The oil markets were rattled last weekend (and into Monday) when news reports confirmed that Saudi Arabia’s oil giant, Aramco, had suffered attacks at their Abqaiq oil-processing facility. The destruction removed some 5.7 billion barrels a day out of production, which represents approximately half of Saudi Arabia’s total output and nearly 5% of global supply.1

The response in the oil market was nearly instantaneous – the price of Brent crude soared +15% to $69.02 when the market opened on Monday, posting its largest one-day gain since 1988.1

30 years ago, alert investors may have seen this event as an opportunity to enter the energy trade, anticipating that an attack of this size would lead to sustained higher oil and gas prices. And in many cases, they would have probably been right.

But I would argue today that immediate and widespread access to information has made markets far more efficient at pricing these types of supply shock events. The end result, in my view, is a near instantaneous reflection in prices, which totally undermines a strategy of going long energy in the wake of a supply shock.

Another factor that’s much different today than it was 30 years ago is technology. Where an attack of this size may have led to months of supply disruptions in the past, today the recovery times have been narrowed to just days and weeks. Indeed, within a day of the attacks on Aramco, Saudi Arabia’s Energy Minister assured markets that oil output would be fully recovered within weeks, with a target date of the end of September. By Tuesday, Aramco had already restored 50% of lost production, and oil prices retreated back to around $60 a barrel. 1 Trading on the news, in this case, meant only participating in the downside.

The last thing investors must remember is that Saudi Arabia is no longer the world’s largest oil producer. The United States is.3 So, while an attack on a critical oil production facility in Saudi Arabia is no doubt a negative, the United States (and others) have the capability and the supply to keep prices stable – if doing so is the desired result. In this case, the U.S. offered to do just that, but in the end, it wasn’t even necessary.

The United States is the World’s Biggest Oil Producer

Source: Energy Information Administration2

 Another Approach to Energy Investing

Short-term oil shocks make a difference, but long-term supply and demand trends are what drive prices over time, in my view. And that’s where investor focus should be.

When thinking about long-term demand for oil, the key in my view is to look at trends in petroleum and distillate fuel oil consumption. Petroleum is the largest U.S. energy source, and we use petroleum products to propel vehicles, to heat buildings, and to produce electricity. According to the U.S. Energy Information Administration (EIA), in 2017 the consumption of finished motor gasoline averaged about 392 million gallons per day, which was equal to about 47% of total U.S. petroleum consumption.3

Next in line was diesel fuel, which is used to power diesel engines of heavy construction equipment, trucks, buses, tractors, boats, trains, some automobiles, and electricity generators. The EIA says that total distillate fuel oil consumption in 2017 was equal to about 20% of total U.S. petroleum consumption.3

These two sources of consumption—petroleum and distillate fuel oil—account for nearly two-thirds of U.S. consumption today. The question is, where will it be 10, 20, or even 50 years from now?

Recent trends suggest that long-term investors may want to think about a diversified portfolio of energy companies versus an energy allocation exclusively focused on oil. While I’d venture to say that oil will remain the primary energy source for decades to come, the rise of electric vehicles and falling costs of renewable energy sources are a dual threat to long-term profits in the industry.

As you can see in the chart below, the EIA estimates that liquid fuels (derived from oil) should remain the top source for energy use in the U.S. through 2050, but the biggest leaps in market share come from natural gas and renewables. Oil is no longer the only game in town.

Liquid Fuels May Continue Dominating, but Natural Gas and Renewables Should Gain Market Share Over Time

Source: Energy Information Administration4

 Proven reserves for natural gas here in the United States are enormous, and within the renewable energy space, solar and onshore wind turbines saw the largest price declines between 2009 and 2017. Solar panels got 76% cheaper and turbine prices fell 34%, actually making them competitive alternatives to fossil fuels for the first time in history.5

Source: Energy Information Administration5

Bottom Line for Investors

 Oil remains on the top of the energy pyramid, and it is likely to remain there for decades to come, in my view. But oil’s position at the top is far from assured over the long term. Investors should continue to watch trends in natural gas, wind, and solar, particularly as natural gas and wind are seen as the two fastest growing energy sources in the U.S.’s energy portfolio. With rapid changes in technology likely to reduce demand for oil, and with natural gas and wind emerging as viable alternatives, a diversified approach to energy investing makes the most sense for long-term investors, in my view.

Disclosure

1 The Wall Street Journal, September 17, 2019. https://www.wsj.com/articles/saudis-have-restored-50-of-lost-production-energy-minister-11568743711?mod=hp_lead_pos1

2 U.S. Energy Information Administration, April 22, 2019. https://www.eia.gov/tools/faqs/faq.php?id=709&t=6

3 U.S. Energy Information Administration, September 28, 2018. https://www.eia.gov/energyexplained/oil-and-petroleum-products/use-of-oil.php

4 U.S. Energy Information Administration, Annual Energy Outlook 2018. https://www.eia.gov/outlooks/aeo/data/browser/#/?id=1-AEO2018®ion=0-0&cases=ref2018&start=2016&end=2050&f=A&linechart=ref2018-d121317a.30-1-AEO2018~ref2018-d121317a.31-1-AEO2018~ref2018-d121317a.32-1-AEO2018~ref2018-d121317a.33-1-AEO2018~ref2018-d121317a.34-1-AEO2018~ref2018-d121317a.35-1-AEO2018~ref2018-d121317a.36-1-AEO2018~ref2018-d121317a.37-1-AEO2018&map=&ctype=linechart&sourcekey=0

5 U.S. Energy Information Administration, Annual Energy Outlook 2019, https://www.eia.gov/outlooks/aeo/pdf/aeo2019.pdf

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