Russia outside SWIFT: Will we relive the ‘oil chaos of 1979’?

By Michael Lynch

After the first oil crisis, a number of politicians murmured that they did not want to see their citizens frozen in the dark. Thus, they have adopted various approaches to the supply of oil, such as foreign aid, diplomatic measures in favor of the Palestinians and the development of alternative energy sources – from natural gas to synthetic liquid fuels. Unfortunately, high oil prices – which few governments have been able to tackle effectively – have caused a massive recession and people have been frozen in the dark due to unemployment. The International Energy Agency was set up to prevent an embargo, and large oil consumers began to accumulate strategic reserves, partly for the same purpose.

However, opponents of the Shah’s regime were not interested in taking any of the above steps, and the disturbances of the Iranian Revolution were not averted. By the time the perch fell, the oil industry had changed: the price of oil more than doubled from $ 44 to $ 98 a barrel (at $ 2021). The amazing thing is that the real market remained – with the exception of a very short period of time – balanced and overcrowded for most of the 1978-1980 period. As the chart below shows, OPEC members were able to rapidly boost supply, bringing the cartel’s total output back to November 1978 levels in April 1979.

In fact, 3/4 of the rise in oil prices occurred after the second quarter of 1979, when stocks had already risen, as the table below shows.

Why did stocks increase? Mainly due to uncertainty – geopolitical and industrial. Geopolitics concerns the fact that after the seizure of power in Iran, Ayatollah Khomeini began to threaten his neighbors, such as the Gulf monarchs and Saddam Hussein in Iraq (with whom he would be involved in a war in less than two years) . The occupation of the Grand Mosque in Mecca in November 1979 by radicals / terrorists led many to fear that the Saudi government could be overthrown or the country plunged into civil war. Given these ongoing threats to a significant amount of global oil supplies, it made sense to build up reserves to deal with adverse developments.

But few remember that at the same time a revolution broke out in the structure of the industry. Although the majority of OPEC member countries had nationalized their oil operations, most continued to sell the lion’s portion to old customers, most notably the Seven Sisters. Iranian Consortium “, a cartel that dominated the global oil industry from the mid-1940s to the mid-1970s). In 1979, these companies not only lost oil supplies from Iran, but also cut off the supply of crude oil they bought from other exporting countries. Libya, for example, canceled contracts with the Seven Sisters claiming there were technical problems in production – it then sold the same oil on the spot market at much higher prices, as countries and companies without access to the Iranian market were willing to make better offers.

At the same time, however, the fact that most countries followed the practice of selling oil at an “official price” agreed in OPEC did not help. When the Iranian oil crisis erupted, the amount of oil globally traded in the spot market was very small and was quickly absorbed by willing buyers, which pushed the spot price well above the “official price”. For an exporter, canceling or not renewing contracts for oil traded at the official selling price paid off, as he could resell it at the highest spot price. Kuwait, for example, had agreed to sell most of its oil to BP, Gulf and Shell. Eventually, it reduced supply to those companies by 80% and resold the released oil to other customers for a higher price.

But this meant that companies that lost their oil supply in this way had to look for new sources, while at the same time restricting sales to third parties – especially to Japanese oil companies – which in turn had to look elsewhere for their own new supplies. And all this while the governments of the consuming countries urged each other not to move in the spot market, but on the other hand encouraged their own companies to buy what they could find.

The market had no shortage of oil, but supplies had become extremely unreliable: a company never knew a state-owned oil company would cancel its contract or when a major oil company would resort to force majeure. Many buyers have been found to rely on short-term contracts and spot sales instead of decades-old deals. All this climate of uncertainty has boosted the value of stocks and partly explains their quantitative increase. None of this is evident in the market equilibrium and few today are aware of the microeconomic developments that have caused them.

The expulsion of Russian oil companies from the SWIFT banking system could have similar consequences. They could find new buyers and replace Western customers (states and companies): only China imports more oil than Russia exports. But to change these barrels will require a complex trading network as well as new logistical arrangements. Transporting oil from the Baltic and Black Seas to Asia will take more weeks than sending it to European markets, and in the meantime the Chinese are unlikely to hand over existing Middle Eastern barrels to “thirsty” European refineries. (Tanker owners will definitely benefit).

Could the price of oil triple, as it did from 1978 to 1980? Probably not, as the crude that will be released from the strategic reserves will probably close many of the new “holes” that appear in the oil “map”. However, the coming weeks are expected to be extremely “wild” for the oil market.

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