Texas Tech University

How does the current oil and gas price drop compare to other drastic decreases in history?

McKenzi Morris

April 6, 2020

Nikki Kantelis

Nikki Kantelis discusses how the lower prices will shape the future of the industry, especially for West Texas.

Texas Tech University's Nikki Kantelis, an assistant professor of practice in energy commerce in the Jerry S. Rawls College of Business, said while the declining prices are a supply issue stemming from the oil war in the Middle East, specifically Saudi Arabia and Russia, they also are, in part, attributed to a lack of demand resulting from COVID-19.

What are the short-term impacts of the drop in oil and gas prices?
Normally, you would expect to see some uptick in demand with low oil and gas prices. A big uptick in demand requires sustained low prices for structural and behavioral changes. This time, COVID-19 has destroyed demand (demand for travel, demand for manufacturing, demand at the retail level, etc.) which outweighs typical responses to price signals.

What are the long-term impacts we will see in the next few months and years?
If the low prices are sustained, domestic energy (oil and gas) will see a major and almost devastating collapse and re-structuring. However, that reduction should end the price war between the Saudis and Russia, and we should see some price rebound and a resurgent fracking industry, albeit at a lower level of production than in 2019-2020. Saudi Arabia and Russia cannot withstand long-term, low oil prices and simultaneously satisfy their domestic needs.

COVID-19 should not be a factor longer term, so demand should rebound, thereby saving refiners, midstream and retail from major re-structuring.

What influence does the COVID-19 outbreak have on oil and gas prices, especially as demand has dropped with more stay-at-home orders being issued?
The outbreak has led to demand destruction and negative price pressures, particularly for motor gasoline and jet fuel. It also has crushed refining margins, reduced volumes moving through infrastructure and resulted in lower midstream and retail income.

How does this price drop compare to other drastic decreases in history? What is unique about this situation?
Previous significant oil price collapses (1986, late 1990s and 2014) were different than what we see currently. Previous price collapses could be attributed to either an over- supply or "soft" demand. In the current situation, we have both an over-supply (overproduction and flooding of Saudi and Russian crude oil into market) and soft demand (COVID-19 pandemic means less travel, less manufacturing and thus less energy demand) issues. Both the supply and demand issues will have to be resolved prior to a return to market normalcy.

Do you expect prices to continue dropping in the coming weeks or will it start to pick back up soon?
Prices reflect the current supply/demand balance, as well as the expectations that Saudi Arabia will flood the market with more barrels of production, as threatened. Under this scenario, crude oil prices should bottom out at $15-20/barrel (barring any sort of OPEC production agreement) but we should expect to see continued lowering of gasoline retail prices until retail margins reach more normal levels. Currently, retail gasoline margins are quite high – the price of gasoline at the pump compared with wholesale prices for gasoline.

How do the declining prices specifically impact the West Texas and Permian Basin region as one of the largest oil and gas producers?
There are several Permian producers that will not survive the current price collapse. Those carrying too much debt and those with weak balance sheets are particularly vulnerable. Investors and operators currently are focused on free cashflow, and those who can cover their variable costs in the short run will continue to operate. However, we should expect continued cost-cutting, potential layoffs and significant cutbacks in capital expenditures during this challenging price environment. As has been the case in the past, we can expect some entities will opportunistically come in and buy assets and companies for "pennies on the dollar."

Is there anything else you would like to add?
We are all "waiting and seeing." It's hard to know the timing and when we might "get back to normal." Markets hate uncertainty, and we should expect oil and gas prices to continue to be volatile until we re-establish some normalcy. Unfortunately, none of us knows when that is likely to happen.