© 2016 Shmoop University, Inc. All rights reserved.

Economy in The War on Terror

Economic Terrorism

Long before the attacks of September 11, many Americans felt they were under assault from the Islamic world—by soaring prices at the gas pump, not by bombs on airplanes.  Since the 1970s, Middle Eastern nations, tied together within the Organization of Petroleum Exporting Countries, have worked to control oil prices, at times wreaking havoc on the American economy. In 1973, for example, an embargo on sales to the United States boosted prices 400%—from $3 to $12 per barrel.  Between 1979 and 1981, Middle Eastern production cuts forced oil prices to $35 per barrel.6

For many Americans, OPEC’s manipulation of oil prices has been tantamount to economic terrorism—an unprovoked assault on innocent and unsuspecting civilians.  Yet like everything else in the history of U.S.-Mideast relations, the story is more complex.  During the 1970s, the United States did not suffer through an unprovoked or unpredictable economic assault from the oil-rich nations.  Nor has OPEC ever been quite the all-powerful cartel that many believe it to be.  

1900-1920: British Pioneers

Great Britain was the first western country to fully appreciate the importance of the Middle East’s rich oil resources.  In 1901, British investors secured a concession from the Shah of Iran to tap into the nation’s vast reserves and in 1908 these investors established the Anglo-Persian Oil Company—the forerunner of British Petroleum, now branded more simply as BP (with a cute sunflower logo!). National security concerns drove Britain’s interest in Iranian oil.  The island nation needed a reliable source of oil if its navy was to rule the seas as it had during the previous century.

In fact, Iranian oil was deemed so vital to British security that in the months before the outbreak of the First World War in 1914, the British government acquired a 51% interest in the Anglo-Persian Oil Company. It also increased its control over the Turkish Oil Company, a consortium of British, German, and Dutch oil companies interested primarily in Iraq’s rich reserves. 

1920-1940: The First Mideast Conflict

After World War I, however, Britain’s monopoly over the region’s black gold was challenged and the century's first “Mideast conflict” was born—between the United States and Great Britain.  Britain sought to retain control over its assets in Iran and Iraq, while the US sought recognition of an open door policy. Local governments should be permitted to extend concessions to whomever they liked, Americans argued; no foreign power should be allowed to exercise a colonial monopoly.   But Britain dug in its heels, arguing that its needs were vital and that the Americans already had access to vast resources on their own territory.  America’s domestic wells accounted for 70% of global production and American control over Mexico’s rich oilfields added an additional 12%.  In contrast, Britain’s Anglo-Persian Oil Company only accounted for 4.5% of world production.7

This Anglo-American “Mideast conflict” resulted ultimately in the 1928 “Redline Agreement.” American companies were guaranteed a 23.75% share in the Iraq Petroleum Company (formerly known as the Turkish Oil Company) and all oil ventures in the other new nations carved from the former Ottoman Empire (most importantly, Turkey and Saudi Arabia).  Britain, with its monopoly in Iran, still controlled the lion’s share of the region’s oil, but the United States had established a significant toehold.

1950-1970—Era of Nationalization

Britain continued to dominate Middle Eastern oil production through World War II.  But following the Allied victory in war, the United States government sought to win even larger access to the region’s oil.  And toward this end, the US followed what proved a risky strategy.  As the countries of the region, like Iran, also sought to increase control over their own resources, the United States quietly promised them financial support.  The intent was to drive a wedge between Middle Eastern countries and the British—and it worked.  But perhaps it worked too well.  In 1951, Iran nationalized its oil fields, excluding the British completely, and vowing to exclude other nations—including the United States—as well.

Iran’s attempt to nationalize its oil fields forced the British and Americans back into the same camp.  The reconciled Anglo-American allies first closed international markets to Iranian oil, then they engineering the coup that restored the west-friendly Shah, Mohammed Reza Pahlavi, to the throne.  For the next quarter century, the Shah repaid his western backers by supporting their geopolitical interests in the region and maintaining a steady supply of affordable oil.

In other Middle Eastern nations, however, American and British efforts to establish pro-western governments proved less successful.  Most critically, in Iraq, western attempts to control the country’s oil backfired, leading to the nationalization of Iraq’s oil and the formation of OPEC.

For most of this period, Iraq’s oil production lagged significantly behind Iran’s.  This was due largely to a policy of slow development pursued by the foreign consortium governing the Iraq Petroleum Company.  Since many of the IPC shareholders were also invested in the Anglo-Persian Oil Company, they sought to maintain high prices by limiting Iraqi production.  As a rule, the IPC developed only five percent of the fields granted to the company under its original concession. 

