David R. Henderson  

Who Caused the August 1990 Spike in Oil Prices?

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Who caused the August 1990 spike in oil prices? If you learned that someone had reduced the supply of oil substantially just before the spike, wouldn't you think that that someone caused the price increase? You might think that I'm asking a trick question. I'm not. But what's striking is how even sophisticated energy economists get it wrong.

Here's James Hamilton, one of the country's leading energy economists:

In 1990, after eight years of falling oil prices, and eight years without an economic recession, Iraq invaded Kuwait, knocking out two of the world's biggest oil producers. Oil prices rocketed back up . . .

So Hamilton gets it right that the "knocking out" of "two of the world's biggest oil producers," Iraq and Kuwait, caused the oil price increase. But Iraq didn't knock itself out. Saddam Hussein had no desire and no incentive to end exports from Iraq and Kuwait. That would have hurt his export earnings badly.

Indeed, it was to hurt Iraq's government badly that the United Nations, at the behest of the U.K. and U.S. governments, imposed an embargo on oil exports from Iraq and Kuwait. In other words, it was the UN, not Iraq, that knocked out two of the world's biggest oil producers.

Hamilton is not alone in making this error. Here's what I wrote in 2007 in David R. Henderson, "Do We Need to Go to War for Oil?":

[The] United Nations sanctions, passed on August 6, 1990, . . . forbade any country from importing oil from Kuwait or Iraq. By doing this, the U.N. kept reduced world supply by over 4 mbd, at the time a 7 percent reduction in world output. Even some normally sophisticated economic analysts got it wrong. Here, for example, is what the prestigious President's Council of Economic Advisers wrote in its 1991 Economic Report of the President. I reproduce almost the whole section titled "Recent Oil Price Movements."

The recent increase in oil prices began in July 1990, when the members of the Organization of Petroleum Exporting Countries (OPEC) began their negotiations to reduce the supply of oil to the world market. The spot market price, the price at which crude oil for near-term delivery is bought and sold, rose from an average of about $17 a barrel in June 1990 to almost $21 at the end of July.
After Iraq invaded Kuwait on August 2, the spot price rose quickly, reaching about $28 a barrel on August 6. The spot price went as high as $40 a barrel in mid-October and then generally declined through the end of 1990. Soon after the start of Operation Desert Storm in mid-January 1991, the spot price fell to about $20 a barrel, not far from its level just before Iraq invaded Kuwait.
Soon after Iraq's invasion, uncertainty concerning the timing of the resolution of the Gulf crisis increased uncertainty about future oil supplies, which in turn increased the precautionary demand for oil inventories. Several countries began to increase their oil production in August, and by November these additional supplies had completely offset the loss of 4.3 million barrels in daily exports form Iraq and Kuwait. . . .
It is clear that the proximate cause of the rapid oil price increase late in the summer of 1990 was Iraq's invasion of Kuwait and its threat to Saudi Arabia. Had Iraq dominated both Kuwait and Saudi Arabia, it would have controlled almost one-half of the world's proven oil reserves. The international community responded to this aggression vigorously, deploying multinational forces and initiating an embargo against Iraq. These responses to the Iraqi threats to both peace and economic security have averted even sharper and longer lasting increases in the price of oil and a greater deterioration of economic conditions. (italics in original)

This passage is striking in a few ways. First, note the timing of the price increases. The major jump, notes the Report, happened between the end of July and August 6. And August 6 was the day that the United Nations took 4.3 mbd of oil off the world market, a fact that the Report admits. But one searches in vain for a straightforward statement that the U.N. embargo caused the price increase. Second, note that the Bush economists implicitly admit that the embargo was to blame. Although they state that the Iraqi
invasion of Kuwait was "the proximate cause," they emphasize in the middle paragraph above the reduction in supply from Iraq and Kuwait. Who caused this reduction in supply? Not Saddam Hussein, who would have committed economic suicide by refusing to sell oil, but the United Nations. Of course, it goes without saying that none of this analysis is meant to justify Saddam Hussein's actions. Rather, it's to say that whoever cuts the world supply, no matter his intentions, is responsible for the consequent price increase.


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COMMENTS (8 to date)
ThomasH writes:

OK so Hamilton should have said that the invasion of Kuwait by Iraq AND the subsequent embargo of Iraqi oil caused the spike. So what? Demand curves slope downward to the right regardless of the motivations of suppliers. Had anyone been under the misconception that the price increase was a sudden increase in the quantities demanded? Did anyone arguing for the embargo claim there would be no effect on prices?

happyjuggler0 writes:

ThomasH,

It matters a lot whether the cause was Saddam Hussein raising prices or the UN causing prices to rise because of its embargo.

If the average citizen thought that Iraq invaded Kuwait in order to raise the price of oil, and succeeded in his goal, then the general public would be dramatically more supportive of war contrasted with the scenario where the general public was aware that without a UN embargo that oil prices would have stayed about the same as before the invasion.

On a more anecdotal note, I was living in MA at the time of the 1990 elections and John Kerry ran for reelection in part by alluding to the price spike in oil and promising to take steps so that our economy wasn't vulnerable price spikes such that recently happened.

Grant Gould writes:

I think you will find that this counts as Iraq cutting off oil under the "Now look what you made me do!" principle of international relations.

ThomasH writes:

I was around and paying attention and never heard the argument that Saddam invaded Iraq to raise the price of oil. Presumably he did it to control a larger quantity of oil. Now I guess that he might have had in mind that by controlling Kuwait he might have a greater influence in shaping OPEC production and could use it to reduce supplies and increase the price. But is still sounds pretty absurd as a motive for war. It seems a huge stretch to claim that is what Hamilton meant or what anyone would reasonably think he meant.

Thanks for this reminder and clarification. I know I sometimes get sloppy in this regard and casually point to the Iraqi invasion of Kuwait as responsible for the price spike.

David R. Henderson writes:

@Michael Giberson,
You’re welcome.

NPW writes:

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I agree with Grant Gould. When governments (or the UN) do damage, they see themselves as transparent to the cause.

In the early 1990s a teenager sped away from a chasing police car in Hillsborough, NC. The chasing police officer lost control of his car and collided with another car, killing the driver. When they caught the teenager they charged him with homicide.

I believe such lies are standard fare in government lore.

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