Retro Biden snatching oil price defeat from the jaws of irrelevance

Returns not rhetoric driving current tight oil markets

Biden’s bark not biting…yet…

It is easy and fun to blame the Biden Administration for its unfriendly rhetoric and high-profile but low-impact policy steps against the US oil industry. Somehow they have managed to snatch “defeat” — i.e., being blamed for high oil and gasoline prices — from the jaws of irrelevance. No US administration has any material impact on short-term oil supply/demand/price cycles…long-term potentially, but short-term barely.

Here is a partial list of high-profile, low-impact steps the administration has taken that are broadly viewed as anti-US (and Canadian) oil:

• Temporarily halting federal drilling permits during the first few months of the administration; this occurred at a time very few oil companies were clamoring to drill let alone on the federal acreage where new permits were paused; permit availability has long since resumed.

• Suspending oil drilling leases in the ANWR area of Alaska: there is perhaps no major oil region on Earth attracting less interest from fewer companies than ANWR. ANWR today is essentially a battle between NY Times and Wall Street Journal OpEd writers; it has long since lacked oil market substance or investor relevance. The families of Senators Bob Dole and George Mitchell appreciate the memories.

• Cancelling the long-delayed Keystone XL pipeline from Canada to the US Gulf Coast (discussed below).

• Asking the Federal Trade Commission to investigate potential price gouging by US gasoline retailers. This is perhaps the most laughable “policy” step—does any reasonable American believe this to be the case? Surely the administration realizes evil Big Oil companies (the presumed rhetorical target) own very few of the gas station that bear their brand?

To compound the perplexing actions taken, the administration has further:

• Asked OPEC+ to accelerate its post-COVID production ramp, which the group has repeatedly refused to do. OPEC countries have offered something of a Loza Alexander-inspired response (that was a pretty mild joke; if you are easily offended, this may not be the Substack for you; if you are not American and don’t get the reference, check out Loza on Spotify);

• Asked China to sell oil from its strategic petroleum reserve (SPR);

• Threatened to release oil from the US SPR.

• Has not taken any steps or offered any rhetoric to encourage higher US shale oil supply.

Biden pursuing a 1990s retro energy policy agenda

Who doesn’t like 1990s era Houston Astros jerseys, Guns’N’Roses at their peak, and the New York Yankees dynasty years! But why bring back 1990s US energy policy in 2021? Is the administration unaware that the USA is now the world’s largest oil producer with a massive, developable resource we all know and love called shale? Building back better somehow includes every imaginable source of spending but does not call for more US shale supply that would come with US jobs, US tax revenues, US investment, and US energy security. And isn’t the great state of Texas not as deep red as it once was?

Love the 1990s-era Houston Astros jerseys as modeled by the great Nolan Ryan…but 1990s-era energy policy? Not so much. Source: derivative work: Amineshaker

It is true that here in the US we have a private sector oil industry. But if you are going to use the bully pulpit to beg OPEC+ for more oil and pursue the range of other high profile low impact steps noted above, why not at least try yelling at US shale producers to get American oil workers back on the job! Oil industry jobs are good jobs, often higher paying and with better benefits than over-hyped “green” jobs (to be clear, I support all private-sector jobs). I’d rather my kids work for a Midland Basin oil company than as a solar installer any day of the week. And the men and women in the oilfields deserve our collective gratitude for the work they do to keep our economy running: thank you.

Aside from the unwillingness to call for more US shale, Keystone XL gets the next most unfavorable coverage from detractors. If there is blame to place it goes back to the initial delays during the Obama Administration (to my knowledge, then Vice President Biden was not a driver of those delays). But Keystone XL as a tangible issue for November 2021 oil markets based on a January 2021 “cancellation” is not a credible critique (side note: are we really only in month 10?). The pipeline for whatever reason did not move forward under the previous administration despite more favorable rhetoric, and would not come on line for many years even if it had not been cancelled in January. Canadian oil supply continues to grow thanks primarily to rail and debottlenecking other pipelines as well as its own high-performing, high-quality industry and workforce. KXL is more of a symbolic slap in the face to a close ally than a substantive oil logistics issue, at least in the near term. One can argue that KXL would motivate even faster Canadian oil supply growth in future years, though how much is debatable. And whether KXL flows were destined for the US Gulf Coast or as a transit passthrough to export markets is not relevant (a point often made by enviros); crude oil is a global commodity.

Partisan sniping is easy and even fun, but I don’t think provides any insight to the current $80 oil environment

For non-Democrat Americans (a growing breed?), it is easy to tick off the aforementioned anti-oil steps and declare that President Biden’s hostility toward the US oil industry is why oil markets are tight. In my view, this would be a wholly inaccurate assessment as to why current supply/demand is tight and we have $80 oil.

To be sure, the administration isn’t helping. But the #1, #2, and #3 reasons we have had a heretofore slow US shale rig count response to the current bullish oil backdrop is due to traditional investors demanding a significant improvement in capital discipline on the part of both independent producers and major oils after a decade-plus of disappointing profitability and greatly diminished market relevance.

There are no E&P companies I know of that can not get a permit, hire a rig or completion crew, or bring new oil to market. Rather, traditional investors are skewering the occasional outlier publicly-traded E&P that dares to talk aggressive volume growth (see $EOG earlier this year). Yes, the Biden Administration’s rhetoric is some combination of short-term unhelpful, long-term hurtful, mis-guided, and perhaps from the Paleozoic era. But its actual impact on November 2021 oil supply/demand balances is as close to zero as one can get. Again, this is my view. You are free to disagree. And I would sincerely welcome a quantification of how their steps have limited supply in 2021 (a potentially excellent use of the Comments section).

