Oil and the International Economy

Georg Koopmann, Klaus Matthies, Beate Reszat

• Publisher: Routledge
• Year: 2022
• eBook ISBN: 9781000678437
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

The oil price increases of the 1970s left deep marks on the world economy. They led to a massive redistribution of income in favor of oil-producing countries, and caused serious disruption of growth, imbalances in foreign trade, and problems of stability in oil-importing countries. Despite the present levelling off, the authors suggest that more price increases remain a distinct possibility.Oil and the International Economy examines the effects of rising oil prices on the international financial system and identifies ways that oil-importing countries can overcome the financial and adjustment problems caused by them. The authors project the long-term trend in real oil prices and present economic policy options to help avoid future financial problems for industrialized and developing nations alike.

Chapter 1: The longer-term trend in real oil prices

1. The world oil market after the oil price shocks

a. History of oil prices to date

During the fifties and sixties the price of crude oil showed very little nominal change, so that in real terms it fell considerably. The posted price¹ for Arabian Light, the reference or “marker” crude, was at US$ 1.80 a barrel in 1970 and the average export price for crude slightly less, at $1.73. In 1971 oil prices began to rise (see Table 1.1). The rise was quite in line with long-term demand and supply trends - the shortening lifetime of world oil reserves and a rapid increase in US import demand, among other things - but it was institutional changes and political factors that determined the strength of the rise and its timing.

The rise came in two large jumps. After a moderate increase in the average export price between February 1972 and September 1973 to $ 3, the first oil price explosion in 1973-74 in the wake of the Yom Kippur War led to a quadrupling of the price to more than $ 11. During the second oil price explosion the price tripled again from almost $ 13 a barrel in December 1978 to more than $ 35 in January 1981.

The price of oil remained largely unchanged in nominal terms for five years after the first massive increase in 1973-74, so that in real terms it declined considerably. This was due partly to the dampening of oil consumption in industrial countries and partly to the moderating influence of Saudi Arabia, the dominant oil supplier. The period of stable oil prices was brought to an end in late 1978 by OPEC’s decision to raise the price by a total of 15 % in several stages within the space of one year against the background of a cyclical revival in the demand for oil. However, the loss of output in Iran and the consequent precautionary buying by oil consumers in fact caused Saudi Arabia to lose control over the common price, so that oil prices were raised at a much faster rate. The posted price for Saudi oil became the minimum price for OPEC oil.

Table 1.1: CRUDE OIL PRICES, 1970-83 (AVERAGE OFFICIAL EXPORT PRICE OF OPEC OIL)

		Indices, 1972 = 100
Years	US dollars per barrel	nominal	real^a
1970	1.73	71	82
1971	2.14	87	95
1972	2.45	100	100
1973	3.37	138	117
1974	11.25	459	319
1975	11.02	450	278
1976	11.89	485	296
1977	12.95	529	299
1978	12.98	530	261
1979	19.00	776	333
1980	31.51	1,286	502
1981	35.01	1,429	586
1982	33.39	1,363	578
1983	29.33	1,197	530

a Deflated by the unit value indices in US dollars of the world exports of manufactured goods.

Sources: OECD: Economic Outlook, various years; UN: Monthly Bulletin of Statistics, various years

The tide turned in the first half of 1981 as a result of the onset of recession in Western industrial countries in 1980, increasing success in energy conservation and oil substitution and the high level of production maintained over a long period by Saudi Arabia. Oversupply on the world market persisted, despite the continued losses of production in Iran and Iraq and a restriction on liftings in the other OPEC countries that remains in force. A few oil-exporting countries reduced their export prices during 1982, and by the spring of 1983 it was inevitable that the OPEC reference price would have to be reduced substantially for the first time in view of the continued contraction in oil demand; accordingly, the price was cut from $ 34 to 29 a barrel.

The OPEC countries had clearly underestimated the reaction of oil consumers to the price rises, for despite continued slow economic growth world petroleum consumption steadily declined from the peak of 1979; by 1983 it had fallen by a total of 11 %. This decline will, of course, come to an end with the resumption of stronger growth; world oil consumption declined for two years after the first price jump, only to expand again until 1979, albeit at only half the rate recorded in the time of cheap oil and faster economic growth. However, the adjustments made by oil consumers as a result of the further dramatic increase in oil prices after 1979 is probably largely permanent.

The deciding factor in the sharp contraction in oil demand was the development in the Western industrial countries. They account for more than half the world consumption of oil, with the USA alone taking more than a quarter. The centrally planned economies consume one-fifth; within this group, the USSR is the largest oil consumer after the USA. Around half the oil consumed in the world is traded on the international markets. The main suppliers of crude to the world market are still the OPEC countries, although their market share contracted from 87 % in 1973 to less than two-thirds in 1983. As production in other countries was not reduced or was even increased -as in the new production areas in the North Sea, Mexico and Alaska - OPEC bore the full brunt of the fall in demand and its members’ export earnings also declined appreciably again. Between 1978 and 1980 they had more than doubled from US$ 133 to 279 billion, but by 1983 they had fallen back to an estimated $ 160 billion owing to falling prices and deliveries (see Table 1.2).

b. Present projections of oil prices

The considerable raising of oil prices from the end of 1973 onwards was possible because the OPEC countries had taken over control of their output from the foreign oil companies and ensured that the higher price would hold by restricting production. Nevertheless, the change in supply policy within OPEC brought about by the nationalisation of oil reserves was aided by events in the world oil market. Even before 1973 it became clear that proven oil reserves were declining in relation to pruduction in several important producing countries, so that constraints on a continued rapid expansion in production were becoming discernible and in some cases were already being felt. In the USA, for example, oil production had peaked in 1970 and had steadily declined thereafter, with the result that purchases from abroad increased rapidly and the USA once again became the largest oil importer in 1973, as it had been until 1966.

After taking control of the oil supply, the producing countries sought to bring oil prices closer to those of other forms of energy in order to increase their receipts. This goal had both short-term and long-term connotations, for the expected dampening of demand would extend the lifetime of oil reserves. Even if OPEC had not existed, the common interest of the main oil-producing countries to restrict supply in order to support the price would probably have triggered oil market developments similar to those that occurred, at least in the long run. The second price surge, which extended ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Preface
• Table of Contents
• List of Tables
• List of Charts
• Introduction
• Chapter 1 The longer-term trend in real oil prices
• Part I The Effects of Rising Oil Prices on the International Financial System
• Part II Internal and External Adjustment to Real Oil Price Increases
• Summary and conclusions
• Appendix 1 List of oil-importing developing countries
• Appendix 2 List of traded goods with a high energy content
• Appendix 3 Tables A-1 to A-33
• References