Brazil, Russia, India and China disappoint as manufacturers face investment demands of EVs © Bloomberg
Less than a third of China’s 31,000 auto dealers were profitable in the first half of 2019, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
Auto markets in the Bric countries are facing two major challenges. The first relates to the downturn already under way in the two largest markets, China and India, where 2019 sales seem likely to be at least 10 per cent below the previous year’s levels.
The second is the need for manufacturers and parts suppliers to spend billions of dollars on the transition to electric vehicles in order to meet Chinese government production targets in 2021-23.
It therefore seems probable that winners and losers will emerge over the next 18 months, as companies along the value chain find themselves short of cash to fund the new investments required.
China’s downturn is particularly important as sales in Brazil, Russia and India have already fallen by 20 per cent since peaking in 2012, as the chart below shows (January-November basis). Chinese sales have been in a downturn for more than a year, and the impact is broadening along the supply chain.
As Automotive News reported: “We knew China had been in a prolonged auto sales slump, and we knew the market was under pressure from tougher municipal and provincial emissions standards. Now, we’re seeing how these factors are devastating dealerships, to the tune of half of them being sold and several hundred being driven out of business.”
Less than a third of China’s 31,000 dealerships were profitable in the first half of 2019. The downturn is particularly bad news for western manufacturers, whose global profits have depended on China volumes.
US brands are worst hit, with January-November sales down 23 per cent due to frictions caused by the US-China trade war. General Motors reported third-quarter China sales down 17.5 per cent, continuing their slide since the second quarter of 2018, with sales also hit by strong competition in the key mid-priced sport utility vehicle segment. Ford saw its third-quarter sales fall 30 per cent — accelerating the downturn that began at the end of 2017.
French brands are having a difficult time, with volume down 54 per cent in January-November. Seventy per cent of Peugeot, Citroën and Renault’s dealerships were lossmaking in the first half of last year.
Korean brands were down 15 per cent, and even German brands had no growth over the previous year.
The problem is magnified by the fact that China’s market has seen rapid growth since 2008. Many companies and dealerships therefore assumed that the sales ramp-up from 550,000 vehicles a month in 2008 to 2m a month by 2016 was somehow “normal”. They have no concept of a slowdown, or how to survive it.
The downturn is likely to intensify as the government continues to squeeze the shadow banking sector and hence the property market. As the chart below shows, shadow lending remains well down on its earlier peaks, averaging just $67bn a month in the 10 months to October. This means, as we noted here a year ago, that “buyers can no longer count on windfall gains from property speculation to finance their purchase”.
As Reuters notes, the scale of the previous stimulus-driven growth also means that today, “much of the urban middle class has already purchased a vehicle. Household ownership rates were nearing 50 per cent in the provincial-level cities of Beijing and Tianjin and the wealthy province of Zhejiang by the end of 2017… Pushing ownership further down the income scale in urban areas as well as out into the poorer countryside is harder without generous tax incentives, plentiful credit and fast growth in incomes.”
Sales in the other Bric markets are also slowing. India’s sales were down 13 per cent at the end of November, while in Russia the industry is now forecasting a 2 per cent decline. Even in Brazil, industry trade group Anfavea has reduced its growth forecast to 8 per cent, due to the slowing Latin American economy.
The downturn creates a major dilemma for the industry, as it coincides with the need to commit to major new investments in EV manufacture.
China is proposing to set a 14 per cent target for EV production in 2021, rising to 16 per cent in 2022 and 18 per cent in 2023. Similarly, the industry ministry has called for EVs to be 25 per cent of total new car sales by 2025, and announced that “regions with ripe conditions have our support if they establish trial projects to establish no-go zones for gasoline-powered vehicles and replace them with new energy vehicles in the urban public transport system”.
Companies therefore have to move forward with EV investments, even though their profits are under pressure from the sales downturn.
Volkswagen, for example, is planning to open two Chinese EV factories this year with total capacity of 600,000 cars, and aims to produce 11.6m EVs in China by 2028. Tesla is opening capacity for 250,000 cars and plans to double production in the future.
With other manufacturers following suit, some in the industry expect EV prices to fall below those for internal combustion engines within the next two years, which would further accelerate the transition.
The industry is therefore faced with a stark choice. The need to commit to EV manufacture means there is no “business as usual” strategy for either manufacturers or parts suppliers. Those who decide to conserve their cash risk finding themselves without the relevant products and services in the world’s largest auto market.
