Crude calculation: Another decade, another oil bust

Thirty years ago, a steep slide in crude prices forced Larry Oldham to gut the payroll at his Midland oil company down to just himself and one other who worked as secretary, accountant and oil lease specialist.

His wife worked there, too, but the company didn't have the money to pay her. In that West Texas city, atop the ancient bed of petroleum called the Permian Basin, it seemed to Oldham that everybody owed somebody else a little money.

Survival instincts kicked in hard. But the oil bust of the mid-1980s still swallowed up oil companies, banks, real estate markets, and thousands of jobs in Texas, sending the state's roaring economy into a slump for years.

Oldham's company survived, but the mechanical beasts that drew millions of barrels of crude from subterranean Texas went still, and some repossessed drilling rigs were torn apart and sold for scrap, at pennies on the dollar. Worth only as much as their metallic hides, they became lifeless steel symbols of just how far the oil economy had fallen.

Now, after four years of leading the nation's job growth on a tidal wave of shale oil, Texas is beginning to hear echoes of the past. U.S. benchmark crude brought $54.11 a barrel last Thursday - a low for the year and barely half its 2014 high of $107.26 on June 20. The price recovered on Friday to $56.52.

Oil's fall in early 1986 was farther and faster - from a high for the year of $26.57 on Jan. 6 to a low of $10.42 on March 31, and only $12.78 by the end of June. Adjusted for inflation, the 52 percent January-June drop was about $27.

"I wish I could paint a rosy picture, but I'm a realist. This is my fourth downturn," said Oldham. "Everything's going to get pretty ugly. It'll take a couple of years for this to work itself out and get back on track."

In the first half of 1986 as in the second half of 2014, oil prices dropped by about half. But the 1980s bust lasted for years, and it wasn't until the early 1990s that prices began a halting recovery.

Texas, always the first to buff up when money pours out of oil fields, also has chronic bouts of pain from deep-diving oil prices, and now faces its third major slump since the one in the 1980s devastated the economy.

In the late 1990s, oil fell again because of financial turmoil in Asia.

And in 2008, crude prices cratered along with the global economy, down 75 percent from a record $145.29 a barrel on July 3, 2008 to $33.87 on Dec. 19, although a strong price recovery began early the next year.

This time around, economists, bankers, analysts and energy's financiers say the state is going to see thousands of job losses, billions less in capital investment, stunted economic growth and oil-company bankruptcies, depending on how long oil stays cheap.

At $55 a barrel, Texas could lose 128,000 jobs by the middle of 2015, even as other states that don't produce energy boost their payrolls by 1 million jobs next year, elevated by falling gasoline prices and greater purchasing power, according to Federal Reserve Bank of Dallas models of how oil prices affect U.S. job growth.

Rough road ahead

Across the planet, says Goldman Sachs, big oil companies may have to suspend up to $930 billion in oil projects. Analysts say 500 to 800 U.S. rigs may be sprung from the oil fields next year. And the highest-stakes credit markets, now heavily tied to the U.S. shale energy surge, are going through their biggest upheaval since the financial crisis six years ago.

In Texas, the economic factors that fueled the state's crash 30 years ago are eerily similar to the way things are now. About 11 percent of the gross state product is oil and gas, as it was in 1986, and 3.7 percent of Texas jobs were in oil and gas in 1985, as 2.7 percent are now, according to JPMorgan Chase & Co.

The state's $1.4 trillion economy pumped out 100 million barrels of oil a month this year, and the New York bank credits Texas with two-thirds of the growth in the U.S. shale-oil boom, which began in the previous decade when engineers figured out how to tap into long-trapped shale oil and gas reserves.

Texas' share of the nation's oil harvest has climbed from 25 percent to more than 40 percent over the past half-decade, giving it the most skin in the game as oil prices fall.

In 1986, the state's unemployment rate jumped to more than 9 percent, nearly 3 percentage points higher than the national rate at that time. Texas is in for another hard landing next year, JPMorgan said, and might even tumble into a statewide recession.

