By Emil Widdig (WHU - Otto Beisheim School of Management) and Shannon Keegan (Wake Forest University)
Synopsis
With all the hype surrounding electric vehicle companies and new IPOs, it’s time to provide some insights into the hype and investigate the impact EVs will have on the automotive and energy industry.
Table of Contents
Section 1: Origin of the EV Hype
Tesla is leading the charge in a wave of investor confidence in electric vehicles
Larger automotive incumbents are also expanding their EV involvement
Tesla is unbelievably highly valued despite being the most shorted stock of all time
Section 2: The impact of EVs on the automotive and energy industry
The automotive industry traditionally had high barriers to entry caused by brand image and motor engineering capabilities. EVs shift competitive advantages from motor engineering to battery production and enable new brands to establish themselves.
Second-life applications of batteries will become critical as more and more batteries go past their useful lifetime. Refurbishing batteries will also play a key role in lowering costs.
In terms of the energy market, EVs will cause an increase in peak demand times and will require significant investments in energy distribution through charging stations.
While there are alternative technologies to battery electric vehicles, none of them experienced the breakthrough that batteries have had over the last year. Hybrid-based EVs will be a contender for batteries as it is especially interesting for high-load vehicles where batteries can hardly be used.
Section 3: Looking Ahead
The automotive market remains a competitive market and not every EV company will be able to survive.
As the adoption of EVs increases, subsidies will decrease potentially exposing battery EVs to alternative technologies.
EVs represent a greater shift to renewable energies that will shape all industries for years to come.
Origin of the EV Hype
Led by Tesla, the past few years have seen an extremely disruptive emergence of electric vehicles. However, they are not alone since many competitors are appearing in the form of various startups and even SPACs.
The popular and well-funded companies such as Fisker, Karma Automotive, and Rivian are evidence of a trend towards investment in the EV industry, with billions of liquidities pouring into their fundraising. Additional competition to Tesla is emerging in the form of automotive industry incumbents such as GM, which plans to begin manufacturing EVs in a new factory. The hype is most clearly evident in Tesla’s current market valuation, which shows investor sentiment could not be higher. With the highest valuation of any automotive player, it is difficult for many analysts to justify its growth prospects. “I am yet to come up with a logical explanation for Tesla’s valuation.” Further evidence of the hype can be seen in the Nikola fraud, whose valuation exploded after it went public in a SPAC, only to be exposed as a fraudulent company. Investors seem to have become irrational in their willingness to go long on EVs, which is evident in its status as the most shorted stock of all time. This amount of shorting could indicate investors' suspicion of fraud, but many believe that it is difficult to price innovation and that Tesla could reasonably grow into its current valuation and then some. There are many attractive aspects of the industry, and from the outside, it is easy to see why investors would be attracted to the industry. From positive implications for climate change to general car performance, EVs offer an incredibly attractive investment, whether you believe Tesla is overvalued or not. Tesla potentially becoming an autonomous vehicle company offering driving services instead of selling actual cars, is driving its stock price, too.
Figure 1: Ark Testla Valuation (Ark Invest)
One of the main reasons for the massive surge in EV stocks is investor speculation. Tesla has been around for over 10 years, but only recently saw massive increase in market cap. Something that investors often forget is that while the stock price is dependent on the fundamentals, the stock price can also influence the company’s success. In Tesla’s case, it managed to successfully pull in 5bn USD in capital at the height of its market cap. With enough confidence from its investor base, Tesla could grow into its own valuation. From a free cash flow perspective, it is also interesting to consider the impact of EVs upon the renewable energy credit market. In the second quarter of 2020, Tesla’s topline was supplemented by 428M of revenue from renewable energy carbon credits, and in 2019 it sold 593M of credits. In the following section we want to investigate the hype of the electric vehicle industry and its promising technologies.
