In the latest instalment of our editorial series, Link, experts from our infrastructure, credit research and equity teams discuss why efforts to ‘build back better’ as economies recover from COVID-19 could further accelerate investment in electric vehicles and associated infrastructure.
7 minute read
Transport has been one of the industries hit hardest by the economic fallout from COVID-19
Transport has been one of the industries hit hardest by the economic fallout from COVID-19, as the movement of people and goods have been subject to severe restrictions.
The auto sector’s experience of the pandemic is especially complex, with the crisis happening while the industry is in the middle of a profound transformation towards a low-carbon future. The short-term reality is that lockdowns have shut factories and crushed demand. On the other hand, governments have taken significant measures to support the industry, a major employer in many countries, while travellers are likely to prefer individual cars to mass transport for some time.
Other industries linked to the auto sector have been similarly impacted; most notably oil and gas, which is suffering from a price war as well as long-term, structural decline in demand due to decarbonisation initiatives.
Will governments use the huge COVID-related incentives to force carmakers’ hand into switching to electric vehicles (EVs) at pace?
The biggest question facing the two sectors is the pressure governments will exert on them to accelerate the transition to cleaner vehicles. Will they allow companies to clear their inventories and get back to a firmer financial position, or will they use the huge COVID-related incentives to force carmakers’ hand into switching to electric vehicles (EVs) at pace?
To discuss these themes, the AIQ editorial team brought together Darryl Murphy (DM), managing director of infrastructure, Alessandro Rovelli (AR), senior credit research analyst, and Frederique Nakache (FN), European equities portfolio manager at Aviva Investors. They argue that the economic crisis could accelerate the transformation of autos and other industries, encompassing everything from infrastructure charging programmes to falling production costs.
Does COVID-19 change the investment case for the auto sector and oil and gas companies?
FN: The picture for gasoline is mixed. It is interesting to see what is happening in China after the end of lockdown; peak-hour traffic is higher than it was before lockdown. This can be explained by people being reluctant to take public transport or share cars.
Figure 1: Congestion recovers in Chinese cities
But, overall, traffic is lower with people preferring to stay in their homes, and if they’re not at work they are not travelling as much. Looking at the assumptions of the International Energy Agency and others, they indicate we will not see a return of the trend before COVID and that traffic volumes will be much lower.1
AR: Congestion in the major Chinese cities is encouraging from an automotive investor perspective, especially after a weak first quarter for carmakers, automotive suppliers and related industries like chemicals. The second quarter will likely be the worst, but I do expect a recovery in the second half of the year.
We will probably see a 20 per cent decline in car sales in 2020 and approximately an 80 per cent decline in profits
Even so, we will probably see a 20 per cent decline in car sales in 2020 and approximately an 80 per cent decline in profits. Many companies will report losses, and any profits will come from cutting costs; furloughing employees or cutting them completely. We are even seeing significant cuts in salaries in some cases.
Governments have a vital role to play in supporting the industry – they already did this in 2008 and 2009, by giving incentives to purchase new cars and scrappage schemes for older vehicles. It worked well in 2009, and it can work again. Germany has set aside €850 billion to help companies through the pandemic and the most efficient way to kickstart the German economy, which is dependent on the auto industry to a large extent, is to give incentives and then rely on the multiplier effect.
DM: The low-carbon transition is clearly a huge issue in the car industry. A number of countries have resisted an obvious step, which is accelerating the scrappage of diesel cars.2 Does the economic necessity override the push to become greener?
AR: Germany has introduced a scrappage scheme to encourage buying battery-powered vehicles over diesel or petrol vehicles. But there is still a decent amount of inventory for car companies and they will want this to be cleared. The UK government is ruling out any scrappage scheme for now.3
Electrification of the auto sector will require investment in EV charging infrastructure. Are oil companies, which are having to adjust to a low-carbon world, and governments genuinely committed to deliver this?
FN: It is worth mentioning what oil companies said in terms of their renewables capital expenditure plans in their first-quarter results. Despite economic pressures, they committed to devoting part of their capex to these areas and even increasing it alongside investment in EV infrastructure, as well as hydrogen and biofuels. This trend is accelerating; partly because of investor pressure but also customer demand.
DM: EV charging infrastructure is interesting, but in the UK, it doesn’t seem like there is a grand plan from the government. The approach is very laissez faire, with almost an expectation market forces will be enough, particularly a faith that oil companies will help build the network.
FN: Across Europe, there are differences between companies in terms of the size of their commitment and what they are focusing on. ENI, for example, has invested a lot in EV charging stations, but Total is waiting for government support as profitability is not currently high enough – it wants to see some form of risk-sharing, with governments and perhaps auto companies. More broadly, I think it is more convinced about investing in hydrogen.
It is the same with biofuels; the projects are already there in Europe and some states in the US. Oil companies can see a quicker return on their investments, so the capex commitment is easier. Just as in areas like solar and windfarms, the technology is established, and the returns are there. As such, there is more visibility.
Oil companies will increasingly reference EV in their long-term strategy announcements
All the oil companies have retail station networks. It might seem easy to provide EV charging facilities there, but it isn’t, as they need infrastructure and cables from the utility companies. Everyone would benefit, but it comes down to cost. This is why governments have a role to play to share the cost and risk, and to create incentives for development overall.
