Oil Crises, Historical PerspectiveMAMDOUH G. SALAMEHOil Market Consultancy ServiceHaslemere, Surrey, United Kingdom1.2.3.4.5.6.7.8.IntroductionThe Road to the First Oil CrisisThe Oil WeaponThe EmbargoThe Second Oil CrisisAnatomy of Oil CrisesThird Oil Crisis?Implications for the Global Economynatural gas to liquids, known collectively as syntheticfuels or synfuels.Glossaryaramco The Arabian American oil company that obtained the concession for oil exploration in the Eastern Province of Saudi Arabia in 1933. It was originally made up of four American oil companies: Standard Oil of California (Socal), Texaco, Standard Oil of New Jersey (then called Esso and later changed to Exxon Mobil), and Socony-Vacuum (Mobil). In 1976, it was purchased by the Saudi government and renamed Saudi Aramco.conventional crude oil The oil produced from an under- ground reservoir, after being freed from any gas that may have dissolved in it under reservoir conditions, but before any other operation has been performed on it. In the oil industry, simply termed crude.proven reserves The quantities that geological and en- gineering information indicates with reasonable cer- tainty can be recovered from known reserves under existing economic and operating conditions.renewable energy An energy source that does not depend on nite reserves of fossil or nuclear fuels, such as solar energy, wind energy, biomass, hydroelectric power, and hydrogen. All of these renewable sources involve the generation of electricity.shale oil A distillate obtained when oil shale (a rock of sedimentary origin) is heated in retorts.ultimate global reserves This is the amount of oil reserves that would have been produced when production eventually ceases.unconventional oil Oil that has been extracted from tar sands, oil shale, extra heavy oil, and the conversion ofThe 20th century was truly the century of oil.Though the modern history of oil begins in the latterhalf of the 19th century, it is the 20th century thathas been completely transformed by the advent ofoil. Oil has a unique position in the global economicsystem. One could not imagine modern societiesexisting without oil. Modern societies transporta-tion, industry, electricity, and agriculture are virtuallydependent on oil. Oil makes the difference betweenwar and peace. The importance of oil cannot becompared with that of any other commodity or rawmaterial because of its versatility and dimensions,namely, economic, military, social, and political. Thefree enterprise system, which is the core of thecapitalist thinking, and modern business owe theirrise and development to the discovery of oil. Oil isthe worlds largest and most pervasive business. It isa business that touches every corner of the globe andevery person on earth. The nancial resources andthe level of activity involved in exploring, rening,and marketing oil vastly exceed those of any otherindustry. Of the top 20 companies in the world, 7 areoil companies. Human beings are so dependent onoil, and oil is so embedded in daily life, thatindividuals hardly stop to comprehend its pervasivesignicance. Developing nations give no indicationthat they want to deny themselves the benets of anoil-powered economy, whatever the environmentalquestions. In addition, any notion of scaling back theworlds consumption of oil will be inuenced byfuture population growth.1. INTRODUCTIONNo other commodity has been so intimately inter-twined with national strategies and global politicsEncyclopedia of Energy, Volume 4. r 2004 Elsevier Inc. All rights reserved.633634Oil Crises, Historical Perspectiveand power as oil. In World War I, the Allies oated tovictory on a wave of oil. Oil was central to the courseand outcome of World War II in both the Far East andEurope. One of the Allied powers strategic advan-tages in World War II was that they controlled 86%of the worlds oil reserves. The Japanese attack onPearl Harbor was about oil security. Among Hitlersmost important strategic objectives in the invasion ofthe Soviet Union was the capture of the oilelds in theCaucasus. In the Cold War years, the battle for thecontrol of oil resources between international oilcompanies and developing countries was a majorincentive and inspiration behind the great drama ofdecolonization and emergent nationalism. During the 20th century, oil emerged as aneffective instrument of power. The emergence of theUnited States as the worlds leading power in the20th century coincided with the discovery of oil inAmerica and the replacement of coal by oil as themain energy source. As the age of coal gave way tooil, Great Britain, the worlds rst coal superpower,gave way to the United States, the worlds rst oilsuperpower. Yet oil has also proved that it can be a blessing forsome and a curse for others. Since its discovery, it hasbedeviled the Middle East with conict and wars. Oilwas at the heart of the rst post-Cold War crisis ofthe 1990sthe Gulf War. The Soviet Uniontheworlds second largest oil exportersquandered itsenormous oil earnings in the 1970s and 1980s in afutile military buildup. And the United States, oncethe largest oil producer and still its largest consumer,must import almost 60% of its oil needs, weakeningits overall strategic position and adding greatly to analready burdensome trade decita precariousposition for the only superpower in the world. The world could face an energy gap probablyduring the rst decade of the 21st century onceglobal conventional oil production has peaked. Thisgap will have to be lled with unconventional andrenewable energy sources. A transition from fossilfuels to renewable energy sources is, therefore,inevitable if humans are to bridge the energy gapand create a sustainable future energy supply. Some-time in the 21st century, nuclear, solar, geothermal,wind, and hydrogen energy sources may be suf-ciently developed to meet a larger share of theworlds energy needs. But for now humans willcontinue to live in an age of oil. Oil will, therefore,still be supplying a major share of the global energyneeds for most, perhaps all, of the 21st century andwill continue to have far-reaching effects on theglobal economy.2. THE ROAD TO THE FIRSTOIL CRISISOne distinctive feature dominated the global eco-nomic scene in the decades following World War II.It was the rising consumption of oil. Total worldenergy consumption more than tripled between 1949and 1972. Yet that growth paled in comparison tothe rise in oil demand, which during the same periodincreased more than 51 times over. Everywhere, 2growth in the demand for oil was strong. Between1948 and 1972, consumption tripled in the UnitedStates, from 5.8 to 16.4 million barrels/dayunprecedented except when measured against whatwas happening elsewhere. In the same years, demandfor oil in Western Europe increased 15 times over,from 970,000 barrels/day to 14.1 million barrels/day.In Japan, the change was nothing less than specta-cular; consumption increased 137 times over, from32,000 barrels/day to 4.4 million barrels/day. The main drivers of this global surge in oil usewere the rapid economic growth and the cheap priceof oil. During the 1950s and 1960s, the price of oilfell until it became very cheap, which also contributedmightily to the swelling of consumption. Manygovernments encouraged its use to power economicgrowth and industrial modernization. There was onenal reason that the market for oil grew so rapidly.Each oil-exporting country wanted higher volumes ofits oil sold in order to gain larger revenues. In the buoyant decades following World War II,oil overtook coal as the main fuel for economicgrowth. Huge volumes of oil surged out of Venezuelaand the Middle East and owed around the world.Oil was abundant. It was environmentally moreattractive and was easier and more convenient tohandle. And oil became cheaper than coal, whichproved the most desirable and decisive characteristicof all. Its use provided a competitive advantage forenergy-intensive industries. It also gave a competitiveedge to countries that shifted to it. And yet, there wasa haunting question: How reliable was the ow of oilon which modern societies had come to depend?What were the risks? Among the Arabs, there had been talk for morethan a decade about wielding the oil weapon. Thiswas their chance. On June 6, 1967, the day after thestart of the Six-Day War, Arab oil ministers,members of Organization of Arab Petroleum Ex-porting Countries, formally called for an oil embargoagainst countries friendly to Israel. Saudi Arabia,Kuwait, Iraq, Libya, and Algeria thereupon bannedshipments to the United States and Great Britain.Oil Crises, Historical Perspective635 