By Abbas Chagani and Courtney Kirkby

History is full of repeating patterns, yet there never fails to be new twists in the sweeping plotlines that re-emerge time and again. After decades of cheap and stable oil prices, increasing at roughly two per cent a year, oil consumers in the 1970s began to face major leaps in the price per barrel. The price of oil grew by more than 10 per cent per year for a number of years during this energy crisis. The hard realities of dealing with high oil prices caused considerable public reaction, perhaps the most poignant in December of 1973, when President Nixon left the National Christmas tree unlit and instead, decorated with non-energy consuming decorations. The time was most memorably characterized by large lines at gas stations. For a period of time only those with odd-numbered license plates could purchase gas on odd days and even-numbered plates on the other days. The period also saw the development of national energy conservation strategies and a large shift into energy efficient designs.

Three decades later dramatic price hikes are happening again. In 1980 the inflation-adjusted price of oil peaked at just over $100 per barrel. The price of crude just recently broke through the $100 mark for the first time since then and is now hovering around $125. Many experts are predicting even further increases, some even going as far as $200 per barrel within the next few years. While there are similarities, there are also important differences between today's oil crisis and the one in the 1970s. For example, unlike in the 1970s, energy efficiency is already fairly mainstream due largely to growing awareness around climate change. The price of oil is serving to add tangible market pressure for real energy conservation and the search for alternative energy. One need not look much farther than the gas pump on the corner, or flip through the paper to see the tens of thousands of laid off autoworkers, and yet another airline hiking its prices or shutting down all together. This article takes a closer look at the 1970s energy crisis in order to compare the ‘then and now’ with the hopes of using history to our advantage in trying to understand current high prices and the impact they will have.

In 1971 the United States went off the Gold Standard and moved to a floating exchange rate. U.S. politicians put pressure on the international community to devalue the dollar, leading to an agreed devaluation of a little over 10 per cent.¹ This had a direct impact on oil producers. Oil was priced in dollars, and thus the dollar’s devaluation equated to less ‘real’ income for them. The desire to replace this lost real income was contributed to the oil price crisis that followed shortly thereafter.

Today a similar situation exists between the US dollar and the price of crude oil. For the last five years the US dollar has been depreciating relative to most other major currencies, most notably the Euro and the Canadian dollar. The teeter-totter effect is happening again—as the US dollar goes down, up goes the price of oil. This time the declining value of the US dollar is not taking place as part of official policy, but rather in response to a weak economy, low interest rates and the ‘sub prime’ mess, yet the effect is the same. Figure 1 shows the relationship between the US dollar and price of crude oil.

Figure 1: US dollar $ vs crude oil price

The weak US economy is not only pushing down the value of the dollar, it is also leaving investors seeking alternative investments. Investors are moving away from traditional stocks and bonds and towards physical assets like commodities. The Goldman Sacs Commodity Index (GSCI) depicted in Figure 2 shows the returns of the GSCI over the last 30 years. Seventy percent of the index is currently invested in energy and over the last five years the index has increased by 240 percent. Most of the price pressure is coming from the market fundamentals of tight supply constraints in the face of strong demand, but it is clear that speculation may play a part as investors see these triple digit returns as a great opportunity. The increasing investments may potentially be adding extra kick to rising oil futures prices.

Figure 2: Goldman Sacs Commodity Index

In the autumn of 1973, shortly after the US devaluation of the dollar, the first oil shock hit North America. The Yom Kippur War was initiated by a military attack launched on Israel by Syria and Egypt. The decision to use the “oil weapon” to punish Israeli-supporting nations was initiated in strategic talks between Saudi Arabia and Egypt. In mid-October the Organization of Arab Petroleum Exporting Countries (OAPEC) raised the posted price for a barrel of crude, taking it from $3.12 up to $3.65. By the end of the year a barrel was $11.65 and production was slashed by 25 per cent. OAPEC announced an embargo on oil exports, imposed on Western, Israeli-supporting nations. Less than six months after it started, the embargo was lifted through negotiations at the Washington Oil Summit, temporarily calming the accelerated pace of oil prices.²

Just when prices looked to be settling down, another political upheaval wrought havoc on world oil prices. In the late 1970s, the Iranian Revolution severely disrupted a significant proportion of world oil supply. Oil production began to drop off in November of 1978 when a major strike occurred at nationalized oil refineries. Tens of thousands of Iranian oil workers mobilized and brought about a reduction of Iran’s oil supply by four and a half million barrels a day. During the time that the Shah was pressured to leave Iran through increasingly violent protest, global oil supply dropped by four per cent. After Ayatollah Khomeini gained control of Iran, oil refineries were up and running again, but at lower capacity and with less consistency. While overall oil production was not affected significantly, political uncertainty and OPEC’s oligarchic market influence put strong upward pressure on posted prices. However, by 1986 crude prices had dropped almost 50 per cent from 1980, as OPEC’s power dwindled and other oil exporters from the North Sea, Russian and South America increased their production.

OPEC now represents more than 12 oil-producing countries located in the Middle East, Africa and South America. Together they represent roughly 40 per cent of the world’s crude oil production and still hold significant sway over prices on the supply side of things. However, over the last few years, OPEC’s price-setting influence has been decreasing as emerging market powerhouses like China, India, Russia and the Middle East all ramp up their use of petroleum products leading to higher prices that even OPEC finds may be too high for their liking.

Shock or fundamental shift? The supply constraints that we face today are a significantly different from what we saw in the 1970s. Back then crude prices were driven up primarily by a structural change in the organization of oil-producing nations and the use of supply and price control as a means to exert pressure on the international community. Today, there continue to be a variety of factors that push and pull on oil prices, including geopolitical turmoil in countries like Nigeria, Iraq, and Iran, OPEC’s supply control and macroeconomic factors, but at the heart of the issue is the concept of 'peak oil' characterized by growing consciousness around supply limitations. Demand is growing rapidly and oil supplies are finite.

Despite the high oil prices and negative effects on the economy, oil spikes were not all doom and gloom in the 1970s. High prices served as a strong incentive to crackdown on inefficient energy utilization technologies and practices. Out of the 1970s oil shocks, we saw concerted efforts to improve the efficiency of the economy; cars became smaller with higher fuel efficiency, renewable energies expanded and businesses developed better energy management practices. Throughout the 1980s and early 1990s we experienced what is referred to as an ‘oil glut’. Energy was once again cheap, abundant and accessible and the earlier movement to conserve energy was quelled. The period of low prices has ended and it is time to again tighten belts and get serious about reducing our oil dependency, because this time it is not a simple matter of waiting out the political storm for oil prices to drop again.

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Sources: ¹ http://in.biz.yahoo.com/
² Energy Information Association