In the early 2010s, US shale players were producing oil like crazy, with no concerns about profitability. Then the legs were kicked out from the industry, causing a massive bust, and massive oversupply. In 2021 and 2022, it looked like a very different story. Oil prices were surging and it seemed as though US players had found religion, learning how to maintain production discipline and improve profitability. But now we’re in a new era that nobody saw coming: US oil production is booming. In in fact, it’s at a record high. What’s more, industry participants are actually making money at the same time. So how did they do it? And how did the prognosticators get things wrong? On this episode of the podcast, we speak with Bloomberg Opinion columnist and commodity specialist Javier Blas. We discuss the state of US supply and what it means for OPEC. We also talk about the rising tension in the Red Sea, as well as his reporting on the rise of electronic electricity trading in the European market. This transcript has been lightly edited for clarity.
Key insights from the pod:
The numbers around record US oil production — 3:15
Where is the new oil production coming from? — 4:43
Technological advances in shale — 7:09
Standardization in oil production — 8:36
How is shale maintaining profitability? — 11:06
Who is investing in shale now? — 13:02
The response from OPEC — 15:25
Disruptions in the Red Sea and oil prices — 21:34
A reconfiguration of the world’s energy trade — 27:19
Relationship between the oil industry and the Biden administration — 28:55
The new electricity traders in Europe — 30:16
Joe Weisenthal (00:10):
Hello, and welcome to another episode of the Odd Lots podcast. I’m Joe Weisenthal.
Tracy Alloway (00:15):
And I’m Tracy Alloway.
Joe (00:17):
Tracy, remember a couple years ago when oil prices started booming and there was this big story that production wasn’t coming back? That all these oil companies had found discipline, they were all focusing on profits, etc., and not just volume? And that the expectation would be that production would be depressed for a long time?
Tracy (00:36):
Wait, I don’t think it wasn’t that production was ever coming back. ..
Joe (00:40):
Sure.
Tracy (00:40)
It was that production would slow substantially. And the idea was that this is one part of the oil boom story of the sort of mid 2010s that always fascinated me. It was actually a capital market story.
Joe (00:54)
Yeah.
Tracy (00:54)
So it was all these investors who just poured money into shale oil basically, and thought they were going to make millions and millions. Shale completely overexpanded. It became very, very difficult for them to actually pump at a profit. And so they all started collapsing. They all started pulling back, all the investors got burned. They were like ‘We’re never going to touch this industry with a 10-foot pole ever again.’
And then lo and behold, in sort of the early 2020s, shale starts to become profitable again. It starts to expand. It says it’s expanding at a more disciplined pace than previously. But I have questions about that. But it’s all changed, It’s all turned around.
Joe (01:36):
Yeah, I’m glad you brought up that capital markets aspect. That did seem to be this idea of depressed production [that] seemed to be all part and parcel of that. That suddenly financial conditions were tightening, that the market was placing this premium in this new non-zero sum world of cash flow today, etc.
And so I’m still confused what exactly happened with that story. There’s lots of things as production has come back. It seems like investors are still into the space. Prices have come down, there’s all kinds of obviously geopolitical stuff going on. It seems like it’s time to sort of take stock of what’s going on in the energy world.
Tracy (02:17):
Yeah. Well, US oil production in particular, I think that’s an all time high. Actually if you look at domestic production in the US, I think it’s something like 13 million barrels of crude per day and 20 million including LNG and things like that. So an all-time high. And it means that US oil basically accounts for one of every eight barrels of global output. So pretty big stuff there.
Joe (02:48):
Pretty extraordinary. So what happened to all the narratives? Is production coming back? Why have prices fallen? I’m very pleased to bring in the person we always love to turn to when it comes to oil and energy. We are going to be speaking to our colleague Javier Blas, Bloomberg Opinion columnist on oil and energy. Javier, thank you so much for coming back on Odd Lots.
Javier Blas (03:09):
Thank you for having me again.
Joe (03:11):
Javier, what is the deal with that? So we’re back at records again in the US production?
