By: Dr. M. Ray Perryman
Published in syndication April 22, 2020
Oil markets are in turmoil. In January, oil prices were trending in the upper $50s per barrel. Now, spot prices are a fraction of that level and futures prices actually went decidedly negative for the first time in history for certain contracts as they neared maturity. Traders scrambled to avoid taking delivery of oil they didn't want or have any place to store.
Prices have declined due to the combination of (1) plummeting demand as economies and industries around the world shut down due to COVID-19 and (2) rising supply with threats of even more due to the collapse of talks earlier this year among major oil producers to try to bring discipline to the market. As I've discussed previously, the recent agreement by OPEC++ (which includes market-based adjustments in the United States) is not sufficient to rebalance markets, though it's an important step.
In the midst of the market turmoil, unfavorable comparisons to the 1980s oil bust are inevitably being drawn. I want to emphasize that the current situation is completely different. In the 1980s, prices fell to around $8.00 per barrel and didn't recover for a long time because of massive structural problems in the market, Cold War geopolitics, and a weak economy (from the savings and loan and real estate collapse) which exacerbated a growing oversupply situation (I wrote a book about it). Even further back, prices fell to a dime per barrel in the East Texas oil field in the 1930s and didn't rebound for a while due to the Great Depression and the Dust Bowl.
By contrast, the current situation is caused by a health crisis that rapidly shuttered much of the world economy. There were no major structural problems prior to COVID-19; in fact, we were in the midst of the longest expansion in history. Once the economy can reopen, a substantial portion of global consumption should resume quickly. In fact, with the recent OPEC++ agreement and the related effects of bringing fewer wells online in the US and elsewhere, only about half of the lost demand must be restored to facilitate a more orderly market.
Recovery of oil prices is particularly critical to Texas. When exploration, drilling, production, oilfield services, pipelines, storage, refining, shipping, and other aspects of the energy sector are considered, oil from the Permian Basin alone supports about 10% of the Texas economy, with the industry statewide comprising about 13-14%. As the economy begins to recover from COVID-19 restrictions and travel prohibitions, oil markets can normalize expeditiously. Prices should recover to sustainable levels for West Texas producers (where costs were falling notably for years before the pandemic) in the next few months, which will be good news indeed. Be safe!!