Amidst the chaos of information and social upheaval the past few weeks, I’ve found it easy to let certain events or bits of news float to the back of my mind. While I knew the Saudi-Russia oil price war, ignited on March 8th, served as the second major catalyst for the market crash on the March 9th, I hadn’t spent much time understanding what happened or its second order effects. After taking some time to digest the state of energy markets around the world, I think it’s worth relaying the dynamics of the situation, the impact on a large pocket of the American economy, and how this may affect us in the technology and startup community.
What happened? For more in-depth coverage, I’d recommend the Invest Like the Best podcast with Deep Basin Capital, as well as NYT writers Stanley Reed and Clifford Krauss. In recent years, China became the largest net importer of petroleum in the world due to manufacturing and industrial growth. When COVID-19 hit China hard in December and January, energy demand collapsed as the country essentially shut itself down, bringing industrial production to a halt. On top of that, people were already concerned about an oversupply of oil prior to the demand shock.
The major global powers in energy production are OPEC (spearheaded by Saudi Arabia), Russia, and the United States. In 2016, Saudi Arabia and Russia came together in an unprecedented fashion to form “OPEC+” placing a market floor on the world’s oil supply and allying against the then-booming US energy industry (more on that soon). The recent demand shock gave the Saudis and the Russians a chance to reconvene on the agreement with the goal of cutting down the supply. When they couldn’t come to terms, Saudi Arabia decided to flood the market with cheap oil, causing a dramatic price drop with increasing supply and decreasing demand.
The US shale boom: To understand the impact on US energy companies, it’s important to backtrack a little bit. After the last financial crisis and up until last year, US energy (specifically oil and gas) has gone through a renaissance, known as the “shale boom.” Shale oil is a type of crude oil discovered through onshore drilling by breaking up bits of rock near the surface. New technologies for energy exploration and drilling coupled with low-interest rates fueled massive expansion for US energy production. According to NPR, “For years operators focused on drilling lots of new wells very fast, prioritizing explosive growth over profitability. Until now they've been able to rely on deep-pocketed investors who were willing to pour fresh capital into the industry, despite years of lackluster returns. It's a story that may be familiar to anyone who's been following the tech industry in recent years. Deckelbaum compares it to a kind of a prospector mentality.”
Upstream companies (exploration, production, and oilfield services) boosted economies across the heartland and created hundreds of thousands of jobs. Yet, in the last year or so, investors were feeling skittish about the sector given the excess of corporate debt and leverage. Excess borrowing fueled growth. The Saudi market flood looks like it may be the final nail in the coffin with the steep decline in oil prices. There’s been a near-term sell off of energy equities, and the only buyers are long-term optimists like Warren Buffett. Energy companies are hiring restructuring bankers and laying off personnel in the *hundreds of thousands.*
Tech startups serving oil & gas: Traditionally, selling software into the energy industry was a death wish due to slow sales cycles with legacy buyers. But other features — the size of the industry and lack of data / digitization — always made it an attractive area for tech startups if GTM was cracked. The recent American shale boom, with new companies and younger buyer personas, enabled Silicon Valley to enter this market. Companies like Tachyus optimize oil and gas-specific operations in order to maximize energy production. Other companies started to follow the vertical software playbook in order to create “industry clouds” — system of record, payments, safety & compliance, supplier management, procurement, etc. RigUp, a labor marketplace for energy contractors, is the most well-known SV company in oil and gas, and they were the beneficiaries of a large growth investment from Andreessen Horowitz in the fall.
As energy companies falter and local economies suffer, I’m wary of how they will view the tools and datasets of the past few years. The old guard may claim that technology vendors are examples of discretionary spend — first to get cut in dire times. Others could argue that these solutions can improve operations and efficiency. Ultimately, it will be an uphill battle to fight the cyclical forces of this industry. Upheaval might lead Silicon Valley investors to reconsider how they fund startups in cyclical industries or “software going from vertical to horizontal” in the future. They may fold into the Terry Smith view of markets.
Chain reaction: The technology world makes up a tiny slice of who will feel the turbulence. Domestic oil production boosted the American chemical, manufacturing, and steel industries. If they also stumble, it goes without saying that this will be felt in Washington. The Saudis and Russians could come to an agreement in the near future, but that won’t solve the credit issues for energy companies or the demand shocks from COVID-19. On a different note, Silicon Valley was heating up on climate tech in the months before the pandemic. Observing what’s going to happen there deserves a separate post, but I could see arguments in both ways for how this current energy crisis could catalyze or deter a green revolution.
The situation is changing on a daily basis, and for now, only time will tell.