American drivers are seeing gas prices rise as a result. Fossil fuel boosters are now extinctFor policies that they claim limit U.S. energy production, President Joe Biden. “We have the reserves here and this is preventable,” Rep. Garret Graves of Louisiana, the ranking Republican on the House Select Committee on Climate Crisis, told reporters in Washington Tuesday. “No leasing or energy production—that’s not an energy policy.”
However, to understand why the industry really isn’t ramping up production, it helps to hear what its leaders are telling each other off camera. In Houston this week, where oil and gas executives are gathered for the industry’s most influential annual conference, CERAWeek by S&P Global, industry insiders are having a very different conversation than the one broadcast on cable TV. The primary thing holding back more production isn’t government policies, they say. It’s money.
Capital is required to increase oil flow. This comes at the cost of high risk in volatile markets. Recent losses have been severe and the investor who controls the purse strings is keeping companies in check. “Ultimately, companies have to make a decision to risk their capital… nobody knows how this episode is going to play out,” Mark Viviano, managing partner at Kimmeridge, a private equity firm focused on oil and gas, told a packed conference room on March 8. “I don’t think it’s realistic to think there’s going to be a collective industry response to this crisis. Unfortunately, it’s just not the way the industry is.”
In theory, that’s not how the market is supposed to work. The normal pattern is that a dramatic rise in oil price would lead to a significant increase in drilling. However, this may not be true. Safe profits are still the top priority for investors after huge industry losses over the past years. Even though Biden has not enacted any climate regulations that restrict oil or gas, the industry leaders still feel the pressure of investors.
The oil industryIt adopted its timid Investment approach has changed over the years. The oil industry, and all those that followed it for many decades, considered oil a finite resource. It would run out eventually. Industry leaders began to search for black gold, hoping that they would find it.
The dynamics of the industry were altered by hydraulic fracturing. It was introduced and widely used a little more than fifteen years ago. The areas that were ripe for oil production grew dramatically with fracking at an extremely low cost. Oil companies responded and began to produce. More oil—a lot more. They produced so many barrels that the supply outstripped the demand by 2014. Prices began to drop quickly as a consequence. From June 2014 to July 2016, the U.S. benchmark for oil prices fell by more than $100 from its peak of over $100 to just $30.
Companies that focused solely on fracking lost huge amounts of money at those rates. Some of these companies ended up going bankrupt. Some were taken over by larger oil companies, who were losing money. All of this contributed to oil and gas ranking as the worst performing sector on the S&P 500 stock index over the past decade. Upset at their returns, investors started demanding changes, imposing what is widely referred to as “capital discipline.” Instead of financing drilling anywhere and everywhere, investors told oil companies to focus on their most profitable oil projects and shelve the others. This strategy was confirmed by the COVID-19 pandemic and subsequent lockdown, which briefly drove oil prices down.
Jeff Ritenour, Chief Financial Officer at Devon Energy, an Oklahoma City-based oil and gas company, described at CERAWeek a “fundamental shift” that his business made to use profits to pay down debt, provide a reliable dividend to shareholders and buy back shares. In order to do that, the company has maintained a “low reinvestment ratio”—meaning it limits its investment in new production. Similar approaches have played out at firms across the industry and made “capital discipline” industry orthodoxy.
Russian invasion of Ukraine and the subsequent moves targeting the country’s energy exports have created the biggest challenge yet to that way of thinking. Many oil executives want to increase oil production, as oil prices have risen well beyond $100. According to the Dallas Fed data, Permian Basin producers could profitably drill new wells if the benchmark price in the United States is $50/barrel. That’s a lot of potential profit if prices stay high.
But investors aren’t convinced that drilling is the best best this time around. High oil prices can be a good investment. This is the most obvious reason to keep going. Oil companies are extremely profitable right now and Wall Street firms generally prefer that the companies return those profits to investors—either through dividends or stock buybacks—rather than spend it on new projects that may not be profitable down the road. The profits that investors can return to them will increase as oil prices rise. They can be recouped if prices fall.
It is not known how the crisis in Ukraine will persist or the impact it will have on the world’s economy. In the long-term, a war in Ukraine will lead to sustained high prices. This suggests that it is a good idea to produce more. However, an extended war can also lead to a global recession and a drop in oil demand. It is difficult for industry leaders to anticipate the volatility. “You can’t deliver consistent market leading returns, if you’re yanking around activity from month to month,” said Ritenour.
Republicans quickly place blame for climate change policy in Washington, as well as conservative media. It’s certainly true that President Biden put the oil and gas industry on notice when he took over in Washington last year. But the administration hasn’t succeeded in enacting any stringent regulations and the policies that are under active consideration largely offer carrots for clean energy rather than actively demonizing fossil fuels. “There is nothing that the administration is doing to restrict,” Amos Hochstein, the State Department’s point person for energy security, told CERWeek conference goers on March 8.
Oil and gas executives are pointing the fingers at investors rather than the government, despite being in the spotlight. Trillions upon trillions have been poured into the oil and gas industry. ESG funds, short for environmental, social and governance, and investors have become skeptical of the industry’s long-term future in the face of climate change. For many investors, the opportunity for a quick buck in the space isn’t worth it. “So far, and I am on the frontlines, I see this every day, there is no interest to go in this space,” Jeffrey Currie, the global head of commodities research at Goldman Sachs, told the crowd on March 8 as he shared the stage with the head of OPEC.
Here at CERAWeek, there is a clear bitterness about investors’ climate concerns. Industry executives blame “underinvestment” for the current crisis and complain that their recent returns make the industry investment ready. It’s reminder of the degree to which climate change has reshaped the industry: even amid a land war in Europe and soaring oil prices, the industry needs to respond to calls for reduced emissions. “In the world of money, everyone lives on bended knee,” Brian Thomas, a managing director at Prudential Private Capital, told a crowd. “The industry is beginning to kind of morph its behavior to reflect the concerns of its investor base, right or wrong.”