Last month OPEC+ opened up the taps and increased global oil supply. Two weeks later, the acceleration of Covid’s delta variant meant that in some global markets, demand drained away. As even the most basic economic textbook will tell you higher supply and falling demand tends to equate to lower prices while the market finds its equilibrium, but it also creates several difficulties up and down the supply chain. Just when you hoped things were getting back to something like normal, we are reminded about the clear need for reform, suggests Kay Rieck, an experienced professional oil and gas investor.

A couple of months ago, things were starting to look quite positive for the global economy. After an admittedly patchy start, vaccine roll-outs were gaining momentum in many developed economies, and economic confidence was starting to return.

For the oil sector, this meant rising demand and the prospect of an almost unexpectedly good year. The price of oil was in the doldrums well before Covid-19 tore up every short to medium term economic forecast, but the rising demand coupled with constrained supply put the industry back on the front foot by late spring 2021. There were some, admittedly very optimistic, prognosticators that were suggesting the sector could be enjoying prices of US$100 per barrel by the end of the year.

Rarely optimistic, the Organisation of the Petroleum Exporting Countries and its affiliate states, collectively known as OPEC+, held off increasing production rates until the start of August. The group made its announcement at the start of July, at which point the price of oil had climbed to around US$77 per barrel for Brent Crude and US$75 per barrel for West Texas Intermediate.

News of the increase in production led to a sharp decline in the price of oil on the markets and the deteriorating confidence in the face of rising Covid cases in several countries has kept prices supressed in the US$65 region ever since.

A challenge for projects…

This is not specifically anyone’s problem, like any market, oil has its nuances and its wrinkles, but it the current position highlights two challenges for the whole of the oil sector.

The first is for the parts of the sector involved in exploration and production. The viability of a project depends on achieving a certain price per barrel, and in a world where that price is fluctuating so considerably from month, it becomes very difficult to make decisions on hiring either people or hardware for a project.

This boom-and-bust cycle makes it difficult for some people working in the oil sector to think of it in the long term. The pandemic has changed the dynamic in several other sectors, and it may be that some of these workers, rather than put up with the oil sector’s fluctuations, will start to look for work elsewhere. I discussed why I think the oil sector is still a great place for people to work in this article , but the reality remains that given a choice, some people will opt to move away from the industry given the current levels of uncertainty.

…and consumers

The second challenge is even more fundamental. There is a saying that the price of gas at the pumps rises like a rocket but falls like a feather, in other words, gas prices rise very quickly whenever there is a hint of a cloud on the horizon but are then very slow to decline, even when the shadow passes over. Irrespective of what the price on the international markets is doing, it takes a long time for falling oil prices to reach the retail consumer.

In the short term this is simply the nature of the markets. But the problem is that oil’s monopoly is not as secure as it was a decade ago from the consumer perspective, and there is a decent chance that consumers will be driven more quickly into the arms of the increasing number of electric alternatives if the sector doesn’t find a way to move away from what can be perceived to be monopolistic behaviour.

As I’ve discussed in other articles, this isn’t a change that is going to happen overnight, but if retail prices don’t become more responsive to wholesale prices, the change is likely to happen more quickly, particularly as economies of scale come into play and start to bring down the cost of electric vehicles. Obviously, there is more to the oil industry than simply helping motorists get from A to B, but it is an important part of keeping the industry relevant.

And staying relevant could well be the overall challenge for the industry over the next few years. The wholesale price of oil is likely to continue to rise and fall erratically over the next couple of years, but if the sector continues to struggle to respond flexibly, consumers will move away increasingly quickly. This is probably a very good time for the oil industry to show that it has the capacity to be responsive.

Kay-Rieck

About the Author

Kay Rieck has been an investor in the US oil and gas sector for more than two decades. He was a financial advisor and stockbroker on the New York Stock Exchange (NYSE) for many years.

He quickly developed his interest in the oil and gas sector and related assets, building his expertise in investment banking and asset management at the New York Board of Trade and the Chicago Board of Trade.

Leveraging his exceptional network of global contacts, he founded his first oil and gas development company in the U.S. in 2008, selecting investments in the Haynesville Shale, Permian Basin, Eagle Ford Shale, Dimmit County, and anywhere else that offered and continues to offer exceptional return prospects.