A brief history of oil price collapses

Updated: Mar 14



Let's talk about oil price collapses.


Unless you are living in a cave for the past week, you must have heard about the dramatic oil price collapse which is triggered when Saudi Arabia announced increased oil production and deep cuts of prices over the past weekend. This in response to Russia refusing to OPEC's suggestion to reduce oil production to cushion the impact from the current coronavirus crisis.


The world must have really hate the year of Rat.


2 big crises when we are barely out of the first quarter. I can't recall when was the last time we have such "dramatic"times.


The market responds in swift manners on Monday with most of the oil majors experiencing anything between 10 and 30 percent drops in their share prices in a single day. Even the first circuit breaker for the US market was triggered within four minutes of trading as S&P500 plunges 7%. This has never happened since 1997. Yes, you read it right. It was not even triggered during the 2008 Great Recession.


While we are in the midst of a oil price collapse or rather oil price war right now, let's take a brief walk down the history lane to see what had happened in the past few oil price collapses.


Since the formation of OPEC in 1960, this is the fourth time we are experiencing an oil price collapse


The first oil price collapse happened during the mid 1980s. During then, members of OPEC could not come to an agreement on the reductions for oil output in response to the changes in the global market. The aftermath of it is an extended period of low oil prices (around 20USD/Bbl) from the mid 1980s until 2000. It was only during 2000 did the oil price begin to slowly rise from the 1986 lows.


The second oil price collapse happened during the 2008 Great Recession. Oil was doing really well back then with the rapid growth in oil demand from China. The oil price rose quickly above 100USD/Bbl, only to have the Great Recession crashing it rapidly down to a lowest price of around 38USD/Bbl. Thankfully, the drop did not last as long as the previous one. China together with most of the other advanced economies recover rapidly. This then in turn revives the oil demands and oil price quickly recovers in 2009. Back then, oil production from new shale oil industry have already surfaced, though insignificant.


The third oil price collapse is probably still fresh in most of our minds. It was during the period between 2014 and 2016 when we see the rise in shale oil production in United States. Shale oil production increases rapidly and reacts much faster to the market as compared to the conventional oil fields. This means that when oil prices are high, shale oil production could scale up much quicker and respond faster to the market demands. This then results in shale oil productions in United States being able to gain more and more market share- which is something that the members of OPEC are clearly not too happy about. The plan to kill off competition from shale oil producers with overproduction by Saudi Arabia, coupled with the slowdown in growth of China's economy (anyone still remembers the 2015 stock market crash in China?), quickly pushes the oil price to fall below 30USD/Bbl by January 2016.


And now, finally the fourth oil price collapse. To be honest, few of us are expecting the fourth one to happen so quickly, especially when it has only been four years after the last oil price collapse.


While the current price war seems to be a tic-for-tat response from Saudi Arabia, the real targets or casualties from this price war could really be the shale oil producers in United States. Since the 2014-2016 oil crash, these shale oil producers emerge even stronger from the crisis and United States being the world leading oil producer now.


This certainly does not sit well with the members of OPEC. With the great economy slowdown in various countries amid the current coronavirus (China's manufacturing purchasing managers' index plunged to 35.7- denoting contraction), oil demand is bound to weaken. And it's probably not in the interest of Russia to agree to oil production cuts and have the shale oil producers in United States quickly gaining more market share amid the already weakened oil demand.


So how will this eventually turn out?


To be honest, I do not think there is a quick resolution to the current situation. The fact that the current oil price collapse happens so quickly after the previous oil price collapse goes to show that the fundamentals in oil production has changed with the rise of shale oil production. Shale oil production responds much quicker to oil prices than conventional oil fields, allowing them to quickly scale up and benefit whenever oil price rises. This then drives the oil supply in a overproduction mode quickly, thus limiting the rise of the oil price in an ever reinforcing cycle. This situation is likely to persist unless shale oil production producers go out of business. This might happened as shale oil usually requires around 50USD/Bbl to breakeven and many of them are heavily indebted. This means that they are not likely to last long in such depressed oil prices, unless Donald Trump and his economic team steps in timely to provide some reliefs. Until then, the world will forever be stuck in this cycle with oil prices never returning to its previous highs of more than 100USD/Bbl.


While it's almost impossible for us to return to previous highs, the current lows of the oil price are also not too likely to last a long period of time. Despite claims that Russia could last a decade on ~30USD/Bbl and Saudi Arabia has a low production cost of 3USD/Bbl, there will still be significant economic impact to both countries if such situation persists. For eg, Russia will run into huge budget deficit in prolonged periods of such depressed oil prices and they will likely not want that to happen. For Saudi Arabia, the fiscal breakeven price for their budget is around 80 USD/barrel. That is nearly twice the level required by Russia, and is also far from where we are right now.


All these point to the fact that a prolonged price war on oil prices is not likely to happen in today's terms, though return to former historic highs is also likely not possible. We will probably be stuck in a limbo of 40~70USD/Bbl for some time.


Oil price collapse might also happen more often now than ever. Oil supply has never been a problem in recent years with the overwhelming contributions from OPEC and United States shale oil producers. The same can't be said for the demand. As soon as the world gets into a crisis like now or not growing as fast as expected, we will quickly run into an oil oversupply situation. And this will bound to increase the chances of yet another price war happening, and hence yet another oil price collapse.


Reduced duration between each oil price collapse, together with a very limited range bound level of oil prices, will likely be the new norm moving forward until something fundamental about the oil industry changes.


Let the blinking contest begin.



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