Oil Crisis of 1979

The Oil Crisis of 1979, also called the Second Energy Crisis, was a sharp surge in oil prices triggered by the Iranian Revolution. Iran, then the world’s second-largest oil producer, cut exports as the Shah’s regime collapsed. Global oil supply fell by about 6%, and prices doubled to over $100 per barrel (in nominal terms). The shock revived stagflation and deepened the economic and political malaise of the 1970s.

The Iranian Revolution and the supply disruption

For decades, Iran had been a stable, if autocratic, US ally. The Shah ruled with firm control and had kept Iran’s vast oil reserves flowing to global markets. In 1978–1979, the Shah’s regime fell to an Islamic Revolution led by Ayatollah Khomeini. The new Islamic Republic was hostile to the US and to the capitalist oil industry.

As the political transition convulsed, Iranian oil production ceased. At its peak, Iran had produced over 6 million barrels per day; by spring 1979, production had fallen to nearly zero. For a world oil market supplying roughly 60 million barrels per day, the loss of Iranian production was a massive shock — equivalent to about 10% of global supply, though OPEC members partially offset the loss by increasing production.

The price surge and the global impact

Oil prices, which had been drifting upward from the post-1973 levels, surged. By the end of 1979, prices had reached roughly $100 per barrel (in nominal terms; about $130 in 2023 dollars). The sharp, sudden jump created economic havoc.

Inflation, which the US had partially tamed from its 1974 peaks, resurged. In 1979 and 1980, inflation reached double digits. Unemployment also rose, as the oil shock depressed economic activity. The developed world faced stagflation again — the worst of the 1970s nightmare.

The Volcker response

Federal Reserve Chairman Paul Volcker, newly appointed, took the view that the only solution to stagflation was to break the inflation psychology that had developed in the 1970s. He dramatically raised the federal funds rate, pushing it toward 20% in mid-1981. This was extraordinarily painful but effective.

The high interest rates crushed demand, triggered a severe recession, and sent unemployment soaring to 10%+. But they broke the back of inflation. By 1983, inflation was falling sharply, and the financial system had been cleansed of its inflationary expectations. The cost, however, was millions of lost jobs and a sharp contraction in economic activity.

The long-term energy response

The 1979 crisis accelerated the energy efficiency improvements and conservation measures that the 1973 embargo had initiated. The 1980s saw the deployment of renewable energy research, the expansion of nuclear power (in some countries), and widespread adoption of energy-efficient technologies.

OPEC’s power began to erode. The high oil prices of 1979–1981 incentivized the development of non-OPEC oil sources: the North Sea, Alaska, Mexico, and later the Caspian. OPEC’s share of global oil production fell from over 50% in the late 1970s to below 30% by the 1990s. The cartel’s pricing power was permanently diminished.

The geopolitical aftermath

The Iranian Revolution and the oil shock had geopolitical consequences. The US, seeing Iran as a strategic threat, moved closer to Iraq and Saudi Arabia. The Soviet Union’s invasion of Afghanistan later in 1979 further elevated regional tensions. Energy security remained a central concern of US foreign policy.

The crisis also contributed to the election of Ronald Reagan in 1980 on a platform of economic conservatism and military buildup. The stagflation of the 1970s and the energy shocks were seen as symptoms of American decline; the early 1980s recovery, driven by Volcker’s disinflation and supply-side economic policies, was cast as a reversal of that trend.

See also