Outstanding Arjun. Thank you very much for your informed, intelligent reporting. I will look forward to reading all of your articles. You have been very helpful to me.
Love your videos with supporting data. This article's math is rebasing capex to avg demand. I suspect the 'is consistent with a 60 percent decline' is based on the same math. But isn't the 'correct' capex proportional to demand *growth* + avg decline of existing production? Maybe interesting reverse insight: What shrinkage does one have to assume to make the current capex expenditure 'midcycle'? Thanks again
Thank you Francisco. There is indeed many different ways to look at "what are we getting from current CAPEX". I definitely took a simplified approach. In reality it is indeed the iteration of spending to offset decline plus spend to meet future growth. That picture was meant more as a simple rule-of-thumb. I would note that unit development costs tend to pro-cyclical with the oil cycle...such that I would expect current lower unit development costs to inflate going forward.
I love Super-Spiked! The best analysis out there today.
Question: does it make sense to say that the CAPEX deficit is well known, virtually everyone knows that capital is being constrained to the O&G industry, but few people are concerned about it because the general consensus is that it isn't a problem because global demand will peak soon based on the IEA/EIA's demand projections? And that the surprise, the 'aha' trigger moment, comes when the reality of sustained high global demand finally sinks?
Investor, thank you very much! It's been a lot of fun writing for a broader audience again and the support and comments from folks like yourself are hugely motivating.
On your question, you nailed it in your assessment. The lack of CAPEX is broadly understood. It is the resilience of demand that isn't.
As I read this we are at a restaurant for lunch. We are discussing your comment about demand resilience and, as if on cue, the power just went out. Immediately people have begun asking for discounts because of the inconvenience of having to eat by the light of their phones. Developed countries have zero tolerance for even the tiniest energy discomfort! 😄
Fantastic analysis as usual! Amazing how often figures are presented without normalizing for inflation! Exhibit 3 is even more revealing, and I think the separation between the last cycle and the current one is even larger - since normalizing just by future demand does not factor into consideration the higher “Maintenance Capex” needed at the higher output levels today. In other words, even in a flat demand world, the capex needed today is higher vs the capex needed 20 years ago just to keep production flat at the higher output levels (from a geeky viewpoint, the relation is not Y=mX which you can normalize by division, but a Y = mX + c relationship 😊).
To begin, many, many thanks for the fabulous information that you provide. I have only been an active investor in the energy sector since the beginning of 2021. Prior to that I was essentially a passive investor buying index funds; a better understanding of the cyclical nature of the energy sector is thus of paramount importance. There are two issues that I would like to submit to you; the first one deals with the approach I have used thus far for my oil and gas investments while the second one deals with the electricity sector in which I have (think at least) relevant knowledge and expertise. (1) The first issue, on which I would appreciate your comments, is that, up to now, I have only invested in Canadian companies, not for patriotic reason (but yes I’m Canadian) but because of the oil sands: I figure that with the third largest oil reserves in the world and low depletion rates, little if any exploration is required which seems to me very positive in terms of the cyclical pitfalls that you so aptly describe. In addition Imperial Oil (69.6% owned by Exxon/Mobil) seems to agree with me; upon selling their conventional oil assets in Canada, their August 31, 2022 press release states the following: “The sale is consistent with Imperial’s strategy to focus upstream resources on key oil sands assets and its commitment to deliver long-term value to shareholders.” Should some of your readers be interested in the Canadian energy sector they could start by looking at XEG, the iShare Canada ETF (traded in $CAD on the TSX) provided by the Blackrock group; in that ETF the 5 largest companies (72.4% of total assets) can also be traded on US markets in $USD (4 on the NYSE and 1 on the OTC). (2) I will conclude this post with brief remarks on the role of wind and solar in the electricity sector; this role should be gross zero percent because both feature 2 terminal diseases. The fact that they have the bad habit of not producing when needed is the first obvious reason but the second reason is the worst offender; it is the reverse situation when, during low demand periods, they start producing large quantities of kWh. In such occasions wind and solar systematically destroy the economics of base stations. The inevitable result of these two terminal diseases is thus stratospheric electricity rates on one hand and a tremendous loss of reliability on the other. Regards and I can’t wait until next Saturday.
