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Crude shock

June 2004

What are the causes and consequences of rising oil prices?

Crude shock

Oil prices hit their highest level for nearly a quarter of a century at the beginning of June. Some of the world’s major oil producers – known collectively as OPEC – have agreed to increase production from their wells, in an attempt to boost supplies and stabilise prices. Yet the fear of a repeat of events 30 years ago, when oil price rises spiralled out of control, plunging the world into economic chaos, is still very real.

The recent price of $42 per barrel of crude oil was the highest for 21 years, prompting OPEC (the Organisation of Petroleum Exporting Countries) to raise output. By doing so, prices cooled for both consumers and producers. OPEC normally restricts the flow of oil from its members’ wells in order to allow the life of this precious non-renewable resource to be extended, thereby offering a more sustainable development opportunity to oil-rich nations. If OPEC did not carefully regulate its production, the lifespan of existing reserves would be reduced, while market prices would plummet, due to over-supply.


Where’s all the oil going?

America will be especially pleased with the news that production is to be stepped-up. 26% of the world’s oil is consumed by the US, although just 4.7% of its population live there (The Guardian, 03 June 2004). The US has 2,000 million barrels of its own oil supplies in reserve, but this is not enough to meet its own needs for long. Production in the US peaked in 1970, and the lower 48 states (including oil-rich Texas) now produce less than half of what they did then.

Meanwhile, exports to China are keeping step with its phenomenal annual growth rate of 10% (See China set to overtake UK) as new factories and rising levels of car ownership drive up demand (The Guardian, 18 August 2003). As India – also home to a billion people and already demanding 750,000 barrels a day – begins to import more, will there be enough oil to share around for much longer? Many analysts now believe that the historical peak in the supply of this vital but non-renewable resource is about to hit – probably somewhere between 2016 and 2040 – and thereafter it will become an expensive, diminishing commodity.


How is oil made?

Oil is a non-renewable resource. Viewed from a human point of view, it is the product of a very lucky chain of events:

“The first break came in a life-rich sea: sediments buried the organic material raining down on the sea floor faster than it could decay. The next break: eons later, the seafloor sediments ended up at just the right depth – generally between 7,500 and 15,000 feet – for heat and pressure to slow-cook the organic material into oil. Then the oil collected in a ‘trap’ of porous sandstone or limestone and an impermeable cap of shale or salt kept it from escaping.” [National Geographic, June 2004]


How are western governments reacting to oil fears?

When figures are adjusted for inflation, oil is not yet more expensive than in the 1970s, when political events conspired to push prices through the roof. However, petrol costs are already high enough to make front-page headlines and this will certainly be concerning policy-makers. In the UK, there is now likely to be stiff opposition to the government’s planned increase in fuel taxes this autumn. Government taxes already make the UK second only to Netherlands for expensive petrol. At 78.6p, we are far ahead of the US, where prices are only 26.7p. 60p of this price consists of duty and VAT – three-quarters of the final fuel pump price! Already, there are fears that steeper rises could drive farmers and hauliers out of business. (The Daily Telegraph, 01 June 2004). Meanwhile, in the US – where petrol prices have risen by 50% since the Iraq war ended – fuel costs may become an election issue, as President Bush seeks his return to the White House.

In the short-term, we will now see increased output from both OPEC and non-OPEC oil-producing nations (such as Canada, Russia and the former republics of the USSR). This may help stabilise supplies and allay public fears for a while. But in the long term, prices are likely to remain higher than in the past and concerns over future oil supplies will remain a key political issue for western governments. More worryingly, the terrorist group Al-Qaida is now thought to be targeting Saudi Arabian production facilities. Saudi Arabia is currently a major producer of oil consumed in the US, and disruption of supplies would hit America badly. As a result, US foreign policy will continue to focus upon the Middle East for the foreseeable future.


What is the history of OPEC?

The foundation of the Organization of Petroleum Exporting Countries (OPEC) was announced in 1960, in response to a period of over-production of oil in the late 1950s that had caused prices to drop drastically. OPEC initially included the five major oil-producing countries of that era: Iran, Kuwait, Saudi Arabia, Venezuela and Iraq. The objective of OPEC, as stated by the member countries, is “to co-ordinate and unify petroleum polices among member countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.”

Given that oil is a non-renewable resource, there were concerns by 1960 that without careful regulation, oil supplies would be drained too fast. Oil-producing nations were also worried that over-production and competition amongst themselves had driven down world oil prices too far. As a result, their most valuable resource was being sold to MEDCs at prices that were too low to satisfactorily assist with their own economic and social development processes. By banding together and fixing prices higher, the OPEC nations hoped to improve their bargaining position with the west.

OPEC nations and their exports (% contribution to output)

Saudi Arabia

28.8

Iran

14.1

Iraq

8.4

Nigeria

8.2

Venezuela

7.8

UEA

7.7

Kuwait

7.2

Libya

5.4

Algeria

4.0

Indonesia

3.5

Qatar

2.8

The figures above show the percentage contribution made by each member nation to OPEC’s combined output of 27.78 million barrels per day. Non-OPEC nations now account for a further 47.88 million, nearly a third of which comes from North America (US and Canada). But the US’s appetite for oil is so immense that it has to import additional supplies. Source: The Guardian, 02 June 2004

The goal of this new producer cartel was to secure stability in the oil market by regulating the rate of production. This was seen as the best way of protecting the interests of both oil consumers and producers and of guaranteeing stable and sustainable oil revenues for the latter. OPEC membership was soon enlarged to include Qatar, joined shortly after by Indonesia, Libya, the Emirates of Abu Dhabi, Algeria, Nigeria, Ecuador and Gabon (although the latter two left OPEC in the 1990s). Enlargement at this stage strengthened OPEC’s negotiating power even further, with very few major oil producers left outside the cartel. Nations such as the US and UK, by now heavily dependent upon foreign imports of oil, were suddenly highly vulnerable to any decision made by OPEC to raise oil prices or to limit production. This shift of world power first manifested itself in the early 1970s.


What were the 1970s “oil shocks”?

The history of the oil industry took a very dramatic turn in 1973, when OPEC decided to re-negotiate prices with major oil companies such as Exxon and Shell. After they buy crude (unrefined) oil from OPEC nations, these companies in turn refine and sell the product on to consumers at petrol pumps. Before 1973, western car owners were being charged markedly higher prices than the oil companies were paying to the producing nations. Consequently, OPEC nations felt that they were not getting a big enough share of the end profits.

After a failure to reach a compromise, OPEC fixed the price of its oil unilaterally. A decision was announced to increase the crude oil price by 70%, much to the horror of the oil companies and western oil-consuming public. The situation then worsened further. The decision of the US to support Israel in a war against Egypt and Syria prompted the other Arab oil-producing members of OPEC to use oil prices as a political weapon. The Arab nations placed an oil embargo on the US, and massively cut their output in the hope that steep petrol price rises might lead to a loss of public support for the American government.

By the end of 1973, pump prices had risen by 400% across America and Europe. However, no sooner had the world started to live with this new high oil price than another, even greater, price shock occurred. In 1979, a revolution in Iran interrupted the flow of 4 million barrels per day of Iranian oil. This temporarily resulted in oil prices nearly twice as high as those of today (when adjusted for inflation). The disappearance of Iranian oil from the market was soon compensated for by an increase in production from other OPEC nations such as Saudi Arabia, Kuwait and Iraq. But the damage was still done. As a net result of the two oil shocks, prices in January 1981 were around nine times higher than they had been at the start of 1973.


What was the reaction to the 1970s oil shocks?

The significance of the oil shocks should not be under-estimated. As leading theoretician Manuel Castells puts it:

"The oil shock of 1973-4… prompted the restructuring of the capitalist system on a global scale, actually inducing a new model of accumulation in historical discontinuity with post-Second World War capitalism." (Castells, 1996, 51)

Now that oil had become an extremely expensive commodity, consumption fell in Europe for the first time since the invention of the petrol engine. Drastic measures had to be taken by oil-consuming nations such as Britain and America, as inflation began to spiral out of control and workers across all sectors of industry began to make demands for increased pay to meet the costs of running their cars. These measures included:

  • The introduction of energy-saving measures and devices and the promotion of greater efficiency in fuel usage
  • Fiscal policies that included increasing the tax on petrol and other petroleum products such as plastics (especially in Europe)
  • A renewed search for alternative sources of energy (France in particular stepped up its efforts to switch to nuclear power)
  • The growth in value of oil supplies from non-OPEC nations, as well as new efforts made by oil companies to seek out fresh reserves in areas such as the North Sea, the Gulf of Mexico, Alaska (construction of the Trans-Alaskan pipeline began in 1975) and Canada, often with great success.

This last point provides support for Ester Boserup’s famous argument about resources, namely that “necessity is the mother of invention”.

North Sea production (both British and Norwegian) almost doubled between 1975 and 1985. OPEC’s high prices provided such a wide profit margin for oil investors that high-cost areas such as the North Sea became financially viable to exploit. New technologies were rapidly developed that allowed fresh reserves to be mapped and found. For instance, recent geological surveys have shown that 11 billion barrels lie under the waters of Sao Tome and Principe, islands off the coast of West Africa (The Daily Telegraph, 31 May 2004).

