Oil Prices and Car Dealers:”Peak Oil Demand”

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This article is the second in a series on the impact of energy costs on car retailing in a dynamic automotive world. Click on any image to see a full sized version.

 

Gap between Oil production and discoveryWhat if, oil prices stay low indefinitely because the demand for oil peaks and supply outstrips demand? How will that impact car retailers and distributors?

Answer:  In 2016 petrol and diesel used 56Mn BDP – about 60% of the oil demand. If electric cars get a significant share of global new car sales volume, say 25 – 35%, the cumulative impact will be to reduce oil demand by around 13Mn BPD. That would change the business model for oil producers and car retailers. The rest of this post explains how and why.

In 1956 a respected oil geologist named M. King Hubbert argued that oil production would peak in the 1990’s and be in serious decline by now – between 2015 and 2025. From then on the developed world’s way of life would be seriously threatened.

Hubbert was wrong about oil production declining. According to the BP Statistical Review 2016 oil output rose in most years since 1965. In 2016 it was 92Mn barrels per day (BPD); In 1965 it was less than 32MN BPD. But, Hubbert might still be proved right, if we separate the demand for oil from the demand for energy as a whole. The aggregate global demand for energy is rising, albeit slowly – BP says that it is averaging under 2% a year for the last decade – while the aggregate demand for oil is falling. In other words, the world still needs energy, it just doesn’t need so much oil in the mix. The reasons, according to McKinsey’s Occo Roelofsen is due to three factors, “…first, overall GDP growth is structurally lower as the population ages; second, the global economy is shifting away from energy-intense industry towards services; and third, energy efficiency continues to improve significantly.” He said, “Peak oil demand could be reached around 2030.”

BP and McKinsey are not alone in signalling the advent of Peak Oil Demand. “We’ve long been of the opinion that demand will peak before supply, and that peak may be somewhere between 5 and 15 years hence, and it will be driven by efficiency and substitution, more than offsetting the new demand for transport,” said Shell Chief Financial Officer Simon Henry, in November 2016. On the other hand, OPEC and Exxon-Mobil both think that electric vehicle sales will peak at 6% and there will be no impact on the demand for oil.

Who is right? Is Peak Oil Demand going to happen or not? And if it does, what will be the impact on car retailers and distributors?

Three ‘Peak Oil Demand’ scenarios

In 2016 Boston Consulting Group (BCG) tested three scenarios that could lead to peak oil demand by 2030. They argue that any one of these could halt oil demandScenarios for Peak Oil Demand growth.

  1. Electric cars: These remain a drop in the auto-making ocean: about 1 million are sold each year, about 2-4% of global new car sales. For electric to substantially replace the internal combustion engine over the next few decades two changes have to happen. The true – unsubsidised – operating cost must fall and the convenience of re-charging the car must go up. The key is to develop sub $100, faster-charging and more durable batteries. If that happened – a big ‘If’ – then electric cars could be 90% of the global fleet by 2050. Peak Oil Demand would have occured by 2030.
  2. Slower Growth and Fuel Efficiency: If global growth slowed from 3.5% to 3% and vehicle fuel efficiency doubled – for cars from 2 gallons per 100 kilometres down to 1 with a similar proportional fall for trucks – Peak Oil Demand would arrive by 2025 or thereabouts.
  3. Gas Substitution: If natural gas prices outside the US fell to the 2014 level inside the US ($5/1,000,000 BTU), then gas would be an economic  substitute for oil. Again, Peak Oil Demand would arrive by 2025 or thereabouts.

BCG based their forecasts on oil at $60/barrel but added that, if oil re-bounded upwards to pre-2014 levels, peak oil demand would be a virtual certainty. Put differently, the lower the oil price, the longer it would be used; the higher the oil price, the faster it would be substituted by lower cost alternatives.

Does fuel efficiency have the potential to reduce demand?

Probably. Passenger cars make up 60% of global oil demand. Urban and commuter trips makes up 65% of car use. In the UK average vehicle mpg is now 25 – 30. The Toyota Prius averages 60mpg and the GM Volt is touted at 230mpg! If initial price and reliability challenges can be overcome, and adequate incentives are given, future consumers may well be encouraged to switch more quickly.

Fuel Efficiency

Average mpg evolution 2010 – 2030

The pace and size of demand reduction depends on many factors: the number of cars on the road, average annual miles, average mpg. However, Deutsche Bank estimates suggest that passenger car mpg could rise progressively from 28mpg to 57mpg by 2030. More importantly, they predict that demand for petrol will begin to fall by 2021. Petrol demand in the US has been flat since 2007 and in Europe since 2000.

