1973 oil crisis

The 1973 oil crisis began on October 17, 1973, when the members of Organization of Arab Petroleum Exporting Countries (OAPEC, consisting of the Arab members of OPEC plus Egypt and Syria) announced, as a result of the ongoing Yom Kippur War, that they would no longer ship oil to nations that had supported Israel in its conflict with Syria and Egypt (the United States, its allies in Western Europe, and Japan).

The same time, OPEC members agreed to use their leverage over the world price-setting mechanism for oil in order to raise world oil prices, after the failure of negotiations with the "Seven Sisters" earlier in the month. Because of the dependence of the industrialized world on crude oil and the predominant role of OPEC as a global supplier, these price increases were dramatically inflationary to the economies of the targeted countries, while at the same time suppressive of economic activity. The targeted countries responded with a wide variety of new, and mostly permanent, initiatives to contain their further dependency. The United States of America, however, failed to produce any major intitiatives towards reducing its foreign dependency.

Background

Founding of OPEC

The Organization of the Petroleum Exporting Countries (OPEC) consisted of twelve countries, including Iran, seven Arab countries, plus Indonesia, Nigeria, Angola and Venezuela. OPEC had been formed on September 14, 1960 at the Baghdad conference. It was made to protest pressure by major oil companies (mostly owned by U.S., British, and Dutch nationals) to reduce oil prices and payments to producers. At first it had operated as an informal bargaining unit for the sale of oil by Third World nations. It confined its activities to gaining a larger share of the revenues produced by Western oil companies and greater control over the levels of production. However, in the early 1970s it began to exert its strength.

Yom Kippur War/Ramadan War

On October 6, 1973, Syria and Egypt launched a military attack on Israel starting the Yom Kippur War, also known as the Ramadan War or October War. The persistence of the Arab-Israeli conflict finally triggered pressure on the West over its support of Israel (in part because of operations such as Operation Nickel Grass). Egypt and Syria, though not major oil-exporting countries, joined the latter grouping to help articulate its objectives. On October 17, 1973, Arab states placed an embargo on oil as punishment for U.S. support for Israel in the Yom Kippur War. During the war the Arab world imposed an oil embargo against the United States, Western Europe, and Japan for their support of Israel. By the early 1970s the great Western oil conglomerates suddenly faced a unified bloc of producers.

The Arab-Israeli conflict triggered a crisis already in the making. The West could not continue to increase its energy use 5% annually, pay low oil prices, yet sell inflation-priced goods to the petroleum producers in the Third World. This was stressed by the Shah of Iran, whose nation was the world's second-largest exporter of oil and the closest ally of the United States in the Middle East at the time. "Of course [the world price of oil] is going to rise," the Shah told the New York Times in 1973. "Certainly! And how...; You [Western nations] increased the price of wheat you sell us by 300%, and the same for sugar and cement...; You buy our crude oil and sell it back to us, refined as petrochemicals, at a hundred times the price you've paid to us...; It's only fair that, from now on, you should pay more for oil. Let's say ten times more."

End of Bretton Woods

On August 15, 1971, the United States pulled out of the Bretton Woods Accord taking the US off the Gold Exchange Standard (whereby only the value of the US dollar had been pegged to the price of gold and all other currencies were pegged to the US dollar), allowing the dollar to "float". Shortly thereafter, Britain followed, floating the pound sterling. The industrialized nations followed suit with their respective currencies. In anticipation of the fluctuation of currencies as they stabilized against each other, the industrialized nations also increased their reserves (printing money) in amounts far greater than ever before. The result was a depreciation of the value of the US dollar, as well as the other currencies of the world. Because oil was priced in dollars, this meant that oil producers were receiving less "real" income for the same price. The OPEC cartel issued a joint communique stating that forthwith they would price a barrel of oil against gold. This led to the "Oil Shock" of the mid-seventies. In the years after 1971, OPEC was slow to readjust prices to reflect this depreciation. From 1947-1967 the price of oil in U.S. dollars had risen by less than two percent per year. Until the Oil Shock, the price remained fairly stable versus other currencies and commodities, but suddenly became extremely volatile thereafter. OPEC ministers had not developed the institutional mechanisms to update prices rapidly enough to keep up with changing market conditions, so their real incomes lagged for several years. The large price increases of 1973-74 largely caught up their incomes to Bretton Woods levels in terms of other commodities such as gold.

