Sunday, November 8, 2015

What were the real origins of the great oil crisis of the 1970s? Politics or depletion?



If you happen to be caught in a boat in a major storm, such as in this image by Hokusai, you'll surely think you experiencing a major shock. However, it is also true that no storm changes the average water level of the oceans. So, the oil storms of the 1970s were perceived as major shocks, but did they change the average patterns of the world's oil production? In this post, I argue that they didn't. Just like a sea wave has to crash on a shore, sooner or later, so oil production had grown so fast in the 1950s and 1960s that it had to crash, sooner or later. And it did. 


The oil crisis that started in the early 1970s is still widely remembered today and much of the interest in the vagaries of the present oil market is derived from a comparison with the events of that time. Yet, it may also be that the crisis was widely misunderstood while it was taking place and that it remains misunderstood even today; often reduced to the work of a small group of evil Arab sheikhs, perhaps the ancestors of today's Daesh. But, as it often happens, every question may have an explanation that is simple, obvious, and totally wrong.

Last week, there was a meeting at the University of Venice, Italy, dedicated to this issue: what were the origins of the oil shock and of the countershock of nearly half a century ago? The conference collected for two days experts in subjects such as political science, economics, communication science, history, and more and I won't even try to summarize for you all what was said. Suffice to say that even after you study a subject for 15 years (as I did with peak oil) there are always chances to learn something new that you didn't suspect before. I emerged out of the meeting with the understanding that there was an important political and human side to the great oil crisis. Yet, I remain convinced that there are deeper factors; those factors that people call "fundamentals." And, when dealing with a mineral resource, crude oil, depletion is the fundamental factor.

Not that I pretend to have "the" answer to the origins of the great oil crisis of the 1970s, but I can't avoid to note that the magic word "depletion" was almost never mentioned at the meeting. It is the usual problem: depletion remains a widely misunderstood concept. For the oil industry; as long as their books list "reserves" existing somewhere; then the problem is not considered to be of any importance. And, for historians, if oil production restarted after the crisis, then it means that there never was any lack of oil and, as a result, the crisis must have had political or financial reasons. But depletion doesn't mean "running out" of anything; it is a gradual phenomenon that was already strongly affecting the oil markets at the time of the crisis.

Here, I'll discuss a little only the case of Iran; examined at the Venice meeting by Abbas Maleki, former Iran's deputy foreign minister, and by Claudia Castiglioni, researcher at the University of Florence, Italy. Both of them appeared to see the history of Iran's oil as mainly the result of political and financial factors. Surely, these factors played a role in the crisis, but I thought they couldn't be the whole story. So, after hearing Maleki's talk, I looked for the data for the Iranian oil production; and here they are (image by Plazak, Wikipedia):
Looking at this graph, I was struck by a curious thought. There came to my mind Hokusai's famous "great wave" image, you see it reproduced here, on the right. Note the shape of the oil production curve for the period from about 1950 to 1980; doesn't it look like an ocean wave that grows and then crashes down? From 1955, for some 20 years, Iran's oil production doubled approximately every 5 years; something that corresponds to a yearly growth rate of about 15%. And now ask yourself: how long can anything double every five years?

If you think about that, it makes little sense to ask why Iran's production collapsed; it had to. Just like an ocean wave, it had to crash down sooner or later. Keeping oil production rising for a longer time would have needed not only to match investments to the rapid doubling rate, but also to increase them further in order to overcome the progressive depletion of the "easy" oil resources. Iran was not running out of oil; it was running out of the capital resources needed to extract it.

So, I think that the conventional explanation for the collapse of Iran's oil production is wrong: it is not correct to say that it collapsed because of the revolution. But it would be just as wrong to say that the Iranian revolution was caused by the production collapse. The two phenomena went together and reinforced each other; one more example of another misunderstood concept: that of "enhancing feedback". The same phenomenon affected the Soviet Union, but Iran turned out to be more resilient: the country survived the revolution, the oil shock, economic sanctions, and a major war. Slowly, Iran reached a new stability, the oil industry was rebuilt; and Iran became again an oil exporting country, even though it never reached the peak level of 1979 (and probably never will).

The interest in the great oil crisis of the 1970s-1980s is not just a game for academic historians; it is something that has deeply affected the world's history and it is still affecting our perception of the factors affecting the supply of crude oil that, today, we need as much, and even more than, we needed it at that time. So, there is a crucial question to ask: could we see another great oil crisis in the near future?

As always, the future is obscure, but at least not beyond all conjecture. Today, we don't see in any country (with a single exception) oil production growing so rapidly as it was the case for Iran and others before the great crisis. Hence, it seems unlikely that we'll see again an abrupt crash (apart from the above exception, which seems to be already crashing). Nevertheless, the problem of depletion remains, and it can only grow bigger as more oil is extracted and burned. So, we are heading toward a difficult future; we may not see another "oil shock", but an "oil decline", even a rapid one, very likely, yes.



