The oil-gold nexus

Crude oil has a unique status in global energy markets and underpins global economic activity. Since the 1970s, it has taken on a role as a quasi-monetary commodity. By the end of World War II, the US held around 70 percent of global gold reserves. The US supplied 6 billion out of the 7 billion barrels of oil consumed by the Allies for the period of World War II. Japan and Germany’s deficiency in oil were key factors in the Allied victories.

The Bretton Woods agreement of 1944 shifted the dominant trading currency from the pound sterling to the US dollar, fixed national currencies to the US dollar, and converted the dollar to a fixed amount of gold. The collapse of Bretton Woods in 1971 occurred at the same time as US hegemony in oil production passed its peak. By 1973, when the US was dependent on imported crude, it became impractical to regulate the price of oil and local price regulation of oil ended. This marked the beginning of the modern era of oil markets.

In Australia, the local oil price was regulated, which led to a sharp disparity when the world price rose in 1973. In 1975, the Federal Government introduced a levy on domestic production, and in 1977 introduced a phased introduction to import parity pricing.

Since the 1970s, oil and gold prices have tracked remarkably closely. One explanation is that in the absence of a metallic monetary base, oil has taken on a role as the base for a quasi-monetary commodity (Sager 2016). In recent years, both oil and gold seem to have been driven by factors other than simply supply-demand relationships. Oil and gold can also act as safe havens during extreme declines in other asset classes, such as equities and bonds. The departure from the relationship since late 2014 suggests that the current low oil price should be seen as an deviation from the long-run trend, and that a price of in the range $60 to $80 would better reflect fundamentals.

fredgraph_oil_gold

Oil and gold price in current USD. Source: St Louis Federal Reserve

In the US, high and rising oil prices often precede US recessions and there seems to be a threshold for expenditures, above which the US economy tends to be in a recession (grey shaded areas in graph). At $45/barrel, oil makes up around 2% of global GDP, but its role in the macroeconomy is much greater than its factor share would suggest.

None of the other energy sources or natural resources seem to have this intimate role with the monetary base. Wood and coal are solids and shipped by bulk transport, and require materials handling at each stage. Combustion produces a solid waste that must be disposed of. At standard pressure, natural gas is only tradable within fixed pipeline networks, but can be shipped as a highly pressurized liquid, at a cost. Both coal and gas can be upgraded via Fischer–Tropsch to substitute for petroleum, although the upgrade carries a significant net-energy penalty. Electricity has the highest utility (i.e. is easily convertible to heat, light or motion) but requires connection to a grid operating in a real-time supply-demand balance.

The dual identity of rooftop solar

We usually purchase energy, not because we value energy per-se, but because we value the energy services they provide – natural gas because we want warm homes or petrol because we want to get somewhere.

cullen-global-energy-conversion-to-economic-services1
‘Fuel to service’, from Cullen and Allwood, 2010, The efficient use of energy: tracing the global flow of energy from fuel to service.

The curious thing about solar is that many consumers are buying solar, not just for the energy, but because they value solar as a consumer product.  Remaining connected to the grid is an essential prerequisite for maximising the value of solar – solar is not adding energy services that wouldn’t otherwise be available. The solar heating Sun Lizard product (seen on the ABC Inventors) was an example of a useful but high-priced consumer product that mostly gave householders the satisfaction of having a solar product installed on their roof.

Rooftop solar is perhaps unique in being the first energy supply product that is part of consumer culture. Josh Floyd suggests that solar has a kind of dual identity at the microeconomic level. The fact that it operates outside of the conventional energy paradigm is the reason that electricity utilities have struggled to effectively grapple with the rapid uptake of solar. Similarly, many environmental economists argue that the high carbon abatement cost of solar leads to the misallocation of low-carbon investment if carbon abatement is the goal.

From a net-energy perspective, the interesting question is the degree to which the installed solar capacity contributes to national wealth and taxation, and how much could be considered consumer surplus (i.e. consumers deriving satisfaction from the ownership of solar). A food corollary might be to consider to what degree a value-added food service (i.e. restaurant service, premium wine, etc.) contributes to calories and nutrition, and to what degree society remains dependant on the mass production of grains and staples to underpin calorific and nutritional intake. Consumers that elect to consume a greater proportion of their income on discretionary foodstuffs do so because they value the ‘food service’ – the purchase of expensive wine is an example. But in the context of ensuring that everyone has adequate nutrition and calories, it might be unreasonable to expect the cost of premium wine to be absorbed into the cost of bread and milk, for example.

The case of off-grid solar represents the paradox of green consumerism – householders chose to forgo the purchase of other consumer products in order to buy into a culture of sufficiency. Yet the additional energy cost of going off-grid far exceeds the energy cost of remaining connected and simply reducing energy consumption.

figure_5_5
Dynamic EROI of off-grid solar, from Palmer, 2014, Energy in Australia

Despite making up a small proportion of annual energy supply, solar is nonetheless leading to a reappraisal of the Australian wholesale electricity market. It is a global characteristic of electricity systems, that unlike pharmaceuticals and computer software, investment on research and development makes up a very small proportion of revenue. Hence solar is leading the charge for a consumer-centric re-examination of electricity supply and may eventually disrupt the conventional tariff model.