Arab oil embargo

On October 16, 1973, OPEC cut production of oil and placed an embargo on shipments of crude oil to the West, with the United States and the Netherlands specifically targeted. The Netherlands had supplied arms to Israel and allowed the Americans to use Dutch airfields for supply runs to Israel. Also imposed was a boycott of Israel and price increases. Since oil demand falls little with price rises, prices had to rise dramatically to reduce demand to the new lower level of supply. Anticipating this, the market price for oil immediately rose substantially. A world financial system already under pressure from the breakdown of the Bretton Woods agreement was set on a path of a series of recessions and high inflation that persisted until the early 1980s, and elevated oil prices persisted until 1986.

Over the long term, the oil embargo changed the nature of policy in the West, towards more exploration, towards energy conservation, and towards more restrictive monetary policy, which more aggressively fought inflation.

Chronology

• August 23 1973—In preparation for the Yom Kippur War, Saudi King Faisal and Egyptian president Anwar Sadat meet in Riyadh and secretly negotiate an accord whereby the Arabs will use the "oil weapon" as part of the upcoming military conflict.

• September 15—The Organization of Petroleum Exporting Countries (OPEC) declares a negotiating front, consisting of the 6 Persian Gulf States, to pressure for price increases and an end to support of Israel, based on the 1971 Tehran agreement.

• October 6—Egypt and Syria attack Israel on Yom Kippur, starting the fourth Arab-Israeli War.

• October 8– October 10—OPEC negotiations with oil companies to revise the 1971 Tehran price agreement fail.

• October 16—Saudi Arabia, Iran, Iraq, Abu Dhabi, Kuwait, and Qatar unilaterally raise posted prices by 17% to $3.65 per barrel and announce production cuts.

• October 17—OPEC oil ministers agree to use oil as a weapon to punish the West for its support of Israel in the Arab-Israeli war. They recommend an embargo against unfriendly states and mandate a cut in exports.

• October 19—Saudi Arabia, Libya and other Arab states proclaim an embargo on oil exports to the United States.

• October 23– October 28—The Arab oil embargo is extended to the Netherlands.

• November 5—Arab producers announce a 25% output cut. A further 5% cut is threatened.

• November 23—The Arab embargo is extended to Portugal, Rhodesia, and South Africa.

• November 27—U.S. President Richard Nixon signs the Emergency Petroleum Allocation Act authorizing price, production, allocation and marketing controls.

• December 9—Arab oil ministers agree to another five percent cut for non-friendly countries for January 1974.

• December 25—Arab oil ministers cancel the five percent output cut for January. Saudi oil minister Yamani promises a ten percent OPEC production rise.

• January 7– January 9, 1974—OPEC decides to freeze prices until April 1.

• February 11— United States Secretary of State Henry Kissinger unveils the Project Independence plan to make U.S. energy independent.

• February 12– February 14—Progress in Arab-Israeli disengagement brings discussion of oil strategy among the heads of state of Algeria, Egypt, Syria and Saudi Arabia.

• March 17—Arab oil ministers, with the exception of Libya, announce the end of the embargo against the United States.

Price controls and rationing

The crisis was further exacerbated by government price controls in the United States, which limited the price of "old oil" (that already discovered) while allowing newly discovered oil to be sold at a higher price, resulting in a withdrawal of old oil from the market and artificial scarcity. The rule had been intended to promote oil exploration. This scarcity was dealt with by rationing of gasoline (which occurred in many countries), with motorists facing long lines at gas stations.

In the U.S., drivers of vehicles with license plates having an odd number as the last digit (or a vanity license plate) were allowed to purchase gasoline for their cars only on odd-numbered days of the month, while drivers of vehicles with even-numbered license plates were allowed to purchase fuel only on even-numbered days. The rule did not apply on the 31st day of those months containing 31 days, or on February 29 in leap years — the latter never came into play, since the restrictions had been abolished by 1976.

