History of Crude Oil

8/8/2019 History of Crude Oil

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Introduction

Crude oil prices behave much as any othercommodity with wide price swings in times ofshortage or oversupply. The crude oil price

cycle may extend over several yearsresponding to changes in demand as well asOPEC and non-OPEC supply.

The U.S. petroleum industry's price was heavilyregulated through production or price controlsthroughout much of the twentieth century. In thepost World War II era U.S. oil prices at thewellhead averaged $26.64 per barrel adjustedfor inflation to 2008 dollars. In the absence ofprice controls, the U.S. price would have

tracked the world price averaging $28.68. Overthe same post war period the median for thedomestic and the adjusted world price of crudeoil was $19.60 in 2008 prices. That means thatonly fifty percent of the time from 1947 to 2008have oil prices exceeded $19.60 per barrel.(See note in box on right.)

Until the March 28, 2000 adoption of the $22-$28 price band for the OPEC basket of crude,oil prices only exceeded $24.00 per barrel in

response to war or conflict in the Middle East.With limited spare production capacity, OPECabandoned its price band in 2005 and waspowerless to stem the surge in oil prices, whichwas reminiscent of the late 1970s.

Crude Oil Prices 1947 - August, 2009

Click on graph for larger view*World Price - The only very long term pr ice series that exists is theU.S. average wellhead or first purchase price of crude. Whendiscussing long-term price behavior this presents a problem sinceU.S. imposed price controls on domestic production from late 197January 1981. In order to present a consistent series and also reflethe difference between international prices and U.S. prices we creaa world oil price series that was consistent with the U.S. wellhead padjusting the wellhead price by adding the difference between therefiners acquisition price of imported crude and the refiners averagacquisition price of domestic crude.

The Very Long Term View

The very long-term view is much the same.Since 1869, US crude oil prices adjusted forinflation have averaged $22.52 per barrel in

2008 dollars compared to $23.42 for world oilprices.

Fifty percent of the time prices U.S. and worldprices were below the median oil price of$16.71 per barrel.

If long-term history is a guide, those in the

Crude Oil Prices 1869-2009


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upstream segment of the crude oil industryshould structure their business to be able tooperate with a profit, below $17.65 per barrelhalf of the time. The very long-term data andthe post World War II data suggest a "normal"

price far below the current price.

Click on graph for larger view

The results are dramatically different if onlypost-1970 data are used. In that case, U.S.crude oil prices average $32.36 per barrel andthe more relevant world oil price averages$35.50 per barrel. The median oil price for thatperiod is $30.04 per barrel.

If oil prices revert to the mean this period islikely the most appropriate for today's analyst. Itfollows the peak in U.S. oil productioneliminating the effects of the Texas Railroad

Commission and is a period when the SevenSisters were no longer able to dominate oilproduction and prices. It is an era of far moreinfluence by OPEC oil producers than they hadin the past. As we will see in the details belowinfluence over oil prices is not equivalent tocontrol.

Crude Oil Prices 1970-2008


Post World War II

Pre Embargo Period

Crude Oil prices ranged between $2.50 and$3.00 from 1948 through the end of the 1960s.The price oil rose from $2.50 in 1948 to about$3.00 in 1957. When viewed in 2008 dollars anentirely different story emerges with crude oilprices fluctuating between $17 and $19 during

World Events and Crude Oil Prices 1947-1973


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most of the period. The apparent 20% priceincrease in nominal prices just kept up withinflation.

From 1958 to 1970, prices were stable near

$3.00 per barrel, but in real terms the price ofcrude oil declined from above $19 to $14 perbarrel. The decline in the price of crude whenadjusted for inflation for the internationalproducer suffered the additional effect in 1971and 1972 of a weaker US dollar.

Established in 1960 OPEC, with five foundingmembers Iran, Iraq, Kuwait, Saudi Arabia andVenezuela, took over a decade to establish itsinfluence in the world market. Two of the

representatives at the initial meetings hadstudied the the Texas Railroad Commission'smethods of influencing price through limitationson production. By the end of 1971, six othernations had joined the group: Qatar, Indonesia,Libya, United Arab Emirates, Algeria andNigeria. From the foundation of theOrganization of Petroleum Exporting Countriesthrough 1972 member countries experiencedsteady decline in the purchasing power of abarrel of oil.

