The end of fossil fuel cars in Europe

To help meet the EU’s net-zero target of 2050, in June, members of the European Parliament voted to mandate that all new car and van sales should be zero emissions from 2035. It remains to be seen how such a significant ban could impact the auto market, but experts expect this to be neutral or negative.

The share price performance of major car manufacturers is set to depend on the ability of original equipment manufacturers (OEMs) to maintain margins while transitioning to new drivetrain technology, and maintaining or increasing volumes, according to Garland Buchanan, senior research analyst, Legal & General Investment Management (America).

Buchanan explains: “Car demand is less a function of the type of drivetrain as it is of vehicle density, demographics, and macro considerations.”

For now, European OEMs are presenting a strong margin profile against higher electric vehicle (EV) penetration. This brings a further consideration to the impact of the ban, as Buchanan elaborates: “From a stewardship perspective, we have been engaging with companies on the EV transition for quite some time now and most seem to be strategically aligned with a phase-out of ICE [internal combustion engine] vehicles, at least on paper."

The EU isn’t the only region banning fossil fuel cars. In the US, California plans to phase out gasoline-powered cars and reduce the demand for fossil fuels. The California Air Resources Board will develop regulations to mandate that 100% of in-state sales of new passenger cars and trucks are zero-emission by 2035.

Investors in Europe should take note of this according to Buchanan: "California tends to lead the nation in emissions standards. If EV production and adoption curves play out as expected (per OEMs), then theoretically, the US becomes less dependent upon fossil fuels.”

Buchanan highlights that this also assumes no offsetting increase in fossil fuel demand for broader energy production, or elsewhere in the economy.

A new opportunity for investors

The move toward EVs is creating new opportunities for automobile manufacturers and investors.

“We believe the leading EV players will redefine the relationship between carmakers and consumers, driving a major transformation of the auto industry,” says Owuraka Koney, equity research analyst at Jennison Associates.

According to the Electric Vehicles Tracking Report, International Energy Agency from November 2021, electric car sales reached a record three million in 2020, up 40% from 2019. This growth contrasts with the general car market globally as overall car sales declined 16% due to Covid-19. Although uptake in EVs has initially been slow, there are now over 10 million electric cars on the road, representing 1% of the global car stock.

The uptake means EV makers can offer subscription services to extend the relationship between the consumer and the manufacturer. This could pose an entirely new business model for carmakers that would redefine the economics of the automobile industry, according to Koney.

However, Koney notes that for this to occur, EVs need to gain a share in the market, and a shift in consumer sentiment will be important to this. As auto brands and investors prepare for an EV future, Koney suggests: “In our view, the winners will be those companies that have the largest installed base of monetisable assets because they can capture a disproportionate share of the recurring revenue and cashflow streams of the entire industry.”

Market considerations aside, the prospect of banning fossil fuel for cars could form a significant step towards net zero. According to the Global Energy Review 2021, as much as 60% of fossil fuel demand comes from transport.

Though shipping and aviation make up the bulk of this, road and freight are still significant consumers of fossil fuels. That said, a ban for the latter will not mean immediate success. Buchanan explains: “I would think auto demand remains as expected, and perhaps oil demand declines. This will all take some time to play out.”

Meanwhile, experts predict that fleet electrification will be a critical catalyst that will enable the EV revolution in the UK. According to PwC’s ‘Leading the charge! Fleet charging – a catalyst for the EV’ report, fleet electrification providers will be an attractive opportunity for institutional investors – if the target can demonstrate the right capabilities and can access the scale that fleet electrification offers.

However, if investors are targeting businesses with large fleets, a robust strategy to electrify their assets will be essential to ensuring long-term value, PwC concludes.