Scared of Secular Stagnation? Just Look at Oil Industry's Innovations

In recent years, it's been in vogue to claim all the "big" innovations -- the real game changers like the steam engine, car, airplane, computer and internet -- are behind us.

We've entered secular stagnation, as humans have maxed out creativity, proponents presume, and all that's left is to tweak past ideas for minor gain. To my mind, this is as short-sighted today as it was in 1938, when economist Alvin Hansen first came up with this notion.

It overlooks how even seemingly small innovations can trigger a revolution. And it also overlooks one under way right here and now -- in the oil patch. The current pace of innovation in oil production is staggering, and it likely extends oil prices' cyclical downturn longer than most investors think.

A short decade ago, many economists believed U.S. oil production was past its peak -- headed for terminal decline driving energy prices to a permanently high plateau.

Yet a funny thing happened on the way to this dystopic future: High oil prices in the period from 2005 through 2008 got energy innovators thinking.

Eventually, what they came up with wasn't totally new -- not all innovation has to be. It was the fusion of three existing factors: known, but hard-to-access, shale oil deposits; horizontal drilling; and hydraulic fracturing, or "fracking."

Horizontal drilling gave drillers much more flexibility to access viable seams. And, once they reached the layer of hard shale rock preventing oil extraction, hydraulic fracturing -- cracking rock through the injection of water, sand and chemicals -- unlocked the deposits. The combination was huge, relegating peak oil fears to the trash heap.

Exhibit 1: Innovation Causes an Oil Resurgence

Source: US Energy Information Administration, as of 7/13/2017. 1946 - 2016.

However, the influx of American oil caused supply growth to top demand growth -- resulting in a glut. Beginning in June 2014, oil prices fell deeply -- and many presumed this meant the shale revolution was over. Production would fall fast, many argued, as firms failed and took rigs offline.

To be sure, some weak firms did fail, and many rigs were taken offline. But rather than kill the shale revolution, it seems this ushered in a new chapter -- one targeted at slashing production costs and massively increasing productivity.

Firms are employing newly improved technologies like remote-controlled well heads, which allow drillers better oversight and control of production. They can turn the spigots on by pressing a button from their desks.

Better seismic imaging allows explorers to identify targets more easily. Some rigs are now designed to walk from location to location, limiting the costs and labor required to move it and set it back up.

Others can simply use directional drilling to drill many shafts from a single location. Moreover, as a Bloomberg article noted earlier this year, innovation isn't limited to the well head: "To me, it's not just about automating the rig, it's about automating everything upstream of the rig," says Ahmed Hashmi, head of upstream technology for BP Plc. "The biggest thing will be the systems."

That means an engineer can design an oil well at his desk. With the press of a button, an automated system would identify the equipment needed from a supplier, create a 3D model and send instructions for building it out into the field, Hashmi says. "That is automation."

And innovation.

Now, individually perhaps, none of those things are huge developments. But, taken in concert, the impact is massive.

At drilling activity's 2014 high, 1,609 rigs were drilling for oil in America, according to Baker Hughes. As of July 14, 2017, less than half as many -- 765 -- were active. Yet, despite the 52% decline in active rigs, U.S. oil production is down only 2.2% from its June 2015 high.[i] Rig machinery is far more productive than just two years ago.

Exhibit 2: Oil Output per Rig Surges

Source: Energy Information Administration, as of 7/14/2017. January 2007 - May 2017.

Furthermore, during the downturn, many feared oil rig crews would leave the industry, driving up costs and leaving shale firms unable to ramp up production when prices rose. Yet we've seen massive labor productivity gains in energy, too.

Exhibit 3: Oil Output Per Worker

Source: U.S. Bureau of Labor Statistics, St. Louis Federal Reserve and the U.S. Energy Information Administration, as of 7/14/2017. April 2007 - April 2017 (latest data available).

Secular stagnationists miss or discount all this. So do many investors. All the focus in the press on deals by the Organization of Petroleum Exporting Countries, or OPEC; inventory levels, Russian compliance with deals and more overlooks the fact that the fast pace of innovation in oil is driving up production while using fewer and fewer resources.

That seems like a recipe for the supply glut sticking around longer than most investors think.

If so, low oil prices should persist for quite some time -- ironically, their operational resiliency isn't likely to help energy firms' stock prices any time soon. That doesn't mean oil is dead -- quite the contrary.

There will come a time again when energy firms have insufficiently invested in production, and prices rise. And when they do, these technological gains should boost profits big time. The current bust is sowing the seeds of an eventual boom. But to me, that boom looks pretty far off from where we are today.

[i] Source: Energy Information Administration, as of 7/14/2017.

Fisher Investments is an independent, fee-only investment adviser serving investors globally. To learn more about Fisher Investments, please visit www.fisherinvestments.com.

The content contained in this article represents only the opinions and viewpoints of the author. It should not be regarded as personalized financial advice and no assurances are made the firm will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Aaron Anderson is senior vice president of research at Fisher Investments and a member of the firm's five-person Investment Policy Committee.

Fisher Investments is an independent, fee-only investment adviser serving investors globally. To learn more about Fisher Investments, please visit www.fisherinvestments.com.

The content contained in this article represents only the opinions and viewpoints of the author. It should not be regarded as personalized financial advice and no assurances are made the firm will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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