Report on the Current Oil
Crisis, How it is
Affecting the Economy,
and Some Possible Outcomes
November 14, 2000
With the current spike in oil prices, many American consumers have asked, “what is going on?” In order to fully understand the current situation and how it is affecting the economy one must look at a variety of factors including: the history of oil crisis in the United States, causes of the current situation, and possible outcomes for the future. It is only after meticulous research in these topics that one is prepared to answer the question, “what is the best possible solution to the oil crisis?”
Although many critics have not yet labeled the current oil situation a “crisis,” there is sufficient evidence that it is becoming more severe and is beginning to reflect oil crisis of the past. The current crude oil price spike began early in 1999 due to a variety of factors. Struggle in the Middle East along with minimal policy changes from the Organization of Petroleum Exporting Countries and the U.S. Government has kept prices high to this very day.
The History of Oil Crisis Within the United States
Before looking at the current oil situation, it is important to understand the times of oil crisis in our country’s past. Through the years between 1970 and 2000, the price of oil has risen and fallen in often-drastic amounts. It is these price fluxuations in crude oil that has caused fuel prices to vary and the economy of the United States to be volatile.
Throughout the past twenty years there have been several drastic changes in oil prices. These dramatic shifts are helpful to look at because of their impact upon the economy and the oil industry. During this time period there are three major shifts in oil price that can be linked to specific events in world history (Miller, 1998). First, the Arab oil embargo of 1973 caused a widespread oil crisis and brought crude oil from three dollars a barrel to a staggering twelve dollars a barrel. Second, the 1979 Iranian revolution caused another crisis that brought crude oil prices to an all time high of thirty-six dollars per barrel. Finally, the third major shift occurred in 1991 due to the Persian Gulf War (Miller, 1998).
Source: The Energy Information Administration (Hakes, 1998).
Oil crisis of 1973
The first large price shift in oil prices came in 1973. The oil crisis of 1973 began in the Mediterranean because of a war. The Yom Kippur War was a result of an attack on Israel by Syria and Egypt an October 5, 1973. Throughout history, the United States has always shown support for Israel and its campaigns. This situation was no different. The United States and many countries in the western world showed strong support for Israel (Williams, 1999). As a result of this support, Arab exporting nations imposed an embargo on the nations supporting Israel (Williams, 1999). Because these nations had the power of a monopoly in the oil industry, they tried to use the embargo as a blackmail technique. The Arab nations began the embargo by curtailing oil production by five million barrels per day. In turn, the United States increased production in other countries by about one million barrels per day. The remaining net loss of four million barrels per day extended through March of 1974 and represented seven percent of the free-world production (Williams, 1999).
The oil embargo was imposed by Arab oil producers through the then-powerful cartel, the Organization of Petroleum Exporting Countries (OPEC)(Miller, 1998). OPEC was founded in 1960 with five members: Iraq, Kuwait, Saudi Arabia, and Venezuela. Six other nations had joined OPEC by the end of 1971. These included Qatar, Indonesia, United Arab Emirates, Algeria, and Nigeria. This cartel had experienced a decline in the real value of their product since the foundation of the Organization of Petroleum Exporting Countries (Williams, 1999). But in March of 1971, the power to control crude oil prices shifted from Texas and the United States to OPEC because of a change in governmental regulations. If there was any doubt that the ability to control crude oil prices had passed from the United States to OPEC, it was removed during the Arab Oil Embargo. During the oil embargo, OPEC boosted prices from $2.90 per barrel before the embargo to $11.65 by Christmas. Prices in other markets were even worse; some Iranian oil went for $17 per barrel (Sheets, 1998). The extreme sensitivity of prices to supply shortages became all too apparent. Prices increased four hundred percent in six short months (Williams, 1999). Even though the OPEC induced embargo lasted only six months; it triggered worldwide energy shortages that lasted eight years, a global recession, and permanent changes in the oil market and U.S. economy.
