How Low Is Too Low for Oil Price?

How Low Is Too Low?

          A field operator was checking his calendar, smiling. The man, who was still in his coverall, has concluded the last day of his shift rotation in an oilfield in Southeast Asia. He has pictured the face of his pregnant wife who was going to deliver their baby 2 weeks in advance. His boss, however, unexpectedly made him waiting a little longer as he was ordered to directly report to the office. "Just one more day, what's the matter?” thought the wishful husband. It did matter.

         They were sitting face to face. The boss, who looked unusually pale, whispered a devastating but absolute decision that the worker was fired. Their company was thriving to survive as the oil price decreased. The soon-to-be-father's heart was agonizingly shattered; the timing of the verdict could not be worse. In a tearful way, he ultimately begged his boss to keep the news secret to anyone else but them. He did not want his pregnant wife, something his boss did not know until that very meeting, to hear any of this since he was afraid she could suffer from mental shock. His boss, a husband and a father himself, eventually let him keep the job until his child was born. The decision, though not the most satisfying, was relieving enough for the unease husband. Later, he would see himself becoming a father, but not a field operator any longer.    

          The dramatized but fact-based story above illustrates the current condition faced by vast number of oil companies and several countries depending on petroleum to keep their finance balanced. During the 2014-2015 period when West Texas Intermediate (WTI) price radically dropped from $107.08 to $44.8 in only a mere of 7 months’ time, the once heavenly prosperous oil companies were agonizingly hurled into the pits of hell, spreading a wave of dread as the words “low oil price environment” jeopardized the black gold industry. A mammoth number of 200,000 people were axed in this painful oil catastrophe.  

          However, before you put the current situation into your most updated list of 10 most terrifying nightmares, please be seated and take a deep breath as we are about to have a more unblemished standpoint on that. Let us start from the fundamentals: Are we really that low? How low is “low”?

          Obviously, an appropriate price baseline is required in determining “low” and “high”, and historical data may serve as an undeniable scientific basis on that matter. The compiled WTI price data, as seen Figure 1, however, may dissatisfy several fuss enthusiasts as it is evident that the recent condition is anything but extraordinary. During a period of 29 years until present day time, most of the WTI price line lies below $50 price tag. Statistically speaking, the average price of that period is $42.85, somewhat near from the current price. Furthermore, we may also notice that in 2008, not quite long ago, WTI was traded for as low as $30.28 per barrel after a severely rapid decline from $122.61 just 3 months earlier.

Figure 1: WTI price 1986-2015

          The main benchmark in most Europe, Brent Price, follows an analogous story as displayed on Figure 2. After traded below 50 USD for the majority of 27 years’ time, Brent started to climb above $50 on 2005 until it reached a sky-high record of $143.95 in 2008. It was then followed by an abrupt plummet as it touched $39.9 only 7 months in advance before gradually rebounded until its price was above $100 once again. During period of 2014-2015, it heavily dropped from $101.2 USD to $46.5, presenting a scenario largely similar to WTI.

Figure 2: Brent price 1988-2015

          Judging from above data and analysis, a knowledgeable oil & gas expert is not required to conclude that the so-called terror called “low oil price environment” is nothing more than a shallow rumor. History has revealed that the world, in point of fact, has been accustomed to oil price below 50 USD per barrel. A sharp fall in the price is also something the industry is, or at least has to be, familiar with as it occurred less than a decade ago. Hence, rather than claiming that oil price has gone from “normal” to “low”, it is more scientifically acceptable to state that the price has moved from “high” to “normal”.

          Hold on right there, on what basis can we define the standard for “high, normal, and low” oil price? In this case, however, history will once again be our best teacher as its data will become the fundamental of our deeper statistical analysis. In our means to group the price into three as seen on Figure 3 and 4, 33.3% and 66.7% percentiles are utilized.

Figure 3: Categorization of WTI Price

          Quite shockingly, the analysis from 29 years of WTI price data shown in Figure 3 exposes that the price is considered high when it reaches a little above 50 USD. Below that level, as long as it is higher than 20.29 USD, we will have normal WTI price, which is exactly where the price currently stands. Rewinding to Figure 1, we may see that WTI never actually touches low price after 2014, a period on which “low oil price environment” is recurrently pronounced.  

          Brent price follows a similar pattern as observed in Figure 4, with the borders of low-normal and normal-high price are 19.4 USD and 54.11 USD respectively. Earlier in 2015, it seemed that everyone loses their mind as the Brent was around 40s and 50s USD, claiming that the price has dropped far from normal. The claim was barely backed by science, however, as it is apparent that the price perfectly stood on normal price all the time, never being even near of the low oil price. In fact, Brent was in high price for the whole April and May 2015, as it was traded above 55 USD all the time.

Figure 4: Categorization of Brent Price         

          As a revelation has descended in the form science, we now possess tougher analytical foundation to hinder ourselves from clicking panic button every time oil price propaganda merges as the standards for “low, normal, and high price” have been scientifically defined. Following up that conclusion, however, are question marks subjected to oil companies and some oil-dependent nations: Have they learnt from those past events? What have they prepared during heavenly period to ready themselves when things return to normal?

          Oil was, is, and will always be, an unforgivingly volatile business. Everyone involved in that industry should be completely aware of it. For oil workers, as inconvenient as it can be, it is always more advisable to have Plan B for the anticipation of never-stable oil price environment. Also, it should always be in top management's mind that the corporations they are running have to be prepared for any disturbance in the industry. Shareholders, meanwhile, need to further realize that their investment may not always guarantee smooth stream of cold hard cash. They should not drain too much dividends during high oil price, leaving their corporations dry during tougher times. In the end, we should all learn to history or else we are doomed to repeat it.

29 October 2015

Aldinal Rachman 

Data source: US Energy Information Administration (EIA)

www.eia.gov