We need more good barrels and fewer bad barrels
A plan for USA + Canada to displace 10 mn b/d of Russia + Iran oil exports by 2030
Russia-Ukraine has made tragically clear that there is in fact such a thing as "good" and "bad" barrels, a point Super-Spiked has previously argued. A healthy energy transition era will ensure that "bad" does not gain undue leverage on "good", as we can so clearly see with the hold Russia has over Europe. Europe is free to make its own choices. Historians will have to be the judge of the degree to which Europe's energy choices contributed to emboldening president Putin. And to be clear and as I have said previously, president Putin bears full responsibility for the atrocities occurring in Ukraine.
Domestic "climate only" policies that do not adequately take into account broader energy issues such as energy security, reliability, and affordability is perhaps the major contributor to how we ended up in this worst-of-all-worlds situation of high and volatile commodity prices with no meaningful change to the world's CO2 trajectory. One of the more perplexing developments in the aftermath of president Putin’s tragic decision to invade Ukraine has been the inability for western leaders and public policy makers, especially in the USA, to clearly and forcefully articulate a preference and prioritization of USA + Canadian oil over Russia and Iranian oil.
This should not be a close call. It is not a serious critique to claim our climate goals would move off track if we produce greater amounts of oil and gas in North America. Is should be painfully clear by now that the strategy of limiting oil supply in some areas (i.e., good areas) does not impact global oil demand and merely shifts oil supply to bad areas. The climate clearly wins when we have more USA + Canadian barrels instead of Russia and Iran. Energy security wins. Availability and affordability win. Autocrats, dictators, and ideologues lose. Gender equality and LGBTQ+ rights win. Climate justice for the developing world wins. Rule of law wins. Traditional health, safety, and the environment win. Methane reductions win. Mullahs lose. Baltic and former Eastern block countries win. Western Europe wins. Putin loses. Canada wins. Liberty and freedom wins. America wins.
It is not about whether leading government officials are being nice or not nice to private oil company CEOs. It is about coming together for the national interests of the USA and Canada in ensuring energy is available, affordable, reliable, and secure for all of our allies, with as small of a climate and environmental footprint as possible. It's about leadership—from leading government officials and private industry CEOs. These overall objectives have the highest probability of being achieved with USA + Canada oil supply instead of Russia and Iranian supply. How is this even a question, controversial, or necessary to highlight?
North America energy and the triumph of good over evil
Currently, US and Canadian oil supply/demand are broadly in balance. Net import dependence for the region was at its worst point in 2006-2008, the peak of the last commodity super-cycle. Since then, massive shale oil growth coupled with steady albeit more modest growth from Canada's oil sands region has completely eliminated our combined oil import dependence. It is a miraculous development, something yours truly (and most others) did not think was remotely possible...ever.
Due primarily to poor profitability over the past decade coupled with an uncertain future demand outlook in the aftermath of the pandemic and as investors consider how quickly energy transition might impact future oil demand growth, the CAPEX response to sharply higher oil prices has been significantly more muted than prior cycles. There has been opposition by environmental activists and some ESG investors to fossil fuel investment. However, I am not in the camp that for US shale that “ESG”, thus far, has been a major driver for why CAPEX growth has been subdued. However, in Canada, opposition to new pipeline/export infrastructure along with ESG virtue signaling I believe has been a more meaningful disincentive to higher CAPEX.
A public policy push that sought to maximize good barrels I believe will address the broad spectrum of energy issues: availability, affordability, reliability, and security, and will RAISE the odds of meeting the world's CO2 reduction objectives. A good barrel will inherently be one that is better for the climate and environment than a bad barrel. It will also be profitable.
I am not going to write thousands of words on why environmental and climate controls will be better in USA and Canada than Russia or Iran. Is there a single person that credibly would believe otherwise? If you block/impede/deny growth of good barrels, you end up with bad barrels. Full stop. Bad barrels contribute to war, civilian atrocities, terrorism, environmental degradation, inflation, potential stagflation, and decreased economic growth. Bad barrels are f—ing evil.
A plan for 10 million b/d of net oil export growth from 🇺🇸 + 🇨🇦 by 2030
With USA + Canadian oil supply/demand broadly in balance, there is a significant opportunity for oil supply growth in both countries to be exported to the rest of the world. I believe a reasonable aspiration for 2030 would be for combined USA + Canadian net exports to reach 10 million b/d via a combination of steady shale oil growth, new oil sands output, and a renewed emphasis on domestic demand reduction (non-GDP driven) via accelerated fuel economy + EV gains.
Exhibit 1 highlights historic and projected net oil exports from USA + Canada. The low-end of the forecast range reflects a scenario through 2030 that would be consistent with a $60-$70/bbl Brent oil world. Under a moderate oil-price paradigm, I would expect neither accelerated supply growth or demand destruction. In a world of $100+ oil prices, both faster supply and slower/negative demand growth seem plausible, consistent with a net 10 million b/d export aspiration. To be clear, I am no longer in the public oil price prognostication business. The price ranges are used to illustrate possible net export scenarios.
Exhibit 2 highlights key assumptions for the 10 million b/d export scenario. North America oil demand would decline at 1% per annum, shale oil supply would grow 0.3-0.5 mn b/d per year (3%-5% production CAGR), other US liquids would grow 0.2-0.3 million b/d annually, and Canada would grow 0.4 million b/d per year. I will provide greater details and sensitivities around these assumptions in future posts.
A Super Vol oil price regime will likely help meet climate objectives, i.e., transitioning away from fossil fuels. It is demand trends that will drive the world’s CO2 trajectory rather than taking steps to try to restrict supply but only in some regions. In the interim—i.e., during the transition era—higher North America oil supply will make all of our allies safer and less prone to whims of bad actors and their bad barrels.
