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Deep Dive: The Math Regulating EV’s Impact on Oil Demand

This deep dive is for readers who want more background to our Insights post on Friday, August 20, 2021, regarding the drivers of electric vehicle adoption across the on-road fleet and the glacially slow impact we expect it to have on oil demand over the next ten years. In our opinion, the four factors that drive this result are:

  1. The portion of new vehicle sales that are EV (or powered by any non-petroleum-based fuel);
  2. How quickly the on-road fleet turns over (e.g. the scrappage rate of existing vehicles);
  3. Growth in miles driven and the need for new vehicles to meet that demand; and
  4. Demand growth for non-transport uses of crude oil (e.g. petrochemicals and fibers, lubricants, asphalt, space heating and industrial energy usage).

Since there are already a host of oil demand forecasts out there from organizations that do forecasting for a living, we took a different approach and simply modeled the on-road vehicle fleet and set inputs at extreme levels that would drive EV adoption faster than anyone is forecasting. While we maintained the current scrappage rates, we used the following three input parameters, which, in our view, no responsible forecaster would sign off on:

  1. That 50% of ALL global on-road vehicle sales, not just passenger cars, would be EV or fuel cell powered by 2030, and that 100% would be reached by 2035;
  2. That off-road transport (shipping, rail, aviation) would follow a similar path away from petroleum-based fuel;
  3. That the annual growth in the on-road fleet going forward would be 2% rather than its historic rate of 4% in the five years prior to COVID.

The result of our inputs was lower oil demand in ten years compared to all the other forecasts but still at or above what it was in 2019 prior to COVID.  Between 2030 and 2035, our model has oil demand declining about 2% per year.  It’s only after 2035 that our model, with these aggressive assumptions, starts predicting faster declines in worldwide oil demand.

The math behind the model is relatively simple but proves curiously difficult to overcome.  New vehicle sales are important, but what matters most are the rate of growth in the on-road fleet (which is still mostly ICE) and the scrap rate.  Simply stated, it will take time to replace today’s global fleet of nearly 1.5 billion[1] internal combustion engine vehicles (ICEs) that continues to grow every year.

Changing the result offered by our model would require a higher scrappage rate that would in turn drive more EV sales which would ultimately require converting most of global vehicle manufacturing from ICEs to EVs at a record pace. The scale of meeting such a challenge, in our view, is proportional to the manufacturing mobilization efforts seen during World War II.

What follows is a walk-through of the math behind our model to illustrate the impact these inputs have on the resulting demand for crude oil.

We’ve left two other important topics surrounding rapid EV penetration for future Deep Dives: 1) implications for and the investment opportunities surrounding upgraded global power grids to handle all the charging needs associated with these additional EVs, and 2) implications for oil industry capital spending. 

But first a word about why we did this analysis.

Why We did This Analysis

The headlines that global crude oil demand is not likely to fall – and may even rise – over the next ten years is the source of endless questions from our investors, yet it has no practical impact on our portfolio.  Why? Because crude oil logistics is a very small part of our portfolio, and the profitability of those assets are driven by the cost position of the oil fields at the supply end of the system and the refineries at the demand end of the system combined with competition from other logistic assets.  Natural gas and electric power logistics make up the bulk of our portfolio because the investments there are less exposed to merchant competition and are experiencing higher growth rates due to cost and performance advantages.

It has long been our view that EV adoption will happen for the same reasons that drive adoption of all new technology: cost and performance.  Thomas Edison and Henry Ford formed an electric vehicle joint venture about 100 years ago[2] but neither performance nor cost has been able to beat that of the ICE vehicle, primarily due to the battery.

But batteries are improving rapidly in both cost and performance. The lines are converging, and it is easy to see them crossing in just a few years, especially when governments subsidize EVs. Betting against the engineers and the breakthroughs in technology they exploit is never a good wager. Instead, there will likely be numerous opportunities for our regulated monopoly gas and electric network operators to invest in EV related projects like charging facilities as well as grid and generation assets needed to support growing demand.

From a policy perspective, decarbonization should happen first where it is cheapest and where it will have the least negative impact on performance (and if done right, an improvement in performance).  Decarbonizing the power sector is happening first and, in our opinion, electrifying the transport system likely follows on its heels.  Together these sectors account for 70%[2] of global carbon emissions and both have a material impact on our investment universe of energy infrastructure companies.

Energy policies in the US have thus far encouraged and benefitted from technology and innovation resulting in lower, not higher, costs for natural gas and electricity. A modeling exercise like ours is doubly useful in that it identifies the levers policy makers will have to pull if they want to drive a faster transition but also the ones that will have little to no effect.  Perhaps a cash-for-clunkers program paired with incentives for manufacturers could accelerate fleet turnover.  But extending incentives beyond passenger vehicles to commercial vehicles and off-road transport would also have a significant impact because, combined, they represent just as much of global oil demand as passenger cars.

If policy makers were to pull these levers, the EV industry would need to make massive investments in manufacturing capacity to meet the extra demand and electric utilities would need to accelerate their growth in grid capacity to produce and deliver the extra electricity needed.


A Walk Through the Modeling Exercise

In making our first major assumption regarding EV sales as a percent of all vehicle sales (50% by 2030 and 100% by 2035), we set aside any issues of costs, range anxiety, and EV charging infrastructure constraints that could impact market demand for EVs.  In short, the assumption we made implies that regulatory policies will be sufficient to incent both demand and what’s needed to deliver it. This represents a faster rate of growth than anyone, to our knowledge, is forecasting.