In 1973, the President of the United States, Richard Nixon, tried to bring peace between the Arab states and Israel. His attention could have been more helpful if it was not overshadowed by the scandals of Watergate. The nation at this time was dependant upon foreign oil to keep its transportation systems and factories working (Sheets, 1998). In 1977 – four years after the embargo – President Jimmy Carter appeared on national television and declared “the moral equivalent of war” on the nation’s dependency on imported oil (Miller, 1998). Because the nation was heavily dependent on outside sources for oil, the impact of shortages and higher prices rippled through the economy and left motorists in a predicament. According to Daniel Yergin in his book The Prize, “motorists waited in line an hour or two, with their engines running and their temperature rising, sometimes seeming to burn more gas than they were able to purchase.” When the crunch hit, motorists felt security in having a full tank and went to the pumps whenever the needle dipped below completely full. True, some stations had no gasoline and others rationed out what they had. But the main reason for the long lines was related to the increased trips of Americans to the gas pump (Popular Mechanics, 1996).
Although the oil crisis of 1973 affected motorists, it also created havoc in other areas of transportation and the economy. The airline industry was forced to cancel flights and raise the price of tickets. The United States government imposed a blanket fifty-five mile per hour speed limit so that fuel efficiency could be optimized. An all year daylight savings time was instigated as an energy-saving measure. During the holiday season many neighborhoods banned Christmas light displays and the population had to live with turning down their thermostats. Office building lights were extinguished and big-city skylines faded into the night (Sheets, 1998). The economy was also affected during this time. As the oil crisis hit the country head on in 1973, the economy was slowed dramatically. The stock market became volatile and the American people were thrown into a time of uncertainty.
One lasting effect on America that came out of this time of crisis was switch to smaller, more economical cars. For many years the general public had driven large cars made by Lincoln, Buick, and Cadillac. With the rise in fuel prices, Americans began to buy smaller imported cars. This shift of the market helped the Japanese who had been bringing in nothing but small cars for a decade. But as always there are two sides to an issue. The American car manufacturers were hurt by the shift of the market. This decline in the U.S. auto industry further helped to push the economy into a slump (Popular Mechanics, 1996).
Oil crisis of 1979
The oil embargo ended in the spring of 1974. But a second oil shock jolted the industrial world in the winter of 1978-1979, when crude oil shipments from Iran were halted by a revolution and the overthrow of the Shah (Sheets, 1998). Problems in the Middle East only escalated over the next few years as Iran and Iraq became involved in war. The Iranian revolution resulted in the loss of two to two and a half million barrels per day between November of 1978 and June of 1979. In 1980, Iraq’s crude oil production fell by 2.7 million and Iran’s fell by six hundred thousand barrels of oil per day. The combination of these two events resulted in crude oil prices more than doubling from $14 in 1978 to $36 per barrel in 1981 (Williams, 1999).
Once again this oil crisis sent the economy into disarray. Motorists had to line up outside of gas stations as they watched the prices go higher and higher. The same governmental controls were still in effect from the oil crisis of 1973 and energy saving methods were once again reinstated. The one thing that did change through the oil crisis of 1979 was the government’s attitude. They began to realize that if nothing were done soon, the U.S. dependency upon foreign oil and the vicious cycle of oil problems would continue. Therefore, at this time the United States government launched programs to develop electric vehicle, gasohol blends, and expand oil exploration (Popular Mechanics, 1996).
During the mid 1980’s, an oil glut developed as a result of a global recession and strict conservation measures (Sheets, 1998). The methods of conservation in the United States and other countries around the globe were finally making a difference. The price of oil plunged from $32 a barrel in 1985 to $10 a few weeks later. Some Persian Gulf cargoes sold for about $6 a barrel. The stranglehold that the Organization of Petroleum Exporting Countries had on the rest of the world was finally broken. Although this price drop was good for American consumers, it did little to help the struggling U.S. oil industry. The recession in the petroleum industry caused companies to restructure, downsize, and adapt (Sheets, 1998). By the late 1980’s a newly refocused industry had emerged. It was this new industry that helped America find new sources of oil production and solidify that there would never again be another oil crisis to the extent of the ones in the past.
Oil crisis of 1991
The third and final major oil crisis in U.S. history began in 1991 as a result of the Persian Gulf War. This war originated in the Middle East when Iraq invaded Kuwait on August 2, 1990. After Iraq finished the invasion it proceeded to annex Kuwait, which it had long claimed (Infoplease.com, 2000). Iraqi president Saddam Hussein declared that the invasion was a response to overproduction of oil in Kuwait, which had cost Iraq over fourteen million when oil prices fell. Saddam Hussein and the Iraqis also accused Kuwait of illegally pumping oil from Iraq’s Rumaila oil field (Infoplease.com, 2000).
