Battery-electric vehicles [BEV] are on the move. While declining hybrid-electric vehicle [HEV] sales in the U.S. have kept overall EV sales here down, they are rising globally despite the continued presence of inexpensive petroleum. BEV sales are rising in the U.S. as well despite the fact that they should be less competitive than HEVs when gasoline prices are low. Cheap crude has slowed EV adoption, perhaps, but the sales data no longer suggests that it has reversed the overall trend.
This development has prompted numerous predictions of still lower petroleum prices in the relatively near future as EVs displace gasoline demand at an increasing pace. Wood Mackenzie Ltd. expects EVs to reduce gasoline consumption by 10%, or approximately 2 million barrels per day [mbpd], by 2035. Bloomberg New Energy Finance has projected this displacement rate to increase to an incredible 13 mbpd by 2040. Most recently a senior executive at the world's largest corporate power producer, Engie SA (OTCPK:ENGIY) predicted that petroleum prices will fall as low as $10/bbl by 2025, which would represent declines of 80% from today's prices and 90% from the prices of a few years ago.
So why aren't petroleum prices and, by extension, the share prices of major publicly-traded producers such as BP (NYSE:BP), Exxon Mobil (NYSE:XOM), Royal Dutch Shell (NYSE:RDS.A) and Chevron (NYSE:CVX) falling rapidly? After all, while commodity prices tend to reflect current supply and demand, share prices have more of a tendency to front-run the short-term headlines. More to the point, many energy analysts were skeptical when BP released the 2016 edition of its annual energy outlook, which showed global petroleum consumption rising steadily through at least 2030 with electricity providing only a tiny share of the transportation sector's energy demand. Are major producers and their investors simply being short-sighted, or is something else at play?
First, any prediction about future petroleum prices from an executive in the electricity generation sector must be taken with a grain of salt. Electric utilities, which in the developed world have struggled in recent years with rising energy efficiency and slow-to-no demand growth, will oversee major increases to consumption if EVs replace traditional internal combustion engine vehicles on a wide scale. Furthermore, within individual continents electricity is electricity regardless of its fuel or point of origin. Assuming no demand growth, a zero-sum game exists between owners of existing power plants and builders of new ones. Coal consumption in the U.S. has declined as natural gas has gained favor as a power plant fuel, for instance, since the two fuels produce identical products (albeit via pathways that are not identical).
Petroleum, on the other hand, operates in a very different environment, especially now that very little is consumed by developed world power plants. Just 50% (and even less at some refineries) of each barrel of petroleum that enters a refinery is converted to gasoline on a volumetric basis (see figure). Diesel, jet fuel, asphalt and an array of other products that are essential to modern economies are also produced. More importantly, while the exact yields of each product can be tweaked, they reflect the fact that petroleum compositions are both very diverse and highly variable. Gasoline, for example, is primarily comprised of one type of chemical (alkanes) while most petrochemicals are comprised of other types (alkenes and aromatics). It is generally not cost-effective (in terms of both financial and energy requirements) to convert the baseline gasoline share into other fuels, let alone into other refined products. In some cases the technology required hasn't even been commercialized, such as for the conversion of the gasoline fraction to asphalt.
Source: U.S. Department of Energy (2011).
Many of the projections for low future petroleum prices resulting from EV displacement that I have read appear to ignore this fundamental difference in process chemistry. One clue that such a failure has occurred is when a prediction conflates displaced gasoline demand with reduced petroleum consumption - e.g., stating that 2 mbpd of displaced gasoline is equivalent to 2 mbpd of displaced petroleum. The first data point simply reflects the fact that one barrel contains 42 gallons. The second data point, on the other hand, assumes that 1 barrel of gasoline is equal to 1 barrel of petroleum, and this is not the case with the refining process.
In fact, it is possible for the displacement to not occur at all in theory. Assume that EVs displace 1 mbpd of future gasoline consumption. Let us further assume for the sake of simplicity that each barrel of gasoline requires 2 barrels of petroleum, with the remaining barrel by volume being converted to other refined products. (In other words, the refining process has a 50% gasoline yield.) Electricity has replaced 1 mbpd of daily gasoline consumption but it has not (and cannot) replace the remaining refined products.