A (lack of) profitability crisis

Over 2011-2020, oil-leveraged US E&Ps generated an average return on capital employed (ROCE) of negative 1.3%. Let me repeat that and clarify, without forgiving write-downs, on an as reported basis, over a decade the sector generated negative profitability. If you instead use annual, reported profits, the median company over the period generated a still paltry 6% ROCE (you can think of the difference as effectively forgiving the big write-offs).

Over the prior 20 years, 1991-2010, oily E&Ps generated an average ROCE of 10%, which I would characterize as “cost of capital” for a mature, capital intensive, commodity sector. The corresponding median ROCE (by company on annual basis) was a better 14%, boosted undoubtedly by the “super-spike” era that began in 2004 and for which this newsletter is named.

While 2021 ROCE will be significantly improved — the sector has averaged an 8% ROCE year-to-date including a 12% ROCE in 3Q2021 — no rationale investor is looking for any company to quickly return to the failed “drill, baby, drill” era of last decade. Drill-baby-drill was a bad, or perhaps insufficient, energy policy (we can save a deeper discussion until perhaps 2024-2025; for example, methane was not addressed and should have been) and was an even worse corporate strategy.

Traditional investors are understandably skeptical that E&P capital discipline will hold. Frankly, the Biden Administration’s anti-oil rhetoric coupled with ESG & Climate investor pressures is supportive of improved E&P capital discipline and higher sustained ROCE over the long run. I will repeat this point: the Biden Administration’s (mis-guided) energy & climate policies and rhetoric have been positive for the oil & gas sector at the macro level (might not be true for individual companies). This point is a long-term issue and worthy of a deeper discussion in the future. At this time, I believe there is nothing holding back the US shale rig count right now from a policy, ESG, or climate perspective other than traditional investors demanding better long-term returns on capital.

Some of you will ask: isn’t ESG/Climate-driven long-term oil demand uncertainty contributing at least somewhat to a slower rig ramp? Maybe. However, it is my experience that oil executives are among the least bearish on long-term oil demand, at least versus the uber-bears contributing to IEA Net Zero or BP Rapid oil-demand-falls-off-a-cliff scenarios. No oil executive I am aware of believes oil demand will decline sharply this decade…perhaps in the 2030s. While investors might indeed be more cautious on medium-to-long-term oil demand, robust free cash flow suggests external financing is not required at this time. A faster rig count is entirely plausible from internally generated cash flow—frankly at $65 oil let alone $80/bbl.

Mis-guided US energy policy is a long-term concern

I am sure I will be accused of being a closet Democrat and Biden Administration shill by not hitting the easy “Blame Biden for high oil prices based on his anti-oil rhetoric” button. I already get that from right-leaning friends that know I am an energy analyst. I am not a political person. I despise partisan politics. I love capitalism. I hate socialism. I take no public view on the merits of the Biden Administration outside of its energy & climate policies that are within my purview of expertise and which I am largely not a fan of. The good news is I am eligible to vote and free to write a Substack and will continue to do so.

My main energy & climate concern with the Biden Administration extends to the broader issue of “energy policy” being relegated to derivative status versus “climate policy”. In my opinion, you will never have sensible climate policies without first getting energy policy right. Energy is primary. We have the air we breathe, the water we drink, and the energy we use. I would define any policy that seeks to reduce energy supply as definitionally a bad idea, especially if an abundant, affordable, dependable alternative is not yet available. The energy transition does not have to be as messy as it is on track to be. Global elites and those with resources will be fine. As always, it is those mostly without that will suffer most. How can the energy transition ever be “just” if it doesn’t solve for the least advantaged?

Some day the world’s 1.2-2 billion car (and light truck) park may well all be electrified. But that time frame isn’t any time soon. Not this decade or next. I am a very happy owner of a Tesla Model 3 and will personally never again have an ICE vehicle as my primary ride. But I am also a lucky American with the privilege of choice and resource. The 5-7 billion people that do not currently use very much energy deserve an explanation and pathway on how “we” can provide them higher energy supply.

This post is already too long, so I will save some of this for the future. I suspect with climate policy clearly the primary objective (over energy) for this administration, an unhealthy obsession with our Nationally Determined Contribution (NDC) to CO2 reductions is a major driver of the unwillingness to embrace US shale oil. If the Biden Administration wants to do retro energy policy, how about channeling the administration he was previously part of. To his credit, the shale revolution flourished under former President Obama, largely due to his willingness to stay out of the way and to embrace all forms of energy supply, while still pursuing sustainable development objectives that included stricter environmental and climate measures (again, for a future post, the oil industry to its detriment still has not figured this out — i.e., incorporating industry-wide, climate-friendly business practices into its core objectives).

In the time being, you can hate on the Biden Administration’s anti-US oil rhetoric all you want. But I would suggest an analysis of E&P company ROCE, prospectively of undrilled Permian Basin acreage, reinvestment rates, free cash flow, and dividend policies will be more helpful in understanding the outlook for prompt oil. It’s a cycle. Economics 101 rules, sometimes distorted by geopolitics. The political blame game is for the mainstream media and cable news, which I don’t watch. I hate cable news channels. I love improving ROCE, free cash flow, and the Permian Basin.

Personal update

I do not miss working full-time as a Wall Street analyst, but I do miss the interaction, debate, discussion, pushback, friendly and sometimes less friendly back-and-forth with many of my former institutional investor clients. It was the best part of my old job. It is one of the reasons I started Super-Spiked. I hope some of you that I used to know will start reading this and reach out via the Comments section or on Twtitter or via my former colleagues.

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. You are under no obligation to stay subscribed to a free Substack.

Regards,

Arjun