1973 oil crisis

The world oil shock of 1973 began in earnest on October 17, 1973, when Arab members of the Organization of Petroleum Exporting Countries (OPEC), in the midst of the Yom Kippur War, announced that they would no longer ship petroleum to nations that had supported Israel in its conflict with Egypt—that is, to the United States and its allies in Western Europe. At around the same time, OPEC-member states agreed to use their leverage over the world price-setting mechanism for oil to quadruple world oil prices. The complete dependence of the industrialized world on oil, much of which resided beneath the surface of Middle Eastern countries, became painfully clear to the U.S., Western Europe, and Japan, marking a watershed requiring Western policymakers to respond to international economic constraints that were qualitatively different from those faced by their predecessors.¹

Origins of the 1973 world oil shock

World competition over resources

The Arab-Israeli conflict triggered an energy crisis in the making. Before the embargo, the industrialized West, especially the United States, had taken cheap and plentiful petroleum for granted. (Indeed, the form American cities took after World War II - with expansive suburbs full of detached, single-family homes - depended on the automobile as the principal means of transportation - a form that consumes oil en masse as fuel.) Between 1945 and the late 1970s, the West and Japan consumed more oil and minerals than had been used in all previous recorded history. Oil consumption in the United States had more than doubled between 1950 and 1974. With only 6 percent of the world's population, the U.S. was consuming 33 percent of the world's energy.

The fall of the dollar

U.S. economic policies had an important effect on the crisis. While the OPEC boycott was an immediate trigger historians increasingly see the crisis as being rooted in American economic policies.

Oil, especially from the Middle East, was paid for in United States dollars, at prices fixed in dollars. U.S. President Richard Nixon had inherited an economy in which growth was already sluggish, in which inflation was already troubling. By the summer of 1971, the president was under strong public pressure to act decisively to end the dilemma of rising prices and general economic stagnation (see "stagflation"). Nixon thus released the dollar from the fluctuating gold standard that had controlled its worth since the signing of the Bretton Woods pact at the end of World War II, allowing its value to fall in world markets. The United States suspended convertibility of the dollar on August 15, 1971; the dollar was devalued by 8 percent in relation to gold in December 1971, and devalued again in 1973.

The devaluation resulted in increased world economic and political uncertainty. Concurrently, in the early 1970s, the fall in the dollar went along with a fall in the price in dollars for oil. This improved the situation of U.S. industrialists in relation to European and Japanese competition. But the de-valorization, and then devaluation, of the dollar crystallized the unease of raw materials producers in the Third World who saw the wealth under their lands being reduced and their assets growing in a currency that was worth significantly less than it had been worth just quite recently. This set the stage for the struggle for control of the world's natural resources and for a more favorable sharing of the value of these resources between the rich countries and the oil-exporting nations of OPEC.

OPEC devised a strategy of counter-penetration, whereby it hoped to make industrial economies that relied heavily on oil imports vulnerable to Third World pressures. Dwindling foreign aid from the United States and its allies, combined with the West's pro-Israeli stance in the Middle East, angered the Arab nations in OPEC.

Founding of OPEC

OPEC consisted of thirteen nations, including seven Arab countries but also other major petroleum-exporting countries in the developing world like Iran and Venezuela. It had been formed in 1960 to protest pressure by major oil companies (mostly owned by U.S., British, and Dutch nationals) to reduce oil prices and payments to producers. At first it had operated as an informal bargaining unit for the sale of oil by Third World nations. It confined its activities to gaining a larger share of the revenues produced by Western oil companies and greater control over the levels of production. However, in the early 1970s it began to display its strength.

The Yom Kippur War

The persistence of the Arab-Israeli conflict finally triggered a response that transformed OPEC from a mere cartel into a formidable political force. After the Six Day War of 1967 the Arab members of OPEC formed a separate, overlapping group (Organization of Arab Petroleum Exporting Countries) for the purpose of centering policy and exerting pressure on the West over its support of Israel. Egypt and Syria, though not major oil-exporting countries, joined the latter grouping to help articulate its objectives. Later, the Yom Kippur War of 1973 galvanized Arab opinion. Furious at the emergency re-supply effort that had enabled Israel to withstand Egyptian and Syrian forces, the Arab world imposed the 1973 oil embargo against the United States, Western Europe, and Japan. By the early 1970s the great Western oil conglomerates suddenly faced a unified bloc of producers.

