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Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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Why Cramer Is Wrong About Oil Stocks

Three weeks ago, Mad Money host Jim Cramer raised eyebrows after claiming that the oil industry was in the “death knell phase” and that “fossil fuel stocks are now like tobacco stocks”.

“I’m done with fossil fuels ... they’re just done. We’re starting to see divestment all over the world,” Cramer said. “You’re seeing divestiture by a lot of different funds. It’s going to be a parade. It’s going to be a parade that says, ‘Look, these are tobacco and we’re not going to own them,’” Cramer opined in his usual fashion. 

In the past, Cramer has received plenty of blowback about his stance on fossil fuels, and this time it was not any different. The polemic by the hard-hitting former hedge funder rubbed many in energy circles the wrong way, with some finding the claims flippant and outlandish. 

One aggrieved respondent was Chevron Corp. chairman and CEO Michael Wirth, who predictably came to the industry’s defense.

Oil Not in Terminal Decline

Wirth said it’s unfair to compare the oil and gas industry to tobacco because oil actually plays a big role in the global economy, while tobacco can be more easily done away with.

“The reality is the world runs on the energy system that we have today,” Wirth said Friday on CNBC’s “Squawk Box”. “I think the comparison to tobacco is not an appropriate one at all. If tobacco use were ceased today, I think the world would be just fine. If we ceased use of all hydrocarbon products today, the world would not be fine, and I think that’s the reality.”

Which is obviously true. 

Tobacco and alcohol stocks are regarded as sin stocks because people will continue to happily consume these commodities even in poor economic cycles--their life-threatening side effects notwithstanding. 

Yet in the global north, the cigarette industry has been in terminal decline for decades now, with sales volumes recently tumbling in the double-digits. Incumbents like Phillip Morris and Altria are only barely hanging on after launching a series of RRPs (Reduced Risk Products) that can replace some of this lost business.  Related: The World’s Top LNG Producer Is In Trouble

Further, tobacco products exhibit lower price inelasticity compared to energy products like oil and gas, meaning demand is more strongly influenced by price. One study done in 28 EU countries found that a 10% increase in the price of cigarettes resulted in a significant reduction in demand. The paper concluded by saying that all EU countries ought to levy higher tobacco taxes in order to increase consumer prices and in effect reduce cigarette consumption.

In contrast, the demand for oil is relatively inelastic with respect to price, mainly because oil has few direct substitutes. Similarly, demand for oil is relatively inelastic with respect to income especially in the advanced economies

If anything, oil demand is still rising mainly fueled by growing energy demand across the globe. 

In 2018, the IEA reported that worldwide energy demand grew 2.3% Y/Y, the fastest pace over the decade. Fossil fuels met nearly 70% of that demand growth with renewables meeting the rest. 

In 2019, oil demand grew sluggishly during the first half of the year before surging 1.1 million b/d during the third quarter. Supply growth, however, clocked in at more than 1.5 million b/d after Saudi Arabia’s situation normalized, which in effect kept the market oversupplied. 

The IEA sees oil demand continuing to grow into the 2030s, while peak oil forecasts--the theorized point in time when the maximum rate of extraction of petroleum will be reached before entering a terminal decline--range from the early 2020s to the 2040s.

It’s quite evident that what’s ailing the oil and gas industry is not dramatically lower consumption--as is the case with the tobacco industry--but rather persistent oversupply mainly due to American shale. 

Can Oil Bounce Back?

Wirth made a bold prediction that the sector can and will recover, and that the stocks will head higher once again.

“We’ve been in a rough period of time. Commodity prices had a historic collapse last decade. They’re still very low because we’ve got a well supplied market, and I think companies have had to re-size their investments accordingly,” he said. Related: The New ‘Must-Have’ For Energy Hedge Funds

Like everyone else, we do not have any timelines when that might happen. However, It’s blindingly obvious that supply/demand imbalances are mostly to blame and the divestments that Cramer is talking about here are likely to persist until oil and gas companies scale down production appropriately, i.e., the big shakeout.

That said, oil demand could be sluggish at the moment but is bound to keep growing in the foreseeable future as the global economy bounces back. 

The clean energy industry is growing at an admirable clip, but not quite fast enough to meet the world’s energy demand, which is growing even faster.

The belief that the fossil fuel industry is about to disappear forever can spook investors more than any old hat bearish argument ever could. However, it’s a big stretch to say that oil has already entered a terminal decline phase akin to the tobacco industry as Cramer has purported.

By Alex Kimani for Oilprice.com

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Leave a comment
  • Warren Bonesteel on February 20 2020 said:
    The author is behind the tech curve.

    hint: What happens to oil stocks when EV's replace 5% of the vehicles on the road? 15%? 50%? 70%?

    This will happen over the next ten to twenty years. Depending on source, 63% - 70% of new car buyers are interested in EVs.

    Also, solar power and battery packs are now replacing peak plants on the grid.

    e.g. 46% of homeowners want solar roofs. Many of them are also interested in Tesla battery packs.

    All of these technologies are now more efficient, more cost effective, and more reliable, than traditional vehicles and sources of energy.

    Do your research. You will see what I mean. ;)
  • Mamdouh Salameh on February 20 2020 said:
    Such talk is intended to curry favour with the divestment campaigners or to draw attention to himself. Either way he is wrong.

    Mr Cramer is well advised to acquaint himself with the realities in the global oil market. There will be neither a post-oil era nor peak oil demand either throughout the 21st century and probably far beyond. Moreover, the notion of an imminent global energy transition is an illusion. Oil and natural gas will continue to be the fulcrum of the global economy and the core business of the oil industry well into the future.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • ALBolo on February 20 2020 said:
    Mr. Cramer, wrong? ....well, let’s be honest this can’t come as a surprise considering the multiple antecedents. The real issue is elsewhere: such comments simply amplify and thus give support to a rampant narrative that end up hitting hard to the necessary funding to an industry that remains, and for long years to come all things being equal, the cornerstone of our economies. Unfortunately, the green washing embedded in the speeches of so many of O&G execs (the BP CEO being the latest avatar of) simply accredit the idea that here is an industry that destroy without adding to the well being of the people. As such it add to the woes of the industry and reinforces the drying up of investment in an industry that it is need of it, increasingly.

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