Electric vehicles: disruptive forces

Electric vehicles clearly qualify as a disruptive force, but what is most interesting is how many industries could be roiled by greater penetration of electric vehicles over the next decade. At a minimum, the regulated power, metals, oil and gas, and automotive sectors will face significant consequences from an increased number of electric vehicles on the road, and, to be sure, the impacts could vary widely based on geography.

Oil and gas

At first sight, companies in the oil and gas industry look like the biggest losers from the shift to electric vehicles. In a world without internal combustion engines, demand for oil products such as gasoline and diesel could evaporate. But while the adoption of EVs is a growing reality, in the next few years global oil demand also looks likely to continue growing, potentially above 1%. The rate at which EVs are adopted in the coming years and decades is absolutely critical — and highly uncertain — but it’s not the only factor.

For oil producers, growth in demand from emerging markets for transport remains the larger factor in the near term, whereas 47% of crude oil is currently used in road transportation. The 1 million EVs sold in 2017 compare with total global car sales of 80 million. Platts Analytics has pointed to oil demand loss of 20,000 b/d for each additional million EVs. Even if assuming a growth to annual sales of 11 million cars in 2025, the total impact is going to be about 220,000 b/d, compared with current production of about 95 million b/d.

We see oil focused producers with reserves at the high end of the cost curve as most exposed. While producers have focused on shorter cycle developments, including shale, in recent years of low prices, the investment pro le is also important. A high cost development could still be economically attractive, if the costs are front loaded and the long-term investment needs to maintain production are low. As with existing, producing developments, even if oil prices are low, the capital cost is largely sunk. As demand and potential returns wane and companies pull back on investment, free cash flow generation could actually increase. Such a lack of reinvestment can’t ultimately support a sustainable business model, however.
In our view, the long lead time until EVs take over will allow the oil majors to look for alternative growth routes, with more focus on gas and renewables. These two energy sources are well placed to meet some of the increased demand for electricity from power producers as a result of EVs. Gas makes up about half of the reserves and production of the five supermajors.

Oil refineries also face a potentially painful transition over time as both demand for their oil products softens and declines, and also as the mix of products changes over time. Many refineries can only make relatively modest changes to their product slate. Changing their configurations, to produce, at first, less gasoline, then also likely less diesel, even where possible could involve material investment, which might not be economic.

Regulated utilities

For US utilities, the “electrification of transportation” presents growth opportunities when pursued in a credit-friendly manner with adequate regulatory support. It could be a solution for utilities to counter slumping electricity demand by generating additional revenue streams. We expect growth to be two pronged, resulting from an increase in electricity demand as well as from higher capital investment in electric vehicle supply equipment (EVSE) or EV charging infrastructure.

We believe greater electricity demand from drivers will result in moderate growth, with any meaningful increase in consumption accruing over about five to seven years or longer. We project EV-induced load, in aggregate, to remain less than 5% of total projected load growth from 2018 through 2035. This estimate includes projected demand from battery plug-in electric light-weight vehicles, but excludes recently announced electric heavy-duty trucks. Large-scale production of electric heavy-duty trucks has the potential to increase demand over and above our current projections. With load from EVs contributing about 1%-4% to total projected load over the next 15 years, EV-related consumption is not likely to be a major growth contributor to overall electricity sales in the sector.

EV charging infrastructure, on the other hand, offers more immediate growth potential because it entails asset ownership, expansion of the rate base, and an opportunity to earn a regulated return on EV investment. We consider availability of EV-charging infrastructure as an important catalyst for widespread adoption of EVs. The US currently has only about 43,000 charging outlets and would need many more to match the projected growth in EVs. A study by Edison Electric Institute (EEI) estimates that five million charging outlets will be needed by 2025 to support about seven million electric cars on the roads. To get a sense of how behind the US is in deploying charging outlets, we compared EV-charging infrastructure in the US to that in China, which is among the fastest-growing EV markets, with roughly 150,000 charging outlets.

