Profiting from the Automotive Energy Revolution

There have been significant improvements in automobile power train efficiencies over the past couple of decades. But have these improvements translated into any overall reduction in demand for fuel? Byron King explores…

Every automobile on the roads of the world reflects a long and complex chain of industrial production and energy usage. Yet we live in a world where many of the highest quality resources and energy supplies have already been exploited. And lower quality resources are more expensive to extract and exploit, if they are even available. So the world’s automobile industry is in the midst of a revolution in both resource availability and energy consumption. In this article we will look for a way to profit from the energy revolution in automotive transport.

Today the automobile business is vast. It is a global industry that has evolved by leaps and bounds in the 100 years since Henry Ford made his famous remark in 1908 about building "a car for the great multitude." The worldwide customer base includes at least a billion people – spread over six continents – who have income sufficient to buy a car or small truck. According to figures assembled at the MIT Sloan Automotive Laboratory, there are about 700 million automobiles and light trucks in the world. About 30% of those vehicles are in North America. And that world number is growing fast, particularly in Asia. Just in 2006 (the most recent year for which there are accurate figures), almost 63 million new vehicles rolled onto the world’s roads, and 80% of them were sold outside of North America. So these days Henry Ford’s reference to the "great multitude" takes on a whole new meaning.

Every car requires steel, aluminum, copper and lead. Each car requires rubber, plastic, and myriad of other petroleum and natural gas by-products. And there is much else in the long industrial ladder of automobile production. Just think in terms of the energy that goes into processing materials, fabricating parts, building components, assembling a finished product, and all the transportation along the way. In addition to the basic energy and material resources that go into manufacturing an automobile, the sheer number of vehicles reflects a lot of fuel tanks to fill with gasoline and diesel. And this does not even touch on the energy and resources that go into building road systems.

In the U.S., for example, transportation consumes about 30% of all primary energy, according to the MIT Sloan Laboratory. (The two other large energy using sectors in the U.S. are electricity production and space heating.) Within the transportation category, essentially all fuel has historically been petroleum based. In the U.S., about 60% of all liquid fuel goes for personal transportation. Freight hauling uses 30% of fuel. And aircraft burn the remaining 10% of fuel consumed. The recent push in the U.S. towards utilizing corn-based ethanol as fuel has consumed near half of the domestic grain crop in 2007 to supply about 3% to 4% of daily U.S. demand for blended transportation fuel. Using half the grain crop for fuel has also, of course, led directly to increasing the price for many basic foodstuffs.

The oil shocks of the 1970s-in both price and availability – spurred improvements in auto energy efficiency within the U.S. as well as worldwide. In the U.S., the increase in fuel efficiency was related to rising costs for gasoline, as well as government mandates for higher fuel efficiency dating from the late 1970s. On average over the past 25 years, the typical power train of gasoline-fueled automobiles in the U.S. has improved in efficiency by about 1% per year according to data gathered by MIT. While discrete, 1% improvements may not appear to be much, the compound improvement in the typical U.S. automotive engine over 25 years has been about 30%.

There has been even more progress in the fuel efficiency of diesel engines over the past 25 years. Diesel power trains are no longer the sooty, "knock-knock" devices that they were back in the days of disco. Most cars sold today in the European Union (EU), for example, are powered with clean-burning, fuel efficient, smoothly running diesel engines. In fact, the demand for diesel fuel in Europe is such that EU refineries routinely ship surplus gasoline to sell into the North American market. And in North America the relatively low prices for gasoline throughout the 1980s and 1990s discouraged the use of diesel engines.

So there have been significant improvements in automobile power train efficiencies over the past couple of decades. But have these improvements translated into any overall reduction in demand for fuel? No. In 2007 motor fuel consumption in the U.S. was high as it has ever been. (Although according to the American Petroleum Institute, demand for motor fuel may be at a plateau due to price increases at the pump in 2006 and 2007.) Between 25 years ago and now, there are more people driving more cars for more miles. But compounding the fuel issue, the cars that people are buying and driving tend to weigh more and offer higher performance. And it is not just those dastardly soccer-moms driving their fuel-guzzling SUVs. Even compact and sub-compact cars tend to have more elements that require higher fuel burn, from safety features to power-sucking accessories. So almost all of the progress of the past 25 years – that 30% improvement in power train efficiency – has been internalized to the vehicle and driver, and not reflected in overall demand destruction for motor fuel.

As we say over and over again in Outstanding Investments, we live in a world of peaking oil output, and of energy and resource scarcity. So the trend lines for fuel usage by automobiles simply cannot continue for much longer. The first, most obvious sign is the rising price for oil and by extension for fuel at the pump. Something has got to give, and the energy markets are sending signals of long-term high prices for motor fuel. Where do we go from here?

