Carlos Ghosn has at least three lessons to teach energy investors.
1. The world is split into two distinct economies, one stable and one growing rapidly.
2. Jevon’s Paradox is alive and well in India (and elsewhere).
3. The electric car has huge implications for oil demand, and the timing relates in a strange way to #1 above.
Ghosn is the Brazilian born chief executive of two major car companies on two continents, Nissan and Renault. He speaks six languages and has such a successful track record that last year some G.M. investors turned to him as a potential savior for the failing company, although current management did finally retain their job.
In an interview with reporters from The Wall Street Journal on 1/28/08, Ghosn described two separate car markets. He said , “…if you go out of Japan, Western Europe, and the U.S. … in 2007, Russia 30% increase, China 20% increase, India 20% increase, … South America 25% increase.” He went on to say that a declining U.S. economy would reduce those growth rates by about half. That would be a worst case, Ghosn seemed to be saying.
Ghosn’s world, then, is divided into two parts:
- The OECD countries that are fairly stagnant or growing slowly and
- The developing countries that are growing at extremely rapid rates.
I use “OECD” as a shorthand to mean the developed economies of Western Europe, North America, Japan, Australia, etc.. Actual OECD countries, other than Mexico, generally are highly developed and slower growing countries that import oil and have a very high ratio of automobile ownership to total population. A few actual OECD members are in between; they are Eastern European economies that are faster growing than most OECD members but far more wealthy than "developing" economies.
Ghosn’s vision of the automobile markets can be projected to the entire global manufacturing economy. This reality often escapes U.S. observers who tend to think that an OECD or even just a U.S. slowdown will mean the end of global economic growth. Ghosn’s reality is that an OECD slowdown would cause growth in the developing economies to slow from a breakneck speed to just a very rapid rate. This reality may account for the resistance of the oil price to fall much below $90 despite widespread pessimism on the U.S. economy. The oil market seems to know that global oil demand growth will continue, even in an OECD slowdown.
In sum, oil demand growth is coming almost exclusively from developing countries. That trend has a long way to go, so we can expect 1 - 2 mb/d demand growth to continue for quite a while. The health or stagnation of OECD countries will determine only whether oil demand grows at the slower or faster part of the range.
Which leads to a second lesson that can be derived from Mr. Ghosn’s remarks.
Tata Motors (NYSE:TTM) of India recently announced a $2,500 car. When asked, “how are you going to meet the challenge from China and India in…low cost cars?” Ghosn had an interesting answer. He said that rather than try to “de-cost” a western car model, he has bought a company that currently makes motercycles which they can now “upgrade” to an automobile. (Incidentally, Ford had just the opposite reaction: they are going to try to build a cheap car in India themselves.)
The Tata Nano car will get 59 miles per gallon. So the question is: will the impact of the Tata Nano on oil demand be positive or negative? The answer (you may be ahead of me here) is that the Nano car with much greater fuel efficiency will substantially increase the demand for oil. Why?
The Tata Nano is a perfect example of Jevon’s Paradox, which says, according to Wikopedia, “that as technological improvements increase the efficiency with which a resource is used, total consumption of that resource may increase, rather than decrease." Said more colloquially, a car that increases fuel efficiency often causes oil demand to increase because more people then buy cars.
The impact of the Nano is two-fold. Greater fuel efficiency will help increase demand for driving cars instead of motorcycles. Probably more important, the low entry cost of the Nano will clearly let millions more people in developing countries afford a car when previously all they could afford was a bicycle or a motorcycle.
Will the Nano cause people switch to a more fuel efficient car and thus reduce oil demand? The customer for Tata’s Nano is not the owner of a less fuel efficient car. He is the owner of a motorcycle. Current Indian car owners are hooked on substantially more luxury than the Nano will provide. The Nano is not being developed so they can downgrade and it is unlikely that many will unless the price of oil rises very rapidly.
In OECD countries, there the market of people too poor to own a car is very small. The likelihood of a Nano or similar car causing people to switch for fuel efficiency or purchase price reasons is small given customers’ addiction to the benefits of current car performance and comfort features that a Nano cannot begin to match. In fact it is doubtful that a Nano-type car would even meet the standards that would allow it to be sold in many OECD countries.
