The price of gas is seen as traffic moves through Annapolis, MD, on November 23, 2021. (Photo by Jim … [+]
Harold Hamm, founder and chairman of Continental Resources, recently emphasized the challenges faced by U.S. shale producers at current price levels. He noted that many fields are struggling to remain viable. Hamm warned, “when you get below the cost of supply, you can’t ‘drill, baby, drill.'”
This same message was recently echoed by Scott Sheffield, the founder of Pioneer Natural Resources, who highlighted the impracticality of increasing production given escalating costs, and reduced pricing. Sheffield, who recently sold the company to Exxon, noted that companies were simply “running out of inventory.”
These are stark warnings. It’s important to caveat them though with the fact that a lot of future inventory for the oil and gas industry is a function of the current pricing environment; many locations come into play as soon as prices rise again, which mitigates some risks. The world likely doesn’t want that required price spike though, and several factors suggest that the optimal pricing for North American strategic interests is likely a moderately high global oil price.
U.S. shale has represented the primary source of supply growth for the past decade and a slowdown in growth would risk future price spikes. The last thing incumbent governments want are price spikes, but industry is the same. No one wants price spikes as they choke demand, raise inflation and rates, and ultimately hurt the very sector that people assume benefits.
North American citizens and politicians have long viewed energy as most beneficial when it is as cheap as possible. There was a period where this was true but the growth of shale now sees energy as one of the most significant contributors to manufacturing in the U.S. and a source of critical revenue for several states. The U.S. is one of the world’s largest oil and gas producers, providing a strategic security and manufacturing advantage. At current levels, oil prices risk hollowing out that progress. This is also true in Canada, where the natural resource sector was one of the primary sources of recent private sector job growth in an economy that has otherwise struggled to add private sector jobs over the last few years.
The second unique benefit of slightly higher oil prices is that the U.S. needs more global buyers of treasuries. The deficit continues to increase, and every time buyers don’t show up at treasury auctions, then the interest rates that the market requires are higher. This becomes a dangerous cycle as you are eventually just raising money to pay interest, which investors don’t like to see and requires even higher interest rates. The problem becomes self-fulfilling. Governments can always print money, buy their own bonds, and then commit to devaluing the currency. They can also force domestic banks to hold more, but then they crowd out opportunities for private investment. This is why you need foreign buyers but treasury buyers don’t come out of nowhere. If anything, many countries, primarily China and Japan, already reached their highest levels of treasury holdings years ago. They have either stopped buying or are selling significant amounts outright, as in the case of China. One of the few ways to see new potential buyers at scale is to find countries that end up exporting many high value items or commodities, priced in US dollars, and then need a place to park the money. That last sentence describes many of the world’s current and upcoming oil producing nations.
These two dynamics, likely make the optimal oil price for America slightly higher every year. A slightly higher price maintains domestic manufacturing strength, prevents a price spike, and supports long-term financial goals. A sharp price drop, a continuation of the recent trend, likely does the opposite as it hollows out a leading North American industry and ensures a price spike and higher rates down the road. As the current administration starts to reveal their agenda focused on energy security, it will be interesting to see if the early push for lower prices softens given these competing factors.