Kyle Macintyre - The Future of Oil
As more people resume travel following the pandemic, demand for oil is expected to rise…the world will need more oil from the same companies currently being told to limit spending, as many investors shun the fossil-fuel industry. Today my guest talking about the price of oil and what it all means is Kyle Macintyre from Firetrail Investments Kyle believes that in spite of the move to green energy and electric vehicles, and the pressures of ESG investing, that the price of oil is heading upwards.
"Where things start to get really interesting is that history shows that the prices of commodities are set by the supply and oils are a really unique commodity in that it's actually driven by pressure and you actually get declines in supply when you don't have continued investment in oil." – Kyle Macintyre
Kyle is an Investment Director at Firetrail Investments. His primary responsibility is providing investment and portfolio insights to professional investors. Kyle is also member of the Firetrail Investment and Management Committees. Kyle is an MBA graduate with over 10 years relevant investment and SME experience.
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Philip Muscatello (0s):
G'day and welcome back to Shares for Beginners. I'm Phil Muscatello. As more people resume travel following the pandemic, demand for oil is expected to rise. The world will need more oil from the same companies currently being told to limit spending as many investors shun the fossil fuel industry. Today, my guest, talking about the price of oil and what it all means, is Kyle Macintyre from Firetrail Investments. G'day Kyle.
Kyle Macintyre (24s):
Philip Muscatello (25s):
So it's been nearly two years. I was just looking up. It was September 2019 since you were one of my first guests on the podcast.
Kyle Macintyre (32s):
Yeah, no, it's good to be back. It's been too long between drinks.
Philip Muscatello (36s):
It sure has. So Kyle, you believe that in spite of the move to green energy and electric vehicles and the pressures of ESG investing, that the price of oil is going to be heading upwards. Tell us about that.
Kyle Macintyre (49s):
Yeah, that's right. I mean, I suppose if you take a step back and you think about what drives commodity prices or what drives energy prices, it all starts with supply and demand. And we obviously do a lot of work on supply and demand at Firetrail. And when we look at our forecast, looking forward over the next decade and beyond, even factoring in for things like the move to green energy and to electric vehicles, we do believe demand is going to remain robust. But where things get really interesting when you speak about oil, or when you speak about energy and in particular old energy, is on the supply side, which we'll dig into today.
Kyle Macintyre (1m 35s):
And I think the supply crunch that's coming is going to cause higher commodity prices, higher energy prices in particular for oil over the medium term. Think over the next 5 to 10 years.
Philip Muscatello (1m 48s):
Before we get into that, it's just interesting to reflect, as well, is that oil is not just for putting in your gas tank. There's plenty of other uses for oil as well. Isn't it?
Kyle Macintyre (1m 57s):
Yeah, that's that's right. I mean, when I think about oil, it is predominantly a transport fuel, but it's not just used for filling up your car. You know, cars would make up around about a quarter of oil demand today, but then you've got things like chemicals make up around 30% of oil demand. So I think things like plastics, oils
Philip Muscatello (2m 17s):
Yeah, plastics are basically oil aren't they? Oil products
Kyle Macintyre (2m 20s):
That's exactly right. But then you've got other methods of travel where there aren't really any alternatives to oil at the moment. So think things like shipping, think aviation, think trucking and then there's still a small amount of oil used for traditional power and energy needs. You know, oil is still burned for either heat or to turn into electricity as well. So it's pretty broad, but yet cars only make up about a quarter of oil demand and then you've got the mix of the rest coming through there.
Philip Muscatello (2m 48s):
So how do you think the transition to electric vehicles and green energy is going to look like for fossil fuels? I think there's a lot of people at the moment who think that it's going to be like a very hard switch and about two or three years time.
Kyle Macintyre (2m 60s):
The fact is, Phil, that electric vehicles are coming. They're coming and if you're investing in oil or you're considering an investment in oil, you know, you need to factor that into your forecast on the demand side of things. You know, based on our analysis, over the next decade or so, EV sales will probably represent around 40% of car sales by 2030. So that's a pretty material shift and it's only nine years away. And it factors in things like early adopters: like the EU is obviously leading the way, the US is a bit of a laggard and in Australia we're a real laggard, you know, less than 2% of car sales are actually EVs. But interestingly, when we model it out, despite those EV concerns, we actually expect oil demand to increase out until 2026.