By June 8, the ow of Arab oil had been reducedby 60%. The overall initial loss of Middle Eastern oilwas 6 million barrels/day. Moreover, logistics were intotal chaos not only because of the interruptions butalso because, as in 1956, the Suez Canal and thepipelines from Iraq and Saudi Arabia to theMediterranean were closed. The situation grew morethreatening in late June and early July when,coincidentally, civil war broke out in Nigeria,depriving the world oil market of 500,000 barrels/day at a critical moment. However, by July 1967, a mere month after theSix-Day War, it became clear that the selective Araboil embargo was a failure; supplies were beingredistributed to where they were needed. And bythe beginning of September, the embargo had beenlifted. The 1970s saw a dramatic shift in world oil.Demand was catching up with available supply andthe 20-year surplus was over. As a result, the worldwas rapidly becoming more dependent on the MiddleEast and North Africa for its oil. Oil consumption surged beyond expectationaround the world, as ever-greater amounts ofpetroleum products were burned in factories, powerplants, homes, and cars. The cheap price of oil in the1960s and early 1970s meant that there was noincentive for fuel-efcient automobiles. The late1960s and early 1970s were also the watershed yearsfor the domestic U.S. oil industry. The United Statesran out of surplus capacity. In the period 1957 to1963, surplus capacity in the United States hadtotaled approximately 4 million barrels/day. By1970, it had declined to only 1 million barrels/day.That was the year, too, that American oil productionpeaked at 10 million barrels/day. From then on, itbegan its decline, never to rise again. With consump-tion continuing to rise, the United States had to turnto the world oil market to satisfy its needs. Netimports tripled from 2.2 million barrels/day in 1967to 6 million barrels/day by 1973. Imports as a shareof total oil consumption over the same years rosefrom 19 to 36%. The disappearance of surplus capacity in theUnited States would have major implications, for itmeant that the security margin on which theWestern world depended was gone. For the UnitedStates, it marked a shift from: (1) oil self-sufciencyto reliance on Middle East oil; (2) being a majorexporter to becoming a major importer; (3) loss ofthe ability to control the global oil markets at a timewhen Middle East oil producers (Arab Gulf produ-cers) began to assert themselves on the globalmarkets; and (4) inability to provide stand-by supplyto its allies in an emergency. This meant a major shiftfrom energy security to vulnerability and depen-dency. Indeed, the razors edge was the ever-increas-ing reliance on the oil of the Middle East. Newproduction had come from Indonesia and Nigeria (inthe latter case, after the end of its civil war in early1970), but that output was dwarfed by the growth inMiddle Eastern production. Between 1960 and 1970,Western world oil demand had grown by 21 millionbarrels/day. During that same period, production inthe Middle East (including North Africa) had grownby 13 million barrels/day. In other words, two-thirdsof the huge increase in oil consumption was beingsatised by Middle East oil. In a wider sense, the disappearance of surpluscapacity caused an economic and geopolitical trans-formation of the global oil market. In an economicsense, the center of gravity of oil production,energy security, and control of global oil supplies hadshifted from the United States to the Middle East. Ina geopolitical sense, the oil revenue and the globaldependence on Middle East oil provided the ArabGulf producers with unprecedented political inu-ence. This they channeled into support of theirpolitical aspirations as they did during the 1973 warand the resulting oil embargo. Another disturbing development was that therelationship between the oil companies and theproducing nations was beginning to unravel. Ingaining greater control over the oil companies,whether by participation or outright nationalization,the exporting countries also gained greater controlover prices. The result was the new system that wasforged in Tehran and Tripoli, under which priceswere the subject of negotiation between companiesand countries, with the producing countries takingthe lead in pushing up the posted price. However, the supplydemand balance thatemerged at the beginning of the 1970s was sendinga most important message: Cheap oil had been atremendous boon to economic growth, but it couldnot be sustained. Demand could not continuegrowing at the rate it was; new supplies needed tobe developed. That was what the disappearance ofspare capacity meant. Something had to give, andthat something was price. By 1972, many experts reckoned that the worldwas heading for an acute oil shortage in a few years.The signs of a shortage were visible everywhere. Thedemand for oil in the summer of 1973 was goingabove the wildest predictionsin Europe, in Japan,and most of all in the United States. Imports from the636Oil Crises, Historical PerspectiveMiddle East to the United States were still racing up:production inside the United States was still falling.In April, U.S. President Nixon lifted restrictions onimports of oil, so the Middle East oil owed in stillfaster. There was a new danger sign when Kuwaitdecided in 1972 to conserve its resources and to keepits production below 3 million barrels/day. As late as 1970, there were still approximately 3million barrels/day of spare capacity in the worldoutside the United States, with most of it concen-trated in the Middle East. By the second half of 1973,the spare capacity had shrunk to only 500,000barrels/day. That was just 1% of world consumption.With a 99% capacity utilization and a 1% securitymargin, the oil supplydemand balance was indeedextremely precarious. In June 1973, as prices were zooming up, theOrganization of Petroleum Exporting Countries(OPEC) summoned another meeting in Geneva toinsist on another price increase because of the furtherdevaluation of the U.S. dollar. The radicalsAlgeria,Libya and Iraqwere pressing for unilateral controlof price, but eventually OPEC agreed on a newformula that increased prices by another 12%. BySeptember 1973, for the rst time since the foundingof OPEC, the market price of oil had risen above theposted price. It was a sure sign that OPEC was in avery strong bargaining position. Armed with thisknowledge, OPEC invited the oil companies to meetthem in Vienna on October 8 to discuss substantialincreases in the price of oil. In this atmosphere of crisis, the oil companydelegates prepared to confront OPEC in Vienna onOctober 8. And then, just as they were leaving forVienna, Egypt and Syria invaded Israeli-occupiedterritories. There was war. While the shortage loomed, the Arabs were at lastachieving closer unity. They were determined to useoil as a weapon against Israel and by 1973 themilitants were being joined by Saudi Arabia. Thevery fact that Saudi Arabia had become the largest oilexporter made King Feisal more vulnerable in theface of his Arab colleagues and the danger of anembargo more likely, for he could not afford to beseen as a blackleg. The international oil order had been irrevocablychanged. However, it was not only a question ofprice, but of power. The extent of dependence by theindustrial countries on oil as a source of energy hadbeen exposed and the practicality of controllingsupply as means of exerting pressure for raising theprice of oil had been dramatically demonstrated.Although the oil weapon had not worked in 1967,the rationale of those who called for its use as aweapon in the Middle East conict has beenstrengthened in current circumstances.3. THE OIL WEAPONContrary to popular belief, the Americans, not theArabs, were the rst to wield the oil weapon. Theyused it against Japan when on July 25, 1941, theUnited States announced a freeze on Japanese fundsnecessary for Japan to buy American oil, which, inpractice, meant an embargo on oil. The embargo wasthe result of Japanese military aggression in Asia. Increasingly worried about a cut-off of oil suppliesfrom the United States, Tokyo instituted a policy toestablish self-sufciency and to try to eliminatedependence on U.S. oil supplies. In 19401941, itwas energy security that led Japan to occupy theDutch East Indies and take control of its oilelds.Indeed, the U.S. oil embargo was an important factorleading Japan to attack Pearl Harbor, bringing theUnited States into World War II. Oil had been centralto Japans decision to go to war. Ever since the 1950s, the Arab world had beentalking about using the oil weapon to force