Throughout the post war period exportingcountries found increasing demand for theircrude oil but a 40% decline in the purchasingpower of a barrel of oil. In March 1971, thebalance of power shifted. That month theTexas Railroad Commission set proration at100 percent for the first time. This meant thatTexas producers were no longer limited in thevolume of oil that they could produce. Moreimportantly, it meant that the power to control

crude oil prices shifted from the United States(Texas, Oklahoma and Louisiana) to OPEC.Another way to say it is that there was no morespare capacity in the U.S. and therefore no toolto put an upper limit on prices. A little over twoyears later OPEC, through the unintendedconsequence of war, obtained a glimpse of theextent of its power to influence prices.

Click on graph for larger viewMiddle East, OPEC and Oil Prices 1947-1973



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Middle East Supply Interruptions

Yom Kippur War- Arab Oil Embargo

In 1972, the price of crude oil was about $3.00

per barrel. By the end of 1974, the price of oilhad quadrupled to over $12.00. The YomKippur War started with an attack on Israel bySyria and Egypt on October 5, 1973. TheUnited States and many countries in thewestern world showed support for Israel.Because of this support, several Arab exportingnations and Iran imposed an embargo on thecountries supporting Israel. While these nationscurtailed production by 5 million barrels per dayother countries were able to increase

production by a million barrels. The net loss of 4million barrels per day extended through Marchof 1974 and represented 7 percent of the freeworld production.

Any doubt the ability to control crude oil priceshad passed from the United States to OPECwas removed during the Arab Oil Embargo.The extreme sensitivity of prices to supplyshortages became all too apparent when pricesincreased 400 percent in six short months.

From 1974 to 1978, the world crude oil pricewas relatively flat ranging from $12.21 perbarrel to $13.55 per barrel. When adjusted forinflation world oil prices were in a period ofmoderate decline.

U.S. and World Events and Oil Prices 1973-198


OPEC Oil Production 1973-2009


Crises in Iran and Iraq

In 1979 and 1980, events in Iran and Iraq led toanother round of crude oil price increases. The

Iranian revolution resulted in the loss of 2 to 2.5million barrels per day of oil production betweenNovember 1978 and June 1979. At one pointproduction almost halted.

The Iranian revolution was the proximate causeof what would become the highest price in post-WWII history. However, its impact on prices

Iran Oil production 1973-2009


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would have been limited and of relatively shortduration had it not been for subsequent events.Shortly after the revolution, production was upto 4 million barrels per day.

In September 1980, Iran already weakened bythe revolution was invaded by Iraq. ByNovember, the combined production of bothcountries was only a million barrels per day and6.5 million barrels per day less than a yearbefore. Consequently worldwide crude oilproduction was 10 percent lower than in 1979.

The combination of the Iranian revolution andthe Iraq-Iran War cause crude oil prices to morethan double increasing from $14 in 1978 to $35

per barrel in 1981.

Three decades later Iran's production is onlytwo-thirds of the level reached under thegovernment of Reza Pahlavi, the former Shahof Iran.

Iraq's production remains a million barrelsbelow its peak before the Iraq-Iran War.


Iraq Oil production 1973-2009


US Oil Price Controls - Bad Policy?

The rapid increase in crude prices from 1973 to1981 would have been much less were it not for

United States energy policy during the postEmbargo period. The US imposed pricecontrols on domestically produced oil. Theobvious result of the price controls was thatU.S. consumers of crude oil paid about 50percent more for imports than domesticproduction and U.S producers received lessthan world market price. In effect, the domestic

US Oil Price Controls 1973-1981


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petroleum industry was subsidizing the U.S.consumer.

Did the policy achieve its goal? In the short-term, the recession induced by the 1973-1974

crude oil price spike was somewhat less severebecause U.S. consumers faced lower pricesthan the rest of the world. However, it hadother effects as well.

In the absence of price controls, U.S.exploration and production would certainly havebeen significantly greater. Higher petroleumprices faced by consumers would have resultedin lower rates of consumption: automobileswould have achieved higher miles per gallon

sooner, homes and commercial buildings wouldhave has better insulated and improvements inindustrial energy efficiency would have beengreater than they were during this period.Consequently, the United States would havebeen less dependent on imports in 1979-1980and the price increase in response to Iranianand Iraqi supply interruptions would have beensignificantly less.


OPEC Fails to Control Crude Oil Prices

OPEC has seldom been effective at controllingprices. While often referred to as a cartel,OPEC does not satisfy the definition. One of theprimary requirements is a mechanism toenforce member quotas. The old joke wentsomething like this. What is the differencebetween OPEC and the Texas RailroadCommission? OPEC doesn't have any TexasRangers! The only enforcement mechanismthat has ever existed in OPEC was Saudi sparecapacity.