Much will depend on communicating facts  to consumers beyond why they should choose a particular brand. Almost 90% of car trips are less than 20 miles round trip. In these the relative advantage of hybrids and fuel-efficient engines over conventional vehicles is even greater.

 

Post ‘Peak Oil Demand’

BCG remind us that a significant demand for oil remains even after peak oil demand is reached. They estimate at least 80MB BPD and growing at 0.5% pa. Other estimates suggest peak oil demand per capita may be possible, but global peak oil demand in total may be an illusion. Oilprice.com argue, “Underlying oil demand is growing for several reasons. The population is growing, the middle class is growing, car sales in developing countries are growing at a blistering pace and the number of miles driven is reaching all-time highs.” Taking these views into account, even if ‘Peak Oil Demand’ is reached for use in vehicles, overall oil demand will not outstrip supply because oil will simply be diverted by price to those uses where no economic alternative is available – for example, chemicals, trucking, shipping and aviation.

What the ‘experts’ say..

The New Policies Scenario, a forecast by the International Energy Authority (IEA), a consortium of 29 oil-importing countries committed to improving energy efficiency, says, “Under a scenario where fossil fuel use is restricted to limit global warming to 2°C, oil use would be significantly more limited.” They forecast demand will fall to 74.1MN BDP by 2040. According to a 2°C Renewal scenario developed by Norwegian oil firm Statoil and assuming accelerated clean technology transitions, for instance, oil use would be roughly 15% lower than today at below 80 million b/d by 2040. A similar scenario study by University of California Davis (UCD) found that the age of information technology and big data is bringing revolutionary changes to daily life with potentially dramatic consequences for energy savings. Exponential gains in productivity are expected in several areas including transportation logistics, industrial equipment and mobility services. UCD added that massive urbanization might curb the viability of private car ownership in the places expected to be the new centre of oil use, such as India, Indonesia and the Arab Gulf. Exxon-Mobil’s 2015 Energy Outlook forecast about 69MN BPD by 2040 on the back of reduced demand in the developed world but with the savings partially offset by increased demand in China and India, marine, heavy trucks, aviation and trains.

Are they right? Will there be a step-change in fuel efficiency as fuel efficient, electric or hybrids replace conventional engines in the next five to ten years? And, even if the energy demand per capita falls, will the global demand level fall as well or will increases in population and affluence simply take up the slack? In any event, whatever the methods of acquisition, fuel systems and patterns of use, will the global demand for vehicles fall or will it be just the mix of vehicles that changes?

Managing the Transition

OPEC IncomeIn July 2008 oil was selling for $147 a barrel. Now it’s barely $50. It’s no surprise that few people in oil importing countries care about the economic impact of the price fall on oil producers. Many of their governments are seen as corrupt and wasteful. The reputed $450m yacht bought in 2016 by the Saudi deputy crown prince, Mohammed bin Salman, didn’t help. However, as pointed out by the US Energy Information Administration in May 2017, the falling incomes of oil exporters has potential impacts on the rest of us.  The combined OPEC income fell over 64% between 2012 and 2016 in real terms. Five or more OPEC states are at substantial risk of economic and political instability: Venezuela, Nigeria, Libya, Algeria and Angola. Given the  high levels of youth unemployment across OPEC, its demographic – skewed towards 15 to 25 year-olds – and its existing tribal and religious conflicts, the outlook for the region is much less optimistic than just a few years ago. Even in the wealthy GCC, the risk of debt defaults is significant. The oil-rich GCC states enjoy similar economic structures: the national budget is based on the oil price. They give massive subsidies – fuel, utilities and housing to the native population and they speculate heavily in real-estate. There is great concentration of debts with individuals and their companies. The risk of default is much higher due to their lack of economic diversification. At the same time, for the region as a whole, political instability remains an important factor and political violence is emerging as a potent export to Europe, Africa and Asia-Pacific. If you are selling vehicles into the OPEC member states expect demand to be volatile and higher financial defaults until the economies adjust to a different level of government income.

Managing Automotive Brands: China sets the pace.