Paul Hodges publishes The pH Report.
Major disruption is starting to occur in the world’s largest manufacturing industry. Hundreds of thousands of jobs will likely be lost in the next few years in auto manufacturing and its supply chains, as consumers move over to Electric Vehicles (EVs).
As the chart from Idaho National Laboratory confirms, EVs have relatively few parts – less than 20 in the drive-train, for example – versus 2000 for internal combustion engines (ICEs). There is much less to go wrong, so many servicing jobs will also disappear.
The auto industry itself was the product of such a paradigm shift in the early 19th century, when the horse-drawn industry mostly went out of business. Now it is seeing its own shift, as battery costs start to reach the critical $100/kWh levels at which EVs become cheaper to own and operate than ICEs.
Unfortunately, this paradigm shift is coming at a time when global sales and profits are already falling. As the chart shows, sales were down 5.4% in January-August in the Top 7 markets versus 2018. And in the Top 6 markets, outside China, they were only 4% higher than in 2007, highlighting the industry’s current over-dependence on China:
- India is suffering the most, with sales down 15% this year
- But China’s woes matter most as it is the largest global market; its sales were down 13%
- Europe was down 3% YTD, but on a weakening trend with August down 8%
- All the major countries were negative in August, with Spain down 31%
- Russia was down 2%, despite the economic boost provided by today’s relatively high oil prices
- The USA and Japan were marginally positive, up 0.4% and 0.6% respectively
- Only Brazil was showing strong growth at 9%, but was still down 28% versus its 2011 peak
EV sales, like those of used cars, are heading in the opposite direction. China currently accounts for 2/3rds of global EV sales and sold nearly 1.3m EVs in 2018 (up 62% versus 2017). They may well take 50% of the Chinese market by 2025, as the government is now focused on accelerating the transition via the rollout of a national charging network.
Interestingly, it seems that Europe is likely to emerge as the main challenger to China in the global EV market. The US has Tesla, which continues to attract vast investment from Wall Street, but it is only expected to produce a maximum of 400k cars this year. Europe, however, is ramping up EV output very fast as the Financial Times chart confirms:
- The left-hand scale shows EV prices v range (km) for EVs being released in Europe
- The right-hand scale shows the dramatic acceleration in EV launches in 2019-21
One key incentive is the manufacturers’ ability to use EV sales to gain “super-credits” in respect of the new mandatory CO2 emission levels. These are now very valuable given the loss of emission credits due to the collapse of diesel sales.
2020 is the key year for these “super-credits” as they are the equivalent of 2 cars, before scaling down to 1.67 cars in 2021 and 1.33 cars in 2022. Every gram of CO2 emissions above 95g/km will incur a fine of €95/car sold. And as Ford’s CEO has noted:
“There’s only going to be a few winners who create the platforms for the future.”
VW NOW HAVE BATTERY COSTS AT BELOW $100/kWh
VW is likely to be one of the Winners in the new market. It is planning an €80bn spend to produce 70 EV models based on standardised motors, batteries and other components. This will enable it to reduce costs and accelerate the roll-out:
- Its new new flagship ID.3 model will go on sale next year at a typical mid-market price of €30k ($34k)
- Having disrupted that market segment, it will then expand into cheaper models
- And it expects a quarter of its European sales to run on battery power by 2025.
The key issue, of course, is battery cost. $100/kWh is the tipping point at which it becomes cheaper to run an EV than an ICE. And now VW are claiming to have achieved this for the ID.3 model.
Once this becomes clearly established, EV sales will enter a virtuous circle, as buyers realise that the resale value of ICE models is likely to fall quite sharply. Diesel cars have already seen this process in action as a result of the “dieselgate” scandal – they were just 31% of European sales in Q2, versus 52% in 2015 .
One other factor is likely to prove critical. The media hype around Tesla has led to an assumption that individuals will lead the transition to battery power. But in reality, fleet owners are far more likely to transition first:
- They have a laser-like focus on costs and often operate on relatively regular routes in city centres
- They don’t have the “range anxiety” of private motorists and can easily recharge overnight in depots
The problem for auto companies, their investors and their supply chain, is that the disruption caused by the paradigm shift will create a few Winners – and many Losers – as Ford warned.