During the 1950s, however, the Iraqi government grew increasingly impatient with IPC production and the small tax revenues generated.  Therefore, in 1951, when Iran attempted to nationalize its oil, Iraq took advantage of the temporary instability to wrestle control over one production facility in Kirkuk.  And the next year, Iraqi officials won even more concessions from the foreign oil companies anxious to avoid further trouble in the region—they imposed a much higher tax on foreign oil profits.   In 1960, Iraq took an even more dramatic step in calling for a meeting of all oil producing nations; this led to the formation of the Organization of Petroleum Exporting Countries.  And in 1961, Iraq completed its move toward oil self-government by expropriating all of the oil fields left undeveloped by the IPC. Over the next decade, foreign oil companies were driven completely out of Iraq and all production was turned over to the Iraq National Oil Company.

The OPEC Era

By the mid-1970s, therefore, Middle Eastern countries had for the most part seized control of their vast oil reserves.  They had also banded together in OPEC and established quotas that limited production and led to higher prices.  Just as important, OPEC learned in 1973 that it could use its collective muscle to pursue political objectives in the region.  When Israel defeated Egypt and Syria in the Yom Kippur War of 1973, OPEC punished Israel’s supporters by embargoing sales of oil, leading to shortages and price hikes in dependent nations.  It was during this period that prices in the United States immediately jumped 400%, from $3 to $12 per barrel.8

Prices might have risen still further over the rest of the decade had not Iran remained a loyal provider of oil to the West and a voice of moderation within OPEC.  But in 1979, Islamic radicals drove the West-friendly Shah from power and took revenge against the Americans they held responsible for his antidemocratic regime.  Student radicals stormed the American Embassy in Tehran and took more than 50 Americans hostage.  The revolutionary government also suspended oil sales to the United States.

For many analysts, the fall of the Shah prompted fears that even more severe oil shortages and prices would follow. They envisioned a strengthened OPEC and a more united front on production and prices. 

But these analysts proved only half right. Prices did soar between 1978 and 1981—more than doubling to $35 per barrel.  But this was caused by increased conflict, not cooperation, within OPEC’s membership.   In 1980, old tensions between Iran and Iraq exploded into a war.  During the conflict, production slowed and the resulting shortages sent prices climbing.

OPEC: Bogeyman or Paper Tiger?

Many viewed the schism within OPEC during the Iran-Iraq War as a welcome surprise—an unanticipated chink in the cartel’s armor of solidarity.  But in fact, for all of OPEC’s bogeyman status among western oil importers, the cartel has enjoyed only sporadic success in regulating production and controlling prices.  One problem for OPEC has been its inability to control is own members.  Small countries, in particular, have chafed at the restrictions set on their production—and they have frequently violated their assigned targets, flooding the markets with oil.  For example, just four years after oil climbed to $35 in the early 1980s, increased production among member nations caused oil prices to fall to just $10 per barrel.

But OPEC’s inability to control world prices goes beyond its members’ lack of discipline. Larger market factors have also converged to shape oil prices and reduce OPEC’s influence.  Most critically, since the 1970s, when OPEC was able to send prices soaring through embargoes, oil production in other parts of the world—the North Sea, Alaska, China, and Mexico—has increased. Most recently, Russia has begun to produce at the sort of levels it did prior to the collapse of the Soviet Union.  During the late 1980s, Russian production was reduced by half but by 2000, all wells were back online, making Russia the third largest producer and the second largest exporter in the world.

America’s War on Terror and the Price of Oil

As analysts consider how America’s War on Terror will impact oil prices, that Middle Eastern oil is part of a global market provides some reassurance.  Even if Arab nations were to decide to punish American consumers, their ability to target one part of the world and act without regard to broader market forces is limited.

But that does not mean that American consumers can look forward to a future of cheap energy.  Global market forces may weaken OPEC but they also impact the price Americans must pay for oil—and over the past two decades, competition within that market has increased. American consumption has grown significantly during this period; from 1980 to 1990, America consumption of oil held steady at about 17 million barrels per day, but over the next decade American consumption increased to almost 20 million barrels.  But that increase is nothing compared to growing energy consumption in other rapidly developing countries.  Economic growth in India and China, in particular, has placed enormous pressure on oil supplies.  Even when adjusted for inflation, China’s per capita GDP quadrupled between 1990 and 2005 (from $1103 to $4088) and India’s doubled (from $1202 to $2202).9 And this economic growth has been accompanied by massive increases in these countries’ consumption of oil. 


Oil has been a critical factor in the history of US-Mideast relations.  But only the most shortsighted believe the power wielded by OPEC during the 1970s captures the complexity of this history.  Over the past century, all sides have taken turns controlling the vital resource and taking advantage of the leverage that control of oil provides.   History therefore suggests that oil will continue to play a part in the geopolitics of the region.  But history also suggests that the leverage wielded by one side or the other will be temporary and that larger market forces will prevent any single player from exercising long-term control over production and prices.

People who Shmooped this also Shmooped...