National Economy &

International Linkages
Assignment
On
Oil Crisis of 1970’s

Presented By
Syndicate 10
Animesh Sahu (068)
Ankit Dubey (069)
Asim Daruwala (071)
Nivedita Kerketta
(082)
Nimesh Bhatia (093)
Rohit Tayal (104)
Oil Shocks: 1973-74

Abstract

The oil shock of 1973-1974 was an economic and politic important event that produced controversies
in the years that followed. No event in the last decades of the 20th century was as visible as the fourfold
increase of the oil price in 1973-1974.

OPEC success showed at the beginning of the 70s, as the rising oil demand exceeded production.
Moreover, producing countries began to ask for ever more concessions. Muammar-al- Qaddafi, taking
over power after the military coup in Libya, obtained a 20% due increase and an agreement to split
profits 55-45%.1 This move led to new requests, which resulted in increased oil price and exporting
countries’ profit.

As oil market was ever straitened, the Arab world began to use oil as a weapon to reach its economic
and political goals. This was mainly achieved through the oil embargo during the war between Egypt
and Israel, in October 1973. Saudi Arabia refused to increase production in order to stop the price from
decreasing, unless the US supported the Arab case. Arab oil Ministries decided to set an embargo in
order to reach their political goals. Production was to be reduced by 5% monthly, until the West gave
up. The countries which adopted a “friendly” attitude towards Arab states were not to be affected.
When President Nixon suggested that a $2.2 billion military aid be given to Israel, Arab countries set
the embargo against the US (afterwards extended to the Netherlands, Portugal, and South Africa).

The official oil price was set by OPEC members at $11.65/barrel. The price increase was without
precedent in the oil history, from $3/barrel to 11.65/barrel. The embargo caused a deep economic world
recession.

The Arab embargo was set at a time when American oil production was decreasing, while demand and
import were increasing. OPEC production decrease, together with minimal world excess production
capacities, created oil shortage on the market and, consequently, increased price. At the end of the
embargo, six months after it was set, the price was four fold and OPEC controlled world oil market.

Effect:

Immediately there were reactions in the market:

• Refineries changed oil suppliers, starting to import from other available sources.
• Imports from Arab members of OPEC were begun again immediately after the embargo and
started to grow until 1977. Though exploitations in the North Sea and Alaska had become
important, OPEC quota in American imports rose from 26% in 1973 to 36% in 1977.
• The refining industry began to develop oil processing technologies and methods to reduce oil
consumption and to enhance operational efficiency.

The embargo led to massive increases in the price of refined products. Between 1972 and 1975, period
in which OPEC returned to the production level before the embargo, consumers paid on average 57%
more on gas. The high increase in energy price recorded is considered to be the cause for the 1974-1975
economic recession. Considerable efforts were made, after the embargo, to preserve energy and to pass
from oil to alternative energy sources.
A result of this embargo was also the creation of the International Energy Agency in 1974 by the US
and other 20 states. The purpose of this Agency was securing oil supply. Thus, member countries
developed plans with regard to creating strategic reserves necessary in times of oil supply interruptions.
Law was also improved in the years following the embargo, in order to stabilise oil market.

Economists’ analysis often comprises referrals to the oligopolistic structures of oil companies, to the
collective decisions of OPEC and to the demand-supply interaction on the international oil market.

The oil crisis is considered to be a form of manifestation of economic nationalism in Third World
states, in order to gain an “equality position” in their relationship with industrial powers. The 1973-74
crises were a consequence of the fight for economic independence of raw materials producing
countries, in general, and of OPEC countries in particular. The situation created was a riot of oil
exporting countries, a riot against inequitable changes between the “centre” and the “suburbs”, a riot
against the exchange of cheap raw materials from Third World states and expensive imported goods
from industrialised countries.

The immediate results of the Oil Crisis were dramatic.

1. Prices of gasoline quadrupled, rising from just 25 cents to over a dollar in just a few months.
The American Automobile Association recorded that up to twenty percent of the country’s gas
stations had no fuel one week during the crisis. In some places drivers were forced to wait in
line for two to three hours to get gas. The total consumption of oil in the U.S. dropped twenty
percent. This was due to the effort of the public to conserve oil and money. There was an instant
drop in the number of homes created with gas heat, because other forms of energy were more
affordable at this time. The U.S. government went to desperate measures to improve the
situation that America found itself in. Congress issued a 55mph speed limit on highways. This
was a good thing. Not only did oil consumption go down, but fatalities decreased overnight.
Today’s fuel economy stickers come from the effort to preserve oil in the 70′s. Daylight savings
time was issued year round in an effort to reduce electrical use. These changes were made in
hopes of preserving oil.

