Steven Kopits is the president of Princeton Energy Advisors, and contributes guest posts to The Barrel.

In an interview with Bloomberg TV, BP CEO Bob Dudley took a bearish view on the price of oil, noting that the present feels like 1986, when oil slumped from $30 a barrel to $10 and did not recover until in 1990. “The fundamental supply and demand does remind me of 1986 a bit, where we could go into a period in this decade of lower oil prices,” Dudley noted, adding that prices may stay in a range below $60 for as long as three years. “It will be a long time before we see $100 again.”

I agree with Dudley: 1986 is the appropriate template for today’s oil market dynamics. However, the understanding of the precedent is incomplete, and the analogy, imperfect. The differences matter.

In 1986, as in 2014, oil prices had been high for many years, and OECD oil consumption had been falling — indeed, much more after 1980 than it has since 2008. Just as in 1986, oil prices collapsed due to a supply surge, not a global recession. But beyond this, the differences are material.

After 1979, Saudi-led OPEC decided to maintain high prices by cutting production, even in the face of rising non-OPEC supply from Alaska, the US Gulf of Mexico, and the North Sea. To maintain prices, the Saudis cut production in sequential rounds, with Saudi output ultimately falling from 10.3 million b/d in 1980 to 3.6 million b/d in 1985, according to BP’s own Statistical Review. As a consequence, by 1985 OPEC had approximately 13 million b/d of spare capacity — 22% of global oil consumption. Of this, 7 million b/d was in Saudi Arabia alone. When Saudi Arabia capitulated in 1986 and switched to a volume-based strategy, this spare capacity was deployed, depressing oil prices not for four years, but materially until 2003, when the surplus was ultimately consumed. This period, from 1985 to 2003, has a name: the Great Moderation.

For BP and others, this matters. In its 2014 Energy Outlook, BP correctly anticipates that supply will increase faster than demand (something which I did not). However, BP anticipates that OPEC will cut production to maintain prices. As I wrote earlier here on The Barrel: “Discipline could depend heavily on the Saudis, [nevertheless] such restraint may prove elusive.” And indeed, Saudi Arabia had not forgotten the Lessons of ’79. As a consequence, the kingdom has refused to cut production, and oil prices have plunged as a result. However, this also implies that no massive spare capacity has been created. Indeed, discretionary spare capacity remains around 2 million b/d — all of it in Saudi — and a pretty thin margin on 92 million b/d of consumption. Consequently, when Dudley compares 2014 to 1986, he is neglecting to account for diametrically opposed Saudi policy during the current period and the lack of spare capacity today as a consequence.

Moreover, demand responded sharply in 1986. If it responded as OECD demand responded in 1986, demand would soar to nearly 96 million b/d — a 4 million b/d gain — by mid-year.

Furthermore, supply would collapse. Based on the 1986 example, some 2.4 million b/d of conventional production would be expected to roll off in the next 12-18 months at current prices. Given that shale oil production is expected to peak around mid-year, the second half of the year could see a dramatic reversal in the supply-demand equation, potentially setting up the third oil shock in a decade. It is for this reason that OPEC’s Secretary-General Abdulla al-Badri recently stated that “if you don’t invest in oil and gas, you will see more than $200” when it comes to future oil prices.

For BP and other companies, getting the strategic context right is enormously important. If one believes oil prices will soon rebound, Dudley’s pessimistic view of the market may put excessive pressure on the company’s fabled deepwater group (notwithstanding Macondo, a tremendous collection of talent and capability). The company will over-react to the current downturn. Moreover, BP will under-react in shales and fail to sufficiently strengthen its position in shale oil during the relatively thin window when valuations are likely to be depressed.

On the other hand, if one believes in low prices for a long time, then the future of deepwater will be grim, and divesting the capital intensive (primarily deepwater) divisions of the company has to be on the table. And of course, low oil prices can only arise from continuing spectacular success in US shale oil production growth. US shale production represents three-quarters of global supply growth since 2005; without continued success in this arena, oil prices cannot remain depressed. This, in turn, suggests that BP should further expand its positions after the current spell of low oil prices has sufficiently weakened the independent US operators. By this line of thinking, the company can afford to wait before pouncing on targets.

Dudley is right. The correct precedent is 1986. But the differences with that time are as important as the similarities, and getting the analysis right will be critical going forward.

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