EU Fuel Economy Rule Violations Could Cost Manufacturers Big.
“We expect the EU to stand firmly behind the regulation and to strictly enforce fines for non-compliance”
European auto makers face massive fines if they haven’t slashed the fuel consumption of their vehicles by 2021, and a couple of reports published this week suggest some of the biggest manufacturers will be caught out in a big way.
Investment bank UBS, in a report entitled “CO2 compliance in EU – a disaster in the making?” said PSA Group of France faces a 25% hit to its profits and Fiat Chrysler Automobiles (FCA) will lose 20%. BMW, Mercedes parent Daimler and Renault of France are less vulnerable. The EU regulations express fuel consumption in terms of grams of carbon dioxide (CO2) emitted per kilometer.
Moody’s Investors Service said Volkswagen, Europe’s biggest auto maker, will be hit hard and adds Hyundai/Kia of Korea and Ford Motor to the list. Moody’s also said Toyota leads the way in compliance in Europe. Toyota never fully embraced Europe’s love affair with diesel, and has led the way with gasoline electric hybrids.
The trouble is, the EU’s regulations to curb fuel consumption assume electric cars will be available to take up the slack. That is not a foregone conclusion. Manufacturers worry that after spending massive amounts of money investing in electric cars, buyers will shun them on grounds of price and utility.
The EU has mandated average fuel economy across manufacturer’s fleets the equivalent of about 57 U.S. miles per gallon mpg in 2021, up from 41.9 miles per U.S. gallon in 2015, and 92 miles per U.S. gallon by 2030. This can only be achieved by a huge, and maybe impossible, contribution from expensive electric cars. The EU now insists on a 37.5% cut in carbon dioxide (CO2) by 2030 to 59 g/km from 2021’s 95 g/km.
The European Car Manufacturers Association is angry, saying the target for 2030 is totally unrealistic, and is driven purely by political motives, without taking technological and socio-economic realities into account. It hasn’t got quite so excited about the 2020/21 targets, but perhaps it should.
Diesel engines were supposed to provide much of the fuel efficiency to meet the targets, but following the VW dieselgate scandal, and mounting evidence that at least older diesel engines are spewing out health-damaging poisons, diesels have fallen out of favor. In 2018, diesel powered cars and SUVs market share in Europe fell to 36% from 44% in 2017, and compared with a peak of 56% in 2011.
UBS, in its report, said in 2018 emissions of CO2 were 25% above target on average. It expects EU regulators to show no mercy if the industry lags.
“We expect the EU to stand firmly behind the regulation and to strictly enforce fines for non-compliance. Complying means about 7.4 billion euros ($8.7 billion) additional EBIT (earnings before interest and tax) for headwinds for EU (manufacturers), 14% of sector 2018 EBIT, a burden still under-estimated by consensus,” UBS analyst Patrick Hummel said.
Moody’s estimates fines for non-compliance could range from 2 billion euros ($2.3 billion) across the industry to 11 billion euros ($12.9 billion) depending on the severity of the failure. This will also provide an incentive for carmakers to launch new electric or hybrid vehicles.
“The potential for large fines is acting as a big incentive to launch unprecedented numbers of new electric or hybrid models over the next year,” said James Leaton, analyst at Moody’s.
“Some manufacturers may fall short and have to pay fines or lose market share as they forego sales of high-emission models. Volkswagen, Fiat Chrysler, Ford, Hyundai and Kia are most exposed, based on their current gap to 2020/21 targets,” Leaton said.
Leaton said half of large European manufacturers need to take drastic action over the next two years.
Reuters’ Breaking Views column has also pointed to this potential financial black-hole for European car makers.
“New standards for fuel economy and tailpipe emissions are pushing carmakers to engineer ever-cleaner machines, and regulators are becoming more ambitious. A ban on conventional engines looms in parts of Europe, and beyond. That means frequent investment, and occasional fines. European Union rules are so exacting that Nomura estimates the industry faces almost 30 billion euros ($35 billion) of fines over the next three years,” Breaking Views columnist Katrina Hamlin said.
As manufacturers grapple with meeting the ever-tightening rules, they face a dilemma. Electric cars and hybrids are much more expensive than the cars they are replacing. Even if they succeed in producing enough high-tech cars and SUVs to meet demand, it is likely that prices will be too high and consumers will shy away.
“As many (manufacturers) executives say “we’re developing cars for the regulator, not for consumers”. The big hope is that consumer demand for electric vehicles will suddenly surge. But if that doesn’t happen, there is a huge risk of surplus electric vehicle capacity and weak pricing – as soon as 2021,” said Bernstein Research analyst Max Warburton in a recent report.
“At that point, either regulators will need to back off on their targets, or manufacturers will need to take an axe to costs,” Warburton said.
UBS said in its report that manufacturers will bring forward a mix of 48 volt mild-hybrid, plug-in hybrids and all-electric cars. It said VW, its top investment pick, has aggressively pursued a battery-electric policy. BMW and PSA will have to increase spending on battery electric vehicles after 2021 when their plug-in hybrids don’t do enough to meet the regulations.
Companies like VW have a target for global battery electric vehicle (BEV) sales of 25% by 2025, although for Europe this is between 15 and 18%. But many independent forecasts are much lower. Bernstein Research’s latest estimate sees BEVs accounting for 8.2% of global sales in 2025, and 3.4% for plug-in hybrid electric vehicles.