WTRG Economics Crude Oil Price History and Outlook
A discussion of crude oil prices, the relationship between prices and rig count and the outlook for the future of the petroleum industry.
For more oil and gas analysis and forecasts:
Energy Economics Weekly
 
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Market Share within OPEC

One of the most frequent questions WTRG receives is "Why doesn't OPEC just cut production? They will increase total revenue." This article explains one of the major problems OPEC faces each time it meets. It is the third in a series on crude oil pricing issues.

 
Oil Price History and Analysis
The recent downturn in crude oil prices will as usual have the greatest immediate impact on the exploration segment of the industry. Coincident with that will be a decline in sales and manufacture of oil and gas equipment. The next segment of the industry to feel the pressure of the price decline will be the oil and gas services. This page will address the causes for the precipitous drop in prices in an historical context. If you find it of interest you might want to bookmark the page and check back often.  We will be adding to this analysis on a regular basis.  Of course, if you need help determining the impact on your company please contact WTRG Economics.
Introduction

Oil Prices behave much as any other commodity with wide price swings in times of shortage or oversupply. The domestic industry's price has been heavily regulated through production or price controls throughout much of the twentieth century. In the post World War II era oil prices have averaged $19.27 per barrel in 1996 dollars. Through the same period the median price for crude oil was $15.27 in 1996 prices. That means that only fifty percent of the time from 1947 to 1997 have oil prices exceeded $15.26 per barrel. Prices have only exceeded $22.00 per barrel in response to war or conflict in the Middle East. 

Crude Oil Prices 1947-1998
Crude Oil Prices 1947-1998
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The Long Term View
The long term view is much the same.  Since 1869 US crude oil prices adjusted for inflation have averaged $18.63 per barrel. Fifty percent of the time prices were below $14.91. 

If long term history is a guide, those in the upstream segment of the crude oil industry should structure their business to be able to operate, hopefully  with a profit, below $15.00 per barrel half of the time. 

Crude Oil Prices 1867-1998
Crude Oil Prices 1867-1998
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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 1996 dollars an entirely different story emerges. In 1996 dollars crude oil prices fluctuated between $14 - $16 during the same period.  The apparent price increases were just keeping up with inflation. 

From 1958 to 1970 prices were stable at about $3.00 per barrel, but in real terms the price of crude oil declined from above $15 to below $12 per barrel.  The decline in the price of crude when adjusted for inflation was further exacerbated in 1971 and 1972 by the weakness of the US dollar. 

OPEC was formed in 1960 with five founding members Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.  By the end of 1971 six other nations had joined the group: Qatar, Indonesia, Libya, United Arab Emirates, Algeria and Nigeria.  These nations had experienced a decline in the real value of their product since foundation of the Organization of Petroleum Exporting Countries. 

Throughout the post war period exporting countries found increasing demand for their crude oil and a 40% decline in the purchasing power of a barrel of crude.  In March 1971, the balance of power shifted.  That month the Texas Railroad Commission set proration at 100 percent for the first time.  This meant that Texas producers were no longer limited in the amount of oil that they could produce.  More importantly, it meant that the power to control crude oil prices shifted from the United States (Texas, Oklahoma and Louisiana) to OPEC. 
 

World Events and Crude Oil Prices 1947-1973
World Events and Crude Oil Prices 1947-1973
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Middle East, OPEC and Oil Prices 1947-1973
Middle 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 and by the end of 1974 the price of oil had quadrupled to $12.00. The Yom Kippur War started with an attack on Israel by Syria and Egypt on October 5, 1973. The United States and many countries in the western world showed strong support for Israel. As a result of this support Arab exporting nations imposed an embargo on the nations supporting Israel. Arab nations curtailed production by 5 million barrels per day (MMBPD) about 1 MMBPD was made up by increased production on other countries. The net loss of 4 MMBPD extended through March of 1974 and represented 7 percent of the free-world production. 

If there was any doubt that the ability to control crude oil prices had passed from the United States to OPEC it was removed during the Arab Oil Embargo.  The extreme sensitivity of prices to supply shortages became all too apparent. Prices increased 400 percent in six short months. 

From 1974 to 1978 crude oil prices increased at a moderate pace from $12 per barrel to $14 per barrel.  When adjusted for inflation the prices were constant over this period of time. 

Crises in Iran and Iraq
Events in Iran and Iraq led to another round of crude oil price increases in 1979 and 1980. The Iranian revolution resulted in the loss of 2 to 2.5 million barrels of oil per day between November of 1978 and June of 1979.  In 1980 Iraq's crude oil production fell 2.7 MMBPD and Iran's production by 600,000 barrels per day during the Iran/Iraq War. The combination of these two events resulted in crude oil prices more than doubling from $14 in 1978 to $35 per barrel in 1981. 

