If you believe Bloomberg New Energy Finance, sometime around 2030 the world will enter a long decline in demand for oil-derived transportation fuels. If you believe the International Energy Agency, well, not so much. Not surprisingly, oil executives believe IEA and auto executives believe BNEF. So far this year, the BNEF folks look prescient, with plug-in vehicle sales in China hitting 31% market share in May and 25% year-to-date, and Europe following close behind with 19% market share in June. But consumers are a fickle bunch, and the IEA forecasters may yet have the last word. One thing is certain when the decline comes into oil markets, it’s going to be a bumpy ride down the decline curve.
We start with a fundamental truth: Shifts in supply are investor-driven phenomena, shifts in demand are a consumer-driven phenomenon, and therein lies the cause for the predictable turbulence ahead. Investors are paid to anticipate the future behavior of consumers and preemptively respond. Consumers are, by their nature, more reactionary – responding to the fact on the ground and the prevailing sentiments as they appear. When these forces encounter one another in a growth market, investments appear ahead of demand and the fore market almost miraculously satisfies demand just in time. When they encounter one again in a declining market, investment disappears ahead of demand, driving prices higher and accelerating the anticipated decline.
Shifts in supply are an investor-driven phenomena, shifts in demand are a consumer-driven phenomena, and therein lies the cause for the predictable turbulence ahead
As anyone with even a passing familiarity with the oil markets will know, capacity in the oil business drops out in chunks, not in increments. When investor sentiment shifts, drops in capacity quickly outpace declines in demand. (I should probably make a second, obvious point: investors are almost never fired for an investment they did not make, but a great many have found themselves seeking a new line of work for investments that went wrong. Declining to invest is usually the safer option.
A market perceived to be headed toward the sunset – even a nominally growing market – will be perpetually short of long-term investment dollars which will drive prices high and accelerate substitution. (A lesson most of us will recall from the too-often-citied whale oil market of the nineteenth century when turpentine, coal oil, and kerosene pushed the nation’s fifth largest industry (whaling) into oblivion.) These relatively high prices will be anything but stable. Dramatic shifts of economic rent across sectors of the supply chain will be a feature as chucks of capacity drop out. Economic stresses and bounty will shift with alarming volatility between upstream, refining, transportation, retail, services, and labor (you think a good petroleum engineer is expensive today, just wait until 2040!).
As the COVID mess reminds us, when external events intersect with investor perception of long-term decline, the capacity drops will be precipitous and rapid. If the world economy lurches into a recession, another COVID-like capacity reduction will surely follow. When the economy emerges, no surge in investment will cushion the impact. Consumers will react – as is their nature – to the facts and sentiment on the ground (just as the 31% of Chinese new car buyers last month) and the decline will accelerate.
From a trading perspective this all adds up to historically anomalous shifts in relative pricing. It means significant mid-term volatility (over 12 to 36-month cycles). All of this creates an opportunity for a return to more strategic trading of the sort that was perhaps more common in the previous century before the trading markets were all electronic. This will demand new skills from commodity traders who were raised playing the daily or monthly volatility and believe the trend is your friend when P&L is tallied. For suppliers, it will mean that long-cycle hedging will often be the difference between surviving the next dip or being part of the next chucks of capacity to drop out. One thing is certain: it’s going to be a bumpy ride.
