Investment Primer – Oil

Effect on Oil Prices

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Mark Twain

It seems that everyone in the oil industry “knows” that oil prices are going back to $75+ and that is what is priced into stocks – a permanent increase in the oil price. If that fails to come through, and excluding short-term price spikes I think it will, then look out below. See the video below for our webinar or read on below:

Oil is just another energy source, but it has a “portability premium” baked into it – it’s a lot more convenient to fill a car with oil than it is to fill it with coal. Also, batteries are too heavy for planes, small/backup generators that run on oil are way more convenient than small coal-fired power plants. This portability premium is currently about $35 per barrel.

But batteries change the equation. It means that oil fits onto the “energy parity” curve as well – and it will lose its portability premium.

Levelised cost of driving

In our energy primer, we discussed the notion that backup generators are already at the point where they have lost the portability premium – wind or solar + battery now beats a diesel generator for cost. But these are only a small part of oil demand.  And planes are nowhere near ready for batteries – the power to weight ratio doesn’t make sense.

So it is down to transport – which is the main area of demand for oil.

The good news for oil aficionados is that private cars have another 10-15 years or so before battery economics start to hurt demand.

The bad news? If pump prices were 50% higher than current levels, then you only have 5 years. For a taxi, it is worth switching to electric about now. In 10-15 years time, a number of regions (California, Germany, China, Netherlands, Norway) are likely to have partial or even full electric vehicle mandates on new cars.

Either way, oil demand is probably not dropping significantly in the near future based on electric car take-up unless we see:

  • higher oil prices
  • increased taxes
  • regulation/mandates
  • a faster than expected take up for driverless taxis

This isn’t a bull case for oil prices:

  • the short term is stuffed due to oversupply
  • the long term is stuffed due to falling demand
  • the mid term may be OK if there are supply shortages (although this looking increasingly unlikely with the latest shale oil production statistics)

However, I need to acknowledge that I went looking for a 3-5 year bear case for oil based on lower battery costs, but struggled to find one.

Driving numbers

  • Battery cost: $10,500 for a 60kW with a range of 400-500km
  • The power of compounding: Costs have been decreasing about 20% per annum for batteries. If this continues then in 5 years batteries will be around $3,500. If costs then decline at a lower rate of 10% per annum until 2030 then batteries will cost around $1,500.
  • Electricity vs Petrol Cost saving: $150-$350 per 10,000 km (depending on taxes, country costs, time of day that the battery charges)
  • Typical driving distance: Consumers 10,000-20,000 km/year = $150-$700 in annual savings, Taxis 80,000 to 150,000 km/year = $1,200-$5,250 in annual savings
  • Transport oil demand as a % of total: a little under two thirds

 Oil consumption by sector 

Electric cars have a number of other benefits, the main economic one being lower servicing costs as there are far fewer moving parts.

Levelised Cost of Driving

On an energy content basis, oil trades at a considerable premium to other energy sources:

  • $50 per barrel oil equates to $8.6/mmBtu
  • $75 per ton coal equates to $2.8/mmBtu.

So, “energy parity” comes down to economics once again. If the cost of a battery per kilometre is less than the cost saving then people switch en masse. If not then they don’t. But there are more complicating factors for driving, the key ones being range anxiety and how far you travel.

If you need to buy a 100kW battery to assuage your range anxiety then the upfront cost is a lot larger than if you are happy with a 60kW battery.

How far you travel is even more important. Someone driving 10,000km per year is amortising the battery cost over a lot fewer kilometres than a driver doing 100,000km per year.

In the table below I have shown the approximate costs for a taxi doing 100,000km per year with a 300km range battery (recharging about once a day), vs a passenger car travelling 15,000km per year.

Levelised cost of driving

Based on current oil prices and current electricity prices it is around 1.5c-2.5c cheaper to drive a car on electricity rather than oil. This can vary quite widely based on oil prices and taxes in individual countries.

But for taxis, the point is around about now – a taxi amortises the cost of a battery over a lot more kilometres.

Taxis switching to batteries are unlikely to move the needle much on oil consumption. But if driverless taxis work then we could see a significant change in oil consumption.

Driverless taxi exploration

A key question is this. If: (1) driverless taxis are cheap and (2) battery power makes sense for taxis, could we see a major shift to driverless electric taxis have a big impact on oil demand?

Yes. Yes we could. And probably will eventually. It is just that even the techno-optimist in me has trouble coming up with a scenario where that happens in the next 5 years.

Economics

I have cut this a number of different ways, but the simplest way is to look at car hire companies:

  • Car hire companies are happy to rent a car to users for $60 a day with about a 75% utilisation rate = $45 a day to the car company. Let’s call that the capital cost for a car.
  • Now let’s add a third to the cost to cover the battery and the driverless technology – puts us back at $60 per day.
  • Given its driverless, it can operate for 24 hours a day – but call it 15 hours to take into account time to charge the battery, cleaning, slow periods, servicing and to make the math easier.
  • So, the car owner needs to make $4 per hour to make a return.
  • Assuming 1.5 trips per hour (roughly the average), add in electricity costs, 10% to the booking company and about $3.00 per trip is the end cost to the user.

It is pretty compelling. Basically, a driverless taxi would be cost competitive with public transport.

Having said that, a driverless bus could mean that public transport also gets much cheaper. And driverless buses will be much easier to program – set path, usually in a city that can be easily mapped.

For many people those economics will work out to be better than owning a car.

As an aside, my expectation is that by the time the current light rail tearing up Sydney and causing traffic chaos is complete, driverless electric buses will be just about ready to go. With basically all the benefits of light rail. And they don’t need a track. And you can easily re-route them.

Ethics

Yes, there are lots of problems. And legal/insurance issues.

At some stage though we will see a government somewhere decide that an aggregate saving of lives is more important. My bet is that it will be difficult for a traditional democracy to be the first. Singapore makes a lot of sense as the first: rich, educated, small area, already discourages people from owning cars.   China is another that could take the plunge – and at that point, I’d bet that America’s “competitive spirit” kicks in and results in driverless cars there as well.

After that, it will be a lot easier for other countries.

Who knows when this will occur. Trials are active in a range of markets. We are probably talking 3-5 years at least just to start.

Acceptance

Uber/Lyft combined took around five years from launch to now delivering the same number of trips as taxis in New York.

I suspect there is a similar fear/greed matrix:

Fear vs Greed: Ridesharing and driverless cars

Will it take longer? Who knows.

I’ll bet the first few driverless car deaths get a lot of headlines.

But I bet that a $5 ride rather than a $50 ride will also attract a lot of headlines.

I’m tipping greed to win out– it usually overcomes fear, eventually.

Technology

Is the technology ready? It is close.

The problem is that releasing a beta version of a new social media platform that doesn’t quite work sometimes doesn’t have much downside. A beta version of a car does have a lot of downside.

The final technology polishing may take a number of years, it may be ready in a few months – it is very hard to tell.

Keep watching this space.

Summing it all up

Best case for driverless cars would be a limited release before 2020 in somewhere like Singapore. Taking into account rollout in other countries, acceptance, fleet build-up etc its probably not going be significant for world oil prices before 2025.

Worst case we are 50 years away.

Either way, oil demand is probably safe for the next 5 years. But its time is not far off.

 
 

Damien Klassen is Head of Investments at the Macrobusiness Fund, which is powered by Nucleus Wealth.



The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.