The oil industry is currently undergoing a generational slump. One of the tough things about investing in the energy space is that the price of oil is heavily dependent on the actions of large geopolitical actors like Saudi Arabia, Russia, Iran, Iraq, Venezuela and other such unpredictable entities. As the price of oil directly impacts the bottom line for energy businesses, earnings will fluctuate, and there is nothing an ordinary investor can do to change that.
This geopolitical calculus is especially important for U.S. shale producers. Unlike Aramco (SAU:2222, Financial), which is controlled by the Saudi Arabian government, or the Russian state-controlled energy industry, U.S. shale is not a coordinated entity (though President Trump's administration recently floated the idea of providing state support for flagging shale producers). Here's what the future of the industry could hold for investors.
Fewer costs to cut
Until very recently, shale was leading the energy revolution in the United States, reducing its reliance on foreign oil imports. However, a combination of falling demand, excess supply and increasing political pressures to transition to greener energy have hit the industry hard. An additional issue is that shale companies had to cut costs significantly back in 2014 when OPEC and Russia tried to squeeze shale out by upping production, so now there is less fat to trim this time around, as spending is less across the board.
Political issues
So what has the damage been to investor confidence? Today, energy companies represent around 4% of the S&P 500 by market capitalization, compared to around 16% at its height. The growing trend toward electric vehicles has contributed to the falling share of the market. Other problems for U.S. oil producers include political pressures to shut down projects like the Dakota Access Pipeline, or Trans Mountain Pipeline in Alberta, which aren't felt anywhere nearly as keenly as they are in places like the Middle East or Russia.
Moreover, a win by former Vice President Joe Biden in the November general election might make the regulatory regime less favorable for U.S. shale. However, it remains to be seen whether a President Biden would be that amenable to curbing the powerful oil lobby, particularly if the economy continues to be in the doldrums and unemployment continues to run high. In short, the U.S. shale industry is in a period of serious transition right now, so it's very difficult to make accurate predictions on how it is going to come out on the other side.
Disclosure: The author owns no stocks mentioned.
Read more here:
- The State of the Oil Industry, Part 3
- Warren Buffett Dives Into Gold
- The State of the Oil Industry, Part 2
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