As mentioned, the Arab-Israeli conflict triggered a crisis already in the making. The West could not continue to increase its energy use 5 percent annually, pay low oil prices, yet sell inflation-priced goods to the petroleum producers in the Third World. This was stressed by the Shah of Iran, whose nation was the world's second-largest exporter of oil and the closest ally of the United States in the Middle East at the time. "Of course [the world price of oil] is going to rise," the Shah told the New York Times in 1973. "Certainly! And how… You [Western nations] increased the price of wheat you sell us by 300 percent, and the same for sugar and cement… You buy our crude oil and sell it back to us, redefined as petrochemicals, at a hundred times the price you've paid to us… It's only fair that, from now on, you should pay more for oil. Let's say 10 times more.""²

Arab oil embargo

On October 16th, 1973, as part of the political strategy that included the Yom Kippur War, OPEC cut production of oil, and placed an embargo on shipments of crude oil to the West, with the United States and the Netherlands specifically targeted. Also imposed was a boycott of Israel, and price increases. Since oil demand falls little with price rises, prices had to rise dramatically to reduce demand to the new, lower, level of supply. Anticipating this, the market price for oil immediately rose substantially. A world financial system already under pressure from the breakdown of the Bretton Woods agreement, would be set off on a path of a series of recessions and high inflation that would persist until the early 1980's, and elevated oil prices that would persist until 1986.

The graph to the right is based on the nominal, not real, price of oil, and so overstates prices at the end. However, the effects of the Arab Oil Embargo are clear - it effectively doubled the real price of crude oil at the refinery level, and caused massive shortages in the US. This would exacerbate a recession that had already begun, and lead to a global recession through the rest of 1974.

Over the long term, the oil embargo would change the nature of policy in the West, towards more exploration, towards energy conservation, and towards more restrictive monetary policy, which more aggressively fought inflation.

Chronology

• Sept. 15 - The Organization of Petroleum Exporting Countries (OPEC) declares a negotiating front, consisting of the 6 Persian Gulf States, to pressure for price increases and an end to support of Israel, based on the 1971 Tehran agreement.
• Oct. 6 - Egypt and Syria attack Israel on Yom Kippur, starting the fourth Arab-Israeli war.
• Oct. 8–10 - OPEC negotiations with oil companies to revise the 1971 Tehran price agreement fail.
• Oct. 16 - Saudi Arabia, Iran, Iraq, Abu Dhabi, Kuwait and Qatar unilaterally raise posted prices by 17 percent to $3.65 a barrel and announce production cuts.
• Oct. 17 - OPEC oil ministers agree to use oil as a weapon to punish the West for its support of Israel in the Arab-Israeli war. They recommend an embargo against unfriendly states and mandate a cut in exports.
• Oct. 19 - Saudi Arabia, Libya and other Arab states proclaim an embargo on oil exports to the United States.
• Oct. 23–28 - The Arab oil embargo is extended to the Netherlands.
• Nov. 5 - Arab producers announce a 25 percent output cut. A further five percent cut is threatened.
• Nov. 23 - The Arab embargo is extended to Portugal, Rhodesia and South Africa.
• Nov. 27 - U.S. President Richard Nixon signs the Emergency Petroleum Allocation Act authorizing price, production, allocation and marketing controls.
• Dec. 9 - Arab oil ministers agree a further five percent cut for non-friendly countries for January 1974.
• Dec. 25 - Arab oil ministers cancel the five percent output cut for January. The Saudi oil minister promises a 10 percent OPEC production rise.
• Jan. 7–9, 1974 - OPEC decides to freeze prices until April 1.
• Feb. 11 - U.S. Secretary of State Henry Kissinger unveils the Project Independence plan to make U.S. energy independent.
• Feb. 12–14 - Progress in Arab-Israeli disengagement brings discussion of oil strategy among the heads of state of Algeria, Egypt, Syria and Saudi Arabia.
• Mar. 17 - Arab oil ministers, with the exception of Libya, announce the end of the embargo against the United States.

