Despite a momentous and at times gut-wrenching year for the world’s car industry, its biggest test is yet to come, writes MATTHEW SYMONDS

THE LAST 18 MONTHS WILL LONG BE REMEMBERED BY the car industry as a period in which one shock followed another and in which the global automotive map was indelibly redrawn. It was quickly apparent that this was not just a turn in the business cycle but a restructuring of the economic order – one in which carmakers reluctantly found themselves in the frontline of change.

The results of this cataclysmic period for the industry can be seen everywhere. They range from the bankruptcy of General Motors and the first-ever losses in Toyota’s history, to the rapid emergence of China as the world’s most important car market and the beginnings of a shift towards zero-emission, battery powered vehicles.

The GM diet

Although GM’s entry into Chapter 11 protection from its creditors on 1 June had seemed probable for months, it still sent a shockwave through the global car industry. Until 2008, when it was overtaken by Toyota, the 101-year-old firm was the world’s biggest carmaker, producing well over nine million cars and trucks a year in 34 countries. It had 463 subsidiaries and employed 234,500 people, 91,000 of them in America, where it also provided healthcare and pension benefits for 493,000 retired workers. In the US alone, it would typically spend US$50bn a year buying parts and services from 11,500 vendors.

GM was eventually overwhelmed by a lethal combination of the structural weaknesses that it had unconvincingly grappled with for years and the unprecedented collapse of the North American car market in the second half of last year.

When sales of US passenger vehicles fell from a rate of nearly 17 million units a year to less than 10 million, GM simply ran out of road. Burning cash at a rate of more than US$2bn a month, with assets of US$82bn against liabilities of US$172bn, GM was bust.

So too was Chrysler, the smallest of Detroit’s so-called Big Three, while Ford was only just hanging on, thanks only to a bold plan to raise cash by mortgaging all its assets that had been put into place just before credit markets began to freeze over. With the help of massive financial backing from the White House, GM and Chrysler both emerged from bankruptcy after only a few weeks, shorn of debt (in GM’s case, about US$79 billion worth), unwanted factories and thousands of dealers, with the government and a United Auto Workers trust as major shareholders.

Can GM and Chrysler survive in their new streamlined, slimmed-down form and what are the implications for other carmakers? Chrysler’s fate now depends on Fiat. The Italian carmaker, which has taken an initial 20% stake in the American firm in exchange for access to its advanced engine technology, is now in effective management control of Chrysler.

Fiat’s boss, Sergio Marchionne, has performed miracles reviving the company in recent years with strong brand management and new models, such as the retro-styled Fiat 500 and the Mini-rivalling Alfa Romeo Mito. He is now hoping that a dose of the same medicine will work for Chrysler, while giving Fiat some of the additional scale he believes is essential for survival. However, after the failure of his bid in May to acquire a controlling stake in GM’s cash-strapped European arm, Opel/Vauxhall, there are doubts whether the synergies between Fiat and Chrysler will be of sufficient benefit to either. In particular, Fiat’s best engines are diesels, which have very little traction in America.

As for GM, it will struggle to hold on to the  
18.5% share of its home market it is aiming for. But a gently declining GM that is no longer driven to over-produce and under-price is good news for everyone else. It may take several years for US sales to recover to the level seen earlier in the decade, but when they do, the market should be more stable and profitable for most manufacturers – even if there is a further move away from the gasguzzling pick-up trucks and SUVs that in the past have been the big money-earners for the Detroit Three. Whether the 40% tougher fuel economy standards mandated by the Obama administration (35 mpg by 2020) will make much difference is debatable.

Riding on (less) heavy fuel

The industry now thinks it will have little difficulty meeting the new standard several years ahead of time and without much need for Americans to give up the big, comfy cars they like. Heavy SUVs will give way to lighter so-called crossovers, such as Buick’s Enclave. Relatively small, turbocharged V6 engines will produce the same power as V8s, but with better fuel mileage, while increasingly makers will offer hybrids across their model ranges. On past experience, the one thing that could radically change buying habits is another big hike in fuel prices. When pump prices hit US$4 last summer, there was a lemming-like rush towards small cars that came to a shuddering halt the moment things returned to “normal”, which in America means a gallon of gas for around US$2.

