Miller/Howard Investments

Peak Oil (Demand): The Stubborn Persistence of the Oil Age

June 17, 2016  |  Michael Roomberg, CFA, Portfolio Manager/Research Analyst

Michael Roomberg: Good day and thanks for joining in for our third in a series of podcasts on the North American energy revolution and the outlook for crude oil. My name is Michael Roomberg and I'm a portfolio manager at Miller/Howard Investments.

Over the past several months we've used these podcasts to discuss: 1) the circumstances of the 2014‒2015 oil price collapse; 2) the likely path to a recovery; 3) what Shale Oil might mean for OPEC countries in the broader geopolitical order over the long-term; lastly, how natural gas will play an essential role in the global economy for decades to come.

Today in this third podcast we're going to try to provide a window into how we think about the very long-term outlook for crude oil demand and also the rise of electric cars and what that means for oil, and more importantly for us and our investments, natural gas. To be clear in this context, we'll define the very long term as a period that starts today and ends around the year 2035, almost 20 years from now.

Periodically throughout the last 50 years, and most recently in 2008, a common topic of discussion was "the end of oil"—the notion that the world might run out of oil to meet future population needs that it would become cripplingly expensive or that an alternative energy supply would be required to save mankind. As happens very quickly thereafter, of course, instead of a Malthusian catastrophe, we got a tidal wave of technology that enabled us to tap new sources of energy from shale, which in turn led to far more oil than supply and eventually a price collapse, which in turn led to far more oil supply than we could use and eventually a price collapse.

Today there's little debate whether American—and if necessary, global—shale resources contain enough oil to meet demand growth for the foreseeable future. Instead, when most people discuss "the end of oil" today, what they mean is the end of oil demand. We've recently heard someone say that the world will run out of oil demand before it runs out of oil supply. We agree with this.

Why waste our waking hours investing in shale oil companies? It's simple. Everything ultimately has an expiration date. We think that the end of oil is further out than most realized and that there will be many oil price cycles to come—several lifetimes for most investors.

Yes, cars and planes are becoming more efficient. Yes, more stringent CAFE [Corporate Average Fuel Economy] auto emission standards are coming. Yes, electric cars will displace gasoline. Yes, natural gas is displacing diesel demand in trucking and shipping. Yes, home heating oil is being displaced by electric, gas, and propane, and buildings are becoming more energy efficient. All of these factors are true. They can continue to reduce demand, oil demand for each person.

According to a recent report by Sanford C. Bernstein, by 2040 there will be 9.2 billion people on planet Earth, 25% more than there are today. The amount of cars on the road globally will double from 1 billion to 2 billion. The number of trucks will double to nearly 800 million. Seaborne trade will grow over twofold. Production of plastic, which uses petroleum as a feed stock, will grow to nearly 300 million tons a year, more than double the current production capacity. The number of air passenger miles will double to 12.5 trillion miles per year. And here's hoping that the TSA processes improve by then.

Annual global economic output will rise by 2 1/2 to $164 trillion per year. To hammer home how much growth is yet to come, we point out that on a per capita basis the country of India, which has been a huge source of oil demand growth this year, is today, economically speaking, where China was back in 2002. Both countries are similar in population size. Other countries have even further to climb up the ladder than India.

All these trends create more demand for oil without which modern life is impossible. Still, nonetheless, the counter trends are there. Total oil demand in developed Europe and the United States has been flat since the 1970s due to extraordinary leaps in efficiency, which we expect will continue. At the current moment US and European oil demand is growing, a response to the low prices of late, but over time it's far more important for supply and demand that CAFE standards are on the rise in these regions.

Today compact cars sold in the United States must get 31 miles per gallon. In 10 years they're going to require 43 miles per gallon. A Boeing 787 flies 20% further on a tank of jet fuel then does a 767. Today electric cars are going to drive 10 million miles around the world's roads. Tesla hopes to sell a million more of these cars by the end of the decade. The foundations for the end of oil are therefore in place. Our best guess is that these efficiencies will not be enough to overcome emerging market economic and population growth for the next 15 years.

World oil demand, we believe, will continue to rise. Taking in both sides of the equation, our best guess is that oil demand, which is currently about 95 million barrels a day, will rise to about 105 million barrels a day by 2030, at which point efficiencies and alternative energy will begin to put an end to the oil age. This is the so-called tipping point. A rise from 95 million barrels today to 105 million barrels a day over 15 years doesn't sound very bullish. In most industries that type of growth over that time period would be far less than spectacular. That's only 10 million more barrels per day, right? Wrong.

The world's oil wells are wasting assets. On average, a well in production anywhere in the world today will naturally decline by about 5% per year. In aggregate, all of the world's currently producing oil wells, which currently supply us with about 95 million barrels of oil per day, will dwindle to just 46 million barrels a day by 2030 when we'll need that 105 million barrels to serve mankind.

That means that between now and [2030] we'll need to find, develop, and bring to market a new source of 59 million barrels of oil per day of production. To put this in perceptive, over 10 years, a mid-range Eagle Ford Shale well might produce an average of 80 barrels of oil per day. We'll need nearly 750,000 of those types of wells to meet the demand. At today's average cost of $6 million per well, that's a cumulative investment of almost $5 trillion. Of course, not all future oil will come from the Eagle Ford Shale in Texas but you get the point.

Under any conceivable scenario oil is not over. Many opportunities lie ahead for those companies producing, transporting, processing, and providing goods and services to the oil industry and for those investing in these companies. US shale will remain a large piece of the global oil supply equation in the years to come.

This podcast represents only the views and opinions of Miller/Howard Investments or certain of its personnel.

Further, these views and opinions are as of the date herein; the views are subject to change at any time based on market and other conditions.

We disclaim any responsibility to update these views. These views should not be relied on as investment advice or an indication of trading intent.

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This podcast contains certain statements that may include forward looking statements. All statements, other than statements of historical fact included herein are forward looking statements. Although Miller/Howard believes that the expectations reflected in these forward looking statements are reasonable, they do involve assumptions, risks and uncertainties and these expectations may prove to be incorrect. Actual events could differ materially from those anticipated in these forward looking statements as a result of a variety of factors. You should not place undue reliance on these forward looking statements.

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