Lesson 10 covered the golden age of OPEC, and also saw significant conflict and upheaval in the Middle East, especially with Iran and Iraq. As noted in the previous lesson, there continued to be shifting from concessions to nationalization in the producing countries. These conditions led to adjustments in the consuming nations to the new realities of oil supplies and markets.
All of this helps usher in a second oil shock with the usual panic, price increases, leapfrogging and scrambling. Gas lines and the Iran hostage crisis helped bring down a presidential administration. During the oil price increases, all other outputs that required oil also increased in price. This, as expected, led to inflation, high interest rates, and a world-wide recession that led to declining oil demand. But the greed of OPEC in increasing prices (despite the war), the declining demand for oil because of inflation, the surge in non-OPEC production, and the great inventory dump all led eventually to further declining prices.
By the end of this lesson, you should be able to:
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Activity | Location | Submitting Your Work |
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Read | The Prize: Chapters __ (select sections) The Quest: Chapter __ (select sections) |
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Discuss | Participate in the Yellowdig discussion | Canvas |
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Begin | The Unessay Project | Canvas |
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The key to a successful group of entities, be they companies are countries, is some degree of cooperation and consistency. OPEC has always been plagued with challenges from within. Some want higher prices; others want less production to grow demand. Iran was a short-term thinker, Saudi Arabia a long-term thinker. On paper, OPEC is a powerhouse, controlling so much of the world’s oil that they can make or break economies. And they have. OPEC became a major force in the world economy, with the flow of petro-dollars earnings increasing from $23 billion in 1972 to $140 billion by 1977. The international oil order had been turned upside down. OPEC essentially then determined if there would be inflation or recession, and they were the world's new bankers.
During OPEC’s golden age, 1974-1978, they acquired complete control of their own resources, and there was no longer confusion on who owned the oil. When you have much of one thing, regardless how valuable, it can lead to desiring things you do not have. With the wealth and riches, the oil-producing countries acquired the spending trappings of the West — industrialization, infrastructure, subsidies, services, necessities, luxuries, weapons, waste, and corruption. To ensure the security of oil access, weapons sales were used as a way to enhance security and maintain and gain influence. The OPEC shopping spree, through the attempt to buy a modern economy off the rack and build modern military forces, led to the evaporation of the financial surpluses. By 1978, the 1972 surplus in the balance of payment of OPEC of $67 billion had become a deficit of $2 billion.
Had the poor management and strategy of OPEC been confined to the member countries it would be one issue. But the oil price hikes and the “OPEC tax” brought about a deep recession in the industrial countries. For example, the gross national product (GNP) of the US plunged by 6% between 1973 and 1975 and unemployment doubled to 9%. In 1974, Japan's GNP declined for the first time since WWII. The impact of the oil shocks was stagflation (high inflation and unemployment rates; high prices and slow/low economic growth). Thus, the price hikes resulted in inflationary shocks to most economies, especially developing countries without oil. The developing economies around the world struggled with inflation and recession. Their balance of payments bottomed out, which prevented investment and any growth within these developing economies. When the price of oil went up, it caused them to go into debt to cope with the new oil price. Importing countries had to find ways to negotiate with all of the countries, which meant different strategies with different countries.
Iran is a great case study of how a sudden influx of money can destabilize a society. The huge inflow of money to Iran was causing drastic changes in the Iranian society that included chaos, waste, inflation, temptation, corruption, and political and social tensions. We shall see as time passes that this country has become almost the opposite of what it was leading up to the riches of the Middle East oil industry boom.
As we discussed in Lesson 9, there has always been tension between concessions and participation, and the nationalization of oil. The exporting countries had always found the concessions degrading and a symbol of colonial power. Iraq had also completed the nationalization of the Iraq Petroleum Company (IPC) in 1972. That left the only remaining major ones not yet nationalized as Kuwait, Venezuela, and Saudi Arabia. Kuwait decided to nationalize the remaining 40% of Kuwait Oil Company of BP and Gulf in December 1975.
