Many of the most disruptive events for the world’s economies over the past several decades have originated in the world market for oil. The two oil price shocks in 1973 and 1979, as well as the sharp price increase at the beginning of the 1990s, were not really rooted in a narrow economic sense of supply and demand, but to a larger extent in security-related political developments. The supply of oil is one of the determining factors in this issue. Firstly, because oil is a limited resource, secondly because of its geographical distribution. Roughly 63 % of all worldwide oil reserves are concentrated in the Middle East. Therefore, this region is of strategic importance for the oil supply of industrialized western countries.
The first oil crisis in 1973-74 was triggered by the Yom-Kippur War, the second in 1979 by the revolution in Iran and the war with neighboring Iraq, and the third oil price peak examined was triggered by the annexation of Kuwait and the Gulf War.
Oil crisis 1973: On October 19, 1973, immediately following President Nixon’s request for Congress to make available $2.2 billion in emergency aid to Israel for the conflict known as the Yom Kippur War, the Organization of Arab Petroleum Exporting Countries (OAPEC) instituted an oil embargo on the United States. The embargo ceased US oil imports from participating in OAPEC nations and began a series of production cuts that altered the world price of oil. These cuts nearly quadrupled the price of oil from $2.90 a barrel before the embargo to $11.65 a barrel in January 1974. In March 1974, amid disagreements within OAPEC on how long to continue the punishment, the embargo was officially lifted. The higher oil prices, on the other hand, remained. Manipulation of oil prices and supplies by the oil-exporting countries came at the most inopportune time for the United States. In the middle of 1973, wholesale prices of industrial commodities were already rising at an annual rate of more than 10 percent; the industrial plant was operating at virtually full capacity; many major industrial materials were in extremely short supply. In addition to these cost pressures, the US oil industry had a lack of excess production capacity, which meant it was difficult for the industry to bring more oil to the market if needed. Thus, when OAPEC cut oil production, prices had to rise because the American oil industry could not respond by increasing supply.
Economists have since come to understand that a central bank can influence the extent to which supply shocks affect inflation, but they face a trade-off. Higher oil prices, because of the widespread effect they have on commodities throughout the economy, will tend to generate both inflationary pressures and slower growth. In the short run, these forces tend to have an inverse relationship, meaning when one rises, the other falls and vice versa.
This oil crisis was rooted mainly in a supply cut and was followed by skyrocketing prices. The economic impact had been short-term – at least in terms of GDP growth and inflation, which returned to previous levels in 1976-77. However, unemployment remained high. Long-term effects were also caused by increasing budget deficits and the higher debt burden of the affected countries.
Oil crisis 1978-79: The second oil shock in 1978-79 was associated with events in the Middle East and strong global oil demand. The political environment of this oil crisis was determined by three major factors. The first was the fall of the Shah Regime. The second factor was the Iranian hostage crises from 1979 until 1981 and the third was the war between Iran and Iraq from 1980 to 1988. During the Iran-Iraq War (1980–88), in 1981 the price of oil was stabilized at $32 per barrel. By 1983, however, major capitalist economies had adopted more-efficient methods of production, and the problems of the 1970s had been transformed into a relative oversupply of oil rather than a shortage. This lead to demonstrations in Iran followed by heavy riots and labor strikes in the oil sector, which was of high importance for the economy of the country. The oil price dropped below $15 in December 1978. After the Islamic Revolution in January 1979, the price skyrocketed to $30 within 1 year, which was an increase of 100 % within 12 months. One major reason was the disruption in supply. Due to labor strikes and the overall political situation, the oil supply from Iran nearly came to a halt at the end of 1978. The aggregated production of Arab oil-exporting countries fell by 15 % from September 1978 to January 1979. World oil production suffered a cut of about 5 %.
Meanwhile, in September 1980, neighboring Iraq attacked the country. The main reason was the struggle for dominance in the region between the two oil-rich countries.
The overall economic situation in the mid-seventies was still clearly determined by the aftershocks of the first oil price shock. The world economy and international trade had just recovered from the slump and grew both by roughly 4.7 % in 1978. The US economy also seemed to have recovered and increased by about 5 % p.a. from 1976 to 1978. The unemployment rate was at 6 % after having been at more than 8 %, and US consumer prices were at 7.6 % after 11.1 % during the first oil price shock. Despite the fact that the global oil supply decreased by only 4%, widespread panic resulted, driving the price far higher. The price of crude oil more than doubled to $39.50 per barrel over the next 12 months, and long lines once again appeared at gas stations as they had in the 1973 oil crisis.
Gulf war 1991: The main factor which characterized the condition of this episode of Gulf war at the beginning of the 1990s was the Iraqi invasion in Kuwait in August 1990. While Saddam Hussein (former president of Iraq) claimed that Kuwait had always been a part of Iraq and one of the country’s provinces, the real reasons of this violent occupation were that oil stocks in the Kuwaiti-Iraqi border region were claimed by both nations (Iraq accused Kuwait of oil “theft”) and economic conditions in Iraq had been weak that suffered from a high financial burden following the long and costly war with neighboring Iran.
When Iraq invaded Kuwait on August 2, 1990, the markets reacted with panic, fearing that the oil supply from Iraq or Kuwait could be threatened and that there would be an oil shortage. Furthermore, with the USA announcing that it would not tolerate this act, the fear of a war in the Gulf region impacted upon prices. And finally, given that more than 60 % of the world oil reserves are concentrated in this region, the fear of a major armed conflict affecting Iraq’s neighbor Saudi Arabia, which alone holds more than 20 % reserves, had its effect. The oil price thus skyrocketed from $16.54 per barrel in July 1990 to $32.88 in October, an increase of 100 % within just two months. Oil speculations on the markets also had its effect.
While the annexation of Kuwait and the Gulf War led to a short-time price peak, the oil supply was also affected. In August 1990, the oil supply from Arab countries fell by 25 %, mainly driven by the dropout of Kuwait as a supplier, and possibly also due to the trade embargo that was imposed against Iraq.
Worldwide GDP growth dropped in the year of the war from 2.5 % to 0.8 % in 1991. It remained low and only recovered to 2.2 % in 1994. Worldwide merchandise exports remained stable at an annual growth rate of around 4 %. FDI inflows were negative from 1990 to 1992.
Conclusion: Looking at the three past crises and their consequences, several similarities were observed. What all three crises have in common is that these led to pressure on supply, market mechanisms and to a certain extent psychological factors that influenced the oil price. The outcome was also similar, depending on the size of the price increase and its duration: declining GDP, increasing inflation and rising unemployment, not to mention budgetary effects. These effects are complex but apparently of short duration, at least in most cases.