In a free market, the saying goes, high prices cure high prices. If a good or service is expensive, people will see an opportunity to make money by producing more of it, which will lower the price.
The reality is messier. Oil prices have now risen to $104 a barrel. But investment to produce more, measured by the number of oil rigs actively drilling for oil and gas, has barely responded. Since oil prices bottomed out in mid-2020, they have nearly doubled, but the number of new rigs accounted for by drilling services company Baker Hughes has only increased by 13%.
With the oil market facing disruption from the Russian invasion of Ukraine, as well as rocky economic conditions and rising inflation, this appears to be a missed opportunity for investors. It’s certainly a political issue for the White House, where officials know many voters are driven by gas prices. That’s why the Biden administration released U.S. strategic reserve oil to the market and allowed drilling on more federal lands. These solutions are temporary and long term respectively.
The main problem facing the oil industry is underinvestment after the collapse of the hydraulic fracturing boom. The company is in recovery mode, focused on paying regular dividends to shareholders as prices rise, rather than taking the risk of investing in new production. Some may believe that the high prices we see today for oil and natural gas will fall rapidly if Russia ends its attack on Ukraine or if the economic environment influenced by the pandemic continues to return to normal. .
Oil producers have other complaints beyond the licking they have suffered in the market. As the reality of climate change takes hold around the world, policymakers and investors have pushed for more investment in decarbonizing the economy. In the long term, this naturally makes oil investment less attractive.
Is ESG investing to blame?
One of the main villains for commodity traders is the ESG community, which has seen large funds and individual investors concerned about environmental, social and governance issues seek sustainable assets for their money. Much of this funding goes to renewable energy, but most sophisticated analyzes of ESG investments reveal that they are not truly green. Still, oil market watchers say the strategy deprives the sector of much-needed capital.
This seems a little odd, if your baseline expectation is that investors will seek out arbitrage opportunities. If oil assets are underpriced due to non-economic factors, shouldn’t a smart trader make a killing?
“The scale of these industries is unlike anything else on planet Earth,” Goldman Sachs chief commodities officer Jeff Currie said in response to this question about the odd lots Podcast. “You take a Kashagan in the Caspian. His nickname was “Cash all gone”. Why? You know, it was somewhere around a $60 billion project… so the first and most important issue is scale.
That’s a good point, but at a time when Elon Musk can find banks willing to lend him $25.5 billion to buy money-losing Twitter, surely there must be big investors out there who see an opportunity. in the oil market. Currie says private investors are driving up the price of oil stocks, which are up nearly 78% in the past year, according to an S&P index that tracks those stocks.
It could lead to more production, but not anytime soon.