The alphabet soup of oil patch recovery

— The oil industry has always had buzz words and unique verbal shorthand. Remember the “Year of the MLP” (2007) and “Drill, Baby, Drill” (2008)?

During the last down cycle in 2008-2009, oil executives debated whether the recovery – when it came – would be “V”-shaped or “U”-shaped. That is, a relatively rapid bottoming of oil prices in the former instance, followed by a fairly quick rebound – or, alternatively, a steep falloff of oil prices, a plateau as the market got its bearings and settled out, and then a fairly rapid climb back up the price ladder.

It turned out to be a virtual “V” as oil prices – which if you recall reached about $147/barrel in July 2008 and then began drifting down – parachuted off a cliff after an economic collapse shook world markets that September and October. The industry also unraveled as the rig count tumbled and concerned CEOs reined in spending almost instantaneously even though they still had a full quarter to finish out the year’s budget and activities. Upstream capital spending for 2009 took a hard plunge and at least one company – Pioneer Natural Resources, then as today a large producer in the Permian Basin of West Texas and New Mexico – dropped to zero rigs for part of the year.

In any event, oil prices hit a trough in February 2009 and almost immediately began to turn around and increased, albeit gradually. By September 2009, a full year after the crisis had begun, oil was back up to the $70s/b and industry was gearing up for an activity resumption the following year. It took another roughly 18 months, but oil prices made it to the $90s/b and $100s/b level and with a couple of notable dips, largely stayed there for about three and a half years.

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But this time around,

to describe how this industry down cycle will recover. Some are talking about a “W” shaped recovery, where demand picks up as refinery turnaround season ends and more crude begins to be used, especially during the summer driving season. In that scenario, the price lifts modestly but then – as companies begin drilling or completing wells that were drilled but not completed, coupled with the sheer production capacity of an industry eager to start churning once oil prices hit even a modest $65 or so – producers may pull the trigger and start turning out lotsa oil again. And that may cause a repeat of the original scenario where prices plunge, producers get scared and stop producing, and so on.

Or, in an even more ominous letter, a few industry-watchers have posited an “L” shaped recovery, where the steep drop in oil prices does not recover for a longer term. This scenario depicts a market that has realized its fundamentals have permanently changed and that current and projected demand levels are not enough to balance the level of production growth that has occurred for several years now, notably from the US’ shale boom. Indeed, there are voices around that have claimed the landscape needs to get worse if it’s ever going to get better.

Under a “long-term low” scenario, what happens to oil markets? No one really knows in the present day. Things stayed low, long in the late '80s/early '90s, but it was a different world. One would think such a brave new world in today's environment might surely involve some sort of basic industry re-prioritizing. Some comical but improbable scenarios might involve government campaigns to encourage use of more fossil fuels, including purchases of gas-guzzling cars and less use of public transport. Those are highly unlikely, though, given current sensibilities.

More rational might be an every-company-for-itself attitude, leading to further consolidation on a wide scale as companies seek to conserve cash and get to a place where they can operate profitably at very low oil prices. In the late 1990s/early 2000s we saw just such a wave of mergers that brought together BP, Amoco and later Arco; Exxon and Mobil; Conoco and Phillips; Chevron and Texaco, and a rash of smaller independents which merged to become what was then known as "super-independents" such as Anadarko and Kerr-McGee (which Anadarko later acquired). A few thinkers are saying that might occur again, given impetus by the pending merger of Shell and BG.

So whether we’re really in a “low-for long” scenario – even despite recent encouraging signs that US production may be finally be ebbing – or a transition period that will bob around before stabilizing and turning up, is still really anyone’s guess. That is, until we figure out what letter we are.