"Oil Glut, Price Collapse Spread Across World's Economies: Ripple Effect at U.S. Firms Unmistakable"
-- Los Angeles Times headline
Many headlines have been written over the years that point to the near-term devastating ramifications of an oil-price collapse. Oil prices are plunging, and the destruction will spread like wildfire across the economy. Those headlines instill a healthy dose of fear because unknowns on the horizon can be, well, actually frightening.
However, that L.A. Times headline actually comes from March 2, 1986. It was simply the first one I found in a quick Internet search looking for a headline surrounding the oil-price crash of the 1980s. All of the fears of that time are a distant memory. However, it's in reliving those memories that reminds us of how to read the energy news of today.
A trip down memory lane
The reason I focused my search for a headline from that year is that so many energy executives and analysts believe the current market turmoil reminds them a lot of 1986. BP (NYSE:BP) CEO Bob Dudley, for example, recently said: "It's a really tough time for the industry. It does feel like 1986." And, while that scares a lot of investors, since the late 1980s were a really tough time for the oil industry, even if this downturn is a repeat of 1986, it's not exactly the end of the world.
For example, in the months preceding the L.A. Times article that accompanied that headline, the price of crude had plunged 30%. Crude would go on to plunge another 15% in the weeks following the article, but it would end the year up nearly 50%. In the decades since, oil is substantially higher:
That's even after the recent 50%-plus price crash. Meanwhile, many oil stocks, which were just pummeled in the 1980s -- as they're being pummeled today -- have done a lot better than oil since that article was published. Several well-known oil stocks have nicely outperformed the total return of the market since the 1986 crash:
So even though the energy news headlines that year were fearful because prices were plunging, it was actually a pretty good time to buy oil stocks.
It really doesn't matter if history repeats itself
Don't get me wrong. The 1980s were horrendous for the oil industry, and the devastating ripples within the economy were real. Thousands lost their jobs, bankruptcy courts -- especially in Texas -- were swamped, and housing prices in oil-boom towns plunged. However, the industry eventually rebalanced and recovered, as it has in every other oil-price plunge over the past 150 years. It will rebalance this time, too, because of two very important factors: the decline rate and demand growth.
This chart from a Chevron (NYSE:CVX) investor presentation sums things up.
Production from currently producing fields is expected to slowly decline over the next decade, because worldwide production declines by roughly 4% per year as pressure is released inside the reservoir. To put what this means into perspective, if oil companies around the globe refused to drill another new well, production would drop by 4%, turning the current 1%-2% oversupply into a 2%-3% deficit within a year. In other words, the current oversupply of oil could very quickly become an undersupply, leading to a price spike. Meanwhile, demand for oil is growing each year by roughly 1%, with demand growth this year accelerating as the low oil price is spurring incremental demand.
Just to meet future demand, oil companies will need to invest upwards of $10 trillion to overcome the base decline and meet the projected demand growth by 2030, despite an expected the rise of renewables and energy efficiency. Fueling future demand is an projected massive rise in diesel consumption that's expected to be driven by emerging economies around the world, as we see in the following slide from an ExxonMobil (NYSE:XOM) presentation.
It's in this light -- of the long-term supply-and-demand story -- that energy news must be consumed. Absolutely, times are tough right now, and they could get tougher. Some oil companies could, and probably will, go bankrupt. However, the strong will survive and will more than likely outperform over the very long term.