What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing in 2022. Most of the world is facing an energy crisis caused by a variety of factors from russia's invasion of ukraine to under investment during the covet pandemic. This is causing 40-year high inflation in the u.s and europe. Consumers are struggling to fill up their gas tanks and higher input costs are threatening to plunge the world into a painful recession.

This has been a disaster for everybody, except the oil industry, which has seen their profits explode over the past year. The xle oil etf has massively outperformed the broader stock market since the beginning of the year reversing a previous decade of lagging behind. In fact, the situation has gotten so bad that the uk is imposing a six billion dollar windfall tax on their oil and gas industry. To pay for consumer subsidies, with inflation, fears rising to record highs, it seems like the current situation of rising energy prices will last forever.

But if we look back at history, there's reason to believe that a current energy bubble may not last that long back in the early 2010s, a combination of opec supply cuts in the libyan civil war sent oil prices skyrocketing to record highs. Similar to today, oil companies were raking in record profits at the expense of consumers. Wall street pumped hundreds of billions of dollars into oil startups, who promised to revolutionize the industry with new fracking technologies. But just as quickly as oil prices rose, they crashed in 2015.

As the market couldn't soak up so much new supply, almost half of the u.s fracking companies went bankrupt and the industry still hasn't fully recovered. Today, we'll look at the fracking bubble of the 2010s and compare it to the current energy situation. For more than a century, oil and natural gas have been crucial inputs to the global economy as more and more people started to own automobiles and travel on airplanes. Oil demand increased steadily around the world throughout the 20th century.

Oil is a non-renewable resource. There is a finite number of barrels in the ground and eventually we will extract it all and run out, especially as demand increases all the way back in the 1950s scientists were sounding the alarm about peak oil. The geologist maureen king hubbard predicted that the u.s would reach peak oil in the 1970s. After this point, production would steadily fall as the wells dry up.

While his projections were controversial at the time over the next 50 years, they turned out to be spot on. U.S production peaked at 3.5 billion barrels in 1970. by the mid 2000s annual production was cut in half to just 1.6 billion, but at the same time, demand continued to increase as the economy developed. As a result, the us became a net energy importer.

It was increasingly reliant on imports from countries like saudi arabia, russia and libya. In 2011, political unrest related to the arab spring decreased oil exports from egypt, libya, yemen, bahrain and other countries. By this point, the us was so dependent on middle eastern oil that they couldn't make up for this gap with domestic production. This caused prices to skyrocket and threaten the post-recession recovery.

However, these high energy prices wouldn't be sustained indefinitely around this same time. U.S oil production unexpectedly started skyrocketing completely contradicting maureen hubbard's peak oil prediction. So what happened? Peak oil is predicated on the oil supply being limited and will eventually run out, but this is a little bit of a misnomer. There are 1.7 trillion barrels worth of oil reserves in the world.

This is enough to fulfill demand for thousands of years. The problem is most of this. Oil is deep under the oceans under difficult terrain or for whatever reason, it is economically infeasible to extract oil. Companies extract the easiest oil fields first and once those are exhausted, they move on to the more difficult ones.

Eventually, the only places left are remote or extremely difficult oil fields which may not be economically viable. Once you get to this point, production must decrease if the oil companies still want to make any profits. What hubbard didn't consider was technological innovation, making previously untapped oil reserves economically feasible for the first time, shale is a fine-grained sedimentary rock formed from mud. That is a mix of flakes of clay, minerals and tiny fragments of other minerals.

Shale often contains oil or natural gas, but is very difficult to extract. The main way that natural gas and oil is extracted from shale is a method called hydraulic, fracturing or fracking. For short, a well is drilled thousands of feet below the ground to where the shale is small. Explosives are used to form cracks in the shale.

