My recent musings on peak earnings, cyclical industries, value traps, and Chevron got me thinking about the state of the energy industry and whether it is a shimmering opportunity at once-in-a-blue-moon price for entry or a cross-dressing value trap disguised as an opportunity. Everyone knows that the price per barrel of oil has been getting decimated for about a year now – it has dropped over 50% in price since July 2014. That has led to the price of ownership in companies such as Exxon and Chevron to fall almost as drastically, with share prices collapsing ~30% for Exxon and ~40% for Chevron from their peak. What to make of all of this?
In order to arrive at a conclusion, we first need to back up and zoom way out to see the narrative of the big picture. What are the secular trends out into the future to say, 2040, like in Exxon’s energy outlook to 2040.
First, global population is projected to increase by 2 billion people by 2040. It might seem like a bit of a paradox since global birth rates have been dropping. Why will population keep growing? In a nut shell, it’s the momentum created by earlier, higher birth rates that are echoing into the present and the future. If you want more details, check out this great video on global population by Hans Rosling:
Second, along with an increase in overall global population, prosperity is projected to increase resulting in an additional 2.8 billion people joining the middle class. Exxon’s definition of middle class in its 2015 Outlook for Energy means earning enough to have discretionary spending power beyond basic necessities: the ability to purchase durable consumer goods, climate controlled rooms, access financing, purchase homes and cars, etc. 2.8 billion people are projected to move up the income ladder to have discretionary spending power by 2040.
Effects on Energy
With data projections showing overall global population growth and a growing “middle class” with discretionary income to spend, the main secular trend of our generation seems to be: more people with more money. What are the possible effects this could have on energy companies such as Exxon and Chevron?
Demand for energy will rise. That’s pretty obvious once you realize just how much energy you and I spend in the developed world. If we have 2 billion additional people added to the world, with 2.8 billion people rising out of poverty to have discretionary income, there is going to be an overall increase in global energy use.
Even though the developed world will see total energy use actually decrease because of increased efficiency and technology, it will rise for the rest of the world as the 2.8 billion people demand the luxuries of modern life which in turn depend on energy.
What’s interesting is that transportation fuel demand is set to rise, but it’s actually going to decrease for light-duty vehicles, like the cars you and I drive; those are going to get more fuel-efficient.
However, the majority of the increase in transportation fuel demand is going to be from heavy-duty, the trucks and freight moving goods around the economy. This makes sense as 2.8 billion more people will be demanding all sorts of consumer goods with their discretionary income, which have to be transported to the customers. And again, that growth will be coming mostly from the rest of the world outside the developed countries.
There will be more chemcial demand as well to create the plethora of consumer goods in modern society. Companies such as Exxon and Chevron are integrated energy companies and are in the business of discovering, extracting, and processing petroleum. The processing part not only creates all the fuels we use – from jet fuel to gasoline – it also produces the chemicals necessary for making plastics and all sorts of consumer and industrial goods that we find in modern life.
I found this really interesting as it shows what the projected energy sources in 2040 will be. Even though oil and coal demand will only grow at 0.8% and 0.1% over the next 25 years, it will still be dominating the energy needs of the world. Green energy such as wind and solar is expected to grow the most at 5.8%, but since they only make up such a small part of the energy picture today, that robust growth will not make a dent to our hydrocarbon energy needs.
Global Energy Consumption
I apologize that this graph is based on data from 2007: I wasn’t able to find an updated graph on world energy flow closer to the present (if anyone does stumble across it, please send me a message). However, for all intents and purposes, I believe this is still accurate enough to reflect humanity’s energy consumption on 2015.
You can clearly see what energy sources dominate humanity’s energy needs. You can peruse the rest of the world in the 2011 report by Lawrence Livermore National Laboratory.
Now for fun, let’s take a look at energy consumption flows for OECD and non-OECD countries, this time with up to date information.
OECD Energy Flows
The United States:
The United Kingdom:
With the exception of France and Iceland, in this small sample of OECD countries, hydrocarbons are by far the dominant energy source. I found Japan interesting as it’s common to hear about nuclear being a big energy source in Japan. But perhaps it’s some sort of mental bias caused by repetitive coverage of the Fukushima nuclear disaster in 2011.
Non-OECD Energy Flows
Countries at the bottom of the economic development rung, like Haiti, still rely primarily on the most ancient form of humanity’s energy: biomass (ie. burning wood for energy). As you start to progress up in economic development, you utilize more efficient and abundant energy sources, such as coal (as India and China have done for the past few decades). From coal you move onto even more efficient forms of energy, such as petroleum and natural gas. You see the pattern?
- Total population will grow by 2 billion more people, from 7 billion today to 9 billion by 2040.
- Around 2.8 billion people are projected to move into the middle class, where they will have discretionary income and higher energy needs.
- Hydrocarbons will continue to dominate humanity’s energy needs by 2040, despite robust 5.8% in wind/solar/biofuels growth and 2.3% and 1.8% growth in nuclear and hydro.
- Based on the energy flows that occur when countries move from developing to developed countries, hydrocarbons historically play a large role in meeting energy needs.
- Even mature, developed countries – outside a few outliers – rely heavily on hydrocarbons.
Based on the data I can see, I don’t see how hydrocarbons are not playing an important role in humanity’s energy needs by 2040. Could some black swan event, such as the invention of some radical clean, renewable energy technology completely change the energy game? Sure it could. But based on the data and evidence I have on hand, it seems more likely that hydrocarbons are here to stay as the dominant form of energy, at least in my lifetime.
So what does that say about investing opportunities in the energy sector? Where on the graph are we:
To leave you with a most underwhelming answer: you need to gather the data and facts and come to your own conclusion.
*A place to start with gathering data on this topic is here.