U.S. and World Events and Oil Prices 1973-1981
Middle East, OPEC and Crude Oil Prices 1947-1973
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US Oil Price Controls - Bad Policy?
The rapid increase in crude prices in this period would have been much less were it not for United States energy policy during the post Embargo period. The US imposed price controls on domestically produced oil in an attempt to lessen the impact of the 1973-74 price increase.  The obvious result of the price controls was that U.S. consumers of crude oil paid 48 percent more for imports than domestic production. Of course U.S producers received less. 

Did the policy achieve its goal? In the short term the recession induced by the 1973-1974 crude oil price rise was less.  However, it had other effects as well.  In the absence of price controls U.S. exploration and production would certainly have been significantly greater. The higher prices faced by consumers would have resulted in lower rates of consumption: automobiles would have had higher mileage sooner, homes and commercial buildings would have been better insulated and improvements in industrial energy efficiency  would have been greater than they were during this period. As a consequence, the United States would have been less dependent on imports in 1979-1980 and the price increase in response to Iranian and Iraqi supply interruptions would have been significantly less. 
 

US Oil Price Controls 1973-1981
US Price Controls 1973-1981 Refiners Aquisition Cost of Crude Oil
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OPEC's Failure to Control Crude Oil Prices
OPEC has seldom been effective as a cartel. During the 1979-1980 period of rapidly increasing prices, Saudi Arabia's oil minister Ahmed Yamani repeatedly warned other members of OPEC that high prices would lead to a reduction in demand. His warnings fell on deaf ears. The rapid price increases caused several reactions among consumers: better insulation in new homes, increased insulation in many older homes, more energy efficiency in industrial processes, and automobiles with higher mileage. 
These factors along with a global recession caused a reduction in demand which led to falling crude prices.  Unfortunately for OPEC only the global recession was temporary. Nobody rushed to remove insulation from their homes or to replace energy efficient plants and equipment -- much of the reaction to the oil price increase of the end of the decade was permanent and would not respond to lower prices with increased demand for oil. 

From 1982 to 1985 OPEC attempted to set production quotas low enough to stabilize prices. These attempts met with repeated failure as various members of OPEC would produce beyond their quotas. During most of this period Saudi Arabia acted as the swing producer cutting its production to stem the free falling prices. In August of 1985, the Saudis tired of this roll.  They linked their oil prices to the spot market for crude and by early 1986 increased production from 2 MMBPD to 5 MMBPD.  Crude oil prices plummeted below $10 per barrel by mid year. 

A December 1986 OPEC price accord set to target $18 per barrel was already breaking down by January of 1987. Prices remained weak. The price of crude oil spiked in 1990 with the uncertainty associated Iraqi invasion of Kuwait and the ensuing Gulf War, but following the war crude oil prices entered a steady decline until in 1994 inflation adjusted prices attained their lowest level since 1973. 

The price cycle then turned up. With a strong economy in the United States and a booming economy in Asia increased demand led a steady price recovery well into 1997.  This came to a rapid end when the impact of the financial crisis in Asia was underestimated by OPEC.  In December, OPEC increased its quotas 10 percent to 27.5 MMBPD but the rapid growth in Asian economies had come to a halt.  If the EIA's crude oil price forecast is on target, this year will, on an inflation adjusted basis, surpass 1994 as the worst year for oil prices since 1973. 

World Events and Crude Oil Prices 1981-1998
World Events and Crude Oil Prices 1981-1998
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Impact of Prices on Industry Segments

Drilling and Exploration

Boom and Bust
The Rotary Rig Count is the average number of drilling rigs actively exploring for oil and gas. Drilling an oil or gas well is a capital investment in the expectation of returns from the production of crude oil or natural gas. Rig count is one of the primary measures of the health of the exploration segment of the oil and gas industry.  In a very real sense it is a measure of the oil and gas industry's confidence in its own future. 

At  the end of the Arab Oil Embargo in 1974 rig count was below 1500. It rose steadily with regulated crude oil prices to over 2000 in 1979.  From 1978 to the beginning of 1981 domestic crude oil prices exploded from a combination of the the rapid growth in world energy prices and deregulation of domestic prices. Forecasts of crude oil prices in excess of $100 per barrel fueled a drilling frenzy. By 1982 the number of rotary rigs running had more than doubled. 

It is important to note that the peak in drilling occurred over a year after oil prices had entered a steep decline which continued until the 1986 price collapse. The one year lag between crude prices and rig count disappeared in the 1986 price collapse. For the next few years the towns in the oil patch were characterized by bankruptcy, bank failures and high unemployment.

