Stuck in a Multi-Year Oil Demand Downturn?

Increasingly the economists and politicians discussing the current economic downturn are referencing the early 1980s recession, or in some cases the 1973-74 recession. Both of these recessions were hard and lasted about 16 months, whereas the current recession is only 13 months old, but is already a challenging one. There has also been talk by economists and stock market seers about how the current recession could morph into the next Great Depression. Unfortunately, a Great Depression comparison
provides little help for investors trying to understand how energy markets might be affected. The International Energy Agency (IEA) in its recent oil demand forecasts has been commenting that the back-to-back declines of 2008 and 2009 would mark the first time for that to occur since 1982-1983, some 25 years ago.


In our November examination of the possible future course of the U.S. drilling rig count, we used the 1980s downturn to plot how the current rig count downturn might unfold if this one were similar. At the time, we speculated that if this cycle’s rig count fall followed the 1980s downturn pattern, we were at risk of losing about 1,000 rigs from peak to trough. Now, we are seeing and hearing estimates that this rig downturn will be so severe, largely because of how low natural gas prices have fallen and the absence of a catalyst for them to rise soon, that the rig count could fall to a low of 800 active rigs. We have had discussions with various drilling company management teams who suggest, based on the rate of weekly rig count declines that we could reach that target sooner rather than later. It’s amazing how, when things come unglued, the outlook rapidly shifts to the catastrophe scenario. Maybe it’s because people want to emulate President Obama.

If the U.S. rig count reaches the 800 working rig number sometime this year, the drilling industry will have lost about 1,200 active rigs from its peak activity level last fall. With that many rigs going idle, it will be extremely difficult for drilling contractors to sustain profitability and if a contractor has significant debt levels, companies may have issues with remaining in business. On the other hand, the level of optimism within the drilling contractor fraternity that this downturn will be quick to rebound is keeping managements focused on where the geographic strength will be on the upside.

The key question, however, is will the global economy remain depressed for several years making the energy demand forecasts of almost all analysts wrong, and suggesting that 2010 will be another down year for energy consumption rather than a year of demand recovery? As we have pointed out before, the 1980s downturn actually lasted for four years. The peak in oil demand came in 1979 and growth resumed in 1984. It was not until 1989, however, that global oil use exceeded the total consumed in 1979. Could a multiyear oil consumption downturn happen today?

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