Javier (03:15):
We had record levels, and it’s just an incredible number. As Tracy said, if you look just at what we say is ‘crude oil,’ it’s more than 13 million barrels a day. But if you add on top of that number other things that go into the oil, liquids streams or condensates and NGLs (natural gas liquids), a bit of ethanol, etc., etc. — we are well above 20 million barrels a day of oil production that compares to a hundred million worldwide.
So you put everything together, the US is producing one in five barrels of oil consumed. That is just an incredibly high number. And it doesn’t seem to be stopping. Probably it’s going to slow down a bit in 2024, but it’s going to continue to go up.
Tracy (04:04):
Okay, where is all that new oil actually coming from? Because it’s been a while since I’ve brought up the rig count chart. But if you look at the rig count chart, this is such a fun one because you can see the big humps of the early 2010s and then the big slide into 2015, and now it seems kind of flat. So there’s been some increase between 2020 and 2022. The number of new rigs being drilled has gone up, but it’s not like we’re seeing a boom in new gas rigs and new explorations. So where is all this oil coming from?
Javier (04:43):
Well, it’s coming from the very same places that it was coming about 10 years ago, but it’s coming in some way, and for lack of a better word, better. So it’s coming from Texas, it’s coming from New Mexico, and it’s coming a bit from North Dakota, Oklahoma, etc., etc. It’s coming from the shale regions of the United States.
But if we were to say ‘where’ in just one single or two, or in this case, three single words, it’s Texas and New Mexico. That’s where the new oil is coming. And you are right Tracy, the recount is not significantly up. Actually, you look at [it] from a loan perspective, it’s lower than it was during the previous booms of shale.
But it’s just that the oil companies in Texas and New Mexico have [gotten] very good at extracting more oil from those rigs, from those wells that they’re drilling. And they’re also doing much longer wells. If you think about how a shale oil well looks like, it first goes down vertically and then it just turns around 90 degrees and it goes horizontal for a while. At the beginning, those horizontal wells were relatively short. Perhaps a quarter of a mile, half a mile at most. Now they’re going as much as three miles horizontally. They can get a lot more oil than they were able to do a few years back.
Joe (06:05):
So it’s in part, and we’re going to talk a lot about the capital markets and investor aspect, but it’s in part just ongoing technological improvements as well. What else is happening on this sort of tip?
Tracy (06:17):
Can I read — sorry, I never get a chance to do this — can I read one of my all time favorite leads from a story that is all about technological improvements and oil drilling? Javier, Joe, you guys are ready? I’m going to read it. This is a story from 2016: “Last spring, Statoil announced it had used the same oil well design and components to drill three reservoirs for the price of one. While the specs for Norwegian sea drilling might provoke reactions akin to the oil field’s name — the Snorre — such standardized pipes and casings could hold the key to a pervasive mystery about today’s energy market. Why is everyone still drilling when prices are in the basement?” Snore! Get it?
Joe (07:02):
Oh, that’s good!
Tracy (07:03):
Maybe you have to read it.
Joe (07:04):
So that really held up well. So what’s changed since 2016 Javier? Tech?
Javier (07:09):
Technologically-wise, we can drill longer, particularly the laterals. We can pump fracking fluids at a higher pressure. And companies are also very good at doing this super quick. Previously our well could have taken 30 days — now it takes 10. Companies and the crews have gotten very good at doing it. And that means that they can do it cheaply. And that’s the funny part of the whole boom of 2023 and 2024, a difference of the previous ones. Companies are making money and investors are making money. So everyone is loving it. This is the first time, and this is what really terrorized OPEC, that shale oil is growing and making money at the same time. And that’s a big problem if you are in Saudi Arabia.
Tracy (07:56):
Definitely want to get to the possible response from OPEC. But just in terms of technology, one of the things, and the reason I brought up that story, was the idea of standardization. So,before you used to have all these bespoke custom fittings for oil rigs or platforms or whatever. But then, I think there was actually an industry-wide effort or attempt to start standardizing some of these things so you didn’t have to order a bespoke component for every single oil project that you were doing. And that seems to have helped make things go faster — to Javier’s point and also brought down costs. Javier, how much of a big deal is that in the industry?
