Germany will be first in EVs – but don't invest in VW!

Mike Smitka

The first big market for EVs will be the EU, not China and certainly not the US. This is not common wisdom: after all, isn't Beijing pushing EV technology, including forcing firms to buy batteries from "domestic" players? And then there's Tesla in the US. Of course in terms of hype no one can beat Elon Musk (and in semiconductors, NVDIA). But against global production of 90+ million units Tesla's puny 80,000 units in 2016 is on the order of the reporting errors in global sales data. They aren't disrupting anything. Instead the disruptor will be VW, adding to the presence of Renault and Nissan.

This was one of my key takeaways from the 25th GERPISA conference in Paris in June, garnered across 4 days of R&D center visits, presentations and conversations. [For fellow researchers, next year's GERPISA will meet in June in Sao Paulo Brasil.]

On the regulatory side, EU fuel efficiency rules cinch tighter in 2020-21, and thanks in part to VW the test cycle standards – currently the New European Driving Cycle – will be tightened to better reflect actual EU driving patterns. (Currently, for example, back seats can be removed and the alternator disconnected, while accelerations are unrealistically slow and idles too frequent.) That will make it extremely difficult to meet CO2 mandates. Reconfiguring diesel systems that passed due to "cheats" will lower their efficiency and raise their costs. Keeping to a diesel-centric strategy won't work. This will be a particular challenge for VW. At the same time, France was already moving to limit the presence of diesels in urban areas.

Hence BEVs (battery electric vehicles). VW just announced they've frozen the design of their first model, to be launched in 2020, and will thereafter start turning over their fleet to BEV models. For now they are basing their model on the underlying architecture of the Gulf. However, they are working on new architectures that will facilitate flat battery packs – we at GERPISA visited Renault's vehicle competitive teardown facility, and that's one of the things they look for in their analysis of new platforms.

Then there are batteries. VW will not make their own cells, reflecting both a lack of internal capabilities and to maintain the flexibility to shift their sourcing as cell technology advances. But they will make their own modules and packs, to better control weight and safety. Those are also heavy and bulky, so doing this in their assembly plants makes sense. Ditto Daimler.

Now VW is not alone, even if their diesel-heavy strategy and legal issues places them in an awkward position. Renault continues to update the Clio (and Nissan the Leaf), and both are poised to launch additional vehicles in line with demand. Meanwhile, the various EU members are building out base infrastructure. France already has charging capabilities along major highways; Norway (a small market!) is already 30+% electric. The government role is central, because infrastructure is expensive, and needs to be pervasive. Private efforts suffer from chicken-and-egg issues. For-profit charging ventures inevitably focus on dense areas. But for consumers to make a BEV their sole vehicle, national availability helps: there's always that trip to the beach, or a quick weekend getaway to the countryside. Such locations wouldn't generate enough business to make it pay to set up charging, at least early in the rollout of BEVs. But their presence facilitates market expansion.

After hearing pieces of this story from multiple people, I'm now convinced that BEVs will happen sooner than I expected in Europe. Key is that they will now provide a better value proposition relative to diesels, which intrinsically sip rather than gulp fuel. But batteries remain expensive, so that's not good news for VW. To meet efficiency standards they'll need to sell a lot of EVs. To do so on a competitive basis against the standard gasoline vehicles from other manufacturers means VW will lose money on each one it sells, to the tune of billions of euros as volumes rise. So VW has solved the subsidy dilemma: economies of scale and competitive costs can't be achieved without somehow getting BEV volumes up. EU incentives aren't enough; paying for a test fleet is one thing, doing it for millions of cars is another. VW incentives may well make the difference – indeed, Volkswagen is betting the company that that will be the case. In the interim, though, VW will not be particularly profitable. That interim will extent until 2027, at which point costs will fall, or VW will. Don't invest in VW!

...for the next 10 years, don't invest in VW...

For the US, the current administration is hostile to environmental issues, and is promising to roll back fuel efficiency standards (which will benefit luxury car makers, primarily German, and hence is not particularly helpful to domestic manufacturing). At the same time, the current Congress seems unable to pass any legislation, much less focus on such long-run issues as energy policy. That may change over the next couple elections, but for the time being there will be no national infrastructure policy in the US, and without that BEVs will remain a niche product. Yes, the fines VW is paying will be used to build charging infrastructure, particularly in California. But there's no national vision behind it, only an attempt of VW to get some modest indirect benefit out of their fraud settlement.

Then there's China. For the same budgetary reasons as elsewhere, Beijing will rein in central government subsidies by 2020. Yes, they want electric vehicles, they want to have a presence in new technologies. No, they don't want to pay for it. Economic nationalism fails as a policy when it requires spending serious money. Meanwhile Panasonic and others are building plants there, suggesting that a "Chinese companies first" stance will work no better there than it has in the passenger car market, where VW and GM are #1 and #2. In fact, China has already relaxed its stated limitations on foreign firms setting up new joint ventures: new ones are fine if they're for EVs.

...China may be the largest single BEV market, but it lives on subsidies and those are fading...

One presentation at GERPISA made that clear, using insurance data (not registration data, known to be misleading due to false registrations by various corrupt "car companies" that let them pocket government EV subsidies without actually making vehicles). As everywhere, BEVs are a small share of the market. Once the data were disaggregated geographically, it turns out that in many regions there are essentially no sales. In contrast, in some metropolitan areas BEVs appeared quite popular.

Ah, but the details! Tomasso Pardi of ENS-Paris Saclav, the Director of GERPISA, together with Deng Xiaoxiang presented those. In such cities BEVs qualified for a license plate at no cost and with no wait, while buying a plate for an ICE (internal combustion engine) car requires entering a lottery with average wait times of 2 years, and paying up to $12,000 in fees. The BEV exemption thus provides a huge implicit subsidy – but the BEV quota is finite. In one major city the quota of 50,000 was quickly filled. Total BEV sales: 50,800. Absent subsidies, there's as yet no market for BEVs in China, and these subsidies are not set to expand. At the national level they are already shrinking, and there's no systematic rollout of charging infrastructure. Instead, we have owners dropping wires from the window of 5th floor apartments to let them charge their cars. [There were a couple news stories last year on this, if I can find the links I'll edit them into this post.] So while China may be the largest single BEV market, that's due to a confluence of idiosyncratic and transient subsidies, not to effective policy or consumer demand.

So in the end the EU will be first. What is not yet know is whether battery prices will fall sufficiently to become competitive with ICEs. After all, ICE costs are also falling – a decade ago, did anyone foresee "real" cars running on 3-cylinder engines? Lower component count aside, those save weight in a manner that batteries don't, and so allow downsizing in suspensions, frames – everywhere! – with attendant cost reductions. No current commercial battery technology can offer those indirect savings. Even if things go well, it will still be well into the 2030s before EVs will comprise half of sales in development markets. By that time biofuels will also have advanced. My own belief is that in 2030 we'll see a variety of drivetrains coexisting in the global market, with variations in dominant power sources from country to country.