2. Tax credits were offered to those who developed and used alternative sources for energy. These
included solar and wind power. Nixon, who was president at that time, ordered the department
of defense to create a stockpile of oil in case the country needed the military to carry it through a
time of chaos. There was a large cutback in oil consumption. Emergency rationing books were
printed although they were never necessary due to the end of the embargo. Nixon formed the
Department and it became a cabinet office. It developed the national energy policy. They made
plans to make the U.S. energy independent companies and stations also did all that they could to
preserve oil. Nixon had issued a voluntary cutback on the consumption of gasoline. Gas stations
would voluntarily close on Sundays. They refused to sell to customers who weren’t “regulars.”
Gas stations also wouldn’t sell more than ten gallons of gasoline to a customer at a time. They
felt that these efforts would help the public to become more fuel-efficient.

The Arabs began to ship oil to Western nations again, but this time at inflated prices. One of the long-
term effects of the embargo was an economic recession throughout the world. Inflation remained above
ten percent and unemployment was at its record high. The era of economic growth which had been in
effect since World War II had now ended. It also ended the common belief that economic prosperity
reflected oil consumption statistics.

Conclusion

Although the embargo ended only a year after it began in 1973, the OPEC nations had quadrupled the
price of oil in the West. The embargo opened a new era in international relations. It was a political and
economical achievement for the Middle East. Third World states discovered that their natural resources,
on which they depended upon, specifically oil, could be used as a weapon in both political and
economical situations. The Rising oil prices continued to be a threat to not only America’s economy,
but also that of the world.

Oil Shocks: 1979

Introduction - The 1979 (or second) oil crisis in the United States occurred in the wake of the Iranian
Revolution. Amid massive protests, the Shah of Iran, Mohammad Reza Pahlavi, fled his country in
early 1979 and the Ayatollah Khomeini soon became the new leader of Iran. Protests severely disrupted
the Iranian oil sector, with production being greatly curtailed and exports suspended. When oil exports
were later resumed under the new regime, they were inconsistent and at a lower volume, which pushed
prices up. Saudi Arabia and other OPEC nations, under the presidency of Dr. Mana Alotaiba increased
production to offset the decline, and the overall loss in production was about 4 percent. However, a
widespread panic resulted, added to catastrophic decisions like U.S. President Jimmy Carter ordering
cessation of Iranian imports to the U.S., driving the price far higher than would be expected under
normal circumstances. In 1980, following the Iraqi invasion of Iran, oil production in Iran nearly
stopped, and Iraq's oil production was severely cut as well. After 1980, oil prices began a 20-year
decline down to a 60 percent price drop in the 1990s. This was due to reduced demand and over-
production, which caused OPEC to lose its unity. Oil exporters such as Mexico, Nigeria, and Venezuela
expanded production; USSR became the first world producer. Ending of price controls allowed the US
and Europe to get more oil from Prudhoe Bay and the North Sea.

Start of Oil Crisis - Following a lengthy series of paralyzing strikes and sporadic work slowdowns by
anti-Shah oil workers last fall, the Iranian oil industry ground to a near halt and suspended oil exports
on December 26, throwing world oil markets into disarray and generating intense consternation among
oil-importing states. Although Ayatollah Khomeini's revolutionary Islamic regime has recently ordered
the oil workers back to work, it is unclear at this time to what extent these orders will be obeyed and
when oil exports will in fact resume.