Javier (08:36):
It is a big deal. It has happened everywhere in the oil industry. Let me give you my favorite anecdote of a standardization in the oil industry. So you are working on a North Sea oil platform, this is offshore outside Norway and the United Kingdom. You need to paint a lot of the stuff yellow, kind of yellow [for] danger, very visible etc., etc. Very stormy areas of the wall. The North Sea fog, it’s not the kind of place that you really want to spend an evening in winter there.
So every company has their own shade of yellow. There were 19 different kinds of yellow to paint things in the North Sea. Each company has their own shade with their own specification, and it was just ridiculous. So at one point, a few engineers in the industry got together and said ‘Well, this is a bit ridiculous. I mean, can we not just do a yellow North Sea?’
And so they got together and everyone decided this is the shade of yellow that we’re going to use. And now everyone is painting everything that they need to paint in yellow with the same shade. That at a much bigger scale has happened across the oil industry. Everything has got a standard. And companies within themselves, they like to do everything bespoke. They really, in some way, gold-plated a lot of projects. So each well was a bit different to the other one. Now, companies are designing one single design. And when they have really thought ‘Okay, this is it. This really works very well, now copy and paste for the next 25, 50, 100 wells’ — that has cut costs significantly.
Joe (10:10):
I love the fact that just as something as simple as the color painting on the rigs.
Tracy (10:15):
I’m imagining a room full of oil executives looking at different swatches of yellow and being like ‘No, that one’s too orange. Can we get something a little bit more buttermilk, maybe?’
Javier (10:25):
I would love to be the competition lawyer who has to stop in in the meeting to make sure that no one is saying anything inappropriate that the Department of Justice could get us like ‘There was a conspiracy for the yellow color.’
Joe (10:39):
Yeah. They’re all looking at the different Pantone shades, but got to do so in a legal way. All right, let’s talk about the capital markets aspect because it did seem like, you know, the way people thought about it was that the industry had to face a choice. Would it be pursuing volume or would it be pursuing profitability? And as you’ve just said, there seems to be this very weird situation in which volume is ramping and productivity is sustained. How is that happening and how sustainable is that?
Javier (11:06):
Well, to the question of how long and how sustainable — I’m going to be honest, I don’t know. I thought that production growth would have a slowdown in 2023 and it never happened. It did the opposite, it accelerated. You look [at] every oil executive, if you look at the forecasters of the industry, everyone is saying it’s going to slow down in 2024. But also they said the same for 2023, and they were wrong.
So we’ll see what happens, really. But yes, I mean the industry went into this new era thinking about profitability. So everyone cut CapEx, everyone tried to get more efficient. And everyone thought that production growth was going to slow down because the focus was profitability. The fact that they were able to grow quite strongly came [as] a bit of a surprise to the industry. And then everyone kind of celebrated it.
But here there is a very important question. If OPEC has not cut production to make room for all this new shale oil from the United States, prices will have come down. And then the industry would have faced the same kind of dilemma of the past. You are producing too much, then the prices come down, your profitability comes down, and then you have a problem. So a lot of these that we are putting based on efficiency, it’s true. But if not for OPEC cutting production and keeping prices above $70 a barrel, then shale companies will be in trouble.
Tracy (12:47):
One thing I’m really curious about is who is actually funding production now versus, say, in the early 2010s.
Joe (12:56):
And just to add onto that a little bit, is there any difference between private and publicly-traded domestic US players?
Javier (13:02):
Okay, so let’s in parts. On Tracy’s question, who is funding this? Well back 10 years ago, five years ago, it was Wall Street. It was a mix of equity and credit markets which were funding all of this growth through different instruments. I mean sometimes it was just issuing fresh equity. Sometimes it was bonds, high-yield bonds, reserve lending where a bank is lending to an oil company based on the reserves underground; more or less like a mortgage rather than a house. You mortgage the oil reserves that they’re underground.
