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China spearheading EV adoption

The country leads the world in embracing electric vehicles, but this does not necessarily mean domestic demand for oil will decline anytime soon

China surpassed the United States as the number one crude oil importer in 2017 and again bolstered its import record in 2018, according to the International Energy Administration, while maintaining vast refining capabilities that exceed domestic demand.

But the country also has the fastest growing adoption of electric vehicles (EVs) and is a world leader in several forms of renewable energy. Together, these attributes mean it perhaps forms the most useful microcosm of how the global EV revolution will play out for the energy sector.

Passenger vehicles account for about a quarter of global oil demand. But BNP Paribas paints a dire picture for the future competitiveness of oil in the sector,  in research published in August. It calculates that the long-term breakeven oil price to remain competitive as a source of energy for passenger cars for gasoline is $9-10/bl and for diesel $17-19/bl.

The oil industry has "never before in its history faced the kind of threat that renewable electricity in tandem with EVs poses," the report concludes.

The authors created the concept of energy return on capital invested (EROCI) to measure the amount of energy provided for mobility from investments in oil and renewables. For the same capital outlay today, wind and solar energy projects in tandem with battery EVs will produce between six and seven times more power at the wheel compared with oil.

“[The rise of EVs] may not be a smooth, steep upward slope” — Hari, Vanda Insights

The potential long-term implications for Chinese oil demand is striking if you consider the speed of electric car adoption. The Chinese government is spending billions of dollars to subsidise production of EVs and batteries as well as encourage their uptake. Chinese consumers bought 1.1mn EVs last year, more than the rest of the world combined and nearly triple the number purchased in the US.

Jack Barkenbus, a researcher at the Vanderbilt Institute for Energy and Environment in Tennessee, argues that China is likely to produce as much as 70pc of the world's EV batteries—a key determinant of electric car cost—by 2021, even as the demand for batteries grows.

The speed of oil's decline will be "inversely related to the battery technology curve," says Kristoffer Laurson, syndication director at Camco Clean Energy in London.

Petrol-powered vehicles will only be competitive for special applications in 10 years' time, he says. "Anything moving less than 300km per day will transition to electric at an accelerated pace since the payback is less than five years."

He predicts continuous downward pressure on oil prices and "massive downside risk for the internal-combustion engine (ICE) value chain".

Incumbency advantage

In China, that downside risk is unlikely to unfold in a linear way. Oil has a "massive incumbency advantage," argues Dr Michal Meidan, director of the China Energy Programme at the Oxford Institute for Energy Studies.

Gasoline demand in China could peak in 2025 or so and start falling thereafter, she says, but China is still set to consume around 3.5-4mn bl/d of gasoline over the next decade. China's car fleet is still growing and, while the share of electric fleet share is rising, there is still "ample growth in ICE vehicles," Meidan argues.

Researchers at the Baker Institute for Public Policy at Rice University in Houston argue that the emergence of low-speed EVs—which cost as little as $3000—means that Chinese consumers do not need to be able to afford expensive EVs before they cease gasoline-powered driving.

The institute finds that gasoline demand growth in China is already decoupling from car fleet growth. From 2012 to 2018, China's private vehicle fleet grew by nearly 150pc while gasoline demand rose just 50pc.

But small vehicles that are suitable for local driving may not be so attractive to Chinese consumers in the long term. The Baker Institute says that if small EVs pushing down gasoline demand leads to lower pump prices, many consumers are likely to turn back to ICE vehicles; the evidence indicates that Chinese consumer demand is driven mainly by price considerations.

If economic constraints ease, particularly for relatively affluent consumers, the institute notes that a surge of road construction in China and the emergence of a more "American-style road trip culture" could drive gasoline demand increases at a pace that even rapid electric car penetration cannot offset.

Road demand from both freight and passenger vehicles in China is set to peak in 2025-30 while rail, marine and aviation numbers are all on the rise, according to Meidan. Moreover, demand for oil for use in petrochemicals is still rising in China and "will continue to grow for some time".

Matthew Parry, head of long-term research at Energy Aspects in London, agrees. He says that persistent demand from petchems and aviation will keep total Chinese oil demand rising until the late 2030s. He predicts that Chinese oil demand will increase by roughly 4mn bl/d between 2018 and 2040, or an average 1.3pc annual gain, led by jet/kerosene (+1.5mn bl/d), naphtha (+1.1mn bl/d), diesel (+0.7mn bl/d) and LPG (+0.6mn bl/d).

Spike in the tail

While a major evolution in mobility has arrived, according to Vandana Hari, founder of Vanda Insights in Singapore, it is "not a revolution". Government subsidies for car makers and buyers in China can boost the market for a while but they will have to be withdrawn at some point, she says.

Analysts have argued that the rush to electric and hybrid vehicle showrooms in June—which only took place due to the pre-announced scaling back of government incentives for buyers—augurs badly for longer-term demand. The China Association of Automobile Manufacturers in July reduced its forecast for 2019 new-energy vehicle sales from 1.6mn to 1.5mn units.

1.1mn — Chinese sales of EVs in 2018

Limiting factors—such as lack of adequate charging infrastructure, or under-supply of metals such as lithium and cobalt—will also delay electric-car take-up, Hari argues. The rise of EVs "may not be a smooth, steep upward slope".

Keun Wook Paik, senior research fellow at the Oxford Institute for Energy Studies, argues that BNP's oil price projection "seems to have underestimated the money politics" involved. Renewable energy is not yet a trillion-dollar business, he says. "Ultimately, it is a brutal money battle."

Wook Paik finds it difficult to imagine that China will allow the pendulum to suddenly shift from oil to renewables without taking protective measures. Beijing must consider the potential for mass unemployment that could be caused by a rapid transition from gasoline to electric cars, he says. "The collapse of gasoline-based car production would cause a massive social instability problem."

China is grappling with the contradictory challenges posed by poor air quality and potential social instability caused by large scale oil industry unemployment. They will leave "no stone unturned" to ensure a balanced energy sector transition, Wook Paik says. He expects Beijing will pay more attention to the expansion of natural gas in China's energy mix in coming decades. China is set to experience an era of 500-600bn m3 gas demand in 2030 and will be keen to source competitively priced LNG, he argues.

The first car purchased by hundreds of millions of Chinese people is likely to be electric. Many will never own a car that uses gasoline—but that does not mean that peak oil demand in the country can yet be predicted. Nothing guarantees that China will be able to make its energy transition smoothly; Hari sees the danger of underinvestment in the oil sector leading to "at least one more cycle of scarcity and a price super-spike" before Chinese oil demand begins to sustainably fall.

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