• FIC Hansraj

The OPEC Oil Price Shock Of 1973

Today, the United States is the biggest oil-producing country with an average of 17.87 million barrels/day, which accounts for 18% of the world's oil production.

Seems impressive right!


But this had not always been the case. The 1973 oil crisis was a clarion call for the U.S. to identify its high-level dependability on other countries for energy resources to meet their high domestic demands, forcing them to rethink their national security agendas.


Oil Price Shock of 1973 | FIC Hansraj Refined
Oil Price Shock of 1973

CAUSES

The price shock of 1973 had its genesis in the U.S. economic policy changes of 1971. During this time, the U.S. economy was in a thick soup with it facing the international dilemma of looming run gold whilst the shackles of inflation had gripped the economy to its core back at home. In order to bring the U.S. economy out of the pitch dark situation, the then President, Richard Nixon's administration came up with a new economic policy with one of the orders aiming to end the Bretton Woods Agreement of 1944.


As per the agreement, the gold standards were replaced by the U.S. dollars which made it a global currency and hence the countries vowed that their central banks will maintain a fixed exchange rate between their currencies and dollars, thereby closing the gold window and forbidding the foreign governments from no further convertibility of their dollars into gold.


Unfortunately, Nixon's decision was so sudden that it caused the value of the dollar to drop which had hurt the sentiments of the OPEC countries whose government revenue was dependent upon the petrodollar. With the falling value of the dollar, they were losing out on revenue due to the pricing of their contracts in U.S. dollars, with the cost of imports denominated in other currencies to either rise or remain the same. Now if you think this was it, then you are probably wrong.


The match in the powder barrel came when the U.S. extended military assistance to Israel in the Yom Kippur War of 1973. This reassuring gesture of America towards its ally Israel didn't go down well with the Arab countries of OPEC, who in retaliation declared an oil embargo stopping the export of oil to the United States and Israeli allies in October 1973.


EMBARGO AND NIXON’S RESPONSE

To deal with the embargo, Nixon’s administration constituted additional price controls and started rationing oil to states. On November 7, 1973, he initiated “Project Independence” to promote conservation and alternative energy initiatives with the aim of ending the reliance on oil imports by 1980. Further, he also increased the funding for mass transit and authorized the Trans-Alaska Pipeline by signing legislation that disposed of legal challenges from the project’s opponents. Soon after, the National Maximum Speed Law was passed, reducing the maximum speed limit nationwide to 55 miles per hour.


EFFECTS

The oil embargo is widely blamed for the 1973-1975 recession. It came at a very inapt moment for the US economy as it catalyzed the effects of the economic policy of 1971 popularly called Nixon’s shock. Under this new policy, Nixon brought three significant changes:

  • wage-price controls forced companies to keep their wages high leading to laying off of workers (high unemployment) and not lower prices.

  • The Federal Reserve raised and lowered the interest rates so frequently that it refrained businesses from making future plans and as a result, they kept the prices high and desisted from hiring new workers further worsening the recession.

  • Violation of the Bretton Woods agreement.


This 1973-1975 recession gave stagflation its name. Stagflation is a combination of stagnant economic growth and inflation that results in rising prices and high unemployment. This is what exactly happened in the United States.


Further due to the embargo, the OPEC nations initiated production cuts that quadrupled the price of oil from $2.90 a barrel before the embargo to $11.65 a barrel in January 1974, fluctuating oil prices globally. U.S. domestic producers failed to produce enough oil thereby raising the prices at home. High gas prices forced consumers to change their purchasing habits as they had relatively less money to spend on other goods and services which also had shaken their confidence in the government.


Ever since the 1973 crisis, every President has placed the agenda of energy security high on the presidential priorities and dealt with it in different ways. OPEC has lost some power but still continues to supply a good share of the world’s crude oil imports and therefore still has its short-term ability to globally influence prices intact. But lessons from history remain afresh and America continues to work towards its most contested goal of energy independence.



Author: Sanaah Jain