This Time It’ll Be Different
Or will it? We’ve been through oil busts before. But that doesn’t mean we’ve learned our lesson.
Late last June, the price of a barrel of oil, which stood at $108, began to slide. By July 14 it had dropped to $102. By August 19 it had reached $94. But it wasn’t until autumn, when West Texas Intermediate crude—the benchmark for U.S. oil prices—slid below $90, that producers and investors began to worry. The price kept slipping. On November 26, it stood at a measly $74. Then, a day later, on Thanksgiving, OPEC announced that, contrary to the hopes of many, it would do nothing to cut production. Oil went into a tailspin. By early January, the price of a barrel had sunk to $48, less than half of what it sold for just six months earlier.
That’s the sort of precipitous decline that changes everything—hiring practices, driving habits, consumer purchasing decisions. As if on cue, oil companies slashed jobs and drilling budgets. Permits for new wells fell 50 percent in November from the previous month. Bloomberg News wrote of a coming oil “storm.” But in Texas, people were thinking of another word that still sends chills down spines from Kilgore to the Permian Basin: bust.
It’s been almost thirty years since Texas has experienced a boom-bust cycle as extreme as this one. Sure, in the late nineties oil dropped below $11 a barrel, touching off a string of mega-mergers that brought us the likes of ExxonMobil and ConocoPhillips. And in 2008 the global recession caused oil to plunge from $145 a barrel to less than $40 in six months. But those busts weren’t preceded by frenetic, dancing-in-the-gusher booms.
The best parallel to what’s happening now is the boom and bust of the eighties. At the beginning of the decade, Texas loomed large in America’s response to the OPEC oil embargoes that had panicked the country during the seventies. Never again, we vowed, would people line up at gas stations in the wee hours hoping to get a tankful before the stuff ran out. To encourage domestic production and discourage consumption, Jimmy Carter deregulated the price of crude, which jumped from around $16 in 1979 to almost $40 by the end of the next year. Drilling increased across the country, especially in Texas, where the average annual rig count rose from 770 to more than 1,300 in just two years.
The sudden wealth that followed defined a new Texas in the eyes of the world (with a little help from J. R. Ewing) and made our economy the envy of the nation. By 1982 the Houston Chronicle was shipping its classifieds-heavy Sunday papers to Michigan, where one newsstand owner reported selling nine hundred copies a day to eager job-seekers in the unemployment-ravaged Rust Belt.
Everyone wanted to cash in on the boom. Few tried harder than Bill Brosseau, a Dallas dentist turned oil and gas promoter, who sat smiling on the September 1981 cover of Money magazine for its “Moneymakers of the ’80s” feature. Dominating the photo: Brosseau’s snakeskin boots with “BB” monogrammed on each. The story line, which Brosseau hawked to any media outlet that would hear it, was that he had been born poor and, having gotten into the University of Texas on a basketball scholarship, was determined to get rich. Dentistry proved too boring, so he decided to drill for oil instead of cavities.
Amid all the ostentatious displays of wealth, a lot of real drilling got done. By 1985 the U.S. had managed to boost its production by almost 420,000 barrels a day—a significant increase for a country whose fields were thought to have peaked years before.
But the boom’s success sowed the seeds of its own failure. The increased oil production caused a glut and, as always happens in such circumstances, prices fell dramatically. The Saudis tried to maintain oil’s high price, slashing production from 10 million barrels a day in 1980 to 3.8 million by 1985. It didn’t work, though, because other OPEC members refused to follow suit, and production from new fields in the U.S., Britain, and Norway kept downward pressure on prices. Eventually, the Saudis reversed course and pumped more oil. The fallout in Texas was swift and devastating. Crude tumbled to $10 a barrel in 1986. By 1989 the number of rigs working in the state had shrunk to 206.
So much of the state’s economy was tied to oil and gas extraction—it accounted for 19 percent of our gross domestic product in 1981—that the price collapse took much of the Texas economy with it. In Houston one out of every seven workers lost his job. Developers across the state found themselves overextended, their buildings unleased and houses unsold. As properties went into default, the state’s banking industry took a dive as well. Savings and loans had provided easy financing for anyone who wanted to drill a well or build an office tower, and by the end of the decade, nine of the state’s ten biggest banks had failed. Given that more than a quarter of the state’s tax revenue was tied to the oil industry, when the Legislature convened in 1987 it faced one of the worst budget shortfalls since the days of the Republic.
