Recalling The 1980s Oil Glut In Today's Context

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Includes: CVX, OIL, RDS.A, USO, XLE, XOM
by: Atlas Grinned
Summary

Much of the 1980's has been forgotten from an investment perspective.

The 1980's oil glut saw a sustained collapse in oil demand for a whole decade.

Production cuts out of Saudi Arabia for instance were as high as 80%.

Today's "production cuts" are laughable, and oil production is at or near record capacity.

Despite this, oil keeps heading higher, signifying a long term bull market may be in place.

Who remembers the 1980’s? In many ways, the economic experience of the 1980’s has been completely forgotten. Not just in terms of double digit inflation and double digit interest rates which are barely remembered at all. There is something even more forgotten: The 1980’s oil glut.

The thrust of my thesis here is that today’s oil production “cuts” barely register on a quantum scale, oil producers are near maximum output, and still the oil price is heading up. Any supply disruption could bring prices much higher. It looks like we are in a long term oil bull market.

In any case, the 1980’s glut, which had serious consequences for the oil price, has been completely wiped from Wall Street’s collective memory from a 1-2 punch of the oil crashes of 2008 and 2014. Even so, the oil glut of the 1980’s was much more extreme than either of those market events.

Ever since the oil crash of 2014 particularly, reports of inconsequential production cuts by the Organization of the Petroleum Exporting Countries (OPEC) have been big stories, but they are nothing compared to production cuts that happened in the 1980’s. Those were real, major production cuts that today’s “cuts” don’t even come close to.

First, some historical context. The oil crash of the 1980’s began in earnest in November 1985 and ended in March 1986. Over the space of 5 months, oil fell nearly 70%. Now, some will see that number and make the objection that the crashes of 2008 and 2014 were more extreme by percentage. True, oil fell by 80% in 2008 and 75% in 2014 from top to bottom, more than oil’s fall in 1986. But the oil crash of 1986 outdid the crashes of 2008 and 2014 in one very important respect. The fall actually reflected seriously falling oil demand.

What, and 2008 and 2014 didn’t? Not really, not compared to 1986. Here’s why.

Take a look at this chart of global crude oil consumption going back to 1965.

oil consumption.png

Here you can see a small drawdown in oil consumption, or oil demand, in the mid 1970s due to the Saudi oil embargo and ensuing energy crisis, and then a more precipitous fall in the first half of the 1980’s. The rest of the chart is a consistent and smooth move higher except for a very minor blip in 2009 to 2010 due to the financial crisis. Notice, however, the complete lack of any fall in oil consumption during or after the oil crash of 2014.

Here’s an even more revealing chart. Same data, just a different way of plotting it.

oil consumption.png

Here you can see a small blip in oil demand during the 1970’s energy crisis, a tiny almost insignificant blip in the mid 1990’s, and a minor 1.5% fall in oil demand after the financial crisis. Again, no fall at all from highs after 2014. The most obvious feature of this chart though is a major and sustained collapse in oil demand as high as 10% in the 80’s. It wasn’t just one year either. The fall from highs lasted almost the entire decade.

What is the significance of this observation? I would make the case that the minor falls in demand in the 1970’s and 2008 were not results of phenomena intrinsic to oil. The fall during the 1970’s was politically motivated and artificial, a result of the involvement of the United States in Israel’s Yom Kippur War with its Arab neighbors. As for 2008, that could be said to be mostly a monetary phenomenon due to a liquidity crunch that drove up the demand for US dollars, and therefore drove down the dollar price of oil. Demand for oil did dip a little bit, but not significantly, at least not compared to the 1980’s.

Oil production didn’t noticeably fall around 2008 outside of mere long term chart noise. See production out of Saudi Arabia for example post financial crisis. There is not much of a change.

Saudi Arabia Crude Oil Production

2014 doesn’t even make a mark on the long term chart.

In the 1980’s though, oil production not only fell. It underwent a bona fide colllapse. Saudi Arabia’s oil production for example cratered a dizzying 80%. Now focus in on the end of the chart above. Saudi Arabia’s current oil production is right near all time highs, despite all the talk of production cuts. The world’s leading oil producer has very little capacity to expand current oil production.

With no significant sustained slack in oil demand since the 1980’s and laughable production cuts despite media coverage of every sound bite out of OPEC, there seems little chance of any near term oil slump, especially with Iranian oil about to be taken off the market come November. Combine that with the continued collapse of Venezuelan infrastructure, the country with the largest known oil reserves in the world, and the possibility of a near term high in the dollar, and you have a recipe for steadily higher oil prices.

Disclosure: I am/we are long XLE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.