While passenger cars and road freight make up only 1/8th of the world’s carbon emissions, a collection of factors have come together to provide the move to electric vehicles with a momentum that now appears unstoppable. The oil industry’s heavy reliance on this market sector means that not only will legacy car manufacturers be disrupted but with them, a whole energy industry will need to re-evaluate the value of staying in the business.
Over the past 200 years, the world economy has been through three revolutions – the industrial revolution, the technological revolution and now, the more recent clean energy revolution which started in earnest about 10 years ago.
All three revolutions have had and will have fundamental implications for the world economy and society. However, the clean energy revolution has a major difference. It has been driven primarily by governments, concerned about the climate changing impacts of CO2 emissions from the burning of fossil fuels. While the two previous revolutions have largely been driven by private risk capital being directed into producing products for human consumption, the green energy revolution is essentially a government led strategy to conserve the earth for longer term human habitation.
While governments are usually clumsy and inefficient when trying to direct economic development, in the absence of any market mechanism to put a price on carbon to efficiently direct capital into the best and lower cost solutions, governments have had to fall back on their old policy tools – regulatory restrictions and subsidies. However haphazard these tools often are, in a wider sense these can play the part of a shadow price of carbon if intelligently calculated and have a reasonable outcome of directing capital into the desired areas.
The gathering global momentum by governments to come together and force a move away from fossil fuels is almost unprecedented but no less powerful. The COVID-delayed meeting in Glasgow in November of this year succeeded in further committing economies around the world to take the next significant steps towards reducing carbon. This building momentum has in no doubt been given a further boost with the re-entry of the USA into the Paris Agreement and with the joint US/China statement on cooperating to escalate their efforts in moving away from fossil fuels. Already industry advisers are recommending that any company working in the fossil fuel industry either directly or indirectly, should be wary of the future and be wise to develop medium term plans to either exit the business or develop a strategy to join the new industries developing around the core of the clean energy revolution.
The global drive to reduce carbon emissions will focus on three main areas. Electricity generation, industry, agriculture and transport with the latter making up about 16% of total global carbon emissions.
As energy and heat use make up over 73% of these emissions, it is not surprising that the electricity generation sector will remain the primary focus of the shift to clean energy sources with massive investments in wind, solar and storage continuing to ramp up exponentially. Agriculture (18%) is a special case given that this sector has a significant ability to create carbon offsets in the normal course of their business. So why does the road transport sector, which makes up about 12% of carbon emissions, attract so much focus by governments as part of their emission reduction strategies?
There are three main reasons for this. Firstly, any emission reductions process will pick the low hanging fruit first. It is already clear that the transport sector has a viable technology to replace Internal Combustion Engines (ICE’s) in the form of Electric Vehicles (EV’s) and the investments required to complete the transition is manageable over the next 10-20 years. Secondly, the transport sector is a huge contributor to air pollution in cities where apart from carbon dioxide emissions, cars and trucks are responsible for other pollutants such as carbon monoxide as sulfur dioxide, nitrous oxides, cancer causing particulates and other pollutants. As cities are where the vast majority of voters are, governments cannot ignore this or be seen as supporting the transport industry over the health of the population. Thirdly, just like the move from horse drawn power to ICE’s, the move to EV’s presents an opportunity to create new industries and sustainable jobs. One only has to look at China, the largest car market in the world, to see the business opportunity that the transition to EV’s presents and their current drive to be a world leader in this area, just as they have been with solar panels.
But despite the support governments around the world are giving to the take up of EV’s, so far the market has been slow to warm to the idea of driving a car that may run out of energy before it gets them home. While new car sales in Norway is currently 70% EV’s, other developed countries such as the US has a take up of only 2% of new car sales. Even in China where the government is clearly supportive of the move away from ICE’s sales to EV’s, so far in 2021 only represented 7% of sales.
