Will there be more blood for the oil sector?
By Joe Mares, manager of the Trium ESG Emissions Impact Fund
While the recent turmoil in the oil markets might seem extraordinary, history shows the present situation is a return to the past, argues Joe Mares, manager of the Trium ESG Emissions Impact Fund.
In the below insight, he discusses how pressure on upstream oil returns were once a perennial feature of the market, and how improving environmental regulation means we will not see owners setting fire to their oilfields to avoid swallowing a negative price.
“Our strategy is focused on finding companies in high-emitting sectors that have the best potential emissions reductions plans, and providing advice and encouragement to management teams to deliver these plans. We are market neutral, and focus on shorting companies which we believe are ESG under-performers in similar sectors. I have had several conversations with investors in recent weeks, and many have asked my opinion on oil prices going negative, and how very low oil prices impact environmental investors. I try to take a long-term view measured in decades, not years. Most people just look at data you can get on your Bloomberg screen – which only goes into the early 1980s, when the first oil futures contract started trading on NYMEX.”
Lessons from history
“I think to understand the current situation, we need to look much further back to the 1920s, 1930s or 1950s. Indeed, for most of the oil industry's history, returns in the upstream were low. The original oil billionaire was John D. Rockfeller. He controlled 80 per cent of the US oil industry a century ago. To gain this position, he first took control of the railroads, then the refineries. Oil is worthless if it cannot be transported to a refinery and turned into gasoline or diesel.
"If you control the infrastructure around an oilfield, you control the price. The 'Seven Sisters' did the same thing to Middle Eastern countries in the 1950s and 1960s, keeping upstream prices low to producers, while keeping the economic rent in the midstream and downstream. It was only with the Yom Kippor war in 1973, the OPEC embargo, and then the Iranian revolution in 1979, that returns in the upstream really took off.
"Pre-1973, unless you had an absolutely enormous oilfield, you had little economic rent and were, therefore, usually pushed around by bigger companies with downstream access. If you have time on your hands during lockdown and want to watch a good movie, check out There will be Blood with Daniel Day Lewis. This is the central question of this movie. Daniel Day Lewis finds an oilfield but Standard Oil will not pay him for his oil as he does not use their pipeline.”
Energy is going green
“The point is this: we are returning to the normal state of the oil industry over the last 150 years; if you do not have infrastructure and downstream access – you cannot guarantee a fair price for your oil, and whenever the market is over-supplied, your marginal price is zero. Obviously demand will recover, and I think the infrastructure problems will get easier, but it is important to recognise what happened at expiry for the May contract has happened before in the 1920s and 1930s – you just cannot see it on Bloomberg.
"The only difference between now and then – thank goodness – is that environmental regulation has improved. Prices in 1920s never went to zero as the producer would just literally set the oil on fire rather than take a negative price, with terrible environmental consequences. This is demonstrated during an evocative scene in There will be Blood. Fortunately, this is no longer allowed. If you have more time and would rather read a book rather than watching a movie, Daniel Yergin’s The Prize is an industry classic, or Bob Mcnally’s Oil Volatility, or Bryan Burrough’s The Big Rich, or Ron Chernow’s biography Titan about John D. Rockefeller, all discuss the oil industry in the 1920s and 30s.”
“The key point is that we need to examine the complete span of history, not just what we can easily pull up on a Bloomberg chart. The other point I want to mention is that the ECB, Federal Reserve and of Bank of Japan are buying fixed income, and even equities sometimes, but they will not buy commodities, in our view. The only commodity European governments have the ability to reduce supply of is carbon emissions – through the tradeable emissions markets. Buying EU emissions at roughly EUR20 a tonne may be more attractive than buying oil at EUR20 in the long run.”