For the last several years a common media story has been that Wall Street investors are tired of pouring money into oil and gas wells for paltry returns. When prices rise, the story goes, Wall Streeters will hold drillers back. Wall Streeters want to first recover past losses before unleashing a new wave of drilling. Wall Street discipline will mean a delayed response to higher world oil prices.
Versions of the story have been around for a while. In 2019 a CNN story was headlined, “Wall Street taught oil drillers restraint. That could lift oil prices.” “There’s a renewed discipline,” said one oil company CEO. The article explained, “Pioneer and other oil drillers are instead focused on returning cash to shareholders in the form of dividends and buybacks. The shift is a reflection of Wall Street’s disappointment with the industry’s shoddy returns.”
Just a few days ago–March 2022–a CNN story, “Gas prices are high. Oil CEOs reveal why they’re not drilling more,” explains that Wall Street is to blame. The article said, “Today, oil companies are under enormous pressure from Wall Street to return cash to shareholders through dividends and buybacks, instead of investing in badly needed supply.” The article quoted an oilfield services executive as telling the Dallas Fed, “Discipline continues to dominate the industry.” It is not just CNN. The discipline story has been just about everywhere: Forbes in 2019; NPR , CNBC, and WSJ in 2021; CBS News and Investor’s Business Daily in 2022.
My view throughout has been that it is nigh impossible to impose cartel-like discipline on competitive industries. Both investing and upstream oil and gas development are pretty competitive businesses. Individual investors may hold back and drillers may find their traditional funding partners reluctant, but when a profit opportunity is out there someone will chase it.
In other words, while the discipline story may be true of many investors and for many drillers, it will not substantially delay a supply response to higher prices. Recent stories appearing in the WSJ (here, here, and here) and in the Financial Times make the case. Private equity, privately-owned drillers with some cash on hand, and other independents and minor players are out there chasing the higher prices.
The Benefits of a Competitive Market as Swing Producer
There is a feature of fracked oil wells often presented as a detriment but one which comes with some advantage. Fracked wells produce a lot quickly, but then production falls off quickly as well. A traditional vertical into a large reservoir may take a decade or more to produce half of its reserves. For fracked horizontal wells half of the production may come in the first one or two years. Fracked wells are exposed to much smaller market and political uncertainties.
Look at the growing electric vehicle market, consider carbon-connected innovation, examine climate regulations now and future policy options being debated. How confident can anyone be that they know what oil markets will look like in 2035?
One side benefit: macroeconomic swings should be moderated by having the competitive American oil industry as the markets primary swing producers. Adjustments are more incremental and market-focused relative to a world in which the Saudis acted as the swing producer. Saudi decisions are made by a few powerful men who have to balance Saudi national politics and interests along with international political and economic factors. Their decisions then swing output choices of the worlds biggest oil exporter.
In the competitive US oil business, each company is a tiny sliver of overall world production. The range of interests and outlooks are more varied and each personality affects just a little bit of the action. Yes, boom and busts, but economic theory suggests we’ll see much more moderated boom and bust cycles (probably more frequent but also lower highs and higher lows).