Oil shocks have a long history, but the current situation is perhaps the most complex
Three developments ahead of Russia’s attack on Ukraine have traders worried about looming shortages
The world is in the grip of an oil shock. In just a few months, prices have soared from $65 a barrel to over $130, leading to soaring fuel prices, mounting inflationary pressures and a spike in consumer anger. Even before Russia invaded Ukraine, prices were rising rapidly due to high demand and limited supply growth.
Price shocks are nothing new. Viewed historically, they are part and parcel of oil market dynamics, not anomalies. They have been happening since the birth of the industry.
Many factors can trigger oil shocks. They include large shifts in 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 countries; and internal problems in supplier countries, such as political conflicts or lack of investment in the oil industry. Overall, the worst spikes 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-1800s 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 that were created after the Supreme Court ordered the dissolution of Standard Oil in 1911 — operated effectively as a cartel, maintaining production at levels that kept oil plentiful and cheap to encourage its consumption.
This ended when Iran, Iraq, Kuwait, Saudi Arabia and Venezuela formed the Organization of the Petroleum Exporting Countries in 1960, nationalizing their oil reserves and gaining real supply power. Over the following decades, other nations from the Middle East, Asia, Africa and Latin America joined, some temporarily, others permanently.
In 1973, Arab members of OPEC cut oil production when Western countries backed Israel in the Yom Kippur War with Egypt and Syria. Global oil prices quadrupled from an average of $2.90 a barrel to $11.65.
In response, wealthy country heads of government 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 when the Iranian revolution brought production to a halt. Between mid-1979 and mid-1980, oil fell from $13 a barrel to $34. Over the following years, a combination of economic recession, the replacement of oil with natural gas for heating and industry, and the shift to smaller vehicles helped dampen oil demand and prices.
The next major shock came in 1990 when Iraq invaded Kuwait. The United Nations imposed a trade embargo with Iraq and Kuwait, which caused oil prices to rise from $15 a barrel in July 1990 to $42 in October. US and coalition troops entered Kuwait and defeated the Iraqi army in just a few months. During the campaign, Saudi Arabia increased its oil production by more than 3 million barrels per day, roughly the amount previously supplied by Iraq, to help mitigate the increase and shorten the period of rising prices.
More disruptive price shocks occurred in 2005-2008 and 2010-2014. The first resulted from the increase in demand generated by economic growth in China and India. At that time, OPEC was unable to increase production due to a lack of long-term investment.
The second shock reflected the impacts of pro-democracy Arab Spring protests in the Middle East and North Africa, combined with the conflict in Iraq and the international sanctions Western countries imposed on Iran to slow down its weapons program. nuclear. Together, these events pushed oil prices above $100 a barrel for a four-year period – the longest on record. Relief finally came via a flood of new oil from shale production in the United States.
A perfect storm in 2022
Today, multiple factors are driving up oil prices. There are three key elements:
Oil demand has grown faster than expected in recent months as countries emerge from pandemic shutdowns.
OPEC+, a loose partnership between OPEC and Russia, has not increased production to a commensurate level, nor have US shale oil companies.
Countries have dipped into their oil and fuel stocks to fill the supply gap, reducing this emergency cushion to low levels.
These developments have oil traders worried about the impending shortage. In response, they drove up oil prices. It should be noted that while consumers often blame oil companies (and politicians) for high oil prices, these prices are set by commodity traders in places such as the New York, London and Singapore stock exchanges.
In this context, 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 also emerged. Major oil companies, including Shell, BP and ExxonMobil, are winding down their operations in Russia. Spot market buyers rejected Russian crude transported by sea, likely for fear of sanctions.
And on March 8, the US and UK governments announced a ban on Russian oil imports. Neither country is a major Russian buyer, but their actions have set a precedent that some analysts and traders say could lead to an escalation, with Russia reducing or eliminating exports to U.S. allies.
In my view, this set of conditions is unprecedented. This not only reflects increased complexity in the global market, but also an imperative for energy companies – already under pressure from climate activist shareholders – to avoid further reputational damage and leave one of the world’s worst countries. richest in oil in the world. Some companies, like BP, are giving up assets worth tens of billions of dollars.
What could lessen this shock?
In my view, the main players who can help limit this price shock are OPEC – mainly Saudi Arabia – and the United States. For these entities, withholding oil supply is a choice. However, there is no evidence yet that they are likely to change position.
Restoring the Iran nuclear deal and lifting sanctions on Iranian oil would add oil to the market, but not enough to significantly reduce prices. Increased production from smaller producers, such as Guyana, Norway, Brazil and Venezuela, would also help. But even combined, these countries cannot match what the Saudis or the United States could do to increase supply.
All these uncertainties make history only a partial guide to this oil shock. At present, there is no way of knowing how long the factors driving it will last or if prices will rise. That’s not much comfort to consumers facing higher fuel costs around the world.
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Scott L. Montgomery, Lecturer, Jackson School of International Studies, University of Washington
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