The automotive sector is facing unprecedented change and uncertainty. This includes the challenge of meeting increasingly stringent global regulation of pollutant and carbon dioxide emissions leading to a risk of financial penalties and reputational damage.
The risk of non-compliance with these new targets is increasingly apparent and costly, although still difficult to quantify. Without progress based on its 2018 emissions, the combined sector could in theory face fines of over €30bn (US$33bn). However, demand remains extremely fluid and manufacturers can still adjust their product portfolio and powertrain mix to lower their emissions and comply with their individual targets.
While the need for powertrain change is clear to compensate for the decline of diesel engines, which emit less CO2 than gasoline engines, and for the success of SUVs, which are less fuel-efficient than equivalent saloon cars, uncertainty remains for the automotive industry about the pace, magnitude and direction of change. Forecasts for the growth of electric, plug-in hybrids, diesel, gasoline and even fuel cell technologies vary wildly. This is a major challenge for automakers in terms of their future industrial and financial strategies.
Loss-making, but on the up
For now, at least, the dominant direction of development is the adoption of fully electric technology. Automakers are rising to the challenge being set by regulators by launching an increasing number of electric models. Globally, by 2025 Fitch Ratings estimates that electric vehicle (EV) production will reach somewhere between 6.3 and 10.7 million units based on announcements made by the major car manufacturers.
Yet the road to full adoption of electric powertrain technology is neither simple nor cheap. Selling more EVs will be critical to reach upcoming CO2 targets. However, because manufacturers need to amortise the significant investments being made in new powertrain technologies, and EVs are not yet sold in large numbers, EVs remain significantly less profitable than traditional ICEs, with most electric models still loss-making. Increasing the sales of EVs to comply with emissions regulation creates therefore something of a financial paradox for automotive manufacturers through which they need to boost sales of unprofitable models.
Increasing EV sales primarily takes the form of incentives to bridge the gap for the customer between the higher cost of an EV compared with a vehicle equipped with a traditional internal combustion engine (ICE). Incentives have been primarily offered by national governments so far, and further intense lobbying is being made by manufacturers to introduce some in other countries. However, public policy may not develop in the direction currently anticipated. Macro-economic and fiscal considerations, such as lost duties and tax on gasoline, may prompt governments to review their stance on EVs in the medium term, making them less financially attractive to customers. This could place the burden on manufacturers themselves.
Build it, and they will come?
Even assuming that the electric powertrain will become the preferred option to lower direct automotive emissions, customers will still need to be persuaded to buy. Major uncertainty regarding the vehicle’s residual value could act as a powerful deterrent to the development of EV sales. Customers and manufacturers generally have a good idea of the future vehicle’s value after a few years as the secondary market has had a long track record of depreciation rates and valuation. At times of technological revolution, such estimates of residual value cannot be made with the same confidence and customers may be wary of taking the risk.
One possible solution is to transfer the residual value risk to the manufacturer, possibly through different forms of car ownership and appealing financing schemes. Leasing is likely to grow as an alternative to traditional ownership and may also occur in the context of shared ownership. Furthermore, manufacturers are likely to boost EV sales through less profitable sales channels such as subsidised sales to employees and fleets. Buying incentives and favourable fleet incentives may ultimately support EV sales, but will then impose significant additional costs on manufacturers, on top of the investment costs.
While attractive funding can help to encourage consumer demand for the vehicles themselves, the move towards electrification will not be driven only by the cars and engines available, but also by battery capacity and accessibility to charging infrastructure. A kind of vicious circle operates here. While consumers continue to suffer from range anxiety, or find it inconvenient or difficult to charge the electric vehicle, demand will be dampened. Yet without sufficient EVs in operation, it will be harder to achieve the economies of scale enabling automotive suppliers and infrastructure providers alike to operate profitably.
Moreover, the development of charging infrastructure may not manifest in the same way, even between the more economically developed countries. In markets with a higher proportion of car owners living in apartments and the impossibility to use chargers in private driveways or parking facilities, alternative charging solutions will need to be developed by planning authorities. Governments and utility companies are under significant pressure to develop a robust charging network, but the time and investment required are also pushing manufacturers to invest billions in developing their own recharging networks. As an illustration, several automakers have joined a consortium building a network of around 400 fast-charging stations across Europe to ease range anxiety.
As far as battery development is concerned, analysis carried out in cooperation with research firm CRU suggests that sufficient quantities of lithium and cobalt exist to meet demand for new battery technologies, at least in the short term. Assuming a doubling in demand for lithium by 2021, proven reserves would last for another 200 years, while reserves of cobalt, where demand is estimated to rise by a third in the same period, would last for another 42 years. The more immediate issue is one of supply, but with the appropriate market signals, the currently high prices for these base metals should moderate. In addition, as these base metals are mined in a relatively small number of countries, there will be other challenges for manufacturers, including changes in ESG and political risk considerations inherent in the new supply chain.
Finally, another risk potentially building for manufacturers in the longer term is how emissions are calculated, not only including tailpipe emissions but on the basis of ‘well to wheel’ and ‘cradle to grave’, including notably how electricity is produced, and how the car and its battery are produced and recycled. This could ultimately show a very different picture of EVs and necessitate yet another expensive technology to develop for manufacturers.
Emmanuel Bulle is Senior Director, Head of EMEA Manufacturing at Fitch Ratings
This article also appeared in Automotive World’s October 2019 report, ‘Special report: The path to the electric car – 2019 edition’, which is available now to download