Some people who know me will have heard me passionately explain why I think electric vehicles (EVs) are the future. I believe both EVs and renewables’ uptake will likely accelerate over the next few years and is inevitable for economic reasons, due to the declining costs of the new technology relative to the old.
Why then; political, and environmental reasons aside, am I now bullish on oil?
Before we dig into the four components underpinning my thesis, let us set the scene by looking at the world’s oil consumption by country:
From 2000 to 2017, despite the OECD’s best efforts to make reductions, their demand for oil has only declined by 2.1%. Over the same period, demand for oil among non-OECD countries has grown by 79.8%. China and India, two rapidly growing emerging markets, have seen their oil demand grow by 189.4% and 99.1% respectively, and these countries are now the second and third largest consumers of oil in the world.
Now that we have established the largest markets for oil consumption, let us examine the end uses. Based on the U.S.’ data, we can see that the predominant use for oil continues to be transportation fuels:
Motor vehicles account for 45% of U.S. oil demand, with jets for another 8%, signifying that over half of the oil demand stems from these transportation fuels. According to the EIA, 68% of U.S. petroleum consumption is utilized by the transportation sector, suggesting that the remaining consumption of 15% comes from diesel fuel.
With the above in mind, my premise boils down to 4 potential drivers:
- Stabilization or a rebound in oil prices: The pandemic’s impact on oil demand has resulted in Brent declining 35% year-to-date (as at 13/11/2020) and the virus may continue to act as a headwind in the near term due to national lockdowns being re-enacted. Nevertheless, it is rational to assume that prices are likely to stabilize once COVID-19’s economic impact dissipates.
Furthermore, over the last few years, there has been continued, and in many cases accelerated, reduction in capital expenditure across the oil industry. According to one estimate, capital expenditures are expected to reach a 13 year low. This suggests that growth in demand, beyond pre-pandemic levels, will unlikely be met with new supply in a timely manner. Therefore, in this scenario, oil prices will likely be pushed higher.
- Continued growth in non-OECD countries: As highlighted earlier, emerging markets are the key growth driver behind oil demand over the last 17 years, largely driven by China and India. In my view, this is unlikely to change in the near term despite China’s best efforts to shift to cleaner forms of transportation and energy. In fact, China’s demand for oil has already started to reflect its improving economic position since the country’s restrictions eased. I believe emerging markets will continue to outpace developed markets’ economic growth, suggesting oil demand will likely come roaring back once the pandemic’s economic effects subside.
- Comeback in inflation benefiting commodities: with record low interest rates globally, in addition to aggressive money printing (“QE”) and loose fiscal policy across the developed world, inflation is likely to start rising sooner than most expect. Firstly, this will impact the prices of oil, given the historic link between inflation and commodity prices (which is also why I am bullish on gold). Secondly, oil and gas stocks, which are largely labelled as ‘value’ stocks, are historically more likely to outpace ‘growth’ stocks in an inflationary environment.
- Depressed sentiment: I personally like to use extreme sentiment as contrarian indicator. While it seems investors can never seem to own enough tech stocks, especially the cloud names, the low valuation of oil and gas names suggests that the sector’s sentiment is towards the opposite end of the spectrum (valuations, of course, can always go lower/higher for much longer than we can fathom). It also appears that many investors and lenders are throwing in the towel when it comes to the oil and gas sector, after over 6 years of poor performance (down over 60% since the start of 2014).
Interestingly, even the European Integrated Oil Companies (IOCs) are shifting their investments away from oil and gas and toward renewables, an area I believe they are unlikely to have any durable competitive advantage in. This will further limit oil supply growth.
Current sentiment offers an attractive entry point to gain exposure to the oil and gas industry ahead of several potential catalysts.
As a result of my views, I initiated a position in the Vanguard Energy ETF (ticker: VDE). After Pfzier’s positive COVID-19 vaccine announcement, I added to my position throughout the week. I will continue to add to my VDE exposure and as I see confirmation of my thesis, I will look to gain exposure to specific names within the energy sector.
I particularly like that this U.S. focused ETF currently pays a dividend yield of around 5%, while I wait for the rebound in the oil sector. This is valuable given it is likely to be a multi-year play. As ever, there are no guarantees when it comes to investing.
Full disclosure: I am long VDE.
Disclaimer: The information posted above are my own personal views at the time of publishing and should not be construed as investment advice. My personal views do not necessarily reflect that of my current or past employers’. This material does not take into account your particular investment objectives. Investors should consult their own financial or investment adviser before investing or acting upon any information provided. Past performance is not indicative of future results.