Those who delay making the investments required are almost certain to become Losers. The reason is simple – if today’s decline in auto sales accelerates, as seems likely, the investment needed for EVs will simply become unaffordable for many companies.
China is now developing a used car market for the first time in its history. This means the end of global auto sales growth, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
China’s car market has been key to the recovery in global auto sales growth since 2009, as the chart shows.
Its passenger car sales in the first half of each year have risen threefold between 2007 and 2017, from 3.1m to 11.3m today, while sales in the other top six markets have only just managed to recover to 2007 levels.
But now major change is coming to China’s market from two directions.
The first sign of change is the fact that H1 sales rose just 2.7% this year. This is the lowest increase since our records began in 2005 (when sales were just 1.8m), and compares with an 11% rise last year.
Official forecasts for full-year growth have also been revised down, to between 1% and 4%, by the manufacturers’ association. A further sign of the slowdown is the rise in price discounting, with Ford China suggesting prices were down 4% on average in the first half.
The second change may be even more important from a longer-term perspective. It seems likely that China’s used car market is poised for major growth. As the second chart shows, only 10m used cars were sold last year, versus 24m new cars.
Yet used car sales are typically between 2 and 2.5 times new car sales in other large markets such as the US, where 2016 saw 39m used car sales versus 18m new car sales.
The background to this unusual situation is that China’s new car sales were relatively small until the government’s stimulus programme began in 2009. Their quality was also poor, as most cars were produced domestically and only lasted an average of three years. As a result:
The auto market only really began to take off in 2009 under the influence of the stimulus packages, when annual new car sales jumped 53% from 6.7m to 10.3m. About 200m Chinese were able to drive a car in that year, and the stimulus programme suddenly provided them with the cash to buy one
Used car sales were much slower to develop, as it took time for the introduction of western manufacturing techniques to gradually extend the average life of a car from 3 years in 2012 to 4.5 years today. But now the pace of change is rising, and it is expected to reach 10 years by 2020
The chart also shows our forecasts for the used car market out to 2020, when we expect used car sales to equal new car sales at 23.5m. This would still only represent a 1x ratio, but the forecast is in line with a new report from Guangzhou-based analysts Piston, who told WardsAuto:
“The used-car market in China is expected to have an explosion in the coming decade, because the ratio of used to new is [the opposite of that in] the US.”
One sign of the change under way was seen last month, when Guazi.com, China’s largest used car trading site, was able to raise a further $400m from investors to expand its service.
Guazi, like BMW and others, have seen that the used car market offers very favourable prospects for growth prospect — as long as attention is paid to boosting buyer confidence by providing sensible warranties and service packages.
Local governments have also played their part under pressure from central government. The state-owned China Daily reports that 135 local authorities have now removed barriers that prevented used cars from one province being sold in another. The effect of these changes is having an effect, with used car sales in January-May jumping 21% versus 2016.
Such strong growth rates, and the slowdown in new car sales, suggest China’s auto market may have reached a tipping point.
All good things come to an end eventually, and it seems prudent to assume that China will no longer be the main support for global auto sales. We expect China’s new car sales to plateau because of the combined impact of the end of stimulus (as discussed here in June), and the rise of used car sales, as these will inevitably cannibalise their volumes to some extent.
Clearly this is not good news for those western manufacturers that have made China the focus of their growth plans in recent years. And there may be worse news in store, given the government’s determination to combat urban pollution by promoting sales of electric vehicles and car-sharing.
Yet it will be good news for those prepared to develop new, more service-related business models. Used-car sales themselves can be highly profitable, while servicing and spare parts supply are likely to become equally attractive opportunities.
Paul Hodges publishes The pH Report.
Oil markets have been at the centre of the recent myth that economic recovery was finally underway. The theory was that rising inflation, caused by rising oil prices, meant consumer demand was increasing. In turn, this meant that the central banks had finally achieved their aim of restoring economic growth via their zero interest rate policy.
This theory was first undermined in 2014, when oil prices began their fall. There had never been a shortage of oil. Prices rose to $125/bbl simply because the hedge funds saw commodities like oil as a ‘store of value’ against the Federal Reserve’s policy of weakening the dollar.