The recovery didn’t begin until the early nineties, and the energy industry is still feeling the effects today. Companies that slashed their employee ranks to the bone back then now find themselves in need of engineers and other highly skilled workers. Many of the most senior people who survived the boom are beginning to retire—known in the industry as “the great crew change”—and companies are scrambling to replace them. Banking, too, was fundamentally altered. With our homegrown institutions devastated by the bust, big out-of-state banks swooped in, and they still dominate the financial landscape. As for Bill Brosseau, in 1997 a federal judge in Dallas declared that he was “just a con man” and sentenced him to five years in prison for securities fraud.
Today, with Texas once again on the downside of a boom, there’s a tendency to claim that things are different this time—and in many ways they are. For starters, our financial system is much sounder than it was in the eighties. “We don’t have the underlying instability like we did with the savings and loans,” says Boyd Nash-Stacey, an economist with BBVA Compass in Houston. “The overall financial sector isn’t feeding the entire oil and gas industry.” Money for new wells is less likely to come from banks than from private equity firms and junk-bond dealers. That means the pain of any losses will be spread globally among investors, instead of being carried by local banks.
Another change that will soften the blow is that the booms and busts of the past thirty years have tamed some of the industry’s swagger. Companies are more focused on minimizing financial risk than they once were, and producers in the shale say they have lowered costs significantly. William Thomas, the chief executive of EOG Resources, a major producer in the Eagle Ford Shale, told investors recently that the company can make money at as low as $40 a barrel. If that’s true, the Eagle Ford could continue churning out 1.6 million barrels a day, about the same as the output of Qatar.
And it certainly helps that the state’s economy is more diversified than it was. These days, the manufacturing sector (including, yes, petroleum refining) and the tech and health care sectors play a bigger role in the economy than they used to, and finance and real estate have grown as well. It will likely take a while for the effects of cheaper oil to ripple through the rest of the Texas economy. Nash-Stacey’s forecast for Texas’s economic growth over the next year and a half has dropped from 5 percent to 3 or 3.5 percent. But that’s still a growth rate most states would kill for.
While the price drop will hurt producers, it will help the refineries and petrochemical plants dotting the Gulf Coast, because they will pay less for raw materials. Meanwhile, cheap natural gas—an earlier result of the fracking boom—is attracting tens of billions of dollars for construction of liquefied natural gas export terminals along the coast. Those projects are going to continue regardless of fluctuations in oil prices. “We’re going to have this split between the upstream decline and this massive construction boom that’s really built on cheap energy,” says Bill Gilmer, the director of the Institute for Regional Forecasting, at the University of Houston.
But there’s another difference between the eighties and today that cuts against all this optimism. As big as the eighties boom was, this one is bigger, which means it could take an even harder fall. Back then, that nation-wide 420,000-barrel-a-day increase took five years. This time, daily production in Texas alone jumped 552,000 barrels between 2012 and 2013. With two of the country’s three largest oil-producing formations—the Eagle Ford and the Permian Basin—located here, Texas has become one of the world’s largest oil producers (which is one reason for our current glut and the expected bust). We added more than 19,000 oil and gas jobs in 2013, the highest number in the nation, and almost six times as many as runner-up New Mexico.
The Texas economy may be more diversified than it was back in 1985, but oil and gas extraction now account for 14 percent of the state’s GDP, compared with 10 percent in 2010, when the fracking boom began to kick in. That means a bust could really start to hurt. “If oil stays at its current price for a sustained period, it would result in one-hundred-forty thousand fewer jobs created in Texas this year,” says Mine Yücel, the senior vice president and director of research for the Federal Reserve Bank of Dallas. We’re already seeing shrinkage in the energy sector. BP and Hercules Offshore have announced plans for job cuts; ConocoPhillips has slashed its 2015 capital budget by 20 percent; and in November Halliburton said it would buy rival Baker Hughes in a $35 billion deal that echoes some of the major oil company mashups of the late-nineties bust.
The workers who don’t lose their jobs will have plenty to worry about too. As companies’ finances come under pressure, safety and maintenance budgets can suffer and the risk of accidents goes up. “When oil prices fall, activities that are not core to the business tend to be the first to be cut,” says Ian Sutton, a chemical engineer and risk consultant.
Then there’s the public sector, which may take a hit as well. State budget writers based the 2015 revenue estimates on $80-a-barrel oil. The recent price plunge could cause some painful recalculations in Austin this spring.
Of course, the bust may not last that long. T. Boone Pickens, for one, believes that the slump will be relatively short-lived. “I think you’ll be back up to ninety dollars a barrel in twelve to eighteen months,” he says, citing the likelihood of an uptick in global demand. Pickens has made and lost billions being right and wrong about the timing of booms and busts in oil and natural gas. And that may be the most important lesson from Texas’s recent, checkered history: most predictions are wrong. Perhaps, as the familiar refrain goes, it will be different this time. Or perhaps it will be almost exactly the same.