"Far Worse Than 1986": The Oil Downturn Has No Parallel In Recorded History, Morgan Stanley Says

Tyler Durden's picture

On Tuesday the market got yet another reminder of just how painful the "current commodity price environment" has been for producers when Chesapeake eliminated its common dividend in order to conserve cash.

After noting the plunge in Chesapeake’s shares (to a 12-year low) we subsequently outlined why the US shale "revolution" is now running out of lifelines as hedges roll off and as the next round of credit line assessments looms in October.

A persistent theme here - as regular readers are no doubt aware - has been the extent to which an ultra-accommodative Fed has contributed to a deflationary supply glut by ensuring that beleaguered producers retain access to capital markets. In short, cash-strapped companies who would have otherwise gone out of business have been able to stay afloat thanks to the fact that Fed policy has herded investors into risk assets.

In a ZIRP world, there’s plenty of demand for new HY issuance and ill-fated secondaries, which means the digging, drilling, and pumping gets to continue indefinitely in what may end up being one of the most dramatic instances of malinvestment the market has ever seen

Those who contend that the downturn simply cannot last much longer - that the supply/demand imbalance will soon even out, that the market will clear sooner rather than later, and that even if the weaker hands are shaken out, the pain for the majors will be relatively short-lived - are perhaps ignoring the underlying narrative that helps to explain why the situation looks like it does. At heart, this is a struggle between the Fed’s ZIRP and the Saudis, who appear set to outlast the easy money that’s kept US producers alive.

Against that backdrop, and amid Wednesday's crude carnage, we turn to Morgan Stanley for more on why the current downturn will be "worse than 1986." 

From Morgan Stanley

Worse than 1986? Really?

We have been expecting the current downturn to be as severe as the one in 1986 – the worst for at least 45 years – but not worse than that. Still, if oil prices follow the path suggested by the forward curve, our thesis may yet prove too optimistic.

Our constructive stance on the majors is based on four factors: 1) supply – we expected production growth to moderate following large capex cuts and the sharp decline in the rig count; 2) demand – we anticipated that the fall in price would boost oil products demand; 3) cost and capex – we foresaw both falling sharply, similar to the industry's response in 1986; and 4) valuation – relative DY and P/BV indicated 35-year lows.


So far this year, we can put a tick against three of them [but] our expectation on supply has not materialised: US tight oil production growth has started to roll over, but this has been more than offset by OPEC, which has added ~1.5 mb/d since February. 

On current trajectory, this downturn could become worse than 1986: An additional +1.5 mb/d is roughly one year of oil demand growth. If sustained, this could delay the rebalancing of oil markets by a year as well. The forward curve has started to price this in: as the chart shows, the forward curve currently points towards a recovery in prices that is far worse than in 1986. This means the industrial downturn could also be worse. In that case, there would be little in analysable history that could be a guide to this cycle. 



[There are] strong similarities between the current oil price downturn and the one that occurred in 1985/86. The trajectory of oil prices is similar on both occasions. There were also common reasons for the collapse. 


A high and stable oil price in the preceding four years stimulated technological innovation and led to a high level of investment. This resulted in strong production growth outside OPEC, exceeding the rate of global demand growth. When it became clear that OPEC would no longer rein in production to balance the market (as it did during both the Nov 1985 and Nov 2014 OPEC meetings) the price collapsed. 

And although MS notes that similar to 1986, costs and capex are likely to come in sharply while demand growth should materialize, the supply side of the equation is not cooperating thanks to increased output from OPEC. 

Due to the sharp slowdown in drilling activity and the high decline rate of tight oil wells, we expected production in the US to flatline and start declining in 2H. This seems to be happening: according to the US Department of Energy, tight oil production in June was 94 kb/d below the April level, and it forecasts further falls of 90 kb/d in both July and August.


Now that capex is falling, we anticipated non-US production to be flat at best. Still, this has not yet been the case. At the time of our 'Looking Beyond the Nadir' report in February, OPEC production stood at ~30.2 mb/d. This increased substantially to 31.3 mb/d in May and 31.7 mb/d in June, i.e. OPEC has added 1.5 mb/d to global supply in the last four months alone.


Our commodity analyst Adam Longson argues that the oil market is currently ~800,000 b/d oversupplied. This suggests that the current oversupply in the oil market is fully due to OPEC's production increase since February alone. 

We anticipated that OPEC would not cut, but we didn't foresee such a sharp increase. In our view, this is the main reason why the rebalancing of oil markets had not yet gained momentum.

