Monday, April 13, 2009

Fuel of the Past?

Today's Wall St. Journal features a front-page article sounding the death-knell for the growth of US gasoline demand. The combination of recession, stricter fuel economy standards, and the hangover from last year's high gas prices, together with growing biofuels consumption, appears to herald a peak in gasoline sales. The Journal cites a forecast from ExxonMobil in support of its conclusions. However, to assess the full implications of such a shift, it's important to differentiate between a decline in the requirement for the petroleum-based components that gave gasoline its name and the demand for the fuel generically referred to as "gasoline", which in most of the country already includes up to 10% ethanol, and is likely to include a more diverse mix of non-oil constituents in the future.

According to data from the Energy Information Agency of the DOE, US average daily gasoline consumption peaked in 2007 at 9.29 million barrels per day (MBD), declining by 3.5% last year. However, if we back out the blended ethanol volumes included in that tally, petroleum-based gasoline demand peaked a year earlier at 8.93 MBD and has fallen by 5.3% since then. With a federal renewable fuel standard (RFS) that mandates ever-higher volumes of biofuels, and with the apparent breakdown of many of the trends that have been driving gasoline consumption up since the end of the energy crisis of the 1970s and early 1980s, including annual vehicle miles traveled, that 2006 figure could prove to be the high-water mark for petroleum gasoline. However, the Journal's analysis also ignored or downplayed several factors that could soften its decline, particularly for the oil-and-biofuel blend that "gasoline" has become.

The most obvious of these is low fuel prices. Since monthly gasoline demand bottomed out at around 8.5 MBD last August, we've seen demand rebound somewhat, in response to the dramatic drop in gasoline pump prices. But while this factor might be self-correcting, since higher demand will tend to push up prices, which will retard further demand growth, another factor is creating a new source of steady underlying demand growth: As the RFS ratchets higher, the energy content of gasoline falls, and it takes more gallons to travel the same distance. With 8 billion gallons of ethanol included in last year's gasoline sales, the average gallon of gas delivered 112,700 BTUs to your car in 2008. At the 13.2 billion gallons of ethanol required in 2012, that figure would fall by 1.2%, requiring a corresponding increase in volume to compensate for its lower energy content. In fact, unless sales of biodiesel ramp up significantly, relieving the pressure to blend more and more ethanol into gasoline to satisfy the RFS, the current car fleet would require 7% more of 2022's "gasoline" to drive the same total miles as last year.

Under the federal fuel economy regulations enacted in 2007, the increased demand for less-energetic fuel should eventually be overwhelmed by the energy-efficient cars expected to make up a sizable fraction of the US car fleet by 2022. If anything, those standards will become even stricter, as the administration seeks to align fuel-economy rules with California's pending tailpipe standard for greenhouse gas emissions. As with everything else, though, there's no free lunch for CAFE standards. The same weak economy that is constraining gasoline demand is depressing car sales to an even larger extent. I haven't seen any credible forecast suggesting those sales will bounce back to their pre-2008 level of roughly 16-17 million vehicles per year any time soon. At 12 million cars per year, which would represent a nice rebound from today's levels, it would take an extra 5 years to turn over the existing US fleet of 245 million light-duty vehicles (ignoring motorcycles.) That assumes no net growth in the fleet, despite US population growth of roughly 1% per year. It also remains to be seen whether fuel prices and/or tax policy will effectively nudge Americans into the more efficient cars that the government wants us to drive.

On balance I think the Journal is right to conclude that the heyday of US gasoline has passed. However, much as with Peak Oil, anyone expecting a prompt and precipitous sustained drop in US gasoline demand is likely to be disappointed by the structural inertia of an enormous, slowly-changing vehicle fleet, a growing population, and alternative fuel regulations that are steadily diluting the energy content of the fuel. That means that while oil companies can't count on gasoline sales growth here to drive future profits, the mature US gasoline sector could still serve as a cash cow for their other business lines, including the search for more oil to meet the growing energy needs of large developing countries. Every first-time car buyer in China and India adds another increment of net global demand, and the industry will have its hands full satisfying that demand, once the global economy gets back on track.

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