Emissions crisis underscores shift to low carbon future

The emissions crisis that started at Volkswagen (VW) late last year continues to rumble on; Mitsubishi admitted the falsification of fuel efficiency test data in April, and a number of other high profile carmakers have been implicated in emission-fixing activities. Investors are not only asking what went wrong at individual companies, but are beginning to question whether the crisis is the manifestation of secular pressures in the sector: is the internal combustion engine facing obsolescence? Change is already afoot: just as the UK government led the way in phasing out incandescent lightbulbs in Europe, the Dutch parliament is considering banning the sale of petrol and diesel cars from 2025.

What went wrong at VW?

For VW, the emissions scandal partly originated from a flawed strategy and a troubled corporate culture. Developed under Martin Winterkorn’s tenure as VW’s chief executive, VW’s corporate mission was to become the world’s leading automaker by 2018, “both economically and ecologically”. Rather than “ecologically” being an unfortunate afterthought, VW’s plan for world domination had to incorporate producing low emission vehicles: it is impossible to be the world’s leading auto producer without a major presence in the North American mass market, which demands high standards for NOx (oxides of nitrogen) emissions.

Ultimately, the twin aims to produce low emission vehicles while growing profitability proved catastrophically incompatible for VW. The group’s engineers struggled to find a solution that could satisfy the regulators and produce a mass-market affordable product without investing hundreds of millions of dollars in development spending. Only through the deployment of the infamous ‘defeat device’ could the engineers meet the demands of their superiors while appearing to comply with emissions regulations.

Company culture really counts

Eleven million vehicles later, not only is it clear that VW’s strategy was critically flawed, but also serious questions have been raised about the group’s culture. After the financial crisis VW shares seemed to offer an attractive investment opportunity. The company had been one of the few auto manufacturers to invest throughout the downturn, building out modular production facilities for its range of leading brands. VW appeared to be on the verge of a significant improvement in profitability and cash flow. But, even then, something was amiss with the group’s culture.

VW was reported to have an overbearing and dominant management style, and employees felt uncomfortable questioning the group’s strategy, let alone whistleblowing on employee misdemeanours. The breakdown of trust between the company, its customers, employees, and investors will take many years to rebuild.

Tesla 3 presages fundamental industry change

The events at VW highlight the challenges facing incumbent autos companies as we move towards a global economy that is less dependent on fossil fuels for its energy needs. Free of heritage and huge investments in existing technology, and with an ability to act and innovate with imagination, new players can thrive in a rapidly changing world.

The launch of Tesla’s Model 3 heralds the start of a fundamental change in the auto industry. Tesla’s electric vehicle (EV) boasts all the latest safety features, with a range of 215 miles, and 0-60mph in under six seconds.

Importantly, the starting price will be US$35,000 (before taking any account of government incentives), in line with the average price for new cars in the US. Reservations for the new model soared upon its release in early April, topping 325,000 in the first week alone. Ultimately, a combination of cost and utility will drive the penetration of electric vehicles – and these are moving in the right direction now. Although EVs account for a tiny proportion of new car sales today, once a tipping point is reached expect adoption to be rapid. Please note stock examples are intended for illustrative purposes only and are not indicative of historical or future performance. References made to individual securities do not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.