All kinds of commodities matter to the global economy. Without steel or concrete the world's construction industries would grind to a halt, while the electrical grids that give us our power supply are dependent on copper wire. However, no commodity has been as important -- or occasionally as troublesome -- over the past century as crude oil.

Three times in the past fifty years oil prices have jumped sharply, pushing up the cost of living significantly throughout the developed world. The first two price rises happened for largely political reasons, while the third was chiefly due to economic forces, but each time the price spike forced politicians to ask searching questions about humankind's complex relationship with its sources of energy.

This relationship is hardly a new one. Since prehistoric times people have used natural resources to enhance their existence -- first through the burning of wood and peat for survival. Then, in the Industrial Revolution, coal was burnt to produce steam power. In the 20th century, other carbon-based fossil fuels (so called because they come from the fossilized remains of dead plants and animals in the earth's crust) such as oil and natural gas became key sources of energy. So ingrained has the use of petroleum-based products become in modern society that it is easy to forget there would be no cars or air travel without them, and the vast majority of our power stations would close down. But oil is not just used for energy; 16 per cent of our usage goes into making plastics, together with various pharmaceuticals, solvents, fertilizers and pesticides.

OPEC and the First Two Oil Crises

Although developed countries such as the United States, United Kingdom and Norway have extensive
oil reserves, a far greater proportion of the world's oil is to be found in the Middle East and a number of other volatile political areas. Chief among them is Saudi Arabia, which has a fifth of the world's known reserves. In the 1970s, in response to a number of political issues in the Middle East, producers with large reserves banded together to form the Organization of Petroleum Exporting Countries (OPEC). This was designed as a cartel -- that is, a group of sellers collaborating to control prices. Between 1973 and 1975 they shut down much of their production, and the resulting lack of global supply doubled the oil price.

As a result, inflation in the US jumped into double-digits and economic growth stalled, leaving the country, and a number of other Western nations, facing stagflation. Unemployment in the US rose from 4.9 per cent to 8.5 per cent during the same period.

The same happened again in the early 1980s, with even more dire consequences, since on this occasion the Federal Reserve, under Chairman Paul Volcker, attempted to fight the rise in inflation with high interest rates, pushing unemployment levels up beyond 10 per cent. The crisis eventually abated following political negotiation with the Saudis, while at the same time OPEC was hit by economic reality: fewer buyers of oil meant less revenue for OPEC, so members of the cartel began pumping more than their stated allowance to try to raise their incomes.

A Third Oil Crisis?

Between the early years of this millennium and 2008, oil prices increased in value seven times. In real terms (in other words after inflation is taken into account) they rose past the peak they hit. Although the developed world continues to consume record amounts of oil -- in terms of number of barrels -- the amount of oil it needs to generate an extra dollar of economic growth has diminished since the 1970s. According to the US Department of Energy, energy consumption per dollar of gross domestic product has declined at an average annual rate of 1.7 per cent over the past quarter-century.

Alternative Energy

The energy shocks of the 1970s prompted companies and governments to seek new ways of becoming energy efficient, and of reducing reliance on oil. Car producers devised ways of making engines run for more miles on less fuel -- particularly in Japan and Europe, where high fuel taxes already made efficiency an attractive goal. A number of countries increasingly turned to nuclear power -- despite a temporary plunge in its use following the 1986 Chernobyl disaster. They also began to look at other sources of energy that do not rely directly on fossil fuels. Most Western countries, for example, have now developed small but growing schemes to generate solar, wind, wave or geothermal energy. In the wake of the recent energy crisis, the quest for alternative technologies has intensified, with major car producers building hybrid and fully electric cars that can be recharged from mains electricity.

Although many of these technologies are still at a nascent stage, their adoption shows how even in an inelastic market (that is, one where consumers cut back relatively slowly in response to price rises), slowly but surely humans adapt and change their behavior when the balance between supply and demand shifts.
in the 1970s. However, whereas the previous crises were specifically political, generated by the actions of OPEC, this one was more speculative in nature.

Investors, such as hedge-fund managers, bought up millions of barrels of oil, suspecting that its price would continue to soar higher still. Part of their rationale was that China and other fast-growing countries would demand significant amounts of oil in the coming years; another justification was that oil is a finite resource which could, at some point in the future, run out. Indeed, many believe that oil production has passed its peak, and that in years to come it will no longer be possible to produce as much oil as previously. If such a theory is true, countries will either have to find new sources of energy or accept an inevitable decline in their standards of living.

The fact that terrorists were increasingly targeting oil rigs and refineries in the Middle East, Nigeria and elsewhere in the wake of the invasion of Iraq and the overthrow of Saddam Hussein in 2003 gave prospective buyers another reason to fret about supply. Meanwhile, on the other side of the supply/demand equation, the rapid rise of China and other fast-growing developing nations meant that demand for energy hit record levels. The combined effect was to push up the price of oil to just under $150 a barrel in the first half of 2008.
Higher oil prices again pushed up inflation across the world, but the global financial crisis of the time brought about a major economic downturn, which quickly pushed oil prices back down to below $40 a barrel by the end of the year.