Authors: Ryan M. Couture and John Auers
Over the last two weeks, we’ve looked at how the “Wolf” has brought to the forefront the “dieselization” of passenger vehicles and the potential problems with that strategy. The reported admission by VW of “cheating” on emissions testing for 11 million of their diesel vehicles worldwide has brought into question not only Volkswagen, but the credibility of diesel as a “green” alternative and the emissions testing programs themselves. The latest report on November 2nd is the U.S. EPA has expanded their investigation to include the VW 3.0 liter diesel engines for potential violations as well (VW has denied the allegations). These engines are used in larger cars and SUVs across the VW, Audi and Porsche lines. The expansion broadens the scandal, potentially impacting an additional 10,000 vehicles in the U.S. and many more worldwide, showing this story is still unfolding. While the modern diesel engine may produce less CO2 and as a result appear to be greener than gasoline, diesel produces other, potentially more environmentally harmful pollutants. In this final installment, we will take a look at what some of these unintended consequences have meant, with our focus on Europe since it has moved the farthest along the path of dieselization. We will also examine what the revelations mean for dieselization and how the potential shift away from diesel passenger vehicles could impact both product markets and balances. Will the “Wolf” be able to blow down a diesel market made out of “sticks or straw,” or is it made out of “bricks” and will be able to withstand the “Big Bad Wolf of Wolfsburg?”
The Diesel Impact
European countries have been struggling to meet their air quality requirements in recent years. With many major European cities out of compliance, the negative impacts of dieselization can be felt (and often seen). Diesel engines not only produce more NOx, but also tend to emit substantial amounts of particulate matter. Both of these are major contributors to smog and the negative health effects it can have.
Paris is a posterchild for the smog that EU cities face. As Paris has struggled with crippling smog, lawmakers have, for several years, looked for ways to reduce emissions. Before the scandal in December 2014, France’s PM Manuel Vallis said, “In France, we have long favoured the diesel engine. This was a mistake, and we will progressively undo that, intelligently and pragmatically.” At the time, France announced they would introduce plans to raise the diesel tax (2 euro cents/L to start), and institute a 10,000 euro credit for diesel cars that were traded in towards an electric vehicle.
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Paris is not alone, however. The EU has 4000 testing stations across the continent monitoring air quality. The last full data set from 2013 had areas from many of Europe’s major cities at double the maximum levels considered healthy. An example is London, with areas downtown at an annual average of 85 µg/m3, or Stuttgart at 89 µg/m3 (the worst in the dataset), versus New York City, at 42 µg/m3. The maximum safe limit is considered 40 µg/m3. While diesel cars may produce less CO2 (the original reason for incentivizing diesel use), the unintended consequences of the policy on air quality have been negative.
The Impact on Demand
The ramifications for “dieselgate” on diesel cars, and subsequent diesel demand both in the U.S. and elsewhere, should not be discounted. While it is clear VW did significant damage to their brand (a bit ironic that in the U.S., Audi’s slogan is, “Truth in Engineering”), the impacts have sent ripples throughout the diesel car industry. The claims regarding the “clean” diesel engines of today have been thrown into doubt, with the public linking diesel engines with emissions cheating and false environmental assertions. Just as what happened in the 1970s and early 1980s when GM, through their Oldsmobile diesels, tainted the U.S. market for diesel passenger vehicles for decades, VW’s “dieselgate” threatens to do that again.
The impacts in Europe, because of the scope of diesel usage on the Continent, could be even more substantive than in the U.S. While diesel passenger vehicles may be a common part of the culture, it is driven, in large part, by government incentives. Even before the revelations, countries were realizing the impact that diesel vehicles were having, and taking steps to move away from them. Since the announcement, those plans have been expedited. France has already taken steps; the aforementioned increase in diesel tax and EV benefits. In addition, France, the country with perhaps the biggest diesel love affair, announced they would wind back tax benefits over the next five years. In true political fashion, however, it must be done slowly. Struggling with unemployment, France is reticent to do it too quickly, for fear of impacting Renault and Peugeot, whose diesel cars account for more than 60% of their total sales. The results can be seen in road fuel demand for various countries, shown in the figure below. In the U.S., on the other hand, is the inverse, with about 70% of road fuel sales as gasoline. The move to electric and hybrid will take place for European automakers, making the landscape more competitive, but the transition will likely be more abrupt and costly than they first anticipated.
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From a demand standpoint, it is likely that it marks a tipping point in the shift away from diesel and toward hybrids and electrics for passenger cars. Despite the impetus, shifts in overall automotive makeup are notoriously slow to take place, with millions of vehicles already on the road. In the long term, as diesel demand shifts away from passenger cars, demand will increase in the bunker fuel market. As we discussed in a previous blog, the shift to lower sulfur bunker fuels for ships through 2020-2025 will require increasing amounts of low sulfur diesel fuels to be required.
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It is worth noting that the transition from diesel will be in the passenger car market, but not in the larger vehicle segment. In the EU, the changes in incentives for purchasing diesel cars will gradually be phased out, resulting in consumer shifts toward other vehicles. Trucks and industrial equipment will continue to use diesel engines. The cost and size associated with the more advanced emission systems required to meet current emission standards does not pose the same challenge as it does for low cost passenger vehicles. Alternatively, the power required for trucks, heavy equipment and large ships (in many cases) cannot be easily replaced by other fuels.
In addition to bunker fuel demand, overall petroleum demand has been steadily growing worldwide. While there have been slowdowns in demand (especially for diesel, which is more closely linked with economic activity), long-term projections show demand on the rise. Demand for petroleum in the advanced economies (U.S., EU, Japan) have been falling for years, and the shift from diesel cars to what will likely be hybrid cars is expected. The economies of the developing world, on the other hand, still have room to grow. The economies of China and India in particular are still in early stages of their auto revolution. As more people move to higher standards of living, the demand for vehicles, goods and services will increase. This economic growth will continue to drive increases in diesel demand.
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Conclusion
Over the last three blogs, we have taken a detailed look at the Volkswagen emissions cheating scandal and potential implications for the global diesel market. The effects of “Dieselgate” will impact more than just the costs Volkswagen will have to endure in the form of fines, vehicle recalls and brand impact. It is entirely possible that as we look back, it will mark a major turning point away from diesel as a fuel for passenger vehicles. This impact will be felt particularly in Europe where major cities across the Continent are struggling with poor air quality. Even before the crisis, many politicians on the Continent were beginning to point out the downsides of dieselization, but equipped with the scandal and shift in public opinion, it will make legislation easier to implement. Hybrid and electric vehicles will begin to displace diesels, although the change will be gradual, as millions of vehicles currently on the road serve out their useful life and are retired. In the U.S., where diesel vehicles make up a much smaller portion of passenger vehicles, the impacts will be less noticeable, but the potential opportunities for growth have definitely been damaged. It is important to point out that despite the decline in prospects as a passenger vehicle fuel, diesel will remain an important and growing part of the refined products market. Its dominance in heavy-duty vehicle applications has yet to be seriously challenged, and as developing economies continue to grow rapidly, consumption in this sector will increase accordingly. Other applications, including use as a replacement for resid in the bunker fuel market, will also contribute to diesel demand growth.
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