A Silver Lining to the Oil Price Cloud
Russia’s war on Ukraine will likely accelerate reductions in transportation emissions.
This week’s blog is co-authored with Erich Muehlegger and David Rapson of UC Davis.
On the growing list of “things to keep you up at night”, this week offered us the opportunity to worry about skyrocketing oil prices. The Brent Crude benchmark approached $140 per barrel briefly and, at the time of this writing, has dropped to $112 – still roughly 50% higher than it was in early December. Average gasoline prices nationwide have jumped to record-highs (unadjusted for inflation).
Oil is an essential input into all sorts of other goods and services that we consume and use on a daily basis, so as oil becomes more expensive, so do lots of things that we buy. No commodity price spikes make headlines as much as those for gasoline. Concerns about how higher fuel prices will contribute to inflation (i.e., erode consumer’s real purchasing power) are growing, and policy-makers are looking for options, like gas tax holidays.
However, the oil price news is not all bad. Many readers of this blog are interested in the so-called “energy transition”, which hopes to steer our economies away from fossil fuels and towards clean electricity as the primary source of energy. And for these readers, the “dismal science” is here today to offer a silver lining. The higher oil prices get, the more economically advantageous it is to buy an electric vehicle (EV). Now that we’re experiencing an oil shock reminiscent of the 1970s, could this be another catalyst that accelerates the adoption of EVs? Let’s take a look at some of the factors.
The Demand Side
Although discussion of EVs often focuses on things like range anxiety, charging access, and other features, EVs are generally cheaper to drive than gas cars, and much more so when gas prices are high. For each additional dollar per gallon of gasoline, the cost to drive the average conventional car in the U.S. rises by roughly $400-500 per year. Over a vehicle’s lifetime, these costs add up and make owning an EV more attractive.
But, do these potential savings meaningfully boost EV sales amongst car buyers? In a new working paper, “Do Energy Prices Affect Electric Vehicle Adoption?”, we quantify the importance of electricity and gasoline prices to the EV adoption decision. The logic is simple. High electricity prices make it more expensive to drive EVs, making them less attractive relative to gasoline alternatives (all else equal). On the other hand, high gasoline prices have the opposite effect – they make traditional cars more expensive to operate (again, holding other factors constant), and make EVs more attractive to new car buyers.
Our study takes advantage of the fact that there are lots of electric utilities in California, each of which sells electricity at a different price. The details are complicated, but the upshot is that the big three utilities – Pacific Gas & Electric, Southern California Edison, and San Diego Gas & Electric – have very high (marginal) prices, whereas their municipal utility counterparts charge much lower prices. While EV-specific rates exist and tend to be lower today than the default tariff of the big three, the majority of EV owners were and still are on the default rate plan. Even the EV rates in the IOU territories tend to outstrip the rates of their neighbors. Of course, gasoline prices also vary by location and over time. Our analysis matches EV purchase data to electricity and gasoline price data, and we use some standard approaches to isolate the effects of energy prices from other factors that might also affect EV demand.
It turns out EV buyers are sensitive to energy prices, but much more so to the price of gasoline than the price of electricity. No matter how we sliced and diced the analysis, the results showed that EV demand was 4 to 6 times more responsive to gasoline prices than it was to electricity prices.
To put this in perspective, we calculate how much EV demand changes in response to a 1 standard deviation increase in the cost of driving a mile (this allows for an apples-to-apples comparison across electric and gasoline drivetrains). A 5 cent per kWh increase in electricity prices leads to an 8 percent reduction in EV demand. A roughly “equivalent” per-mile change in the cost of gasoline – a 40 cent per gallon increase in the gasoline price – increases EV demand by a whopping 57 percent. Although we’d be speculating if we were to forecast from the gasoline prices in our study to today’s super-high gasoline prices, our results suggest that there will be a lot more people out shopping for EVs because of high gas prices.
The Supply Side
However, that’s not the end of the story. Several aspects of the post-pandemic world push in the opposite direction, to slow EV adoption, and these factors have been accentuated by the war in Ukraine. First, while high gas prices make a new EV look more attractive relative to gasoline cars, rising prices have hit the pocketbooks of US households, making them less inclined to buy any new car.
More significantly, however, is the fact that it’s not just the price of oil that’s going through the roof. Even before the war in Ukraine, prices of commodities like nickel, lithium, and cobalt had surged. And since Russia is an important producer of metals, the war has caused prices to spike even further. These are some of the key inputs into the production of batteries, which are in turn one of the biggest input costs of an EV.
Price of Nickel ($/ton, Source: Wall Street Journal)
These sharp increases in the costs of EV components have coincided with ongoing logistical problems that have bedeviled so much of the world’s economy over the last couple years. Again, the situation in Ukraine has only made supply chain woes worse. These last two points in particular have stymied EV buyers who have faced higher prices and increasing wait times.
EVs still have a long way to go
Despite the supply shocks, there is every reason to expect that the attention on fuel prices will further accelerate EV adoption. But don’t expect the green vehicle transition to substantially reduce oil demand and lower gasoline prices anytime soon. Worldwide in 2021, EVs were less than 9% of new car sales, with five out of every six of those purchases happening in China and Europe. In addition, it’s not clear just how much gasoline today’s EVs are saving the U.S. economy. Related work by ourselves and others on EV usage in California has hinted that EVs are driven less than conventional cars, so we can’t count on every new EV displacing the average amount of gasoline used by a currently circulating car.
