1979 Energy Crisis – Causes & Lessons for Today’s Portfolios
The energy crisis of 1979 was a pivotal event in global economic history.
With repercussions that reverberated across continents, the crisis highlighted the world’s heavy reliance on fossil fuels, specifically oil, and underscored the need for diverse and sustainable energy sources.
For traders, it underscored how inflation impacts traditional investments like stocks and bonds, which created the need to find diversifiers such as commodities and tangible assets.
Key Takeaways – 1979 Energy Crisis: Causes & Lessons
- The 1979 energy crisis highlighted the world’s heavy reliance on fossil fuels, specifically oil, and emphasized the need for diverse and sustainable energy sources.
- Geopolitical events, such as the Iranian Revolution, can have significant impacts on global markets and investment portfolios.
- Diversification, being mindful of geopolitical risks, and using commodities as a hedge remain important considerations in modern portfolio management.
What Caused the 1979 Energy Crisis?
The roots of the 1979 energy crisis can be traced back to the Iranian Revolution.
The revolution, which began in 1978 and culminated in 1979, significantly disrupted Iran’s oil production.
Iran, at the time, was the second-largest exporter of oil globally, accounting for 7% of the world’s total output.
Following the revolution, Iran’s daily oil production fell from 6 million barrels in 1978 to approximately 1 million barrels by 1979.
This sudden drop in supply led to a sharp rise in oil prices globally.
From an average price of $14 per barrel in 1978, the cost of oil soared to nearly $40 per barrel by 1980, marking a staggering 186% increase. (Before the 1973 energy crisis, oil had been $3 per barrel.)
The oil price surge had far-reaching economic impacts.
Many countries, particularly those heavily dependent on oil imports, such as the United States and European nations, faced significant inflationary pressures.
In the US, for instance, the inflation rate rose from 7.6% in 1978 to 13.5% in 1980.
How Did the Energy Crisis Impact Portfolios?
The 1979 energy crisis led to more market volatility, as naturally such events are considered tail risks.
The S&P 500, a benchmark for US stocks, dropped by approximately 10% in 1980.
In contrast, the energy sector, specifically oil companies, benefited from rising oil prices.
Companies like Exxon Mobil saw their share prices increase significantly. However, this was a short-lived boost as the subsequent recession, exacerbated by high inflation, negatively impacted even the energy sector.
The crisis also precipitated a shift in investor behavior, with many reallocating assets to safer, more tangible investments.
Gold, traditionally viewed as a potential hedge against inflation, geopolitical risks, currency devaluation, and broader unknowns, surged during this period.
From 1979 to 1980, gold prices spiked from $306 per ounce to $615 per ounce, a 101% increase.
Lessons from the 1979 Energy Crisis for Today’s Portfolios
The energy crisis of 1979 holds important lessons for contemporary portfolio management.
Having a Balanced Portfolio
One lesson is the importance of diversification and not being too dependent on any one thing.
During the crisis, those investors with diversified portfolios, spanning various sectors and asset types, were better able to weather the economic storm.
Geopolitical Risks and Realizing What We Don’t Know
Another insight relates to the importance of geopolitical risk in investment decision-making.
The crisis underlined how global events, such as the Iranian Revolution, can significantly impact markets and, by extension, investment portfolios.
Role of Commodities in a Portfolio
The 1979 crisis underscored the role of commodities, such as gold and oil, in portfolio hedging strategies.
These assets can provide an effective hedge against inflation and market volatility, offering a level of protection in times of economic uncertainty.
Applying Lessons to Modern-Day Portfolio Management
Applying these lessons to modern portfolio management, most traders/investors today should ensure they have a more balanced portfolio.
This includes a mix of assets such as equities, bonds, commodities, and other stores of value.
Being mindful of the geopolitical landscape and its potential impact on markets is also important because it widens the distribution of potential outcomes.
Finally, commodities continue to play a role in hedging strategies.
While oil may not hold the same sway as in 1979, assets like gold and other precious metals, along with commodities like agricultural products and lithium and cobalt critical for certain products (e.g., battery cells), can provide an effective hedge against market volatility.
In other words, they act differently than traditional investments in certain environments.
Example
Let’s say we have two simple portfolios:
Portfolio 1
- 40% Stocks
- 60% Bonds
Portfolio 2
- 35% Stocks
- 45% Bonds
- 20% Gold
We can see the relative difference in performance below:
| Portfolio | Initial Balance | Final Balance | CAGR | Stdev | Best Year | Worst Year | Max. Drawdown | Sharpe Ratio | Sortino Ratio | Market Correlation |
|---|---|---|---|---|---|---|---|---|---|---|
| 40/60 | $10,000 | $655,491 | 8.48% | 8.16% | 31.94% | -16.96% | -19.39% | 0.50 | 0.76 | 0.80 |
| 35/45/20 | $10,000 | $826,223 | 8.96% | 8.19% | 34.62% | -13.85% | -17.69% | 0.55 | 0.86 | 0.70 |
We can see that the diversification benefited the portfolio not just from a risk/reward standpoint (higher return per unit of risk, higher Sharpe ratio, higher Sortino ratio, lower market correlation), but in terms of overall return as well.
