The origins of this global energy crisis can arguably be dated several years back when policy uncertainty around the future of fossil fuels began to penetrate the public psyche. It set the stage for the drastic ramp in rhetoric following the COVID-19 and OPEC+ debacle.
It was this rhetoric that *largely* contributed to the now-apparent underinvestment in the fossil fuel supply industry. Politicians seized the opportunity to demonize the fossil fuel industry, threatening bans on federal land drilling, cancelling pipelines that are 50%+ built, and even mandating companies to reduce their *full* scope emissions (includes vehicle combustion emissions - completely out of producer’s hands).
Capital fled the space in droves.
“But ser - crude prices hit -$40/bbl in 2020, of course no one would invest in this environment!” Crude prices were severely depressed for just a few weeks in 2020. And though companies choked off wells to avoid selling barrels at a loss, prices recovered shortly after and wells began to flow again. Crude prices averaged about $40 in both 2020 AND 2016, though investment remained relatively strong through 2016.
In 2021, despite crude averaging nearly $70/bbl, a mass exodus of capital outflows ensued, and fossil fuel stock multiples never recovered to this day.
Side Note: This draws a striking parallel to the demise of the coal industry. It began in 2013 with the World Bank Group’s move to exit the sector. Soon after, credit agencies began restricting coal power lending, and global insurers restricted coal investment and insurance policies. The snowball effect took over, with large sovereign wealth funds altering investment criteria to exclude coal from its holdings, and banks followed suit. The Paris Climate Agreement in 2015 was the nail in the coffin.
Back to oil & gas. The shale revolution in the mid-late 2000s took the world by storm. Equity and debt investors piled into oil & gas producers to fund the ingenious technologies that promised to secure cheap and abundant energy to the world for decades to come.
Over a decade later, after trillions have been poured into the industry, investors have yet to receive a reasonable return on their investment. Declining stock multiples had much to do with it, along with the inherent decline rates of shale production. After funding management’s seemingly never-ending production growth spree, coupled with a rising uncertainty of the future of fossil fuels, investors feared they would never receive a return on their investment.
The most loyal investors began punishing stocks whose management teams insisted on continuing to invest in production growth. The moment guidance for double-digit growth levels were announced, the producer’s stock cratered.
This was a shift in the zeitgeist. It led to management teams obliging to investor demands.
Growth spending and flat production guidance for years to come became the favored metrics among investors. Management then began allocating their newfound free cash flow towards paying down the debt accumulated since the beginning of shale, and implemented dividend and share buyback programs. Everyone (including OPEC+) was happy.
The shift from “drill baby drill” to “maintenance mode” led to balance sheet reductions and favorable returns to shareholders. An unintended consequence of this new maintenance mode paradigm, whose rhetoric began around 2018 but really only came to fruition post-COVID, was severe underinvestment in short and long-cycle production projects.
Knock-on effects were felt downstream. Midstream companies realized infrastructure was going to be overbuilt at their rate of spending, and were forced to delay and even cancel infrastructure projects, many of which were already half-built!
Refiners began converting smaller refineries to renewable diesel or mothballed them completely. Little investment flowed through the production, transportation, processing, exporting, and refining of oil and gas. The whole industry inadvertently adopted the “maintenance mode” paradigm set by the upstream sector.
Today, we see the impact the increasing Net Zero rhetoric has had on energy prices, and subsequently our cost of living. Inflation in the UK and other developed nations rose to levels only seen in 3rd world countries, food supply has become threatened, and the real risk of not being able to survive upcoming winter seasons surfaced. Citizens scrambled to load up on coal, propane, and gasoline in the global energy crunch to ensure the safety of their families. Panic among the public and market commentators alike ensued.
Has the Net Zero narrative peaked?
It's tough to say whether peak Net Zero narratives are behind us. It’s certainly here to stay. The Inflation Reduction Act signed into law on August 16, 2022 is evidence of that. However, the pendulum is beginning to revert. Regulators are starting to recognize the importance of a responsible energy transition, demonstrated by the EU Taxonomy Delegation Act set to enter force January 1, 2023. The goal of the Taxonomy is to boost green investment and prevent greenwashing, though the significance of this amendment to the Taxonomy is that it includes natural gas and nuclear energy as environmentally sustainable economic activities.
Recognizing the importance of natural gas and nuclear energy in the green energy transformation is a huge step towards achieving climate mitigation while continuing to enjoy energy abundance. It’s unfortunate an energy crisis disproportionately impacting the middle and lower-class’ livelihoods is what it took for decision-makers to acknowledge the realities of an aggressive energy transition. We hope the public perception that originally forced producers to dial back growth spending could see some mean reversion.
Do you think the rhetoric from clean energy talking heads has peaked? Will regulators only quietly become more responsible in their shift to a Net Zero world, while keeping up the current narrative?
Next time we’ll dig into some numbers on the EU gas storage situation, and whether a worse-case scenario is enough to keep the continent from freezing over.