Mike Disabato: What's up everyone? And welcome to the weekly edition of ESG Now, where we cover how the environment, our society, and corporate governance affects and are affected by our economy. I'm your host, Mike Disabato. And this week, we are going to talk about the deep structural changes in the auto industry as it increasingly moves toward electric vehicles. Thanks as always for joining us, stay tuned.
Cars are a central part of our economies and of our daily lives. They are unique in that they are both an asset owned by an individual and part of a larger public infrastructure in the roads that we build for them. The companies that make up the auto industry reflect this dynamic. Most are mega cap, meaning they are massive. The industry exports more in revenue than oil and gas does, and it could be argued that the growth of a developed market is intricately tied to the fate of its auto industry. Industry is also going through a massive change at the moment in the push toward electrification, through regulation, legislation, and consumer preference. For example, China is now getting a seat at the global auto manufacturing table, taking on old guards like Toyota, Honda, and VW.
But with these deep structural shifts comes a more complicated relationship with auto workers and their companies, as well as the increased level of technology in each vehicle that is presenting security risks, which are subverting the usual route of globalization. Together, these emerging trends are having major market-moving effects in all three major regions and contributing to increase in competition. Today, we're going to focus on the auto industry as a whole, because it is uniquely linked with ESG and because of all those things I just mentioned. To help me with that, I called on my colleague, Yu Ishihara, who covers the auto industry for us. And I asked him what he wanted to talk about first. He told me that when it comes to the auto industry, China's push into the production of EVs is one of the most important factors for us to follow.
Yu Ishihara: So if you think about, I guess, the traditional automotive industry, it's dominated by American, European, Japanese, and I guess, Korean companies. So obviously, traditionally, there weren't that many Chinese car companies in the global market. But as the Chinese economy developed rapidly over the last decade and the technological, as well as financial resource discrepancy narrowed between China and the rest of the world, electric vehicles offered a new era for these Chinese vehicle manufacturers to potentially level the playing field with incumbent industry players. If the Chinese automotive industry could potentially take the lead in EV technologies, either through the supply chain and resources or actual manufacturing of vehicles, not only would it allow for domestic car makers to thrive and take local market share in China, as you so pointed out, but if some of these companies were able to export their product to overseas markets, it would help to establish a significant export and trade opportunities for the overall Chinese economy.
Mike Disabato: This can be seen if you look at low carbon patents held by different auto companies. Of course, Toyota and Ford still reins supreme, but Chinese auto companies, such as BYD Company or Geely are starting to climb the ranks, especially when it comes to battery patents. For example, if you look at our patent data, BYD ranks up with Ford when it comes to patents held in battery technologies. Chinese auto companies have nowhere to go but up, because China is the number one country for sales for cars in 2021, and EV sales nearly doubled in the country compared to 2022. Many people in China are still buying their first car, so there's a lot of room to grow. Now, VW, Toyota, and Honda still accounted for the majority of the combustion engine sales in China. But as I noted at the beginning, domestic Chinese auto makers accounted for almost 80% of EV sales through the first seven months of 2022. And these companies would love to export and grow their international presence along with their domestic one. But unlike their already established peers, Chinese auto companies need to contend with a couple hurdles before they can start to take on more market share. The first is actually getting a consumer base that likes the norm to switch and go to something new.
Yu Ishihara: Right now, there just aren't that many Chinese cars available for sale in developed markets. And so, availability right now is poor. So these Chinese brands would need to not only export, but they would need to build up brand equity across areas such as reliability and quality aspects, which are areas consumers would traditionally place a lot more importance on than technological prowess or even value for money when it comes to cars relative to something like consumer electronics, where Chinese manufacturers have enjoyed a lot of success in penetrating developed markets. But there's obviously a lot more at stake in the quality assurances of a car compared to your washing machine or even a smartphone.
Mike Disabato: Some Chinese auto companies actually may have the upper hand when it comes to product quality and safety. BYD Company and SAIC Company are two major auto companies in China, and they have higher product quality scores than do Ford, Toyota, and VW. Those are our product quality scores. Now, those giants sell millions more cars than BYD and SAIC. The more products you sell, the more product quality issues you're going to face, but the systems are in place at those two companies to get the trust of consumers when it comes to safety and quality. That can't be said for all Chinese companies. The other two major Chinese auto companies, Geely and Great Wall, that have product quality scores that are much lower than the industry average. The other hurdle that Chinese auto companies may face is one that is much more indicative of the changing world where globalization is no longer the default and the mistrust between countries is only increasing.