A mixture of water sand and lubricating chemicals are pumped through the well at high pressure to form a network of cracks where the oil and gas can escape. While fracking has existed for a long time for most of the 20th century, it was economically infeasible in most places. That's because you need to dig a very deep and expensive well to get only a minimal amount of natural gas. This all changed in the 2000s when frackers started, employing horizontal drilling after drilling down into the ground.

The drill bit turns sideways and can drill horizontally for miles. This increases the surface area by orders of magnitude allowing each well to extract far more reserves. With the advent of horizontal drilling, fracking finally became economically viable. This was great news for the us, as the country has massive shale oil and gas reserves, most notably in the permian basin in texas, in the back in in north dakota wall street fell in love with the idea and started supplying tents and eventually hundreds of billions Of dollars to fund the exploration and development of new wells flush with cash, the frackers started, buying up land in texas, north dakota, pennsylvania, ohio and other shale rich states, as fast as they could and laying down fracking rigs at an alarming rate.

The frackers first started off with natural gas, because prices were very high in the early 2000s and the fracking process is easier to do with gases rather than liquids. The number of natural gas rigs in the us rose from 500 and 2 000 to 1 500. In 2009, mostly driven by fracking, decreased demand related to the 2008 recession, as well as the rapidly increasing supply from the frackers caused natural gas prices to tank u.s natural gas prices fell from a high of 13 per british thermal unit in 2008 to just two dollars By 2012., needless to say, this was a complete disaster for the frackers, many of whom financed their expansion with debt. However, not all was lost.

At the same time, the natural gas situation was deteriorating, the price of oil was being shot up to record highs due to political unrest in the middle east. While fracking was originally intended for extracting natural gas, it can also be modified to extract oil. The fracking companies shifted their focus from natural gas to oil, a move that was applauded by wall street. The number of oil rigs in operation started skyrocketing almost right after the natural gas rigs started decreasing, while fracking wells are cheaper to operate than many forms of drilling.

The output of each well decreases exponentially as the ground underneath runs dry, so, while a well may be extremely profitable for the first few years, production will soon fall off a cliff. An oil company has to spend money up front to build a fracking well in the hopes that the oil it produces over its lifetime will be enough to cover this cost to decide whether an oil field will be profitable. Geologists perform various tests to estimate the amount of oil that can be feasibly extracted. These estimates require significant judgment.

It is often more of an art than a science. Loyal executives would fly over to wall street to raise money from investors. These executives often had their compensation based on production growth, not profitability. This incentivized them to raise as much money as possible to drill new wells, regardless of economics, so they would often adjust their oil reserve assumptions to look more favorable to potential investors in the early 2010s.

With oil trading north of 100 per barrel, and all these new fracking companies promising huge production growth wall street couldn't put money into the sector fast enough. It is estimated that investors supplied fracking companies with more than 300 billion dollars of debt and equity financing. During this period, everything was going perfectly for the frackers production was growing, their stock prices were rising and top executives were taking home annual bonuses in the tens of millions of dollars. This became known as a u.s shale revolution, but there were two big problems.

Firstly, all the investment caused the supply of oil to increase dramatically since the 1980s. America's oil production decreased dramatically consistent with hubbard's peak oil prediction, but starting in 2010 production, skyrocketed increasing by more than 50 by 2016.. At this point, the u.s overtook both saudi arabia and russia, to become the single largest oil-producing country in the world, which is a huge accomplishment and a source of national pride by simple laws of supply and demand. This will inevitably cause prices to decrease oil demand is relatively inelastic.

Most people consume a somewhat fixed amount of oil each day to drive to work, etc. You would prefer gasoline prices to be lower, but you're, probably not going to double your amount of driving. If gas prices fall by 50 percent in 2014, oil prices started to decrease slightly as the glove of new supply started to saturate. The market energy ministers from the opec member nations met in vienna to set their production quotas for the next year.

