We told big oil not to invest. Don't complain now

The cure for high oil prices is high prices, or so says the commodity industry's adage. Let the invisible hand of the free market work its magic. High prices will simultaneously reduce demand and increase supply, eventually making the good less expensive.

This has proven true for centuries: In commodities, a bust follows every boom. It happened after the Klondike Gold Rush in 1896, during the second oil crisis in 1979 and following the most recent US shale boom a decade ago. Generations of petroleum engineers, geologists and financiers have grown up swearing by it.

But the axiom no longer seems to be governing the oil market. 

To be sure, the elevated cost of crude is suppressing appetite. But the other side of the equation — supply — isn't working out. The industry simply hasn't been reacting to high prices with more investment as it has before. This means demand will have to do all the work to rebalance the oil market. The result is likely to be a slower economy and more sustained energy costs than in the past.

Why isn't the supply lever working? Money certainly isn't the problem. Big Oil has reported its best-ever six-month period, earning more than $100 billion in profits from April to September. Exxon Mobil Corp. just enjoyed its best quarter in its 152-year history, which goes all the way back to John D. Rockefeller.

Neither Exxon nor its competitors Chevron Corp., Shell Plc, TotalEnergies SE and BP Plc have announced any major increases in spending beyond what they have already planned. Institutional investors, led by BlackRock Inc., have convinced virtually every oil executive to keep spending under control. Pierre Breber, the chief financial officer at Chevron, put it this way: "We're not really paid for growth by the market." Instead, they are channelling the profits into dividends and share buy backs.

In the past, some executives would have tried to kickstart a boom-to-bust cycle: Boost spending early, increase production and then cash in before prices crashed. Today, the pressure from shareholders to remain frugal is so strong and uniform across the industry that from the outside it almost looks like a cartel. And the result is cartel-like: Big Oil is collectively underinvesting by a lot.

Over a Barrel
Oil industry spending in production and exploration, in billions of dollars

Last year, the industry spent $305 billion on oil exploration and production, significantly below what's required to meet oil demand until the end of the decade based on the most likely scenarios. According to the International Energy Agency, the world's energy industry needs to spend nearly 50% more annually ($466 billion) from 2022 to 2030 to meet the world's oil needs based on current climate change policies. Even if governments implement current strategies and other climate pledges they have made, including some net-zero targets, investment still needs to grow by 25% from current levels until at least 2030. 

Let's not kid ourselves. Oil companies are doing what we told them to do: Spend less on fossil fuel production. From green philanthropists to big Wall Street investors, the message has been nearly unanimous. One can hardly blame the executives for doing as they were told. The industry, of course, soon realized that spending less was rather good business, particularly when very few deviated. Only a handful of state-owned oil companies in the Middle East are today boosting their fossil fuel spending meaningfully.

The industry has been calibrating for a world of peak oil and rapidly declining petroleum demand. But that world simply does not exist today, nor will it tomorrow or in the near future. Russia's invasion of Ukraine has made that all too clear.

Facing high oil prices, Western governments are now trying to force the industry to accelerate spending. But having witnessed how profitable it can be to ignore the industry's old adage, oil executives are very reluctant to cooperate. They know more spending means lower prices.

On Monday, US President Joe Biden threatened the industry with higher taxes unless companies agree to boost not just oil production but also oil refining. White House officials portray the speech as an olive branch to the fossil fuel industry — a direct plea that represents a 180-degree policy change from Biden's campaign, when he promised "no more drilling."

Government officials are wise to arm themselves with a stick when negotiating with a powerful business sector. Windfall taxes could play a role in the talks — though they're unlikely to be effective. Reducing the profitability of an industry via higher levies doesn't encourage more spending.

If Biden wants more oil, he needs to reset the conversation completely, and that means telling green campaigners and Wall Street investors — loud and clear — that America needs fossil fuels right now. 

Javier Blas is a Bloomberg Opinion columnist covering energy and commodities. A former reporter for Bloomberg News and commodities editor at the Financial Times, he is coauthor of "The World for Sale: Money, Power and the Traders Who Barter the Earth's Resources." @JavierBlas

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement