The Roosevelt Project
M.A. Adelman, February 1992
After 1973, oil consumption stagnated worldwide. Non-OPEC output increased, mostly in Alaska, Mexico, and the North Sea, but not because of the price rise.
The cartel nations had to assume the whole burden of cutting back output to maintain price. The demand for OPEC oil, the difference between total demand and non-OPEC supply, declined accordingly. From early 1974, current producing capacity much exceeded current output.
The oil companies were expropriated from production. They were no longer a buffer between the OPEC nations and the market, and no longer equated the amount of crude supplied with the amount demanded.
Thus it was more difficult for the cartel nations to cope with their two objectives: (1) A price and total cartel output to keep or improve total cartel revenues. (2) A division of the market acceptable to the members, at least for the time being. Each objective is difficult, both together much more so. All solutions are temporary. What is right today is wrong tomorrow. The optimal price/output combination may change, or its perception may change. Members may cheat, or the burden of restriction may become intolerably great for one or more sellers.
Despite shrinking demand the loss of the oil companies as agents, the OPEC nations raised the price through 1974, and raised it more moderately through 1978. There was much dissension, which never broke unity.
More price increases were expected in 1978. The demand for oil was misperceived as almost completely unresponsive to price. OPEC decision-making was further biased by the OPEC nations\' chronic financial problems as their spending rose even faster than their revenues. By 1978, Saudi Arabia was in budget and current-account deficit.
The Iranian Revolution led to a temporary loss of all Iranian supply, and a permanent loss of some. There was little if any shortfall in production, and beyond production there was enough excess capacity to have maintained output without price increases. But two output cuts by Saudi Arabia, and refusal to indicate when they would be restored, generated waves of precautionary and then speculative demand which made spot prices explode.
Official or contract prices were ratcheted up to make the increases permanent, roughly from 12.50 to $34 in 1981. We are compelled to go past this date in describing the upward movement because of the general market disarray. One cannot date with precision when it became apparent that the OPEC nations had raised the price too far for their own good. But there was no willingness to retreat on price, and the line was held for the time being.