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Bernstein and Ricardo Report: Cheap Will Beat Cool in Vehicle Electrification


John Petersen

On September 26, 2011, Bernstein Research and Ricardo plc published
a 450 page analytical report titled, “Global Autos: Don’t Believe the Hype –
Analyzing the Costs & Potential of Fuel-Efficient Technology,

which combines best in class securities research from Bernstein with
the deep automotive expertise of Ricardo, a global leader in
engineering, product innovation and strategic consulting. The result
is the most comprehensive, detailed and eminently reasonable
forecast of short-, medium- and long-term trends in advanced
automotive powertrain technology that I’ve had the pleasure to read.

It’s devoid of axe grinding or cheer-leading and simply describes
how the auto industry is likely to evolve over the next couple
decades. The key takeaway is two themes I regularly stress – Cheap Beats Cool and Baby Steps
Rule
.

Since the “Black Book” is far too detailed and comprehensive to
adequately explore in a blog like mine, I think the best approach
will be to summarize the key conclusions and explain how the
expected evolution of powertrain technology will impact the
companies I write about.

Overview.
Bernstein and Ricardo are bullish on gasoline and advanced diesel
technology, but cautious on the near term or medium term prospects
for electric vehicles. They believe advanced automotive technologies
must be affordable before logical consumers will buy new-generation
vehicles in significant quantities. They have concluded that
improvements to conventional engines will be key over the next 10 to
15 years and HEVs will become viable on a large scale by 2020. They
believe near-term mass market adoption of electric vehicles is
unlikely given the tough financial comparison with ever improving
combustion engine vehicles. While premium-priced plug-ins may become
viable earlier, by definition they will be niche products.

Conventional
engines can meet 2020 regulatory targets at low cost
.

While widespread adoption of several emerging technologies including
downsized engines, turbocharging, advanced fuel injection,
stop-start idle elimination, advanced transmissions and other
technologies that reduce rolling losses will be needed to meet
regulatory targets, a shift to more expensive hybrid and electric
drive technologies is unnecessary and unlikely. Except for
Nissan-Renault, automakers’ electric drive ambitions point to
high-profile concept cars coupled with vaguely modest production
plans.

Current
HEVs and Plug-in Vehicles have much higher TCOs than
conventional powertrains
.
Bernstein and Ricardo
estimate the total cost of ownership, or TCO, of a conventional
C-segment car at €21,300 ($28,400) over a typical four-year
ownership period for the first purchaser. Without exception electric
powertrains fail to offer any cost savings with HEVs costing
approximately €1,650 ($2,200) more over four years, PHEVs costing
approximately €4,500 ($6,000) more over four years and EVs costing
approximately €10,800 ($14,400) more over four years.

Aggressive
downsizing and modest electrification will be needed after
2020
.
To move from niche to volume production,
PHEVs and EVs require a breakthrough in battery performance (energy
and power density) and cost to overcome range anxiety and TCO
concerns. While aggressive downsizing and modest
electrification will be required from 2020 on, Bernstein and Ricardo
believe the auto industry can meet regulatory targets with a 10%
market share for HEVs, a 4.5% market share for PHEVs with small
battery packs and a 4% market share for full BEVs. They estimate
that the current cost differential between manufacturing a
conventional car and manufacturing the same car with an electric
powertrain is on the order of €16,000 ($21,500) before incentives.

At
current vehicle costs and tax rates, oil would need to cost
$300/bbl in Europe, $500/bbl in China and $800/bbl in the US
before plug-ins would break even with conventional vehicles
.
Bernstein and Ricardo believe market forces alone are
unlikely to provide enough incentive for a demand pull in
electrified powertrains. While electric vehicles are likely to
benefit from sizable cost reduction opportunities, combustion
engines will require more expensive technology upgrades. The
combination of the two will lower the break-even point for fossil
fuels by ±20% over the next five years and another 35-40% by
2020. By 2025, Ricardo and Bernstein expect EVs to be competitive
with conventional vehicles.

Battery
cost reductions will be a key driver of future vehicle
electrification
.
Bernstein and Ricardo estimate
that currrent battery pack costs range from €4,500 ($6,000) for
PHEVs to €13,500 ($18,000) for full electric vehicles, or $750-$800
per kWh of pack capacity. Battery costs will need to halve if EVs
are to break even with internal combustion. Historical trends
indicate that battery costs will decline by roughly 5% per year,
which should bring costs down into the $310-$350 per kWh range by
2025. Until then, governments will need to bridge the gap with
subsidies of several thousand dollars per vehicle for electric
powertrains to be competitive.

Hybrids,
PHEVs and EVs require significant amounts of additional raw
materials
.
Conventional cars are material
intensive but batteries and traction motors for HEVs, PHEVs and EVs
will require significant additional amounts of raw materials that
are far less plentiful and recyclable than the principal metals used
in conventional cars.

While
lithium supplies are adequate, competing demands for rare earth
metals and copper will be challenging
.
Global
lithium supplies are adequate for the foreseeable future, but rare
earth metal production is dominated by Chinese producers and prices
have skyrocketed. As new mines become productive and recycling
technologies are developed, the constraints will become less
burdensome, but costs will remain significant. The biggest metal
constraint will likely be copper because a conventional car needs 24
kg of copper while an HEV needs 34 kg, a PHEV needs 54 kg and an EV
needs 94 kg. As a result the value of the copper in an EV will probably
exceed the total value of the steel and aluminum combined.

Stop-start
systems offer some of the best value for money CO
2 reduction potential.
Bernstein and
Ricardo expect that virtually every conventional internal combustion
powertrain in the mature markets will feature either simple or
advanced stop-start systems by 2020.

Almost
all widely hyped improvements to powertrain are based on old
concepts
.
The fundamental chemistry and physics
of powertrains have not changed significantly over the past 100
years, but design and combustion efficiency gains have provided
continuous advances in power density while noise, emission and fuel
consumption levels have decreased. The next 15 years will be
characterized by an evolution of existing technologies and
the co-existence of various powertrain options, rather than the
emergence of a disruptive dominant new technology such as electric
or fuel cell vehicles. Over the next 15 to 20 years electrification
is expected to become commonplace, but Bernstein and Ricardo expect
that three out of four vehicles will still have an on-board internal
combustion engine.

While I am a frequent and relentless critic of lithium-ion and
electric vehicle investments because I believe the investing public
has unrealistic expectations about the amount of time that will
elapse between introduction and commercial success Bernstein and
Ricardo didn’t reach any conclusions that I’d disagree with. They
expect battery development timelines to be lengthy and improvements
to be limited to ±5% per year. They expect manufacturers of
electric vehicles and components to lose money for several more
years as they try to overcome immense TCO disadvantages and
establish a toehold in the mass market. These conclusions are
entirely consistent with the industry’s experience with HEVs which
took almost a decade to achieve a 3% market penetration in the US.
The process will be evolutionary rather than revolutionary and
investors who pay premium prices for the stock of companies that
won’t hit their stride for another decade will suffer.

In the energy storage sector, the first big beneficiaries of
powertrain improvements will be Johnson Controls (JCI)
and Exide Technologies (XIDE)
who make starter batteries. Since stop-start technology puts
tremendous strain on the battery from starting the engine several
times during a commute and carrying accessory loads during engine
off intervals, the auto industry is rapidly increasing the per
vehicle amount they spend on batteries. Historically a new car used
a simple flooded lead acid battery that cost the automakers about
$60. Because of the heavier battery demands of stop-start,
automakers are rapidly shifting to AGM batteries that cost about
$120 and dual battery systems that cost $120 to $180. On a per
vehicle basis, JCI expects cars equipped with stop-start systems to
generate twice the revenue and three times the profit margin.

While current battery technology may be good enough for basic
stop-start systems, it is clearly inadequate for the advanced stop-start
systems automakers want to implement to minimize emissions and maximize fuel economy.
Those advanced systems will need far more robust energy storage
devices like the battery-supercapacitor combination that
Maxwell Technologies (MXWL)
has introduced on diesel powered cars from Peugeot and the
revolutionary PbC battery from Axion Power International (AXPW.OB)
which is in advanced stages of vehicle testing by BMW and other
automakers.

I continue to believe lithium-ion cell manufacturers including A123
Systems (AONE),
Valence Technologies (VLNC)
and Altair Nanotechnologies (ALTI)
will be poor investments over the next seven to ten years because
these companies are under immense pressure to reduce costs in an
industry where materials represent 60% of pack level costs and
heavily automated manufacturing methods keep labor and overhead in
the 22% range combined. While there are some potential economies of
scale to be realized in battery management systems and perhaps a
more efficient use of raw materials, the gains are expected to be
slow and painful during a period when profit margins are compressed
to help heavily electrified vehicles overcome crushing TCO
handicaps.

While I’m cautiously negative about battery manufacturers, I don’t
see any possibility that niche manufacturers like Tesla Motors (TSLA)
can possibly live up to outlandishly inflated expectations and
maintain clearly unreasonable stock market valuations by
manufacturing niche products that can only appeal to a minute
fraction of the car buying public. It took three years before Tesla
sold its 2,000th Roadster. While there are a respectable number of
reservations for the Model S that will debut next year, there is no
reason beyond unbridled optimism to believe demand for a $60,000
electric passenger car is a well-spring rather than a puddle. Even NPR,
a bastion of conservative thinking, has taken to pessimistic
reporting on the near-term potential of the electric vehicle sector now that
unlimited government spending on ideology seems to be going the way of
the dodo bird. There will be some demand and Tesla may survive as a going
concern, but I can’t imagine how it will retain a market
capitalization that’s an eye-watering 11.2 times book value and 16.4
times sales. The law of economic gravity simply cannot be denied and it will
not be mocked.

LATE BREAKING ADDITION

Bernstein Research has graciously agreed to let me post a complete
copy of the Black Book in a form that can be downloaded by clicking here.

Disclosure: Author is a
former director of Axion Power International (AXPW.OB)
and holds a substantial long position in its common stock.

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