Welcome to the peak bearishness edition of Oil Markets Daily!
Fundamentals do not determine when markets top or bottom, sentiment does. And this week’s media headlines have been nothing but bearish for oil and the energy sector. What set off this bomb was BP’s (NYSE:BP) renewed outlook about how global oil demand is set to peak in the early 2020s.
To say this report was a complete waste of time to go through would be an understatement, but we pinpointed a few things that will make you roll your eyes.
First things first, BP has this for oil demand consumption:
In BP’s shocking update, it has oil demand forecasted to have peaked in 2019 and stagnating for the years to come. And in the more extreme scenarios, it has oil demand falling rapidly into 2050.
Here are some of BP’s key assumptions to arrive at this outlook (now mind you, it doesn’t actually explain why it assumes any of this in any of the materials it provides):
1. COVID-19 to have a PERSISTENT impact on global oil demand.
One of BP’s first key assumptions is assuming that COVID-19 will have a permanent impact on global oil demand. In the report, it says:
The central view used in the main scenarios it that economic activity partially recovers from the impact of the pandemic over the next few years as restrictions are eased, but that some effects persist. The level of global GDP is assumed to be around 2.5% lower in 2025 and 3.5% in 2050 as a result of the crisis. These economic impacts disproportionately affect emerging economies, such as India, Brazil and Africa, whose economic structures are most exposed to the economic ramifications of Covid-19.
The pandemic may also lead to a number of behavioural changes; for example, if people choose to travel less, switch from using public transport to other modes of travel, or work from home more frequently. Many of these behavioural changes are likely to dissipate over time as the pandemic is brought under control and public confidence is restored. But some changes, such as increased working from home, may persist.
We must say that’s incredibly impressive that BP has managed to quantify the impact of persistent demand loss already. In fact, it’s so convincing since BP was able to provide empirical evidence to back its view.
Now, if you take a step back and look at BP’s “persistent demand loss of ~3 mb/d”, and you look at what’s happening with global export data, you can already tell it’s way off the mark.
For example, we use global crude exports as a proxy for demand from refineries.
And as you can see in the chart above, global crude exports for September is set to be higher y-o-y. Now granted, last year September saw low implied demand, but the impressive recovery is an illustration of higher demand.
In addition, the explanation from BP about the public deciding to use alternative sources of transportation versus public transportation was not explored further. And the reason why it did not want to explore this avenue further is that if people start to travel via their cars as opposed to buses or subways, energy consumption intensity would rise and throw its theory completely out the window.
To back this view up, you can see in the charts below on traffic congestion in major cities. Many are above last year or have returned to normal already, so to assume that there’s a persistent demand loss arising from this is delusional to say the least.
2. Energy consumption growth across sectors slows much more than the past.
And once again, there’s no detailed explanation as to why demand growth across these various sectors slows going forward:
The funny thing about BP’s key points is that it notes:
The outlook for primary energy also depends on the form in which that energy is used at the final point of consumption. In particular, although it is possible to decarbonize the production of electricity and hydrogen, they require considerable amounts of primary energy to produce. As such, increasing the use of these forms of energy carriers tends to boost primary energy.
This goes back to the electric vehicle versus internal combustion engine (ICE vehicle) debate about where that electricity comes from. Not all EVs are created equal because if you are recharging your EV say in China where coal represents more than 2/3 of the electrical grid mix, then you are actually making the environment worse.
So this point from BP is making an implicit assumption that the primary use of energy will change. It’s what you call an assumption on an assumption.
And this brings us to our third point:
3. Energy mix by 2050 suggests all renewables?
So in order for point #2 to be accurate, BP has to be accurate on this point first. And the main driver of this assumption is this:
Most significant is the growing competitiveness of renewable energy, which combined with its widespread availability and the increasing electrification of the energy system, leads renewable energy to be the single largest energy source in all four countries in Rapid by 2050, providing between 45-55% of energy supplies.
Now we won’t make an argument on the cost of renewable energy despite the fact that it’s heavily subsidized by the government. But instead, we will make an argument on the reliability of renewable energy.
For those of you keeping up with the news about California’s recent blackouts, well, it’s no surprise to see the grid “fail” because renewable energy sources that were supposed to be there wasn’t at the wrong time.
That’s really the big issue with renewable energy today, it’s the reliability of it versus the cost of it. Even if renewable never becomes economic on its own, one can argue the merits of governments keeping a lifeline on the sector. But the reliability issue won’t go away unless we have some type of battery capacity that will help support the grid on scale.
So we would say BP’s argument about the growing competitiveness omits probably the most important point in the renewable energy source vs. fossil fuel debate, which is the reliability factor.
This now makes BP’s assumption an assumption on an assumption on an assumption, which is that battery technology along with other net-zero carbon emissions will somehow displace the reliability of fossil fuels.
And BP even fully admits in this section that the cost and reliability will increase the cost:
A fully decarbonized power sector is likely to be dominated by zero- and near-zero carbon energy sources, led by wind and solar power, together with nuclear, hydro and bioenergy and other supporting technologies to ensure reliability. The intermittency of wind and solar power means the cost of balancing the power sector is likely to increase as the share of wind and solar power grows, slowing the extent to which they penetrate the power sector.
