- May 14, 2021
- Posted by: Nick Díaz
- Category: Uncategorized
Back in in the beginning of the decade we saw a massive oil production boom, specifically in the US with a new technology called fracking as well as investments in large offshore drilling rigs all around the world. The oil and gas sectors were booming and capital was flowing in with little due diligence by investors. Companies were exploring oil and gas with giant capital investments for years during the black gold frenzy. However, there was a problem that was bubbling above the surface – the sharp increase supply drove oil prices lower, and quickly! Prices dropped from $100/barrel down to $40/barrel. In the summer of 2014 when the cycle turned most oil companies in the large Permian basin only broke even at $80/barrel and most companies had hefty amounts of debt on their balance sheets. According to a report by Haynes and Boone, from March 31, 2021, North America became the graveyard for 262 oil producers and 298 oilfield services and midstream companies which entered bankruptcy. That’s a total of 560 companies! And almost $180bln in debt!
The boom was followed by a devastating bust to the industry. The only good thing about lower oil prices is that it promotes efficiency, the weak vanish and the industry is forced to focus on cost. Over time, companies have been able to trim down their production costs and operational expenses to a roughly $50.00/barrel breakeven. However, investors have lost appetite in the industry as a whole and attracting capital for new exploration no longer comes as easy as it once did. Not to mention, the industry in itself is subject to environmental scrutiny, regulation and price control by world organizations adding to the difficulties of the space.
Oil demand took a serious beating last year as the pandemic began and drove prices negative due to storage limitations. Since then, demand has picked up and for instance here in the US we are not adding to inventory anymore, the inventory levels have actually been coming down since last fall as we started to open up the economies at most states. Oil demand is expected to persist and increase as the vaccine rollouts continue and activities pickup, reducing inventory levels even further and reducing pressure on oil prices (US output is running at max capacity and unable to keep up with current demand). Prices are highly dependent on potential output increases from other oil producing regions, but high prices (above $50) are certainly in the producer’s best interest. Albeit slow, new rig counts in the US have been picking up this year, but remain dramatically lower than in the early 2000’s. Lastly, as supportive as we may be of alternative, renewable or environmentally friendly energies, none of these are in a position to be scaled to the current industrial levels required to keep up with production rates, hence, oil dependency is not something we can deviate from short term. In fact, it will be fossil fuels themselves who redefines the energy landscape going forward, i.e. we’re far from making Tesla’s with solar power. Oil is cyclical and has now been in a bust for 7 years, with capital being constrained, oil assets depleting and focus on efficiency rather than exploration combined with a large pick-up in demand, we believe the commodity price is ripe for a prolonged uptrend.
It’s worth noting that as recent as 2014, the energy sector was 16% of the S&P500 and Exxon was the largest company by market cap in the world with over a $400mm market cap. The exodus of investors from this sector push Energy as low as 1.5% of S&P500 with Exxon reducing itself to a shameful $200bln market cap in 2020. That’s a wild discount for a company who literally fuels the largest economy in the world! The arguments made against oil by governments, lobbyist and other world organization stating this particular natural resource can easily disappear and not have an impact on everyday life and overall growth and productivity is outrageous.
https://www.haynesboone.com/-/media/Files/Energy_Bankruptcy_Reports/Oil_Patch_Bankruptcy_Monitor