The oil business has had a rough year in 2020, to say the least. The COVID-19 pandemic has forced millions of people across the globe to shelter in place, reducing travel and therefore consumption of oil.
In the first quarter of 2020, the U.S. Energy Information Administration (EIA) predicts that global oil demand will have dropped from 100.7 million barrels per day in 2019 to just 94.4 million barrels in the first quarter of 2020. Some analysts even predict that demand is down 35 million barrels per day in late March and early April, leading to the absolute rout in oil prices that you see below. Strangely enough, the EIA also predicts that global oil demand will jump to 101.9 million barrels per day in 2021, implying a fast recovery. But I think we're seeing that's an optimistic projection, and investors should brace for a structural change in oil markets for years to come.
COVID-19 isn't going away anytime soon
Let's start on the demand side of the equation for oil. We don't know when the U.S. economy or the global economy will return to "normal," but it doesn't appear it'll be anytime soon. In recent reports, the American Enterprise Institute and the Center for American Progress outlined plans for reopening the economy and what to do if and when COVID-19 returns periodically. And neither report is particularly bullish on an economic recovery anytime soon.
The American Enterprise Institute pushes for a regional approach to handling COVID-19 and getting the economy going, triggering into and out of stay-at-home advisories as case counts grow and shrink. The implication is that the U.S. would go in and out of some level of quarantine for the foreseeable future, leading to what it's dubbing the "80% economy." With a vaccine not expected for 18 to 24 months, the ups and downs of the economy could last some time, hurting oil demand as a result.
The Center For American Progress report has similarities but pushes for massive increases in testing and contact tracing. There would also be restrictions on travel and only a slow reopening of parts of the economy. There's no plan for a rapid recovery.
In both plans, it's going to be many months, if not a year or more, before COVID-19 is under any kind of control and the economy can fully reopen again. For oil demand and oil prices, that could mean a rough 12 to 24 months ahead.
How bad will demand be?
The impact on oil demand during our current state of suppressed economic activity is clear. Demand is going to be significantly lower as fewer people travel, and there may not be an end to the decline in demand.
If we just look at some of the more travel-centric uses of oil, we can see a significant long-term reduction in oil demand on the horizon. According to the EIA, jet fuel typically accounts for 7% to 8% of oil demand in the U.S., and demand was down 56% between the week of March 13 and the week of April 3. There's little reason to think air travel will return to any kind of normal anytime in the foreseeable future. No plan to contain COVID-19 will be without suggestions to reduce travel, if not severely restrict it, so reduced air travel alone will be a hit to oil demand for a long time.
Motor gasoline is about 45% of U.S. oil consumption in the U.S. and between the week of March 13 and the week of April 3, demand for motor gasoline dropped a whopping 48%. It's likely that work-from-home policies will be in place for the foreseeable future, cutting down daily commutes and putting a damper on demand for oil that could last for a long time. A near 50% drop probably isn't sustainable, but a long-term reduction of double-digit percentages for over a year isn't out of the question if the distancing policies and travel restrictions outlined above continue.
These numbers are from the U.S., but we're seeing similar trends around the world. Demand for oil is going to be down, and the reduction may last longer than some anticipate.
Just cut supply, right?
If demand is down, the obvious answer is to just cut supply, right? Yes, but that's not as easy as it seems. An expanded cartel known as OPEC+ agreed to cut oil production by 9.7 million barrels per day earlier this week, but even that's expected to leave the market oversupplied.
We don't know exactly what demand declines will look like in 2020, but no country, company, or combination of OPEC+ is preparing supply for a sustained 35 million barrel per day decline in oil demand. And that's likely what's keeping oil prices near $20 per barrel at the moment.
The long-term problem for oil
Short term, oil markets are oversupplied, and we know that demand is down and it'll be a rough year for the oil industry. But the EIA and some investors are still counting on a V-shaped recovery in demand, and that's where I think investors in oil and energy stocks should consider the long-term structural challenges for oil. Competing technologies like electric vehicles aren't going to stop, and that's a problem that's layered.
Globally, passenger EVs accounted for only 2.5% of auto sales in 2019, but the Boston Consulting Group estimates that a third of all vehicle sales will be electric by 2025 as nearly every manufacturer introduces EVs. Tesla is certainly leading the charge, but Volkswagen, Ford, GM, and others will be introducing new models, and then there are new manufacturers like Fisker and Rivian to worry about. That doesn't even account for newer concepts like EV ridesharing from Cruise, Waymo, and others that could upend transportation altogether. Adoption of EVs may slow versus expectations of a few months ago, but all vehicle sales are slowing and I think EVs will continue to take market share even in this tough economic time.
In the trucking market, which includes everything from pickups to semis, electric and hydrogen-powered options are coming as well. Manufacturers like Tesla (TSLA 3.51%), Daimler, Volvo, and Navistar are just a few of the companies introducing electric truck options of different sizes. The industry is early, but McKinsey predicts that by 2030 light and medium-duty trucks will be over 30% market share for new sales in Europe and light-duty trucks will pass 25% market share in the U.S. and China as well. Remember, this isn't just a pipe dream, Amazon (AMZN 3.39%) ordered 100,000 all-electric delivery vans from Rivian last year and companies like UPS and FedEx are starting to order electric trucks as well.
I think there's a structural decline in oil demand coming over the next 2 to 10 years, and that could reduce the possibility of a long-term recovery for oil companies. The short-term outlook may look bad. But long term, I don't think there's much to be bullish about in the oil industry, either.
Oil stocks are already taking a big hit
Financially, oil companies aren't structured to handle extremely low oil prices long term. Below, you can see how some of the biggest producers in the U.S. are faring in the new world. Whiting Petroleum is already bankrupt, but Occidental Petroleum, EOG Resources, Chevron, and ExxonMobil have all seen their stocks crushed. Diversified oil majors are holding up better than most, but they're still down big.
The problem all these companies have is that they've spent billions to increase oil production over the past decade, and now they're seeing the value of that production decrease. It may be hard to make a profit on existing oil wells, much less invest profitably in future production.
Oil has an uncertain future
It may seem unlikely, but the COVID-19 pandemic may be accelerating an energy transition that's been underway for more than a decade. In the short term, companies are going to struggle to make money on new oil wells; in the long term, there's a transition away from oil that's growing in market share. Add the two trends together, and oil stocks may never get back to their former highs.