Why Oil’s More Popular Than Ever
Over the past couple of months, I have written several articles on the factors that are influencing oil prices. These articles have generated quite a bit of interest from readers — one at Forbes called OPEC’s Trillion Dollar Miscalculation stands at nearly 180,000 views after being featured for a short time as the top news story on Yahoo’s home page. I also discussed this issue in a recent appearance on CNBC Asia’s Squawk Box.
One of the questions that has come up most frequently during these discussions is “What factors are really responsible for current oil prices?” Some have suggested that this is all OPEC’s fault, while others have blamed either surging U.S. shale oil production or falling demand.
In fact, it was a combination of a couple of factors. In this week’s Energy Strategist, I am going to discuss and detail the supply-side contributors, but today I want to address the notion that falling demand is behind the plunge.
Since 1983, annual global demand for crude oil has only fallen twice; a small decline in 1985 and another in 2009 in response to the financial crisis:
The growth rate for crude oil has been remarkably consistent, adding an annual average of almost exactly a million barrels per day (bpd) for more than 30 years. The BP dataset doesn’t include 2015, but the International Energy Agency (IEA) reported that demand grew by 1.6 million bpd in 2015, one of the strongest growth rates in many years and one that was certainly aided by low crude prices.
For 2016, the IEA forecasts that demand growth will slow to 1.2 million bpd, which is certainly not surprising given the surge in 2015. But that would still exceed the long-term average annual growth rate of 1 million bpd. And while U.S. demand contracted sharply in 2009 due to the financial crisis and much higher prices, January 2016 demand was reportedly at the highest levels since 2008.
But aren’t there things on the horizon that are likely to cut into our crude oil demand? Global production of biofuels — led by the U.S. — exploded over the last decade. But the 1 million bpd increase in biofuel production over that span contrasted with petroleum demand growth of nearly 7 million barrels a day. Biofuels are certainly not growing at a fast enough rate to meet incremental global demand growth, much less cut into petroleum’s dominance.
Further, there isn’t enough available arable land in the world for biofuels to ever make more than a tiny contribution to the world’s fuel supply. (I go through those calculations in my book Power Plays.) The backers of advanced biofuels who promised to deliver us from our oil dependence have failed to deliver on more than a tiny fraction of their projected volumes.
What about electric vehicles (EVs)? In theory, as the world switches to EVs, crude oil consumption will peak and fall. But what is actually happening?
According to Inside EVs, a website that reports on EV sales, in 2015 year-over-year sales in EVs declined for the first time since 2011. In 2014 there were 122,438 EVs sold in the U.S. In 2015, sales fell to 116,099 vehicles — a decline of 5.2%.
But 122,438 vehicles per year is nothing to sneeze at, right? Well, let’s compare that with overall vehicle sales. According to Automotive News, the U.S. auto industry set a record of 17.5 million light vehicle sales in 2015 (cars, light-duty trucks, and SUVs). That means that electric cars had a market share of about 0.7%.
Further, the one-year increase in the number of cars sold in the U.S. was around 1 million vehicles. That’s 2.5 times total EV sales over the past five years — and almost all of those new vehicles sold run on fuel derived from petroleum (and will for the duration of their lifetime). So even though EV sales have grown rapidly out of the starting gate, they are starting from such a low market share that it will be a long time before they actually make a dent in oil demand. We will likely see the same scenario as with biofuels: growth in EV sales, and still growth in crude oil consumption.
Globally, the situation is much the same. Demand for liquid fuels is outpacing the ability of biofuels to keep up, and conventional vehicle sales are vastly outstripping EV sales (even though EV sales growth outside the U.S. was strong in 2015). This is why global demand for oil continues to grow steadily. So those who expect ExxonMobil (NYSE: XOM) to meet a fate similar to the beleaguered coal producers are going to be waiting a very long time. Coal companies are failing because there are too many available replacements for this fossil fuel, with its high greenhouse gas emissions. Not so with oil.
Demand for oil remains strong and continues to grow. It will continue to grow for the foreseeable future. Why then are oil prices hovering around $30/bbl? In this week’s Energy Strategist, I will cover the supply-side factors that caused the collapse in oil prices. I will also highlight the single most important factor that will signal a market turn.
Williams Weathering Storm
The Williams (NYSE: WMB) fourth-quarter press release trumpeted the 25% year-over-year EBITDA increase fueled by recently completed expansion projects, but the more relevant measure of the company’s performance was the decline in its dividend coverage to 0.91, from 0.99 a year earlier.
It says a lot about how far investor expectations (and midstream equity prices) have fallen that the results were nevertheless greeted with a sigh of relief. That was partly because Williams expects to keep growing this year as a result of pipeline expansions mostly backed by investment-grade natural gas buyers. But it also helped that Williams listed a variety of reasons it won’t be hurt too badly should its top customer, Chesapeake Energy (NYSE: CHK), file for bankruptcy, as it may have to do as early as next year without a meaningful rally in energy prices.
Williams has long-term gathering and processing contracts with Chesapeake, many with onerous minimum volume commitments because production’s fallen short of onetime plans, But Williams management expects these deals to hold up in a restructuring, and even if they don’t Chesapeake has no ready alternatives to Williams pipes if it wishes to keep most of its wells pumping, noted the Williams CEO on last week’s conference call. We recently arrived at similar conclusions in evaluating the midstream fallout from a potential Chesapeake bankruptcy.
Despite WMB’s 44% rebound since the Feb. 8 panic low, the stock trades at an implied discount of 13% to the value of Energy Transfer Equity’s (NYSE: ETE) buyout offer, which includes a promised $8 per WMB share in cash.
That’s hardly extreme, especially in light of today’s New York Times report that ETE has recently considered offering Williams $2 billion in cash to scuttle the deal. But Energy Transfer remains publicly committed to the deal, if only because it doesn’t seem to have a plausible escape clause.
And Williams’ current price should prove a bargain over time whatever happens to the merger, especially in light of the company’s attractive long-term exposure to growing domestic natural gas demand. Its cash flow, which was recently hurt by 13-year lows in natural gas liquids prices, should improve rapidly as energy prices rebound and the new pipes come online. Growth pick WMB is upgraded to a buy below $20.
— Igor Greenwald