Seeking Alpha

The Price Of Oil

by: David Ruggles

By Mike Smitka

Both governments and automotive companies are placing large bets on alternative vehicle drivetrains, above all electric vehicles. In this context, Roberto F. Aguilera and Marian Radetzki's The Price of Oil, which Gavin Roberts reviews for, appears to be a "must read." I have yet to look at it, and would certainly like to see whether more recent evidence backs up their core claims. Their bottom line is that both new technologies and new politics will keep the price of petroleum low for the next decade. In contrast, I believe both high technical and intractable political hurdles impede the commercialization of battery electric vehicles. Low oil prices amplify these challenges. Really cheap oil makes EVs unlikely to eliminate the gas engine by 2040.

...really cheap oil makes EVs unlikely to eliminate the gas engine...

The core argument of the book is that both technical and political factors will lead to a gusher of oil. Cheap oil. Fracking and horizontal drilling are proving robust. Costs continue to fall, and these will prove viable in a world not just of $100 oil but even $50 oil. Furthermore, while to date they have been used mainly in the US, they are of wide applicability. By 2016, US output had risen 70% from 2008, or from 1.8 billion barrels to 3.2 billion barrels a year. Roberts believes this book provides a compelling argument that the same technologies will enhance secondary extraction around the world, as well as the primary development of new fields. The oil boom is just starting.

...fracking and horizontal drilling are proving robust...

Politics will reinforce this. I've argued on this blog (in "Another Fracking Saudi Oil Conspiracy") that the global swing producer, Saudi Arabia, faces strong pressure to pump more, not less. In an economist's jargon, the demand for oil is insufficiently inelastic in price [yeh, I worked at that alliteration]. Politically the Saudis - and a number of other major oil producers - are desperate for more revenue, and that requires pumping as much as possible.

Aguilera and Radetzki extend that argument to other developing country producers. In particular, low prices will pressure these countries to dismantle their national oil monopolies. As long as oil prices remained high, national oil companies generated a lot of revenue for their political masters without a need to invest in new technology or even to push for good day-to-day operational capabilities. To put this in jargon, rent seeking behavior emphasizes extracting short-term profits over long-term investment. seeking behavior emphasizes extracting short-term profits...

With today's prices, these national monopolies are no longer delivering sufficient revenue. Saudi Arabia and Nigeria are poster children for this. But national champions retain latent value: outside investors would see an option value due to the possibility of future oil price increases, and could believe that new management and sources of finance could improve both current operational profitability while improving future revenue streams. Selling off national champions is an option, indeed the only short-term option. Saudi Arabia is talking about an IPO for Aramco (ARMCO). Pemex in Mexico and (since the book was written) Petrobras (NYSE:PBR) in Brazil are already being restructured. I don't know the details, and this book is likely not recent enough to fill them in. Such details are, however, key to evaluating the strength of their argument.

...selling off national champions is an option, indeed the only short-term [revenue] option...

The other key piece is whether denationalization will bring in new and better management. Would new owners have the leeway to improve operations? Would they bring with them access to new technology and new project funding? To me that sounds like a sensible prediction, but I doubt there's as yet much real-world evidence. These changes are too recent, and the gestation period for implementing management change, much less bringing new capacity online, is too long.

Perhaps the book does have additional evidence, but I find the overall argument plausible, and with it the bad news for the market for EVs. Perhaps I'm parochial: while I've spent 8 years of my post-college career outside the US, I've only rented and not owned and operated a car in Japan and Germany. Indeed, the train systems in metropolitan Tokyo and Munich were so good that I rarely even took a taxi or bus. I may thus be overestimating the relevance of low fossil fuel prices, if elsewhere gas (or carbon) taxes keep prices at the pump high.

I'll keep revisiting this issue over the next several years. Making predictions is hard, especially when they're about the future. But in the auto industry, new investments have to be made thinking about what will be needed two model cycles (8-10 years) down the road. The same is true of planning the rollout of new technology. So predict I will, but I will try to revisit them to test my expectations against real-world outcomes.