The fuel of the future isn’t oil - it’s gas

Energy markets are undergoing a revolution as the world abandons oil and turns to natural gas. John Stepek explains what's driving the change, and how you can profit.

The panic over Cyprus has kept all eyes on the Mediterranean in recent weeks. The snatching of bank deposits may have marked another major turning point in the saga of the eurozone.

But this weekend, the Med played host to another major development a far more positive one that hasn't drawn quite as much attention.

Israel started gas production at the Tamar field in the eastern Mediterranean Sea. According to Bloomberg, there's enough gas under the Med "to supply the country for 150 years".

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The country could even become an energy exporter in the future, selling liquefied natural gas (LNG) around the world.

It's all part of the energy market revolution and it's a trend you should be looking to profit from.

Remember when oil was cheap?

It's hard to remember now, but at the end of the 1990s, oil was dirt cheap. The notion that the price would ever rise to the lofty levels of $50 a barrel was seen as nothing short of ludicrous. $100 a barrel wasn't even on the radar.

Most people hadn't even heard of peak oil' theory, which at the time covered almost any concern that oil might just run out at some point. Those who peddled the idea were dismissed as nothing more than gibbering conspiracy theorists.

As so often happens, conventional wisdom proved to be entirely wrong. The trouble with a commodity being cheap, is that there's not much incentive to find more of it. And you can't just turn the tap on and off. Even when prices begin to tick higher, ramping up production takes time.

So oil prices boomed. China's rampant growth was one big factor. And all the cheap money being pumped around global markets didn't help. Even in the big oil crash of 2008, prices only dipped below the $40 mark for the briefest period of time, before rebounding sharply.

The financial crisis put an end to oil's rampant bull market. The 2008 high of around $140 a barrel of Brent crude is intact. But the price remains very high by historical standards.

And these days, peak oil' is practically accepted wisdom. You'll hear it spouted in its most watered-down form by talking heads on CNBC. In essence, this boils down to: "all the cheap oil has been found".

It's an interesting point. It may even be true.

But it ignores one key fact about markets and human nature. If something gets expensive, two things happen. Firstly, producers try to produce more of it. Secondly, users try to find substitutes.

In short, supply increases and demand drops.

In some markets, this happens faster than others. It takes longer to establish a new copper mine, or to develop affordable deep-sea drilling technology, than to grow an extra field of corn, for example. But it does happen.

And this is why we suspect that oil's best days are behind it. Investors should instead focus on the commodity that will increasingly act as a substitute for oil natural gas.

More and more industries are increasing their natural gas usage

There's an interesting column in this morning's FT from Seth Kleinman, Citigroup's global head of energy strategy. He notes that cars accounted for about 22 million of the 87 million barrels of oil used each day in 2010.

That's a big chunk of oil demand. And it may continue to increase as emerging market consumers become wealthier, and drive more cars. This in turn tends to be the key argument of the oil bulls. "More money, more drivers, goes the logic."

However, what the bulls miss is that the sectors that use up the rest of that oil are "using more and more natural gas". In fact, "the prospect of oil demand hitting a plateau this decade is much more feasible than the market seems to think".

Logistics companies are converting fleets to run on natural gas. Oil explorers are doing the same with drilling rigs. Meanwhile, car manufacturers are under pressure to make cars ever more economical. "New vehicles' fuel economy is increasing by about 2.5% a year", enough to "significantly cut the expected growth in global oil demand and, of course, oil prices".

We've been saying this for a while. Barring geopolitical disasters which tend to be short-term events in any case - the oil price is unlikely to embark on another bull run of the type we saw in the run-up to 2008. Instead, it'll either be broadly static, or it will decline.

That has several implications for energy sector investors. For a start, you need to be particularly picky about the oil stocks you invest in. The British government is trying to encourage more investment in the North Sea right now - my colleague James McKeigue looks at some of the best ways to profit.

You should also be looking to profit from the rising demand for natural gas. My colleague David Stevenson has been on top of this story for several years now. You can learn more about his favourite ways to play the sector in his newsletter, The Fleet Street Letter.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.