And a lot of that is still there, but a lot of the money now needed for the expansion and to finance all this new growth is coming from cash flow generation. It’s the internal cash flow of these companies. They generate enough cash to pay for all the new drilling that they’re doing to pay for all the capital investment that they need to do alongside new pipelines, etc., etc. And to pay the shareholders.
These companies now for the very first time are paying dividends. And that sounds like — well, publicly-listed companies should be paying dividends that’s like normal. Well, that was not the case a few years back. But now they generate enough cash to do all of the above.
And in terms of is there a difference? Yes. Publicly listed companies have been a bit more cautious, they have been trying to. They have the shareholders, they have Wall Street on top of them, and they have to really try to focus as much as possible on paying dividends and buying back shares. Publicly-owned [companies] don’t have that pressure, that super strong pressure. So they have done a bit more growing. And there is a suspicion in the industry that a lot of that growth was to try to maximize the amount of production that you are doing so you can sell yourself to a big player, say ExxonMobil or Chevron. And perhaps that’s not as sustainable as it looks like.
Joe (14:58):
Talk more about OPEC, because you mentioned that US Shale has benefited from OPEC cutting production. I remember, I guess it was 2015 I think, when OPEC did that huge increase in production to try to kneecap US shale. Why are they sort of, I guess, in alignment these days? Where OPEC’s impulse to maintain production is good for OPEC, but also I guess, clearly as you say, benefiting US production?
Javier (15:25):
Well, OPEC is trying to keep oil prices as close as it can to a hundred dollars. It’s not as successful as they would hope. Prices have been between $70 and $80, despite a lot of geopolitical tension that you will [keep] in mind will have pushed prices even higher.
I think that the key question here is that OPEC is convinced that this is a bit of a blip. That at some point the growth in US production slows down, the demand remains there, the annual demand growth remains there. And then they have room to expand their production to bring some of the production that they have taken off the market. Now, they will be able to bring it back. And that was, to be honest, the same kind of bet that OPEC made in 2011, 2012: ‘This is a blip. US health growth is going to slow down at some point.’
And after a few years by 2015-2016, they kind of discovered this is not working. At $75, $80, $100 [for] oil, these guys can grow and they can grow forever. We need to change the strategy. And that’s when OPEC decided to flood the market, kill prices, the price of West Texas and a brand crude, the two global benchmarks collapsed to $30 a barrel. And that’s what really brought down shale growth for a few years.
The jury is out whether they’re making the same mistake or not. And I think that we are going to see it by the middle of this year, at most Q3 of this year, we are going to see whether US shale really is slowing down or not, and whether demand is either sustaining the growth or we are beginning to see a slow down in demand because all electric vehicles have more energy efficiency, etc., etc. So this is a very important year for OPEC because if it doesn’t really go as planned, OPEC really needs to change the strategy completely.
Tracy (17:15):
What can it do in that scenario?
Javier (17:17):
Well, they can only do two things. One is to accept that the current prices are $75-plus. They need to cut even more production, giving shale more share of the market. Or they accept that they need to bring prices down because shale can grow at $75 and perhaps cannot grow at, say, $50 or $40. And then OPEC, and that’s Saudi Arabia, puts a lot more production into the market and triggers a crash. But that means lower prices for OPEC.
Tracy (17:49):
And it didn’t really work the last time because it just incentivized everyone to cut costs and streamline and become more efficient.
Javier (17:55):
Indeed, you are absolutely right. And both options mean lower revenue. Either because you are producing less or because you’re accepting lower oil prices. If the strategy of OPEC doesn’t work, and I am not really a hundred percent sure that OPEC really has much of a strategy for the next six months, I think that they are holding the line for the next six months and then they will see what they do. But if they are wrong, it means a period of low revenues for OPEC countries and that will be very painful. Just [keep] in mind, lower revenues, when you have experienced a significant increase in inflation, that means that the purchasing power of your barrel goes even lower. That’s very painful for Saudi Arabia.