Kyle Macintyre (3m 47s):
And as I mentioned before, you know, car transports around 25% of that oil demand and that will fall. But the rest will be made up from things like chemicals, shipping, air, travel, farming all staying constant, or actually even growing marginally. And it's really interesting. You look at the developed nations. Obviously they've hit peak oil, but the developing nations are still pretty big consumers of oil coming through. So that's where I think things are pretty interesting on the demand side. That, I think, would be counted consensus sort of seeing robust oil demand over the next 10 years. Where things start to get really interesting, that I mentioned before, is that history shows that, you know, the prices of commodities are set by the supply and oils are a really unique commodity in that it's actually driven by pressure and you actually get declines in supply when you don't have continued investment in oil.
Kyle Macintyre (4m 41s):
So as an example, an oil well will deplete by around 5-7% per annum without continued investment in maintenance, capex going in there. So you do need to invest in oil and gas assets to maintain current supply. And you actually need further investment in oil to meet even flat demand going out to 2030. And the fact is oil investment has been in decline over the last seven years. Investment in oil and gas capex has more than halved since the peak in 2014. And so, you know, we're in the middle of a supply crunch right now.
Philip Muscatello (5m 16s):
Where's that coming from? Where's the capital expenditure not happening. Why is that?
Kyle Macintyre (5m 20s):
Yeah, it's a, it's a good question. It's, it's actually really broad based when you look at it. And I suppose when you go through the history of what's happened with oil, you actually had a bit of a revolution in the US where new technology, in particular fracking, which is basically where you drill horizontally when you found, found an oil well, and it becomes a much more efficient way to take oil out of the ground. That's absolutely increased supply in the US. But what we've seen globally is that investment in oil supply has been in decline across the board. So whether its in the US where you've seen the oil rig count drop over 60% over the last four or five years, or whether it's looking at offshore expansion.
Kyle Macintyre (6m 9s):
So I suppose if I, if I take a step back and you think about where oil comes from, that's probably one of the most interesting places to start when you think about oil supplies. So, if you look at the oil market, it's around a hundred million barrels per day out there in terms of the oil market, you've got around 17% of that comes from the US. So they're actually the world's largest producer of oil. And then you've got around 30 million barrels or so come out of OPEC. So that's the Saudis, the Middle East, but then you've also got Russia in there as well. And then the balance is, is sort of rest of world. And it's a really long tail. You know, you've got countries like Canada in there and a bunch of other smaller nations that make up the rest.
Kyle Macintyre (6m 56s):
But out of all that, there's a number of really big players in the oil and gas market. You know, Exxon would be one of the big ones, BP, Shell, et cetera. And what you've seen is their willingness to invest has been reduced and it's been reduced because of two key reasons. The first key reason is that their investors have had enough of poor returns. So the capital flow towards traditional energy products is moving away and shareholders have said, Hey, we've had enough of pretty poor returns. And to put that into context for you, you know, you look at one of the world's largest oil companies, Exxon. You look at their annual reports over the last eight years and their return on capital. The return that investors have been getting has been around 6% and that's over a period where the oil prices averaged around $68 a barrel.
Kyle Macintyre (7m 42s):
So the returns have been pretty anaemic and investors have said that they've had enough of low returns and rather than focus on investing in new projects. What they're saying to these big oil and gas majors is give us the dividends so that we can invest that somewhere else. And we can get a better return on capital ourselves from those dividends and stop investing in new energy projects, because they aren't really worth the return on investment you're getting from them. The second thing that's driving it is this push to renewables. So having a look at BP's latest annual report, their 2020 annual report, and I'll read this out verbatim for you: "relative to 2019, we expect our hydrocarbon production to be around 40% lower by 2030."
Kyle Macintyre (8m 26s):
Now that's been driven by the shift to renewables by the fact that they're getting lower returns. You look at the European Union, they're looking to stop funding oil, gas and coal projects by the end of 2021. So that cuts around $2 billion of yearly investments from the European Investment Bank out of there. So, I think to summarize it, what's driving it. It's being driven across the board, but shareholders in energy companies are getting sick of poor returns, similar to what we've seen in other industries. Things like iron ore here in Australia, you know, capital discipline is coming into the market. You know, shareholders are sick of poor returns, both in the us, but in global projects. And so they're saying we want higher returns on capital, and we're not going to put up with lower returns.
Kyle Macintyre (9m 7s):
And then a focus on environmental impacts is really accelerating that supply crunch. And it's really what's caused that halving a global oil and gas CapEx globally since 2014.
Philip Muscatello (9m 15s):
And it's interesting as well, Kyle, I was talking to another guest about this and there's that on a, an adjusted basis. The price of oil today is about the same as what it was in 1910.
