The oil and gas industry plays a crucial role in the global economy. It provides the energy that fuels our modern world, powers transportation, heats homes, and drives industrial processes. In recent years the global push toward decarbonization represented significant challenges to this sector. Much of the investment in the energy sector focused on renewable energy sources. In 2014, oil prices declined sharply and industry reduced capital spending. As oil prices recovered, capital expenditures on exploration and production stayed below 2014 levels. Because demand growth accelerated over the period, the forfeited investment in finding and developing new reserves now represents a significant reduction in available spare capacity. Energy analysts predict a continued strong demand for oil and gas in the decades to come. Confirming this assessment, Donald Trump declared an energy emergency in his speech at the Davos conference this past week.
This article will focus on the exploration and production sector of the industry, particularly regarding supply and demand for the oil commodity.
Investment Opportunities
The oil and gas sector offers attractive investment opportunities for the following reasons:
- The tightening of supply relative to demand argues for higher oil prices and therefore higher stock prices. The supply/demand balance will be discussed below.
- Renewable energy, while important, represents a small portion of global energy requirements. Given the expense and pace of growth in the renewable energy industry, we expect oil demand to grow for decades into the future.
- Renewable energy, because of battery constraints, cannot provide reliable base load energy requirements currently. Electric Vehicle range is improving, but is still less than an internal combustion engine vehicle.
- Technological advancements are improving efficiency and reducing the environmental impact of oil and gas production. This includes advancements in artificial intelligence, automation, and enhanced oil recovery techniques.
Investors can capitalize on these advancements by identifying companies with strong fundamentals.
Investment Risks
Investing in the oil and gas sector carries inherent risks. Geopolitical instability, fluctuating commodity prices, and the potential for stricter regulations can significantly affect profitability. Given the U.S. political environment as of the new presidential administration, the regulatory environment is anticipated to be more favorable to the industry in this country for the next four years at least.
Worldwide Oil Demand
Economic growth is the driving force behind global oil demand. In its latest report, published in October 2024, the International Monetary Fund projected a worldwide GDP growth rate of 3.2% with higher growth in emerging and developing economies[1]. The International Energy Association monthly average demand forecast for 2025 is approximately 103.9 million barrels per day (MM B/D)[2]
Worldwide Oil Supply
Regarding global supply, the data is difficult to obtain. Developed nations regularly report supply data to the IEA by agreement. The emerging economies, except for China and India, report data with a 4–5-year lag. Econometric models, using the most recent actual data provided, generate the IEA supply data. These models then estimate supply based on an assumed GDP growth rate. When new real data emerges, the supply numbers can undergo significant adjustments. For example, a 2022 US Congressional Audit, encouraged by the Department of Energy, determined that the IEA estimate reflected a 2.2B barrel overstatement of actual supply. Following negotiations between the Department of Energy and the IEA, the IEA restated the supply number by 1.1 B barrels. This revision was the largest in history.
Combining OPEC and non-OPEC data, the IEA estimates global supply of 103.4 MM B/D [3]. Cornerstone Analytics estimates that this supply number is 97.95 MM B/D and represents the fourth consecutive year of inventory draws. Cornerstone Analytics also places total global spare capacity at 2,730 MM Barrels versus the IEA estimate of 3,690 MM Barrels[4][5]. Of note, most of the OPEC countries, such as Saudi Arabia, as well as non-OPEC countries, are already producing at or near full capacity. To the extent the IEA estimate of spare capacity once again represents an overstatement, oil prices will likely rise.
Geopolitical factors can result in supply disruption. Of note, the US eased Iranian sanctions to offset Russian supply losses to Western economies at the start of the Russian-Ukrainian conflict. Reinstatement of Iranian sanctions would drive oil prices higher and worsen the supply constraint.
The Future of Shale Oil Production: Can Producers Sustain Output?
The United States is the largest crude oil producer in the world. In 2023, the U.S. produced close to 13 MM B/D from all sources, with shale oil contributing 9 MM B/D. Shale oil production therefore, contributes approximately 70% of total U.S. production [6]. However, production rates from shale wells typically decline rapidly with a 70% production decline after the first two years. Recent reports from the Dow Jones Corporation (as reported by Morningstar), state that U.S. crude oil stockpiles are declining [7]. The recent declaration of an energy emergency by the new presidential administration supports this thesis.