Israel togive up occupied Arab territories. Yet the weaponhad always been deected by the fact that Arab oil,though it seemed endlessly abundant, was not thesupply of last resort. In June 1967, 2 days into the Six-Day War, theArabs wielded the oil weapon when they imposed anoil embargo against the United States and GreatBritain. However, by July 1967, it became clear thatthe Arab embargo had failed. The Arabs would haveto wait for another chance to wield the oil weaponagain. That chance came their way when justmoments before 2:00 P.M. on October 6, 1973,Egyptian and Syrian armies launched an attack onIsraeli-held positions in the Sinai and the GolanHeights. Thus began the October War or, whatbecame known as the Yom Kippur War, the fourth ofthe ArabIsraeli warsthe most destructive andintense of all of them and the one with the mostfar-reaching consequences. One of the most potentweapons used in this war was the oil weapon,wielded in the form of an embargoproductioncutbacks and restrictions on exportsthat, in thewords of Henry Kissinger, altered irrevocably theworld as it had grown up in the postwar period. The embargo, like the war itself, came as asurprise and a shock. Yet the pathway to both inretrospect seemed in some ways unmistakable. ByOil Crises, Historical Perspective6371973, oil had become the lifeblood of the worldsindustrial economies and it was being pumped andcirculated with very little to spare. Never before inthe entire postwar period had the supplydemandequation been so tight, while the relationshipsbetween the oil-exporting countries and the oilcompanies continued to unravel. It was a situationin which any additional pressure could precipitate acrisisin this case, one of global proportions. With supply problems becoming chronic in theearly 1970s, talk about an energy crisis began tocirculate in the United States. There was agreement,in limited circles, that the United States faced a majorproblem. Price controls on oil, imposed by Nixon in1971 as part of his overall anti-ination program,were discouraging domestic oil production whilestimulating consumption. The articially low pricesprovided little incentive either for new exploration orfor conservation. By the summer of 1973, UnitedStates oil imports were 6.2 million barrels/day,compared to 4.5 million barrels/day in 1972 and3.2 million barrels/day in 1970. The oil trade journalPetroleum Intelligence Weekly reported in August1973 that near-panic buying by the U.S., theEuropeans, and the Japanese was sending oil pricessky-rocketing. As global demand continued to rise against thelimit of available supply, market prices exceeded theofcial posted prices. It was a decisive change, trulyunderlining the end of surplus. For so long, reectingthe chronic condition of oversupply, market priceshad been below posted prices, irritating relationsbetween companies and governments. But the situa-tion had reversed and the exporting countries did notwant to see the growing gap between the posted priceand the market price go to the companies. Wastinglittle time, the exporters sought to revise theirparticipation and buy-back arrangements so thatthey would be able to obtain a larger share of therising prices. One of the principal characteristics governing theoperations of the oil industry is that it generates animportant economic rent or oil surplus, theappropriation of which involves three players: theexporting countries, the consuming countries, andthe multinational oil companies. Both the exportingcountries and the consuming countries are effectivelystaking a claim to the signicant element ofeconomic rent built into the price of oil. For theexporters, such as the Arab Gulf producers, oilremains the single most important source of income,generating approximately 85 to 90% of theirrevenues. Signicantly, consumer countries havealways looked on oil as an important source oftaxation since demand for it is relatively inelastic;that is to say, it varies little as the price changes.These countries have more maneuverability when theprice of oil is low. This was amply demonstratedwhen, as a result of the oil price collapse in 1986,many of them took the opportunity to raise tax rateson petroleum products. This practice was, to a lesserextent, in operation in the 1970s but has acceleratedsince 1986 in Europe, with tax levels on petroleumproducts reaching between 80 and 87%. In otherwords, the sharp increases in taxes by the consumingcountries were intended to cream off more of therent. Is it any wonder that the United Kingdom hasbeen for years earning far more revenue from taxeson petroleum products than from its North Sea oilexports? On September 1, 1973, the fourth anniversary ofMuamer Qaddas coup, Libya nationalized 51% ofthose company operations it had not already takenover. The radicals in OPECIran, Algeria, andLibyabegan pushing for a revision in the Tehranand Tripoli agreements. By the late summer of 1973,the other exporters, observing the upward trend ofprices on the open market, came around to that samepoint of view. They cited rising ination, the dollarsdevaluation, and also the rising price of oil. BySeptember 1973, the Saudi oil minister SheikhAhmed Zaki Yamani was able to announce that theTehran Agreement was dead. Even as the economicsof oil were changing, so were the politics thatsurrounded itand dramatically so. By April of 1973, President Anwar Sadat of Egypthad begun formulating with Syrias Hafez Al-Asadstrategic plans for a joint EgyptianSyrian attackagainst Israel. Sadats secret was tightly kept. One ofthe few people outside the high commands of Egyptand Syria with whom he shared it was King Feisal.And that meant oil would be central to the comingconict. In the early 1970s, as the market tightened,various elements in the Arab world became morevocal in calling for use of the oil weapon to achievetheir economic and political objectives. King Feisalwas not among them. He had gone out of his way toreject the use of the oil weapon. It was not onlyuseless, he said, but dangerous even to think ofthat. Politics and oil should not be mixed. Yet, byearly 1973, Feisal was changing his mind. Why? Part of the answer lay in the marketplace. Muchsooner than expected, Middle Eastern oil had becomethe supply of last resort. In particular, Saudi Arabiahad become the marginal supplier for everybody,638Oil Crises, Historical Perspectiveincluding the United States; American dependence onthe Gulf had come not by the widely predicted 1985,but by 1973. The United States would no longer beable to increase production to supply its allies in theevent of a crisis and the United States itself was now,nally, vulnerable. The supplydemand balance wasworking to make Saudi Arabia even more powerful.Its share of world exports had risen rapidly from 16%in 1970 to 25% in 1973 and was continuing to rise. In addition, there was a growing view withinSaudi Arabia that it was earning revenues in excess ofwhat it could spend. Two devaluations of the U.S.dollar had abruptly cut the worth of the nancialholdings of countries with large dollar reserves,including Saudi Arabia. The changing conditions in the marketplace,which with each passing day made the Arab oilweapon more potent, coincided with signicantpolitical developments. By the spring of 1973, Sadatwas strongly pressing Feisal to consider using the oilweapon to support Egypt in a confrontation withIsrael. King Feisal also felt growing pressure frommany elements within his kingdom and throughoutthe Arab world. Thus, politics and economics hadcome together to change Feisals mind. Thereuponthe Saudis began a campaign to make their viewsknown, warning that they would not increase theiroil production capacity to meet rising demand andthat the Arab oil weapon would be used, in somefashion, unless the United States moved closer to theArab viewpoint and away from Israel. On August 23, 1973, Sadat made an unannouncedtrip to Riyadh to see King Feisal. He told the kingthat he was considering going to war against Israel. Itwould begin with a surprise attack and he wantedSaudi Arabias support and cooperation. He got it. On October 17, 1973, 11 days into the war, Araboil ministers meeting in Kuwait agreed to institute atotal oil embargo against the United States and othercountries friendly to Israel. They decided to cutproduction 5% from the September level and to keepcutting by 5% in each succeeding month until theirobjectives were met. Oil supplies at previous levelswould be maintained to friendly states. One clearobjective of the plan was to split the industrialcountries right from the start. On October 19, Nixon publicly proposed a $2.2billion military aid package for Israel. In retaliationfor the Israeli aid proposal, Saudi Arabia had gonebeyond the rolling cutbacks; it would now cut off allshipments of oil, every last barrel, to the United States.The oil weapon was now fully in battlea weapon, inKissingers words, of political blackmail. To counterthat blackmail, Kissinger called for the industrializednations to meet in Washington, DC at the earliestpossible moment. He wanted the oil-consuming Westto make a united stand against the Arabs.4. THE EMBARGOThe embargo came as an almost complete surprisedespite the evidence at hand: almost two decades ofdiscussion in the Arab world about the oil weapon,the failed embargo in 1967, Sadats public discussionof the oil option in early 1973, and the exceedinglytight oil market of 1973. What transformed thesituation and galvanized the production cuts and theembargo against the United States was the very publicnature of the resupply of ammunitions and arma-ments to Israel and then the $2.2 billion aid package. On October 21, Sheikh Yamani met with thepresident of Aramco, Frank Junkers. Using computerdata about exports and destinations that the Saudishad requested from Aramco a few days earlier,Yamani laid out the ground rules for the cutbacksand the embargo the Saudis were about to impose.He told Junkers that any deviations from the groundrules would be harshly dealt with. At the time of the embargo, the management ofthe Saudi oil industry was in the hands of Aramco(the ArabianAmerican Oil Company), the jointventure between Standard Oil of California (Socal),Texaco, Standard Oil of New Jersey (then called Essoand later changed to ExxonMobil), and Socony-Vacuum (Mobil). In 1948, U.S. imports of crude oil and productstogether exceeded exports for the rst time. Nolonger could the United States continue its historicalrole as supplier to the rest of the world. That shiftadded a new dimension to the vexing question ofenergy security. The lessons of World War II, thegrowing economic signicance of oil, and themagnitude of Middle Eastern oil reserves all served,in the context of the developing Cold War with theSoviet Union, to dene access to that oil as a primeelement in Western security. Oil provided the point atwhich foreign policy, international economic con-siderations, national security, and corporate interestswould all converge. The Middle East would be thefocus. There the oil companies were already buildingup production and making new arrangements tosecure their positions. In Saudi Arabia, development was in the hands ofAramco. The company understood from the time itobtained the Saudi oil concession in 1933 that theOil Crises, Historical Perspective639concession would always be in jeopardy if it couldnot satisfy the expectations and demands of KingAbdul Aziz Ibn Saud, the founder of Saudi Arabia,and the royal family. Since then, it has workedtirelessly to enhance Saudi oil reserves and produc-tion and build terminals and pipelines for exportingthe oil worldwide. In October 1972, Sheikh Yamani negotiated a par-ticipation agreement between Saudi Arabia andAramco. It provided for an immediate 25% participa-tion share, rising to 51% by 1983. Aramco had nallyagreed to participation with Saudi Arabia because thealternative was worseoutright nationalization. In June 1974, Saudi Arabia, operating on Yama-nis principle of participation, took a 60% share inAramco. By the end of the year, the Saudis toldAramco that 60% was simply not enough. Theywanted 100%. An agreement to that effect waseventually reached in 1976 between Aramco andSaudi Arabia, almost 43 years after the concessionwas granted. By then, the proven reserves of SaudiArabia were estimated at 149 billion barrelsmorethan one-quarter of the worlds total reserves. But the agreement did not by any means providefor a severing of links. Thus, under the new arrange-ment, Saudi Arabia would take over ownership of allAramcos assets and rights within the country.Aramco could continue to be the operator andprovide services to Saudi Arabia, for which it wouldreceive 21 cents per barrel. In return, it would market80% of Saudi production. In 1980, Saudi Arabianally paid compensation, based on net book value,for all Aramcos holdings within the kingdom. Withthat, the sun nally set on the great concessions. The Saudis had already worked out the embargo insome detail. They insisted that on top of the 10%cutback, Aramco must subtract all shipments to theUnited States, including the military. The Saudis askedAramco for details of all crude oil used to supplyAmerican military forces throughout the world. Thedetails were provided and the Saudis duly instructedAramco to stop the supplies to the U.S. military. Thesituation was serious enough for Washington to askwhether British Petroleum (BP) could supply the U.S.Sixth Fleet in the Mediterranean. At the beginning of November 1973, only 2 weeksafter the initial decision to use the oil weapon, theArab oil ministers decided to increase the size of theacross-the-board cuts. This resulted in a gross loss of5 million barrels/day of supply from the market. Thistime, however, there was no spare capacity in theUnited States. Without it, the United States had lostits critical ability to inuence the world oil market.And with the price of a barrel of oil skyrocketing, theoil exporters could cut back on volumes and stillincrease their total income. The panic and shortage of oil supplies caused bythe embargo led to a quadrupling of crude oil priceand precipitated a severe recession, which adverselyaffected the economies of the industrialized nations.Panic buying meant extra demand in the market. Thebidding propelled prices even further upward. Theposted price for Iranian oil, in accordance with theOctober 16 agreement, was $4.50 per barrel. InDecember, it sold for $22.60. The oil crisis had far-reaching political andeconomic effects. The quadrupling of prices by theArab oil embargo and the exporters assumption ofcomplete control in setting those prices broughtmassive changes to the world economy. The com-bined oil earnings of the oil exporters rose from $23billion in 1972 to $140 billion by 1977. For theindustrial countries, the sudden hike in oil pricesbrought profound dislocations. The oil rents oodinginto the treasuries of the exporters added to a hugewithdrawal of their purchasing power and sent theminto deep recession. The U.S. gross national product(GNP) plunged 6% between 1973 and 1975 andunemployment doubled to 9%. Japans GNP de-clined in 1974 for the rst time since the end ofWorld War II. At the same time, the price increasesdelivered a powerful inationary shock to economiesin which inationary forces had already taken hold.President Nixon later commented that: The oilembargo made it transparently clear that theeconomies of Western Europe and Japan could bedevastated almost as completely by an oil cutoff asthey could be by a nuclear attack. On March 18, 1974, the Arab oil ministers agreedto end the embargo after the United States warnedthat peace efforts between the Arabs and Israel couldnot proceed without the lifting of the embargo. Aftertwo decades of talk and several failed attempts, theoil weapon had nally been successfully used, withan impact not merely convincing, but overwhelming,and far greater than even its proponents have daredto expect. It had transformed world oil and therelations between producers and consumers and ithad remade the international economy. Now it couldbe resheathed. But the threat would remain.5. THE SECOND OIL CRISISThe Iranian revolution was at the heart of the secondoil crisis. The astronomical oil price rises of 1979640Oil Crises, Historical Perspectiveand the emergence of the Rotterdam Spot Marketwere a direct consequence of the Iranian revolution.In January 7, 1978, a Tehran newspaper published asavage attack on an implacable opponent of the Shah,an elderly Shiite cleric named Ayatollah RuhollahKhomeini, who was then living in exile in Iraq. Thisjournalistic assault on Khomeini set off riots in theholy city of Qom, which remained his spiritual home.Troops were called in and demonstrators were killed.The disturbance in Qom ignited riots and demonstra-tions across the country, with further dramaticclashes and more people killed. Strikes immobilizedthe economy and the government and demonstrationsand riots went on unchecked. All through 1978, the internal political strifeagainst the Shahs regime and the political dramathat was unfolding simultaneously in Paris andTehran were pushing Iran toward an explosion. It had become evident in the mid-1970s that Iransimply could not absorb the