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Why Today’s Oil Bust Pales In Comparison To The 80’s

Why Today’s Oil Bust Pales In Comparison To The 80’s

Your writer is both an oil junkie and a pack rat for information. Nothing major ever collected related to the history of petroleum has hit the dumpster. Rummaging through the archives resulted in the discovery of a book titled World Oil Trends 1988-1989 Edition, a joint effort between now-defunct accounting company Arthur Andersen & Co. and the still-functioning Cambridge Energy Research Associates (CERA). CERA is now a unit of IHS Inc., an international business data firm based in Colorado.

The preface reads, “The objective of this 1988-89 edition of World Oil Trends is to give decision makers in the oil industry direction and assistance in analyzing the changes that have taken place over the past year and changes that may unfold over the next few years.” The relentless quest for useful information to help managers run their business is not new.

Numerous comparisons of the present oil price collapse to that of the 1980s are made regularly. Many say this is surely the worst downturn ever in this notoriously cyclical business. It is not and the following data will prove this. There are parallels to the 1980s price collapse but also significant differences. If nothing else, the following information will prove the current market overhang of crude oil supply in excess of demand is nominal and therefore temporary. The long-term future of oil, now that it has become synonymous with the end of civilization, is another matter.

The oil price spike of the 1970s had the same impact on production as it has had in the past 10 years; new supplies of oil were found in new and previously uneconomic places and eventually flooded the market, causing a price collapse. The only difference between the price spike of the late 1970s and this century is that the increases which precipitated the first major oil collapse were much greater. The following chart from the website inflationdata.com tells the story. Related: Rising OPEC Oil Production Worsens Glut

(Click to enlarge)

The red line shows the price of oil (Illinois Crude Oil Sweet which trades slightly below WTI) in inflation-corrected 2015 dollars. The first major OPEC price spike of 1974 raised the price from about US$20 to US$40 almost overnight. The relentless upward climb caused by OPEC flexing its muscles and other events culminated in crude reaching the equivalent of US$117.18 a barrel in 1979. In 1985, Saudi Arabia told the world it would no longer be the swing producer and sustain prices, details below. The price tanked and by 1986 oil would fall to about US$25 per barrel 2015 equivalent, effectively losing 79 percent of its value in real terms. Now that is an oil price collapse — and it would get worse!

With the exception of a brief price spike in 1990 concurrent with the First Gulf War, oil stayed at or near these levels for nearly eight years. During the slump of 1998 it got as low as US$12.47 a barrel, less than 10 percent of its peak price. When oil hit its recent low in mid-January, that price was still not much lower in real terms than prices in the latter half of the 1980s.

The response of the global industry to the 1970s price spike was an unprecedented exploration and drilling boom. The following data from World Oil Trends shows where all the production that would eventually collapse prices came from.

(Click to enlarge)

Source: Arthur Andersen, CERA

Non-OPEC oil production in 1973 was 24.67 million barrels per day (mmb/d) but by 1988 it had risen to 38 mmb/d, a 54 percent gain. Nearly 14 mmb/d were put on stream outside OPEC in this 15-year period. The contribution of Canada and the U.S., source of the 5 mmb/d that precipitated the current mess, was not material. However, the countries that helped change the global supply / demand dynamic were Mexico, 2 mmb/d; Brazil, 0.4 mmb/d; Norway, (North Sea), 1.1 mmb/d; United Kingdom, (North Sea) 2.4 mmb/d; Egypt, 0.8 mmb/d; India, 0.5 mmb/d; Malaysia / Brunei, 0.4 mmb/d; China, nearly 2 mmb/d; USSR (it was still one big country in 1988), 3.6 mmb/d and other non-OPEC Africa, 0.6 mmb/d.

Meanwhile, the Middle East, source of most OPEC production, was a political powder keg. Here are the OPEC figures for the same period. Related: Oil Glut Compounded By Cracks In Global Economy

(Click to enlarge)

Source: Arthur Andersen, CERI

In 1978 Iran produced 5.2 mmb/d. Religious insurgents overthrew the Shah of Iran in 1979, which caused oil prices to spike and production to decline. Within two years, Iran’s output had fallen by more than 3.5 mmb/d or 68 percent. Sensing a weakened and intensely disliked neighbor, in 1980 Iraq invaded Iran and for the next eight years they fought a long and bloody war that would clobber the oil output of both countries. This made room for much of the new non-OPEC production and helped keep prices high for about five years.

By 1981, non-OPEC production gains of about 9 mmb/d were starting to seriously crowd out OPEC. A cartel that was producing 30.9 mmb/d in 1979 (not far from current output of 32 mmb/d) was down to 16.1 million b/d by 1985, a decline of 14 mmb/d or 47 percent.

Saudi Arabia alone lost over 6 million b/d of crude oil output, at which point it announced it would not shut in even more oil to sustain prices. The price collapsed. In late 1986, OPEC formally introduced a 16 mmb/d quota that officially pegged the price at US$18 per barrel, the equivalent of about US$39 today. Markets responded positively but that, too, would prove to be a temporary price spike.

