Further information: 1973 world oil market chronology
The 1973 oil crisis started in October 1973, when the members of Organization of Arab Petroleum Exporting Countries or the OAPEC (consisting of the Arab members of OPEC, plus Egypt and Syria) proclaimed an oil embargo "in response to the U.S. decision to re-supply the Israeli military" during the Yom Kippur war; it lasted until March 1974. OAPEC declared it would limit or stop oil shipments to the United States and other countries if they supported Israel in the conflict. With the US actions seen as initiating the oil embargo, the long-term possibility of embargo-related high oil prices, disrupted supply and recession, created a strong rift within NATO; both European nations and Japan sought to disassociate themselves from the US Middle East policy. Arab oil producers had also linked the end of the embargo with successful US efforts to create peace in the Middle East, which complicated the situation. To address these developments, the Nixon Administration began parallel negotiations with both Arab oil producers to end the embargo, and with Egypt, Syria, and Israel to arrange an Israeli pull back from the Sinai and the Golan Heights after the fighting stopped. By January 18, 1974, Secretary of State Henry Kissinger had negotiated an Israeli troop withdrawal from parts of the Sinai. The promise of a negotiated settlement between Israel and Syria was sufficient to convince Arab oil producers to lift the embargo in March 1974. By May, Israel agreed to withdraw from the Golan Heights.
Independently, the OPEC members agreed to use their leverage over the world price-setting mechanism for oil to stabilize their real incomes by raising world oil prices. This action followed several years of steep income declines after the recent failure of negotiations with the major Western oil companies earlier in the month.
For the most part, industrialized economies relied on crude oil, and OPEC was their predominant supplier. Because of the dramatic inflation experienced during this period, a popular economic theory has been that these price increases were to blame, as being suppressive of economic activity. However, the causality stated by this theory is often questioned. The targeted countries responded with a wide variety of new, and mostly permanent, initiatives to contain their further dependency. The 1973 "oil price shock", along with the 1973–1974 stock market crash, have been regarded as the first event since the Great Depression to have a persistent economic effect.
Background
Founding of OPEC
The Organization of the Petroleum Exporting Countries (OPEC), which then consisted of twelve countries, including Iran, seven Arab countries, plus Venezuela, Indonesia, Nigeria, and Ecuador, had been formed at a Baghdad conference on September 14, 1960. OPEC was organized to resist pressure by the "Seven Sisters" (mostly owned by U.S., British, and Dutch nationals) to reduce oil prices and payments to producing countries. At first it had operated as an informal bargaining unit for the sale of oil by resource-rich Third World nations. Initially, OPEC confined its activities to gaining a larger share of the profits generated by the Western oil companies and greater control over the members' levels of production. As a result of this and other events in the early 1970s however, it began to exert its economic and political strength; the major Western oil conglomerates, as well as the importing nations, suddenly faced a unified bloc of exporters.
End of Bretton Woods
On August 15, 1971, the United States pulled out of the Bretton Woods Accord taking the US off the Gold Exchange Standard (whereby only the value of the US dollar had been pegged to the price of gold and all other currencies were pegged to the US dollar), allowing the dollar to "float". Shortly thereafter, Britain followed, floating the pound sterling. The industrialized nations followed suit with their respective currencies. In anticipation of the fluctuation of currencies as they stabilized against each other, the industrialized nations also increased their reserves (printing money) in amounts far greater than ever before. The result was a depreciation of the value of the US dollar, as well as the other currencies of the world. Because oil was priced in dollars, this meant that oil producers were receiving less real income for the same price. The OPEC cartel issued a joint communique stating that forthwith they would price a barrel of oil against gold.
This led to the "Oil Shock" of the mid-seventies. In the years after 1971, OPEC was slow to readjust prices to reflect this depreciation. From 1947-1967 the price of oil in U.S. dollars had risen by less than two percent per year. Until the Oil Shock, the price remained fairly stable versus other currencies and commodities, but suddenly became extremely volatile thereafter. OPEC ministers had not developed the institutional mechanisms to update prices rapidly enough to keep up with changing market conditions, so their real incomes lagged for several years. The substantial price increases of 1973-74 largely caught up their incomes to Bretton Woods levels in terms of other commodities such as gold.
Yom Kippur War
On October 6, 1973, Syria and Egypt started the Yom Kippur War by launching a military attack on Israeli occupied territories captured in the 1967 Six Day War . This new round in the Arab-Israeli conflict triggered a crisis already in the making; the price of oil was going to rise. The West could not continue to increase its energy consumption 5% annually, while also paying low oil prices, and selling inflation-priced goods to the petroleum producers in the developing Third World. This was stressed by the Shah of Iran, whose nation was the world's second-largest exporter of oil and the closest ally of the United States in the Middle East at the time. "Of course is going to rise," the Shah told the New York Times in 1973. "Certainly! And how...; You increased the price of wheat you sell us by 300%, and the same for sugar and cement...; You buy our crude oil and sell it back to us, refined as petrochemicals, at a hundred times the price you've paid to us...; It's only fair that, from now on, you should pay more for oil. Let's say ten times more."
On October 12, 1973, President Richard Nixon authorized Operation Nickel Grass, an overt strategic airlift to deliver weapons and supplies to Israel, after the Soviet Union began sending arms to Syria and Egypt.
Arab oil embargo
On October 16, 1973, OPEC announced a decision to raise the posted price of oil by 70%, to $5.11 a barrel. The following day, Arab oil ministers agreed to the embargo, a cut in production by five percent from September's output, and to continue to cut production over time in five percent increments until their economic and political objectives were met. October 19, US President Richard Nixon requested Congress to appropriate $2.2billion in emergency aid to Israel, including $1.5 billion in out-right grants. Lenczowski notes, “Military supplies did not exhaust Nixon’s eagerness to prevent Israel’s collapse. ... This decision triggered a collective Arab response.” Libya announced it would embargo all oil shipments to the United States. Saudi Arabia and the other Arab states quickly followed suit, joining the embargo on October 20, 1973. At their meeting in Kuwait the Arab oil-producing countries, proclaimed the oil boycott that provided for curbs on their oil exports to various consumer countries and a total embargo on oil deliveries to the United States as a “principal hostile country”. The embargo was thus variously extended to Western Europe and Japan.
Though United States was the initial target of the embargo, it was later expanded to the Netherlands. The Netherlands had supplied arms to Israel and allowed the Americans to use Dutch airfields for supply runs to Israel. Price increases were also imposed. Since oil demand falls little when the price is raised, the prices had to be risen dramatically to reduce demand to the new lower level of supply. Anticipating this, the market price for oil immediately rose substantially, from $3 a barrel to $12. The world financial system, which was already under pressure from the breakdown of the Bretton Woods agreement, was set on a path of recessions and high inflation that persisted until the early 1980s, with oil prices continuing to rise until 1986.
Over the long term, the oil embargo changed the nature of policy in the West towards increased exploration, energy conservation, and more restrictive monetary policy to better fight inflation.
Chronology
- January 1973—The 1973–1974 stock market crash begins, as a result of inflation pressure, the Nixon Shock and the collapsing monetary system.
- August 23, 1973—In preparation for the Yom Kippur War, Saudi King Faisal and Egyptian president Anwar Sadat meet in Riyadh and secretly negotiate an accord whereby the Arabs will use the "oil weapon" as part of the upcoming military conflict.
- September 15—The Organization of Petroleum Exporting Countries (OPEC) declares a negotiating front, consisting of the 6 Persian Gulf States, to pressure for price increases based on the 1971 Tehran agreement, and an end to support of Israel.
- October 6—Egypt and Syr
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