Editors’ Note: Our political commentary and analysis aims to be nonpartisan. We favor no party nor any politician and assess developments solely for their potential market and economic impacts.
In what now seems to be standard procedure for new Oval Office occupants, President Joe Biden has gotten off to a quick start with a flurry of Executive Orders. As usual with these, most are in the realm of sociology, which is generally outside markets’ purview. But those relating to the Energy sector have received a lot of investor attention, with most presuming they are a large negative. That includes the cancellation of the Keystone XL pipeline and, in orders issued last week and Wednesday, new rules making it harder to drill on federal lands. In our view, however, these developments don’t alter Energy sector fundamentals.
First, a little perspective is in order, starting with Keystone XL. To call this an American political football is an insult to, uh, political footballs.[i] The two parties have fought over its construction for a decade, with Biden’s order overturning former President Donald Trump’s order permitting it, which, in turn, overruled former President Barack Obama’s orders on the subject. All this hullaballoo overrates the macroeconomic effect of a single pipeline. Yes, it would have created jobs to construct a pipeline to move Canadian oil from Alberta to refineries in the Gulf Coast. But assuming this means canceling it is a huge hit is out of step with the scope. Ditto for the environmental impact. The choice isn’t between oil and other forms of energy here. It is, more realistically, between oil shipped by pipeline or train. Sufficient demand at the right price will likely get the oil moving regardless.
The main crude it would have transported, sourced from oil sands, is presently very uneconomical due to its high extraction costs. Even if having an extra-large pipeline made transporting that oil to Gulf of Mexico refineries cheaper than transporting it by rail, profits wouldn’t get a serious boost unless oil prices were to rise materially. Now, American drillers in the Bakken shale may have been able to use that pipeline as well, had it been completed, but producers there have already been dealing with supply bottlenecks—which is partly why most investment has poured into Texas’ Permian Basin instead in recent years.
Beyond Keystone, the larger, more wide-ranging issue is leasing and permitting on federal lands. An oil company looking to drill on federally owned land and offshore faces a two-step administrative process. First, it must secure the lease, including the royalty agreement (that would be Uncle Sam’s portion of the proceeds). Second, it must clear a host of environmental hurdles to receive permits to drill the actual wells. Last week, Acting Secretary of the Interior Scott de la Vega issued an order suspending the Interior Department’s “Bureaus and Offices” from approving new leasing and permitting on federal lands. Note the specific wording: All it meant is that he was no longer delegating authority to the bureaucracy. Instead, for 60 days, only the top brass (e.g., all the political appointees) have decision-making power. As Bloomberg reported today, those agency heads continued granting permits, with at least 31 approved since the order.[ii] Sea change, this was not.
Wednesday’s order is a modest tweak to last week’s move. It changes nothing on the permitting front. But it puts all new leases on ice indefinitely while ordering “a comprehensive review and reconsideration of Federal oil and gas permitting and leasing practices in light of the Secretary of the Interior’s broad stewardship responsibilities over the public lands and in offshore waters, including potential climate and other impacts associated with oil and gas activities on public lands or in offshore waters.”[iii] So oil companies looking to expand their potential footprint on federally owned land and offshore tracts are presently in limbo. But those who have leased-but-not-drilled land should still be able to move forward, presuming agency heads continue doling out permits. Those who have leases and permits but haven’t yet turned on the taps should be unaffected.
The preceding two paragraphs distill the information you can find in the widely available coverage of these orders, and we hope you enjoy having it in one handy place. More important, though, is a little factoid that isn’t getting much ink. For all the talk of this being some huge swing factor for future US energy production and supply, according to a recent report from the Congressional Research Service, less than one-fourth of US oil production occurs on federal land (including offshore). The rest is on private or state-owned land, which the executive actions don’t apply to. Interestingly, federal land’s share of production is down considerably over the past decade: “The federal share of total U.S. crude oil production fell from its peak at nearly 36% in 2009 to less than 24% in 2017 at the same time overall production increased.”[iv] In other words, the industry has already voluntarily become less reliant on federally owned resources. Maybe executive actions accelerate this trend, maybe not, but it isn’t hard to envision the government eventually taking credit for something the private sector was already doing. It wouldn’t be the first time (see falling emissions in 2014).
Those fearing the impact on Energy firms also make a classic error: Ignoring the counterfactual. In our view, there isn’t much reason to believe federal molasses is the only thing holding drillers back. We suspect market fundamentals are doing this already. Energy companies’ earnings tend to rise and fall with oil prices. When prices are low—as they are now—there isn’t much incentive to drill new wells. The up-front costs are too high, and they would take too long to recoup without a significant rise in prices—which would be unlikely if supply were to keep ramping up. If anything, gumming up the works in federal lands could slow supply increases while demand recovers from COVID’s effect, supporting prices. That is only one potential scenario, and we don’t consider it a reason to be bullish on Energy stocks now, but it is worth considering.
Now, many speculate these moves are the tip of the iceberg, with broader bans pending. While that is of course possible, investors should focus on what is probable. Political decisions like these defy that analysis. It is also worth remembering that the Energy sector was just 2.7% of MSCI World market cap at 2020’s close.[v]
Over the more foreseeable future, we don’t think recent developments change the calculus for Energy. Prices are set globally, based on supply and demand. The former is still sky-high, even with OPEC’s ongoing efforts to curb output and US shale firms focused more on debt service than expansion. Demand will likely take more time to recover from COVID, as commuting and air travel don’t appear poised for instant rebounds. Plus, the sector overall largely falls into the value category, and expectations for value are white-hot right now. Usually value does best when no one wants to own it, so we suspect Energy’s time won’t really arrive until all of its cheerleaders capitulate. It will likely take more than false fears over a couple of executive actions to make that day come.
[ii] “Biden Issues Dozens of Oil Drilling Permits in First Few Days,” Jennifer A. Dlouhy, Bloomberg, 1/27/2021.
[iii] “Executive Order on Tackling the Climate Crisis at Home and Abroad,” The White House, 1/27/2021.
[iv] “US Oil and Natural Gas Production in Federal and Nonfederal Areas,” Congressional Research Service, 10/23/2018.
[v] Source: FactSet, as of 1/27/2021.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.