Oil Price Amnesia

Since the decline in oil prices began late last year, there has not been a day on which the media has not devoted considerable time to oil prices and the implications of the current state of affairs.  A lot of the commentary has been borderline apocalyptic because share prices of oil companies have declined, capital spending has decreased, and employment in oil companies and service companies have been reduced.

Too many commentators have been overreacting and ignoring the fact that this is not the first time that oil prices have collapsed.  Indeed the history of the oil industry has been boom and bust because oil prices are cyclical.  They neither go up forever or down forever, although this reality is often ignored.

In the 1970s when oil prices went from $2.80 a barrel to $13.00 as a result of the first oil embargo, the economy took a hard hit, made worse by wrong headed policies and there was  hand-wringing that OPEC was going to buy America and wreck the world economy.  That didn’t happened and when President Reagan ended price controls, the price of oil dropped from $34 a barrel to $14, with the same type of effects being observed today.  In the late 1990s, oil prices again collapsed to about $10 a barrel and many in the oil industry believed that low prices would continue as “far as the eye could see”.  They didn’t.

With conflict in the Middle East and strong economic growth around the globe, oil prices rose,spiking at about $150 a barrel and firms like Goldman Sachs predicted prices of $200 or more that would cause economic collapse and a new day for alternatives.  At that time there was a strong belief in “Peak Oil”

In 2008, there was an economic collapse but not mainly due to the price of oil and alternatives grew rapidly but mainly because of large subsidies not the end of the oil age.

While oil companies are taking an economic hit as a result of the recent decline, consumers and other users of oil products are benefiting from a large wealth transfer.  Since low cost energy is an economic stimulus, the economy here and abroad will benefit.  And, it is likely that as in the past there will be consolidation in the petroleum industry to correct for over investment caused by taking on too much debt.  Smaller producers who took on debt in the belief that high prices would continue will be severely penalized while those who made decisions based on oil price realities will find new and attractive investment opportunities.

The lesson from what has taken place since the shift to oil a century ago is that George Santayana was right, “those who do not learn from history will be condemned to relive it.”  And, some are reliving it to their chagrin. Another lesson in this age of social media and 24/7 news and market coverage, programs need to fill time and that leads to endless and often shallow speculation about what all of this means, where the bottom is, and how high prices will go when they head back up.  The answers are not complex and making them complex doesn’t inform.

Prices go up and prices go down.  Basic economics teaches that when prices are up, consumers use less and look for alternatives.  They respond faster than producers and that leads to an excess of supply that causes prices to decline.  That leads to a shift in preferences that increases demand and prices again rise.

Simple realities may not be exciting but they also are not misleading and confusing.

Houston may now be overbuilt but it also was in the early 80s also.  The stock market appears to be very volatile but it is just back to normal.  Consumer’s are moving back to larger vehicles and driving more because gasoline prices are low but they will not stay low.  As the global economy recovers, oil prices will start to increase once more and while analysts and commentators will speculate how high they will go, no one knows with a high degree of certainty because there are too many unknowns especially those involving technology.  The only certainty is to count on another price cycle.

 

This article appeared on the FuelFix website at http://fuelfix.com/blog/2015/02/15/oil-price-amnesia/

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