Can Volkswagen overcome its troubles; and what’s the impact on diesel?

Volkswagen’s ongoing scandal over phony diesel emissions isn’t just a big story in the auto industry. It also raises key questions for diesel as a transportation fuel at a time when automakers are striving to meet ever-tougher government fuel economy rules.

Just how serious is the revelation that VW, the largest automaker in the world, used special software in some of its diesel-powered cars to cheat on emissions tests? First, consider the numbers. The company estimates that about half a million of the cars it sold in the U.S. with four-cylinder diesel engines during the past five years were programmed to emit fewer pollutants when undergoing emissions test. Worldwide, the total might be as high as 11 million vehicles sporting the “defeat device” software.

The resulting fines from regulators in the U.S. and other countries could run into the billions of dollars. (No wonder VW’s stock has plummeted by 36% since news of the emissions cheating broke.) Even more crucially, the company may have seriously undermined its reputation with customers, many of whom are undoubtedly feeling less inclined to trust a brand that actively sought to evade the rules. The fact that VW markets these polluting engines as “clean diesels” that get great fuel economy adds insult to injury.

“It really is a giant deal” for Volkswagen’s brand perception, says Kelley Blue Book Executive Market Analyst Jack Nerad, though he warns that it’s too soon to gauge the financial impact of all the fines and lost sales the company will suffer. The brand’s loyalists, who are devoted to VW in general and its diesel-powered cars in particular, will be especially put off, he reckons.

“I would say it’s egregious,” adds longtime auto industry analyst and independent consultant Bill Visnic. Rigging cars with software to cheat on emissions tests points to an “institutionalized” problem at VW. This wasn’t the act of some rogue engineer or an oversight borne of cost cutting, but rather a “concerted effort to skirt regulations.”

VW is under pressure to fix the problem in millions of faulty cars. But any solution is going to be painful. Because diesel engines tend to emit more oxides of nitrogen (or NOx) than gas-powered units, carmakers normally add special exhaust treatment gear to their diesel models to meet clean air rules. Typically, that requires a system to inject a chemical called urea into the exhaust, thus neutralizing the harmful NOx emissions. Nerad thinks VW will have to retrofit its affected cars with such a system, which could cost thousands of dollars per vehicle. Visnic thinks VW will opt for a software fix that will reprogram the cars to emit less NOx. The company might also have to install a new catalytic converter. Or it might do some combination of the three.

Any physical retrofit will be expensive and tough to carry out. A software fix might be cheap, but it will probably cost horsepower and fuel economy, making the car less enjoyable and economical to drive. In other words: Spend a fortune on a complicated recall or degrade the driving experience for your customers. Aren’t you glad you aren’t in VW management right now?

The Fallout for Diesel

Are VW’s woes the death knell for diesel-powered cars, though? Long a niche market in the U.S., diesel has been enjoying a modest resurgence in recent years. Modern diesels are very different from the wheezy, smoke-spewing versions many drivers might remember from a few decades ago. And because diesels tend to be more fuel efficient than their gas-powered cousins, some automakers have been hoping they can reach their government-mandated fuel economy goals in part by selling more diesels. In the past few years, there’s been an increase in the availability of diesel models, not just from VW, but also from Mercedes-Benz, BMW, Ram, Jeep and other brands.

Despite the stigma, odds are customers who wanted a diesel before will still want one, says Visnic. Those drivers tend to be familiar with the technology and the unique advantages of diesel engines (lots of torque and towing capability, along with high fuel mileage). And those folks will probably understand that what VW did doesn’t indict diesel power entirely.

Savvy buyers might use the current situation to their advantage. VW can’t sell new four-cylinder diesel models until they get the emissions up to snuff, but that shouldn’t take too long. When those cars return to dealers’ lots in a few months, they’ll likely require some pretty enticing discounts to win back apprehensive or angry customers. Normally, VW’s “clean diesel” models sell at a premium to comparable gas-powered versions, but odds are good shoppers who aren’t put off by the recent deception will see some sweet bargains. Moreover, they’ll have plenty of leverage to negotiate a better price, since Volkswagen’s U.S. sales depend pretty heavily on a high diesel take rate. When it comes to clean diesel, it’s going to be a buyer’s market.

