by Justin Anderson, Mawer Investment Management, via The Art of Boring Blog
In the spring of 2000, Sheikh Yamani gave an unprecedented interview with The Telegraph on the future of oil. As he was the former Saudi oil minister from 1962 to 1986, many paid close attention to his declaration that “[t]hirty years from now there will be a huge amount of oil—and no buyers. Oil will be left in the ground. The Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.”
At the time, it was a huge call to make. And in retrospect, vastly incorrect. Yamani had predicted an oil price crash by 2005, yet WTI more than doubled within that timeframe. By 2008, it had risen nearly fivefold to $102. Moreover, even when the oil price finally halved in 2015, the underlying causes for the decline were different than the ones Yamani had predicted; it was supply rather than demand-driven. Today’s prices are still much higher than in 2000 even adjusting for inflation and the 2015 collapse.
Sixteen years after his assertion, however, Yamani’s perspective still lives on. In fact, the chorus of people who believe oil’s end is nigh has grown louder. With entrepreneurs like Elon Musk pushing for a solar energy future and electric cars on the horizon, many are seriously questioning oil’s dominance. Are we finally moving into a post-oil age?
A brief look at some of the arguments
Oil’s strengths have made it the world’s choice transportation fuel. As a liquid, it’s easy to store which reduces infrastructure costs, and its high energy density makes it cheap. A planet-wide oil transportation infrastructure built over decades also means the cost of accessing markets for incremental supplies is low. However, with its current inextricability from terms such as “unsustainable” and “dirty,” and as an acknowledged source of much political tension, oil’s placeholder as an energy industry staple appears more and more tenuous.
There are three major arguments for why the end of oil is, or should be, here:
Argument 1: Oil is a finite resource. It won’t last forever.
This argument is accurate. Oil was created over millions of years under extreme heat and pressure through a process that converted Kerogen (dead plants that had little exposure to oxygen stunting their natural decay) into its present-day form. Yet extracting, processing, and consuming oil takes mere days—which implies this resource is finite. We consume a lot, quickly, and just don’t have millions of years to wait for the earth to whip up a new batch.
Oil is finite, certainly, but just how finite? Like any short-term investor knows, timing can mean everything. Even the earth will eventually be consumed by the sun when it becomes a giant red star and renders all activity on earth “finite”… it may just take about 7.59 billion years or so. While we don’t know exactly how long we have with the resource, there are two points to be made here. First, present estimations of production seem to suggest the end is not nigh unless nigh means another half century away. For example, BP estimates that global oil reserves rose to 1,707 billion barrels in 2016, “which would be sufficient to meet 50.6 years of globalization production at 2016 levels.” Indeed, most industry experts put oil’s longevity somewhere between 40 and 80 years. We may be eventually forced away from oil, but it’s not likely to be overnight.
Second, predictions around oil supply are almost always understated because of technology. Predictions that the oil supply would run out started shortly after Colonel Drake became the first to successfully drill for the stuff in 1859! Yet time and time again, advances in technology, coupled with the profit motive, have played a part in oil reserves increasing. When Sheikh Yamani gave his interview in 2000, many talked about “peak oil”; fast forward to 2017, however, and the oil price is still low because of enormous supply that was brought on by unconventional drilling technologies. Reserves are now at an all-time high. Yes, oil is finite, but technology has made it less so over time.
It’s important to note that, if oil’s fixed nature becomes the catalyst that ends the oil age, the increasing cost of new supplies will drive the price higher until alternatives become more attractive. Substitution will then occur because of market forces. This strongly suggests that the end of oil will not come about because the pipes run dry.
Argument 2: Extracting oil is invasive and comes with an environmental cost we can no longer afford to pay.
That oil development impacts the environment is not really debated. While the extent and danger this impact has on the environment is outside the scope of this piece, it is certainty true that people are increasingly concerned.
Something to remember when trying to evaluate the environmental trade-off of oil is not just how oil’s current footprint impacts the environment but also the hypothetical footprint of a system that doesn’t use oil at all. Thinking in terms of trade-offs helps focus the environmental discussion.
The critical factor to understand here is energy density. At 38,000 megajoules per cubic meter, crude oil’s energy density is simply one of the best out there. For comparison, wind farm energy density—at typical maximum speed for turbine operation—is only approximately 375 joules per cubic meter (@ 25 m/s), and solar power’s is approximately 14 megajoules per square meter per day.1 While we admit these comparisons are not purely apples-to-apples, the bottom line is that to deliver the same amount of energy output, we must use many times as much material—such as steel for wind turbines and land for solar farms—relative to what oil can deliver. If we swapped out all oil consumption for the equivalent amount in wind and solar tomorrow, even a massive country like Canada would be covered in solar panels and wind farms. The environmental disturbance to maintain our way of life using today’s renewable energy technology would be monumental.
Therefore, when we consider the environmental ramifications of a resource, we need to look at the whole system. In the case of oil, the claim that it is dirty and must be eschewed seems circumspect when its energy density and an overall systems perspective is taken into consideration.
At this point, it seems worthwhile to mention how peculiar it is that we give oil such an overtly negative label in the first place. Oil is ultimately just a resource. While it behoves us to continue to develop technologies with improved environmental trade-offs, oil’s energy density has been a boon to our society for many decades. Indeed, at one point oil and the combustion engine were even instrumental in cleaning up our surroundings.