Oil production from shale wells (also referred to tight-oil wells) faces high demand, but low investment in new wells over recent years (due to a challenging regulatory environment, low commodity prices, and the political pressure to replace fossil fuels with renewables) is reducing capacity from existing reserves [8].
Drill Baby Drill
The current presidential administration indicated in the initial days of the new term that it would ease regulatory and environmental regulation to encourage investment in new oil production. The announcement further stated that it would open the Arctic National Wildlife Refuge (ANWR) to oil drilling and production.
While this is a decidedly positive development for the energy sector, it typically takes many years to identify a promising reserve through geological surveys, seismic testing and exploratory drilling. Shale reserves are more challenging to locate and extract than conventional reserves. Shale reserves require advanced technology to a greater extent. According to Cornerstone Analytics, after the shale reserves are proven and permits are in place, it only takes approximately 4-6 months to begin producing. Offshore wells would require 1-5 years as a comparison. For the ANWR area, the most realistic forecast for commercial operations would trend toward a decades long timeline [9].
Key Considerations for Oil and Gas Investors
Investors seeking to navigate the evolving oil and gas landscape should carefully consider several key factors.
- Understanding the competitive landscape and identifying industry leaders is crucial.
- Assessing the financial health and long-term growth prospects of potential investments is essential.
- Diversification across different segments of the oil and gas industry can help mitigate risk.
- Staying informed about the latest industry trends and technological advancements is critical for making informed investment decisions.
- Oil and Gas production sparks environmental controversy. As climate change concerns rise, renewable energy has received encouragement at the expense of investment in oil and gas projects.
- Many major energy companies now invest in renewable energy. The assumption is that a balanced mix of fossil fuels and renewable energy will create a stable energy future. Despite technological advances in renewable energy, implementation progress is both slow and expensive.
Conclusion
The oil and gas industry remains a critical component of the global energy mix. While renewable energy sources are gaining traction, technological advancements in oil extraction and a projected rise in global demand suggest oil and gas will continue to play a significant role for decades to come. The continued rise in global demand, particularly those in developing economies, will result in an ever tightening in global supply. This dynamic provides investors with a significant profit opportunity.
As always, investors in this sector should carefully consider the evolving landscape, prioritize companies embracing innovation and sustainability, and maintain a long-term perspective amidst a dynamic and complex environment.
Hemispheres Investment Management
Hemispheres Investment Management is a wealth manager with a global (domestic and international investments in the same portfolio) investment management focus. Our team of seasoned professionals each have over 35-years of experience researching, managing or strategizing investments and investment portfolios, including deep proficiency in U.S., international and emerging markets. Hemispheres can assist you in diversifying your portfolio globally. Global Equities is Hemispheres’ flagship investment product.
Please contact Hemispheres Investment Management for free consultation. We provide guidance and strategies to assist you in optimizing your investment policy and helping you achieve your investment goals. Book a meeting.
This article is for informational purposes only. Consult your financial advisor regarding the suitability of any individual security or sector before investing.
[1] World Economic Outlook, October 2024: Policy Pivot, Rising Threats
[2]Oil Market Report – December 2024 – Analysis – IEA
[3]https://www.iea.org/reports/oil-market-report-december-2024
[4] Source: Cornerstone Analytics, by permission
[5] IEA Total Oil Stocks, October 2024 https://www.iea.org/data-and-statistics/charts/opec-spare-crude-production-capacity-and-implied-total-oil-stock-build-2016-2030
[6] https://www.resilience.org/stories/2024-07-03/the-status-of-u-s-oil-production-2024-update-everything-shines-by-dimming/#:~:text=The%20five%20prominent%20shale%20oil,2023%2C%20~70%25%20of%20total
U.S. Shale oil, is primarily exported because as a light, sweet crude, it commands a premium price in the marketplace. The US imports the bulk of its oil requirement from Canada and Mexico. US refineries process the heavy, sour oil sourced from these countries, which is cheaper than US shale oil.
[7] https://www.morningstar.com/news/dow-jones/202501147678/us-crude-oil-stocks-seen-falling-for-eighth-straight-week-analysts-say
[8]Life After 5: How Tight-Oil Wells Grow Old
[9] Source: Cornerstone Analytics, by permission
