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CEO bonuses are fuelling the oil glut

If you owned an oil well today, your best bet would be to cap it, wait for the current over-supply of oil to be used up, and then start pumping again once prices had risen above $100 again.  That would be common sense.  But that isn’t how things are playing out in practice.

Neither Saudi Arabia nor Russia – both of whom depend on oil revenues to pacify their populations – have been prepared to cut production in the face of the massive increase in US and Canadian (fracking and tar sands) oil production.  Nor is Iran prepared to entertain discussions about limiting supply before its exports have reached the pre-sanctions level.  So that leaves the US oil patch as the only place where production cuts could make a difference.

So why aren’t the US energy companies – most of which are making a loss at $40 per barrel – cutting back?

One often overlooked reason is the way oil company CEO bonuses are structured according to Ryan Dezember, Nicole Friedman and Erin Ailworth writing in the Wall Street Journal:

“Production and reserve growth are big components of the formulas that determine annual bonuses at many U.S. exploration and production companies…  The practice stems from Wall Street’s treatment of such companies’ shares as growth stocks, favoring future prospects over profitability. It has helped drive U.S. energy producers to spend more unearthing oil and gas than they make selling it… It has also helped fuel the drilling boom that lifted U.S. oil and natural-gas production 76% and 31%, respectively, from 2009 through 2015, pushing down prices for both commodities.”

Dezember, Friedman and Ailworth suggest that this may be coming to an end as shareholders become increasingly nervous about energy companies’ ability to stay afloat in the face of global over-supply and prolonged low prices well below the breakeven point for many energy companies.

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