Once infrequent, financial crises that require dramatic rescues are quickly becoming the norm. Each of the last four U.S. administrations has grappled with an economic crisis serious enough to warrant government intervention. The current banking crisis comes just three years after the Covid-19 pandemic triggered global supply chain disruptions, which itself came a little more than a decade after the 2008 financial crisis. Unfortunately, energy is one of the sectors that have historically been hammered the most whenever the economy ails. Economic downturns including recessions tend to have a pronounced negative impact on the oil and gas sector, leading to steep decline in oil and gas prices as well as contraction in credit. Falling oil and gas prices means lower revenues for oil and gas companies and tight credit conditions that result in many explorers and producers paying higher interest rates when raising capital, thus crimping earnings even more.
Whereas quick action by the U.S. government appears to have stabilized the banking sector, some experts are warning that we are not out of the woods yet.
Former PIMCO chief Mohamed El-Erian has criticized the Federal Reserve's delayed action to control inflation, and says the central bank's "least bad" option is to immediately pause its interest rate increases,"The degree of economic contagion that resulted from this mishandled interest rate cycle is going to be significant because there are two different drivers here. One is banks themselves getting more conservative and two is banks expecting regulation to get tighter. The regulators and the supervisors have been embarrassed and the response has always been tighter in regulation even though this is a failure of supervision more than a failure of regulation," El-Erian has told CNBC.
Let’s examine how energy markets have reacted to past economic and financial crises.
The Great Depression of 1930
The opening of giant oil fields in the United States in the years heading into the Great Depression of 1930 led to an enormous glut and sent prices crashing to just 13 cents per barrel (~$5.40 today adjusted for inflation).
In October 1929, U.S. commercial crude stocks hit a staggering 545 million barrels, thanks to the discovery of several massive oil fields in Oklahoma, Texas, the rest of the Southwest and California. Back then, that was the equivalent of 214 days of production; for some perspective, U.S. crude oil stocks were 845.27M for the week ending March 24, equivalent to ~42 days of production.
The first gusher came online in 1926 in Oklahoma’s Seminole field, yielding 136 million barrels annually, or 10% of the entire U.S. oil output. A deluge of new discoveries in Oklahoma City, Yates field (West Texas), Van (East Texas), Signal Hill in California, and the super-giant Long Beach Oilfield within Greater Los Angeles quickly put an end to the peak oil fears prevalent in the early 1920s.
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By the summer of 1931, East Texas field alone was pumping 900,000 barrels per day from approximately 1200 wells, up from virtually zero just a few months prior. Unfortunately, too much oil flooded the markets and, compounded with low demand during the depression, triggered a dramatic oil price crash, with prices plunging from $1.88 per barrel in 1926 to $1.19 in 1930 and eventually 13 cents a barrel in the throes of the depression in July 1931.
Oil Shock of 1973/74
The oil shock of 1973/74 is regarded as one of the most important oil crises after an oil embargo by Arab producers against the U.S. deepened the financial crisis of the early 1970s. In this case, it was high oil prices that actually triggered a severe economic crisis.
On October 19, 1973, the Organization of Arab Petroleum Exporting Countries (OAPEC) slapped an oil embargo on the United States in response to President Nixon’s request to Congress to make available $2.2 billion in emergency aid to Israel for the Yom Kippur War. Consequently, OAPEC nations stopped all oil exports to the U.S., and started production cuts that lowered global oil supply. These cuts nearly led to a supply crunch and quadrupled the price of oil to $11.65 a barrel in January 1974 from $2.90 a barrel before the embargo. The embargo was eventually lifted in March 1974 amid disagreements within OAPEC members regarding how long it was to last.
As the then Fed chair Arthur Burns observed, the embargo and manipulation of oil prices had come at most inopportune time for the United States. By the middle of 1973, prices of industrial commodities were already rising at more than 10% p.a. Industrial plants were operating at virtually full capacity leading to deep shortages of industrial materials. Meanwhile, the U.S. oil industry lacked excess production capacity, leading to wide oil deficits and fuel shortages everywhere.
To make matters worse, OPEC was gaining significant market share while non-OPEC sources were in deep decline. This allowed OPEC to wield much more power and influence over the price setting mechanism in global oil markets. Following the devaluation of the dollar, OPEC nations resorted to pricing their oil in terms of gold and not USD, leading to a wild gold rally from $35 an ounce to $455 an ounce by the end of the 1970s.
Ultimately, the oil crisis of 1973 and the accompanying inflation triggered a U-shaped recession characterized by a prolonged period of weak growth and economic contraction.
The Oil Price Crisis of 1998–9
The oil price crisis of 1998/99 was the opposite extreme of what Americans who had lived through the oil price surges during the 1970s were accustomed to, with the Asian financial crisis triggering a dramatic decline in prices.
The collapse of the Thai baht in the summer of 1997 marked the beginning of the oil price crash and led to the stock markets crashing 60%. Consequently, oil demand in Asia, a pillar of global demand, pulled back sharply with demand in other parts of the world also slumping. To exacerbate matters, OPEC production continued unhindered at a time when Iraqi oil had returned to global markets for the first time since the Gulf War. Indeed, Iraq nearly quadrupled production from just shy of 600k barrels per day in 1996 to 2.3 mb/d in 1998.
Just as oil prices started to sink In November 1997, OPEC ministers agreed to raise their production quota by 2 million barrels per day on the erroneous assumption that global demand would continue to accelerate at the same clip it had in the few years prior to 1997 at the height of the Asian economic miracle. It was not long before OPEC realized it had got its timing horribly wrong and lowered production quotas several times in 1998 in a bid to arrest the oil price decline. But several members, most vociferously Venezuela, were loath to lose market share and refused to co-operate with swing producer Saudi Arabia. Not surprisingly, prices crashed 40% between October 1997 and March 1998 to $10 per barrel, with some grades going as low as $6 by the end of 1998 amid OPEC squabbling.
For American drivers, the oil price crash was Eden, and car buyers embraced sport utility vehicles and trucks over smaller cars. Brands like Ford Expedition Lincoln Navigator suddenly could not keep up with demand.
“Bigger may or may not be better, but automakers are scrambling to build the behemoths Americans will buy,” the New York Times reported.
The Global Financial Crisis Of 2008
The financial crisis of 2008-2009 is regarded as the biggest to hit the globe so far this century. The crisis started in the real estate market in 2006 and was marked by a sharp increase in defaults on subprime mortgages. Although the first wave of the crisis was contained, it severely curtailed economic activity as the contagion spread throughout the economy. Commodity prices climbed sharply even as the housing market collapsed.
The crisis eventually triggered a wave of deflation and liquidation that took values of all assets, including oil and gas, lower. Oil prices crashed from $133.88 per barrel in June 2008 to $39.09 in February 2009 while natural gas prices fell from $12.69 per MMBtu to $4.52 over the timeframe.
Thankfully, the crisis came to an end a year later thanks to aggressive stimulus employed by governments that led to expectations of increased inflation, which in turn triggered an increase in commodity buying as well as an improvement in credit conditions.
By Alex Kimani for Oilprice.com
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