Immediate economic impact of the embargo

The effects of the embargo were immediate. OPEC forced the oil companies to increase payments drastically. The price of oil quadrupled by 1974 to nearly US$12 per 42 US gallon barrel (75 US$/m³). [1] (http://www.cbc.ca/news/background/oil/)

This increase in the price of oil had a dramatic effect on oil exporting nations, for the countries of the Middle East who had long been dominated by the industrial powers were seen to have acquired control of a vital commodity. The traditional flow of capital reversed as the oil exporting nations accumulated vast wealth. Some of the income was dispensed in the form of aid to other underdeveloped nations whose economies had been caught between higher prices of oil and lower prices for their own export commodities and raw materials amid shrinking Western demand for their goods. Much of it, however, fell into the hands of elites who reinvested it in the West or enhanced their own well being. Much was absorbed in massive arms purchases that exacerbated political tensions, particularly in the Middle East.

OPEC-member states in the developing world withheld the prospect of nationalization of the companies' holdings in their countries. Most notably, the Saudis acquired operating control of Aramco, fully nationalizing it in 1980. As other OPEC nations followed suit, the cartel's income soared. Saudi Arabia, awash with profits, undertook a series of ambitious five-year development plans, of which the most ambitious, begun in 1980, called for the expenditure of $250 billion. Other cartel members also undertook major economic development programs.

Meanwhile, the shock produced chaos in the West. In the United States, the retail price of a gallon of gasoline rose from a national average of 38.5 cents in May 1973 to 55.1 cents in June 1974. Meanwhile, New York Stock Exchange shares lost $97 billion in value in six weeks.

With the onset of the embargo, U.S. imports of oil from the Arab countries dropped from 1.2 million barrels (190,000 m³) a day to a mere 19,000 barrels (3,000 m³). Daily consumption dropped by 6.1 percent from September to February, and by the summer of 1974, by 7 percent as the United States suffered its first fuel shortage since the Second World War.

Underscoring the interdependence of the world societies and economies, oil-importing nations in the noncommunist industrial world saw sudden inflation and economic recession. In the industrialized countries, especially the United States, the crisis was for the most part borne by the unemployed, the marginalized social groups, certain categories of aging workers, and increasingly, by younger workers. Schools and offices in the U.S. often closed down to save on heating oil; and factories cut production and laid off workers.

The embargo was not blanket in Europe. Of the nine members of the European Economic Community, the Dutch faced a complete embargo (having voiced support for Israel and allowed the Americans to use Dutch airfields for supply runs to Israel), the United Kingdom and France received almost uninterrupted supplies (having refused to allow America to use their airfields and embargoed arms and supplies to both the Arabs and the Israelis), whilst the other six faced only partial cutbacks. The UK had traditionally been an ally of Israel, and Harold Wilson's government had supported the Israelis during the Six Day War, but his successor, Ted Heath, had reversed this policy in 1970, calling for Israel to withdraw to its pre-1967 borders. The members of the EEC had been unable to achieve a common policy during the first month of the Yom Kippur War. The Community finally issued a statement on 6 November, after the embargo and price rises had begun; widely seen as pro-Arab, this statement supported the Franco-British line on the war and OPEC duly lifted its embargo from all members of the EEC. The price rises had a much greater impact in Europe than the embargo, particularly in the UK (where they combined with industrial action by coal miners to cause an energy crisis over the winter of 1973-74, a major factor in the breakdown of the post-war consensus and ultimately the rise of Thatcherism).

Unlike any other oil-importing developed nation, Japan fared particularly well in the aftermath of the world energy crisis of the 1970s. Japanese automakers led the way in an ensuing revolution in car manufacturing. The large automobiles of the 1950s and 1960s were replaced by far more compact and energy efficient models. (Japan, moreover, had cities with a relatively high population density and a relatively high level of transit ridership.)

A few months later, the crisis eased. The embargo was lifted in March 1974 after negotiations at the Washington Conference, but the effects of the energy crisis lingered on throughout the 1970s. The price of energy continued increasing in the following year, amid the weakening competitive position of the dollar in world markets; and no single factor did more to produce the soaring price inflation of the 1970s in the United States.

Response in the industrialized countries

Rationing of gasoline occurred in many countries, with motorists facing long lines at gas stations. In the U.S., drivers of vehicles with license plates having an odd number as the last digit were allowed to purchase gasoline for their cars only on odd-numbered days of the month, while drivers of vehicles with even-numbered license plates were allowed to purchase fuel only on even-numbered days. The rule did not apply on the 31st day of those months containing 31 days, or on February 29 in leap years — the latter never came into play as the restrictions had been abolished by 1976.