Tracy (18:36):
This is a slightly off topic question, but shale producers in the US cannot join OPEC right? Because we do not like price-fixing cartels.
Javier (18:46):
I think that the Department of Justice may have one or two words on that.
Tracy (18:49):
Yeah, it might have something to say.
Javier (18:51):
Yeah, you know, like, ‘NO.’
Javier (18:54):
I mean it’s not completely a crazy question, Tracy.
Tracy (19:00):
I know it’s come up every once in a while.
Javier (19:02):
The state of Texas sent observers to OPEC meetings in the 80s. They never joined, but actually they sent observers and the state of Alaska also sent observers to the OPEC meetings. I mean there would be, you know, an American gentleman [sitting] down during the OPEC meeting as an observer. I mean I think at some point, cool heads and some legal advisors decided that I was not very cool.
Joe (19:25):
It’s funny the things that one remembers from the sort of fever swamp days of spring 2020 during the peak of the pandemic. But I just remembered there was some railroad commissioner in Texas, and of course the railroad commission in Texas is the oil regulator, there was some railroad commissioner who was trying to like do diplomacy with OPEC in the middle of — I can’t remember his name — but he was some guy on Twitter. Do you guys remember that?
Javier (19:53):
Yes. There was someone, I cannot remember a hundred percent. But I will come back to the name.
Joe (19:58):
There was some random guy, some random regulator in Texas trying to…
Javier (20:02):
But let’s not forget that when OPEC and OPEC+, which is this alliance between OPEC and other oil producers including Russia, they were negotiating how to respond to the pandemic and just basically trying to agree how to split a 10 million barrels cut — 10% of global oil production was taken out of the market by OPEC and its allies. A lot of the negotiations at that point, President Donald Trump was heavily involved.
I mean the whole final deal was effectively cooked on a three-way phone conversation between President Donald Trump, President Vladimir Putin, [who] was still negotiating these things with the White House face-to-face effectively, and King Salman of Saudi Arabia. So the US in some ways was not part of the cartel or anything like that, but it was participating in the conversations. And Trump got actually a quite sweet deal because he got the Saudis and the Russians to agree to cut production while the US industry cut absolutely nothing.
Joe (21:02):
I think his name — he even wrote a Bloomberg Opinion column on March 20th, 2020 – Ryan Sitton was his name. The railroad commissioner who called on OPEC to coordinate with the US in constraining supply.
I want to pivot for a second and talk about the Red Sea. And we talked about it a couple weeks ago in the context of container freight. What [causes] the rising tensions there? We recently saw the US strike at Houthis assets. What does the rising tension there mean from an oil perspective?
Javier (21:34):
Well, it’s more or less a binary situation. As long as the strait of Hormuz, which is the big outlet from the Persian Gulf for countries like Kuwait or Saudi Arabia into the open markets, as long as that remains open, what’s happening on the Red Sea is of less importance. Yes, it’s going to mean an increase in cost because a lot of the oil tankers and also the LNG carriers, these are liquefied natural gas carriers. They’re going to have to divert, avoid the Red Sea and go around Africa. That adds from the Persian Gulf into Europe probably a good 10 to 15 days extra. So it is not small and it could really increase the cost of shipping, but it’s not the end of the world. And that’s why the oil market is taking it quite relaxed.
I mean, prices have barely increased over the last few days. But then you could think ‘Well, that is basically on a scale of one to 10, probably a two, maybe a three.’ What is the other scenario? Well the other scenario is the open fight with Iran, not with his proxies — the Houthis in Yemen — but actually with Iran and the strait of Hormuz somehow gets in trouble. Shipping is more difficult though it probably is not completely closed, but things get really bad. And that on a scale of one to 10, that’s probably 25. And that’s the problem. That’s what I say, it’s a bit of a binary situation at the moment. So far not so bad.
Tracy (23:06):
Could it mean that more LNG gets exported from the US to Europe? That seems to be the obvious solution right?
