Crude Oil Price Collapse of 1986
Description:
Faced with declining world oil demand and increasing non-OPEC production, OPEC cut output significantly in the first half of the 1980s to defend its official price. Saudi Arabia, which played the role of swing producer in the cartel, bore most of the production cuts. Saudi Arabia crude oil product, which peaked at over 10 million barrels per day for the period October 1980 through August 1981, fell to just 2.3 million barrels per day by August 1985. In late 1985, Saudi Arabia abandoned its swing-producer role, increased production, and aggressively moved to increase market share. Saudi Arabia tried a netback-pricing concept, which tied crude oil prices to the value of refined petroleum products. This reversed traditional economic relationships by guaranteeing specific margins to refiners, thereby transferring risk from the crude oil purchaser to the producer.
In response, other OPEC members also increased production and offered netback-pricing arrangements to maintain market share and to offset declining revenues. These actions resulted in a glut of crude oil in world markets, and crude oil prices fell sharply in early 1986.
Industry Action/Reaction:
By July 1986, the average per-barrel free on board (F.O.B) price for OPEC crude oil had dropped from $23.29 in December 1985 to $9.85, and prices for crude oil from non-OPEC countries were following a similar path.
The collapse of crude oil prices in 1986 reversed the upward trend in U.S. production of the first half of the decade. Many high-cost wells, which became productive after the oil crisis of 1978-1980, became unprofitable in 1986 and were shut in. Domestic crude oil production began dropping in early 1986. After the world price fell more than 50 percent between January and March 1986, drilling plummeted. Since then, domestic drilling and production have gradually declined.
The net effect of the decline in domestic production beginning in 1986 was an increase in crude oil imports, which climbed from 3.2 million barrels per day in 1985 to 9.1 million barrels per day in 2000. Most of this increase was met by OPEC, whose share of total U.S. crude oil imports rose from 41 percent in 1985 to 60 percent in 1990, before dropping to 46 percent in 1995-1997. Since 1998, the share has gradually increased, reaching 51 percent in 2000.
Oil company investments began shifting to foreign oil exploration and production after the 1986 price drop.(28) Foreign fields are generally much larger than in the United States and average production costs are lower. Changes in policy in the former Soviet Union since 1991 have increased U.S. production investment there, (29) and recent moves toward foreign investments in Mexico have attracted American exploration and production companies. (30)
Results:
The sharp drop in crude oil prices pushed U.S. petroleum demand steadily higher in the second half of the decade. From 1985 to 2000, demand climbed from 15.7 million barrels per day to 19.5 million barrels per day.
Until 1986, the value of U.S. petroleum imports comprised between 15 percent and 32 percent of all imported goods. The steep decline in petroleum prices in 1986 reduced petroleum's portion of the U.S. trade deficit.
The economy expanded at a faster pace in 1987 and 1988. Low petroleum prices stimulated growth in industrial production, employment increased,(31) and travel picked up. Temporary conservation measures that had been instituted during earlier oil price escalations were discontinued. The overall energy intensity of the economy (measured by the ratio of total energy consumption to the constant dollar level of the Gross Domestic Product), a reflection of energy conservation,(32) did not increase between 1986 and 1988.