The U.S. government response to the embargo was quick, but of limited effectiveness. A national speed limit of 55 miles per hour was imposed to help reduce consumption. This, incidentally, was claimed by some to have caused traffic fatalities to drop by 23 percent between 1973 and 1974. As a result this law was not completely reversed until 1995. President Nixon named William Simon as an official "energy czar," and in 1977 a cabinet-level Department of Energy was created, which led to the creation of the United States' Strategic Petroleum Reserve. The National Energy Act of 1978 was also largely a response to this crisis. The crisis was further exacerbated by government price controls in the United States, which limited the price of "old oil" (that already discovered) while allowing newly discovered oil to be sold at a higher price, resulting in a withdrawal of old oil from the market and artificial scarcity. The rule had been intended to promote oil exploration.

Year-round Daylight Saving Time was implemented: at 2:00 AM local time on January 6, 1974, clocks were advanced one hour across the nation; the move spawned significant criticism because it forced many children to commute to school before sunrise. As a result, the clocks were turned back on the last Sunday in October as originally scheduled, and in 1975 clocks were set forward one hour at 2:00 AM on February 23, the later date being adopted to address the aforementioned issue. The pre-existing daylight-saving rules, calling for the clocks to be advanced one hour on the last Sunday in April, were restored in 1976 (this date being changed to the first Sunday in April in 1987).

The 1973 oil crisis was a major factor in Japanese economy shift away from oil-intensive industries and resulted in huge Japanese investments in industries like electronics.

The crisis also prompted a call for individuals and businesses to conserve energy — most notably a sophisticated campaign by the Advertising Council using the tag line "Don't Be Fuelish." Many newspapers carried full-page advertisements that featured cut-outs which could be attached to light switches that had the slogan "Last Out, Lights Out: Don't Be Fuelish" emblazoned thereon.

The western nations' central banks decided to sharply cut rates to encourage growth, deciding that inflation was a secondary concern. Although this was the orthodox macroeconomic presciption at the time, the resulting stagflation surprised economists and central bankers, and the policy is now considered by some to have deepened and lengthened the adverse effects of the embargo.

Long-term effects of the embargo are still being felt. Public suspicion of the oil companies, who were thought to be profiteering or even working in collusion with OPEC, continues unabated (seven of the fifteen top Fortune 500 companies in 1974 were oil companies, with total assets of over $100 billion).

The energy crisis led to greater interest in renewable energy, especially wood fuel and spurred research in solar power and wind power. It also led to greater pressure to exploit North American oil sources, and increased the West's dependence on coal and nuclear power.

In Australia, heating oil ceased being considered an appropriate winter heating fuel. This often meant that a lot of oil-fired room heaters that were popular from the late-1950s to the early-1970s were considered redundant. It also meant that some enterprising individuals designed aftermarket gas-conversion kits that let these heaters burn natural gas or propane.

But the initial moves toward more efficient automobiles and alternative sources of energy stalled as oil prices fell and memories of gasoline shortages of 1973 faded. The U.S. continues to use energy in amounts out of proportion to its population, U.S. automakers continue to oppose legislation that would force them to increase the fuel efficiency of automobiles (see, e.g., "SUV"), and the U.S. continues to regard the supply of oil as a major national security concern. This has played a role in military action in the middle east (see, e.g., Persian Gulf War).

For the handful of industrialized nations that were net energy exporters the effects of the oil crisis were very different. In Canada the industrial east suffered many of the same problems of the United States. In oil rich Alberta there was a sudden and massive influx on money that quickly made it the richest province in the federation. The federal government attempted to correct this imbalance through the creation of the government owned Petro-Canada and later the National Energy Program. These efforts produced a great deal of anger in the west producing a sentiment of alienation that has remained a central element of Canadian politics to this day. Overall the oil embargo had a sharply negative effect on the Canadian economy. The economic malaise in the United States easily crossed the border and increases in unemployment and stagflation hit Canada as hard as the United States despite Canadian fuel reserves.

The Soviet Union was also a net oil exporter and the increase in the price of oil had an immediate effect on that country. The Soviet economy had stagnated for several years and the increase in the price of oil had a beneficial effect, especially after the bloc's internal terms of trade were adjusted to reflect the increased value of Russian oil. The increase in foreign currency reserves allowed the import of grain and other foodstuffs from abroad, increased production of consumer goods and the ability to keep military spending at its traditional levels. Some historians believe the windfall in oil revenues during this period kept the Soviet Union in existence for a considerably longer period of time than would otherwise have occurred.

