There is an idea out there, perpetuated by the breathy, tweety, trader community, that there is a shortage of oil. Nothing could be further from the truth.
Traders like to point at a reduction of exploration for oil and imply, actually, usually flat out say, that less exploration is responsible for lower oil output the past couple years. That's a farce.
The ideological crowd likes to point to newer regulations that would restrict new drilling on public lands, as if, those rules would already have an impact. They say this despite previously permitted drilling not being anywhere near completed yet and that public lands only account for 6% of U.S. production. Another farce.
Lower oil output the past couple years is due to two things:
Refining, on the other hand, is a problem due to lost capacity as a result of financial problems in 2020. That refining capacity is never coming back. In turn, there is a now a window until fuel demand falls late this decade, during which crack spreads will be generous.
According to BP p.l.c.'s (BP) early 2021 Statistical Review of World Energy, there are over 50 years of proven reserves of oil based on current use.
Let me focus on this a moment:
Worldometer has an easy-to-read layout as well and comes up with at least 47 years of oil left based just on proven reserves.
Here's another interesting proved oil reserves item.
The United States has about 69 years of proved reserves at current consumption rates.
Saudi Arabia and Venezuela? Nearly 3 centuries. That's not a typo.
Just for kicks, let's look at recent discoveries:
Even with a multi-decade low level of discoveries in 2021, I would point out two things:
That should make it abundantly clear that there is some other factor than a shortage of oil at play in the rise of prices.
In 2014 and 2015, OPEC flooded the market with oil. The result was a lot of U.S. bankruptcies.
The number of bankruptcies levels off a bit in 2017 and 2018, only to accelerate again in 2019 and 2020 due to a pair of factors:
So, OPEC's first manipulation was to flood the market with oil in 2014-15.
Next, with oil demand in 2020 falling off a cliff, they promised to "rebalance" the oil market, by holding back production. They have in fact succeeded in driving oil prices up exactly as they said they would.
It's easy to see in these Dallas Fed charts from a couple weeks ago:
OPEC is still 3-4 million barrels per day short of its production in 2017-19. And, roughly matching where it was about a decade ago.
From Q2 2020 until about now, OPEC was successfully able to keep global production below global demand. That is just now evening out.
But, I think it is important to consider the role of Saudi Arabia, the largest OPEC producer.
Saudi Arabia clearly used oil as a political tool. It used it with President Trump, who double-crossed them on Iran sanctions, but which then backfired due to Covid-19.
They have recently indicated they need "concessions" from the Biden administration, which has decided to play hardball. Almost simultaneously, Saudi Aramco announced plans to increase oil production over the next five years.
Which is it?
Either way, my money is on Team USA, even if it hurts a bit the next year or so. Here's why.
About a month ago, I made a statement in my weekly Investing 2020s Macro Dashes webinar, that the first sign of oil prices falling would be Venezuelan ships loading with oil bound for American refineries.
I said this because I had just read a report that Chevron (CVX) was given permission to negotiate with Venezuela on an oil deal that would circumvent sanctions.
We just saw an easing of those sanctions ahead of what is likely to be resumed oil shipments from Venezuela, a country that needs the money a lot.
This could partially be what's in play with Saudi Arabia saying they will ramp up production. I think it is also likely that other countries will start to produce more as fast as they can.
Oil companies know something that I have discussed with subscribers since I talked with several oil company execs at CES 2020 and came out with this article:
The linchpin to that idea over two years ago is that in 2026, fuel economy standards will be so tough, that there will be no physical way for car companies to meet them without moving virtually all of their passenger cars to EVs and hybrids.
We have now heard announcements from most large car companies that between 2026 and 2035 they will in fact move virtually of their passenger car offerings, outside of special editions that won't be cheap, to be EV and hybrid.
Ford (F), a company I am invested in and made a top pick at the Money Show, has announced they will be all EVs and hybrids in Europe by 2027 and the U.S. by 2030. I think it is likely that Ford moves that up to 2027 or 2028 in the U.S. as well.
General Motors (GM) is a little behind Ford on timeline, but signs are pointing to them accelerating as well. Go right down the list of major companies and they are all moving capex to EVs.
That raises the threat of stranded assets for oil producers. They realize that they have until around 2030 before oil demand starts to fall. And, it's not just from transportation.
Petrochemical replacements are also on the horizon. Already with proof of concept, several still-private companies are planning to invest in getting to manufacturing scale. Sure, it'll take over a decade for different feedstocks to take hold, but, they'll be chipping away by the end of the decade. And, once they take hold, they'll cause precipitous declines in petrochemical businesses.
In response to the EV transition and replacement feedstocks for petrochemicals, in order to avoid stranded assets, countries with oil will accelerate production.
I'm calling it "panic pumping."
Panic pumping will cause the price of oil to fall back into a range of $60-80 per barrel, which I think is likely to be sustained in an unusual equilibrium for an extended period. I last talked about an eventual range bound price of oil with Forex Analytix last autumn. I'm revisiting it again, look for the interview at their YouTube page in the FACE playlist.
In 2020, due to Covid, U.S. refining capacity fell for the first time in over a decade.
According to the American Fuel and Petrochemical Manufacturers, global refining capacity has fallen by about 3 million barrels per day since January 2020.
This is material in the blowout of crack spreads which show no real sign of abating soon. That is, refiners are charging more for making fuel from oil.
With American refiners operating at well over 90% of capacity, there is very little room for shocks or even higher demand. And, I don't mean higher demand now, I mean ever.
There is virtually no new refining capacity coming online with the exception of some biofuels companies.
This is all material to prices at the pump, of course, but also the cost of airline tickets and freight. There is just very little likelihood that fuel costs drop much even if oil falls to between $60-80 per barrel.
In my Macro Dashes pieces, I look for ETF investments that fit with the theme we are covering. Sometimes there isn't a good solution. I think that is where we are with oil and oil refiner stocks.
Even if there is a spike or two left in oil prices, possibly due to the shifting about from the Russian invasion of Ukraine, oil company stocks are so overextended right now in the face of likely falling oil prices, that ETFs like the SPDR Select Energy ETF (XLE) look like a risky proposition.
That leads me to look for a more pure refining ETF solution. The only one out there with any volume is the VanEck Vectors Oil Refiners ETF (CRAK).
CRAK, very aptly named, has exposure to a global list of refiners. It has edged out XLE since its inception in late 2015.
In the past year, CRAK has trailed XLE quite a bit.
At some point, I'd expect falling oil prices to support CRAK relative to XLE. Historically, refiners outperform during periods of falling oil prices. That said, I am not so sure that will be strong relative performance versus the overall market or other sectors. I still prefer tech for the long-term and view oil related securities as trading vehicles.
And, that's how I think most people should view oil at this point. As a trading vehicle. If you are not a trader, you shouldn't mess with most of it, unless of course, you can find something worth investing in.
With all of oil in the "run off" period now, dynamics will be difficult to navigate. While the "run off" will last decades, manipulative cartels and governments still exist, which can change trades quickly. In addition, we should expect the energy transition to be lumpy with fits and slows, until EVs adopt like cell phones, which probably doesn't happen until very late this decade.
The sweet spot, if it exists, are undervalued companies with a unique growth opportunity related to refining, biofuels, carbon capture and natural gas. Hint: I own three companies that fit into those areas and am looking at a few others.
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