This chart tells the story graphically.

(Click to enlarge)

To stabilize world oil prices, OPEC, as a whole, eventually withdrew some 14 mmb/d from the market. While member country cooperation was helped somewhat by the Iraq / Iran war (over 4 mmb/d lower than 1979), OPEC either accidently, strategically, or both, kept some sort of floor price under oil, which was of enormous benefit to non-OPEC producers. This was particularly beneficial to those in western countries undertaking massive capital investments with high operating costs, like the North Sea and the two mains oilsands plants in Canada, Great Canadian Oil Sands (now Suncor) and the Syncrude consortium.

Following the decision by Saudi Arabia in November 2014 not to restrain production to sustain prices — a move ratified again a year later — many have written about the apparent end of OPEC. But exiting 2014, correcting the market was only a matter of one or two mmb/d, not 14 mmb/d. This is something the Saudis may have calculated would work itself through markets in a reasonable period of time and didn’t involve that country having to shut in over half its production, as was the case in the mid-1980s. Talk about “taking one for the team.”

While commentators are correct that Saudi Arabia has indeed behaved differently in the past 15 months, this information illustrates how those commenting on OPEC then and now should take the entire market situation into consideration before reaching a conclusion.

Another factor contributing to the allegation the current slump is the worst ever is supposedly massive crude oil inventory levels. Every day, the news reports storage is brimming and when full, prices will fall further.

Source: International Energy Agency, January 19 2016

This chart shows the OECD (Organization for Economic Cooperation and Development, the 34 countries most often associated with the western or developed world) oil inventories at Q4 2015. Note the average storage levels for the period 2010 to 2015, which saw both high and low oil prices, is about 2.7 billion barrels. Oil storage exiting 2015 was about 290 million barrels above the five-year average. Related: OPEC Will Not Blink First

(Click to enlarge)

This chart from 1988 shows OECD oil inventories were higher than current levels, even when oil prices were rising, then reaching the peak in 1979. Obviously, high inventories didn’t help the price in the late 1980s but the numbers were larger than today. Presumably OECD countries have built more storage in the past 30 years. Where did they put the oil then? Where is it now?

In Canada, the downturn in the late 1980s was indeed awful. For oil, it lasted nearly 20 years. Following the price collapse in 1986, the federal government dropped the Petroleum and Gas Revenue Tax (PGRT), a wellhead levy introduced in 1980’s National Energy Program. In 1998, the Free Trade Agreement with the U.S. removed export restrictions related to natural gas reserves (the 25-year surplus test) and decontrolled export prices which were previously set by the federal government.

In 1991, Alberta reviewed its exceedingly high royalty regime from the late 1970s and finally introduced lower rates in line with prices. While the 1990s were indeed still challenging, what powered the industry was primarily a resurgence in drilling for natural gas. Right through to 2008, the vast majority of the new wells drilled were for gas. With the exception of Imperial Oil at Cold Lake, Suncor and Syncrude, most of the major investments in growing oilsands production did not begin producing or get underway until this century.

So, to compare the current situation of world oil markets to that of the 1980s is wrong. The crude oil market overhang 30 years ago was 14 million mmb/d. Today it ranges from 1 mmb/d to 2 mmb/d, depending upon which data set you are reading. While the high inventory levels of the 1980s did indeed exacerbate low oil prices for an extended period of time, that slump was caused by massive excess supply and inventories. According to this data, both situations are significantly better for oil prices today.

More analysts are concluding that due to growing oil demand, continuing decline rates in all reservoirs and massive capital spending cutbacks in new supplies, the global supply / demand curves will cross later this year. Short sellers are retreating and more traders are betting the price will go up. In an oil-dependent world, there is increasing understanding the price of oil has already been too low for too long. The resulting drop in production revenue is putting entire countries on the verge of insolvency. Cutbacks in capital spending are being felt in countries with supposedly diversified economies like Canada and the U.S. Some prognosticators believe the lack of investment in new supplies is increasingly being recognized as setting up the world for another oil price shock.

Meanwhile, there are more frequent reports Russia and some OPEC members wish to meet to discuss ways to withdraw some production from markets and stabilize prices. Compared to the 1980s when a protracted and bloody war between Iraq and Iran was required to help reduce production, cooperating to shut in 1 or 2 million b/d should be relatively easy, should the collective economic pain be approaching unbearable.

