Everyone loves a good story. Sometimes, it doesn’t even matter if the underlying facts are true — the narrative can take on a life of its own, and even begin to influence behaviour.
In today’s world, one such narrative is that peak oil demand is right around the corner, and that it will spell the ultimate end for hydrocarbons. To reinforce the story of the conversion to electric vehicles, simply attach that infamous picture of horses in NYC before and after the introduction of the automobile.
You can see this currently playing out in the market, as the shares of U.S explorers and producers have fallen by more than 18 per cent in the past month on worries about the impact the Wuhan coronavirus might have on global growth.
At the same time, shares of electric-vehicle-maker Tesla have surged dramatically — up more than 30 per cent in the past week and 16 per cent on Monday alone — even though the company has significant exposure to China.
Looking out longer term paints an even more interesting picture with Tesla shares being up nearly 250 per cent in the past five years compared to the SPDR S&P Oil & Gas Explore & Producers Index (XOP) that is down more than 63 per cent.
The problem is the world is never black and white.
Currently, vehicles are having zero net impact on the demand for crude oil as the growth in gas-guzzling SUVs are more than offsetting the gains made by EVs.
For example, in less than a decade, SUVs as a per cent of global vehicle sales has grown from 18 per cent to 42 per cent.
According to the December 2019 IEA report, global oil demand increased by 900,000 barrels per day on a year-over-year basis in the third quarter of 2019, the strongest annual growth in a year with nearly three-quarters of that growth coming from China.
Compare this to a recent report by Goldman, which found the coronavirus had the potential to take out only an estimated 260,000 barrels per day of global oil demand in 2020.
Yet, traders have sold WTI oil prices from over $61 to below $51 a barrel in the past month.
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Meanwhile, global demand continues to chug along setting a record high last year of 101.3 million barrels per day. Think about the size of that number for a second, and while you did the world just consumed 1,172 barrels of oil.
Therefore, if demand isn’t the problem, then what is?
Unconventional drilling and fracking technology have resulted in a plethora of oil hitting the market. The U.S. has seen its oil production grow from 4 to 12 million barrels per day in the last decade and is expected to become a net oil and oil product exporter this year. Therefore, the problem is producers themselves who are forgetting that the margin sets the price. Those producers pushed supply growth ahead of demand growth resulting in an oil market being out of balance.
Interestingly though, the peak demand story and the pushback against fossil-fuel development has resulted in capital fleeing this sector and at a record pace. According to gofossilfree.org, 1,181 institutions have already repositioned their portfolios by divesting nearly $14 trillion of fossil fuel investments.
As a result, producers have had no choice but to react by preserving cash flows instead of reinvesting it back in the ground for the first time in a very long time. This will take some time to kick in, but when it does and supply reacts it will have an impact on pricing — but by then it could be too late for many explorers and producers, especially those not prudent with their balance sheets.
That said, there is some irony in that the solution to this correction could come from those seeking its demise in the first place.
Then again, perhaps higher oil prices will mean fewer SUVs and more electric vehicles.
Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.