Even though, in this case, the allocation to gold took away from core assets in the portfolio (the stocks and bonds).
If the gold or commodities had been structured as an overlay instead (e.g., through futures contracts) the benefits would accrue such that it didn’t take away from the stocks and bonds allocation.
We can also look at how each portfolio did through historical stress periods:
Historical Market Stress Periods
| Stress Period | Start | End | 40/60 | 35/45/20 |
|---|---|---|---|---|
| Oil Crisis | Oct 1973 | Mar 1974 | -5.98% | -2.41% |
| Black Monday Period | Sep 1987 | Nov 1987 | -13.23% | -9.68% |
| Asian Crisis | Jul 1997 | Jan 1998 | -2.67% | -2.35% |
| Russian Debt Default | Jul 1998 | Oct 1998 | -5.13% | -6.29% |
| Dotcom Crash | Mar 2000 | Oct 2002 | -5.55% | -6.18% |
| Subprime Crisis | Nov 2007 | Mar 2009 | -13.39% | -14.72% |
FAQs – 1979 Energy Crisis: Causes & Lessons
What was the 1979 Energy Crisis?
The 1979 Energy Crisis, also known as the “Second Oil Shock” following the one in 1973, was a major energy crisis that had global repercussions.
This crisis was triggered by a combination of factors including the Iranian Revolution and decreased oil output in the wake of the revolution.
The revolution disrupted Iran’s oil production and prompted volatility in the global oil markets, leading to significant increases in the price of oil and fuel shortages in many countries.
What were the main causes of the 1979 Energy Crisis?
The main cause of the 1979 energy crisis was the Iranian Revolution, which led to a severe drop in Iran’s oil production.
This reduction, coupled with increasing demand in industrialized countries and market anxiety, caused global oil prices to nearly double.
Furthermore, the subsequent Iran-Iraq War exacerbated the crisis, further disrupting oil production and distribution in the region.
What were the effects of the 1979 Energy Crisis on the global economy?
The effects of the 1979 energy crisis were widespread and profound.
The sudden increase in oil prices led to inflation, unemployment, and economic stagnation in many countries.
Industrial sectors heavily reliant on oil, such as manufacturing and transportation, were particularly affected.
The crisis also caused a shift in the global economy, as countries started to focus more on energy efficiency and alternative energy sources.
How did the 1979 Energy Crisis impact financial markets?
The crisis had a significant impact on financial markets. Commodity prices, especially oil, saw a sharp increase, leading to inflation.
On the flip side, industries heavily dependent on oil suffered losses due to higher operational costs.
Furthermore, the crisis increased market volatility and led to a significant decrease in the stock markets.
What lessons were learned from the 1979 Energy Crisis?
The crisis underlined the economic vulnerability of industrialized nations to disruptions in oil supply and emphasized the need for diversification of energy sources.
It prompted many countries to invest in renewable energy technologies and energy-saving measures.
The crisis also highlighted the interconnectedness of global markets and the potential for geopolitical events to significantly affect those markets.
What implications does the 1979 Energy Crisis have for today’s investment portfolios?
Today’s investors can learn from the 1979 energy crisis.
First, the crisis underlines the importance of portfolio diversification, not only across asset classes but also geographically and sector-wise, to mitigate risks associated with any one area.
Second, it highlights the potential for geopolitical events to impact financial markets significantly.
Lastly, the push toward renewable energy and energy efficiency after the crisis indicates sectors that could see growth in the future.
How can we apply lessons from the 1979 Energy Crisis to modern sustainable investing?
The energy crisis highlighted the need for a transition from non-renewable to renewable energy sources.
Today, many investors focus on sustainable and ESG (Environmental, Social, and Governance) investing, which prioritizes companies that adhere to sustainable practices.
The crisis underscores the potential risks associated with heavy dependence on certain limited types of energy sources and thus reinforces the case for investing in renewable energy and other sustainable technologies.
How should investors prepare for potential future energy crises?
Investors can prepare for potential future energy crises by ensuring their portfolios are diversified across different asset classes, sectors, and regions.
They should also pay attention to geopolitical risks and understand how these can impact their investments.
Investing in renewable energy and other sustainable technologies can be a good strategy to mitigate risks associated with non-renewable energy sources.
Additionally, staying informed about the global energy landscape can help investors anticipate and respond to potential disruptions.
Conclusion
The 1979 energy crisis was a key moment in economic history, significantly impacting portfolios and shaping new investment approaches.
The lessons learned from the crisis – the importance of portfolio diversification, understanding geopolitical risks, and the role of commodities in hedging – are still highly relevant today.