• What happened to “Bakhtiari’s Event of the Century”?
  • Fossil fuels are booming
  • Green policies gave us the price spike – next, they’ll cause a crash

Perhaps the very first investment thesis I ever discovered was about peak oil. I vaguely remember the headline of the research piece as “Bakhtiari’s Event of the Century”. The story was about the greatest fraud in history.

You see, under OPEC, the amount of oil that a nation can sell is partly determined by how much oil it claims to have in the ground. The idea is for every country in OPEC to be allowed to sell a “fair” share of their oil each year without causing a glut that depresses prices.

But not all countries do the same amount of oil exploration, nor do they audit such estimates and release the results publicly…

The analyst who wrote the report argued that several OPEC countries had systematically fudged their estimates of how much oil they have in order to inflate how much they can sell under OPEC each year. But eventually, this would come to a shuddering halt as the oil suddenly ran out, despite official government estimates that many more barrels were being held in reserve.

The evidence for this claim included all sorts of statistics about a suspicious lack of oil exploration taking place in certain Middle Eastern countries. Their estimates of oil reserves had skyrocketed without any actual efforts to find more. How could countries claim to be increasing their reserves while producing a lot of oil and not doing much exploration?

Anyway, at some point, production would suddenly, completely and unexpectedly crater, delivering a vast spike in oil prices. By investing in US and UK oil producers that avoided the Middle East and OPEC, investors could go on to profit from this reckoning.

Although I recall that oil did surge subsequently, needless to say, the story didn’t pan out quite as the analyst had predicted. At least not yet… but it was a great introduction to how geopolitics, financial markets and investing interact.

The peak oil idea more broadly argues that we have pumped out much of the world’s economically recoverable oil and production will go into decline in the future as a result.

A key part of the story is that there is plenty more oil left, but it’s more difficult and expensive to get at. Higher prices make alternatives more viable, and so oil’s role in our lives would decline in some combination of less oil production, more expensive oil and less oil demand.

But the dates for peak oil seem to keep slipping. Oil demand is expected to hit a record high next year and production hit a record high last year, thanks to a boom in the US. Even the very definition of oil seems to be getting a bit greasy as liquefied natural gas (LNG) production elbows its way into the sector as a substitute.

It wasn’t so long ago that Europe was shutting down its industry and asking its people to conserve fuel because of energy shortages. Now, suddenly, we seem to be facing some sort of glut.

European gas storage levels are near record highs for this time of year. US gas storage levels are unusually high, too.

US production of fossil fuel energy is booming. The Americans leapfrogged Australia and Qatar to become the world’s largest LNG supplier.

But you ain’t seen nothing yet, if analysts from Bernstein Research have their maths right. 2025 will see the beginning of a boom in LNG production like we’ve never seen before.

Which begs the question of how it’ll all be used…

Back in November, the UK experienced the dreaded combination of cold weather and low winds, which left it reliant on gas. But there’s only so much capacity to burn gas to generate electricity, even if the fuel is cheap and plentiful. And so, households were paid to cut energy usage.

Are we going to build a lot more gas power plants to use up all this gas that’s coming down the pipeline? I can’t see that being in line with climate change commitments.

And who would build such plants with the prospect of getting used once in a blue moon?

It seems to me that the energy chaos of 2021 and 2022 has triggered its awkward but obvious consequence: extreme overinvestment in supply. We’re going to go from a shortage to a glut in the space of the amount of time that it takes to get more gas online.

The size of the price spikes in 2021 and 2022 was truly vast, especially in Europe. They seem to have triggered an investment in production that is correspondingly large, without reference to climate change constraints. But will the demand for all this gas really be there by 2025?

Well, if the price of gas is very cheap because of its abundance, then it will become more popular in and of itself. It’s a self-solving problem, with demand adjusting to the price.

But we don’t exactly live in a free market. The demand for gas may be artificially constrained by green policies and the time that it takes to build gas power plants. This is what creates the risk and instability in the fossil fuel markets.

The latest twist may be just another part of the commodity and energy investment cycle, with its booms and busts, but we can expect it to be unusually severe this time.

First, green policies resulted in the energy chaos of 2021 and 2022, causing prices to spike and triggering massive investment in gas production. Next, the same green policies may cause bizarre downside volatility as we try to get rid of gas demand in favour of pure green solutions just when the gas that we needed in 2021 and 2022 comes online.

The geopolitics will be interesting because this should leave those countries transitioning to gas for their energy needs with an economic advantage – vast amounts of cheap fuel to power their grids. Gas-producing countries like Australia, Qatar and parts of the US will lose out. And those pursuing green energy policies will see their fate tied to the success of green energy, which is uncertain. That’s quite a shake-up from the past three years of action.

The real question for investors is what the energy glut will mean for energy stocks. Unexpectedly high production should mean lower prices, but how do the two net out in the end – higher or lower profits for fossil fuel energy producers?

I don’t think it’s a good time to be buying and holding such stocks for the long run when there’s a glut on the horizon. But they do remain a good way to play geopolitical instability. And we should get more of that as the pendulum in the fossil fuel market swings.

The better opportunity may be to invest in the fuel of the future, which simply negates all these challenges. That boom has just begun.

Until next time,

Nick Hubble
Editor, Fortune & Freedom