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NEW YORK (TheStreet) -- China's insatiable appetite for oil, and the resulting spike in gasoline prices in the U.S,. could trigger demand for fuel-efficient vehicles before the end of the year.

As Dan Cheng, A.T. Kearney partner and leader of the firm's automotive and transportation practice in North America explains, "if gasoline prices go to $5 over the next year and a half, your disposable income may go up proportionally -- and you will absorb additional costs and still be able to drive your SUV." But, if gasoline prices were to go up overnight due to an oil shock for example, "it would be harder to tolerate that increase."

Cheng says since 1996, gasoline price fluctuations have explained more than 72% of the volatility shown in fuel-efficient vehicles such as small cars. A migration to small cars was triggered in 2008 when gasoline prices went well above $4 in a short period of time, said Cheng. But when gasoline prices fell back to $2 near the end of 2008, there was a return in interest to gas-guzzling trucks.

Analysts believe that the gasoline price pop required to trigger greater demand for fuel-efficient vehicles could indeed occur

before the end of 2011.

Oil prices are expected to heat up before the end of the year thanks to strong demand from China -- and the brevity of the lag between a rise in oil spot prices and increases in prices at the pump. There is around a one to two week-lag in the corresponding oil spot and gasoline prices depending on whether it's an increase or decrease, according to John Gamel, gasoline analyst for MasterCard Advisors SpendingPulse. It actually takes longer for prices at the pump to drop in response to a fall in spot oil prices.

For every dollar increase in crude, gasoline could go up on average by $1.15 a barrel, or about 3 cents a gallon, according to Neal Walters, A.T. Kearney partner in the utility and energy practice. The wholesale price of gasoline has on average been priced at about 115% of crude over the past ten years, according to the analyst, who notes that there are seasonal variations to his estimates, with the ratio being typically higher in the summer and spiking during short-term supply shortages during the summer peak driving season; and hitting a low during the winter and during short-term supply gluts.

Since October, China has raised interest rates five times to stem inflation. Yet second-quarter gross domestic product came in better than expected, as did June industrial and retail sales data in the week of July 15. Even amid signs of cooling manufacturing activity in the country, A.T. Kearney's head of energy practice Vance Scott maintains his view that U.S. gasoline prices are bracing for a surge.

"If China continues to expand this way, I would expect

U.S. fuel prices to go up 20 to 30 cents a gallon by the end of the year ... I would be inclined to say that even if China slows in the second half, we're talking about a relative slowdown of a couple percent maximum of China's industrial output growth, at about 15% today, or GDP growth, at 9.7% today, so that probably pushes things to the low end of my range rather than nullifying the statement."

Based on the recent three-year period, which incorporates a boom-bust-boom cycle on crude, Walters observes a 96% correlation between gasoline and crude oil prices.

While electric vehicle demand looks like it's poised to pop by year-end, cuts to federal tax incentives for the vehicles could tap the brakes.

"As we get further along election cycle, cost expenditures at the federal level are being scrutinized a lot," said Center for Automotive Research director Kim Hill. "I think there's resistance to putting money into programs on a lot of fronts."

Meanwhile, Cheng of A.T. Kearney notes that "without some of these tax credits, the cost of plug-in hybrids would be "prohibitively high" -- mainly due to the cost of the large battery pack required in the vehicle to sustain its propulsion. He estimates that gasoline prices would probably need to approach about $8 a gallon or levels similar to those in Europe before buyers, aside from the early adopters and those interested in making a statement on their commitment to environmental sustainability, would buy plug-in hybrid electric vehicles like the



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"It would be relatively safe to say that if incentives were eliminated, the total cost of ownership for plug-in electric hybrid vehicles could push many potential buyers away," says Cheng.

Wall Street Strategies analyst David Silver estimates a potential cut in the range of $4,000 to $5,000, noting that tax breaks for ethanol producers were recently repealed, so a reduction on the fuel-efficient vehicle incentives could also be on the table. It takes about 24 months of buying gasoline, or 200 miles a week, to make up for the difference between the cost of a hybrid vehicle when compared to a "normal" vehicle, adds Silver.

Right now the federal tax credit for plug-in electric drive motor vehicles that qualify for such incentives has been between $2,500 and $7,500 and limited to 200,000 vehicles for each manufacturer, according to Cheng. That would be a maximum of $500 million per manufacturer at the low end or $1.5 billion per manufacturer at the high end.

"Over time, if plug-in hybrids go into mass production, you would expect to see economies of scale drive down the overall cost -- perhaps to a point where government incentives would not be required -- but that might take five to ten years," said Cheng.

Despite all this, Hill says it's important not to forget that certain states could continue to offer attractive incentives for fuel-efficient vehicles despite a reduction in Federal incentives. Much of it still "boils down to the will of the people in that individual state," he notes.

Based on CAR's study of hybrid vehicle sales during the last three years, the group projects an electric vehicle sales rate of roughly 120,000 units a year. That's about a 1% share of the total automobile market for 2011 to 2015.

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Looking at the projections, Hill thinks California would likely account for about 25% of the electric vehicle sales, and New York and Virginia would be among the states to follow at about 4% to 5% of the sales. "The states with more incentives due to any public policy is based on who's electing the folks going into public office," Hill noted. "California is more progressive and left-leaning with politicians that like to advance social causes."

Hill thinks California's large Asian population might be another reason why the overall sales count for hybrid vehicles has been higher in California, with Japanese automaker


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enjoying sales in California that are almost three times its national sales rate. Toyota is the maker of the popular Prius hybrid, which has been available to consumers for more than a decade and is a bellwether for hybrid vehicle demand.

Lithium battery product suppliers were losing ground Tuesday morning.

A123 Systems

( AONE) was falling 2.4% to $4.72,


( HEV) was lower by 0.3% to 90 cents,



was behind by 0.8% to $1.28,

Polypore International


was losing 5.1% to $65.06,

Sociedad Quimica y Minera

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was behind 0.2% to $65.33,

Johnson Controls

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was falling 1.1% to $37.10 and

Advanced Battery Technologies


was down 0.8% to $1.38.

-- Written by Andrea Tse in New York.

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Andrea Tse


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