Crude oil just set a record of sorts, by falling for eleven consecutive days (as of this morning). Fears that sanctions on Iran would cause a supply shortage, leading to a price spike, now seem unfounded. Not long ago, many were surprised at the high degree of compliance. France’s energy giant Total’s CEO said it was, “…impossible for big energy firms to work in Iran.”

The big stick America wields on this issue is access to the U.S. financial system. If a company is deemed to be trading with Iran, it can find itself unable to conduct financial transactions in US$. This is a surprisingly powerful tool, since a substantial amount of trade is conducted in our currency. Total concluded that being unable to transact in US$ would be too disruptive to contemplate.

In the summer, the U.S. appeared to be taking an uncompromising approach, and Iranian crude exports were forecast to fall from 2.5 Million Barrels per Day (MMB/D) to as little as 1 MMB/D. Crude oil futures correspondingly rose. Pressure was put on Saudi Arabia to provide offsetting increased output, as the Administration fretted over high gasoline prices before the midterms.

More recently, waivers granted by the White House to eight importers of Iranian crude have calmed fears of a price spike. China and India, who are both continuing to buy Iranian crude as a result, imported over 1 MMB/D last year. As a result, the January ’19 Brent Crude month futures contract has slid from $86 in early October back to $68 where it was in the Spring. For now, it seems that the Iranian sanctions aren’t that significant.

Saudi Arabia probably expected the U.S. to be stricter in following through on sanctions, and was surprised by the waivers. They have just reduced December exports by 0.5 MMB/D. The Saudis surely expected to be selling oil at higher prices a month ago. Recent data shows that Saudi exports to the U.S. have been falling, and floating storage (i.e. crude on tankers in transit) is the lowest in four years. Some believe that Saudi Arabia is unable to sustain production above 10.6 MMB/D or so without damaging their oilfields.

Although the gyrations of the front month futures contract have commanded attention, crude prices farther out have moved much less. The December ’20 futures contract fell from $76 to $70. Fear of sanctions had caused backwardation (near contracts higher than farther out ones), and this has corrected.

Investments in conventional oil production are driven by the price of crude expected to prevail over the life of the project. The front month gets the attention, but it doesn’t drive the decision. Because new oil projects take several years to reach production, many in the industry continue to worry that falling investment levels will eventually cause higher prices. The International Energy Agency (IEA) recently released their World Energy Outlook. They warn of a looming supply crunch, with the world seemingly too reliant on increasing U.S. production to meet demand growth. Investment spending collapsed during the 2015-16 industry downturn, and remains more than one third lower than it was in 2014. Discoveries of conventional hydrocarbon reserves are correspondingly down.

Crude oil along the futures curve is still at levels that have drawn repeated warnings of future supply shortfalls. Moreover, Saudi Arabia is finding that the U.S. administration ultimately wants low prices, with Trump recently tweeting, “Hopefully, Saudi Arabia and OPEC will not be cutting oil production. Oil prices should be much lower based on supply!” Expecting Americans to tolerate higher pump prices so as to pressure Iran is an unlikely strategy for any president to pursue. But Saudi Arabia needs higher prices to balance their budget. These conflicting goals will continue to impact oil prices.

Low investment means higher prices are likely over the intermediate term; perhaps sooner, based on the drop in Saudi exports.

One official says the shale industry may be “set up for failure.” “It is quite likely that many of these companies will go bankrupt,” a senior adviser to the Energy Information Administration administrator predicts.

This is from the New York Times. However, it wasn’t part of The Next Financial Crisis Lurks Underground, Bethany McLean’s recent article promoting her upcoming book. In 2011, the NY Times ran a series of articles by Ian Urbina that was critical of many aspects of the Shale Revolution, including the shaky finances underlying its companies. In the ensuing seven years, U.S. crude oil production has doubled and we’ve moved from planning imports of Liquified Natural Gas (LNG) to exporting it. Behind the Veneer, Doubt on Future of Natural Gas, Urbina’s June 2011 article predicting failure, was spectacularly wrong.