U.S. Rotary Rig Count 1974-1997
Crude Oil and Natural Gas Drilling
U.S. Rotary Rig Count 1974-1997 Crude Oil and Natural Gas Drilling
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After the Collapse
Several trends established were established in the wake of the collapse in crude prices. The lag of over a year for drilling to respond to crude prices is now reduced to a matter of months. (Note that the graph on the right is limited to rigs involved in exploration for crude oil as compared to the previous graph which also included rigs involved in gas exploration.) Like any other industry that goes through hard times the oil business emerged smarter and much leaner. Industry participants, bankers and investors were far more aware of the risk of price movements. Companies long familiar with accessing geologic risk added price risk to their decision criteria. 

Technological improvements were incorporated: 

  • Increased use of 3-D seismic data reduced drilling risk.
  • Directional and horizontal drilling led to improved production in many reservoirs.
  • Financial instruments were used to limit exposure to price movements.
  • Increased use of CO2 floods to improve production in existing wells.
In spite of all of these efforts the percentage of rigs employed in drilling for crude oil decreased from over 60 percent of total rigs at the beginning of 1988 to under 40 percent currently. 
U.S. Rotary Rig Count
Exploration for Oil
U.S. Rotary Rig Count Exploration for Oil
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U.S. Rotary Rig Count
Percent Exploring for Crude Oil
U.S. Rotary Rig Count Percent Exploring for Crude Oil
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Well Completions - A measure of success?

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

After a well is drilled it is either classified as an oil well, natural gas well or dry hole. The percentage of wells completed as oil or gas wells is frequently used as a measure of success.  In fact, this percentage is often referred to as the success rate. 

Immediately after World War II 65 percent of the wells drilled were completed as oil or gas wells. This percentage declined to about 57 percent by the end of the 1960s. It rose steadily during the 1970s to reach 70 percent at the end of the decade. This was followed by a plateau or modest decline through most of the 1980s. 

Beginning in 1990 shortly after the harsh lessons of the price collapse completion rates increased dramatically to 77 percent. What was the reason for the dramatic increase? For that matter, what was the cause of the steady drop in the 1950s and 1960s or the reversal in the 1970s? 

Since the percentage completion rates are much lower for the more risky exploratory wells, a shift in emphasis away from development would result in lower overall completion rates. This, however, was not the case. An examination of completion rates for development and exploratory wells shows the same general pattern. The decline was price related as we will explain later. 

Some would argue that the periods of decline were a result of the fact that every year there is less oil to find.  If the industry does not develop better technology and expertise every year, oil and gas completion rates should decline. However, this does not explain the periods of increase. 

The increases of the seventies were more related to price than technology. When a well is drilled, the fact that oil or gas is found does not mean that the well will be completed as a producing well.  The determining factor is economics. If the well can produce enough oil or gas to cover the cost of completion and the ongoing production costs it will be put into production.  Otherwise, its a dry hole even if crude oil or natural gas is found.  The conclusion is that if real prices are increasing we can expect a higher percentage of successful wells. Conversely if prices are declining the opposite is true. 

The increases of the 1990s, however, cannot be explained by higher prices. These increases are clearly the result of improved technology. The increased use of and improvements to 3-D seismic data and analysis combined with horizontal and and directional drilling. Most dramatic is the improvement in the the percentage exploratory wells completed. In the 1990s completion rates have soared from 25 to 45 percent. 

Oil and Gas Well Completion Rates
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Oil and Gas Well Completion Rates
Development

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U.S. Oil and Gas Well Completion Rates
Exploration

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Workover Rigs - Maintenance

Workover rig count is a measure of the industry's investment in the maintenance of oil and gas wells.  The Baker-Hughes workover rig count includes rigs involved in pulling production tubing from a well that is 1,500 feet or more in depth. 
Workover rig count is another measure of the health of the oil and gas industry. Most workovers are associated with oil wells. Workover rigs are used to pull tubing for repair or replacement of rods, pumps and tubular goods which are subject to wear and corrosion. 

A low level of workover activity is particularly worrisome because it is indicative of deferred maintenance.  The situation is similar to the aging apartment building that no longer justifies major renovations and is milked as long as it produces a positive cash flow. When operators are in a weak cash position workovers are delayed as long as possible. Workover activity impacts manufacturers of  tubing, rods and pumps. Service companies coating pipe and other tubular goods are heavily affected. 

 

U.S. Workover Rigs and Crude Oil Prices
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Click here for Current Update:
OPEC's Failed Meeting: Price vs. Market Share

This update begins a series on crude oil pricing issues on a new page by examining some of the conflicting goals of OPEC members.

Future topics:

Impact of Prices on Industry Segments

    More on the relationship between drilling and completion
    Oil and Gas Manufacturing Equipment
    Oil and Gas Services
Will prices recover?
    Details of the current collapse
    Potential for recovery
     




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