If oil prices follow the path suggested by the forward curve, and essentially remain rangebound around levels seen in the last 2-3 months, this downturn would be more severe than that in 1986. As there was no sharp downturn in the ~15 years before that, the current downturn could be the worst of the last 45+ years.


If this were to be the case, there would be nothing in our experience that would be a guide to the next phases of this cycle, especially over the relatively near term. In fact, there may be nothing in analysable history. 


Needless to say, this does not bode well for everyone who has unwittingly thrown good money after bad on the assumption that the Saudis will cut production and trigger a rebound in crude.

In addition to the immense pressure from persistently low prices, US producers also face a Fed rate hike cycle and thus the beginning of the end for easy money.

Of course, the more expensive it is to fund money-losing producers, the less willing investors will be to perpetuate this delay-and-pray scheme, which brings us right back to what we've been saying for months: the expiration date for heavily indebted US drillers is fast approaching, and if Morgan Stanley thinks the oil downturn has no parallel in "analysable history," wait until they see the carnage that will unfold in HY credit when a few high profile defaults in the oil patch send the retail crowd running for the junk bond ETF exits.

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BoPeople's picture
BoPeople (not verified) Jul 22, 2015 3:34 PM

Now that the futures hedges are coming off, they can really ram the price into the ground.

Pinto Currency's picture



Wait until the run on currencies starts from the deflationary debt crash.

Good luck buying oil with paper or digits.

Antifaschistische's picture

I don't want to sound like a broken record....but in 1986 the real estate market in Houston got completely wiped out...Condo's selling for $15,000, darn nice homes going selling under 100k.

There is absolutely  no hint of that now in Houston...real estate prices are still on full-retard mode, and nice homes built in the mid/late 60's are being mowed down every single day in 77024 to make way for the 8,000 square foot, "my ceilings are higher than your ceilings" homes.

as for me....I can't wait for mean regression...the sooner the better, but as of today, Houston skyline is still loaded with cranes and a race to build as fast as they possibly can.

Jumbotron's picture

Think what a bargain you'll get in North Dakota come spring time.

aVileRat's picture

Yes it is worse than 87, and 83. In fact you have to reach all the way back to 1860 and the brief 1931-33 period to figure this one out. And given that most of the majors will require fresh credit roll over and drilling capital for the 2016 drill programs, this could get nasty. Most bonds are pricing that debt will be rolled over at the same terms, with at best 500 basis point moves for some of the most horrible offenders of debt binge drilling. Those were financed at 80/bbl projections on Par. Most corporates have locked in their hedges down at the low 60's. (all USD). For some corporates the capital programs needed to keep production flat, plus roll their bonds over at the 80/bbl interet rate are nearly 4x their current cash flows.Yet most HYG still trades at 80/100 or better.

This sailent fact is what is keeping the 51 billion in special situations PE money on the sidelines. Who wants to buy into the next GDP or PVA ? and then see a 50% haircut in 6 months. Very few on a standard 5% WACC (going to 8). That is also what keeps most of the major Pensions, Endowments and bond managers awake at night. What happens when a BBB+ rolls the yield at 300 bps. What happened to the money markets when nobody knew what was economical.


MonetaryApostate's picture

I believe that banking institution are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs. - Thomas Jefferson

There are two ways to conquer a nation. One is by the sword. The other is by debt. - John Adams


Jumbotron's picture

All of which means that the Shale boys HAVE to keep drilling the fuck out of the plays just to have ANY kind of revenue stream.

Which reinforces the glut and drives the price down....and on and on and.......ooopsies.

Squid-puppets a-go-go's picture

insistence on maintaining a strong dollar is what gutted the american export sector

strong dollar now means nothing but perpetuation of americas urban decay

sounds like a good reason to stack to me.

cnmcdee's picture

It could be worse, they could have a market capital like Twitter at $24 Billion but produce nothing at all..  There is so much stupid money in the markets right now it is unfathomable, really.

Bibi is going to start a war here pretty soon, and then the price of oil will skyrocket back to $200 / barrel. Just watch, nukes are gonna fly in 2016.

HardlyZero's picture

YES !! 100% correct.  The recently established shale production in ND and a handful of other states, must run at a loss (very hot) just to keep shale oil production volumes up.  As a moth goes to the flame and gets burned, the shale production (in 2015) will cause massive overproduction and may completely collapse the price of oil worldwide, until either shale production shuts down or OPEC production shuts down or rest of world shuts down production.  On top of that there may be the largest deflationary spiral ever due to the 7 years of LIRP, ZIRP, and NIRP; so, all the false cities and false economies with shadow demand will now collapse and dry up.  

