Peak Oil Investments I'm Putting My Money On: Part VI, Barriers to Substitution

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Includes: FUE, GAZ, KOL, UNG
by: Tom Konrad, CFA

As I wrote the first five parts of this series, looking into potential substitutes for gasoline and diesel, it was clear that many potential substitutes would need to overcome barriers to its adoption. This article and the next will look at these barriers, and what they say about the potential for investments in substitutes for liquid fuels from petroleum. Part VII will look at factors which constrain the supply of these substitutes. Part VIII will combine the resulting understanding of these barriers and constraints to highlight the investment opportunities arising from them.

Barrier: Infrastructure

One great advantage gasoline and diesel have over most of the proposed alternatives is an extensive infrastructure. In addition to an extensive pipeline network, we also have a large number of competing fueling stations. If a new fuel requires new fueling stations, like natural gas and hydrogen, or charging points and (potentially) battery swapping stations (electricity), it may not be enough to make sure that enough filling stations exist for would-be drivers to make long trips. If there is only one national network of filling stations, drivers will likely become concerned that the lack of competition will mean that they overpay for fuel.

Among the possible substitutes, the synthetic fuels discussed in part IV, as well as biogasoline are the best placed in that they can use existing infrastructure.

In terms of having a nationwide transportation network, the best placed substitutes are natural gas and electricity. In terms of point of sale delivery, electricity has an advantage in that it's safe and relatively cheap to place charging infrastructure in parking lots, and most homes already have the capability of charging an electric vehicle, although it takes a long time from the 120V outlets in most garages. Most homes do not have natural gas in the garage, and even when they do, a compressor is necessary.

Conventional biodiesel and ethanol can be dispensed from the same pumps used for fossil fuels, but both present some difficulties in transport and storage. Biodiesel cannot be allowed to get too cold, because it begins to congeal, so in colder climates, storage tanks as well as transport tankers must be insulated and even heated. Ethanol cannot be shipped through pipelines that are also used for gasoline, because it absorbs too much water. Hence ethanol and biodiesel are mostly shipped in tanker trucks and rail cars. But both can be blended with conventional fuels, meaning that little new dispensing infrastructure is needed. The importance of a competitive fueling infrastructure can be seen in this November 2009 statement from the Trucking industry to the US Senate [pdf] about the conversion of trucking from diesel to natural gas. They say:

It is not sufficient to have a single LNG vendor with stations built at strategic locations along key freight corridors. Absent a competitive refueling infrastructure, trucking companies could face unreasonably high prices at individual retail LNG stations that have no competition in a particular geographic area. While competition exists in the natural gas industry, the high barriers to entry for retail LNG refueling stations may slow the development of a competitive refueling infrastructure. A competitive LNG refueling model would require the presence of multiple entities selling LNG in the same geographic area.

This objection applies to any potential alternative vehicle which locks the user into one fuel, and includes Electric Vehicles [EVs] such as the Nissan Leaf and Hydrogen Fuel Cell Vehicles, but not to flex fuel vehicles (E85 ethanol) or biodiesel (which can be used in any diesel engine.) It also does not apply to Plug-in Hybrid Electric vehicles, such as the Chevy Volt, because while charging points and battery swapping stations may be limited, the existing fueling infrastructure provides supply competition.

The fuel with the weakest infrastructure is hydrogen. Like natural gas, it needs specialized filling stations, but hydrogen lacks a national pipeline network.

Incomplete infrastructure can be either a barrier or an opportunity. If a potential fuel is compelling for other reasons, firms well placed to provide the necessary infrastructure should be able to profit handsomely. If, on the other hand, a fuel lacks an existing infrastructure and also faces significant other barriers, it will be unlikely to become a significant transportation fuel, and infrastructure investors are likely to lose their shirts along with everyone else interested in the fuel.

Barriers: Energy Density

When talking about energy density, it's important to consider not only the fuel, but the tank. Both volume and weight are important. Few fuels are as energy-dense as gasoline and diesel, both of which can be stored in simple, unpressurized fuel tanks. In contrast, the fuel tank for electric vehicles is the battery, and batteries are not only large and heavy for the amount of energy they store, they are also extremely expensive and degrade over time. Although the costs of driving an electric vehicle are very low compared to gas or diesel, the large up-front investment in batteries makes the total cost of owning an electric vehicle higher, except for drivers who use the vehicle for frequent, short trips with time to recharge in between.

The big winners for energy density are synthetic fuels, as well as conventional biofuels such as ethanol and biodiesel. Although ethanol has been criticized because it only contains about 2/3 of the energy of the same volume of gasoline, it's close enough that people using ethanol don't have to completely change their behavior in order to use it in a conventional vehicle. In contrast, electric vehicle manufacturers find that the range of their vehicles is constrained not only by the cost of batteries, but also by their size and weight. Weight is particularly important, because as a vehicle gets heavier, more of the energy is used to move the vehicle rather than the occupants, which in turn requires even more batteries.

In between energy-dense biofuels and bulky batteries lie gaseous fuels: natural gas and hydrogen, which have good energy per gram, but require heavy pressurized tanks to pack them into a space small enough to fit in a vehicle. Hydrogen requires a pressurized tank that takes up a lot of space, even if it is not very heavy. Natural gas can either be used as Compressed natural gas [CNG] or Liquid Natural Gas [LNG]. CNG is similar to hydrogen, although it is a little more energy dense. LNG has the same energy density as diesel, but requires considerable energy to compress into that form, and is not available from a home fueling station. Hence, natural gas vehicles present a tradeoff between energy density and fueling infrastructure.

Conclusion

Considering just the barriers of energy density and infrastructure, it is clear why the conventional biofuels ethanol and biodiesel gained an early lead over alternatives such as electricity and hydrogen. The big questions about biofuels arise from constraints in their total supply, and the harm that many forms of biofuel agriculture do to the environment.

Synthetic fuels made from natural gas and coal (GTL and CTL) can also have excellent energy density and can take advantage of existing infrastructure and vehicle fleets, but so far have not been adopted in a large way because they have had to compete with cheap oil. As oil prices rise, we will probably also see the rise of synthetic fuels, but, like biofuels, their long term prospects will be limited by total supply and possibly by concern about the environmental harm they do.

Disclosure: No positions