Michel, thank you very much for your kind words on Super-Spiked. I am a big fan of the Canadian oil sands industry as I am sure you have seen in my "#FreeCanada and "Good barrels vs bad barrels" series. For many of the reasons you highlight. Obviously, there is a risk that export infrastructure will face obstacles from both local governments but that is probably also helping keep competition at bay. Agree with your point on the electricity sector. Arjun
Excellent framework for determining where we are at in the cycle. The one thing that would be helpful to understand along with the capital spend is the capital intensity of bringing the marginal barrel to market and how this compares to the last cycle. I suspect that depletion of more easily recoverable resources has led to more expensive marginal barrels (shale, ultra deep water, etc), which has been at least partially been offset by advances in technology, productivity and scale. Any sense of how much capex is needed for today's marginal barrel vs last cycle?
Thank you! I do spend a lot of time looking at marginal costs though for that work tend to rely on my former colleagues at GS, other investment banks, and some of the data service providers like Enverus.
I think I have a related question and request. I ran across this article ( link below ) at the Dallas Fed from 2019 discussing the interplay of the Oil Cost Curve / Breakeven Prices / Long Dated Oil Futures. I've noticed in the Q1 Dallas Fed Energy Surveys they always ask about WTI break even prices need to justify new drilling and that prices seems to be creeping up significantly the past two surveys.
So I'm an amateur oil investor and trying to create an intelligible question out of all this so bear with me. You adjusted CAPEX for long dated oil demand / futures, but maybe you could also write about how the cost curve and break evens affect CAPEX and how you might adjust those capex charts for the cost curve and break evens? If that makes any sense? I'm looking also looking to learn more about how to make practical use of the cost curve and more up to date versions of it if you have any suggestions.
On an unrelated note pretty much everything you've written is on my read list, but if I'm prioritizing, would you say your ROCE series is the most important?
Robert, yes, the ROCE series is my pride and joy and the place to start. Your question is a good one and you are on the right track in wanting to better understand the interplay between cost curve, long-dated prices, where we are in the cycle, ROCE, etc.
I am not going to be able to give you a fuller answer at this moment, but the short answer is the cost curve evolution definitely informs where one is in the bigger cycle. Simplistically, when you add a lot of resource, the cost curve tends to flatten as it did with the shale revolution, leading to lower prices. As projects are developed and future supplies are less apparent, the cost curve tends to steepen which is a bullish signal. But it is more complex than this very simple explanation.
I still rely on Street research to assess cost curve, including work I used to contribute to at GS (though there are others that also do an excellent job). Probably harder for a retail investors to get access to that, though I am not 100% sure.
Great article. However, I didn't see oil demand get mentioned. When comparing to the previous boom/bust period from a decade ago, oil demand was projected to grow for the foreseeable future. Currently though, it's not as sure of a bet that oil demand will continue to increase as it did in the past due to converting to cleaner and more renewable energy sources.
I was thinking that chart that compared CAPEX between our current period and the previous oil boom, could that be added, adjusted, or correlated to paint a clearer picture? (Who knows though, maybe future oil demand for the next 10 years is close to the same as the prvious 10 years.) Thanks!
100% on distinction between "demand" and "consumption". I do, lazily, stick with the Street convention of using the terms interchangeably even though they clearly are not as you correctly articulate.
Very nice analysis! Thanks for posting. All topics I spend a lot of time thinking about and I appreciate the clarity of your thinking. In my own work I analyze various oil companies on a quarterly basis, and its obvious they are underinvesting to maintain future energy supply. It makes for good short term results, but we are headed for a production cliff that the world just isn't ready to deal with. Again, thanks for a great post. Glad to be here. Cheers
Great breakdown and supporting graphs! One factor keeps nagging me r/e the next bull cycle relates to the availability of adequate accretive projects to actually invest in. What are your thoughts around the runway left in US unconventional inventory and whether there’s enough left in the tank to underwrite another run? I’m curious if we could see US unconventional ROCE degradation in lockstep with well productivity declines (as we transition from higher tier to good but not as great acreage), even in higher price environment. Oil could still have a sustained bull run but the balance between US and the rest of the world could dramatically shift. Thoughts?
Kevin, this is a great question and the core uncertainty. Running room on US unconventional definitely varies by company, but from an industry perspective, the days of "easy" 1+ mn b/d seem very unlikely to return...or if the did, it would not be sustainable. The obvious caveat would be a breakthrough that reclassified current Tier 2/3 acreage as better. Canada is certainly an area that could see more CAPEX but has egress challenges. Latin America is always super promising in terms of geology but has gov't challenges. So back to deepwater? or...long-term demand destruction....
