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Consolidation on horizon for Chinese carmakers as EV goalposts move

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BYD executives showcase an electric vehicle at an auto show in Shanghai.
Source: AP Photo

China continues to press the pedal on electric vehicle adoption with more ambitious targets and policy changes, initiatives that the country's car manufacturers are struggling to keep up with and that could provoke consolidation in the segment, industry observers said.

Beijing on Dec. 3 raised its 2025 clean energy vehicle sales target by five percentage points to 25% of total vehicle sales under its 2021-2035 New Energy Vehicle Development Plan. China broadly categorizes plug-in hybrid, battery-electric and fuel cell-powered vehicles as new energy vehicles, or NEVs.

Considering NEVs accounted for just 4.5% of total car sales in 2018, the target looks difficult to achieve as things stand. China has experienced a 17-month slump in overall vehicle sales and a five-month drop in demand for electric vehicles, putting the segment on the verge of its first full-year drop in more than a decade.

The country's top auto industry group, China Association of Automobile Manufacturers, expects the overall sector decline to continue through 2020, which analysts believe will drag down clean energy vehicle sales as well.

Additionally, while Beijing's incentives and favorable policies over the past decade led to the creation of a market for clean energy vehicles, it also led to the proliferation of dozens of electric vehicle startups, causing overcrowding in the NEV space.

SNL Image

China in 2009 launched the "Ten Cities, Thousand Vehicles" program, aiming to promote the adoption of electric vehicles by deploying them in government fleets. By 2011, it was expanded to 25 cities, selling just over 8,000 NEVs during the year. A nationwide incentives program was rolled out in 2015. By 2018, NEV sales skyrocketed to 1.3 million vehicles.

The sharp growth continued through the first half of 2019, up almost 54% year over year. However, China's rollback of NEV incentives on June 27 sparked a downward spiral that saw electric vehicle sales fall nearly 45% in October and November, exposing clean energy vehicles' over-reliance on incentives.

In 2018, the state issued 13.78 billion yuan in NEV subsidies, with BYD Co. Ltd. the biggest beneficiary at 3.63 billion yuan, as per China Ministry of Industry and Information Technology data. Overall, Beijing invested roughly 390 billion yuan in incentives and other fundings, according to estimates from the Center for Strategic & International Studies.

The incentives have been slashed to one-third in 2019 and are set to be completely withdrawn for all vehicles under the NEV category by the end of 2020.

Tu Le, managing director at Sino Auto Insights, said in an interview that the 2 million NEV sales target for 2020 is now out of reach.

Already suffering from the withdrawal of incentives, the sharp drop in demand has caused an existential crisis for Chinese electric vehicle startups.

Under the circumstances, analysts believe that a long-overdue consolidation of the country's NEV sector is imminent.

"It is the beginning of consolidation that we have all been waiting for, not only for international brands but also Chinese brands. Many of them will go. It's starting now," said Jochen Siebert, managing director at JSC Automotive, which provides consultancy services to automotive companies in the Chinese market.

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To push for greater NEV adoption, the government now relies on a dual-credit policy, a system that requires manufacturers to meet annual NEV production quota of 10%, which will be increased to up to 18% in 2023. The system allows conventional automakers to purchase credits from electric vehicle companies if they are at risk of failing to meet the NEV quota.

However, sluggish demand means that EV startups may also miss out on benefits from selling credits to carmakers that do not meet the prescribed EV production quota, Le said.

The NEV segment is set for a challenging 18 months and EV startups without sufficient backing will struggle to raise the much-needed funds to bring a product to the market, analysts said.

"You are going to see in the next 12, 18 months, the sector moving into the competition phase. The headline isn't going to be 'NIO Ltd. raises a billion dollars,' 'WM Motor Technology Co. Ltd. raises 2 billion dollars.' It is going to be: 'NIO launches this vehicle to compete with Tesla Model Y,'" Le said.