Yu Ishihara: So for US, European car makers, there's an obvious concern around loss of market share if Chinese EVs start to dominate the market, which would lead to subsequent loss of US car maker revenues and jobs, et cetera. But when it comes to EVs and new emerging technologies, I think there could be even more complex risks at play. Typically, electric vehicles are associated with much more connectivity, including many more sensors that can collect data, obviously connected to the internet, and have lots more software features.
Just as a tangent, I would look at the US Intelligence Services calling out Chinese telecom giant, Huawei, for spying on the US on behalf of the Chinese military through its installed based of cellular antennas. Meanwhile, on the other hand, there have been reports out of China that the Chinese military had banned Teslas from being on Chinese military grounds on security concerns from potential use of cameras for spying. It does point to a broader issue around tensions or risks that could arise from rising penetration of a [inaudible 00:07:00] electric vehicles between any countries. So it doesn't mean that there won't be a market for Chinese EVs in the US, or even vice versa. But I just want to point out again that beyond market forces, there are a lot of stakeholder interests, which can have a significant influence on the outcomes for each of these markets,
Mike Disabato: By the way, just to give you some Chinese market perspective. Tesla is the only auto company that is allowed to operate in China without a local partner. And so, let's now shift to the US. We mentioned three big stories in the US for autos. The first is the possible 7,500 discount for the price of electric vehicles that was set in place by the Inflation Reduction Act. If you want to hear more about that, definitely go check out our podcast on the Inflation Reduction Act that we put out on August 12th.
There are two other stories though, that we should talk about today. The first is the decision by California regulators to ban the sale of new combustion engine vehicles by 2035. This is alongside similar bans by the EU, so Cali isn't first, but it's significant because the US is right behind China in auto sales. It's second in the world. And where California goes, the US goes because California commands such a high market share. The other reason why this is going to be such a big deal for automakers is because infrastructure development is going to have to increase substantially to make this actually viable.
Yu Ishihara: Governments and regulators can... They can restrict the sale of gasoline cars, but mass adoption probably won't happen unless consumers thinks that they can derive better, or at least the same financial as well as practical utility out of an EV as their current car. So it makes sense for car companies, which are now... I don't want to say being forced. But which are now transitioning to electrify their portfolio much faster to partner up with infrastructure companies, support legislation to expand charging networks or go the vertical integration route like Tesla did and just build out their own network. And again, I just cited Tesla. They're clearly the best example with their supercharging network, but there are industry open initiatives, such as EVgo or Ionity, where various car makers have signed up to help fund and build out a joint infrastructure network. From a car maker's perspective, having the infrastructure certainly helps. I don't know if the return on capital would be there to do it alone. And so, that's why I think we're seeing a lot of these consortiums happen.
Mike Disabato: These infrastructure projects, these consortiums are going to be really useful because of the often talked about issue that comes with the transition toward electric vehicles for the auto industry, and that is labor management.
Yu Ishihara: There are plenty of studies and reports done by different countries or NGOs stating that the transition of car makers towards electric vehicles could cost incumbent industry employees, tens or even hundreds of thousands of jobs as these companies phase out combustion engine and traditional industrial manufacturing and associated components and move towards software digitalization, et cetera. And on the other hand, when the supply chain shifts away from traditional manufacturing, there'll also be an increasing demand for jobs, demand for battery and associate in component manufacturing, software engineers, and I guess new skill sets that are required to design and assemble the next generation of vehicles, including EVs,
Mike Disabato: Regardless of what happens, there's going to be headwinds that the industry is going to have to prepare for. The latest example is the decision by Ford to cut 3000 workers as it transitions toward electric vehicles. In announcing its move, Ford's CEO, Jim Farley, said Ford was changing and reshaping virtually all aspects of the way it's operated for more than a century. Ford has cut around 12,000 jobs since 2020. And when companies start to restructure like this and they employ a lot of people, what we start to look at is the labor structure of the company. How strong are their unions? How competitive are the benefits and packages and all that? What incentive structures do they have in place? Ford has around 180,000 workers according to our data, and they have subpar labor management policies in place. And this has resulted in clashes with its employees as plants have closed. Yet, the change to electric vehicles is so structurally different, that even if you have good labor management in place, you might not be saved from getting into trouble.
