The week of June 13, 2022: Why energy companies could go private, inflation, the Fed, antitrust, and much, much more.
The week of June 13, 2022: Why energy companies could go private, inflation, the Fed, antitrust, and much, much more.
I think that it’s fair to say that Harold Hamm has had enough.
Harold Hamm?
In a recent Wall Street Journal article Hamm, (who has written for NR in the past) was described as “the billionaire fracking pioneer who helped launch the U.S. shale boom.” That is as good a quick description as any, but for those who’d like to know more, please do look at this piece by NR’s Jay Nordlinger from 2013. For a more recent take, an interview Hamm gave to Derek Brower, who leads U.S. energy coverage for the Financial Times, admittedly a newspaper that has now espoused, one way or another, the Davos variety of climate fundamentalism, is a good read. It’s also interesting sociologically (Brower mentions, not altogether approvingly, I feel, that Hamm has five guns mounted in his office), politically, and economically. What also emerges is a tale of what entrepreneurial drive can achieve when combined with the opportunities offered by the free market.
A child of privilege? Not exactly. Hamm is “the 13th child of a sharecropper in Lexington, Oklahoma, [born] just after the second world war.”
Brower:
Hamm is not a typical American corporate titan with an Ivy League background or MBA. His geological knowledge was self-taught. He learnt to fly so that he could more easily explore forlorn parts of the American west, making trips up to North Dakota — home of the first big shale discoveries he made — in his own single-prop plane.
“There was just so much more you could do with an airplane,” he says, his voice dropping a little and a glint appearing in the eyes. “You can’t travel much, north-south, particularly in the Rockies. Everything goes east-west in America, not north-south. So if you wanted to do business in the Rockies, you better own an airplane.”
Yes, an entrepreneur.
Given Hamm’s track record, there is every reason to pay attention to his comments on the oil-and-gas sector and, for that matter, the way in which that industry is now being treated by Wall Street, where, Brewer writes, “much to Hamm’s annoyance . . . shale companies such as Continental [are scrutinized] for their environmental, social and governance performance.”
“Capitalism is great. It works — everybody jumps on the bandwagon and makes a buck,” Hamm says, referring to Wall Street’s ESG trend. “But you look at the green stuff, it’s like an industry on its own.”
Indeed it is, and the Financial Times is, in many respects, a part of it.
Some months later, it was announced that Hamm is trying to take his flagship, Continental Resources, private.
The Wall Street Journal (June 14):
Mr. Hamm, 76, and other members of his family collectively hold about 83% of Continental, the Oklahoma City-based oil producer he ran for decades as chief executive, fueling a shale-drilling bonanza in the Bakken Shale of North Dakota which is today one of the largest U.S. oil-producing regions.
His offer of $70 a share represents a premium of about 9% over the company’s share price as of Monday and would value Continental at about $25.4 billion. . . .
The company’s initial public offering had brought Continental funding it would need to exploit the Bakken, as it became one of the first companies to combine hydraulic fracturing and horizontal drilling techniques to tap into once-inaccessible shale rock formations.
Over the years, Mr. Hamm has hinted he could eventually try to take the company private, recently lamenting that his company, as a publicly traded shale driller, didn’t have the flexibility that private oil producers do in deciding how much oil they can pump. Most public shale companies have acquiesced to investors’ demands for capital discipline, spending conservatively this year and focusing on returning more money to shareholders, despite the highest energy prices in more than a decade.
Those investor demands are understandable enough. In the last decade shale companies focused on the top line, rather than the bottom. The result was a remarkable technical feat, which transformed the U.S. energy sector, but also contributed to a glut (those were the days) that led to a helter-skelter and often bloody ride for shareholders. Now there are worries that the industry has plucked all the low-hanging fruit (yes, a weird analogy in a story about minerals, but there we are). Flowing from that is the argument that the best approach is to husband remaining resources in a way that ought to guarantee decent profitability for some years to come, rather than let rip in one last splurge. On the other hand, Projections by the US government’s EIA (Energy Information Administration) paint a somewhat rosier picture, suggesting that there is more shale oil to be tapped (particularly if high oil prices make it economical to do so) than the pessimists suggest, so there’s that.
