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Oil exporters’ hopes for a freeze in crude production melted in the Doha sun this past weekend. And for the coal industry, a glimmer of hope amid recent news of sliding demand and bankrupt mining giants.
OPEC Strikes Out
Since reaching a low of about $26 per barrel in February, benchmark West Texas Intermediate (WTI) crude has rallied sharply on hopes that the world’s major exporters would work together to curtail excess production. That optimism sent WTI as high as $42 per barrel last week, shortly before members of the Organization of Petroleum Exporting Countries met with Russia (not a member, but a major oil producer) in the city of Doha on the coast of Qatar. Despite Iran’s refusal to join with its OPEC colleagues in a pact to jointly freeze output at January levels, many of the meeting’s participants sounded a hopeful note that some sort of agreement could be hammered out.
But Saudi Arabia had other ideas. The de facto leader of OPEC announced that it wouldn’t agree to any freeze in production unless every member of the group did so as well. That effectively torpedoed the meeting, since Iran has been adamant that it won’t restrict oil production until its exports rebound after the recent termination of Western oil sanctions. The Saudis clearly did not want to hold back their own production just to let Tehran grab a larger share of the global oil market.
Oil prices promptly dipped on the news, slipping back below $40 per barrel. But OPEC’s failure to strike a deal doesn’t necessarily spell doom for oil producers.
Granted, the oil market is still oversupplied. And while an agreement to put a ceiling on output would have been a first step toward curing that oversupply, there is reason to believe that supply will naturally edge down even without a formal campaign from OPEC.
U.S. crude output has already slipped from its peak of 9.7 million barrels per day in April 2015. A year later, the Department of Energy’s weekly Petroleum Status Report pegs production at about 9 million barrels per day. And with the number of active oil rigs continuing to decline, production figures to drop further. Meanwhile, oil companies around the world have been announcing cuts to their capital budgets, suggesting that fewer new wells will be coming on line in coming months and years.
Eventually, demand will catch up with diminished supply. But it will be a slow process. Oil bulls hoping that OPEC would put a sudden end to the oversupply situation will have to be content with a slow, grinding decline instead. That means crude prices are unlikely to move much higher this spring from their current levels.
Meanwhile, in Coal Country …
Last week brought news of the latest casualty of the swoon in coal demand: Peabody Energy filed for bankruptcy protection. The company cited the “unprecedented industry downturn” for the move.
The U.S. coal industry is indeed facing tough times. The combination of stringent new air quality rules for power plants and rock-bottom natural gas prices has prompted electric utilities to close older, coal-fired power plants and generate more power from natural gas and renewable sources. Last year, the U.S. burned about 800 million tons of coal, the lowest level since the mid-1980s. And 2016 is likely to see further declines.
Overseas trends are also worrisome for coal producers. Last December, the International Energy Agency reported that global coal usage plateaued in 2014 after steadily climbing for years. China, which burns fully half of the world’s coal, is seeing growth in coal demand slow. In fact, the IEA says that a peak in Chinese demand might be near, if the country’s economy slows and if Beijing moves toward less-polluting alternative sources of energy.
But don’t write any obituaries for the U.S. coal sector just yet. Andrew Moore, managing editor of Platts Coal Trader, says that coal’s biggest challenge right now is cheap natural gas. At a bit less than $2 per million British thermal units (MMBtu), gas is very attractive to electric utilities. But as gas prices climb, he expects certain varieties of U.S. coal to become more cost-competitive next year.
Of course, not all coal is created equal. Some types contain more sulfur than others, for instance. And mining costs can vary by region. Moore reckons that coal from Wyoming’s Powder River Basin becomes economical for electric utilities when natural gas prices reach $2.50 per MMBtu. Should gas prices rise to $3.50, coal mined in Illinois can compete with gas. Appalachian coal requires a gas price of about $4.50. So, if and when natural gas prices turn higher, look for Wyoming coal to be the first beneficiary of the trend. That would spell some relief for ailing mining firms such as Peabody and Alpha Natural Resources, which have major operations in the Cowboy State.
In the short term, coal’s outlook is still grim. Reports from freight railroads indicate that coal volumes moving by train are way down (a 35% drop in March 2016 compared with March 2015, for instance). Platts’ Moore figures that total U.S. coal consumption this year will slip to between 650 million and 700 million tons, comparable to levels from the late 1970s.
But 2016 could mark a trough for the industry, with demand making a modest comeback as natural gas prices rise. So, while King Coal won’t be returning to his throne anytime soon, reports of his death may be a bit premature.
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Can Tesla finally go mainstream with its recently unveiled Model 3 electric car? The company’s pricier offerings get rave reviews for their handling and high-tech design, but a sustainable business model depends on selling larger volumes and exploiting economies of scale.
Model 3: Third Time’s the Charm?
