NSI Chairman’s Corner January 2020
It’s 4 am and I am thinking about….
The Arab/OPEC oil embargo was in effect when I got my driver’s license. Memories of waiting in line for gas. People selling their really nice gas guzzlers for a couple dimes on the dollar because 50 cent per gallon gasoline freaked them out. Another memory. My Grandmother passing and her, seriously, only driven to church on Sunday, 3 year old, decked out Chrysler New Yorker being sold for less than half of what it would have brought without the increased cost of gasoline. My saying: don't sell it, this is nuts! But who listens to their 16-year-old whose real motive was pretty obvious: wanting a lux car to cruise around in? (Flash forward to 2008 when gasoline had again run up. Remembering the Chrysler. As a company run-around vehicle, I bought a Tahoe SUV, leathered up, low mileage, for a paltry $12k because the owner was freaked out over $4 gasoline. Sold it 8 years and many miles later when gas had dropped 50% for $9k.)
Jump back to the mid 1970’s. Toyota, Datsun (now Nissan) and the VW Bug becoming household names and common on the road. And then the Japanese cars were really crappy! Poor design. Poor quality. Their only redeeming feature was better gas mileage than the Detroit beasts. But how quickly they got their act together and for decades became the quality metric by which other manufacturers are compared is a great bit of business history.
Living in Michigan (at that point Detroit, MI being the global hub of the auto industry) I had a front row seat to watching the embargo, coupled with other macro-economic problems, decimate the U.S. auto industry, the lives of millions, and create what has become known for decades as the Rust Belt.
Perhaps for me, seeing the impact of oil on the economy elevated the industry into my consciousness, so that coming out of grad school with zero experience (Good grief. I grew up about as far from any meaningful oil production as was possible in the continental USA, and in grad school I was working on high level nuke waste disposal!) I joined the oil and gas industry. Which for me was a great and lucky decision!
Again…. back to 1973. Some facts to absorb.
Pre-embargo, Middle East crude was about $3/bbl. The “Seven Sisters”, several of which we now call super majors, had control over world supply and pricing. Nixon took the USA off the gold standard late 1971, which allowed the dollar to float, and it promptly sank like a brick. Oil, being dollar denominated suddenly became effectively priced lower for international producers because the dollars these producers received in 1973 were not worth as much to them as before. From mid 1971 to mid 1973, the dollar fell about 25% relative to other currencies.
In late 1973 OPEC announced a 17% price increase to $3.67/bbl. This flew in the face of history where the majors dictated pricing, not OPEC. Then OPEC cut production and embargoed certain countries, mainly the USA. With the embargo, OPEC further wrested price control away from the major oil companies and in less than a year nearly quadrupled the price to $12/bbl. Which, coincidentally, adjusting for inflation is equal to about our current price of oil in today’s dollars.
Another big reason for the embargo was the US’s support of Israel for the Yom Kippur war. France and Great Britain, which did not provide Israel with support, were not subject to the embargo. Holland was. Who knew?
At the same time, there were other USA policy decisions (are you old enough to remember widespread wage price controls of the early 1970’s?? Here’s some further reading: https://www.cato.org/publications/commentary/remembering-nixons-wage-price-controls) that along with the oil price “shock” caused stagflation and other economic problems. The US stock market collapse of 1973/74 started 10 months before the embargo, and the DJIA fell 45% from January 1973 to December 1974. In the UK it was even worse. The FTSE losing over 70% in the same period.
What’s the point of the above data? 1973 really, really sucked if you were trying to make a living for yourself and your family in America. The embargo, and more so the newfound pricing power of OPEC, extended the pain into 1974 and beyond.
The cost of energy plays a huge role in any economy, and the quadrupling of OPEC pricing wreaked havoc on the world economy.
Now think about the economic collapse of 2008/2009, the cause of which was not related to energy and was manifest as the housing collapse. It took 6 years for USA GDP and employment numbers just to get back to 2008, pre-crash levels. Overlaying simple population growth effects, it took more like a decade to get back on track with pre-crash levels. During the first 6-year period WTI fell from $120-150/bbl to $90-100/bbl.
What would the US economic landscape have looked like, if contemporaneously we had not had the enormous benefit of the technologies that coalesced to radically improve horizontal drilling and hydraulic fracturing (I give most of the credit to the drillers!) to make the “shale revolution” possible? What would the recovery have looked like? The oil supply countries would have increased their ability to impact the US economy as our domestic production continued to decline. Would these countries have behaved nicely and given us a break during the crises by lowering the cost of energy to help us get our economic house back in order, or would there be actions taken with oil pricing to punish the USA for whatever geopolitical or theocratic reasons?
Being a bit older and maybe just a tiny bit cynical, I lean toward the latter scenario. We would have had very few “friends” amongst the major oil producing nations. Not nearly enough to offset those who would look favorably on screwing up our economy to their gain.
I am confident the recovery the US economy has experienced over the past decade is in large measure due to energy costs that, with shale, are much, much lower than they would have been otherwise. There is no way natural gas would be at $2 and change without horizontal drilling and high intensity fracturing. There is no way the US economy would have an industrial energy cost advantage over the rest of the developed nations that has resulted in our economy performing much better than average, and our balance of trade being stable over the past decade. And for the environment, there is no way we would have displaced a bunch of coal for natural gas, resulting in big emissions improvements, without cheap and plentiful natural gas from horizontal completions.
There is no way the Saudis would have collapsed the price of oil on November 24, 2014 without US shale production eating into “their” market. What they got wrong was not understanding the economics of US shale basins, particularly Permian shale; with continuous improvement from the service industry, the development costs of which are just so much lower cost than they anticipated and thus have kept the global price of crude down while USA production continues to grow. Nor would the price of oil today be in the $60 range without shale oil. I would cuff that it would more likely be in the $150-200/bbl range today if shale oil were not on the market.
However, it is very tough to come up with hypothetical oil pricing because at these higher levels there would be all sorts of variables coming into play: further gains in energy efficiency, conservation and substitution would all lower demand. Investments would be made in other oil producing technologies/areas (remember sub-salt offshore Brazil?) that would increase supply. However, big changes in potential supply and demand cannot happen as quickly as an OPEC price decision…. or another embargo. There would be, as is always the case with commodities, unforeseeable stair-step price changes that would cause macro-economic disruptions.
And remember Russia as an oil and gas supplier? They are right up there with Saudi Arabia as the largest non-shale oil producer. How helpful would Russia have been in supporting the American economy if we didn’t have shale oil? I’m going for the obvious: Not. Very. Likely.
How might this have all played out geopolitically? That’s another thought experiment I have been rolling around for a while and will share another time. But a preview. There is a case to be made that the combined technologies of horizontal drilling and fracturing have saved tens, likely hundreds of thousands of lives.
Something the anti-frackers will refuse to understand.
Be safe. Be well. Do good.
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