Hydraulic fracturing (‘fracking”) is how shale extraction of oil and gas has revolutionized America’s energy security. It has its opponents, whose worries include water contamination and earthquakes. We are environmentalists too – it is everyone’s environment. We like the reduced CO2 emissions made possible by natural gas substituting for coal-burning power plants (see Guess Who’s Most Effective at Combating Global Warming). Robust regulation is in everyone’s interests, so that the Shale Revolution’s benefits can continue to outweigh its costs. The NY Times has a long history of criticizing fracking.

Ms. McLean’s essay was appropriately in the Op-Ed section, which acknowledges that it’s not intended as a news article. Her previous book, The Smartest Guys in the Room, recounted the collapse of Enron and was published six years after Skilling and Co’s demise. Similarly, Ms. McLean is forecasting a crisis in the energy sector after it’s already occurred. From June 2014 to January 2016, the Energy SPDR ETF (XLE) dropped 44%. An over-leveraged industry was hit by falling crude oil, which plummeted from $110 per barrel to $26. Investors complained that cash was being excessively reinvested in new wells, leaving too little available to be returned to investors via dividends or share buybacks.

Moreover, the energy sector endured its collapse pretty much alone. The rest of the U.S. economy shrugged. There was no recession, and the broader stock market averages meandered mostly sideways. During this period, Alerian’s MLP Index fell by 58.2%, more than during the 2008 financial crisis. It’s hard to imagine a more adverse scenario for America’s energy sector, and it suffered in isolation with no collateral damage. Bethany McLean may have missed all this; she might just as well breathlessly announce that the Philadelphia Eagles are about to win their first Super Bowl (note to non-U.S. readers – the Eagles did this in February).

Since then, leverage has been falling, profitability rising and investors have been receiving more cash (see U.S. Oil Producers Continue To Chart Path to Long-Term Growth). Ms. McLean pays this little heed. She notes that, “By mid-2016 American oil production had declined by nearly a million barrels a day” although this relatively modest drop testifies to the resilience of the business, not its frailty. To assert that, “…the Federal Reserve is responsible for the fracking boom…” because of low interest rates sounds as if the Fed’s bond buying program included the debt issued by energy companies. Fed policies have increased risk appetites for equity of all kinds, increasing the competition for capital from non-energy sectors.

The energy sector is slowly recovering from its 2016 low, and the first question of potential investors is about a repeat of $26 oil. Free cash flow yields on the American Energy Independence Index are 9.5%, almost twice the S&P500 (see Reliable Yields Are the Best). This doesn’t look like a bubble.

The fast decline rate of shale wells that Ms. McLean criticizes are in fact a substantial risk mitigant. It’s how shale drillers earn back their invested capital more quickly, and is why the world’s biggest oil companies are substantially investing in North America (see The Short Cycle Advantage of Shale).

Because The Next Financial Crisis wasn’t published in 2015, it’s of little actionable use. However, the upcoming book from which it’s drawn (Saudi America; The Truth About Fracking and How It’s Changing the World) may well be interesting. It’ll probably be more useful as history than as a forecast.

When it comes to limiting CO2 emissions, the results are not always what you’d expect.

Debates about climate change often draw zealots on both sides. The common accusatory opener, “Do you believe in global warming?” betrays the binary, almost religious argument between those who think we’re wrecking the planet and those who don’t. Pragmatism is rare on either side.

The science of climate change is complex, and we won’t attempt to assess man’s contribution to global warming. For a thought-provoking view of the issue, read Alex Epstein’s “The Moral Case for Fossil Fuels”. In one section, Epstein comments on U.S. Secretary of State John Kerry’s 2014 plea for Indonesia to cut carbon emissions to fight global warming. From 2006-16 Indonesia’s CO2 emissions grew by 3.1% annually, the Asian average. It’s no coincidence that in 2016 Indonesian life expectancy reached 69, up by 17 years over the previous half century.

