Global Effects of The Late 1980’s Oil Price Collapse
1. Introduction
In this study, the modern history of the crude oil, including the impact of early industrialization activities on the crude oil production, will firstly be summarized. In the following section, the effect of the 1973 Oil Crisis will be discussed. Later, this paper will focus on the crude oil prices that were affected with the consequences of Iran Crisis in 1979, and the war between Iran and Iraq. This study will then explore the late 1980’s oil price collapse, the invasion of oil-rich Kuwait in 1990 by Iraq, the First Gulf War in 1991, and the 1997 Asian Financial Crisis. There were other crude oil price crises, such as the 2008-2009 global financial crisis and the sharp oil drop in February 2016 due to the strong American dollar currency and declining demand. However, those crises happened many years later since 1986, and they are believed to be beyond the scope of this paper. The global effects of the late 1980’s oil price collapse will be analyzed by taking crises of “1986-1997 period” into consideration.
2. The Modern History of Crude Oil
Early use of the crude oil may date back to several thousand years in the history, but its efficient use in the industry started with the 19th century’s rapid industrialization advancements, such as the invention of internal combustion engine, developments of iron and steel industries, nation-wide railway constructions, etc. American oil companies were the early pioneers to produce, refine and consume oil for the wealth of their economy in the 19th century. Those national oil producers drilled oil wells in various regions, such as Pennsylvania, Oklahoma, Texas, California and others, to increase their revenues and profits. After the exploration of vast oil fields in the middle east region that enabled oil companies to produce low cost crude oil, the global oil companies began investing in the middle east region at the mid of the 20th century. Giant oil companies -Texaco, Gulf Oil, Royal Dutch Shell, SoCal, Socony, and so on- succeeded to control the great portion of the crude oil production around the world by using their strong financial and political positions.
In 1960 Organization of the Petroleum Exporting Countries (OPEC) was founded to stabilize crude oil market and protect rights of member countries. Saudi Arabia, Iran, Iraq, Kuwait, and Venezuela were the first five countries that founded OPEC in 1960. Later Qatar, Libya, UAE, Algeria, Indonesia, and Nigeria joined OPEC in 1971. Meanwhile, the crude oil production countries in the region started to nationalize their oil industries to increase their shares from the crude oil production. However, those giant companies succeeded to control around 85 percent of global oil reserve from the mid-1940s to the oil crisis happened in 1973. From the mid-1940s to the 1973 Oil Crisis, the oil price per a barrel was regulated by multinational companies as well as their governments without considering inflation adjustments. As a result, crude oil prices per barrel had stayed very stable, ranging from $2.50 in 1948 to $3.00 the end of 1972. On the other hand, everything was about to change because of the Yom Kippur War, which was an Arab coalition war against Israel to win back the territories that were lost during the Six-Day War of 1967 between Arab states and Israel.
During the Yom Kippur War, the Syrian and Egyptian armed forces attacked to the Israeli armed forces on the Jewish Holiday in October 1973, and the conflict ended with a decisive victory of Israel. During the war, several countries -United Kingdom, Canada, Netherland, Japan, Portugal, Rhodesia, South Africa, and the U.S. –supported Israel politically. Then, Arab countries began imposing sanctions against those nations as a retaliation by limiting their oil productions. Imposing sanctions with the crude oil was the first time the crude oil was used as a political tool to punish western countries that provided support during the conflict. The cut in crude oil production ended up creating panic around the world. Because of crude oil reduction by 5 million barrels per day (MBPD), the crude oil price increased to $12.00 by the end of 1974.
In fact, oil importing nations were not ready to the crude oil production embargo that was imposed by Arab nations. Moreover, economies of many developed countries were very vulnerable to crude oil productions because their electric infrastructures, petroleum refineries, chemical industries, transportation systems, heating systems, and even exports were built on crude oil existence. For instance, in the U.S., the economy went into stagflation, and many people lost their jobs while the inflation rate kept increasing. Consumers around the world could not afford to spend on goods and services they would need. So, the global demand had fallen drastically. As a result, many businesses got into financial difficulties, and were forced to reduce their costs or close their operations. Majority of developed countries managed to protect their economies with their strong monetary system during the oil crisis. On the other hand, for developing countries, the increase in the crude oil prices meant a total disaster, such as collapsing their financial systems, extra burden on their debts due to their poor currency systems, losses in their imports, losses in their exports, higher inflation rates, higher tax rates, higher interest rates, bankruptcies, higher employment rates, and other many social and political issues.
In the meantime, the increase in the crude oil price meant generating more revenue and cash for crude oil production nations. Those nations were convinced to invest their petrodollars in the U.S. financial system by purchasing the U.S. bonds and securities. Moreover, some portion of those petrodollars were attracted by European financial systems. As a result, both the U.S. and European economies had enjoyed vast amount of cash flow investments – around $500 Billion – from those crude oil producing nations between 1974 and 1981. Recycled petrodollars also enabled developed countries to acquire enormous arm contracts from oil-rich countries. In addition to gaining massive arm contracts, developed countries succeeded to export more products to petrodollar countries due to the increased wealth in the region. The oil-earned dollars especially helped the U.S. to increase its super power around the world.
In the period of 1978–1979, the Iranian Revolution, which ended up overthrowing the monarchy of Shah Mohammed Reza Pahlavi, resulted in the crude oil production loss by 2.5 MBPD. After the Iranian Revolution, the war started between Iran and Iraq in September 1980 and lasted until August 1988. During the Iran-Iraq war, both countries’ crude oil productions were affected by the total loss of 3.3 MBPD. Those two conflicts caused another global shock around the world. As a result, the crude oil prices increased from $14 in 1978 to $35 in 1981.
