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China emissions rules threaten carmaker profits

Domestic brands face biggest challenge adjusting to tougher rules commonplace elsewhere

A woman (C) wearing a mask stands besides her bicycle as vehicles stop at a traffic junction on a busy street amid thick haze in Beijing February 25, 2014. China has sent teams of investigators to parts of the country worst hit by air pollution as part of efforts to stop the heavy smog engulfing about 15 percent of the country, including Beijing. REUTERS/Barry Huang (CHINA - Tags: ENVIRONMENT TRANSPORT) - RTR3FP24©Reuters

Three months after announcing the biggest annual loss in the company’s history for 2015 due to its diesel emissions scandal, Volkswagen in July unveiled unexpectedly high profits for the first half of this year, fuelled by sales of VW cars in China.

There, unlike Europe and the US, the VW brand has not been tarnished by the German carmaker’s scandal, and Chinese demand for vehicles is strong in spite of the country’s economic slowdown.

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But China’s tolerance for polluting vehicles — the market is dominated by cars powered by petrol engines — is now drawing to an end. A rollout of new legislation due to be completed by 2020 aims to tighten China’s rules on cars’ emissions and fuel economy, bringing them into line with western countries and thereby curbing the industry’s contribution to global warming and air pollution.

The legislation is expected by some analysts to hit the profits of companies operating in what is the world’s largest automobile market, but VW and other overseas carmakers are better placed than their domestic rivals to cope with China’s shift to stricter standards, says Jane Lewis, analyst at Macquarie.

“The domestic brands are hit disproportionately as international brands face similar emission and fuel economy requirements in other markets,” she adds.

Some overseas carmakers, such as Jaguar Land Rover, may struggle to meet fuel economy targets set by the Chinese government for their fleets but most international brands will reach these goals, says Ms Lewis. The worst hit will be smaller domestic carmakers, she adds.

The main drivers behind China’s emissions and fuel economy targets are efforts to reduce air pollution in towns and cities and promote technical developments in the domestic auto industry, says a report by the Innovation Centre for Energy and Transportation, a Chinese think-tank.

In order to push companies towards hitting fuel-economy targets, Beijing has begun to name and shame carmakers whose fleets are inefficient.

Twenty-two carmakers on the Chinese mainland — including joint ventures involving Sweden’s Volvo and Germany’s Mercedes-Benz, as well as major domestic brands such as BAIC Motors — failed to meet their passenger vehicle fuel economy targets for 2015, according to a report released last month by China’s ministry of information technology.

The Chinese rules represent a huge challenge for industry profits

– Bernstein analysts

No public action has been taken against non-compliant companies. But overall, the report by the ministry of information and technology found the fuel economy of Chinese carmakers’ fleets dropped by 0.9 per cent last year, while those of international brands increased by 3.1 per cent.

The fuel consumption target for each carmaker’s fleet in 2015 was for vehicles on average to travel 100km on 6.9 litres of fuel. But the average fuel required for domestic and overseas carmakers’ vehicles was 7.04 litres last year. By 2020, the Chinese government wants that figure to fall to 5 litres.

To try and avoid penalties for non-compliance with China’s fuel economy rules, carmakers are starting to change the composition of their Chinese fleets by bringing in electric vehicles. They are also looking to introduce more so-called hybrid vehicles, which have a combination of a combustion engine and electric power.

Japanese carmakers including Toyota have already begun to establish factories to produce hybrid vehicles in China.

This tactic may be less helpful for domestic carmakers as the numbers of electric vehicles they would need to sell in order meet the fuel economy targets is unrealistically high, says Yale Zhang, analyst at Automotive Insight, a consultancy.

“Right now it looks like no Chinese automakers can hit the targets unless they allocate about 20 to 25 per cent of their sales to new energy vehicles,” he adds. “No one is ready to hit that kind of level by 2020,” he added.

Meanwhile, China is preparing to introduce a new set of emissions testing standards, with tougher limits on exhaust gases such nitrogen oxides, which cause respiratory diseases.

The so-called Beijing 6 rules that are due to take effect in 2018 will be an adapted version of US emissions standards, and should take a harder line than the EU on nitrogen oxides, which are generated by both petrol and diesel engines.

Analysts at Bernstein say the Chinese rules represent a “huge challenge for industry profits”, estimating that meeting fuel economy targets alone will cost overseas carmakers Rmb5,000 to Rmb7,000 ($ 752 to $ 1,052) per vehicle sold between now and 2020.

But for some domestic brands, whose fleets are increasingly made up of gas-guzzling sport utility vehicles, the cost of meeting the targets could be between Rmb10,000 and Rmb16,000 per car for the same period, they add.

Jaguar Land Rover said it was confident of meeting all its global emissions targets, including those in China.

Fujian Benz Automotive, a joint venture in China involving Daimler, Mercedes-Benz’s parent company, said it was “continuously working on optimising the energy consumption of our vehicles”.

Volvo did not respond to requests for comment. BAIC could not be reached.

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