Sell Now, Pay Later? - WSJ

[Klaus]

Sell Now, Pay Later?
July 12, 2004

This is summer vacation time for most of the big car companies, but that doesn't necessarily mean anyone in the business can relax.

The past week illustrated just how tough it is going to be for the industry to balance the tension between short- and long-term problems. In America, still the world's biggest car market, the short-term difficulty is reviving demand after disappointing June sales results. To prop up demand for the sport-utility vehicles that sustain their profits, General Motors Corp. and Ford Motor Co. last week tacked on rebates of up to $5,000 a truck. The new round of discounts from the Big Two officially kick off the "summer selldown" season, which is simply a push to make short-term calendar and model-year sales goals and clear the way for 2005 models coming in the fall.

Meanwhile, two events last week, one in California and one on Wall Street, offered reminders that the car business can't afford to ignore the long view.

In California, which accounts for about 12% of new U.S. vehicle registrations annually, regulators at the California Air Resources Board, or CARB, held a public meeting to discuss a draft of regulations that would compel auto makers to redesign the models they sell in the state to achieve as much as a 30% reduction in their greenhouse-gas emissions by 2014. Greenhouse gases means principally carbon dioxide – a by product of burning petroleum products in an internal combustion engine.

The agency, which has a long history of pushing reluctant auto makers to invent technology to make vehicles cleaner, isn't initiating these tougher rules just to be ornery. It is complying with a law that passed the California legislature in 2002, and has since won support from Gov. Arnold Schwarzenegger. By law, the agency is supposed to have regulations for putting the legislature's greenhouse-gas reduction goals in place by the end of this year.

The CARB draft proposals, which can be found at the agency's Web site1, are complex, and built on detailed assumptions about how soon various fuel-saving technologies could be pushed into mainstream vehicles. For the lay reader, the draft rules make great summertime reading -- if you are looking to take an afternoon nap. For the auto industry, however, the CARB proposals are alarming.

By the agency's estimates, the cost of technology that would be needed to meet the state's 2014 CO2 reduction goals could run to $1,047 per vehicle for a passenger car or a smaller light truck to $1,210 per vehicle for larger light trucks. Those figures could be lower or higher, depending on whether a given manufacturer is already making use of advanced fuel-saving technology. But at the high end, these per-vehicle cost estimates exceed the current average profit per vehicle for GM and Ford in North America.

The CARB draft makes a case that technologies that could help car makers achieve California's CO2 reduction goals without drastic changes to the kinds of vehicles offered either exist, or soon will exist. Selling more hybrid gas-electric vehicles, for example, could help a car maker meet the California carbon constraints. Hybrid SUVs like the Ford Escape Hybrid and the Lexus RX400h hybrid – both of which are supposed to hit the market in the next few months – represent the kind of vehicle the California regulators want the industry to sell. But from the car makers' point of view, the fact that they can build hybrid SUVs doesn't mean they want to immediately convert their SUV fleets to hybrid technology. Some car makers haven't invested as much in hybrid technology as Toyota, Honda and Ford but don't want to suffer in the market as a result. Gas-electric powertrains also are more expensive – by $2,000 to $3,000 or more – than conventional engine systems. That's one reason hybrids are a tiny sliver of the market, the hype over the technology notwithstanding.

The industry's broader criticisms of the CARB proposals, aired at last week's meeting, are that the agency is overestimating how much fuel can be saved by applying new technology, underestimating the costs of that technology, and stepping over the limits of its authority to regulate the fuel efficiency of cars and trucks. That last issue could well lead to a legal challenge by the industry, which contends that California's greenhouse gas initiative is fuel economy regulation by another name, and only the federal government can control fuel economy.

Peter Welch, president of the California Motor Car Dealers Association, summed up the industry's concerns this way. Historically, California clean air regulators have almost always stuck to three basic principles: When they have mandated new technology, it has been done so that the added costs to consumers are relatively slight. They have worked with auto makers to assure that the new technology is virtually transparent to the consumer in daily use. And they have linked their mandates to easily understood goals so that car dealers and manufacturers could effectively sell consumers on the need for the new hardware and its added cost.

"In LA, you can see the mountains that you couldn't see 20 years ago," Mr. Welch says. That's a benefit that's easy to explain to consumers who might otherwise gripe about catalytic converters or other pollution-control systems.

Electric vehicles failed in California because they violated these three conditions, Mr. Welch says. "We are concerned they are violating the three [standards] with this package. The prices depending on the model can be huge."

