With consumers reeling from skyrocketing prices, a cynic might say that Russia's invasion of Ukraine is good news for the oil and gas industry. 

The West, led by the United States, has slapped sanctions on Russia, one of the world's largest producers of oil and gas. This means Russia will find it harder to export energy, causing a reduction in supply that drives up prices (as you’ve no doubt noticed at the pump).

Indeed, the International Energy Administration recently warned of the "greatest supply crisis in decades" because of Russia's actions.

But in truth, the conflict spells bad news for an industry whose long term outlook was already looking increasingly bleak because of nagging supply gluts over the past few years and a rapidly warming Earth. Rising prices and short term supply shortfalls might tempt producers into reactivating the drills at a time when they should be figuring out how to adjust to a post-carbon economy.

"First and foremost, energy security and affordability are back at the top of the agenda," said Maciej Kołaczkowski, manager of the oil and gas industry for the World Economic Forum in Geneva. "It seems that climate change and sustainability are not the number one priority anymore."

Higher prices might generate cash in the short term. But they do nothing to solve the industry's long term problems. Meanwhile, a cash grab born of geo-political crisis can be a distraction for an industry that depends on stability and consensus for its very survival.  

The state of the oil and gas industry

Oil and gas producers are like Schrodinger's cat: they are both alive and dead. They make tons of money from making something the world desperately needs. At the same time, the industry faces extinction.

After years of overdrilling, the industry now suffers from too much competition. Throw in Covid-19, which shut down much of the world's economy, and the climate change crisis, and suddenly the demand outlook doesn't look so great either.

WTI prices fell from $110 per barrel in 2013 to below $10 during the start of the Covid pandemic seven years later. Since Russia's invasion, prices shot back up to $110 before dropping to $96.

Philip Verlerger, a prominent industry analyst, suspects the price gains reflect Wall Street trading algorithms rather than actual demand. He noted options on oil have reached as high as $300.

But the trading frenzy is removed from reality, he said.

"Oil companies will find that even if prices go to $150, the demand won't be there," Verlerger said.

Companies like BP and ExxonMobil, once the darling of investors, are now feeling their scorn as environmental concerns mount. 

Last year, Engine No. 1, an activist hedge fund, waged a successful campaign to place three candidates on Exxon's once tightly controlled board of directors. The firm accused Exxon of wasting shareholder money on bad exploration projects and not taking climate change seriously. 

At the same time, investment giant BlackRock, which owns nearly 5% of ExxonMobil shares, said in a letter to clients that it will prioritize "climate change, not only in terms of the physical risk associated with rising global temperatures, but also transition risk — namely, how the global transition to a low-carbon economy could affect a company's long-term profitability."

Major change needed

It’s not just investors – there's broad consensus that producers need to rapidly readjust their business models and transition to clean energy and low carbon technologies.

The United Nations Paris Agreement calls for lowering global temperatures 1.5 to 2 degrees Celsius below pre-industrial levels. 

In order to meet this goal, consulting firm McKinsey says the industry needs to spend trillions of dollars over the next decade to get things moving: $750 billion for carbon capture technology, $200 billion for electric vehicle infrastructure, and $700 billion to hydrogen-production capacity, and $8.5 trillion for solar and wind. 

So how has the industry responded? American firms have mostly been limiting capital investments in new projects and returning money to shareholders through buybacks and dividend payments.

There has been some progress, though. Occidental Petroleum is currently building what will be the world's largest carbon capture and storage plant in the Permian basin. The independent hopes to complete the construction of the plant, designed to remove and store one million metric tons of carbon dioxide a year by 2024. 

And ExxonMobil launched a new business unit dedicated to low carbon technologies.

"This is a big opportunity for our company," chief executive officer Darren Woods told investors earlier this month. "Leveraging a core set of capabilities and existing advantages, we can develop each of our businesses in line with the evolving markets." 

"If the transition happens faster than projected, we can allocate additional resources to our low carbon solutions business," Woods said. "If it happens more slowly, we can retain resources in our oil and gas businesses."

Committed or addicted?

Some observers are skeptical that the industry has changed its ways. Producers have historically made a lot of money from extracting and selling oil and gas. Walking away from that cash, especially when prices exceed $100 a barrel, won't come easy.

Even before Russia's invasion of Ukraine, OPEC struggled to maintain discipline among its members, as several countries have consistently flouted production caps the cartel has set.

"What a lot of investors are looking at is how does this industry respond and do they maintain discipline in a volatile oil price environment," Mark Viviano, a managing partner at private equity firm Kimmeridge Energy Management Company told Argus Media. “Ultimately, there is still a lot of skepticism that anything has structurally changed."

The bigger problems don’t disappear just because prices are spiking. For one thing, there are still too many producers in the United States, analysts say. Consolidation has come frustratingly slow. While bankruptcies rose during the pandemic, the industry continues to see new players enter the market.

And the temptation for companies to rapidly increase production because of short term supply needs from conflicts like Russia's war on Ukraine might be too great to resist.

"If you too quickly try to take it…to something much higher, are you going to end up really breaking the business model again?" Chad Michael, president of investment bank Tudor Pickering Holt, said at an industry conference earlier this month. "There is real concern about that."

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