So, both massive Oil overproduction and massive loss of (fiat built-up) actual demand and fake demand...concurrently !!  wow.



But it might take 1 year, 5 years or 10 years to burn through all that misallocation, with many small flame-outs along the way ?

Tall Tom's picture

Yeah...Sell at an operating loss and then make it up in volume of sales.



GRDguy's picture

Mining companies are doing just that, right now.

Tall Tom's picture

No shit.


It is not just Oil Drillers and Miners.


Stock Prices are elevated by Corporations acquiring insane amounts of debt to finance buybacks of Stock in order to keep share prices elevated.


There is no production.

There is no demand due to lack of liquidity.

They cannot create enough QE as the existing Finance fess cause insolvencies.



We are cooked.

cnmcdee's picture

Saudi Arabia makes sweet at $12 barrel.  They can do this all day every day for the next 15 years.  Canada makes sweet at $50 / barrel and moved quickly to devalue their dollar to make sure there oil industry does not get wiped out.  Shale makes sweet at what $80? a barrel?

The major players can outwait the next two years to starve off the weak members of the oil pack..  Then like magic it will start creaping back up.

Tall Tom's picture

You seem to miss the point.


This is noy just about Oil.


This is not just about Gold. Silver, Copper or Nickel.


This is not just about Stawcks or Bonbs.


And as for the price of Oil??? It will not take that long.


$20 in Novenber followed by $200 next July...that is right...July, 2016.


Of course Gold will be at $1000 in November and by July, 2016 it will be at $5000.


Good luck enduring the HYPERINFLATION..


Deflations hisorically precede them.

new game's picture

courtesy of da fed -ZIRP up the arse, but hey someone was behind all these hy loans and trades,

S.A, vs the fed, yup the two major players, one with goods and the other with fiat. interesting...

carnage along the way, an economic battle in the war against humanity courtesy of da bankster cabel of econ hitmen...

JoWazzoo's picture

OPEC is the cause of this.  1.5 MB/day added since February.  That oil was and is not needed.  They know that.  But for that, oil would be 55 - 65 and US producers would not get creamed.  But that IS the goal of OPEC.  They also caused the 80s problems.

Sam Spade's picture

The Saudis made no secret of their intentions here.  It amazes me that investors underestimated their resolve, or simply didn't believe them. 

Zoomorph's picture

Saudis have a bigger war chest than the shale producers and could certainly sustain low prices for much longer, plus debt roll over is not a major factor in their decision-making, pricing out competitors however is, shale being the first. And if history is any guide, Saudis could play their role in collapsing another competitor, only this not Russia, but US. Russia most certainy suffers, but will benefit along with Saudis when prices recover and shale boom is done for.

new game's picture

they are making tons of cash at 59, 49 and even 30. who will win? ha...

sun tzu's picture

US oil production also increased 1 MB/day since last summer, going from 8.5 MBd to 9.5 MBd

Why is it that OPEC should be the ones to cut production?

Arnold's picture

It's just a theory of mine, but the revulsion that the Arab world has for POTUS, both as a man and as a weak wrist-ed leader, is the heart of many of our international woes.

POTUS legacy building is epic.

jerry_theking_lawler's picture

So, are saying that financial engineering is coming to an end in the oil patch? And if so, will it spread?

I hope it YES to both. Ready for a real economy to sprout out from the ashes of this bastardized beast.

HardlyZero's picture

Yes. But it may take 5 years for the fiat financed excess shale Oil production to top-out and die off. 

So it might be 10 years out before green shoots come out of the 'burn-out' ashes and rubble.

Tall Tom's picture

That is highly unlikely. It shall be far worse.

Tall Tom's picture

Ready for an economy to sprout out from the ashes and embers of a Thermonuclear Holocaust? Laughable in a macabre sense.


The outcome of the financial predicament will be DISMAL at best...and FATAL at worst.


I do not foresee a return to anything which we have ever knowm. Lack, destitution, and famine are actually the best that one can hope for.


The survivors will be healthy, strong, and laborers in the fields to eek out a meager survival.


Most skills which people have in a post collapse society will be without a market. Financialization and innovation will become forgotten vestiges of a prosperous past.