The theory sounded attractive and plenty of people had initially made a lot of money from believing it. But it didn’t mean that the global economy had recovered. And by August 2014, as I highlighted at the time, oil prices were starting to collapse under the weight of excess supply. As I also suggested in the same post, this meant “major oil price volatility is now likely”. By luck or judgement, this has indeed since occurred, as the chart shows:
□ The 2009 – 2014 rally was dominated by “technical trading”, as oil markets lost their role of “price discovery”
□ August – December 2014 then saw prices crash to $45/bbl
□ Prices rose nearly 50% in early 2015 in a “failed rally”, as hedge funds assumed prices would quickly recover
□ Prices then halved to $27/bbl in January 2016 as the reality of over-supply swamped the market
□ Since then prices have doubled as OPEC combined with the hedge funds to try and push prices higher
□ This rally now seems to have failed, as US shale supply continues to increase
In reality, as I discussed last month, this final rally merely enabled new US production to be financed. The US oil rig count has doubled over the past year, and each rig is now 3x more productive than in 2014. At the same time, the medium-term outlook for oil demand in the key transport sector is becoming more doubtful, with China and India both now moving towards Electric Vehicles as a way of reducing their high levels of air pollution.
A measure of how far the market has moved was seen at last week’s Clean Energy Ministerial meeting, which:
“Set a collective aspirational goal for all EVI members of a 30% market share for electric vehicles (EVs) by 2030. It does so with the aim of taking advantage of the multiple benefits offered by electric mobility for innovation, economic and industrial development, energy security, and reduction of local air pollution.”
Already oil price targets, even amongst the optimists, are now being revised downwards. Nobody now talks about a “quick return” to $100/bbl, or even to $70/bbl. Instead the hope is that possibly they might return to $60/bbl at some point in the future – others merely hope that today’s $50/bbl level can be maintained.
Hope, however, is not a strategy. And in the absence of major geopolitical disruption, it seems likely that the hedge funds will continue to withdraw from the market and leave supply/demand fundamentals to once again set the price. In turn, this will challenge the reflation and recovery myth that grew up whilst the funds were boosting their bets on the oil and commodity markets.
As the second chart shows, inflation has already begun to weaken in China as well as in the US and Eurozone economies. China’s move away from stimulus will help to accelerate this move in H2, In turn, markets will likely return to worrying about deflation once more.
Japan is an excellent indicator of this development. Its inflation rate completely failed to take off despite the major rise in oil and other commodity prices. As I have long argued, Japan’s ageing population means that its previous demographic dividend has now been replaced by a demographic and demand deficit.
The US and Eurozone economies are both going through the same process. 10k Americans and 18k Europeans have been retiring every day since 2011 as the BabyBoomer generation reaches the age of 65. They already own most of what they need, and their incomes generally suffer a major hit as they leave the workforce.
Companies and investors therefore need to prepare for a difficult H2. The failure of the latest oil price rally, and the return of deflation worries, will puncture the myth that reflation and economic recovery are finally underway. Political stalemate will increase, until policymakers finally accept that demographics, not central banks, drive demand.
On Monday, I discussed how OPEC abandoned Saudi Oil Minister Naimi’s market share strategy during H2 last year.
Naimi’s strategy had stopped the necessary investment being made to properly exploit the new US shale discoveries. But this changed as the OPEC/non-OPEC countries began to talk prices up to $50/bbl. As CNN reported last week:
“Cash is pouring into the Permian, lured by a unique geology that allows frackers to hit multiple layers of oil as they drill into the ground, making it lucrative to drill in the Permian even in today’s low prices.”
Private equity poured $20bn into the US shale industry in Q1
Major oil companies were also active, with ExxonMobil spending $5.6bn in February
US oil/product inventories have already risen by 54 million barrels since January last year and are, like OECD inventories, at record levels. And yet now, OPEC and Russia have decided to double down on their failing strategy by extending their output quotas to March 2018, in order to try and maintain a $50/bbl floor price. US shale producers couldn’t have hoped for better news. As the chart shows:
US inventories would be even higher if the US wasn’t already exporting nearly 5 million barrels/day of oil products
It is also exporting 500 kb/d of oil since President Obama lifted the ban in December 2015
Nobody seems to pay much attention to this dramatic about-turn as they instead obsess on weekly inventory data
But these exports are now taking the fight to OPEC and Russia in some of their core markets around the world
None of this would have happened if Naimi’s policy had continued. Producers could not have raised the necessary capital with prices below $30/bbl. But now they have spent the capital, cash-flow has become their key metric.
