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Jim Harrison’s 1979 novella Legends of the Fall references the biblical fall from innocence. The epic tale, further popularized by the 1994 film of the same name, chronicles the Ludlow family lineage; unfolding over numerous time periods and geographies. Comparing Brad Pitt’s depiction of the protagonist Tristan Ludlow to the modern history of oil in the global economy may be a rather “crude” comparison, but, stay with us – both have experienced a multi-generational degradation of virtue.
Despite the resoundingly negative connotation now attached to oil, gas, and the broader fossil fuels complex, these energy sources were once celebrated for powering the industrial revolution, which greatly enhanced the global standard of living. The oil market has experienced numerous regime changes and regional centers of influence, as corporations and governments wrangled for control of the lucrative commodity.
In the early 1900s, the oil market was dominated by a handful of “super-major” companies (which have amalgamated into the oil majors still present today, such as ExxonMobil, Shell, and BP) concentrated in the U.S. and Europe. The formation of the Organization of the Petroleum Exporting Countries (Opec) in 1960 did not initially have a major impact on the market, but by the mid-1970s, the Middle East had become oil’s epicenter and trans-governmental price-fixing became an overriding industry fixture.
A resurgence in U.S. production brought us to where we are today, which is a fractured and volatile market seemingly still in search of equilibrium. Focusing specifically on this last regime change, it is critical to understand the underlying drivers and their implications for the future.
The term “peak oil,” now commonly the central debate surrounding the trajectory of global oil demand (more on this later), once referred to concerns that the world was running out of oil supply. This belief helped underpin a structural rise in oil prices from 2002 to 2014 (albeit with a short-lived but severe crash during the Global Financial Crisis in 2008). Predictably, capital investment was deployed in droves. The oil and gas industry’s capital budget increased nearly ten-fold from 1999 to 2012 to approximately US$1 trillion.
Critically, this explosion of investment occurred simultaneously with (and was further enabled by) the development of new techniques of hydraulic fracturing, or “fracking,” which allowed oil and gas in large U.S. shale deposits to be economically extracted. U.S. production soared, increasing over 60%, to approximately 9 millions barrels per day between 2010 and 2014. This rapidly rising incremental supply source was a key contributor to the oil price crash of 2014-15.
Despite the collapse in prices, the U.S. continued to ramp up production, hitting an all-time high in 2019 of over 12 million barrels per day. The nation is now viewed as the world’s “swing producer,” meaning that it is the supplier with the greatest spare capacity and thus has the greatest influence over oil prices. West Texas Intermediate (WTI) crude oil prices have essentially orbited around the average U.S. producer’s marginal cost of production, which the Federal Reserve Bank of Dallas survey shows is currently near US$50 per barrel.
Major trend changes are always triggered by a catalyst. In Legends of the Fall, the death of Tristan Ludlow’s younger brother during World War I not only caused him to become temporarily unhinged, but also represented a turning point in his overall psyche and outlook on life.
Oil’s transition from darling to pariah was not quite as straightforward. However, the aforementioned surge in fracking activity was certainly a contributor. While oil extraction was never an environmentally friendly pursuit to begin with, fracking is particularly harmful, with widespread concerns about ground and surface water contamination, methane leakage, seismic activity, and numerous others.
Additionally, resource depletion, air quality, and global warming concerns are not a new phenomenon for carbon-intensive industries. However, alternative energy sources were previously either prohibitively expensive or, in the case of nuclear energy, tarred by previous catastrophes and anxiety towards radioactive waste disposal.
The tide began to turn over the last decade, as technological proliferation in renewable energy generation (particularly solar), battery storage, and electric vehicles (EVs) led to sharply improving efficiency and falling costs. Solar consumption has increased from approximately 21 terawatt-hours (TWh) in 2009 to 724 TWh in 2019. While subsidies have been heavily relied upon to stimulate demand, unsubsidized solar energy is reaching cost parity versus fossil fuel-generated electricity in a growing number of markets.
Both the solar and EV markets continue to benefit from advances in battery storage efficiency, which has improved solar economics and the range EVs can travel on a single charge. EV global market share has more than quintupled since 2015, from 0.6% to 3.2% in 2020.
Taken together, the breakthroughs in renewable energy and EVs now provide tangible alternatives on both the supply and demand side of the energy market. This has enabled significant commitments from governments (such as the 2016 Paris Agreement) and corporations alike to reduce their respective carbon footprints.
Next time: Covid-19 as a decarbonizing accelerant, and investment implications
David Kletz, CFA, is Vice President & Portfolio Manager at Forstrong Global Asset Management. This article first appeared in Forstrong’s 2021 Super Trends Report. Used with permission. You can reach David by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at dkletz@forstrong.com.
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The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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