A “Black Eye”

Lost in all the talk about VW’s perfidy in cheating the emissions tests is the fact that they were able to get away with it for such a long time. Only when a private research consortium started studying the company’s diesel emissions did word start leaking out that something was amiss. Otherwise, it’s impossible to say when, or if, the U.S. Environmental Protection Agency would have caught on.

That failure is a “black eye for the regulators,” says Nerad. The fact is, the agency doesn’t test every new car to verify the maker’s claimed fuel efficiency, and it doesn’t have the resources to look too closely at emissions compliance, either.

But look for EPA to compensate by scrutinizing other brands’ diesel models much more closely now. Whether the agency uncovers any more funny business is impossible to predict, though it should be noted that other automakers use expensive chemical injection systems to clean up their diesels’ exhaust, and it seems unlikely that they’d go to such an expense if they weren’t trying to comply with the rules. Still, when regulators suddenly focus their attention on a problem they’d missed for years, you can never be sure what else they’ll find.

Despite roller coaster ride, oil prices will stay low

With oil prices unlikely to rebound from their steep slide anytime soon, producers all around the world will have to scramble to adjust. U.S. shale drillers are slashing their costs to remain competitive, while OPEC and other big oil exporters are looking for a new strategy to cope with cheap oil, now that they can no longer force prices up by restricting output.

Lately, the oil market has felt like a roller coaster: soaring one moment, plunging the next. But pretty much no one is betting on the price of a barrel of crude returning to $100, the level that had come to seem “normal” until recently. We’re expecting the U.S. benchmark, West Texas Intermediate crude, to average between $45 and $55 per barrel next year. If that pans out, expect to see some big changes in the resurgent U.S. oil industry.

American oil production is already starting to slide because of the price drop. And further cutbacks are all but certain in coming months. According to the latest data from the Department of Energy, crude oil production peaked in April at 9.6 million barrels per day. That’s nearly double the level in 2005, before the combination of hydraulic fracturing and horizontal drilling allowed drillers to tap huge deposits of previously unreachable shale oil. But since April, output has slipped to about 9.3 million barrels per day, according to Uncle Sam’s latest monthly numbers.

The decline is no surprise. According to drilling services provider Baker Hughes, the number of rigs actively drilling for oil in the U.S. is down by 60% from a year ago, when the price slump was just beginning. Wells that may have been quite profitable at $100 per barrel suddenly weren’t worth drilling when the price of crude dipped below $45. So, as older shale wells dry up (something they tend to do quickly), fewer new ones have come on line to make up for the lost output.

But the production boom isn’t over. It’s simply on hold until producers figure out how to cope with the new, low-price environment. Here’s why:

Productivity Push

If a return to high prices isn’t imminent, drillers will have to cut their way to profitability. Drilling wells in shale fields is expensive. So expensive, in fact, that many oil market analysts have long assumed that a sustained price drop would wipe out shale operators in areas such as North Dakota and Texas. But so far, that hasn’t happened. The incentive of low oil prices is pushing drillers to cut costs wherever possible, which has allowed more of them to at least weather the current downturn. Even at today’s price of less than $50 per barrel, many of them can turn a profit.

The cost-cutting drive is just getting started. One Houston-based oil industry consultant, who agreed to speak with Kiplinger’s Energy Alert anonymously, says that drillers increasingly see working in shale as an industrial process, one that can be done faster and for less money. Given how well-explored many of the big shale fields are, he says, “you know there’s oil there.” Now it’s just a matter of getting as much of it as possible, as cheaply as possible.

Call it “shale 2.0.” The name of the game is drilling wells faster, with less down time between jobs to minimize costs, while concentrating on the richest oil deposits and using rigs best suited to that particular geology. Equipment makers are designing drills and other gear based on direct feedback from producers about what works best in a given shale reservoir. Drillers such as Hess, a major producer in North Dakota’s Bakken Shale, liken this approach to the concept of lean manufacturing that Toyota popularized decades ago. (Hess even sent executives to Japan in recent years to study Toyota’s approach to optimizing every step of their manufacturing process.)

The bottom line: more oil from each new well. In its latest Drilling Productivity Report, the Department of Energy estimates that producers in the largest shale plays will extract significantly more crude from a newly drilled well this October than they did last October. In North Dakota’s Bakken field and the Eagle Ford Shale of Texas, those gains are on the order of 50% more. That will cushion the blow from falling rig counts, allowing overall production to decline only slightly despite the sharp drop in the number of rigs working.