Most analysts expected them to cut production and prevent prices from falling any further. This is a common strategy that they used in the past, and many other member nations needed high prices to balance their fiscal budgets. However, saudi arabia and some of the other opec countries were thinking more strategically. Instead of cutting production to accommodate the american frackers, they increased production to drive prices down further and put the frackers out of business.

While this would cause some short-term pain. The long-term gain of crushing the competition was well worth it, and the plan worked flawlessly. The oil price collapsed from 100 to 50 in a matter of months to make matters even worse. Many of the fracking companies over promised and under-delivered one of the most extreme examples of this was sandwich energy, which was forced to decrease its oil reserve estimates and 8 out of 10 years during the 2010s.

According to ihs market, as their original sms turned out to be overly aggressive, the combination of low oil prices and worse than expected, well efficiency caused operating cash flows to plummet to fund well growth. Most of the frackers relied heavily on debt, borrowing hundreds of billions of dollars in aggregate they borrowed this money under the assumption that oil prices would remain high when prices collapsed, they were unable to make their interest payments since 2015, more than 230 north american oil and Gas producers, owing more than 150 billion dollars in debt, have filed for bankruptcy. Even the companies that avoided bankruptcy decreased their production dramatically to conserve cash. The number of oil rigs in operation collapsed by more than two-thirds in 2016..

Hundreds of thousands of oil workers in the us were laid off both those who worked directly for the frackers and those who worked for oil field service companies from 2017. Through 2019, oil prices partially recovered, as demand increase in the us fracking decelerated, but in 2020 the coven pandemic abruptly destroyed this recovery with lockdowns reducing transportation, oil demand plummeted and prices tanked with oil futures briefly falling below zero. This was the biggest shock to the industry since 2016., in the us alone, almost 100 oil and gas companies with close to 100 billion dollars in aggregate debt filed for bankruptcy. According to the research firm fitch solutions, global oil and gas capex fell by roughly 20 in 2020, as companies look to conserve cash capex is not expected to surpass pre-covered levels until 2025..

Remember that fracking wells deplete very quickly after the first few years of operation. Just to maintain current production levels, capex needs to stay at least constant and with most countries having all but completely rolled back covet era. Mobility restrictions, oil demand is expected to exceed 2019 levels this year. Add to that the decrease in output from russia, and it's not hard to see why oil has once again surpassed 100 per barrel with prices so high.

You might expect the frackers to start drilling again in the boom bus cycle that we saw in 2016 to repeat, but the current situation isn't exactly the same. Investors are still shell shocked from the previous fracking bubble of the fracking. Companies that survived their stock prices are just returning to their 2014 highs. Today, eight years later, the sector has been dead money for the past decade.

Neither the company executives nor the shareholders want to repeat this. Oil companies are using their excess free cash flow to increase dividend payments to investors to avoid over building capacity like they did last time. Pioneer natural resources is one of the largest and previously most aggressive frackers in the us. During the peak of the fracking bubble in 2013 and 2014, they only paid a nominal dividend of 4 cents per share.

Despite sky-high oil prices, they invested substantially all of their excess free cash flows into building new fracking wells. This strategy ended disastrously, as your stock price was cut in half by 2016.. Despite a similar oil price backdrop, their strategy has changed completely. They recently declared a dividend of seven dollars and 38 cents per share and are targeting to pay 80 percent of their free cash flow as dividends.

They will only invest the minimum amount necessary to maintain their current production quantity or increase it by five percent. At the most, everything else goes to dividends: investors viewed this new strategy, very favorably, with the stock price now trading at all-time highs. So, despite the superficial similarities of the 2014 fracking bubble, it's unlikely that we'll see a similar collapse in prices. This is bad news for the consumers, who will be stuck paying higher prices at the pump, but it's good news for the oil companies who are likely to see extraordinary profits for years to come.

Alright, guys that wraps it up for this video. What do you think about the 2016 fracking bubble? Let us know in the comment section below as always. Thank you so much for watching and we'll see in the next one wall, street millennial signing out.