Podcast Summary
Changes in US oil production and investing opportunities: Principal Asset Management identifies opportunities in US oil sector by combining local insights and global expertise. Overexpansion of shale production led to financial difficulties, but production is expanding again at a disciplined pace. US oil makes up a large portion of global output.
The energy market, specifically US oil production, has seen significant changes in recent years. Principal Asset Management, a real estate manager, applies local insights and global expertise to identify investing opportunities in this sector. The oil boom a few years ago led to an overexpansion of shale production, resulting in financial difficulties for many investors. However, production is now expanding again at a more disciplined pace, and US oil accounts for a large portion of global output. The narrative around depressed production and falling prices is complex, with factors including geopolitical events and changing financial conditions. Javier Blas, Bloomberg opinion columnist on oil and energy, sheds light on these developments. Empathy and awareness towards the challenges people face, both in business and personal life, can lead to better understanding and improved outcomes. For more insights on investing and energy, visit principalam.com or listen to the Visibility Gap podcast presented by Cigna Health Care. Investing involves risk, including possible loss of principal.
US Oil Production: Technological Advancements, Not Rig Counts: The US oil industry's advancements in extracting more oil from existing wells and drilling longer horizontal wells have led to increased production, even with a lower rig count compared to previous booms.
The US is currently producing approximately 1 in 5 barrels of the world's oil consumption, with a significant portion coming from Texas and New Mexico. This production increase isn't due to a significant rise in rig count but rather from the oil industry's advancements in extracting more oil from existing wells and drilling longer horizontal wells. For instance, wells that once went down vertically and then turned horizontal for a quarter to half a mile now extend as far as 3 miles horizontally. This technological improvement allows companies to extract more oil than before, even with a lower rig count compared to previous booms. This ongoing innovation is crucial for understanding the current energy market dynamics. A 2016 article from Statoil highlighted the importance of technological improvements in the oil industry, stating that the same oil well design and components could drill three reservoirs for the price of one. Since then, the industry has continued to innovate, enabling longer laterals and more efficient oil extraction. This progression is a significant factor contributing to the US's continued oil production growth despite the overall market's price fluctuations.
Standardization in Shale Oil Industry: Technological advancements and standardization in shale oil production have led to faster growth, lower costs, and increased profitability for companies, challenging traditional oil-producing countries. Simple changes like using a single standardized shade for painting projects have resulted in significant cost savings.
The shale oil industry's technological advancements, including the rapid pumping of fracking fluids and standardization of components, have led to faster production and lower costs. This has resulted in profitable growth for companies and investors, posing a significant challenge to oil-producing countries like the US and Saudi Arabia. An example of standardization is the North Sea oil industry's shift from using 19 different shades of Jell-O for painting projects to using a single standardized shade. This simple change has significantly reduced costs across the industry. The capital markets have played a crucial role in the industry's success, as companies faced a choice between investing in expensive, bespoke projects or adopting standardized designs to cut costs and increase profitability.
Shale oil industry's surprising efficiency and high production volumes: OPEC's production cuts kept prices above $70, enabling shale companies to self-fund new drilling and expansion, shifting away from external financing
The shale oil industry's ability to maintain high production volumes while becoming more efficient has been a surprise to many, as the industry had previously focused on profitability and expected production growth to slow down. This has been made possible in part due to OPEC's production cuts, which have kept prices above $70 a barrel and allowed shale companies to generate enough cash flow from their operations to fund new drilling and expansion. However, if OPEC had not made these cuts, prices would have likely come down, and the industry would have faced the same challenges of overproduction and decreased profitability that it has in the past. The funding for this new production is coming primarily from internal cash flow rather than external sources like equity and debt markets. This shift towards self-funding is a significant change from just a few years ago when Wall Street provided the majority of the financing. Companies are now able to pay for their operations and even pay dividends to shareholders, marking a new era for the shale oil industry.
OPEC's Struggle with US Shale Growth: OPEC aims to maintain oil prices but faces challenges from US shale growth and pressure to expand production. Potential strategies include cutting production or accepting lower prices, both impacting OPEC's revenue.
Publicly listed oil and gas companies are more focused on dividends and share buybacks due to pressure from shareholders and Wall Street, while private companies have been growing more aggressively. However, there's a suspicion that some of this growth was to maximize production for potential sale to larger players. OPEC's current strategy is to maintain oil prices near $100, but they believe US shale production growth will slow down and demand will remain, allowing them to expand production. This strategy worked in 2011-2012, but it's unclear if it will again. If US shale growth doesn't slow down, OPEC may need to cut production or accept lower prices. Both options mean lower revenue for OPEC. The coming year will be crucial for OPEC as they may need to change their strategy if US shale growth continues and demand doesn't slow down.
OPEC's Production Strategy Could Lead to Painful Consequences for Members: OPEC's decision to maintain oil production levels may result in decreased purchasing power for oil due to lower revenues and inflation for its members, while shale producers in the US cannot join due to regulations and geopolitical tensions could disrupt exports from the Persian Gulf.
The current strategy of OPEC to hold oil production levels for the next six months could lead to painful consequences for OPEC countries if the market conditions do not improve as expected. Lower revenues, combined with inflation, would significantly decrease the purchasing power of oil barrels for countries like Saudi Arabia. Additionally, shale producers in the US cannot join OPEC due to anti-price fixing regulations. During the pandemic, there were attempts by a Texas railroad commissioner to negotiate with OPEC, but these efforts were ultimately unsuccessful. Previously, OPEC and its allies agreed to cut 10% of global oil production in response to the pandemic, with the US participating in negotiations but not joining the cartel. The rising tensions in the Red Sea, particularly the US strike on Houthi assets, could potentially impact oil exports from the Persian Gulf if the Strait of Hormuz is disrupted.
