Is Oil Really Dead?

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Includes: BNO, DBO, DBRT, DNO, DRIP, DTO, DWT, GUSH, IEO, NDP, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, PXE, SCO, SZO, UBRT, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU, XOP
by: Jeff Malec

How big of a threat are renewable energies and electric cars to the oil industry and oil prices? It's a question more than a few investors have an interest in answering, given that the Energy sector is about 6% of the S&P 500 market capitalization (which is down from around 16% in 2008). Technological advances in the oil industry and renewable energy are changing the way we produce energy, with some oil companies having reduced the cost to produce oil almost in half. Meanwhile, renewable energy (wind and solar) is the fastest growing energy sector.

We're perfecting the art of generating energy, but does that mean that renewable energy will soon overtake oil over the next couple of decades? Jeremy Grantham thinks so, saying we've hit peak oil from the other side - meaning it's going to become irrelevant eventually. Here's his quote on ESG investing (Environmental, and Social Governance) via Josh Brown:

You can divest from oil-or about anything else-without much consequence for performance. Yet today, the rationale for divesting from fossil fuels isn't just about aligning with an investor's values, it reflects a forward-looking view that these industries are in long-term decline and their reserves will become stranded assets.

Oil may have a last hurrah before the electric cars arrive, but when they do, there will be some tough times for a long time."

We recently had a chance to sit down with Emil Van Essen (see part 1 here) to get his take on all things oil, and started things off with just this question…. What happens when the electric cars take over? His quick take, renewable energies may be making gains, but oil production isn't going anywhere anytime soon. Van Essen says the demand for oil will come from the developing world and electric cars are but a blip on the bigger radar:

The amount you save off the electric car coming on - is just a drop in the bucket in comparison. For the new 15 to 20 years, there's going to be a growth of a million barrels of oil per day in the demand for fuel.

The fact is there's a lot of new cars coming out in the developing world every year and they are gas and diesel. Sub 1 percent are electric. If that sub one percent goes to one percent, two percent - it won't change things all that much. Plus, generally, impractical. There are big problems with the battery they haven't solved yet. The Cobalt - with the lithium. They don't know where they are going to get the supplies from for battery power. They are not good for long distance transportation.

What percentage of electric cars would there need to be to make a difference?

Maybe they go up to 5% over a 20-year period.

It's not just cars that need the energy to run. What are your thoughts on renewable energy powering a city?

If you want to take a city like Chicago and polar it off solar power - it's never going to happen. They are good ideas - Technology is improving for solar and wind, but essentially the growth in renewables is going to go up fast, but the growth in terms to natural gas, or oil is going to be small.

Let's shift to crude prices themselves. There have been mountains of articles written about rising oil prices, but what should investors be looking at? What drove crude oil prices this year?

I think oil prices are higher than they should be long term, but in the short run, we are seeing a number of circumstances that are driving prices higher.

We have Iran being driven out of the market in the next 180 days, we have Venezuela being pushed out of the market, and we have very strong demand for oil, and OPEC really sticking with its quota system. This is resulting with a decline in storage level and driving up prices.

Technology is improving and the cost of producing is going down - prices right now are considerably above the cost of production and they will probably in time, drive down prices.

There is a new China crude oil contract. What is the supply and demand looking like in the east?

China in terms of demand for oil is one of the key factors. I think when prices went up, they allowed their inventories to go down, because they thought there was going to be a correction. Now, the inventories in China are too low and they are going to have to buy, which is part of the reason oil has been so strong. The recent price drop has been a result because I think Russia and some others are going ramp up production.

WTI and Brent historically have been divergent from each other in price. This changed in 2015 when President Obama announced the U.S. would lift the ban on exporting crude oil. This caused the divergence in price to all but disappear. But now in 2018, we are seeing the spread between WTI and Brent prices as high as $11. Can you speak to that?

The divergence - we call it "the arb" of WTI Brent differential. WTI has fallen considerably below Brent. The main reason is because all of the supply is coming out of the United States. All the Shale oil is light sweet and it's all coming out of the Dakotas. The US doesn't need this supply, so it's all for export. Meanwhile, demand is high because of the sanctions. So, there is tightness in the Brent market, and supply in the WTI market. The market must adjust to the pipeline cost, the tanker cost to get to wherever it is going.

The other factor is they are running into some pipelines constraints in the United States. They can't necessarily get it out, which actually makes WTI fall even lower. The transportation costs are say five dollars, then it's actually the differential falling below ten. I don't think that's sustainable.

Can you speak a little to Crude oil being in backwardation and what that means?

We were in contango because there was too much supply. OPEC started adhering to its quotes, storage levels came down, demand went up, economy was really strong, all of the sudden we are in backwardation. Backwardation just means there's supply and demand tightness. But we will continue to see prices go from backwardation to contango and back again as supply and demand changes.

Cushing, Oklahoma: where all the crude oil is stored. At least, that's how it used to be. Now, it seems like a mere stop off point. Why is Cushing becoming less significant?

Cushing is becoming a non-factor. Because of the growth in Permian - really the oil isn't flowing through Cushing anymore. A lot of the oil from Canada is going to Midwest refineries. The Permian is going to the gulf coast. Cushing is becoming a stop off point, along the way. The problem comes - your pricing in Cushing compared to WTI - if a pipeline breaks down - and you can't make a delivery in Cushing - you'll see a big space - potentially in the summer driving season.

Can the Dakotas get all that nat gas to China and India?

The biggest problem they have is takeaway capacity for natural gas. By some point in 2019, they are going to run out of takeaway capacity and they thing the hub in wauhau (not sure what this is) is going to show a zero bid because they are going to have more gas than they have pipelines.

In oil you can rail it and truck it - but natural gas - you have to pipe it - and Permian is drilling so much there's not enough space.

Emil Van Essen knows a thing or two about the energy sector, recently launching an MLP investment, designed to capture returns on the growing infrastructure in the energy sector.

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