Why I am a Big Bear on Oil and a Bull on Vanadium

September 4, 2017

John Lee, CFA https://twitter.com/johnlee25893955?lang=en

Future predictions of oil prices vary wildly. I am fundamentally long-term bearish oil by going in great details on some key factors that increases oil supply and reduces demand which many analysts underestimated or overlooked. Then I will talk about the surging popularity of lithium ion batteries, the technology’s merits, drawbacks and my future outlook on lithium ion batteries. Finally I will talk about vanadium batteries and how it could revolutionize the energy storage market, and particular ways to profit from the future use of vanadium battery.

Oil Supply

As depicted in the graph below, world crude oil production has increased 50% since 1985, with unconventional crude oil production accounting for the majority of the crude oil production increase since 2010.


Source: YCharts.com


Source: Forbes

The increase in shale oil supply in the face of declining oil prices, is closely related to the much improved fracking technology. This enhanced technology has cut the breakeven price for key United States shale oil plays by more than half since 2013.


Source: Rystad

As indicated in Forbes,
the decrease in the breakeven price is a factor in the significant crude oil production and exploration in the Permian Basin of Texas and New Mexico.

“Today, at around 2 million b/d, the Permian accounts for over 20% of the country’s (USA) crude production and is the second largest oil field in the world, after Saudi Arabia’s legendary Ghawar field.

A barrel of oil currently sells for $53-54, which is well above the break-even oil price of $35 or so in the Permian.

This year, expect an average of 345 oil-directed rigs in the Permian in 2017, or a 93% increase over the 2016 average, followed by a 25% increase in 2018 y/y.”

Shale oil production propelled the USA to third largest oil producer in the world.


(millions of barrels per day, crude oil including gas condensate)
Source: Wikipedia

While much of the increase in unconventional oil production (i.e., shale oil) has come from the United States, China’s shale oil resources may exceed that of the United States, suggesting that we are only at the beginning of a major shale oil boom at a global scale.

A shale oil boom at a global scale, coupled by decreasing breakeven costs, will have a very bearish implication on the price of oil.

Technology is also bringing down the production cost of oil from Canadian oil sands. For instance, according to Oil Sands Magazine:

“…the Canadian Energy Research Institute (CERI) pegs breakeven costs at $43.31/bbl for SAGD projects (steam-assisted gravity drainage) and $70.08/bbl for a stand-alone mine. The figures exclude blending and transportation costs but include capital expenditures.”

In addition to increases in unconventional oil production, the ever increasing supply of conventional oil from Russia, Iran and other OPEC countries means the oil price ceiling is getting lower.

Oil Demand

Many oil bulls forecast forever increase in global oil consumption linearly or even exponentially, which will drive up the oil prices. However, closer inspection of oil demand by country or region reveals that the growth is uneven and mostly declining.

European and North American oil consumption, which accounts for roughly half of all global oil consumption, peaked around 2005 and has declined 10% since 2006. This decline is mainly due to improving vehicle fuel economy and maturing GDP with aging demographics.

Consumption chart of oil products by country


Source: Enerdata


Source: Our Finite World

Most of the consumption growth in the last 10 years has come from China with a registered consumption growth of just 1% in 2015.


Source: Energy Insights

With a maturing Chinese economy and improving vehicle fuel economy, alternative rail transportation and aging demographics, peak oil consumption may have already arrived.

It seems Saudi Arabia already knows this. Reuters noted the following in July 2017:

“Saudi Arabia is curtailing oil shipments to the United States with the likely intention to drain visible inventories and support prices. The United States imported an average of 524,000 barrels per day (bpd) of crude from Saudi Arabia in the week ending July 14, the lowest volume for more than seven years.”

This raises the question: Why is Aramco, the state oil producer of Saudi Arabia, going IPO to raise over $100 billion when it has the capacity to produce12 million barrels per day at an operating cost of merely $10 per barrel? Arguably the world’s largest oil supplier and employer to some of the brightest minds in the industry, perhaps this is Amarco’s attempt to rake in more money before the imminent collapse in oil prices…

With an already grim outlook for the future of oil consumption, I have not even metioned the bearish game changer in oil consumption: Electric Vehicles

Electric Vehicles (“EV”)

One cannot analyze oil demand without studying electric vehicles, which I believe could decrease the global demand for oil in the same dramatic fashion that shale oil has increased oil supply.