Of course, cost cutting has its downsides. Employment in shale country is already suffering and won’t bounce back anytime soon. Running fewer rigs and drilling wells faster means fewer workers are needed to produce a barrel of crude. In Louisiana, which produces a modest amount of oil and hosts many companies that supply drillers in other states, the push to pump more with less is costing jobs, says Ragan Dickens, director of communications for the Louisiana Oil & Gas Association. Much of the talk in the Pelican State centers on “who’s merging next?” and “who’s bankrupting now?” he says.

Wally Drangmeister, director of communications for the New Mexico Oil & Gas Association, echoes those sentiments. The state’s rig count has dropped from 100 to 50 recently, and each of those rigs typically employs about 50 workers. Employees who remain on the job are finding themselves in “spirited negotiations” with drillers over their pay, he says. Odds are, many of the jobs being lost now won’t return, even when oil prices rise. Producers that have figured out how to get by with lower head counts won’t be eager to surrender those cost savings.

The Global Picture

So, what happens to U.S. oil output from here? Odds favor a slight dip, and then a resumption of output growth, as rising production from new wells starts to offset the effect of fewer rigs operating. Demand for refined fuel is strong, meaning drillers will have a market for their crude if they can find a way to pump it profitably.

The U.S. will remain the top producer of petroleum, which includes crude oil and related hydrocarbon liquids such as ethane and butane. Output won’t fall enough to allow number two producer Russia or number three Saudi Arabia to overtake the U.S.

Major oil exporters in the Middle East and elsewhere are in a pickle. Historically, when faced with a major price drop, OPEC would dial back production to tighten the market and put a floor under prices. But now, the cartel seems unable or unwilling to act. To really give prices a lift, the group would have to cut production by about 2 million barrels per day. But cutting back by that much would just open the door to U.S. shale producers, who have shown they can ramp up output very quickly when oil prices are high. Moreover, any OPEC member who honors a production cutback has to worry about its colleagues cheating on the deal to grab market share.

So, despite the low price, expect most major exporters to keep the taps open in a bid to maintain their share of the global oil market and earn what revenue they can. The International Energy Agency expects that global oil output will rise by 1.1 million barrels per day this year, even as prolific shale production in the U.S. starts to falter. That trend should continue, especially with Iran likely to ramp up its output now that U.S. and European governments are preparing to loosen their sanctions on Tehran’s oil exports. Thus, oil will continue to pile up in storage around the world, helping to keep prices in check, much to the chagrin of OPEC and oil exporters everywhere.

The tech industry needs app developers, network engineers, …

Growing demand for tech workers. New federal telecom spending and defense research projects. FBI warnings pertaining to the Internet of Things. Intel’s latest chips. Best business practices for securing customer data.

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The winners and losers of low gasoline prices

U.S. drivers are no doubt cheering on the drop in gas prices, which began this summer and looks set to continue into autumn. But makers of small, fuel efficient cars are paying the price as car shoppers worry less about gas mileage. That spells deals for those buyers who still appreciate a good gas miser.

Fuel Efficiency on Sale

At $2.39 per gallon of regular unleaded, the national average price of gasoline is already well off its summer peak. And as demand eases and refiners switch to making cheaper winter blends of fuel, more and more drivers should start seeing prices that begin with a 1 instead of a 2. The average pump price in South Carolina is already down to $1.97 per gallon, and other states should slip beneath the $2-per-gallon threshold soon.

Cheaper gas is great for consumers, and it should lend some support to the overall economy because drivers who save at the pump have more cash left over to spend on everything else. But one thing they’re not buying: Small cars.

That’s a real reversal from several years ago, when gas prices spiked as high as $4 per gallon and compact, fuel efficient models were all the rage. Manufacturers responded by rolling out higher-quality compacts with snazzy styling, plush interiors and new electronic amenities that let buyers downsize their rides without feeling that they were settling for less car. The age of the big SUV seemed to be over.