The justification for the legislation that would require car makers to reduce CO2 emissions is that global warming could "impose compelling and extraordinary impacts on California," the CARB draft says. The CARB staff draft also argues that the costs of CO2 constraints would be more than offset by savings from reduced fuel consumption. But consumers are getting mixed signals: Even now, gasoline still is relatively inexpensive compared to the early 1980s in inflation-adjusted terms. And SUVs remain high-volume sellers. That might change if prices for SUVs rose sharply due to environmental regulations, but so far it appears that a lot of consumers want SUVs even with higher gas prices and warnings about global warming.

The question is, will auto makers put more than $1,000 per car at risk if they don't do what California and the rest of the world wants?

That's where Wall Street comes in. Last week, Merrill Lynch's auto industry analyst, John Casesa, sponsored a conference call for clients and media that offered a podium for Duncan Austin, senior economist of the World Resources Institute, to present a case that auto makers risk significant damage to their earnings power and share values if they don't invest now in the technologies required to cut fuel consumption and emissions of greenhouse gases.

Mr. Austin's message was that whether or not you believe that global warming is real and that cars make it worse, most of the world's major car markets, including Europe, Japan, Australia, Canada, China and California, are taking steps to demand that vehicles burn less petroleum and chug out less carbon dioxide.

"We think the climate change issue is going to be a key driver for the industry over the next decade," Mr. Austin said, "and it will probably change competitive position of different manufacturers."

Mr. Austin presented an analysis developed by researchers at a Swiss organization called Sustainable Asset Management that projected the costs per vehicle that 10 major global car makers would face to meet the most likely "carbon constraint" regimes in the major developed markets. The range ran from more than $600 per vehicle for BMW to about $400 a vehicle for Ford, slightly less than $400 a vehicle for GM, under $200 a vehicle for Toyota and less than $50 a vehicle for Honda.

The flip side of that analysis is that earnings at companies that are less competitive in fuel-saving technologies or more reliant on fuel-thirsty vehicles for profits could see earnings suffer as more countries tighten carbon caps. GM and Ford could suffer earnings declines of as much as 10% or more, depending on what governments around the world do.

Mr. Austin said in a conversation after his presentation that the threat posed to auto makers' profits is a long-term issue. However, he says short-term events, such as a return to $40 a barrel oil, could trigger faster action by government regulators.

Still, Mr. Austin says, the picture that's shaping up should be of concern to car makers that aren't investing aggressively in fuel saving technology. Assuming that China carries through on its stated intentions to require significant improvements in vehicle fuel efficiency, and assuming that California, the Northeastern U.S. and Canada also move to restrict carbon dioxide emissions, "you could be in a situation where the remainder of the U.S. market looks increasingly different to the global market," Mr. Austin says.

The central U.S. would be a place of high-income consumers driving relatively inefficient vehicles -- an island in a world where smaller, more efficient vehicles are the norm.

That sounds like the premise for a science fiction movie, a follow up to the Road Warrior series, perhaps. But it's not that far from the reality the industry faces today as Europe and Asia prepare to embrace the Kyoto climate change treaty, and the U.S. stands against it.

These long term, what-if scenarios could give anyone a headache. It's a lot easier to mark down the SUVs, and rev up the publicity for the hot new 2005 models.

[Klaus]

Sell Now, Pay Later?
July 12, 2004

This is summer vacation time for most of the big car companies, but that doesn't necessarily mean anyone in the business can relax.

The past week illustrated just how tough it is going to be for the industry to balance the tension between short- and long-term problems. In America, still the world's biggest car market, the short-term difficulty is reviving demand after disappointing June sales results. To prop up demand for the sport-utility vehicles that sustain their profits, General Motors Corp. and Ford Motor Co. last week tacked on rebates of up to $5,000 a truck. The new round of discounts from the Big Two officially kick off the "summer selldown" season, which is simply a push to make short-term calendar and model-year sales goals and clear the way for 2005 models coming in the fall.

Meanwhile, two events last week, one in California and one on Wall Street, offered reminders that the car business can't afford to ignore the long view.

In California, which accounts for about 12% of new U.S. vehicle registrations annually, regulators at the California Air Resources Board, or CARB, held a public meeting to discuss a draft of regulations that would compel auto makers to redesign the models they sell in the state to achieve as much as a 30% reduction in their greenhouse-gas emissions by 2014. Greenhouse gases means principally carbon dioxide – a by product of burning petroleum products in an internal combustion engine.

The agency, which has a long history of pushing reluctant auto makers to invent technology to make vehicles cleaner, isn't initiating these tougher rules just to be ornery. It is complying with a law that passed the California legislature in 2002, and has since won support from Gov. Arnold Schwarzenegger. By law, the agency is supposed to have regulations for putting the legislature's greenhouse-gas reduction goals in place by the end of this year.