Clearly, the future potential of the EV market is being held back by the cost of new vehicles, their range, the lack of recharging infrastructure and the as yet uncertain application of this technology to the freight industry. However, despite these barriers, government action is likely to lower these obstacles by mandating targets that the industry will need to meet. The UK and other European governments have banned the sale of new ICE’s by 2030 and even hybrids by 2035. the new German Government wants 15 million EV’s to be on its roads by 2030. The Biden administration has announced a sales target of 50% EV’s also by 2030. Other regulatory measures include tightening emissions from ICE’s and requiring vehicle manufacturers to meet total emission targets across their range of models sold. What this suggests is that governments are increasingly willing to force the transition, confident that they, together with industry is fully capable of overcoming the perceived disadvantages of the EV technology in the medium term.
And there is no more important factor in the potential success of the EV technology than the battery. For those who think that the penetration of EV cars into the automotive market will be held back by the current Lithium-Ion battery technology and cost, think again. The technology around Lithium-Ion batteries is still in its infancy (15 years ago, the use of Lithium-Ion batteries was limited to some phones and laptops) and significant improvements in this technology alone is likely to continue for some time. With improvements in the energy density and charging times being implemented as we speak, technical breakthroughs in such alternatives as Lithium Sulfur, Solid State, Graphene Tube and Aluminium Ion batteries are now on the foreseeable horizon. We are starting to see the fruits of massive investments in research and development of the ultimate replacements of the current Lithium-Ion battery. These alternatives will be capable of delivering extended range beyond 1000 km, charging times down to single digit minutes and battery life extended to well beyond 1000 cycles (i.e. the so-called million km car).
The future battery technology will not only extinguish the psychological hesitancy of the market to commit to purchasing an EV vehicle, but governments around the world are increasingly confident of starting the formal policy implementation of the transition away from ICE cars. Based on the wider availability of components which make up these new battery developments, governments now believe that they can act safely in the knowledge that the supply constraints of the current Lithium-Ion battery components such as cobalt will not present a security supply issue to the ever important transport sector of their respective economies. Indeed, most countries in the world will view their security as being enhanced by the reduced reliance of their economies on the supply of oil and refined products which history tells us can and will remain a potential source of volatility under most global scenarios going forward.
So, if we are indeed moving to a net zero world by 2050 or 2060 which involves a major shift away from oil as a transport fuel, what is the economic impact of battery-based transport over the next 30 years? Although Australia will most likely be a slow mover to the new transport technology, the impacts on the oil industry will vary little from what is happening overseas. Australia’s only advantage will be to watch what happens rather than trying to anticipate the changes. However, we have already seen the demise of an uncompetitive oil refinery industry in many countries and it did not need a move to cleaner technologies to make this happen.
In all practicality, the die has been set. It is not a matter of whether EV cars, utilities and even trucks will take over the transport industry, but how quickly it will happen. While the global drive to reduce carbon emissions still focuses mainly on the electricity generation and industrial heat sectors, the transition to EV’s in the transport sector will have a significant impact on the oil industry. About 45% of the oil barrel currently goes to the domestic road transport sector and therefore any transition away from ICE’s alone has the potential to have a fundamental impact on the industry overall. If we add other sectors such as power generation and some process heat applications which also have potential to be supplied by clean energy, the impact only becomes starker.
But the big question is how quickly the transition away from fossil fuelled vehicles will happen and therefore how long does the industry have to adjust to this change? Currently the take up of electric vehicles across the major car markets (China, USA and Europe) may appear to be small. EV’s currently attract a significant cost premium and consumers’ concerns about range anxiety and recharging rates pose significant barriers to the market embracing the new technology. But with Government incentives currently being offered and new battery manufacturing ramping up exponentially, the cross over of cost between EV’s and ICE’s may be very soon (this cross over is represented by when battery costs get down to $100/kWH). As recently as 2017, the EIA published a forecast of various bodies’ estimated when this crossover would occur with the average being 2025-26. This year however, BYD in China announced that the cost of producing its Lithium Iron Phosphate blade battery (LFP) had reached $93/kWh. The ground is moving quicker than expected.
And what about hydrogen you may say? Firstly, the hydrogen industry can only progress if it is green hydrogen. Otherwise, what is the point? Secondly, even green hydrogen is essentially used to generate electricity to drive a hydrogen vehicle anyway via fuel cells. With a supply chain energy efficiency of only 23% compared with a pure EV of greater than 69%, where is the cost advantage that would drive this particular fuel option? Nevertheless, hydrogen may well play a significant role in fixed applications in industry, chemicals, shipping and power generation and storage. But it is difficult to see it competing against the new generation of batteries that are on the horizon for the transport sector. The jury is still out on hydrogen for the heavy vehicle sector however and the cost showdown with new batteries is likely to play out with a decisive conclusion in the near future as Tesla, Nikola and others fight over this market sector from 2022. Whatever the outcome, oil will be the big loser.
