Shale, Renewables, and Fundamental value

A lot of discussions with investors since #COVID19 took the globe by storm a couple of months ago have revolved around the energy landscape in light of our current situation and what a post-COVID world might look like.  Many of them are looking at shale producers and thinking that the vast majority of the E&P players are going to get washed out and there’s going to be a big opportunity there.

That alongside a rebound in demand and a potential production cut from OPEC+ (some day) will push WTI back to $50/bbl and they’ll be printing money.

A Little Bit of History

In early 2008, HH NG was north of $10/mmbtu and the long run average price was generally thought to be $7.5/mmbtu

GFC comes, the market collapses, shale comes online, etc. For a decade, the whole world has been thinking $2.5-3 is awfully cheap.  Know where it is today?  $1.7/mmbtu

Oil was at $99/bbl in ’08, dropped to $62, retested the highs, and then plummeted to $43 in ’16. Everyone was thinking it was a bargain but it barely got to $60 before it rolled over again and you see where it is now – $25

So that’s the brief history lesson of the last 12 years of fossil fuel prices in the United States.

Back to the Present

The estimates I’ve seen are that there’s been a 25Mbbl/day reduction in demand against a 100mbbl/day total use.  A 10mbbl/day cut from OPEC+ isn’t going to do anything. 

“Ultimately, the size of the demand shock is simply too large for a coordinated supply cut, setting the stage for a severe rebalancing,” the Wall Street bank said in a note dated on April 8.
A headline cut of 10 million bpd would still require an additional 4 million bpd of supply reduction via the shutdown of production due to low prices, the bank said.

Here’s where the train leaves the tracks – the OPEC+ nations are facing massive budget deficits in front of them.  Oil revenues are a primary source of income.  When the market goes from $55 to $28, the last thing they want to do is cut output because it amplifies the deficit.  So compliance is a fundamental problem with the arrangement.

And even when the world gets back to “normal”,  telecommuting, less air travel, less going out, etc. are all going to be here for a while – permanently impairing oil demand.

Here’s the Kicker

There’s a common misunderstanding of the way oil and gas prices relate to renewables.  The correlation between solar and oil returns is basically zero.  The correlation between solar and gas is about .14 – virtually meaningless.  You know what happened to renewable capacity while gas was kicking around the basement?

Installed wind capacity almost quadrupled from 25GW to 94GW
Installed solar?  .5GW to 51GW – 100-fold increase

Coal over that period?  Toast
Even Gas for generation is getting kicked around now.

The last bastion of gas demand has been plastics – but if you haven’t noticed, single-use plastics are disappearing faster than you can say “Houdini”.

Investors have made really good money in renewables while the oil and gas guys have been treading water for a couple of decades on a nominal basis.  Inflation adjusted, they just got smoked.

Fundamental Value & the Value Trap

With all that said, if shale collapses, it puts a floor under oil which pushes investment back to renewables (because of the misunderstanding I just outlined).  A lot of investors want to get long collapsed shale with DIP financing or buying credits at 20 cents on the dollar.  Either way, renewables is going to continue its assault on carbon assets.  You can’t put the horse back in the barn.

Last but not least, there’s the regulatory risk:
– that the world will get its act together and price carbon
– that some percentage of “proven reserves” are going to stay in the ground
– that wellhead methane is going to be regulated
– that states are going to want more jobs and will get on or continue to ride the massive job creation engine that is renewables

I’m calling it here – just like coal and gas before – oil is now a value trap;  getting long carbon assets is a mistake.