Guest post by Isuru Seneviratne, Founder & Portfolio Manager, Radiant Value Management. Isuru has specialized in energy sector analysis and investing since 2004. Visit www.radiantval.com for more information on the author and firm. Image from Electricity May Be the Driver (1957) – America’s Electric Light and Power Companies.
“The Stone Age came to an end not for the lack of stones… And the Oil Age will come to an end not for lack of oil.”
– Sheikh Yamani, Saudi Arabian Oil Minister 1962-1986
Through most of the 21st century, as demand from emerging markets accelerated, energy markets grappled with the prospect of oil production rate reaching a peak (or plateau) due to geological limitations. While conventional U.S. production has peaked, the tight oil revolution turned the ‘peak oil’ thesis on its head. Abundant resources, previously bypassed, are now accessible with new technology. However, the hump-like oil chart has reappeared in energy discussions, but this time driven by declining demand.
Exhibit 1: Source: Financial Times (BP Statistical Review; Bernstein estimates for 2016 and beyond)
The century-old model of road transportation is ripe for transformation. Three self-reinforcing trends are shifting transportation away from individually-owned, human-driven, internal combustion engine (ICE) vehicles. The convergence of all three aspects – on-demand ride sharing, electric vehicles (EVs) and artificial intelligence – can enable better utilization of vehicles and passengers’ time. Individually owned vehicles, despite being the second most expensive possession for many, are used a mere 4-5% of the time. Note on our use of the term: EV includes Plug Hybrid Electric Vehicles and Battery Electric Vehicles, but excludes hybrids. In this report, we explore how emerging changes could affect vehicle utilization, reduce costs and impact the demand for oil and lithium, the essential EV battery material.
We anticipate EV adoption will be constrained by raw material supply, primarily cobalt and copper. In the meantime, oil demand will continue to rise, driven by the emerging global middle class. Oil demand peak may well come in the mid-2030s, but low-cost, fast-turnaround producers should benefit before and during this time.
Compared to individually owned vehicles, car-sharing companies like Zipcar have seen increased vehicle utilization. Zipcar’s annual member survey revealed that nearly 10% of members got rid of personal cars after joining and 32% would have purchased a vehicle were Zipcar unavailable.
Exhibit 2: Source: ARK Investment Management LLC (who annualized the first quarter volume estimates from Hillhouse Capital)
In the next level of outsourced mobility, ride-sharing businesses have demonstrated much higher capacity utilization than traditional taxis. The modern iterations that offer Mobility-as-a-Service (MaaS) can better match demand and supply due to superior technology, lower regulation and unmatched scale.
During the decade that ended in 2015, the annual vehicle fleet growth was 3.7% for the world (17.8% for China and 10.8% for India). The burgeoning global middle class and urbanization in the emerging world is the most important market for incremental transportation demand, with car ownership a mere fraction of what it is in the U.S. or the G6. OPEC World Oil Outlook 2016 expects the world’s passenger car fleet to grow from 1,040 mn in 2015 to 2,111 mn by 2040, with developing markets accounting for 916 mn of the increase. While demand growth is strong, emerging markets have been much quicker to choose MaaS (Exhibit 2) over personal cars. Here, the vehicle cost vs. income ratio is much higher, as is the percentage of people without a driving license. Shared mobility could leapfrog the personal ownership model much the same way that cell phones proliferated ahead of fixed lines in most of the world.
While such a change would affect the long-term car demand, cheaper transportation could increase the demand for MaaS, and therefore vehicle miles and fuel use.
“We expect the metropolises in China and Asia will switch to pure electric mobility very fast… I believe there will be few pure combustion engines to be seen in the large cities there in five years’ time. The development in rural areas will, however, proceed much more slowly.”
– Oliver Blume, CEO of Porsche AG
Currently the lithium-ion battery pack that powers an EV accounts for 32-40% of the vehicle cost. Battery costs per kWh have been declining at an astounding 20% per annum since 2010. After tearing down the first mass-scale full-battery EV, the Chevy Bolt, UBS research expects battery costs to decline a further 37% by the mid-2020s to reach unsubsidized cost parity with comparable ICE vehicles. In Europe, which has high petroleum taxes, the Bolt may achieve total cost of ownership parity for a personal owner by 2018.
The rechargeable battery manufacturing industry is slated to multiply worldwide manufacturing capacity from ~103 GWh currently to over 273 GWh by 2021, according to Bloomberg New Energy Finance. The firm estimates the learning rate (the price decrease for every doubling of capacity) to be 19%.
Electric drive trains have a fraction of the moving and wearing parts of ICEs, lowering maintenance needs.
