The Arab Oil Embargo—40 Years Later

  • photo courtesy of wikipedia http://en.wikipedia.org/wiki/File:Potlatch_gas.jpg
    Oct 16, 2013

    This week marks the 40th anniversary of the Arab Oil Embargo. And while certain (and selective) aspects of the event will undoubtedly be commemorated with policy fora and written reflections, it is useful to recall the contributory causes, significant impacts, and resultant policy- and market-induced outcomes in order to view the event in proper perspective.

    In truth, the seeds of the embargo were being put in place long before October 1973. The Organization of Petroleum Exporting Countries (OPEC) was formed in 1960, in no small part to allow producer nations greater control of the pricing and production of their indigenous oil resources. In 1968, several of the Arab members of OPEC formed the Organization of Arab Petroleum Exporting Countries (OAPEC), essentially putting in place the organizational vehicle for executing the 1973 supply disruption. But it was a combination of economic and military/political actions and circumstances that teed the action up.

    During the 1950s, with the construction of the National Highway System and spurred on by America’s love affair with the automobile and the migration to suburbia, domestic oil consumption increased by 50 percent—from 6.5 to 9.8 million barrels per day (mmb/d). That growth rate continued over the next decade, and by 1970, when U.S. oil production peaked at just over 9 mmb/d, demand approached 15 mmb/d. Global demand for oil was also rising, fast outpacing available new supplies. The loss of available “surge capacity” outside of the Middle East was shifting market advantage to this smaller group of oil producers.

    In August 1971, the United States unilaterally pulled out of the Bretton Woods Accord, taking the country off the Gold Exchange Standard and allowing the value of the dollar to “float.” The industrialized nations subsequently followed suit and increased their reserves (by printing paper money) as their currencies stabilized against each other. Since oil was priced in dollars, the depreciation effectively reduced the value of producer barrels, while the cost of goods they imported from the industrialized world increased.

    That same year, in an effort to combat inflation at home, the Richard Nixon administration imposed Phase I of its domestic wage and price control program—the net effect of which, in the oil sector, was to further retard domestic oil production already under stress from field decline/depletion. Demand continued to rise even as domestic production declined. The demand “gap” was left increasingly to be filled by imported oil. In 1950, oil imports accounted for less than half a million barrels per day or about 8 percent of domestic petroleum demand. By 1970 the figure had almost tripled to over 1.3 mmb/d, and in 1973 oil imports constituted 19 percent of U.S. petroleum consumption. Because of the inability to ramp up new supply quickly enough, even in the aftermath of the embargo and the consequent oil price increases, America’s import dependence continued to increase, reaching over 5 mmb/d or 31 percent in 1980.

    Politics and Disruption

    On October 6, 1973, Syria and Egypt launched a surprise attack on Israel (the Yom Kippur War). On the 12th, President Nixon authorized the delivery of supplies and weapons to Israel, while the Soviets were resupplying Syria and Egypt.

    Four days later (October 16), OAPEC announced a decision to increase the price of oil by 70 percent—to over $5/barrel. On the 17th, the OAPEC ministers agreed to cut production by 5 percent (from the previous month’s liftings). On October 19, President Nixon asked Congress for $2.2 billion in emergency aid for Israel, triggering a collective OAPEC response (now joined by Syria, Egypt, and Tunisia) to impose a total embargo on shipments of oil to the United States (including our military) and to selectively curb exports to other consumers in Western Europe and Japan. The price of oil rose to $12/barrel.

    In the United States, spot shortages of refined petroleum products—a consequence of increasing demand and reduced supply/domestic price controls—were already beginning to be seen in the summer of 1973, months

    before the onset of the embargo. A “voluntary” allocation program was put into effect, using historical consumption patterns as “base periods” for allocating current volumes. With the imposition of the embargo and the passage of the Emergency Petroleum Allocation Act (EPAA) in November 1973 (EPAA authorized the imposition of broad price, production, allocation, and marketing controls), the allocation effort became mandatory, and gas lines and odd-even rationing ensued.

    Throughout the fall of 1973, a series of economic and diplomatic efforts were launched to mitigate and unwind the embargo and end the military conflict. On Christmas Day of 1973, the Arab oil ministers announced the cancellation of proposed January cutbacks. Oil Minister Ahmed Zaki Yamani of Saudi Arabia actually promised a 10 percent rise in output, and prices were frozen until April. On January 18, Israel signed a withdrawal agreement to pull back to the east side of the Suez Canal. The withdrawal was completed in early March. A week later (March 17), the Arab oil ministers (with the notable exception of Libya) announced the end of the embargo against the United States and an increase in production and exports.

