There has been unprecedented volatility in both supply and demand for oil during the past three or four years. After a very strong year in 2019, the menace of COVID-19 saw oil demand decline by nearly 20%, and prices collapse. Producers, wherever possible, shut in and capital expenditures dried up. Climate alarmists celebrated while continuing to discourage oil production and limit both equity capital and lending..Notwithstanding that, oil demand will set a record by the end of 2023. Security concerns and a mix of common sense and common practice have seen the hydrocarbon complex remain above 80% of all sources of energy, consistent with many recent decades. But as investment languishes — for good reason — this has not translated into stock market metrics, as last year's 10% contribution of the S&P’s total profitability of energy companies only represents 5% of market capitalization. And Canada’s multiple of cash flow generates only half the share price valuation of similar US enterprises. There remains a lot of valuation upside..DEMAND IS GROWING.Energy consumption for the last 56 years has grown on average more than 3%. As pointed out above, hydrocarbon’s component of the energy mix has been remarkably stable, with oil in particular remaining at roughly 36% of the total..What has changed dramatically, however, is the emerging world is now responsible for at least half of that annual growth of oil consumption. It's an inconvenient fact, especially for those who wish otherwise, there's a one-to-one relationship between population growth and oil consumption. World production per capita has been consistently flat for 30 years..Importantly, nor is the solution to GHG anxiety to attack production and use in the upstream in the advanced world. Emissions grow despite trillions invested in renewables: climate crusaders must somehow convince the large and growing populations of the emerging world they cannot enjoy the same lifestyle as we in the advanced world enjoy..And a further point too often overlooked is 80% of emissions are the result of consuming hydrocarbons. The only real solution is to reduce demand which will in turn reduce supply. The anti-industry protagonists live at the wrong end of the pipelines..SUPPLY SECURITY REQUIRES INVESTMENT.There are many dynamics influencing the current and future supply of petroleum. We cannot remind ourselves too frequently lack of investment is not an option as the global supply of oil declines 5 - 6% annually. The industry requires capital just to stand still..Given the current upstream uneasiness to allocate growth capital, the reticence of conventional lenders, and the unpredictability of energy policies, oil investment — which averaged about $500 billion per year before 2015 — since declined to a range of $300 to $400 billion. Even before recent further production quota reductions, OPEC countries produced less than the almost 40 million barrel quota by almost two million barrels per day. Russian supply has — or will — inevitably decline..Following a decade of remarkable growth from the horizontal multi frac revolution (HMF), growth prospects in the US and Canada remain tepid. To lower the growing risk of capital constraints, companies are paying down debt, buying back shares, and paying out dividends. By design, there's limited growth capital allocated by boards and management teams..Where will inadequate supply come from?.Heretofore unwisely assumed, security is now driving most countries. The German experience with its Russian supplier has been informative. This led to partial acceptance, but even more confusion, with respect to the top down driven “energy transition.” The mixed message includes the United States which achieved one of the few emission reduction successes when significant coal consumption was replaced by a mix of natural gas and so-called renewables..The Inflation Reduction Act, misnamed and understated as to costs, is a bold intervention by the US federal government to advance the transition objective while upsetting trade relationships with important counter-parties. Can the global energy system be transformed by subsidies?.The Biden administration requested more oil and gas production while persistently pledging to eliminate the industry. It reduced the Strategic Petroleum Reserve security blanket after, for a second time, cancelling the final leg of the Keystone XL pipeline that would have supplied almost the same level of oil on an annual basis..Instead, the president went on his knees to Saudi Arabia after calling it “a pariah state,” not surprisingly receiving a chilly reception. Even more confusing is asking Venezuela to restart sanctioned production. More recently the administration approved a long-awaited and significant Alaska oil project, albeit smaller. Does anyone understand this logic?.None of this encourages investors..PRICE DISCOVERY.The pandemic and Russian aggression greatly enhanced the natural volatility of an important commodity. The downward pressure was enhanced as put option derivative holders rushed