Then along came 2014 and the rout in oil markets that sent gas prices as low as $2 per gallon by early 2015. Sales of big SUVs and pickups, which had already been trending up as the economy showed signs of improvement, shifted into higher gear. While not exactly thrifty, those big rigs do get significantly better mileage than their predecessors of several years ago. And with gas nearing $2 per gallon, the cost of fueling up a new Ford F-150 or Jeep Grand Cherokee doesn’t seem so daunting anymore.

The latest monthly auto sales data tell the story. Motor Intelligence, a provider of auto data and analysis, shows that sales of all cars in August were down about 10% from the same month a year ago. Sales of small cars were down 13.5%. Pickup trucks, by contrast, logged a year-over-year gain of about 8%. SUVs were up a whopping 11%, with gains being fueled by sales of new, smaller models (which don’t use as much gas as their full-size cousins but can’t compete with conventional compact cars on mileage).

That spells bargains for car shoppers seeking good mileage. Granted, many buyers need the towing ability or cargo payload of a full-size truck or SUV, and thus won’t care how good a deal they might get on a fuel-sipping compact. But folks who don’t have heavy loads to haul and want to compound the benefit of today’s cheap gas by using less of it should have plenty to choose from.

Late summer always brings sales to dealer lots as manufacturers sell off their remaining inventory to make way for the next model year autos, which tend to arrive in fall. This year, says car shopping website Edmunds.com, some of the best deals should be on fuel efficient models that were already struggling to get off car lots and are due for major overhauls.

They include the 2015 Chevy Volt plug-in hybrid and the 2015 Toyota Prius, both of which will be heavily updated for 2016. Also going for a discount: Honda’s fuel-sipping 2015 Civic and the 2015 BMW 3 series, which is a powerful car but also nets up to 36 miles per gallon on the highway for gas-powered versions and up to 45 mpg for diesel.

Discounts on these and other models will vary by region, since different dealers have differing levels of inventory that need to go. But the potential savings are substantial. Edmunds calls the 2015 Chevy Volt a “steal,” with discounts of almost $4,000. The 2015 Prius is being marked down by about $3,000.

What to Expect Next from Gas Prices

Speaking of saving at the pump, where do gas prices go from here? With Labor Day and the summer travel season behind us, gasoline demand figures to fall a bit at the same time that refineries stop producing summer-blend fuel (a variant that suppresses smog in the warm months and costs more to produce). And with oil prices largely stagnant, look for further price declines at the pump.

The question is, How much more of a drop in gasoline prices can drivers expect? If the price of crude oil continues to hover around the mid-$40 per barrel, we will look for the national average price of regular unleaded to fall 20¢ or so per gallon, into the neighborhood of $2.20 per gallon.

But another tick down in oil prices can’t be ruled out. If it occurs, gasoline could hit its lowest prices since early 2009. Should crude dip well below $40 per barrel this fall, it wouldn’t be surprising to see the national average gas price fall well below $2 per gallon. That would be even lower than the lows plumbed early last winter, when the average fell to about $2 per gallon. By comparison, when the U.S. economy was diving into a deep recession in late 2008, gas fell to as low as $1.61 per gallon on average.

Odds are we won’t see prices fall quite so far as they did during the last recession. But don’t be surprised if they come within shouting distance sometime this autumn.

Energy Alert update for Aug. 26, 2015

The price of oil has taken a beating in recent weeks, dashing hopes of a quick recovery from the swoon that hit crude last autumn. Plenty of factors are pushing prices down now, but where does the market go in the longer term?

Was it really just one year ago that West Texas Intermediate crude oil was selling for about $95 per barrel? Twelve months later, we’re closer to $40 per barrel, thanks to a flood of new oil coming from U.S. shale producers and certain OPEC nations, not to mention a stronger dollar and a weaker Chinese economy that suddenly seems to need less oil and other raw materials.

The short-term outlook doesn’t hold much comfort for oil bulls. Oil demand in the U.S. is running strong now, but with the summer travel season nearly over, gasoline use is probably about to trend lower, meaning less need for crude. Soon, refineries that are currently working overtime churning out fuel to meet high demand will dial back, and crude oil will probably start piling up in storage. Those factors could push WTI down close to $30 per barrel, says Stephen Schork, editor of the Schork Report, a daily publication that specializes in energy markets. “We are certainly geared to lower prices” as seasonal demand downshifts, he argues.