Tesla, the electric vehicle start-up helmed by tech entrepreneur Elon Musk, has come a long way in its short history. Its first vehicle, the Roadster, was based on a Lotus Elise sports car with the gas-powered engine replaced by batteries and an electric motor. In other words: An electric novelty for well-heeled buyers (George Clooney was an early customer). But then Tesla began building its electric cars in-house, starting with the Model S luxury sedan and following up that sales success with the Model X crossover SUV. And last week, Musk took the wrapper off the long-awaited Model 3, a smaller sedan with a much lower starting price, which the company is banking on to become its high-volume seller.
One measure of success that has largely eluded Tesla so far: Profitability. Despite selling 25,000 Model S sedans last year (priced at about $75,000 and up) and beginning delivery of the Model X SUV, Tesla lost nearly $900 million. Musk likes to point out that the company is producing positive cash flow from its “core operations” of selling cars, and predicts that Tesla will achieve “moderate” profitability in the fourth quarter of 2016.
Higher volume will be one key to stanching the red ink. And that’s where the Model 3 comes in. Musk claims that the new, entry-level Tesla will start at $35,000 before any federal or state tax incentives (more on those in a moment) while still offering at least 215 miles of driving range per battery charge. That sounds ambitious, considering that BMW’s i3 electric hatchback starts at $42,400 and travels about 80 miles on a charge. But it’s just what Tesla needs to lower its per-unit manufacturing costs.
Demand for the Model 3 is strong. But can Tesla deliver? Within days of its unveiling, the company announced 300,000 orders, with would-be buyers each putting up a $1,000 deposit. Musk says that the first cars will reach customers by “late 2017,” implying a wait of up to 20 months. Moreover, Tesla’s track record of meeting self-imposed deadlines isn’t exactly stellar; the Model X SUV arrived nearly two years later than originally scheduled, with production slow to ramp up.
The Road Ahead: Paved with Question Marks
We don’t claim to know what the future holds for the Model 3. But we can think of quite a few hurdles it needs to clear. Can Tesla increase its production capacity to deliver a batch of 300,000 new cars, when so far it has sold only 107,000 vehicles in its entire history? Much of that depends on the vaunted Gigafactory battery plant being built in Nevada to supply the lithium-ion batteries for future Teslas at significantly lower cost than today’s units. Will that facility be up and running and churning out enough cheap batteries in time to equip all the Model 3s for which Tesla is now booking orders?
Will enough buyers actually pony up for the new car whenever it does become available? Musk’s promised starting price of $35,000 is a bit more than today’s average new-car transaction price of $33,666. But once options such as all-wheel drive with bigger battery packs are included, Musk expects the price for the average Model 3 to climb to about $42,000.
Will demand waver when the federal tax credit runs out? Right now, anyone who buys a new Tesla will drive off with a $7,500 tax credit from Uncle Sam. But that subsidy starts to phase out once a manufacturer has sold 200,000 electric vehicles. Tesla is more than halfway to that threshold, which means that many of the folks putting up their $1,000 for the right to buy a Model 3 won’t be getting any help from the feds when their cars are ready for delivery. Meanwhile, other makers that have sold fewer electric vehicles will remain eligible far longer, posing tougher competition for Tesla. (General Motors’ forthcoming Chevy Bolt figures to be an early Model 3 rival. GM says it’ll start at $37,500, with at least 200 miles of driving range.)
Many state governments also offer some form of financial incentive, from exempting electric cars from sales tax (as in Washington) to hefty subsidies (such as Colorado’s $6,000 tax credit). But how many states are going to be able to keep offering such deals on cars that are already skipping the gasoline taxes most states depend on to fund road construction?
Can an electric sedan captivate American drivers in a time of low gas prices and strong demand for SUVs and pickup trucks? Predicting what gas will cost in December of 2017 is tricky, but we’re fairly sure the price won’t skyrocket from today’s level of roughly $2 per gallon. Those low prices are fueling demand for SUVs and pickups, which generate big profits for their makers. Hybrids and other electric cars remain a small slice of the market. So, even if Tesla delivers an exceptionally well-built and fun-to-drive electric car at a reasonable price, a great many drivers simply won’t be interested.
The bottom line: Tesla needs a lot to go right as it seeks to rev up production enough to lower its per-car manufacturing cost. The market for its newest model seems hot now, but 20 months is a long time for folks to wait while the Model 3 assembly line tools up. Start-up delays will further push back that distant deadline. The federal subsidy that has bolstered Tesla’s sales to date will phase out. And electric cars are a tough sell as long as gas prices aren’t too painful for the average driver.
This feels like a make-or-break moment for Tesla. Either the company makes good on its ambitious plans and starts making a profit selling affordable electric cars that people really want to buy (even without subsidies), or Musk is going to need a Plan B. No pressure, Elon.