vast increase in oilrevenues that was ooding the country. The petro-dollars, misspent on grandiose modernization pro-grams or lost to waste and corruption, weregenerating economic chaos and social and politicalunrest throughout the nation. Iranians from everysector of national life were losing patience with theShahs regime and the rush to modernization.Grasping for some certitude in the melee, theyincreasingly heeded the call of traditional Islam andof an ever more fervent fundamentalism. Thebeneciary was Ayatollah Khomeini, whose religiousrectitude and unyielding resistance made him theembodiment of opposition to the Shahs regime. TheIranian oil industry was in a state of escalating chaos.The impact of the strikes was felt immediately. OnOctober 13, 1978, workers at the worlds largest oilrenery, in Abadan, suddenly went on strike at theinstigation of the exiled Ayatollah Khomeini, whowas inciting them from Paris in recorded speeches oncassettes smuggled to Iran. Within a week, the strikehad spread throughout most of the oil installationsand Iran was, for all intents and purposes, out of theoil business. Iran was the second-largest exporter of oil afterSaudi Arabia. Of the 5.7 million barrels/day pro-duced in Iran, approximately 4.5 million barrels/daywere exported. By early November 1978, productiondecreased from 5.7 million barrels/day to 700,000barrels/day. And by December 25, Iranian oil exportsceased altogether. That would prove to be a pivotalevent in the world oil market. Spot prices in Europesurged 10 to 20% above ofcial prices. The ceasingof Iranian exports came at a time when, in theinternational market, the winter demand surge wasbeginning. Oil companies, responding to the earliergeneral softness in the market, had been letting theirinventories fall. On December 26, Khomeini declared, as long asthe Shah has not left the country there will be no oilexports. On January 16, 1979, the Shah left thecountry. And on February 1, Khomeini landed inTehran. By the time the Khomeini regime decided toresume pumping, they could not restore productionto prerevolutionary levels because the Ayatollahkicked out of Iran all the Western companies thatoperated the Iranian oilelds. During the productiondisruption, these elds lost gas pressure and the lackof maintenance made matters worse. The Iraniansapparently did not have enough technical know-howto maintain or operate the elds. In effect, theIranians pulled the rug from under the feet of the oilmarket, the world panicked, and the prices started tohit the roof. Up until September 1977, there was actually a glutof oil in the market, which meant that the continuousrise in oil prices had come to a halt. The oil surpluswas due to a number of factors. North Sea oilproduction increased much faster than expected,Mexico became a large oil exporter, and in July 1977oil from Alaska started its long-awaited ow to theUnited States. At the same time, Saudi Arabia, theworlds largest oil exporter, was pumping 8.5 millionbarrels/day in the rst half of 1977 in an attempt tofrustrate demands for high price increases by somemembers of OPEC. Another reason is that demandfor crude oil in Europe barely increased from the1976 levels, as the economies there recovered moreslowly than expected from the worldwide recessionthat followed the Arab oil embargo 3 years earlier.Also, the demand for gasoline in the United States,expected to rise 3% in 1977, grew only 2% due tothe introduction of new fuel-efcient American cars. However, between 1974 and 1978, the world oilsupplies seemed to have reached some kind of uneasystability. Before Iranian oil production ceased, theworld oil output approximately matched demand at63 million barrels/day. By December 26,1978, whenall oil exports from Iran ceased, the world oil markethad a shortfall of 5 million barrels/day. Part of theshortfall had been made up by other OPEC members.This left a shortfall of 2 million barrels/day. Yet when measured against world demand of 63million barrels/day, the shortage was no more than3%. Why should a 3% loss of supplies have resultedin a 150% increase in the price? The answer wasOil Crises, Historical Perspective641panic. The rush to build inventories by oil companiesresulted in an additional 3 million barrels/day ofdemand above actual consumption. When added tothe 2 million barrels/day of net lost supplies, theoutcome was a total shortfall of 5 million barrels/day,which was equivalent to approximately 8% of globalconsumption. The panic buying more than doubledthe actual shortage and further fueled the panic. Thatdrove the price from $13/barrel to $34/barrel. As the world oil shortage became more serious,there was frenzied activity on the Rotterdam SpotMarket, which rapidly became the barometer of thecrisis and also an indicator of the extreme pricelevels, and this market became the new frontier ofthe oil trade. Many factors conspired in early 1979 tomake the Spot Market more excitable. The NewIranian regime decided to sell more and more oil on aday-to-day basis instead of on term contracts, so thatin effect became part of the Spot Market. TheJapanese had been dependent on Iranian oil and asthe crisis deepened, they came unstuck. It was Japanthat led the panic buying and by May 1979 spotcrude leapt up to $34.5/barrel. The Spot Marketbecame still more excited as the Europeans tried toreplenish their declining oil stocks. American oilcompanies with rened oil in the Caribbean beganshipping it to Rotterdam instead of the east coast ofthe United States. Throughout the cold spring of 1979, the oilshortage was being felt across the industrial worldand by the week beginning May 14, the Spot Marketbegan to go crazy. Oil deals by the major oilcompanies at the Spot Market helped push the pricefurther up. It became evident that the major oilcompanies previously sold cargos of their cheap oilbought out at the long-term contract prices, makinghuge prots. They were now rushing in to buy oil forstorage because they were not sure how long theIranian oil exports cutoff would last. The next bigmove in the Spot Market came in October 1979,when the spot prices hit $38/barrel. Then, in earlyNovember, 90 people, including 63 Americans, weretaken hostage at the U.S. Embassy in Tehran. Aninternational crisis with grave military overtonessuddenly erupted onto the world scene. Spot crudehit $40/barrel. However, the panic buying of 19791980 wouldbecome the glut of 19801986. Prices wouldeventually tumble. By the summer of 1980, oilinventories were very high; a pronounced economicrecession was already emerging; in the consumingcountries, both product prices and demand wereeven falling; and the inventory surplus continuing toswell. Now it was the buyers turn to walk awayfrom contracts and the demand for OPEC oil wasdecreasing. Indeed, in mid-September, a number ofOPEC countries agreed to voluntarily cut backproduction by 10% in an effort to rm prices. But as the world oil market was becoming calmer,on September 22, 1980 Iraqi troops began an attackon Iran. The outbreak of war threw the oil supplysystem into jeopardy, threatening a third oil crisis. Inits initial stages, the IranIraq War abruptly removedalmost 4 million barrels/day of oil from the worldmarket6% of world demand. Spot prices jumpedup again. Arab light crude oil reached its highestprice ever: $42/barrel. Panic was once again drivingthe market. However, supply from other sources wasmaking up for the lost output from Iran and Iraq.Within days of the war, OPEC producers raised theirproduction. At the same time, production in Mexico,the North Sea, Alaska, and other non-OPECcountries was continuing to increase as well. Non-OPEC producers, anxious to increase market share,were making signicant cuts in their ofcial prices.As a result, OPECs output in 1981 was 26% lowerthan the 1979 output and in fact was the lowest ithad been since 1970. In retrospect, one important question presentsitself. Could the astronomical rise in the oil priceshave been held in check? Sheikh Yamani seems tothink so. He expressed the view that if the UnitedStates government and the governments of othermajor consuming nations intervened at the time andforbade the oil companies from trading in the SpotMarket, the prices could have been checked and thepanic would have ended.6. ANATOMY OF OIL CRISESThe world witnessed two oil crises during the last 30years of the 20th century. The topic will return to thefront pages soon, however, because the world may beconfronted by a third oil crisis. This third crisispromises to be similar to but have a more modesteconomic impact than the two previous crises, unlessthe price