I would argue that these voices are not just anti-capitalism and pro-socialism, but in many cases anti-human. I was just watching an interview with renowned CPU architect Jim Keller by Jordan Peterson on the subject of the future of AI and Jim pointed out two things: 1. His children are basically being taught in university that humans are a virus on the planet and 2. he's an optimist that shares Elon Musk's view that we actually don't have enough people and we need more. I was trying to communicate to my own daughter this idea that the anti-human view is generally held by politicians and academics of little practical accomplishment, the optimist pro-human view is held by some of the worlds most prominent and practically accomplished intellects.
Thanks again for another excellent weekly column. I started to invest in energy in March 2020. I have made a lot of mistakes and some gains too. I have learned from a lot people. But your weekly columns and videos, which I discovered in Spring of this year, have been the most beneficial ones to me (and are free too). Thanks again! I am looking forward to hearing your space with George Noble on Monday.
That was a great analysis, definitely worth the read. Is there a publication that digs deep into oil and gas companies and recommends potential investments in these companies?
Thank you Jay, very much appreciated. Based on your question, I am going to presume you are not an institutional investor that would receive Street research? If not, I am probably the wrong person to ask. There are a lot of great public resources available on the general macro environment for the stock market, economy, and oil/gas/energy. But on stock specific recommendation sources, I don't know the answer. If there are others that read this with suggestions, pleas reply.
FYI. I have 2 large tracts of land in the Eagleford in Texas and there is a substantial amount of activity in new leases and drilling . Have not seen this activity for a long time.
Arjun, we really appreciated your personal note above. We couldn’t agree more.
thank you Six Bravo
Outstanding Arjun. Thank you very much for your informed, intelligent reporting. I will look forward to reading all of your articles. You have been very helpful to me.
thanks so much Martin! very much appreciate your comment.
Love your videos with supporting data. This article's math is rebasing capex to avg demand. I suspect the 'is consistent with a 60 percent decline' is based on the same math. But isn't the 'correct' capex proportional to demand *growth* + avg decline of existing production? Maybe interesting reverse insight: What shrinkage does one have to assume to make the current capex expenditure 'midcycle'? Thanks again
Thank you Francisco. There is indeed many different ways to look at "what are we getting from current CAPEX". I definitely took a simplified approach. In reality it is indeed the iteration of spending to offset decline plus spend to meet future growth. That picture was meant more as a simple rule-of-thumb. I would note that unit development costs tend to pro-cyclical with the oil cycle...such that I would expect current lower unit development costs to inflate going forward.
I love Super-Spiked! The best analysis out there today.
Question: does it make sense to say that the CAPEX deficit is well known, virtually everyone knows that capital is being constrained to the O&G industry, but few people are concerned about it because the general consensus is that it isn't a problem because global demand will peak soon based on the IEA/EIA's demand projections? And that the surprise, the 'aha' trigger moment, comes when the reality of sustained high global demand finally sinks?
Investor, thank you very much! It's been a lot of fun writing for a broader audience again and the support and comments from folks like yourself are hugely motivating.
On your question, you nailed it in your assessment. The lack of CAPEX is broadly understood. It is the resilience of demand that isn't.
As I read this we are at a restaurant for lunch. We are discussing your comment about demand resilience and, as if on cue, the power just went out. Immediately people have begun asking for discounts because of the inconvenience of having to eat by the light of their phones. Developed countries have zero tolerance for even the tiniest energy discomfort! 😄
LOL. you must be in California!
Fantastic analysis as usual! Amazing how often figures are presented without normalizing for inflation! Exhibit 3 is even more revealing, and I think the separation between the last cycle and the current one is even larger - since normalizing just by future demand does not factor into consideration the higher “Maintenance Capex” needed at the higher output levels today. In other words, even in a flat demand world, the capex needed today is higher vs the capex needed 20 years ago just to keep production flat at the higher output levels (from a geeky viewpoint, the relation is not Y=mX which you can normalize by division, but a Y = mX + c relationship 😊).
thank you Nihal!