In some U.S. states, a three colour flag system was used to denote gasoline availability at service stations. A green flag denoted unrationed sale of gasoline. A yellow flag denoted restricted and rationed sales. A red flag denoted that no gasoline was available at the service station but was open for other services.

Coupons for gasoline rationing were ordered in 1974 and 1975 for Federal Energy Administration, but were never actually used for this crisis or the 1979 energy crisis.

Conservation and reduction in demand

The U.S. government response to the embargo was quick but of limited effectiveness. A National Maximum Speed Limit of 55 mph (near 90 km/h) was imposed through the Emergency Highway Energy Conservation Act to help reduce consumption. President Nixon named William Simon as an official "energy czar," and in 1977, a cabinet-level Department of Energy was created, leading to the creation of the United States's Strategic Petroleum Reserve. The National Energy Act of 1978 was also a response to this crisis.

Year-round daylight saving time was implemented: at 2:00 a.m. local time on January 6, 1974, clocks were advanced one hour across the nation. The move spawned significant criticism because it forced many children to commute to school before sunrise. As a result, the clocks were turned back on the last Sunday in October as originally scheduled, and in 1975 clocks were set forward one hour at 2:00 a.m. on February 23. The pre-existing daylight-saving rules, calling for the clocks to be advanced one hour on the last Sunday in April, were restored in 1976.

The crisis also prompted a call for individuals and businesses to conserve energy — most notably a campaign by the Advertising Council using the tag line "Don't Be Fuelish." Many newspapers carried full-page advertisements that featured cut-outs which could be attached to light switches that had the slogan "Last Out, Lights Out: Don't Be Fuelish" emblazoned thereon.

The U.S. "Big Three" automakers' first order of business after Corporate Average Fuel Economy ( CAFE) standards were enacted was to downsize existing automobile categories as mandated by the U.S. Department of Transportation. By the end of the 1970s, full-size luxury cars with a 130-inch (3.3 m) wheelbase and gross weights averaging 4,500 pounds were a thing of the past. Before the mass production of automatic overdrive transmissions and electronic fuel injection, the traditional front engine/rear wheel drive layout was being phased out for the more efficient front engine/front wheel drive, starting with compact cars. Using the Volkswagen Rabbit as the archetype, much of Detroit went to front wheel drive after 1980 in response to CAFE's 27.5 mile per gallon fuel consumption mandate.

Though not required by legislation, the sport of auto racing voluntarily sought reductions. The 24 Hours of Daytona was cancelled in 1974. Also in 1974, NASCAR reduced all race distances by 10%. At the Indianapolis 500, qualifying was reduced from four days down to two, and several days of practice were eliminated.

Search for alternatives

The energy crisis led to greater interest in renewable energy and spurred research in solar power and wind power. It also led to greater pressure to exploit North American oil sources, and increased the West's dependence on coal and nuclear power. This included increased interest in mass transit and personal rapid transit, which do not use petroleum directly.

In Australia, heating oil ceased being considered an appropriate winter heating fuel. This often meant that a lot of oil-fired room heaters that were popular from the late-1950s to the early-1970s were considered outdated. Gas-conversion kits that let the heaters burn natural gas or propane were introduced.

For the handful of industrialized nations that were net energy exporters, the effects of the oil crisis were very different. In Canada the industrial east suffered many of the same problems of the United States. In oil rich Alberta, however, there was a sudden and massive influx of money that quickly made it the richest province in the country. The federal government attempted to correct this imbalance through the creation of the government-owned Petro-Canada and later the National Energy Program. These efforts produced a great deal of anger in the west producing a sentiment of alienation that has remained a central element of Canadian politics to this day. Overall the oil embargo had a sharply negative effect on the Canadian economy. The economic malaise in the United States easily crossed the border and increases in unemployment, and stagflation hit Canada as hard as the United States despite Canadian fuel reserves.

The Soviet Union was also a net oil exporter. The Soviet economy had stagnated for several years, and the increase in the price of oil had a beneficial effect, especially after the bloc's internal terms of trade were adjusted to reflect the increased value of Russian oil. The increase in foreign currency reserves allowed the import of grain and other foodstuffs from abroad, and increased production of consumer goods and kept military spending at its traditional levels. Some historians believe the windfall in oil revenues during this period kept the Soviet Union in existence for a considerably longer period of time than would otherwise have occurred.