With enough spare capacity at times to be ableto increase production sufficiently to offset theimpact of lower prices on its own revenue,Saudi Arabia could enforce discipline bythreatening to increase production enough to



U.S. Petroleum Consumption


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crash prices. In reality even this was not anOPEC enforcement mechanism unless OPEC'sgoals coincided with those of Saudi Arabia.

During the 1979-1980 period of rapidly

increasing prices, Saudi Arabia's oil ministerAhmed Yamani repeatedly warned othermembers of OPEC that high prices would leadto a reduction in demand. His warnings fell ondeaf ears.

Surging prices caused several reactions amongconsumers: better insulation in new homes,increased insulation in many older homes, moreenergy efficiency in industrial processes, andautomobiles with higher efficiency. These

factors along with a global recession caused areduction in demand which led to falling crudeprices. Unfortunately for OPEC only the globalrecession was temporary. Nobody rushed toremove insulation from their homes or toreplace energy efficient plants and equipment --much of the reaction to the oil price increase ofthe end of the decade was permanent andwould never respond to lower prices withincreased consumption of oil.

Higher prices also resulted in increasedexploration and production outside of OPEC.From 1980 to 1986 non-OPEC productionincreased 10 million barrels per day. OPEC wasfaced with lower demand and higher supplyfrom outside the organization.

From 1982 to 1985, OPEC attempted to setproduction quotas low enough to stabilizeprices. These attempts met with repeatedfailure as various members of OPEC produced

beyond their quotas. During most of this periodSaudi Arabia acted as the swing producercutting its production in an attempt to stem thefree fall in prices. In August of 1985, the Saudistired of this role. They linked their oil price tothe spot market for crude and by early 1986increased production from 2 MMBPD to 5MMBPD. Crude oil prices plummeted below


Non-OPEC Production & Crude Oil Prices


OPEC Production & Crude Oil Prices


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$10 per barrel by mid-1986. Despite the fall inprices Saudi revenue remained about the samewith higher volumes compensating for lowerprices.

A December 1986 OPEC price accord set totarget $18 per barrel bit it was already breakingdown by January of 1987and prices remainedweak.

The price of crude oil spiked in 1990 with thelower production and uncertainty associatedwith the Iraqi invasion of Kuwait and theensuing Gulf War. The world and particularlythe Middle East had a much harsher view ofSaddam Hussein invading Arab Kuwait than

they did Persian Iran. The proximity to theworld's largest oil producer helped to shape thereaction.

Following what became known as the Gulf Warto liberate Kuwait crude oil prices entered aperiod of steady decline until in 1994 inflationadjusted prices attained their lowest level since1973.

The price cycle then turned up. The United

States economy was strong and the AsianPacific region was booming. From 1990 to 1997world oil consumption increased 6.2 millionbarrels per day. Asian consumption accountedfor all but 300,000 barrels per day of that gainand contributed to a price recovery thatextended into 1997. Declining Russianproduction contributed to the price recovery.Between 1990 and 1996 Russian productiondeclined over 5 million barrels per day.


RussianC

rude Oil Production


OPEC continued to have mixed success incontrolling prices. There were mistakes intiming of quota changes as well as the usualproblems in maintaining production disciplineamong its member countries.

The price increases came to a rapid end in1997 and 1998 when the impact of the



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economic crisis in Asia was either ignored orseverely underestimated by OPEC. InDecember, 1997 OPEC increased its quota by2.5 million barrels per day (10 percent) to 27.5MMBPD effective January 1, 1998. The rapid

growth in Asian economies had come to a halt.In 1998 Asian Pacific oil consumption declinedfor the first time since 1982. The combination oflower consumption and higher OPECproduction sent prices into a downward spiral.In response, OPEC cut quotas by 1.25 millionb/d in April and another 1.335 million in July.Price continued down through December 1998.

Prices began to recover in early 1999 andOPEC reduced production another 1.719 million

barrels in April. As usual not all of the quotaswere observed but between early 1998 and themiddle of 1999 OPEC production dropped byabout 3 million barrels per day and wassufficient to move prices above $25 per barrel.

With minimal Y2K problems and growing USand world economies the price continued to risethroughout 2000 to a post 1981 high. Between

April and October, 2000 three successiveOPEC quota increases totaling 3.2 million

barrels per day were not able to stem the priceincreases. Prices finally started down followinganother quota increase of 500,000 effectiveNovember 1, 2000.


OPEC

Production 1990-2007


Russian production increases dominated non-OPEC production growth from 2000 forwardand was responsible for most of the non-OPECincrease since the turn of the century.

