. On the domestic front, the 1973 crisis made energy a major policy issue, as importing states began to consider the lifestyle changes necessary to reduce their levels of dependency on OPEC oil. The choices, however, were inevitably unpleasant, and by the mid-1970s, the United States in particular preferred to regard the 1973 crisis as an aberration. It was a convenient fiction, making it unnecessary for Americans to rethink their love affair with large cars, their suburban dwelling patterns, and their generally profligate use of energy.

The 1979 crisis exploded that myth, as it unfolded between two political events: the fall of the shah of Iran in January, 1979, and the outbreak of war between Iraq and Iran that officially began in 1980. The first event plunged Iran into disarray, effectively shutting down its oil industry and depriving an already tight international petroleum market of Iran’s 3 to 4 million barrels per day of oil exports. The price of oil rose almost daily with Iran’s continuing political turmoil. Then, in late summer, the turbulence in Iran tempted Iraq into invading the country. The resultant war removed Iraq’s more than 3 million barrels of oil per day from the market as well. The cost of oil skyrocketed. By late September, 1980, OPEC oil, which had been selling for sixteen dollars per barrel in January, cost more than thirty-six dollars per barrel.

This twenty-dollar-per-barrel increase in the price of oil had a devastating impact on the global economy. Western oil importers hastily employed harsh monetary policies to combat the new inflationary pressure. As countries’ economies sharply contracted, unemployment rates unseen since the Great Depression ensued. By 1980, Japan’s unemployment rate, which had averaged 1.0 percent from 1960 to 1978, was 13.5 percent; for France and the United States, the 1980 figure was 15 percent; for the United Kingdom, 23 percent. A decade later, when Saddam Hussein’s army invaded and temporarily annexed oil-rich Kuwait, double-digit unemployment, dating from the second oil crisis, still lingered in much of Western Europe. So, too, did the developed democratic world’s dependency on imported oil from OPEC in general and its Arab exporting states in particular.

Impact on Resource Use

The link between the cost of energy and economic growth—and hence the utilization of a broad range of resources—is generally a direct one. It also involves an inverse relationship. Low energy prices keep down the cost of everything related to energy use, from heating oil and gasoline to commodities mass produced and distributed via systems relying on some form of energy. Conversely, because in the immediate short term the demand for energy is usually inelastic, high energy prices do not immediately result in less energy use, only in higher energy costs, which invariably translate into inflationary pressures, counter-inflationary policies likely to increase unemployment, and recessionary periods of stagflation, low economic growth, and low overall resource utilization.

Because their operations were rooted in the developed democratic world, the western oil companies that largely controlled the petroleum market prior to 1970 were geared to maintaining a stability in the price of oil that would allow them to make a consistent, small profit on each unit of a commodity used in abundance in times of steady economic growth. They also controlled a large enough portion of the international oil-producing market and sufficient internal cohesiveness to enable them to do so effectively during most of the middle half of the twentieth century. OPEC has never had the same ability for two reasons. First, there are major exporters of oil outside OPEC who, as in the case of Britain during the 1980s, have been willing to undersell OPEC and set into motion a downward spiral in the price of oil on the world market. Second, there are major divisions inside OPEC which, in markets of reduced supply or rising demand, have often made it difficult for price moderates like Saudi Arabia to keep the price of oil from spiraling upward to global recession-inducing levels.

Consequently, since OPEC replaced the Seven Sisters cartel in the 1970s, there has been a marked absence of the general stability in the price of oil that characterized the reign of the Seven Sisters, and on the basis of which Western economies recovered from World War II and expanded from 1950 to 1970. Instead, internal squabbles among OPEC nations have combined with political and economic developments outside its control, producing a roller-coaster effect on the global economy that has frequently had a profound impact on the lives of its citizens and their use of its resources. Thus, the high price of oil at the end of the 1970s had a gradual, dampening effect on the demand for oil in the 1980s, as Western economies contracted and industrial production fell in many states to 60 percent of its pre-recession levels. At the same time, the high price of oil encouraged not only the exploration and development of other sources of oil, like the North Sea, the Caspian Sea, and Alaska, but also the development of alternatives to conventional petroleum, like the shale oil in Colorado, the tar sands oil in Canada, and oil-from-coal projects similar to those that allowed Germany to fuel its war machine in World War II. When, however, the reduced demand for OPEC oil combined with the overproduction and price cheating that occurred inside OPEC by states desperate for development funds in a market to produce a sharp drop (at one point to below ten dollars per barrel) in the price of oil in the mid-1980s, many of these costly, alternative energy projects were abandoned even as consumer demand for oil began to grow again.

The same pattern repeated itself near the end of the twentieth century and during the first decade of the twenty-first century. The low price of OPEC oil in the 1990s not only stimulated increased energy in the United States and other parts of the developed Western world but also encouraged a series of developing countries, including India and China, to accelerate their development plans, and hence the need for imported oil. The result was a steady upward pressure on the price of oil, only temporarily disrupted in the late 1990s by an economic crisis in East Asia. When the demand of these countries surged in the early twenty-first century at the same time that the United States occupation of Iraq removed its ability to export large amounts of oil and even turned Iraq momentarily into an oil-importing state, the resultant tightness in the energy market produced a steady upward spiral in the price of oil, to a recession-inducing peak of approximately $150 per barrel. Then followed a predictable decline in the demand for imported oil and the price of oil and, in turn, the cancellation of many of the alternative-energy schemes born during the era of $150-per-barrel OPEC oil. The global financial crisis that occurred shortly thereafter further reduced Western demand for resources, from the wood to build homes to the metals to make steel, but it was the high price of oil preceding that crisis that had already softened up such key economic sectors as automotive production and the demand for the resources used by such sectors.

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