The impact of EVs on the automotive and energy industry
The automotive industry has faced some tough challenges. Incumbents in the auto market have been hit hard by the recent disruption of the industry. The automotive industry has historically been shaped by high barriers to entry because of the engineering expertise and the high amount of capital investments needed, as well as high brand awareness of customers signaling build quality. These barriers to entry are now gone. Electric vehicles are way easier to produce. The design of an electric motor is simple in comparison to a traditional gas-powered engine and can be easily procured instead of manufactured. Electric motors, for example, do not require any transmissions because of the higher torque they are able to produce and no differentials because each wheel is powered by its own electric motor. Brand awareness of customers is also beginning to shift as customers start looking for more innovative brands and car designs. Now, the most important and expensive part of an electric vehicle, and by far the most difficult to get right, is the battery. This completely shifts the power dynamic of the automotive industry. Car companies that have been successful over the last century possess excellent engineering capabilities but not nearly as many capabilities in battery production and electrical technology. A window of opportunity opened for tech-savvy companies to disrupt the automotive industry. Many new players entered the industry in hopes to cash in on the window of opportunity. Nearly all battery producers are headquartered in either China, South Korea, or Japan. In 2017 these three countries supplied around 97% of all batteries used in electric vehicles worldwide. Meanwhile, other car-parts have become mostly commoditized, meaning car producers now have to be convinced with their range, efficiency, brand, and, of course, the actual car.
Figure 2: Tesla dominates the current energy market followed by Chinese manufacturers (McKinsey)
Incumbent automotive manufacturers are trying to catch up. Most producers already have an EV in their product portfolio or announced an EV of their own coming between 2020 and 2021. Still, Tesla dominates the EV market with a market share of 16.2%, followed by BYD and BJEV with market shares of 10.0% and 7.1% respectively. In the future, the automotive industry is forecasted to remain fragmented and incumbent producers will most likely catch up, owed to their brand image, their automotive expertise and existing customer base. According to Deloitte, Tesla will be able to defend its current dominant position regning the future EV market together with VW. Closely following them are Chinese car producers BYD, Geely, BAIC, and SAIC.
Figure 3: The future EV market will see different leading car producers than today’s market (Deloitte)
As can be seen in the future outlook of the EV market, competition from China is serious. China has used the opportunity to get ahead in the EV market and other markets tangential to the EV market such as renewable energies. Around 2/3 of global EVs are situated in China. Not only is China very advanced in their adoption of electric cars but also other electric vehicles such as buses or micro mobility like e-scooters and e-mopeds. The main reasons for China’s progress are its vast market of 1.4 billion Chinese and the relatively straightforward regulation that companies face. The proportional penetration of EVs is actually lower than in many other, mostly European countries, but the gigantic scale on which Chinese manufacturers can produce and market EVs makes Chinese EV producers very competitive.
a. The Second Life of Batteries
Because the electric vehicle industry is as young as it is, there haven’t been many cars that are already at the end of their lifecycle. EV batteries are designed to last roughly one decade. With today’s demand not only for electric, but also for hybrid vehicles, recycling of batteries will become a critical question. Not only can a second life for EV batteries save costs, it is also necessary because of limited global resources of commodities such as cobalt and lithium. Hence, the increase in EV sales will see an increase in battery refurbishing companies that recycle batteries to make them available for other use cases. One main application in which these refurbished EV batteries could be found in is stationary power storage, especially since renewable energies is another technology on the rise together with EVs. Renewable energies are cyclical. Energy sources such as wind and solar specifically, don’t produce energy at all times leading to the problem of storing the energy of renewables. Refurbished EV batteries offer a cure for this problem and in turn make renewables more attractive and viable, because they can act as a storage medium. The market for second-life batteries will scale as fast as the EV industry itself exceeding 200 gigawatt-hours by 2030. Refurbished stationary power storage will be a market worth more than $30bn in 2030 and will be able to fulfill all demand for stationary storage power at that time.