3. Global Effects of The Late 1980’s Oil Price Collapse
Because of the increase in the crude oil prices from the mid-1970s to the mid-1980s, developed countries -the U.S., Japan, United Kingdom, Netherlands, France, Germany, Canada, so on- started changing their energy policies by investing in advanced technologies that would enable to extract the crude oil from harsh-conditioned regions, such as under the ocean and sands. Furthermore, the developed countries began modifying their oil dependent electric and fuel infrastructures to natural gas compatible systems. They also tried to reduce their oil dependency by incentivizing economy cars with better mileage per gasoline figures. Moreover, they promoted energy saving campaigns by providing tax incentives for houses that would have better insulation and efficient heating/cooling systems.
The price of the crude oil per barrel started declining from its highest limit $35 in December 1981. So, OPEC countries tried to control the crude oil prices by applying quotas that would limit the production amount of each member. According to the quota agreement, OPEC countries were required to provide estimations about their national crude oil reserves. Once crude oil reserves were determined, each member country was supposed to drill and sell the crude oil within its quota limits. It was also agreed that Saudi Arabia, which had the largest oil reserves among OPEC countries in that time, would play a swing-producer role to backup consolidated production amount and to control the crude oil prices around the world.
After all OPEC members submitted their national crude oil reserve figures, they began producing the crude within their quotas. However, there were still a debate going on between OPEC members with respect to national crude oil reserves declared. Some of OPEC members were accused of exaggerating their crude oil reserve figures to grow their oil income. In addition to overstating national crude oil reserve figures, several OPEC members attempted to produce the crude oil beyond their quota rates to inject more cash into their monetary systems. In fact, economies of OPEC nations solely relied on earnings from their crude oil productions. Because of quota limitations and drops in oil prices, their weak financial infrastructures were affected very badly. Their annual revenue losses from the crude oil productions ended up causing social and political tensions.
Meanwhile, due to technological breakthrough in the oil industry, other nations -Soviet Union, the U.S., China, Mexico, United Kingdom, and Norway- were able to access new oil reserves with affordable production costs. So, those non-OPEC countries started competing against the OPEC cartel in the market. To increase market shares from the crude oil production, those non-OPEC oil producers began selling the crude oil as much as they could afford to drill.
To regulate the crude oil prices around the world, Saudi Arabia as a swing-producer had to carry a heavy burden by cutting its oil production from 10 MBPD in 1980 to 3 MBPD in 1985. However, Saudi Arabia could not stand playing the regulator role anymore, and it decided to produce the crude oil with its full capacity to meet spot market demands. As a result, there were the crude oil supply surplus in the global market, and the price of the crude oil per barrel dropped to $14 in 1986. The crude oil price decline had continued until the invasion of oil-rich Kuwait by Iraq in 1990. Moreover, in 1991, the First Gulf War Operation started against Iraq to liberate Kuwait. Both conflicts ended up increasing oil prices again. The recovery of the U.S. economy and developments of Asian economies also helped to keep the crude oil prices steady until the 1997 Asian Financial Crisis. The following paragraphs are the analysis of the global effects of the late 1980’s oil price collapse:
The Fall of The Soviet Union
Prior to the mid-1980’s oil price collapse, the Soviet Union had faced economic struggles because their state-centered economic system was too slow to respond to global crises on time. Moreover, the Soviet Union had to subsidize economies of both its republics in the union and its satellite countries in the East Europe with earnings from the crude oil productions. However, its oil reserves started declining from the 1980s. Furthermore, the Soviet Union invaded Afghanistan, which lasted from December 1979 to February 1989, to control oil of the Persian Gulf, get closer to Indian Ocean, and strengthen its political influence in the region. The long-lasting Afghanistan war ended up failing the economy of the Soviet Union. In addition to the Afghanistan war, when the prices of oil dropped to its lowest amount in 1986, the Soviet Union started losing its revenue from the crude oil production. The Soviet Union spent most of its petrodollars on goods imported from Japan and Western countries. Due to oil price declining, the Soviet Union could not afford to subsidize economies of its republics and satellite countries, and the Soviet Union disintegrated into separate countries in December 1991.
The invasion of Kuwait and The First Gulf War
During long lasting Iran-Iraq war, both countries had suffered from oil production cuts and related revenue losses. Because of the war, the national debts of Iraq had risen to $60 Billion. In addition to the higher national debts, Iraq continued to suffer from oil production revenue losses due to the glut of the crude oil in the 1980s. Iraq then asked for applying more quotas within OPEC to regulate the crude oil prices. However, none of the OPEC nations agreed to cut its productions, which would have meant the revenue losses. During the war, Iraq had also borrowed money from Kuwait, which was around $14 Billion. Moreover, Iraq did not want to pay that debt back to Kuwait. Instead, Iraq claimed that it protected Kuwait from the political influences of Iran with Iran-Iraq war. So, Iraq demanded Kuwait to clear its debts in return for Iraq’s sacrifice during the war. On the other hand, Kuwait did not accept either production quota or pardoning Iraq’s debt. Later, Iraq invaded Kuwait in August 1990 and occupied Kuwait’s oil reserves until the First Gulf War. During the invasion, Iraq assigned a puppet governor and started looting the richness of Kuwait. The United Nations demanded Iraq to withdraw from Kuwait, but Iraq’s government refused to accept the United Nation’s ultimatum. As a result, the First Gulf War started to liberate Kuwait from Iraq, and the war ended with the withdrawal of Iraq from Kuwait in February 1991. The First Gulf War also showed that ensuring the regional security is very important, and the United Nations should take every action to protect and stabilize major energy resources and routes.