Amid a tightening world market and global diplomatic tensions, the oil trade is a balancing act

Last week was the 45th anniversary of the oil embargo on the United States, launched by a group of Arab countries in response to American support of Israel in the war with Egypt and Syria.

Since then, regional politics and the global oil market have changed enormously. But the possible use of the “oil weapon” has again been raised in recent days, and is it feasible?

The war broke out on October 6, 1973, and on October 16, Saudi Arabia and several other Arab states raised posted oil prices by 70 per cent and decided to reduce production by 5 per cent each month. The then Saudi King Faisal had been sceptical of using the “oil weapon”, but US President Richard Nixon’s announcement of military aid for Israel forced his hand.

On October 19, the Arab states banned oil supplies to the US. In contrast to their failed policy during the 1967 war, they realised they had to prevent the US from sourcing supplies from other countries, hence they also reduced overall output. Other Opec countries, such as Venezuela, had not participated in a quarrel that did not implicate them.

Iran, under the pro-American Shah, increased output to record levels but also took advantage of the situation to raise prices. Iraq also did not join the boycott despite its strong anti-Israel stance, claiming it would not work, and wanting to benefit from higher production. The measures were therefore not issued by the Organisation of Arab Petroleum Exporting Counties but a new ad hoc body, the Conference of Arab Oil Ministers.

By March 1974, the US politician Henry Kissinger’s diplomacy had brought an Israeli withdrawal from west of Suez and, even though it had not achieved its main objective, the conference (minus Libya) ended its embargo. But the long-term consequences were profound. The oil shock came against the backdrop of a tightening world market, driven by three factors.

Real prices had been low and declining throughout the 1960s, undermining investment in new production outside the Middle East and Soviet Union, and reducing US spare capacity to zero. Demand had increased rapidly due to a robust world economy. And the oil exporters had gradually gained greater control over their industries and pricing, following the founding of Opec in 1960, the nationalisation of western oil interests in Libya and Iraq, their stronger bargaining position and more competition for the Anglo-Saxon majors from continental Europe, US independents and Japan.

Prices, already creeping up since 1970, rose in real terms by a quarter in 1973 and then more than tripled in 1974, going from $14.53 in today’s money in 1972 to $52.54 in 1974, and remaining in the $50s until a fresh shock in 1979. The industrialised world fell into deep stagflation.

The economic malaise was not caused but catalysed by the political action. As American energy economist Morry Adelman put it: “We ought not blame the Arabs for what we did to ourselves.”

Price controls prevented supply and demand from adjusting to the shock, leading to the long lines at petrol stations, famous in photos of the time. But Opec had allowed the price to go unsustainably high, and the developed countries had great powers of recuperation. They founded the International Energy Agency in 1974 to co-ordinate responses to oil shocks.

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Efficiency measures and a turn to alternative fuels – coal, gas and nuclear – cut oil demand. European oil consumption has never returned to its 1979 peak. The seeds of today’s renewable revolution were sowed by initial research. And huge new oil provinces were opened up in the North Sea, Mexico and Alaska, undermining Opec’s dominance throughout the 1980s and 1990s.

Politically, the Arab oil exporters were tarred as unreliable, a tag they have never fully shaken off. In response to the death of journalist Jamal Khashoggi, US politicians talked of imposing sanctions on Saudi Arabia. The head of the Al Arabiya news network, Turki Al Dakhil, wrote an opinion piece suggesting retaliation in the oil sector, reminiscent of Mohamed Hasanein Heikal’s 1972 call in the Egyptian newspaper Al Ahram (I thank oil analyst Anas Alhajji for drawing my attention to this article). Mr Al Dakhil talked of a cut in exports that would send prices to $100, $200 or even more per barrel, as well as of switching pricing from the dollar to the Chinese yuan.

This brings us to the present day. The environment now is very different from that of 1973, but the lessons of that embargo remain. Clearly Riyadh has an indispensable political role as a level-headed producer of oil and holder of nearly all the world’s spare capacity. Saudi oil is needed to fill the gap left by American sanctions on Iran, a campaign which the kingdom supports wholeheartedly. Already in June, Saudi Arabia led Opec members to agree effectively to scrap individual production limits.

Donald Trump, tweeting several times against Opec, is clearly concerned about high oil prices going into November’s congressional elections. Meanwhile, although unlikely to pass, a “Nopec” bill allowing the government to sue Opec members is wending its way through the US legislature. The key growth markets, China and India in particular, would search for other oil partners, and likely tilt to Tehran. But neither China or Russia can yet fill the role of the US and EU as Saudi Arabia’s economic and security guarantor.