Through a number of laws passed in 1971 and 1972, Venezuela took control over oil, effectively achieving the objectives of nationalization without actually nationalizing. It eventually led to the state holding company, Petroleos de Venezuela (PDVSA). A number of operating companies each fully integrated were also formed to ensure quasi-competition. The Venezuelan nationalization eventually took place on the first day of 1976.
That left Saudi Arabia with the mother of all concessions. This led Saudi Arabia to find a model that was not full nationalization but gave them more control. Under the agreement, Saudi Arabia took over ownership of the assets and oil rights. The companies now became like contractors providing “services” involving the operation and all the things they previously did. Thus, the oil companies were now simply buyers & refiners (“contractors”) and not producers in those countries. Instead, they provided “services” by exploring, producing, refining, and marketing oil. Hence the global oil industry took on a new form after the OPEC golden ages and the nationalization when the state-owned companies moved downstream, beyond production, into the international oil business outside their own boundaries.
How things change with time. While in the 1950s and 60s, inexpensive oil had fueled economic growth, in the 70s, oil seemed expensive and insecure. Also, before the 70s, it was oil exporters who complained that their sovereignty was being impaired by oil, but in the 70s, it was the industrial countries that found their sovereignty, security, and foreign policies threatened by oil. Since the hydrocarbon man was unwilling to surrender his newfound love of petroleum, adjustments to the new realities had to be made.
Countries sought to secure their own energy sources after the embargo. While the mix for various countries may have been different, the elements were virtually the same and included alternative fuels, diversified sources of oil, and conservation. The French, for example, rapidly developed nuclear power, returned to coal, and emphasized conservation.
The threat to oil companies now came from the importing countries, not the exporting countries. Gas allowances and foreign tax credit were rescinded as the companies became increasingly unpopular. Some people insinuated that the oil companies had planned the crisis to raise their profits, and the government even threatened “divestiture”- breaking up the oil companies' integrated structure so that each stage was a different business. Oil companies had become the enemy of the people.
Already by mid-decade, profits dropped back down in 1975 due to weakened demand, increased royalty taxes, and the removal of tax exemptions at home. Profits increased slightly over the next few years but remained constant with inflation. Between government policy attempts to control prices, and companies adapting to changing acceptance by culture, domestic oil policy in the 1970s was somewhat marked by divisive, angry, bitter, confused debate on price controls and company practices and policies.
Ironically compared to today’s sentiment, coal was seen as a possible solution to the oil crunch. Actions during the 70s included the Trans-Alaskan pipeline (TAPS), an increase in 1975 of automobile fuel efficiency standards, and the establishment of a strategic petroleum reserve that was part of the fuel efficiency bill. This reserve is the same one that President Biden has tapped in an attempt to stabilize oil prices.
With the exit of the Nixon Administration and arrival of the Carter Administration, there was an attempt to remove the price controls on oil and natural gas, as well as put greater emphasis on the use of coal. Their top priority was to remove the oil subsidy and let domestic oil that was under price control rise to the world market price. It also sought to encourage the development of alternative sources of energy (e.g., solar) and to improve competition in the electricity sector.
The public that had gotten accustomed to the hydrocarbon lifestyle, however, did not think there was a crisis, and there was significant push-back on the new policy. As a reaction to the embargo, price hikes, and expectation of increases, a frantic search for new oil ensued, and the cost for everything related to drilling doubled relative to its value in 1973. Companies were determined to avoid nationalization at all costs and redirected their exploration and production to the industrial and “friendly” nations of the Western world (US, Canada, British Isles and Norway). The 70s saw rapid expansion of Alaska, the North Sea, and even Mexico was making a comeback.
The companies also embarked on “diversification” in non-oil businesses. As examples, Mobil bought Montgomery Ward (a now defunct department store), Exxon went into office automation, ARCO went into copper, and Gulf bid for the Ringling Brothers and Barnum & Bailey Circus.
