Summary

The oil market is now in a cyclical upswing due to the rebalancing of offer and demand, calling for higher oil prices forward.

This will have two major consequences for the energy commodity that is already growing at a subpar growth rate below GDP growth: to reduce even further the oil demand growth rate, and to accelerate the development of competitive energy sources.

The production of shale gas and tight oil is booming in the US, which is massively encroaching in the market share of other producing nations.

Solar and wind energy price have been declining exponentially for decades and have reached the point where they can establish themselves as the default new power source in a majority of country, a trend that will intensify with higher oil prices.

The price of electric batteries is as well decreasing exponentially and the same cause will have an identical effect on the growth of the electric car market share, which should develop much faster than most commentators expect. Our moderate estimate is that no gasoline and diesel cars will be sold any longer before 2030.

From an investment perspective we prefer to look for companies in the fastest and exponentially growing renewable energy and new energy vehicle markets rather than in the mature fossil fuels and traditional energy sectors in their senescent growth phase.

Oil Price Bouncing

The oil market offer and demand is finally rebalancing with Brent Crude Oil (BCO) now moving into backwardation:

The oil price reacts very sensitively to minor imbalances between offer and demand resulting in major price swings and both BCO and WTI benchmarks are now in a cyclical price upswing that should extend far into next year with the WTI now expected to move into the $70 per barrel:

Oil Price vs. Oil Demand Growth Rate Inverse Relationship

But the oil demand appears to be very elastic in response to oil price variations with an historical comparison since the mid-1960ies showing that the oil demand growth rate (purple line) makes major swings mirroring the oil price fluctuations (orange line):

The growth rate of the demand for oil has been sub-par averaging only 1% over the last ten years, which is around 2.5% lower than the World GDP over the same time period. Economic analysts like to speak about the strong growth of the oil market but due to the shear size of the world oil output that has been powering the world for the last 70 years they refer of course to volume growth, but not to the growth rate of the sector.

Lasting price upswings in a market have always spearheaded innovation and stimulated competition and the energy and transportation markets are not any different. The most recent oil price upswing is an enticing factor that will accelerate the development of competing technologies: shale gas & tight oil / renewable energies / electric vehicles and energy storage.

Shale Gas and Tight Oil Development in the US

Brent Crude vs. WTI Spread

The tug of war between OPEC and shale producers ended up with the spread between BCO, the benchmark for the Saudi crude, and WTI, the US benchmark, to rise significantly as a consequence of oil inventory drawdowns (see here for a detailed explanation about the interplay between the crude varieties, their uses and trade routes).

Rig Count Lags Oil Price

The number of US producing is lagging the oil price by around four months since the producers are developing or closing theirs rigs with oil price anticipations in mind:

With the rising oil price the number of producing oil rigs is now not only expected to climb but the productivity per rig is rising as well due to major technological improvements:

Rig Productivity Improves Dramatically

US Oil Production Booming

The tightening of the BCO offer has thus boosted the output of US oil with no end in sight.

US Crude Oil Exports Soaring

US crude oil exports are soaring and more particularly to Asia, which have been the preserve of OPEC nations. Exports from U.S. “tight oil” extracted from shale formations alone are expected to swell to over 3 million barrels a day by 2022 — with a third of that volume absorbed by Asia, said one economist.

Enough oil for the world

The rebalancing act in the oil market will certainly not have long lasting effects on crude prices beyond 2018 due to the rapid development of the vast conventional and non-conventional oil and gas reserves as the US example demonstrates. In the mean time higher prices will support the economic growth of the renewable energy sector.

Solar and Wind Energy at A Tipping Point

We described previously how wind and solar energy combined have reached a tipping point. Contrarily to oil, which is a finite fossil resource controlled by producing countries there is no scarcity of sun energy that is hitting the last inches of the globe available and is available for anyone to collect and convert into energy, enough in one day to power the world for one year.

In parallel the cost to produce wind and sun energy has been declining exponentially for the last four decades:

Scarcity versus abundance, finite resource versus unlimited supply, chaotic price fluctuations vs. exponentially declining costs, local availability vs. logistic-heavy supply chains, no wonder that wind and solar are developing at two-digit growth rates with annually installed solar capacity growing at an average of ca. 30% over the last six years, which we expect to continue or even accelerate in the years to come:

Electric Vehicles and electric Batteries

The Great Horse Manure Crisis of 1894

In 1894 London and New-York were “droning” in horse poop. It was estimated that within 50 years, London streets would be buried in 9 feet of poop and horse carcasses. In 1900 the traffic in New-York was a matter of horses and carriage traffic. No one had any idea the car is coming, an invention of the very last years of the 19th century.

In 1903, the President of the Michigan Savings Bank advised Henry Ford’s lawyer, Horace Rackham, not to invest in the Ford Motor Company insisting, “The horse is here to stay but the automobile is only a novelty — a fad.”

Only a few years later in 1909 the American Horse Exchange and carriage trade in New York City closed its doors as the streets had been mostly cleared of horse traffic to make place to the automobile.

The Internal Combustion Engine (ICE) car has displaced horse transport within a decade, but the ICE car paradigm has now been around for more than a century. Maybe time has come for the next paradigm?

Massive Air Pollution from Coal Burning in China

Massive development of energy production from coal power plants in China have thrown a veil of heavy smog over the big Chinese cities, which has received extensive media coverage in the last five years.

In 2013 China unveiled comprehensive new measures to tackle air pollution, with plans to slash coal consumption and close polluting mills, factories and smelters. One year later the world coal consumption has peaked essentially due to Chinese consumption declining over the following two years and that trend is certainly not to reverse with policy efforts of the Middle Kingdom to develop cleaner energy sources, solar and wind called upon playing an important role in the energy mix of the nation.

Traffic Pollution in New Delhi and elsewhere in Asia

In New Dehli traffic is the root cause of frequent episodes of thick smog that is swathing the city, with the Chief Minister saying few days ago that the city has turned into a “gas chamber”:

To reign into air traffic pollution both India and China have tall order plans to replace ICE car with electric cars.

China will require automakers to comply with a quota of 10 percent of New Energy Vehicles (NEV’s) from 2019, a level that would rise to 12 percent of sales in 2020. This target may not be as far fetched as proclaimed by the car brands in the most dynamic NEV market in the world that is guaranteed to pass the 2% sales mark by year’s end.

India plan is to sell only electric cars by the end of next decade, which is seen as ambitious (not to say utterly impossible) by the IEA, the same organization that has done hilariously bad predictions about solar photovoltaic installations:

What IEA has been ignoring and with them many economic pundits is the exponential cost reduction of solar systems and they are now adopting the same ‘Horse is here to stay’ attitude towards electric cars.

Battery prices plummeting

But similarly to the solar PV market the price of electric batteries is declining exponentially. The same cause should have an identical consequence, the exponential growth of the market and the disruption of the incumbent paradigm: fossil fuels in case of solar and wind, diesel and gasoline powered cars in case of electric cars.

According to BNEF data and predictions electric cars are going to undercut gasoline cars in price by 2025, which is when the battery price should cross through the 100 $/kWh.

Both the most recent data price point for electric batteries in 2016 and the predictions of the BNEF appear to be inaccurately conservative by a very wide margin as TESLA claimed a battery cost less than 190 $/kWh for 2016. General Motors product chief Mark Reuss has confirmed earlier this year that the cells used to make the battery pack of the new Chevy Bolt cost $145 per kWh. Half way through 2017 Audi’s senior vice-president of R&D claimed to be paying around 100 €/kWh (ca. 115 $/kWh) for the cells referring to this price as being expensive. Adding 20-30% to the cell price the battery pack should cost Audi around 150 $/kWh.

On a semi-linear plot an apparent linearly decline corresponds to an exponential reduction in price. Extrapolation based on the BNEF prices extrapolates to cross over the 100 $/kWh mark in 2021, not 2026. By correcting the BNEF price point for 2016 with the Tesla battery pack ‘lower than 190 $/kWh’ (we used 185 $/kWh) there appears to be an extremely fast drop over the last three years at a rate of around 45% per year. The truth may lie somewhere in between but the price for battery packs is certain to cross the 100 $/kWh before 2020, and possibly as early as 2018, which is aligned with the massive price reduction of 35% claimed by Tesla, which corresponds to a price estimate of 124 $/kWh in 2017.

Acceleration of NEV sales

This is important since when cell prices really do drop to 100 $/kwh or less, expect many more mass-market, long-range electric cars to come to the market. With 10% of the moving parts of a traditional ICE car, instant torque, enhanced safety, no emissions, low maintenance and reduced noise pollution the electric car is sure to become the default option for the majority of individual buyers. This is before considering the continuation of the exponential price decrease of the battery pack, which is a main cost factor of NEVs and also without factoring in the rising oil price that should accelerate their development by making total cost of ownership of ICE cars even more expensive comparatively.

We compiled total vehicle sales from various sources to plot the share of NEV sales in percentage of total vehicle sales, which will have crossed 1% of total sales in 2017. Thus it took seven years for NEVs to come from 0.01% to 1% market share, which means half way to 100% for exponential technologies.

Our expectation is for electric car sales to completely sweep out ICE car sales over the next 10 years, years ahead of 2030.

“The gasoline car is here to stay, the electric car is only a novelty – a fad.