Second life of batteries will be one of the levers with which manufacturers can achieve lower costs. Still, in order to capture all the benefits, some challenges and obstacles need to be overcome. The biggest two challenges concern recyclability and standardization of batteries. Recyclability means that EV batteries can actually be extracted from the car. Currently, many electric vehicle manufacturers produce their EVs in a way that make it hard to impossible to actually recycle the batteries, for example because they use adhesives that are cheap but not optimized for disassembly. The second obstacle is that currently batteries aren’t standardized. Car manufacturers engineer their batteries together with their suppliers in a way that fits their production model the best. For uses in second-life applications the batteries need to be fairly similar. The country or company who is able to overcome these obstacles first, be it through regulation or a clever business model designed around used EV batteries, will benefit enormously. One of these business models could be that car buyers are buying the car but only leasing the battery for the time the car is in use. Once the battery’s lifecycle for EV use is over, the car manufacturer will claim the battery and recycle it for other applications.
b. Increasing Peak Demands and Renewables
EVs will also influence the electricity grid and infrastructure. EVs only make up a small fraction of total energy demand (most of the energy demand stems from buildings and industry) and that trend is not going to change in the future. EVs therefore will most likely not significantly influence the total demand for energy in the future. However, EVs have the potential to influence the times at which peak energy is demanded. As EV owners will plug in their car in the evening and leave it charging throughout the night, peak demand will increase by an estimated 30% during the evening and nighttime. Potential solutions include varying tariffs throughout the night to disincentivize charging at peak demand, or by implementing local storage solutions that store energy when the energy grid experiences low demand and discharges at high demand, again creating the need for stationary power storage. In the future, energy grids will not only experience fluctuations in demand, but also in supply as the increase in renewable energies leads to more cyclical energy production. This will again lead to an increase in battery storage, which could make EV batteries cheaper in the future due to their second life uses.
The surge in EVs will also lead to an increase in charging infrastructure. Sufficient charging infrastructure is one of the most important keys to success for the EV market. A lack of charging infrastructure is one of the main concerns for customers regarding battery electric vehicles together with cost and driving range. The problem of the charging infratrucure is that it represents a chicken and egg problem. For EVs to be attractive, a charging infrastructure is needed, but for charging infrastructure to be attractive for providers there need to be many EVs. To mitigate this problem, charging infrastructure providers and EV producers will need to work together to find attractive business models. At the same time, Tesla decided to take the problem in its own hands and create the one of the world’s largest charging station network, making their cars very attractive for consumers. China’s advantage is the firm grip its government has on its economy. It will be able to construct its charging network using its state-owned grid providers in no time.
Figure 4: Peak household energy demand with EV charging (McKinsey)
c. Exploring Alternative Technologies
Europe has been remarkably slow in adapting new battery technologies and in preparing to ramp up production of batteries. One reason may be that automotive producers may still hope that the technology of the future is hydrogen-based. Hydrogen-based motors have quite a lot in common with traditional gas-powered cars, because they both require combustion engines. Incumbent car companies have amounted decades worth of expertise in combustion engines and would thus be able to successfully defend their competitive advantage should hydrogen-based transportation become the future. In fact, the German government, a country that relies heavily on its automotive industries, just recently announced that it will rely on a future based on hydrogen-based power storage.
Hydrogen is similar to batteries as it is a different way to store energy. Its benefits are quicker refill times and higher energy density, but its downside is its inefficiency of energy transmission. Batteries are more efficient at transferring energy to the wheels of the cars, according to VW only around 20% to 30% of energy gets lost in transmission from the energy grid to the battery and from the battery to the electric motors. With hydrogen, around 65% to 75% of energy gets lost in the process. The winner of the two methods is not easy to determine. While VW is certainly convinced of batteries, not every car manufacturer is of the opinion that batteries will win the duel. Companies like Toyota, Honda, and Hyundai are fierce defenders of hydrogen-based transportation. In the end, which technology will persist depends on how attractive the technology is to the customer. Unfortunately for Toyota, Honda, and Hyundai, the benefits of hydrogen are not as convincing as battery-powered EVs for most consumers. EVs are catching up to hydrogen- and gas-based recharging times and being able to plug in your car at home instead of driving to a refueling station is very attractive. Hydrogen could however be a very interesting power storage for high load vehicles such as trucks and airplanes and for customers who want a high range for their vehicle. As hydrogen has a higher energy density than batteries it is more attractive for commercial purposes where higher direct costs can be justified by higher utilizations. The future will probably see a combination of hydrogen and batteries. Battery electric vehicles, however, have the head start for consumer vehicles and will likely dominate for the next years to come.
