A short history of (ev)erything
Although EVs are seen by many as a new technology, the first commercially available models date from the 19th century (in 1900, electric vehicles accounted for around two-thirds of vehicles on the road in the US1 before cheaper technology and even cheaper fuel led to the dominance of the ICE).
A false dawn occurred for EVs in the 1990s, after the US state of California passed the zero-emissions vehicle (ZEV) mandate. This legislation required the seven major US auto manufacturers to offer electric vehicles in order to continue sales of petrol vehicles in the state. However, pressure from lobbying groups resulted in the repeal of the law and the withdrawal of EVs from sale, a story examined in the documentary Who Killed The Electric Car?
Since then, while petrol-electric hybrid vehicles (PHEVs) have captured a small but increasing share of the global market, EVs have remained little more than an automotive sideshow. While Tesla and its charismatic CEO Elon Musk have garnered plenty of media attention, actual EV market penetration has remained minimal: global sales of EVs were still below 2% of the market in 20162.
Figure 1. With the exception of Norway, EV usage remains small but has accelerated quickly
Regulation: in the driving seat
Recently however, environmental concerns have led to regulation once again becoming a key driver towards alternative fuels, this time on a global scale. Air pollution is a major issue not only in the West but also in emerging markets, including India and most significantly China, which produced 43% of global EVs in 2016 and overtook the US for having the highest number of EVs on the road3.
China has rolled out incentives and regulations including consumer grants and subsidised charging stations, as well as a requirement for any manufacturer producing or importing more than 30,000 cars to make EV sales 10% of their total in 2019 (rising to 12% in 2020)4.
The European Union (EU) has the strictest rules governing the use of ICEs, which are responsible for more than 10% of CO2 emissions across the bloc. In response, the EU has set incremental targets designed for gradually reducing toxic emissions, with the next deadline falling in 2021. It specifies that a maximum of 95g of CO2 per kilometre, a progression from the 130g target in 2015 must be the fleet average for all cars.
Meanwhile, Norway leads the world in terms of market penetration, with plug-in vehicles comprising just over 39% of sales in 2017, and is currently scheduled to be the first country to ban ICE sales, in 20255,6. And California has returned to its ZEV approach, with a goal of 1.5m EVs on the road by 2025 and a total ICE ban by 20407,8.
Figure 2. EVs: market share by new registration, 2016
Adding to the effect, municipalities are also turning to EVs as a solution to local pollution issues, with cities across the globe introducing low-emission zones, as well as measures including dedicated parking spaces, subsidised charging stations and tax incentives designed to boost EV uptake.
The EV tipping point
Until recently, many producers remained focused on improving the efficiency of their ICE vehicles in order to reduce their average fleet emissions. However, several factors are combining to make this approach less tenable even in the medium term.
In Europe, the popularity of diesel cars – once encouraged by the EU as a more fuel-efficient alternative to petrol – is being undermined both by the aftermath of the VW emissions scandal and increasing concerns over air pollution (diesel emissions have much higher levels of harmful particulates than petrol, and are therefore no longer considered as a greener alternative). Diesel sales in Europe – which have historically been far higher than in the US and China – are now predicted to drop from 50% of the market in 2016 to 30% in 2025, while global sales are set to plummet from 13.5% to 4%9. This threatens manufacturers’ ability to meet the EU 2021 regulation for average fleet emissions, and elevates EVs as a more viable means of achieving the target and avoiding large fines.
Figure 3. The EU's emissions-reduction targets for 2015 and 2021
In addition, new regulation mandating that diesel-car emissions tests are performed on the road instead of a laboratory. (The controlled environment of a lab allowed VW to install the infamous ‘defeat devices’ that enabled its diesel cars to cheat emissions tests.) This scrutiny, plus the growing awareness that diesel cars are no longer considered more environmentally friendly, should further incentivise manufacturers to invest in electrified motoring.
Furthermore, the lower oil price and auto dealers' sales incentives have helped sustain the long-running consumer trend for SUVs ‘crossovers’ – cars which combine the look and feel of SUVs with better road manners and less focus on four-wheel-drive and off-road ability – thereby impeding manufacturers’ ability to reduce emissions across their fleets.