Take VW. VW is a top quartile performer when it comes to labor management. For example, it has industry-leading risk mitigation practices, including having a 98% unionized workforce with evidence of collective agreements. It has strong performance base incentive structures in place, and it offers non-compensation benefits for all of its employees. But the transition to electric vehicles is so structurally deep, it can mean that if the CEO and the board is not communicating well enough or ensuring that their workforce understands the changes that might be made. Then, there could be conflict ahead. And this is what happened to VW CEO, Herbert Diess, who abruptly stepped down from VW on July 22nd after reports of continual friction with the car maker's powerful union. Now these are just reports, so I asked you if he knew whether or not the problem at VW was actually because it didn't do a good enough job to ensure employee satisfaction as it tried to transition toward electric vehicles.
Yu Ishihara: I mean, the truth is we don't exactly know what happened in that boardroom, but that is certainly suggested. Volkswagen is often cited as one of the leading incoming players in terms of making an aggressive push towards electric vehicles. And so from that perspective, it begs the question, well, it seems like the company was transitioning quite rapidly, so what happened? According to media reports there... And again, looking at their history of vehicle launches, while the company did pivot to electric vehicles quite aggressively, they were notable for having many issues regarding the software element of it. They just couldn't keep up with, I guess, what the company wanted to benchmark, which was Tesla. And so combined that with discontent from the labor union, again, possibly from all these pressures about transitioning rapidly, retraining the workforce, all of this could have probably played a role in Volkswagen former CEO's departure.
Mike Disabato: And remember, the whole reason the auto industry's changing, the reason VW's pushing so hard to transition to electric vehicles is because states see the auto industry as one of the easiest ways for it to lower its emissions. We're talking about California's recent ban. I quickly touched on the EU's decision to also ban the sale of gas-powered or combustion engine vehicles by 2035. But that isn't all the EU is trying to do to lower its tailpipe and auto industry emissions. Alongside Japan, the EU has enforced the strictest carbon dioxide emission standard for autos in the world, and auto makers that miss these targets that the EU have set are subject to significant fines.
So aside from banning the sales of new combustion engine vehicles by 2035, like California, the EU said that by 2030, average fleet emissions for auto companies need to be reduced by 37.5% compared to emission levels in 2021. And if the average CO2 emissions of a manufacturer's fleet exceed its specified emissions target in a given year, the manufacturer has to pay for each vehicle, for every newly registered vehicle in that year, around 95 euros. Let's take Toyota for example. They make 10 million new cars per year. If they don't meet their emission standards in the EU by 2035, they would have to pay 950 million euros as a fine. The pressure has gotten so intense that we actually have another Dieselgate on our hands after Kia and Hyundai were busted for the same cheating scandal that VW was busted for in 2015, and their then CEO, Herbert Diess tried to steer them out of.
Yu Ishihara: It was both surprising and not surprising at the same time. And so just to give a quick rundown, what happened is that the German authority rated both Hyundai and Kia over the use of potential defeat devices to cheat emissions testing for diesel vehicles. And like you rightly pointed out, this is the exact same controversy on a smaller scale as what happened to Volkswagen in 2015 with their Dieselgate. Dieselgate ended up costing Volkswagen something like 30 billion euros between fines, lawsuits, penalties, and damages. So going back to Hyundai and Kia doing the same thing, it's surprising in that these companies were still engaging in the same malpractice nearly seven years, or I think maybe five years, since the last vehicle implicated for these companies was sold in 2020, five years after Dieselgate. But I said at the beginning, it's also not completely unexpected.
And while it certainly didn't have to be Hyundai or Kia, but there have been other global instances of car makers cheating emissions testing in Europe, or even in Japan. And so, I think this is just another potential example of this. And like you said, I think it speaks to the difficulties of maintaining good oversight of corporate governance behaviors and practices across such a complex supply chain, but also the difficulties for car makers to actually meet all these increasingly stringent regulations on emissions. I guess at the end of the day, there's no excuse for lying and cheating about your product claims, but there's been repeated nature of similar controversies throughout their industry. And so, I think it really just does paint a picture of how aggressive some of these regulatory targets are in pushing the industry towards electrification.
Mike Disabato: Of course, this is a push that has been decades in the making, and we will likely see a lot more changes as it continues to progress. But I hope this has been a useful overview of everything that is going on in the industry. Because since they are so ubiquitous in our lives, since cars are, it might be easy to forget how important the auto industry is for our economies and for our efforts to reduce our economy's collective emissions.
That's it for the week. I want to thank you for discussing me the news with an ESG twist. And I wanted to thank you so much for listening. I really appreciate it. If you like what you heard, don't forget to rate and review us and subscribe if you want to hear myself or Bentley's voice every week. Thanks again, and talk to you soon.
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