Tailpipe tangles…

I was speaking at a UK event last week and was asked a question about the impact of the Zero Emissions Vehicle Mandate – the UK legislation that will enforce 100% zero emissions car sales by 2030, five years ahead of the equivalent enforcement date in the EU.  My response was pretty brief and a bit glib (related to politicians’ focus on their next electoral test), partly because we were running over on time having gone through agency and other topics, but also because the implications are huge and far-reaching.

The UK legislation was inspired by the EU equivalent from those happy days when we were ‘in the club’ but the deadline pulled forward by five years for passenger cars because Boris Johnson wanted to show how concerned he was about the environment, and without the recent EU concession on e-fuels.  The EU regulations allow manufacturers to pool their emissions, with most groups declared so far reflecting larger family groups, e.g. Stellantis, but with some exceptions so that MG and Nio sit in the VW group for example, and Tesla, Honda and Jaguar Land Rover sit in another.  In the UK, manufacturers will be able to ‘borrow’ credits from future years which must then be repaid through over-performing in those later years, and it will also be possible to earn credits by selling zero emissions vehicles to car clubs, on the logic that one car club car replaces multiple privately owned cars.  In the EU and UK, the final rules are not yet in place, so there is still the potential for changes, and for subsequent reversals depending on the political mood.

To be clear, I am not anti-zero emissions, nor anti-electric car.  The current weather patterns are a clear enough indicator that the climate is in trouble, and road transport has to play its part in tackling that.  Unfortunately the car manufacturers lose their credibility in Brussels through the diesel emissions testing manipulation that affected VW, then caught up many other brands from 2015 onwards, which has influenced a focus on the solution rather than the outcomes, but arguably it is the outcomes – or at least how they are achieved – that might cause the greatest disruption.

The regulations require a fleet average to be achieved each year on a progressively rising scale to the respective end dates in order to avoid paying hefty fines, based on the extent to which the target has been exceeded.  This is obviously driving the growing number of zero emissions vehicles being brought to market, almost all battery electric vehicles (BEVs), but as we have seen in recent months, the demand for these is mainly coming from business customers, drawn to them by favourable tax treatment as business users, or driven to them by corporate green targets that affect company car policies.  Retail demand has remained weak due to continuing concerns on usability and the price premium over combustion engine (ICE) models.  This feeds through into weak retail demand for used models, that affects residual values and will feed through into the leasing cost for the business customers.

In the face of demand that falls below the level needed to achieve the fleet average target, manufacturers will focus their incentive spend on the BEVs, but also price ICE models at a premium to recover some of those incentive costs.  Supply of ICE models will also be restricted, particularly as year end approaches, so you can expect exceptionally high BEV mix every December.  Higher real pricing on ICE models will also deter some customers, so the overall market will probably remain lower than would otherwise be the case.  For the manufacturers who do not face these challenges directly, like Tesla, they will still be affected as the competition in BEVs will heat up.  A race to the bottom perhaps?

In an effort to protect the residuals of BEVs, manufacturers may turn to approaches that allow them to reduce the disruptive effect of visible discounting when new, such as subverted finance.  A safety valve for the initial sale is to use channels that take the car out of circulation for a while, so car-sharing subsidiaries become more attractive as a way to allow instant registration of a few thousand cars at year end, which are gradually filtered back out into the used market as and when conditions allow.  The UK provision for car club credits would take advantage of that holding pattern, but also offer the bonus of some credits on the fleet average, so they can look forward to some cheap cars!

Manufacturers will also look at defleeting approaches that allow true used transaction prices to be muddied, such as leasing cars out on a second cycle at three or four years old.  This is quite high risk as there may be an accumulating level of optimism that builds over several years until the accountants eventually cry enough, and the values need to be written down in the balance sheets of the manufacture or their finance captive.  In the UK, any manufacturers who choose to borrow forward, perhaps because of the timing of their BEV model launches, are also taking a huge risk that they will effectively be able to beat the regulatory requirement in the following years and that consumer attitudes support this.

With the manufacturer pools in the EU, particularly those that include non-family brands, the under-achievers will have a very weak hand in negotiating the price for the credits they are effectively buying from the over-achievers, so Tesla, MG and others will get further funding for their growth.  That in turn will encourage the under-achievers to resort to the other levers I have mentioned.

Taken together, what seems like a laudable goal of achieving necessary environmental goals is going to impact on every aspect of the distribution system, and all players with that – manufacturers, distributors, dealers, leasing companies, daily rental companies, car clubs – and the list could continue.  A few might manage their way through this reasonably well, but others will face serious challenges.