Podcast: Whiplash!
Columbia Energy Exchange (CGEP): Oil Markets Experience Whiplash
Links to the full audio podcast:
CGEP website: here
Apple podcast app: here
Spotify: here
You can also listen in your favorite podcast player by searching for “Columbia Energy Exchange” or “Oil Markets Experience Whiplash”.
Host: Jason Bordoff, founder of the Center on Global Energy Policy and co-founding Dean of Columbia University’s Climate School
Guests:
Bob McNally, Founder and President of Rapidan Energy Group (Rapidan Energy Group)
Amrita Sen, Founding Partner and Chief Oil Analyst at Energy Aspects (Energy Aspects)
Arjun Murti, former Goldman Sachs energy analyst, current energy sector senior advisor and board member, author of Super-Spiked on Substack (@ArjunNMurti).
It was my honor and pleasure to join Bob McNally and Amrita Sen on the Columbia Energy Exchange (CGEP) podcast hosted by Jason Bordoff, published December 1, 2021. Links to the full audio are included above. I have summarized the Q&A for my portion of the podcast below. It is not a transcript, but rather a summary of key points I made. I would encourage you to listen to the full audio to hear the great insights from Bob and Amrita as well as my full remarks.
Summary of points I made during the discussion
Question from Jason Bordoff: Set the scene for what’s happening in oil markets today.
Answer from Arjun Murti:
I believe we are at the start of a what could be a pretty decent upcycle driven by an increasingly messy energy transition.
Fears of long-term oil demand erosion due to the energy transition is causing near-term oil supply shortfalls owing to less capital investment.
OPEC is nearly out of spare capacity; by early 2022 I think they will be down to their usual “minimal” levels of around 2 million b/d. OPEC tends to overstate its capacity.
There is still lots of potential non-OPEC supply that could be developed if incentivized.
However, after a decade of really poor E&P/energy sector profitability, traditional investors are saying “don’t spend” and ESG/climate enthusiasts are saying “keep it in the ground”.
It does not have to be such a tight environment, but it is an investment and policy path we are choosing.
We are setting up for a pretty volatile oil price period over the next 5-10 years.
The key question is what combination of price and ROCE is going to motivate companies to start investing again at a time everyone is saying don’t spend, but where the billions of people on Earth who like driving cars and consuming electricity are saying we want to demand the energy you produce.
It does not have to be this way: We are choosing a messy energy transition.
Q from Jason: Some people listening will say something like you just don’t understand S-curve adoption curves with EVs and that we have to address the climate crisis. The idea of rising oil demand is climate failure. Why shouldn’t we be more skeptical of the (constructive) oil demand outlook Bob just described?
Arjun:
No one is saying a long-term transition is either undesirable or will never happen.
I think the question is what is the pace and timing of the transition and what are the policy sign posts that suggest we are on-track or not for an energy transition.
It is much easier to create policies that kill oil supply than kill oil demand. In essence, the decline rate on supply is much sharper than the decline rate on demand.
Today, we have real polices (and investor demands) killing supply, while we have “fake” (or policy light) policies going after oil demand.
If oil demand is to peak and roll over this decade, the heavy lifting would have to come from fuel economy gains, with ramping EV sales impacting the 2030+ period.
There is no evidence that we are on-track for a step-change improvement in fuel economy this decade as the “SUV-ification” of our ICE car mix offsets any impact from the sale of what are otherwise more fuel efficient cars and light trucks.
I am bullish EV sales long-term, but thinking it will be as fast and easy to transition from ICE-to-EVs as it was in consumer tech for say landlines-to-mobile or DVDs-to-streaming is the definition of ludicrous mode.
It is a reality today that policies and investor demands are having a much more negative impact on oil supply than oil demand.
Q from Jason: Wasn’t shale supposed to be a short-cycle source of supply that could act as a swing supplier?
Arjun:
Shale is short-cycle and in my view there is still an abundant resource to be developed in particular in the Permian Basin.
The big issue is over the past decade shale E&Ps massively over-promised to investors the profitability they could achieve in shale drilling.
Versus promises of 30%, 50%, even 100% well-level IRRs, companies actually delivered a 0%—zero—corporate-level ROCE over the past five years on average. Shale has been a not-for-profit business!
Investors have reacted by saying at a time we are unsure about energy transition and the outlook for demand, we are certain that E&P companies have not been good stewards of capital. So don’t invest!
For most of my 30 year career, energy has had a 6%-15% weighting in the S&P 500. Today it is just over 2%, an irrelevant weighting that makes energy a sector an investor can simply ignore.
What motivates investors to come back?
