Oil Is Dead – Long Live Oil

Monday, Nov 06 2017 by
12

Literally on a daily basis I read something that implies that the end of oil is nigh. This something is usually related to electric vehicles and the demise of the internal combustion engine. Broadly speaking, I think that oil is finished and is on its way out. The real issue is the time frame, especially in terms of peak demand.

An article published in the Wall Street Journal in May 2017, stated that the International Energy Agency saw growing demand for oil, albeit slow, going past 2040. That said, it also went on to point out the wide variations in predicting peak demand – ranging from Statoil believing it could be reached in the mid 2020s through to Aramco that does not see the peak in sight at all.

However you view it, estimating the demise of oil is largely guesswork. There are simply too many variables – technological, legal, ecological, political, etc. That said, there are certain undeniable factors such as the numbers of vehicles currently using combustion engines and the means to ensure that they can be refuelled and serviced. Safely replacing all those vehicles and putting in place the infrastructure to service a new generation of electric vehicles will be expensive and time consuming. As regards the airline industry, in 2016 it consumed some 6% of the world's total oil output. I would suggest that the prospect for an electric airline fleet is a very long way off. And there is the not so small issue that some 50% of oil is not used for transport but goes into industrial processes such as making plastics.

For investors, I would argue, the real point is this. Sure, oil is in its twilight years. But we need to get things into perspective. Between now and its ultimate death may be a very long wait. In the meantime, there could be substantial profits to be gained from an industry that is no longer perceived as go go or glamorous. By comparison, biotech is far sexier than oil but from an investors' perspective it appears to be a minefield – losses, no dividends and cash calls are often the norm. Whereas there are many profitable, cash generating, oil companies. And again, getting it into context, the FDA issues drug patents lasting 20 years. But that does not stop a rival company producing something more effective and outside the scope of the patent within that period. There are an awful lot of expensive hurdles that a drug must clear before receiving FDA approval. Sexy may not equate to profitable for shareholders.

Putting the oil industry alongside other sectors is, I believe, a useful framework. Retail, banking, transport even education face real and possibly near term threats from disruptive technology. Maybe, as investors, we need a new paradigm – ten to twenty years of growth and then the industry gets turned on its head. Agreed, oil is on its way out. But would you like to bet the ranch on Marks and Spencers being around in 20 years? Peer to peer lending could threaten retail banking. From that standpoint, an oil industry with say a 25 year shelf life looks pretty attractive.

As is often said, do your own research. A lot of assumptions are being made about electric vehicles. For instance, we assume that they will be safe or safer than internal combustion engine driven vehicles. But do you really believe that the makers have the will let alone the ability to figure out the long term health consequences of spending long periods of time surrounded by magnetic fields? Try getting planning permission to build a house in the UK close to an electric pylon! As for the raw materials needed for the large scale production of electric vehicles, there appears to be a mad scramble to find more copper and lithium in particular. Incidentally, cobalt, another key component, is largely found in the Democratic Republic of Congo which holds some 60% of the world's reserves. I would suggest that supply bottlenecks for many key commodities used in electric vehicles will be a growing concern. In addition, from what I can understand, most of the assumptions about peak demand for oil are based upon the reliability of supply. This may be questionable. The industrialised world has experienced some 70 years of peace. Refineries, pipelines and trade routes have been unhindered. If something disturbs this peace, I would suggest, that the price of oil will rocket.

Paradoxically, oil's decline may extend its life. Oil is big – big pipelines, big tankers, etc. And big is expensive. In recent years, many big, especially offshore oil projects, have been cancelled. According to a report by Wood Mackenzie published in 2016, some US$1 trillion of projects had been postponed, largely the result of a relatively depressed oil price. Reserves are being depleted and the necessary investments do not appear to have been made in order to maintain supply. I would argue that many do not seem to appreciate that these projects may not be viable in a higher interest rate environment. Incidentally, while this has been going on, the middle classes in the developing world are simply consuming more oil whether for transport or in the products they now use.

As for the US shale revolution, the engineering may prove to be sounder than the financing. With many highly leveraged players capitalising their costs and management reward structures geared to production rather than profit, it is little wonder that some fund managers such as Jim Chanos see it as an area ripe for shorting stocks. Again, rising interest rates may have substantial implications as these companies seek to roll over their debt.

