Diesel's Rosy Future
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The updated average fuel economy standards under the Corporate Average Fuel Economy (CAFE) law is not necessarily recent news, but it is still the underpinnings of the most important changes the auto industry has faced over the past two decades. Originally established in 1975 and mandating that automakers reach an average (between cars and light-duty trucks) of 18 miles per gallon across their vehicle lineups, CAFE was most recently updated under the Obama administration with targets of 35.5 mpg and 54.5 mpg average fuel economy ratings in 2016 and 2025, respectively.
The primary hurdle for automakers thus far has not been the successful research and development of high fuel economy technologies – hybrids, plug-in EVs, and even some smaller conventional gas engines have all proved to be viable alternatives – but instead has been the juggling of different vehicle technologies while attempting to maintain consumer loyalty for a particular brand.
First, given the unique driving habits and budgetary concerns of individual car shoppers, one propulsion technology will never win the “format war” in the auto industry. High volume automakers will need to continue producing a variety of vehicle types – fuel-efficient gas and/or flex fuel engines, diesels, hybrids, EVs – to remain relevant to a wide base of consumers in the market. Such a broad portfolio endeavor is extremely expensive. Second, significantly more intense competition in the space has made it even more difficult to obtain customer loyalty. Some of the higher volume producers today, including Hyundai, Kia, and Volkswagen (NASDAQOTH: VLKAY), were considerably less competitive ten years ago.
Although some auto manufacturers will continue to attempt to make a big splash into the hybrid market – the only wildly popular hybrid thus far has been the Toyota (NYSE: TM) Prius – recent research has shown that hybrids will probably not be the most important technology to maintain consumer loyalty on the route toward complying with CAFE standards.
Recent Polk (an automotive data aggregator and provider) data has shown that the loyalty rate among hybrid owners is slowly waning. Only 35% of hybrid vehicle owners that traded in their vehicles in 2011 – there were around 75,000 in the study – went on to purchase another hybrid vehicle. This repurchase rate, which is down from 39.6% in 2009 and 38.9% in 2010, is actually below 25% when factoring out the hybrid market leader in the Prius.
There are several drivers behind the falling rate of hybrid loyalists, and the fact that other automakers have yet to produce as compelling of a vehicle as the Prius is but one of them. For many buyers, most of which shop with a “What’s good for me now?” type mentality, the purchase of a comparably expensive hybrid does not maximize short-term satisfaction. The Ford (NYSE: F) Fusion Hybrid, which is rated by the EPA at a combined (highway and city) 39 mpg and only sold 11,300 units in 2011, offers a suitable example of the notion of “adequacy.” Buyers can purchase GM's (NYSE: GM) similarly sized Chevrolet Malibu with an adequately comparable 33 mpg for more than 20% less. Likewise, potential Fusion shoppers can scale down to an adequately sized Ford Focus or Chevrolet Cruze, get more fuel efficiency, and save nearly $12,000 on the purchase price. Although a hybrid drivetrain may provide some fuel cost savings over the entire lifetime of a vehicle, the majority of consumers make extremely short-term purchase decisions. The relatively higher price of hybrids as well as the increasing fuel economy of conventional gas engines has reduced the loyalty rate among hybrid owners.
An attractive alternative route for the automakers’ simultaneous quest for consumer loyalty and CAFE compliance may be diesel engines, and the increased activity in the diesel market shows that manufacturers understand this to be true. The same Polk study has shown that diesel repurchase loyalty was 28% in 2011 – 28% of diesel owners who traded in their vehicles in 2011 went on to purchase another diesel – which is up from 19% in 2008. Although diesel fuel represents a higher variable cost over the lifetime of the vehicle’s operation, diesel engines can be as much as 30-35% more efficient than comparably sized gas counterparts, and are not necessarily much more expensive as an option upgrade. Likewise, by producing more torque than gas engines, diesel engines make vehicles feel faster and more powerful, so drivers are not foregoing performance for more fuel efficiency points like they would be doing so with a hybrid purchase.
Diesel engines have long been a popular, with an almost cult-like following, option in German-produced autos (Volkswagens, BMWs) and larger heavy-duty pickup trucks. Volkswagen’s diesel sales represented nearly a quarter of its total U.S. market volume in Q1 2012, which implies a run rate of nearly 100,000 diesel VWs by year-end. Likewise, all diesel sales in the U.S. market in 2011 grew 27.4%, compared with a decline in hybrid sales of 2.2% (Source: The Detroit News). Such a swiftly growing vehicle niche cannot be ignored by other high volume automakers for long, and the same source does not expect it to – the number of diesel models in the U.S. market is expected to double, from 25 to 50, by 2014.
Several notable diesel engine projects have already been initiated. Chevrolet has already released a diesel version of its hugely successful compact Cruze in the European, Asian, African, and South American markets, and sold 33,000 units in 2011. The success of the Cruze Eco-D (diesel) has given GM the motivation to make it available in the U.S. market in 2013, making the automaker the first among Detroit’s Big Three to offer a diesel option on an American family sedan. The Eco-D is nearly 25% more fuel efficient than the gas engine already offered in the traditional Cruze Eco model.
Fiat and Chrysler, which plan on redesigning six Jeep products as the team’s key to global market penetration, is also in the developmental stages of a diesel Grand Cherokee. The model, like the Cruze, will be launched in the U.S. in 2013.
Lastly, Mazda, which generates a significant portion of its sales from its native-Japan market, will be including its Skyactiv diesel technology in the United States to capitalize on the trend. Mazda is definitely in need of a knockout product, as the automaker has suffered large operating losses and expects substantial workforce cuts whereas Japanese counterparts including Toyota and Nissan have rebounded after the 2011 Japan earthquake/tsunami disasters.
Although there are still some roadblocks preventing diesel technology from reaching significantly higher volumes (primarily the price of the fuel), it would not be surprising to see additional small diesel launches in the U.S. as pent-up demand boosts the intensity of the competition in the market and automakers seek to reach the game-changing 2025 CAFE fuel economy standards.
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