The Brazilian government implanted a very large project called " Proálcool" (pro-alcohol) that would make a mixture of ethanol to gas for using in the vehicles. This project, focused on producing ethanol from sugar cane, is still ongoing and has reduced the oil importation needs of the country, and also has decreased the price of the gas in that nation.

Macroeconomic effects

The 1973 oil crisis was a major factor in Japan's economy shifting away from oil-intensive industries and resulted in huge Japanese investments in industries such as electronics.

The Western nations' central banks decided to sharply cut interest rates to encourage growth, deciding that inflation was a secondary concern. Although this was the orthodox macroeconomic prescription at the time, the resulting stagflation surprised economists and central bankers, and the policy is now considered by some to have deepened and lengthened the adverse effects of the embargo.

Long-term effects of the embargo are still being felt. Public suspicion of the oil companies, who were thought to be profiteering or even working in collusion with OPEC, continues (seven of the fifteen top Fortune 500 companies in 1974 were oil companies, with total assets of over $100 billion).

Effects on international relations

The Cold War policies of the Nixon administration also suffered a major blow in the aftermath of the oil embargo. They had focused on China and the Soviet Union, but the latent challenge to U.S. hegemony coming from the Third World became evident. U.S. power was under attack even in Latin America.

The oil embargo was announced roughly just one month after a right-wing military coup in Chile toppled elected socialist president Salvador Allende on September 11, 1973. The United States' subsequent assistance to this government did little to curb the activities of socialist guerrillas in the region. The response of the Nixon administration was to propose doubling of the amount of military arms sold by the United States. As a consequence, a Latin American bloc was organized and financed in part by Venezuela and its oil revenues, which quadrupled between 1970 and 1975.

In addition, Western Europe and Japan began switching from pro-Israel to more pro-Arab policies (some of which are still in effect today). This change further strained the Western alliance system, for the United States, which imported only 12% of its oil from the Middle East (compared with 80% for the Europeans and over 90% for Japan), remained staunchly committed to its backing of Israel.

A year after the unveiling of the 1973 oil embargo, the nonaligned bloc in the United Nations passed a resolution demanding the creation of a "new international economic order" in which resources, trade, and markets would be distributed more equitably, with the local populations of nations within the global South receiving a greater share of benefits derived from the exploitation of southern resources, and greater respect for the right to self-directed development in the South be afforded by the North.

Decline of OPEC

Since 1973, OPEC failed to hold on to its preeminent position, and by 1981, its production was surpassed by that of other countries. Additionally, its own member nations were divided among themselves. Saudi Arabia, trying to gain back market share, increased production and caused downward pressure on prices, making high-cost oil production facilities less profitable or even unprofitable. The world price of oil, which had reached a peak in 1979 during the 1979 energy crisis, at more than US$80 per barrel, decreased during the early 1980s to US$38 per barrel (239 US$/m³). In real prices, oil briefly fell back to pre-1973 levels. Overall, the reduction in price was a windfall for the oil-consuming nations: United States, Japan, Europe and especially the Third World.

Part of the decline in prices and economic and geopolitical power of OPEC comes from the move away from oil consumption to alternate energy sources. OPEC had relied on the famously limited price sensitivity of oil demand to maintain high consumption but had underestimated the extent to which other sources of supply would become profitable as the price increased. Electricity generation from nuclear power and natural gas, home heating from natural gas and ethanol blended gasoline all reduced the demand for oil.

At the same time, the drop in prices represented a serious problem for oil-producing countries in northern Europe and the Persian Gulf region. For a handful of heavily populated, impoverished countries, whose economies were largely dependent on oil — including Mexico, Nigeria, Algeria, and Libya — governments and business leaders failed to prepare for a market reversal, the price drop placed them in wrenching, sometimes desperate situations.

When reduced demand and over-production produced a glut on the world market in the mid-1980s, oil prices plummeted and the cartel lost its unity. Oil exporters such as Mexico, Nigeria, and Venezuela, whose economies had expanded in the 1970s, were plunged into near-bankruptcy, and even Saudi Arabian economic power was significantly weakened. The divisions within OPEC made subsequent concerted action more difficult.