Kyle Macintyre (9m 26s):
It's absolutely amazing. I was actually looking at that longer term chart before I popped on today. Yeah, it's, it's amazing now that the price of oil, you know, in, in the mid seventies. But still, I think this drive towards renewables is still going to be one of those big driving forces that will stop investments in new energy projects moving forward and with relatively robust demand and declining supply, you know, the natural response to that will be a period of higher energy prices over the next five or so years.
Philip Muscatello (9m 56s):
Oh well, we'll get to that, but also in terms of the transition period that we're going through, oil and gas companies are pretty intertwined, aren't they?
Kyle Macintyre (10m 4s):
Yeah, they are.
Philip Muscatello (10m 4s):
And gas is presumably one of those transition technologies as lower carbon, but provides a lot of backup around the world for renewable solar and wind.
Kyle Macintyre (10m 16s):
Yeah, that's that's right. I mean, you know, they've got a lot of similarities, you know. They're both energy commodities and they're both, uses fuels. I suppose if I had to take step back and, and separate the two, I think of oil as more of a transportation fuel and I think of gas as more of a power fuel, so use for electricity, for heating. It obviously has broader applications, but that would be the difference. But the price is definitely interrelated. And traditionally what you've seen is, is what's called an inter commodity spread between the two. And that's the change between the price of the two commodities in relation to other. And I suppose historically, the reason you have that into commodity spread is that when one becomes more expensive, people would switch and start to use the other, right?
Kyle Macintyre (11m 1s):
So it's a pretty rational response, but you also find that those two commodities, oil and gas, that many companies produce both. Because in terms of production, when you're looking at natural gas or crude oil exploration, they're usually found in similar sorts of areas and the capture of natural gas can actually occur as part of the oil drilling process. So it's actually quite reasonable that they're linked and put together in terms of thinking of gas as a transition fuel. I'd say it depends, it depends who you talk to. And it depends on what your view is with regards to getting toward net zero. I mean, our view at Firetrail and the way we invest is, you know, the move towards net zero is happening and natural gas is obviously a larger emitter, but I think absolutely to your point, Phil, it is going to be used as a transitionary fuel.
Kyle Macintyre (11m 51s):
And when you look at it versus alternatives, so say things like coal, natural gas emits around 50% less CO2 than a coal fired power station for single unit of power. So a pragmatist like me would say, you know, it's going to be a better buffer while the world transitions towards renewable energies. And it also has lower emissions than things like diesel and gasoline. So, you know, in terms of the whole mix, in terms of older energy, well it's a cleaner source, but not the perfect solution. But during that transition, you know, we're a long way to go, in my view. You know, and that transition will require, in my view, a combination of current renewable technologies, new technologies that haven't been developed yet and some of these old energy sources we've been discussing coupled with something like a carbon capture or an offset to bring it down to being carbon neutral.
Kyle Macintyre (12m 39s):
So I still think over the next two decades, I agree with you, Phil, it's going to be an important part of the energy transition mix that's for sure.
Philip Muscatello (12m 45s):
Talking about all these forces that are now acting on oil supply, you then think that we're in for a period of higher oil prices. How does that look? What is a world with higher oil prices going to look like?
Kyle Macintyre (12m 59s):
Yeah, for sure. I suppose the only thing I think is I actually think it's just going to be an inevitable part of what we're going to have to deal with over the next 5 to 10 years. In terms of an investment perspective, I wonder if there becomes a catalyst for there to be new investment coming in, but because there is such a lag, even in the U S right? So in the U S where you've got fracking, it's a much simpler process and you can actually plug a well in the US and then you can come back to it and open it back up. But even there, it takes around six months for a new rig to come back online. And you have a really good look through for those projects coming in, but that's not going to be enough to move the dial over the medium term in terms of oil supply coming back online, what you need is some of these bigger projects to be invested in and to take off.
Kyle Macintyre (13m 48s):
And you just haven't seen the capital moving towards those bigger projects. And, you know, you can understand why when you've got a 10 to 20 years sorta lead time for some of these big projects, and you're sort of learning with, with EVs et cetera
Philip Muscatello (14m 2s):
And there's pressure, so much pressure coming along, you know, large hedge funds and investment managers, just not wanting to invest.
Kyle Macintyre (14m 8s):
Exactly, people just don't want to commit capital to it. Governments reducing the costs of renewables and basically funding for renewables coming up the curve, but it's also accelerating this issue. So I just think it's going to be an inevitable part of life over the next five to 10 years.
Philip Muscatello (14m 25s):
Higher oil prices
Kyle Macintyre (14m 26s):
Higher oil and gas prices. Yeah. But I haven't thought about what the consequences for, you know, the normal everyday person is. It's just going to be higher prices, I think.
Philip Muscatello (14m 35s):
Yeah I mean, we haven't all got EVs yet, so it's going to be a bit of a shock when you go and fill up the tank.
Kyle Macintyre (14m 41s):
And maybe what it does is it helps to accelerate some of this transition towards EVs, et cetera, coming through and makes them more affordable. And that, I suppose, is one of the positives from a higher energy price over the medium term is it will allow other technologies that are lower cost to come in and be replacements. I suppose the key question is, you know, what do you do for those segments of the economy, where there are no replacements. And shipping is a great example where, you know, you just could not run a massive ship on anything other than, I suppose, nuclear, which is what you use in subs. But yeah, I think it's just going to be a higher price for a lot of things, which you are seeing at the moment.
Kyle Macintyre (15m 22s):
You know, you're seeing an inflationary impact that maybe it has a longer term inflationary impact on the underlying cost of moving goods around the world, et cetera.
Philip Muscatello (15m 30s):
So in terms of investment then, are you're looking at this as an investment opportunity?
Kyle Macintyre (15m 34s):
Yeah, we, we absolutely are. We're looking at it as an investment opportunity over the next 5 to 10 years. And I suppose the key thing for us is whilst investors are moving capital away from some of these energy companies and these older energy cell companies. What we've seen historically is that share prices will in the end follow the earnings of the business. And in Australia in particular, you know, there are some great high quality oil and gas companies that you can get access to. And interestingly, in the Australian market, whilst the global peers have actually moved in terms of their share prices with the move in the oil price you've seen from, you know, $45 just a year ago to $75 US a barrel today.
Kyle Macintyre (16m 22s):
You actually haven't seen that same move in the Aussie peers and they're underperforming by anything from 20-30% the global peers at the moment
Philip Muscatello (16m 29s):
The actual share price of those particular companies. Is that what you're saying?
Kyle Macintyre (16m 32s):
That's right. The Aussie listed oil and gas majors have been underperforming the global peers by around 20-30% over the last 12 months. So I guess the question as an investor is, you know, is that an opportunity to buy these companies at a discount to their global peers? Or is the Australian market seeing something that the global market isn't? Are there bigger risks in these oil and gas majors than what the global market is pricing in? My view is, you know, the global peers are accurately reflecting what's happening rationally in the price. A lot of these businesses are really well leveraged to increases in the oil price, and you see a pretty material increase in free cash flow in an oil business when the oil price is $30 higher than where it was 12 months ago.
Kyle Macintyre (17m 15s):
And so that should be reflected in the underlying valuation. So we're definitely seeing it as an investment opportunity.
Philip Muscatello (17m 22s):
Yeah, it's a really interesting dynamic with the ESG pressures at the moment. Because in one sense, there's a lot of money that's not going into investing in these companies. I mean, I do own a couple of oil producing companies in my portfolio. And also if you hold an ETF, you're automatically going to be owning some of these and you look at the share price and you go, they've just done nothing for a year or so. Do you think that is totally ESG pressure?
Kyle Macintyre (17m 49s):
I do believe that it is. I mean, I suppose when you think about the Australian market relative to the global peers, and it is just in Australia that you've seen the oil and gas majors underperform the move in the oil price, I suppose you've got a really large superannuation industry here, and you are seeing a big push towards ESG style investing. So that could be weighing on the underlying share prices of those oil and gas companies. But yeah it's interesting to see when you see that period of underperformance. And generally what you've seen historically is that when our market is lagging, a global market or vice versa, you do tend to see a catch up and you do tend to see that start to play out.
Kyle Macintyre (18m 33s):
And it can just be supply demand dynamics being that there are more sellers than there are buyers at a certain point in time. And that could be the case with what we're seeing here in Australia right now. And potentially it's creating an opportunity to buy assets that are currently undervalued versus their global peers. But I do think that the ESG element is weighing on the share prices at the moment, or, you know, that is what my gut is telling me.
Philip Muscatello (18m 59s):
Although interestingly, just as I was researching this morning for our discussion, and I was looking at the share registries and the ownership of a couple of the oil majors, and it is still large superannuation companies, large listed investment companies, a lot of the ETF providers. You know, it's those large institutions that still have a big holding and own these companies.
Kyle Macintyre (19m 21s):
Well, they're a big part of our index. When you look at the ASX 200, you know, energy is still a large part of our market. And I suppose if you're trying to replicate the index, which is what a lot of these ETFs and large superannuation funds are doing, then you are going to have a large allocation towards energy towards commodities and towards more cyclical style assets in the Australian market. And, you know, it is a pretty unique feature of the Australian market is that it is generally overweight commodities and energy companies. So it makes sense that they are big owners. What we are seeing more and more of is a push towards excluding certain industries, certain sectors, you know, you've seen it globally with tobacco style companies.
