By Alex Kimani
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. 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.
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.