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ESG Explainer: On the Road to Transition

With the transport sector a significant generator of greenhouse gas emissions, electric vehicles are an important element of the net zero transition.

In 2021, global electric vehicle (EV) sales more than doubled to 6.6 million, representing nearly 9% of the overall car market, says the International Energy Agency (IEA). This represented a tripling of EV’s market share from two years earlier. Moreover, all of the net growth of global car sales in 2021 came from the sale of EVs.

“In the world of clean energy, few areas are as dynamic as the electric car market,” says the IEA. “In the whole of 2012, about 130 000 electric cars were sold worldwide. Today, that many are sold in the space of a single week.”

China has emerged as a driver of the global EV market, almost tripling sales in 2021 to reach 3.4 million units sold. More electric cars were sold in 2021 in China alone than were sold in the entire world in 2020.

At COP26 in Glasgow last year, governments, businesses, and other stakeholders in the automotive industry and road transport committed to “rapidly accelerating the transition to zero emission vehicles to achieve the goals of the Paris Agreement”. Signatories to the declaration included EV-focused car manufacturers such as Avera Electric Vehicles, BYD Auto and Etrio Automobiles, along with internal combustion engine (ICE) incumbents such as Ford, Mercedes-Benz and Volvo.

“Every OEM (original equipment manufacturer) has to become a manufacturer of EVs,” says Philippe Houchois, Equity Analyst at Jefferies. “It is not clear that all start-ups bring an edge to the automotive industry, apart from Tesla. However, pure EV manufacturers can potentially scale up at much lower volumes – batteries are modular, motors are identical – and therefore could bypass incumbents and render them less relevant.”

This explainer looks at how asset owners should approach investment in the EV market.

What are the main gains of EVs from a climate viewpoint?

Electric vehicles powered by low-emission electricity offer the largest decarbonisation potential for land-based transport, says the Intergovernmental Panel on Climate Change (IPCC) in its most recent report on climate change mitigation.

In most countries, the transport sector is the largest contributor to greenhouse gas emissions and wide-scale adoption of EVs features in many countries’ net zero transition plans. In the UK, the Climate Change Committee (CCC) has called for all new light-duty vehicles (including passenger vehicles, taxis, vans, motorbikes etc) to be fully battery-electric by 2032. “The full transition to EVs will be one of the most important actions to achieve the UK’s Net Zero target,” says the CCC.

Released last month, the UK’s new EV infrastructure strategy commits £1.6 billion to expand the country’s charging network, with around 300,000 public chargers expected to be available by 2030.

The European Green Deal proposes zero emissions from new cars by 2035 and a 55% reduction of emissions from cars by 2030. A significant increase in the uptake of EVs will be needed to achieve these goals.

The EU’s subsequent ‘Fit for 55’ strategy further ramped up road transport decarbonisation ambitions with measures to accelerate the roll-out of charging infrastructure, make EVs more accessible to consumers and establish a clear, binding phase-out date for fossil fuels.

In the US, the Biden Administration has committed to make half of all new vehicles sold in 2030 zero-emissions vehicles, including battery electric, plug-in hybrid electric, or fuel cell electric vehicles.

For EVs to unleash their full potential to combat climate change, says the IEA, the 2020s will need to be the decade of mass adoption of light-duty EVs. In addition, specific policy support and model expansion for the medium- and heavy-duty vehicle segments will be crucial to mitigate emissions and make progress toward climate goals.

More than 20 countries have announced the full phase-out of ICE car sales over the next 10‑30 years, including emerging economies such as Cabo Verde, Costa Rica and Sri Lanka.

What are policy incentives for the sales of EVs?

Significant fiscal incentives, including purchase subsidies or tax rebates, spurred the initial uptake of light-duty EVs, says the IEA, and underpinned an accompanying scale-up in EV manufacturing and battery industries. These have been complemented by tightening of fuel economy and tailpipe CO2 standards, with more than 85% of car sales worldwide subject to such standards. “CO2 emissions standards in the European Union played a significant role in promoting electric car sales, which in 2020 had the largest annual increase to reach 2.1 million,” says the IEA.

In markets that demonstrated significant progress on EV sales in the 2010s, the primary focus should be to continue to implement and tighten, as well as to broaden, regulatory instruments. Examples include the European Union CO2 emissions regulation for cars and vans, China’s New Energy Vehicles (NEV) mandate and California’s Zero-Emission Vehicle (ZEV) mandate.

Near-term efforts, says IEA, must focus on continuing to make EVs competitive and gradually phasing out purchase subsidies as sales expand. This can be done via differentiated taxation of vehicles and fuels, based on their environmental performance, and by reinforcing regulatory measures that will enable the clean vehicle industry to thrive.

“In the long term, realising the full potential for EVs to contribute to cut vehicle emissions requires integration of EVs in power systems, decarbonisation of electricity generation, deployment of recharging infrastructure and manufacturing of sustainable batteries,” said the IEA.

“The EV sector has been very dependent on government actions such as subsidies and grants for several years,” says Houchois at Jefferies. “Germany is reviewing the amount and focus of its subsidies, and in general, governments have many externalities to consider, such as replacing fuel excise duties with other sources of tax income, which is already an issue in Norway.”

What role can investors play in accelerating the EV sector?

A recent report by responsible investment NGO ShareAction assessed the progress European car manufacturers were making towards decarbonisation and highlighted key questions investors should put to them. Helen Wiggs, Head of Climate at ShareAction, cites three forms of engagement: questions, public statements when companies are non-responsive, and finally AGM action and/or board level proposals.

According to Wiggs, key engagement questions include: does the manufacturer have a plausible net zero commitment for emissions from new vehicles in use by 2050, including short- to medium-term targets? Does the car manufacturer have electric vehicle sales targets aligned with its emission reduction commitments? Does it have a commitment to stop selling ICE cars and finally, does the car manufacturer have plans to transition away from hybrids and towards fully electric vehicles, in light of a required ICE phase out by 2035 and net zero in 2050?

Investors should keep checking on progress on a yearly basis to make sure transition plans are on track, she adds.

It is also worth asking car manufacturers about their lobbying activities, particularly those aimed at delaying the speed of net zero transition. If responses are insufficient, Wiggs says, it is worth going public, as a group of investors did over Volkswagen’s lobbying activities.

“Other forms of escalation are now emerging,” says Wiggs. “Concerned about their pace of transition to 100% EV production, Inyova Impact Investing has this year proposed a board member with EV expertise to BMW.”

What are the risks on the demand side?

Acceleration of the EV transition can include engagement with those on the demand side too. Asset owners should work out which companies and organisations have significant fleet size in their portfolios and ask what their transition plan is for them, says Wiggs.

ShareAction has been flagging the importance of corporate fleet conversion for some time, including in its most recent report in October last year. From a campaign perspective, the group has mostly focused on corporate fleet for light duty vehicles. Here the technology has been further advanced and the necessary infrastructure is being built out to enable adoption.

Some fleets are owned directly and others through leasing companies. “Either way, particularly for those companies with net zero commitments and science-based targets, investors need to check that phase-out plans are well under way,” says Wiggs.

For those firms apparently struggling to keep pace, Wiggs says investors should ask where the bottleneck is – technology, a lack of infrastructure, or supply chain issues such as a chip shortage. These issues reduced vehicle choice and availability over the past year. “Some of these problems could potentially be addressed through policy means such as infrastructural changes or through peer learning,” she observes.

Peer learning is a benefit of membership in EV100, a group of more than 121 companies that have committed to switch their fleets to EVs and/or install charging for staff and/or customers by 2030. “With ICE phase-out plans well under way in the UK and similarly not far off in Europe, investors should also be mindful of stranded asset risk for those companies slow to convert fleets,” says Wiggs.

Costs are rising for laggards in a number of ways. Western auto OEMs have specific targets for tailpipe emissions that differ in each major market (Europe, US, and China), but are all moving towards increasingly stringent targets, notes Jefferies in a recent ESG research note. Non-compliance can trigger penalties and fines or restrain the ability to sell ICE vehicles (China). In addition to direct financial cost, missing targets could carry reputational and competitive risks, such as brand image, or restricted ability to sell to fleets.

Jefferies also notes that emissions regulation tends to be technology-agnostic and results-based, but achieving targets set for OEMs is also dependent on public policy measures, notably the evolution of purchase incentives and tax breaks and the pace of private and public investment in infrastructure, such as EV charging points and publicly funded support to battery manufacturing and recycling.

Houchois says investors need to be mindful of the risks of manufacturers decarbonising at a fast pace while the grid (charging infrastructure etc) lags.

Supply-chain disruptions and increased battery costs are another challenge for EV manufacturers. Fitch Ratings reported that because of these issues, manufacturers may “continue prioritising their product mixes towards premium models to cover higher costs of production and to increase the low margins on EVs”.

Are incumbents a better bet than disruptors?

The inevitability of the arrival of EVs is “obvious”, says a research paper from Bocconi University in Italy. “Who will be able to dominate this new market in the end is much less so. At present, traditional car manufacturers that have perfected their business models and value chains for decades are competing for control with new, disruptive tech companies. The approaches of these two kinds of companies are vastly different and which companies will ultimately be successful remains to be seen,” it says.

The disruptors – the emerging EV-based manufacturers – possess “great technology and innovation skills”, but often lack the necessary manufacturing capacity and supply chains to successfully compete in the new EV market, says the Bocconi paper. Moreover, frequently the disruptors still need to establish effective structures for supplier management.

Nevertheless, their expertise in other areas means they should not be discounted. “Although new EV manufacturers entering the market are lacking in manufacturing capacity with respect to traditional manufacturers, they make up for it by their expertise in software and batteries. Tesla and Lucid have invested significantly more into the development of battery storage systems than their counterparts and are therefore able to offer vehicles with longer range,” the report noted.

“Furthermore, the disruptors are superior in terms of software. Tesla continuously incorporates the user data it gets from its customers in order to provide useful updates on a rolling basis. This is opposed to incumbents where the software mostly stays the same for the entire life of the car.”

Traditional automotive manufacturers might have long-standing experience, but have to enter the new business of EV while continuing to support their core business of ICEs. The Bocconi report says they will need to balance finding new electronic powertrain partners and procuring EV batteries with fostering business relations with existing partners and suppliers.

For investors, manufacturers and consumers, it is clear that timing is a critical factor in successful transition. The opportunities and risks of allocations will be more transparent as firms increasingly adapt to the immense shift from ICEs to electric vehicles (EVs) in line with the goal of net-zero emissions by 2050.

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