Oil & Gas Financial Journal

among consumers, only to prove false. In the 1990s and 2000s, many hailed the progress in both electric and fuel cell vehicles, predicting early market penetration, only to see them completely fail to win consumer acceptance.

Which doesn’t mean that electric vehicles will never be ready for market. Battery costs have come down and performance has improved, but with the thin market until recently, estimates of cost trends are hardly reliable. To date, most sales appear to be spurred by hefty government incentives.

However, performance is also a major factor in consumer choice. Engine performance is as good as or better than ICE vehicles, but inconvenience remains a barrier. Range anxiety is a very real thing, in part because drivers are advised against charging the battery more than 80% or discharging it below 20% on a regular basis, meaning an estimated 200-mile range is actually more like 140 miles. In cold weather, the range drops further, at least 5%.

And although many BEV advocates deny it, recharging remains significantly more inconvenient than refueling an ICE vehicle. Use of a Tesla Supercharger cuts the time from as much as eight hours to as little as 30 minutes, although other manufacturers’ vehicles can’t use them. Still, the difference between five minutes for 300 miles of range in an ICE and 30 for “up to” 170 is significant.

Consumers are being asked to spend substantially more money for a product that delivers much poorer services. The evidence of consumer preference is particularly clear where subsidies have been reduced or ended. In Georgia, the state withdrew a $5,000 per vehicle subsidy and sales dropped by 80%. It would seem that, as with renewable energy, governments are beginning to regret the benefits and subsidies offered electric vehicle buyers, especially as sales have risen and the payouts become more substantial.

Enthusiasm for BEVs looks like irrational exuberance.

PEAK DEMAND AND EQUITY PRICES

The most extreme case for lower oil company equity prices comes from Carbon Tracker Initiative which states that “…up to 80% of declared reserves owned by the world’s largest listed coal, oil and gas companies and their investors would be subject to impairment as these assets become stranded.” Further, they believe that “greater than 50% of the value of an oil and gas company resides in the value of cash flows to be generated in year 11 onwards.” The implication is that oil company equities should be discounted by 25% or more.

This does not appear to conform to the general understand-
ing of discounted cash flow in the oil industry. With the usual
industry practice of a discount rate of 10%, about 65% of a
constant cash flow would be received in the first ten years.
And the decline rates of reserves translate into an additional
discount factor: if 10% of proved reserves are produced in a
given year, the depletion or natural decline rate is 10%, which
means that production and cash flow will decline by 10% per
year (assuming constant prices) and the discounted cash flow
would decline by 20% per year. In that case, about 90% of the
value of the reserves would be received in the first ten years.
Table 2 shows recent production rates for a number of
countries and locales, which highlights the importance of
differentiating types of production. The clear lesson is that
synfuels such as tar sands have very low decline rates, while
offshore reserves tend to be highest. (Shale oil generally has
very even higher decline rates, but company data will show a
mix of new, fast-declining well
and older wells with more sta-
ble production.) Table 3 indi-
cates how much of the total
discounted cash flow will be
produced within 10 years, given
different decline rates.

So, only for oil sands production and some conventional onshore oil should there be any significant discounting of reserve values due to expectations of weak oil demand, and even that is problematical. In most cases, the majority, if not the bulk of the value, of proved,

developed reserves is recovered within a decade and events beyond that period are all but irrelevant for current reserve and equity values.

PRICES AND DEMAND

And of course, economics could play a role in reducing oil demand. A reduction in subsidies in oil producing countries could reduce oil demand slightly, but moves in that direction have been slow, while large consumers like China and India have only modest subsidies. So even a complete termination of product price subsidies would only moderate world demand trends slightly.

A bigger effect would be from rising crude oil prices, as many predict (Figure 1). Unfortunately, Lynch (1992) showed that long-term oil price forecasts have tended to be overly optimistic or bullish for many years, due to a belief that depletion must send costs rising over time. But this was countered by Adelman (1986): “Diminishing returns are opposed by increasing knowledge, both of the earth’s crust and of methods of extraction and use. The price of oil, like that of any mineral, is the uncertain fluctuating result of the conflict.” In both the 1970s and 2000s,

T2: 2016 DECLINE RATES

US Europe Bitumen
Shell 21.5% 18.6% 4.0%
BP 10.2% 17.5%

Chevron 13.4% 14.9% 2.9% COP 11.9% 11.6% 2.3% EOG 21.2% — — T3: SHARE OF PRODUCTION AND DISCOUNTED CASH FLOW IN 1ST 10 YEARS (OUT OF 35 YEARS TOTAL)