Possibly a bit intoxicated by what has happened in the coal sector over the course of the past 12-months, namely the following....
.... my gaze naturally turned to the oil and gas sector, where the industry fundamentals are remarkably similar to those of the global coal market.
https://hotcopper.com.au/posts/53454533/single
(In that post, ignoring the actual names of the individual producers, if one simply replaces the word "Coal"with "Oil" the story is almost identical. In fact even the industry structure on the supply side is similar; in the analogue, OPEC is to Oil what Indonesia is to Coal.)
Normally - probably 99% of the time - I have zero interest in investing in commodity businesses.
Because, to me, they represent the ugly shareholder value destroying trifecta of:
1. No pricing power
2. High degrees of capital intensity
3. Finite asset lives
To top this off, I have a strong view - based on much evidence - that trying to forecast commodity prices with any amount of accuracy is overwhelmingly a bit of a fool's errand, because it is impossible to get it right on any reasonably sustainable basis.
However, every once in a blue moon - maybe every 10 or 15 years - some unique set of circumstances can be identified which offer the opportunity to be able to make a reasonable prediction of commodity prices (if not accurately, then certainly directionally).
In the case of the global oil industry, we are seeing - according to my assessment of it - a supply-side shock of sorts in the making.
This supply side shock is, in great part, due to the "ESG" influences in the boardrooms of the major oil companies which are headquartered, and have their shareholder bases, in the developed world.
We know that the geophysical nature of oil fields is that they experience a natural decline from the very first day they commence production. So - forgetting about increasing supply - just to stand still requires continuous investment to be made.
According to WoodMackenzie, one of the world's pre-eminent oil & gas consultancies, to maintain global oil output at the current 91 m bpd, around US$600bn pa needs to be spent on oil exploration and development globally. For the past few years, the world has been running at roughly US$300bn, so half of the rate required to maintain output.
The International Energy Agency, in its March 2021 report, "
Oil 2021 - Analysis and Forecast to 2026" forecast that
non-OPEC supply will increase by
7%, from 63.1m bpd to 67.6m bpd, over the next 5 years. However, given the current rate of under-investment in supply, globally, there must be a measure of downside risk to that expectation of a 7% ex-OPEC supply increase.
But even assuming the non-OPEC supply does manage to increase by 7% between 2020 and 2026, by comparison
global oil demand will increase by
14% (by 9% in OECD countries and 19% in Non-OECD countries), from 91m bpd to 104 bpd.
So the
ex-OPEC deficit will rise by a very significant
31%, from 27.9m bpd to 36.5 m bpd.
That's a big gap for on which the world would need to depend on OPEC to fill.
And remember, that's based on assumptions of expected ex-OPEC supply increase which are not being supported by the level of capital investment inputs that are required for such an increase.
If non-OPEC output stalls at roughly the current level, which is not at all implausible given the increasing momentum to cease investing in dirty fossil fuels, then the OPEC deficit gap would grow each year to reach 41 mbpd in 5 years' time, from 28mbbl today.
So to keep the market balanced, OPEC output will need to be 13mbpd greater (a~45% increase) in 5 years' time than it is today.
There is zero precedent for that happening in the word of OPEC.
So that's the top-down picture, as I see it.
Someone kindly forwarded a report to me yesterday that included a far more detailed analysis of the supply and demand outlook for the global oil market than I've provided here.
One of the striking observations in that report is that its authors made reference to the possibility of global oil demand reaching global pumping capacity sometime over the foreseeable future, something which has apparently never happened before.
They talk about that crunch possibly occurring in Q4,2022 but how they can be so specific in terms of timing escapes this reader of the report.
But irrespective of the precise timing of this sort of possible acute market tightness crunch, the unambiguous tone of the industry fundamentals means that, it terms of pricing scenarios for oil, there is a significant skew to the upside.
As the classical economists among us know, when the demand curve moves to the right, but the supply curve is unable to respond, then the equilibrium price is ratcheted upwards:
In that circumstance, the oil price forward curve (off which equities tend to be priced), which is currently in contango (see below) will certainly have to undergo some significant adjustment.
WTI Futures (figures in US$/bbl):
June 2022: 65.08
June 2023: 60.40
June 2024: 56.96
June 2025: 54.60
June 2026: 53.13
Because that futures profile looks nothing like an industry which is experiencing once-a-generation structural under-investment, meaning that the futures market must be thinking that global oil demand is going to fall as well.
Which is clearly not the case.
Not even the fossil fuel loathing IEA believes that.
Accordingly, I commenced buying shares in WPL this morning.
That this year is the first time in decades that I have owned shares in companies involved in the business of oil and gas production is an indication to me of the extent of asymmetrical upside-vs-downside investment returns on offer.
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(20min delay)