When the United Nations became involved, it called for Iraq to withdraw it’s troops and issued an embargo on trade with Iraq as well. Subsequently this embargo also applied to the vast amounts of oil that America depended on from Iraq and Kuwait. On August 7, United States troops moved into Saudi Arabia to protect Saudi oil reserves from their neighbors in the east (Infoplease.com, 2000). When Iraq failed to meet the deadline for peaceful withdrawal set up by the United Nations, Operation Desert Storm was launched. This attack by the U.S. and its allies began on January 18, 1991 and came to a close by the twenty-eighth of the following month.
This war in the Persian Gulf had a great affect upon the U.S. economy. The shortages sustained during the conflict were comparable to those during the oil crisis of 1973 and 1979. Once again American consumers were forced to pay outrageous gas prices and deal with shortages at the gas pump. Also, the New York Stock Exchange was deeply impacted by the oil crisis that ensued due to the Persian Gulf War. Stock prices plummeted and the American public went into a slight panic.
The Current Oil Crisis
Recently, oil prices have been rising at an unprecedented rate. Crude oil has been flirting with twenty to twenty-five dollars per barrel, levels almost reminiscent of the shocks of the seventies (Jaffe, 2000). These dramatic price increases have both impacted the U.S. and world economies.
Causes of the Current Oil Crisis
Although there are many issues involved in oil’s recent price fluxuation, the causes can be narrowed down into three main factors: the influence of the Organization of Petroleum Exporting Countries (OPEC), the dependency of the U.S. upon foreign oil, and the recent conflicts in the Middle East. A near tripling in price of crude oil from March 1999 to the first months of 2000, coupled with developments, initially brought about sharp increases in the price of heating oil and gasoline.
The influence of OPEC
The first factor that is to be considered in determining the causes of the current oil crisis is the influence of OPEC. During this period of soaring oil price, concerns were raise that a commitment from OPEC producers to boost production by roughly two million barrels per day would be needed to replenish worldwide crude inventories and forestall the potential for price volitity and spot shortages of gasoline in late spring and summer of 2000 (Bamberger, 2000). These petroleum-exporting countries held the power to continue the oil crisis by further cutting back on production and raise the crude price even higher.
When OPEC adjusted the production quotas of member nations in March 1999, crude oil supply was reduced by approximately two million barrels per day from previous production levels. In its estimate of global demand for the remainder of 1999, OPEC seriously underestimated the demand for oil. By early 2000, the resulting supply balance from the production cuts was a contributing factor to a raise in crude prices to thirty-two dollars per barrel, significantly higher than the level targeted in the March 1999 meeting (Bamberger, 2000). In the United States, concerns about reliability of supply and the high price of oil fuels escalated all winter. By late winter, inventories were so low that gasoline supply and avoiding further price increases for the rest of 2000 appeared in jeopardy (Bamberger, 2000).
In the weeks prior to the Organization of Petroleum Exporting Countries’ meeting scheduled for March 27, 2000, the United States Administration vigorously pursued a diplomatic course to persuade the OPEC nations that the sharp run up in prices in prices and volatility in world markets threatened the generally upbeat international economic climate (Bamberger, 2000). Due to these diplomatic efforts, most of the OPEC producers agreed that a boost in production was warranted. On March 28, 2000, OPEC and other producers agreed to raise production (Bamberger, 2000). This increase in production followed up on anticipation of price drops and caused crude oil prices to decline to roughly twenty-five dollars per barrel by the end of the first week of April. Still, this price of crude oil was significantly higher than in the past few years and brought consumers to question the stability of the oil market.
The dependency of the United States upon foreign oil
In its annual report, the Department of Energy forecasted that the United States dependence on imported oil will grow to sixty-six percent by 2020, far higher than the record set in 1998 of fifty percent (Miller, 1998). To illustrate how much this percent has changed over the past twenty years, at the time of the 1973 oil embargo the nation was importing a mere thirty-three percent of its oil. This increase in oil imports is largely due to a reduction in oil production within the United States and an increase in U.S. demand for petroleum products (Miller, 1998).