The CARB draft proposals, which can be found at the agency's Web site1, are complex, and built on detailed assumptions about how soon various fuel-saving technologies could be pushed into mainstream vehicles. For the lay reader, the draft rules make great summertime reading -- if you are looking to take an afternoon nap. For the auto industry, however, the CARB proposals are alarming.

By the agency's estimates, the cost of technology that would be needed to meet the state's 2014 CO2 reduction goals could run to $1,047 per vehicle for a passenger car or a smaller light truck to $1,210 per vehicle for larger light trucks. Those figures could be lower or higher, depending on whether a given manufacturer is already making use of advanced fuel-saving technology. But at the high end, these per-vehicle cost estimates exceed the current average profit per vehicle for GM and Ford in North America.

The CARB draft makes a case that technologies that could help car makers achieve California's CO2 reduction goals without drastic changes to the kinds of vehicles offered either exist, or soon will exist. Selling more hybrid gas-electric vehicles, for example, could help a car maker meet the California carbon constraints. Hybrid SUVs like the Ford Escape Hybrid and the Lexus RX400h hybrid – both of which are supposed to hit the market in the next few months – represent the kind of vehicle the California regulators want the industry to sell. But from the car makers' point of view, the fact that they can build hybrid SUVs doesn't mean they want to immediately convert their SUV fleets to hybrid technology. Some car makers haven't invested as much in hybrid technology as Toyota, Honda and Ford but don't want to suffer in the market as a result. Gas-electric powertrains also are more expensive – by $2,000 to $3,000 or more – than conventional engine systems. That's one reason hybrids are a tiny sliver of the market, the hype over the technology notwithstanding.

The industry's broader criticisms of the CARB proposals, aired at last week's meeting, are that the agency is overestimating how much fuel can be saved by applying new technology, underestimating the costs of that technology, and stepping over the limits of its authority to regulate the fuel efficiency of cars and trucks. That last issue could well lead to a legal challenge by the industry, which contends that California's greenhouse gas initiative is fuel economy regulation by another name, and only the federal government can control fuel economy.

Peter Welch, president of the California Motor Car Dealers Association, summed up the industry's concerns this way. Historically, California clean air regulators have almost always stuck to three basic principles: When they have mandated new technology, it has been done so that the added costs to consumers are relatively slight. They have worked with auto makers to assure that the new technology is virtually transparent to the consumer in daily use. And they have linked their mandates to easily understood goals so that car dealers and manufacturers could effectively sell consumers on the need for the new hardware and its added cost.

"In LA, you can see the mountains that you couldn't see 20 years ago," Mr. Welch says. That's a benefit that's easy to explain to consumers who might otherwise gripe about catalytic converters or other pollution-control systems.

Electric vehicles failed in California because they violated these three conditions, Mr. Welch says. "We are concerned they are violating the three [standards] with this package. The prices depending on the model can be huge."

The justification for the legislation that would require car makers to reduce CO2 emissions is that global warming could "impose compelling and extraordinary impacts on California," the CARB draft says. The CARB staff draft also argues that the costs of CO2 constraints would be more than offset by savings from reduced fuel consumption. But consumers are getting mixed signals: Even now, gasoline still is relatively inexpensive compared to the early 1980s in inflation-adjusted terms. And SUVs remain high-volume sellers. That might change if prices for SUVs rose sharply due to environmental regulations, but so far it appears that a lot of consumers want SUVs even with higher gas prices and warnings about global warming.

The question is, will auto makers put more than $1,000 per car at risk if they don't do what California and the rest of the world wants?

That's where Wall Street comes in. Last week, Merrill Lynch's auto industry analyst, John Casesa, sponsored a conference call for clients and media that offered a podium for Duncan Austin, senior economist of the World Resources Institute, to present a case that auto makers risk significant damage to their earnings power and share values if they don't invest now in the technologies required to cut fuel consumption and emissions of greenhouse gases.

Mr. Austin's message was that whether or not you believe that global warming is real and that cars make it worse, most of the world's major car markets, including Europe, Japan, Australia, Canada, China and California, are taking steps to demand that vehicles burn less petroleum and chug out less carbon dioxide.

"We think the climate change issue is going to be a key driver for the industry over the next decade," Mr. Austin said, "and it will probably change competitive position of different manufacturers."

Mr. Austin presented an analysis developed by researchers at a Swiss organization called Sustainable Asset Management that projected the costs per vehicle that 10 major global car makers would face to meet the most likely "carbon constraint" regimes in the major developed markets. The range ran from more than $600 per vehicle for BMW to about $400 a vehicle for Ford, slightly less than $400 a vehicle for GM, under $200 a vehicle for Toyota and less than $50 a vehicle for Honda.

