EME 801
Energy Markets, Policy, and Regulation

OPEC Seizes Control: The Energy Crisis and the Arab Oil Embargoes of 1973 and 1979

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OPEC was formed in 1960, largely as a way for governments of oil-producing nations to capture oil revenues that, at the time, were going to foreign producing firms. The motivation for founding OPEC was not market power, but rather a tax dispute. Oil was originally taxed as income. Thus, as prices fell with increased competition, the tax collected by the oil-producing nations also fell. The members of OPEC decreed that oil taxes would now come in the form of excise taxes, levied on a per-barrel basis. In other words, they succeeded in separating tax revenue from the value of the taxable commodity. The rise in oil prices around this time (see Figure 1.1) reflects the fact that spot prices reflected taxes collected by OPEC governments, rather than market transactions, since excise taxes act as a floor on prices. As a cartel attempting to coordinate actions among its members, OPEC has had only mixed success as we will discuss below. Two incidents, one in 1973 and one in 1979, however, did impact the world oil market substantially, as shown in the middle section of Figure 1.1, and cemented OPEC's reputation into place for the following decades.

In 1971 and 1972, fears began to grow in the developed world that if we were not already running out of energy supplies, we would soon as additional nations adopted western industrial structures. Then-president Richard Nixon appeared particularly concerned that Arab nations might impose a selective embargo on the United States for its pro-Israel policy. Such a selective embargo could not have worked; the world crude-oil market was too large, and replacement oil could have been found in too many places. The energy crisis was largely hysteria - production was increasing with no end in sight, and imports, particularly from Saudi Arabia, were rising.

It is important to separate the energy crisis from the Arab oil embargo of 1973. The two are separate but related events. The Arab oil embargo was successful only because of the price controls and rationing that occurred as a result of the energy crisis. It is possible (but perhaps a stretch) that the high prices and lines at the gas pumps may have happened even without cutbacks in supply from the Arab oil producers. The oil embargo officially started in October 1973, when a group of Middle East countries announced a 5% production cut per month as a reaction to the Yom Kippur war between Egypt and Israel (or, more precisely, Israel's victory in that war, aided by nations such as the United States). The embargoing nations said that the cuts would be restored once Israel withdrew from Palestine and Jerusalem.

The oil embargo of 1979 was not really much of an embargo at all, at least not in the sense of the 1973 embargo. The output cuts in 1979, however, were much larger and the overall effect more lasting than its predecessor six years earlier. The primary player in the 1979 embargo was Saudi Arabia, which cut production following a strike by Iranian oil workers. The production cuts were an attempt to raise prices. This they did, but they also reawakened fears of an energy crisis, with politicians muttering I-told-you-sos about how the world was in for a severe energy shortage. The cutbacks by Saudi Arabia only lasted three months, but the damage was done, and Saudi Arabia was recognized as the only single player that had the capability to move the world oil market. The following year, the Saudis found themselves in the enviable position of being able to raise prices without lowering output.