from Energy, Security, and Climate and Energy Security and Climate Change Program

Lessons from Energy History

October 15, 2012

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Fossil Fuels

Financial Markets

Today the State Department released  the thirty-seventh volume of its history of U.S. foreign relations. It’s one that many readers of this blog will find fascinating. “Energy Crisis: 1974-1980” runs 1,004 pages, consisting mostly of previously classified meeting records and memos that give a window into a tumultuous time in U.S. energy history, and one in which many of the roots of our ongoing energy debates were first established.

I obviously haven’t had time to read all the way through, but upon skimming, one thing in particular struck me. (If you want the juicy quotes, check out my colleague Micah Zenko’s post.) When we think about the relationship between oil markets and international relations today, one of the most important features we often focus on is the existence of a robust spot market, in which buyers and sellers can come together to discover the “right” price for oil. Spot markets make the geographic origin of any country’s oil far less important than it otherwise would be: If a regular oil source cuts off supplies, the consumer can turn to the spot market for relief. Spot markets therefore help depoliticize the global oil market and provide critical resilience for consumers.

In the new State Department history, the words “spot market” only appear once prior to late 1978, but at that point, they start coming up a lot. Unlike today, though, the spot market isn’t seen as a savior – instead, it’s a menace. “Spot market is a small residual market that is not representative of appropriate or market clearing prices,” warns one State Department cable. In May 1979, the Treasury Secretary floats the possibility of an “agreement by the oil-importing counties to boycott the spot market”.  That June, the Secretary of State writes that “we will seek to diminish substantially the role of the spot market – and thus bring more order into the world’s oil pricing and marketing system”. Throughout the discussion a consistent theme emerges: spot markets are too vulnerable to speculators, and must thus be suppressed.

There are at least two lessons worth taking away from the sharply different view of a critical element of today’s global energy system. The first concerns financial speculators. It’s tough to read the 1970s rhetoric about spot markets without hearing echos of how people talk about oil-related financial markets today, right down to the worries about speculation, lack of transparency, and price distortions, and the potential benefits of reining dangerous markets in. When it came to physical markets, though, the best cure for small and volatile spot markets turned out to be bigger and more liquid ones (along with greater transparency). The same may be true for commodities-related financial markets today: the right cure for whatever problems they currently pose may be a mix of greater scope (rather than new restrictions) along with more transparency.

The second lesson is that the current market-based system of assuring energy security was never inevitable or somehow the natural order of things. Instead, it’s a political construct, and one that didn’t come into being easily. It would be unwise to assume without question that it will be around forever.