As in much of the developing world, Indonesians are living longer. This is because increased energy use supports cleaner water and food, improved hygiene and better medical care, staples of developed country life. Because fossil-free energy is not yet price-competitive, its adoption implies using less energy. This in turn means shorter life expectancy for Indonesians and citizens of other developing countries. If the science around man-made climate change was unequivocal, it would imply acceptance of briefer lives today so that subsequent generations may live longer. But the science isn’t clear, and a warmer planet may be manageable. Moreover, climate prediction models have consistently overestimated actual warming. Epstein’s book offers a rare, stimulating perspective and seizes the moral high ground assumed by the anti-fossil fuel crowd. He defines improving human life as the standard against which to test climate change policies. By this measure, greater energy use has been a success.

The BP Statistical Review of World Energy 2018 reports on emissions of carbon dioxide, a greenhouse gas. It has some surprising facts.

Global CO2 emissions continue to rise, reaching 33.4 Billion tons last year. Yet, many will be startled to learn that America easily leads the world in reducing CO2 output. Our reduction of 794 million tons over the past decade is a 1.4% annual rate of decrease. The Shale Revolution has certainly helped, although U.S. CO2 emissions peaked in 2005, long before Shale started to have its positive impact. Improved energy efficiency is one reason. More recently, cheap natural gas, combined with regulatory constraints on coal-burning utilities, have favorably altered the mix of hydrocarbons burned to produce electricity. Regrettably, the Trump Administration’s weakening of Obama-era coal constraints will moderate this positive trend.

Another surprise is that the UK managed the second biggest ten-year drop in CO2 emissions, at 170 million tons. This represents a 3.5% annual reduction rate, easily the best for any big country. Lower coal use is similarly the cause here, caused by exhaustion of commercially accessible coal reserves.

The 2015 Paris climate accord represents the world’s desire to combat climate change through reduced greenhouse gas emissions. The U.S. withdrew from it last year. The Climate Action Network, an EU-sponsored NGO, finds that only five EU members are even halfway on track to meeting their obligations under the Paris accord. Some of the most vocal Paris supporters have been the biggest laggards.

For example, Germany has famously managed to be a leader in renewables while failing to lead in emission reductions. Heavy dependence on solar and wind requires baseload electricity generation for when it’s not sunny or windy. In Germany, that’s primarily coal (see It’s Not Easy Being Green). As an unfortunate consequence, Germany plans to increase its reliance on Russian natural gas via the Nord Stream 2 project.

Spain, Italy and Greece have all managed very credible 2-3% annual reductions in CO2 emissions. However, this is due to chronically weak economies: over the past decade, Spain has managed only one quarter of GDP growth above 1% and Italy none, while Greece has been in economic purgatory. By constraining growth in southern Europe, the Euro has been environmentalists’ most effective tool.

China produces 28% of the world’s CO2 emissions, spewing out 9.2 Billion tons which is 50% more than second placed America. This is almost four times India’s emissions level, even though they have similar sized populations. However, India is catching up, with a CO2 growth rate twice China’s.

Over the past decade, China’s increased CO2 output of 2.02 Billion tons was 60% of the global increase. Clearly, lowering CO2 won’t happen without China’s help. That will require reconciling conflicting objectives: developing countries are striving to achieve developed country living standards and longevity, which requires more energy use. Developed country advocates of reduced emissions are, in effect, seeking to slow this progress.

Thoughtful advocacy of renewables recognizes the symbiosis with natural gas in providing reliable electricity generation. The purity of thought required of renewables advocates has them rejecting even those fossil fuels that can help achieve lower overall emissions. Few would enjoy a world in which the Sierra Club had achieved all its goals.

Fossil fuels aren’t equally bad. Electricity generated by burning natural gas results in around half the CO2 output as does coal, and far less damaging particulates. Some may be surprised to learn that investing in fossil fuel infrastructure can be consistent with desiring a cleaner planet. But that’s where your blogging team sits, occupying the lonely, pragmatic middle ground and advocating natural gas as an environmental solution.