It would be a mistake, therefore, to assume that the more recent slowdown in investment in new production is necessarily the result of large institutional shareholders (or bank lenders) backing away for reasons that owed more to ESG (a variant of “socially responsible” investment that measures actual or potential portfolio companies against environmental, social, or governance measures) than to the need to generate return for their investors. But ESG (and similar disciplines, as well as related pressure from regulatory agencies) is clearly having some effect, and it will weigh even more heavily in the future. In that connection, it was interesting to see this from a recent FT comment on Hamm’s offer:
Hamm has railed against the “religion” of climate change and constraints of the environmental, social and governance movement on Wall Street, and once said the efforts of European supermajors such as BP to green operations would “basically cut their throat”.
Analysts said Hamm’s move to take the company private reflected his view that fossil fuel operators should be unshackled to produce more oil.
“This offer completely aligns with Mr Hamm’s long-held belief that the world’s thirst for hydrocarbons will not be quenched by ESG,” said Andrew Gillick, a strategist at consultancy Enverus.
By offering to buy out Continental, Hamm is putting his money behind his words. I doubt that he sees this as a charitable venture.
Hamm and other public shale bosses watched as their privately held rivals sharply escalated drilling activity this year, unbothered by institutional investors insisting on scooping up their piece of the windfall.
Executives have often seethed in private about their difficulties in persuading ESG-focused portfolio managers in long-only funds to back more oil and gas exploration.
The shale pioneer’s move could tempt others to follow suit, using a cash flow bonanza to buy back shares they think have been unfairly discounted, concentrating them in a smaller group of loyal investors, analysts said. In theory, that smaller group could eventually take the entire company off the public market.
“Investors have stopped valuing the long term for oil and gas producers, so their market value is quite low,” said Raoul LeBlanc, vice-president of upstream at S&P Global Commodity Insights. “But every day the spiking commodity price is bringing in real cash, while spending on new wells is disciplined.”
LeBlanc said the “highly unusual” situation means some of the largest shale companies “could theoretically buy themselves back entirely in less than five years.” . . .
Given the constraints on capital spending, share repurchases increasingly make sense, said Matt Portillo, an analyst at Houston investment bank Tudor, Pickering, Holt.
“If the market doesn’t start to recognise the value [shale companies are] creating through equity repurchases, you’re just going to continue to see shares gobbled up by management teams,” Portillo said.
In the next two to three years, several shale producers could buy back between 30 and 40 per cent of their existing market capitalisation just through free cash flow generation, leaving them an opportunity to privatise the rest, Portillo added.
And then, of course, there is the question of shale gas. The EIA continues to project a steady increase in production, at least until 2050, even if the rate of increase in production does not compare with that seen between 2000 and 2020. In 2000 the U.S. produced 5.9 million cubic feet, a total that increased to 29.2 trillion by 2020, and is forecast to grow to 39.7 trillion by 2050. Long-term estimates are never the most reliable, but those projections don’t suggest that a shortage lies ahead, unless we choose not to exploit those reserves.
And much will hang on who “we” are supposed to be, regardless of whether the fossil fuel is oil or gas. As we have seen, the current administration is capable of restricting access to new reserves on public lands. On top of that, both environmentalist litigation and regulatory demands can make investment in new production too time-consuming and/or expensive to be worth pursuing. And then on top of that, there is additional taxation, or even the threat of taxation: Neither are likely to encourage increased production.
As I noted on Friday, the British government has imposed a “windfall” tax on oil and gas businesses. Those companies are now rethinking projects in the North Sea, as indeed they should. No fossil-fuel-company executive can safely rule out something similar happening in the U.S. Some Democrats are certainly considering either that or something more targeted. Bloomberg reports that Senate Finance Committee Chairman Ron Wyden is crafting a plan that would double the taxes on energy earnings above a 10 percent return.
