It’s not EVs that get ya, it’s the efficiency standards

In 2015/2016, my team did a deep assessment on what uptake of EVs might do to oil demand. What we found was that efficiency standards had far greater power to decrease oil demand but agreed with other investors and forecasters that high uptake of EVs (particularly policy-supported) could create unexpected supply-demand imbalances which reduced oil prices (and oil company earnings).

Our starting thesis was that there was an under pricing of risk of long term decreasing demand in the oil driven by lower demand in transportation. We hypothesised that transportation was beginning a secular shift towards non-oil based fuels with a repricing event coming for oil & gas supply chain.

It was not just prompted by Tesla but also discussions we had with oil and gas analysts who touted the relative flexibility of the shale oil sector to ramp up and down faster than existing producers. At the same time, oil majors were producing long term forecasts about stable oil demand (see below from Exxon’s Energy Outlook in 2015).

Oil demand was assumed to grow at a stable 0.8% out to 2040 but the analysts were saying ‘the oil company value is in the ability to turn off and on’ which suggested that there was volatility in demand coming. So we wanted to understand why flexibility, which is per unit more expensive than building a massive oil platform, would be more valuable. The source of the volatility had to come from the transportation sector as the major consumer of oil.

Our central resource was a global vehicle transport sector model developed by The International Center on Clean Transport. It was a great model because:

• it was geographically detailed
• focused on technology within the vehicle
• had a stock and flow model to capture the time that vehicles were in use
• captured the multitude of vehicle policies (CAFE standards, EV incentives etc).

We worked on building out scenarios where oil demand experienced long term decreases or there were short term demand drops which might result in major price falls.

Around the same time, ArkInvest and Bloomberg NEF (who we had engaged with during our analysis) published their own analysis. Both suggested that EVs would be the driver of oil demand decreases.

ArkInvest produced the following chart.

While Bloomberg produced this chart.

Both focused on the EV uptake scenarios with ArkInvest including a discussion on the impact of autonomous vehicles. Both concluded that a displacement of more than 2 million barrels per day demand would occur sometime in 2024-2026 and Bloomberg concluded that there was a good chance of a ‘forecasted crash’.

We also concluded that there was a chance of a 2 million barrel per day in the same period from EVs but that the uptake of EVs only created short term imbalances.

Much more important for long term o earnings in the oil and gas sector was that oil demand could be permanently displaced by advancing efficiency standards (of which EVs are only a part of). EV policy, in the absence of advancing efficiency standards, may not permanently displace oil demand because the remaining fleet may actually increase in oil demand.

Just look at high oil consuming SUV sales in 2017!

The ICCT, as noted above, captures the actual and proposed passenger car efficiency standards across the world. These targets are average fleet efficiency that company sales in each country (or region) has to achieve.

Things to note from this chart:

• See where China and India sits compared to the US – not much different. These countries, who are still increasing in car ownership, are likely to end up with a far more efficient average fleet than the fleet in the US and result in far lower oil demand growth than expected in these countries.
• Anything that increases car turnover will increase the number of fuel efficient vehicles on the road (think cash for clunkers) and drive down oil demand.
• Our assessment was that it was nearly impossible for a car company to sell into any country with less than 5L/100km average without having an EV model (zero oil use). Fuel efficiency standards make EVs inevitable.

So we came to realize that EVs posed short term risks to oil demand but that the advancing fuel efficiency standards were the drum beat of falling oil demand.

Repricing events should then happen on the back of new efficiency standard announcements (or freezes like the US in August 2017).

Below is the Global Energy Producers ETF (FUEL)

Could we link repricing events (big jumps up and down) with fuel efficiency announcements rather than EV sales?