Will the world face the seventies oil shock once more?

So, will it be seventies once more or are economies more resilient now? 

Deepak Mahurkar, leader-oil and gas industry practice at PwC India, does not see a repeat of the decade happening. “Then, there was no alternative to oil. Therefore, the kind of impact it (oil crisis) had in the seventies–with economies getting impacted and oil consumption going down, and so on–will not happen. Economies could continue to do not so badly but, if the situation persists for a longer period, then there is a definite possibility of oil consumption going down.”

The steady climb in oil prices could be pegged to a “very unusual” situation today. Mahurkar said, “It is very unusual because all the commodity prices have gone up, therefore the impact of inflation on all economies is being felt severely. There is no alternative that people can switch to.” He sees prices for oil, gas and coal to remain firm for some time. 

Prashant Vasisht, vice president and co-group head at corporate ratings in ICRA, said that it is hard to predict if things will go as badly as they were in the seventies but added that they see crude price averaging somewhere between $100 and $120 in FY23 with an upward bias. “A lot will depend on whether the Russia gas (pipeline) will reopen because European and north Asian countries are heading towards winter,” he added.

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What were the oil crises in the seventies?

In the first half of the decade, the Arab nations stopped oil supplies to the US and its allies, accusing them of supporting Israel during the Yom Kippur War, and also raised the price per barrel from $3 to nearly $12. This led to acute shortage in the western countries, the US rationed supplies and people were lining up at fuel pumps. In the US, inflation was already running high, with policies that tried to tame unemployment by increasing the supply of money, and the oil crisis made it worse. In the late seventies, a revolution broke out in Iran, which further squeezed oil supply and forced countries to invest in alternate sources of energy. 

India thought that it would be protected from the oil crunch and resultant price rise, but it didn’t play out that way. In the first oil crisis, the OPEC countries raised the rates for everyone and India’s oil bill came to nearly half of its export earnings and twice its forex reserves. Food production plummeted with fertiliser shortage, and worsened a food shortage that came with the 1971 war with Pakistan.

India was just recovering from a balance of payments (BOP) crisis when the second oil crisis from the instability in Iran hit. “The BOP situation changed dramatically in 1979– 1980 as agricultural growth suffered and industrial bottlenecks emerged owing to shortages of power, coal, cement and a deterioration of labour relations, difficulties with ports and railway transportation. Infrastructure inadequacies bedevilled the economy, and these were accentuated by a poor monsoon which affected hydel generation,” V Srinivas in his book India’s relations with the International Monetary Fund. Srinivas, who was Additional Secretary to GoI, worked as Advisor to the Executive Director of IMF. In the second half of seventies, inflation in India shot up from 3 per cent in 1978-79 to 22% in 1979-80. According to a speech given by former RBI governor YV Reddy, average inflation rate during the seventies was at 9%. 

“The external terms of trade worsened significantly owing to higher prices for imported petroleum and fertilisers,” Srinivas wrote.

Why does the IMF think it won’t be that bad?

The senior economist at IMF, Nico Valckx discusses a metric called oil intensity, which captures how many barrels are needed to produce $1 million in gross domestic product. He wrote, “this measure (oil intensity) was about 3.5 times higher than current levels when crude prices almost tripled between August 1973 and January 1974.” So any change in oil prices won’t be as disruptive as it was in the seventies. 

Besides this, wages today don’t automatically adjust to inflation–for example, your parents’ salary slip may have had a component called Dearness Allowance (DA) which yours may not–and central banks function differently. “More (central banks) are independent today, and the credibility of monetary policy has broadly strengthened over the intervening decades,” he wrote. 

The oil intensity measure is a good measure for oil demand, in fact it is the most reliable measure we have for predictions, said PwC’s Mahurkar. But, he added, there is a shift that is taking place in oil use. 

“Dual-fuel capabilities are being built into automobiles and, more importantly, in industries. Therefore, people are swiftly changing from one fuel to another and not for environmental reasons but for economic reasons,” he said. 

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ICRA’s Vasisht believes that the drop in oil intensity does not really capture the oil demand scenario. “When you are selling more software than big machinery, then oil intensity would go down. But oil is still the primary source of energy. With American households spending around $1,000 per month on gasoline, which is a huge amount, oil prices are a big political issue. So the fall in oil intensity does not capture the reliance the world still has on the fuel,” he said.

He also does not see the oil producers investing more to meet the excess demand because the replacement capex would be around $500 billion annually, which is a “massive, massive jump” from the current annual capex of $340 billion.

“Already upstream companies are going for short cycle, more lucrative projects that will yield returns faster and not projects that have a longer start to production. Also, there is a view that before renewable energy kills the upstream industry, the bankers will choke the funding,” he said.

Despite seeing oil’s hold on the economy weakening, Mahukar believes that the scenario emerging in India from the current oil crisis is a bit scary because switching between fuels (say from oil to natural gas or combustion fuel to electricity) isn’t easy, except like in south Gujarat. “Changes are definitely happening, the oil price shocks have led to a lot of dual-fuel capability being built by industries but the change isn’t going to show immediately. For India, the reliance on oil is high and will continue to be high, in fact because of the economic growth it is going up,” he said. The best case scenario would be oil coming down to $60 a barrel in about two to three years time, he added.

“One of the worst things that could happen is global unrest of any sort because we are heavily import dependent. Also, if growth in various economies return to normal and demand for oil, then we cannot afford higher prices. India will benefit from a stronger move towards renewable energy,” he said. If the rest of the world is forced to move towards green energy, then there is less demand for fossil fuels, then prices of the fuels can moderate and India can continue to use fossil fuels as a developing economy.