H/T to the organizers of this excellent meeting, Duccio Basosi, Giuliano Garavini and Massimiliano Trentin.

9 comments:

  1. Do you know of any specific reasons for Iranian oil production not to stay at a level of 4 - 6 Million Barrels per day but to precipitate down to 2, that lay in the nature of oil production?

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    1. Well, not sure about the "specific" reasons. The point I am making is that keeping production going requires investments. Then, when finding enough capital becomes impossible, the result is a vicious circle in which less investments generate less revenues and the government desperately tries to squeeze out the necessary money out of the groups that earlier on were used to get money from the government, and these groups are not happy, and they resist. And that means that the government has to use force to get the money it needs, and then the resistance become stronger and......

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  2. Very interesting post, Ugo, as always. From your graph it does look like depletion in Iran might have played some role. I also read in a peak oil economics book (title and author lost to memory) that another major part was the psychology of fears of shortages in America that became a self-fulfilling prophecy as everyone tried to keep their gas tanks full. Typically the average tank is half full, so when suddenly millions and millions of automobile owners decide all at the same time that it would be a good idea to keep the 20 gallon tank of their gas-guzzling land yacht topped off, this action alone actually generates the shortage. The filling stations were getting their regular deliveries, supposedly as much as they were before the "embargo" (maybe from tank storage?), but the demand suddenly skyrocketed all at once and the tanks at the gas stations thus ran dry. We went from an average of auto tanks half full to them being 7/8 full or something like that, which was a very large spike in gasoline demand in a very short time. Then of course once the filling stations started running dry, panic set in, long lines formed, and it became a self-reinforcing spiral.

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    1. Well, yes, that was one of the feedbacks that enhanced the crisis. Which, however, was created by depletion.

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  3. Not even a mention of US 1970 peak for th "oil crisis of the seventies" ?
    A bit strange .... Except if the subject is the second shock only ..

    By the way Ugo (and all), a truly great documentary about oil history (with interviews of plenty of key people, like Akins, Yamani, etc), below :
    http://www.dailymotion.com/video/xewm92_la-face-cachee-du-petrole-2-2-les-g_news
    (this is the second part starting from the Mossadegh story and with the seventies oil shocks stories, there is also a first part from the beginning of oil period)
    Note : that "reopen 911" logo has nothing to do with the original doc, added by the person who put it on dailymotion, , the documentary is from "arte" (the franco german culture channel).
    There is also a German version but unfortunately not an English one to my knowledge.

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    1. Oh, yes, but the US peak is much less dramatic, much less "Hokusai-like" than the Iran peak. And the US peak caused just a ripple in the market in comparison to the Iran peak - that was when things changed; so far the only phase in the history of oil when the world production significantly decreased (more than 10%) for an extended period, more than two years. Iran (and, in parallel, Saudi Arabia) was the real deal.

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    2. BTW, the US is also hinted about in the links. And the interesting part is that now it is their turn to crash down, Hokusai-like, Iran-like. We live in interesting times, in the sense of the old Chinese malediction.

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  4. I still think blending the two 70ies oil shock in the second one is strange, when referring to "the great oil crisis of the 70ies".
    And by the way in terms of prices :
    first oil shock : from 1,8 To 14,02 (times 7,7)
    Second : 14,02 to 36 (times 2,56)

    As to the collapse of Iranian production, it was clearly due to the revolution ( Khommeiny ordered all foreigns companies out, or they just left, especially following the hostage crisis).

    And one thing for sure, what remains very little known regarding these oil shocks, is that it started in the US from the 70 US peak, that from there US diplomacy and the majors wanted a price rise, but all this has then been totally overlooked under the "embargo story" (which is almost a non story in reality, and was never effective from KSA to the US for instance).

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  5. Mathematically the breaking of waves is caused by non-linear interactions between variables. This interaction causes somthing unsustainable to happen. For instance: the top of the water wave is accelerated up to a point were it has a faster velocity than the water below. The top tries to run in advance of its foundation. We then get the familiar results we see from the shore.

    This is somewhat similar to the the example you gave where the variable capital has to be increased to unsustainable levels in order to keep up oil production. This made inbalances in the society even worse.

    Gail Tverberg has another view, she thinks oil production will crash by financial reasons. Her reasoning is unfortunately not unrealistic according to me. Do you think the central banks will be able to prop up the economy to avoid a crash or will we avoid a crash by other reasons.

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Who

Ugo Bardi is a member of the Club of Rome and the author of "Extracted: how the quest for mineral resources is plundering the Planet" (Chelsea Green 2014)