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When will digital transportation impact oil markets?

When exactly will oil markets feel the pressure from Tesla? Not anytime soon, but Tesla is just a distraction from the main show.

 

 

I attended yet another meeting in Calgary with an oil company where the attendees dismissed the impending threat to oil demand from encroaching transportation change. I get that – oil companies are vested in the status quo, but the signposts of change are now popping up everywhere.

France, the UK, Norway, India and China all have plans to phase out fossil fuel cars. Tesla is hammering the competition in the markets, and it’s hurting car companies. Even big oil execs know that change is approaching.  

A formula for figuring out timing

 

At what point would there be enough demand destruction of transportation fuel (gasoline) that the demand shortfall would impact the price of crude oil?

 

This is a twisty problem if your goal is precision, but a blunt way would be to figure out how much gasoline a typical car uses each year, estimate how quickly cars can adopt digital and electric features, and identify the point when digitally destroyed demand triggers a price move.

 

How many cars are there?

 

There are about 1 billion cars in the world, give or take, according to the Paris-based organisation that tracks these sorts of things. Let’s assume they’re a reliable outfit. They also estimate the global car manufacturing capacity at about 72m units per year. As for demand, about 40m cars are for brand new drivers (i.e., growth in demand) and the balance, 30m cars, are replacement as old clunkers are junked. That gives us a rough estimate of the number of gasoline engines out there, and the growth rate in the market (5% per year or so). For convenience, let’s just ignore lawn mowers, jet skis, motor boats and other gasoline internal combustion engines (ICE). I’m sure they matter but intuition suggests they are not the majority of consumption.

 

The top six major car companies account for over 50% of vehicle production, and all claim to be developing new drive trains that rely on electric power partially (the hybrids) or fully (the all electrics). Ford, for example, clearly states that all electric is the way to go to achieve a zero emission future. Hybrids may be just a stepping stone. Check out their plans.  Toyota; Volkswagen; Hyundai; GM; Ford; and, Nissan.

 

Other transportation technologies

 

What we don’t hear as much about, but will have just as big, if not bigger, impact, is all the other technologies that are getting stuffed into the car. Three key advances are moving along at very high pace, and much faster than designing and building new electric drive trains.

 

Connected cars

 

Once vehicles get on the grid, they can talk to each other. Once that happens, cars can drive much closer together because the computers can take over the brakes (a computer’s reaction time is so much better than human). By driving closer together, cars can draft, just like bikes in a peloton in the Tour de France. Drafting is extraordinarily efficient – cyclists gain a 40% productivity improvement when they cycle in formation, ducks get the same benefit flying south, and so will vehicles on the highway. And cars don’t need to be electric to be connected.

Autonomous cars

 

Once vehicles become autonomous (and they don’t need to be fully electric to be more robotic –cruise control is a robot), they can take over more of the driving. No more jack-rabbit starts, hard braking, idling while waiting, and inefficient gearing on hills. This equates to fuel efficiency and therefore less fuel demand. By how much is uncertain, but a recent case study by some Tesla drivers shows that a Model S could drive up to 1000km on a single charge.

 

Shared cars

 

Services like Car2Go, Uber, Whim and Lyft eliminate the need to own a vehicle at all. They reduce the demand for new and replacement vehicles. Most personal vehicles are used just a fraction of their available capacity – most of the time they sit idle in garages and parking lots. Assume a standard commuter personal car drives 25,000 km per year at an average speed of 60 km per hour. That’s a utilisation rate of 4.7%. To many millennials it doesn’t make sense to own something that expensive that gets so little use when a shared vehicle is just around the corner. As the shared car fleets grow, will they acquire older dumb gasoline models or newer smart models that incorporate autonomous, connected, hybrid and electric features? I’m betting on smarter cars.

 

Digital trucks

 

The same technologies also apply to the trucking industry, which are even more susceptible to these technology developments (except perhaps the sharing phenomenon). Truck operators aim for high utilisation already, and so their biggest lever to improved economics is to reduce fuel consumption (ie, connected and automated). The truck fleet turns over much faster, and there’s only 330 million trucks worldwide.

 

The combined impact

 

Adding up the impacts of these three digital advances suggests as much as a 40% fuel reduction for long distance driving, a halving of the number of vehicles to raise utilisation rates, and a fuel efficiency gain of 25% from robotic management of the vehicle. I’m precisely wrong on all of these estimates, but they are directionally correct.

 

The Tipping Point

 

Oil markets tipped into oversupply in June 2014 by a piddling amount – OPEC estimated anywhere between just 1-2 million barrels of daily production. So markets are finely balanced, as 1-2m bbls per day was about 1-2% of daily production (back then, somewhere around 95m bbls/day), not a lot.

 

So the question is how many of these new fangled digital cars does it take to displace 1m bbls of crude oil per day? Let’s call this the demand destruction tipping point.

 

The world consumes about 100m bbls of oil per day, or 36.5 billion barrels per year. About 20% of that crude oil (more or less) is converted to gasoline for gasoline cars, or about 7.65 billion barrels of gasoline per year. Therefore the billion cars out there consume about 7.65 billion barrels of gasoline, which is about 7.6 barrels of gasoline per car per year. That’s a really blunt instrument approach to the numbers but it gives us an idea of demand per car.

 

A million barrels of crude oil, or 200,000 barrels of gasoline per day, or 73m barrels of gasoline per year, supplies 9.5 million cars per year at a rate of 7.65 barrels per car.

 

Just 10m all electric cars on the road, or 20 million highly digital cars, will permanently destroy demand for 1m barrels of crude oil. The first million all electric are on the road now, but the shared car fleets are growing very rapidly. Autonomous vehicles are coming fast. The automakers have started the conversion. It won’t take 10 years to get to 10m because of the cumulative effect of adding more digital cars every year.

 

Once we reach the tipping point, demand destruction will accelerate. Diesel demand destruction won’t be far behind.

 

Oil supply

 

OPEC’s attempts to manage oil production for the past several months has not worked out. Prices are still stubbornly low, stuck in the 50’s. Supply management isn’t going work out because many oil producing nations (all of OPEC, Norway, Russia) realise that their only play now is to produce their oil as fast as possible before the tipping point arrives, prices fall again and reserves are stranded.

 

Furthermore, shale will just get more productive over time, increasing supply. Recovery rates for shale oil deposits are much lower than for conventional oil deposits, but by applying digital to the problem of improving recovery rates in shale, the industry will unlock a lot more reserves. Today, shale recoveries are 15% compared to 60% for conventional. Quadrupling recovery rates for shale is a digital problem, solved by studying flow rates, pressures and proppant behaviour in the shales. Yet more pricing pressure.

 

Implications for the industry

 

It may well be too late for Canada to worry about pipelines to supply global markets. The markets we want to supply (Asia, Europe) are intent on eliminating oil from the transport sector. It will likely be more economic for Europeans to satisfy their dwindling demand from existing sources (the Middle East, Russia, North Sea).

 

The threat to high cost oil producers is existential. If costs and productivity are not reset to world beating levels, those reserves are valueless. $50 is not the floor, it’s the ceiling.

 

Companies in the industry or serving the industry need to start thinking about diversification. Once the tipping point is reached, balance sheets are going to come under severe pressure as investors reprice the value of reserves, service companies and related businesses.

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