Impact on World Oil Supplies - Before the chronic work stoppages began in October, Iran was the
world's fourth largest oil producer with an average output of 6.05 million barrels a day (MBD) the
equivalent of almost one fifth of OPEC's total production. Its 5 MBD average export level provided for
roughly 10 percent of the non-communist world's oil needs. When the politically-motivated strikes
reduced Iranian oil output below Iran's domestic energy requirements, the global oil production network
was stretched taut as more than 3 MBD of surplus production capacity was thrown into the breach,
leaving oil importers to make up the remaining shortfall by drawing down worldwide oil reserves by an
extra 2 MBD.
The chief source of new oil output was Saudi Arabia, the swing producer par excellence which
functioned as a balance wheel to partially offset the Iranian shortfall and stabilize the volatile world oil
market. A spectacular 3 MBD production boost brought Saudi production up to 10.5 MBD by mid-
January, about 2 MBD higher than Riyadh's 8.5 MBD self-imposed average annual production ceiling.
In addition, Kuwait raised output levels by about 550,000 BD, Nigeria and Venezuela provided
significant supplementary oil production and Iraq, Abu Dhabi, and other Persian Gulf emirates provided
marginal additions to world oil supplies.

Reaction of Other Oil Producers - While the privately-owned international oil industry smoothly
reallocated the Iranian oil shortfall to minimize its impact on world oil markets in general and Iran's
individual customers in particular, various national petroleum organizations have sought to extract
economic and political windfall benefits from the Iranian oil shutdown.

1. Abu Dhabi opportunistically exercised a contractual option to cutback all its long-term oil
supply contracts by 5 per cent, thereby enabling itself to auction off two million barrels of oil on
the spot market in late January. In early February Libya mysteriously cutback oil production by
10 percent citing technical problems in three oil fields, and it is widely suspected that it is
holding back oil in anticipation of future price hikes which might be precipitated by Iran's
current difficulties.

2. The Kuwaiti Oil Minister Sheik Ali Khalifa-al-Sabah has publicly advised other OPEC states
not to raise production levels further until consuming nations have depleted t heir crude oil
stockpiles, presumably because by then OPEC's scheduled price increases will have taken effect
and producers will realize greater returns for identical quantities of petroleum.

3. However, the most unsettling development to date has been the recent Saudi decision to scale
down production in the first quarter to an average rate of 9.5 MBD, a loss of .7 to 1.0'MBD
relative to point 2. Last year Riyadh had indirectly indicated that it would suspend its self-
imposed production ceiling of 8.5 MBD as long as Iran was shutdown. Aramco(Saudi Arabian
oil corporation) boosted production to unprecedented levels (up to 12.85 MBD during one day
in December before having the 8.5 MBD ceiling re-imposed in late January with output
regulation administered on a monthly rather than an annual basis.

4. A "special dispensation" allowed Aramco to produce 1 MBD more than the production ceiling
in the first quarter of 1979 as long as the additional oil produced in excess of 8.5 MBD was sold
at fourth quarter prices. This 10 percent premium was justified in Saudi eyes because the
incremental production was assumed to be borrowed" from the fourth quarter of 1979 when oil
is scheduled to cost 14.55 per barrel.

Impact on Oil Prices - The International Energy Agency (IEA) estimates that the Iranian shutdown has
generated a daily shortage of 1-2 MBD in the international oil marketplace. Such a surfeit of demand
over supply naturally will exert an upward pressure on oil prices, but this pressure on prices is
circumscribed by the fact that more than 90 percent of the oil sold on the world market is sold under
long-term contracts which are ostensibly insensitive to momentary market fluctuations. Such
fluctuations instead register on the spot market which is the closely-watched barometer of prevailing
moods among oil insiders.

In the immediate aftermath of the Iranian shutdown, spot market prices spiralled to $23 a barrel before
settling down to below 20, still $4-5 more than the current OPEC price of $13.34 per barrel. The spot
market scramble was partially caused by major firms invoking force majeure clauses to cutback long-
term supply contracts, forcing independent oil firms and refineries into an enlarged spot market.

