THE CONVERSATION:
The world is in the grip of an oil price shock. In just a few months, prices have risen from US$65 a barrel to over $130, causing fuel costs to surge, inflationary pressure to rise and consumer tempers to flare. Even before Russia’s invasion of Ukraine, prices were climbing rapidly because of roaring demand and limited supply growth.
Price shocks aren’t new. Viewed historically, they are an integral part of oil market dynamics, not anomalies. They have occurred since the birth of the industry.
Many factors can trigger oil price shocks. They include large shifts in either demand or supply anywhere in the world, since oil is a global commodity. Shocks can also result from war and revolution; periods of rapid economic growth in major importing nations; and domestic problems in supplier countries, such as political conflict or lack of investment in the oil industry. Overall, the worst spikes have combined two or more of these factors – and that’s the situation today.
50 years of ups and downs
Global oil production began in the mid-1800s and grew rapidly in the first half of the 20th century. For much of that time, oil majors – companies like Chevron, Amoco and Mobil that were created after the Supreme Court ordered the breakup of Standard Oil in 1911 – operated effectively as a cartel, maintaining production at levels that kept oil abundant and cheap to encourage its consumption.
This ended when Iran, Iraq, Kuwait, Saudi Arabia and Venezuela formed the Organization of Petroleum Exporting Countries in 1960, nationalizing their oil reserves and gaining real supply power. Over the following decades, other nations in the Middle East, Asia, Africa and Latin America joined – some temporarily, others permanently.
In 1973, Arab members of OPEC cut their oil production when Western countries supported Israel in the Yom Kippur War with Egypt and Syria. World oil prices shot up fourfold, from an average of $2.90 per barrel to $11.65.
In response, government leaders in wealthy countries introduced policies to stabilize oil supplies. These included finding more oil, investing in energy research and development, and creating strategic oil reserves that governments could use to mitigate future price shocks.
But six years later, oil prices more than doubled again when Iran’s revolution halted that country’s output. Between mid-1979 and mid-1980, oil rose from $13 per barrel to $34. Over the next several years, a combination of economic recession, replacing oil with natural gas for heating and industry, and shifting to smaller vehicles helped to mitigate oil demand and prices.
The next major shock came in 1990 when Iraq invaded Kuwait. The United Nations imposed an embargo on trade with Iraq and Kuwait, which raised oil prices from $15 per barrel in July 1990 to $42 in October. U.S. and coalition troops moved into Kuwait and defeated the Iraqi army in just a few months. During the campaign, Saudi Arabia increased oil production by more than 3 million barrels per day, roughly the amount previously supplied by Iraq, to help dampen the increase and shorten the period of higher prices.
More disruptive price shocks occurred in 2005-2008 and 2010-2014. The first resulted from increased demand generated by economic growth in China and India. At that time, OPEC was unable to expand production due to long-term lack of investment.
The second shock reflected the impacts of Arab Spring pro-democracy protests in the Middle East and North Africa, combined with conflict in Iraq and international sanctions that Western nations placed on Iran to slow its nuclear weapons program. Together, these events pushed oil prices above $100 per barrel for a four-year stretch – the longest such period on record. Relief finally came via a flood of new oil from shale production in the U.S..
A pefect storm in 2022
Today, multiple factors are raising oil prices. There are three key elements:
