Global Energy: Positioning for the Long Term

A long-term orientation allows us to move from today’s headlines to tomorrow’s prospects. While current energy headlines are focused on OPEC’s ability to accelerate the rebalancing process, we are focused on two longer-term developments that are influencing our positioning in the energy sector. First, the leaders of the domestic exploration and production (E&P) industry have already adapted to lower prices and are ready to accelerate capital investment (see Global Energy: Adapting to New Realities August 2015). Second, momentum behind electric vehicles is increasing and new battery technologies have the potential to erode oil’s monopoly position in the transportation sector. In this Industry Perspective, we will explore developments underway in the transportation sector that may lead future oil demand to differ from the “business-as-usual” expectations presently imbedded in the oil industry.

An Evolving Transportation Sector

Currently, oil is central to our transportation system due to its superior energy density and logistical advantages over alternative energy sources. Equally, the transportation sector is vital to oil prospects as it generates over 60% of global oil demand and contributed 80% of cumulative growth in demand since 2000. However, over the past few years, a number of new trends have developed that are capable of reshaping oil’s role in the transportation sector. Individually, each trend is significant, but we believe the combined impact could prove transformational – at least to many industry projections for oil demand. It is important to take a long-term integrated perspective of the individual developments underway as there could be a powerful dynamic of mutual reinforcement at work.

At a high level, global fuel economy regulations are forcing substantial changes to automobile engine designs. In order to comply with stricter standards, automakers are downsizing gasoline engines, incorporating turbochargers and/or connecting electric motors to form more efficient drivetrains without compromising performance. These changes add incremental costs to internal combustion engines and help to make electric vehicles cost-competitive alternatives in the mass market.

Additionally, recent rapid improvements in battery technology have been key in overcoming electric vehicles’ main hurdles of short driving range and high upfront cost. Data from the U.S. Department of Energy (DOE) shows that battery costs dropped by 73% from $1,000 per kWh1 in 2008 to $268 per kWh in 2015. Ambitious targets for further improvements in battery costs and energy density are also in place. By 2022, the DOE expects battery costs to reach $125 per kWh – a level widely viewed as the crossover point at which electric vehicles become cost-competitive with internal combustion vehicles. In anticipation, major automakers like Volkswagen, Ford, Mercedes-Benz, and BMW have all recently shifted and expanded research and development efforts toward electric vehicles. Growing competitive pressures, and consequent technological innovation, hold the potential to significantly expand the appeal of electric vehicles in the mass market.

Emerging markets sit at the nexus of multiple trends impacting oil and automobile markets. Since 2000, emerging market countries generated approximately 90% of the overall growth in oil demand within the transportation sector. The dominant demand-side narrative has been that a rapidly growing middle-class population will continue to drive strong oil demand for decades. However, major cities in China and India are facing severe congestion, affordability, and environmental challenges on the back of rapid economic growth. A more sustainable alternative path may be needed and increasing urbanization levels provide the catalyst for change. New business models, such as Uber and Didi Chuxing, were unheard of five years ago but have already influenced mobility preferences in major cities. Further innovations in shared mobility and autonomous driving are on the horizon. We believe these advancements are very likely to be integrated with electric vehicles to create a powerful alternative mobility system. Given the circumstances, there is a growing possibility that China will leapfrog most developed economies in the adoption of electric vehicles. This could have profound implications for oil markets.