Capitalist Nexus

Great article on the Chevy Volt program.

The auto and oil industry are on the verge of significant change, as the America auto fleet begins a slow and steady migration towards electric plug-in cars.

From an auto maker perspective, the playing field will be wide open with new start-ups having a legitimate shot to become future industry titans and existing giants vulnerable to David’s sling. In addition to the Volt, Toyota, Nissan, Tesla, and Fisker, are developing plug-in hybrid cars. Both Tesla and Fisker hope to have models out by 2009. Fisker has leaked recent video of its Karma model on the test track, and this car looks sharp. Tesla already has a battery powered car with a range of 200 miles before it needs to be recharged. Clearly technology is answering the market’s demand for an alternative to the gas powered car.

With the right break, any of these cars can be the next i-pod and propel the company to corporate stardom. The key insight behind these upcoming vehicles, is the ability to travel about 40 miles on a charge, but also have a small motor that continuously charges the car’s battery. As it turns out, 40 miles exceeds the average daily drive for about 85% of the population, and having a gas or flex fuel powered combustion engine allows for unlimited distance when the need arises. As petroleum is primarily used to power autos, being able to shift energy from the wellhead to the electric grid will cause interesting disruptions in the world’s energy market in the years to come.

While much is written and discussed about oil’s inelastic demand, supply is similarly inelastic for a couple of reasons. The most obvious and least interesting reason is the fixed cost nature of producing oil. Once wells are in place, it takes a dramatic fall in the price of oil in order to not at least cover the variable cost of operating the well. That is the simple and classic economics answer.

A much more interesting perspective however, is the political condition of the countries producing the majority of the world’s oil at the moment. Take for example Venezuela. If the price of oil begins to fall, Chavez’s budget and political ambitions will face significant stress. Given the social unrest resulting from food shortages and his attempt to become to a dictator, with record high oil prices, imagine the issues he will face if his treasury runs dry or encounters a significant deficit requiring scaled down ambitions? He is not alone, all over the world oil based nations tend to lack the infrastructure that rewards a society where many citizens grow and prosper. As a result, the leaders in these countries become very dependent on existing oil revenue streams to finance their power, rather than a growing and prosperous society. This leads to a rapidly expanding supply of oil, as these countries will do what they need to in order to achieve certain minimum revenue thresh holds. As the price of oil falls, this require increasing production to meet revenue targets.

This situation is not unlike the incentives that generally exist for cartels to cheat in order to earn excess profits. Such was the case when oil prices fell significantly in the 80’s due to new supply coming online from the North Sea fields. This time, “new supply” will come online from decreased demand which naturally takes place due to higher prices, but more importantly as a result real substitutes in how autos get their fuel. Should be interesting times.