Cheaper Oil Does Not Spell Doom | Seeking Alpha
In spite of being posted on SeekingAlpha, I found this article helpful for putting oil prices into perspective. In particular, the author provides a chart of historical oil prices adjusted for inflation and points out that the real price of oil is simply coming down to its longterm average. Relative to other goods and services, oil has been overpriced since about 2005. We have simply gotten used to it, but when energy is overpriced it creates a drag on the economy, the global economy, and this contributed to the Great Recession.
The key contribution that energy makes in the economy is that it leverages human productivity. When energy is too scarce or costly, it undermines productivity and leads to poor job creation. But how we're we able to get out of the recession with the price of oil still high? Well, natural gas came down from about $7/MBtu to $3. Usually, oil and natural gas prices move with each other and with coal, but in 2009 natural gas descended in price while oil and coal recovered in price. So natural gas helped with the recovery of the over all economy. Coal and oil producers continued to make gains, but in 2011 coal started to crash. The coal industry has lost over 80% of its value, and many key players are presently going bankrupt. So the electricity markets have been replacing coal with natural gas. And for a few years this supported the price of natural gas, but early last year natural gas began to decline again and coal with it. My view is that as natural gas comes down in price, it will lead to more substitution of natural gas for oil. Oil was spared this fate while the coal was losing ground to natural gas, but as natural gas began to fall again a year ago, it took oil with it. So now we see that economic recovery was not fueled by cheap oil, but by cheap natural gas and cheaper coal.
So the market is trying to figure out why demand for oil is softening. Is it a recessionary decline in general demand? Certainly the situation in China may call this in question, but I think there is a deeper structural changes at work. Demand for oil may simply be losing ground to natural gas that competes in heating, electrical, chemical and transportation markets.There really should be an equilibrium between oil and natural gas. Likewise in the electrical and heating markets, there should be an equilibrium between natural gas and coal. So why are all three continuing in decline and not simply converging to equilibrium? And more mysteriously, why did natural gas break from this equilibrium back in 2009? Why did gas drillers frack themselves into a glut in the first place? One possibility we must consider is that some new energy sources came into the mix and changed the game. Specifically wind and solar made great gains through the first decade this century. While the volume of energy output was not initially threatening, the both of these technologies were rapidly declining in price. It was simply a matter of time before wind would be competitive with natural gas in the electricity market, and then a few years later solar would be competive with natural gas too. Back in 2009 it was clear that both would undercut natural gas within a decade. Today the most competive PPA for solar is about $39/MWh and wind is down to $25/MWh, while a year ago a new natural gas combined cycle plant starts at about $61/MWh with natural gas around $3.5/MBtu. Today NG is down to $2.7MBtu. You see the problem. If natural gas does not come down in price, more and more wind and solar will be installed. I believe that the gas fracking revolution took off because the industry realized that it only had a few more decades left. When you're sitting on 50 years worth of reserves and two technologies come along that will undercut you within 20 years, you start fracking like there's no tommorow. Natural gas, being more expensive traditionally than coal, was first in line to get disrupted by wind and solar. But the glut of natural gas has disrupted coal, while wind and solar take their bite as well. Natural gas has enjoyed some advantage in the the peaking plant market, but batteries threaten to disrupt even that with half a decade. Likewise oil has had certain advantages in the transportation fuel markets, but batteries now threaten that market with a decade. So now the economics of divestment have finally come to the oil industry. The Saudis sit on at least 50 years worth of oil reserves, but near term demand erosion from surplus natural gas and longterm disruption from batteries mean that the Saudis and all other oil producers must race to get there product to market. This is the economics of divestment. So while many investors discount the intrusion of renewable energy and struggle to understand how demand for oil may be fallen, key players are taking action to liquidate their assets before it is too late. It is simply a convenience to those who are presently divesting that so many investors are confused by this. The slow ones will be left holding the bag on stranded assets. By the time they figure out what the score is, the game will be over.
So investing in companies like Tesla and SolarCity puts you at the front of the line for all this turmoil. While the fossil industry is divesting, investors will be mislead all over the place, and they will transfer their uncertainty, fear and even hatred on stocks like Tesla. The economics of divestment leads to flooding the market with soon to be obsolete products at incredibly low prices. Tesla will face this kind of resistance from here on out. Gas will get cheaper, and conventional cars will get cheaper too. Electricity will get cheaper. We should embrace these outcomes. They are not threats, they are indications that we are winning. First, they ignore you. Then they laugh at you. Finally, they fight you, and you win. We are just starting to get to the fighting stage.
So what does it matter that oil is crashing and the market does not know what to do about it? This is actually what the Tesla investor should expect to happen as EVs and batteries become a credible threat to oil interests. Moreover, the market will not be able to make sense of it, because those who are divesting need willing and unsuspecting buyers. But once the market knows what the score is, the game will be over. So the smart thing is to divest fossil assets and quietly buy up the things that will survive the fossil bubble. When this thing pops, you're going to want to be sitting on a pile of Tesla shares.
All the best, James
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Does this mean what I think it means?