The flip side of that analysis is that earnings at companies that are less competitive in fuel-saving technologies or more reliant on fuel-thirsty vehicles for profits could see earnings suffer as more countries tighten carbon caps. GM and Ford could suffer earnings declines of as much as 10% or more, depending on what governments around the world do.

Mr. Austin said in a conversation after his presentation that the threat posed to auto makers' profits is a long-term issue. However, he says short-term events, such as a return to $40 a barrel oil, could trigger faster action by government regulators.

Still, Mr. Austin says, the picture that's shaping up should be of concern to car makers that aren't investing aggressively in fuel saving technology. Assuming that China carries through on its stated intentions to require significant improvements in vehicle fuel efficiency, and assuming that California, the Northeastern U.S. and Canada also move to restrict carbon dioxide emissions, "you could be in a situation where the remainder of the U.S. market looks increasingly different to the global market," Mr. Austin says.

The central U.S. would be a place of high-income consumers driving relatively inefficient vehicles -- an island in a world where smaller, more efficient vehicles are the norm.

That sounds like the premise for a science fiction movie, a follow up to the Road Warrior series, perhaps. But it's not that far from the reality the industry faces today as Europe and Asia prepare to embrace the Kyoto climate change treaty, and the U.S. stands against it.

These long term, what-if scenarios could give anyone a headache. It's a lot easier to mark down the SUVs, and rev up the publicity for the hot new 2005 models.

[Klaus]

Sell Now, Pay Later?
July 12, 2004

This is summer vacation time for most of the big car companies, but that doesn't necessarily mean anyone in the business can relax.

The past week illustrated just how tough it is going to be for the industry to balance the tension between short- and long-term problems. In America, still the world's biggest car market, the short-term difficulty is reviving demand after disappointing June sales results. To prop up demand for the sport-utility vehicles that sustain their profits, General Motors Corp. and Ford Motor Co. last week tacked on rebates of up to $5,000 a truck. The new round of discounts from the Big Two officially kick off the "summer selldown" season, which is simply a push to make short-term calendar and model-year sales goals and clear the way for 2005 models coming in the fall.

Meanwhile, two events last week, one in California and one on Wall Street, offered reminders that the car business can't afford to ignore the long view.

In California, which accounts for about 12% of new U.S. vehicle registrations annually, regulators at the California Air Resources Board, or CARB, held a public meeting to discuss a draft of regulations that would compel auto makers to redesign the models they sell in the state to achieve as much as a 30% reduction in their greenhouse-gas emissions by 2014. Greenhouse gases means principally carbon dioxide – a by product of burning petroleum products in an internal combustion engine.

The agency, which has a long history of pushing reluctant auto makers to invent technology to make vehicles cleaner, isn't initiating these tougher rules just to be ornery. It is complying with a law that passed the California legislature in 2002, and has since won support from Gov. Arnold Schwarzenegger. By law, the agency is supposed to have regulations for putting the legislature's greenhouse-gas reduction goals in place by the end of this year.

The CARB draft proposals, which can be found at the agency's Web site1, are complex, and built on detailed assumptions about how soon various fuel-saving technologies could be pushed into mainstream vehicles. For the lay reader, the draft rules make great summertime reading -- if you are looking to take an afternoon nap. For the auto industry, however, the CARB proposals are alarming.

By the agency's estimates, the cost of technology that would be needed to meet the state's 2014 CO2 reduction goals could run to $1,047 per vehicle for a passenger car or a smaller light truck to $1,210 per vehicle for larger light trucks. Those figures could be lower or higher, depending on whether a given manufacturer is already making use of advanced fuel-saving technology. But at the high end, these per-vehicle cost estimates exceed the current average profit per vehicle for GM and Ford in North America.

The CARB draft makes a case that technologies that could help car makers achieve California's CO2 reduction goals without drastic changes to the kinds of vehicles offered either exist, or soon will exist. Selling more hybrid gas-electric vehicles, for example, could help a car maker meet the California carbon constraints. Hybrid SUVs like the Ford Escape Hybrid and the Lexus RX400h hybrid – both of which are supposed to hit the market in the next few months – represent the kind of vehicle the California regulators want the industry to sell. But from the car makers' point of view, the fact that they can build hybrid SUVs doesn't mean they want to immediately convert their SUV fleets to hybrid technology. Some car makers haven't invested as much in hybrid technology as Toyota, Honda and Ford but don't want to suffer in the market as a result. Gas-electric powertrains also are more expensive – by $2,000 to $3,000 or more – than conventional engine systems. That's one reason hybrids are a tiny sliver of the market, the hype over the technology notwithstanding.

