Recently I picked up a book that predicts a long-term glut in the oil market. Potential oil reserves, the book asserts, are huge relative to world oil demand, and costs of production are declining. Although the oil cartel has had some success in keeping prices up, its power is waning. The prospect is for flat or falling prices as far as the eye can see. Sound reasonable in these days of exceedingly low petroleum prices? Well, yes-but Morris Adelman's The World Petroleum Market was published in 1973. You might call this a case of oil wells that ended well-that Adelman had it right and that the oil price hikes that began almost as soon as the book was in print were merely a blip. But what a blip! Oil now sells for around $10 a barrel, which in real terms is about what it sold for in 1972. In 1975 the price rose to the equivalent of $25, and peaked in 1981 at around $53; not until 1985 did the era of high oil prices truly come to an end.
And during those dozen years of high oil prices, the energy crisis loomed large in economics and politics. Oil shocks, argued many economists, were a major culprit in the "stagflation" that afflicted the world economy. Jimmy Carter told us that to fight the energy crisis, the nation needed to declare the "moral equivalent of war." (Washington desperately needed someone to police these 1970s-era acronyms. In addition to the "meow" program, we also had a Council on Wage and Price Stability, or "cowpiss".) Lines at the gas pumps helped make Ronald Reagan President; reckless "recycling" of Arab oil money helped cause the Latin American debt crisis.
How could such a thing happen? During the '70s, doomsayers declared that the world was running out of resources, civilization was doomed, and that was that. In retrospect, it seems clear that this was all wrong; experts like Adelman were right that there was plenty of oil and for that matter most minerals. (Renewable resources like fisheries are another story.) But then how could prices have gone so high for so long? One answer is that this was a case of a cartel that made good, then went bad. For a while, goes the story, oil-producing nations agreed to limit their production and raise prices; but then they got greedy, started cheating, and the whole thing fell apart. The trouble with this story is that OPEC was never a very cooperative group; indeed, during the cartel's glory days two of its members fought a remarkably vicious war with each other. How can so quarrelsome a club have been effective enough to engineer the most spectacular commodity price increases in history?
Another answer says that OPEC was a myth, that it was all really about Saudi Arabia, which was essentially the pricemaker for the world. According to this story, the global shortage following the 1973 Arab-Israeli war revealed to the Saudis that they had far more market power than they realized-that if they cut production, nobody else was in a position to make up the shortfall, and prices would soar. So they took advantage of this discovery, but over time their market power was eroded by cutbacks in demand and new sources of supply. Eventually they realized that by restricting their production they were simply providing a price umbrella to their cheating OPEC partners, and the game was up.
Yet a third story says the energy crisis was a classic case of market instability. Oil rich countries found it hard to spend the new wealth generated by high prices, so they attempted to save for the future-believing wrongly that the best way to do that was to leave the oil in the ground. The initial result was that higher oil prices reduced supply and drove prices still higher-but eventually it became clear that oil in the ground wasn't that good an investment after all, and the bubble burst.
So what's the right story? Nobody knows-and we're not likely to find out. You see, when oil prices dropped after 1985, interest fell off. Grants to study the economics of energy dried up; ambitious economists shifted to other topics. Never mind that the rise and fall of oil prices was one of the most spectacular and puzzling events in economic history; as soon as oil was cheap again, the subject was dropped.
And that is a shame. History is the main laboratory for economic theory; a theory of markets that can't explain the energy crisis is probably not much good for anything else. Moreover, as the saying goes, history may not repeat itself, but it does rhyme. Anyone who thought that the banking crises and liquidity traps of the 1930s carried no lessons for the modern world has had a rude awakening in the past year and a half, as Asia has experienced a minor-key replay of the Great Depression. Wanna bet that one of these days the energy crisis will seem equally relevant?
Originally published, 2.1.99