Riding the Switchback

A Brief History of Booms and Busts: Part II
This article appeared in Vol. 14, No. 5 - 2017


This article continues the history of oil price booms and bust, and Part I can be read here.

In this second part we review the history of oil booms and busts during the 1960s–2010s, which witnessed the turbulent rise of OPEC.

At the end of WWII in 1945, the USA held a prominent position in the world in terms of oil reserves and production, but over the following two decades power shifted to the Middle East. Between 1948 and 1972 (just before the First Oil Shock), the world’s proven reserves grew from 62 Bbo to 534 Bbo, the Middle East accounting for 70% of this increase. During the same period, the western world’s production grew from 8.7 to 42 MMbopd while that of the Middle East grew from 1.1 to 18.2 MMbopd. This growth in production was in response to a rapidly rising market, especially in America, Europe and Japan where the manufacturing and use of cars were rapidly increasing. Throughout the 1950s and ’60s, oil prices remained relatively low and stable at US$ 1.70–2.1, thanks partly to the production of cheap oil from the Middle East which was controlled by the ‘Seven Sisters’. This control of oil in the Middle East and North Africa by major Western enterprises in conjunction with the spread of anticolonial sentiments in the region heralded major changes in the relationships between the Seven Sisters and the oil-producing countries, climaxing in the formation of OPEC in 1960 (see GEO ExPro, Vol. 7, No. 6).

Two Oil Shocks

The Iranian delegation at the inaugural OPEC meeting in 1960. The rapid increase in oil prices from $2.48 per barrel in 1972 to $11.65 at the end of 1973 was associated for months with public panic, oil shortage and gasoline lines in the USA and most industrial nations. It was the First Oil Shock on a global scale (see GEO ExPro, Vol. 12, No. 3) and occurred against a backdrop of latent factors that surfaced during 1972–73. OPEC, largely ignored by the major Western oil companies throughout the 1960s, was like a fire under the ashes and blazed up in the early ’70s, asserting its powerful presence in the international oil market against the Seven Sisters. The cheap oil of the 1950s and ’60s had addicted the USA and Europe to oil and the industrial countries dependent on oil imports were thus vulnerable. Domestic oil production in the USA indeed peaked in 1970 as M. King Hubbert had predicted in 1956; from 1970 onward, the US significantly increased its imports of foreign oil. Finally, the Israel-Palestinian conflict was revived in October 1973, when Egypt and Syria invaded Israel to expel it from the land it had taken in 1967. The oil-rich Arab countries imposed an oil embargo against the US and other countries for their support of Israel. This did not achieve its objectives against Israel, but the OPEC countries as a whole came out in financially a much better position than ever before.

A common sight in 1973. These factors triggering the 1973 oil shock are well known, but what is perhaps less discussed is that the US administration actually favoured oil price increases for a number of reasons. For one thing, high prices would decrease oil consumption in Western countries and would also make the development of the recently discovered oil fields in Alaska and the North Sea financially feasible. On the foreign policy side, it would strengthen Iran and Saudi Arabia, the main US allies in the region, against the Soviet Union during those years of the Cold War. This aspect of the 1973 oil shock has been articulated by several OPEC insiders including Francisco Parra in Oil Politics (2004) and Fadhil Chalabi in Oil Politics, Oil Myths (2010).

The Second Oil Shock in 1979–80 was also due to political unrest in the Middle East. In 1978, a popular revolution began against the Shah’s regime in Iran and a consequent strike in Iran’s oil industry decreased its oil exports from 4.5 MMbopd to less than 1.0 MMbopd. A year later, the Shah’s pro-US government was replaced by Khomeini’s less USfriendly Islamic Republic. Oil prices rose from $12.80 in October 1978 to nearly $40 in November 1979, the year in which the USSR invaded Afghanistan, further disrupting the geopolitics of the Middle East. In September 1980, Iraq invaded revolutionary Iran – a futile war that lasted eight years and weakened both nations’ economies. Other oil-producing countries seized these opportunities and raised oil prices drastically. Overall, oil prices increased from $14.00 in 1978 to $36.83 in 1980. Gasoline lines again hit American consumers and cost President Jimmy Carter his re-election in 1981. The Second Oil Shock further strengthened OPEC’s position internationally.

The 1986 Oil Glut

The 1980 price increase motivated rapid increases in oil production by both OPEC countries and non-OPEC producers, especially the Soviet Union, the USA and Mexico. This increase in production, however, went in parallel with decreasing demand as a response to high prices; consumption in the US, Europe and Japan fell by 15% between 1979 and 1984.

With the prominent position of non-OPEC producers, OPEC members were weakened. Although they decided to cut production several times from 1980–85 to maintain high oil prices, they were not united and cheating on production quota or selling oil below official prices tore them apart. Moreover, in the first half of the 1980s, non-OPEC oil producers had become far more important players. Saudi Arabia produced over 10 MMbopd in October 1980 but had cut back to only 2.3 MMbopd by August 1985. In 1986, Saudi Arabia, tired of OPEC members’ non-compliance with their production quota, increased its own oil production to 6.2 MMbopd, flooding the world market with cheap oil; it did not want to be a swing producer any longer. Rumour also has it that Saudi Arabia’s push for oil production was encouraged by President Reagan’s administration in order to hurt the Soviet economy, which was increasingly dependent on oil revenues. True or not, the oil price plunge indeed contributed to the decline of the Soviet economy.

The oil glut of 1986 brought about the most severe market crash in oil history (matched only by the 2014 bust). Oil prices in 1986 were $14.43 on average, but at times fell below $10. Oil companies shut down exploration projects and laid off hundreds of thousands of workers. The independent oil producers in the US were hit hardest; more than half went out of business. It took ten years for prices to rise to the level of $20 a barrel. From 1985 to 1995, US oil production steadily declined from 10.6 to 8.3 MMbopd.