To recap, OECD countries will not be impacted by the Nano. Developing countries will experience enormous growth in car population due to the Nano and its imitators. So the net impact of the Tata and its various spin-offs in both the developing and developed worlds will be to substantially increase the global demand for oil.
Oil Prices and the Electric Car
So much for very cheap, fuel efficient cars. What about electric and hybrid electric cars, the other end of the technology spectrum? The underlying premise of my investment posture is that oil prices will rise going forward, probably in a range around the 30% per year that has occurred since 2003. Could electrics be a threat to that assumption?
Well, we know that eventually electrics will take over. In the end (fifty years, let’s say) all vehicles will be electric because petroleum will be too scarce and biofuels cannot be scaled with foreseeable technology to substitute very much. So it is really the timing of the transition to electric cars that could impact investors. How fast can electrics come to dominate the market?
We will see that Ghosn’s vision helps us discover the answer. Ghosn’s important distinction between the two very different economies of the world is critical to understanding what the impact of electric and hybrid-electric vehicles will be. Also, Ghosn is at the center of the most pressing current effort to power cars with electricity instead of oil.
As I wrote earlier, the announcement that Israel intends to transition to all-electric vehicles was a clear indication of what the future will bring. Israel’s strategy combines three elements. One is new electrical generation via solar technologies. Another is the electric vehicles themselves, which Ghosn’s Nissan and Renault companies will partner with Israel to develop. And the third is a 500,000 location electric refueling infrastructure that the government will help install.
Israel’s announcement came soon after new developments in generating electricity with solar thermal technology were announced . The solar/thermal system promises cheap, reliable, 24/7/365 carbon-free electricity, especially for sunlight-intensive areas such as Israel. The combination of unlimited cheap electric power with a transition to electric transportation is stunning because the two developments are obviously symbiotic. Each is critical to the success of the other. In combination, they suggest what the entire world’s ultimate solution to the coming petroleum shortage will tend to look like.
What are the implications of this new paradigm for an energy investment strategy? Will the world quickly adopt the new Israeli model and rapidly reduce its need for oil?
Israel’s example will certainly tend to inspire similar governmental policy actions around the world as it begins to take effect. Israel estimates a ten year period to convert the entire country to electric cars. Startup is expected in 2010. By 2012 perhaps 7% of Israeli cars could be electric. Of course the project, like all revolutionary and complex programs might suffer delays. But it is likely that at some point between 2010 and 2012 there will be enough accomplished on the ground to make for good journalism.
That is when the Israeli experience will start to impact the policies of other countries. I take the operative time frame for current investment strategy to be about five years. Therefore, it does not seem likely that investors should be concerned about this quite yet.
Let us look longer term, though, out of academic interest. Using Ghosn’s important distinction between the two economic worlds that exist, what will be the impact of Israel’s model?
OECD countries come in two flavors: parts with highly concentrated populations and parts with big open spaces. Europe, coastal North America and Japan look like the former, as does Israel. Non-coastal U.S, Canada, and Australia do not. So the former will be the first imitators of a successful Israeli program of “city cars.”
We could begin to see large scale transitioning to electric city cars in the 2012 - 2020 time frame. Perhaps there will be 10% penetration of the appropriate OECD markets by 2015. Of course, there will also be continuing transitions to hybrid electric vehicles. So, by 2015, we could see OECD demand for oil having declined by 5% given offsetting increases in industrial demand and some impact of Jevon’s Paradox on the car market.
Now what about electric cars in the second of Ghosn’s markets, the developing countries from whence nearly all the new demand for oil has been coming. China makes up nearly half the population of the developing world.
Perhaps the most dramatic energy news of recent weeks, after the Israeli announcement, was reported on page 8 of The Wall Street Journal on January 24th under the headline, "China Aims to Curb Power Shortages". The story details the impending shortfall of about 70 gigawatts of electrical generating capacity in 13 of China’s provinces and major regions. And that was before recent heavy snows crippled the Chinese electrical infrastructure. China needs a lot more electricity despite its construction of one new coal fired electrical plant per week. It is also severely lacking in electrical distribution capacity.
