How long would it take you to drill an oil well or frack a gas well? I haven’t got a clue, and I doubt you do either. Let alone how… and that may be the key to why energy investors can make copious amounts of money too. It’s all down to timing.
You see, it’d damn hard to figure out what energy demand will be in the future. As 2020 taught us all the hard way, when the oil price managed to go negative. And it wasn’t just by a little bit, either. The WTI price went to -$37 in April 2020…
The reason why was a lack of storage as demand collapsed. People had bought oil, couldn’t sell it, and couldn’t find a place to store it either.
But it’s the supply side that I want to focus on today. Because that’s a little more predictable.
Well, 2022 taught us the hard way that it’s not entirely predictable. You still get your surprises.
But I want to talk about the longer-term cycle. The sort of thing investors can profit from.
Just like commodities and the commodity cycle, energy has a cycle too. That’s because it takes soooo long for supply to shift.
It takes years to find, develop and produce oil and gas. And then you need to process it with refineries and other infrastructure. Not to mention all the shipping involved.
The whole thing is incredibly capital intensive too. And the capital doesn’t provide a real pay back for a long time. And so capital allocation decisions take time and plenty of analysis.
All this creates a lagging effect. And that means a mismatch in supply and demand, because supply takes so long to adjust to significant changes in demand.
This lag is what creates the implicit profit opportunity for all energy investors. Because it promises what economists call “excess profits”. That has a very different meaning to the political version. In this case, it means profits that the market can’t just remove with competition. That’s because it takes time for competition to react by producing more oil.
Say oil were to become suddenly more popular tomorrow. How long would it take to produce significantly more oil in reaction to a higher oil price?
It depends on how much more and how much higher, of course. There is some give in existing oil and gas production, for example. And prices shift to make previously discarded and uneconomic wells viable. Those obviously take less time to get up and running.
But, for longer term shifts in demand, we’re talking decades for oil and gas supply to catch up. The oil has to be found and exploration resources are limited. The size of the find has to be established. Then the economics of extraction have to be studied. Then you need permission from the government. Then you need to install infrastructure. Only then you can develop the site and start producing.
All this creates the profitable opportunity for energy investors because of what happens in the meantime. If demand spikes prices, those companies that invested in production during the lean years stand to profit until new supply comes online to bring prices back down.
That’s how the cycle works…
You can start the story anywhere, because it’s a cycle, but let’s focus on where we are now.
Years of ESG pressure, government regulations and climate commitments have led to a severe underinvestment in energy. Meanwhile, demand is booming and existing supply can’t keep up. We’ve had shortages, supply spikes and the rest of it.
Deloitte, for example, pointed out how drastic things got in 2015 and 2016:
The crude oil and natural gas industry worldwide has slashed its capital spending by about 50 percent in 2015 and 2016, risking future availability of supplies. In 2015, conventional discoveries of oil and gas outside North America were reported to have dropped to the lowest levels since 1952. This lower-for-longer price environment will challenge E&P companies to achieve full reserve replacement, especially considering capex is not their only priority.
A 50% cut is extraordinary. But it’s a classic sign of a cycle, with too much and then too little investment in new production.
Geopolitical Intelligence Services points out things didn’t improve, with the 2022 energy crisis exposing an “investment gap”:
Often used loosely, the concept of an investment gap has not been well defined. Put simply, it refers to the difference between actual investment and the investment needed to meet future demand. The implication is that insufficient investment today will not generate enough energy supplies in the future.
In oil and gas, the argument is often made that the world is already bearing the high cost of constrained supplies due to lower investment since the collapse in oil prices in 2014.
But 2022’s price spike has incentivised new investment in production again. This boom, of course, encourages new investment. That’s what our Power Play Summit details. The flood of money into the sector to secure future profits.
The expected profits for companies that have secured production, or imminent production, are large because, while prices spike on rising demand, supply can’t yet keep up.
At some point, supply will, of course, catch up. But by then, the energy demand may not be there anymore. Or investment in supply may overdo it, again. And so the price falls again.
This falling price discourages investing in new supply projects. And that sets up the next shortage.
A new cycle begins. Rinse and repeat.
The implication is that investors also need to beware and sell out of energy positions at some point.
Investors who can figure out where in the cycle we are know whether to buy into it, and when to sell.
So, where in the energy cycle do you think we are?
If, like me, you’ve been watching declining investment in production and surprising amounts of demand coming online, you know what’s coming – it’s only a matter of when.
Now, according to our energy expert James Allen.
That’s why he has launched his Power Play Summit now. To help you reap the energy sector profits which 2022 were merely an appetiser of.
Which is quite a claim given the dramatic outperformance of energy stocks last year. In the first six months of the year, 19 of the top 20 performers in the US’ S& P500 index were connected to fossil fuels. The UK’s FTSE 100 outperformed global peers in 2022, thanks to its heavy weighting towards oil and miners. Australia’s coal stocks were the best performers for the year on that market as the world’s foremost clean energy virtue signallers, Germany, went back to coal.
If this was only the beginning of a longer-term investment gap opportunity, then those gains can’t be ignored.
As I understand it, episode 2 is going live at 2pm today – you’re not too late to join us, just sign up here.
Editor, Fortune & Freedom