OPEC’s recurring Trillion Dollar Gamble: Unlearnt Lessons Relearnt in the Oil Crisis

Unlearnt Lessons

I have been in the energy industry since 1986 and have seen more than my fair share of oil price busts.  I have seen the price busts of 1986, 1998, 2008 and 2015.

The one common aspect in all these price crashes is that, despite the industry giving great lip service to lessons learnt, we have actually learnt very little.  The causes of the crashes have startling similarities and resemblances in the way the crash occurs, the oil industry’s response and the lessons learnt in the moment and unlearnt when the price rises again.

A History of Oil Crises

In 1986, I was looking at career prospects in the oil industry and the oil price crash to $14 persuaded me to join the Nuclear industry instead.   The main reason for the 1986 price collapse was Saudi Arabia’s efforts to increase its share of the oil market. The Saudi’s were the prominent player in OPEC and drove policy to suit its needs.  Ultimately the Saudi’s were affected by the crash and restricted output to raise the prices again.  This was not the first time oil was used as a weapon by the Saudi’s and OPEC.  In 1974, the Saudi’s restricted oil production (the ‘oil embargo’) to increase the oil price and reduce the West’s support for Israel.

Recovery from the crash of 1986 was gradual and difficult. The price of crude rose slowly and crashed to $11 in 1998 and did not break the $40 mark again until 2004.  In 1998, I joined the North Sea Oil industry after much talk about the forthcoming huge demand in oil coming from China and Asian countries.  There was serious oil stock build-up in late 1997 and in 1998 Q1. The weakness of oil prices was largely attributable to a set of factors on the demand, supply and inventory side which began to play out around October 1997 and only became significant in December 1997 to March 1998. This is when prices began to fall but the producers continued to push hard on production when they no longer had the excuse of believing that demand was growing (they could see the Asian economies collapsing and the winter turning out warm in North America and North West Europe).   Again, a price crash aided by an OPEC led approach of banking of immediate profits in favour of a balanced approach to production and inventories aided by poor forecasting of demand, or not believing the answer.

In 2008 I was deeply immersed in an engineering consultancy for a prominent company and our order book was severely affected.  Oil prices dropped from historic highs of $144 in July 2008, to $33 five months later. OPEC, the world’s “swing crude oil producer,” took its traditional actions, cutting production by 16 percent in eight months to bring stability to global prices, which was led primarily by the group’s largest producer, Saudi Arabia. Crude oil consumption and production dropped by 1.5 percent and 1.2 percent, respectively, before coming back to parity from 2008 to 2010.  The world recession and reducing demand was part of the reason for the drop but there was also panic selling of the oil stocks by traders that caused the drop in oil price.

In 2015, I was dismayed when by now I was a joint owner of energy related businesses and our customers were decimated by the oil price crash.  There are many factors of the 2015 (and current) oil price crash that are covered by my previous blogs.  Key factors were a price war between the Saudis and Shale Oil producers and OPEC’s desire to gain market share, underestimating a disruptor technology and in the words of Michael Porter, not seeing the threat of this crude oil substitute.  The oil price bubble was ripe for bursting given the oil industry’s addiction to sky high oil prices and lazy practices with huge inefficiencies and expensive cost bases.

Redrawing the Lines of Engagement

It’s great to see ethical practices being promoted by the oil industry.  I have been involved in energy business management for many years and one aspect always present in contracts from our customers is that collusion with any other business to fix prices is the best way to get disqualified (or imprisoned!).  However, we aptly accept collusion for political positioning and profiteering for countries by the biggest cartel in history OPEC and that led by one or two main companies!  It is time to reconsider the future role of OPEC given its collusive and political nature.

Unlearnt Lessons, Painfully Relearnt

Some lessons we can draw from the past are:

  1. We actually do not learn lessons from negative events in the past.  We should probably focus on positive lessons that may reinforce good actions that we did.
  2. Do not leave the future of millions of people and trillions of dollars in the hands of a collusive cartel that has a breathtaking record of causing horrific economic crashes in the past.  We cannot isolate ourselves from politics; but leaving the oil price to meet the self-interest of a couple of major oil producing nations that have no interest in our well-being has got to be irresponsible. In fact, some of their decisions make me wonder if they really understand what is in their best interests either.
  3. The Energy industry cannot rely on a future based on burning fossil fuels alone. An energy mix has to be an essential part of oil companies of today, in order to protect earnings and increase flexibility.  The success of the oil companies is essential; otherwise the supply chain also crumbles.
  4. Oil companies need to look at vertical and horizontal diversification. Traditional industry demarcations need to change; oil companies may need to provide services from drilling to electricity distribution.
  5. Our governments and institutions need to take more responsibility in preventing erratic crashes in commodity prices. Our governments need to protect businesses better by preserving our national economic interest and must play a pivotal role or lead any external institutions that have a massive impact on our economy.

A More Hopeful Future…

On a positive note, you can be assured that any companies surviving the oil crisis will be excellent companies that will be leaner, fitter and more focused.  In addition to the above corporate strategic lessons, there are many tactical lessons that could be the subject of a book.  I do hope we learn some lessons from the many oil price crashes. Hopefully I will not witness too many more oil crashes in my short remaining career but for the sake of our younger industry colleagues I do hope we learn from the past.

With the oil price hovering around $60 and the slashing of the cost base, some oil companies think that they can make more profits now than when oil was at $100 per barrel.  Recent results from a number of oil companies show this.  Theon is seeing increased activity in the market from our clients including consolidation activity.  Many critical investments have stalled, particularly safety and asset integrity projects.  If the oil price remains at current levels I would expect to see an increase in market activity.

Look out for my next blog where I will look at what the oil company of the future should look like, how the oil industry can improve its profits and take a more responsible approach to energy management. In the meantime, do respond and tell me what lessons have been learnt in your company during this crisis.

 

Zulfiqar Hussain
Director

zulfiqar.hussain@theonltd.com