Even though I am bearish about the long term outlook for the oil industry, I am invested in several smaller oil companies. All low cost producers with low/zero debt. Underpinning them is the ability to ride out the full cycle from boom to bust – should the oil price collapse they can simply leave the reserves in the ground and come back at a later date. All operating in environments that require creative problem solving skills – a difficult barrier for rivals to overcome.


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50 Posts on this Thread show/hide all

herbie47 9th Nov '17 31 of 50
1

"You clearly have no desire yourself to have an EV"

Really you have not read my other posts, where I said I would consider one in about 10 years time.

It's the timing I have an issue with, yes it will probably happen but not when he predicts.

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JohnEustace 9th Nov '17 32 of 50
3

In reply to post #238738

Self driving cars are completely lost when it snows because they can't see the white lines any more. So unless and until that's fixed we really would grind to a halt at the first snow fall.

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herbie47 9th Nov '17 33 of 50

"It will be human error causing multiple pile ups as they drive too close and cut up cars as you say. The AEVs will be programmed to drive at a distance that is safe so youv'e kind of scored an own goal there."

Not really because there is a long time before all cars become fully AEVs, probably over 10 years. So plenty of time for AEVs to cause accidents. I'm sure there will be technical failures also. I still think they have some way to go yet, I won't be getting one any time soon. Over and out.

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peterg 9th Nov '17 34 of 50
3

Currently you can drive your car to a charging point and charge yor car, a Tesla takes 40 minutes to charge 80% capacity, not great but infrastructure improvements will improve this. So you can still charge your EV even if you have no parking outside your house, inconvenient yes, but much cheaper,

I did find the recent argument about the cost of drives rather odd, as one of the big issues is charging for the very many people who are unable to keep cars off road by their house (googling has failed to come up with numbers , but I would not be surprised if approaches 50%)

Having to drive somewhere to find a public charging point that is not already in use and then waiting 30 mins plus for a charge is massively inconvenient, and it it's likely to be impossible to provide the density of public charge points in cities and built up areas to be able to avoid frequent queuing for vacant charging spaces if EV take up becomes widespread.

And just how much cheaper will it be? Currently a significant part of the cost of HC fuel is tax. The cost of roads and associated infrastructure will still have to be funded - and that is going to have to mean taxation on evs in some form or other. If you buy in electricity that is not greatly (or at all) cheaper than buying in untaxed HC fuel, by the time the cost of infrastructure (transmission lines, construction of vast numbers of EV enabled parking bays) and generation costs (even with solar or wind there are big capital costs that have to be repaid) are considered. Currently EVs are very cheap to run as they are heavily subsidised in order to encourage their adoption. That will not continue.

Peter


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kalkanite 9th Nov '17 35 of 50
1

In reply to post #238773

PG

You make a good point regarding the loss of tax on fossil fuels and how that loss will be recovered. I guess if you are a net importer of energy then this would help trade balance but still leaves a hole in the tax income. Much green energy is heavily subsidised so there is the relief from this when the cost of solar reaches grid parity. Having said that I'm not quite sure how much the subsidies are made by governmaent and how much is borne by the consumer? The government can only charge so much tax for electricity once GP has arrived.

You say EVs are heavily subsidised. I'm not aware of this except domestic charging points, road tax and driving into London, although admittedly that can add up to quite a great deal. Perhaps there will be a per mile tax for Taas and this will indeed impact upon the economics?

Re charging points, agree that until AEVs arrive, charging is a bit of an inconvenience albeit cheaper, can you imagine what it must have been like to get petrol at the start of the 20th century? Add to that the conditions of the roads back then. Yet it didn't stop the speedy disruption that ICEs caused over horse transportation. Economies in a capitalist environment are brilliant at adapting to modern needs, where there is a profit to be had there will be someone to fill that need, especially if they can get browny points for creating a green environment.

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paraic84 9th Nov '17 36 of 50
2

My favourite play on oil is the ETF ISHRS OIL & GAS EXPL & PROD USD ETF (LON:SPOG) <- it follows a range of North American large cap oil and gas explorers so is a good way of spreading risk.

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ISAallowance 9th Nov '17 37 of 50
1

In reply to post #238798

"You say EVs are heavily subsidised. I'm not aware of this except domestic charging points, road tax and driving into London, although admittedly that can add up to quite a great deal."

Well a very quick google of UK EV incentives suggests there is a £4500 plug-in car grant available. That's quite a chunky subsidy!

https://www.tesla.com/en_GB/su...

