Dateline January 2015: The Perilous Plummet

The week of January 26, 2015, saw the price of a barrel of oil drop below $45. It has been a perilous plummet from a high of $100.52 just six months ago. If you ask a Goldman Sachs trader, they may tell you the price will probably continue to decline to as low as $30. If you ask an Iranian oil minister, he may tell you the industry might endure a further slump toward $25. Funny thing – if you had asked a trader at Goldman Sachs or an Iranian oil minister the same question 17 years ago in 1998, they may have had the same negative sentiment: “The price of oil is going down, and it is going to stay that way for a while. So just you tighten your belt!”

If we pinpoint the beginning of the commercial oil industry as Edwin Drake’s 1859 machine-drilled well near Titusville, Pennsylvania, then we can say with confidence that oil prices have always known dramatic growth and decline. Mr. Drake did indeed touch off the first major boom, soon to be followed by the first major shock a few years later due to the US Civil War. Indeed, technical innovation, commercial interests, geo-politics, and war have always driven the booms and busts of the oil industry.

The Seven Ages

For clarity, we will define the “Seven Ages of Oil” as those periods in time that saw oil price growth followed by periods of accumulated average price decline of greater than 30% (all prices adjusted for inflation to 2014 dollars). These price climbs and subsequent descents can be extremely dramatic in the short term, as demonstrated by the current 55% drop over the past six months. Or, it can be more gradual as with the multi-year decline from a high of $110 in 1979 to less than $25 in 1994. Similarly, oil prices reached an astonishing near all-time low in 1998 at just over $17 before reaching an all-time high of $140 in June 2008, only to fall once again below $40 by the end of the year. Clearly, oil trading is a high stakes endeavor not fit for the faint of heart. Let us then describe the Seven Ages of Oil in an attempt to discern some measure of commonality or predictability.

  1. 1859-1870: Illumination Births an Industry
  2. 1870-1911: Rockefeller Creates the Multinational Oil Standard
  3. 1911-1921: A Pax on Arabia
  4. 1921-1973: Texas Oil Boom in the Gusher Age
  5. 1973-1994: The Middle East Shrugs its Shackles
  6. 1994 -2008: Deregulation, Speculation, Manipulation, and Detonation
  7. 2008-2015: All Fracked Up
Figure 1 – US oil price fluctuations throughout the Seven Ages of Oil (1859-2015)

Figure 1 – US oil price fluctuations throughout the Seven Ages of Oil (1859-2015)

Figure 2 – Percentage fluctuations throughout the Seven Ages of Oil (1859-2015)

Figure 2 – Percentage fluctuations throughout the Seven Ages of Oil (1859-2015)

1859-1870: Illumination Births an Industry

When Robert Edwin Dietz produced a modern kerosene lamp in 1853, thousands of whales breathed a short sigh of relief. Illuminants, lubricants, and solvents prior to the commercial introduction of oil were obtained from a variety of natural sources including the much persecuted whale and sometimes exploited plant resources. There was limited production of petroleum or gas from coal, asphalt, coal-tars, and shale. It was another Edwin, not Dietz, but Drake who ushered in the Age of Illumination by oil. Edwin would drill the first commercially owned well in Titusville, Pennsylvania, in the year 1859. The 69-foot (21 m) well was drilled for the Seneca Oil Company.

The first yields of 25 barrels per day fetched a pretty premium at the equivalent of $2,000 per barrel – not so surprising given the expensive process of making oil and the high consumer demand for this new luxury product. Production grew sharply in Pennsylvania, and prices dropped nearly tenfold in a single year. In 1859, two thousand barrels were produced. In 1860, half a million barrels were produced, quadrupling by 1861 to more than two million barrels. Correspondingly, prices dropped into the teens before the US Civil War (1962-1964) and brought on the first oil shock. Subsequently, with a massive surge in demand for all commodities generated by the war effort, constriction in oil supply, blockages of turpentine from the south, and a larger tax on alcohol (then a competing illuminant), prices escalated well north of $120 per barrel the following year.

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