But there is every indication that EVs are going to play an increasingly prominent role in the transportation mix and will put downward pressure on the demand for gasoline powered vehicles in the medium to long run. If energy prices are allowed to reflect their true social costs, customers will increasingly be drawn to EVs, even in the absence of tax-credits and other incentives. The events of the last month have been tragic in so many ways, but their impact on gasoline prices will likely make the energy future arrive a little bit sooner.
Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.
Suggested citation: Bushnell, James, Muehlegger, Erich, and Rapson, David. “Silver Lining to the Oil Price Cloud” Energy Institute Blog, UC Berkeley, March 14, 2022, https://energyathaas.wordpress.com/2022/03/14/a-silver-lining-to-the-oil-price-cloud/
While electricity rates are generally stable across months or years, it seems gasoline prices are more volatile. Therefore, is correlation found between gasoline prices and EV demand describing sustained price changes or price changes for some shorter duration? Presumably there is also a time lag between change in gas price and change in EV demand?
To Rogerl47: Agreed that raising the price of oil by itself is not the most efficient way of reducing greenhouse gases. This is especially true if the increase in price just goes to oil companies to increase the supply, pushing up all prices while producing more Carbon emissions. While price increases will reduce some consumption, it is not likely to be the most cost effective method of carbon reduction. While I agree it is politically difficult, the best method is probably the carbon fee and dividend: https://citizensclimatelobby.org/basics-carbon-fee-dividend/
This should actually increase income for low-income residents while encouraging the lowest cost carbon emission reduction.
Unfortunately, in the short term, the supply of EVs is pretty much fixed. All manufacturers are now producing EVs as quickly as they can, given existing production capacity, and that will be the case over the next 6-12 months. I’ve asked and that is what they tell me. Even if the spike in gas prices causes a significant increase in EV demand (and I believe that it is), it will take a year until supply responds, by which time the price spike will probably be tailing off.
Very interesting that the price elasticity of gasoline is so much higher than electricity. That raises a question rarely addressed by economists about how price volatility enters into the price elasticity estimation. Gasoline prices are much more volatile than electricity. Looks like including the second moment on price calculations could be an interesting parameter.
A review of the comments on the two blogs summarizing research on EV use will delineate the problems with using what is now obsolete data from pre 2017. It’s like using data on flip phones to look at smart phone usage. Time to move on to more current data sets.
If utilities, especially in California, reduce retail energy prices (not total average cost) to track spot market energy prices, the shift to renewables should eventually yield substantial periods each day when the retail price of electric energy (cents/kWh) is low, zero, or even negative. (As many at UC/Berkeley have pointed out, this means shifting a lot of fixed costs to fixed charges, which raises other issues.). If, in addition, forward markets “go retail”, EV owners might be able to lock in those low energy prices for months or years. Finally, EVs are a form of mobile energy storage, and smart charging would allow EV owners to earn revenues by providing ancillary services to the grid (e.g., frequency control). Actual behavior in 2014-17 may turn out to be a very inaccurate predictor of future behavior.
Thanks for covering the EV costs. I always appreciate your research on the economics of carbon emissions.
Unfortunately, even if EV’s market share become significant it will still take many years to replace the existing vehicle fleet with EV’s. If the price of conventional carbon fuels increases, and with the possible implementation of a carbon tax, I wonder if you have plans to evaluate carbon neutral fuels. These include efuel (Google search terms “efuel” for example https://www.cnet.com/roadshow/news/porsche-efuel-climate-gamechanger/), biodiesel, and plant based ethanol. For example, I had assumed E85 made from ethanol was a waste of corn grain. I didn’t realize the fermented mash left over can be used for a high protein cattle food (https://www.ag.ndsu.edu/publications/livestock/feeding-coproducts-of-the-ethanol-industry-to-beef-cattle) When fed back to ruminants this should result in them being able to digest low nitrogen cellulose, meaning that the ethanol produced is using the starch in the corm but recycling the rest of corn nutrients. One advantage to either efuel or bio-fuels is that they can be relatively easily stored and transported as a liquid. Existing gas turbines can be run on these fuels which might make them a relatively cheap low carbon “peaking” generator when other renewables are not producing much power. Shipping and airplanes would also be major beneficiaries of these fuels.
Of course this is satire, right? Raising the price of oil reduces transportation emissions and in the process creates inflation which raises the cost of food, housing, clothes, medicine and everything else which tanks the economy. Sounds like a wonderful tradeoff.
If we’re our goal is to incent consumers to change their choices so as to reduce GHG emissions and the most successful strategy is likely raising prices on the commodity that is the core source of GHG emissions, what policy is preferable to using direct market forces to cause this change?
Chris Knittel wrote a paper while he was at UC Davis on the impact of CAFE standards and horsepower. An unpublished finding in that paper I discussed with him via email was that CAFE did not drive fleet fuel economy until 1984 when oil prices collapsed. From 1973-83, consumers bought more efficient cars simply because gas prices has risen so high. We may be entering a similar phase.
“what policy is preferable to using direct market forces to cause this change?”
Richard start with these.
1. Continue to push research into more efficient combustion technology, improve hybrid options, and provide competitive non-tax oriented incentives for more rapid development of other options
2. Reconsider and revise the restrictions that hamper and increase the cost of pursuing nuclear and hydro – both of which are critical to support the mining and manufacture of solar, wind, and EV’s.