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OPINION

Russian oil embargo won't be as damaging as 1973 oil crisis

Russian oil embargo won't be as damaging as 1973 oil crisis
March 10, 2022
Russian oil embargo won't be as damaging as 1973 oil crisis

The Arab countries were backed by Russia and Israel was supported by the US. It was the same countries playing power politics even if the proxy nation has changed. The other parallel is that both the Yom Kippur and Ukraine wars occurred when inflation was starting to pick up in UK and US. The big differences though is that the UK is much less dependent on Russian oil than it was on Saudi Arabia 50 years ago.

The Saudi embargo was launched in October 1973 and by March 1974 the inflation adjusted price of oil had risen around 500 per cent from $26 a barrel to nearly $134. UK CPI - which was already around 9 per cent in 1973 - then jumped to 16 per cent in 1974. In response, the Bank of England ramped up interest rates, with the base rate rising from 8 per cent in the summer of 1973 to 12 per cent the following year.

The rising price of fuel undermined people’s purchasing power and, coupled with increases in the cost of borrowing, the UK economy shrank 2.5 per cent in 1974. This was followed by a 1.5 per cent reduction in GDP in 1975.

Stagflation is not good for stocks. Rising interest rates hits growth companies, while rising energy costs lower corporate profits. In a shrinking economy, it is tough to pass on costs especially when consumers are spending a much higher proportion of their income on fuel. In 1974, corporate profits fell 13 per cent and the stock market recorded its worst annual performance since 1900.

If history were to repeat itself exactly, then we could expect the next few years to be an incredibly difficult investment environment. However, the UK is not as dependent on Russian oil today as it was on Saudi oil in 1973. According to BP’s Statistical Review of World Energy 2021 report, the UK consumed 2.23mn barrels of oil a day in 1973. In 2019, it consumed just 1.53mn a day despite real GDP being over three times higher.

The UK’s national output per barrel of oil is around four times higher today than during the Yom Kippur war, which means we can expect a less severe hit to GDP than in 1973. Part of this is due to the switch to gas and renewable energy but also the UK has a much less energy intensive economy. Whatever concerns exist around the death of domestic manufacturing, when there is a global energy crisis, having a strong service based economy suddenly looks more appealing.

On top of the lower dependence on oil, Russia also exports less today than Saudi Arabia did in 1973. Russia makes up 11.5 per cent of global supply. Currently only the UK and US have announced they will cease importing Russian oil and they consume just 2 per cent and 8 per cent of Russian oil exports respectively. So, this Anglo-American embargo will only reduce international supply by around 1 per cent. In 1973, the embargo reduced traded oil supplies by 14 per cent internationally.

Predicting where this war is heading is almost impossible and there are many potential pitfalls for investors. The risk of the UK oil embargo on Russia being the cause of 1970s' style stagflation is not one of them though.