oil and the economy

Despite decades of climate activism and climate science, oil still remains the world’s most

dominant energy source. Since the start of the industrial revolution, energy has been a key focus. Oil emerged as the dominant energy source due to its significant advantages: it is a liquid and therefore permits large economies of scale, and has a large energy content. Thus, oil has maintained its position as a very cheap and easy to transport natural resource.

Because of oil’s significant role in energy production and in industry, geopolitics have inevitably influenced its production, transportation, and price. We saw possibly the greatest example of this in the 1970s during the United States’ 1973 oil crisis. After President Richard Nixon’s request for $2.2 billion for emergency aid to Israel during the Yom Kippur war, the Organization of Arab Petroleum Exporting Countries (OAPEC) announced that it would cease oil exports to the United States, spiking oil prices from $2.90 a barrel to $11.65. The massive spike in prices incited public outrage. This price spike is comparable to the price of one barrel of oil going from $14 to $80 in today’s market. After this event, we saw high inflation and unemployment in many industrialized nations. Similar price shocks occurred in 1979 during the Iranian Revolution and 1991 during the First Gulf War, both causing severe recessions.

Oil also has wider-economic effects. Oil supply shocks have had a moderate effect on stock

returns, accounting for about 16% of U.S. stock return variation. Oil price hikes appreciate the U.S. dollar relative to other currencies, which boosts U.S. consumer purchasing power. Since oil price shocks introduce volatility into the stock market, investors have been demanding greater compensation and higher interest rates for purchasing government bonds. This strains the economy as it introduces fiscal pressure, decreases investment due to higher loan interest rates, and introduces higher mortgage rates. Overall, when oil price shocks are intense and enduring, there is a serious risk of a recession.

This is especially important in light of the recent Israel-U.S.-Iran conflicts, which have led U.S.

oil to soar past $100 a barrel. For context, on February 28, the United States and Israel launched missile strikes at Iran, targeting Iranian military assets and killing Supreme Leader Ayatollah Ali Khamenei. Iran has retaliated and targeted U.S. military facilities, and most crucially, energy and civilian infrastructure in the Gulf states. More than a dozen countries have been attacked. At least 1,800 people have been killed since the start of this conflict. Iran has also effectively closed the Strait of Hormuz, a crucial sea passage connecting the Persian Gulf to the Arabian sea. In 2024, more than a quarter of the world’s seaborne oil trade passed through here.

The broader economic fallout mirrors historical precedents. Higher energy prices have

significantly affected consumer and producer prices globally, with former Treasury Secretary

Janet Yellen warning that the conflict could stagnate the United States’ economy and exacerbate inflation. This has restrained the Federal Reserve from cutting interest rates. Economists have forecast that if the conflict is prolonged, oil prices may rise an average of $150 per barrel over the next six months, devastating the global economy.