There are a variety of factors that are involved in the decision to import. The truth from an economic perspective is that it is cheaper to import oil rather than to try to develop it domestically. It is also true that any reasonable level of dependence in itself would not make a country vulnerable (Aaron, 2000). The problem that arises in situations that involve dependence is that no matter the degree of dependence, sudden disruptions of supply can occur. Furthermore, a country that is heavily dependent upon a good or service is extremely vulnerable to economic catastrophe.
Because of the market for oil and the countries that produce it locally, some degree of dependence is inevitable. To combat this vulnerability, a country must minimize its vulnerability at any moment of time. Diversity of supply has to be front and center (Aaron, 2000). For the United States, oil must be acquired from as many sources as possible. The most secure supply source, all things being equal, has to be within the United States (Aaron, 2000). If the United States continues to rely upon foreign oil sources too heavily, the doors are left wide open for oil crisis in the future and the current situation will have difficulty culminating.
The recent conflicts in the Middle East
Just like a decade ago, the current conflict in the Middle East is threatening to end the longest-running economic expansion in United States history. The events that take place in the Middle East have a great impact upon the U.S. economy and the price of oil worldwide. The recent events that transposed have caused conflict between the Israelis and the Palestinians. According to Barbara Slavin in USA Today:
It has been only two weeks since Israeli opposition leader Ariel Sharon visited Jerusalem’s disputed Temple Mount to underscore Israel’s claim to a site deemed holy by Jews and Muslims alike. But in days of rage that followed, as Palestinian riots swept the West Bank, “the conflict has been transformed from a nationalist one to an ethnic, religious one that is much harder to control,” says Shibley Telhami, a Middle East expert at the University of Maryland. “It’s automatic now that most of the passion is going to be anti-American. We are entering a period of huge uncertainty.”
This current situation suits Saddam Hussein interests perfectly and allows him to “attack” Arab leaders without raising a finger. Some have speculated that Iraq might take advantage of the current tight market to turn off the tap of more than two million barrels a day, thereby throwing the industrial world into a financial crisis (Slavin, 2000). These events leave the rest of the world on the edge of their seats in anticipation. This conflict has done much to raise the price of oil worldwide.
The Affect of the Oil Crisis upon the Economy
Since 1970, sharp increases in the price of oil have always been followed by economic recession in the United States (Blake, 1997). The impact on the economy of U.S. dependence on foreign oil is great. Because the U.S. imports over half its oil, the energy efficiency of the nation is steadily decreasing. In 1996, the U.S. sent 60.13 billion dollars overseas to pay for fossil fuels, funding foreign economies rather than strengthening American communities (Blake, 1997). This loss in energy efficiency will ultimately undermine and weaken the economy.
One important factor to consider when looking at economic stability is the United State’s share of oil in the gross domestic product. For example, before the U.S. ended price controls in 1979, oil in the gross domestic product (GDP) was 8.7% (Aaron, 2000). Because of this it is not surprising that until 1990, every time oil went up, the U.S. went into economic recession. But a dramatic rise in oil prices in 1999-2000 has not led to a measurable decline in the growth of the GDP. This is because currently, the share of oil in the GDP is only about three percent (Aaron, 2000). Therefore, one can surmise that oil has a smaller affect upon the nation’s economy than in previous years. According to Larry Goldstein, the director of the Petroleum Research Foundation:
I think we’re less vulnerable today to a political disruption in supply in part because oil is less important to the United States economy. However, while the economy has tried to insulate itself from oil price shocks, it is still not fully immune (Aaron, 2000).
In late August 2000, oil prices which had dipped below thirty dollars per barrel began to rise again and the Dow Jones Industrial Average slipped toward ten thousand, a level not seen since March. The United States economy is cushioned more against a possible recession than it was a decade ago but, higher oil prices combined with a plummeting stock market could have a significant impact (Slavin, 2000).
Coping With High Oil Prices: A Summary of Options
With the continued rise of petroleum, the Government and other sources have begun to look at possible solutions to this problem. The impact of a virtually doubling in residential home heating costs along with sharply higher gasoline prices has had an “adverse economic impact” that seems to justify drastic measures (Burt, 2000). When considering possible solutions to the oil crisis, it is important to look at a verity of options that would be beneficial.