Nevertheless, the 1973 oil shock provided dramatic evidence of the potential power of Third World resource suppliers in dealing with the developed world. The vast reserves of the leading Middle East producers guaranteed the region its strategic importance, but the politics of oil still proves dangerous for all concerned to this day.

Long term effects

Despite efforts by the Arab states to use the "oil weapon" to display Western energy vulnerability and the futility of maintaining a heavy-handed pro-Israeli policy, it can be argued that the Arab states ultimately traded diplomatic gains for ever-increasing dependence on the West for economic and military security. The sharp reaction by the United States, Western Europe and Japan, the Soviet Union, and the influx of new oil wealth, had dire effects for the Arab states in the years following the 1973 Yom Kippur War and OPEC embargo. Prior to the embargo, the geo-political competition between the Soviet Union and the United States, in combination with low oil prices that hindered the necessity and feasibility for the West to seek alternative energy sources, presented the Arab States with financial security, moderate economic growth, and disproportionate international bargaining power. Following the embargo, higher oil prices opened new avenues for energy exploration or expansion including Alaska, the North Sea, the Caspian Sea, and Caucasus.

Soviet reaction

Prior to the ascendence of Mohammed Anwar Al Sadat to president of Egypt in 1970, the Middle East had been an important arena in the global superpower competition, most lucidly displayed in the arms sales and cooperation between the American and Soviet governments with Israel, Saudi Arabia, and Iran on one hand and Egypt, Syria, and Iraq on the other. Although none of these states entered into any formal alliances comparative to the North Atlantic Treaty Organization, they did benefit greatly from the geo-political competition in the region and vacillations in alignment often resulted in greater gains of assistance. This competitive environment, beneficial to the regional states involved, was mitigated sharply after 1970. Sadat's dismissal of Soviet specialists in Egypt and the dramatic price increases in hydrocarbons hardened relations with all of the Middle East and created new opportunities for the export of Soviet oil. Exploration in the Caspian Basin and Siberia became more cost effective. Former cooperation evolved into a far more adversarial relationship as the Soviet Union increased oil production and export (by 1980 the Soviet Union was the world's largest producer of oil) to take advantage of the supply problems in the West created by OPEC's production reductions. This growing economic competition turned into genuine fears of military aggression after the 1979 Soviet invasion of Afghanistan, leaving the Gulf States to look to the United States for the type of security guarantees against Soviet military action in the Persian Gulf that the Israelis had exclusively received only a decade earlier.

Growing security concerns

The Soviet invasion of Afghanistan was only part of the growing security destabilization in the Middle East, most obviously seen in the increased sale of American weapons, technology, and outright military presence. Saudi Arabia and Iran became increasingly dependent on bi-lateral American security assurances to combat both external and internal threats, including increased military competition between these states because of the increased oil revenues. Both states were seemingly competing for preeminence in the Persian Gulf and using increased revenues on disproportionately powerful military forces. By 1979, Saudi weapon purchases from the United States was in excess of five times the amount that Israel was purchasing annually. Following the failure of the Shah during January 1979 to maintain control of Iran, the Saudis were forced to deal with the prospect of internal destabilization via Islamic fundamentalism, a reality which would quickly be revealed in the seizure of the Grand Mosque in Mecca by Wahhabi extremists during November and a Shia revolt in al-Hasa during December.

Conclusions

Growing fears about eventual Western energy independence, various security threats, and the absence of a Western rival in the geo-political competition over the Middle-East led the Arab states in a more dependent relationship with the West. This is most explicit in Saudi Arabia's consistent policy of price and production moderation in an effort to reduce the chances of Western alienation and the opportunity costs for alternative energy production. The exchange for Western moderation in Arab-Israeli affairs ultimately led to a reshaping of the Middle-Eastern geo-political landscape that was significantly less advantageous than prior to 1973.

Impact on motor industry

Impact on West European motor industry

The motor industry was one of Western Europe's most affected industries in the wake of the 1973 oil crisis.

After the Second World War most West European countries applied heavy taxes to motor fuel because it was imported, and as a result most cars made in Europe were small and economical. However by the late sixties as wealth increased car sizes were rising despite heavy fuel taxes, although some of the more upmarket brands were building cars that could take lead-free fuel, and there were still a number of "economy" cars in production at this time.