According to the Wall Street Journal in May 2017:

“Transport fuel accounts for about 50% of the demand for crude oil, with cars accounting for half of that; that means 25% of total oil demand hinges on autos. BP, meanwhile, expects the number of electric cars to skyrocket to 100 million by 2035 from one million today—but thinks even that rise will likely shave only one million to 1.5 million barrels a day off oil demand.”

“Wood Mackenzie expects roughly 2% of global oil demand—or two million barrels a day—to be lost to electric vehicles by 2035.”


Source: From the Same WSJ article

My Take on EVs

I believe that the experts cited above have greatly underestimated the impact that EVs will have on oil demand – possibly by a factor of 10.

As seen in the chart below, global electric car stock has increased an average of roughly 170% every year:


Source: Bloomberg

At such a compounded growth rate, global electric car stock should reach over 200 million by 2025. Granted, some EVs made in 2017 might not survive eight years, BP’s projection of 100 million EVs by 2035 is way too low to be plausible.

As noted in the following chart, there seems to be consensus that by 2040, EVs will account for 35% of all new car sales.


Source: Bloomberg New Energy Finance


Source: Bloomberg

Source: Bloomberg

Why 2040? With approximately 80 million vehicles manufactured per year globally, I wonder if 35% of those production capacities can be retro-fitted to produce electric vehicles within the next 5 to 10 years…

A basic EV like the Chevy Volt, which looks identical to a regular car (run on gas), costs an estimated US$35,000 and prices are coming down every year. Will it really take until 2022 for electric vehicles and gasoline vehicles to arrive at comparable price points?

So long as there is a positive sales margin (i.e., revenue minus cost), there are no practical constraints to EVs’ sales growth as giant battery factories are erected across the United States and Asia. We could very well see one in three vehicles powered by batteries within 10 years – way before 2040.

How much oil consumption will be displaced by EV?

The transportation sector was responsible for 50% of petroleum consumption a ratio is more than 75% in the US, according to the Energy Information Agency. If 35% of the transportation sector’s petroleum consumption is displaced by batteries, we would see not just 2 million but 15 million barrels per day of oil demand disappear (i.e., 80 million barrels per day x 50% transportation sector consumption x 35% displaced by EV).

You might argue that there is a big difference between EVs becoming 35% of new car sales versus EVs becoming 35% of all of the cars on the road and you would be right. However, I ask that you consider the following:

According to CNN, India, France, Britain and Norway all want to completely ditch gas and diesel cars in favour of cleaner vehicles. At least 10 other countries have set sales targets for electric cars.

Further, according to Reuters, China set a goal for new energy vehicles (i.e., NEVs”) to make up one-fifth of the total vehicles manufactured by 2025.

Once the mass adopt of electric vehicles sets in, the government can phase out gasoline cars based on a vehicle’s age and impose additional tariffs on the sales and production of new gasoline cars. In addition to EV dedicated parking spaces in California, citizens can anticipate an EV lane and an imminent monthly (or even weekly) EV day where only EVs are allowed on the road.

Today shale oil production floods consumers with 15 million barrels of oil per day but most of that production did not exist 10 years ago. In the next 10 years, EVs will have a similar impact as they displace demand for 15 million barrels of oil per day with demand of batteries.

I do not know if oil will go back to $20/barrel, given that the price of oil is impacted by geopolitics and the strength of the US dollar. However, I am selectively selling oil on strengths when it gets to over $50/barrel.

I am a big oil bear.

Lithium

Even though lithium ion batteries, with surging popularity and adoption, have the best energy density in today’s battery space, their inherit flaws remain: a short life span of a mere 2 to 3 years, up to about 1,000 charge cycles and potential safety hazards.


Source: Electronics 360

Much like Ni-Cad batteries, which were largely replaced by lithium ion batteries, lithium ion batteries can be replaced by new technologies. Such new technologies include hydrogen fuel cells that have up to four times greater energy density by volume and up to 20 times by weight.


Source: REB Research Blog

According to a CNBC, Toyota, Mercedes and others are investing heavily in fuel cells with some technologies already nearing the commercial stage.

I suspect lithium-ion technology replacement will come sooner than we think. I am not a big lithium fan and would avoid any lithium mining investment.

