Yes, EVs are the future, but oil is still in high demand … even green energy requires oil … recent Omicron fears present a bullish setup … how you might play it
Electric vehicles (EVs) are going to destroy the oil industry.
That belief has gained steam in recent years as our world has increasingly embraced EVs and all things “green.”
The logic makes sense. As our macro specialist, Eric Fry, points out in his latest issue of Investment Report, more than half of every barrel of crude oil becomes fuel for an internal combustion vehicle. So, a massive migration from gas guzzlers to EVs would appear to spell doom for the oil sector.
Perhaps, but we’re nowhere close to that tipping point.
It was nearly a year ago that we wrote a Digest recommending an oil trade. In it, we noted that, long-term, our world is moving away from oil toward renewable energy.
We highlighted a series of facts and statistics supporting this conclusion, one of which was the Biden administration’s plans to make the U.S. a 100% clean energy economy with net-zero emissions by 2050.
But as we wrote in that Digest…
There’s a lot of time between now and 2050 for a profitable oil trade.
In Eric’s recent issue, he echoes this point:
To put it simply, the road to a $10-per-barrel oil price might pass through $150, or even $200, on the way.
I understand that many investors may have little interest in buying an energy stock. I get it.
But the near-term bullish backdrop has become too compelling to ignore.
Today, let’s look at Eric’s case for a bullish oil trade. Yes, green energy is the future, but there’s still plenty of “green” to be made by betting on oil in the present.
***Why oil demand isn’t going away anytime soon
For newer Digest readers, Eric is our global macro specialist and the editor behind Investment Report. As a macro investor, he evaluates markets and asset classes from a big-picture perspective to identify attractive opportunities.
Once a macro trend is in his crosshairs, he digs down to find the right, specific investment to play the opportunity.
It’s been a powerful strategy. In his decades in the business, Eric has dug up more 1,000%+ gaining investments than anyone we know of in the newsletter industry.
Returning to oil, what market dynamic is Eric seeing that’s making him so bullish? After all, the news is filled with stories about car manufacturers moving toward EVs. Why is that not a death knell for oil?
From Eric:
Even though EVs will capture a growing share of the global auto market, the total auto market will continue to grow larger, which means the number of gas-powered automobiles on the road will continue to increase for several more years.
The U.S. Energy Information Administration says the total number of internal combustion vehicles on the world’s roads will not peak until 2038.
Meanwhile, because crude demand from other end users will continue growing past that date, the International Energy Agency (IEA) expects worldwide oil demand to be at least 25% higher in 2050 than it is today.
Keep in mind, that’s just one possibility from the IEA. Under a different scenario, they suggest demand could climb about 50% above current levels.
***But let’s say that these forecasts are wrong
Let’s imagine the migration to EVs is faster than anyone dreamed, causing oil demand to drop far quicker than forecasted.
Well, here’s a dirty little secret…
While EVs might be green, “making EVs” is a very dirty, oil-rich process.
Back to Eric:
Renewable energy is not oil-free energy.
Producing an EV, for example, requires about twice as much energy as producing an internal combustion engine vehicle. This differential results mostly from battery production, which uses a lot of energy to extract and refine metals like copper and nickel.
A green energy fairy doesn’t simply drop these metals on the doorstep of EV manufacturers every night.
Instead, great big gas-guzzling and/or coal-fired equipment like earth-movers, conveyors, processing plants, container ships, port-cranes, alloy fabricators, and big-rig trucks combine to do the dirty job of converting hunks of ore into battery-grade alloys… and transporting these essential metals from their source to their end-users.
With few exceptions, every step of the process consumes some form of fossil fuel.
***A major supply/demand imbalance is brewing
Eric notes that demand for crude in many major economies remains well below pre-COVID levels.
To illustrate, the 38 major economies of the Organisation for Economic Co-operation and Development (OECD) are currently consuming about three million barrels per day (MBPD) fewer than before COVID struck. Meanwhile, crude oil consumption by the global aviation industry remains well below pre-COVID levels.
Back to Eric:
If these two sources of demand – OECD and aviation – merely returned to pre-COVID levels, global crude demand would jump about five MBPD to 104 MBPD.
That figure would not only be the highest level ever but would also be about two MBPD higher than the world’s oil producers have ever supplied to the market.