The industry's broader criticisms of the CARB proposals, aired at last week's meeting, are that the agency is overestimating how much fuel can be saved by applying new technology, underestimating the costs of that technology, and stepping over the limits of its authority to regulate the fuel efficiency of cars and trucks. That last issue could well lead to a legal challenge by the industry, which contends that California's greenhouse gas initiative is fuel economy regulation by another name, and only the federal government can control fuel economy.

Peter Welch, president of the California Motor Car Dealers Association, summed up the industry's concerns this way. Historically, California clean air regulators have almost always stuck to three basic principles: When they have mandated new technology, it has been done so that the added costs to consumers are relatively slight. They have worked with auto makers to assure that the new technology is virtually transparent to the consumer in daily use. And they have linked their mandates to easily understood goals so that car dealers and manufacturers could effectively sell consumers on the need for the new hardware and its added cost.

"In LA, you can see the mountains that you couldn't see 20 years ago," Mr. Welch says. That's a benefit that's easy to explain to consumers who might otherwise gripe about catalytic converters or other pollution-control systems.

Electric vehicles failed in California because they violated these three conditions, Mr. Welch says. "We are concerned they are violating the three [standards] with this package. The prices depending on the model can be huge."

The justification for the legislation that would require car makers to reduce CO2 emissions is that global warming could "impose compelling and extraordinary impacts on California," the CARB draft says. The CARB staff draft also argues that the costs of CO2 constraints would be more than offset by savings from reduced fuel consumption. But consumers are getting mixed signals: Even now, gasoline still is relatively inexpensive compared to the early 1980s in inflation-adjusted terms. And SUVs remain high-volume sellers. That might change if prices for SUVs rose sharply due to environmental regulations, but so far it appears that a lot of consumers want SUVs even with higher gas prices and warnings about global warming.

The question is, will auto makers put more than $1,000 per car at risk if they don't do what California and the rest of the world wants?

That's where Wall Street comes in. Last week, Merrill Lynch's auto industry analyst, John Casesa, sponsored a conference call for clients and media that offered a podium for Duncan Austin, senior economist of the World Resources Institute, to present a case that auto makers risk significant damage to their earnings power and share values if they don't invest now in the technologies required to cut fuel consumption and emissions of greenhouse gases.

Mr. Austin's message was that whether or not you believe that global warming is real and that cars make it worse, most of the world's major car markets, including Europe, Japan, Australia, Canada, China and California, are taking steps to demand that vehicles burn less petroleum and chug out less carbon dioxide.

"We think the climate change issue is going to be a key driver for the industry over the next decade," Mr. Austin said, "and it will probably change competitive position of different manufacturers."

Mr. Austin presented an analysis developed by researchers at a Swiss organization called Sustainable Asset Management that projected the costs per vehicle that 10 major global car makers would face to meet the most likely "carbon constraint" regimes in the major developed markets. The range ran from more than $600 per vehicle for BMW to about $400 a vehicle for Ford, slightly less than $400 a vehicle for GM, under $200 a vehicle for Toyota and less than $50 a vehicle for Honda.

The flip side of that analysis is that earnings at companies that are less competitive in fuel-saving technologies or more reliant on fuel-thirsty vehicles for profits could see earnings suffer as more countries tighten carbon caps. GM and Ford could suffer earnings declines of as much as 10% or more, depending on what governments around the world do.

Mr. Austin said in a conversation after his presentation that the threat posed to auto makers' profits is a long-term issue. However, he says short-term events, such as a return to $40 a barrel oil, could trigger faster action by government regulators.

Still, Mr. Austin says, the picture that's shaping up should be of concern to car makers that aren't investing aggressively in fuel saving technology. Assuming that China carries through on its stated intentions to require significant improvements in vehicle fuel efficiency, and assuming that California, the Northeastern U.S. and Canada also move to restrict carbon dioxide emissions, "you could be in a situation where the remainder of the U.S. market looks increasingly different to the global market," Mr. Austin says.

The central U.S. would be a place of high-income consumers driving relatively inefficient vehicles -- an island in a world where smaller, more efficient vehicles are the norm.

That sounds like the premise for a science fiction movie, a follow up to the Road Warrior series, perhaps. But it's not that far from the reality the industry faces today as Europe and Asia prepare to embrace the Kyoto climate change treaty, and the U.S. stands against it.

These long term, what-if scenarios could give anyone a headache. It's a lot easier to mark down the SUVs, and rev up the publicity for the hot new 2005 models.