February 21 , 2020
The Coming Collapse of Oil
The global oil industry has been one of the most profitable and massive industries of the last hundred years. The oil majors, companies like Exxon, Shell, and British Petroleum, earn tens of billions of dollars in profit, and provide their shareholders steady dividends and consistent returns for decades. But that is about to change.
In the last ten years, the coal industry in the US collapsed with several major coal producers going bankrupt. This reflected the underlying reality that global coal demand peaked around 2013, and has been falling. In the US coal demand has collapsed, dropping 18% in 2019 alone. Coal is also shutting down rapidly in Europe, where coal mining in Britain, France, and Germany has a very long history that shaped societies and cultures. This drop in demand resulted in falling prices, which coal producers could not withstand, and forced many into bankruptcy, including America’s largest coal miner, Peabody Coal. Peabody went through Chapter 11 and returned to operations as a public company in 2017, but its stock has dropped 80% in the last 18 months. Investors don’t see much future there.
Are oil companies headed the way of coal companies? They are, and when the collapse happens it will not be pretty for investors. 20 years ago, most observers predicted that the oil companies would do very well for decades to come. As Third World countries got richer, their citizens would buy cars, and oil consumption would continue to rise year after year. In fact, in the last 10 years, China’s auto market exceeded the US in terms of cars sold per year. But the predictions about oil use have not been as high as expected.
It turns out that advancing fuel efficiency, such as hybrid cars, kept a lid on oil demand. In the US, annual oil consumption is not much higher than it was in 1980. While oil demand and consumption around the world has risen in the last 20 years, it has done so at slow rate, much slower than expected.
What is coming though is going to totally disrupt the oil markets. Electric vehicles, primarily in response to concerns about carbon emissions and climate change, are going to ramp up global sales rapidly in the next five years. Already, 8% of cars sold in California are EVs. In China they are 5% of sales.
The EU and China have ambitious targets for EV uptake by 2030, and several nations are contemplating a total ban on gasoline vehicles after 2040. If the Democrats take power after the next election in the US, expect they too will enact ambitious targets. One dynamic which many observers don’t give enough credit to, is consumer behavior. Once the automakers put their billion-dollar advertising budgets behind EVs, consumers will respond. More importantly, when it becomes clear that EVs are the future, high end consumers will stop buying luxury gasoline vehicles, knowing that in 6 years they will have little resale value. As consumers begin to see the future, they will stampede out of gasoline cars and into EVs.
The oil markets are predicated on growing demand. Oil is priced internationally to keep supply and demand in tight balance, but all the oil producers are always looking to increase production. Traditionally oil has sold at a price far above the cost to produce it, which is why oil is such a profitable industry. The Saudis, for example, are able to produce a barrel of oil for less than 10 dollars, but then sell it for it 60. This is very unusual in commodity businesses. Normally commodities sell at a price just above the cost of production, which is why no one gets rich growing wheat or mining iron ore.
Once EVs start to take enough market share to cause the global demand for oil to actually shrink, even a little, the oil markets will be in free fall. Once supply exceeds demand, and demand continues to shrink every year, oil producers will race to the bottom to sell their oil. The price of oil will collapse to something near the cost of production, probably around 25 dollars per barrel or less. At that price, the oil companies will lose much of their profitability and their stocks will plunge. This same dynamic will affect OPEC nations that rely on their oil sales. Many of them will be poorly prepared for this catastrophe when it hits. The welfare petro-state will be in deep financial trouble and will be unsustainable.
How soon will this happen? Sometime in the 2020’s, and I think likely before 2025. But investors are already starting to get worried about the oil companies. Since 2009, the American stock market has quadrupled in value, and more than doubled from its peak in 2007 just before the Great Recession.
Oil companies though, have not seen their stocks rise in line with the rest. In fact, Exxon, Shell, and British Petroleum have share prices lower than what they were in 2007. The markets are already looking downstream and not liking the future for these firms.
