A couple of months ago, I wrote a post here on LinkedIn suggesting that what the industry and the world needed was a “goldilocks” oil price. A few days later Goldman Sachs published a thought piece entitled Goldilocks and Big Oils – The temperature is just right in “The Age of Restraint”. As someone once said, whoever believes in coincidences doesn’t understand maths.
The GS piece was a detailed analysis of how and when Big Oil makes value for its shareholders – a pertinent distinction compared to the more usual analysis of how oil companies make money for themselves (then blow it all). Their conclusions is that (a) “periods of restraint” were the best for shareholders of Big Oil and (b) we are entering to a period of restraint.
GS have analysed the historical record by looking at key shareholder metrics. In this world view Restraint is caused by a perception of long-term abundance of oil resources. Backwardation in the forward curve creates structural positive earnings revisions as consensus oil price gets rolled up over time, following the forward curve. The low price at the end of the curve preserves capital discipline. Expansion, in contrast, is a period of perceived tightness in the supply side which tends to favour service companies and explorers as big oil scrambles for resources.
Whilst this analysis has the usual rigor and depth one would expect from a big Investment Bank (and indeed makes a lot of sense), I think it is wrong one respect: that we are entering an age of restraint. I see a period of expansion and in all likelihood, a subsequent period of contraction, ahead, but only a tiny window for restraint.Continue reading “Big Oil and the illusion of Capital Discipline”