Once again it appeared that OPEC overshot the

mark. In 2001, a weakened US economy andincreases in non-OPEC production putdownward pressure on prices. In responseOPEC once again entered into a series ofreductions in member quotas cutting 3.5 millionbarrels by September 1, 2001. In the absenceof the September 11, 2001 terrorist attack thiswould have been sufficient to moderate or even



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reverse the trend.

In the wake of the attack crude oil pricesplummeted. Spot prices for the U.S. benchmarkWest Texas Intermediate were down 35 percent

by the middle of November. Under normalcircumstances a drop in price of this magnitudewould have resulted an another round of quotareductions but given the political climate OPECdelayed additional cuts until January 2002. Itthen reduced its quota by 1.5 million barrels perday and was joined by several non-OPECproducers including Russia who promisedcombined production cuts of an additional462,500 barrels. This had the desired effectwith oil prices moving into the $25 range by

March, 2002. By mid-year the non-OPECmembers were restoring their production cutsbut prices continued to rise and U.S. inventoriesreached a 20-year low later in the year.

By year end oversupply was not a problem.Problems in Venezuela led to a strike atPDVSA causing Venezuelan production toplummet. In the wake of the strike Venezuelawas never able to restore capacity to itsprevious level and is still about 900,000 barrels

per day below its peak capacity of 3.5 millionbarrels per day. OPEC increased quotas by 2.8million barrels per day in January and February,2003.

On March 19, 2003, just as some Venezuelanproduction was beginning to return, militaryaction commenced in Iraq. Meanwhile,inventories remained low in the U.S. and otherOECD countries. With an improving economyU.S. demand was increasing and Asian

demand for crude oil was growing at a rapidpace.

The loss of production capacity in Iraq andVenezuela combined with increased OPECproduction to meet growing internationaldemand led to the erosion of excess oilproduction capacity. In mid 2002, there was


RussianC

rude Oil Production


Venezuelan Oil Production


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over 6 million barrels per day of excessproduction capacity and by mid-2003 theexcess was below 2 million. During much of2004 and 2005 the spare capacity to produceoil was under a million barrels per day. A million

barrels per day is not enough spare capacity tocover an interruption of supply from most OPECproducers.

In a world that consumes over 80 million barrelsper day of petroleum products that added asignificant risk premium to crude oil price and islargely responsible for prices in excess of $40-$50 per barrel.

Other major factors contributing to the current level

of prices include a weak dollar and the continuedrapid growth in Asian economies and theirpetroleum consumption. The 2005 hurricanes and

U.S. refinery problems associated with theconversion from MTBE as an additive to ethanol

have contributed to higher prices.


ExcessCrude Oil Production Capacity



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One of the most important factors supporting a highprice is the level of petroleum inventories in the U.S.

and other consuming countries. Until spare capacitybecame an issue inventory levels provided an

excellent tool for short-term price forecasts.

Although not well publicized OPEC has for severalyears depended on a policy that amounts to worldinventory management. Its primary reason for

cutting back on production in November, 2006 andagain in February, 2007 was concern about growing

OECD inventories. Their focus is on total petroleuminventories including crude oil and petroleum

products, which are a better indicator of prices thatoil inventories alone.

Impact of Prices on Industry Segments

Drilling and Exploration

Boom and Bust

The Rotary Rig Count is the average number ofdrilling rigs actively exploring for oil and gas.Drilling an oil or gas well is a capital investmentin the expectation of returns from the productionand sale of crude oil or natural gas. Rig count isone of the primary measures of the health ofthe exploration segment of the oil and gas

industry. In a very real sense it is a measure ofthe oil and gas industry's confidence in its ownfuture.

At the end of the Arab Oil Embargo in 1974 rigcount was below 1500. It rose steadily withregulated crude oil prices to over 2000 in 1979.From 1978 to the beginning of 1981 domesticcrude oil prices exploded from a combination ofthe the rapid growth in world energy prices andderegulation of domestic prices. At that time

high prices and forecasts of crude oil prices inexcess of $100 per barrel fueled a drillingfrenzy. By 1982 the number of rotary rigsrunning had more than doubled.

It is important to note that the peak in drillingoccurred over a year after oil prices hadentered a steep decline which continued until

U.S. Rotary Rig Count 1974-2005

Crude Oil and Natural Gas Drilling



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the 1986 price collapse. The one year lagbetween crude prices and rig countdisappeared in the 1986 price collapse. For thenext few years the economy of the towns andcities in the oil patch was characterized by

bankruptcy, bank failures and highunemployment.

