Like many of my age cohort, I often
listen to podcasts on my daily
commute to work. One of my
favorites is Motley Fool’s “Rule Breakers,”
a stock market-oriented podcast by
Motley Fool co-founder David Gardner.
One of the common refrains he uses to
describe his stock-selecting philosophy
is that he looks for “dark clouds I can
see through.” The premise is simple: if
a company has been beaten down for a
good reason, but you have line of sight
on that issue being resolved, there exists
an opportunity to acquire at a good value
and profit from the recovery.
Can we see through the dark clouds
that hang over the industry today, to a
brighter future?
Dark Clouds All Around
As a representative of AAPG’s Mid-Continent Section, which includes
Kansas and Oklahoma, the stormy
weather metaphor to describe the
industry today seems appropriate. As I
write this – coming up on Oklahoma’s
tornado season – the industry has seen
a slate of metaphorical dark clouds. Last
year we saw a global pandemic and a
Saudi-Russia price war that coalesced
with soaring production growth from the
U.S. onshore sector to result in a severe
shock to the supply/demand balance.
Looking ahead there is long term demand
pressure from the energy transition to
renewables.
Spotting the dark clouds is the easy
part, however. The challenge resides in
the attempt to see through them. The oil
and gas industry is often described as
“boom and bust,” so I turned to history’s
lessons from some of the great busts for
clues on how to see through our current
situation. According to Mark Twain,
history doesn’t repeat itself, but it often
rhymes.
Can we find any rhymes to our current
circumstances?
Lessons from Oklahoma’s
Early Oil Fields
There has been a plethora of oil price
crashes over the industry’s 150-year
history, but not many of them match
the severity of the “one-two punch,” to
quote Warren Buffett, of an oil price
war-driven supply shock and COVID-19
demand shock. The closest I could find
happened to be right down the road
from where I’m sitting as I write this:
the Oklahoma City field. Like many of
the early oil busts, the discovery of this
new large oil field resulted in a drilling
frenzy and subsequent flood of supply
when it was discovered in 1928. What
makes the story of the Oklahoma City
field relevant today was the onset of
the Great Depression following Black
Tuesday in October of 1929. Here you
had a demand shock from the Depression
and a flood of supply entering the
market simultaneously, causing prices to
crash to 25 cents per barrel. The crash
was severe enough that the Oklahoma
governor sent in the National Guard in
1931 to halt the oil production until prices
recovered to a dollar per barrel.
Imagine yourself as a Young
Professional in the industry during that
time. You entered the industry during
the Roaring ‘20s as the stock market
boomed. Times were good and there
was plenty of oil to be discovered. Then
the industry you are a part of becomes
a victim of its own success as the new
production floods the market. To top it
off, the entire nation was hit by a severe
economic downturn.
Sound familiar? It’s hard not to feel a
sense of camaraderie with the geologists
of that day, like Dean McGee. McGee
was a 26-year-old YP when he began
working the Oklahoma City field for
Phillips Petroleum. I try to imagine what
he would have thought as he watched
the oil glut grow, the world economy
crater, and then the governor sent in the
military to prevent production. Talk about
unprecedented!
Eventually the economy recovered, the
Oklahoma City field peaked then declined,
and the oil glut subsided, although it took
several years. Dean went on to great
success in the oil industry as the McGee
of Kerr-McGee.
The long-term transition to renewables
presents a structural change that
hasn’t really been seen before with oil.
Previous energy transitions (wood to
coal, coal to oil, etc.) happened more
gradually and organically over time.
The massive intervention by the world’s
governments to speed the transition is
what is unprecedented about the current
environment. The closest analogy I
can think of to this level of government
activity in the oil markets would be the
various OPEC interventions. While these
market activities initially accomplished
their goal, there were often unintended
long-term consequences. Production cuts
designed to increase prices did indeed
drive up oil prices but resulted in non-
OPEC production gains and lost market
share. Current policies designed to
reduce carbon emissions could very well
create supply shortages in the future.
Is the history of the Oklahoma City
field analogous to the current industry?
As sure as the United States emerged
from the Great Depression, it is likely that
we will emerge from the COVID-19-driven
demand slump. On the supply side, the
price war has seen a cease-fire and even
surprise production-cut extensions, along
with capital discipline from U.S. shale
companies.
What about the energy transition?
Government intervention will almost
certainly result in significant disruptions
to the supply/demand balance. It’s
commonly said that the cure for low
prices, is low prices. Unfortunately,
we seem to keep redefining what “low
prices” actually means, as seen by the
April 20, 2020 unprecedented closing
price of -$37 per barrel. The inflation-adjusted
150-year chart of oil prices
shows that we have discovered a new
low for prices, sending the necessary
signal to reduce investment until balance
is achieved. The rebalancing is painful,
but inevitable.
A lot of perspective can be gained
by studying history. As the story of
the Oklahoma City field shows us, our
time may be unprecedented, but there
exists a precedent for getting through
the unprecedented times. Adhering to
that, it can be said that today’s industry
does have dark clouds, but with the right
perspective, maybe one can see through
them.