Thread by @davidfickling

Very much agree with this @matt_levine piece about the simpler explanation for the lack of oil drilling in the U.S.: it's not ESG, it's just usual expectations around cashflows.

The past ~15 years in oil markets make show this pretty well:

bloomberg.com/opinion/articl… via @bopinion

@bopinion When I first started following energy markets 15 years ago, the big thing everyone was talking about was the revenge of state oil companies and the decline of the old "Seven Sisters" -- Exxon, Shell, Chevron, BP, Total, Eni, etc:

ft.com/content/471ae1…

The thinking here was pretty straightforward. The offshore and onshore oil basins outside of OPEC that oil importers and international oil companies had used to diversify supply since the 1970s oil crisis (the North Sea, for instance) were more or less tapped out.

That meant the future belonged to OPEC and other state-owned companies in Russia, China, Brazil, etc.

You see this clearly if you look at a global oil cost curve:

Cost curves are how people in commodity businesses decide whether to go ahead with a project.

The projects to the lower left have the cheapest operating costs and can survive the wildest swings in commodity prices. Those on the top right are far more marginal.

If your project is on the top right and you think long-term prices may be heading lower due to peaking or declining demand, you might decide not to go ahead with it -- especially if it's a project that takes years to break even.

We now tend to think that the "decline of non-OPEC" story from the mid-2000s was obviously wrong, because the biggest increase in oil supply between 2000 and 2019 -- more than the entire Middle East -- came from the U.S., with the birth of fracking.

Look back at that cost curve. Fracking ("NA tight liquids") isn't as cheap as new Middle East production, but it's pretty close and, crucially, the upper end of costs is pretty low too.

So it's obvious why it's more attractive than stuff like oil sands and conventional offshore which is further to the top right and so higher cost.

The only surprise relative to the mid-2000s view is that fracking had a boom the scale of which surprised almost everyone.

Fracking has another crucial advantage, though. Wells decline at an astonishing rate, often being tapped out in 18 months. That means that they *pay for themselves* in a couple of years too, whereas offshore projects may take a decade or more.

If you think oil demand may soon peak and decline, you go for the projects that will pay for themselves quickly, because the longer you wait to make your money back the more risk you're taking on.

Here's a conventional narrative.

1. 2000s: OPEC and National Oil Companies are the future of oil supply!
2. 2010s: That's wrong, OECD countries can produce waay more oil!
3. 2020s: Waaah, ESG and greenies are stopping OECD countries producing oil!
4. ENERGY CRISIS!

A better narrative:

Throughout this whole period, western oil companies have struggled to compete with lower-cost Middle East production.

Fracking (and to a lesser extent deepwater) have helped to level this playing field.

But deepwater depends on long-term demand which now looks shaky, and fracking was just smashed apart by last year's collapse in oil prices.

The problem in 2021 is the same as the problem in 1973: OPEC still has all the best oil wells.

It's not ESG that's changing this picture but the fundamental expected decline in oil demand. Lower-cost Middle East nations are still sanctioning huge petroleum projects, because they have the low costs to win for the next few years.

One other thing to bear in mind looking at that Rystad cost curve: the x-axis is in billion barrels of oil.

Most estimates I've seen reckon there's a good 600 billion barrels that can never be burnt if we want to avoid catastropic warming:

rystadenergy.com/newsevents/new…

eg. figure 1 in this recent Nature article: nature.com/articles/s4158…

In other words, basically every field that's not already in production risks pushing the world into catastrophic warming if it starts -- the same argument made by the @IEA recently, that no investment in new oilfields is needed if we want to hit net zero: iea.org/reports/net-ze…

@IEA So no wonder there's reluctance to invest. In the net zero world that governments are promising, even new Middle East fields are marginal and may never make an economic return.

Those that are further up the cost curve are even dicier. (ends)

Oh, one PS going back to Matt's original point: If you think the world won't hit net zero targets, there is free money lying around for the taking everywhere in oil markets right now. Short-term cashflows should be very strong.

That's one reason I am (idiosyncratically, for someone who thinks the energy transition is necessary and happening) a bit more bullish on fracking than on conventional non-Opec oil: bloomberg.com/opinion/articl…