"There are some reasons to think that it may not be as bad this time around, but there are even better reasons not to be complacent about the risk of a regional recession in Texas," JPMorgan analyst Michael Feroli wrote in an economic research note last week.

Lower investments in the oil industry will slow and probably reverse growth in a sector of the economy that has been one of the biggest boosters of U.S. gross domestic product for four years. Spending on oil is expected to slow from $134 billion this year, after rising from about half that amount in 2009, to $122 billion in 2016, said Doug Handler, U.S. chief economist with research firm IHS Global Insight.

The state's housing market also sees big dips in home permits when U.S. crude prices fall sharply, and the current oil crush may hit the market as hard as it did in 1986 and in 2009, according to Barclays. In both years, housing permits trailed behind U.S. oil in sweeping downward arcs.

One of the things that will help Texas is that the expected fallout next year - the Dallas Fed's 128,000 projected job losses - accounts for just 1.1 percent of the state's total employment. That wouldn't be enough to slow Texas job growth to zero, as it is on track to add 390,000 jobs this year and added 295,000 in 2013, said Michael Plante, a senior research economist at the Dallas Fed.

'It won't sink the boat'

IHS Global Insight expects oil prices to remain low in 2015 but to begin cutting upward in 2016.

"This might take some wind out of the sails, but it won't sink the boat," said Karl Kuykendall, the firm's U.S. regional economist. "We're expecting it to have some downward pull on Texas, but we're not expecting it to be a repeat of the 1980s."

Since then, the elaborate financial system underpinning the state's oil industry has seen a seismic shift.

Only a few companies locked in prices for their oil production through financial hedging instruments, as many do now to protect against falling prices.

A change in the Texas constitution allowed big out-of-state banks to turn a patchwork of disconnected lenders into networks that trace their money to massive balance sheets in New York.

And Texas banks have shunned some of the loose lending practices of the 1980s. Now they don't tie loans to the wobbly value of drilling rigs. And they avoid what proved toxic for savings and loan banks and thrifts - making highly risky loans and participating in the same real estate developments they were lending to, a sort of double-dipping that had disastrous results.

"What was going on at that time was a wild and woolly, crazy thing," said James D'Agostino, former chief executive of Houston bank company Encore Bancshares. "The financial system was all in."

And it was the biggest domino to fall. But now, bigger banks are making more conservative loans, with more stringent rules.

But in this latest boom, oil companies have found a new source of eager money lenders.

Seven years ago, U.S. oil companies figured out how to tap into long-trapped oil and gas reserves in shale rocks, by combining horizontal drilling and hydraulic fracturing, the process of blasting open deep-buried shale with payloads of water, chemicals and sand.

It's an expensive process that has prompted many oil companies to outspend their incomes so they can goose oil fast enough to overcome the steep production declines in shale basins. It's the only way for some companies to keep enough cash coming in to pay off the debt they're absorbing.

Time to 'buy low'

The Federal Reserve has kept interest rates low since the financial crisis, prompting investors to seek better returns by pumping more than $200 billion into higher-paying - but risky - low-grade corporate bonds for energy companies.

The oil price tumble has put those energy bonds on track for their worst year since the crisis, according to Barclays. Prices for the U.S. energy sector's high-yield debt instruments, known as junk bonds because they carry high risk for investors, have dropped nearly 20 percent since June.

"The whole credit spectrum has been experiencing a significant amount of shock," said Shaia Hosseinzadeh, a principal at investment firm WL Ross & Co.

Some see it as a time to buy. Even as oil companies begin to hunker down as Oldham's Parallel Petroleum did in 1986 - likely laying off contractors and staff members - Oldham is looking to get back into the game.

He and some friends are positioning themselves to "make some strategic acquisitions in this downturn," Oldham said.

"It's a perfect time to buy, because you've got to buy low."