Effects on international relations

The Cold War policies of the Nixon administration also suffered a major blow in the aftermath of the oil embargo. They had focused on China and the Soviet Union, but the latent challenge to U.S. hegemony coming from the Third World was now starkly evident. U.S. power was under attack even in Latin America.

The oil embargo was announced roughly just one month after a right-wing military coup in Chile toppled elected socialist president Salvador Allende on September 11, 1973. The U.S.'s subsequent assistance to this government did little in the short-run to curb the activities of socialist guerrillas in the region. The response of the Nixon administration was to propose doubling of the amount of military arms sold by the United States. As a consequence, a Latin American bloc was organized and financed in part by Venezuela and its oil revenues, which quadrupled between 1970 and 1975.

In addition, Western Europe and Japan began switching from pro-Israel to more pro-Arab policies. This change further strained the Western alliance system, for the United States, which imported only 12 percent of its oil from the Middle East (compared with 80 percent for the Europeans and over 90 percent for Japan), remained staunchly committed to its backing of Israel.

A year after the unveiling of the 1973 oil embargo, the nonaligned bloc in the United Nations passed a resolution demanding the creation of a "new international economic order" in which resources, trade, and markets would be distributed "equally."

Decline of OPEC

Since 1973, OPEC failed to hold on to its preeminent position, and by 1981 its production was surpassed by that of other countries. Additionally, its own member nations were divided among themselves. Saudi Arabia, trying to gain back market share and to make the most expensive oil production facilities less profitable or even unprofitable, exerted pressure toward lowering prices. The world price of oil, which had reached a peak in 1979, at more than US$80 a barrel (503 US$/m³), decreased during the early 1980s to US$38 a barrel (239 US$/m³). In real prices oil briefly fell back to pre-1973 levels. Overall, the reduction in price was a windfall for the oil-consuming nations: Japan, the consuming nations of Europe and of the Third World especially.

Part of the decline in prices and in the relative economical and geopolitical power of OPEC and other oil-producing countries, as well as of oil-related companies, comes from the move away from oil consumption, which was a foreseeable consequence of the cartelization of any market as consumers look for alternatives. (OPEC had relied on the famously limited price sensitivity of oil demand to maintain high consumption, but had underestimated the extent to which other sources of supply would become profitable as the price increased.)

At the same time, the drop in prices represented a serious problem for oil-producing countries in Northern Europe and in the Persian Gulf region. And for a handful of heavily populated, impoverished countries, whose economies were largely dependent on oil — including Mexico, Nigeria, Algeria, and Libya — and whose governments and business leaders failed to prepare for a market reversal, the price drop placed them in wrenching, sometimes desperate situations.

When reduced demand and over-production produced a glut on the world market in the mid-1980s, oil prices plummeted and the cartel lost its unity. Oil exporters such as Mexico, Nigeria, and Venezuela, whose economies had expanded frantically, were plunged into near-bankruptcy, and even Saudi Arabian economic power was significantly weakened. The divisions within OPEC made subsequent concerted action more difficult.

Nevertheless, the 1973 oil shock provided dramatic evidence of the potential power of Third World resource suppliers in dealing with the developed world. The vast reserves of the leading Middle East producers guaranteed the region its strategic importance, but the politics of oil still proves dangerous for all concerned to this day.

In thirty year old British government documents released in January 2004, it was revealed that the United States considered invading Saudi Arabia and Kuwait during the crisis and seizing the oil fields in those countries. According to the BBC, other possibilities, such as the replacement of Arab rulers by "more amenable" leaders, or a show of force by "gunboat diplomacy," were rejected as unlikely. ³

Notes and references

¹ See, e.g., Alan S. Blinder, Economic Policy and the Great Stagflation (New York: Academic Press, 1979); Otto Eckstein, The Great Recession Amsterdam: North-Holland, 1979); Mark E. Rupert and David P. Rapkin, "The Erosion of U.S. Leadership Capabilities," in Paul M. Johnson and William R. Thompson, eds., Rhythms in Politics and Economics (New York: Praeger, 1985)
² Quoted in Walter LaFeber, Russia, America, and the Cold War (New York, 2002), p. 292.
³ See the January 2, 2004 article by BBC News Online world affairs correspondent Paul Reynolds "US ready to seize Gulf oil in 1973" at [2] (http://news.bbc.co.uk/1/hi/world/middle_east/3333995.stm).

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