In a moderate oil price regime ($60-$70/bbl Brent), North America oil demand would be expected to grow by positive 0.5%-1.0% per year. Previous work I had contributed to at Goldman Sachs showed that demand destruction and fuel economy gains are impacted by a mixture of rate of change and absolute price levels. I would expect a "high and volatile" price paradigm and significant geopolitical uncertainty would contribute to renewed consumer preference for more fuel efficient vehicles, including an accelerated take-up of all forms of electric vehicles (i.e., BEV, PHEV, HEV).
Export growth is predicated on profitability and strict but sensible environmental protections
Key tenets of North America growth philosophy:
The top two quartile companies in USA + Canada will generate mid-teens+ ROCE and the industry average will be at least 10%.
Industry will remain committed to generating and distributing free cash flow to shareholders.
Net Zero Scope 1 and 2 by 2050, with credible 2030 and 2040 intensity reduction metrics consistent with ultimately reaching net zero by 2050.
A "zero" methane flaring/venting/leaks goal by 2030, independently verified.
Development of CCUS hubs in Canada and the US Gulf Coast to assist in meeting net zero objectives.
Growth does not occur without both profitability and climate/environment objectives being met.
Aggressive build out of public EV charging infrastructure and other support for a ramp in EV sales and ICE fuel economy gains.
Target US + Canada to be the lowest C02 (net) hydrocarbons in the world with an aim to being the "last barrels" produced through the energy transition era.
How can public policy help and not hurt a maximize good barrels objective?
Fortunately, the USA and Canada still practice an economic philosophy that can loosely be called "capitalism". As you all know, I am pro-capitalism, anti-socialism. Here are areas where public policy can start helping and stop hurting:
President Biden can use his "bully pulpit" (a concept I learned in the 1970s/80s...hopefully it hasn't been cancelled) to declare his preference for good barrels over bad barrels.
Declare it a North America doctrine that the last barrels produced in the energy transition era will come from the USA and Canada.
Declare it a North America goal to displace all net exports from Russia + Iran by 2030, available to all allies of USA and Canada, including Europe, India, and various African and other Asian countries (Latin America is or could be self sufficient on energy.)
USA and Canadian federal governments can help pushback against ill-advised environmental activism toward new North American pipelines.
Take steps to incentivize EV charging infrastructure in middle/working class areas.
Work with industry and pragmatic environmental groups to figure out the best regulatory/enforcement mechanisms to ensure all of industry moves in a direction that ensures North America produces "zero" methane barrels.
Work with industry and pragmatic environmental groups to figure out a pathway that ensures North American barrels are the lowest carbon barrel in the world, net of a possible carbon price and low carbon CAPEX paid for by industry (directly or indirectly).
⚡️On a personal note...
One of the best pieces of advice I received in my career was during new partner orientation at Goldman and was from a senior female partner who implored all of us to make a concerted effort to evaluate people based on our first-hand experience and not what we might hear through second hand sources or rumors. The demonization by politicians and some media outlets of oil company CEOs is at odds with my near 30 years of first-hand interactions as an equity analyst. To be sure, not all of them would win humanitarian awards and professional investors will push back on the examples where executive pay did not match overall performance. But in some, if not most cases, they are actually pretty nice people if you get to know them.
For example, I really liked covering John Hess, on a personal basis; he's a nice guy and good human being. John Watson, formerly of Chevron, was wonderful to interact with. Same thing with Mark Papa formerly of EOG...not to mention his predecessor, Forrest Hoglund. Claiborne Deming of Murphy Oil was an absolute treasure to call on, as a person. And I enjoyed sitting with his family at Murphy shareholder meetings. I was always a fan of Steven Chazen when he was at Oxy. Greg Garland of Phillips 66 is a really good guy. Chuck Davidson, formerly of Noble Energy, is a person I enjoyed being around. Lynn Elsenhans, one of the few female energy CEOs I covered, was delightful...even when I had a Sell rating on her stock to her credit. In Canada, I have fond memories of getting to know Steve Williams of Suncor. John Langille of CNQ was crazy nice. How could anyone demonize John Langille? I haven’t even mentioned Bill Barrett from the start of my career, who sat down and patiently explained why diagonal wells in the Piceance Basin would be revolutionary (a forerunner to horizontal drilling) when I had neither an engineering nor petroleum background and wasn’t more than a few months out of college (Finance major).
All of the executives mentioned I only know on a professional basis. I have always kept something of a wall between my personal and professional lives. My life is better for having had the opportunity to interact with each of them. Within this theme of good vs bad, I’ll put North America oil company executive teams in aggregate on the good side of the ledger. I suspect that their loudest critics haven’t met most of them outside of (forced) Congressional testimony.
⚖️ 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
💿 Super-Spiked Energy Transition playlist update
The Super-Spiked Energy Transition playlist is my artistic attempt to highlight the absurdity and ridiculousness of much of the discussion around energy & climate. This week’s additions take a patriotic turn. The full playlist can be found on my YouTube channel and on Spotify. Let’s play ball and Lets-Go-Ran-Gers!
Bonus content: This gem of a video still gives me chills.
Great piece. I think this is the trap of western environmentalism: we push problems to other corners of the world where we don't have to look at them. Nickle, cobalt, and lithium mining are other great examples of this phenomenon.
Thanks again Arjun for a very nice piece. If I was going to nitpick, I do think the Brent price range probably would need to be $10/bbl, or higher, to ensure the industry generates sufficient FCF and ROCE as unit costs would inflate (both opex and capex) if the industry attempted to increase production to the level you propose, and to incent demand to contract. Otherwise, keep sharing these articles as they are great thought prices and I hope are read by many outside the energy industry to get a better understanding of how the industry works and what is at stake.