A power system dominated by wind and solar power generation is likely to require a range of different energies and technologies to help balance their intermittency. For short-duration, high-frequency balancing, lasting from a few seconds to a few hours, this is likely to be met largely from a combination of batteries, pumped hydroelectricity and demand-side responses.
But some of these technologies and actions are unlikely to be technically or economically feasible for longer-duration balancing across multiple days, weeks and seasons. This longer-term balancing is likely to be met by a combination of bioenergy; natural gas (or coal) combined with CCUS; hydrogen; and hydroelectricity combined with high-capacity reservoirs. In Net Zero, bioenergy, natural gas with CCUS, hydro and hydrogen collectively account for 30% of power generation in 2050.
The issue here is that if there’s acknowledgement that renewables like solar and wind offer unreliable sources of energy during chaotic times, why would utilities switch to ~70% renewables?
It’s like selling a product to a customer and saying, “Oh btw, you also need these just in case it doesn’t work when you really need it to work.”
The underlying unreliableness of this will make it very difficult to gain mass adoption. Now we move onto the fact that if there’s even enough batteries to support this outlook.
4. Battery technology… Wait, is there even enough lithium?
This brings us to point #4, which is that BP’s point about higher electric vehicle penetration and renewable penetration requires more lithium.
Before we even get to the point about battery technology, which by the way improves on a linear scale. Is there even enough lithium supply in the world to support a ~75% EV penetration rate and ~50% renewable electrical grid mix?
According to Platts, lithium supply will triple by 2025, but the increase will be met with the increase in electric vehicles (e.g. EVs using lithium not even factoring in utility grid needs).
And based on Bloomberg’s global lithium supply vs. demand forecast (thanks for Matt Bohlsen for posting this), all of the supply increases will be met by demand outlook by 2030. And if you look at the current nameplate capacity, we will be needing a whole lot more lithium than what’s currently available. So someone hurry up and find more lithium to support BP’s outlook.
5. Fuel efficiency to offset the increase in passenger cars, but wait, that doesn’t make sense.
Now let’s look at the ICE car fuel efficiency assumption, which basically cancels out car liquid fuel demand.
One of the points made in BP’s demand assumption is that fuel efficiency improvements in ICE vehicles will cancel out the increase in passenger cars. And according to IEA, which tracks average fuel consumption of new light-duty vehicles, we are not even close to being on track.
And the reason for the stalling average fuel consumption per vehicle is because more and more consumers are going into SUVs.
Despite ongoing efficiency improvements within each vehicle segment, consumer demand for larger vehicles has risen significantly. This trend is common to all vehicle markets and has led to a slackening – or in some cases even reversal – of national rates of fuel consumption improvements.
The worldwide market share of SUVs rose 15 percentage points between 2014 and 2019, to make up 40% of the global LDV market. Shares in North America and Australia were particularly high, around 50%. In addition to SUVs, pickup trucks – which tend to be even larger – also make up a significant share of sales in these markets.
Markets that traditionally have smaller vehicles, such as Europe and Japan, have also joined this global trend: in Europe 38% of new vehicles are SUVs, compared with 10% in 2010. The greatest market share growth has been in the small SUV segment, which includes many crossover versions of popular passenger cars. The average fuel consumption of a small SUV/pickup is more than 15% higher than for an average medium-sized car, for which market shares have fallen the most in recent years.
Now to be fair, we would argue a big part of the shift to SUVs is likely the result of very low oil prices in the last 5-6 years. This has lowered gasoline prices, which has inherently made consumers less worried about gas consumption and thus indirectly boosted demand for larger passenger vehicles.
So considering that low oil prices were part of the shift to less fuel-efficient vehicles, and considering that BP’s lower oil demand outlook relies in large part on fuel efficiency offsetting the increase in vehicles on the road. And you quickly realize that it’s a contradicting argument.
Media bias… hinged on BP’s report?
After dissecting the BP report, we quickly realized just how biased the media is. As Pinecone Macro perfectly put it in this tweet:
It’s been nothing but love fest for oil lately.
And the interesting timing of all of this comes just as oil and energy sentiment is close to extremes:
And for those that follow the “Economist cover contrarian indicator,” the last time the Economist declared that it was the end of the oil age, we rocketed ~400% in five years:
And if these media headlines were hinged off of this report by BP, then we can tell you its bearish sentiment is completely misplaced.
Now there are so many more points we wanted to cover, but if we continued, we probably lose you. Perhaps that was BP’s goal of publishing an 81 page report full of nothing?
All things considered, we knew from the onset that there were going to be a lot of flawed assumptions in this report. But the fact that BP’s report relied on assumptions on top of assumptions on top of assumptions makes its outlook very susceptible to failing. And with one of the key assumptions being that COVID-19 will permanently destroy ~3 mb/d of demand, we can’t help but find the entire report dismissive from the start. Next year’s demand recovery will likely already make one of BP’s key assumptions invalid.
Well, only time will tell. And we hope you go through this report in detail. But if our initial overview of this report is correct, then the recent media onslaught will likely mark the bottom of the current oil cycle.
HFI Research, #1 Energy Service
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.