What’s good for investors is sometimes terrible for the U.S. economy, and what’s good for the economy is sometimes terrible for investors.
You know that old saying, “What’s good for General Motors is good for America”?
Sometimes, that saying is completely backwards. What is bad for an industry can be wonderful for America on the whole — and vice versa.
The all-time champion of this phenomenon is the oil and gas industry in the aftermath of the shale revolution. The fracking-based shale revolution was one of the best things that ever happened to the U.S. economy. It was also one of the worst things that ever happened to oil and gas investors.
This is not a coincidence. The cause-and-effect mechanism that helped the U.S. economy immensely was the same one that, for the period of 2009-2019, made the U.S. energy sector one of the worst places to invest, ever (more on that shortly).
To put it simply, the shale revolution was so successful that a flood of cheap capital was converted into a superabundance of low-cost oil and gas.
That tremendous supply of American oil and gas, pulled up from rock that was previously deemed worthless, did two things. It helped various sectors of the U.S. economy boom, while creating jobs in dozens of states — and it caused investment returns in the oil and gas industry to collapse.
The shale revolution was vital to economic recovery in the aftermath of the global financial crisis.
The post-2008 recovery will be remembered for being sluggish and slow as it stands — but if it weren’t for the boost created by shale, and America returning to glory as an oil and gas superpower, that recovery might not have happened at all.
It was almost as if oil and gas investors had chosen to sacrifice themselves — or sacrifice their capital, at any rate — for the sake of helping America out.
After 2008, so much capital poured into the shale space, in part due to easy money conditions at near-zero interest rates, that an ocean of low-cost financing more or less created an ocean of low-cost oil and gas supply. By ignoring the basic economics of supply and demand, oil and gas investors financed their own doom (in terms of generating viable investment returns).
But this catastrophic investment error was an incredible boon to other industries, like chemical companies and light manufacturers who benefited from the guarantee of a long-term cheap energy supply and the ability to lock in supply contracts on a 20-year time horizon.
Prior to the shale revolution, it was conventionally received wisdom to believe America was running out of oil and gas. One notable energy company, Cheniere Energy, was set up to run liquid natural gas (LNG) ports expected to handle natural gas imports, with the LNG coming in from other places.
But then, after shale got going, Cheniere had to completely reverse its business model. Instead of LNG ports that received natural gas, the U.S. needed facilities to liquify local gas and ship it out.
At the same time, chemical companies that had been building new production plants in far-flung locations, like the Middle East, started tearing up their international plans and building in the United States instead. The difference was a sudden superabundance of cheap, natural gas.
That cheap gas made such a difference, in fact, that Chinese chemical companies, which were previously run in China, and set up to serve Chinese markets, started building multi-billion-dollar facilities in the United States.
Why? Because American natural gas had grown so cheap, it became more economical to build facilities tapped into low-cost U.S. gas supply, and ship the finished product back to China, than to use the more expensive gas available at home.
Again, all of this was wonderful for the U.S. economy. Low-cost energy creates an economic tailwind for a wide variety of industries. It makes production cheaper, and transportation cheaper, and also lowers the cost of electricity and heating homes.
But the oil and gas industry itself suffered mightily from the energy bonanza it found beneath the earth.
In 2007, Warren Buffett jokingly wrote the following about the airline industry: “If a far-sighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.” Ironically, Buffett became the butt of his own joke years later, after Berkshire Hathaway took heavy losses in airline stocks.
A far-sighted oil and gas investor, with knowledge of what would happen in the 2009-2019 period, might comparably have tried to stop George P. Mitchell, the father of fracking, from getting his tenacious experiments off the ground.
But the fracking boom unfolded, and America is much the better for it — even in the midst of utter carnage for the oil and gas industry.
To grasp how much the mighty have fallen, consider the following.
On Oct. 29, the market valuation of Zoom Video Communications (ZM), an online video conferencing firm, surpassed that of Exxon Mobil (XOM), one of the largest oil majors in the world.
Exxon has since bounced back as of this writing, but for at least a day or so, Zoom was worth $140 billion while Exxon was at $137 billion.
“Exxon Mobil Corp. posted its third consecutive quarterly loss for the first time on record,” The Wall Street Journal reported on Oct. 30, “and disclosed that it may write down the value of natural gas assets worth as much as $30 billion.”
“Energy has been the worst-performing sector this year,” Bloomberg reports, “dropping more than 50% and underperforming the best-performing group — tech — by 70 percentage points.”
“Energy is the worst sector, ever,” says a research note headline from Jason Goepfert of Sundial Capital. “Energy has been one of the most consistently losing sectors out of any sector since 1928,” says Goepfert. “It’s also suffered one of the largest drawdowns.”
Why did this happen? More pointedly, why did the oil and gas industry keep allocating capital to new and existing projects, to the point of burying itself in a supply glut now worsened by a pandemic?
It wasn’t really a coordinated thing. Rather, there was a lot of cheap capital available after the global financial crisis — thanks to zero interest rate policy, or ZIRP — and so a whole lot of projects got funded.
Then, too, a well-developed financial industry meant that very few shale products had to shut down, even if the original producer went bankrupt. Rather than capping the wells, or otherwise mothballing the project, the assets could be sold at a distressed value to a private equity buyer — and the oil and gas could keep flowing.
Robust financial support of the shale complex explains why Saudi Arabia failed in its attempt to kill off U.S. shale producers in the “Saudi Oil War” of 2014. The Saudis tried to glut the oil market and put U.S. oil producers out of business, repeating a play they had used successfully in 1986.
But in launching a new oil war, with the hope of bankrupting U.S. oil producers, the Saudis didn’t count on the finance angle, or the ability of busted shale operations to simply change hands and keep on pumping. Eventually the Saudis gave up.
So, what will save the oil and gas industry, or at least help turn it around?
Amusingly, it might be green regulation.
“While Biden has called for prohibiting new oil and gas projects on federal land,” Bloomberg reports, “the candidate has made it clear he does not support a widespread ban on fracking — which involves pumping water, sand and chemicals underground to free oil and gas from dense rock formations.”
“Even if Biden wanted to, he couldn’t unilaterally ban fracking on private lands,” Bloomberg goes on to add. “Under a 2005 law, the Environmental Protection Agency has almost no regulatory power over fracking. Changing that would require an act of Congress.”
So, if environmental regulation is used to restrict fracking, while still enabling fracking on private lands and the continuation of key projects, guess what happens to the oil and gas supply glut? It starts to shrink.
Then, too, we are going to have high-priced oil again. It is just a matter of time.
The global economy is struggling right now, thanks to a 100-year pandemic, but eventually America, and the world, will return to a robust pattern of economic growth.
When this return to economic growth occurs, even if renewable energy projects are expanding at the fastest clip imaginable, the expansion of renewable energy supply will not come fast enough to fill in the fossil fuel gap.
As a result of this, the crude oil price, and the natural gas price, will shoot up again as fossil fuel demand outpaces supply. If green regulation has hemmed in the footprint of U.S. fracking, meanwhile, that supply restriction will be even more bullish for oil and gas names.
Investing can be funny sometimes. That which seems good can be bad, and that which seems bad can be good. For the oil and gas industry specifically, the restrictive nature of green regulations could help speed up a renaissance.
In markets, sometimes what you wish for isn’t actually what you want — and what you wind up getting is better than you expect.