As authors Levitt & Dubner describe in Superfreakonomics2 the realities of horse-based transportation in 19th century cities like New York were often unpleasant. By the end of the 1800s, the 15 to 30 pounds of manure produced daily by each horse multiplied by the 150,000+ horses in New York City tallied into over three million pounds of horse manure per day. Beyond the obvious stench and health concerns, it got to the point where vacant lots became piled 40 to 60 feet high with horse manure because removal became too costly. Then, along came the automobile with its internal combustion engine. According to Eric Morris, author of From Horse Power to Horsepower, “the private automobile was widely hailed as an environmental savior. In the span of two decades, technology eradicated a major urban planning nightmare that had strained governments to the breaking point, vexed the media, tormented the citizenry, and brought society to the brink of despair.”3
In short, oil’s high energy density powered our rapid industrial growth throughout the 20th century and, in turn, allowed for a greater population density and standard of living than what its energy predecessors (coal and domestic animals) could offer.
Ultimately, we know there are new technologies on the horizon that promise a superior environmental trade-off. If these deliver, oil will be elbowed out as the world’s staple energy. But until then, oil may—surprisingly—be one of the better environmental options we have.
Argument 3: Oil’s unequal distribution across the globe causes toxic political tension.
Arguably, this is one of the most compelling arguments for why oil should end. Historically, oil has propped up many political regimes whose values have been at odds with those of liberal democracies; a number of dictators and authoritarian regimes have been sustained because of their control over oil resources. Moreover, the commodity has played a key part in various conflicts and flare-ups throughout the 20th century: WW2; Iran-Iraq War; Iraq’s invasion of Kuwait; Sudan vs. South Sudan; and the South China Sea disputes and so on.
While this argument remains important, concentration of global production has fallen in recent decades which blunts some of the geopolitical tension surrounding the resource. In particular, the power of OPEC has weakened. In 1973, OPEC had enough market share (over 50% of global production) that it issued an oil embargo against western nations as a punishment for the West’s support of Israel during the Yom Kippur War. Today, it seems doubtful whether OPEC could coordinate a similar kind of move. With OPEC member countries now accounting for roughly 40% of the world’s crude oil production, and nonconventional sources in North America gaining greater share of the market, the balance of power seems to be shifting. True, OPEC member countries still influence geopolitics; but their role seems to be diminishing.
Not Dead Yet
Given what we’ve outlined above, it seems unlikely that we are hearing the death knell of oil. While this is not something we can know for certain, the system is set up in such a way, and the commodity still has so much going for it, that our best guess would be: not yet.
That said, this is an area that is rapidly shifting. Our assessment could easily be wrong if some trends move differently than our current assumptions. In particular, technological alternatives and the environmental movement could finally disrupt oil’s dominance.
About a decade ago in grad school, I was part of the MIT Energy Club. Our group often debated how long it would take before technologies such as electric vehicles, cellulosic-based biofuels, plug-in hybrids, hydrogen fuel-cells and other alternative energies took over the transportation fuels market. The only thing I am confident about today is that a technological change will come, and that no one knows when, or how quickly its adoption will be. Currently, the strongest challenger in technological alternatives comes in the form of electric cars which offer some benefits such as fewer moving parts than IC engines while also carrying weaknesses such as limits on energy storage and infrastructure.
As for the environmental concerns, my assumptions are (hopefully) clear above. While I agree wholeheartedly that we should pursue technologies with better environmental trade-offs, discussions on the environmental impact of oil are often so fraught with emotionally charged language and rhetoric (on both sides) that we miss the critical points in the debate. When we review oil’s environmental impact, given alternatives, it does not usually look as bad as one might presuppose. At least not compared to how oil is typically vilified.
However, the veracity of this argument is less important here than what is widely believed. The idea that oil is bad for the environment is fairly pervasive—migrating from popular media, to academia, and now into the business world. This widespread view may be oil’s greatest threat. If enough believe that oil must end, a political response could emerge that forces it to, whether or not that decision is rational.
At Mawer, our strategies tend to have far less exposure to the oil sector than what one might expect from a Canadian manager. This is because we generally do not find oil and gas business models to be wealth-creating (more on this another time). But even if we had zero exposure to oil companies, we would still track how oil markets progress because it is such an integral commodity in society. A shift away from oil as an energy staple would have many first and second order consequences: in Canada and abroad, to the environment, politics, and the global economy.
Oil is certainly an imperfect choice for powering our world; however, our reality is that we are forced to choose between imperfect alternatives. What can be determined is that oil’s reign will certainly end. The impossible question to answer is when and how quickly.
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About Justin Anderson
Justin Anderson, CFA, is an Equity Analyst at Mawer Investment Management Ltd., which he joined in 2014. In 2016, Mr. Anderson completed the rotation program, working on each asset class, and joined the Mawer Canadian Equity Fund as an equity analyst. Learn more
1 Schroder, K.-P. and Smith, R.C. “Distant Future of the Sun and Earth Revisited” which appeared in the Monthly Notices of the Royal Astronomical Society, January 25, 2008.
2 Levitt, Steven D. and Dubner, Stephen J. Super Freakonomics: Global Cooling, Patriotic Prostitutes, and Why Suicide Bombers Should Buy Life Insurance. Deckle Edge, October 20, 2009
3 Morris, Eric. From Horse Power to Horsepower. Published in 2007 in Access, a University of California transportation publication.
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