of oil hits the $50/barrel mark.6.1 Denition of Oil CrisesFor economic purposes, an oil crisis is dened here asan increase in oil prices large enough to cause aworldwide recession or a signicant reduction inglobal real gross domestic product (GDP) belowprojected rates by two to three percentage points.642Oil Crises, Historical Perspective The 1973 and 1979 episodes both qualify as oilcrises by this denition. The 1973 oil crisis caused adecline in GDP of 4.7% in the United States, 2.5% inEurope, and 7% in Japan. According to the U.S.government, the 1979 increase in oil prices causedworld GDP to drop by 3% from the trend. The price increase following the rst oil crisis rai-sed consumer payments for oil by approximately $473billion (in real 1999 U.S. dollars), whereas the secondoil crisis increased consumer expenditure by $1048billion. By contrast, the oil price hikes during 19992001 raised consumer expenditure by $480 billion.6.2 Characteristics of Oil CrisesThe 1973 and 1979 crises shared four characteristics.First, the disruption in oil supplies occurred at a timeof rapid expansion in the global economy. The rapideconomic growth fueled greater consumption of oil.In the 5 years that preceded the 1973 crisis, global oilconsumption had grown from 38.3 million barrels/day in 1968 to 52.7 million barrels/day in 1972, anaverage annual increase of 7.5%. Similarly, in the 5years preceding the 1979 crisis, global consumptionhad risen from 53 million barrels/day in 1974 to63 million barrels/day in 1978, an average annualincrease of 3.8%. Second, both disruptions occurred at a time whenthe world crude oil production was operating at vir-tually full capacity. Global capacity utilization reached99% in 1973, with OPEC accounting for 56% of totalproduction. The second oil crisis had seen a decit of 5million barrels/day resulting from the disruption inIranian oil production. Third, each crisis took place ata time when global investment in oil exploration hadbeen declining, making it impossible to achieve aspeedy increase in non-OPEC production. In both1973 and 19791980, the global oil industry was atthe end, rather than the start, of a new surge in non-OPEC output. Fourth, in both crises, OPEC membershad made a deliberate decision to reduce oil produc-tion in order to achieve political ends.energy demand. The global economy is projected togrow by 3.2% per annum, on average, to 2025.Global GDP is projected to rise from $49 trillion in2000 (year 2000 dollars purchasing power parity) to$108 trillion in 2025 and $196 trillion in 2050. World population is expected to grow from 6billion in 2000 to 8 billion in 2020. The populationgrowth among the 4.8 billion people living indeveloping countries is estimated at 1.7% per annum.This compares with an average 0.3% per annum inthe developed countries. Expanding industrializationand improving standards of living will contributesignicantly to the growing energy demand. The developed countries produce approximatelyone-third of global oil but consume two-thirds,whereas the developing countries produce two-thirdsbut consume only one-third (see Table I). Annual percapita consumption in the developing countries is2 barrels/year. This compares with 14.2 barrels/yearin the developed countries and 25 barrels/year in theUnited States. The International Energy Agency (IEA) and theU.S. Department of Energy forecast that the worldoil demand will grow from 76.1 million barrels/dayin 2001 to 95.8 million barrels/day in 2010 and 115million barrels/day in 2020, with Middle Eastproducers having to meet the major part of theadditional demand. However, this will depend onsufcient investment to expand production capacity(see Table II). 6.3.2 The Global Sustainable Productive CapacitySustainable productive capacity is here dened asbeing attainable within thirty days and sustainableTABLE IWorld Crude Oil Production versus Demand in 2001Production (billion barrels)819272Demand(billionbarrels)1810287RegionShare (%)30701007Share (%)6436100256.3 Underlying FactorsIn a tight oil market, any of the following underlyingfactors could, individually or collectively, trigger aprice escalation reminiscent of the spot market pricesof 1979 and precipitate an oil crisis. 6.3.1 The Global Oil DemandEconomic growth and population growth are themost important drivers behind increasing globalDeveloped countriesDeveloping countriesWorldUnited States Sources: British Petroleum Statistical Review of World Energy,June 2002; and U.S. Energy Information Administration, June2001.Oil Crises, Historical Perspective643TABLE IIWorld Oil Demand and Supply (Million Barrels/Day), 200020202000World demandWorld supplyNon-OPECOPECStock changeSynfuelsTotal supplyGlobal oil decit45.229.31.7 1.276.2aTABLE IIIOPEC Sustainable Capacity and Capacity Utilization (MillionBarrels/Day) in January 2001CountryAlgeriaIndonesia46.130.01.3a76.144.736.01.8a80.72.843.645.92.7a89.56.349.651.14.2a100.714.0IranIraqKuwaitLibyaNigeriaQatarSaudi ArabiaUnited Arab EmiratesVenezuelaTotalCapacity Production Capacity utilization0.8801.3003.5003.0002.2001.4502.1000.7209.2502.4002.90029.7000.8601.3003.5002.9002.2001.4502.1000.7009.0002.4002.90029.31098%100%100%97%100%100%100%97%97%100%100%99%200176.1200583.5201095.82020114.776.2 Sources: U.S. Department of Energy; British PetroleumStatistical Review of World Energy, July 2002; and InternationalEnergy Agency. aSynfuel oil production is already included in non-OPECsupply gures.for three months. OPECs sustainable productivecapacity stood at 29.7 million barrels/day in January2001 with a 99% capacity utilization (see Table III).The organizations immediately available sparecapacity stood then at 390,000 barrels/day. However,with the production cutbacks since March 2001,spare capacity has risen to 4 million barrels/day. The capital costs of maintaining and expandingOPECs capacity over a 5-year period are estimatedat $112 billion, money that members do not have.These projected costs are based on the membercountries planned capacity increase of 7 to 36.7million barrels/day. There is no non-OPEC spare capacity. Thenancial incentive of high oil prices and rm demandmean that every non-OPEC oileld is being exploitedand any capacity brought onstream is being utilizedas quickly as possible. 6.3.3 The Ultimate Global Proven ReservesWorld ultimate conventional oil reserves are estimatedat 2000 billion barrels. This is the amount ofproduction that would have been produced whenproduction eventually ceases. Different countries areat different stages of their reserve depletion curves.Some, such as the United States, are past theirmidpoint and in terminal decline, whereas others areclose to midpoint, such as the United Kingdom andNorway. The U.K. sector of the North Sea is currentlyat peak production and is set to decline at approxi-mately 6% per year. However, the ve major GulfproducersSaudi Arabia, Iraq, Iran, Kuwait, and Sources. Energy Intelligence Groups Oil Market Intelligence;Petroleum Review, April 2000; International Energy Agency; andAuthors projections.United Arab Emiratesare at an early stage ofdepletion and can exert a swing role, making upthe difference between world demand and what otherscan supply. They can do this only until they themselvesreach their midpoint of depletion, probably by 2013. The expert consensus is that the worlds midpointof reserve depletion will be reached when 1000billion barrels of oil have been producedthat is tosay, half the ultimate reserves of 2000 billion barrels.With 935 billion barrels already produced, this willoccur probably between 2004 and 2005. The yet-to-nd (YTF) oil reserves are estimated at 280 billionbarrels (see Table IV). As the world production peakapproaches, the oil price will soar. However, if the potential of unconventional oil,such as tar sand oil and extra heavy oil, is included,amounting to 572 billion barrels, then the midpointof depletion could be delayed for a few more yearsbut not beyond 2010. In 1956, the geologist M. King Hubbert predictedthat U.S. oil production would peak in the early1970s. Almost everyone, inside and outside the oilindustry, rejected Hubberts analysis. The contro-versy raged until 1970, when U.S. production ofcrude oil started to fall. U.S. production peaked at9.64 million barrels/day in 1970 and has been fallingsince then, reaching 5.77 million barrels/day by2001. Hubbert was proven right and his bell-shapedcurve became a useful tool of oil production analysis.644TABLE IVOil Crises, Historical PerspectiveUltimate Global Reserves of Conventional Oil and Depletion Rate (End of 2001)Volume or rateUltimate reserves (billion barrels)Produced