1. Drawdown of the Strategic Petroleum Reserve (SPR)
This option has been vigorously advocated by some, though pressure for an immediate drawdown has diminished since crude prices began to soften after the OPEC producers met. The Strategic Petroleum Reserve was authorized in 1975 to create a below-ground reserve of crude oil that could be tapped in the event of an interruption in supply, comparable to the experiences of 1973-74 and 1979-1980, when oil supplies were interrupted or declined due to international developments (Bamberger, 2000). The drawdown authority has been expanded in recent years to provide for a drawdown if a supply shortage led to price increases that appeared to threaten adverse economic consequences (Burt, 2000). The Clinton Administration has opposed a drawdown of SPR oil, arguing that the present situation does not fit the sort of supply problem for which the Strategic Petroleum Reserve is intended (Bamberger, 2000).
The Administration had indicated that the SPR was an option it might turn to if OPEC did not agree to boost production adequately. Following OPEC’s commitment on March 28, 2000, to boost production, crude prices began to decline to the mid-twenties per barrel. Later in the year, however, crude prices again began to climb into the high-twenties and low-thirties (New Straits Times, 2000). With this sudden jump in prices, the Clinton Administration called for the drawdown of a large portion of the Strategic Petroleum Reserve. Although this action did not help for an extended period of time, the SPR is a viable option in combating oil crisis (Bamberger, 2000).
2. Decrease in Motor Fuel Excise Tax
After the meeting of the OPEC producers on March 27, 2000, policymakers focused on possible tax options to address the recent spike in petroleum prices, including a decrease on the payment of gasoline and diesel fuel excise taxes (Bamberger, 2000). Prospects for a reduction in gasoline taxes dimmed on April 6, 2000, when the Senate passed, 65-35, an amendment to the budget resolution expressing the sense of the Senate that fuel tax revenues should continue to be used for highway construction and rehabilitation. On April 12, a motion to proceed to debate was defeated (43-56) (Bamberger, 2000). Legislation to reduce or lift gasoline taxes was also introduced in the House in late March, but this particular initiative, for the moment, appears unlikely to receive further attention unless crude prices spike sharply once again.
Although these initiatives seem rather unlikely, the proposed reduction in the tax of gasoline, diesel, and kerosene would not actually cost the Government anything. In order for this to be achieved, the estimated revenue loss would be made up from general revenues so that the Highway Trust Fund would not loose money (Burt, 2000). Through this proposed decrease in Motor Fuel Excise Tax the burden of overpriced petroleum would be lightened.
3. Ban Alaskan Oil Exports
In 1995, against a backdrop of low oil prices and plentiful global supply, a bill was passed permitting North Slope crude exports in Alaska. Exports began and continued without expression of concern or market disruption until the current round of price and supply difficulties developed (Kumins, 2000).
Between 1995 and 1999, Alaskan oil output declined from 1.50 million barrels per day to 1.05 mbd, greatly diminishing any West Coast production surplus that might have once existed. Exports during 1999 averaged 74,000 barrels per day, or about 7% of Alaskan production (Bamberger, 2000). Half those exports were to Korea, 35% to Japan and 12% to China. The total amount exported represents less than 3% of regional consumption, but could currently be contributing to price disparities on the West Coast (Bamberger, 2000). Highly inelastic oil markets can experience large price swings in response to small changes in supply.
Two bills were introduced on March 16, 2000, which would suspend or prohibit the export of Alaskan oil. The presumption is that this supply, roughly 74,000 b/d in 1999, would be directed to the West Coast market where tight supplies have contributed to price increases (Bamberger, 2000). The bills would suspend exports until the President determines that shortages and related price impacts are no longer a concern, and would reinstate the export ban on Alaskan crude.
4. Low Income Home Energy Assistance Program (LIHEAP)
The Low-Income Home Energy Assistance program, originally established in 1981 and reauthorized several times, is a block grant program under which the federal government gives states, the District of Columbia, U.S. territories and commonwealths, and Indian tribal organizations annual grants to operate multi-component home energy assistance programs for needy households (Bamberger, 2000). This program is designed to reimburse needy consumers who have responded to higher oil prices and have made rational decisions, including being sensitive to conservation (Goldstein, 2000). The President sent Congress an emergency supplemental request for $600 million which would provide additional emergency funds for LIHEAP through the end of this fiscal year (Bamberger, 2000). Action has become stalled on the measure, but if passed, would help those who need help most.
