By Robert L. Hirsch.

The recent world oil supply/price decline situation looks very much like what happened in 1985-86, when the Saudis dramatically increased oil production, causing world oil prices to crater.  That Saudi action was the result of their having acted as swing producer in OPEC, which under those circumstances caused a progressive loss of theiroil market share.  Back then, I was at ARCO and was provided the unwanted “opportunity” of reengineering ARCO’s upstream R & D program – Read, “fire a number of very good people.”

In those years, the Saudis maintained high production, and it took roughly a decade for oil prices to regain their previous levels. Other producers refused to cut production, and it took increasing world oil demand to bring a supply/demand balance that eventually resulted in increasing oil prices.

What motivates the current Saudi action to crater oil prices?  Analysts suggest a number of possibilities, including a desire to cripple US light tight oil (shale) production; an effort to hurt Iran with which Saudi is in conflict; and/or a desire to hurt ISIL, Russia, and Syria.  Or it could be all of the above.

As in the mid-1980s, it is conceivable that Saudi might maintain high oil production for many years, forcing oilprices to remain around $40-50 per barrel, possibly lower.  If that were to happen, the US and world tight light oilenterprise would be decimated, a number of deep-water and expensive frontier projects would be suspended or canceled, and heavy oil production in Canada and Venezuela would falter, to name just some of the obvious.  Rigs would be idled and could eventually be scrapped; a large number of service contracts would be canceled; people throughout the industry would be laid off and seek employment outside the industry; and royalties would be lost.  US GDP would be negatively impacted, and U.S. oil imports would increase, negatively impacting the U.S. balance of payments.

Outside the US, prolonged low oil prices would significantly damage Iran, Russia, and other oil exporters, possibly even to the point of civil unrest.  ISIL and Syria would be impacted but their situation is so complicated that it is uncertain how they might farep.

The current reduced oil price environment is different from the mid-1980s in significant ways.  First, the Saudi “neighborhood” is especially unsettled, because of the “Arab Spring,” widespread terrorism, and Iranian adventurism.  MENA OPEC countries are under significant, unusual pressure, so meaningful rebellion within OPEC is possible.

Secondly, there is a “twist’ this time.  A number of analysts believe that the world is close to the onset of world oilproduction decline, often called “peaking.”  In a worst case scenario, the onset of decline could start after 2015, when U.S. and world high-cost oil production capability will have been significantly degraded, making catch-up much more difficult than it might have been just a year ago.

Finally, that so-called “tax cut” that U.S. consumers are supposed to have received because of lower oil prices would not only evaporate, but a sudden increase in oil prices could cause a recession and immediate inflation.

“May you live in interesting times”!

PS.  After this note was drafted, I received the latest issue of World Oil in which Kurt Abraham made the same connection to the mid-1980s situation in an editorial entitled “Numbers help explain Saudi mindset on global production.” January 2015.

PPS.  Rarely in human history has one country had the ability to inflict such a large impact on the economies of so many other countries with just the turn of a valve.

PPS.  What might happen if the house of Saud is overthrown and unfriendlies take charge of the Saudi oil valve?  Before the onset of decline?  After the onset of decline?

PPPS.  What can we learn from this event to help us understand how Saudi might behave after the onset of worldoil production decline?