Hundreds of Millions, if not Billions, will die as a direct result of the Economic Collapse. The victims claimed will be your progeny, your relatives, your spouse, your friends, and many other acquaitances.  NOBODY will escape this unscathed. . And if it does degenerate to Nuclear War then it will be an Extinction Level Event.


You had best be prepared for this horror, mentally, physically and spiritually.


And I just do not believe that you have considered the impact of what you desire.


Is that really what you want? If so, then for what reason?


I am looking forward to this. And I have thought it through and I do have my reasons. Do you?


This is not just addressed to you, but, it is addressed to all that read it.


What are your reasons for desiring the consequential pain, suffering and death upon the unworthy?


Or is your statement and position not well thought through, flippant, lacking any moral foundation, and the truth is that you really do not want any of that?

NoPension's picture

I've thought long and hard.
To me, the species ( human) does not deserve to exist in an overpopulated real life version of Idiocracy.
I just want to be around to see some of the arrogant fuckwad entitlement whores suffer. I won't have to go far. I'm married to one.

They fucking made me like this.

Salah's picture

I remember that.  And a reversion to the mean is just about here; Neptune's in Pisces = oil found everywhere by damn near everybody.  Until 2026.

bbq on whitehouse lawn's picture

You are missing the malinvested point. Companies no longer need to produce. Financial creativity is enough to float all boats. Fraud is now legal. So if you dont need to do anything but sell shares to the various central banks, pention funds and play computer games with the price discovery.
Thats why you can have a company that produces at a lost because oil selling is not what that business does, all business now sell, debt to the markets.
The whole world is now a vertual simulation of markets.
Reality has no place in it. Everyone will become to big to fail since they all are chained togather.
The value of money may not continue if there is no expectation of getting paid in it. What is the value of debt that cannot be paid in full only in depreciated payments that are ever extended and reduced. Thats how this all ends, death of money.
It can end no other way. Like a hole in the belly matters not how often you eat.

mkkby's picture

They still have to pump oil to make their debt payments. 

That is what everyone is missing here.  The saudis have to pump to pay their people not to revolt.  The shale idiots have to pump to service their debt.  The russians have to pump to maintain the gov and military.  Iraq/iran have to pump to not be broke.

Because of all the debt nobody can stop until they go broke.  The winners are the banksters, of course.  And consumers who don't have jobs in the oil patch.

Lyman54's picture

The same thing happened in Alberta in the 1980's.  You could buy a house for a dollar just by assuming the mortgage remaining.  Some properties only had 5 or ten years left on their mortgage.  At lot of houses were taken off the market by the banks and given to property managers to rent out.

cornflakesdisease's picture

They are also building apartments everywhere and the rents are increasing at breakneck pace.  I don't think this will end well.  They say folks are moving in from other states, but to do what jobs?  Crime is also up very very high with record theft and break ins in ALL parts of Houston.  From what I was told, most of those cranes are building jobs paid for with money that was borrowed two or more years ago so they have to finish.  The amount of commercial square footage comming on line in Houston to rent is more then most cities put together.



cnmcdee's picture

The price of a house was only marginally correlated to the price of oil, however 18% prime Reagonomics definitely put an end to the debt binge.  And this is going to repeat.  History repeats, repeats repeats..

Sam Clemons's picture

House prices are no longer driven by quality of the real economy.  They're driven by artificial liquidity and debt.  

We're going to see the crack up boom in real estate before this thing implodes.

InjuredThales's picture

Same thing in Calgary and Edmonton, which just makes me that much more scared that we will be that much more overbuilt when TSHTF.  Average commercial rents fell 2$ a sq ft (from $28 down to $26) in the last month in Calgary, and there is a shit ton of inventory that will soon be hitting the market. Edmonton is adding 20-25% more leasable commercial area in its downtown with no discernible uptick in demand from quality tenants.

I hope it won't be, but this could be unbelievably bad...


Carpenter1's picture

Billions invested in bonds of shale producers last 6 months. Laughing my ass off thinking about just how terrified those investors must be right now.


Jumbotron's picture

OH OH....

Qualcomm is in the shitter.

Firing 15% of its workforce.

"We are making fundamental changes to position Qualcomm for improved execution, financial and operating performance," said CEO Steve Mollenkopf in a press release. "We are right-sizing our cost structure and focusing our investments around the highest return opportunities while reaffirming our intent to return significant capital to stockholders and refreshing our Board of Directors."


HEHEH....yeah....right sizing.  No money to be made in premium Android phones as the likes of Mediatek and Samsung are eating away at that market.  Apple supplies their own ARM based designed  for their phones, so the high end is off the table.  And they have no ARM based micro-server plans to speak of.