Kyle Macintyre (20m 2s):
And so, you know, potentially there is a push towards that here in Australia. Although I think when you think about energy, people tend to be a little bit more pragmatic when it comes to energy and energy markets. Given that there is a transition going on and in the interim, we are going to have to make good with the fuel and energy sources that we've got. But it's an interesting debate. You know, it's one that we have internally in the team is how long this plays out. You know, we often talk about the potential for stranded assets, et cetera, coming through. And it's just something that you need to reflect in your valuation is the fact that, you know, in 20 to 30 years, time oil may not be as big a part of the energy mix as it has been in the past.
Kyle Macintyre (20m 43s):
And you need to factor that into your evaluations. But I think looking out over next 5 to 10 years, it still looks like a compelling space for us in our view.
Philip Muscatello (20m 52s):
During each of these episodes, I always like to focus on one particular piece of jargon that listeners may not understand. And today we've been talking about commodities. Tell me about your definition of a commodity.
Kyle Macintyre (21m 4s):
Well, the advantage I've got Phil, which I always think that I've got, is that I am a layman. And so I'm pretty good at turning things into layman's terms. But when I think of what a commodity is. For me, it is something, a raw material, or it could even be an agricultural product like oil, copper, gold, or even coffee, that goes into making something. So, you can use it, it can be bought and sold. It's a raw material. Yeah. It's an input. And generally these inputs can be turned into something that can be sold and that you can add value to as an output. But for me, yeah, it's a raw material and it's an input.
Philip Muscatello (21m 44s):
And how do people gain exposure to commodities. Like you can buy, for example, gold, you could buy gold directly, or you could buy a gold producer. There's various ways of doing it, isn't there?
Kyle Macintyre (21m 54s):
Yeah, that's, that's right. Yeah. You can even buy synthetic versions and derivatives of these different commodities coming through. You know, there are commodities exchanges. At Firetrail, you know, we look to get exposure through the underlying companies. That is my preference, because let's say you're looking to gain leverage to an improving gold price. You know, there's nothing more leverage to an improving gold price than a gold company.
Philip Muscatello (22m 19s):
Yeah. The price of gold goes up and the price of the company goes up even greater.
Kyle Macintyre (22m 22s):
The company is selling gold. And so when you've got pretty fixed costs and the price of gold is going up. If you want to gain leverage to that, then potentially the best way you can do that is by buying the company that sells the underlying commodity. So, you know, we like to keep it pretty simple at Firetrail and just buy the company that's selling the underlying commercial.
Philip Muscatello (22m 40s):
Yeah, it's interesting that you mentioned also about synthetics that's when you're not actually buying the physical product. And is that what happened last year when the price of oil went, what was it, minus $35 at one stage?
Kyle Macintyre (22m 51s):
Yeah, that's right.
Philip Muscatello (22m 52s):
People would pay you to take oil away.
Kyle Macintyre (22m 54s):
Well the issue and what happened there was people will trade these commodities on an exchange. But what actually happens is when you trade a commodity on an exchange, you can either trade it synthetically where you don't hold the underlying asset itself, or you can trade it physically where you do have an ownership of the underlying asset. And really interestingly, during that period, during March where the price of oil went negative, you had a bunch of traders who were buying underlying holdings of physical oil, but they had nowhere to store it. Once they'd purchased it, there were no buyers on the other side.
Kyle Macintyre (23m 34s):
And so they were doing anything to try and get rid of this oil. Because, you know, it had come due and they needed to store it somewhere and there was just no storage, the oil. So you just had four sellers in the market at hugely discounted prices because there was just nowhere to store the oil coming through. So it was an interesting quirk in markets during that time. And as you saw, the oil price actually went negative for a while there, and people were paying you to take oil.
Philip Muscatello (24m 2s):
That was the time to fill the tank, wasn't it?
Kyle Macintyre (24m 4s):
Yeah, that's exactly right. I know I filled my car up.
Philip Muscatello (24m 7s):
So did you want to say something about Firetrail?
Kyle Macintyre (24m 10s):
Yeah for sure. Well, if you want to learn a bit more about Firetrail and how we invest, you can visit our website, www.firetrail.com. You can also visit our LinkedIn for Firetrail Investments. And I'm obviously always putting things out there on LinkedIn about our different investment views and different ideas. So, yeah, we've got plenty of good material on our website for people who are interested in investing.
Philip Muscatello (24m 34s):
Kyle Macintyre, thanks very much for joining me today.
Kyle Macintyre (24m 35s):
Thanks for having me.
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