The second chart confirms the turnaround that has taken place across the US shale landscape, as the oil rig count has doubled over the past year. Drilling takes between 6 – 9 months to show results in terms of oil production, and so the real surge is only just now beginning. Equally important, as the Financial Times reports, is that today’s horizontal wells are far more productive:
“This month 662 barrels/d will be produced from new wells in the Permian for every rig that is running there, according to the US government’s Energy Information Administration. That is triple the rate of 217 b/d per rig at the end of 2014.”
Before too long, the oil market will suddenly notice what is happening to US shale production, and prices will start to react. Will they stop at $30/bbl again? Maybe not, given today’s record levels of global inventory.
As the International Energy Agency (IEA) noted last month, OECD stocks actually rose 24.1mb in Q1, despite the OPEC/non-OPEC deal. And, of course, as the IEA has also noted, the medium term outlook for oil demand has also been weakening as China and India focus on boosting the use of Electric Vehicles.
The current OPEC/non-OPEC strategy highlights the fact that whilst the West has begun the process of adapting to lower oil prices, many oil exporting countries have not. As Nick Butler warns in the Financial Times:
“Matching lower revenues to the needs of growing populations who have become dependent on oil wealth will not be easy. It is hard to think of an oil-producing country that does not already have deep social and economic problems. Many are deeply in debt.
“In Nigeria, Venezuela, Russia and even Saudi Arabia itself the latest fall, and the removal of the illusion that prices are about to rise again, could be dangerously disruptive. The effects will be felt well beyond the oil market.”
OPEC and Russia made a massive mistake last November when when they decided to try and establish a $50/bbl floor for world oil prices. And now they have doubled down on their mistake by extending the deal to March 2018. They have ignored 4 absolutely critical facts:
Major US shale oil producers were already reducing production costs below $10/bbl, as the Pioneer chart confirms
The US now has more oil reserves than Saudi Arabia or Russia, with “Texas alone holding more than 60bn barrels”
At $30/bbl, US producers couldn’t raise the capital required to exploit these newly-discovered low-cost reserves
But at $50/bbl, they could
Former Saudi Oil Minister Ali Naimi understood this very well. He also understood that OPEC producers therefore had to focus on market share, not price, as Bloomberg reported:
“Naimi, 79, dominated the debate at OPEC’s November 2014 meeting, according to officials briefed on the closed-door proceedings. He told his OPEC counterparts they should maintain output to protect market share from rising supplies of U.S. shale oil.”
Naimi’s strategy was far-sighted and was working. The key battleground for OPEC was the vast Permian Basin in Texas – its Wolfgang field alone held 20bn barrels of oil, plus gas and NGLs. By January 2016, oil prices had fallen to $30/bbl and the Permian rig count had collapsed, as the second chart confirms:
Naimi had begun his price war in August 2014, and reinforced it at OPEC’s November 2014 meeting
Oil companies immediately began to reduce the number of highly productive horizontal rigs in the Permian basin
The number of rigs peaked at 353 in December 2014 and there were only 116 operating by May 2016
But then Naimi retired a year ago, and with him went his 67 years’ experience of the world’s oil markets. Almost immediately, OPEC and Russian oil producers decided to abandon Naimi’s strategy just as it was delivering its objectives. They thought they could effectively “have their cake and eat it” by ramping up their production to record levels, whilst also taking prices back to $50/bbl via a new alliance with the hedge funds, as Reuters reported:
“OPEC and some of the most important hedge funds active in commodities reached an understanding on oil market rebalancing during informal briefings held in the second half of 2016…. OPEC effectively underwrote the fund managers’ bullish positions by providing the oil market with detail about output levels and public messaging about high levels of compliance”.
This gave the shale producers the window of opportunity they needed. Suddenly, they could hedge their production at a highly profitable $50/bbl – and so they could go to the banks and raise the capital investment that they needed.
As a result, the number of rigs in the Permian Basin has nearly trebled. At 309 last week, the rig count is already very close to the previous peak.
The Permian is an enormous field. Pioneer’s CEO said recently he expects it to rival Ghawar in Saudi Arabia, with the ability to pump 5 million barrels/day. It is also very cheap to operate, once the capital has been invested. And it is now too late for OPEC to do anything to stop its development.
On Thursday, I will look at what will likely happen next to oil prices as the US drilling surge continues.