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Black Swan Event: The Drop in Oil Prices

March 20, 2020

With the dramatic drop in oil prices, are we likely to see economic conditions similar to 2015–16? In this week's TrendsTalk, learn the steps you should take in the face of this black swan event.

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Transcript by Rev

Alan Beaulieu:
Hello, everyone. This is Alan Beaulieu, President of ITR Economics, and we're glad that you're with us today for another one of our trends talks. We want to talk to you about oil today and the price of oil, the kerfuffle going on with Saudi Arabia and Russia and what it means to the United States. And perhaps kerfuffle is too light a word. The question becomes is this 2000 and 2015 and '16 again? Are we really going to do that again? And what does that mean to us? Today's oil price right before this broadcast on March 11th was $33.34 a barrel, West Texas Intermediate. And the low point in the 2015, '16 troubles was on January '16 at $33.62 cents. So we're slightly below where we were then. Will we see the same problems is the big question of the day.

And if this continues, I'm afraid the answer will be yes. Now here at ITR, the team is extremely busy working on COVID-19 and working on the oil crisis to see what the impact will be, whether we will have to change our forecasts. Most of you know that we do not forecast and cannot forecast black swans. And at the moment we have two black swans upon us, so we were running all the algorithms and everything that we know how to throw at it to see whether we will have to change our outlook for the second half of 2020, and if we do by how much, and will it impact 21?

Stay tuned, we'll get back to you on all of that. But let's get back to oil right now. At low 30s for a price of oil, there's only five companies that are in the United States that have drilled wells that are going to be profitable. Those would be Exxon, Occidental, Chevron, and Crown Quest Operating LLC. When we look at other 100 plus companies out there, they're in trouble. And the outlook seems to be that if this lasts 60 to 90 days, there's going to be a lot of trouble in the oil industry.

There's a lot of debt already, and we can expect that if this goes 30, 60 days, we'll begin to see more credit problems, perhaps more bankruptcies and this could begin to look a lot like 2015, '16 where there were employment problems. Certainly the output of oil drops dramatically in the United States as companies stop producing because they're losing money or they're no longer there to produce. The new profitability floor seems to be around, and this is not absolute, so please take it in the spirit in which it's giving, approximately $50 a barrel for profitability among most producers.

We're a long way from that. Watch oil carefully. At the moment, it does not look like oil's going to be making a strong rebound to $50 a barrel. And if it does not, that could change the face of oil output in the United States. Fracking has certainly saved the day. It has certainly produced a lot of oil. We've seen a dramatic increase in our output, which has allowed us to export oil. But if we can't do it profitably, we probably won't do it, which would be a shift of power back to Russia and back to Saudi Arabia, which when you think about it, may be exactly the goal. If this Russian move to not go to the table and talk with Saudi Arabia about output has an effect on Saudi Arabia, that will not be pleasant either. Saudi Arabia cannot produce as cheaply as Russia can because of their Vision 2030 program, while Russia can probably produce profitably in the low 40s. So with the United States and Saudi Arabia needing something higher than that, Russia can probably outlast us in a waiting game.

The trouble is what is the impact? What is the blow back? How much will the politicians tolerate and how much can the economy stand? Those are unknowns. At the moment, I would suggest that you look at your business, please, in terms of what happened in 2015 and '16. What do you wish you had done differently? What do you wish you could have known, and therefore been proactive about or just stopped doing? Be ready to do that. If this begins to drag on, be ready to implement the I wish I hads and be ready to stop the things you wish you had stopped. Be ready to act quicker than you did last time. We're trying to do the same thing. Make sure that you are ready to face the pressures that'll be on the energy industry, whether you're an engineering firm or you're providing sand, cement, whatever it is that you do. We're at a really dangerous point in your industry right now.

And because it's political, we have no economic answers for you, which leaves us feeling very frustrated indeed, since we like to be able to do what we can to help you with the future. I was particularly struck by the fact that a client of ours, and I don't have permission to mention their name, was hurt in 2015 and '16 to the point where they said, "Never again." So that company has worked hard to diversify their company so that their portfolio of businesses is much less oil and gas than it was before. Still very important to them, but much less so that in this downturn it'll be annoying, but it will not be very painful.

Now perhaps that's one of the overriding lessons of this fear that is upon us with oil and with COVID-19. What should we be doing differently to protect ourselves with COVID-19? Connor Lokar expressed it beautifully in a previous podcast where he said, "Look for near sourcing. Look for alternative sourcing. What are the lessons that we could learn so that our supply chain is not disrupted or that the disruptions are minimal?" And the same thing with your dependence upon the oil industry, if that's you. What can you do to lessen that dependence on the oil industry? And if you can't, what can you do about driving efficiencies so that you can be profitable at lower levels of activity?

And I don't mean just drillers, I mean engineering firms and everything associated with the industry. What can you do if the amount of demand for your company dries up so that you can continue on in business and continue to be profitable? Being liquid is certainly important. Having less debt is certainly important. Driving efficiencies ruthlessly is certainly very important. And having a plan B seems like a great idea. Thank you for listening. We will certainly get back to more about oil prices in blogs and on our social media outlets. Please keep tuned and we'll let you know as soon as we know what the end of this is going to look like. Thank you. Have a good day.

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