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Life Energy

Indeed the oil and gas industry complex is so out of favor these days.

28 . 11 . 2019
ANDRÉS Allende

3 minutes

Energy equals life. Without it, life is not. I guess we live off sun energy mostly, captured and converted by plants, passed on to animal life, used up everyday to remain in existence. It is transformed as it is used up, and in that way gives way to chemical byproducts such as CO2, and over millions of years also gives way to coal, crude oil and natural gas, chemical byproducts too. Byproducts which store chemically concentrated energy again.

So energy is life. But in a different way to water. Because beyond survival, a growing use of energy can increase our quality of life more and more – we get to saturation much later than with water, if at all… I would consider this a “fundamental Law of good living”. That is why energy also equals power – hence all its geopolitical ramifications. Mad Max, the movie, might have deeper philosophycal roots than many might have realised!  (i just watched it again, this time with my older sons, as part of their basic education…)

 

Take the example of crude oil. With the industrial revolution horses were replaced with coal as the source of brute force to pull cargo. Then coal was replaced by oil in many uses. Every barrel of crude does the work of 130 horses. And every horse does the work of 11 men. So crude oil (as well as coal, natural gas…) liberated horses and elevated people from having to toil at a wheel to pull water from the well, generate electricity to power our myriad devices and factories, heat up homes in the winter and cool them off in the summer too. We can basically say that without crude oil, natural gas and coal there would be little room or time left for high value added activities as of today – we would all need to “pull our own weight” – pun intended – in that subsistence economy. Global travel distances (and trade) would be insurmountable. And we would face impossible challenges to keep up food supply for so many people (and horses). And by the way, there would be other types of (smelly) emissions too  – today c. 20% of global GHG emissions come from livestock digestion… Obviously there are tradeoffs in this equation. But overall one can say energy use is really tough to reduce without giving away quality of life.

Therefore energy consumption is not really discretionary. People cannot choose to use it or not. Or they don´t really want to – the “fundamental Law of good living” rules. People don´t want to stop living the best life than human kind has ever lived. Nor should they. We have come a long way, especiaally over the last 100 years. And developing countries are catching up fast – great for them.

Energy use must probably remain, or keep its slow but sure growth

On the other hand, as energy is very valuable, “homo-economicus” has always been all too aware that efficiency can be good for business, and keeps pressing on to get an edge, cut costs and if possible keep the extra profit. That is why we moved from burning wood to coal, onto crude oil, onto natural gas. That is why container ships got larger, cars and planes got more fuel efficient, agriculture looked for scale and for better seeds, mining moved to trucks the size of houses, etc. There are all kinds of examples of this focus on efficciency – most recently, even bitcoin mining centres often settled very up North where power for refrigeration is less needed.

So if the number of people on Earth are not going down significantly or at all, if everybody wants to live a good life, and if energy efficiency has always been a key focus and hence not easy to improve on, that means that energy use must probably remain, or keep its slow but sure growth. That means solid demand.

When demand for something is solid we have a very favorable set up to look for investment opportunities in that particular area. All we need is some high profile, noisy narrative, to give us an entry point. And that is precisely what we have got over the last few years on the demand side of things. For example, many warn that electrification and emissions will soon bring the end to oil and gas and to coal. Let me just say that their replacement would need to overcome huge technological and infrastructure barriers that would take decades to be figured out.

 

But, can it get better than this? Well, actually yes. We could get also a high profile noisy narrative on the supply side things. And guess what? We got it!

Oil supply has been dealing with some very noisy hiccups for the last 5yrs. It all started with the US shale revolution, which miraculously supplied c. 8mmbblpd (million barrels per day) extra from 2008 (virtually 80% of the global oil supply growth globally). That is a big number, as much as Kuwait + UAE + Nigeria, created “out of thin air”. US private sector ingenuity found a way to extract oil from its geological trap in shale rock. This eventually upset the balance in the market, and OPEC, the only legal cartel in the World, reacted by trying to drown the US producers in a sea of cheap oil, in November 2014. But aside from a lot cheaper energy for consumers, the OPEC measures didn´t get the intended permanent wipe out effect on the flexible US private players – they simply slowed down. Yes, some suffered, but overall the US shale oil industry remained very much alive and kicking. And by November 2016 the OPEC through in the towel, and tried to rebuild the balance in the market by pulling out a bit themselves. Meanwhile, with all that back and forth in events and in oil prices the oil industy cut down investment by -40%. The noisy narrative was (and still is to a large extent) that shale oil supply can continue to improve and improve, and grow and grow, and traditional oil investment became too risky and too slow moving to even try to compete.

But for a number of reasons that narrative cannot be true, and events are step by step, slowly proving it so. On the one hand, technological and efficiency improvements are already slowing down in US shale. That makes sense – at least the marginal rate of improvement for costs and volumes cannot remain – simple math at work. Also, many of the best spots have been drilled already and geology itself is making overall productivity improvements tougher and tougher – that also makes sense. Additionally, financing is becoming less and less available to US shale players – growth is no longer the only game in town, investors want some cash back as well – that makes sense also, at least to an old fashioned investor like me.

At the same time and most  importantly, natural decline rates – the natural reduction in oil production volumes after oil starts to flow and field pressure falls – are kicking in on a larger and larger base for the US. The replacement of volumes themselves becomes a huge challenge (a new Kuwait needed every year now within shale!). And that doesn´t even include the natural decline rate in the remaining 92mmbblpd globally not coming from US shale – another 1.5x Kuwait needed there just to stand still. This last bit has been very neglected for the last 5 yrs given the lack of investment caused by the noisy narratives. But geology has its fundamental laws too…

So much noise and so many “easy narratives” accepted by the market and crystalized in cheap valuations caught our eye of course. Indeed the oil and gas industry complex is so out of favor these days. And that is a good starting point to invest, particularly when fundamentals have been slowly moving away from those narratives. We will probably be off by a few quarters, especially if global growth slows down a bit. But i do get some comfort from the fact that the underlying ”laws of good living” and those of “geological decline rates” will be there to help out sooner rather than later.

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