But big oil isn’t in the best position to easily meet this demand.
Eric writes that OPEC is currently producing about 27.5 MBPD. In theory, OPEC has 33 MBPD of total capacity, but it hasn’t pumped at that pace since 2016.
If we turn to the U.S. to help make up the difference, we find many oil companies not investing in exploration and production (E&P) projects that could help boost output.
Here’s Eric, pointing out two big reasons behind this:
(U.S. oil companies) are hesitant to repeat the errors of past cycles when high oil prices tempted them to overspend on future production projects.
Moreover, shareholders are pressuring these companies to defer new E&P investments in favor of using corporate cash to pay down debt, boost dividends, and/or repurchase shares.
This same dynamic has played out globally. Rystad Energy puts numbers on this, finding that global investments in oil and gas E&P have plummeted by about 65% since the 2014 peak.
Here’s Eric with the takeaway:
This non-spending creates two bullish tailwinds for oil company stocks:
- It will reduce future crude production, which could lead to soaring oil prices.
- It will convert the oil sector into a sort of publicly-traded garage sale – an industry that simply sells off what it already owns.
You see, as oil companies slash their spending on exploration and development, their free cash flow will surge.
Instead of continuously plowing that cash into future projects, oil companies can drop most of it onto their balance sheets like dollar bills into a shoebox at a garage sale.
***Despite these supply/demand dynamics, oil’s price tanked in November, presenting a bullish trade setup
Below, we look at a chart of West Texas Intermediate (WTI) crude. After its late-October peak, it fell more than 20% before bouncing north here in December.
The knife-edge drop in November came thanks to paranoia about the Omicron variant of Covid-19.
But the data we’re getting on Omicron is painting a picture of a strain that, while more transmissible, is far less virulent. And that’s actually incredibly bullish.
Back to Eric, explaining why:
(Professor Karl Lauterbach, a clinical epidemiologist who is in the running to be Germany’s next health minister), theorizes that Omicron may be a variant that is “optimized to infect,” but is less lethal than Delta.
Therefore, if Omicron “conquers” Delta to become the dominant worldwide strain, it could help end the pandemic entirely.
It wouldn’t be the first time a milder viral strain turned into a societal positive. This “antigen drift,” as it’s called, helped end the Spanish Flu.
Eric points toward History.com, which explains how slightly altered versions of the Spanish Flu kept popping up in successive winters. But they became far less deadly, and eventually were indistinguishable from the seasonal flu.
If we’re beginning to see that with Omicron, it will help speed up our world’s return to normalcy. It would be what Lauterbach calls an “early Christmas gift.”
***How might you trade this setup?
I’ll reserve Eric’s recently recommended play for his Investment Report subscribers. But let’s review the three trades we’ve highlighted here in the Digest.
The first was the Energy Select Sector SPDR Fund ETF (XLE) that holds oil heavyweights including Exxon, Chevron, ConocoPhillips, Schlumberger, Occidental, and Valero to name a few. This was our “broad sector” play.
The second was Diamondback Energy (FANG), which is a Texas-based energy exploration company. This was more of a concentrated, returns-focused trade.
And the third was Exxon (XOM), the massive multinational oil and gas company. This was our cash-flow trade, since Exxon pays a massive dividend.
Since our recommendation, XLE has climbed 28%.
Exxon has added 25%, while paying three fat dividends (the current dividend yield is 5.6%).
And Diamondback has soared 69%.
Given Eric’s research, I believe there’s still juice in all of the trades. Though one note on timing…
***If you want to be conservative, I recommend a wait-and-watch approach for a few days
Let’s return to XLE’s chart for the reason.
Below, I’ve added XLE’s 50-day simple moving average. As you can see, the price is bobbing up and down, right around this moving average.
If XLE doesn’t climb back above its 50-day and resume upward momentum, there’s the risk of a near-term pullback as technical traders bail on the trade.
Given this, if you want to wait a few days to see which way the price breaks, that would be a cautious approach. In any case, we’re bullish, even if oil sees near-term pressure.
Wrapping up, I’ll give Eric the final word:
A tightening oil market, coupled with a rising inflationary trend, provides ample reason to add an oil stock to your portfolio, at least as a hedge.
Have a good evening,
Jeff Remsburg