To begin, many, many thanks for the fabulous information that you provide. I have only been an active investor in the energy sector since the beginning of 2021. Prior to that I was essentially a passive investor buying index funds; a better understanding of the cyclical nature of the energy sector is thus of paramount importance. There are two issues that I would like to submit to you; the first one deals with the approach I have used thus far for my oil and gas investments while the second one deals with the electricity sector in which I have (think at least) relevant knowledge and expertise. (1) The first issue, on which I would appreciate your comments, is that, up to now, I have only invested in Canadian companies, not for patriotic reason (but yes I’m Canadian) but because of the oil sands: I figure that with the third largest oil reserves in the world and low depletion rates, little if any exploration is required which seems to me very positive in terms of the cyclical pitfalls that you so aptly describe. In addition Imperial Oil (69.6% owned by Exxon/Mobil) seems to agree with me; upon selling their conventional oil assets in Canada, their August 31, 2022 press release states the following: “The sale is consistent with Imperial’s strategy to focus upstream resources on key oil sands assets and its commitment to deliver long-term value to shareholders.” Should some of your readers be interested in the Canadian energy sector they could start by looking at XEG, the iShare Canada ETF (traded in $CAD on the TSX) provided by the Blackrock group; in that ETF the 5 largest companies (72.4% of total assets) can also be traded on US markets in $USD (4 on the NYSE and 1 on the OTC). (2) I will conclude this post with brief remarks on the role of wind and solar in the electricity sector; this role should be gross zero percent because both feature 2 terminal diseases. The fact that they have the bad habit of not producing when needed is the first obvious reason but the second reason is the worst offender; it is the reverse situation when, during low demand periods, they start producing large quantities of kWh. In such occasions wind and solar systematically destroy the economics of base stations. The inevitable result of these two terminal diseases is thus stratospheric electricity rates on one hand and a tremendous loss of reliability on the other. Regards and I can’t wait until next Saturday.
Michel, thank you very much for your kind words on Super-Spiked. I am a big fan of the Canadian oil sands industry as I am sure you have seen in my "#FreeCanada and "Good barrels vs bad barrels" series. For many of the reasons you highlight. Obviously, there is a risk that export infrastructure will face obstacles from both local governments but that is probably also helping keep competition at bay. Agree with your point on the electricity sector. Arjun
Excellent framework for determining where we are at in the cycle. The one thing that would be helpful to understand along with the capital spend is the capital intensity of bringing the marginal barrel to market and how this compares to the last cycle. I suspect that depletion of more easily recoverable resources has led to more expensive marginal barrels (shale, ultra deep water, etc), which has been at least partially been offset by advances in technology, productivity and scale. Any sense of how much capex is needed for today's marginal barrel vs last cycle?
Thank you! I do spend a lot of time looking at marginal costs though for that work tend to rely on my former colleagues at GS, other investment banks, and some of the data service providers like Enverus.
I think I have a related question and request. I ran across this article ( link below ) at the Dallas Fed from 2019 discussing the interplay of the Oil Cost Curve / Breakeven Prices / Long Dated Oil Futures. I've noticed in the Q1 Dallas Fed Energy Surveys they always ask about WTI break even prices need to justify new drilling and that prices seems to be creeping up significantly the past two surveys.
So I'm an amateur oil investor and trying to create an intelligible question out of all this so bear with me. You adjusted CAPEX for long dated oil demand / futures, but maybe you could also write about how the cost curve and break evens affect CAPEX and how you might adjust those capex charts for the cost curve and break evens? If that makes any sense? I'm looking also looking to learn more about how to make practical use of the cost curve and more up to date versions of it if you have any suggestions.
On an unrelated note pretty much everything you've written is on my read list, but if I'm prioritizing, would you say your ROCE series is the most important?
Robert, yes, the ROCE series is my pride and joy and the place to start. Your question is a good one and you are on the right track in wanting to better understand the interplay between cost curve, long-dated prices, where we are in the cycle, ROCE, etc.
I am not going to be able to give you a fuller answer at this moment, but the short answer is the cost curve evolution definitely informs where one is in the bigger cycle. Simplistically, when you add a lot of resource, the cost curve tends to flatten as it did with the shale revolution, leading to lower prices. As projects are developed and future supplies are less apparent, the cost curve tends to steepen which is a bullish signal. But it is more complex than this very simple explanation.
I still rely on Street research to assess cost curve, including work I used to contribute to at GS (though there are others that also do an excellent job). Probably harder for a retail investors to get access to that, though I am not 100% sure.
Arjun
I forgot the links:
https://www.dallasfed.org/research/economics/2019/0521?topics=Economic+Conditions
https://www.dallasfed.org/research/surveys/des/2022/2201#tab-questions
Great article. However, I didn't see oil demand get mentioned. When comparing to the previous boom/bust period from a decade ago, oil demand was projected to grow for the foreseeable future. Currently though, it's not as sure of a bet that oil demand will continue to increase as it did in the past due to converting to cleaner and more renewable energy sources.