Well first, people and policy makers have to realize that there is an energy problem. Everyone has to realize that this is something permanent, going forward. "Peak Oil" will not pass if we ignore it long enough. And no one can solve the problem just by bellyaching about the rising price for gasoline.

It helps to view the age of the automobile-and its future – as a systemic whole. And some social critics are out in front of the broad discussion, with a sharp focus on the automobile and what it has brought us as a society. James Kunstler, for example, author of highly regarded books such as The Geography of Nowhere and The Long Emergency, believes that the car-dependent suburban buildout of the U.S. may be "the greatest misallocation of resources in all of human history." That is, in an era of expensive energy and scarce resources, a car-dependent culture has no real future and is in fact a hindrance to progress in other directions. That is quite a viewpoint, well-presented by Kunstler in his writing. It’s depressing, but it sure gets your attention.

And criticism of the automobile culture is not confined just to social commentators like Kunstler. Another remarkable indictment comes from no less an automotive insider than Prof. John Heywood, the director of the MIT Sloan Automotive Laboratory. He has stated that "cars may prove to be the worst commodity of all." According to Prof. Heywood, cars are "responsible for a steady degradation of the ecosystem, from greenhouse emissions to biodiversity loss. What’s worse, even if we improve vehicle efficiency, turn to fuel hybrids or make rapid advances in hydrogen-based fuel technologies, the scale for slowing down the degradation may run to the decades. Turning the curve won’t be easy."

You can agree or disagree with the broad themes of Jim Kunstler or John Heywood. But there’s no argument with one of Prof. Heywood’s points. Wherever we are going, it will not be easy to "turn the curve." Looking forward, the oil just is not there to fuel cars in the future in the way that we did it in the past. So a lot of people are going to have to do things differently.

Worldwide, the automobile industry has seen the handwriting on the wall. Fuel is expensive, and is getting more so with each passing year. So the industry has invested tens of billions of dollars in improving engine and power train efficiency. In addition, auto designers are coming up with new ways to eliminate weight and drag. (At higher speeds, up to 70% of the energy used to turn the wheels on a car goes just to push the air out of the way of the chassis.) The auto industry is looking towards different sorts of fuels, and moving towards what is called fuel-flexibility. One example is called the GEM engine, which can run on gasoline, ethanol or methanol. (The methanol could come from coal; the ethanol could come from non-food biomass.) And other concepts for running cars include using hybrid engines that incorporate novel battery or fuel cell technology. These electric technologies commonly incorporate an ultra-efficient internal combustion engine to charge the cells. Or the electric drive might incorporate "plug-in" features that will closely tie the future automobile into the electric grid.

All of this lays the foundation for our investment idea. We are going to stake a claim to the very heart of the car of the future. As you can probably discern from the discussion of cars and power trains in this article, the car of the future-and I mean the near future, within the next couple of years – will not be, as the commercial says, "your father’s Oldsmobile." But the car of the future will trace some of its lineage back to Henry Ford’s experimental "soybean car" of 1941. And then some.

The car of the future will be much lighter due to the extensive use of plastics and other engineered materials. The only way to increase mileage is to eliminate weight. And the car will be far more aerodynamic than anything you are used to seeing. Under the hood – well, there might not be a hood like you are sued to seeing; the power train will actually run throughout the length and breadth of the vehicle – the future car will be powered by far more than an internal combustion engine. It will be something like a GEM engine at the core. Much of the mass of the car, and even some structural elements, will be a series of storage batteries. To make it all run, there will be a very robust electrical system that powers almost everything. Down where the rubber meets the road, electric motors will drive each wheel.

At the heart of that electrical system in the future car will be a small army of computer chips and power distribution buses and other related devices. These chips will control the power train, and send electricity to numerous motors that do everything from turn the wheels to adjust the rear view mirror. The chips will monitor and control overall power levels. The chips will also monitor safety features and conduct internal diagnostics of auto systems. The chips will communicate the status of the vehicle to you personally if not to some central location (similar to the General Motors On-Star feature, but more evolved). Overall, the car of the future will have more chips inside it than the space shuttle.

Until next we meet,

Byron W. King
for The Daily Reckoning
March 12, 2008

P.S. Until tomorrow night at midnight, you can get Outstanding Investments (which I co-edit with Kevin Kerr), my newest service Energy & Scarcity Investor, and Kevin Kerr’s Resource Trader Alert.

You’ll get subscriptions to all three of these – for life. And until tomorrow night, with the purchase of the Resource Reserve, you will get our brand-new stock and options research service that would focus in on profiting from the boom in precious metals free of charge.

Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments, and editor of Energy & Scarcity Investor.

Maybe we’re wrong. If yesterday illustrated the essence of this market, we are definitely wrong.

Our hypothesis is that the fed’s efforts to inflate will show up more in the gold market than in the stock market. That – and an instinct for self-preservation – is why we’re long gold and short stocks. Stock prices depend, ultimately, on earnings. Gold’s price depends, ultimately, on inflation. The feds can make more cash and credit available…but they can’t wipe away all those bad debts, which are hurting earnings. That is, they can increase the rate of inflation…but not make businesses more prosperous.

We’re witnessing a War of the Worlds – between inflation and deflation. We don’t know which side will win, but we’re betting that while inflation favors gold, deflation has it in for stocks.

But what’s this? Yesterday, the Fed promised inflation – big time. It said it would pump in an extra $200 billion to fight deflation. Europe and Canada said they were in too – for another $45 billion.

Where does all this moolah come from…savings? Don’t make us laugh, dear reader. It comes "out of thin air" as Keynes once said.

And what is the effect of pulling money ‘out of thin air’ and putting it in the money supply? More dollars…more monetary inflation.

According to our hypothesis, investors should see what’s coming a mile away. They should have jumped to buy gold. Instead, they bought stocks. The Dow roared up more than 400 points. Gold barely went up $4.

So go figure. Still, oil hit a new high over $108. And sometimes it takes investors a little while to put 2 and 2 together. So, let’s see what happens tomorrow before we come to a conclusion.

Besides, stocks may have gone up yesterday anyway; a rally was probably overdue. Commodities are at an all time high. Oil too. And more and more evidence comes to us that consumers are feeling squeezed…and forced to cut back on spending – which will further hurt business earnings.

"Surging cost of groceries hits home," says the Boston Globe.

"Paying at the pump, in a big way," says the New York Times. "Record fuel prices blow budgets," adds the USA TODAY.

"401(k)s tapped to save homes," it continues.

While rising prices pinch family budgets, falling asset prices pinch everyone. Most of the economy seems to be deflating. Housing is going down. Household incomes are going down. We’ll have to wait a few days to find out what direction stocks are going.

The big picture still shows the same scene: America is getting poorer. Its money buys less stuff. Its working people earn less money. Its assets are worth less than they used to be.

"This thing is not about a recession or not a recession…and it’s not about inflation or deflation. It’s about re-pricing the U.S.A., downward. Sell America…sell its money…sell its stocks…sell its property…sell its politics…sell its economy…sell its I.O.Us. Sell it all," said a friend over the weekend. "It’s clear to me that America’s best days are behind it. The United States has had a disproportionate share of everything for too long – stock market valuations…the world’s savings…the world’s energy…the world’s calories…the world’s military power. That’s what is changing. The world is readjusting…it’s not getting out of balance; it’s getting back in balance. It will be a world where the United States plays less of a role…and takes less of the world’s resources."

He is probably right. Asia is growing much, much faster than the United States. Wages are going up 10% per year in China…15% per year in India. Stock markets are booming. GDP growth in many foreign countries has averaged about three times the U.S. rate for the last ten years. Now, with the U.S. economy not growing at all…Asia is racing ahead.

We have no particular quarrel with this. America has enjoyed an extraordinary run of luck. She had cheap energy…history’s most powerful military…and the world’s reserve currency. Now she has the world’s biggest debts…its highest deficits…and the most colossal financial problem ever. In short, it has passed its I.O.Us out all over town and now owes more money to more people than anyone ever did. It now has more financial commitments any nation has ever had (with a financing gap of $60 trillion – not including the cost of the Iraq War…which is expected to be as much as $5 trillion)…and has a competitive disadvantage against much of the rest of the globe. Asians make things cheaper. Europe makes them better.

How did such nice people get themselves into such a mess? Are Americans stupider than other people? Are they lazier? More reckless…more feckless?

Nah…we’re just victims of our own good fortune. We had it too good for too long. A unique set of circumstances allowed Americans to borrow and spend more than anyone ever could before…and so they did.

As an aside, this turn of events for America is where we got the idea for the title of our documentary film, I.O.U.S.A. We are hoping to have an exciting update for you, dear reader, in coming days. Stay tuned. In the meantime, check out the film’s website.

*** "It’s the credit bubble, stupid," says Forbes.

Yes, that is what it is…a credit bubble that is deflating. The tide is going out, as Warren Buffett puts it. Now we see who’s been swimming naked. Not a pretty sight. So ugly, in fact, that people can’t stand to look.

"Fed takes boldest action since the Depression," says an article in the London Telegraph.