Javier (23:12):
The obvious solution is that all the Atlantic LNG goes into Europe. So that’s the US, Nigeria, Trinidad — that’s going to go as much as possible to Europe. And then all the non-Atlantic based LNG goes to Asia. So Qatar will try to redirect as much of the LNG that they can into Asia and could provide some training opportunities for LNG exporters in the United States. And let’s not forget that means also more Russian LNG is going to remain in Europe rather than going into Asia because Europe continues buying LNG from Russia. We stopped buying Russian gas through pipeline but LNG is a free for all.
Joe (24:07):
Real quickly, just going back to the OPEC conversation, I just remembered one of the other things that we talked about a lot I think in 2021-2022. Setting aside what was going on with US shale production, there were various structural impediments to OPEC supply or non-OPEC supply or OPEC+ supply. A number of countries had let their own infrastructure slowly get into disarray with the low prices of 2010s. That was constraining the ability to expand. What is happening with sort of non-US OPEC related capacity?
Javier (24:39):
Well, it’s true in part. Look at some of the African producers of OPEC, the likes of Nigeria. Well, they have been in trouble and they have been struggling to meet their own production targets. Recently, Angola left OPEC because it was not happy with the fact that OPEC was pointing [out] to Angola [that] ‘You cannot produce as much as we even allowed you to produce. So we are going to bring your production level officially to what you are able to do.’
Well, the Angolans didn’t take that very well and then decided that ‘Well, we don’t want to be part of this club anymore.’ Then we have two other countries that have been producing far less than in the past but due to sanctions — that’s Venezuela and Iran. The sanctions are still there, but the US is enforcing them. Well, the US is not really enforcing them anymore.
It’s particularly in the case of Iran [that] has turned a blind eye because the priorities get oil prices under control. So Iranian and Venezuelan production has increased significantly last year. To the point, in 2023, the biggest source of extra oil into the market was the US shale industry. The US was the big number into the oil market, putting [out] extra oil.
The second source of extra oil in 2023 compared to 2022 was Iranian oil production. And that’s just incredible to me that Iran added so much oil into the markets to the tune of about half a million barrels a day. So the story of OPEC struggling is not as true as it was three, four, five years ago. And then you have the UAE, which is adding a lot of production and [is] not happy that it cannot produce more.
And we are beginning to see also the Saudis starting to try to increase their production capacity. Some of that will come onstream next year, and then in 2026 and 2027. So the story within OPEC is starting to change from one of struggling to keep production to one where Iran and Venezuela are adding a lot of barrels. But also we have these new production capacity expansion plans of the UAE and Saudi Arabia really about to hit the market potentially. We don’t know if they will translate that capacity into actual production or not. That’s a political decision.
Tracy (26:49):
Yeah, Saudi Arabia needs to pump more in order to afford Ronaldo’s contract, I guess. Hearing you lay all this out Javier, it sounds almost as if we’re watching a slow motion reconfiguration of the world’s energy sources or energy trade. One where the US is far more prominent. Iran is more prominent than it used to be. Is that a fair way of putting it? Is this a reordering of the system in some respects?
Javier (27:19):
I think that you are putting it absolutely right. I mean, the fact that the US is exporting so much oil, and when you count crude and refined products, many weeks, the US on a gross basis is exporting more than 10 million barrels a day. Obviously at the same time, its importing a bit. So on a net basis, about 2 million barrels a day.
But the fact that the US has oil to export on a net basis more than it consumes and it can export is just mind blowing. And particularly, you know, I have been writing about this industry for 25 years. If even 10 years ago you had told me that the US was going to be exporting the amount of crude that it’s doing today, I would have said absolutely not. No way. No way this is happening.
And, you know, the fact that Iran under sanctions is back producing quite a lot of oil is also quite surprising. And the fact that Saudi Arabia has accepted again to cut unilaterally its production without the help of other production countries, something that it promised it would never do again, that is also very surprising.