Whoopsies.   Qualcomm is the Intel of the mobile world.


" Qualcomm also announced a partnership with hedge fund Jana Partners through which three members will be added to Qualcomm's board of directors. The company has been under pressure from the hedge fund to spin off its chip business from its highly profitable patent-licensing business."


Great....a fucking hedge fund manager on the board.  Now THAT'S a good sign !!    LOL !!


29.5's picture

Qualcomm also taking "heat" from their overheating 810 chip. 

cheech_wizard's picture

But will they shitcan their full-time employees or their H1-B Indian contingent?

I took a contract job with them about 3 years ago. I was the token white person with actual experience in my group.

Standard Disclaimer: Sweat shop and the illogical pursuit of a 64-bit ARM processor. The reference manual is over 5,000 hyperlinked pages in a pdf file... By comparison, the SPARC architecture manual (v9), although a bit dated is just under 200 pages.



cnmcdee's picture

Right sizing sounds like something McDonalds would do to my french fries if I dare buy any of the non-rotting entitities from the counter.  In 2000 I still remember Nortel Networks was the hottest crap since sliced bread there shares $100/per.  I personally knew people that invested $100,000 thinking that Nortel was going to go into China, was going to do this, was going to do that - blah blah blah.  The reality was whatever Nortel did was irrelevant.  Hot market money decided it was 'in' and money flowed into it by the billions. Today Nortel Network stocks are worth $0.00

Today hot money flows into Google and Twitter and Facebook by the billions.  $24 Billion market cap for Twitter?!  At least Nortel Networks produced a phone and run some fiber optic lines.  History repeats repeats and repeats,  I see twitter becoming worthless here in a year when the fad is over. I see facebook loosing 90% of it's share value. 

steelhead23's picture

I would assume that MS sent a forward copy of this to the FOMC because this information is likely to encourage the Fed to continue ZIRP.  Those with rose colored glasses should stop reading this comment now.

The U.S. economy is a virtual zombie, kept alive by easy credit.  Even those seemingly good numbers coming out of the car biz is simpy another credit bubble, including a huge amount of high risk credit.  Let's use autos as a metaphor here.  If interest rates increase, tight oil producers would not be able to roll their debt and would go bankrupt.  U.S. oil production would decline.  If OPEC did not fill the supply gap, prices would rise.  If they did fill the gap, the U.S. trade balance would get worse, but let's assume OPEC sits tight (not a great assumption, but I want to make a point).  The effect of increasing interest rates would be to reduce production.  Prices would then rise.  Now, let's look at our new car owner.  The increased cost of gas would consume more of his/her cash flow.  They could either buy less, causing an economic downturn, or default.  If either the economy goes down or defaults increase the Fed would be looking to juice the economy and would reduce rates, reinitiating ZIRP.  The Fed is a reactionary organization, not a leader.

Folks, we are in the throes of economic war and most of us haven't a clue as to the enemy.  It isn't really OPEC, but they may be an ally of the enemy.  The true enemy is the financial system itself - the big banks.  To the extent the Fed enables this behavior, it is part of the problem, not the solution.  Easy credit is creating dilemas that constrain policy choices.  By issuing too much high risk credit the banksters have made it tough for the Fed to raise rates.  Welcome to Japan.

From where I sit the best answer is a painful one.  The Fed should do a Volcker; raise rates and keep raising rates until credit is being created at a rate equal to or lower than economic growth.  Yes, there would be an absolute hemorroage in the markets.  Lots of folks would lose lots of money.  As long as this global Ponzi scheme continues we will be seeing rampant insider looting and other criminality because prosecution could cause the systemic collapse the entire regulatory apparatus fears most.  End ZIRP now!

Meat Hammer's picture

Whatver happened to ekm? I'd love to hear his take on this?

Dr. Engali's picture

Imminent never came so he slinked away....... again.

emersonreturn's picture

MH & DE,

or CIO.  he's been silent for a long while now.

r00t61's picture

His account was banned.


"Access denied.  You are not authorized to access this page."

Maybe he will / or has come back under a different name.

I also hope TruthInSunshine returns.

mkkby's picture

Yep, most of the scared rabbits predicting imminent doom slunk away like cowards.  I hope they are at least quietly reading, so they might learn something. 

The only moron I see left is Tall "nuclear war" Tom.  Hopefully he'll fuck off soon when the world doesn't blow up tomorrow.