What After Peak Oil: Oil, Lithium Batteries, Fuel Cells, Or All Of Them?

Includes: DBO, OLO, USL, USO
by: Juan Carlos Zuleta

In a blog published more than four-and-a-half years ago, I argued that global oil production may have already peaked (or will do so in a couple of years). I then contended that peak oil, together with global warming, will force most countries to reduce both their demand for oil in response to an ever-diminishing supply and their carbon dioxide emissions to avoid climate change. This will only be possible - I said - through a major transformation in the global automotive industry: the transition to electric propulsion.

After General Motors' (NYSE:GM) announcement in January and June 2007 to launch by 2010 the first mass-produced plugged-in hybrid cars with lithium-ion batteries, I sustained that all major car producers in the world were engaged in a furious competition for a share of this promising market. In this connection, lithium, a mineral with countless applications in different industrial sectors, may become a key factor for the emergence of a new techno-economic paradigm. Surprisingly, the main thrust of my original argument appeared almost ten months later in a Merrill Lynch report entitled "The Sixth-Revolution: The Coming of Cleantech" authored by Steven Milunovich.

In recent months, some analysts have questioned the peak oil hypothesis. In an article entitled "Sustainable Energy Development (May 2011) with some Game-Changers" available online in November 2011 in the leading journal Energy, Noam Lior, for example, speaks of the apparent postponement of the threat of fossil fuel depletion. This view is consistent with the main conclusions of a more recent Harvard study. Take note that following this publication, one analyst has indicated: "We were wrong about peak oil: There's enough in the ground to deep-fry the planet." And another one has wondered whether this finding will "kill development of alternatives to oil."

New discoveries and exploitation technologies of large amounts of "unconventional fuels" (i.e. tar or oil sands, extra heavy crude oil, coal bed natural gas, tight gas, shale oil and natural gas, and methane hydrates) seem to explain why this may be the case.

In a recent article published on Seeking Alpha, I have concluded that the apparent abundance of oil deriving from the discovery and development of new shale oil and gas deposits particularly in the United States does not explain why oil prices went up so much in the last seven years or so, leaving the peak oil hypothesis intact. Furthermore, the increased production of oil may have to do with the new definition of oil, which includes not only crude oil but also natural gas plant liquids (NGPL) (mainly, ethane, propane, butane and pentane) and biofuels. However, as argued in the previously mentioned article, there are limits to using different types of NGPL as equivalent to oil.

True, Lior does acknowledge that there are two factors conspiring against any possible emergence of unconventional fuels as substitutes for conventional oil: Higher beneficiation costs (between $75 and $100) because alternative fuels are in general much more difficult to develop, and negative environmental impacts because by and large they happen to be dirtier sources of energy. Nevertheless, his prescriptions (proper technology; and environmental regulation) to take care of them are not very convincing.

Indeed, use of appropriate technology is likely to increase exploitation costs of some of these new energy options exerting pressure over oil prices and paving the way for the consolidation of oil substitutes, particularly in the automotive sector. This may in turn tend to disincentivize investments in new oil fields and only further aggravate a possible energy crisis as the demand for fuel continues to grow in the most important emerging economies (i.e. China and India) in the years ahead. As argued in a recent article, we may now in fact be witnessing the end of an era of cheap oil in the world.

Similarly, it is hard to imagine how environmental regulation will have any bearing on increased greenhouse gas emissions resulting from intensive use of "alternative fuels" or even environmental contamination emerging from deep (and complicated) offshore oil exploitation, as recently occurred in the Gulf of Mexico, which may also end up diminishing oil investment while reinforcing an upward trend in oil prices.

This brings into play one of the main determinants of the demand for oil, as suggested by Lior: substitutes (which Lior labels - again - technology). Here he refers, among other things, to the current transition to electric cars, which may become - much sooner than initially thought - a potential source of destruction of demand for oil with similar implications for the price of the fuel. As for the extent of the possible oil price increase, a recent International Monetary Fund (imf) article predicts that any small further expansion in world oil production will come "at the expense of a near doubling, permanently, of real oil prices over the coming decade." This price hike may prove sufficient to inaugurate a new techno-economic paradigm in the world. Nonetheless, after Hyundai´s announcement that between the end of the year and 2014 it will introduce 1,000 fuel cell cars into the market, one needs to wonder whether lithium will remain its key factor.