Tracy (28:23):
Yeah. Where does the Biden administration sit in all of this? And we’ve sort of touched on it in a few episodes at this point, but Biden came on a very oil unfriendly campaign, basically talking about transitioning to green energy. And yet, here we are a few years later and US domestic production is at a record. Iran is pumping again, which is a whole other political situation. But you talk to people in the industry, how are they feeling about the Biden administration at the moment?
Javier (28:55):
Well, I think that the Biden administration has a narrative in public that’s very climate change, green transition. And in practice what you see is they have not really done much to limit the US industry ability to expand. Yes, people in the oil industry will say ‘Oh my God, we have all these problems with the White House, and you know, they are really anti-oil and anti-fossil fuels and so on.’
But if]you really sit down with them, talk privately and relax, they will admit ‘Look, they leave us alone. We can produce as much as we can. They’re focus is on keeping energy prices down, and we are all happy. Can we get more things from them? Yeah, probably with a Republican administration we would be getting more. But to be honest, we are getting more than enough. And actually we should not really produce too much oil [at] the same price is crashing.’ So I think that everyone in the industry, privately at least, is pretty happy with the Biden administration. In public, of course, the lobbies and so on have to say ‘Oh my gosh, President Biden is threatening an energy crisis in America.’ That’s just completely utter nonsense.
Joe (30:04):
Let’s pivot real quickly. You have a new big piece out. Not oil-related, but about the changes happening in European energy markets. What’s the story about?
Javier (30:16):
Well, it’s particularly about how we trade electricity. And you think about a few years back — and by that I mean five, six years ago — a lot of the electricity market in Europe was controlled by the typical names that we all knew. The utilities that have been privatized, but used to be state-owned companies, big names like EDF (Électricité de France), RWE, etc., etc.
And the market was quite sedated. Prices were not really moving much. There was not much volatility. There were very few of the independent traders really making money trading electricity. And a few years back, in the middle of nowhere, Denmark, in a town called Aarhus, it’s a big university town in rural Denmark, a group of companies kind of started to plot how we can make money out of this market.
And they were really driven by two things that were happening in Europe. It was the liberalization of the markets. There was a lot more cross-border electricity trading in Europe. And there was also a lot more volatility in the supply of electricity in Europe because of wind and solar.
You cannot predict how much wind and solar power you’re going to get more than five days, perhaps 10 days [out]. But you know, meteorologists have a limit of how strongly the wind is going to blow or whether it’s going to be cloud covering one area of the continent or not for solar, etc., etc.
So that variability created a lot of price volatility, particularly in the very short [end] of the short-term market. I mean, electricity used to be traded one year in advance, one month in advance. And these companies kind of specialize in trading the next 30 minutes of the electricity market. You know, mid-morning, what is going to be the demand for electricity by lunchtime? That’s what they specialize in.
But, you know, the five or six top of these companies were making perhaps $100 million combined. So not a lot. And they were in the rather of the industry, but not that … In 2022, they made $5 billion. The return on equity in many names of the industry went well above 100%. In some cases, well above 250%. So let me put it this way — the companies that were making a couple of million dollars were making $10, $25, $30 million.
The guys who were making $25, $30 million before were making a couple of hundred million dollars. And the guys who were making a hundred, they just went to a billion. It was just one of the biggest booms in commodity trading profitability I have ever seen. And the piece is about these names, which outside of the industry, basically no one really knows about.
Tracy (33:02):
Wait, how much of a parallel is there with the sort of old school commodities traders, like a Glencore or a Trafigura? To the point where as we saw after that pandemic, you had sort of systemic issues among those commodities traders that became a headache or a problem for everyone in Europe at one point in time. Could something like that happen with this new breed of electricity trader?
Javier (33:26):
The risks are different, but there are very significant risks with this new breed of electricity traders. A lot of what they’re doing is computer-driven. Some of the desks where this [is] happening, they’re called automated electricity trading desks. I mean, everything is done by computers.
I have been on their trading floors, and in some cases, 80% of the volume is run by computers with the traders and the meteorologists just sitting in front of the computers making sure that everything is fine, but just the computers deciding when to buy and sell.
