Ring of Fire

So much attention is paid to alternative fuels and vehicles, including by us at the Transportation Energy Institute, but the relationship between traditional fuels and the opportunity for alternatives to gain market share is one that has been demonstrated time and time again. In mid-January, the U.S. Energy Information Administration (EIA) released its Annual Energy Outlook 2020 presenting their projections for the energy sector through 2050. I look forward to this report every year – it is big and complex, but when using the interactive table viewer, I am able to narrow my focus on those elements that will have the most relevance to the transportation energy market.

And as much as I enjoy AEO2020 and all other forecasts I come across, they are not certainties and they are often maligned by those who question the methodology, the assumptions and the outcomes. I think these attacks are a waste of time, but I also caution against assuming any projections are locked-in realities – we should use the data as a point from which to have further discussions about what might transpire and what factors might wield influence in the future. But, when you put something out like there like the AEO, you are opening yourself up to attacks and have to be careful not to fall into a “Ring of Fire.”

Yep, it’s time again for a twofer on the musical reference. The first song I remember hearing by punk rock icons Social Distortion (one of my all-time favorite bands) was a cover from a very surprising influence, Johnny Cash. Ring of Fire continues to be a fan favorite, sparking mosh pits of such exuberance that Mike Ness and company often hold the track for their encore in order to send the crowd home on a high note with a strong anthem echoing in their heads.  Take a listen to both versions by Johnny and Social D (clip from a live show at the famed CBGB’s in New York) – both are absolutely great tunes:

I fell into a burning Ring of Fire,
I went down down down
And the flames went higher
And it burns burns burns
That Ring of Fire
That Ring of Fire

Fuel Efficiency Improvements

When I speak with fuel marketers and producers, they often ask what is going to happen with overall demand of the most common transportation energy products in the market – gasoline and diesel fuel. I typically start out by explaining that fuel efficiency programs and improved vehicle technologies have had and will continue to have a major influence on the amount of energy needed to travel a certain distance and that understanding how these relate is critical. And I stress that there are a lot more factors affecting fuel demand and technologies improving efficiency than the overwhelmingly big story of the day, electrification.

First of all, between 2000 and 2017 passenger cars improved their efficiency by 38% and light trucks by 34% without much help from electrons.  And much of this improvement was achieved prior to the current era Corporate Average Fuel Economy (CAFE) standards, although clearly the current policy resulted in accelerated improvements in the second half of this time frame.

As we look forward to better understand what efficiency will do in the coming decades, EIA is constrained to evaluate market evolution based upon current regulations – and the Obama-era CAFE program remains in place.  However, because that program does not stipulate efficiency targets beyond 2025, EIA’s model holds regulatory requirements at that 2025 level going forward. Their forecast is for the fleet to become 47% more efficient by 2040 – meaning a vehicle will be able to travel the same distance on about half the fuel required today.

Increasing Miles Traveled

What impact will these improvements have on fuel demand? Leveraging efficiency data alone is insufficient to make that projection – we must also consider anticipated miles traveled. In this respect, EIA anticipates miles driven to increase between 7% and 20% by 2040, depending on the assumptions used.  (I present in the slides below the EIA reference case projections as a solid line and the range of potential outcomes associated with EIA’s low oil price and high oil price scenarios in the shaded areas.) Contributing to the increase in miles traveled is an increase of 12% in the number of licensed drivers. This increase in miles traveled offsets to a degree improved vehicle efficiency, at least in terms of the impact on total fuel consumed.

Gasoline and Diesel Demand Destruction

In balancing efficiency improvements with miles traveled, EIA is able to forecast that gasoline consumption could drop between 13% and 26% by 2040 in the two oil price scenarios. Meanwhile, diesel fuel could yield 3% to 15% volume under the similar conditions.  This destruction in demand is a direct result of efficiency improvements delivering greater benefits to consumers.  For fuel retailers, this could be a very challenging development, but it does not tell the whole story. More importantly will be what happens with the number of visits consumers need to refuel their vehicles.