Electric utilities appear positioned to participate in EV infrastructure development. Utility companies’ in Georgia, Massachusetts, Kentucky, and Washington, in collaboration with state regulators, are in the process of launching pilot EV-charging infrastructure programs to comprehend and address the technical and regulatory issues. However, over the next few years, large-scale deployment is expected to be limited to California where the state’s three largest investor-owned utilities are ready to spend close to a combined $1 billion over five years on EV infrastructure programs, subject to regulatory approval. The potential for rate basing of EVSE costs could result in utilities being more aggressive in installing the charging stations.

Metals and mining

The auto industry is one of the main customers of bulk commodities. About 25% of the total production of steel is transformed into car bodies. The long arching trend of improving the efficiency of cars led to a transition from commodity grade steel into a highly advanced composition, mixing the iron ore with other metals (such as moby, chrome…) and more recently using aluminum, plastic and carbon ber. The electric cars are not going to accelerate the shift to complex materials.

Currently the auto industry is responsible for 5% to 35% of the main commodities. The introduction of electric cars will result in higher demand for commodities, but the impact of the swing will not spread evenly. We see three categories of demand:

  • More abundant and cheaper commodities such as copper; aluminum and nickel.
  • Critical commodities for batteries such as lithium and cobalt.
  • Energy and grid commodities such as coal and nuclear.

One of the main concerns in the market is that a healthy demand for electric vehicles will be slowed down by the short supply of lithium and cobalt (each car requires about 60-65 kg of lithium and 3.8-4.2 kg of cobalt).

In 2016 the total mined cobalt was about 100,000 tons and could reach 200,000 tons or more by 2025, depending on different electric car penetration scenarios. Recently Glencore announced that it will double its cobalt production, aiming to produce 63,000 tons of cobalt by 2020. This increase is equivalent to about 7.5 million new cars.

With lithium prices soaring by more than 300% over the last two years, there are more than 20 lithium projects in the market in different stages, mostly executed by junior miners. While there could be a timing mismatch between the demand and supply, a scenario that will translate into oversupply of lithium in the next decade cannot be ruled out. It is important to mention that even a very sizeable hike in lithium prices will have only modest impact on the price of a battery and on the overall demand for electric cars.

Looking further into the future, the change in the technology of batteries may lead to some changes in the battery composition and to slightly less demand for specific commodities, with cobalt being the main candidate to be replaced with nickel.

Most of the major miners have a sizeable exposure to copper and iron ore. We believe that the demand for electric vehicles will result in higher demand for copper, resulting in high prices and profitability. As of today we expect a short-fall of copper taking place in 2019 without any large-scale projects coming online. On the flip side, the exposure of the major miners to rare commodities is rather small (for example, the contribution of lithium to Rio Tinto’s EBITDA is less than 1%).

On the other hand, companies such Eurasia Resource Group (ERG) will be the immediate winners. The company is about to launch a tailing reclamation project in the Democratic Republic of the Congo, and with current prices it is estimated to have abnormal returns. Other junior miners with sizeable projects include Montero Mining in Namibia, Kodal Minerals with a project in Mali and Premier African Minerals with a project in Zimbabwe.

Automotive

There also is the possibility that other disruptors, such as autonomous vehicles, could have similar and even greater impacts over time. Beyond EVs, autonomous vehicles (AVs) will drive the next phase of disruption in the infrastructure space. Full-scale testing of self-driving vehicles without human control is being done by a number of companies now. Clearly how people travel has been changing, as a result of ridesharing, new offerings from transport network companies, such as Uber or Lyft, and is about to get even more interesting. Similarly, large US shippers, distributors and retailers, such as UPS and Wal-Mart, are placing orders for new transport technology, such as Tesla’s heavy-duty electric tractor trailer truck, that will upend how goods and services are delivered to customers.

Importantly, though electric vehicles are likely to have a dramatic impact on the landscapes of several industries, any ratings actions are likely to be longer term in nature, and, at this point, remain subject to the actions of management teams; additionally, the effects are likely to vary greatly by region, depending on a variety of factors. Still, a focal point of ratings surveillance is ensuring that the full impacts of disruption are captured. The coming years will determine which companies have best positioned themselves to compete in this changing framework.

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