As I watched a CBS 60 Minutes piece this week focused on the economic stress in west Texas I was reminded of a similar scene 20 years ago when I lived in Dallas. Oil was approaching $10 a barrel and the Economist went out on a limb suggesting $5 was near. Eventually recanting, the Economist was eager to dramatize similar to the media coverage today. It is true that oil inventories have soared and the supply side has been painfully slow to respond to cooling demand. This is mostly due to the fact that there are more producers acting independently who are more concerned with total cash flow than price per barrel. In other words, when prices fall, sell more barrels adding more supply to the market. Saudi Arabia and Mexico can be likened to a small producer in West Texas that is deeply in debt. Governments depend on cash flow to subsidize their budgets and small independents need cash flow to service debt. Both are now facing reality and managing the best way possible. Many large and small independent producers are now owned by debtors who face depressed prices high yield bond markets as few dare buy these companies.
The economic stress of low prices is now being felt across North America with oil prices falling below $20 a barrel in Alberta, Canada and some US markets. This has led to wide spread lay offs, rigs idled and service equipment sent to auction. Labor is moving and looking for alternative work. Although a slow process it is fully underway.
As new supply is tightens and inventories begin to drop, I expect to see a price recovery similar to the pace in 2002-2004. This could begin late in 2016 but this view remains in the minority.
CBS News – The Downside of Cheap Oil
Bloomberg – Oil Prices Could Jump 50% by the End of 2016 By Ben Sharples