Many auto engineers tell me that in order to support efficiency gains, the size of a vehicle’s fuel tank will shrink in order to save weight. If this is the case, to what extent will a vehicle’s range improve along with its overall fuel efficiency?  I suspect that the tank will not shrink at a ratio that will prevent improved range per full tank, but the impact of retail fueling trips is unlikely to be proportional to the reduction in gallons consumed.  In other words, consumers are likely to buy fewer gallons per visit than they do today, but still travel further on the gallons they do buy. This will reduce refueling trips, but not as significantly as it will reduce gallons consumed.

Forecasting Fuel Prices

The alternative scenarios on which I focused relied upon EIA’s projections for the price of oil. EIA generated forecasts for a low price and high price scenario. The variability in these forecasts is significant – ranging from a potential low of $41 to a high of $171 in 2040.  The reference case puts oil in 2040 at a level almost equivalent to today’s prices adjusted for anticipated inflation of about 2% – 3%. The result would be $86 for West Texas Intermediate and $90 for Brent.

Why is the price of oil so important?  Well, oil prices influence prices at the pump. According to EIA’s monthly report of the retail price of gasoline, crude oil routinely represents about two-thirds of the retail price of gasoline and has at times exceeded 80% of the posted retail price. So, if the high oil price scenario were to materialize, prices at the pump would be expected to increase. In fact, EIA’s forecast for retail gasoline prices is presented below – the range is significant from a potential low of $2.20 to a high of $5.00.  This has implications for the ability of alternatives (absent government incentives or requirements) to gain market share.

Impact of Fuel Prices

We know and have demonstrated that a consumer’s decision to purchase any vehicle is complex and involves a significant array of factors. However, in our 2018 report, “Driving Vehicle Sales,” we concluded that the primary factors are need (What kind of vehicle do I need for my daily activities?), affordability (Can I afford to buy the vehicle I am considering?) and efficiency (How much will it cost me to fuel this vehicle compared to other options?). Again, there are many other factors, but these are significant considerations.

We also know from past experience that the price at the pump influences how consumers weigh these issues. In consumer surveys and examinations of raw data, it is clear that consumers are much more willing to consider purchasing an alternative vehicle (such as a hybrid electric vehicle) when pump prices are high than when they are low.  For example, in 2014 when retail gasoline prices were around $3.50 per gallon, 84% of consumers said they would consider a hybrid for their next vehicle and 3.2% of consumers actually purchased such vehicles. Fast forward to 2016 when retail gasoline prices dropped to less than $2.00 per gallon, those willing to consider a hybrid dropped to 44% and those who actually purchased one dropped to 1.9%.  Consequently, what happens to prices at the pump (all things being equal) will have an impact on consumer adoption of alternative transportation technologies.

Avoiding the Ring of Fire

EIA’s AEO2020 is a fascinating report that provides some insight into how the market might evolve – but it is not a prescription. Models and forecasts are only as good as the assumptions and inputs they leverage. Technological advances, manufacturing breakthroughs, policy adjustments, geopolitical risk and global economic health will all affect the trajectory of this market and they are impossible to accurately model. Consequently, it is relatively easy to poke holes into forecasts like AEO2020, but that misses the point.

We are at a stage of market development and transition that is a moving target and it is impossible to get our arms around every moving facet that will influence the eventual outcome. Resources like AEO2020 give us a reference against which to evaluate what is happening, a starting point for discussion and debate, and a way to begin introducing alternative scenarios that could play out.  I applaud the team at EIA for their diligence in delivering their forecasts for us to consume, ponder, tear apart and build upon. But just as it is a waste of time to nitpik, it would also be a mistake to take such forecasts as guarantees or to assume one forecast is 100% accurate – none are, but they give us ammunition to continue exploring the market and try to make some sense of what is often a chaotic situation.

If we approach such resources with intellectual curiosity and an appetite for learning what could be, rather than as a pack of wolves seeking to undermine the source, we will all be a lot better off. I encourage you to spend some time with this outlook and be open to the possibilities and curious about the alternative.  But be careful and don’t start spouting such forecasts as gospel – that path is rife with rings of fire as well.

The taste of love is sweet
When hearts like ours meet
I fell for ya like a child
Oh, but the fire went wild.