Natural gas is going to be a vital part of our energy mix for decades to come. Although movements in crude oil prices drive sentiment around U.S. energy infrastructure stocks, we have over 300,000 miles of gas transmission pipeline compared with 79,000 moving crude oil. The American Energy Independence Index provides broad exposure to the U.S. energy infrastructure network. It has a long, bright future ahead of it. We expect 10% annual dividend growth this year and next on its constituents.

Every year Exxon Mobil publishes their outlook for global energy over the next 25 years. It’s an absorbing read for people who care about such things. Their projections may not all be right, but they have to think about such issues pretty carefully and make long term investment decision based in part on their views. In reading the latest edition: 2017 Outlook for Energy: A View to 2040, a few slides jumped out.

The U.S. Energy Information Agency (EIA) also just published their 2017 Annual Energy Outlook which includes projections out to 2040. Although these two reports are structured differently (Global versus U.S.; Exxon makes single case forecasts whereas EIA includes multiple scenarios) they are generally consistent. They agree on broad issues such as improving energy efficiency, more U.S. consumption of natural gas for electric power and industrial use, and gradually increasing crude oil production. The EIA forecasts the U.S. to be a net energy exporter within 5-10 years (depending on scenario), driven by sharply higher natural gas production displacing imports and leading to a net export position, and somewhat higher crude oil output reducing but not eliminating oil imports.

Although the world will drive more cars and many more miles thanks to demand in Asia, gasoline use for private automobiles is expected to peak within just a few years. Increasing use of electric and hybrid cars along with continued improvements in conventional engine fuel efficiency will more than offset more driving. China for example just announced plans to invest almost $400BN in renewable fuels by 2020. Although this is directed at reducing pollution from power generation, to the extent hybrid and electric cars gain market share in China they will use cleaner electricity. Based on today’s heavy reliance on coal for generating electricity, Chinese Tesla drivers have little to brag about. It’s also worth noting that the EIA in its Reference Case forecasts continued growth in U.S. exports of petroleum. This isn’t necessarily at odds with Exxon’s forecast of flat global gasoline use if U.S. refiners gain market share.

Germany has become a pioneer in the use of windpower, aided by many flat areas on which to build windmills as well as the very windy Baltic and North Seas. Germany sees itself as a leader in the use of renewable energy, a responsible global citizen limiting its contribution to global warming. And yet, few probably realize that the U.S. now generates electricity with less CO2 output than Germany. The improvement in the U.S. is due in large part to greater burning of natural gas instead of coal for electricity generation, a consequence of the Shale Revolution. Meanwhile, Germany’s green efforts have been harmed by its sharp reduction in nuclear power following the near meltdown of Japan’s Fukushima reactor in 2011. Renewables can only do so much, and as a result Germany’s use of coal has stayed higher than it might otherwise. Germans may not feel they need a lecture from Americans about saving the planet, but America can demonstrate better results.

The third slide highlights the highly undeveloped use of energy in homes across Africa and parts of Asia. Biomass (wood, in different forms) may be renewable but it’s not especially clean burning for those in its immediate vicinity. A complete assessment of its environmental impact is complex and depends on how it’s harvested, the climate, what type of wood and the available alternatives. We just found it surprising to see how much of the world still relies on a relatively primitive source of energy.

Finally, although demographics shift slowly, they’re still worth a look from time to time. China’s working age population is peaking around now. Since GDP growth comes from only three sources: (1) Labor force growth, (2) Productivity improvements and (3) Capital, Chinese GDP growth will need to come fully from the latter two now on. Developed economies are reckoned to be capable of 1-2% annual GDP growth before adding in the effect of labor force changes. Few are forecasting that China’s GDP growth will sink to this level, but it’s an interesting thought that ALL their growth will have to come from doing things better than before.

Meanwhile, Africa is forecast to add twice the population of North America in about a generation. Providing food, employment, housing and infrastructure for so many people is a challenge no region of the world has faced before.