This article will not do full justice to the technically complex issue it addresses; what I do hope to accomplish is to give readers a framework for thinking about the issue and being able to respond to the inevitably surprising changes in technology, energy markets, and government policy which will affect the outcome. For energy engineers and consultants, this will probably appear to be ridiculously oversimplified. For most investors, I think it will help clear away some cobwebs.
First of all, it is vitally important to understand why we are on the threshold of major changes in the transportation fleet. Petroleum has always had significant advantages in energy density and ease of transport and storage over the other fossil fuels - coal and natural gas. For years and years, when an oil developer drilled a well that produced both oil and natural gas, he sold the oil and flared the gas. For a time, the above advantages enabled petroleum to sweep the market and capture important parts of the space heating and electric generation markets. Starting in the 1970s, this comparative advantage, as well as certain important geological considerations and geopolitical developments, led oil to command a premium price over the other fossil fuels. In a sense, because petroleum is the "best" of the fossil fuels, it was the one to be used up first.
Years ago, there was a rule of thumb that a barrel of oil was worth 10 times the price of an MCF (thousand cubic feet) of natural gas (comparing West Texas Crude to gas at the Henry Hub). Since a barrel of oil has roughly 6 times the btu content of an MCF of natural gas, even this rule of thumb implied a premium price for oil.
Over the years, the price gap has grown so that earlier this year the ratio was not 10 to 1, but approached 25 to 1. As this ratio has grown, natural gas (and other energy sources) have displaced petroleum in many markets. In the 1970's there were years where 15% of the electricity in the United States was generated by petroleum powered plants; today, it is less than 1% (largely in Hawaii and Puerto Rico). Similarly, heating oil has lost considerable market share to natural gas. Petroleum has become more and more a specialty transportation fuel because its comparative advantage (energy density and ease of transport and storage) is most important in the transportation market where you have to carry around your energy source with you as you travel.
It is, thus, fallacious to argue that the construction of windmills in North Dakota or nuclear power plants in Virginia will somehow reduce oil imports on a btu for btu basis . We aren't using oil to generate electricity anymore; the days of easy displacement of oil imports are over.
The widening gap between oil and natural gas prices creates a kind of arbitrage opportunity to substitute cheap natural gas for expensive oil in the transportation market. There are at least three primary ways to do this - use natural gas directly in the form of compressed natural gas (CNG) or liquified natural gas (LNG), use natural gas to make methanol and mix the methanol in with gasoline, or use electricity generated primarily with natural gas.
Many analyses of this issue assume that the additional electricity used by electric cars will be generated by the same percentage mix of power sources used presently to generate all the electricity in the United States. This is a superficial and misleading approach to the issue. For example, hydro plants and nuclear plants will generally be operated to the maximum extent possible because of their very low marginal operating costs; the addition of marginal demand for electricity due to electric cars will not affect the extent to which these plants are in operation. On the other hand, natural gas is generally the fuel that is "on the margin" and will be used to respond to an increase in demand.
The operating economic advantages of alternate fuel vehicles have become compelling. I have examined a great deal of literature regarding electric cars and, depending upon a number of factors, an electric car travels roughly the same distance on between 6 and 10 kilowatt hours of electricity that it would travel on a gallon of gas. There is considerable variation depending upon a variety of factors - in stop and go city driving the electric engine has a huge advantage; a very large battery is heavy and reduces mileage so that miles per kwh may decrease as range increases, and in cold climates, the "waste heat" generated by the gasoline engine can be used to heat the car. In areas where electricity is selling at 8 -12 cents a kilowatt hour, the operating cost per mile could be as low as one fourth the cost of operating with a gasoline engine.
The electric engine is generally much much more efficient than the gasoline engine in converting BTUs of energy into forward motion rather than noise, heat and friction. As noted above, this advantage is especially strong in urban driving and the prospect of using an electric or plug in hybrid vehicle for a daily downtown commute and charging the battery each night in the garage will become very attractive. The night time load created by this activity would be (at least initially) off peak and should command a discount price from the electric utility.
Similarly, CNG vehicles are using a much less expensive fuel than are gasoline engines and can have operating costs that are less than one third those of gasoline powered vehicles. This is not surprising given the 4 to 1 price premium of petroleum over natural gas on a BTU equivalent basis. For large vehicles that operate completely within one metropolitan area and return to the same lot each day, a fueling station can be established at a reasonable cost per vehicle mile.
Before going into more detail, a few important considerations should be in the front of investors' minds. The market penetration of these alternatives depends heavily on the continuation of a substantial price differential between oil and natural gas. There is a reason that the Saudis would like to get the price of oil back down to $80 a barrel, and it is not altruism. They are painfully aware that a high price will call forth these new technologies and that some of the demand they lose will be lost forever. Conversely, if the price of oil returns to 1990s levels, alternative fuel vehicle technologies will begin to face serious head winds.
The industry has begun to increase the efficiency of petroleum powered vehicles - the hybrid is gaining more market penetration, diesel is more efficient than gasoline and may make a comeback and various other strategies to increase miles per gallon are being implemented. If the gasoline or diesel consumption per mile is reduced sufficiently, it may not be worth a customer's while to incur the capital cost of switching to an alternative.
When I think back over my life in cars, I remember the Dodge Dart I drove for 15 years as a graduate student and public interest lawyer and continued to drive as I set up my own law firm; then, the 450SL that I drove after we merged into a larger LA firm that provided cars for its partners: then the station wagon we got when we had kids; then the candy apple red minivan my wife loved; then the monster SUV for long trips; then the mid-life crisis BMW convertible; and - finally - the Prius. Like Shakespeare's "Ages of Man."
Anyhow, the world vehicular market is marvelously diverse. It includes garbage trucks in Camden New Jersey, sports cars in the South of France, jitney vans in Uganda, tractors building infrastructure in China, double decker buses in London and SUVs in Wyoming. And it is a world market. Foreign companies are planning to enter the US CNG market. Ford (NYSE:F) and GM sell cars almost everywhere. As we shall see, China is blending in lots of methanol with gasoline, Brazil is using sugar, there are countries with cheap electricity or "stranded" natural gas that will use these resources. In simple terms, there is no one car or vehicle of the future - it is like the Family of Man, remarkably diverse and resourceful. And - for our purposes - there will be lots of opportunities to make money, but it is sometimes maddeningly hard to identify them with a reasonable level of certainty.
Before we go on, let me mention two names. Methanex (NASDAQ:MEOH) is a relatively low risk play on the methanol market. It is the world's largest supplier of methanol, has a huge first mover advantage in the industry, and is ramping up production using existing capacity that will not necessitate enormous capex over the next few years. It is earning a profit and paying a dividend. I have written it up before. At a price of $28.89, I think it has a very compelling risk/reward ratio. Westport Innovations (NASDAQ:WPRT) has a strong position in the large vehicle (garbage trucks, etc.) conversion to CNG. It is a more speculative play, but at $21.49 is worth examination because of its potential to take off if CNG conversion really gets going
Disclosure: I am long MEOH.