But the oil crisis gradually saw many West European car buyers move away from larger, less economical cars. The most notable result of this transition in the car market was the rise in popularity of compact hatchbacks.

The only notable small hatchbacks built in Western Europe at the time of the oil crisis were the Peugeot 104, Renault 5 and Fiat 127. By the end of the decade, the market had massively expanded with the introduction of the Ford Fiesta, Vauxhall Chevette (sold as the Opel Kadett City in West Germany), Chrysler Sunbeam and Citroen Visa.

Buyers looking for larger cars were increasingly drawn to medium sized hatchbacks that were virtually unknown in Europe in 1973, but by the end of the decade were gradually replacing saloons as the mainstay of this sector. Between 1973 and 1980, the following medium sized hatchbacks were launched across Europe: the Chrysler/Simca Horizon, Fiat Ritmo (Strada in the UK), Ford Escort MK3, Renault 14, Vauxhall Astra (also sold as the Opel Kadett) and Volkswagen Golf. These cars offered new standard of fuel economy, which were much needed in the aftermath of the oil crisis.

The modern hatchbacks launched in the wake of the oil crisis were considerably more economical than the traditional saloons they were taking the place of, and even attracted a considerable number of buyers who would have otherwise chosen cars in the next sector. Their success continued into the 1980s and by the later part of the decade, some 15 years after the oil crisis, hatchbacks almost monopolised most European small and medium car markets, and had gained a substantial share of the large family car market.

Impact on U.S. motor industry

Like Western Europe, Detroit was significantly impacted by the 1973 oil embargo. Before the embargo American cars got bigger and thirstier each year. V8 engines got bigger, the cars got longer wheelbases, and more and more power and convenience features added weight and sapped power. By 1971 the standard engine in a Chevrolet Caprice was a 400-cubic inch V8, and most came with power windows, seats, and air conditioning. The wheelbase of this car was a long 121.5 inches (3,090 mm), and Motor Trend's 1972 test of the similar Chevrolet Impala could not yield more than 15 miles per gallon, even on the highway. However, after the oil embargo, these big behemoths sat on dealers' lots week after week, month after month, without being sold while the newly-introduced four-cylinder subcompacts and six-cylinder compacts were in greater demand than the supply. In addition, Japanese and European automakers began to export more compact cars into the US than ever before to meet the demand. Toyota become a top seller in a short time due to the superior quality of their models. Nissan (Datsun prior to 1984)), Peugeot, Volkswagen, Mazda and Honda also racked up record sales in the US during this period.

This forced the Big Three (GM, Ford, and Chrysler) to introduce smaller and fuel-efficient models for domestic sales. The Chrysler Omni/Horizon, Ford Fiesta and Fairmont, and the Chevrolet Chevette all had four-cylinder engines and room for at least four passengers by the late seventies. But Toyota, Honda, and Nissan had by that time captured the market to a great degree with their improved, front-wheel drive models that offered more for the money and better fuel mileage than their American competitors.

The February 2008 issue of Collectible Automobile magazine contained an article titled "Designing Cars of the Seventies: Freedoms Lost" which detailed the following: federal safety standards e.g. NHTSA Federal Motor Vehicle Safety Standard 215 (pertaining to the 5 mph (8.0 km/h) safety bumpers), and marketing compacts like the 1974 Mustang II as a prelude to downsizing (where the DOT revised vehicle categories). An article in the March 2008 Collectible Automobile magazine detailing GM's 1977 full-sized cars reflected on the 1973 oil crisis and subsequent downsizing. It concluded that if mass production of overdrive transmission been introduced, there would not have actually been any vehicle downsizing.

By 1979, virtually all the big "full size" American cars were "downsized," featuring smaller engines and smaller dimensions outside, but generally retaining the roominess demanded by Americans. These new smaller models were able to achieve much better fuel economy than their predecessors. GM and Ford Motor Company continued production of downsized luxury cars while Chrysler Corporation ended production of their full-sized luxury sedans in 1981, leaving the company with a full front wheel drive lineup.