When Will the Party Be Over for Oil?

Art by Mark Wang

Is oil a dinosaur, headed for extinction like T-Rex and all the other ancient life forms whose moldering carcasses created deposits of what’s now the world’s largest fuel source? Most probable answer: not for a long time.

It’s the great guessing game when the petroleum party will end. At some point, the supply of oil will ebb, and other forms of energy will replace it. Most likely solar and wind for electricity generation and electric vehicles for transportation. There’s a clearer picture for the near future, though, and things look dicey owing to geopolitics and other factors.

For the next couple of decades, rising world wealth and population, especially in emerging market nations, should produce enough demand to keep prices up. That’s provided that oil supply and demand rise as expected, and alternative energy sources don’t elbow them out of the way earlier than expected.

No one knows when the supply of oil will peak and then drop. Past forecasts have been proved wildly wrong.  Example: during the Arab oil embargo of the 1970s, when conventional wisdom held that the world would be out of oil by now. Today’s estimates for a peak range from 2025 to a quarter-century beyond. “It could be 2030 at the earliest, but 2050 is more likely,” said David Grumhaus, head of the infrastructure group at Duff & Phelps Investment Management.

New techniques of extracting, i.e., fracking, and finding oil have been developed in recent years, with more to come. Frackers can tap crude deposits in hard rock deep underground that before were inaccessible. A newly discovered plethora of oil pools deep in the earth and offshore suggests that plenty of supply exists to meet any demand for some time. Over the past 35 years, for every barrel of oil that was used, two were added to estimates of proved oil reserves.

“Long term, oil demand will move higher and higher,” said Mike Morey, CIO of Integrity Viking Funds. “China and India have more and more people entering the middle class” who will want cars and other carbon-emitting amenities.

The trend for demand has been ever-upward since the Great Recession put a dent in the oil industry’s production and demand from consumers and industry. In 2010, the first full year of the economic recovery, the average daily global demand for oil was 86.4 million barrels, according to research firm Statista. For 2019, the estimate is that world-wide demand will hit 100.6 million barrels.

Near-Term Jitters

The growth of US oil has been astounding, largely due to the shale revolution. American oil production is projected to hit 12.2 million barrels a day this year, with two-thirds of that from shale. The biggest upward move in output occurred last year, rising from 9.3 million in 2017 to 11 million by December 2018, up 1.7 million. The growth pace should slow going forward, to 1 million added in 2019, versus 1.2 million this year.

In the near-term, the recession that many are predicting, or today’s apparent growth slowdown, would shrink demand. Manufacturing weakness in the US and Europe, plus Britain’s messy exit from the European Union, along with the Washington-Beijing trade war all add to the anxiety over a slump coming. In a recession, the oil price would slip anew as fewer people drive and construction of new buildings, which consume oil, gets choked off. “Brexit, Germany, and the rest mean there are a lot of wild cards,” said Ed Egilinsky, head of alternative investments for Direxion.

The attack on Saudi oil production facilities knocked out 5% of the world’s oil supply, sending the WTI crude price soaring to $63 per barrel. But the rapid restoration of the Saudis’ production and its sizable reserves helped stem the upward price movement, and now the price has settled back to $54.

This all comes despite OPEC efforts to limit output and support the price. Last December, the Organization for the Petroleum Exporting Countries, where Saudi Arabia is the foremost producer and hence leader, and some other non-member players like Russia agreed to curb their production and limit the supply. That action was to support the price. The pact’s success is arguable: At minimum, it has kept oil from free-falling below $50.

The production limits came in reaction to the mid-decade oil bust, when robust international output sent the price skidding—to a February 2016 low of $27 from an October 2015 high of $107. This huge drop hurt many other commodity prices and dampened manufacturing activity the world over.

Bad news like this has been soiling the energy industry, of which oil is the biggest part, for some time. In equities, the energy sector is the S&P 500’s worst performer over the past 10 years. The SPDR S&P Oil & Gas Exploration & Production ETF, for instance, is down 19% this year.

Result: Many drillers lately are having a hard time getting capital.  The number of oil rigs in operation has dipped. In the futures market, oil is in what’s called backwardation, meaning spot prices are higher than prices for futures contracts, which puts a pall on energy investing. The oil industry “overbuilt, and with the growth rate slowing, investors are cautious,” Viking’s Morey said.

Another dark cloud is geopolitical. Sanctions on Iran and Venezuela have restricted their oil exports. Nigeria and Libya are subject to disruptions. Now, big producers can make up any oil output losses. The overwhelming worry, though, is Saudi Arabia: The surprise drone assault on its production sites, widely thought to be Iran-backed, illustrates how vulnerable the kingdom is to attack. While the Saudis may have rebuilt their production sites quickly, what about the next attack and the one after that? “Iran is saying: If we can’t sell our oil, you can’t either,” said Scott Colyer, CEO of Advisors Asset Management.

Longer Term Situation: Oil Stays on Top, But for How Long?

Oil remains the most popular fuel in the US, according to the US Energy Information Administration. For American consumption, its share is 36%, followed by 31% for natural gas, and 13% for coal. Renewables make up 11%. Natural gas, the preferred source for electrical utilities because it is cleaner burning than other fossil fuels, is gaining as it displaces coal. So are renewables.

Renewables have great promise, yet the day they dominate the energy scene is distant. Although their prices are coming down thanks to technological advances, using them still proves more costly. The price of an eco-friendly Tesla, at an average $75,000, is more than two times that of a Toyota Camry, the best-selling sedan in the US. “Conversion to electric vehicles will be slow,” said Duff & Phelps’ Grumhaus. “We still have a lot of gasoline engines out there.” What’s more, people tend to keep their cars longer nowadays.

Since fossil fuels are cheaper than renewable energy at this stage, emerging markets opt for oil and coal. India’s Prime Minister Narenda Modi has argued that his poverty-stricken country can’t afford the low- or no-carbon alternatives. “The green movement wants to curtail the growth of fossil fuels,” said Advisors Asset Management’s Colyer. “But look at what Modi says. We’re going to need fossil fuels for a long time.”

“There will continue to be decent growth” for years ahead, said Grumhaus of Duff & Phelps. At some stage, however, that no longer will be so.

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