Peak Oil? Or Peak Confusion?
Taking a look at the recent oil mega-deals, and suggesting a framework for approaching the market
Thanks for reading The Market Beat! Today we take a little bit of time to dive into the recent super-deals by oil majors Exxon & Chevron, and what I think is a better question to ask oneself when investing in oil than ‘have we reached peak oil?’ Cheers!
A New Era
Well folks, its here: the new era of consolidation among oil supermajors is officially upon us. Following the October 11th announcement that Exxon XOM 0.00%↑ would acquire Pioneer Natural Resources, Chevron CVX 0.00%↑ announced two days ago that it would acquire Hess for $53 billion.
In the unlikely event that you might believe that these two mega-deals occurred in a vacuum, and that it’s simple coincidence they both took place in short time frame, I hope to disabuse you of that notion.
We’ve talked here before about peak oil (the idea that oil consumption will cease its secular growth and begin a secular decline), and observers of these deals are likely to draw two conclusions from them:
Peak oil is indeed imminent, and it’s time for majors to consolidate to give themselves the best chance of long-term survival, or
Peak oil is quite far off, and rising geopolitical tensions around the globe and gargantuan cash flows are driving oil majors push to expand their reach.1
Figuring our what side to fall on in this debate is… tricky.
If the International Energy Agency’s outlook is to be believed, option 1 clearly seems like the winner. Just yesterday the IEA cut its 2050 oil demand projection by 2.4 million barrels per day. S&P Global reported the following:
The International Energy Agency on Oct. 24 lowered its 2050 oil demand projection by 2.4 million b/d to 54.8 million b/d along with a 0.5 million b/d reduction for 2030 under its central scenario in the World Energy Outlook.
The annual outlook cited a faster pace of adoption of electric vehicles as the main reason for the change in its Announced Pledges scenario, which assumes fulfilment of current government commitments, but no move to more ambitious climate pledges.
The scenario envisages 2030 oil demand of 92.5 million b/d, down from 93 million b/d in last year's report and actual consumption of 96.5 million b/d in 2022.
For the uninitiated, this seems like a pretty cut-and-dried analysis, but the IEA’s track record isn’t exactly great, especially when the time frame gets longer.
For example, a 2018 study on the accuracy of IEA projections published in Applied Energy concluded that:
Based on past performance, the uncertainty of current oil price projections is high. The mean absolute percentage error for oil prices is 17, 37 and 67 percent on 1, 5 and 8 year horizons, respectively. From a probabilistic view, taking the five year horizon as an example, this result implies that the WEO 2016 five year ahead point projection for year 2020 of 78 USD/b has at best a 58 percent chance of being within 49–107 USD/b, or a 89 percent chance of being within 20–135 USD/b.
So, not great! But alas, the IEA is made up of humans who make human assumptions, and it’s difficult to fault them for not being hyper-accurate (what fun would the oil market be if they were?).
But that’s not the only problem. In recent years the IEA has come under fire with accusations of being more or less co-opted by a political agenda that wants to mandate clean and green energy worldwide.
Things likely aren’t helped by the fact that the IEA’s Executive Director, Dr. Fatih Birol, has this on his official bio:
Dr Fatih Birol has served as Executive Director of the International Energy Agency since 2015. Under his leadership, the IEA has moved to the forefront of global efforts to reach international climate goals, safeguard energy security and manage the social and economic impacts of clean energy transitions.
Those inclined to believe in the Green Conspiracy no doubt see sinister undertones in the above blurb—the IEA’s job, after all, is usually conceived of as a forecasting and standardizing body, not one meant to push agendas.
On the other side, we have the Big Oil Chieftans, whose job is to expand the role and production of oil across the globe while maximizing value for shareholders.
To get a sense for how the moral battle lines are being drawn, consider FT’s recent interview with Chevron CEO Mike Wirth, where the headline reads: Chevron’s Mike Wirth: ‘We are not selling a product that is evil.’
Hm.
Anyway, Wirth and other CEOs at Big Oil writ large take the opposing view of the IEA, and insist that their data (naturally) represents the true and scientific forecast, free of any political stink that might accompany the IEA’s forecast.
So, what are investors to make of this?
Astute readers will hopefully find flaw with both approaches—it’s impossible to free oneself of bias when the political and economic pressure is so obvious.
So, I would propose that, ultimately, the question of whether peak oil is imminent is the wrong question to ask.
The question to ask, I think, is whether or not we have reached peak confusion.
Peak oil, in my opinion, is an un-investable concept: the future balances of supply and demand are what’s at question, and we are always acting with imperfect information.
Peak confusion, on the other hand… is slightly less un-investable. (In the world of finance, it’s all about finding that slight edge, baby—there are no slam dunks.)
Taking the stance that things could go either way allows one to remain flexible in making investment decisions, keeps the mind open and receptive to new information, and helps one from staying awake at night wondering whether or not the latest API or EIA figures will come in on the right trajectory.
Put another way, I think it might be helpful for investors to come to the entirely plausible conclusion that nobody really knows what the hell is going on, and nobody will definitively know for quite some time.
Eventually the market will reach some sort of equilibrium and consensus, but that day is not today. And that’s alright. After all, people are people, and forecasts aren’t prophecies. Things will always have a degree of chaos and uncertainty to them, and embracing that as an investor is quite important—indeed, it is precisely how the best investors consistently generate alpha.
So, in closing, stay flexible, embrace the chaos that is the interconnected world of commodities, and happy investing.
Of course it’s not necessary that these be the specific reasons, but they seem pretty obvious to me.