With transportation accounting for 60 per cent of global oil consumption, demand has evaporated on a never–before–seen scale. Things were made profoundly worse when talks between Saudi Arabia and Russia broke down in March, triggering an all–out price war that unleashed even more supply. Benchmark oil prices Brent and West Texas Intermediate dropped 30 per cent immediately. On March 9, the ASX recorded its second–worst session in history, shedding $126 billion. Investors fled from energy stocks in particular, hitting oil and gas giants Woodside, Santos and Oil Search hard.
In a world awash with unwanted oil, the “peak oil” question is gaining greater attention from investors, analysts and the energy producers. While peaking oil is not expected to trigger a sharp fall in demand and the low prices are expected to eventually recover, the current supply glut and dramatic price falls are fuelling conversations among investors: Is now a good time to cash in on depressed prices and buy into big energy companies? Or will the pandemic accelerate a longer–term movement away from oil?
Fund manager Ausbil, which invests more than $11 billion on behalf of superannuation funds and retail clients, has cashed in on low stock prices by increasing its exposure to companies like Santos, one of Australia’s largest oil and gas producers, whose share price has slid 57 per cent since January.
“We are seeing value emerge in the sector and have a preference towards businesses sustainable at lower oil prices,” Ausbil’s global resources fund portfolio manager Luke Smith says.
Although travel lockdowns have severely impacted oil demand, Smith says efforts to limit supply will support price normalisation. Instead of reaching “peak oil”, Smith says, the industry has reached the inflection point. “Pricing should recover over the medium term,” he says.
Meanwhile, other investors, including the so–called value investors, are taking a different approach. While they acknowledge prices may bounce back in the short term, they see the oil sector in structural decline and a poor long–term investment. Even after coronavirus, some say, the potential for reduced levels of international travel, more people working from home and the growing uptake of electric vehicles will hasten oil’s demise.
“Cheap oil and cheap coal basically drove the second industrial revolution,” Hyperion’s chief investment officer Mark Arnold says. “We think the second industrial revolution is coming to an end and technology, renewables and EVs [electric vehicles] will be the next stage.”
Hyperion sold its stock in BHP around seven years ago and the $7 billion investment firm has since bought a stake in Tesla. According to Arnold, oil is an “older world business” and its role in global markets will diminish in the next 5 to 10 years as lower battery prices and improving technology will see autonomous, electric vehicles becoming the dominant mode of transport.
“We’ve got demand destruction going on,” Arnold says. “Globally, probably the consensus view is that oil has decades and decades of reasonably high prices once you get through COVID–19. But we think it’s [fall] is going to happen much quicker.”
At the same time, says Arnold, rising investor awareness around climate change risks will push the financial sector further away from fossil fuels in general.
“Climate change is slowly filtering through to the finance world,” he says. “It’s definitely talked about more these days than it was a few years ago and people are now considering where capital is allocated.”
Investors can profit from oil in two ways. Either through buying futures contracts or acquiring shares in oil producing companies. Futures contracts are risky at the best of times, but when the US benchmark oil price, West Texas Intermediate, dropped into negative territory last month, it was especially bad news for hedge funds, energy traders and index players. Exchange traded funds (ETF) provider Betashares’ oil futures ETF has lost over 78 per cent in returns over the past three months and its buy–in price has reached record lows of below $3 per share, down from $54 when the fund was launched in 2011.
Betashares chief executive Alex Vynokur says demand for the fund has flatlined and an updated product disclosure statement warns the ETF may have to be terminated if prices fall into negative territory again. “Investors should exercise caution in light of the unprecedented volatility and heightened risk in the global oil market,” a stark message on Betashares’ website warns.
According to Mike Henry, the head of Australian mining giant BHP, which operates Victoria’s Bass Strait oil fields in a joint venture with ExxonMobil, investor concerns about oil’s place in a carbon–constrained future have been elevated by the coronavirus crisis. However, under most scenarios, the world will still be consuming massive amounts of oil, he says, until at least the middle of the century.
“Let’s frame this: even low-case forecasts are for the world to consume another trillion barrels of oil over the next 30 years,” said Henry earlier this week. “And that’s relative to 900 billion over the past 30 years.”
Conservative estimates predict natural oil fields would decline at about 3 per cent a year, meaning that unless demand fell consistently at a rate greater than that, “the world is going to need investment in fresh supply which will support prices”, he said.
“I have to say, it’s hard to see demand falling year in, year out at greater than 3 per cent per annum.”
Australia produces some oil but far greater amounts of LNG, last year overtaking Qatar as the world’s top LNG exporter. As LNG is tied to the oil price with about a three–month lag, the extent of the impact for ASX energy producers are yet to be fully felt. Revenue from LNG sales, one of the country’s most lucrative exports, could fall from $50 billion to as low as $30 billion in the 2021 financial year, according to an analysts from energy consultancy EnergyQuest, and the shelving of tens of billions of dollars’ worth of investment spending in new projects had “national economic implications”.
Representatives for Australian oil and gas producers say the “double whammy” hit from the economic impact of coronavirus and the near record–low oil prices are causing an “incredibly challenging time” for the sector.
“The price weakness will remain a constraint on the local oil and gas industry as the COVID–19 threat diminishes and the broader economy begins to recover,” says Andrew McConville, of the Australian Petroleum Production and Exploration Association.
“But our industry is accustomed and geared to cyclical commodity prices.”
Energy demand – and oil demand with it – will return as travel restrictions and economic activity resumes, according to McConville, who adds that Australian producers emerged “leaner and fitter” from the price falls of five years ago.
In Australia and around the world, the future of oil and gas companies is increasingly becoming the focus of shareholder activists groups, such as the environmental group Friends of the Earth’s subsidiary Market Forces, which has been lobbying the nation’s top superannuation funds and other large investors.
Research prepared for The Age and Sydney Morning Herald, which compares the value of nine oil producing companies to the ASX300, shows oil stocks have consistently under–performed over the past decade and it’s a trend campaigner Will van de Pol says should give super funds further impetus to divest from the sector.
“Clearly the economic justification is not there and it hasn’t been there for quite some time now,” he says.
“[The research] really shows the recent pandemic has merely exacerbated a trend that’s been going on for some time now.”
Sunsuper’s chief investment officer Ian Patrick said the $70 billion fund had not made short-term changes to its exposure to oil during the crisis but acknowledged demand would phase out as the world moves towards a carbon-reduced world.
“Whether peak oil is today or in the next decade, I don’t know. Five per cent of global emissions come from oil wells to refining, that’s a reasonable proportion,” he says.
The fund has no plans to divest in major oil players, which Patrick adds have green transition plans in place.
In the past week, oil prices have lifted slightly on the back of encouraging signs that output is falling. But investors remain cautious, wary of the fact that the pandemic is far from over with the risk of a second wave of infections still in the picture.
“The market is much stronger now than a month ago as we have seen signs of demand recovering and supply contracting,” says Chris Midgley, director of analytics with S&P Global Platts.
“Availability of storage remains tight in the US and as such in theory WTI could go negative again this month. However, people should have learnt their lesson from last month’s experience and unless able to take delivery will avoid being caught long in the days up to expiry.”
Charlotte is a reporter for The Age.
Business reporter for The Age and Sydney Morning Herald.