Yes, dear reader, our leaders are doing something. Now, we just wait to find out how much damage they have done.

The hardest thing to do is nothing.

But in matters of politics and money that is usually the best thing to do.

As we’ve pointed out many times, nothing gets no respect. "Do something," come the cries from all corners. Even those who should know better implore public officials to take action:

"When a man is having a heart attack, you have to intervene…you can give lectures about his diet later," they say.

But the U.S. economy is not dying. It is merely adjusting to a new set of circumstances. The consumer is tapped out. Without more income he cannot increase his buying. And without more spending, the consumer economy stalls…and contracts. No, don’t even think of lending the consumer more money – he has too much debt already.

This is an election year and the politicians want to dodge a contraction in the worst possible way. What would be the worst possible way? Easy – add more debt. That is precisely what the Bernanke Fed is doing. Yesterday, they offered another $200 billion to their friends in the banking industry – lent against the trashy collateral that no one else would accept. Now, the Peoples’ Bank of America – ultimately, the taxpayer – will be holding the bag.

*** And Bryon King sends us this note:

"While Ms. H. Rodham-Clinton and Mr. B. (No Middle Name) Obama battle out over who will be the Democratic Party nominee for U.S. president, there is another Great Smackdown occurring within American politics.

"This other match – a true eye-gouging, ear-biting cage-match by any standards – may well determine the success or failure of the next U.S. president, no matter who is elected next November. (Presumptive Republican nominee John McCain has admitted one of his own limitations, ‘I don’t know as much about economics as I should.’ He gets points for honesty, if not candor.) And this other knock-down, drag-out competition is taking place within the marbled hallways of a certain institution located prominently on Constitution Avenue in Washington, DC, just across from the Lincoln Memorial.

"It appears that a certain Mr. Richard Fisher, of Dallas, Texas (and by occupation, president of the Dallas Federal Reserve Branch) is lobbying for the job of ‘Successor to Ben Bernanke.’ That is, Mr. Fisher wants to be the next Chairman of the U.S. Federal Reserve.

"The current course of U.S. monetary policy is not sustainable. The Bernanke monetary policy is wrecking the value of the U.S. dollar. The charts don’t lie. Inflation is rising. The prices for gold and silver are soaring, as is the price of oil. The dollar is at historic lows against the euro, as well as numerous other world currencies. U.S. import costs are exploding. And despite his academic credentials as a historian of the 1929 crash and Great Depression of the 1930s, Bernanke is simply in over his head.

"We may be witnessing some macabre and tragic drama scripted by the gods. And in this play, it may be the unpleasant role of Mr. Bernanke to lower interest rates to the point where he must take the sword. Bernanke may or may not understand that he is the star of the R-rated version of a snuff film. Bernanke’s sad destiny is – paraphrasing the words of Gen. George Patton here – to grease the treads of someone’s tank. The best that Bernanke can hope for is a relatively dignified and hasty departure from the Fed, with perhaps a final limo ride in which he is not garroted like in the chilling scene that occurs at the end of The Godfather.

"No matter what, and in the best of possible outcomes, Mr. Bernanke will not escape the Circus-Circus atmosphere of a summary dismissal from his current job. His trip to the unemployment lines will be heralded by calls from Congress for his removal, if not his head.

"This is all another way of saying that over the long term the world’s bond markets cannot afford – and will not tolerate – the current sordid state of monetary affairs. Bernanke is costing a lot of people a lot of money. He is bad for business. And so Bernanke as Fed Chairman cannot last much longer. He is going to go, sooner or later. Probably sooner.

"It is the nature of the position of ‘America’s Central Banker’ that someone will have to take Bernanke’s place. At 81 years of age, Paul Volker is probably too old to retake the job he held from 1979 to 1987. And Volker may not be ready for a replay of his previous efforts, marked by angry mobs burning his figure in effigy. (And second acts do not play well in Washington D.C. Look what happened to Donald Rumsfeld during his rerun at the Department of Defense.) So someone will have to step up to the plate, take the seat as Fed Chairman and start pulling triggers. Someone will have to call a halt to the serial interest rate reductions that have occurred on Bernanke’s watch. Someone, in fact, will have to raise interest rates and squeeze the monetary poison out of the U.S. economy – and by extension the connected world markets.

"Someone will have to administer the medicine that both the United States and the world requires. Someone will have to do the dirty work. Someone will have to take the hit – ‘for the team,’ as they say down at the football pitch. Richard Fisher appears to be volunteering for the job. Good luck, Mr. Banker-Man. You are going to need it. Really. You are going to need a lot of luck."

Until tomorrow,

Bill Bonner
The Daily Reckoning