The first major oil shock was experienced in the 1970s, immediately after the oil production peak in the United States of America (Ammann 219).
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The main reason for oil shocks was the peak production of oil as most experts in the oil industry say. The 12 member countries of OPEC formed the organization in September 1960 (Ammann 219). The Organization of the Petroleum Exporting Countries began as a strategy to resist the mounting pressure by other oil producing companies for them to reduce fuel, prices to fellow oil producing companies.
The first oil price shock experienced in the United States was due to dollar depreciating. Floating of the dollar when the US pulled out of the Bretton Woods Accord (Ammann 219) caused the decrease in value. This window gave the dollar a way to float since most of the other currencies pegged on it. After the US had pulled out of the accord, Britain followed and like the dollar, the sterling pound floated. It did not take long before the rest of the industrialized countries pulled out as well.
Oil by then traded in dollars and with the low value of the dollar then, producers realized less income for the same price (Frum 318). The OPEC then decided to shift and price of their oil to trade against the gold value (Frum 318). This was how the mid-1970s oil shock began. OPEC did not adjust their prices as fast as the currencies were depreciating. This caused a lapse in the fuel prices hence the oil shock. OPEC lacked the mechanism to revise and adjust prices to remain within the shifting market environment.
The Yom Kippur War in 1973 was another cause of the oil shocks. The Arab- Israeli conflict crippled the oil market and the prices of oil were rising dramatically. The Middle East was frustrated with the way the Americans exploited their resources by buying crude oil at very cheap prices and selling it back to them as refined petrochemicals. For that reason, the Arabs resolved to increase their prices to about ten times higher (Frum 320). The shah of Iran made this clear to the American people.
The conflict between the Arabs and Israelis went on as both sides gathered support from different countries. The Americans supported Israel while the Soviet Union was in support of Egypt and Syria (Richie 186). With such backing from both sides, the war affected the oil trade causing shortages and hence the law of demand and supply fell into place.
The oil embargo was another reason for the oil shocks experienced in 1973. With the American quest to prevent the collapse of Israel through military support and supply, the major oil producers threatened to hold oil supplies to the US. OPEC collectively made public their intentions to raise oil prices by 70% while continuing with the supply cut of about five percent (Yergin 589). OPEC responded after the president of the United States granted $ 2.2 billion in aid to Israel (Ammann 210).
Soon after Libya announced that it would embargo all oil shipments destined for the United States, other Arab countries did the same (Ammann 210). This came along with an increase in oil prices since OPEC imposed it as a restriction plan. Short-term oil demand is however inelastic and this meant that the increase in the price of oil had little or no negative impact on the demand (Yergin 587).
For the market to feel the impact of an increase in oil prices, the price had to increase significantly in order to achieve the low levels of demand that would accommodate the new low supply levels.
The anticipated low supply led to an immediate increase in oil prices from $ 3 per barrel to $ 12per barrel (Frum 318). Oil prices continued the upward trend until 1986 (Richie 185). The impact of the increase in oil prices was felt instantly especially in the oil exporting countries.
The west could no longer dominate the Middle-East countries now that they were in control of a very vital commodity (Richie 185). Oil in the Middle East became the “oil weapon” since the Arab countries used it to manipulate and influence their political and economic interest.
Industrialized countries like the United States, Japan, Great Britain, and Canada were the major targets. The Arab embargo had a negative impact on the American economy. Companies in America had to find new energy sources a move that was rather expensive. Inflation due to high prices of goods that depend on petroleum as a raw material either directly or indirectly was also a factor to consider.
OPEC tries to broker trade agreements between member states and the global market over the years. The success of the organization is due to its control of the major oil producing regions especially in the Middle-East countries and other Muslim countries such as Libya. Oil trade being a profitable endeavor attracts investors and the product thereof is of global economic value. This is why the Middle East can hold other industrialized states hostage until those countries honors and meet their demands.
Although the organization is good for the well-being of the suppliers, it is different when dealing with the entire market. It is vital to look into the impact of their actions on the global scene. Oil prices affect every other segment of the global market and hence checkups are vital to protect economic Co-existence. Economic shocks always affect the global economy since it is through oil trade that most countries find a common market-need through either demand or supply of the product.
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The Middle-East region is very rich in oil reserves and the resource is a global demand hence the ready market for it and its byproducts. Nonetheless, this might change with the recent calls for international firms to find and implement new alternatives for energy sources. If there were cheaper and sustainable alternatives, the global shift from the east might be inevitable. The solar energy is currently gaining momentum as well as the wind energy. This may prompt the OPEC to revise their strict trade measures with the compromised monopolistic advantage they currently enjoy.
Oil and its products are major components of the world’s economic growth and activities. Fluctuating oil prices may cause economic recessions and affect the entire global economy. This research shows that oil shocks had direct impacts on the past economic meltdown in the past decades. However, the commodity is vital for any economy to thrive. Unless the world pursues other options of environmentally friendly sources of energy, world’s dependency on the Middle East will remain unchanged.
Ammann, Daniel. The King of Oil: The Secret Lives of Marc Rich, New York, NY: St. Martin‘s Press, 2009. Print.
Frum, David. How We Got Here: The ’70s, New York, NY: Basic Books, 2000. Print.
Richie, Ovendale. The Origins of the Arab-Israeli Wars, New York, NY: Pearson Longman, 2004. Print.
Yergin, Daniel. The Prize: The Epic Quest for Oil, Money, and Power, New York, NY: Simon and Schuster, 2008. Print.