The Demand for Oil will drop but is that enough?

                                                   Comments due by April 7, 2017

IT HAS BEEN a bad couple of years for those hoping for the death of driving. In America, where cars are an important part of the national psyche, a decade ago people had suddenly started to drive less, which had not happened since the oil shocks of the 1970s. Academics started to talk excitedly about “peak driving”boomers, car-shy millennials, ride-sharing apps such as Uber and even the distraction of Facebook. Yet the causes may have been more prosaic: a combination of higher petrol prices and lower incomes in the wake of the 2008-09 financial crisis. Since the drop in oil prices in 2014, and a recovery in employment, the number of vehicle-miles travelled has rebounded, and sales of trucks and SUVs, which are less fuel-efficient than cars, have hit record highs. This sensitivity to prices and incomes is important for global oil demand. More than half the world’s oil is used for transport, and of that, 46% goes into passenger cars. But the response to lower prices has been partially offset by dramatic improvements in fuel efficiency in America and elsewhere, thanks to standards like America’s Corporate Average Fuel Economy (CAFE), the EU’s rules on CO2 emissions and those in place in China since 2012. The IEA says that such measures cut oil consumption in 2015 by a whopping 2.3m b/d. This is particularly impressive because interest in fuel efficiency usually wanes when prices are low. If best practice were applied to all the world’s vehicles, the savings would be 4.3m b/d, roughly equivalent to the crude output of Canada. This helps explain why some forecasters think demand for petrol may peak within the next 10-15 years even if the world’s vehicle fleet keeps growing. Occo Roelofsen of McKinsey, a consultancy, goes further. He reckons that thanks to the decline in the use of oil in light vehicles, total consumption of liquid fuels will begin to fall within a decade, and that in the next few decades driving will be shaken up by electric vehicles (EVs), self-driving cars and car-sharing. America’s Department of Energy (DoE) officials underline the importance of such a shift, given the need for “deep decarbonisation” enshrined in the Paris climate agreement. “We can’t decarbonise by mid-century if we don’t electrify the transportation sector,” says a senior official in Washington, DC. It is still unclear what effect Donald Trump’s election will have on this transition. In a recent paper entitled “Will We Ever Stop Using Fossil Fuels?”, Thomas Covert and Michael Greenstone of the University of Chicago, and Christopher Knittel of the Massachusetts Institute of Technology, argue that several technological advances are needed to displace oil in the car industry. Even with oil at $100 a barrel, the price of batteries to power EVs would need to fall by a factor of three, and they would need to charge much faster. Moreover, the electricity used to power the cars would need to become far less carbon-intensive; for now, emissions from EVs  powered by America’s electricity grid are higher than those from highly efficient petrol engines, say the authors. My kingdom for a cheap battery They calculate that at a battery’s current price of around $325 per kilowatt hour (kWh), oil prices would need to be above $350 a barrel for EVs to be cost-competitive in 2020. Even if they were to fall to the DoE’s target of $125 per kWh, they would still need an oil price of $115 a barrel to break even. But if battery prices fell that much, oil would probably become much cheaper, too, making petrol engines more attractive. Even with a carbon tax, the break-even oil price falls only to $90 a barrel. Those estimates may be too conservative, but the high cost of batteries and their short range help explain why EVs still make up only 0.1% of the global car fleet (though getting to 1m of them last year was a milestone). They are still mostly too expensive for all but wealthy cleanenergy pioneers. Many experts dismiss the idea that EVs will soon be able seriously to disrupt oil demand. Yet they may be missing something. Battery costs have fallen by 80% since 2008, and though the rate of improvement may be slowing, EV sales last year rose by 70%, to 550,000. They actually fell in America, probably because of low petrol prices, but tripled in China, which became the world’s biggest EV market. Next year Tesla aims to bring out its more affordable Model 3. It hopes that the cost of the batteries mass-produced at its new Gigafactory in Nevada will come down to below $100 per kWh by 2020 (see chart), and that they will offer a range of 215 miles (350km) on a single charge. Countries that have offered strong incentives to switch to EVs have seen rapid growth in their use. Norway, for instance, offers lower taxes, free use of toll roads and access to bus lanes. Almost a quarter of the new cars sold there are now electric (ample hydroelectricity makes the grid unusually clean, too). This bodes well for future growth, especially if governments strengthen their commitment to electrification in the wake of the Paris accord. The Electric Vehicles Initiative (EVI), an umbrella group of 16 EV-using nations, has pledged to get to 20m by 2020. The IEA says that to stand a chance of hitting the 2ºC globalwarming target, there would need to be 700m EVs on the road by 2040. That seems hugely ambitious. It would put annual growth in EV sales on a par with Ford’s Model T—at a time when the car industry is also in a potentially epoch-making transition to self-driving vehicles. But imagine that the EVI’s forecast were achievable. By 2020 new EV sales would be running at around 7m a year, displacing the growth in sales of new petrol engines, says Kingsmill Bond of Trusted Sources, a research firm. Investors, focusing not just on total demand for oil but on the change in demand, might see that as something of a tipping point. As Mr Bond puts it: “Investors should not rely on the phlegmatic approach of historians who tell them not to worry about change"