05 Jul Reacting To A Ban On Petroleum-based Mobility
Yet another more aggressive target for ending the sale of new petroleum vehicles was announced last week. What are the implications for companies merchandising in petroleum?
I cycle in the mountains on the wet Coast for fun, and the conditions here are very dry. My personal data about dryness is pretty simple—on one particular trail is a chronically wet patch that is always muddy, no matter how dry it is. Now it’s parched. Blackberries, a prickly crop that seems to love the heat, are going to have a banger year, and I now travel with a pair of pruning shears to trim these inch-thick cords of pain from the trails.
To add to the heat, last week western Canada sweated through an atmospheric heat dome, largely blamed by scientists on climate change, that caused massive loss of life primarily among the elderly, the homeless, and the poor. Dozens of temperature records were set.
Coincidentally(?) Canada’s federal government last week announced that they are accelerating the deadline to halt all sales of new gasoline vehicles including cars and Canadian limos (pickup trucks), by five years, from 2040 to 2035. Transportation represents 25% of Canada’s emissions load, and with auto makers transitioning to battery vehicles, the federal government has latched onto the possibility of advancing the calendar.
As usual, the media concentrates their stories on the impacts on auto making, the absence of battery factories, the handful of Union jobs in Windsor, the need for North American aligned industrial and climate policy, the shortage of charge points, and almost nothing on the impacts on the existing petroleum infrastructure.
Simple Rules for a Complex Industry
The oil industry has done an amazing job in managing the supply of gasoline and diesel across global markets. Complexity is hidden from view. Supply shortages do sometimes happen but they’re rare—oil and gas wants to be produced and consumed because they’re so valuable, and markets step up quickly to fix any supply gaps. But in the main, the industry has only ever had to contend with demand growth.
The policy-driven reduction in demand will chart novel territory for industry managers who have to balance the overall value chain. Here’s a handful of the “rules” about the industry that make such moves tricky.
1) Refineries are located near population centers or on coasts. As they have just one input (crude oil) and dozens of outputs, keeping them close to demand centers keeps the handling costs of the small volume outputs low, and coastal locations give them lots of supply flexibility and low crude input costs. Cities are likely to shift faster to battery vehicles because daily driving distances are less, and charge spots are more economical to set up. Inland refineries might be poorly located for their future demand.
2) Refineries are not infinitely reconfigurable. You can’t easily replace gasoline and diesel output with other products, and certainly not without some investment in new equipment. Between 25% and 50% of a barrel of oil converts into transport fuels, the demand for which is to be banned. Premium capital markets are unlikely to invest in a sector that has no exit strategy and a pre-defined demand collapse.
3) Refining assets don’t work properly when less than full. For example, pipelines that supply refineries are designed to run at the max. Tanks and storage can run below 100%, but refineries like to be north of 90% utilized.
4) Refinery capacity is added and taken away in lumps. The production volumes from a refinery do not generally slope—they step. As demand slowly ebbs, refinery volumes will erode, eventually to a point where no amount of reconfiguration will save them. Volumes will be ahead of demand, and there is no prize in storing the excess as the forward demand curve will be forever backwardated (product pricing and volumes go down in the long run).
5) Tanks leak. All those refinery facilities, tank farms, and fuel retailers with underground tanks are likely to be contaminated sites. Banning fuel cars and trucks automatically triggers the environmental liability and puts it on a timeline. The oil industry is based on the idea of selling off older assets to another operator before the environmental liability is real and needs to be reflected on the balance sheet. This strategy works until there’s no market for used assets, as in this case.
Fall-out From a Ban
Bans typically have an effective date, usually well off in the future to give companies time to react. But managers being managers, many companies will wait until the last possible minute before doing anything, in a forlorn hope that minds will be changed.
Hope is not a strategy. A useful lesson comes from the shipping industry, who first agreed to low sulphur fuel oil in 1997, but without enforcement until a number of countries signed up. Finally, low sulphur standards became international law in 2020. It looks like governments are now pretty resolute in their positions on the environment, and will not bend.
Here’s a handful of implications from banning petroleum-based mobility on the existing world of petroleum supply.
Pace of conversion
If European experience is an indicator, fleet operators will find the conversion to battery vehicles pretty compelling. Tesla cars have proven themselves in Amsterdam to be superior to gasoline taxis with their lower fuel and running costs. German rental car operators are committing to zero emission futures too, and are already migrating their fleets to battery. This will trigger the investments in charge points, a market that power utilities have been eying for years as a new growth market, given the slow response from petroleum companies to the change. The pace of change may well be faster than imagined.
The premium capital suppliers do not invest where they cannot see an exit strategy, where an environmental liability becomes real, and increasingly where the product is a direct source of emissions. Oil investments now fail on all three criteria. Major oil refinery projects take years to plan and execute, but with an end in sight, the forward curve for oil looks backwardated and investment economics don’t work. I can well imagine governments investing in oil refining as an energy security imperative. They own pipelines now for this reason.
Stranded asset risk
Transmission pipelines that supply inland refineries are at risk of becoming stranded. It’s not like there’s a lot of alternative uses for long distance buried steel tubes. The best ones will have contracted using take-or-pay arrangements with their refinery customers, but if the refinery goes out of business, now what?
Running a business anywhere in the petroleum value chain is about to get a lot more complex. Accurately forecasting demand will rely on fascinating new datasets that might not be readily available, such as new battery car sales, charge point expansions, commuting behavior, and power grid upgrades. All the players in the value chain will be constantly trying to adapt to a newly volatile demand world.
The market for real estate tied up in petroleum handling will tumble. For example, small independent owners of fueling businesses (and there are thousands in Canada alone) need to rethink their exit strategies. These businesses may not be able to escape their environmental liability for site remediation. Bankers are already wary of financing businesses on the wrong side of their ESG performance measures.
In the same way that there is a market for handling the abandonment and remediation of oil wells, there will be a temporary market for environmental remediation of tank sites. Canada alone has thousands of retailers, not including marine, air fields, construction sites, fleet operators, rail, trucking businesses, and many others sites. All these tanks will call out for help.
Market strategies for all kinds of companies tied to the fuels business will need to be reconsidered:
- Big box retailers who have placed fuel assets on their forecourt (parking lots).
- Companies that are rolling up fuel retailers into vast convenience retail networks.
- Fuel retailing businesses that are part of the super majors.
- Equipment companies that sell and service tanks, pumps, and piping.
- Logistics businesses that supply the market, such as cardlock businesses, blending services, and haulage.
- Services companies that calibrate measurement gear, handle clean ups, and provide security.
It’s all well and good to discuss the upside of fuel transitions, such as great new auto jobs, a cleaner world, and a better environment. But a balanced discussion also takes into account the implications of energy transition. Policy makers need to be equally sensitive to the challenges of withdrawal of demand for petroleum as they are enthusiastic for its replacement. Private companies need to start thinking about how they’re going to position themselves for the future now that the policies are moving.
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