How I think about O&G cycles.

(akin to building a house)

The Gist: This post is the framework around how I think about cycles in oil & gas. There are 3 parts to it and I use the analogy of building a house (1) the secular piece - laying the foundation (2) where we are within an up-cycle - ie the walls & roof (3) the shorter economic cycles a.k.a. selecting the trim & accessories. I explain where I think we are with each of the above.

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Hey gang, here in the Crude Chronicles household we are in the midst of a major renovation. It started off as just a kitchen remodel but branched into the entire first floor. (I married a designer….nuff said).

This week, I will be using an analogy to demonstrate how my method of analyzing oil and gas cycles is akin to the process of building a house.

1. Building the foundation: Are we in a secular bull or secular bear market for energy?

2. Putting on the wall & roof: Understanding where we are within a three-stage up-cycle.

3. Adding the trim, fixtures & appliances: Gauging where we are within the shorter economic cycles.

Let’s begin.

Step 1: Building the foundation: Are we in a secular bull or secular bear market for energy?

For students of history, the oil patch has had 5 distinct cycles and we are now in the midst of the 6th.

They are as follows in the chart below.

Within each of these cycles, there are 6 stages that the industry goes through as listed below.

The columns in the chart narrate the 6 cycles (5 past + 1 present) and the rows represent each stage of the cycle:

• Stage 1: War ends, new supply comes online, demand slows and oil capitulates.

• Stage 2: Instability in oil-producing regions.

• Stage 3: Low capital spending and industry consolidation.

• Stage 4: Debasement of the currency.

• Stage 5: A new demand hub emerges & a global conflict begins.

• Stage 6: A “Hubbert’s Peak” fear of supply running out, prices go parabolic along with capex.

So if you are reading this table in conjunction with the historical oil price chart, the green text in the chart that reads “peak” would be equivalent to row 1 and/or row 6.

The red text in the oil price chart that reads “trough” would be equivalent to row/stage 3 “low capital spending & consolidation.”

Within this context, I believe we are between row 4 “Debasement of the Currency” & row 5 “New Demand Hub/Global Conflict.”

I don’t think we have fully left behind stage/row 4 “Debasement of the Currency.”

I know what you may be asking, "we have had some major M&A announcements of late (CVX & HES, XOM & PXD), why are we not in stage 3 - low capital spending & industry consolidation?”

I would rebuttal that capex has already picked up, the nuance is that NOCs are leading the way.

Industry consolidation that characterizes Stage 3 is usually driven by the need to cut costs within a lower for longer price environment.

I think we are 3 years past the trough. Yes, recent M&A announcements are big but in terms of relative size, when Russia joined OPEC and rumors of a XOM & CVX combination a few years ago (HERE), were more an indicator of the bottom akin to the merger wave of the late 1990’s/early 2000s (HERE).

However, the world is relative and commodities such as oil are judged relative to other assets such as stocks so I rely a lot on my oil/S&P ratio.; the most important commodity (oil) versus the most widely followed stock index (S&P 500).