My work with energy-return-on-investment suggests that the maximum value from solar is likely to be achieved with a small amount of storage attached (2 to 4 hours) where it can add value to the low-voltage distribution network. Although most attention has been directed towards considering how distributed solar might interact with other renewable energy, the combination of solar and a small quantity of storage could arguably work better with conventional baseload. In the long-run, I think the penetration of rooftop solar is going to be limited to 10 to 15% in most regions because of the strong seasonality at latitudes higher than around 30 degrees and low annual capacity factor – the global distribution of population and wealth tends to be in regions at greater than 30 degrees latitude.

 

gpw2
Global population density, from internetgeography.net

 

 

 

EV penetration in Australia

The Australian amateur astronomer Bob Evans has such an incredible knack for spotting minute changes in the night sky that he holds the record for visual discoveries of supernovae. There seems to be an evolutionary advantage to being able to spot changes in the natural world but it also means that we tend to overstate rates of change in the technical sphere. In various experiments, Sterman and others have shown that people tend to misinterpret system dynamics problems, such as carbon accumulation, and the fluid balance of bodies. The problem stems from a misunderstanding of the principles of accumulation.

Another example is the hype surrounding electric vehicles (EVs), and the tendency to directly translate rising global sales to a meaningful proportion of the total stock of motor cars. Most energy transition studies project increasing electrification of transport. Trying to derive plausible substitution rates of EVs is essential to understanding future energy scenarios. Horace Dediu also covered this topic in Asymcar episode #28. As Horace noted, the proportion of the EV stock in the future is several times removed from the current sales growth, as shown in figure 1.

ev-stock

Figure 1.

In order to derive projections for Australia, I took Australian Bureau of Statistics car census datanew car data and average age data. I used census data to derive sales data back to 1955. I used the historic attrition rate of 4%. By optimisation, I found that the proportion of cars of a certain age remaining after t years can be roughly described by a logistic distribution –

Yt = 1 / (0.995 ( 1 – 0.995) e^(0.305 (t – 0.25)))   where t is age in years

The ABS does not disaggregate EV data so I’ve had to use other published data. There have been around 3,300 electric vehicles sold since 2010, with 1,140 sold in 2014 and 942 sold in 2015. Assuming that new models and lower battery costs will drive compound growth of 40% through to 2030, the sales volume of EVs in 2030 will be around 146,000 units per annum or 10.5 % of new car sales, and make up 2.5% of the total stock of passenger vehicles. Around 20% of the passenger vehicles that will be on the road in 2030 are on the road today. The 40% projection is a best guess based on strong but plausible growth. The year on year growth up to September was 23% and 33% for Europe and the US respectively. I suspect the tip-over point will occur when the the price of an EV drops below internal combustion of an equivalent vehicle, and the case for electric is compelling. People will simply adapt to the charging regime.

abs-9309-0-do001_2016-motor-car-census

Figure 2. Number of passenger motor cars first registered from 1955 to 2015 as at 2015. Smoothed estimate with logistic distribution, based on ABS car census, sales data, and average age data, various years.

stock-of-cars
Figure 3. Historical and projected stock of passenger motor cars and EVs. Assume compound sales growth of 3% for new cars and 40% for EVs.

There are several challenges I see with increasing the adoption of EVs.

Firstly, the charging infrastructure may take decades to be comparable with petrol/diesel refuelling. It isn’t just a matter of infrastructure, but overcoming the limitations of electrical charging. For example, the Tesla Supercharger delivers 120 kW and takes 30 minutes to deliver 270km of range, or 0.15 km of range per second of charging. In the future, this will improve, but there is a limit to the charge time and current – assuming 7,000 batteries in the Model S (Panasonic NCR18650B, 3.6 volt) calculates to 4.6 amps per cell. Most homes have a single phase 40 to 80 amp 230 volt connection, equal to 9 to 18 kW, and therefore rapid charging is not going to be possible at home. In contrast, a fill-up at a petrol station delivers around 500km of range in about 2 minutes plus another 2 or 3 minutes to go inside and pay, or about 1.7km per second at the petrol station. Hence electric fill-up takes around 12 times as long. Management of electrical assets will require that most charging takes place overnight.

When I had a pre-injection Commodore V-8 (a while ago), the most annoying thing was always being conscious of the fuel gauge. I now drive a diesel and fill up once every 2 or 3 weeks  and never worry about refuelling.

Early adopters find plugging in at home a few times a week a novelty, but it remains uncertain how average consumers will take to plugging in. Many people in inner-city houses without off-street parking, plus apartments, etc. won’t have the option of an overnight charge. Yet this is potentially a key early adopter demographic.