As thousands upon millions of Chinese ascend to a modicum of middle class consumption habits, the first thing they require is electricity. More than a car, the ability to power their homes with basic modern electrical conveniences is the first priority. You can be middle class without a car but not without a TV. So as China continues to encourage the migration of its peasant population into the modern economy, resulting in an 11% Q4 GDP growth rate, the sine qua non is electricity.
This is not a short term problem for China. The country seems to be falling further behind rather than solving the problem. It will continue to dog their progress for many years to come. Moreover, electricity shortages are compounded by the increasing international and domestic pressure China faces to clean up its environment, which means pressure to stop building more coal fired power plants. As if that were not enough, China was a coal exporter a few short years ago but is now a significant importer of coal and China now faces difficulties in importing enough coal to meet its demand. So China faces multiple challenges to its ability to close its electricity demand/supply gap.
There are many implications for China’s electricity shortage, but one is that it will preclude China from developing electrical cars any time soon. As much as China would love to cure its growing petroleum shortage by leapfrogging over the west’s dependence on the internal combustion engine for transportation, its growing shortage of electricity for more basic demands precludes them from adding to their electricity deficit with electric cars. China simply does not have the electrical capacity to support electric cars and it will not have it for many years. Therefore, China will be well behind the OECD countries in developing electric “city cars” no matter how much sense they may make for China on many levels.
The Chinese must be looking at the recent Israeli decision to transition to electric cars with unmitigated envy. If only they could do the same it would put them at such a strategic advantage compared with the petroleum dependent OECD countries. But alas, the time for doing that must await a solution to their very complex electrical infrastructure problems.
What about India? We have already seen where India is headed. Tata’s Nano car is diametrically opposed to the Israeli program. It will mean many millions more gasoline powered cars on the road than would otherwise be the case, not only in India, but also in many other developing countries. These countries, like China, will lag the West in emulating the Israeli strategy.
The truth is that Israel’s transportation revolution is being undertaken to avoid oil dependence, not to save money. On the contrary, electric vehicles and the infrastructure to support them will be more expensive than present internal combustion transportation. It is a strategy that is thus ill suited to economies that need to provide cheap basic transportation to millions who are newly able to afford it. And it is especially ill suited to China and the many other developing countries that have immature electrical distribution and generation infrastructures.
In sum, I doubt there will be much if any Asian impetus toward transitioning to “city cars” until after petroleum becomes prohibitively scarce and expensive. So oil demand in the Asian and fast growing oil-exporting countries like Russia and the Middle East is likely to continue growing at about 1.7mb/d per year, or about 8% of their usage. Such demand will add 10 mb/d to demand by 2012 and about 17 mb/d by 2015. If the OECD countries manage to reduce their oil consumption by 5% by 2015, that would take about 3 mb/d from global demand. Thus, it seems that we are looking at about 14 mb/d greater oil demand by 2015 even with substantial movement toward electric cars, partly motivated by the Israeli program.
It seems likely, therefore, that the transition to electrical cars and to solar/thermal electrical production is coming just in time for the OECD economies to mitigate a catastrophic shortfall in oil production to a more manageable level. However, it will not have much impact on the developing world from which oil demand growth is coming. Thus by 2015 the world is likely to see both a substantial reduction in oil supply and a modest increase in oil demand. That pretty much defines the crisis that many more distinguished energy observers than I have been quoted as describing in the past year. From an investment viewpoint, the above analysis supports the basic thesis underlying the attractiveness of investing in oil-related stocks and I do not see that changing.
The transition to all-electric cars and the related massive new requirements for electrical infrastructure will open many new investment opportunities. There is not space here to address this energy investment strategy. But I will mention that the EIS portfolio has been accumulating an increasing concentration of stocks in the electricity production and distribution field. They include in no particular order, Ormat (NYSE:ORA), Applied Materials (NASDAQ:AMAT), Ener1 (ENEI), AZZ (NYSE:AZZ), General Cable (NYSE:BGC), Fushi Copperweld (NASDAQ:FSIN), Suntech (NYSE:STP), and Sunpower (NASDAQ:SPWR).