• The world goes green. Is that bad for conventional energy producers?
• Game plan for a gravy train collapse
• Supply response vs. higher prices may be different this time
• As convoluted as this might seem green may be good for fossil fuel producers for some time to come.

No Question: the world is going green

Climate change is real. Some may debate the cause but, excepting a few Luddites, this has become a consensus. Hydrocarbon emissions are front and center, the main source of blame for our current environmental issues and the major target for reduction or elimination. This fact is not lost upon oil-producing countries or the companies that find, produce, and market the ‘black gold.’

What to do when your gravy train begins to collapse

My advice-begin to look for a new gravy train! If you are Saudi Arabia, stop investing in new production or worrying about maintaining market share and start doing everything possible to maximize cash flow and investment in alternative industries that will take you into and finance the future. This may very well be an explanation for the current discipline we are seeing in OPEC+.

If you are Chevron (CVX) or Exxon (XOM) you may want to adopt the same strategy. Exxon in particular may want to think about this as three of their twelve directors are now green beans.

If you are Apache Corporation (APA) (be careful … I own this one), you may want to hold your maintenance capital expenditures flat and use any excess cash flow to pay down debt. This is exactly what they are doing. Prior to the Covid 19 collapse in oil prices, the company had been paying a quarterly dividend of $.25 (annually $378 million).  It was cut to $.0625 during the crash. In the first quarter of 2021, the company generated $502 million in free cash flow (an amount well over that needed to fund the entire old annual dividend at $1 per share). During the quarter-end conference call they were asked about increasing their dividend. Their response was that that was not even in the cards until they returned their debt rating to investment grade. They have about $8 billion in debt. If that level of free cash flow continues (no big bumps in spending to increase production, which they stated would be the case), my armchair analysis says that they could pay off 25% of that debt this year.

What about financing new oil exploration?

So, you’re a banker or investment banker and it is not lost upon you that the future is beginning to look dim, at least in the longer term, for certain fossil fuels what is the likelihood that you might want to loan or give equity to such a venture? I believe financing really does become an issue even if oil prices remain high.

Up the Down Escalator

This is an apt descriptor for the oil and gas industry. The minute you begin to produce an oil or gas reservoir the production rate starts to decline. In some cases that overall decline rate can take decades before the supply is exhausted and in some cases, like shale oil, it can happen more quickly. On a worldwide basis to maintain current production you have to continue to explore and develop new sources. What I have described above is definitely not conducive to this.

My conclusion: Supply Response vs Higher Prices May Be Different This Time

First and foremost, oil demand continues to grow and was forecasted to grow in 2020. Covid obviously changed the equation. As we reopen it will be coming back with a vengeance. 

As a point of reference daily world oil demand in 1987 was 85.8 Million barrels. It did a tiny stutter-step down during the Great Recession (2008-2009) and then began to grow again to about 100 million bpd in 2019. In 2020 we lost 9 million bpd due to covid related economic shutdowns. (Statista)

Now demand is snapping back quickly but the normal supply response is not happening. Note the very muted supply response from OPEC. For example, even with the price of Brent North Sea Crude over $70 per barrel, the Saudis are still holding 1 million barrels daily off the market from their peak level in 2020 (9.1 million bpd at the height of the price war). 

Why should they or any other oil producer be in a hurry to increase production when a 10% production cut equates to $30 or $40 per barrel more cash flow at a time when your most important source of revenue is under threat by the ‘green revolution?’ Maximizing cash flow and investing away from hydrocarbons would seem a rational course to take. This same question I am certain is being asked in oil company board rooms all over the world and it may very well be why this time the normal policy response, PRODUCE MORE-FIND MORE, is off the table.

The new mantra might become "Produce Less, Maximize Cash Flow, Direct New Investment To Alternative Energy Enterprises."

THE WILD CARD

The longer it takes for the ‘green revolution’ to transpire the bigger the supply gap/demand and the greater the economic pain of higher oil prices. This could play out over many years because of reticence on the part of management and countries to invest heavily in new hydrocarbon sources.

As convoluted as it sounds, going green truly becomes a lifeline to fossil fuels. I think you want to own this sector. The caveat, I already do!