However, I do believe oil companies will increasingly reference EV in their long-term strategy announcements, particularly the likes of BP and Repsol. I would not be surprised to see a big increase in capex there.
AR: Tesla has clearly led the way in the auto sector. It was the first to build an electric car and the infrastructure to go with it; the so-called superchargers that are very developed already in North America and Europe. A lot of companies will try to replicate what Tesla has done over the next five years.
I believe Tesla is thinking of making its infrastructure interchangeable. There is also a big consortium between Volkswagen, BMW, Daimler and Ford investing in a parallel infrastructure – ideally you would want it to converge with the Tesla infrastructure. It makes sense to have one standard.
During the COVID crisis, no carmaker has brought into question their commitment to stick to 2021/22 stricter emissions requirements
In Europe, around 15 per cent of car sales have electrified power traits – one third of those are EVs, one third plug-in hybrids and one third mild hybrids. It is interesting that during the COVID crisis, no carmaker has brought into question their commitment to stick to 2021/22 stricter emissions requirements. The auto industry in Europe claims to have carried out the biggest R&D [spending] to meet stricter emissions targets; around 25 to 30 per cent of the total. The trend is encouraging.
The other point is that Volkswagen, which is the largest EV player after Tesla, is providing customers with charging equipment they can use at home. Over the next couple of years, 80 per cent of their charging may be done at home. There is no point spending all that money on infrastructure in the UK and elsewhere if charging times are too long or cars cannot go far enough. Perhaps it works for people in Lille or Manchester if they are only using their cars to go to work or to the shops. They can charge the vehicles overnight at home and will have enough power for their needs.
What will the next ten years look like?
DM: I have seen a number of reports with wildly varying projections on the level of EV take-up over the next decade. It is difficult to get a firm grasp on the pace and scale of change.
AR: A consensus is emerging that the cost to build an electric car will be the same as a combustion engine car within the next three years. We know things are challenging right now for economies, but carmakers will sell EVs because the total cost of ownership has become much cheaper for consumers.
They save on gas and other costs such as congestion charges, so EVs are already a winning proposition in the medium-sized premium segment. They are at 15 per cent in terms of new sales; this could easily rise to 30 or 40 per cent by 2025 including plug-in hybrids and mild hybrids.
DM: In infrastructure circles, people have looked at this with an eye on autonomous vehicles (AVs). We often have debates about the future of cities and what that looks like. There is a clear direction towards clean energy, and that is where the knock-on effect will be of this move to EVs.
The increase in EVs doesn’t materially change the infrastructure network or the way we live our lives from a transport point of view
The increase in EVs doesn’t materially change the infrastructure network or the way we live our lives from a transport point of view. The AV impact is potentially much more profound as far as the forms of transport and society goes, but that world feels a long way off and a distant dream.
AR: COVID has had an impact on AVs, the investment has slowed down. Both Google and Uber, who were among the biggest investors, have scaled back; so have General Motors, Ford and Volkswagen. This will push the development of AV out further.
EV investments are already so far ahead, it wouldn’t make sense to cut them, especially given the pressure to cut emissions. With AV, there isn’t the same pressure. Even companies with a lot of cash like Google and Amazon, which could be disruptors, have other priorities right now, like maintaining advertising growth.
Are market dislocations leading to attractive investment opportunities?
AR: If you believe, as I do, that car companies will recover fairly rapidly, with people potentially driving more rather than flying in the short term, valuations – particularly on the equities side – are very cheap. It depends on the economy, but there could be opportunities, especially if some governments announce support measures.
FN: Clearly, the oil and gas sector has been badly hit by the crisis. This is a cyclical market and, even if there is a lag between the supply response and demand response, I expect supply to remain down even when demand recovers.
The second quarter will be a big test for the oil and gas sector
There is still a big question mark over the long-term oil price. The second quarter will be a big test for the sector; we will see who is resilient, who has a low breakeven point, and who has done some integration/restructuring to offset the economic trouble.
Margins for petrochemicals are very strong; the oil companies who have exposure to this market should be better positioned to withstand the crisis. The same goes for those who have invested in renewables – companies like Neste, which has invested in biofuels production.
I do think oil and gas companies are going to focus a lot on their long-term strategies, particularly on how they adapt to the energy transition. It will not be driven by greenwashing, but by a long-term view.
Could COVID accelerate the reshoring of supply chains?
AR: Supply chains are a big focus for the auto sector. COVID-19 has caused some stresses, but we are not seeing car companies in Europe waiting to get all their parts from China. The trend towards reshoring was already very much on the minds of company executives, largely due to President Trump and the threat of higher tariffs.
There was talk of three regions for auto manufacturing: North America, with a large base in Mexico; Europe, with a lot of production shifting from west to east; and China, with production moving inland from the coast in recent years. Those regions were on the verge of self-sufficiency, and over the medium to long term, COVID will accelerate that trend. However, ownership of the means of production will remain mixed. German companies will continue operating in China, and US and Asian companies in Europe, for example.