Many commodities have rebounded strongly since the depths of the coronavirus outbreak.
Copper – generally viewed as the most economically sensitive of all metals – has rocketed. The precious metals have soared.
One glaring omission however, is oil.
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So what’s going on?
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Reasons to be bearish on oil – there are too many to count
There are lots of good reasons to be bearish on oil right now.
First and foremost, there’s the coronavirus. When we’re locked down, we don’t go out as much. That means we don’t drive as much or as far. That means lower demand for petrol.
Even when we’re not locked down nationally – and I’ll admit that the roads around my area seem to be very much back to normal – we are locked down globally. No one wants to go on holiday when they could be quarantined at any minute. Airlines and cruise operators are struggling and that will probably continue for a lot longer.
As Helen Thomas of Blonde Money put it in our recent podcast, the “velocity of people” has been hit hard. And few prices reflect that more explicitly than the oil price.
Secondly, there’s the broader structural changes in the oil market. Saudi Arabia and Russia embarked on an oil price war at the start of the coronavirus outbreak. It’s hard to say if it was purely a miscalculation or if the hope was that one or other could be last man standing while the US shale producers took the brunt of the pain.
Whatever the reason, it’s indicative of a far more significant issue. You can argue that oil cartel Opec never had as much power in the oil market as people ascribe to it. But it certainly doesn’t have that power today, now that the US is a major oil producer. Quite simply, there’s a lot more potential supply in the world than there once was.
Thirdly, there’s the competition from and the mania for electrification. Tesla is the stock market darling of the day. Whether you are among those who marvel that the company has managed to get away with skating on such thin ice for so long, or you’re a true believer who thinks that Tesla is on course to be the Apple of motoring, it’s clear that the electric, self-driving car revolution has elements of the railroad and tech bubbles about it.
And when you look at the latest figures on UK car registrations, it’s really quite striking - there is definitely a strong move towards vehicles that rely less on petrol.
Between April and June, 33,000 electric and hybrid cars were registered. For the first time, that outstripped the number of diesel cars (at 29,900). Now, obviously car sales were hit hard this year – the total was down by about 75% on the same time last year – so there’s only so much that you can pull out of these figures.
But it’s a striking headline and an indicator of the direction in which we’re going.
So without even going into the usual geopolitical stuff, that’s three big reasons. In the short term, demand has been hammered by Covid-19. In the medium term, potential supply is much greater than it was even a decade ago. And in the long term, we might not even need that much of the stuff because our cars will run on sunbeams.
Given all that, it’s not surprising that oil prices are weak and that – incredible as it may seem – the price of the UK-listed oil majors is now pretty much back where it was at the lows of March this year.
The only good reason to have exposure to oil right now
So what’s the flipside here? What’s the bull case? What’s the contrarian argument for taking a bet on a sector that is perhaps the most detested in the world right now (I mean, except perhaps for the banks)?
The most obvious argument is precisely that one – that sentiment is strongly against the energy sector right now. For example, BP itself recently declared that we might have already have seen “peak oil demand”. It's possible, the company argued, that 2019 represented the all-time high for global oil consumption and it’ll never be higher.
The oil major was at pains to make sure that it described the scenario – painted in its annual Energy Outlook report – as an illustration rather than a forecast, which is a rather weaselly way of saying: “don’t blame us if this doesn’t happen”. But it drew a lot of attention (including from us – if you haven’t read this week’s issue of MoneyWeek, subscribe now to get your first six magazines free).
This is clearly a story that the world is eager for and primed to believe. When the world is eager to believe something, the odds of it being priced in – and beyond – are usually quite high.
It’s worth remembering that peak oil demand does not mean we never use any oil again. In fact, it’s a lot like the old days when we used to talk about plain old “peak oil”, which was when all about the supply.
Peak oil didn’t mean oil would run out. It meant we’d reached the point where we’d reached the peak rate of extraction. So supply wouldn’t be able to keep up with demand.
Similarly, peak oil demand represents the peak rate of consumption. The difference, of course, is that when you’re using a vital commodity with very few substitutes faster than you can produce it, you’re in trouble. That’s why “peak oil supply” was such a worry.
If instead, people aren’t using as much of your product – well, that’s a little easier to cope with. You just stop producing as much of it. And of course, the producers are just like everyone else in markets. They get swept up in the excitement / panic as well.
If oil producers really believe that we’re in a world where oil demand is permanently lower, they will cut too hard. In turn, we’ll end up with a situation whereby, even if oil demand really has peaked, supply will be falling even faster.
That’d be good for oil prices and good for oil stocks.
The $64 trillion question is “when”? My unsatisfactory response is: “I don’t know”. But that lack of a crystal ball is the reason that we have diversified portfolios. I’m not suggesting you punt all of your money on oil.
However, having a bit of exposure to the sector strikes me as a solid contrarian bet right now, particularly when oil shares are back to their Covid-19 lows. Throw in some patience and hopefully you won’t have to wait too long before you see at least some improvement.
We looked at one potential fund to pick up in the current issue of MoneyWeek – subscribe here if you haven’t already.
