Electric vehicles are a great story, but energy may be the better investment.
Peak oil demand mystifyingly remains secret to investors
Everybody loves a good story especially when it comes to buying and selling certain themes in the market. This phenomenon is more apparent now than ever as investors herd into those segments telling the best story while selling those that tell a bad one. This type of dualistic thinking is only widening the gap between the have and the have- nots, when in reality the truth isn’t black and white but often some shade of grey.
A great example of this is what is happening with the electric vehicle and oil and gas industries. We don’t think it’s a coincidence that companies such as Tesla are setting new highs pushing the boundaries of euphoric valuations as investors are eager to drink the peak oil demand Kool-aid that is being accelerated by the COVID-19 pandemic.
Adding fuel to the narrative are developments such as California’s recent announcement that it is mandating only zero- emission cars to be sold in the state starting in 2035. The potential impact though is something that shouldn’t be taken lightly, especially given that the state represents more than 11 per cent of total U.S. car sales.
Then you have Walmart Canada’s plan to triple its order for electric semi- trucks from Tesla. In total, it is committed to converting 20 per cent of its fleet to electric power by the end of 2022 as part of a broader goal of complete fleet conversion to “alternative power” by 2028.
While these kinds of lofty ambitions are getting significant attention, we are left wondering just how achievable they really are. California, for example, experienced blackouts this summer due to spikes in air conditioner use — how specifically is it going to handle the incredible demand from the conversion to electric vehicles in only 15 years?
Likewise, a Wood Mackenzie report cited on the website electrek forecast that U. S. electric truck sales are expected to increase to over 54,000 by 2025 — quite the prediction given there were only 2,000 electric trucks on the U. S. roads at the end of 2019. Some industry watchers, including Microsoft founder Bill Gates, have been more skeptical, and have suggested semi- trucks and airplanes may be impossible to efficiently convert to electric power.
We think many are also grossly overestimating the conversion of gasoline to electric and its impact on oil demand. When it comes to its ability to disrupt, EVS are lacking key components needed for scaling including affordability for the average consumer, and the overall lack of convenience and reliability. This could change with new battery technology for example, but this is a bet on something that just hasn’t happened yet.
Moving to the other side of that trade, in all of my years of covering the energy space I have never witnessed the level of pessimism as there is now. Despite WTI oil prices rebounding back to US$ 40 a barrel, U. S. and Canadian oil and gas producers are quickly approaching their March lows.
Here in Canada, Suncor (SU:TSX) is trading only 11 per cent off its low whereas Exxon ( XOM: NYSE) is 10 per cent off its low. For some further perspective, both stocks have lost more than 57 per cent of their value over the past five years. As a whole, Canadian producers as represented by the Capped Energy Index are down a whopping 65 per cent while U. S. producers as represented by the SPDR S& P Oil and Gas Exploration and Producers Index have been crushed losing over 73 per cent of their value in the past five years. Think about this, especially with WTI oil prices only being down four per cent over the same period.
Finally, take a look at the forward curve that currently has oil prices over US$ 46 per barrel out in 2025 and over US$ 51 per barrel out in 2030.
According to Eric Nuttall, senior portfolio manager at Ninepoint Partners, at those prices producers are currently trading at roughly half of their historical Enterprise Value to Cash Flow multiples, which in theory implies they are factoring in forward oil prices half that of what oil futures are currently trading at. If this is the case, it makes much more sense for companies to acquire a barrel than drill for it.
Therefore, this begs the question, if oil commodity investors are not buying into the peak oil demand theory, why are oil stock investors? Only time will provide the answer, but one has to wonder at the potential that exists for those brave enough to take the other side of yet another black and white story.
Martin Pelletier, CFA, is a portfolio manager at Wellington- Altus Private Counsel Inc. ( formerly Trivest Wealth Counsel Ltd.), a private client and institutional investment firm specializing in discretionary risk- managed portfolios, investment audit/oversight and advanced tax and estate planning.