Drilling slowdown shows Paradox of Thrift in practice

— During the Cold War era, PBS producer Hedrick Smith, then a New York Times reporter in Moscow, wrote a book called The Russians. In it he described the chronic scarcity of everyday goods in that country in the Soviet era, and the long waiting lines when items became available. Frequently, Smith said, when Russian citizens saw a line forming, they queued up--often before they even knew what was on sale--just in case the item turned out to be something they needed.

It's not possible to know how much of the current oil patch downturn is traceable to E&P companies that are still showing solid profits from oil and natural gas sales, but like Smith's Russian citizens, for caution's sake have joined the lineup of 2009 budget cutters that plan to drill fewer wells "just in case" the economy sours even more than expected. But the consequences of such protective, basically healthy actions may have hurt industry as a whole, as economist John Maynard Keynes stated in his "Paradox of Thrift" principle, formulated decades ago. According to the principle, saving money individually actually undermines economic growth because it slows demand. In the 1930s Depression, if people feared a bank would collapse, they would flock there and pull out their money, thus provoking a collapse which might not have otherwise occurred. Translated to today's environment, industry's proactive moves on the hunch of a future slowdown may have caused some of the current sluggishness. There's no denying the current economy has slowed, and in the oil patch has done so more rapidly than many had projected just weeks ago. For example, industry estimates of the number of US drilling rigs that could be idled this cycle swelled from 200 to 500 widely projected in October to as many as 800, according to presenters at the Merrill Lynch and FBR Capital Markets energy conferences this week. The most recent guesstimate represents nearly 40% of the 2,031 rigs working in early September, according to Baker Hughes data. By contrast, the US rig count declined by about 550 during each of the downturns of 2001-2002 and late 1990s respectively. But the summits were also lower during those booms: the 2001 peak rig count was 1,293 and the cycle's trough was 747 in early 2002, while the late '90s high was 1,032 rigs in September 1997 and 488 at the trough in early 1999. While those valleys took at least a year to work through, observers say current events are snowballing at such breakneck pace that they expect an equally speedy upturn, as the effects of halted drilling show up in reduced production and higher commodity prices. This week a long-time Nabors executive projected the rig cycle bottom could occur as early as the end of February. And Halliburton recently said it sees the recession--at least in the oil patch--as "V-shaped," with a steep falloff followed by a quick upturn. Some say the shifts created by recessions result in greater efficiency. And yet another economic principle--Jevons' Paradox--states that efficiency increases lead to even larger increases in demand. But if industry executives are correct in their forecasts of a short duration for the current sluggishness, there may not be enough time for any major restructuring. For industry's sake, let's hope the executives turn out to be correct.