The Fuse

Short-Term Thinking in Oil Industry Collides With Broader, Long-Run Transportation Vision

by Matt Piotrowski | June 30, 2017

During the past several years, after oil prices collapsed and did not rebound swiftly, the industry, and the oil market as a whole, was forced to shift its outlook and investment strategy. Capital expenditures on big projects were cut, OPEC has tried to lift prices by throttling back after pumping all out, hedge funds have embraced bearish sentiment, even oil majors have moved resources to short-cycle shale plays that give quick paybacks, and the futures curve is trading below $50 per barrel through the end of 2020. All of this reflects short-run thinking throughout the oil market. This mindset is, of course, dangerous in that the oil market 3-5 years from now might look far different than today’s.

Today’s short-run strategies in the oil industry contrast sharply with what’s transpiring in the automotive sector, where the race toward autonomous technology and alternative fuels is accelerating and providing a glimpse of what the future might look like.

Short-run strategies in the oil industry contrast sharply with what’s transpiring in the automotive industry, where the race toward autonomous technology and alternative fuels is accelerating.

Both the oil and car industries are cyclical, require deep capital investments and long lead times, and are impacted significantly by global macroeconomic forces beyond their control—with the financial collapse of 2008-9 hitting demand in both industries as the best example. The differences between the two industries, however, are unambiguous. A glance at research and development shows differing priorities. From 2013-15, the six top oil companies all cut R&D, with BP slashing the most, by 41 percent. Oil producers have always touted technology as a main factor in solving industry problems, including reducing costs, producing hard-to-find reserves, and reducing environmental damage, but today’s price environment has forced budget cuts, limiting opportunities to innovate. From 2006-14, the oil-field services sector was ahead of producers in R&D investments, leading to increased innovation, such as hydraulic fracturing. Analysts lament that all across the upstream industry, whether among the majors, shale companies, or OPEC, there is a lack of longer-term planning and investment. The limited R&D comes at a time the industry is now coming off two straight years of declining outlays in exploration and production.

The auto industry boosted its own R&D by 6 percent from 2013-2015, spending over $100 billion each year

By contrast, the auto industry boosted its own R&D by 6 percent from 2013-2015, spending over $100 billion each year. In fact, its spending on R&D rose by a massive 53 percent since 2010 when it sank after the financial crisis. According to PWC, in a study published last year, the auto sector’s R&D spending ranks third behind computing/electronics and healthcare. Its R&D intensity, spending as percentage of revenue, is at 4 percent, while chemicals and energy is at less than 1 percent. These divergent trends are likely to continue, with low oil prices undermining the oil industry while a new mobility paradigm spurs increased outlays in the auto sector.

Investment in autonomy is another reflection of increased investment and long-term thinking. There are now 44 tech and auto firms investing in autonomous R&D, and OEMs have accelerated its number of deals with startups, investors, and other corporations in order to become mobility companies (see graphic below for the amount of activity over recent years).

big-auto-tech-timeline-august-2016-1

Challenges ahead

Moving forward, the two industries will continue to be defined by the challenges that they’ve dealt with over the past several years. For instance, shale producers helped drive the price collapse that has imperiled them, and they are nervously watching a similar scenario play out during the current price downturn, which could force them to lay down rigs again. Petro-states will have to balance austerity and commitments to upstream investments, and choose between cutting back to support prices versus fighting for market share. Measuring geopolitical risks is another challenge that plagues the oil industry. They are not impacting prices now but could eventually cause a paroxysm when the fundamental outlook changes. For IOCs, many have to navigate in unstable countries and make decisions on long-term conventional investments while also pleasing shareholders.

Automakers are adjusting to competition from tech companies as they are worried about becoming the Blockbuster (defunct and bankrupt) or Foxconn (manufacturers without creative input) of their own industry.

Meanwhile, automakers are adjusting to competition from tech companies as they are worried about becoming the Blockbuster (defunct and bankrupt) or Foxconn (manufacturers without creative input) of their own industry, with analysts saying that “peer pressure” is motivating companies to invest more, recruit top talent, expand into new markets, and build partnerships with mobility and tech services. Their big bet is that consumers’ preference will change over time and they will be ready when this shift occurs, unlike the oil sector, which is making decisions on the whims of the current market and may not be prepared for a future deficit. But auto companies will have to continually adjust to fuel efficiency mandates and other regulations, shifting demographics, and a possible decline in personal car ownership.

Although auto companies are forward looking in their strategies, they face the challenge of finding growth in the short term. The industry in the U.S., for instance, has seen seven straight years of growth, with sales last year reaching a record. Some forecasts suggest that sales have plateaued in some mature Western markets and they are set to stagnate in the U.S. and all of North America for the rest of this decade. “We are now entering a post-peak era,” Michelle Krebs of AutoTrader told The Fuse. Because of the slowdown in the U.S., competition will become more aggressive, particularly if new players, most notably Tesla, can eat into market share of the incumbents. Automakers also don’t want to miss out on markets where demand will grow, such as China. While China provides opportunities for growth, it is also fiercely competitive and some companies may not be able to keep up with rivals or established domestic players. In sum, auto companies have to “straddle two worlds,” Krebs said. They have to focus on short-term discipline in order to sustain profits, but they also need to make investments for the autonomous, electric, and connected future even though they don’t know when paybacks will come.

IHS

Peak demand in the back of everyone’s mind

The divergent paths of the two industries come with caveats, of course. In the oil industry, a number of companies and oil-producing states are looking to diversify with natural gas and renewables over the longer term as a hedge against demand growth plateauing and eventually declining. The irony, however, is that the less focused oil companies are on producing oil, the greater the chance of underinvestment and in turn a tighter crude oil market with higher prices. “It’s easy to buy into the bearish narrative for the short term, and any talk of peak demand in the long run compounds this bearish sentiment,” Jeff Quigley of Statas Advisors told The Fuse. “Shale is picking up the slack now, but shale is also a distraction from other new global supply. Something has to give eventually. If shale remains the marginal barrel going forward, that barrel will become more expensive and oil will have to rise.”

In the car industry, particularly in the U.S., companies are still leaning toward selling vehicles such as light trucks and SUVs that are less efficient, because of higher profit margins in the short run.

The world still needs massive investment to keep a future price spike from occurring. There are tentative signs now that a supply gap will eventually emerge.

For oil producers, today’s technological advances in transportation have spurred existential issues they haven’t dealt with in the past. During previous oil price busts, a rebound was inevitable given petroleum’s monopoly in the transportation sector, virtually guaranteeing that investments would eventually be paid back. Now, however, oil industry executives are forced to envision a future with an entirely different vehicle fleet, even as some say peak demand remains decades away. But the world still needs massive investment to keep a future price spike from occurring. There are tentative signs—low spare capacity, capex cuts, continued oil demand growth, increased focus on short-cycle plays, turmoil in producer countries—that a supply gap will eventually emerge.

 

 

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