to exit causing prices to decline further. Biden “borrowing” from the SPR was a successful political tactic by reducing short term prices, but a poor strategy for energy security..What has become clear is a structural long term supply deficit from chronic under investment. Even as the moderation of China's growth rate remains uncertain, its recovery from its medical shutdowns, and India's record consumption, will likely increase future demand..There's consensus demand growth this year will reach 2.3 million barrels per day, exceeding 102 million bpd, a new historical high for annual demand..At the same time there's increasing recognition the amazing growth of oil and natural gas production in the US cannot continue after production more than doubled in the decade 2009-2019. Most shale basins were peaking and it's widely anticipated the prolific Permian, showing reduced well performance in many areas, will inevitably also decline. As per a Wall Street Journal article, “the recent degradation of well performance stoked executive and investor concerns about the industry's runway for growth.".There are many reasons why oil prices may continue to languish. These possibilities include uncertainty in China, a global recession, continued Russian production, industry recovery in Venezuela and Nigeria, and new production from Angola. Bullish price dynamics include the loss of Russian production, continued OPEC under performance, SPR replenishment, economic recovery, and most of all, chronic under-investment..To sum up, let's take the final word by the Oxford Institute for Energy Studies: “Oil has always assumed a special position within the energy complex. Oil is a global mature market with many interrelated physical and financial layers, diverse set of players both on the demand and the supply side and has dealt with many shocks in the past. Nevertheless, 2022 generated new types of shocks and the oil market has not been immune from government interventions which added new layers of uncertainty.".The recent Saudi led OPEC cutback of at least a million bpd perhaps portends forthcoming global economic weakness. It's also likely a deliberate repudiation of US energy policy, and maybe a personal rebuke of the president. It is certainly another “government intervention,” a surprise if not a “shock.” It lays in a price floor for oil in the short term while awaiting the inevitable impact of the structural supply deficit..Stay tuned for higher prices..Herb Pinder is a Saskatchewan-based private equity investor.
There has been unprecedented volatility in both supply and demand for oil during the past three or four years. After a very strong year in 2019, the menace of COVID-19 saw oil demand decline by nearly 20%, and prices collapse. Producers, wherever possible, shut in and capital expenditures dried up. Climate alarmists celebrated while continuing to discourage oil production and limit both equity capital and lending..Notwithstanding that, oil demand will set a record by the end of 2023. Security concerns and a mix of common sense and common practice have seen the hydrocarbon complex remain above 80% of all sources of energy, consistent with many recent decades. But as investment languishes — for good reason — this has not translated into stock market metrics, as last year's 10% contribution of the S&P’s total profitability of energy companies only represents 5% of market capitalization. And Canada’s multiple of cash flow generates only half the share price valuation of similar US enterprises. There remains a lot of valuation upside..DEMAND IS GROWING.Energy consumption for the last 56 years has grown on average more than 3%. As pointed out above, hydrocarbon’s component of the energy mix has been remarkably stable, with oil in particular remaining at roughly 36% of the total..What has changed dramatically, however, is the emerging world is now responsible for at least half of that annual growth of oil consumption. It's an inconvenient fact, especially for those who wish otherwise, there's a one-to-one relationship between population growth and oil consumption. World production per capita has been consistently flat for 30 years..Importantly, nor is the solution to GHG anxiety to attack production and use in the upstream in the advanced world. Emissions grow despite trillions invested in renewables: climate crusaders must somehow convince the large and growing populations of the emerging world they cannot enjoy the same lifestyle as we in the advanced world enjoy..And a further point too often overlooked is 80% of emissions are the result of consuming hydrocarbons. The only real solution is to reduce demand which will in turn reduce supply. The anti-industry protagonists live at the wrong end of the pipelines..SUPPLY SECURITY REQUIRES INVESTMENT.There are many dynamics influencing the current and future supply of petroleum. We cannot remind ourselves too frequently lack of investment is not an option as the global supply of oil declines 5 - 6% annually. The industry requires capital just to stand