OPEC saw its own market share fall from 62% in the mid-1970s to 37% in 1985, all as a result of increasing supplies from outside OPEC, coupled with the fall in demand that came as a result of higher prices.

In the future, OPEC’s market share could fall even further if scientific ingenuity allows more reserves to be discovered. In relation to the recent discovery of 25 billion barrels beneath the Gulf of Mexico, National Geographic magazine (June 2004) quotes one geophysicist as saying “if you had asked me in 1961, I’d have said that what we’re doing now is impossible” in US waters. In the future, technological progress may even allow up to 1.6 trillion barrels of oil to be extracted from Canada’s tar sands, which would make Canada the world’s greatest oil producer.


“Necessity is the mother of invention”

In 1972, The Limits to Growth model was published, forecasting that the earth’s finite resources, such as oil, were due to run out. In contrast to this pessimistic view of affairs, others believe that human ingenuity will ultimately find a solution to any shortage of resources. This is the basis for Ester Boserup’s optimistic theory of resource growth. She claimed that population growth stimulates development and not the other way around. It is the drive to feed and house increasing numbers of people that stimulates the scientific community into working to raise the carrying capacity of the environment. Boserup based this argument on her own anthropological studies of agrarian improvement in LEDCs during the 1960s. Her convincing field evidence suggests that population growth encourages crop rotation and changes in land tenure. Such reforms occur only when the threat of population pressure is evident and the carrying capacity of the land is about to be exceeded. Over time, she envisages a series of sudden leaps forward in the scale of resource production.


What is meant by the “Oil Curse”?

It seems at first to be fairly self-evident that the presence of abundant natural resources might aid development processes within a country. Writing in 1982, Chisholm pointed out that a very high proportion of known resources are found in Russia, the US, Canada, South African and Australia. He also forecast bright futures for Chile, Peru and Zaire, amongst others, on account of their own rich endowments. Yet, the link between resources and development is far from convincing. Oil revenues have certainly boosted GDP and have funded massive investment in Saudi Arabia, where the city of Riyadh is an ultramodern assemblage of skyscrapers and neon lights.

However, oil is also frequently associated with poverty and oppressive government. In 1995, Sachs and Warner showed that the more a country depends upon natural resources, the lower its growth rate. Nigeria is the clearest case of what Christian Aid calls the “oil curse”. The proportion of households there living in absolute poverty has grown from 28% to 66% since 1980. Meanwhile, conditions in oil-rich Angola, Venezuela and Sudan have deteriorated, with the latter currently facing a humanitarian crisis (The Guardian, 08 June 2004) Too often, wealth does not trickle-down to the poorest people. The discovery of oil can also lead to other promising industrial enterprises becoming abandoned, potentially slowing down development.

In some countries, the scramble for control of lucrative oil revenues results in corruption and even civil war (New Statesman, 02 June 2003). Last year, a report by US charity Catholic Relief Services revealed staggering links between oil wealth and corruption, environmental degradation (The Guardian, 17 June 2003). Four billion dollars’ worth of oil revenues are thought to have vanished into the pockets of corrupt officials in Angola (National Geographic, June 2004). Even Roman Abramovich- Russia’s second richest oil man and Chelsea football club owner supporter – is currently facing questions about his Siberian activities. (The Guardian Weekend, 08 May 2004).

The same pattern is often repeated in nations enriched with other kinds of valuable natural resource. Sierra Leone is greatly endowed with diamonds, yet is also the scene of a brutal civil war that waged throughout the 1990s. This war was, in part, related to control of the diamond trade. As a result of this “resource curse”, Sierra Leone, like some other resource-rich countries such as Sudan, is now said to be under-developed, with an average life expectancy of only 36.


What is a resource?

Parts of the physical environment that are used to satisfy human needs and wants. Natural resources may be renewable (sustainably managed forest, wind power and solar energy) or non-renewable (fossil fuels). There are also human resources (labour and its skills) and material resources (machinery and the built environment). Resources are a ‘relational’ concept. This means they are only defined as such when they are discovered to be useful. For instance, it was only with the invention of the petrol engine that oil was perceived to have real value. This can be summed up in the saying ‘resources are not; they become’. For instance, new resources are designated as technology develops, such as the tar sands in Canada; while additional reserves of existing resources can be discovered that were previously undetectable, such as oil in the Gulf of Mexico.


Further reading and references

Appenzeller, T. (2004) “The end of cheap oil” National Geographic, June, page 80-109

Castells, M. (1996) The rise of the network society Blackwell, Oxford

Cohen, N. (2003) “The curse of black gold” New Statesman, 02 June, page 25-27

Corbridge, S. (1986) Capitalist World Development Macmillan, London

Dr Simon Oakes teaches geography at Mander Portman Woodward (London) and is a senior human geography examiner for Edexcel.

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