5. Energy Alternatives for Heating Oil
As winter approaches, it is clear that the heating oil crisis is in full swing. During the latter parts of the previous winter the heating oil price rose by eighty-four percent in six weeks (Knight-Ridder, 2000). This coming winter promises to be even more severe and will have a greater negative impact upon the economy than last year’s. According to Carmen Armenti, the Board of Public Utilities commissioner:
We seem to find ourselves in this situation every few years, there needs to be an ongoing dialogue with the public, industry, and government in order to reach a solution.
With this ongoing cycle and the severe costs over the past year, much of the population has turned to alternative heating sources (Johnson, 2000). In the past, although there were fluxuations in the price of heating oil, it still remained more cost efficient than natural gas. But with the recent developments in the Middle East and the continued rise in price of crude oil, more and more consumers are switching to natural gas (Johnson, 2000).
Many of the new homes being constructed are utilizing natural gas as a source of heat. This recent trend has helped because the surging oil prices have less affect on the economy as a whole than in the past. As of now, a mere thirty percent of residential customers heat their homes with oil (Johnson, 2000). If these trends toward natural gas continue, our nation will be in superior shape to face a prolonged oil crisis.
6. Electric Vehicles
Analysts at Cambridge Energy Research Associates recently reported that high gasoline prices in the U.S. have revived interest in electric vehicles (Evans, 2000). However, the organization noted that it would take more than soaring gas prices to move American motorists away from conventionally powered vehicles. Motorists will not change to more efficient energy cars, not unless gasoline prices stay this high for a long time (Evans, 2000). Industry analysts have said that electric vehicles will have to cost significantly less in order to match the style and safety of conventional cars. However, with gasoline prices rising well above two dollars in parts of the country earlier this year, drivers could be facing an end to the days of cheap fuel and the beginning of the electric vehicle (Burt, 2000).
Because electric and hybrid vehicles are rather expensive, car manufacturers have experimented in hopes of finding an affordable solution. The Advanced Lead Acid battery Consortium will carry out major surgery to Honda’s prestigious Insight hybrid electric coupe which, if successful, could dramatically reduce the manufacturing costs of all future hybrid cars and quicken their introduction (Cole, 2000). The impact on petrol consumption could be enormous.
This proposed reconstruction of Honda’s hybrid will involve removing the car’s small but extremely expensive nickel hydride pack and replace it with a designed lead acid battery (Cole, 2000). The nickel hydride battery that is now in the hybrid is the same battery chosen to power second generation mobile phones. This battery stores more than twice the energy of a comparable lead acid battery but costs ten times as much (Cole, 2000). Not only will the lead acid battery be affordable, but it will also last.
Another project underway in the fight for alternative fuel vehicles is the fuel-cell car. Although there are currently a wide array of problems with this vehicle, improvements are being made and there are several already in production. A fuel cell works by chemically combining hydrogen with oxygen from the air (The Economist, 1999). The result is energy in the form of moving electrons, which is used to power an electric motor; and water, the fuel cell’s principal waste product. That the GM-Toyota deal and the trial cars were wheeled out just before “Earth Day” (April 22) was probably not a coincidence (The Economist, 1999). Water, after all, hardly counts as a serious pollutant. With the continued development of this infinitive design, the transportation industry as we know it could be turned upsidown and our reliance upon oil could finally be broken. The dawning of the electric car age is nearly here and once it comes, the nation will never go back.
What is the Best Solution to the Oil Crisis?
There is not a single solution to such a complex problem but much can be done towards its resolve. Each of the possibilities that I listed above are viable solutions to solving the oil crisis. But what is the best solution? In order to answer this important question one must first have a vision of where the oil industry is headed. I believe that a new age is upon us. Throughout history there has been ups and downs in the price of cruse oil, but now this price has risen to an unprecedented level and is remaining steady. This new price trend is exactly what the country needs in order to initiate invention. As electric and hybrid cars become increasingly affordable, the general public will begin to accept them as standard. Therefore, I believe that cars with alternative fuel sources are the best solution to the oil crisis.
As more and more electric and hybrid cars enter the market, the price of oil will be driven down due to a lack of demand. For the first time in history this really won’t matter. Once alternative fuel sources are established, there will be no turning back. This will be the greatest moment in the history of U.S. energy: when we no longer will rely upon petroleum as a fuel source.