The Fuse

Analyst Fears of Supply Gap Collide with Pending Rulemaking on Fuel Economy

by Leslie Hayward | July 31, 2018

The oil price collapse of 2014 has cast a long shadow across the energy system, continuing to impact strategic decisionmaking from the oil and automotive industries and the regulators who monitor them.

Washington’s energy watchers have been waiting for the release of the Notice of Proposed Rulemaking (NPRM) for fuel economy standards, as inter-agency deliberations have delayed the document’s publication for public comment. But a draft version from approximately one month ago sheds light on what can be expected to come from the joint NHTSA/EPA proposal.

The approach outlined in the 700-page document makes a number of aggressive moves. They include freezing fuel economy targets at 2020 levels through 2026, a proposed withdrawal of California’s waiver to manage CO2 emissions, creating concurrent rulemaking through EPA and NHTSA, and consideration of eliminating some or all of the flexibilities provided by the different credit programs currently in place.

The draft proposal argues that such changes are necessary because the current program was written in 2012 during a very different oil market, in which fuel prices were expected to continue to rise and the United States would remain vulnerable to price shocks. “Things have changed significantly during this time, with fuel prices significantly lower than anticipated, and projected to remain affordable through 2050,” it reads.

Such assumptions about oil prices remaining low and stable are unrealistic, and counterproductive. Top traders and price forecasters don’t see price stability through the end of next year, let alone thirty years in the future. Projections from Goldman Sachs, Bank of America, RBC Capital Markets, and others within recent months see a return to $100 per barrel likely within the next 18 months. Oil prices are, by nature, characterized by boom-bust volatility and a 30-year era of price stability has never been achieved.

Fears of an oil supply gap have been reiterated continuously since the oil price collapse began. The latest analysis from Rystad Energy adds to such warnings—the consultancy notes that production decline rates in non-OPEC countries have increased significantly, effectively doubling between 2014 and 2016 from 3 to 6 percent. Meanwhile, the industry’s investments have dropped off precipitously. Oil-industry investments fell 25 percent in 2015 and 2016, according to the International Energy Agency. Capital expenditure was flat in 2017 and 2018 is only seeing a modest rise so far, despite prices increasing by around 30 percent this year. The staggering decline in upstream investment has coincided with disruptions in Venezuela, Iran, Libya, and Nigeria, which, combined with OPEC’s successful effort to wind down the oil inventory glut, contribute to both supply uncertainty and a lack of cushion in the market.

Gasoline demand has been relatively flat in the total OECD, increasing by approximately 500,000 barrels per day in 2018 since 2015. Demand in OECD Asia has stayed between 15.4 and 15.5 mbd during the same period, while OECD Europe’s gasoline demand has stayed steady at just below 2 mbd (although diesel demand has inched up by approximately 500k b/d). In three years, U.S. gasoline demand has climbed by about 350,000 and currently approaches 9.4 mbd, accounting for the vast majority of demand growth in the OECD. The NPRM draft estimates that changes in the rulemaking will add 500,000 barrels per day to U.S. fuel demand, although the timeline is ambigous. This is a significant increase in gasoline consumption—volumetrically equivalent to over half of current crude oil imports from Saudi Arabia—that will impact the U.S. balance of trade and undermine trends to reduce the oil intensity of the U.S. economy.

Lack of global upstream investment in new oil supplies and policies that will increase U.S. demand are two decisions that put the American economy at risk—and both are a reaction to a oil price downturn that is unlikely to last. The oil industry’s continued recovery from the price collapse has deferred final investment decisions. Meanwhile, the temporary reprieve from high gasoline prices has pushed consumers towards larger vehicles, and an assumption of low oil prices through 2050 is listed as justification for freezing fuel economy rules. The United States has been burdened with the negative consequences of boom-bust oil price cycles for decades—allowing four years of comfortable fuel prices to set such a precedent will not serve the interests of motorists today or in the future.