Figure 5: Costs for hydrogen-based trucks are approaching those of diesel and battery electric vehicles (ICCT)
There is one downside to the recent increase in attention to EVs and the corresponding increase in capital in the industry. Many other promising technologies experience less interest. For example, synthetic gas has the potential to make even cars from the last centuries green. It is not getting nearly as much attention as battery electric vehicles do. Some of the missing interest in these technologies stems from regulations that do not differentiate between carbon neutral or fossil fuels and because the technology is not yet ready. But one reason for the missing attention is definitely that the technology’s big brother, battery electric vehicles, is getting all the attention now. Car producers, governments, and consumers are now committed to batteries and the opportunity for synthetic fuels may have already passed.
Looking ahead
Despite the change in market structure caused by electric vehicles and the lower barriers to entry, competitiveness in the market is still at its height. Car production remains a labor and capital-intensive process. Batteries and electric motors could become a commodity soon, leaving the only differentiating factor the brand and build quality of the actual car. Customers seem to like the idea of a brand that is specifically associated with electric vehicles combined with innovative car design instead of today’s cars with an electric motor, hence the popularity of Tesla. This also explains the surge in EV players and brands and why pickup companies such as Rivian are able to compete with giants such as Ford. According to estimates of Deloitte,there will be a higher supply of EVs than demand in 2040 at current production forecasts, meaning not every car company will be able to sell its forecasted amount of cars. Many of today’s automotive companies will not be able to survive in the fierce competition ahead. It remains to be seen which companies that will be and whether today’s disruptors can stay ahead in the EV market.
In the future, as electric vehicles begin to replace traditional cars, there will most likely also be less subsidies by governments. There are many ways government are currently incentivizing their population to buy electric vehicles. One way is through direct rebates and income tax credit, essentially reducing the purchase price of an EV. In times of Covid-19 many governments resorted to using additional rebates for EVs to increase consumer spending. Another way to subsidize EVs is through the sale of environmental credits. The reason Tesla was able to achieve profitability in its last quarter was because it was able to sell $428 million, or 7% of Tesla’s revenues, worth of credits to other car manufacturers. Both of these subsidies will decline as EVs become more popular and other car manufacturers sell their own electric vehicles.
Batteries will play a significant role in the future, although it could still face competition by synthetic and hydrogen-based fuels. It is too early to tell which technology will eventually be the choice for EVs. Currently, battery-based EVs are the most attractive but it isn’t unrealistic to assume that other technologies will experience a similar breakthrough as batteries have recently.
Electric vehicles can also be seen in the larger trend of searching new sustainable energy sources for the world. Energy will be the one of the most important resources of the 21st century. Increased cloud computing and other technological innovations as well as general population growth will lead to an incredible increase in energy demand. Fulfilling that demand with current energy sources would not be sustainable, thus the search for alternative energy sources. In the case of electric vehicles this means a shift from oil-based energy to electric energy. As a larger trend, this shift will need to happen in many other industries as well. The aerospace and the transportation industry in general are already exploring hydrogen as a storage of energy. All these forms of energy storage only work, however, if the electricity it is being charged with, is also carbon neutral. This is currently not the case and it will be interesting to see how we will be able to achieve it. We are currently relying on renewable energies such as wind, solar, and water, but if demand for energy continues to rise, we may need to explore new and more efficient technologies of energy production.