While hikes in spot prices have little effect on consumer prices or supplies given the relative smallness
of the spot market the danger is that high spot market prices encourage OPEC price hawks, who
understandably feel that they have as much a right to the extra revenues as do spot market speculators.
The Iranian disruptions last fall (79) were a major reason behind the higher than expected price rises
proclaimed last December and since then the Iranian situation has significantly deteriorated. OPEC
price restraint next year (80) depends on a resolution of the Iranian crisis this year (79) and a slowdown
in the dollar's decline in relative value. Unfortunately, the abrupt contraction of the Iranian arms market
and the 14.5 percent increase in oil prices scheduled for 1979 will tend to weaken the dollar further.
Impact on The U.S - In the first half of 1978, the U.S. was importing Iranian oil at a rate of 885,000
BD, the equivalent of about 10 percent of its oil imports and about 5 percent of its daily oil
consumption. Because other exporters picked up the slack, the U.S. shortfall actually amounted to a net
loss of 500,000 BD. In view of the huge 1.2 billion barrel stock of reserves on hand, Secretary
Schlesinger called the situation "serious but not critical" and maintained that oil market conditions in
the U.S. would remain "quite manageable without Iranian crude at least through the end of March and
possibly up to summer. Thus far the shortfall has exerted, a negligible influence on the economy, but
the returns are not completely in yet. Ultimately the shortfall is expected to trigger higher world oil
prices which will add to inflationary pressures within the U.S. and slow real economic growth. Since
trading partners, like Japan and West Ger many, have historically reacted to such external shocks by
markedly slowing their own economic growth rate, lowering import levels and encouraging exports, it
is likely that the U.S. trade deficit wil1 be adversely affected but this will take time to run through its
course.
 Line at a gas station in Maryland, USA, June 15, 1979.

U.S. Response - Since the controls cannot be immediately dumped due to domestic political pressures,
the Carter Administration started seeking the best way to allocate shortages in the least disruptive
manner. The Administration's immediate response to the Iranian short fall was to call for voluntary
"prudent" conservation aimed at speed limits and eliminate unnecessary driving while asking home
owners to lower their thermostats. This conservation effort was to depress demand while an oil
inventory drawdown of about 500,000 BD increased market supplies. The Administration's second line
of defence, outlined in early February, maintained that the U.S will have to begin to constrain demand
or we will be in trouble next winter Secretary of Energy Schlesinger held out the prospect of mandatory
energy conservation measures which could be triggered by April 1, if Iran had not yet started up
production and voluntary conservation failed to erase the shortfall. Schlesinger focused on the
cumulative effect of tapping oil inventories which would soon need to be built up in preparation for
next winter's heating season. In order to prevent Americans from "borrowing against the future" the
Administration readied mandatory conservation curbs and emergency crude allocation schemes which
would serve the function of redistributing the burden of the Iranian oil shutdown without hindering the
inventory build-ups needed for next winter. Department of Energy was considering in direct curbs
aimed at altering driving patterns by closing gas stations on Sunday or allowing motorists to fill up their
tanks only on alternate days and was preparing a standby gasoline rationing program for submission to
Congress in late February to be used only as a last resort were measures promoting the use of natural
gas rather than oil the easing of clean air regulations to permit more coal consumption and the diversion
of oil from the strategic oil stockpile to the internal oil market Other policy options under consideration
The Iranian shortfall forced the Administration to postpone previously considered energy policy
proposals as well as develop new contingency plans.

Gas coupon printed but not issued during the 1979 energy crisis

Conclusion - The timing of the Iranian oil shutdown was fortuitous for the West. Petroleum stocks
were at an all-time high due to the nor mal build-ups for the winter heating season and abnormally high
stockpiling in anticipation of the OPEC price hike announced in December. The 5 MBD shortfall in
Iranian' exports was made up by approximately 3 MBD of extra production from other oil producers
especially Saudi Arabia, and a 2 MBD faster than normal drawdown of world oil stocks. The United
States suffered a net deficit of 17 500,000 BD and initially sought to make this up through voluntary
conservation measures. However, if the Iranian shutdown lasts much longer, the Carter Administration
may be forced to resort to mandatory allocation measures in order to prevent a major drain on
inventories which would give rise to shortages during the summer driving season or more importantly,
the winter heating season.

Although several oil-exporting states have sought to exploit the tightened supply situation by
opportunistically boosting prices the most ominous development was Saudi Arabia's signal that it was
no longer willing to fully offset the Iranian shortfall. Riyadh's imposition of a 9.5 MBD production
ceiling possibly foreshadows a significant alteration in Saudi long-term oil production plans a move
caught with serious political, economic, and energy supply consequences for the West in general and
the United States in particular.

At this point (79), the single most important determinant of the overall global impact of the Iranian oil
shutdown is the length of time that Iranian oil exports will be denied to the world.

References:

1. www.wikipedia.org

2. www.voltairenet.org/IMG/pdf/1979_OIl_Shock.pdf

3. www.experiencefestival.com/1979_energy_crisis

4. www.heritage.org/research/reports/1979/02/the-iranian-oil-crisis

5. www.recession.org