|August 29, 2016|
The Slow Death of Diesel
|Oil industry investors are all too familiar with the concept of "stranded assets": the risk that climate policies make hydrocarbon resources financially unviable. It's not just oil. In Europe, coal and gas-fired power stations have been left stranded by solar and wind's ascendance, resulting in billions of euros of impairments.|
There are reasons to think Europe's autos industry might be sidelined too.
Carmakers outsource a lot to suppliers, but still insist on building their own combustion engines. They form the bedrock of brand identity and the added value in manufacturing. The effort still consumes billions of euros in capital, but the assets risk being stranded by the rise of electric vehicles.
The danger's acute in Europe because carbon dioxide emissions rules are stricter than in the U.S. The big bet on diesel by the continent's carmakers (the chart below shows their percentage of diesel sales in Europe) just makes things worse. Thanks in part to Volkswagen, it's not a technology winning many friends.
For smaller cars in particular, the technical effort of making diesel engines compliant is becoming uneconomical. While more than half the cars sold in the continent are diesel-powered, consultants at Alix Partners expect this to be just 9 percent in 2030. Combustion engine plants will close:
The number of plants in Europe producing combustion engines is set to shrink.
The problem for the industry is that the plants, technology and tools needed to make combustion engines, vehicle transmissions and gearboxes, make up a big chunk of company balance sheets. As Philippe Houchois at Jefferies points out, there's a real risk that Europe's autos industry will have to write down investments.
In the Balance
If diesel's demise is rapid and electric vehicles arrive quickly, some of these assets could be at risk
It's hard to say by how much because there isn't much detail on those balance sheets. But you get some indication about the industry's exposure from Fiat Chrysler, which estimates that powertrain tooling and R&D is 20 percent of the cost of developing a vehicle.
Engineering the Car
Developing engines is a costly business so it's crucial to build the right technology
Tesla, the electric bogeyman to Germany's wheezing carmakers, has its own problems, as chronicled by my colleague Liam Denning. But Elon Musk won't have to write down a bunch of legacy diesel plants. It's no wonder carmakers trade on such lowly earnings multiples.
The balance sheet hit will depend on how quickly electric vehicles take off. They account for less than 2 percent of Europe's car sales and the industry thought they'd be a minority pursuit for years, giving it time to depreciate investments at a manageable pace.
Yet with battery costs plummeting, Bloomberg New Energy Finance expects the cost of owning an electric vehicle to fall below conventional fuel vehicles as soon as 2022. Having dragged its heels, even Volkswagen says as many as one quarter of its sales will be electric cars by 2025.
Ideally, carmakers would halt diesel spending. Unfortunately, they'll have to keep investing to hit Europe's tough 2021 emission targets. Electric cars won't have picked up the slack by then. So they're stuck. Daimler announced a 3 billion euro ($3.4 billion) investment in diesel engines this year. It says it still sees a long future for combustion engines -- both for new cars and spares.
VW's new boss Matthias Mueller at least seems to recognize the danger. He's said there may be a time when it's no longer worth investing in diesel. BMW's chief Harald Krueger says similar. But that time's getting uncomfortably close.
There are things that can be done to smooth the transition. Besides cutting diesel investment to the minimum, carmakers could partner with rivals. Engine joint ventures already exist: Renault has one with Daimler.
Trade unions will demand carmakers preserve jobs, so expect some to try converting combustion engine factories to electric technology. VW is among those considering investments in battery production.
But making electric motors and transmissions is much less complicated than combustion engines, meaning there's less value added by carmakers. Some may outsource to a supplier. Meanwhile, battery production won't be labour intensive, otherwise costs won't fall enough to make electric vehicles economical.
With the demise of diesel looking assured, employees and investors face an electric shock.