Insight from Shanghai: NEV regime takes off training wheels as government slashes subsidies

China has put leadership in the development of New Energy Vehicles (NEVs) – battery electric, plug in hybrid and fuel cell vehicles – at the heart of its industrial policy.

The country is the world’s largest market for electric vehicles, with 2.3 million battery electric and plug in hybrid vehicles on the road in 2018, accounting for 45% of the global stock.

In a draft of the latest development plan for the sector released early December, the government envisages that NEVs will account for a quarter of all auto sales by 2025. In June 8% of all passenger cars sold were NEVs.

But since then sales have tumbled and the trend has been in reverse: NEVs accounted for just 3% of total passenger car sales in October. Something will have to change if the government is to hit its NEV target of 25% by the mid-2020s.

NEV growth and policy

Sales of electric vehicles are down more than 20% this year as China takes an axe to the buyer subsidies that have made the price of NEV more competitive with conventional ICE vehicles since they were introduced in 2009. Back then fewer than 1,000 battery electric and plug in hybrid passenger cars were sold in China.

By the end of 2018 this had risen to more than million vehicles, making China by far and away the world’s largest market for electric cars, well ahead of the global number two, the United States.

But this soaring growth cost the government an estimated RMB 245 billion ($36.6 billion) in direct central and local government subsidies to buyers according to the Center for Strategic and International Studies, a think tank.

Add in lost revenue from exempting EVs from sales tax, as well as mandated government procurement of vehicles like electric buses and investment in charging infrastructure, and total government largesse was RMB 390 billion ($58.3 billion) between 2009-2017. That’s more than the economy of Slovenia.

The subsidy programme inadvertently helped create and sustain a huge number of NEV manufacturers. By the end of 2018 more than 200 companies were authorized to make EVs, and a further 200 were awaiting government approval. A government investigation in 2016 found that some of these manufacturers had been fraudulently claiming subsidies. Little wonder the government decided enough was enough.

Starting January 2017, the government tightened the requirements for subsidies, making them more dependent on the energy density of the battery, a measure of how much charge it can hold for its weight. This meant that autos using older battery technologies would not qualify for subsidies.

But the big change came in March this year. Tighter technical requirements around range and battery density mean that many passenger cars are no longer eligible for subsidies.

And for those NEV that can still claim them, they are a lot less generous. The funding for the most efficient BEV with a range of more than 400 km has been halved from RMB 50,000 to 25,000. PHEV subsidies have also been slashed and are now one third of what they were in 2016.

And if that wasn’t enough, local governments are no longer allowed to offer subsidies to buyers. In an already weak auto market paring back all these purchase subsidiaries has made buying an NEV a lot less attractive. Little wonder that EV sales have been so feeble since June when the policy came fully into effect.

Less carrot, more stick

The subsidy programme will be fully phased out by the end of 2020 to be replaced by a new policy called the “dual credit policy”. This scheme compels manufacturers of passenger automobiles to make NEV and improve the fuel efficiency of ICE vehicles if they want to avoid financial penalties.

Each NEV produced is awarded NEV credits according to a complex formula which takes into account factors like type of vehicle, maximum speed, energy consumption, weight, and range.

These credits are used to offset against a target based on total production of passenger cars. Those manufacturers that do not earn enough credits must purchase them from manufacturers that have surplus credits or face financial penalties.

This year the target number of NEV credits is equal to 10% of total production. The 15 million passenger cars sold in the first nine months of this year must therefore earn 1.5 NEV million credits. Over the same period 800,000 NEVs have been produced suggesting that each car will need to earn on average 1.9 NEV credits.

This year the target should be relatively easy for the industry to meet. But it will rise by 2% in subsequent years so that by 2023 car makers will need to earn enough NEV credits to meet 18% of their output.

Manufacturers will have little choice other than produce higher volumes of more efficient NEV with a higher range if they are to gain the required number of credits.

The government’s hope is that the stick of sanctions, if car makers do not meet their NEV credit targets,  will be more effective than the carrot of subsidies to make China a global leader in NEV production and battery technology.

In the short term the removal of buyer subsidies will likely see NEV sales continue to contract. Without government subsidies, only the strongest domestic auto companies are likely to survive. And they will be encountering stiff competition.

The dual credit policy is forcing foreign carmakers, which hitherto had little interest in NEV, to invest heavily in electric vehicles in order to maintain their position in the world’s largest auto market. VW and its local partners aim to be able to produce 1.5 million EVs by 2025. That’s about 6% of China’s total passenger car sales last year.

Others want a slice of the action too. In October Tesla gained approval to start producing cars at its factory in Shanghai and in November Mercedes launched its first all-electric SUV in China.

Given all the new NEV capacity set to open over the next few years it’s very possible that a quarter of all cars sold by 2025 will be NEV. But in the new Darwinian landscape created by the dual credit policy, which car makers will thrive and which will perish remains to be seen.