The strong will survive

Falling sales have not deterred Germany's Volkswagen AG from its ambitious plan to build two electric vehicle plants in China in 2020 that will have a combined production capacity of 600,000 vehicles. CEO Herbert Diess announced that half of VW's sales in China will be new energy vehicles by 2035.

"The VWs and GMs have brand recognition. They have a dealer network across China, not only in tier 1 and tier 2 cities, but tier 3 and tier 4 cities, and they are going to have so many products in the market in the next 24 months that it is going to be really difficult for the EV startups to carve up positioning," said Le.

With Tesla Inc. starting to roll out its Model 3 from its Shanghai gigafactory, the premium EV market is likely to get more crowded.

Siebert, however, pointed out that large carmakers will still have to meet China's NEV quota requirements and sell green vehicles, which have lower profit margins compared to conventional internal combustion engine, or ICE, vehicles.

"[T]his is the end of the pre-market phase … other incentives will also go. This is now the start of the actual market. Now we will see who is still swimming on top," Siebert said.

Price and ICE

Keeping pricing competitive with ICE vehicles due to high battery costs and lack of strong charging infrastructure add to the challenges facing the NEV industry.

"You have to set the price to be lower than the ICE cars so that [consumers] will buy it. Will that happen? Likely not. We don't see that happening very soon actually," said Alex Xie, managing director and partner at Boston Consulting Group.

SNL Image

SNL Image

BYD, which is the world's largest electric vehicle maker and partly owned by billionaire Warren Buffett's Berkshire Hathaway Inc., in October reported an 89% drop in its third-quarter earnings and slashed its annual profit outlook to a decline of up 43%. The company sold just 11,220 NEVs in November, down 63% year over year. Sharp growth in the period before the rolling back of incentives meant year-to-date sales rose 7.58% to 216,407, accounting for nearly one-fifth of all NEVs sold in China.

Like most other local makers, BYD's NEV portfolio largely consists of low-priced passenger cars such as the Yuan and the E5 with a range of around 200 miles. The two brands are the second and third largest-selling NEV models in 2019, as of Oct. 31.

On the other hand, the demand for premium long-range NEVs is steadily increasing. BAIC Motor Corporation Ltd.'s EU series, a significantly pricier BEV with a longer range, is the best-selling NEV model in 2019, while Bayerische Motoren Werke AG's 530e and BYD's Tang, both of which retail for more than $30,000, were also among the 10 highest-selling vehicles.

Alibaba Group Holding Ltd.-backed high-profile EV startup Xpeng Motors also offers low-cost electric vehicles, but a slowdown may force these companies to shift their focus to higher-end cars with more premium features and longer ranges.

"If Berkshire Hathaway were to look at it, they would certainly tell BYD to go where the margin is, because your cars are cheap," said Siebert of JSC Automotive. He added that BYD has its battery business to fall back on, but other homegrown carmakers like NIO and Xpeng "don't have the luxury."

Preparing for the future

Lack of adequate charging infrastructure could mean customers may stick with petrol and diesel vehicles, while plug-in hybrids are also emerging as an alternative to low-range battery-electric vehicles.

Other alternatives to BEVs, like fuel-cell vehicles and methanol fuel vehicles, are still at the early stages of adoption.

China recently announced plans to have 1 million fuel-cell vehicles and 1,000 hydrogen refueling stations on the roads by 2030. Its 2021-2035 New Energy Vehicle Development Plan also expands the NEV category to include vehicles developed from new materials, energy sources as well as the connected vehicles, loosening its earlier focus on battery technology.

The revision may potentially allow companies to include converted methanol fuel vehicles, like the ones by Geely Automobile Holdings Ltd., to be included in the NEV quota.

Sino Auto Insights' Le said that the withdrawal of incentives indicates that China feels it has achieved its goal of establishing a clean energy vehicle market that is ready to grow on its own.

"They [the Chinese government] look at it and say, 'We see momentum from the market. If it isn't for the trade war and the economy slowing down, we will be a lot further along with the targets,'" Le said. "But overall, at a higher level, [the government has] accomplished what it wanted to do, which is to kickstart the NEV sector in China."