Oil prices and layoffs

What now for the oil and gas industry's professional dimension?

It is, of course, too soon to declare $10/bbl oil yesterday's news. The possibility nevertheless looms that the recent layoff spree by oil companies will appear in retrospect to have been hasty.

Yet what are companies to do when their central commodity loses half its value in 2 years' time? Durable profitability is essential. Workers cost a lot of money. When oil prices slump, something must give, including payroll.

Startling numbers

The numbers, however, are startling. In its February Statistical Report issued this month, American Petroleum Institute estimates that in the U.S. alone the upstream oil and gas industry since December 1997 has shed 51,400 jobs-more than 15% of the work force.

Some of the loss, of course, relates to the regrettable trend of small producers forced out of business. Most of it, however, must reflect layoffs by large companies. Big producers seem to have felt the need to brace for a structural devaluation of crude oil such as that of 1986, start of a decade of both hardship and innovation in the petroleum industry. If so, they made excessive sacrifice to a misconception.

The current slump, however deep and painful, differs from the crash of 1986. It's a market phenomenon that will end when inventories, which swelled due to a demand reversal in 1997, return to normal levels in relation to consumption. The crash of 1986 was a long market slide aggravated by the inevitable abandonment of efforts by the Organization of Petroleum Exporting Countries to enforce price targets by creating shortage. It was structural in that it returned the market to supply management, which it always needs, and relieved it of ambitious price management, from which it always suffers.

Other changes that have occurred since then give the industry little reason to expect this slump to last a decade. However slowly supply adjusts to a demand slump, the market now reacts more quickly than before to upsets. Computerization and the maturation of derivatives trading turned it into a highly visible, rapid-response mechanism. When Iraq invaded Kuwait in August 1990, removing 4.5 million b/d of oil from total supply, the market adjusted within a few weeks. A comparable jolt 11 years earlier, occasioned by the Islamic revolution in Iran, created greater disruption that lasted much longer than the 1990 correction. So there's reason to expect even a major correction to run its course more quickly than it might have done in 1986, although downward supply responses obviously happen slower than the other kind.

What's more, OPEC members have more incentive than they did 13 years ago to stick to their production quotas. Operating costs for the most important members remain very low. But the costs of running oil-dependent nations increased in the past decade while those of commercial producers plummeted, which has moved oil-price pain thresholds closer to balance.

There is, therefore, more reason than usual to expect OPEC's agreement last week to cut production to last for at least a while. Ten-dollar oil hurts everyone and cannot last.

Decade of hurt?

So why have oil companies acted as though they expect another decade of hurt, laying off workers by the hundreds and thousands on the heels of an aggressive round of hiring? They must have ignored the ways their market and industry have changed and assumed that the future would duplicate the past. In a dynamically technical business like petroleum, operating as it does in an aggressively self-correcting market, assumptions like that are always wrong.

Uncertain as any OPEC agreement is, companies should recognize that they might be recruiting again sooner than they think. It's not too early to consider ways to ensure that this downturn's lasting legacy doesn't prove to have been a brain drain manifest in a generation of disaffected professionals off in pursuit of more-stable careers.