A Major Flaw in the Global Oil Sector Means Prices Will Hit Record Highs
I was a writer during dark days.
This was the early ’90s in Texas. The oil patch. Another oil bust was playing out. Banks were failing. The savings and loan crisis was still ongoing. Oil prices had plunged into the mid-teens per barrel, down from the mid-$20s…and on their way to low double-digits.
One of the more common laments of the day in all the oil company offices I visited as a Wall Street Journal writer was: “Dear, Lord—Let me have just one more oil boom.”
I have a hunch we’re on the cusp of that now.
Ukrainian President Volodymyr Zelensky has posted on his Facebook page that Russia will invade his country on Wednesday…which, frankly, strikes me as a bit weird. I mean, when did countries begin announcing the time of an invasion, as though it were some kind of Winter Formal?
Whatever the case, major conflicts generally lead to a spike in oil prices. Prices are already in the $90s and heading well over $100 soon.
This is the destination to which I said we were headed a year ago, in the aftermath of COVID, when oil was commodity non grata. No one was driving. No one was flying. No was cruising the high seas. Who needed oil?
Well, of course, that was always going to be a temporary state of being. Oil prices were always going to rebound. And they were going to rebound with a vengeance—I just wasn’t expecting a Russian/Ukrainian conflict to be the source of that.
Instead, I was expecting what’s actually happening beneath the veneer of potential war: a supply-demand imbalance propagated by shuttered exploration and production.
That was my big trade back in the ’90s.
Oil had collapsed so far by the late-’90s that it was basically valued at the price of a bottle of dirty water. But I saw the emerging economies emerging…it’s why I’d begun investing directly in foreign markets in 1994. They were clearly consuming lots of energy even as exploration companies were sharply curtailing exploration budgets because oil prices didn’t justify the expense. So, I started buying oilfield stocks.
And what happened?
Oil prices shot up in a near-straight line over the next decade, soaring to more than $140 per barrel from just over $11.
We’re not going to see the same caliber of increase, certainly. But I won’t be surprised to see oil prices exceed those highs over $140. We could close in on $200.
The reason is the same dynamic at play this time around.
COVID shut down exploration, in part because energy demand vanished and crushed prices.
The end result, according to a McKinsey & Co. report in 2021, saw exploration companies slash exploration budgets by 10% to 80%. That’s billions of dollars not spent on finding reserves. That’s important because production companies need new sources of oil to replace the ever-dwindling reserves they’re currently draining.
So, demand is growing again, but supply growth has slowed.
And it’s not like America’s vast shale-oil reserves are coming to the rescue. Other researchers are now pointing out that shale producers have limited capacity to flood the world with cheap oil, as they once could. Moreover, many are pulling forward production of their tier 1 projects at a greater-than-average rate. That means lower quality reserves are in the offing, which will come into production later, when energy demand is even higher, which those lower-quality reserves won’t be able to meet.
This is all part of the ongoing commodity super-cycle I’ve been talking about for the last year.
Oil prices will likely run higher over the remainder of this decade (assuming no new viral lockdowns). When means inflation keeps on keeping on.
Best bet right now: Invest in commodity plays to buffer the pain higher oil prices will have across the economy.
There’s simply no short-term fix to this.
If a Russian/Ukrainian war of words turns into a war of bullets, oil will spike, then slide back once the conflict ends (likely quickly). But if that happens, don’t be fooled by oil’s retreat.
War is a sugar high. What’s going on fundamentally in the oil market is a chronic condition that will lead to record high oil prices soon enough.