As a result of these factors, the tipping point for EV, which once appeared far down the road, looks to be drawing rapidly closer: estimates vary considerably but the general trend is significantly up: in 2017 Exxon Mobil revised its figures from 65m to 100m EVs on the road by 2040, while OPEC raised its from 46m to 266m. Meanwhile the International Energy Agency more than doubled its central forecast for EVs, raising its 2030 EV fleet size estimate to 58m from 23m10.
Off-road: assessing the broader impact of EVs
Manufacturers change gear
Behind the Tesla-driven headlines, mainstream manufacturers such as Renault-Nissan, Honda, Toyota and BMW have long been pursuing the development of alternative power sources for their vehicles. However, regulatory change and consumer pressures are causing a step-change in approach.
Confronted by the potential cost in terms of regulatory fines – and the reputational damage such breaches will incur – the more forward-looking mainstream producers are making significant bets on EVs.
Most dramatically, in 2017 Volvo announced its range would go ‘all electric’ in 2019, although by this they actually mean all their cars will have an electric element to their propulsion systems, rather than that they will no longer produce ICE vehicles at all11. Virtually every major manufacturer is trumpeting a commitment to EVs: in the US, GM plans to introduce 20 EV models by 2023 and Ford has announced an $11bn investment in the technology and aims to launch 16 EV models by 2022; while in Europe, VW aims for EVs to account for 20-25% of its total sales by 2025 and Daimler has announced that Mercedes will put 10 EV models on the road by 202212,13. This mass-market momentum, driven by ongoing reductions in the cost of producing pure EVs, is critical to the growth of the market.
The road ahead
In the short term, the barriers to EV uptake in terms of economics and convenience may still tend to trump any environmental rationale for most buyers. However, the expected shifts in the landscape we have outlined, coupled with the declining cost curve and financing structures such as battery leasing which reduce upfront cost, are likely to change consumer behaviour in the near-to-medium term.
Implications for Hermes Credit
There are significant synergies between EVs, autonomous driving, shared mobility and connectivity. These need to be considered in tandem to enable a deeper understanding of how the automotive market will evolve. We have seen a significant acceleration in investment plans and dialogues about EVs from OEMs and auto parts suppliers recently; companies involved in the sector must position themselves now or risk being left behind, so this topic needs to be taken into account by credit investors.
In the US auto industry we tend to favour General Motors (GM) over Ford, and hold GM credit in our portfolio. GM has recovered from bankruptcy in 2009 to become an investment-grade company, and now has a deeper exposure to motoring trends and stronger geographical diversification than Ford. It already has a mass-market EV, the Chevy Bolt, on the road, which was the second-most-popular EV in the US behind Tesla in 2017.
At an investor day in November 2017, GM announced significant progress on reducing battery cost, thereby increasing EV profitability. GM also has a more robust market position in China than Ford and has exited its weak European operations (it sold Opel to Peugeot in 2017), relieving it of the pressure of meeting EU regulatory targets.
In contrast, Ford seems to be in GM’s rear-view mirror. While its new CEO announced a significant boost in EV investment at the Detroit Auto Show in January 2018 (up from the previous figure of $4.5bn to $11bn from now until 2022), we still need to see how Ford delivers on this promise given its limited experience in producing EVs. Ford also remains exposed to the challenging EU market, and has a weaker foothold in China.
Figure 7. GM is in the EV fast lane (click the image below)
Credit profiles for the two companies are broadly comparable: both have significantly lowered fixed costs since the financial crisis, reducing the sales volumes required to reach break-even, while also achieving investment-grade ratings and net cash positions in their industrial divisions, which are supported by robust liquidity. While cash generation from both companies is healthy, it is typically consumed by capital expenditures and some distributions to shareholders. Even if this regard, however, GM seems more robust with a stronger operating margin and free cash flow generation.
Overall, we prefer GM’s long-term strategy and commitment to future mobility. Until very recently, Ford seemed to have been thinking more medium-term and, as a consequence, may struggle to catch up. Until the Detroit Auto Show in mid-January, GM CDS was trading wider relative to Ford despite its stronger business and financial profile, but this trend has now reversed after GM announced better-than-expected Q4 2017 and 2018 guidance and Ford’s 2018 expectations were disappointing. We believe this trend will persist, and GM should continue to trade inside Ford.
Figure 8. GM v Ford: CDS spread differential