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LongValue 9th Nov '17 38 of 50

A substantive move away from oil will be, in my view, a long and difficult process fraught with many problems. From sourcing scarce resources such as lithium through to coordinating the international development of charging points. Lots of issues will need to be addressed. Putting that into context, Airbus has just won some US$40 billion of orders at the Paris Air Show. Does anyone seriously believe that there is an electronic airline fleet in the offing anytime soon? What about the military – from tanks to troop carriers they are driven by oil? Are they going to go eco-friendly within the foreseeable future? Oh yes, and then there are the shipping fleets. All needing to be re-tooled. And that is just for starters.

Although I can appreciate the analogy of cars replacing horses. Therefore, the electric engine will replace the internal combustion engine. The major flaw with that argument, in my opinion, is that the former provided a materially better service: A more comfortable journey and more commercially productive. With electric vehicles, aside from less noise, the driving experience will be very similar to that from driving a traditional vehicle. It may well make ecological sense and may economically benefit the country. But for the driver the benefits seem debatable. The advantages appear largely macro and strategic and accruing nationally..

Again, at risk of repeating myself, I think that oil is finished. There are too many factors pushing for its elimination. But from here until its eventual demise will be, I believe, a long winded affair with many pitfalls. In the meantime, small low cost oil producers could thrive. Pushing up production in the good times and cutting it in the bad times. Monetising assets and doing smart small deals along the way. Keeping their costs down. Extending the life of their assets and adding to those assets at opportune times.

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peterg 10th Nov '17 39 of 50
1

You say EVs are heavily subsidised. I'm not aware of this except domestic charging points, road tax and driving into London, although admittedly that can add up to quite a great deal. 

Exactly! They may not pollute (locally anyway) to the same degree, but they use the road infrastructure in the same way.

Plus the purchase subsidies that ISAallowance mentions.

I'm not saying any of that is wrong, there is a case for encouraging the use of low polluting cars, particularly in built up areas, but those subsidies only make sense, and will only occur while EVs form a small minority.

Peter

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extrader 10th Nov '17 40 of 50
2

Hi all,

kalkanite has pointed out a relevant factor in the debate EV/ICE, when he wrote ....can you imagine what it must have been like to get petrol at the start of the 20th century?

Answer : you went to the nearest station and, after filling up, bought a can or two of the stuff as spare.

Leaving aside the fire hazard, the current 'portability' advantage that oil has over electricity is a factor that hasn't (yet) been successfully countered.

ATB

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herbie47 10th Nov '17 41 of 50
1

I'm quite in favour of EVs but at the moment the price is too high, when the price difference comes down then sales will take off. What is the cost per mile, I have seen 3p quoted but that's based on 10p per kwh, how efficient are these batteries, do they hold their charge for weeks? In cold weather I hear you get less miles on a charge. So I'm thinking it's around 5p per mile, which is ok, but my diesel is about 9p, so not a huge difference, on 5,000 miles that's only £200, yes servicing and road tax should be less. That's why I'm a bit sceptical about Tony Seba's claims that everyone is going to rush out and buy them even if they have an older car. Leasing them maybe a better idea until the technology settles down. As for cars taking over from horses that took about 50 years to fully replace, in the first 30 years cars were only for the rich, in the 1920s they became popular, first car was in 1879. Of course electric vehicles have been around for almost as long.

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LongValue 10th Nov '17 42 of 50
1

In my view, this concise report is well worth a read for anyone interested in investing in oil stocks. In summary, Wood Mackenzie forecasts what might be described as peak oil demand. But this is some way off into the mid 2030s. Broadly, it predicts falling demand in OECD countries but rising demand in the developing world.

https://api.pressly.com/hubs/835/files/95453/download/Thought_Leadership___Peak_Oil_Demand_LowRes.pdf

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LongValue 14th Nov '17 43 of 50
2

This might be worth bearing in mind. According to a report produced by Goldman Sachs in 2016, a Tesla Model S uses some 63 kilos of Lithium Carbonate Equivalent in each vehicle. In the same year, Tesla forecast production of 500,000 vehicles in 2018. Considering the potential market size for Lithium, it might be natural to assume that there is a futures market for this obviously strategic resource. After all, there's a futures market for Corn – the Romans had one some 2000 years ago. So where is the futures market for Lithium? There isn't one. The market appears, at best, to be opaque. Presumably, one will be developed. Given its dependence on Lithium, does it mean that the price of a Tesla will be closely linked to one of the key commodities used in its batteries?

