The Oil & Gas Inflation Trap Causing Concern For Global Investors

Recently, President Joe Biden sought to calm fears that rising inflation might hurt the U.S. economy and threaten his $4 trillion spending plans. After the Covid-19 lockdowns, U.S. inflation accelerated to its fastest pace since 2008.

According to the Labor Department the consumer price index (CPI), rose 5.4% Y/Y during June. This is almost twice the average rate for the past decade. There’s another thing Biden should be concerned about: rising oil prices.

Because of the potential risk to Democrats’ future political ambitions, the administration will be a bit nervous about high gasoline and oil prices. Gas prices have a significant impact on the consumer’s mind, it is a well-known fact. Nationally, gas prices are currently at $3.18 per gallon. This is a full dollar more than last year.

This is evident to Republicans who have taken advantage of the moment to blame Biden for rising gas costs.

Investors should be concerned about rising oil prices. This is due to the historical role of oil in dictating inflation trends, but also because Wall Street has stopped being enthusiastic about oil stocks, which could lead to higher inflation.

Inflation and oil prices are closely linked in a cause-and effect relationship. Inflation tends to rise in tandem with rising oil prices. However, falling oil prices tend to cause inflation to drop. This is because oil is a key input to the economy and increases in input costs will cause an increase in the price of end products.

Peak Oil Supply is a possibility, even though it is less often discussed than Peak Oil Demand. This is due to significant underinvestments in oil.

In the past, supply-side theories of “peak oil” were often wrong because their advocates invariably underestimated how large the potential for yet-to be discovered resources. Recent years have seen demand-side “peak oils” theories overestimate the potential of electric vehicles and renewable energy sources to replace fossil fuels.

It was then that few could have predicted the rapid growth of U.S. Shale, which added 13,000,000 barrels per day of global supply from just 2 million b/d over a decade. Ironic therefore that, Peak Oil Supply will likely be triggered by the shale crisis.

Vice chairman of IHS Markit Dan Yergin writes in an excellent op-ed that it is almost certain that shale production will decline due to drastic cuts in investment, and then recover slowly. The decline in shale oil production is extremely rapid and requires constant drilling to replenish the supply.

Rystad Energy, a Norwegian energy consultancy, recently warned that Big Oil’s proven reserves could be exhausted in 15 years. This is due to the fact that oil production volumes are not fully replenished with new discoveries.

Rystad reports that the proven oil and gas reserves of the Big Oil companies ExxonMobil and BP Plc, are falling. (NYSE :BP), Shell (NYSE.RDS.A), Chevron (NYSE.CVX), Total (NYSE.TOT) and Eni S.p.A. (NYSE.E) are all in decline, because the volumes of produced oil are not being completely replaced by new discoveries.

Big Oil’s proved reserves fell by 13 billion boe last year due to massive impairment charges. This is a drop of 15% from its ground stock. Rystad says the remaining reserves will run out in 15 years, unless Big Oil finds more commercially profitable oil.

The primary culprit is rapid shrinking exploration investment. Global oil and gas companies reduced their capex by a staggering 34% in 2020 as a result of shrinking demand and investors becoming wary of the sector’s poor returns.

This trend is not slowing down: First quarter discoveries were 1.2 billion boe. This is the lowest figure in 7 years, with wildcats only delivering modest-sized finds according to Rystad.

Norwegian’s proven reserves fell by 7 billion boe (or 30%) in 2020, which was a significant decrease from the 2019 levels.

Shell saw its proven reserves drop by 20% to 9 Billion Boe last year. Chevron lost 2 Billion Boe due to impairment charges, while BP lost 1 BOE. Over the past decade, only Total and Eni avoided a reduction in proven reserves.

However, the policy changes made by Biden’s administration and fever-pitch climate activism are likely to make Big Oil very difficult to return to its trigger-happy drilling days. This could mean that U.S. Shale could struggle to return to its glory days.

Clark Williams-Derry is an energy finance analyst at IEEFA. He has warned of a “tremendous amount” of investor scepticism about the business models of oil and natural gas companies, due to the deepening climate crisis and urgent need to shift away from fossil fuels. Williams-Derry claims that the market actually likes when oil companies shrink. Instead of investing in new production, they use the additional cash from higher commodity prices to repay investors and pay down their debt.

This trend will likely lead to an oil supply shortage, high oil prices and high inflation.

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