50th Year of the First Oil Crisis
After the end of World War II, the world has established the United Nations, signed the Bretton Woods Agreement for the establishment of the General Agreement on Tariffs and Trade (GATT), and the implementation of the USD-centered quasi-gold-standard currency system. All these new institutions had brought 25-year post-war economic recovery.
The 1970s — a restructuring era
However, after 25 years of relatively stable international trade and economic growth, problems of the institutions were surfaced out. In the 1960s and 1970s, many crises broke out, and some systems started collapsing.
One of the most important collapses was the ‘suspension’ of the Bretton Woods Agreement. “In August 1971, US President Richard Nixon announced the ‘temporary suspension’ of the dollar’s convertibility into gold” (IMF, n.d.). This announcement de-facto marked the breakdown of the Bretton Woods Agreement. The world has then switched into a fiat money system, and last year marked the 50th year anniversary (Yiu, 2021). The collapse immediately resulted in a surge of inflation, and exacerbated the poor international relationships!
The First Oil Crisis in 1973
In early 1973, the Yom Kippur War broke out. The Organization of Petroleum Exporting Countries (OPEC) imposed an oil embargo, and the price of oil tripled! It also triggered the depreciation of the US dollar and a crash of the stock market. It is known as the first oil crisis in history.
Many analyses believe that the oil crisis was caused by the War and the embargo, but some researchers, such as Amadeo (2022), contends that (part of) the cause of the oil crisis is the ‘suspension’ of the Bretton Woods Agreement. The plummet of the US dollar has led to a significant reduction in the income of oil-exporting countries. In fact, some analysts pointed out that because oil is priced and traded in US dollars, The U.S. dollar becomes an oil-standard currency system and is coined as ‘Petrol Dollar’.
After World War II, the global economy has become highly dependent on oil, a stable oil price has become a damper of inflation. Therefore, oil production has become a weapon — ‘Oil Weapon’ for bargaining or intimidation.
UK and US stop importing Russian oil in 2022
What happened 50 years ago seems to be repeating in 2022, a Russia-Ukraine War broke out (Russia invades Ukraine since February 24). Many countries including the US and UK announced a new sanction on March 8 to stop buying oil from Russia. Russia has also warned that natural gas export may be stopped in retaliation. (BBC, 2022) Since Russia is the third biggest exporter of oil and natural gas and is a key supplier of fuels to Europe, the sanction has immediately caused a surge of oil price.
Oil prices soared by 30% after 13 days of war
Since the invasion on February 24, 2022, the international crude oil price has risen from about US$90 per barrel to US$124 on March 8 (Figure 1), and some market analysis estimate that oil prices could break through US$200, leading to a further deterioration of global inflation.
Weaponization of oil
It is undeniable that oil trade is often used as a weapon, as a rise in oil price can spread to increase inflation globally. For example, the extreme extents of ups and downs of oil price in the past two years indicate that it is heavily manipulated which makes oil price stray from the law of market supply and demand under the normal free trade system.
Figure 2 shows the WTI crude oil price from 2018 to 2022. In early 2020, the oil price plunged from about US$60 to an unprecedented negative market value — below -US$25! It is totally beyond the general explanations of Laws of Supply and Demand to buy a valuable economic good at negative price!
It can neither be explained by the pandemic as the virus is still lingering in the world today. Simply put, it is related to disputes between oil-producing countries and is also affected by some constraints of derivative market. Let’s discuss it separately in detail later. However, interestingly, in just less than two years, the oil price has risen from -US$25 to US$124. The fluctuations are clearly not caused by normal market supply and demand for actual usage of oil.
Strategic Consideration of Energy Supply
Since fuel is used as a weapon, strategic consideration must be taken to deal with the energy crisis. Countries are not only deploying strategic petroleum reserves or extending the use of nuclear energy, but also mobilizing countries to increase oil production. Yousef Al Otaiba, the UAE’s ambassador to Washington, said “the country wants to increase oil production and will encourage the OPEC to ramp up supply” (CNN, 2022), but it is noted that OPEC+ and Russia have an agreement on oil production. Consumers can also help reduce energy consumption energy, and producers of renewable energy can help increase production and so on.
In fact, the previous oil crisis 15 years ago was overcome by mobilizing the oil production capacity by a technological advancement. Figure 3 shows the oil crisis after the Global Financial Crisis in 2008. The oil price hit an all-time high of US$140! But it fell almost vertically from US$140 to about US$40, a drop of more than 70%, in just a few months!
The technology is a revolutionary breakthrough in shale oil extraction technology in the United States after 2008. It made the cost of extraction drop significantly, which stimulated a substantial increase in U.S. oil and gas production. How will the new oil crisis be resolved, and will the oil price break through the previous record high? Let’s wait and see.
Amadeo, K. (2022) OPEC Oil Embargo, Its Causes, and the Effects of the Crisis — The Truth About the 1973 Arab Oil Crisis, The Balance, January 30. https://www.thebalance.com/opec-oil- embargo-causes-and-effects-of-the-crisis-3305806
BBC (2022) US announces ban on Russian oil imports Crude oil prices hit record high, BBC, 8 March. https://www.bbc.com/zhongwen/simp/world-60672297
CNN (2022) First sign of oil price relief: UAE says it wants OPEC to increase production. CNN, March 9. https://edition.cnn.com/2022/03/09/energy/oil-uae-production-increase/index.html
IMF (n.d.) The end of the Bretton Woods Agreement (1972–81), International Monetary Fund. https://www.imf.org/external/about/histend.htm#:~:text=In%20August%201971%2C%20U.S.%20President,the%20dollar's%20convertibility%20into%20gold.
Yiu, C.Y. (2021) 50-Years of Fiat Money, Medium, November 14. https://vocus.cc/eyanalysispoliecon/618ece91fd897800011507ad