Even if a fossil-fuel company does, after all this, decide that it wants to invest in increased production, ESG and all its kin may stand in the way. BlackRock’s Larry Fink may have some doubts about how far his campaign against fossil fuels has gone, but publicly quoted fossil-fuel companies are still going to find institutional capital more difficult or more expensive to secure than in the past. They are also likely to be burdened by new SEC disclosure requirements designed, although the agency doesn’t quite put it that way, to bully public companies away from fossil fuels.
These requirements, which we have discussed before on Capital Matters (and will doubtless be discussing again) are still at the proposal stage, but the best guess is that they will, after some tinkering, be approved. To summarize (far too briefly), companies will, among other matters, be required to disclose their greenhouse gas (GHG) emissions, the climate risks they face and what they are doing about them. Given that public companies are already required to disclose material risks, these new rules are, for the most part, designed, not to ensure that investors are better informed (which is what the SEC should be doing), but to act as a form of harassment, whether through the sheer amount of paperwork involved, or, more insidiously, by smoothing the way for future regulatory assault or lawfare against companies responsible for what someone somewhere has deemed to be unacceptably high GHG emissions.
Here’s the Wall Street Journal from March:
Companies will have to report greenhouse-gas emissions generated directly by their operations (e.g., refining oil) as well as from their energy consumption. Companies will also have to report what are called Scope 3 emissions from their supply chains and customers if they are material, which will be in the eyes of progressive investors.
For example, Exxon Mobil would have to report its direct emissions as well as any from fossil fuels burned to generate the electricity it uses. It may have to quantify emissions from the combustion of its products, the tankers that deliver them, and the manufacturing of its rigs and plastic products when they degrade.
Scope 3 emissions have no clear definition. The agency says it has “not proposed a bright-line quantitative threshold for the materiality determination” for Scope 3 emissions because this “would depend on the particular facts and circumstances, making it difficult to establish a ‘one size fits all’ standard.”
To an ambitious regulator, attorney, or activist, that absence of a bright line will be a feature, not a bug. It will be all to easy to argue that GHG emissions have been inadequately disclosed, just as (with regard to other proposed rules), it will be all too easy to claim that a company has not gone far enough in its efforts to disclose climate risk.
We’ll have to see whether this rule leads to any significant exodus from the public markets. Maybe, maybe not. But it does seem clear that some oil and gas companies will either follow Harold Hamm’s example or avoid going public in the first place. Taking those routes would not enable them to avoid the effects of increasing bank unwillingness to lend to fossil fuel companies, but it should mean that they can draw on a pool of private-equity finance, less subject (for now) to ESG constraints. And it will free them from the SEC’s regulatory excesses.
In a good number of cases, this will be the right thing for those companies to do, but it should not be forgotten that this is the least bad option, and that it has been forced upon them. By shutting themselves out of the public markets, these companies will be drawing on a smaller pool of (probably more expensive) capital than would once have been available. That may well work for them, but it will not be enough to offset the reality that, if trends in the public markets, especially when reinforced by regulatory and government action, continue on their current course, the U.S. will not take advantage of its oil-and-gas reserves in the way that it should. That might bring some limited benefit to the climate, but it will hurt the U.S. consumer (more greenflation!) and damage this country’s geopolitical position. In the course of his interview with the FT’s Brower (which was published in early January, and so some time before the invasion of Ukraine), Hamm describes the administration’s efforts to persuade the Russian and Saudi regimes to pump more oil “as the silliest thing you ever heard of.” Hamm, Brower reports, had requested a meeting with John Kerry, but had had no reply.
Doubtless, our climate Metternich was busy persuading Xi to give up on coal.
Or not.
To be fair, Hamm and Kerry did meet later in January.
I don’t know how it went, but I do know that in March, Hamm wrote this in the Wall Street Journal:
Gasoline prices are higher than we have ever seen. The government reported a year-over-year inflation rate of 7.9% for February [those were the days], the highest since 1982. Americans need relief, and one thing stands in the way: President Biden’s unwillingness to reverse course on his administration’s commitment to put the American oil-and-gas industry out of business at the consumer’s expense.
