Oil price shocks have a long history, but today’s situation is perhaps the most complex of all time


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Scott L. Montgomery, University of Washington

(THE TALK) The world is in the grip of an oil price shock. In just a few months, prices have soared from $65 a barrel to over $130 a barrel, fueling fuel costs, rising inflationary pressures and a flare-up in consumer sentiment. Even before Russia invaded Ukraine, prices were rising rapidly due to huge demand and limited growth in supply.

Price shocks are not new. Historically, they are an integral part of oil market dynamics, not anomalies. They have appeared since the birth of the industry.

Many factors can trigger oil price shocks. This includes large shifts in either demand or supply around the world as oil is a global commodity. Shocks can also result from war and revolution; periods of rapid economic growth in major importing nations; and internal political problems in the supplier countries, such as political conflicts or a lack of investment in the oil industry. Overall, the worst spikes have combined two or more of these factors – and that is the situation today.

50 years of ups and downs

World oil production began in the mid-18th century and grew rapidly in the first half of the 20th century. For much of this period, the oil majors — companies like Chevron, Amoco, and Mobil, formed after the Supreme Court ordered Standard Oil’s dissolution in 1911 — effectively acted as a cartel, keeping production at levels that made oil plentiful and plentiful considered cheap to encourage its consumption.

This ended when Iran, Iraq, Kuwait, Saudi Arabia and Venezuela formed the Organization of Petroleum Exporting Countries in 1960, nationalized their oil reserves and gained real supply power. In the decades that followed, other nations in the Middle East, Asia, Africa, and Latin America joined—some temporarily, some permanently.

In 1973, Arab members of OPEC cut 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 a barrel to $11.65.

In response, government leaders in wealthy countries introduced measures 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 cushion future price shocks.

But six years later, oil prices more than doubled again when the Iranian revolution halted that country’s production. Between mid-1979 and mid-1980, the price of oil rose from $13 a barrel to $34 a barrel. Over the next several years, a combination of economic recession, the replacement of oil with natural gas for heating and industry, and the shift to smaller vehicles helped reduce oil demand and prices.

The next big shock came in 1990 when Iraq invaded Kuwait. The United Nations imposed a trade embargo with Iraq and Kuwait, pushing oil prices up from $15 a barrel in July 1990 to $42 in October. US and coalition forces invaded 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 a day, about the amount previously supplied by Iraq, to ​​dampen the surge and shorten the time for higher prices.

Other disruptive price shocks occurred in 2005-2008 and 2010-2014. The first resulted from increased demand brought on by economic growth in China and India. At that time, OPEC was unable to expand production due to a long-term lack of investment.

The second shock reflected the impact of the pro-democracy Arab Spring protests in the Middle East and North Africa, combined with conflicts in Iraq and international sanctions imposed on Iran by Western nations to slow its nuclear weapons program. Combined, these events have propelled oil prices above $100 a barrel over a four-year period – the longest such period on record. A flood of new oil from shale mining in the USA finally brought relief.

A perfect storm in 2022

Today, several factors are driving oil prices higher. There are three key elements:

Oil demand has risen faster than expected in recent months as countries emerge from pandemic lockdowns.

OPEC+, a loose partnership between OPEC and Russia, has not increased production at a commensurate level, and neither have U.S. shale oil companies.

Countries have drawn on stockpiles of oil and fuel to fill the supply gap, reducing this contingency buffer to a low level.

These developments have oil traders concerned about an imminent shortage. In response, they have raised oil prices. It’s worth noting that while consumers often blame high oil prices on oil companies (and politicians), those prices are set by commodity traders in places like the New York, London, and Singapore stock exchanges.

Against this background, Russia attacked Ukraine on February 24, 2022. Traders saw the potential for sanctions on Russian oil and gas exports and offered even higher energy prices.

Unexpected factors have also emerged. Big oil companies like Shell, BP and ExxonMobil are closing their operations in Russia. Spot market buyers have turned down Russian crude oil from the sea, likely over fears of sanctions.

And on March 8, the US and UK governments announced import bans on Russian oil. Neither country is a major Russian buyer, but their actions have set a precedent that some analysts and traders fear could escalate as Russia reduces or halts exports to US allies altogether.

In my view, this set of conditions is unprecedented. This reflects not only the increasing complexity of the global market, but also the need for energy companies – already under pressure from shareholder climate activists – to avoid further reputational damage and exit one of the world’s most oil-rich countries. Some companies like BP are giving up assets worth tens of billions of dollars.

What could soothe this shock?

In my view, OPEC – mainly Saudi Arabia – and the US are the key players that can help contain this price shock. For these companies, holding back oil supplies is a decision. However, there is no sign yet that they are likely to change positions.

Restoring the Iran nuclear deal and lifting sanctions on Iranian oil would enrich the oil market, though not enough to drive prices down sharply. More production from smaller producers like Guyana, Norway, Brazil and Venezuela would also help. But even combined, these countries cannot match what the Saudis or the US might do to increase supply.

All of these uncertainties make history only a partial guide to this oil shock. There is currently no way of knowing how long the factors driving it will last, or if prices will rise. This is of little consolation to consumers who are facing higher fuel costs around the world.

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This article was republished by The Conversation under a Creative Commons license. Read the original article here: https://theconversation.com/oil-price-shocks-have-a-long-history-but-todays-situation-may-be-the-most-complex-ever-178861.


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