    Impacts of the Embargo

    In purely economic terms, the embargo and its aftermath produced broad macro impacts. On a net basis, after accounting for “leakage” and production increases from non-OPEC sources, the oil supply curtailments that resulted from the embargo approximated some 4 million b/d (roughly 7 percent of pre-embargo consumption). Industry’s willingness and ability to spread the production cuts more evenly actually undercut the impacts of a targeted embargo effort. And while scholarly tomes and analyses have been written to “document” the macro and microeconomic impacts of the event, suffice it to say that the economic consequences were significant and extended. The price shock of 1973 is reported to have shrunk the U.S. economy by approximately 2.5 percent, increased unemployment and inflation, and spun the economy into a severe and extended recession (1973–1975).

    However, maybe more importantly, the embargo carried significant geopolitical consequences as well. The enormous transfer of wealth to an emerging group of oil producing nations created a new challenge to U.S. hegemony, even as it also provided income and new opportunities for oil rich provinces, including in the United States, Canada, and the North Sea. The embargo put pressure on the Western alliance, as the disruption created tension among our allies (e.g., Japan and parts of Europe) as their import reliance caused them to reexamine their policies vis-à-vis Israel and the Arab states. It also was a major factor in shifting Japanese investment away from oil-intensive industries and into electronics (during the embargo, Japan was very active in the spot market seeking replacement oil at almost any price). For the Arab OPEC states, the “success” of the embargo proved somewhat pyrrhic and fleeting, as the price and disruption shock spurred new government policies and investments in energy efficiency, including the adoption of fuel efficiency standards for cars (CAFE), research into and the accelerated deployment of alternative fuels, and in the United States, the eventual removal, beginning in 1979, of oil price controls. On an international basis, the interruption in oil supplies spawned the creation of the International Energy Agency (IEA) and the establishment of strategic stocks, including the United States’ Strategic Petroleum Reserve (SPR).

    Legacy and Change

    On a policy basis, the embargo—and the oil price/disruption shocks following the Iranian Revolution and the Iran-Iraq War in the late 1970s—created an energy policy framework for the United States built on the dual notions of resource scarcity and growing demand (as well as increased concern about undue import reliance) that has been memorialized in legislation and regulation over the past 40 years. Every U.S. president since Richard Nixon has committed the nation, at least rhetorically, to energy independence. And except for Iran’s notable threats to close the Strait of Hormuz, the so-called oil weapon has remained unsheathed.

    Yet, even as we remember the embargo and the turbulent times of the 1970s, we would do well to take note of the significant changes that both domestic and global energy markets have undergone. At this writing, the United States is poised to become the world’s number one producer of oil and gas, and we are on our way to achieving more than 90 percent energy self-sufficiency. We have enormous coal resources and have made remarkable strides in promoting efficiency and renewables growth. The technological advances that helped promote the “unconventional” oil and gas revolution we are currently experiencing and our ability to explore and develop frontier resources are nothing short of astounding. Additionally, our energy usage per unit of GDP is less than half what it was back in the 1970s—all great advances.

    But we also live in a dynamically changing world with growing demand, especially in the developing economies, a roster change of emerging regional and global players that matter, new political alliances in various stages of development, and complex supranational issues, including how to address the threats of a changing climate. Oil markets remain global (even exporters like Norway feel the impact of disruptions half a world away). And while institutionally OPEC/OAPEC may not be the powerhouse it once was, a handful of enormous resource holders, mostly in the Middle East, still matter—a lot.

    As we look to the future, constructing new policies to effectively address this changing landscape will inevitably be difficult and more complex. In times of great change, being flexible, adaptive, and collaborative may prove to be a more prudent course than being strident, inflexible, and shortsighted (based on the notion du jour of what the future will look like—after all, 30 years ago we were running out of natural gas; less than a decade ago, we were building import facilities).

    That said, a thoughtful reexamination of both the premise/limitations and policy choices of the past is clearly in order. This is especially true in the areas of resource management and production; environmental regulation; industrial policy; infrastructure; taxation; the size, disposition, and management of the SPR; exports; and Jones Act restrictions— just to name a few. But even as we strive to adopt a “new” framework, it is imperative that we remain securely anchored by the larger principles/objectives of preserving global markets and allies, promoting sustainable development, and enhancing our national (and global) security.

    Frank Verrastro is senior vice president and James R. Schlesinger Chair for Energy & Geopolitics at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Guy Caruso is a senior adviser with the CSIS Energy and National Security Program.

    Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

    © 2013 by the Center for Strategic and International Studies. All rights reserved.

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