The oil shocks of the 1970s

During the 1970s, oil prices rose sharply due to geopolitical tensions in the Middle East. Similar to the current gas price crisis, this led to disruptions in the global economy.

In 1960, Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela founded OPEC (Organization of the Petroleum Exporting Countries). The creation of OPEC is closely tied to the economic and political upheavals that accompanied decolonization, particularly in oil-rich Middle Eastern states such as Iraq, Iran, and Kuwait. These new nations emerged—often through brutal wars of independence—from long periods of dependence on their colonial rulers, Great Britain and France.

The founding of OPEC was a reaction to the West’s growing interest in the oil reserves of these countries. The “Seven Sisters”, a cartel-like alliance of American and British oil companies, controlled 86 percent of the oil fields located in OPEC territory. Through this dominance, they were able to secure substantial monopoly profits by controlling production volumes and prices. They did so with little regard for the interests of the host nations—whose populations were far away and whose democratic concerns mattered little in corporate headquarters in London or the United States.

For example, the Anglo-Iranian Oil Company (today BP) allocated only 8 to 22 percent of the net profits from oil production to Iran. After gaining independence, the newly established regimes carried out expansive nationalizations, drastically reducing the influence of Anglo-American corporations.

However, this did not bring stability to the region. Civil wars, uprisings, and revolutions followed—bringing to power the Islamist clerical regime in Iran and the socialist Baath regimes in Iraq and Syria. These conflicts were only marginally about religion or ideology; they were primarily about control over vast oil reserves and the enormous revenues and power they provided to competing factions.

Figure 2: Oil refinery in Abadan, Iran, 1938. (Source: Wikimedia Commons, 1970)

The First Oil Price Shock of 1973

An opportunity for OPEC to demonstrate its power arose in October 1973, when tensions between the newly founded Middle Eastern state of Israel and its Arab neighbors escalated into open war on the Jewish holiday of Yom Kippur. Western countries sided with Israel. To pressure them and force an end to their support for Israel, the Arab countries (Algeria, Iraq, Qatar, Kuwait, Libya, Saudi Arabia, and the United Arab Emirates) reduced their production volumes by about five percent. As a result, on 17 October 1973, the price of oil rose by 70 percent in a single day, from three to five US dollars per barrel. By 1974, they had driven the price per barrel up to 12 US dollars.

The price surge of the most important fuel for industrial production in the United States and Western Europe led to severe economic downturns. Although Britain had become an oil producer itself, it remained—like the United States—heavily dependent on imports. In 1974, the American economy shrank by 0.5 percent and again by 0.2 percent in 1975. Unemployment rose from 4.6 percent in October 1973 to nine percent in May 1975.

Inflation accelerated from 6.2 percent in 1973 to a peak of 11.1 percent in 1974, settling at 9.1 percent the following year. (For comparison: the natural gas price shock during the Ukraine war led to inflation rates of around eight to nine percent in the eurozone in 2022.) The British faced a similar situation but recorded even larger contractions of 2.5 and 1.5 percent, as well as inflation rates of up to 24.4 percent. Germany’s economic decline and price increases were more moderate, but unemployment surged from 1.2 percentage points to 4.4.

The French, the other colonial power in the Arab region, experienced comparable effects, suffering an inflation rate of 13.6 percent. In 1974, their economic output decreased by one percent, and their unemployment rate rose by 1.5 percentage points.

Figure 3 The share of OPEC in global oil production since 1971. (Source: International Energy Agency, 2022.)

The Second Oil Price Shock

In 1979, the Islamic Revolution, which overthrew the pro-Western Shah of Iran, triggered a new shock to the global economy. It caused uncertainty in international oil markets and disruptions in production. In 1980, Iraq launched an attack on Iran. Saddam Hussein—supported by the United States, the Soviet Union, and other regional powers such as Saudi Arabia and Kuwait as a bulwark against fundamentalist Islam—sought above all to seize Iran’s lucrative oil fields and establish a comprehensive oil monopoly of his own. As a result of the war, which was fought by both sides with extreme brutality, including child soldiers and chemical weapons, oil prices climbed to 40 US dollars per barrel.

However, the effects of the second oil price shock in 1980 were far less severe than those of the first. Countries had adapted, built up oil reserves, and Germany had increased its imports of fossil fuels from the Soviet Union. Major economies experienced only slight contractions, with GDP falling by up to two percent. Inflationary pressures rose to over 13 percent in the United States and France, to 18 percent in the United Kingdom, and to 5.4 percent in Germany. However, these developments occurred against the backdrop of already high inflation rates and persistently high unemployment, which had never returned to pre-crisis levels after the first oil shock. Stagflation had taken hold.

In 1980, unemployment in Germany rose again from three to 8.3 percent, in France to nine percent, and in the United Kingdom it even doubled to ten percent.

At the beginning of the 1980s, due to a recession and the increased use of alternative energy sources, demand for both energy and oil declined. As a result, OPEC’s share of the world oil market fell to 40 percent. In the mid-1980s, the market experienced a sharp collapse; the market was awash with oil. Prices fell to less than 10 US dollars per barrel. Oil revenues for OPEC member states dropped dramatically, leading to economic and political instability in these countries, which ultimately resulted in even more authoritarian regimes.