By David Yager for Oilprice.com

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  • Sean on February 11 2016 said:
    It'll stop when Saudi says it will stop... or next year sometime.
  • Lenb on February 11 2016 said:
    excellent work....continues to pt to much more then fundamemtals at work
  • Rd on February 12 2016 said:
    Prices at the pump are great! Keep it low(er)..
  • Matt on February 12 2016 said:
    Good work on your article. I've been saying the same thing. This is not 1986 all over again. In my opinion, for some reason, there has been a major propaganda campaign being waged on the psychology/perception of the oil market fundamentals. The EIA and IEA continually utilize terms like "drowning" and "awash" to describe oil stocks/supply. When the global demand is about 96 mmbopd and there is about a 2% oversupply to that demand, I don't think those terms are accurate in the least. There is definitely going to be another oil price shock due to the crash of investments in future supply and the peak price will most likely surpass the previous peak.
  • Jack on February 12 2016 said:
    I agree with Matt. Everyone seems to think that there is a spigot somewhere that the "Frackers" will just turn on and off at will when the prices reach a certain level. The truth of it is that entire industry runs off of small "Mom and Pop" service companies. They are the ones that are closing up shop and moving on, and without them there will be no rapid return to supply.
  • Craig D on February 14 2016 said:
    IMO, this decline is more structural than speculative. Three major structural changes have occurred since the 1980's.
    1. Oil is no longer considered to be a finite limited resource, doomed to perpetual decline. We now know that oil was deposited during anoxic events during the Mesozoic, which deposited great pools of it on the continental shelves. Large undiscovered pools are expected to be found on them. That is why China wants the South China Sea, there is Arctic exploration, exploration off of Brazil, and in many other areas.
    2. Fracking is freeing up cheap natural gas production, and increasing production of oil wells. Fracking production is expected to establish energy production in previously unproductive countries.
    3. The global movement to renewable energy is increasing each year. Most new electrical energy production was renewable energy last year. In a few years, all new electricity production will be renewables. Fewer and fewer power plants will be fueled by oil, natural, gas or coal.

    Each of these are putting long time downward pressure on oil prices. Taken together, they create an environment where recovery of oil prices above $40 is hard to imagine. Price will be determined by actual cost of production. Speculative premiums on oil prices will be minimal or non-existent.
  • George on February 16 2016 said:
    Yours is a rational analysis. We lived on boot leather and shoe laces for 14 years from '86 to 2000 and then got rehammered by 9/11 just about the time we thought it was safe to stick our heads out again. The bust of 98 began in Jan '97 and went to bottom two years later then back up in another year. The drop in price was not nearly so steep as this one. We figured convergence of supply and demand by October and got pretty close. We also figured then that the decline rate was so fragile and the consumption increase small as a percentage but still a big absolute number. The result of that was a prediction that the future would be one of increased frequency and amplitude of price. We did not see shale coming as it did.

    It is interesting that the rig count now is just about the same as it was at this time of year in 2010. Shale kicked off after Mocondo when there were lots of people available and lots of capital looking for a quick turn. It managed a huge growth in about 4 years. Astounding in fact. Now we need to thank KSA for helping to lift the export ban and allow our dumb bell shale oil to become the fungible commodity it needs to be and reach world markets setting up the next price war. So it will probably go. We never moderate but lurch from one extreme to another.

    While you are looking at data look at the US stock build in 1Q15. Bigger and faster than ever in history. Mass balance of EIA Production + Imports - Refinery Runs = Change in stock pretty much works before and after 1Q15 but not at all during that quarter. This mas balance accounts for 16 to 20 mmbo of the nearly 100 mmbo build in that time but where did the other 80 mmbo come from in 1Q15? My rough convergence plot with a modest 1% decline in global supply and an equally modest 1% increase results in a convergence rate of about 1.8 mmbo/year.

    Can KSA increase production that month in a year to keep the oversupply going? Can Iran contribute? I can't say for certain. IEA numbers are sketchy at best and hard to count on for much. Unlike the WWII legacy system of the US the production and consumption are old guesses. The US with its captive market becomes the proxy for world supply, demand and storage so far as traders are concerned. It is not a very good proxy.

    KSA are not only behind the curve in paying for their country they are losing the same money in investments we are. Their behavior is irrational and yes, the "glut" is a mere 1 to 2 mmbo/d. If you were to balance the temperature in your house on such a fine dead band you would be keeping the temperature within about 1/4 of a degree of a 70 degree set point. That isn't a "glut" it is too fine a control and the system will not tolerate it.

    I claim that this has been created and not just by KSA. Someone explain the material balance inconsistency of 80 mmbo in 1Q15 and why it was a one time event far out of trend and why after that event the storage trends paralleled historical trends but at an 80 mmbo to 100 mmbo higher level. I'll leave my tinfoil hat on for now.
  • Hong Fat on February 19 2016 said:
    What the Saudis should do is to shut in 3 mln b/d. Moreover they will discontinue this shut in for 2 years or when the price rises to $60/bbl. What this does is prevent US tight oil companies from responding until the price is well above $60. At 3 mln b/d, the tanks should empty very quickly and so will the price.
  • Jeremy on June 22 2016 said:
    Is there anyway to find out the formula (or who's formula) he used to figure inflation? I was showing this to somebody that said inflation was an opinionated thing. Hoping for some advice! Lol

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