Will plug-in electric cars impact oil demand?

If you take a quick look at my portfolio, it is no secret that I am heavily invested in the energy sector, especially oil weighted companies. As much as I enjoy investing in this sector, I have built a case justifying my decision based on a 10 year timeline. Since I am investing my money and not gambling, I need to take into consideration any risks to my investment for this time frame.

The majority of oil in the world is used as a transport fuel. On average it’s about 60 per cent of all the oil consumed. Planes fly on jet fuel made from oil, ships run on bunker fuel made from oil, and, most importantly, motor vehicles run on gasoline or diesel made from oil. However, electric cars will be rolling off the assembly lines, in small numbers first, by the end of 2010 and in increasing numbers year after year. What would the impact of Electric Vehicles (EVs) be on my oil investment scenario?

Let’s take a look at EVs from 2 companies amongst several working on this new technology.

Meet the Electric Vehicles (EVs)

Chevrolet Volt EV

The Chevrolet Volt is a plug-in hybrid electric vehicle to be produced by Chevrolet, a division of GM. It is expected to be launched as a 2011 model in Q4 2010. Fully charged on-board batteries can power 40 miles (64km) and it can be recharged by plugging the car into a 120V residential electrical outlet. Chevrolet is taking your orders for the upcoming Volt EV since the end of July. The pricing starts at $41,000 or as low as $33,500 if your tax situation qualifies for the full $7500 federal income tax credit in the US.

So far, GM planned production for 2011 is only 10,000 units rising to 45000 units in 2012.

The Nissan Leaf is a plug-in hybrid electric vehicle to be produced by Nissan. It is expected to be launched in December 2010. Fully charged onboard batteries can power 100 miles (160km) and it can be recharged by plugging the car into a 120V residential electrical outlet. The pricing starts at $32,780 or as low as $25,280 if your tax situation qualifies for the full $7500 federal income tax credit in the US.

The initial supply of LEAFs for the first two years will be built in Japan.  That plant has an annual capacity of 50,000 cars, 20,000 of which will be shipped to the US. Nissan expects to sell 500,000 Leafs by 2013. In late 2012, Nissan will open its US-government funded Smyrna Tennessee LEAF plant that can build 150,000 cars per year.

The Consumers

There will definitely be buyers for those cars but it will not be a stampede. Let’s look at some of the factors consumers will consider:

Cost: At this price tag, you are not buying the cheapest vehicle out there; many consumers would probably prefer to buy a car such as a Toyota Corolla. Others would standby and watch until prices drift lower before buying. With increased production and newer generations of EVs, the prices will be falling down over the next few years.

For those consumers that can afford the price tag, usually many of them are not really bothered by the price of gas. On the other hand, the “green” ones amongst them would be first to take the step.

Reliability: We are talking 1st generation technology here. Teething problems are inevitable once these cars hit the road. After 2-3 years of usage, will the battery have the same energy storage capacity? How will that affect the mileage? What kind of problems will the first owners be facing?

Here again, there is a segment of consumers who would sit on the sidelines and wait until newer generations solve any outstanding issues and improve battery performance. It’s a win-win situation for them waiting for higher dependability and lower pricing.

Behavior: I am not sure a lot of people are ready to change their behavior. You have to plug-in your car every night; it’s a routine one has to develop. Some people have trouble brushing their teeth every night before they go to sleep.

Another important issue customers have to cope with is the length of their trip. How far are you going on each trip?  Do you have enough juice after your daily commute to reach another destination? In this case, technology could solve the problem by having the car equipped to keep track of your daily movements as well as calculating any extra distance you will be covering. Simply put, you got to track those miles (kms).

Oil Prices: High oil prices trigger demand destruction. If we were to see a repeat of the prices we saw at the pump in 2008, EV adoption rates will certainly accelerate. On the other hand, OPEC is aware that higher oil prices tip importing economies into recession and boosts alternative energy products. They will make sure that supply and demand are matched at a reasonable price range. That is, until supply tightens and becomes harder to match rising demand. The price of oil is a risk factor that can impact consumer behavior immensely.

The Manufacturers

The car manufacturers are in it for the long term, they know full well that there’s no money to be made in the short term. It’s going to be a while before billions of dollars in investments are recovered.

Profitability: Let’s say it bluntly: in order to make money with EVs, they need to be produced in the hundreds of thousands, not in the thousands which mean that there will be no profits in the first 3 years at least. According to a report in the Wall Street Journal, Nissan US sales and marketing chief Brian Carolin said the LEAF also would lose money in its first two years. “Over the course of the vehicle life, it is profitable—in year three,” he said. Of course, the manufacturers have to start somewhere, so it’s normal.

In the short term, the vehicles that will provide meaningful profit margins for manufacturers will remain pickups and SUVs, neither of which are particularly fuel-efficient. If you’re a conspiracy theorist, this is fertile ground right here to come up with scenarios on how EV numbers could be manipulated to remain low.

Sales Projections: The launch of plug-in electric models is expected to double sales of electric-powered vehicles to 24,000 units worldwide in 2010. In 2015, according to J.D. Power, sales of electric vehicles are expected to total 500,000 units globally. If vehicle sales in the US get stuck at 10 million units per year (highly unlikely), the number of EV units sold globally would be equivalent to 5% of the US market sales, pretty dismal if you ask me.

On a side note, again based on the same source, in 2015 hybrid vehicles are expected to come in at 2.3 million units, and to comprise 4% of global light-vehicle sales.

David Mondragon, Ford Canada’s chief executive, has a different take on numbers. He predicts that at most 2% will make the switch to electric cars by the end of the next decade. He also predicts traditional internal combustion engines will make up about 75 per cent of global demand and hybrids around 20 to 25 per cent in 2020, leaving electric cars with a single low digit for market share.

I like to hear the opinion of someone who is plugged-in (pun intended) to the industry and it certainly gives his opinion more weight. However, I would personally prefer to review the market share of EVs in 2015 since predictions appear to be cloudy beyond that.

Final Thoughts

There is more to this subject than what I reviewed. For example, how far will the government go in subsidizing this sector?

Is there a political will to accelerate the adoption rate of EVs?

Will big bad oil companies stand by watching as EVs eat into their profits?

Do we have the electrical infrastructure to support hundreds of thousands of cars plugged in?

Considering the full life cycle of the car, is it really as “green” as it looks?

In the US 45% of electricity is generated by coal plants, are we just shifting the source of pollution from foreign oil to domestic coal in some states?

The Verdict

With a great degree of certainty and based on the numbers reviewed above, my case for investing in oil is safe until at least 2015 and most likely until 2020. I personally would be part of the consumer group who would wait for reliability to go up and prices to go down before buying in providing the technology accommodates more than the compact car class. I will be reviewing this “risk” factor to my investment thesis as time goes by and new data becomes available.

Do you feel safe investing in oil? Do you plan on buying a plug-in electric car in the near future?