Electric CarsDepending on what variants you include, 773,000 electric cars were sold in 2016 – about 40% of the global total electric vehicles in use and 4% of total global new car sales. So, there is little evidence that the consumer is switching in large numbers towards alternative fuel vehicles yet, but there are signs that the switch-over is coming. The UK, Netherlands, Iceland and Norway are the leading markets in Europe but overall share in Europe is under 2%. The same is true for the USA and China. While the sales levels for electric cars do not yet justify their maker’s investment, no-one is abandoning the project. Why is that? The answer is China. The Ministry of Industry and Information Technology (MIIT) in the People’s republic of China (PRC), see two strategic advantages: First, if they can engineer a switch to Electric and Hybrid, the PRC can break out of dependence on imported oil; second, if the PRC can become the leaders in electric  vehicles, their domestic manufacturer’s can become credible exporters of cars world-wide. For them, the switch of power-trains is a once in a century technology opportunity to leapfrog the existing dominant brands from the US, Japan and Europe. Last year China sold 28MN cars. By 2035 they forecast sales of 35MN cars. China’s MIIT wants all of that growth to come from so-called New Energy Vehicles (NEVs)…and they want to their domestic brands to make them…and then sell them all around the world.  The stage is set for a significant struggle between existing brands from Europe, the US and the far East and newly emerging brands from China.

Electrics and Hybrids – Public Attitudes and Incentives

However, right now, without incentives or penalties, public attitudes to electric vehicles are at best ‘lukewarm. The UK has surveyed people’s attitudes since 2014UK Attitudes to electric cars and positive purchase intentions remain stuck at 5% or 6%. A study by Deloitte’s of 13,000 consumers across 17 countries in 2011 came to similar conclusions: the market potential was between 2% – 4% given existing technology. Consumer barriers included price premium, range, charging time, charging infrastructure and risk aversion to untested technology.

A 2014 report by the International Council on Clean Transportation (ICCT) on electric car incentives revealed that different states in the US offering the same incentive levels achieved very different rates of consumer acceptance but that, in general, higher incentives led to higher market shares for electric vehicles. Their research underlines an earlier report by JD Power that showed willingness to switch to electric was linked to income, education, lifestyle and geography. Put simply, younger, well-educated, affluent West Coast professionals are more positive than a similar demographic based in the Mid West.

In Norway, the switch to electric cars has required heavy subsidies and benefits – exempt from high rates of purchase tax, and VAT, pay no road and ferry tolls or parking fees, cost less to insure and can be charged up for free electricity from thousands of points. Local government in Norway will also subsidise the installation of charging points in homes. Research suggests the subsidies could be worth nearly £5,000/$7,000 a year per car. And, even in Norway incentives will be withdrawn, or reconsidered, when 50,000 zero emission cars have been registered or come 2018, whichever is the earliest.

Electrics and Hybrids – List Price vs Fuel Savings

The challenge for car brands is not just how to market electric vehicles alongside their existing products and their brand heritage. It is to do it without incentives. Without incentives, Electric and Hybrid cars are  more expensive than their stable mates which use conventional fuels, even among cars produced by the same manufacturer. But, they do have marginally better residual values. For example, if you compare  a petrol Toyota Auris with its  Dual-Fuel version, it would take around 30,000 miles to make up the price difference for the average driver. As petrol prices fall, that gap expands.

IHS produced the break-even graph here to show how long it takes the buyer to get the premium back. The green columns are 12,000 and the blue columns are 20,000 miles driven per year. On the left is the Payback Period: Electric versus Conventional Carsprice of fuel. Its chart shows the annual fuel cost for a mid-size car averaging 24mpg at different fuel prices.  On the right is a $3000 price premium and a 25% improvement in mpg. Its chart shows how many years it take to get the price premium back at different oil prices. In this case the higher the fuel price, the shorter the payback period

Much of the price premium reflects the fact that hybrid technology was newly developed during the early part of the 21st Century, while the mechanical elements of conventional engines have long since been paid back. As Electric and hybrid technology matures, the prices of electric and hybrid vehicles should decline so, the new car price premium may be temporary, so may not be a stumbling block for future car buyers. However, it also shows that high fuel prices coupled with higher fuel efficiency are both incentives to switch to electric.

