Save for later Print Download Share LinkedIn Twitter April 2019 Sarah Miller The old saw "as goes General Motors, so goes the nation" no longer works for the US economy, but "as goes the global auto industry, so goes oil" is an important modern-day variant. The auto industry is in trouble. Climate-change and anti-pollution regulations, bolstered by alternative-technology and manufacturing cost advances, are forcing it to accept massive change. Automakers must spend many billions to convert to electric vehicles (EVs) that will never be as profitable as the cars they replace. The center of gravity of the industry is shifting to China. And auto company equity prices are in a chronic, if sometimes volatile, slump. The course of this disruptive transportation transition will heavily impact future oil demand. It could also provide vital lessons for navigating the equally tortuous -- and closely related -- energy transition. After bouncing back vigorously from the devastating 2008 recession, automakers in Japan, South Korea, Germany and the US have hit a brick wall. For varying, sometimes mystifying reasons, unit sales have slipped over the last year or so, including in China for the first time in two decades. And that's just the tip of the troubles lurking below the surface for the industry. First, there's the costly transition to EVs. Tallies of announced corporate spending plans over the next five to 10 years run to $250 billion and more. Much analysis indicates that, at the end of it all, the overall auto sales volume will be lower because electric cars have fewer moving parts and will last longer. What's more, most existing car manufacturers won't make the batteries and many other parts, leaving them with a lesser share of the total take on each car sold. So it's basically a smaller slice of a shrinking pie. A substantial shift to fleet sales and "transportation as a service" could further reduce sales volume. Then there's self-driving, which at some uncertain point will bring in other partners to take a piece of the profits. These two projected transportation trends are related: If people don't own or drive the vehicles in which they travel, they won't care as much about having a car that sets them apart, threatening the brand loyalty and model preferences long central to auto company strategies. Even as automakers attempt to navigate this hostile terrain, trade disputes are wreaking havoc on supply chains. Auto companies bet their future on globalization even more heavily than most, moving increasingly in recent years to an organizational structure in which vehicle models for the entire world are assembled in one location, from parts made in many other spots, and then shipped back out again -- all with great consumption of marine and road fuel, of course. Companies are starting to back away from this globalized system, under pressure not only from US President Donald Trump's existing and threatened tariffs but, in addition, by the shift in demand toward China, India and other developing economies, where car prices tend to be lower and tastes regionally idiosyncratic. This geographic movement is pushing the big European, US, Japanese and South Korean producers into partnerships with domestic companies in these markets, yet again splintering meager future profits and weakening brand identification. It's hardly the business strategy you'd pick. So why have the auto companies picked it? Not because they hate oil. The answer starts with the complex worldwide mix of government regulations designed to fight climate change and localized pollution -- and the way diverse rules are affecting an industry that was aiming to become ever more globally homogenized. Fleet-average mileage standards have long been the preferred tool for reducing oil use on US roads -- except in California and like-minded US states, which also require increasing percentages of sales to be so-called zero-emission vehicles, basically EVs. The EU sets carbon-emission limits, being more open in its drive to fight climate change. China has an evolving set of rules that have of late borrowed heavily from California. Initially, automakers assumed that average-mileage regulations and emission limits could be met for decades to come with more efficient internal combustion engine (Ice) vehicles. But people kept buying SUVs and pickups, even when automakers hiked prices -- and profit margins -- on these vehicles in an attempt to direct customers toward their efficient models to meet required fleet averages. Then the diesel scandal hit. Germany's Volkswagen and other European carmakers had pushed lower-mileage diesel engines as the best path to meet carbon-emission and mileage standards, but VW -- and increasingly others -- was caught cheating on particulate and other locally dangerous emissions in a tradeoff designed to boost mileage and carbon dioxide savings. Meeting efficiency rules with Ice vehicles suddenly looked much tougher. The perception that this made EVs the only way to meet regulations was reinforced when China joined California in mandating rising EV percentages of total auto sales. Then came Tesla's sudden emergence with a highly popular luxury EV, built by a start-up company with the tech world's focus on disrupting old business models. This helped convince most carmakers that customer resistance to EVs will fall away as distances between charges and the availability of high-speed charging spread, battery and overall EV prices plunge, and EV designs emerge that conform more to preferences for SUVs and take advantage of the simpler drive trains to make interiors more appealing. Auto companies gradually accepted EVs as their fate, with varying levels of enthusiasm. Investors in the traditional auto majors were not amused. Morgan Stanley's index of global auto and auto-component company shares fell by 25% in the 12 months to end-March, more than twice the 11% dip in its comparable general market index. The big automakers in the US, Germany, Japan and South Korea mostly have price-to-earnings ratios of under 10, despite strong dividends. That's way below the P-E ratios of even the equity-market challenged oil majors. The only sizable carmaker outside China that did notably well in the stock market in 2018 was Tesla, which became a tech-style darling with a corporate valuation vying with that of traditional US auto manufacturers General Motors and Ford, even though the old-timers make a large multiple of the number of cars Tesla does, and Tesla has never made a profit on an annual basis. Whether Tesla will make it to a stable spot at the top of the industry ranks or crash and burn is anybody's guess, but its debt-driven leap into EVs has already been an industry game changer. Oil Implications If all this sounds familiar to oil executives, there's a reason. The transport transition threatens oil and gas companies nearly as much as it does automakers. Short term, the risk is that auto company weakness will infect the broader economy. In Germany, falling auto sales have been cited as a leading factor in virtually erasing economic growth since late 2018, acting as a drag on the entire EU economy. More recent auto sales declines in China, the US and elsewhere, and the possibility the US will slap higher tariffs on auto imports, increase the risk that this high-employment sector could go into a tailspin, pulling the global economy -- and oil demand -- down with it (WEO Nov.20'18). Auto trade makes up an estimated 8% of the global economy. Then there's the more direct hit oil demand looks set to take from rising EV sales. This will probably show up first in China, where EV sales more than doubled in the first quarter, despite an 11% drop in auto purchases overall. EVs now account for 4.5% of China's new auto sales, so another doubling would lift their market share close to 10%. Most of the world's big auto producers are rushing into EV manufacturing in China, usually in partnership with domestic carmakers. The result will be to create a knowledge and design base in EVs that will quickly be applied in Europe, other Asian markets and the US. Electric buses -- already widespread in China -- and delivery trucks are unlikely to be more than a couple of years behind. Just over one-quarter of oil demand is accounted for by passenger vehicles and another 17% or so by on-land freight movement. It's hard to avoid the conclusion: As goes the global auto industry, so goes oil. Sarah Miller is a former editor of Petroleum Intelligence Weekly, World Gas Intelligence and Energy Compass.