Vanadium vs Lithium

While investors are busy focusing on lithium ion batteries and its explosive demand and application in the mobile battery space, vanadium batteries are quietly making an entry into a rapidly growing utility grid-scale energy storage sector.

Inc. reported the following:

“On Monday, Tesla officially brought a new energy storage facility online at a plant 40 miles east of Los Angeles. With 396 refrigerator-sized stacks of lithium-ion batteries, the plant uses energy collected from the sun and the electric grid to power 15,000 homes for about four hours in the evening.”

While Tesla’s cause was noble with its utility-scale lithium-ion battery deployment, this battery project will eventually prove to be a costly failure.

Lithium-ion batteries are not ideally suited for grid-level energy storage because they have a short-duration and discharge run-time cycle, and begin to degrade after a few hundred discharge cycles (i.e., 1,000 cycles at most). Vanadium redox flow batteries (VRBs), however, can operate for 10,000 cycles over 20 years. Vanadium batteries can also scale up while decreasing unit storage costs, whereas the unit cost of lithium batteries increases when sizing up.

The adoption of VRBs is still in its infancy with less than 500 MW (0.5 GW) of installed capacity at the global level, while the combined capacity of solar and wind energy was at 550 GW in 2016. This, according to IRENA, was up from 100 GW in 2007.

Currently, there is a lot of pent up demand for VRBs and this does not even count any future growth in wind and solar capacity. GTM Research and the Energy Storage Association estimate that the utility-scale energy storage market will grow to 2.6 GW by 2022 withpotential to grow much larger.


Source: GTM Research/ESA U.S. Energy Storage Monitor: Q2 2017 Executive Summary


Could Elon Musk soon discover vanadium batteries?

Vanadium Investment

ThVanadium is the key ingredient in VRBs and vanadium price has gone up 500% from its 2016 low of $2.50/lb. The price has doubled since I began covering the metal in December 2016.

There is no commodity exchange or ETF for the vanadium metal. One can gain vanadium exposure by owning shares in vanadium mining companies.

The three largest vanadium producing countries are China, Russia and South Africa. These three countries account for over 80% of the global vanadium production. That being said, I would not recommend a mining investment in those countries.

While there are currently no operating primary vanadium mines in North America but Prophecy Development Corp. (TSX: PCY, OTCPK: PRPCF) is looking to fast track the development of its Gibellini vanadium deposit, 250 miles east of Tesla’s gigafactory in Nevada and could potentially become the first primary vanadium mine in the United States.

Gibellini is the only North American primary vanadium project with a feasibility study that I am aware of. The project is open pittable and since Gibellini material is low in deleterious metals and non-metals (typically less than 1% Fe, 0.5% Ca, 0.3% Mg and 0.2% Ti), it is conducive to low cost heap leach processing.

Vanadium deserves the attention as an investment due to its potential future demand from vanadium battery manufacturers. It is already embarking on a stealth bull that few talk about. While there is a possibility of the lithium ion battery replacement, vanadium batteries are here to stay.

Fundamentals aside, from a contrarian viewpoint, the lack of vanadium coverage by mainstream media (e.g., Bloomberg, BNN, CNBC and even mainstream metals-websites such as www.kitco.com), suggests that what we have seen so far is nothing compared to what is to come.


Source: 15MW – 60 MWH VRB in Hokkaido by Sumitomo Electric Industry

Disclosure: I am the Chairman and largest shareholder of Prophecy Development Corp. (TSX: PCY OTCPK: PRPCF), which engages in vanadium exploration. The opinions, estimates and projections presented herein are my own and not of Prophecy. This article is not intended to be an offer to sell or a solicitation for an offer to buy securities. Though the sources of information are considered reliable, no representation or warranty, expressed or implied, is made as to the accuracy or completeness of the information contained herein. Neither myself nor Prophecy accepts any liability whatsoever for any loss arising from any use of this article or its contents.

John Lee, CFA is an accredited investor with over two decades of investing experience in metals and mining equities. Lee joined Prophecy Development Corp. in 2009 as the Company’s Chairman. Prophecy aims to provide exposure and leverage to rising vanadium prices by defining and adding attributable vanadium resources in the ground in politically safe jurisdictions, and to build the first vanadium mine in North America by steadily advancing mine permitting, project financing and construction.