In recent years, global oil demand has shown a steady upward trajectory; however, it seems that a peak in supply increase is less likely to reach the soaring levels seen in previous cyclesAs the world navigates through economic recovery, the dynamics of oil pricing are playing a vital role, revealing complexities that point towards prolonged high prices rather than a return to the stagnation of previous years.

Reflecting on a prediction made by Cathie Wood, the chief executive of ARK Invest, towards the end of 2020, she expressed a belief that the substantial cuts to capital expenditures by major energy firms would lead to significant price fluctuations with steep rises followed by quick declinesWood suggested that if crude oil prices exceeded $70 per barrel, it would shock herFast forward to today, and we witness oil prices nearing the $90 per barrel mark, indicating that not only has her initial assessment of volatility proven to be true but has also unveiled the challenging landscape that lies ahead.

Just a year ago, various indicators hinted that global oil demand had not yet peaked

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The disruptions caused by the COVID-19 pandemic did bring about a sudden upheaval, but this did not mark a long-term pivot point in demandInstead, the potential for supply enhancements appears muted when compared to the peaks of earlier yearsPost-2014, global production growth has been on a decline; the U.Sshale boom, particularly in the Permian Basin, temporarily helped mitigate the reduced supplyHowever, the situation has drastically changed.

Taking a closer look at both demand and supply metrics, data from the Energy Information Administration (EIA) shows that the U.S., as the world's largest oil consumer, has returned to pre-pandemic demand levels even while grappling with unresolved supply chain issues, remote working patterns, and reduced flightsHowever, this apparent rebound is juxtaposed against dwindling inventories: diesel and jet fuel stockpiles have fallen well below the five-year average since the strategic oil reserves were tactically drawn down by the government in response to the crises.

On the supply side, the number of active drilling rigs in the U.S

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has seen only a modest increase, far less aggressive than the arrivals seen from 2016 to 2019. Critically, the count of drilled but uncompleted wells (DUCs) has substantially declined from a peak of approximately 9,000 to just over 4,500. Filtered down, excluding wells classified as mother-daughter and abandoned, the number is likely to hover around 2,000, signaling a potential depletion of excess capacity by fall 2022 if trends persist.

Unlike traditional wells, shale wells demand relentless drilling due to their steep production decline ratesThe patterns in the Permian Basin illustrate this well; since 2016, the production decline per unit has accelerated, necessitating continuous, high-volume drilling to maintain or elevate overall outputHistorically, during periods of healthy capital inflow, producers built DUC inventories for future resilience

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Nevertheless, in an environment marked by tight capital, producers prioritize completing existing DUCs as a practical avenue for increasing output.

Post the dual challenges of COVID lockdowns and the Saudi-Russian oil price war, U.Supstream producers have been adhering to strict capital discipline, directing cash flow towards debt repayment, dividends, and share buybacks, ultimately translating to insufficient drilling activity and fast-depleting DUC stockpilesTo spur output growth, a robust ramp-up in rig counts will be essential, necessitating not only new wells but also the replenishment of DUCs to hedge against future uncertainties.

Compounding these challenges is a skilled labor shortageThe shale industry has endured two waves of bankruptcies during the past seven years, leading to a depletion of skilled labor, which is pivotal for driving production

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Additionally, rising inflation manifests through skyrocketing extraction costsDrilling is energy-intensive, reliant on machinery and raw materials like water, diesel, and sand, all of which are currently priced above pre-pandemic levels with no downward trajectory in sightFor instance, companies like SLCA (U.SSilica Holdings) have raised prices for silica sand, crucial for oil and gas operations, by 10%-15% starting February 2022 to offset inflationary pressures.

Despite the capital spend increases by major energy groups in 2022, reflecting 20%-30% growth, a portion of this remains vulnerable to the erosive forces of inflation, suggesting that production increases may not directly correlate with the uptick in spending.

OPEC, another significant player in the global supply chain, continues with its previously established production increase plan aiming for an incremental 400,000 barrels per month

However, a persistent failure to meet these targets raises questions about the accuracy of reported spare capacity and the limited number of member states capable of swiftly ramping up production, primarily Saudi Arabia, the UAE, and KuwaitMoreover, potential growth from Iran remains uncertain due to the complex geo-political landscape surrounding its oil transactions, making the projected increase in output unlikely to exceed 1 million barrels per day.

As we stand on the precipice of new developments and potential shifts in the oil landscape, one must consider: what options lie ahead as these colossal ships approach the shore? Historically, shale oil has provided lifesaving rescues; however, whether that will be the case again remains a crucial questionThis encapsulates the overarching risk currently perceived in the medium termOil is a cornerstone of inflation that extends beyond mere vehicle fuel, impacting essential commodities, materials, and fertilizers that form the backbone of modern economies

The implications of insufficient investment are coming into view, as evidenced by several recent calls among large international manufacturing and materials corporations expressing concerns over raw material pricesEven as revenue growth accelerates for many industry giants, profits remain elusive, particularly exemplified by surging fertilizer prices driven by natural gas cost increases, with consequences for food pricing and agriculture.

In an era where global debt levels are peaking, confronting these challenges is particularly arduousThis points back to my perspective during the Federal Reserve's rate hikes in 2018—the increase didn’t significantly alter the landscape until the Fed embarked on rate hikes as a strategy against inflationThe distinction lies in the proactive approach versus a reactive oneRaising rates can temper demand, an effective solution for inflation, but as seen historically, it risks triggering an economic recession

Enhancing productivity necessitates vast investments, a feat easier said than done amidst the current prevalence of ESG principles guiding investment strategiesA balanced investment in both renewables and legacy energy is essential to navigate towards zero-carbon objectives; however, relying solely on market behaviors complicates decision-making on return timelines, leading to chaotic calculations surrounding investment planning.

Consequently, for an extended period, the global economy will likely function on dual systems, consuming more energy, memory, and resourcesAchieving zero-carbon targets in the future is a necessary journey through this phaseNationalistic approaches could emerge as a pathway within energy transitions, where only state capital can afford to engage in unprofitable investments in aging energy infrastructureNonetheless, politically charged narratives and the associated international perceptions restrict most nations’ capacities to tread confidently down this route.

Finally, it is critical to highlight the noteworthy fluctuations experienced during previous oil upcycles, where pullbacks of over 30% were not uncommon