Is Tesla About To Unleash A Black Swan On The Energy Industry?

As reported by Forbes: Clients often ask me about what might be a “black swan” (an event that comes as a surprise to conventional wisdom, has a significant impact and is often rationalized after the fact) for the oil industry. Lately I’ve been thinking how a dramatic breakthrough in battery technology could be such an event. The implications for the petroleum industry might be broader than you think.

In a recent Forbes blog, tech contributor Mark Rogowsky reported some interesting details of the new Tesla Model 3 scheduled to make its debut on March 31. The Model 3 will be about the same size as a BMW 3 Series, with a price point of $35,000 and a range of 200 miles.

To be viable in the mass market for vehicles, an alternative vehicle needs to be competitive with the internal combustion engine (ICE) in three ways. It must have:

1. a price point of about $25,000
2. a record of reliability, and
3. a driving range of at least 300 miles, typical of mid-size sedans.

So the Model 3 is getting closer, but it’s not quite there. Yet.

A useful rule-of-thumb for automobile makers in model selection and pricing strategy is a price point that is 1.25x personal income. If we use GDP per capita as a proxy for income, then Tesla’s current mass market (at a price of $35,000) would be countries with income levels of about $28,000 per year (on a purchasing power parity basis). The chart below shows a market size of about 675 million (age 15 – 64) in 2015. This market grows to over 700 million by 2025. The market in advanced economies is fairly flat, but the emerging world nearly quadruples from 15 million to almost 60 million in the next ten years. If over the next 10 years Tesla can compress the price of its Model 3 (or equivalent) to $25,000, its market potential expands to almost 750 million drivers.

Today, there are over one billion ICE passenger vehicles on the roads compared to just over one million electric. Electric vehicles sales have increased almost 80% per annum since 2010 and were about 400,000 (equivalent to two weeks of VW’s current sales) of the 85 million vehicles sold globally in 2015.

Driving range is important to compete with an ICE vehicle, which are fueled through a fully depreciated distribution system. For the alternative to be successful, it needs to avoid (or minimize) investments in a network of refueling infrastructure (e.g., charge stalls in store parking lots) to keep down the effective cost of operating the vehicle. Avoiding this infrastructure investment is critical for electric vehicles to compete in advanced economies.

The initial version of the Tesla Model 3 looks to fall short of these mass market parameters. However, it does not take much of a stretch of the imagination for Tesla to close these competitive gaps as it builds actual road and manufacturing experience and production of the Model 3 ramps up.

How long might it take for these vehicles to significantly penetrate the global fleet? Once the technology breakthroughs are made, it will quickly disperse to other automobile manufacturers (similar to the spread of hydraulic fracturing in tight oil).

Technological innovation in automobiles tend to follow the rule of “7 in 10”, shorthand for a technology (e.g., air bags, anti-lock brakes, seatbelts) deployed in 70% of new car sales within 10 years. So if next generation electric vehicles can make the technology leap, then by 2025 they could account for about 70 million car sales annually. Over that pivotal decade, electric vehicles would grow to about 7% of the global car fleet. That might seem small, but without such a technology leap the share would be closer to 2%.

So what is the black swan event? It is not only that such a mass market electric vehicle could threaten oil demand growth, but that the underlying technological innovations necessary to be competitive with ICEs threaten the entire hydrocarbon industry – not just oil, but natural gas and coal as well. My hypothesis is that if a battery is capable of storing enough energy to move a $25,000 mid-size sedan 300 miles, then it would be cheap and small enough to mount another battery in the garage. If the garage battery is charged by roof-mounted solar and/or wind, it removes the need for incremental electricity generation from central power plants fired by natural gas or coal.

A more cost-effective battery (increasingly likely as electric vehicles penetrate deeper into the vehicle fleet) opens the possibility of even greater battery capacity and of households removing themselves from a central power grid. Not depending on a central power grid would be important to consumers in emerging economies who are looking for power reliability in addition to personal mobility.

Former Saudi Oil Minister Zaki Yamani is credited with the quip, “The Stone Age didn’t end because the world ran out of stones – and the same will be true with oil.” I usually conclude these black swan discussions with clients by saying that I won’t see the end of the oil industry, my kids won’t see the end, but my grandkids just might. If Tesla can meet its Model 3 aspirations in the next few years, my observation might be realized much earlier than I used to think. There’s a new Tesla dealership near my house; I think I’ll take a look.