so far (billion barrels)Yet-to-produce (billion barrels)Discovered so far (billion barrels)Yet-to-nd (billion barrels/year)Discovery rate (billion barrels/year)Depletion rate (%)2000 9351065172028073DescriptionAmount of production when production ceasesUntil the end of 2001Ultimate reserves less producedProduced plus remaining reservesUltimate reserves less discoveredAnnual additions from new eldsAnnual production a percentage of yet-to-produceSources. United States Geological Survey, and British petroleum Statiscal Review of World Energy, June 2002. Around 1995, several analysts began applyingHubberts method to world oil production. Based onHubberts pioneering work and an estimated 1.82.1trillion barrels of ultimate reserves, they establishedthat the peak production year will be sometimebetween 2004 and 2009. If the predictions arecorrect, there will be a huge impact on the globaleconomy, with the industrialized nations biddingagainst one another for the dwindling oil supply. Onepromising oil province that remains unexplored isthe Spratly Islands in the South China Sea, whereexploration has been delayed by conicting claims tothe islands by six different countries. Potentialreserves in the disputed territories are estimated atmultibillion barrels of oil and gas. But even if theSouth China Sea oil reserves are proven, they couldhardly quench Chinas thirst for oil. By 2010, Chinais projected to overtake Japan to become the worldssecond largest oil importer after the United States. Another promising province is the Caspian Basin.Estimates of 40 to 60 billion barrels as the ultimatereserve base of the Caspian region are judged to bereasonable by most geologists familiar with theregion. Apart from the limited size of the reserves,the areas oil is very costly to nd, develop, produce,and transport to world markets. Projected CaspianSea oil production of 23 million barrels/day by2010 can be achieved only when prices exceed $20/barrel (in real terms). Oil prices will be the key factorin the expansion of Caspian Sea oil.TABLE VGlobal Crude Oil Reserves Additionsa (Billion Barrels) 19922001Added in year7.804.006.955.625.245.927.6013.0012.60 8.9077.637.76 Annualproduction23.9824.0924.4224.7725.4226.2226.7526.2227.19 27.81256.8725.83As % of annual production331728232123285046323030Year199219931994199519961997199819992000200119922001Average Sources. IHS Energy Groups 2002 World Petroleum TrendsReport, and British Petroleum Statistical Review of World Energy,19932002. aExcluding the United States and Canada. 6.3.4 New Oil Discovery RatesThe widely held view that improved seismic survey-ing and interpretation have improved drilling successrates is not borne out by the level of discoveriesduring the period 19922001 (see Table V). The race for reserves is, therefore, on. With thedemand for oil envisaged for the next 10 years, theworld will consume an average 30 billion barrels peryear over that period. If the global oil industry wantsto replace this consumption with new reserveswithout diluting the worlds existing proven reservesof some 1 trillion barrels, it must nd an additional300 billion barrels of new oil in the next decadeadaunting challenge indeed. 6.3.5 Global Reserve Depletion RateGlobally the reserve depletion rate is generallycalculated at 3%. This means that to sustain theOil Crises, Historical Perspective645worlds current 76 million barrels/day consumptionat that level, approximately 4 million barrels/day ofnew capacity is needed every year. Against this, theworld production capacity has remained static oreven declined while consumption has been increasing. This means that the Middle East producers, with65% of the worlds proven reserves and just one-third of global production, will assume clear-cutleadership of the supply side of the oil market.7. THIRD OIL CRISIS?The parallels between current conditions and theearly 1970s are unnerving. The conditions that madethe 1973 and 1979 oil crises possible exist in theearly 2000s. First, world oil consumption is growingrapidly and is projected to continue expanding.World oil demand grew by 2.4% in 2000, 2.2% in2001 with a projected additional annual increase of1.8% until 2005. Second, every indicator points to the fact thatproduction from OPEC will not rise substantially.OPECs maximum production capacity is estimatedat 29.7 million barrels/day. The organization mustproduce approximately 30 million barrels/day tomaintain a supplydemand balance under the currentlevel of stocks. Yet, an output level of 30 millionbarrels/day may be beyond the organizations reachor, if it is feasible, achievable only with productionfrom Iraq. Third, the pattern of low-level industry investmentin 20002001 is also very similar to that observedduring the rst and second oil crises. Oil companiescapital investment in exploration in 2000/2001 wasslow in the aftermath of low oil prices during 19981999. Capital spending on exploration and produc-tion by the supergiantsExxon Mobil, BP Amoco,and Shellfell 20% to $6.91 billion in the rst halfof 2000 from a year earlier. Most companies decidedto wait before boosting investment, preferringinstead to buy back stocks. This has reduced thecapital investment available for production andproduction capacity expansion. Fourth, as in 1973 and 1979, the causes of thiscrisis will be a reduction in OPEC production andstagnation in non-OPECs taking place at a time ofrapid economic growth. Fifth, as in 1973 and 1979, it will be a majorpolitical event that could send oil prices rocketingand thus precipitate a third oil crisis. The 1973ArabIsraeli war was behind the rst oil crisis,whereas the Iranian revolution was at the heart ofthe second. Similarly, a war against Iraq couldprecipitate a third oil crisis. Such conditions make for a truly tight marketwith the potential for developing into a genuinecrisis. But even if the world manages to escape a thirdoil crisis, oil-market turmoil can be expected to lastuntil 2004. However, a growing number of opinions amongenergy experts suggest that global conventional oilproduction will probably peak sometime during thisdecade, between 2004 and 2010. Declining oilproduction will cause a global energy gap, whichwill have to be lled by unconventional and renew-able energy sources. Various projections of global ultimate conven-tional oil reserves and peak years have beensuggested by energy experts and researchers between1969 and 2002. The extreme end of opinion isrepresented by the United States Geological Survey(USGS), IEA, and the U.S. Energy InformationAdministration (EIA) (see Table VI). The estimate by EIA is so implausibly high that itcan be ignored, whereas the USGS estimate includes724 billion barrels of YTF reserves. Such huge YTFreserves require discovering an additional amount ofoil equivalent to the entire Middle East. But since90% of global conventional oil has already beenfound, trying to nd 724 billion barrels of new oil isnot only an exceptionally daunting task, but virtuallyimpossible. However, such estimates are of only limitedrelevance. What is important when attempting toidentify future supplies are two key factors: thediscovery rate and the development rate, and theirrelationship to the production rate. The technology for extracting oil from tar sands,oil shale, and extra heavy oil, known collectively assynfuels, exists but extraction costs are high. Synfueloil is usually 3 times as labor-to-energy intensive and10 times as capital-to-energy intensive as conven-tional oil. Whereas someand possibly a great dealofunconventional oil (synfuels) will eventually beavailable, there will not be enough to replace theshortfalls in conventional oil. Synfuels will be hard-pressed to meet 3% of the global oil demand in 2010and 4% in 2020, because of the slow extraction rateand the huge investments needed. In 2002, only 35,000 barrels/day of natural gas toliquid oil is produced worldwide. This is projected torise to 685,000 barrels/day by 2010, equivalent to0.7% of global demand. The constraint, however,might be the very large capital commitment. For a646TABLE VIOil Crises, Historical PerspectiveVarious Projections of Global Ultimate Conventional Oil Reserves and Peak Year (Billion Barrels)AuthorHubertBookoutMackenzieApplebyInvanhoeEdwardsCampbellBernabySchollenbergerIEAEIALaherrereUSGSSalamehDeffeyesAfliationShellShellResearcherBPConsultantUniversity of Colorado Consultant ENIAmocoOECDDOEConsultantInternational DepartmentConsultantPrinceton UniversityYear1969198919961996199619971997199819981998199819992000200020012800470027003270200018002100 283618002000Estimated ultimate reserves210020002600Peak