A short 14 years ago, as oil approached $150 per barrel, chants of “Drill, Baby, Drill” were often heard at republican campaign rallies. While the republicans lost the election, the U.S. oil industry heard the message loud and clear, unleashing a torrent of investment in shale oil, boosting American production from about five million to 13 million barrels per day (BPD) pre-COVID. During this same time, world oil demand grew from 86 million to 100 million BPD, such that U.S. production growth satisfied 60 per cent of world demand growth.
American drill rig count ranged from 1,800 to 2,000 between the years 2011-14, declined to 400 after the oil price crash of 2014-15, grew back to 1,000 pre-COVID, collapsed to 250 during the spring of 2020 and has grown back to about 625 today — well below pre-COVID and just 30 per cent of peak levels. Shale oil break-even ranges from $30 to $90, with an average in the low $50s. Shale oil has a rapid decline rate with production from drilled wells typically declining 75-90 per cent in the first three years, making continual drilling a must for sustained production.
U.S. oil production peaked at 13 million BPD pre-COVID and declined to 10 million BPD through COVID, a larger percentage than OPEC+ cut. It has since recovered to 11.5 million BPD. A massive oil glut 18 months ago has now disappeared with current inventories below normal levels, meaning consumption has exceeded production since then. Unprecedented economic disruptions in 2020 caused only a nine per cent oil demand reduction, which has now fully rebounded.
Approximately 30 per cent of oil and gas comes from our oceans and almost all of the publicly traded ocean drilling companies have declared bankruptcy over the past five years, signifying the dearth in ocean activity. While onshore shale can ramp up quickly with the correct price signal, ocean activities require much longer lead times.
Table 1 shows the current (2019) total world energy consumption makeup. Since 1990, total energy consumption has grown 63.2 per cent, or about two per cent per year, with all sources except traditional biomass showing significant growth. Energy consumption growth is highly correlated with economic growth. The only three periods of decline in recent history were the 1980-82, 2008-09 and 2020 severe recessions. If world GDP growth continues, the desired outcome — unless we desire high unemployment — total energy consumption will also grow. Adoption of more efficient systems may slow consumption growth, but GDP and total energy consumption will remain correlated.
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Since the 2007-08 energy price spike, there has been massive investment in wind and solar, yet nowhere near enough to meet energy demand growth, let alone replace fossil fuels. Society appears to be only looking at the negatives of fossil fuels and the positives of wind and solar, but as all of the alternatives become more prevalent, the negatives associated with them will also become more evident.
As an example, while nuclear is a carbon-free and safe energy source, Germany is mothballing its entire fleet, with the last two coming off-line this year. This led to energy supply shortages and emissions growth from electrical production in the magnitude of 20-25 per cent this past summer as coal usage soared. The price of thermal coal tripled. While I support all efforts towards efficiency and the search for viable alternatives, there are simply no readily available substitutes for world energy needs.
The last eight years have been dominated by energy surpluses, and it looks like the next decade could be dominated by shortages as we begin to feel the effects of underinvestment and the political climate. I fail to understand why western democracies insist on shutting down our own energy production systems for the benefit of Russia and OPEC. Shamefully, Canada missed an LNG (liquefied natural gas) opportunity to replace some world coal usage. Shortages could easily lead to price spikes as occurred in Europe and China recently.
This represents an investment opportunity. Energy stocks have rallied significantly but are still cheap relative to the price of oil. Many are trading with 10-25 per cent free cash flow yields. The Canadian energy exchange-traded fund XEG still trades below where it was from 2005 to 2015. I periodically add energy to my portfolios and have no ethical qualms buying shares in companies supplying basic needs in the most efficient manner possible.
Many oil and gas stocks look attractive. Oilsands producers with more than 30 years of supply and improving means of egress, particularly so. I also like ocean-focused companies, which remain depressed. Energy is volatile and portfolio balance is important. If you’re looking to add, the following ticker symbols are in our personal portfolios — SU, IMO, CVE and CNQ in Canada and SLB, OII, RIG and FTI in the United States.