One of two things must occur in this case. First, the refiner could continue to process the entire barrel, gasoline included, and raise the price of the remaining products to offset the lack of value for the gasoline. Second, the refiner could reduce throughput by 2 mbpd so as not to overproduce gasoline, in which case the prices of the remaining refined products increase and consumers look to other fuels to provide them (natural gas to petrochemicals, for example).
In reality, a mix of the two is likely to occur. The "10% of global gasoline consumption" displacement value made by Mackenzie Wood is especially appropriate since something similar has already occurred in the U.S. Biofuels in the form of ethanol rather than EVs have been the agent of change here, however. In October of this year U.S. ethanol consumption reached 10.2% of gasoline consumption by volume, breaching the so-called "E10 blend wall." A gallon of ethanol only has about 67% of a gallon of gasoline, so this does not necessarily equal 10.2% of gasoline consumption overall. That said, the U.S. also displaces large volumes of another refined product, diesel fuel, with biodiesel, making biofuels more disruptive to refined products demand than EVs in other ways.
This displacement has resulted in two developments of note. First, the price premium of non-gasoline refined products, ranging from petrochemicals to asphalt, relative to the price of petroleum has been quite large over the last several years so as to offset the oversupply of gasoline. Second, and this is perhaps most germane, U.S. gasoline consumption is continuing to rise (see figure). It is roughly 0.9 mbpd (the figure shows thousand barrels per day) lower today than it would have been based on the demand growth trajectory that prevailed before 2009, which can be attributed to a combination of changing driving habits, record biofuels consumption and increased vehicle fuel efficiency. Despite all of this, however, low petroleum prices have spurred gasoline demand to near-record levels.
Intriguingly, this gasoline demand trend has occurred even as overall U.S. refined products consumption has decreased by 1.5 mbpd over the last decade. This is because high prices earlier in the decade prompted refiners to convert their heavier refined products such as residual fuel oil, petroleum coke and asphalt to gasoline (while it is difficult to convert gasoline into heavier products, the reverse is not true thanks to crackers, cokers and other specialized refining processes). Especially high displacement of gasoline due to EVs could cause the gasoline yield to decline back to its baseline as a result, but such a reversion would not necessarily cause displacement of overall petroleum consumption, since the yields of the other refined products would increase in response as refiners stopped using their crackers and cokers.
Norway provides another example. That country has been the spearhead of efforts to electrify the passenger vehicle sector, causing EVs to equal nearly 1/4 of new car sales in 2015. Despite this, however, its petroleum consumption in that year was higher than in 2007, when EVs were virtually non-existent in the country. There are few better demonstrations of gasoline displacement failing to account for declining petroleum demand.
BP's most recent outlook alludes to this reality, stating that it expects long-term petroleum demand to remain strong due to heavy petrochemicals consumption and the fact that "over 40% of oil used in industry is not combusted" and therefore buffered from climate policies. The Internal Energy Agency [IEA] generated headlines last month when its own annual energy outlook predicted global petroleum consumption to rise until 2040. It attributed this forecast to "[t]he difficulty of finding alternatives to oil in road freight, aviation and petrochemicals."
None of the above is to say that the oil & gas industry will not experience any disruptions. Some companies are already positioning themselves to benefit from them, albeit in ways that do not benefit from Elon Musk's showmanship. Merchant refiner Tesoro (TSO) recently purchased Virent, a small firm that converts biomass in the form of sugar into hydrocarbons. Total SA (NYSE:TOT) has worked with Amyris (NASDAQ:AMRS) over the last several years to develop renewable refined products, including jet fuel and industrial lubricants (also from sugar). These investments are canny not only because they have the potential to benefit from widespread EV use via higher prices for non-gasoline refined products, but also because they are complementary to EVs if global petroleum consumption is to decline. Given concerns over fossil fuel consumption and greenhouse gas emissions, then, the investments could benefit from future policies as well as higher prices. EVs will disrupt the fuels industry, but not by heralding an era of ultra-low petroleum prices.
Disclosure: I am/we are long XLE.
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.
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