You are starting to see that E&Ps have gotten the message on the need to improve corporate level-ROCE and capital returns (dividends and stock buybacks) to investors. The first three quarters of 2021 have been a good step in the right direction for E&Ps.
I believe we are at the start of what will be a multi-year ROCE super cycle for upstream players.
None of this is to say shale can’t respond and provide greater oil supply. We are trying to calibrate the oil price/ROCE metric that will motivate investors to say it is OK to start spending again.
We are probably getting to the cusp of where returns are good enough to justify higher CAPEX. However, a mere three quarters of better performance is not long enough for investors to green-light spending. Could it take 3 years of better results? More? Less? Three years is probably the over/under.
After an extended period of below-normal ROCE, we will need a longer period of above-normal ROCE to motivate higher spending.
In the 2000s, oil prices went from around $20/bbl to well over $100/bbl as we tried to figure out which area could provide oil supply growth. Would it be deepwater, oil sands, Arctic, or Russia? No one was even looking at shale oil, which turned out to be the answer, until the 2010s.
This time around we are not searching for new oil basins. We know where the available oil supply is. We are instead searching for an acceptable level of profitability at a time of great uncertainty about energy transition that will motivate a supply response.
Q from Jason: How should we think about the recent SPR release from the Biden-Harris Administration?
Arjun:
Factually, oil prices did fall during the time the Administration was discussing the SPR release, though I think we all might believe other factors like the emergence of the Omicron variant and other negative economic data points were the bigger factors driving the correction in oil prices. In reality it is all coincident so who knows the exact cause and effect.
I will use a phrase my former Goldman colleagues are using to describe the SPR release: This is a drop in the ocean in terms of its impact on oil balances.
That said, it is a noteworthy step the administration is taking to at least trial-balloon potentially repurposing the SPR as a price/market volatility management tool and not solely for emergencies.
There is no way the SPR in the USA as currently constructed is set-up to be a price/market management tool. Meaningful changes would be needed.
As a markets-oriented person, repurposing the SPR in this manner is not a line of thinking I would naturally subscribe to.
However, as Amrita and Bob both noted, politicians are very sensitive to gasoline price volatility. As such, it is not outrageous for a politician to think this type of repurposing makes sense, even if last week’s release feels like it was more done on a whim.
Q from Jason: Let’s step back and put this in the broader context of energy transition. This has been a fascinating discussion on the outlook for energy, markets, and geopolitics. But as someone who leads a Climate school, it’s a pretty depresesing conversation as I don’t hear that we are taking the energy transition seriously, and maybe that’s the case. I would be interested in your reflections on what the future might look like and to what extent the urgency of dealing with the challenge of climate change might lead to a much different outlook than we think we have today.
Arjun:
There is an urgency to dealing with our CO2 emissions, but there is also an urgency to ending energy poverty.
In my view, the world will never solve climate without first, or simultaneously, ending energy poverty.
You cannot have 700 million people between the US and Europe consuming a disproportionate amount of oil and the other 7 billion people on Earth getting a much smaller share. You have 2 billion people that are energy poor and billions more aspiring to the Middle Class.
You have to give them energy. They will absolutely take any form of energy over any other consideration.
Even in the United States, we saw that when the Colonial gasoline pipeline (US Gulf Coast to East Coast) went down, the only thing that mattered was getting it back on line. If that is true in the USA, what does that mean for the billions of people in the rest of the world?
No matter how urgent the climate crisis is, as some say, I will maintain that you will never take the steps to solve climate without first, or simultaneously, ending energy poverty. It is as urgent of an issue: Ending energy poverty.
Today, we have policies that are much easier to end fossil fuel supply than to end fossil fuel demand. You do have a choice here. You could have tougher policies on fossil fuel demand, especially in the wealthier countries. But no one’s doing that. Instead, every time prices rise, we take steps to try to lower prices.
It doesn’t have to be this way: we are choosing a messy energy transition.
Personal note
I know this is off brand, but I simply can not participate in a podcast that is titled “Whiplash” without remembering the great Cliff Burton, who tragically died in a bus accident in Sweden in September 1986. His fans have never forgotten him. I have always modeled my career after the sense of urgency Cliff showed in his bass playing. Rest In Peace Cliff. Here is the original Whiplash as I remember it from my youth. #BassSoloTake1 #CliffEmAll
Disclaimer
I certify that these are my personal, strongly held views at the time of this post. My views are my own and not attributable to any affiliation, past or present. This is not an investment newsletter and there is no financial advice explicitly or implicitly provided here. My views can and will change in the future as warranted by updated analyses and developments. Some of my comments are made in jest for entertainment purposes; I sincerely mean no offense to anyone that takes issue.
Regards,
Arjun