To the point that kind of the umbrella of the regulators in Europe that look at the electricity market reported that in 2022, they monitored 4.4 billion transactions in the electricity market in Europe. That’s 140 transactions every second for the whole year. And how [do] you monitor that? I don’t think that the regulators really have the capacity.
And then, a significant chunk of the market now is traded by firms that have relatively small capital bases, that are all trading from the same place in the middle of nowhere in Denmark using the same banks and the same brokers. Well, [that’s] when the worst systemic risk kind of comes to mind. And I’m not saying that there is a problem, but I am concerned that regulators and policy makers in Europe don’t really know much about them.
I was recently, as I was reporting for this column, I was talking to one of the top people in the European Commission that looks at these kinds of situations. And I said ‘Well, what do you know about X, Y, Z, the names of these companies?’ And this person told me ‘Honestly Javier, I know that they exist and that’s about it. I have never met them. I don’t really know much about them.’ And I said ‘Do you know that this company made a billion dollars in 2022?’ And the person was utterly surprised about the level of profitability. And the fact is, I think that a lot of European policymakers, they don’t know what they don’t know.
Joe (35:32):
Probably this could be said about policy makers all around the world. Javier Blas, thank you so much for coming back on Odd Lots and I guess describing across many different realms, the massive changes that are happening in the energy world. Great to have you back.
Javier (35:48):
My pleasure. Thank you.
Tracy (35:49):
Thanks, Javier. That was fun.
Joe (35:50):
Just real quickly, Tracy, we should do more on electricity trading. I’ve had some requests, and I have to say, I still don’t totally understand the basics of electricity trading. In the sense that when I think about trading shops, whether it’s commodities or even just the traditional financial instruments, I think about entities that are able to warehouse or absorb some sort of risk in exchange for [money], but you can’t warehouse electricity because it’s…
Tracy (36:28):
I suddenly have this vision of these electricity traders on a trading floor with tool belts filled with batteries. They’re like ‘I’m buying electricity!’ Then someone comes and charges their battery and then they hold onto it and sell it two days later. But that’s not how it works, is it?
Joe (36:42):
I don’t think so. But for real, there’s not much electricity storage, or it’s pretty small. So I want to do more.
Tracy (36:50):
It does seem like it’s a unique commodity, in the sense that the timeframe is so short. And you don’t have a good line of sight into electricity availability beyond a few days because you don’t know what the wind’s going to be like, how strong the sunlight’s going to be and things like that. So it is really interesting from that perspective.
Joe (37:09):
We should do more just on the basics of what electricity traders do and how they harvest profits. But on the oil question — it’s pretty wild that, at least for the moment and who knows how long it lasts, that US industry hasn’t had to choose between volume and profitability. It’s just like, why not both?
Tracy (37:27):
Yeah. And I think that story about technology. I mean, shale was always a technology story and a capital market story. And investors getting excited about the new technology made all this possible. But it feels like people think about technology and they think [of] some really cool new way of drilling. And okay, yes, the horizontal drills are getting more horizontal and more powerful. But…
Joe (37:53):
Horizontal-er.
Tracy (37:54):
Horizontal-er, that’s right! But we can also talk about just really small incremental changes. Like standardizing the types of bolts that you’re using in a rig, standardizing the color yellow on your North Sea platforms. That was pretty funny.
Joe (38:10):
I love that example. But no, it’s like you just don’t know where you are in the tech cycle. And in fact while you were talking, I looked up your old article from 2015 that you mentioned and you seem to have nailed it perfectly. We should do more on standardization. Standardization bodies are really interesting organizations too.
Tracy (38:26):
Standardization is kind of what drives the world and also causes problems a lot. It’s really interesting. Yes, let’s do a standardization series. I really want to speak to the guys that make the barcodes. The Barcode Association, what are they up to?
Joe (38:41):
I love the idea of a standardization series.
Tracy (38:44):
All right. Well ,this is one of those episodes where we’ve kind of come away with five other things to discuss. Shall we leave it there?
Joe (38:50)
Let’s leave it there.
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