I was thinking that chart that compared CAPEX between our current period and the previous oil boom, could that be added, adjusted, or correlated to paint a clearer picture? (Who knows though, maybe future oil demand for the next 10 years is close to the same as the prvious 10 years.) Thanks!
Thank you Bryce. I did try to address demand in Exhibit 3 and the related comments. Didn't resonate? or not quite what you are asking?
100% on distinction between "demand" and "consumption". I do, lazily, stick with the Street convention of using the terms interchangeably even though they clearly are not as you correctly articulate.
Very nice analysis! Thanks for posting. All topics I spend a lot of time thinking about and I appreciate the clarity of your thinking. In my own work I analyze various oil companies on a quarterly basis, and its obvious they are underinvesting to maintain future energy supply. It makes for good short term results, but we are headed for a production cliff that the world just isn't ready to deal with. Again, thanks for a great post. Glad to be here. Cheers
Thank you Dave! Very much appreciate it.
Very Welcome Arjun. Would you mind establishing email contact? Mine is dcmessler1@gmail.com
I am writing an State of the Industry article for OilPrice and would like to include a comment from you. Cheers, Dave M.
Damn great piece Arjun...such a helpful framing and what a great way to put your years of energy experience to work for the public good
that is very kind of you J J! thank you so much.
Great breakdown and supporting graphs! One factor keeps nagging me r/e the next bull cycle relates to the availability of adequate accretive projects to actually invest in. What are your thoughts around the runway left in US unconventional inventory and whether there’s enough left in the tank to underwrite another run? I’m curious if we could see US unconventional ROCE degradation in lockstep with well productivity declines (as we transition from higher tier to good but not as great acreage), even in higher price environment. Oil could still have a sustained bull run but the balance between US and the rest of the world could dramatically shift. Thoughts?
Kevin, this is a great question and the core uncertainty. Running room on US unconventional definitely varies by company, but from an industry perspective, the days of "easy" 1+ mn b/d seem very unlikely to return...or if the did, it would not be sustainable. The obvious caveat would be a breakthrough that reclassified current Tier 2/3 acreage as better. Canada is certainly an area that could see more CAPEX but has egress challenges. Latin America is always super promising in terms of geology but has gov't challenges. So back to deepwater? or...long-term demand destruction....
I would argue that these voices are not just anti-capitalism and pro-socialism, but in many cases anti-human. I was just watching an interview with renowned CPU architect Jim Keller by Jordan Peterson on the subject of the future of AI and Jim pointed out two things: 1. His children are basically being taught in university that humans are a virus on the planet and 2. he's an optimist that shares Elon Musk's view that we actually don't have enough people and we need more. I was trying to communicate to my own daughter this idea that the anti-human view is generally held by politicians and academics of little practical accomplishment, the optimist pro-human view is held by some of the worlds most prominent and practically accomplished intellects.
Yes.
Totally agree on the anti-human
Excellent writeup !! Thanks 😊🌈
Thank you Gary!
Karnes, Atascosa, and Live Oak.
Hi Arjun,
Thanks again for another excellent weekly column. I started to invest in energy in March 2020. I have made a lot of mistakes and some gains too. I have learned from a lot people. But your weekly columns and videos, which I discovered in Spring of this year, have been the most beneficial ones to me (and are free too). Thanks again! I am looking forward to hearing your space with George Noble on Monday.
thank you very much Tonyforever. That is really great to hear. Looking forward to the Spaces.
That was a great analysis, definitely worth the read. Is there a publication that digs deep into oil and gas companies and recommends potential investments in these companies?
Thank you Jay, very much appreciated. Based on your question, I am going to presume you are not an institutional investor that would receive Street research? If not, I am probably the wrong person to ask. There are a lot of great public resources available on the general macro environment for the stock market, economy, and oil/gas/energy. But on stock specific recommendation sources, I don't know the answer. If there are others that read this with suggestions, pleas reply.
If you don’t want stock specific risk, etf’s are an asset class worth considering. XLE might be one of them.
I am a retail investor. Any resources would be appreciated.
I am in XOP. Yes I am looking for some large/mid cap exposure for holding for an extended period to let the cycle unfold.
FYI. I have 2 large tracts of land in the Eagleford in Texas and there is a substantial amount of activity in new leases and drilling . Have not seen this activity for a long time.
That is pretty cool you have EFS acreage. Curious what county?