The enormous amount of money flowing into Iran caused inflation, waste, and corruption, which generated economic hardship and social and political tensions in Iran. Much of Iran, therefore, began to resent modernization, and instead preferred the traditional Islamic teachings. This was the onset of the collapse of the “westernized” version of Iran. But because they were such a key player in the oil market, “what happened in Iran didn’t stay in Iran.”
This Iran issue helped lead to another oil shock. With Iranian oil off the market, other sources increased their production, but an actual shortage existed, and this helped to create the Second Oil Shock. For example, oil prices went from $13 to $34 a barrel, resulting in huge changes in the world economy and global politics. Panic ensued. The panic resulted from a number of reasons: the growth of oil consumption and its impact on the market, disruptions of contractual agreements and breaking of the industry vertical integration and creating new buyers, the inconsistent and contradictory policies of the industrial nations, the oil exporters taking advantage of any opportunity to increase rents, and the power of pure emotions (uncertainty, anxiety, confusion, fear, and pessimism). The buyers, for fear of a repeat of the oil shock in 1973, worsened the shortage by buying and storing the oil even though it was expensive to hold the oil in inventories as insurance against price and shortage. This, obviously, led to further increases in the price of oil.
Nuclear had become a major alternative source of power to many industrial countries after the Suez Crisis and the first oil shock. Unfortunately, in late March 1979, part of the Three Mile Island nuclear plant near Harrisburg, Pennsylvania malfunctioned from a pump and valve failure. The accident limited the public interest in the nuclear option, and the cost and uncertainty of alternative energy also increased and contributed to the gloom, pessimism, and fatalism in the Western world. While, previously, the industrial countries had been able to obtain both low-priced oil and guaranteed secure supplies, now these two objectives had become contradictory, and governments ended up pursuing the latter.
Gasoline lines, the nightmare of 1973, re-emerged in the US during the Second Oil Shock. The US was caught in a gasoline shortage, and ineffective US policy made matters worse. Price controls limited conservation, and the gas lines essentially led to rationing and created more gas lines. The blame fell on President Carter, and his approval rating fell to as low as 25%. Oil companies once again became public enemy #1.
The gas lines and the Iran hostage crisis helped to bring down Jimmy Carter - and could be a cautionary tale for the Biden Administration in the current geopolitical energy landscape, mainly with the conflict in Eastern Europe. In April 1979, Carter announced decontrol of oil prices (which angered liberals who blamed oil companies). He also imposed a “windfall profits tax” on “excess” oil earnings (which angered conservatives who blamed government regulation and intervention). Thus, the new policy only intensified the barrage. Carter made a series of other mistakes that alienated people on both sides of the aisle as well as the general public. His actions also caused doubt and uncertainty in other countries about the stability and practicality of US policy.
With Iranian oil cut off from the US, redistribution was necessary. Prices soared because of this. The Saudis were the only OPEC nation to advocate lowering prices. They felt that if the price of oil became too high, consuming nations might try to develop alternatives. Also, rising prices could cause recession, depression, or even ruin of the global economy. What mattered most to Saudi Arabia and most nations were the rates: interest, exchange, inflation, and growth rates. The Saudis' objective was to use their significant weight in excess supply to push prices down. The producers had lost sight of the market reality, which would later come back to bite them.
On September 22nd, 1980, the heads of OPEC met in Vienna. At the very same time, Iraq, with a third of the population of Iran, began to launch airstrikes against Iran. The war removed 15% of total OPEC output and 8% of world demand. Thus, the oil supply was cut back sharply as a result of the war, but consumer nations were prepared this time. The International Energy Agency seemed to do a better job (relative to the second oil shock in 1979) of urging companies not to buy in fear or scramble for supplies to drive up prices, but, instead, to draw down their inventories and conserve the oil they had. But, with the war underway, panic buying began again.
A huge inventory build during 1979-1980 made sense when prices were increasing and there was an actual risk of a shortage. However, when demand started to plummet and supply from other non-OPEC sources surged, OPEC had no choice but to unify and bring prices down to Saudi’s $34/ bbl. The prices for “OPEC hawks” began to drop, and October 1981 saw the last OPEC price increase for at least another 10 years.