Does your portfolio manager hold shares in oil and car companies like Exxon and Ford? You might want to read this… by Alex Pollak, Loftus Peak CIO

There hasn’t been much in the way of serious comment about the investment implications of the electric and autonomous car.

The media disruption story, the poster child for what went wrong with a whole industry, resulted in hundreds of billions of dollars of value transferred to those companies which proved more adept at managing copyright and advertising (into Google, Facebook, Apple and Twitter, and out of Time Warner, the TV networks and the record companies).

This will be multiples of that.

Consider the size of transportation. In the US alone, there are nearly 12 million jobs in transport-related industries, or just shy of 8% of the total workforce, with over US$1 trillion of purchases and investments in transportation of goods and services, or just over 5% of GDP. It is estimated that transport accounts for 70% of petrol consumption in the US. (Source: US Department of Transportation, 2013).

The conversation has been about robots taking over people’s jobs, but that doesn’t hit the right note. It won’t be a robot at the wheel of the car, just a piece of artificial intelligence, with no driver seat at all. And no steering wheel.

Investors who think this is far away need only cast their minds back to 2010 when the idea that newspapers like the Sydney Morning Herald would not be printed on paper was ridiculous. This is now expected to happen within a year. Stock markets price this stuff in well before people really get their heads around it.

Right at the heart of this disruption will be the electric car, and shortly after, the driverless car. But we need to separate the issues – the electric car has one set of implications, while self-driving cars have another, completely different set. Putting them together is what creates the perfect disruptive storm.

Let’s deal with the autonomous vehicles first. A major reason for owning a car is that taxi services have been unreliable and slow, so that even though cars are expensive, they are worth it. But we are at a unique point in the evolution of transport, with ubiquitous and powerful mapping tools, billing and communication systems. Uber and others have shown us that we can order a car pretty much in the time it would have taken to get ours out of the garage and in many cases much less than the time taken to park at the other end.

So with the convenience factor matched, other variables can come into play. Those other variables – such as the cost of ownership including depreciation, insurance,and parking  – are an argument in favour of Uber and taxis, but not really necessarily an argument with enough weight to swing the deal away from car ownership, especially when intangibles are included (like the status of owning a car.)

(Some people will always own a car because they just will – in part this is tied up in the possessions-and-status thing. But even status can be bought. Ride sharing is already tiered all the way up the line to the Bentley, so there is no reason to believe that self-drivers won’t be.)

But what is not considered is that a shared driverless car is not just a bit cheaper than owning a car – it will be dramatically cheaper.

Remember, a big part of the cost of a taxi is the driver. Without the need for a driver, the ride virtually halves. And because it goes from being a private car to a ride share, the car goes from being used 10% of the time (which is how much people actually use their car) to 100% of the time, with each ride priced accordingly. Once “our” car has driven us home, it has served its purpose where we are concerned, so the value of our ride forms a smaller and smaller portion of the overall car cost as it goes from passenger to passenger.

Thus, self-driving cars can spend a lot more time on the road, with each user’s ride a lesser amount relative to the cost of owning a car for the 10% of the time you use it.

And if most people use their car 10% of the time, in theory the number of cars on the road could fall by 90%.

(In practice, it won’t work like that at first. The number of cars will be determined in part by peak demand – cars on the road required during peak periods. It won’t necessarily reduce traffic – except to the extent that people share the car.)

Convenience coupled with a dramatic reduction in cost will tip the balance toward ride-sharing compared with ownership, which will reduce the number of cars. A lot.

There are other ramifications. For example, since there is no driver, there is no need to park the car. And if there is no need to park, there is no need to own a parking space – at home, in the shopping centre or in town. One shopping centre investor I spoke to recently is already planning for this. This has implications for the valuations of property (with or without parking) commercial property and so on.

The electric car isn’t necessarily part of this – self driving cars could just as well be petrol-driven (the Mercedes top of the line E class is a case in point) and the equation described above would be the same. But the reason electric cars are disruptive is that they are not just a minor tweak, the way an automatic gearbox is relative to a conventional set of gears. Electric cars don’t require catalytic crackers or exhaust systems or indeed gearboxes at all – they are a fundamental shift away from the existing model, as different from their petrol forebears as a smart phone is to Gran’s rotary dial Bakelite.

And because they can be clean (depending on how the power is generated) they are seen as the way forward – especially in China, but also the US.

The two issues, when combined, form the perfect storm of change – the reduction in the global fleet of cars (because people share their cars so don’t need as many) and of course the write-off of huge chunks of the world’s car and oil economy tied up with a fundamental change in the way that cars are made because of the move out of fossil fuel power.

This is the essence of disruption.

Google is talking about the first commercial release of autonomous vehicle software by 2017. The search company won’t make the car – Fiat Chrysler and Ford, among others, have contracted to do this part. Robin Li, CEO of Baidu, China’s version of Google, said last week on the company’s earnings call that the Chinese search giant will release a self-driving car by 2020. He noted that the competitive edge in car engineering had lived in the west and Japan for 100 years, but in future the car would be more of a mobile computer and less of an engine and gearbox affair, so the playing field will be levelled. China is targeting 5 million electric cars by 2020.

Obviously, Apple is also committed to serious exploration of the idea – it has well over 200 highly credentialed experts already at work. Uber too is on board. Drivers are its biggest expense, and it is focused on “addressing” this issue. US carmaker GM, in addition to getting ready to roll out its own electric car (the Bolt, against the Tesla Model 3) has already announced a US$500m investment in the fleet service company Lyft.

What are the implications of a 10% reduction in car ownership once self-driving cars become a reality, and the move out of fossil fuel engines? Actually, these are pretty easy to conceptualise. Investors will see the writing on the wall, and will start the process de-rating car companies.

This has already begun. GM is on a PER of 5x, Daimler is on 8x and VW is on 10x (having already fallen 30% after the diesel scandal.) Traditional carmakers are in a bind – they must field an electric car, but every electric car they sell calls into the question the value of the remaining fossil fuel plant and the huge sales which keep them in business. In a sense, then, the better they do, the worse they do.

Within this context, the fall in the price of oil suddenly starts to make much more sense, as we flagged in the AFR over a year ago. Market watchers have pointed to the simple 2% imbalance of supply over demand, but this simply begs the question: Why is there an oversupply in the first place? And the answer, dwindling long-term demand, is not what the oil industry wants to hear. This is what is behind the failure at Doha to agree on production cuts, just as it is the sudden decision by the Saudis to float Aramco, the state owned oil company (a 5% stake could be worth US$100b+, if they haven’t missed the moment.)

Investors have to get this right – it’s a once in a lifetime opportunity. Just buying ‘offshore’ companies to diversify risk out of Australia almost certainly won’t work, given the reliance in many portfolios on the Exxon’s, BP’s and Ford Motor Company’s of the world.