Energy Investing May be a Highly Profitable Endeavor: A Contrarian Take on “Peak Oil Demand”

  • The chart below shows the Energy Sector’s weight in the S&P 500 is at the lowest level in history
  • In a recent Quick Take, we showed that the oil industry’s spending to maintain and grow oil production had fallen 76% to levels not seen since 2000
  • We are hopeful that the world finds a future that requires fewer hydrocarbons but believe the hype has priced in the best-case scenario for clean energy stocks and an incredibly bearish one for oil and gas

If you watch our presentation on Inflation, you will notice the first slide shows the powerful inflation hedging properties of energy.   We wonder if index investors realize they are buying a package of equities with record high levels of duration risk that price-in no chance of short term or long term inflation. 

Energys Weight in the SP500 is at All Time Lows

Our upcoming piece on investing in the energy industry will shed more light on one possible method of building a simple investment process around oil and natural gas stocks.

In the remainder of this piece, we provide people with a cascading series of magazine covers that have hit the raw nerves of our contrarian roots.  We believe the pictures below show that today’s euphoria around battery electric vehicles and other future technologies is based on very long forecasts of a tenuous nature.

As our research, quick takes, and charts for the curious have documented in detail, we believe, like in many other manias, visions of “exponential returns” are drawing investors into some of the most speculative stocks in modern history.  To paraphrase a brilliant friend, we’re just linear minds trying to hang in a non-linear world, and in the midst of the greatest bubble in modern history, it doesn’t feel that good….but we believe the opportunities are abundant for long-term investors focused on cash flows and balance sheets.[1]

US Oil Prices: Is Peak Oil DEMAND Consensus?

A large number of recent news articles, nearly all of them published post the collapse in energy use from Covid, discuss the possible end of oil.  This is consistent with the human propensity to extrapolate very recent trends long into the future erroneously.

The zeitgeist today seems to be something like: “Covid caused oil and gasoline prices to collapse, therefore it is proof that we might not need these energy sources as much, therefore we can construct scenarios where we use vast amounts of renewable energy and less WTI crude and, having built those scenarios out with lots of data, what was once unlikely suddenly seems perfectly plausible….”  You get our point.

Magazine Covers: Consensus & The Power of Anecdotes

Check out the beautiful title below.  The article is a fantastic summary of how thinking has changed in the Covid world, and we believe it essential reading for any investor today.  Some highlights:

  • Covid triggered the sharpest decline in oil consumption since the advent of the Ford Model T
  • An influential report from BP called 2019 the peak in oil demand
  • Oil bears see a future of work-from-home, Netflix bingeing, less travel and battery cars for everyone
  • Solar is the new oil

Most interesting to us was the comment right at the start of the article about forecasters.  They noted:

“…these forecasts mark an emerging view that this year’s drop in oil demand isn’t just another crash-and-grow event as seen throughout history… Until the pandemic none of the major oil forecasters had seen an imminent demand peak.” – Bloomberg News, December 2020

Bloomberg Dec 2020 – Demand for Oil Has Reached Its Peak

Let’s look at some other magazine covers.

Less words and more pictures ahead.

Oil prices have played a starring role in many of the world’s booms and busts, and continue to feature prominently in geopolitics.  Predictions are as frequent as they are wrong.  Below are some fascinating anecdotes.

The Economist, a publication we absolutely love[2], put out two magazine covers in 1999 and 2003 when oil was at $10 and $30 respectively.  We are not criticizing The Economist then, now, or ever.

They were simply documenting the fact that the world seemed like oil was “on the way out” at the time.  Here is what happened over the 8 years following the publication of the magazine cover on the left:

  • Oil prices rose a staggering 765%
  • Companies involved in the S&P500’s energy sector soared 300%
  • The S&P500 stock market index rose a paltry 13.8% or only4% a year[3]

The Economist 1999 Too Much Oil Oil at 12 The Economist 2003 Oil is Over Oil at 30

LET’S FAST FORWARD A FEW YEARS,

AFTER ENERGY PRICES WENT SOARING,

AND LOOK AT SOME OTHER MAGAZINE COVERS.

Time Magazine put out the two magazine covers below in 2011 and 2012 when oil was at $100 and $104 respectively.  We are not criticizing Time Magazine in any way.

They were simply documenting the fact that the world did seem like it was running out of oil in those years.  Look at the magazine cover on the left.  You can barely see it.  They put “We’ve got Five years” in shadow font.

Here’s what happened in the years following the publication of these magazine covers:

  • Oil prices plummeted -25%
  • Energy companies in the S&P were FLAT: -5% return from Nov 2011 through Sept 2021
  • The S&P 500 rose 330%[4]

Time 2011 Only 5 Years of Oil Left Oil at 100 Time 2012 End of Cheap Oil Oil at 104

Think about the “peak oil demand” story from Bloomberg we started with.  Is the market too pessimistic? Are index investors in the United States aware that only $0.02 of every dollar is going into Energy stocks?

We believe the record low weight of energy stocks in the S&P and the surge in articles heralding the end of oil are evidence that many have come to believe oil is “dead.”  We cannot be sure but we believe that view is largely baked into the price of energy stocks today.

Please see our upcoming White Paper, on an innovative yet simple method of identifying potential winners in the Energy space.

APPENDIX

The Economist We Have Too Much Oil Contrary Indicator for Oil and Oil Stocks

Time Magazine We Are Running Out of Oil Contrary Indicator for Oil Oil Stocks

[1] Hat tip to the always brilliant SP

[2] We offer new and existing subscribers free books and subscriptions to high quality publications like The Economist – please reach out for more info

[3] See the supporting material in Exhibit 1 in the Appendix below

[4] See the supporting material in Exhibit 2 in the Appendix below

Disclaimer

The information, data, analyses and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. 

Kailash Capital, in preparing the information, data, analyses and opinions presented herein, has obtained data, statistics and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. 

Kailash Capital and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.