With regard to the implications of these developments for investors, in what follows I divide my argument into two parts. In the first part, I update my views expressed in a previous article on the oil ETF and/or ETN options investors have at hand both in the short run as well as in the long run until the sixth techno-economic paradigm actually starts to take place. In the second part, I investigate how Hyundai´s decision to launch a considerable quantity of fuel cell vehicles later this year may shape the investment options available in the car industry.

To the extent that the transition to electric propulsion in the global car industry will most likely take some time, in the above mentioned article, I had identified 10 top oil ETFs-ETNs (6 for long-term investments and 4 for short) for investors to make money by investing in oil. In Figures 1 and 2, I show the evolution of long and short-term Oil ETFs-ETNs since 2009. In general, long-term oil ETFs-ETNs performed much better than short-term oil ETFs-ETNs in the period under consideration.

Within the first group, three ETFs and one ETN are worth mentioning: PowerShares DB Oil ETF (NYSEARCA:DBO), PowerShares DB Crude Oil Long ETN (NYSEARCA:OLO), The United States 12 Month Oil ETF (NYSEARCA:USL), and The United States Oil ETF (NYSEARCA:USO), because they are the only ones that exhibit a positive trend. As shown in Table 1 below, they also reflect the highest general average returns. The reason why they were so outstanding must be found in the upward trend of oil prices (See Figure 3). Regarding the second group of ETFs-ETNs, they resemble a reverse mirror image and should be completely discarded from any investor´s plans in the near future (See also Table 1 to confirm this contention).

Figure 1

Evolution of Long-Term Oil ETFs-ETNs

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Source: Morningstar.

Figure 2

Evolution of Short-Term Oil ETFs-ETNs

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Source: Morningstar.

Figure 3

WTI Oil Prices

2009 - 2012

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Source: Ycharts.

The question remains as to which specific long-term ETF or ETN could be considered as the best shot for investors. As shown in Table 1, DBO, OLO, USL, and USO (in this order) exhibit the highest annual returns in the period 2009-2011, a finding that can be ratified including data obtained up to August 2012 as well. To decide which ETF should be recommended for investment, we need to take account of another variable: the relative liquidity of the share (as measured by the approximate number of shares traded a day or the average volume of shares traded a day), an aspect already contemplated in my 2011 analysis. Taken together, all this information leads us to conclude - again - that DBO can be seen as the best option available for investors. Nevertheless, due to its highest liquidity, USO could still be taken as a second best option. Last but not least, for investors not worried about liquidity, OLO and USL remain two interesting choices.

Table 1

Returns and volume of shares traded of oil ETFs-ETNs

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Source: Morningstar.com September, 2012 and Wall St. Cheat Sheet April, 2012.

Finally, as shown in Table 2, elaborated from a recent report on Fuel Cell Electric Vehicles released by Fuel Cell Today in August 2012, Hyundai appears to be at the forefront in terms of announced launch volumes of fuel cell cars beginning 2012. Although other major brands do have plans to introduce this type of cars in the near future, none of them has made as much progress as the South Korean firm. Moreover, according to the cited report, "in the longer term Hyundai-Kia plans to use the Kia brand to sell smaller battery electric vehicles and the Hyundai brand to sell larger fuel cell electric vehicles."

Table 2

Fuel Cell Vehicles

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Source: Fuel Cell Today.

In the last five years or so, Hyundai and Kia have been characterized as two of the most innovative automotive companies in the world. In a number of blogs and articles, I have advanced the idea that innovation does indeed pay off. It did so in the case of General Motors when it decided to launch the Volt right in the middle of the most severe financial crisis it had ever faced. Something similar occurred with Hyundai and Kia when they launched the Sonata hybrid and the Optima hybrid with Li-ion batteries. And, of course, Nissan (OTCPK:NSANY) also had its share in the reputation pie when it surprised the world with its all-electric Leaf.

But what really makes a difference between Hyundai (005380.KS) and Kia (000270.KS) and the other two car makers - and indeed Toyota (NYSE:TM) and Honda (NYSE:HMC) as well - is that the innovation track is not a static phenomenon but - in fact - a way of living. In Figure 4, we see how the stock market reacted in the last five years or so to that kind of behavior on the part of Hyundai and Kia in relation to their main competitors.

Figure 4

Evolution of Major Stocks in the Automotive Industry

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Source: Reuters.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.