Back To The Future -- September 17, 2015

I remember the North Dakota oil bust in the early 1980s but was not aware just how bad things were back then.

The graph below shows the amount of oil the US imported from Saudi Arabia back in the 1980s. When one looks at those numbers, one can see clearly why Saudi Arabia said they were going to protect their market share this time around:

Right or wrong, this is a 30-second soundbite from DailyReckoning explaining the oil glut in the 1980s:

There were a lot of reasons for that oil price crash of the 1980s. Among them were that the high oil prices of the late 1970s, caused by the loss of oil output from Iran after the fall of the Shah and the Iranian Revolution, led to a worldwide recession.

The recession reduced demand for oil and allowed prices to fall. Also, a number of then new oil provinces of the world were coming on line, and oil output grew rapidly from nontraditional locales such as Alaska, the North Sea and Mexico. And one critical reason for the fall in the price of oil was purely geopolitical, in that the Saudis maximized oil production to drive the price down and hurt the economic interests of the Soviet Union, which had invaded Afghanistan in 1979. By reducing the price of oil, the Saudis indirectly deprived the Soviets of a key source of hard currency, from the sale of Soviet oil for U.S. dollars. As the Mogambo Guru likes to say, “Everything is connected to everything else.”

But as I mentioned above, the falling price of oil severely harmed the world oil patch.

Only the “best” prospects were drilled, and the low-cost oil was extracted and sold at relatively low prices (in retrospect, the prices were ridiculously low). The more high-priced oil was uneconomic to extract, and hundreds of thousands of oil wells across the world, particularly in the United States and Canada, were plugged and abandoned.

Perhaps it made economic sense to plug the marginal wells when oil was selling for $10 or $15 per barrel. But today, when oil is selling for $60 or more per barrel, don’t we wish that we still had many of these old wells, even producing just a few barrels per day? And many elements of the vendor base went out of business as well. From drilling companies to equipment makers to service providers, there was a severe contraction within the oil and gas industry. But with oil appearing “cheap” based on its nominal price, no one was calculating the long-term price to be paid. 

Earlier this year, The Wall Street Journal also spoke of the past:

A surge of oil from outside of the Middle East flooded global energy markets. The world-wide thirst for crude didn’t keep up. The Organization of the Petroleum Exporting Countries stood by and watched as oil prices fell and then fell more.

Welcome to the world of oil in 2015—a repeat in surprising ways of the story 30 years ago. Between November 1985 and March 1986, the price of crude plunged by 67%. Between June 2014 and today, crude prices have fallen by 57% and could well head lower.