Kuwait War to Asian Financial Crisis

Oil wells burning after Iraqi troops retreated from Kuwait in 1991. In August 1990, Saddam Hussein invaded neighbouring Kuwait and the following January the US and allied forces launched a massive military assault on Iraq in order to drive them out of Kuwait. By March Operation Desert Storm had liberated Kuwait, although it took the rest of 1991 to put out fires in more than 700 oil wells that the retreating Iraqi soldiers had started. Oil prices increased from $17 to $36 in September 1990, but Saudi Arabia increased its production from 5.4 MMbodp to about 8 MMbopd in October 1990 to make up for the market loss of Kuwaiti oil. Moreover, the US released 17.2 MMb of its strategic petroleum reserves to the market. These efforts helped ease the temporary oil shortage; nevertheless, average oil prices in 1990 and 1991 stood at slightly higher than $20 a barrel, partly because of the collapse of the Soviet Union in 1991 and consequent disruption of their oil industry.

By 1996, oil from both Kuwait and Iraq were back on the market. Late in 1997, however, financial crisis hit the South East Asian ‘tiger’ economies, reducing demand, which coupled with increased OPEC production resulted in the oil market crash of 1998 with prices below $10 a barrel. This bust was short-lived; by the end of the 1990s, the oil market was set for a dramatic return.

A New Century for Oil?

As the 21st century began, economic growth, especially in populous China and India, together with the resurging Asian tigers, enormously increased global demand for oil. Indeed, from 1999 to 2008, oil prices increased from $18 to $97 a barrel. During the same period consumption rose from 76.3 to 86.6 MMbopd, with China and India accounting for nearly half this increase. This rapid demand reduced spare capacity in oil-producing countries to less than 1 MMbopd in the mid-2000s. From 1999 to 2008, domestic oil production in the US fell from 7.7 to 6.8 MMbopd and the US dollar was weakened against European and Asian currencies.

The US invasions of Afghanistan in 2001 and Iraq in 2003 and the long-term ‘war on terror’ in the Middle East created uncertainty over oil supplies throughout the 2000s. Unrest in the Niger Delta disrupted oil operations. President Putin’s policy of restraining foreign oil companies sent alarming signals about Russian oil. In August 2005, Hurricane Katrina disrupted oil operations in the Gulf of Mexico and southern US coastal states, further adding to uncertainties and price increases.

The rapid rise of oil prices between 2003 and 2008 can be regarded as the Third Oil Shock. Peak oil fears were widespread in the 2000s, with many articles, websites, and conferences promoting the idea that global oil reserves and production had reached a peak and oil was on the verge of a rapid decline. Disciples of M. King Hubbert’s peak oil scenario revived the idea in the late 1990s, suggesting various years of peak oil throughout the 2000s. Politicians were alarmed too; President George Bush, Jr. openly called for a cure for America’s “addiction to oil.” 

Did the 21st century bring peak oil – or a new century for oil? The following years provide some clues to unravelling this question.

2008 Recession and 2014 Bust

The price of oil increased sharply from $50 in early 2007 to $140 in the summer of 2008. Just as some experts were suggesting $200 a barrel by the end of 2009, economic recession hit in late 2008 and oil dropped as low as $32 a barrel. This recession began in the USA as a result of real-estate mortgage crises, tight credit lines and the bankruptcy of large financial institutions, but it rapidly translated into a global economic crisis, the largest since the Great Depression of the 1930s. With slowing economies, consumption dwindled, thus lowering oil prices considerably. Nevertheless, with improving economic conditions, in August 2009 prices rose to $70 a barrel and remained at $90–120 until mid-2014.

The recent oil bust is comparable to the market crash of 1986. It is usually thought that the 2014 bust began when Saudi Arabia again refused to act as a swing producer to stabilise the market and began flooding the world market with oil. Initially, it was argued that they wanted to punish Russia or Iran by weakening their oil-dependent economies. Later, however, it was revealed that the real target was North American shale oil producers; the Saudis wanted to secure their oil market share in the US and other parts of the world by driving shale producers out of business through lower prices. The partial lifting of sanctions against Iran and the return of Libyan oil added to the glut.

The increase in US shale production as well as the strengthening of the US dollar contributed to the oil bust of 2014. In that year, USA became one of the top oil producers alongside Saudi Arabia and Russia, and oil prices fell below $30 a barrel in January 2016. Despite this, current technological developments in shale oil production have made this new oil supply resilient and profitable, making this oil bust different from that of 1986. Only the future will tell where this new oil player will take prices.

A Sum-Up

Chronology of oil prices 1951–2016 (source: BP Statistical Review of World Energy 2017). Oil prices are basically controlled by supply and demand. This simple relationship, however, is complicated by other factors. For one thing, supply is not solely controlled by geology and technology; political conflicts and violence in the Middle East and North Africa obviously played critical roles in the first and second oil shocks, and natural hazards like hurricanes also influence oil supplies, albeit perhaps briefly and locally. Consumption is closely related to economic growth. During the mid-2000s rapid economic growth in China and India increased global demand for oil and thus put restraints on oil supplies and spare capacity. Geology, therefore, is not an ideal indicator for forecasting oil prices and production, despite what the proponents of peak oil say. In fact, technological advances in the oil industry have historically been made in response to market demands. Because of the non-geological uncertainties in oil supply and demand, speculation over future oil sales in stock exchange markets also factor in oil prices. Since much of the world’s oil has historically been traded in US dollars, the strengthening or weakening of the dollar against other currencies also directly affects oil prices.


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