In 1997 I was working for
Just as things were getting interesting, however, the oil-service stocks started to slide. I called the analysts and nobody had a good explanation why. Oil demand was still growing, driven by Asian economies that were expanding at a 7% annual rate. The Organization of the Petroleum Exporting Countries still seemed to have a stranglehold on oil prices, as U.S. crude production, which peaked at around 10 million barrels a day, was down to below 6.5 million barrels a day and falling steadily.
Yet here was
Only later did the entire world realize that Mr. Market, by taking down the oil-service stocks in late 1997, was predicting the Asian financial crisis that would emerge full-blown in 1998. According to this informative bit of Congressional testimony from 1999 by John Lichtbau, then chairman of the Petroleum Industry Research Foundation, Asia/Pacific demand including Japan accounted for 80% of global demand growth from 1990 to 1997, and still expanded by 750,000 barrels a day in 1997. But inventories were building up by the end of the year, perhaps one of the telltale signs investors collectively saw when they started bidding down oil-service stocks.
The single most important reason was, and still is, the Asia/Pacific economic recession, which started in the second half of 1997 but was not recognized by international financial institutions until several months into 1998.
By 1998 Asia’s demand had shrunk by 350,000 barrels a day amid a growing financial crisis that should sound familiar to anybody today. Economies stumbled as companies that borrowed in dollars found it impossible to repay with earnings denominated in falling local currencies. The relative price of oil, denominated then as now in dollars, skyrocketed. The global price of oil which had risen smartly to a nominal $25 a barrel in early 1997 (the equivalent of $36.78 today), plunged below $10 a barrel and as low as $6.31 for heavy Mayan crude.
Also like today, Saudi Arabia was dealing with significant new supplies of oil it couldn’t control through OPEC. That left the raw power of discipline through lower prices, which Saudi Oil Minister Ali Naimi recalled in this fascinating Dec. 21 interview required him to deliver a blunt threat to Venezuela’s state-owned PDVSA in 1997 of what would happen if it continued to exceed its production quota:
The head of PDVSA was convinced he could produce as much as he liked, and he boosted production from just over 2mn b/d to 3.7mn b/d, while their minister kept telling us that they were sticking to their quota. In Jakarta, I told him he had two choices: either to reduce output, or that we in OPEC would split the surplus. He said he would reduce output, but I expressed my disbelief. Then, we split the surplus. The Asian recession occurred, production was high, and the price fell. This is true.
There were also huge new oil supplies coming on stream in the U.S., as companies led by Royal Dutch Shell made billion-barrel discoveries in the deepwater Gulf of Mexico that promised a second Prudhoe Bay. As I recall it, Shell had to mothball some of those projects in 1998 after the price plunged below the $13-per-barrel minimum its planners had factored in for the projects costing more than $200 million apiece. But that must have been temporary indeed; scrolling through the headlines now, I see that Shell, Exxon and other drillers pressed ahead with their deepwater projects in 1998 and 1999 despite low oil prices, and Houston-area employment continued the steady upward climb that hasn’t stopped yet.
What did low oil prices bring the last time around, then? Mostly needed discipline to the oil business, which tends to spend too much and expand too rapidly when prices are high. Cost-cutting drove consolidation, as BP bought Amoco, Exxon bought Mobil, and Chevron bought Texaco.
That discipline also drove oil executives to invest heavily in new technology, including the combination of horizontal drilling and fracking, both well-understood techniques, into a single process for extracting oil and gas from previously impenetrable shale deposits. Which helped set off this latest round of falling oil prices, and will no doubt give rise to another round of consolidation and technological advancement.
Global economic jitters are no doubt the primary cause for falling oil prices, exacerbated by Saudi determination not to cede market share. As Naimi said recently, it makes no sense for the Saudis to cut prices when their oil costs $4 or $5 a barrel to produce. Let the less efficient producers take the hit. All of which means that once again Houston and the U.S. oil industry are getting a lesson in how superior technology is the only way they can stay ahead in a world where the Saudis can drive the price of oil to $10.
And how did the oil-service stocks hold up this time? The Oil & Gas Services SPDR peaked at $49 in July, when oil prices were still close to $100 a barrel, and has since plunged almost 50%.
