Oil rigs on water

For those readers who own oil wells, the last decade has probably not been profitable. The last year has been even less kind, Covid bringing home unprecedented demand destruction on the sector. This has generally been good news for everyone else, with some notable exceptions.

However, 2021 has seen a dramatic recovery in the oil price. This is a dangerous moment that could see the marginal gains of the pandemic pushed back to the benefit of oil executives and at the cost to everyone else, particularly those most affected by climate change.

The last crash

The context for the current price rise is needed to understand the peculiar nature of the oil sector today. In 2008, the US housing market crashed and the world economy was in freefall. Central banks responded by slashing interest rates and flooding the market with cheap money. China responded with a manufacturing focused fiscal stimulus – worth 15% of China’s then GDP – sending commodity demand soaring. The exact causes are still disputed but the general perception is that it was driven by the rise of emerging markets, the decline of traditional oil supplies and a rush of speculators allowing oil prices to soar. Predictions of peak oil led many to speculate that prices where set to rise forever. This was mistaken.

The rosy expectations of prices led to a massive investment in expanding capacity, including in projects that were only economic at historically high prices per barrel. These included offshore projects as well as unconventional oil such as the Canadian tar sands. The most geopolitically significant of these was the US shale boom that moved the USA from being a net importer to the world’s second biggest producer.

This extra capacity contributed to a massive price crash in 2014. Other factors included slowing demand growth, and a determined move by Saudi Arabia to destroy competition. This price and investment was recovering from this crash in 2019.

The commodity super cycle

From a certain perspective, this was entirely predictable. It is called the commodity super cycle highlighting how expectations of high demand drive investment leading to overcapacity. This leads to price falls, destruction of capacity, leading to undersupply and thus price rises.

Following the 2014 price crash we have seen some investment projects abandoned, drilling in the arctic has mostly been shelved, for example. Upstream investment almost halved in the space of two years. Viewed from this perspective the recent price rise looks the inevitable next turn of the cycle.

Not a normal commodity

But the oil sector is not typical. Continued consumption could cause the collapse of civilisation.

In a landmark 2011 report, Unburnable Carbon,  Carbon Tracker estimated 80% of known fossil reserves would need to remain in the ground to meet 2 degrees. This meant investment in oil reserves, or exploration was a massive bet against the world avoiding catastrophic climate change. This was a particularly bad bet as the oil firms supply chain to this day remains poorly equipped to deal with the physical changes of an unstable climate.

This realisation helped turbocharge the divestment movement, which called for social institutions to remove their investments in oil and gas firms both on moral ground and because they represented an investment risk. This has been highly successful with over $14.5 trillion being taken out of the industry.

It is likely that this movement has contributed to the termination of the riskier more expensive projects such as artic drilling.

However, the real question is why in the era of low prices and structural headwinds the industry was expanding at all. Although oil majors continue to make profits the size of small countries these have been low by historic standards and expected returns. Carbon Tracker estimates that since their historic 2011 report oil firms lost their investors £132bn in successive equity offerings underperforming the market by 52%. Exxon Mobil managed to deliver 10% loss to shareholders between 2014-2019. The US shale sector expanded despite most firms barely, or never turning a profit while pilling on debt.

So why have these firms continued to reliably attract investment? In 2020, US shale firms faced £300bn in write downs. A key part of the issue lies in the flow of cheap capital from central banks and the growing saving glut of the wealthy, (around 75% of shale investment was from junk debt promising high yields) . The 2010s saw corporate debt explode particularly in the fossil fuel sector. This included investment supported by central banks.

Fracking firms were able to expand despite operating losses by bringing in new investment. This meant their model became about growing assets (overvalued oil reserves) and sustaining a high share price instead of long term profitability.

Carbon Tracker estimates 90% directors are incentivised to get oil out of the ground rather than deliver profit or sustainability. This meant that even fundamentally flawed projects could persist if admitting their problems would disincentive short term investments.


Covid-19 at first seemed to a burst this bubble. Oil prices collapsed in a manner that the market could not ignore prices even turned negative for West Texas crude futures. Large firms took billions in losses, cancelled dividends and saw their share price collapse. Smaller debt loaded shale producers went bankrupt. Firms revalued their reserves and lowered their expectations of future prices.

The USA rig count is an indicator of the amount of shale production capacity, which collapsed at the start of the pandemic. It seemed the sector’s weakness had been exposed.


However, does this massive loss in production capacity and subsequent price rise mean that we are now approaching the other end of the commodity cycle where under capacity supports higher prices? One of the largest US frackers has seen it’s share prices up by 50% this month on just such a theory. There are a number of firms buying up reserves, presumably with the idea of one day developing them. Once again, articles are appearing predicting oil at $100 a barrel.

This view will be pushed by oil firms encouraging investors back, saying Covid was a blip and normalcy will return. They will also point to the increase in renewable investment of some oil majors. This becomes a dangerous time. With budgets cut and returns increasingly uncertain in a Covid and Climate ravaged world there is a temptation for the divestment movement to lose momentum. This will hand back the oil and gas sector the capital it needs to continue to support projects that are incompatible with tackling climate change.

It would be morally disastrous and likely financially imprudent for two key reasons:

  1. Debt overhang

The sector is far from having removed it’s addiction to corporate debt and has barely begun to face up to the problem it has as Carbon Tracker pointed out in their excellent report Decline and Fall. All oil firms have a number of stranded assets in terms of reserves that will never be exploited and are still listed as assets on their books. As they already exist it makes sense to sweat these assets for as long as possible rather than mothball them and accept the debt write-downs. This could lead to continued overproduction and risks debt being chaotically realised.

  1. Demand destruction

Oil demand is declining. This is though technological change as country after country phases out the internal combustion engine. Regulation in areas such as plastic and actions of the climate movement raising awareness about behaviour change and pushing for the kind of structural shifts that would cut demand more. Alongside this there is a permanent pandemic affect in reduced travel, particularly for aviation.

The other way oil demand can decline is if the world does not act on climate change. The devastation by the end of the century will likely negatively affect oil sales.

Prices may spike but it seems unlikely that they can be sustained short of a major geo-political realignment.

This has many implications. It means that the divestment movement needs to keep building on it’s success. It’s advocates have been spectacularly vindicated in the past decade, but society is still too exposed to the toxic oil sector and too much capital is still going into funding climate chaos.

However the structural weakness of the oil sector has not gone away. Indeed, hopefully it has only just begun. Across the world OECD countries are putting in place dates to phase out oil powered internal combustion engine sales, plastic demand is being scaled back and it is possibly years before car and plane travel recovers. The climate movement is pushing countries to go further.

The sector’s years of refusal to confront these problems are now coming home to roast. In their report decline and fall Carbon Tracker argued that this was insufficient as the sector is still labouring under excess capacity with a large number of stranded assets. Additionally, due to the high level of debt it is unable to write off the assets because that would lead to a deterioration of ability to raise capital.  This will mean excess capacity will continue. Prices may temporarily spike but short of a major geo-political change they are unlikely to be sustained.

However, these prices spikes are dangerous because they may lure the capital that shale firms and oil directors crave to put their troubles aside for another day. Some of this is coming from state owned banks and bailouts. Now is the time for divestment movement to push on to ensure that their gains are not lost.

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Image credit: Carol Highsmith – Creative Commons