The Tesla effect: Oil is slowly losing its best customer

Between global warming, Elon Musk, and a worldwide crackdown on carbon, the future looks treacherous for Big Oil.

The rise of Tesla (TSLA) and electric vehicles broadly pose an existential threat to the oil industry. Passenger vehicles are the No. 1 source of demand for oil — and tomorrow’s transportation system may no longer rely on the gas station.

But it’s unclear if long-term investors should worry that the world’s unquenchable thirst for oil will finally be satisfied. No one truly knows when that moment will arrive: Estimates range from a few years to several decades. The timing depends on how many electric vehicles will be on the road, how seriously governments take global warming and a confluence of other factors.

The lack of visibility in the oil industry’s long-term future remains a big risk for investors. Rapidly evolving technology and shifting political winds could hasten the arrival of peak oil well before Wall Street’s estimates. That could cause serious financial pain.

“Look at what happened to the coal industry,” said JJ Kinahan, chief market strategist at TD Ameritrade. “You have to keep that in the back of your mind and be vigilant. It can turn very, very quickly.”

The gap is so wide, Barclays said in a report published this week that oil demand could range anywhere between 70 million and 130 million barrels per day. That either represents a crushing decline from today’s daily demand of 100 million barrels or a strong increase.

“The next 20 years are likely to prove crucial,” Barclays analysts wrote.

Energy investors should remain vigilant.

Damage already done?

Although peak oil demand feels like a long-term threat, its effects may already be evident in the markets.

After oil prices bottomed in early 2016, energy stocks barely budged — up just 14%, as measured by the S&P SPDR Energy ETF (XLE) (over the same time, the S&P 500 has soared 55%). And yet oil prices have nearly tripled.

Investors may already be penalizing oil companies for the long-run question marks looming over the industry.

“A lot of damage has already been done,” said Adam White, an equity strategist at SunTrust Advisory Services, who drives the all-electric Nissan Leaf. “People are jaded towards the industry.”

The timing of peak-oil demand remains the biggest question mark.

An American flag flies on top of a Unit Drilling Co. rig in the Bakken Formation in this aerial photograph taken outside Watford City, North Dakota, U.S., on Friday, March 9, 2018. When oil sold for $100 a barrel, many oil towns dotting the nation's shale basins grew faster than its infrastructure and services could handle. Since 2015, as oil prices floundered, Williston has added new roads, including a truck route around the city, two new fire stations, expanded the landfill, opened a new waste water treatment plant and started work on an airport relocation and expansion project. Photographer: Daniel Acker/Bloomberg via Getty Images

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Reliance on oil will probably peak between 2030 and 2035 if countries adhere to their recent low-carbon pledges, Barclays said. However, the peak could arrive as soon as 2025 — just six years from now — if the world increases its focus on slashing carbon emissions.

Electric vehicle sales have surged faster than anticipated, but they still represent a small portion of overall car sales. That means EVs are hurting oil demand, but they have yet to put a dent in it.

Although electric cars are on the rise, so is demand for petrochemicals used to create plastics. The International Energy Agency estimates that petrochemicals will account for the biggest source of demand growth through 2030.

Here comes the next oil boom?

Oil bulls point to these facts to support the idea that the industry’s future remains bright.

Fears about peak oil demand and a crackdown on carbon have caused a problematic underinvestment in oil development, according to Bob McNally, president of consulting firm Rapidan Energy Group and a former energy advisor to President George W. Bush. He said underinvestment could set the stage for a supply shortage that causes oil prices to spike, potentially driving up oil stocks along the way.

“Investors would be wiser to purchase oil assets at a discount in anticipation of a medium-term price boom,” he said.

There’s also the possibility that the world’s appetite for oil is not nearly close to be satisfied.

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The arrival of millions of people in fast-growing nations like China and India to the middle class could drive up energy demand more than enough to offset the rise of electric vehicles.

“If peak demand doesn’t show up, oil’s next boom price cycle will reward investors who took today’s peak demand hype with a pinch of salt,” McNally said.

Jason Bordoff, a former energy adviser to President Barack Obama, said it’s “unlikely” that oil demand will peak before 2025.

“Even if it did, it could plateau at a very high level,” said Bordoff, a professor at Columbia University.

In other words, demand could remain robust, without a sharp decline that would hurt oil companies.

Peak oil in 2020s

Others warn that buying oil stocks today is dangerous.

Research firm DNV GL estimates that peak oil will become a reality during the 2020s and demand will flat-line through the entire decade.

“By 2030, oil shareholders will feel the impact,” said Sverre Alvik, lead author of the firm’s energy transition outlook report.

Electric vehicles are likely to cause light vehicle oil demand to plunge by nearly 50% by 2040, Alvik said.

Equinor will link executive bonuses to its climate change targets.

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Jens Peers, an executive at Mirova, an ESG affiliate of Natixis, advised owners of oil stocks to get out while they can.

“We do not find them financially attractive today,” Peers said, noting “prohibitively high” regulatory and technological risks.

European oil majors are hedging their bets

Of course, even if oil demand peaks next decade, it doesn’t mean the industry will go away. Analysts said that the winners will be the lowest-cost producers — the ones who can make money even in a world tilted towards electric vehicles.

“There will still be oil companies out there. Some will continue to make money. Others will have to go out of business or transition to other models,” said Peers.

But not all oil companies are the same. Some companies are pureplay oil drillers, with heavy exposure to swings in oil prices. Others, like ExxonMobil (XOM) and Chevron (CVX), produce natural gas in vast quantities. Natural gas, a cleaner burning fossil fuel, helps power the electric grid that EVs plug into.

Although US oil companies are doubling down on their oil footprint, some European companies are hedging their bets. Under pressure from shareholders, BP (BP), Royal Dutch Shell (RDSA) and Total (TOT) have expanded into solar, wind and electric charging as a way to protect themselves from a more difficult future.

The deep uncertainty surrounding the future of oil demand that long-term investors should use caution in this space by carefully monitoring trends and steering clear of companies that are in denial about the future.