Maybe the meeting didn’t go that well.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 71st episode David is joined once again by Oren Cass of American Compass, this time to discuss the state of American financial markets. The two have a congenial conversation about private equity and venture capital, what is going wrong with the two, and what the solutions may be. There is more disagreement than agreement, but there is a mutual and sincere effort to identify issues and present thoughtful remedies. Whatever your view may be on what is right or wrong in the evolution of financial markets, you’ll find this robust discussion thoughtful, provocative, and engaging.
The Capital Matters week that was . . .
Inflation
The reemergence of inflation may be the economic story of the last year, but stagflation may well take over its relative’s starring role before long. Last week, the latest poor inflation numbers came just three days after a new World Bank report warning of a potential return to 1970s-style stagflation . . .
Inflation is not caused by an unfair tax system, corporations or rich people not paying their taxes, or the lack of environmental justice. It’s caused by increasing the money supply where there is no relative increase in productivity. In that case, you end up with more dollars chasing the same (or fewer) goods and services. The result? Rising prices . . .
Supply Chains
President Biden has been pushing for Congress to pass the Ocean Shipping Reform Act (OSRA) in response to the record prices of containerized shipping and severe port congestion that America has seen recently. He posted a video on Twitter and made a speech at the Port of Los Angeles to make his case . . .
President Biden will be signing the Ocean Shipping Reform Act into law today after it passed the House a few days ago. In a statement from Monday, he said the legislation will “make progress reducing costs for families.”
It won’t . . .
Markets
Whether markets sell down 19 or 21 percent is not that much different from a 20 percent decline, but a 20 percent sell-off is how a bear market is defined, so yesterday the S&P returned to the bear garden for the first time since March 2020 (did something happen that month?). The S&P 500 closed on Monday at just under 3,750, or down nearly 22 percent since its all-time high on January 3, 2022. It edged down a bit more on Tuesday, closing at just over 3,735. Mean-spirited types will note that all gains since President Biden took office have now been wiped out. That would have been bad news for anyone who had had to pay tax on unrealized capital gains (if you remember that idea, as destructive as it was vindictive) on stock in 2021 that they still hold now . . .
The States
Caterpillar, long based in Illinois, announced today it will be moving its headquarters to Texas. The manufacturer of construction and mining equipment said today in a press release that its offices in Irving, Texas (near Dallas), would now be the company’s headquarters instead of its current home in Deerfield, Ill., just outside Chicago.
“We believe it’s in the best strategic interest of the company to make this move, which supports Caterpillar’s strategy for profitable growth as we help our customers build a better, more sustainable world,” said chairman and CEO Jim Umpleby in a statement from the company today.
This news comes right after Boeing announced it would be moving its headquarters from downtown Chicago to Arlington, Va., just outside Washington, D.C., in May . . .
If the climate catastrophists are to be believed, “water wars” are just around the corner, and severe drought is already driving millions of “climate refugees” out of their arid homelands. To cope with expanding populations and diminishing rainfall, nations around the world are adopting desalination technology. From Singapore to Tel Aviv, desalination plants have replaced water scarcity with water abundance. But in California, in the middle of one of the most severe droughts in modern history, desalination at any meaningful scale is not an option . . .
Regulation
If there is an iron law in politics, it’s that when crisis hits, government grows. Rahm Emanuel, President Obama’s chief of staff, advised that politicians should never let a crisis go to waste. And when the crisis passes, government almost always hangs on to some of its new emergency powers. The economic historian Robert Higgs calls this the ratchet effect. Politicians might give back some of their new powers, but not all of them.
We’ve seen it before. And, while past power grabs are likely here to stay, there is a way to dampen future “flash policy” crisis responses: a comprehensive, government-wide Abuse-of-Crisis Prevention Act . . .
