(Bloomberg Opinion) -- The word “transition” has an alluringly smooth quality to it, like the passing of a baton between Olympians. The energy transition is nothing like that. It is the taking of a hammer to a vast, Rube Goldberg-esque squiggle of pipes and wires and what have you — while still depending on that squiggle to work 24/7 for years to come. There will be issues.
An immediate, and growing, risk is that assets may be stranded long before they cease to be useful.
For any sort of plant, fixed costs can force owners to pull the plug before output drops to zero. This is especially thorny for energy because of three things. First, the energy transition entails turning over a gargantuan amount of fixed capital, which is messy and takes time. Second, we have virtually zero tolerance for the interruption of reliable, affordable energy. Third, as the current crisis in Ukraine demonstrates all too viscerally, dependence on others for that energy comes with a hefty dose of anxiety.
Electric vehicles and oil refining demonstrate how this plays out. Consider the U.K., where sales of battery EVs (that is, excluding hybrids) have taken off. New AutoMotive, a transportation research and electrification advocacy organization, calculates that EVs accounted for more than one in 10 car purchases there in 2021, up from less than one in 100 just three years earlier.
Without making a firm prediction, that acceleration fits the profile of a new technology S-curve taking shape. So, keeping in mind Britain's goal of banning internal combustion engines in new cars and vans by 2030, except for hybrids, imagine an S-curve that takes battery EVs to 95% of new car sales by the end of the decade, with hybrids taking the other 5% (see footnote for many assumptions).
This is just a modeled scenario. The main thing to keep in mind, though, is that despite this imagined revolution in new car sales, turning over the existing fleet of almost 33 million U.K. cars to EVs takes much longer — as does cutting the country's fuel demand. Indeed, in this simple model, raising the annual scrappage rate by only half a percentage point has three times the impact of a 5-percentage-point shift in the target EV market share.
One quirk of the U.K. is that diesel cars there are driven more than 50% further per year than gasoline cars, on average. So despite greater efficiency, the collapse in diesel's market share lowers overall fuel demand disproportionately. Yet even though, in this scenario, EVs take more than 90% of the new car market as early as 2027, by then they still make up only 13% of the fleet, and fuel demand is down just 21% relative to pre-pandemic levels.
So here's the point: Even projecting that EVs sweep the market within five years, the U.K. car fleet would still be burning roughly 300,000 barrels of oil a day in 2030. And this is where things get tricky, because while that would still be a lot of oil, it would be roughly a third less than was used in 2019 — a disastrous decline for U.K. refineries.
Six of these are operating, and in broad terms the system is long gasoline, exporting about a third, and short diesel and jet fuel. Alan Gelder, vice president of refining, chemicals and oil markets at the consultancy Wood Mackenzie, puts only Phillips 66's Humber facility facing the North Sea in the top quartile of Europe's most profitable refineries. In an ironic twist, he says it was one of the few facilities to make money in 2020 partly because it produces high-quality coke used in anodes for batteries.
In the near term, falling demand for fuel could be offset to some degree by exporting more gasoline. But if EVs take off in continental European markets, too — and there are equally ambitious targets across Europe — that would push more excess fuel onto the regional market. Gelder also points to the imminent start-up of a new refinery in Nigeria, Africa's largest, which might produce more gasoline than that country imports from Europe. The loss of this export market would crush premiums on spare barrels looking for a buyer.
In that case, pressure on an already relatively uncompetitive refining system would intensify. And the U.K. would face the strategic question of whether to stand by as more refineries close despite its continuing need for large volumes of fuel.
Becoming more dependent on, say, Dutch and American supplies may not seem too bad, but politicians tend to be twitchy about energy security. I'm speculating here, but if EV sales track with government objectives, U.K. refineries might call for some form of payment just to stay open. London isn't necessarily averse to such state aid; it recently extended the payment schedule for taxes owed by the operator of the Stanlow refinery near Liverpool, which has been struggling amid pandemic-related disruption.
Beyond the U.K., Australia has already enacted a formal subsidy program to keep its last two refineries running. And such measures aren't confined to oil. Last year, California proferred off-market payments to old gas-fired power plants and even backyard generators to stand ready. Why? Because even as increasing penetration of solar power squeezes profit margins at conventional plants, those same plants are still needed to meet the surge in demand when the sun sets over the Pacific (see this, this and this).
Energy markets often struggle when it comes to pricing externalities such as greenhouse-gas emissions or notions such as resiliency or redundancy. The energy transition demands that both of these be addressed simultaneously.
Conventional wisdom holds that renewable energy is subsidized and fossil-fuel energy is not. This has always been muddled thinking since unpriced emissions are a de facto subsidy, and our colossal investments in securing energy supply are often underwritten by public or quasi-public entities. The energy transition adds a further twist. We now face an indeterminate period when the drop in energy costs of clean technologies increasingly makes them competitive without subsidies — but perhaps only in the context of being backed up by conventional capacity that seeks subsidies to offset weakening economics. Before the baton passes entirely, it must be held by two hands.
More From Other Writers at Bloomberg Opinion:
- Why You Should Buy a Luxury Electric Car in 2022: Conor Sen
- Oil's Going to Have a Good Winter, Even If You Don't: Julian Lee
- Refined Oil Outsourcing Heads for a Whole New Level: Julian Lee
This assumes aU.K. car fleet of 32.7 million in 2020, as per Department for Transportation data, annual fleet growth of 0.5% and annual scrappageof 5%. Assumes all scrappage is of petrol (gasoline) and diesel cars, split evenly, since hybrids and battery EVs are much younger than existing fleet. Assumes diesel market share continues to collapse, at 6% in 2022, 3% in 2023 and 0% from 2024. Assumes hybrid market share drops from 22% to 5% from 2023. Average fuel economy for existing petrol and diesel fleet is31 and 36 miles per gallon, respectively, calculated using Department for Transportation data. Average fuel economy for new petrol and diesel vehicles is 35 and 39 miles per gallon, as per International Energy Agency data for 2019. Annual mileage for petrol and diesel cars of 6.480 and 10,000, as per five-year averages. Assumes hybrid fuel efficiency of 59 miles per gallon (1.5x diesel level) and annual mileage of 10,000. Assumes 8.35 and 7.46 barrels per tonne for petrol and diesel, respectively, as per BP statistical conversion factors.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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