Exhibit 3: Source: Bloomberg New Energy Finance
After years of disappointments and setbacks, EVs may be reaching a viability tipping point. Recently, many automakers have unveiled goals where 15-30% of sales are EVs by 2025. Major oil producers are raising estimates of EV penetration. OPEC’s changed outlook between the World Oil Outlook reports of 2015 and 2016 is striking (Exhibit 3). Including other non-conventional technologies, OPEC now expects 22% of the world’s 2040 passenger car fleet to not use oil, compared to its prediction of only 6% a year ago.
The third major factor of the mobility transformation is the advent of truly autonomous automobiles. Major automakers and tech giants are racing to
develop unsupervised self-driving vehicles. In a few years, time in a car could be spent productively or used to relax.
When driven by tireless machines, taxis can operate all day except when recharging or undergoing maintenance. This is the key to unlocking the full benefits of the two shifts outlined above. The highest component of annual driving cost is depreciation (44%). Due to higher utilization, autonomous taxi operators can buy more expensive EVs and yet have lower depreciation per mile. Exhibit 4 is a thought experiment comparing the all-in costs of transportation in the U.S. by 2020. At 4x the utilization of personal cars (3.5-5 hours per day at present human speeds), unsubsidized autonomous taxis could cut all-in costs by ~40%, despite repeated battery replacements and MaaS service charges (modeled at 20%). In a MaaS future, a variety of vehicular options can provide cheap door-to-door transportation around the clock.
Exhibit 4: Assumptions: ICE car $30,000 vs. fully autonomous EV $55,000. Full operation over 10-year life with no salvage value.
Annual mileage ICE 10,000-15,000, EV 40,000-60,000. EV battery replaced every 200,000 mi at $10,000/ea.
Gasoline price $2.50/gal, electricity price USc 10.3/kWh. No reduction of insurance cost or finance rate for EV.
Fuel efficiency ICE 32.6 mi/gal (2%/a gain over 2017 small sedan avg), EV 3.5 mi/kWh. MaaS margin + R&D 20% of all other costs.
Sources: AAA Your Driving Costs 2016 (small sedan), EIA (2016 all sector retail electricity), fuelly.com
Oil and Lithium
We are skeptical of aggressive MaaS projections that crow an imminent collapse for oil. (E.g. in their May 2017 report Rethinking Transportation 2020-2030, James Arbib and Tony Seba of RethinkX predict that by 2030, within 10 years of regulatory approval of Autonomous Vehicles, 95% of U.S. passenger miles traveled will be served by on-demand autonomous EVs.) Americans love their cars and families are loathe to give up personal vehicles. The value proposition resonates more strongly in emerging economies, where road conditions and regulations are more challenging.
EVs require less steel than ICEs to build, but demand much more copper, nickel and aluminum on top of specialty battery materials. Over the last 10 years, despite elevated capital spending during the ‘commodities super-cycle,’ base metals production growth has been below long-term averages.
Cobalt, a key component of lithium-ion batteries, is almost entirely a by-product of copper and nickel mining. Nearly two-thirds of mined cobalt is sourced from the politically unstable Democratic Republic of Congo. We see the availability of these materials as a crucial limiting factor for accelerated EV deployment.
Road transportation accounts for 45% of global oil demand, half of which comes from passenger cars. Even if all new vehicles are EVs, the world’s fleet of ICEs will keep consuming oil. A rapid shift to electric MaaS could reduce the number of cars needed and strand higher-cost oil assets. EVs make up 1% of new vehicle sales and the global fleet is presently 2 mn. The average U.S. vehicle (including commercial) consumes about 16 barrels of oil per year. To displace 1 million barrels of oil per day (mnb/d), EVs would have to replace ~22 mn ICEs. OPEC’s updated forecasts for the world’s EV fleet reach this threshold circa-2025 (Exhibit 3). Global oil demand grew by 2.1 mnb/d (2.3%) and 1.6 mnb/d (1.7%) in 2015 and 2016 – above historic levels due to the oil price collapse. Demand growth will likely remain strong at low oil prices. Our oil investment thesis stems from natural field declines and the massive cutback of capital reinvestment.
Low-cost oil producers have strong economics even at depressed oil prices. A few companies with low debt have ample capital flexibility. They offer upside when external capital inflows, which keep propping up U.S. shale production, slow down.
Lithium is essential to EV batteries and the demand is accelerating. A 1% increase in battery-only EV penetration would increase demand by 70kt of lithium carbonate-equivalent per year, or roughly a third of current total production. We invest in attractively-valued lithium producers and developers.
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