year2000201020072019201020102020a2010200520152035a20102020a2030a2010a200420052004 Sources. Various. Note. BP, British Petroleum; DOE, U.S. Department of Energy; EIA, U.S. Energy Information Administration; IEA, International EnergyAgency; OECD, Organisation for Economic Cooperation and Development; USGS, U.S. Geological Survey; ENI, Ente NazionaleIdrocarburi. aThese ultimate reserve estimates include extra heavy crude, tar sands, oil shale, and also projected production of gas-to-liquid oil.production of 400,000 barrels/day, this wouldamount to $8 billion. In 2000, renewable energy sources contributed2% to the global primary energy demand. However,by 2025 they are projected to contribute 4%, risingto 5% by 2050 (see Table VII). Fuel-cell motor technology will eventually have agreat impact on the global consumption of gasolineand diesel. But it could take years before hydrogen-powered cars dominate the highways and certainlynot before they are able to compete with todays carsin terms of range, convenience, and affordability. Fossil fuels, with a growing contribution fromnuclear energy, will, therefore, still be supplying themain share of the global energy needs for mostperhaps all, of the 21st century.TABLE VIIWorld Primary Energy Consumptiona (mtoe), 200020502000Primary energy OilNatural gasCoalNuclearHydroRenewablesb202516,618 6429476032837338185954205019,760 7344620730378251440 907596313835219021366366172172Renewables: % of total8. IMPLICATIONS FOR THEGLOBAL ECONOMYTwenty years ago, oil crises wreaked havoc on theworld economy. Today, although oil remains im-portant, a new crisis will have a much more modestimpact because of the diminished role of oil in theglobal economy, unless the price of oil rises to $50/barrel. Sources. Shell International, Scenarios of 2050; Organizationof Petroleum Exporting Countries Statistical Review of WorldEnergy, June 2002; and U.S. Energy Information AdministrationInternational Energy Outlook 2002. amtoe Million tonnes oil equivalent. bExcluding hydro (i.e., hydroelectric power). One reason is that oil represents a much smallershare of global GDP today than it did during the twoprevious crises. Another reason is that the economy ismore open, which makes it harder for companies topass on cost increases to customers. A third reason isthat customers can hedge against price increases.Oil Crises, Historical Perspective647Finally, economies around the world have becomemore adaptable in their use of every resource,including oil. Consequently, increases in oil pricestrigger substitutions of natural gas or any other energysources in manufacturing. For instance, if one takesthe case of the United States, which accounts for 25%of the global oil consumption, it is found that a rise inoil prices today is much less important to the U.S.economy than it has been in the past. The decline inimportance of oil prices can be seen from Table VIII,which shows the share of crude oil in nominal GDP. Table VIII shows that crude oil accounted for 4%of GDP at the time of the rst oil crisis, 6% at thetime of the second oil crisis, and 2.4% at the time ofthe Gulf War. In 2001, it accounted for 2%.However, if the price of oil hits the $50/barrel markin 2002, then crude oil will have the same share inthe U.S. economy as in 1974, with adverse economicimplications for the U.S. and the global economy. Despite the above, higher oil prices still are veryimportant to the world economy. A new report bythe International Monetary Fund (IMF) notes that awar on Iraq could be the nal straw for aninternational economy still struggling with the after-math of September 11, the 20% drop in world shareprices this year, and the implosion of the Argentineand Brazilian nancial services. The IMF argues thatthe risks are primarily on the downside even beforethe possibility of a conagration in Iraq and theMiddle East is taken into account. The IMF warns of the consequences for the oilmarkets of a war in the Gulf region. It says that aTABLE VIIIOil in the U.S. Economy: Consumption, Prices, and Percentageof GDPOil consumptionOilNominal Oil consumption (millionpricesGDPas percentage of barrels/day)($/barrel) ($ billion)GDP19741980199019992000200120022002aa16.6517.0616.9919.3619.6319.9020.1820.18 9.0728.0722.2217.6027.7225.9330.0050.00138227845744885792249462961196114.06.32.41.42.22.02.34.0 Sources. Courtesy of PKVerleger LLC; British PetroleumStatistical Review of World Energy, June 2002; U.S. EnergyInformation Administration Annual Energy Outlook 2002. aEstimates.$15/barrel increase in the price of oil would be asevere blow to the global economy, knocking at least1 percentage point off global GDP and sending theworld economy spiraling toward recession. Certainly, all the evidence from past conicts inthe region, including the 1973 ArabIsraeli War,Iranian revolution, and the Gulf War of 19901991,suggests that each of these conicts has beenfollowed by recession and unemployment, particu-larly in the West. This time around, the scenario is even moreworrying. Financial markets are already paralyzedas a result of the burst of the technology bubble andthe mammoth corporate accounting frauds in theUnited States. Before Washingtons decision to up the ante withIraq, there was some hope at the IMF that therewould be some kind of bounce-back for the globaleconomy in 2003. The world economy was projectedto pick up speed, growing by 3.7% in 2003, afterslipping this year to 2.4%. The United States wasforecast to pick up from a 1.4% expansion this yearto 2.3% in 2003. But higher oil prices could make all the difference.The IMF notes that oil prices began to surge in thesecond half of August 2002 as the U.S. administra-tion began to talk up the war with Iraq. The price ofcrude oil on both sides of the Atlantic is alreadyabove the $22 to $28 per barrel price range built intomost major economic projections. For oil-importingcountries, higher oil prices act as an immediate taxon consumption and business. An oil price hikemakes it less likely that consumers will spend andbusiness will invest. With the global economy struggling to pick upmomentum, a prolonged period of high oil priceswould, without doubt, delay an upturn. It wouldalmost certainly give another leg to the downturn inshare pricesin 2003, down by 40% since the peakin March 2000hitting condence hard. Although the loss of Iraqi oil supplies over the shortterm might make little signicant difference, it is thecollateral damage that could deliver the most seriousblow. There is the possibility that Iraq might seek todisable the critical Saudi and Kuwaiti oilelds, as inthe Gulf War, or that the Arab countriesoutraged byAmericas attack on one of their ownmight seek toimpose an oil embargo or refuse to increase suppliesto make up for the loss of Iraqi output. The result would be a hike in prices on world oilmarkets and disruption to an already misring globaleconomy. However, once the war is over, there maywell be cheaper and more plentiful oil as Iraqs648Oil Crises, Historical Perspectiveproduction is restored. But by then the damage to arickety world economy will have been inicted.SEE ALSO THEFOLLOWING ARTICLESGeopolitics of Energy Markets for Petroleum Nationalism and Oil National Security and Energy Oil and Natural Gas Liquids: Global Magnitudeand Distribution Oil Industry, History of Oil-LedDevelopment: Social, Political, and Economic Con-sequences Oil Price Volatility OPEC, Historyof OPEC Market Behavior, 19732003 StrategicPetroleum Reserves War and EnergyFurther ReadingDeffeys, K. S. (2001). Hubberts Peak: The Impending World Oil Shortage. Princeton University Press, Princeton, NJ.Nixon, R. (1980). The Real War. Sidgwick & Jackson, London.Robinson, J. (1988). Yamani: the inside story. Simon & Schuster, London.Salameh, M. G. (1990). Is a Third Oil Crisis Inevitable. Biddles, Guildford, UK.Salameh, M. G. (1999). Technology, oil reserve depletion and the myth of reserve-to-production (R/P) ratio. OPEC Review, June 1999, pp. 113124.Salameh, M. G. (2001). Anatomy of an impending third oil crisis. In Proceedings of the 24th IAEE International Conference, April 2527, 2001, Houston, TX, pp. 111.Salameh, M. G. (2001). The Quest for Middle East Oil: the U S Versus the Asia-Pacic Region. International Asian Energy Conference, August, Hong Kong.Sampson, A. (1980). The Seven Sisters. Hodder & Stoughton, London.Verleger, P. K. (2000). Third Oil Shock: Real or Imaginary? Consequences and Policy Alternatives. International Economics Policy Briefs, No. 00-4, Institute for International Economics, Washington, DC.Yergin, D. (1991). The Prize: The Epic Quest for Oil, Money and Power. Simon & Schuster, New York.