It is also revealing what the major industry players are saying about the impact of clean energy in the transport sector and its consequent impact on the oil industry? The World Refiners Association (WFA) in 2019 conducted a survey of its members to assess their levels of concern about the inevitable shift away from ICE’s. 61% said that they were somewhat worried and that they needed to carefully plan ahead. However, they added that the near-term transition timing had been exaggerated, giving them a longer planning horizon than many had thought. Significantly however, 24% said that they were not worried because they planned to exit the industry well before EV’s had any real impact (presumably in the mid to late 2030’s). In the meantime, the industry’s planning will need to consider whether it should endeavour to extract as much rent out of the value of a barrel of oil or reduce margins to extend their market share over the next 20 years. The likely fall out of these decisions will most likely see very volatile fuel pricing leading up to 2030.
Oil companies however have tended to take a more sanguine approach to the changes facing the industry. They tend to take a wider view of oil’s role in the world economy and most oil companies in a survey of the majors’ planning scenarios suggest that the negative impact resulting from the electrification of the transport sector will be somewhat be offset by global demand growth for oil up to 2050. In the US, Exxon Mobile and Koch Industries have been actively trying to stop the roll out of the country wide charging stations that are necessary for the EV market. This strategy may be counter-productive as public opinion concludes that the oil companies are starting to act in ways similar to the tobacco industry. And we all know where that ends.
In May 2021, a class action in the Netherlands resulted in a Dutch court holding Royal Dutch Shell liable for its contributions to climate change, finding the supermajor’s ongoing fossil-fuel operations undermine basic guaranteed human rights. The court ordered the company to act immediately to reduce those harms by slashing its global carbon-dioxide emissions by 45 percent by 2030.The body that brought this action said that Shell was only the first and other suits would be brought against other companies in a ripple effect that suggests the oil industry’s view of the timing of transition may not be within their control. Exxon now is defending a similar action in the US courts.
And that timing has other implications. The transport, power generation and building heat sectors together represent nearly 60% of products from the oil barrel and all these sectors are threatened by clean energy technologies that will dominate this sector of the energy market by 2050. For the refining industry, the immediate implication is what do you do with the light end of the barrel when gasoline and diesel demand is falling rapidly. Most refineries around the world have been configured to largely produce transport fuels and changing the product output will require huge investments in capital equipment that in the end could have very short life spans. In the oil producing sector, the contracting refinery industry may demand more heavy crudes to better match the remaining products markets that they are set up to service. This in turn, is likely to fundamentally change the pricing of the benchmark crudes and which producing countries will lose and which will prosper in this changing oil market environment. The likely losers will be the light crude producers in the middle east, many of which, including Saudi Arabia, are financially strained given their inefficient use of their crude revenues over the past 50 years.
But can the oil industry itself go through a transition of supplying the necessary transition fossil fuels while also embracing the new clean energy that will predominate by the second half of this century? BP is a good example of an oil major that was early to recognise the role that clean energy alternatives would play in the future. It has had several attempts to invest in solar and other renewable businesses but has generally missed the boat, either by being too early or too late to make timely investments. And this is the dilemma for the oil companies. While they have built incredible expertise in finding new sources of oil and gas, driving down the cost of extracting those resources and generally taking significant technical risks in doing so, they are also very conservative companies and loathe to take risks outside of their area of expertise.
New emerging technologies require high risk takers who more often than not fail and go out of business. One should only look at the long list of technology and computer companies that no longer exist today. For an oil company to take a major position in a renewable energy company today is going to be limited to low risk, discrete projects that by their very nature have low investment returns. The real money will be made in the higher risk areas of the industry that oil companies are not currently equipped to venture into.
