Planes, Trains, and Automobiles
Updated: Jul 26, 2018
Trying to figure out what the heck is going on in oil markets, and it’s driving you crazy?
This is the time of year that all of the pundits get all bulled up on oil overanalyze our summer driving season. Except for this year, there is so much more info to overanalyze. Are oil prices going higher? Are they going lower? What does this mean for stocks, travel, blah blah blah? The answer isn’t nearly as simple as determining the short-term direction of oil prices. There is an awful lot going on out there, and I am going to unpack it for you right now.
PLANES: Global supply has remained reasonably stable even though OPEC has cut their production over the last couple of years. Much of resulting shortfall has been covered by new supply coming on line in Iran, Libya, Brazil, and other peripheral producers. The lion’s share of new production has come from none other than the good ‘ol US of A. This is part of the reason why we have seen such a meaningful spread between Brent and West Texas Intermediate (WTI). The US is pumping like crazy and WTI has been lagging quite a bit. This has kept our refined fuel prices somewhat more reasonable than one might expect over the last 6 months. This is why many (not all) of the airlines have not experienced the traditional selloff associated with the increase in oil prices. Airlines that have invested in modernizing their fleets, maximizing efficiency, and actively hedged their fuel costs may be positioned to weather higher oil prices for a longer period of time.
Final thought: For certain types of investors, this is a subsector of the industrials that may be worth a look.
TRAINS: We just covered the basics on global supply. Obviously, the constant geopolitical posturing and flip-flopping makes production targets seemingly irrelevant, so we are going to focus on some concrete information regarding infrastructure. Going one step farther down the line after the black stuff gets pulled out of the ground, the unbelievable production from the US has caused transportation issues and massive supply chain choke points. We could fix all of this by crisscrossing the US, Canada, and Mexico with all sorts of pipelines; however, there is always somebody that is sad about something when it comes to infrastructure development. Since the left is worried about the environment and the right is worried about corporate profits, and both sides are worried about inflation, where do we go from here? Simple answer, choo choo. Our rail system isn’t exactly state of the art, but it is pretty much everywhere. This oil supply increase has forced producers to go old school and use rail as a major mode of transportation. Since the US is increasingly exporting, our refineries are almost exclusively near major ports of industrial transport. The rail systems have been moving stuff to and from these ports since the beginning of time, and transporting oil is no different.
Final thought: If you have exposure in this space, it may be a good time to evaluate whether or not it makes sense going forward. More importantly, you ought to develop a thesis on where energy transportation is going in the future and who will benefit from it.
AUTOMOBILES: The internal combustion engine is dead! Just ask Elon Musk (more on that in a future post). All I have to say to that is “FAKE NEWS!” Second(ish) world countries are seeing massive increases in what they would consider their middle class. From South America to India and China, incredible numbers of people are clawing their way out of poverty and moving away from a subsistence lifestyle. Other than cigarettes and roofs made out of something other than tin, their first major purchase is often a two or four-wheeled vehicle, powered by, you guessed it, a prehistoric dinosaur vaporizing engine. Until we can manufacture electric cars for a thousand bucks, people will need to go to the pump to fill up. This brings me to my next point. Historically, year over year oil consumption goes up about 1.3-1.4% on a global scale. Global consumption is increasing at nearly 2% as you are reading this. On the surface that may not seem like much of an increase; however, that is a 30-40% faster pace than historic averages. To compound this, we are on pace for a year over year decline in total production. Let that marinate.
Final thought: While you may be thinking about researching automobile companies, remember that the type of car they produce, the continuity of their supply chain, and their global distribution networks are probably more important factors to consider than their unit profit margin.
That was 5 minutes of your life that you are never going to get back. On the bright side, at least you know what’s going on in oil markets and how other industries are affected by changing energy costs. That’s what I’m here for… To provide conversation topics that people won’t know how to argue with you about.
1. Any opinions are those of the author and not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice.
2. West Texas Intermediate (WTI) crude oil is the underlying commodity of the New York Mercantile Exchange's oil futures contracts. The major difference between Brent Crude and West Texas Intermediate is that Brent Crude originates from oil fields in the North Sea, while West Texas Intermediate is sourced from U.S. oil fields. Brent Crude is more ubiquitous, and most oil is priced using Brent Crude as the benchmark.