A Quick History of War, OPEC, and Gas Prices

Release Date
March 4, 2013

Topic

Lobbying & Special Interests
Description

Historical trends in gas prices can largely be explained by changes in supply and demand. Demand for oil rose through the 20th century. Although this put upward pressure on price, supply initially increased even more rapidly as people produced newer and less expensive production methods. Professor Art Carden shows how oil prices changed based on various events that caused shifts in the demand and supply of oil.
Political events, economic growth, and international conflicts, among other things, affect the supply or demand of oil. These, in turn, contribute to the prices we see at the pump. Prof. Carden offers several examples, including the following:
–          The 1973 Yom Kippur war led to decreased supply as oil producers cut production to punish countries that supported Israel: prices rose.
–          Iran’s revolution in 1979 and Iraq’s invasion of Iran in 1980 decreased supply: prices rose.
–          The East Asian crisis led to a reduction in the demand for oil: prices dropped.
–          Surging economies in China and India in the last decade combined with political instability in the Middle East have increased demand for oil and decreased available supply: prices rose.
Should we be worried that we’ll run out of oil? Prof. Carden thinks not. He argues that prices, profits, and losses provide incentives for innovation and improvements. “People are pretty clever,” he says. “They come up with innovative and ingenious ways to solve problems every day.”

Professor Carden’s Data Sources
Cowen, Tyler and Alex Tabarrok, Modern Principles of Economics, 2nd ed.
Learn More Beginner Resources
www.opec.org [website]: This website has useful data, commentary, and press about OPEC
A Brief History of OPEC [article]: TIME Magazine’s primer on the history of OPEC
“OPEC” [Wikipedia entry]: A beginner’s guide to the history, economics, and controversy surrounding the Middle-Eastern oil cartel
“1973 Oil Crisis” [Wikipedia entry]: A guide to the infamous Yom Kippur War oil embargo and its economic and political effects
How Oil Prices Affect the Economy (video): A brief explanation of how our dependence on oil dictates the ups and downs of the economy
Learn More Advanced Resources
“Opec” [encyclopedia entry]: The Concise Encyclopedia of Economics explains OPEC
Oil Prices [article]: Robert P. Murphy uncovers the mystery behind volatile oil prices and prognosticates the future of the world oil industry
If Oil Industry Profits Are Up, Why Aren’t Prices Down? (video): Jim Lehrer interviews Chevron’s Vice Chairman Peter Robertson about the price of oil and profits in the oil industry

A Quick History of War, OPEC, and Gas Prices 

What explains historical trends in gas prices? Tyler Cowen and Alex Tabarrok explain in their economics textbook, Modern Principles of Economics. Demand rose through the 20th century. This put upward pressure on price, but supply increased even more rapidly as people developed new sources of supply and newer, cheaper production methods.
Oil started becoming an international political issue through the 1950s, and the Organization of Petroleum Exporting Countries, or OPEC, was founded in 1960 by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. As more and more oil supplies were nationalized by the governments of OPEC countries, and as more and more countries joined OPEC, collusion became easier, and countries were able to withhold oil supplies and increase prices.
This came to a head in 1973 with the Yom Kippur War. Arab oil exporters banded together and cut oil production in order to punish Western countries that had supported Israel, and oil prices exploded. In the late 1970s, additional shocks came from the 1979 Iranian Revolution and from the 1980 attack on Iran by Iraq. Shortly after, prices fell again as high prices signaled the huge demand for oil and therefore attracted entry over the long run by, for example, British and Norwegian producers.
Prices increased again during the 1991 Gulf War, but they fell again when the East Asian crisis reduced demand for oil. Finally, the surging economies of China and India in the last decade or so, combined with political instability in the Middle East, have raised the demand for oil and reduced the supply. Economic growth in countries like China and India will probably continue to put upward pressure on oil and gas prices.
Should we be worried about whether we’ll run out some day? I don’t think so. Prices, profits, and losses are signals. In this case, profits from oil production are a signal that says, “Find new sources and find substitutes.” People are pretty clever, and they come up with innovative and ingenious ways to solve problems every day. If we leave them alone, they can solve this one too.