still..Given the current upstream uneasiness to allocate growth capital, the reticence of conventional lenders, and the unpredictability of energy policies, oil investment — which averaged about $500 billion per year before 2015 — since declined to a range of $300 to $400 billion. Even before recent further production quota reductions, OPEC countries produced less than the almost 40 million barrel quota by almost two million barrels per day. Russian supply has — or will — inevitably decline..Following a decade of remarkable growth from the horizontal multi frac revolution (HMF), growth prospects in the US and Canada remain tepid. To lower the growing risk of capital constraints, companies are paying down debt, buying back shares, and paying out dividends. By design, there's limited growth capital allocated by boards and management teams..Where will inadequate supply come from?.Heretofore unwisely assumed, security is now driving most countries. The German experience with its Russian supplier has been informative. This led to partial acceptance, but even more confusion, with respect to the top down driven “energy transition.” The mixed message includes the United States which achieved one of the few emission reduction successes when significant coal consumption was replaced by a mix of natural gas and so-called renewables..The Inflation Reduction Act, misnamed and understated as to costs, is a bold intervention by the US federal government to advance the transition objective while upsetting trade relationships with important counter-parties. Can the global energy system be transformed by subsidies?.The Biden administration requested more oil and gas production while persistently pledging to eliminate the industry. It reduced the Strategic Petroleum Reserve security blanket after, for a second time, cancelling the final leg of the Keystone XL pipeline that would have supplied almost the same level of oil on an annual basis..Instead, the president went on his knees to Saudi Arabia after calling it “a pariah state,” not surprisingly receiving a chilly reception. Even more confusing is asking Venezuela to restart sanctioned production. More recently the administration approved a long-awaited and significant Alaska oil project, albeit smaller. Does anyone understand this logic?.None of this encourages investors..PRICE DISCOVERY.The pandemic and Russian aggression greatly enhanced the natural volatility of an important commodity. The downward pressure was enhanced as put option derivative holders rushed to exit causing prices to decline further. Biden “borrowing” from the SPR was a successful political tactic by reducing short term prices, but a poor strategy for energy security..What has become clear is a structural long term supply deficit from chronic under investment. Even as the moderation of China's growth rate remains uncertain, its recovery from its medical shutdowns, and India's record consumption, will likely increase future demand..There's consensus demand growth this year will reach 2.3 million barrels per day, exceeding 102 million bpd, a new historical high for annual demand..At the same time there's increasing recognition the amazing growth of oil and natural gas production in the US cannot continue after production more than doubled in the decade 2009-2019. Most shale basins were peaking and it's widely anticipated the prolific Permian, showing reduced well performance in many areas, will inevitably also decline. As per a Wall Street Journal article, “the recent degradation of well performance stoked executive and investor concerns about the industry's runway for growth.".There are many reasons why oil prices may continue to languish. These possibilities include uncertainty in China, a global recession, continued Russian production, industry recovery in Venezuela and Nigeria, and new production from Angola. Bullish price dynamics include the loss of Russian production, continued OPEC under performance, SPR replenishment, economic recovery, and most of all, chronic under-investment..To sum up, let's take the final word by the Oxford Institute for Energy Studies: “Oil has always assumed a special position within the energy complex. Oil is a global mature market with many interrelated physical and financial layers, diverse set of players both on the demand and the supply side and has dealt with many shocks in the past. Nevertheless, 2022 generated new types of shocks and the oil market has not been immune from government interventions which added new layers of uncertainty.".The recent Saudi led OPEC cutback of at least a million bpd perhaps portends forthcoming global economic weakness. It's also likely a deliberate repudiation of US energy policy, and maybe a personal rebuke of the president. It is certainly another “government intervention,” a surprise if not a “shock.” It lays in a price floor for oil in the short term while awaiting the inevitable impact of the structural supply deficit..Stay tuned for higher prices..Herb Pinder is a Saskatchewan-based private equity investor.
