Tuesday, May 03, 2011

The Future Energy Station Arrives

I was very interested to read that Valero, the largest independent refiner in the US, is designing its new gas stations to offer a much wider variety of energy products, including natural gas, E85 ethanol, and potentially recharging facilities for electric vehicles. This is an announcement I've been expecting for more than ten years, and there are good reasons why other companies are likely to follow. At the same time, the economics of doing this now, when the market for non-petroleum fuels is still comparatively small, look challenging. Some will call this a vanity project, and they won't be entirely wrong, even if it also represents the template for the new retail energy facilities that will be built in the next several decades.

Valero's new station design, at least as described in the articles I've seen, embodies the result of trends that my former company, Texaco Inc., identified in the late 1990s in a scenario called Multiple Choice Energy. That view included a combination of new vehicle technologies such as hybrids, EVs and fuel cells, as well as a vision of the retail network that would meet their needs. As attractive as the idea was to many of the top executives to which our team presented, it was a tough sell, because retail fuel is such a difficult business. Margins are slim, competition high, and major redesigns of existing facilities--for rebranding or any other purpose--very hard to justify financially. Several companies have dabbled with elements of this vision, including my former employer, but I'm not aware of anyone deploying the full suite of options in one location.

I think this development, and the company pushing it, is significant for several reasons. First, Valero has already made a major commitment to non-petroleum fuels through its acquisition of ten ethanol plants, bought during a period when the US ethanol industry was being squeezed by poor margins and scarce credit. Those facilities contributed 18% of Valero's operating income in the first quarter of this year, even though they accounted for less than 4% of total output by volume. Adding E85, a blend of 85% ethanol and 15% gasoline, at the company's new stations merely completes a supply chain in which it is already well-established.

Incorporating these capabilities when a station is built, rather than adding them later, is also crucial. It saves a significant amount of money by avoiding the business disruption involved in retrofitting later. E85 faces other challenges, as I discussed recently, but this kind of planning overcomes one of the major impediments to its wider penetration in the US market, which already has millions of flexible fuel vehicles capable of running on it. And for this reason it's especially notable that this initiative is being taken by Valero, which has been expanding its retail network and investing in new sites. That's in contrast to the major oil companies, some of which have been exiting retail, either gradually or on an area-by-area basis, to free up capital for more profitable opportunities in exploration and production.

Adding natural gas and electricity to the array of fuels sold at retail sites is a natural evolution of this strategy but financially much riskier, given the small number of EVs and NGVs on the road so far. Although the company can take advantage of generous tax credits for installing some of these capabilities, the return is likely to be low for some time. EV recharging also requires a large footprint and extra caution, to ensure that it can be done safely in proximity to combustible fuels. Local agencies and fire marshals have definite ideas about this, as I learned when I was involved in plans for recharging facilities for GM's earlier EV-1 plug-in vehicle in the late '90s.

As with the market penetration of the alternative fuel vehicles they will serve, it will be some time before most retail stations offer quite as much choice as Valero's new multi-fuel facility. It takes time to roll out such changes, and the infrastructure can't get too far ahead of the demand for it without its owners going bankrupt in the process. Nor will every new fuel succeed. Methanol blends looked like the next big thing in the 1980s, but they never took off. Still, it wouldn't take many such facilities in each market to break the "chicken-and-egg" barrier that any non-petroleum transportation energy alternative faces. The success of this initiative depends on the demand for these fuels actually materializing. Launching when the average US gasoline price is just a couple of cents below $4.00 looks like good timing to me.

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