Oil accounts for a sizeable part of energy consumption in the modern world. Since 1973, when OPEC became very powerful, oil also became a major ‘political weapon’ used in embargoes. Huge volatility in the price of crude oil, particularly sharp price spikes, had impacted the global economy in a big way. Sharp and swift price crashes also had severely impacted oil exporters and international trade. Let us look briefly at the history of major oil shocks.
First oil shock
The first oil shock that hit the world happened in 1973. Even though OPEC (Organization of Petroleum Exporting Countries) was formed in 1960 to resist pressure from the 7 Sisters – 7 large western oil companies –, it was not a powerful cartel till 1973. In October 1973 OAPEC (Arab members of the Organization of Oil Exporting Countries) declared an oil embargo in response to the US intervention in the Yom Kippur war. The US had supplied arms to Israel in the Israel vs. Egypt, Syria war. From October 1973 to the end of the embargo in 1974 crude shot up from $3 to $12 a barrel. This sharp spike in crude impacted oil importers severely. Stock markets crashed and currencies were impacted. This oil shock led to a global recession. Unlike normal recessions, which are characterized by deflation, this recession was characterized by sustained inflation. Spike in petroleum prices raised the cost of production and transportation resulting in cost-push inflation. Economists referred to this co-existence of recession and inflation as stagflation (economy stagnating with inflation).
From 1974 to 1978 the price of oil remained almost flat ranging from $12.52 to $14.57.
Second oil shock
The second oil shock started in 1979. The political trigger for the shock was the overthrow of the Shah of Iran. Ayatollah Khomeini, the supreme Iranian spiritual leader, returned from his exile in France, causing an Islamic revolution in Iran. The revolution led to a decline in production. Furthermore, fears of the revolution spreading to other countries of the Middle East caused panic in the oil market. Crude shot up from $15.85 a barrel in April 1979 to $ 39.50 a barrel by April 1980. The Iran-Iraq war that began in 1980 resulted in huge production loss in both Iran and Iraq and aggravated the crisis.
Higher prices following the oil shock also resulted in increased exploration and production outside of OPEC. From 1980 to 1986 non-OPEC production increased by 6 million barrels per day. Despite lower oil prices during that period, new discoveries made in the 1970s continued to add to the supply. The sharp increase in non-OPEC production and declining demand made OPEC weak. OPEC members could not agree on production cuts to restrict supply. Consequently, oil price crashed to $ 10 by mid-1986.
Third oil shock
Iraq invaded Kuwait in August 1990 triggering a sharp spike in oil prices and the third oil shock. Crude shot up from $ 17 in July 1990 to $ 36 by October 1990. When the Iraqi occupation ended with the US intervention, oil prices came down. The third oil shock produced profound consequences for the Indian economy. India faced a severe Balance of Payments crisis by mid-1991. India had to pledge its gold reserves with Bank of England for raising emergency foreign exchange reserves. India approached the IMF for assistance under Structural Adjustment Program. This started the process of economic reforms in India.
The end of the Gulf War initiated a period of steadily declining oil prices. The Southeast Asian economic crisis of 1997 further reduced the demand and price of oil. Price of oil declined steadily to touch $ 10 in 1999. Even though prices started to recover by 2001, the terrorist attack of 9/11 led to another major crash in the price of oil.
2003-08 witnessed a global boom: global GDP rose by 4.5 % a year. Sustained high economic growth in China, availability of cheap money and the US housing boom released cumulative forces that resulted in an unprecedented global boom. This led to a commodity super-cycle lifting most commodity prices. Oil touched $ 147 in 2007 bringing great prosperity to oil exporters and problems to importers.
The global financial crisis of 2008 and the Great Recession that followed impacted oil with the price falling to touch $ 32. Recovery from the Great Recession again started lifting oil prices. By 2014 oil price increased to $118.
Price crashes of 2015-16 and 2020
The oil price crash of 2014-16 was swift and sharp. From $118 in May 2014 the price crashed to $26 by early February 2016. Global economic slowdown in general and the sharp slowdown in China in particular, impacted oil demand. On the supply side, a substantial increase in oil supply from shale oil and gas dramatically altered the global oil supply situation. The lifting of sanctions on Iran led to increased supply from Iran. OPEC couldn’t agree on production cuts. This dramatic change in the oil demand-supply equation led to a sharp fall in prices.
The outbreak of the pandemic Covid-19 in 2020 witnessed sharp drop in crude prices. The lockdowns and sharp contraction in economic activity led to crash in Brent prices from around $70 in January 2020 to $ 9.16 in April. Unprecedented disruptions in futures market also led to unusual negative prices in the futures market. Soon Covid vaccines and economic recovery helped prices to recover to pre- pandemic levels.
2022 oil crisis
At the beginning of 2022 Brent crude was trading at around $ 76. But the war in Ukraine led to huge volatility in crude prices. Within days of outbreak of the war Brent crude shot up and reached a high of $139. The RBI had assumed average crude price of around $75 while projecting GDP and inflation for FY23. Even though the price declined to less than $100 it again shot up to above $110. The effect of higher oil price is twofold: One, FY 23 GDP growth will be lower than projected and, two; FY 23 CPI inflation would be higher than projected. How much will be the actual impact on growth and inflation would depend on how long crude prices will remain elevated. If the war in Ukraine ends soon crude price will drift lower; then this temporary crisis is unlikely to become an oil shock. This is the likely scenario.