An even more aggressive element of this model input is to assume the 50% of new sales in 2030 and 100% in 2035 will apply to ALL on-road vehicles, including heavy trucks. While some manufacturers like Tesla are researching electric tractor-trailers, others are looking at hydrogen fuel cells.  Either way, unlike passenger vehicles that already have over 3 million of EV sales per year[3], heavy trucks are still in the prototype phase. This assumption is significant because while passenger vehicles represent 27% of world crude oil demand, commercial vehicles represent an additional 17%[4].  So, while the discussion that follows analyzes the passenger vehicle fleet, in our model we simply applied this math to the 17% of oil demand represented by commercial vehicles.

Today, there are ~1.2 billion passenger cars on the road globally[5]. Less than 1% of these are EVs. The US, Europe, and Asia (excluding China and India) make up 54% of the fleet. The remainder is spread across China, India, and the rest of the world, where ~80% of fleet growth over the next decade is forecast to occur (similar to the last five years).

In our scenario, we first assume an annual growth rate of 2% in the global vehicle fleet.  This is about half of the average rate in the five years that preceded COVID (2015 – 2019) and translates into demand for 25 – 30 million cars to be added each year to the global fleet.  A 4% growth rate would require 50 – 60 million cars.

In addition to the cars demanded from fleet growth, we also need to replace the cars that are retired or scrapped each year.  The scrap rate averaged ~4% of the current global fleet size or ~45 million cars each year in the four years prior to COVID[6].

Therefore, to meet annual demand of 2% growth as well as typical ICE scrap rates of ~4% of the global fleet size with EVs instead of ICEs, we would need an EV production capacity of 70 – 75 million cars per year. Today, global EV production is a small fraction of global vehicle production, amounting to 4% in 2020 and forecast to be 6% this year[7].

We then applied our EV market share targets: 50% of all new sales are EV by 2030 and 100% by 2035. Exhibit 1 illustrates how even under such an aggressive EV adoption curve, fleet turnover from ICEs to EVs takes much longer as it’s limited by the scrappage rate and fleet growth while, in our model, we allowed EV production capacity to grow at 28% per year[8].

Exhibit 1: EV Adoption: New Passenger Vehicles Sold vs On-Road Fleet

EV Adoption
Source: EIP, Bloomberg NEF

Exhibit 2 illustrates the progression of the primary model outputs. The grey-shaded bars represent sales of ICEs, and the green-shaded bars are sales of EVs.  We first allocate all assumed EV production to new sales and then to the base ICE scrappage rate.  Only when there’s enough EV production capacity to cover both growth and the base scrappage rate can we increase to a higher scrappage rate (dark green bar in 2035).

The black and purple lines in Exhibit 2 (right-hand axis) really drive home the point: even with EVs representing 100% of sales in the early part of the 2030’s, the remaining number of ICEs on the road is nearly 1 billion.

Exhibit 2: Annual Global Passenger Vehicle Sales & Fleet Size Mix Over Forecast Period

Global Passenger Vehicle Sales

Source: EIP, Bloomberg NEF.

The pace of the ramp-up in EV production capacity is therefore an important model input because the number of ICEs on the road will continue to increase until EV production is capable of meeting both new fleet demand as well as the annual scrap rate.

Simply put, there are physical limits to producing/selling that many EVs in such short order. For some perspective: Volkswagen Group is the largest automaker in the world, producing nearly 11mm vehicles[10].  It took over 80 years for that company to get to today’s scale.  Tesla has been around since 2003, released its first car in 2008, has an enterprise value of $670 billion[11] but is only just approaching a run-rate of 1mm vehicles/yr sold[12].  Getting to 100 million EVs by 2035 would amount to a CAGR of nearly 30% from today and would require a massive infusion of capital and, in our view, significant additional regulatory policies and incentives.

The result of our model inputs is shown in Exhibit 3. The model results in demand for motor fuel of about 45 million barrels per day in 2030 vs about 44 million barrels per day in 2019 pre COVID.

[1] Source: Bloomberg NEF.

[3] Source: U.S. Energy Information Administration (EIS), 2019 data used to exclude transitory impacts from COVID.

[4] Source: Bloomberg

[5] Source: BP’s Statistical Review of World Energy 2020, Bloomberg NEF.

[6] Source: All references to vehicle fleet size and market share are from calculations by EIP with data from Bloomberg NEF.

[7] By fleet turnover, we are referring to the scrappage rate.  This is calculated as the annual sales of new vehicles minus the Y-o-Y change in vehicle fleet size.  For the past five years, we used Bloomberg NEF data to calculate an average of approximately 4% per year or ~6% of the fleet size from 15 years ago.

[8] EV’s in 2020 represented just 4% of sales and 1% of fleet size globally for passenger and commercial vehicles, per Bloomberg NEF.

[9] CAGR of 28% from 2019 to 2035.

[10] Source: Bloomberg.

[11] Source: Bloomberg, as of 8/19/2021.

[12] Source: Tesla’s Form 10-Q, June 30, 2021.

The Information provided in this article is believed to be accurate as of the date above. EIP reserves the right to update, modify or change information without notice. Any statements of opinion are EIP’s opinion and should not be relied upon as a prediction of any future event. The information is based on data obtained from third party publicly available sources that EIP believes to be reliable but EIP has not independently verified and cannot warrant the accuracy of such information. Investors are encouraged to seek their own legal, tax, or other advice before investing.

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