Oil – The Sun Also Rises

Oil – The Sun Also Rises

The world is drowning in oil, and every day the market seems to take its cues from oil’s ups and downs.  At AJF, we’ve been thinking about this a lot.  Who isn’t?  Is it a result of the reality/perception that China’s economy is slowing down?  Is it a result of OPEC’s decision to continue flooding the world with supply to drive out higher cost producers in the US?  Is it a result of the stronger dollar that continues to benefit from weakening emerging economies that are highly dependent on commodity exports?  Well, the answer is… Yes.  However, these are just a few of the questions relevant to the conversation.

One aspect that hasn’t received as much attention over the future of fossil fuel supply/demand is the issue of climate change.  This past December, 195 countries signed on to the first-ever universal, legally binding global climate deal to limit global warming to below 2°C.  The fight against global warming has been building for decades, but with an ever-shortening timeline, the level of urgency has risen exponentially and now the world’s leaders have come to the realization that either we act now to lessen our dependence on fossil fuels or suffer the irreversible consequences.  Interestingly, one should notice the price descent of Brent crude following December 12, 2015, the day the climate deal was reached in Paris.  The price declined from $38.30 to $27.

Leaders of oil producing nations and fossil fuel CEOs must be aware.  Coal CEOs for certain, the door for coal is closing.  It’s been said that in order to keep global warming at bay, 2/3 of the world’s fossil fuels must be kept in the ground.  And as investments in alternative energy project continue to climb, naturally, less and less will be needed from coal, oil, and natural gas.  So with this agreement, the writing is on the wall in bold faced letters.  It comes as no surprise to us that oil producers continue to extract as much oil as possible due to competitive pressures.  This scenario will naturally leave the majors as the survivors as they scoop up cheap assets from bankrupt outfits.  But as we innovate and find more sustainable options to displace gasoline, heating oil, diesel, jet fuel, and plastics, oil should lose its standing as a barometer for economic growth.  A market will still exist for oil, but the glory days are over.

The ushering in of a new era free of fossil fuels (which is what we believe is happening) has tremendous ramifications for the world’s economies and societies.  Think about it for a moment.  Energy is at the foundation of everything.  You can’t do anything without it.  Fossil fuels served as the main catalyst responsible for the Industrial Revolution and can be credited as the essential ingredient to “fueling” two full centuries of global growth and innovation.  This contribution cannot be understated.  So when we talk about the inevitable transition away from fossil fuels, we are talking about something so revolutionary, so transformational, it is almost difficult to fathom.  Thankfully the technology is here and continues to improve and scale, governments are on board, we have consensus across all generations (with particular emphasis on millennials), and industries are in the process of adjusting.

We are not suggesting the transition will be free of casualties.  Rather we are certain this transformation will subject the market to heightened volatility, similar to what we’ve already witnessed in the first few weeks of this year.  Particularly for those economies that are highly dependent on oil export revenue as a % of their GDP and as a source of revenue to finance fiscal expenditures, what will the eventual loss of revenue mean and how will these economies and societies adjust going forward?  What will happen to the economies of trading partners to these countries, as well as industries that have long been supportive players in the fossil fuel ecosystem?  Tackling these and many other questions will inevitably cause uncertainty in the short term.

But these are the growing pains that occur when such a dramatic shifts take place.  From torches, to kerosene lamps, to light bulbs, to LEDs, innovation will always force change, but that does not mean governments and companies cannot be ahead of the curve and adjust.  One thing is for sure, change is upon us and maintaining the status quo is not a strategy for the future we envision.  That is a world where major oil producers will one day lead the way in alternative energy.  Can you imagine, capex originally meant for exploration and production being diverted to fund alternative energy R&D?  We are simply presenting this argument for your consideration and that in the end to recognize that we all stand to benefit from a safer, healthier planet.

Andrew Friedman: Founder & President

AJF Financial Services, Inc.

*Securities offered through American Portfolio Financial Services. Member FINRA and SIPC. Investment Advisory services offered through AJF Financial which is not affiliated with APFS. AJF Financial Services, Inc. Is a SEC registered investment advisor.

*Opinions expressed are those of The Writer and AJF Financial Services, Inc., not necessarily those of American Portfolio Financial Services.

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*Securities offered through American Portfolios Financial Services. Member FINRA and SIPC.