Electric Cars – Battery Life, Replacement Cost and Disposal

As mentioned in the BCG study earlier, a major hurdle in the widespread adoption of electric cars is the battery itself. The potency and number of miles which a car will go on a single battery charge has made battery-powered electric vehicles (BEV’s)  manufactured in the early 21st century largely impractical for motorway driving, when most battery powered cars are recharged at the owner’s home. However, as battery charging stations become more common, this limitation should be reduced. A more serious concern is the disposal of spent battery packs in hybrid and electric cars. Car manufacturers are aware of this issue, and continue to research and develop less toxic battery packs for electric and hybrid cars. After all, if part of the buying motivation is to be ‘green’, disposing of toxic batteries is a ‘no,no’.

Top of the objections is the replacement cost of battery packs. Extended warranties take the risk of early battery replacement away from initial owners. However, with existing battery replacement costs reported between £4,000/$5,400 plus, this may become an obstacle in the used car market as products age. There is no comparable cost for a conventional engined vehicle and the future cost of  battery replacement could make a large dent in any fuel savings for the used car buyer.

The good news is that battery prices are dropping like a stone at the moment. In 2010 a 25KWh battery pack cost £9,750; by 2020 Deutsche Bank forecast it will cost £3,750. If that sounds optimistic, remember that laptop batteries fell from £1,200 to £150 in 15 years. If these cost reductions do materialise, it speeds the payback of a Hybrid from 15 years down to less than 3.

 

Low Oil Prices and Auto Manufacturing

Impact of Oil Prices on car makersWhat are the direct effects on car makers of  low oil prices? Limited. While there may be marginal reductions in costs for some oil-price related inputs, such as plastics and tyres, resulting in improved profit margins,  a 2015 study by IHS signalled four key impacts from low oil prices, none of which change the strategic position of car makers.  First, they think that global sales of passenger car and vans will rise by 5MN to 7MN above forecast between 2014 and 2021. IHS forecast 760MN through the period and estimate it would rise by 1% more.  Second, the impact will be felt most in markets where fuel taxes are lower, such as the US and the Middle East. Countries with high fuel taxes, such as  the EU and the UK will see much of the oil price fall taken up by taxes. Countries with high fuel subsidies, such as Mexico, India and Egypt may take the opportunity to reduce the subsidy, so consumers see no price change at all. Third,  the consumer’s incentive to switch towards electric vehicles will reduce. The ‘payback’ period will be longer than the first buyer’s ownership period so the incentive to switch will dwindle. Fourth, the manufacturer’s incentive to introduce electric vehicles will depend on the regulatory structure as well as consumer demand. Three-quarters of all passenger cars and vans sold are subject to fuel-efficiency or CO2 regulations or both.

 

What are a dealer’s options?

Perhaps the most important task is to make sure that you don’t get left behind simply because you can’t supply a product that the customer wants to buy. Dealers need access to plug-in electric hybrid vehicles (PHEV), Battery electric vehicles (BEV) and, so long as they’re legal, high efficiency conventional engines at the very least. Some manufacturers are already re-positioning themselves as major producers – Nissan, GM, Ford, Daimler, Honda. Others, like Tesla, Jaguar Land Rover and Volvo (owned by Chinese auto-maker Geely), are positioning to be new leaders. However, with China poised to follow the UK and France in banning diesel and petrol car sales entirely sometime in the 2030’s, and being the world’s largest market, that may be the place to look for new brands to represent if existing franchises are too slow off the mark. Just as dealers switched away from weak home-grown brands to Japanese and European brands  in the 1970’s, we may see dealers trekking to China to find viable new electric car franchises in the next few years.

The next challenge will be after sales. According to Tesla, there is a lot less servicing, lower parts requirements and simpler workshops. There are no Components of an Electric Carfluids or fluid disposal systems because the car doesn’t have oil or power steering fluid. The building doesn’t need the extraction equipment you normally find in workshops because there are no gases to extract. An electric car has fewer moving parts in its drivetrain so there is less to wear out so the workshop doesn’t need to be full of spares. It doesn’t need to carry large stocks of consumables such as brake pads and discs because the car barely uses its friction brakes – the retarding action of the electric motor is such that just lifting off the throttle slows the thing down to the same degree as using the brakes. According to some estimates the maintenance cost will be around one-third of the equivalent conventional car. Bringing sales and service staff to a new understanding of what the future may hold could be a challenge. If the response to earlier technological or service challenges, such as the Internet or Retail Finance, are a guide, inspiring staff to embrace new technologies will take a major effort.

Perhaps the most important issue is dealer management itself. Peak Oil Demand is an event that will likely occur. Only its timing is flexible. The switch to electric and hybrid technology is the most significant change in the last fifty years. Its far more than a change in product; it’s a change in mindset.

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