Welfare
Rodney Davis and Jake Laturner:
It’s time to fix welfare again. Since the historic reforms of the 1990s, welfare has been steadily divorced from work once more. Today, hardly anyone on welfare is required to pursue employment or an upward path in life. Not only is this disastrous for welfare recipients themselves, but it’s also driving America’s record worker shortage. On June 9, we introduced two bills that will restore a welfare system that works in every sense of the word . . .
The Eurozone
The latest European Central Bank (ECB) meeting reminds us that Christine Lagarde’s ECB never fails to disappoint. Faced with the highest euro-zone inflation rate since its 1999 founding, the ECB’s policy response fell miserably short of what was needed in the circumstances. This does not bode well for the ECB’s prospects for bringing inflation back under control or for avoiding another round of the European sovereign-debt crisis . . .
The Fed
Later on, Powell mentioned that things such as the price of gas affect inflation expectations as well as actual inflation. That’s certainly true, and he expressed a commitment to keeping the public’s inflation expectations anchored at 2 percent in the long run.
But that still doesn’t resolve the fundamental tension in the Fed’s position. It’s basically, “We got this! — but also there are all these things we can’t control that keep catching us by surprise and driving inflation up.” The first part is difficult to believe if you also believe the second part.
By this morning, 75bp was more or less priced in. When that number was announced, it sent stocks up (the S&P ended 1.47 percent up), but this move looks (to me) more like a relief rally — investors were relieved that Powell had shown his seriousness about inflation by rejecting 50bp. And that relief was supplemented by the fact that Powell appears willing to contemplate another 75bp on top of it. That may be interesting for two reasons: It shows that, for now, investors are more worried about inflation than a slowdown (or maybe that they are more worried about stagflation than a slowdown; there’s a thought) and it shows that they are easily pleased: Of course, the next increase should be 75bp. No contemplation required. However, even if the S&P ended higher, it ended the day off its peak, something (short-term profit-taking aside) that might suggest that the relief was not uncontained.
Taxation
The “efficiency” of a GHG tax (a “Pigouvian” tax in economic jargon) depends on how the tax rate (per ton of GHG emissions) compares with an honest evaluation of the net impacts of those emissions. The tax can be too low or too high: Are those responsible for the net cost of any negative externality being asked to pay too little or too much? If policy-makers have political incentives to choose a GHG-tax rate essentially unrelated to the magnitude of any negative GHG externality — in particular, one that is too high — then the tax loses the “efficiency” that is its asserted rationale. Essentially, the efficiency argument starts with the assumption that there is a need to reduce GHG emissions, and that a tax is a more efficient way of reaching that goal than command-and-control regulation.
Many economists endorse that argument, which may sound reasonable, but it ignores the incentives that drive government behavior in practice.
Energy
Britain’s Tory party is not good for much these days, except, perhaps, for providing useful lessons on how not to do things.
The U.K., like just about every other Western country, is wrestling with higher energy costs. An obvious move, therefore, would be to encourage oil and gas companies to invest more in North Sea production.
This is not one of those obvious moves . . .
Antitrust
In January, Senator Ted Cruz joined four Republican colleagues to pass Democrat Amy Klobuchar’s Innovation and Choice Online Act out of the Senate Judiciary Committee. The word on Capitol Hill is that Senate majority leader Chuck Schumer has now promised Klobuchar that her antitrust bill, which takes aim at Big Tech, will get a floor vote later this month.
If Cruz maintains his support for Klobuchar’s bill, he could potentially bring enough like-minded Republicans with him to send this progressive dream to President Biden’s desk . . . .
Climate
Expense apart, lithium has its problems, ranging from where it is produced (the U.S. has just one source at the moment, a brine operation, yes, brine, in Nevada), to the mess associated with its mining (it can also be found in a type of rock).
And now there is this (via Reuters):
“Lithium’s pivotal role in electric vehicles makes it an important commodity in meeting global targets to cut carbon emissions, and it was added to the EU’s list of critical raw materials in 2020.”
Great!
But . . .
“The European Commission is currently assessing a proposal by the European Chemicals Agency (ECHA) to classify lithium carbonate, chloride and hydroxide as dangerous for human health.”
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