Mistakes and misjudgments can be more instructive than successful decisions.

Distilled below, in an excerpt from Thomas A. Petrie's new book, Following Oil, are some key lessons learned and observations that he has personally come to internalize, drawing on more than 42 years of developing investment research, advising corporate clients, and helping execute financings focused on the oil and gas business. His assessment of the workings of today's market forces and his reflections on America's future energy opportunities and challenges are through the lens of these time-tested perspectives.

  • Markets continuously endeavor to work, but in their own time and at their own pace.

Repeatedly, in the events previously described (see “Peak Oil Postponed” in January 2014 issue), one can see that this adage is true of a wide variety of markets—for oil tankers, crude oil, natural gas, oilfield services, and energy-related investment securities (equities and bonds). There are often multiple factors affecting each of these markets. Therefore, it is important not to assume that there will always be a direct, obvious, or almost instantaneous correlation between a certain driver and a presumed market response.

Inevitably, strong corrective forces kick in when markets drift (or spike) to excess. As numerous examples depict, the law of unintended consequences tends to be powerful and ever-present. Thus, regulatory measures designed to counter or control market moves often only further complicate or even obscure (at least for a while) market reactions to an unfolding geopolitical event or economic condition. More often than not, much as J. Howard Marshal counseled former Secretary of Defense James Schlesinger in the late 1970s, it is better to allow open markets to run their course rather than to impose arbitrary constraints that inevitably ignore or fail to adequately account for economic or commercial realities.

  • Flawed economic and policy incentives ultimately cause or exacerbate supply shortfalls (or sometimes even undesirable surpluses).

Examples of such incentives, signals, or unintentionally detrimental policy initiatives include arbitrary price regulation, multiple price levels for chemically identical (or sometimes even just similar) commodities, governmentally mandated quotas such as for ethanol, or excessive emphasis on a green energy choice, to the detriment of more cost-effective traditional economic sources that can still offer enhanced environmental benefits. Under such conditions, unnecessary shortages can occur despite the availability of ample raw energy resources. Most interestingly, as the US and Soviet Russia respectively demonstrated in the 1970s and 1980s, both capitalistic and communist economies are capable of creating or exacerbating shortfalls amid an ample (or at least clearly adequate) supply of resources.

  • It is often darkest just before the dawn.

In dealing with economic cycles, one should remember that doubling down on one's investment, or, for that matter, on national energy policy commitments, at a near market bottom can be very rewarding, as long as it is a real bottom. Admittedly, identifying a true market

Excerpted from Following Oil by Thomas A. Petrie. Copyright 2013, University of Oklahoma Press.

bottom with certainty can often be difficult. However, in the energy sector when market values reach or exceed historic extremes, it is usually a lower-risk option to expect a reversion to the longer-term mean. Such is probably the case currently for natural gas (near its low-range value) and possibly for oil (which is nearer its high-side value).

  • Black swan events entail especially noteworthy risks.

The implications of events broadly perceived as improbable are often far greater than many (indeed most) observers anticipate. This is because such outcomes, by definition, fly in the face of expectations for which the majority of market players typically already taken steps to position themselves.

For example, after the extended period of relatively safe offshore oil operations, the Ma-condo disaster involved the tragic loss of many lives and one of the most extensive marine oil-pollution events ever. Its financial consequences for the oil and service companies were very significant. Also noteworthy were the aggregate impacts on the broader US Gulf Coast economy and the knock-on effects for US offshore oil development, with further effects on the country's trade deficit. Given the industry's technical complexity, planning for perceived low-probability contingencies is extremely difficult. Nevertheless, risk mitigation can and must be improved to determine best safety and operating practices and to reduce the occurrence of highly disruptive events.

  • Powerful regenerative economic forces result from the application of well-incentivized capital focused on high-priority societal problems or needs.

This benefit is easily underestimated, especially in highly charged or politicized times. The approximate threefold oil price recovery from a 2008 low of $35 per barrel has been a major driver of the recently transformed outlook for US oil and gas production. Combined with the unusually high percentage of privately owned minerals to be developed in the Willis-ton Basin of North Dakota and eastern Montana, this price level has transformed the region into one having the brightest economic outlook in the country, with low-single-digit unemployment. These price signals also apply across the country. Improved access to undeveloped minerals, whether on federal, state, or private lands, affords the potential to generate roughly similar benefits elsewhere.

  • Old geopolitical grudges tend to reemerge, often at inopportune times and with adverse consequences.

As history shows, these can lead to wars, capital destruction, and broad societal disruptions. There are historic precedents and continuing expectations as well as broader global needs for US leadership in dealing with such events. Accordingly, it is important to maintain an awareness of possible trouble spots and a range of options to respond to them.

The currently unfolding Middle East realignments involving Syria, Turkey, Saudi Arabia, Iraq, and Iran (among others) all pose numerous threats of triggering unresolved historic conflicts. Lessons learned from past successes and failures involving recent US military commitments in Iraq and Afghanistan may be critical in forging future responses.

  • Periodic consolidation and reorganization (via mergers and sales) are integral to the evolving natural order of the petroleum-sector economy.

Periodic consolidation and reorganization is an inherent aspect of the need for economic rationalization of market excesses both on the upside and on the downside. The three waves of petroleum-sector M&A consolidation occurring in the early to mid-1980s, in the late 1990s, and in the early to mid-2000s freed up human resources that unleashed powerful cycles of new entrepreneurial endeavors.

These efforts were aimed at finding and developing new sources of hydrocarbon resources using new state-of-the-art technologies. Capital markets decision makers in both publicly traded companies and private-equity platforms took the cue and responded impressively with ample financings for worthy projects.

  • Shifting global macro-economic drivers can overwhelm even a well-executed plan and thus necessitate midcourse adjustments in strategy for both corporate players and national entities.

These can be likened to the shifts of tectonic plates in the earth's crust that give rise to momentous earthquakes. Each of the previous four decades has experienced at least one or two such broad-scale disruptive events in the energy sector. For example, the revolutionary changes in natural gas supply caused by advances in utilizing technologies to develop unconventional resources rendered invalid the need for natural gas import facilities in the US This resulted in a challenge for Cheniere Energy and many other energy firms to reconfigure their already built regasification plants into export facilities and a major trade-deficit-reducing opportunity as the US becomes an exporter.

Thomas A. Petrie, CFA, is chairman of Petrie Partners LLC, in Denver. He formerly served as vice chairman of Bank of America/Merrill Lynch and was vice chairman of Merrill Lynch until its acquisition by Bank of America in 2009. Petrie co-founded Petrie Parkman & Co., a Denver-and Houston-based energy investment banking firm that merged with Merrill Lynch in 2006.

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