Crossroads (Toward Philippine economic and social progress)
Philippine Star, 9 May 2012


The wide fluctuations oil prices in the past few decades were caused by a struggle between oil producing nations and the power of the international oil companies. This struggle mirrored the need of the producing nations that owned the exhaustible resource to get a higher price for their product. Eventually, this had to be waged against the interest of consuming nations.

The Philippines was, of course, an oil-consuming country affected by this turn of events. Even though our sentiments are with those countries seeking to raise their incomes from their natural resources exports, we were badly served by rising oil prices.

Modern civilization is highly dependent on crude oil and other carbon resources. In 2012, world energy production is 88 percent dependent on carbon-based fuel. Of this, 33 percent is produced from crude oil. Coal-based energy generation accounts for 31 percent and natural gas 24 percent. In the 1970s, the dependence on crude oil was much more. Years of adjustment to substitute crude oil dependence by all countries, including the Philippines, has led to a reduced share of crude oil in energy generation but not necessarily from other carbon-based fuels.

Review of crude oil price developments in recent decades. From a base of $1.8 per barrel in 1971, crude price doubled to $3.29 by 1973. But a major spike in oil prices happened in 1974 to $11.58, almost tripling! Major developments in the structure of the international oil industry took place during this period.

After coasting along this higher level of prices, in 1979, another major rise in oil prices took place. After the second price spike in 1979, the price of crude in 1980 reached $36.8. This was caused by the outbreak of another war in the Middle East, this time between Iraq and Iran which disrupted major oil supplies in the region.

Then, during a two-decade period following 1981 to 1985, the price of oil began to take a downward slide, benefiting oil consumers around the world. It seemed as if the world supplies of oil would stabilize to a much lower level – around the $20 per barrel level. The tide had turned against the oil producers as they began to suffer from a drastic fall in revenues. This was occasioned by the intermediate term response against high prices that led to a fall in demand for oil in the oil-consuming nations.

For a while, a new low price era for oil almost seemed possible. In fact, in 1998, oil prices fell to their lowest in decades. Abetted by concerns about a world economic recession that might follow the 1997 Asian economic crisis, the fell again to $12.75 per barrel. This was only momentary as the world economy recovered.

In 2001, the terrorist attack on the United States signaled further developments that would upset oil prices and they would impact against the oil consumers again. Threat to oil supplies were part of the reasons for the rise of crude prices again, complicated by the prolonged problems of the US and allied invasion of Iraq and subsequently of Afghanistan.

Restructuring of the international oil industry. The first oil shock was brought about by different events that produced a certain impact: a spike in oil prices.

The year 1971 marked major developments in the oil industry. In that year, the oil-producing countries of the Arab world were able to shift the balance of power between themselves and and consumers.

Libya, Algeria, Iraq, and Saudi Arabia declared that they, and not foreign companies, would set the price of oil flowing into international trade. This caused the price of traded oil to rise 35 percent overnight.

At the same time, members of the Organization of Petroleum Exporting Countries (OPEC) raised taxes on oil companies from 50 percent or less to as much as 80 percent. Both measures effectively contributed to rising prices.

Nationalization of oil production also became effective. Libya nationalized BP’s oil concession in the country. Algeria nationalized 51 percent the French oil production company. These acts were eventually followed by nationalizations of oil concessions Iraq and Saudi Arabia.

By 1974, the major oil producing countries began to take control of the production facilities as well as export pricing power over their crude oil resource through their nationalized oil companies.

Another significant factor in 1971 was the United States decision to take the dollar out of fixed exchange rate convertibility. That action paved the way for the eventual breakdown of the Bretton Woods currency system of fixed exchange rates. From then on, the world’s major currencies would be on float against each other depending on market conditions. This system became complete by 1974.

Because the trade in crude oil was denominated in US dollar and that currency became effectively devalued, a new level of high petroleum prices would rule the decade.

OPEC becomes a major player. The OPEC (Organization of Petroleum Exporting Countries) was founded in 1960 with five original members – Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. Today, it has more members among oil producing nations among developing countries. But not all oil producers are members.

One of the major aims of OPEC was to influence prices by setting quotas for production among members and sticking to those production quotas. As a cartel, OPEC’s ambition was to influence the price of oil effectively. For a while this worked.

Saudi Arabia, as the largest oil producer could serve as market supply adjuster. It could withdraw or raise its output to make up for market excess supply or to reduce it toward some more agreeable level. This however was not a very effective tool if other members of OPEC did not produce according to their quotas as agreed upon.

But cartel discipline broke down with high prices inducing other producers to earn more revenues through higher output. Such lack of discipline would make Saudi Arabia tire of its role as supply adjuster and in turn rely on market price developments.

Eventually, a plunge in demand for oil resulting from over-production as a result of high prices would happen. Consumers reduced their purchases to save on fuel. New technologies were invented that economized on oil. Consumers shifted to those products that effectively reduced their consumption of fuel, like massive shifts of buying habits in favor of more fuel-efficient cars, refrigerators, lighting, and home insulation.

There was one major counter-tendency. Rising scale of new demand came from high growth formerly poor countries. China, India, Brazil and other newly industrializing countries had provided counter-tendencies to this fall in demand.

Another major factor is the search for new oil in other areas. Aggressive explorations for alternative sources of supply were made and new major reserves discovered. All these happened during the 1980s and influenced further long term adjustments in consumption, production, and in improved technology.

Such reactions, combined with a recession due to falling demand, produced also harsh drops in the price of crude as witnessed in the late 1980s.

To be continued