Oil Pressures Fade Once Again

Monday 6 May 2019

The US light vehicle market peaked in 2016 at 17.46 million units and has fallen gently since. But 2019 is showing a deeper cut. After last year’s stabilization at 17.21 million units, it seems likely that sales will fall about 4% this year, to roughly 16.5 million units. The decline appears to be concurrent with the cooling of the US housing market. And interest rates, meanwhile, partly reflecting demand for credit, have also fallen accordingly. Yes, I know. It’s more common now to ascribe all interest rate movements to Federal Reserve policy. This perception largely follows the great recession, when policy making by the Fed was overly active. But we are no longer in that period of time. So the Fed is following the market now, not making the market.

More important is that a more pronounced weakness in the vehicle market appears also to be affecting sales of plug-in vehicles. Through the first four months of 2019, sales of EV ( pure electrics and plug-in hybrids) rose to 82,494 units according to InsideEVs. But despite very strong sales of the Tesla Model 3, total EV sales only advanced 10% year-over-year, against last year’s 74,920 units, in the same period. That’s just not enough growth, from current low levels, to make the kind of progress most are forecasting to the year 2025.

Unlike the Chinese market, where at least twenty separate brands of EV are on offer, one problem for the US market is that it’s overly dominated by Tesla. Indeed, without Tesla sales, the US EV adoption track record the past few years would barely register. The rollout of the Model 3 illustrates the dynamic. While sales of the new vehicle were quite strong, they also heralded a large and expected tailoff in sales of other Tesla models. And then other brands, notably the pure electric Chevrolet Bolt, are still not achieving liftoff. Indeed, I happened to recall the Chevy Bolt was the Motor Trend Car of the Year back in 2017. But in the first four months of 2017, the Bolt moved 4,384 units, compared to 5,226 in the first four months of this year. Growth? Sure. But nothing impressive. The Bolt should be flying off the shelves by now.

More broadly, there appears to be a number of delivery and availability problems with other EV models that would be selling quite well, if only customers could buy them. The Kia Niro and the Hyundai Kona EV (mentioned previously in The Gregor Letter) are exactly the type of affordable crossovers that are fated to do well in the US market. Indeed, one of the major mis-steps of Tesla—and it just amazes me they missed this—is the failure to bring an affordable crossover (mini SUV) to market right about now. Not to knock the Model 3—but it’s just another sedan.

One question I and others have had about the EV market, therefore, is whether the strong sales growth of EV could buck an overall decline in the car market. Over the past two years, that seemed to be the case. But while 2019 EV sales will at least match last year’s total of 361 thousand units, an advance this year to, say, 400 thousand units, would make for a poor showing in 2019. If EV sales are able to eke out slow growth in a year where total sales fall hard, I suppose you could still call that a victory. But ultimately, we should never take our eye off an even larger question: does energy transition—new clean power generation, efficiency investments, EV adoption, and grid architecture and battery growth—require some minimum level of economic growth to proceed?

Oil prices recovered into a springtime high around $65, for West Texas Intermediate, and were then summarily pounded lower, as the pull of fundamentals regained control. Historically, geo-political market rallies (and slumps) can take oil prices to unsustainable extremes for about 30-60 days before the humdrum realities of supply and demand return. Something like this is happening this year too. China’s road fuel demand fell last year, for example, for the first time in a long while and is not growing this year either, according to data from IEA Paris. The same story maintains here, in the US. US gasoline consumption, after a 4 year recovery, peaked out in 2016 and has gone flat the last two years. And US gasoline consumption is again flat, so far this year.

This might be a good time to remember that, buried in the details of the latest BP Outlook to 2040, about 90% of the modest oil demand growth BP projects to 2040 actually occurs by 2025. In other words, even BP—which has been far more bullish (in public remarks) compared to its peers—is now acknowledging that oil essentially becomes a no-growth business after 2025. As the old saying goes: act accordingly. In other words, if BP has been forced to consider the oil business loses global demand growth by 2025, the risk is this threshold is crossed well before, as early as one to two years from now.

In London, energy analysts Harry Benham and Kingsmill Bond released their short report, The Decline Rate Delusion, which you can download and read over at CarbonTracker. Please give the report a read, and I will use the space below to offer my own thoughts.

At one time, last decade, the concept of the decline rate, or really the background decline rate, was an unusually compelling and useful concept. The reason? Global oil demand growth was powering ahead at a rate of 2% or more per year, and the global oil industry was failing to keep up. The decline rate became, therefore, a kind of short-hand-analogy for quantity of oil the industry had to replace, before it could even begin to supply the first barrel to meet new growth. One handy rule of thumb used in this period was that we needed a new Saudi Arabia every few years, just to keep up with declines. The image of the treadmill was also quite popular, during this time.

Today, however, the annual growth rate of global oil demand has shifted downward, towards a level consistently below 2%. Meanwhile the oil industry, having finally invested in new resources, has once again been able to keep up. This has rendered the decline rate, which no one disputes, to irrelevancy. Moreover, it should also be pointed out that the early capex dollars gain very little traction and this couldn’t have been more true in the case of the United States, where the first barrels of tight oil were indeed quite expensive. But after a decade, those early dollars eventually triggered a classic learning rate in North American tight oil. So to talk about decline rates as a forward looking problem the industry is ignoring (at its peril) is to equally ignore the ongoing dividend from previous investment. US oil production has gone from 5.5 million barrels per day at the low last decade, and is now above 12 million barrels per day. Yes, all those wells decline. But the dollars spent today are the beneficiaries of the early dollars, when extracting tight oil was so much harder, and expensive.

An enduring truth in the energy space is that lessons learned in one era will only lightly apply, if at all, in a subsequent era. Individual wells still decline, as do large oil fields. But given the array of forces that have been gathering against oil, and oil demand growth, it’s not likely these decline rates will matter much in the years ahead. At best, given the long tail of oil consumption—the likelihood that oil consumption continues for decades long after demand growth dies—small perturbations in the price of oil will be ever present, as declining investment following declining demand occasionally triggers short-term price spikes. But really, who will care?

Further reading: a paradox of OPEC cuts is they translate directly into growth of spare capacity, which makes oil futures markets unworried, thus leading to weaker oil prices. Thus, we get a counterintuitive outcome, observed for a long time, where OPEC production increases are bullish for prices, but OPEC production cuts are a warning of weaker prices to come. The IEA just this March noted that spare capacity is now growing. So, to turn the decline rate concept on its head: how much spare capacity must we work through first, before the oil industry really needs to spend additional dollars to meet demand?

From coal towers to wind turbines. In late April, the giant cooling towers of the now closed Brayton Point coal plant came down, at the mouth of the Taunton River, near Fall River, Massachusetts. The owners of the property have signaled their intent to refashion the land as a staging area for the new offshore wind industry now emerging, not just in Massachusetts, but in every state down the coast from Rhode Island to Virginia. One issue I’m watching closely is whether any adjustment can be made to the Jones Act, as the restrictive rules of that age-old regulation bars the use of any vessel not made in the US to operate commercially in US waters. Here’s why that matters: many of the specialized vessels manufactured in Europe for their advanced offshore wind industry would be attractive for use here, especially as we try to mount an economically efficient supply chain.

—Gregor Macdonald

The Gregor Letter is a companion to TerraJoule Publishing, whose current release is Oil Fall. If you've not had a chance to read the Oil Fall series, the single title just published in December and you are strongly encouraged to read it. Just hit the picture below.