Khuzestan is the major oil-producing region of Iran, and as such is one of the wealthiest provinces in Iran. The prize was Khuzestan. Khuzestan provided 90% of Iran’s oil. Oil has become another commodity. The myth that oil prices have no limit was quickly dispelled in the early 1980s. Oil does have a price ceiling. If the oil price rises too high the world market will abandoned it, never to return, as it invests in alternate energy infrastructure.
Prices in the futures market are influenced by how much the oil commodities cost in the spot market. Supply and demand are the important factors determining price. The first oil shock kicked as the Shah was deposed of power and Ayatollah Khomeini rise too power disrupted oil production.
The second oil shock, the Iraqi-Iran war was characterized by immobilized tankers unable to leave Iraqi ports; 8 mil/bar a day decreased to 1 mil/bar; panicked spot buying in Japan and Europe; US exceeding oil production of Non-Opec locals over OPEC importers; increased US dependence on Alaska, Mexico, and Canadian oil; development of the North Seas Oil production.
Carter lobbied congressional proposals for production of synthetic oil from shale and coal. Synthetic fuel costs $18 billion for 500,000 gallons and the cost and its survivability questionable. Iran withstood the first hard attacks by Iraq. Political instability was exploited by the Media and panic set in.
However, the world’s total oil production was not significantly affected by either of the two shocks. Saudi began escalating its level of daily production and in coordination with other countries exceeded demand. The total amount of daily oil production was about 31 million barrels a day. This was too much supply for the demand. OPEC dropped daily production attempting to soften against a crash in price. OPEC decided price and supply and the oil companies brokered the oil out to world consumers. OPEC wanted a price of $18 a barrel. The price per barrel ranged from $10 to $35 a barrel, a huge increase from the $1.90 a barrel before the shocks. OPEC countries received sudden surge of financial available from banks. The buying spree seemed to have no bounds.
Saudi played the role of the swing producer increasing oil inventory supplies offsetting Iran oil production drops. Saudi became the Arab political leader and often competed head to head with Iran.
Additional shocks included the Arab-Israeli war of 1973, three-mile island nuclear disaster, and Nixon policy of price fixing. Availability of oil was still plentiful and cheap.
What caused the Oil price to rise? Oil traders searched the open market for oil purchases. Japan received 20% of its oil from Iran. BP received 40% of its contracts from Iran. The buyers bought oil now and sold it latter when it was expensive. Oil companies experienced record level profits. The public outrage direct charges at the big oil companies that they caused the shortage. Oil companies defended their position that huge price fluctuations in oil inventories were cyclic and profits were needed to offset drops in price. The oil reserve had billions of gallons of oil in inventory. The oil inventory served to cushion against sudden surges in demand caused from an especially cold winter. The oil companies bought the oil cheap and stored the oil in tankers and oil storage containers and remained fat on the oil. The game increased in danger as the price drove upward and warnings that increasing price could suddenly turn because supply was too large. Political and social instability increased the fear and buyers pushed up price.
Federal Monetary policies were rigidly tight, interest rates rose to 21 percent, and recession set in, unemployment rose sharply, and production dropped. As production drop so did the demand for oil. US car increased fuel efficiency 31 percent with cars achieving 27.5 mpg. Japan reached 51 percent fuel efficiency and consumption decreased. The price is a simple function of supply and demand. If supply exceeds demand than the price will drop. The price of oil dropped suddenly and hard.
The rich began adding oil commodities to their portfolios. Financial portfolio greedy for big profits increased institutional investing in oil commodities and oil stocks and argued that the investment made sense as a hedge against inflation. Oil profits drove up stock prices. The stock market increased in valuation as a direct result of oil company valuation increases. Gold prices rose as dollars were exchanged for Gold. Gold prices may have drove up oil prices. The drop in oil prices hammer oil profits and investors hung too long and kept their money in oil, for the long haul. New oil exploration and discovery could not displace the king of oil and the seven sisters pushed Saudi center stage exploiting the vast oil reserves of the Middle East. The crisis in the Middle East was bound to repeat history again in another round of huge profits for the oil companies.