After the Collapse

Several trends established were established inthe wake of the collapse in crude prices. Thelag of over a year for drilling to respond to crudeprices is now reduced to a matter of months.(Note that the graph on the right is limited torigs involved in exploration for crude oil ascompared to the previous graph which also

included rigs involved in gas exploration.) Likeany other industry that goes through hard timesthe oil business emerged smarter, leaner andmore conservative. Industry participants,bankers and investors were far more aware ofthe risk of price movements. Companies longfamiliar with accessing geologic, production andmanagement risk added price risk to theirdecision criteria.

Technological improvements were

incorporated:

y Increased use of 3-D seismic datareduced drilling risk.

y Directional and horizontal drilling led toimproved production in many reservoirs.

y Financial instruments were used to limitexposure to price movements.

y Increased use of CO2 floods andimproved recovery methods to improveproduction in existing wells.

In spite of all of these efforts the percentage ofrigs employed in drilling for crude oil decreasedfrom over 60 percent of total rigs at thebeginning of 1988 to under 15 percent until arecent resurgence.

U.S. Rotary Rig CountExploration for Oil


U.S. Rotary Rig Count

Percent Exploring forCrude Oil



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Well Completions - A measure of success?

Rig count does not tell the whole story of oil andgas exploration and development. It is certainlya good measure of activity, but it is not a

measure of success.

After a well is drilled it is either classified as anoil well, natural gas well or dry hole. Thepercentage of wells completed as oil or gaswells is frequently used as a measure ofsuccess. In fact, this percentage is oftenreferred to as the success rate.

Immediately after World War II 65 percent ofthe wells drilled were completed as oil or gas

wells. This percentage declined to about 57percent by the end of the 1960s. It rose steadilyduring the 1970s to reach 70 percent at the endof that decade. This was followed by a plateauor modest decline through most of the 1980s.

Beginning in 1990 shortly after the harshlessons of the price collapse completion ratesincreased dramatically to 77 percent. What wasthe reason for the dramatic increase? For thatmatter, what was the cause of the steady drop

in the 1950s and 1960s or the reversal in the1970s?

Since the percentage completion rates aremuch lower for the more risky exploratory wells,a shift in emphasis away from developmentwould result in lower overall completion rates.This, however, was not the case. Anexamination of completion rates fordevelopment and exploratory wells shows thesame general pattern. The decline was price

related as we will explain later.

Some would argue that the periods of declinewere a result of the fact that every year there isless oil to find. If the industry does not developbetter technology and expertise every year, oiland gas completion rates should decline.However, this does will not explain the periods

Oil and Gas WellCompletion Rates





Development


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of increase.

The increases of the seventies were morerelated to price than technology. When a well isdrilled, the fact that oil or gas is found does not

mean that the well will be completed as aproducing well. The determining factor iseconomics. If the well can produce enough oilor gas to cover the additional cost of completionand the ongoing production costs it will be putinto production. Otherwise, its a dry hole evenif crude oil or natural gas is found. Theconclusion is that if real prices are increasingwe can expect a higher percentage ofsuccessful wells. Conversely if prices aredeclining the opposite is true.

The increases of the 1990s, however, cannotbe explained by higher prices. These increasesare the result of improved technology and theshift to a higher percentage of natural gasdrilling activity. The increased use of andimprovements to 3-D seismic data and analysiscombined with horizontal and and directionaldrilling improve prospects for successfulcompletions. The fact that natural gas is easierto see in the seismic data adds to that success

rate.

Most dramatic is the improvement in the thepercentage exploratory wells completed. In the1990s completion rates for exploratory wellshave soared from 25 to 45 percent.


U.S. Oil and Gas Well Completion Rates

Exploration


Workover Rigs - Maintenance

Workover rig count is a measure of theindustry's investment in the maintenance of oiland gas wells. The Baker-Hughes workover rigcount includes rigs involved in pullingproduction tubing, sucker rods and pumps froma well that is 1,500 feet or more in depth.

Workover rig count is another measure of the

U.S. Workover Rigs and Crude Oil Prices


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health of the oil and gas industry. Adisproportionate percentage of workovers areassociated with oil wells. Workover rigs areused to pull tubing for repair or replacement ofrods, pumps and tubular goods which are

subject to wear and corrosion.

A low level of workover activity is particularlyworrisome because it is indicative of deferredmaintenance. The situation is similar to theaging apartment building that no longer justifiesmajor renovations and is milked as long as itproduces a positive cash flow. When operatorsare in a weak cash position workovers aredelayed as long as possible. Workover activityimpacts manufacturers of tubing, rods and

pumps. Service companies coating pipe andother tubular goods are heavily affected.


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History of Crude Oil