Over the past year or so I’ve been arguing that western Canadian oil and gas producers, with support from the federal and provincial governments, need to take maximum advantage of what may be the last significant price boom to prepare for a net zero world.

But a key driver for the natural gas crises hitting Europe and parts of Asia and the recent jump in global oil prices, a lack of capital investment, has led me to become far more bullish about oil and gas prices over the next decade or more.

“It is a cautionary message about how complex the energy transition is going to be,” Daniel Yergin, vice chairman at IHS Markit and author of The New Map: Energy, Climate and the Clash of Nations, told Bloomberg in early November.

As a result, we may now be in the early stages of another commodity super-cycle, as New York-based investment bank Goldman Sachs has been arguing since October 2020, which would mean higher oil and gas prices for longer this boom. More likely, at least from my perspective, we may be entering an extended period of greater volatility in prices, with higher average prices until consumption for these two commodities begin to decline in earnest sometime down the road.

Both scenarios mean far more internal financial resources should be available to fund the energy transition of western Canadian oil and gas companies — whether it be decarbonization efforts like the American majors or shifting into new energy endeavors like European ones — than I previously predicted (see Russia Is Gaining Control Of OPEC+).

Lack of capital investment

Capital investment for upstream oil and gas projects has been hammered lower since the middle of the last decade for several reasons. The 2014-16 oil price crash caused global capex to collapse from almost US$800 billion at the start of the period to around US$425 billion at the end. The first round of the COVID pandemic pummeling oil and gas prices in the first half of 2020, concerns about future consumption levels as we move towards a net zero world, and the ESG phenomena retarding access to outside capital for fossil fuels, caused global investment to collapse from about US$500 billion in 2019 to US$350 billion in 2020.

The collapse in capex in the middle of the last decade has been a major cause of the natural gas crises presently impacting Europe and parts of Asia, according to Nikos Tsafos, chair for energy and geopolitics at Washington-based Center for Strategic and International Studies (CSIS). “New LNG supply projects take four to five years to build, so whatever gap exists today is because of what happened in the mid-2010s,” Tsafos wrote last September.

On that note, global gas consumption rebounded a strong 3.2 per cent last year, after declining by 2.3 per cent in 2020, and averaging 2.1 per cent annual growth over the 2015-21 period. In contrast, growth in global LNG supply in 2021 was roughly half the annual growth rate of about 10 per cent from 2016 to 2019.

At the same time, prices have been buoyed higher in the European gas market by a colder-than-normal winter of 2020-21 severely depleting natural gas inventories and lower than normal imports from Russia since then, for either commercial — the Russians having to meet domestic demand and rebuild inventories at home — or geopolitical reasons.

To date, the impressive rebound in crude oil prices has been more contrived, with growth in global oil consumption less than a third of natural gas in recent years. OPEC+ is continuing to withhold large amounts of oil from the market and U.S. tight oil producers are showing amazing financial discipline after burning through cash to fund rapid production growth for most of last decade.

According to Scott Sheffield, president and CEO of Pioneer Natural Resources, companies such as his have replaced their growth-at-all-costs strategy that led to the 2014-16 oil price crash, and contributed to the one in the first half of 2020, with “a new investor contract.”

As a result, IHS Markit is forecasting U.S. shale firms to generate cumulative free cash flow of roughly US$350 billion between 2021 and 2025, after being negative US$150 billion over the 2010-20 period. These firms made more money last year at US$70/bbl oil than they did with oil prices above $100 in 2014, having slashed industry breakeven in half to around US$40/bbl over this period.

But assuming continuing financial discipline by U.S. tight oil producers — the only ones who can bring on new capacity relatively quickly — the global supply situation will become much tighter by the fourth quarter of this year, the key driver for higher oil prices in recent weeks.

According to Julian Lee, an oil strategist with Bloomberg, the world will have a mere 2.5 million bbls/d of spare capacity once all of the OPEC+ output cuts have been restored to the market in September, representing an extremely low 2.5 per cent of global oil demand based on historical norms. And all of this supply cushion will be found in just three countries — Saudi Arabia, Iraq and the United Arab Emirates.

Another super-cycle?

There have been a number of reasons given for another commodity super-cycle by Goldman Sachs and others, with the New York-based investment bank recently arguing the boom could last up to 10 years. In a nutshell, pandemic-related fiscal spending and increased public and private spending to achieve rapid decarbonization of the global energy mix leading to relatively strong economic growth.

The primary beneficiaries are so-called green metals such as cobalt, copper and lithium. New supply will have trouble keeping up with rapid consumption growth despite the ESG craze shifting capital towards them and away from ‘old economy’ commodities like fossil fuels. This lack of investment for new oil and gas supply will be the primary driver for relatively robust oil and gas prices during this super-cycle, with stronger economic growth to provide some support as well.

“Investment is the greatest challenge the oil industry faces today,” said John Hess, CEO at Hess Corp., at the World Petroleum Congress in Houston in early December. “Oil and gas are going to be needed for the next 10 to 20 years and lot of it is going to be needed.”

However, loose monetary and fiscal policies to combat the pandemic have already led to the highest rates of global inflation in 30 years, suggesting both will need to be tightened to counter it, while extremely high energy prices have either caused — 1975 and 1982 — or contributed to — 2009 — three of the five global economic recessions since World War II. According to Philip Verleger, the renowned American energy economist, energy could account for approximately nine per cent of global GDP in 2022, a similar level as on the eve of the 1975, 1982 and 2009 global recessions — and triple the level in 2020.

More volatile cycles

In contrast, a number of analysts have recently argued the oil and gas investment famine could lead to more extreme cycles as the world transitions to net zero, including Adam Sieminski, a senior advisor to the Saudi Arabian government and former administrator of the U.S. Energy Information Administration.

“Oil and gas markets are naturally cyclical,” Sieminski told me in an interview in November. “A lack of upstream investment, especially in non-OPEC countries such as the U.S., is only going to make it more difficult for OPEC+ to maintain control over prices, leading to even greater volatility in oil prices in the future.”

At the same time, extreme oil and gas prices increase the potential for geopolitical disruptions to supply. Low prices make it more difficult for major exporters to provide the social services and spending expected by their people, while high oil and gas prices, when passed on to their people, can also lead to political instability, as recently seen in Kazakhstan.

And these more extreme oil and gas cycles should last until global consumption begins to decline in earnest. When is that? Based on the International Energy Agency’s landmark net zero emissions report released last May, global oil consumption peaked in 2019, and after a brief post-COVID bounce drops like a rock thereafter. Global gas demand is projected to continue to increase until the middle of this decade, and decline quite rapidly through 2040 before the rate of decline slows somewhat.

Realistically, we should add a decade to each timeline, as it will take time to change direction of the global energy supertanker.

To conclude, we’re fortunate that relatively high oil and gas prices for longer will help to fund the transition efforts of Western Canada’s oil and gas producers. But the more extreme oil and gas cycle scenario has its own risks, which companies should keep in mind when negotiating terms of government support to help avoid overextending in the good times.