2022-12-17

Drill, baby drill!

This abridged report tries to make sense of why, even though energy prices have been so high recently, oil companies still seem very slow to invest in production. The argument is subtle. I will attempt to summarize it: - investors are still refusing to value exploration companies at anything like sensible valuations, so it makes more sense for management to buy back existing shares, rather than deploy cashflow to new rigs, - politicians want to strongly discourage new production, whether through windfall taxes or blocks on pipeline construction, - drilling engineers know that nearly all the ‘Tier 1’ reserves have been exploited, so boosting production will result in lower margins.

Ultimately, I think, this is all bullish for oil. When China emerges from Covid lockdowns properly, and some sort of resolution to the war in Ukraine is thrashed out, demand will pick up a lot and these factors limiting production will result in a big shortfall of supply. Of course, eventually production will respond, but these things take time. New production cannot be turned on like a spigot.