Oil price decline could lead to global shocks: Don Pittis
How low can oil go? Historically the industry has seen boom and bust
It is easy to forget that oil has always been a boom and bust business.
As we watched oil prices tumble over the last four months, from over $100 US to $90 to $80, I was repeatedly surprised by glib comments from people in the oil industry who said the decline would not have a significant effect on business.
Perhaps it's the optimism inherent in the rootin' tootin' resource sector. Maybe it's just that in the oil business, memories are short.
Because if you think falling oil prices are not going to have a big effect on industry or on the rest of us, well, that's not what history tell us. And I'm not talking about ancient history, although that may apply too. I'm talking about my own lifetime.
- Oil price falls below $70 US as OPEC leaves output unchanged
- Oil price falls to $74 US before OPEC meeting
I remember the first time around in university, investing my tuition in Norcen Energy and making a killing before dunning notices from Lakehead U. forced me to sell.
I remember a few years later, around 1980, working with Panarctic Oils during a frenzy of drilling in the high Arctic islands. After all, the world was hungry for gas to pump down the soon-to-be-constructed Mackenzie Valley Pipeline.
A friend from the North who had gone to Calgary to work for an oil company bought the largest house he could afford. That was the advice everyone was giving. With the oil boom on, house prices could only rise.
Rude surprise
But suddenly, in the mid-'80s it seemed the world had changed in an instant. In a matter of months oil prices had started to plunge and the plunge became a rout.
Calgary house prices began to fall. Even successful oil and gas strikes were capped. Norcen Energy disappeared. So did Panarctic Oils, its huge base on Melville Island's Rae Point mothballed. Talk of a gas pipeline faded.
I have no evidence to prove that the same thing is happening now, but before you reject the idea altogether it might be wise to look at a historic graph of oil prices.
The bizarre thing that shocked everyone in the 1980s was how suddenly the market turned. In retrospect it feels as if people in the industry should have known. Surely if they had they would have done things differently. My friend in Calgary would have bought a more modest house.
Happening again?
This time around, just before yesterday's decision by OPEC not to cut output, everyone seemed to think that the OPEC decision had already been priced into the market. After all, oil prices had already tumbled from over $105 US four months earlier to $75 US.
Not so. Minutes after the organization's secretary general Abdalla El-Badri said, "We're going to produce 30 [million barrels a day] for the first half of the year," leaving production unchanged, oil prices started falling again.
West Texas Intermediate, the North American benchmark price, tumbled another four dollars into the $69 US range.
Of course, what everyone is wondering now is how much further it has to fall.
News stories now imply that the decline was obvious. Growing production and falling demand mean there is a glut. But the surprising thing is not how much has changed since June when oil was selling at $105 US a barrel, but how little.
It reminds me of the more recent example of natural gas in 2006 when investors in hedge fund Amaranth lost their shirts as the price of gas plummeted in a matter of months.
With access to so much information in the form of big data, it is hard to say why we are constantly surprised by sudden extreme price changes — in that case from more than $10 per thousand cubic feet to less than $3 — and why we don't do something to mitigate the extremes.
On the other hand, it was amusing to see commentators in the notoriously free-market oil industry regretting the failure of OPEC to manipulate prices. "OPEC just declared war on everyone — including itself," said the pro free market Wall Street Journal.
As I have pointed out many times in the past, the free market can be a harsh mistress.
And it is not just oil investors who will feel the pinch if prices continue to decline. Already there have been reports of banks and bonds hurting because of the fall in oil prices.
Governments from Venezuela to Alberta are losing tax revenue and could well lose more. Lower oil prices will make it harder for green energy projects to compete. Greenhouse gases could rise as people burn fuel more freely. Calgary house prices could fall.
Now that oil prices have started falling, it is impossible to know where they will stop. Certainly in the past they have fallen far below where they are now. On the other hand, if we are using history as our guide, no matter how far they fall, one day oil prices will rise again.
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