Although the London Metal Exchange appears to be planning to launch Lithium futures contracts, that is some 18 months or so away. Which raises the question as to the real value of Lithium. I suggest that will only become apparent when there is a transparent market for the resource, including a futures market. Would a doubling or trebling of the price of Lithium make mass adoption of EVs difficult?

Incidentally, the following piece gives some idea of the scale of demand that will be placed on key commodity markets in an all electric vehicle world.

http://www.visualcapitalist.com/massive-impact-evs-commodities/

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JohnEustace 18th Nov '17 44 of 50
1

The Norwegian Sovereign Wealth Fund is considering selling all of its oil and gas holdings to reduce Norway’s dependence on fossil fuel income. They already sold out of coal. They will not decide for a year and then will have to proceed gradually because they have huge holdings - over $5bn in Shell for example. Shell holders may have to be content with the dividend income rather than expecting a rerating in the share price.
https://www.bloomberg.com/news/articles/2017-11-17/norway-idea-to-exit-oil-stocks-is-shot-heard-around-the-world

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herbie47 18th Nov '17 45 of 50
1

In reply to post #240498

It’s a good point about battery costs, I did not realise how expensive they are, in a Tesla it about $10,000 but prices are falling predicted to be down to $100 per kWh by 2020, Tesla uses a 60 kWh battery. Estimates are the battery cost needs to be around $120 kWh to be same cost as running a petrol vehicle. But if lithium costs soar then it could impact the falling prices.

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LongValue 18th Nov '17 46 of 50
1

In my view, this article from the FT presents a balanced view of some of the issues surrounding the supply of Lithium. It's not all doom and gloom but it does highlight a few concerns.

https://www.ft.com/content/90d65356-4a9d-11e7-919a-1e14ce4af89b

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herbie47 18th Nov '17 47 of 50

In reply to post #242623

I can see that article as I'm not a FT subscriber but I did find this one: https://www.bloomberg.com/graphics/2017-lithium-battery-future/

which says cobalt will have more impact on EV battery costs than lithium. Lithium prices could spike up as new mines are not operational yet, about 50% of world's supply is in South America, Chile mostly.

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Nick Ray 18th Nov '17 48 of 50
1

In reply to post #242643

It's not even certain that lithium will reign for long as the best battery technology. Sodium could take over in solid state batteries, or maybe graphene supercapacitors will make the breakthrough, or even some of the old favourites zinc, manganese, iron, etc could make a comeback in a completely different formulation. (Although actually lithium is about as abundant as zinc so that need not be a factor.)

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herbie47 18th Nov '17 49 of 50

In reply to post #242653

Yes that is true, it's difficult to predict but most of those technologies will take a while to develope. Technology is changing fast that's why I'm not rushing out to buy an EV in the next few years. Wait until prices have come down, technology has levelled off and the infrastructure is all in place, I'm thinking maybe around 8-10 years time if I'm still around, if oil prices do fall then diesel/petrol will be cheaper.

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LongValue Wed 2:19pm 50 of 50

Overdue but certainly worth another look. When I started this thread the price of Brent crude was around US$63 per barrel. One year on, November 5th 2018, and the price had reached some US$72 per barrel. As I write it has fallen back to around US$62 per barrel. However one views it, oil has not gone out off the radar. That said, oil equities have performed poorly over this time. During that one year period, the Global S&P Oil Index went from 1775 to 1829, basically a 3% increase. Considering that oil has broadly risen over the one year period and has only pulled back recently, oil stocks appear oversold. Taking a five-year perspective and the situation is very poor; the same index fell by some 22% from December 2013 to December 2018.

Trying to predict the price of oil or even peak oil demand, in my view, is pointless. I remain invested in several oil companies. All profitable and all in production.

Others, far better informed than me, can pass judgement on Tesla but it has obviously been an eventful year for the most high profile electric vehicle producer. Nevertheless, electric car sales are rising. Thus far some five million vehicles have been sold and the Chinese market now accounts for some 40% of global sales. That said, there still remains some two billion vehicles that are running on oil and the Chinese sales appear to be buoyed by Government subsidies.

At risk of repetition, I still think that oil is on its way out but it's going to be over a very long period. As an investor, the question that still remains for me is whether this translates into profits – capital gains and or income from investing in oil stocks?

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