Has oil had its day?

The House of Commons started its summer holiday on the 20th July, and with that we look forward to a  break from the overindulgence in political stories and events that seem to dominate the news. With the House not set to return until the 5th September, a particular relief will be the lull in articles on the latest political calamity to affect the UK economic outlook and the bearing that it may or may not have on financial markets.
 
With that in mind, we would like to draw your attention to a few stories over the past few weeks. The first was that the Swedish car manufacturer Volvo announced that from 2019, all car models launched will be electric or hybrids. The second story was that France aims to ban the internal combustion engine by 2040.

While they might be fairly small stories in the grand scheme of current ongoing global events, we believe that these recent announcements could be the tip of the iceberg, not only for oil companies, but also for car makers worldwide.
 
Germany is also pushing to ban the internal combustion engine within the next twenty years, with the hope that this will be legally enacted across the European Union within the same timeframes. It may be somewhat surprising that the largest exporter of automobiles is so unconcerned about changing one of the main ingredients for its success. Germany accounts for 19% of global car production. It has a turnover of 404 billion euros, while employing over 800,000 people. It is quite comfortably their largest industry, and the primary reason why they have undoubtedly been one of the biggest beneficiaries of the EU, or more specifically the Euro. By bringing in currency parity across the rest of Europe, it has allowed them to export their main asset across Europe to people who previously could have never dreamed of owning the latest BMW, Audi or Mercedes, to name but a few.  
 
Of course, there is the argument that this is inevitable, due to the harmful emissions produced by the automotive industry and that Germany, like everyone else, has to do its bit to reduce emissions globally. However, a switch to zero-emission cars is likely to put thousands of German jobs at risk, as electric cars only require 10% of the workforce to assemble.

While the automobile industry will undoubtedly adapt to these changes, it is more difficult to see how the oil industry will. While oil is still not set to go away anytime soon, they are already having difficulty with a global supply glut. The Organisation of the Petroleum Exporting Countries (OPEC) has already tried to increase prices by cutting back production. Some will argue that this has not had the desired effect, as it seems that they have only been able to stabilise the price of Brent Crude rather than increase it.  Over the last year, the price for a barrel of oil has bounced around $44 to $58, a far cry from June 2014 when it was $115 per barrel. There are some analysts that don’t think we will ever see $100 per barrel again; with the raft of changes governments and car makers are planning, it is easy to see their point of view.

This is compounded by the fact that previously uneconomic sources of oil, such as heavy oil and shale, are becoming cheaper to extract, which means OPEC has to continue to limit the supply of light oil to keep prices buoyant. If the price of oil increases then heavy oil and shale oil only become more viable, thus preventing any real increases in oil prices to over $100 per barrel. Many oil companies will have to diversify, and indeed some have already started to do so into renewable energy, however many argue that this is not happening fast enough. Even with a depressed oil price, many oil companies can still count themselves as one of the largest companies in existence; and indeed many sit atop their respective indices. Both BP and Shell are still in the top five companies in the FTSE 100.
 
However, you only need to look to the past to see that times do indeed change. Many would say the modern world was created in 1600, when Elizabeth I granted a monopoly of trade to 218 merchants to the east of the Cape of Good Hope. It spawned the East India Company, the first company to offer limited liability to its shareholders and, some would argue that, if it was adjusted for inflation, it would have been one of the largest companies to have ever existed, with a market value running into the trillions. However, despite this, the company paid its last dividend in 1873 and was finally extinguished (admittedly by the British government) in 1874. While the similarities between a company run hundreds of years ago to the big oil companies of today are limited, it shows that all good things come to an end no matter how infallible you think you are.

Furthermore, if they fail to adapt to the changing landscape of future energy demands, they too will find themselves confined to the history books.

In other news, on Monday the IMF cut its growth forecast for the UK economy this year after weak performance in the first three months of 2017. The IMF said it expected the British economy to expand by 1.7% this year, which is 0.3% lower than when it made its previous prediction in April. This slight downgrade has dragged the FTSE slightly lower this morning.

Nevertheless, while it is quiet on the political front, there are a number of company announcements this week which should provide a more accurate picture on the performance of the UK economy, rather than relying on forecasts.  

Guy Stephens, technical investment director at Rowan Dartington

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