Further down the supply chain, the implications are no less significant. People involved in the supply of oil-based fuels, retailing of transport fuels, sales of cars and servicing of cars. With the wide distribution of electricity and charging points being planned for parking spaces and other areas not connected to service station, we are likely to see a significant reduction in these outlets across the country. EV’s are now being sold in pop up stores which by-pass the traditional car show room. Electric cars need far less maintenance than ICE’s and motor mechanics will become more electrical mechanics performing fewer services across the car population. Car showrooms already make most of their profit from servicing cars than selling them so a fundamental change to this part of the retail sector will likely take place. Parts suppliers of ICE cars will be decimated as far fewer parts will be required for EV’s. The largest consumable item for EV cars is the tyres which require changing on average every 4 years.
EV’s are also likely to change the world auto manufacturing industry. Without the need for complex internal combustion engine technology, the heavy reliance on computer controls and the Tesla-led mega-casting process for car chassis construction, it is becoming apparent that the current incumbents are suddenly looking at major competition in what will become the dominant sector of the market. The lowering of barriers to entry is already resulting in not only Tesla which is now the most valuable car manufacturer in the world, but a growing list of new Chinese manufacturers. Indeed, EV’s represent a fast track for the Chinese auto market to grow and supply its own market which is already the largest in the world. With China also the world’s major producer of batteries, the writing appears to be on the wall for yet another industry to be dominated by China in the next 20 years. While the US leads the world in EV development, it cannot afford to wrest on its laurels as old-style companies such as Ford and GM could be quickly overrun by foreign competitors unless they invest heavily now to be ready for the tipping point which may come around sooner than they think. Tesla has a 10-year jump on the current incumbents and will be a major player going forward given its innovation in the manufacturing process, looking and acting much like Ford was in the early 20th century. However, history tells us that technical leaps are rarely held by one company for long and it is quite possible that the world’s largest car manufacturer in 2050 does not even exist today.
There is also a feedback loop that EV’s are likely to facilitate in the overall transition of the electricity infrastructure to clean power. EV batteries will generally average 50 kWh of battery capacity which will be available after every trip to plug into home electricity systems to supply houses with power during the night. As the average house uses 4-5 kWh of power after they cannot generate power from their solar panels, this consumption is likely to have little impact on the operation of cars which are used predominately for short city trips. The whole integration of EV’s into the electricity supply grid will be facilitated by companies developing technologies to enable the most efficient usage of the stored electricity in EV batteries and help shape the overall electricity distribution system over the next 20-30 years. This alone will negate the many concerns around whether the electricity supply system is capable of a major uptake of EV’s which has been calculated to equate to a 30% increase in the per capita use of electricity across the residential sector.
Generally, the overall global move to a clean and renewable based economy has become a juggernaut that will not be stopped even though certain players have had some successes in slowing it down. But the status quo is not considered in anyway sustainable and governments will develop policies and regulations for every sector of the economy to contribute to a net zero emissions target by 2050 or even sooner.
Compared to other sectors, the road transport sector is a relatively smaller contributor to global carbon emissions. However, its transition to clean energy is politically powerful and therefore will be a major area of government policy and support over the next 30 years. Oil’s role in this sector will likely gradually change at first but the momentum is likely to build very quickly as the investments in new battery technologies and EV production capacity start to bear fruit from the mid-20’s. The oil industry by necessity will be faced with a future where it is confined to supplying products to those areas of the economy which do not readily have clean alternatives such as petrochemicals. China and the US alone will have the capacity and the will to drive this change and there is every indication that these superpowers will have the incentives to do it, if only to maintain their economic competitiveness with each other. The only bright side of this scenario for the oil industry is that it will still take up to 10 years before the penetration of EV’s into the transport sector has any significant impact.
With every economic revolution, new technologies come along that fundamentally disrupt the existing industries. The pace of this disruption in previous transitions was fairly modest, allowing those employed in the disrupted industries to adjust, retrain or seek employment elsewhere. While the legacy car manufacturers and the oil and gas industry that fuels them may have the remainder of this decade to make the adjustment, once the tipping point is reached, it will be sudden and potentially catastrophic for those that have been slow to move.
What we do have however, is a reasonably clear view of the future. While the exact timing may not be set in stone, the oil industry can now look into that future and see what its own demise looks like.
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