A Brief History of Oil Prices

The Oil Factor: Protect Yourself-and Profit-from The Coming Energy Crisis
by Stephen Leeb, PhD., Donna Leeb

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It is striking, if you look back at the past thirty years, how closely changes in oil prices have mirrored both the economy and the stock market. During this period, rising oil prices have always preceded economic downturns and falling stocks. Falling oil prices have always led to economic upturns and rising stocks. It's that simple, that predictable.

And there is good reason for this strong correlation. For a long time, oil has been our major energy source, and economic growth depends on the availability of energy as much as the growth of a child depends on the availability of food. When energy is available at low prices, the outlook for growth is good, and stocks go up. When energy prices go up, growth becomes harder to achieve, and stocks go down. Now, you might point out that our economy has run on oil for longer than the past thirty years, and that's true. But in those earlier years, no one ever thought much about oil prices. Oil was just there, like air and water-other commodities we gave a lot less thought to back then. It was cheap, it was plentiful, and it was dependable. Businesses could count on getting all they needed, and so could consumers.

In the fall of 1973, that age of innocence vanished forever, as a result of the 35th OPEC conference, which began in Vienna in September and ended in October. This event transformed our economic landscape and forever changed how we think about oil. During that conference OPEC imposed restrictions on oil exports. In so doing, it engineered a 70 percent increase in oil prices, which rose to the then unheard-of level of more than $5 a barrel. In December the cartel met again, this time in Tehran, and took even more drastic action. Protesting U.S. support for Israel in the 1973 Yom Kippur War, it temporarily embargoed oil exports altogether. By early 1974 oil prices had jumped to more than $7 a barrel, more than 130 percent above levels that had prevailed just a few months earlier, in mid-1973, and, indeed, for the entire preceding decade.

OPEC had done what the Soviet Union, throughout the Cold War, had failed to do-demonstrated not by threats but by action our vulnerability to forces over which we had no control. The cartel continued to flex its muscles, and oil prices continued to rise throughout the 1970s, in a steady but constrained uptrend. Then the situation abruptly worsened. Propelled by the overthrow of the shah of Iran and the Iran-Iraq War, oil prices soared. By the end of 1979, oil-which had averaged a shade over $10 a barrel in 1978-was more than $18 a barrel. And by early 1981, prices had reached nearly $40 a barrel.

Then the pendulum shifted again. The reason: the West had reacted to the rise in prices by cutting back on its oil use through a combination of conservation and the development of other energy sources. Heavy investments in nuclear power and the development of coal and of oil fields outside of OPEC's reach began to pay dividends. The combination of lower demand and increased supply drastically reduced OPEC's ability to control prices. As a result, oil prices were in nearly free fall during much of the 1980s. From their highs of nearly $40 a barrel early in the decade, they plunged to a low of near $10 a barrel in 1986.

By mid-1987, though, oil prices rose significantly once more, though getting nowhere near their previous highs. The reason for the rise was, once again, OPEC, which, alarmed by prices in the single digits in 1986, had reined in production slightly. For the next three years oil prices fluctuated between the mid- and high teens without any obvious trend.

You probably remember what happened next. On August 2, 1990, Iraqi president Saddam Hussein ordered his army to take over Iraq's nearly defenseless neighbor, Kuwait, a Muslim country whose population numbered only about two million. Though Kuwait was barely a speck on the map and shared virtually no Western values, it took just twenty-four hours or so for the UN Security Council to order Iraq to withdraw. Why such a fuss over Kuwait? Oil, and a lot of it. Kuwait, a founding member of OPEC, was one of the world's largest oil producers. It was clear that Saddam had only one thing in mind, and that was possession of Kuwaiti oil. The threat of so much oil in the hands of an unpredictable dictator was enough to make the West act, and act decisively.

As the Gulf crisis unfolded, the oil markets responded by driving up the price of oil by over 50 percent in just a few weeks. A number of catastrophic scenarios were being bandied about. The most alarming one was damage to Saudi Arabia's oil fields. Many analysts argued that a desperate Saddam would send missiles to every corner of the Middle East, inflicting untold economic damage in the West. Saudi Arabia was considered the most likely target because it was the world's largest producer of oil. Oil prices soared to above $30 a barrel.

Once the shooting started, however, in mid-January 1991, it became clear that Saddam offered no real resistance and lacked the means to damage the Saudi fields. Though the Kuwaiti fields were left aflame, the Saudis had more than enough capacity to make up for the shortfall until the Kuwaiti fields were repaired. As a result, by early 1991 oil prices had fallen back to the high teens. For most of the rest of the decade, prices remained well under control. Oil hovered near $20, with the average price a shade above $19. Moreover, as figure 1a, "Oil in the 1990s," shows, whenever oil peeked above $20, it quickly backed down. Remember, too, that $20 oil in the 1990s was comparable, after adjusting for inflation, to $15 oil in the 1980s. It wasn't until the end of the decade that oil began to display any volatility at all. In 1998 OPEC, because of an internal battle over market share, turned on the taps full blast. The extra oil hit the markets just as the Asian economies were entering a serious swoon. At their lows in 1998 oil prices dropped to $10 a barrel. OPEC became more disciplined in 1999, and oil prices recovered all the way back to the mid-20s on the heels of surging economic growth. Oil finished the decade at about $25 a barrel, not alarming but still the highest level since the Persian Gulf War of 1990-91.

Copyright © 2004 by Stephen Leeb and Donna Leeb

About the Author

Stephen Leeb is the president of Leeb Capital Management and editor of the prestigious newsletter The Complete Investor. Renowned for finishing among the leaders in the Wall Street Journal's and Forbes's annual stock-picking contests, Leeb is the author of four previous books. His wife and longtime collaborator, Donna Leeb, has a diversified background in business writing and holds a master's degree in journalism from Columbia University.