A marketing mismatch is between high and low-km motorists – the low running costs of EVs will benefit high-km motorists, but long daily commutes and rural/interstate travel will mostly preclude the use of EVs. On the other hand, low-km commuters with ready access to charging will be less willing to outlay additional capital to reduce already low running costs – fuel costs make up only around 15% of ownership costs for small cars (see RACQ guide).

Much of the hype around EVs comes from Silicon Valley entrepreneurs rather than the car industry. I doubt that many people care what type of driveline a car has except to the extent that the driveline provides the mix of performance, economy, reliability, drivability, etc. that consumers demand. The closest many people get to thinking about the driveline is ticking the ‘auto transmission’ option. A basic error is failing to account for what consumers actually want in a car.

The car ecosystem is complex. Dealerships want cars on the showroom floor that people will buy. Holden stopped selling the Volt because few people wanted to buy an electric-powered 4-seat Cruze, regardless of price. The GM range-extender is a technical fix but doesn’t change whether consumers aspire to own a Volt. GM take electric seriously and want to be in the game, but also need to stay in business while batteries improve. The sales data on the Nissan Leaf is informative – an early spike followed by declining sales despite strong discounting suggests that there is a small demographic of price-insensitive consumers that want electric, but that the majority of consumers do not value electric in-itself.

Until EVs sales reach a critical mass that forces dealerships to take them seriously, sales will be hampered by a lack of commitment – EVs represent a potential threat to profitability because manufacturers and dealerships are heavily dependent on parts and service. Long warranties keep customers within the dealer orbit. The low maintenance of EVs will require a rethink of the current dealership business model that relies on post-sale servicing revenue. Software updates, tweaks and free data features may provide the motivation to keep customers within the dealership orbit.

Having driven a Tesla Model S, my immediate impression was of a tight, sharp and powerful car. Electric works. Home owners with a garage and another car for rural driving will find that electric works for them. But for all the excitement of electric drive, the car didn’t do anything that a conventional car doesn’t already do. The car was silent at low speeds, but a Lexus LS is quieter on the freeway. Long service intervals, twin-clutch transmissions with millisecond gear shifts, high efficiency diesel and hybrid drivetrains are a routine feature of internal combustion. The engineering elegance of so few moving parts is irrelevant for the new car buyer driving a reliable car with 1 year+ service intervals.

I’ll tackle the vital issue of embodied energy of EVs in another post.

Does Australian household spending on electricity conform to the Bashmakov constant?

Igor Bashmakov is one of the leading Russian experts on climate change and energy efficiency. Bashmakov developed three general energy transition laws: the law of stable long-term energy costs to income ratio; the law of improving energy quality; and the law of growing energy productivity. The proportion of GDP that households spend on electricity seems to be remarkably constant across nations and across time. Carey King has also explored similar relationships between energy and the economy (for example, see here and here).

To explore the relationship for Australia, I plotted the real price of electricity from 1955 to 2015 in 2015$AUD as shown in figure 1. I also took the nominal price and multiplied through by the household consumption and divided by nominal GDP, shown in figure 2. Consumption and price data was gathered from various ABS sources and Year Books, ESAA reports, OECD, and historical data. Full electrification of rural areas did not occur until the 1960s. Despite significant changes in the real price and GDP per capita, the share of GDP seems to pull back to within a band of 0.8 to 1.0% GDP. I haven’t carried the analysis further but the next step would be to consider income share and income growth. The recent role of solar may be important here – households offset increased spending due to higher tariffs by installing solar, but may eventually increase electricity consumption to bring annual spending back into line with long-run trends. Consumers probably get used to the magnitude of the electricity bill and adjust behaviour to suit.

I then looked at household spending for a range of countries and plotted them versus the residential price of electricity (figure 3). One would expect nations with higher electricity prices to spend more on electricity. I used the IEA Energy Prices and Taxation report from 2015, household consumption from the World Energy Council, GDP in national currencies from Economy Watch. For the selected nations, there is a six‑fold difference in per‑household energy consumption, a four‑fold difference in PPP‑adjusted electricity prices and a two-fold difference in PPP‑adjusted per‑capita income. Once again, there seems to be a band of spending share on electricity that is much narrower than might be implied by the differences. German households can afford much higher electricity tariffs than the US because they use much less electricity. But German households use more than the Polish because Germans are richer. Either way, the GDP share seems to hover around  1% +/- 0.4%. For policy makers, the lesson is straightforward but impractical – the most effective method of reducing household electricity consumption is to increase tariffs  and/or reduce economic growth. The role of rising peak demand confounds the study because peak demand is related to a peakier load duration curve. Efficiency and conservation seem to be deeply cultural and can be nudged only gradually. The corollary is that consumer price subsidies are a bad idea except to the extent of providing essential support for needy households.

Update: Dylan McConnell also covers this topic here , Keith Orchison covers it here

real-electricity-prices-households
Figure 1. Australian household real price of electricity, included fixed and variable tariffs
real-electricity-v-gdp-households
Figure 2. Australian household spending on electricity as a proportion of GDP

international-electricity-expenditure-per-gdp

Figure 3. Household expenditure as a proportion of GDP versus electricity cost