Potential conflict in the Red Sea could impact global energy markets: A conflict in the Red Sea could disrupt LNG supplies to Europe, potentially leading to increased US LNG exports and Russian LNG staying in Europe, while non-US OPEC related capacity remains a concern.
The situation in the Red Sea, specifically the potential conflict with Iran, could significantly impact global energy markets and shipping costs. If the conflict remains contained, the impact may be minimal, with some additional cost and time for shipping routes. However, if the conflict escalates, it could lead to a major disruption in the global energy market, particularly in Europe, where LNG supplies could be severely impacted. The US could potentially step in and increase LNG exports to Europe, while Russia may keep its LNG in Europe rather than sending it to Asia. The state of non-US OPEC related capacity is also a concern, as some countries, particularly in Africa, have struggled to maintain their infrastructure due to low prices in the 2010s, limiting their ability to expand production. Overall, the situation in the Red Sea and global energy markets is something to watch closely, as even a contained conflict could have significant economic implications.
US Shifts from Net Importer to Exporter in Oil Market: The US is now exporting more oil than it consumes, a major shift in the global oil market. Iran's production return and Saudi Arabia's production expansion add to this transformation, reshaping the energy industry and global politics.
The global oil market is undergoing a significant shift with the US becoming a major exporter, Iran increasing production despite sanctions, and OPEC members like Saudi Arabia and the UAE expanding production capacity. This reconfiguration of the energy sources and trade is surprising given the US's historical status as a net importer and the challenges faced by Iran and OPEC in recent years. The Biden administration's stance on oil and green energy seems to have taken a backseat to these market realities. The US is now exporting more oil than it consumes, a development that would have been unthinkable just a decade ago. The return of Iranian oil production, despite sanctions, and Saudi Arabia's acceptance of production cuts without OPEC's help, add to this changing landscape. The implications of these shifts for the energy industry and global politics are significant and ongoing.
US oil industry thrives under Biden despite green rhetoric: The US oil industry continues to prosper under the Biden administration, prioritizing low energy prices over green transition, while European energy markets offer significant profits for independent traders due to market liberalization and renewable energy volatility.
Despite the Biden administration's public stance on climate change and green transition, the oil industry in the US is thriving under their leadership, with minimal restrictions on production. Privately, industry insiders admit that the focus is on keeping energy prices low, leading to a general satisfaction within the industry. Contrastingly, in European energy markets, the liberalization of electricity markets and increased volatility due to renewable energy sources have led to significant profits for independent traders. In 2022, these companies saw returns on equity exceeding 100%, with some reaching above 250%. The market's shift from long-term to short-term trading has resulted in substantial revenue growth for the top players.
Growth and Concerns in the Electricity Trading Market: Despite profits, concerns rise over systemic risks in electricity trading market due to firms with small capital bases, all trading from same location, using same banks and brokers, and large volume of transactions making it hard for regulators to keep up.
The electricity trading market, driven largely by computers and automated systems, has seen massive growth and profitability, with some firms making billions in 2022. However, concerns have been raised about potential systemic risks, as a significant chunk of the market is controlled by firms with small capital bases, all trading from the same location, and using the same banks and brokers. European policy makers have expressed a lack of knowledge about these firms, and the sheer volume of transactions in the market, with 4.4 billion transactions monitored in 2022, makes it difficult for regulators to keep up. The potential risks are reminiscent of issues faced by traditional commodities traders in the past, and it is crucial that regulators and policy makers gain a better understanding of this new breed of electricity traders to mitigate any potential systemic risks.
Exploring challenges and opportunities in electricity and oil industries: The electricity sector faces unpredictability due to natural elements, while the oil industry experiences growth from tech advancements. Standardization plays a crucial role in both industries, leading to progress and challenges.
The energy industry, specifically the electricity and oil sectors, are subject to unique challenges due to their dependence on natural elements and rapidly evolving technology. In the case of electricity, the unpredictability of wind and sunlight makes it difficult to ensure consistent availability and profitability. On the other hand, the oil industry, particularly shale, has seen unprecedented growth due to technological advancements and capital market excitement. However, there's still much to explore in terms of the basics of electricity trading and the role of standardization in driving innovation and solving problems. Additionally, the world of standardization is an intriguing area to delve into, as it plays a crucial role in various industries and can lead to both progress and challenges. The Odd Lots podcast hosts plan to explore these topics further in future episodes, including interviews with standardization bodies and the creators of barcodes.
Matt Levine and Katie Greifeld team up for a new weekly finance podcast: Popular Money Stuff newsletter duo launch a new podcast, bringing finance discussions to life each Friday on major platforms
Matt Levine and Katie Greifeld are joining forces to bring the popular Money Stuff newsletter to life as a weekly podcast. Each Friday, listeners can tune in to hear Matt and Katie discuss the latest in Wall Street finance and other intriguing topics that have made Matt's newsletter a must-read. The podcast will be available on major podcast platforms, including Apple Podcasts and Spotify. This collaboration is an exciting development for fans of Matt's newsletter and for anyone interested in staying informed about the world of finance. With their engaging and insightful commentary, Matt and Katie are sure to provide listeners with valuable information and thought-provoking discussions. So, be sure to add Money Stuff to your podcast rotation and stay tuned for new episodes every Friday.
