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.  

Source: EV-Volumes.com

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/