September 29, 2015 | 8:36 PM by Fahad Khalid | fkhalid@jaguaranalytics.com

Volkswagen Emission Disaster Questions Internal Combustion Sustainability

Collecting thoughts from various industry reports, Volkswagen emissions news could raise the cost of doing business substantially for all auto makers in the internal combustion engine business, accelerating a potential move to EVs where innovation is just starting to take its roots.

EPA is Tightening Oversight – Aside from the questions about Volkswagen practices and regulatory impact, it has long been known that real-world fuel economy and emissions of vehicles in the fleet do not achieve the same levels of performance as tested in a controlled environment for regulatory/certification purposes. The severity of the response from EPA following VW’s actions could result in a narrowing of the gap between lab tested emissions and real world emissions, at a materially higher cost to auto manufacturers. The EPA is ‘upping its game’ and will initiate new emissions testing protocol for greater numbers of vehicles powered by both diesel and gasoline engines already on the road. These procedures can include spot checks of privately owned cars, rental cars and even vehicles sourced directly from the assembly line.

Cost of Controlling Emissions Rising Outrageously – There are substantial amounts of data from automotive suppliers, OEMs and regulatory agencies alike on this topic. Depending on the starting point, technology and regulatory target, the cost per gram of CO2 reduction can range form $6/gram to over $100/gram. In Europe, relative to today’s 130 g/CO2 baseline, the average car would require EUR 1,000 added manufacturing costs per unit to achieve 95g/CO2, or roughly $32/g. For sensitivity sake, real-world emissions would only need to be off by 2% or 3% to account for a potential increase of $100/cost per car.

The End Game? – What does this VW event say, at a high level, about the prospects of the long term viability of engines that are based on a technology that, at its core, has not changed fundamentally in over 100 years? Let’s face it. Internal combustion engine is getting old. Consumer appeal for electric cars will only get better from here with least amount of regulatory interference. It will not happen overnight. But it is a sea change with foundation already being put in place.

Internal Combustion Engine (ICE) Powertrain Century Old Dominance – The timing of the VW news breaking in the same week that stories are percolating about Apple preparing to ship an electric car by 2019 is symbolic. We are not at all suggesting that internal combustion engine technology will disappear in 10 or 15 years. Given any number of capacity, technological, consumer and political factors, the potential substitution would take far longer to run its course. But the timing of the initial change and steepness of the telemetry may take the market by surprise over the next 3 to 5 years. Driving all of this at the heart is the constantly improving economic gap between EV and ICE.

Consider that manufacturing costs of batteries are falling industry-wide and Tesla has already pushed industry standard down to $300/KwH in 3 years. By 2018 when Gigafactory will come online, Elon Musk is targeting $200/KwH and long term target of $100/KwH by the middle of next decade. This has widespread implications for auto industry as electric cars in out years will compete for mass production and consumer appeal from lower cost point, while internal combustion engine makers will still be fighting the EPA. Emission standards stringency gets materially more difficult over the next 10 year. Plenty of research to support this evidence. Regulatory scrutiny could reasonably be expected to get harder in a post Volkswagen world.

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