During the month we come across an article from Stephen Anness, who is a global manager at INVESCO. Given Wattle Partners recommends some oil and energy exposure in our core portfolio, along with indirect exposure to the electric car market we thought readers would also find it of interest.
Oil consumption is currently 95 million barrels per day (mb/d), an increase of 11% from 86 million barrels in 2008, despite the anaemic economic recovery from the worst financial crisis since the 1930s. However the widely held view is that demand is peaking and will start to fall imminently.
A large part of this thesis is based on the increasing availability of electric vehicles (EVs). The basic argument is that increasing EV adoption will lead to demand for gasoline/oil/diesel products (‘oil’) inevitably falling sharply, leading to a collapse in the oil price. However, we do not believe this to be the case and the claim is undermined by the data. We accept that the future of the car is evolving rapidly, that the proportion of EVs will grow substantially over the coming years, but it appears to us that the likely speed of adoption is overstated. Furthermore, even if the take up of EVs was to rise more quickly than we believe, the impact on total oil demand is likely to be limited.
In this article we seek to challenge consensus and highlight significant issues we have with the expectation of immediate, wide-scale adoption of electric vehicles and its impact on oil demand. We will address four key areas:
- Oil demand derived from passenger cars
- Impact from government subsidies on EVs
- Effect of rapid EV adoption on the battery supply chain
- Requirement for infrastructure
Oil demand derived from passenger cars
We believe many investors under-appreciate the dynamics of global oil demand. Out of the 95mb/d of global demand for oil, only 19mb/d, or c.20%, is actually for passenger cars (see Figure 1).
For the purposes of this article we have assumed that heavy duty trucks and other transport (e.g. ships and planes) cannot be electrified given the power-to-weight requirements. Therefore, our ‘at risk’ portion of oil demand is only 20% of global demand which to some extent debunks the myth that demand is all about cars as we’ve known them, or ‘ICE’ cars (internal combustion engine).
Fig 2. Forecast new cars sold (net) and global car park (bn)
Source: Invesco Perpetual as at 05 September 2017. EV = Electric vehicle; ICE = Internal combustion engine.
The other key element is a stock versus flow argument when it comes to the future of the car fleet. The global car fleet consists of around 1bn cars and virtually none of these are electric. Every year, around 85mn new cars are sold and 40mn are scrapped leading to an increase of around 45mn cars per year in the global fleet. Unless all cars sold move to be electric vehicles very quickly indeed, the fleet of ICE cars will continue to grow, (at least in the medium term) even if adoption of EVs increases rapidly.
Fig 2 shows the impact of rising EV adoption on the global car fleet. Assuming a very rapid adoption to 40% of global car sales being EV by 2024 the global car fleet should still grow by around 30% by 2024. It is therefore hard to see reduced demand for oil even in an aggressive adoption cycle for EV. Moreover, the prospect of peak demand for oil — an end to growth in global consumption — has been discussed in the energy industry for many years, without apparently coming much closer.
Fig 3. Failed forecasts of energy transition
|Year of Forecast||Forecast|
|1971||100% US electricity from nuclear generation|
|1976||33% of all US energy from renewable|
|1977||36% of US industrial process heat from solar power|
|1978||20% of all US energy from solar|
|1978||50% of Swedish energy from biomass|
|1980||49% of US energy from renewables|
|2006||Create rst oil-free economy|
|2007||CO2 emissions 40% below 1990 levels|
|2008||Cut US fossil fuel-based capacity by 88%|
|2008||100% of US electricity from renewables is achievable|
|2008||To replace natural gas – red power generation in the
|2008||To use saved gas in cars and wean US off oil imports|
Source: CLSA as at 2017.
Impact of government subsidies
The world of vehicles is changing, yet how the consumer responds remains uncertain. The shift towards electric has been supported by significant government incentives. Norway, for example, owes its success to the hundreds of millions of dollars in tax revenues diverted towards subsidies making it almost free to drive an electric car. Today it is normal for a Norwegian to buy an electric car in addition to a petrol vehicle for daily use to save money. Yet in countries such as Denmark and Hong Kong, where subsidies have been removed, sales of EVs have dropped dramatically. When the incentive was dropped in Denmark in January 2016, EV sales plunged 80% from the previous year (source: FT, as at 21 March 2017).
There are other considerations too, such as the impact on government coffers from lost revenue of vehicle duty and fuel tax. In the UK around 67% of the petrol price is tax. If the government abolished the UK gasoline market, that would cost $17bn per annum. It should also be noted, even in Norway which has seen rapid EV adoption, that oil demand is still rising.
Impact on the battery supply chain
As we stand today, the battery supply chain is a critical but little discussed constraint to rapid EV adoption. Modern battery technology requires a number of rare materials, for example lithium and cobalt, which are essential ingredients. We do not yet see a robust-enough supply chain for these products for the scale that would be required; cobalt in particular appears to us to be a considerable bottleneck for rapid EV adoption. There is currently enough cobalt mined globally to produce circa 5m EVs, assuming we don’t use cobalt for anything else such as phone and tablet batteries. It is not a matter of just price, production of cobalt simply cannot be ramped up quickly.
Furthermore, some 60% of cobalt production comes from the Democratic Republic of Congo (DRC), which has had issues with political instability and child labour. We are clearly wary of basing a thesis on one rare earth metal; however, there are currently no battery technologies which can produce the energy density required for pure EV which do not use cobalt in the cathode.
Different parts of the world are at different stages of developing the necessary infrastructure for the adoption of EVs. However the questions raised are broadly consistent: where can I charge my battery? How long will it take and how often? And how much will it cost? While none of these issues are insurmountable, the ease of filling up with fuel at your local petrol station is hard to replicate on a mass scale. For consumers with no off street parking, they have to find public charging points. How long they need to wait and how convenient that is, is debateable. Moreover investment is required (public or private) to pay for the infrastructure and it remains unclear who is prepared to do this and what rate of return they will require.
EVs are hugely topical and it is easy (and lazy) to directly extrapolate their impact on the global demand for oil. There are a number of other factors that we must consider: global GDP growth, industrial usage of oil, and how emerging market growth will offset OECD demand falls. By 2040 it is expected that the global population will grow by 23% and GDP will double. While per capita consumption of oil peaked 30 years ago in the US, Germany, France and the UK, it has grown at over 4% in China and India in the last three years. It is also worth considering that the average American currently consumes 25 times more oil than the average Indian. Meanwhile there is currently no readily available technology or alternatives to replace the oil required for shipping, aviation and chemical production.
As with all emerging technologies, the exact impact on consumer behaviour from EVs is difficult to anticipate. A new technology could emerge which can accelerate the pace of adoption. All we can say, with everything we know at this point, it that it is hard to see rapid mass adoption of EV and very difficult to see any dramatic shift in the demand for oil from passenger cars.