Drivers won’t be complaining about oil’s woes. The national average price of regular unleaded gas crept up recently because of a refinery outage in the Midwest, to about $2.70 per gallon. But that increase has already reversed, and the national average will soon be well below $2.50 per gallon. In fact, don’t be surprised if gas nears the low it reached last winter — roughly $2 per gallon — in late autumn. (Certain markets, such as California, will continue to buck the trend because of refinery issues, but even the Golden State should get some relief in coming months.)

Truckers also stand to gain. Diesel should edge down, though probably not as dramatically as gasoline. The national average price of diesel should decline from its recent high of about $2.90 per gallon in late spring to around $2.50 per gallon early this fall. But from there, diesel should start to tick back up as seasonal demand for chemically similar heating oil grows. (How much diesel rises depends on the severity of the winter in the Northeast, home to most heating oil customers.)

Low Prices: The New Normal?

What about 2016? Does oil’s sharp tumble this year point to a sharp rebound next year?

The odds don’t look good. The exact price will depend on economic and geopolitical factors that can’t yet be known in detail, but we see no reason at this point to expect a significant upturn in prices. This oil price slide looks different from the last one, which saw crude fall from about $140 per barrel in the summer of 2008 to about $34 per barrel in February of 2009. That drop resulted from oil demand disappearing amid the worst economic recession in decades. This time around, prices have fallen largely because of a flood of new supply.

Low prices are probably here to stay. It might be tempting to believe that such a sharp decline sets the stage for a strong rebound. But worldwide oil production looks to keep growing, says Michael Lynch, president and director of global petroleum service at Strategic Energy and Economic Research (SEER) and a longtime oil market analyst. Output from U.S. shale fields might falter a bit because of the price slump, but with drilling costs falling, that should prove temporary, he says. Meanwhile, Saudi Arabia is keeping production high to maintain market share, output in Iraq is growing, and Iran could soon be exporting more oil. Given the bullish supply scenario, “I don’t think this is an interlude” before high prices return, Lynch says.

Next year figures to see a muted recovery, at best, in oil prices. Markets will no doubt remain volatile, meaning the price of crude could range considerably over the course of 2016. But for the year as a whole, we think WTI will average somewhere between $45 and $55 per barrel. That allows for the likelihood that some producers will dial back output a bit because of the ongoing price slump, but not enough to meaningfully boost prices. Saudi Arabia, long the swing supplier in the global market that adjusted its mammoth production to keep a floor under prices, shows no desire to play that role again anytime soon.

Living in a Cheap-Oil World

Trying to pin down the price of oil a year from now is fraught with peril, of course. Our forecast could be thrown off by any number of events: a worse-than-expected global economy; a financial crisis somewhere in the world; further instability in the Middle East; a big move in the value of the dollar; and much more. But assuming our expected price is in the ballpark, what does that mean for the economy?

Gasoline will stay relatively cheap, compared with prices from a few years ago. We figure gas prices will average between $2.30 and $2.50 per gallon (national average for regular unleaded), with diesel perhaps a dime per gallon more.

Cheaper gas will keep truck sales humming. That bodes well for the Big Three U.S. automakers, which rack up big profits by selling expensive pickup trucks. Compact cars, hybrids and electrics, by contrast, will continue to struggle as consumers feel less need to save on gas.

U.S. shale drillers will face some challenging times. But the industry will still flourish. Drilling costs, which once made shale oil economically feasible to produce only when oil was nearly $100 per barrel, have dropped dramatically as drillers struggle to cope with oil at $40 or $50 per barrel. Those cost improvements should continue, allowing many companies to profit even in a low-price environment.

Successful drillers will focus their efforts on wells with the biggest production potential, particularly in areas such as Texas’s Permian Basin, says SEER’s Lynch. And many small firms that are weighed down with debt now will become attractive acquisition targets for better-capitalized rivals. So 2016 figures to be a year of consolidation in the oil patch, which should leave the industry as a whole on a sounder footing. As is always the case during a price slump, savvy buyers with cash to spend will know how to take advantage.

Energy Alert for August 12, 2015

President Barack Obama’s long-awaited and just-released rules limiting greenhouse gas emissions from power plants have set off a political firestorm, with some states and businesses already rushing to sue Uncle Sam to halt what they see as a costly and unjustified regulation. Meanwhile, the practical effects of the rules and how they might, or might not, play out are getting overlooked.

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