The carmakers themselves are working on two assumptions. The first is that the current low fuel prices are only a lull and that the moment the global economy cranks up again, oil will quickly get dearer. McKinsey forecasts that energy demand in the next decade will increase by 2.3% a year, more than 90% of it coming from emerging markets, such as China, India and the Middle East. The second is that governments, driven by concerns about energy security and international climate change agreements, will impose ever-tougher penalties on manufacturers who do not steadily reduce the fuel consumption of the vehicles they sell, while providing attractive tax breaks for the least-polluting vehicles.

While the fuel efficiency of every kind of car from Ferraris to the smallest hatchbacks will improve in leaps and bounds, carmakers are initially aiming their most intensive efforts at ensuring that the vehicles they make their highest margins on – relatively powerful, highly specified models – remain socially and politically acceptable. Under threat from new European Union carbon emission rules due to come into force in 2012, BMW and Mercedes are showing that by using clean diesels and a variety of existing fuel-saving technologies, such as stop-start systems, they can produce cars that achieve 21.25km per litre (50 MPG) while retaining all the performance and luxury associated with their brands.

She’s electric… or hybrid… or diesel

Although the German prestige makers will increasingly turn to hybrids to provide the combination of power and fuel economy they require, volume producers, despite the success of Toyota’s game-changing Prius, (the latest version of which is reviewed on page 16) will have more difficulty justifying the expense and complexity of hybrid power trains for their bread-and-butter models. Small diesels produce astounding fuel consumption in little cars, but they may not be as good for emissions overall as the latest petrol engines. Downsizing and turbo charging appear to be the way to go. Fiat, for example, has just launched MultiAir, an electronic valve control system that will endow the 900cc twin-cylinder turbo engine with 80 BHP, while achieving a staggering 69g per km CO2 figure. Volkswagen’s best-selling Golf can now be had with a 1.4 litre engine that with the aid of both a turbo and a supercharger delivers 158 BHP and 45 MPG.

Although the internal combustion engine still has a lot of life (and development) in it, just about every major manufacturer will soon want to have in its range at least one fully electric powered car, partly to show off its green credentials, partly to be ready if demand for such vehicles takes off. Carlos Ghosn, head of the Renault-Nissan alliance, believes that the electric vehicle (EV) future is closer than most other car company bosses do and is putting his money where his mouth is (see page 67).

The speed at which EVs catch on will depend on two things: the ability of the battery makers to deliver more power at less cost; and the willingness of governments to subsidise vehicles until volume production and technological improvement brings prices down.

At first, EVs will be bought by green show-offs and early adopters. They will also be acquired by fleet operators, such as taxi firms and municipal authorities. But for the majority of buyers what will matter most is whether the cost of ownership is no greater than that of a gasoline-powered car. McKinsey reckons that for US car buyers that probably means either a generous subsidy or pump prices back at US$4 a gallon. But it is not impossible to imagine that by 2020 about 10% of all cars could be battery powered.

EVs are an answer to tailpipe emissions problems in congested cities and will help reduce dependency on imported oil. But unless the electricity that powers them is generated by nuclear or renewable energy, they will not do much to save the planet from global warming.

Another rule for China

Nowhere is the encouragement of EVs likely to be greater than in China, where environmental concerns are growing by the day and where local carmakers, such as BYD, hope to leapfrog western manufacturers with innovative new products. Referring to the astonishing growth and potential size of the Chinese market, Renault-Nissan’s Carlos Ghosn said that zero emission vehicles, probably powered by batteries, would be the only way to give people in emerging market countries the cars they wanted without wrecking the planet. “Nothing else,” he says, “will prevent the world from exploding”. According to the China Association of Automobile Manufacturers, with the help of a huge government stimulus package light vehicle sales in China this year could increase by 30% to reach 12 million, easily overtaking those of the (depressed) US market.

Although China is the most spectacular example of the growth in car ownership in emerging markets, the same phenomenon can be found in India and Brazil (Russia has fared less well this year, its natural-resource dependent economy sent reeling by the tumbling price of oil). What is behind this headlong growth? The first reason is steadily rising prosperity for hundreds of millions of people who have benefited from sound economic management at home and, at least until the onset of the recession, the opportunities provided by globalisation. The second is that by western standards, car ownership is still at very low levels – in America, there is nearly one car for each person, while in China there are about 30 people for every car. The third, as Mr Ghosn observes, is that the car “is the most coveted product that comes with development”.

Research carried out by economists at different times shows that US$5,000 a year is the earnings threshold at which car ownership takes off. Tata’s revolutionary little Nano is designed to lower that threshold by half. Economists at the International Monetary Fund predict that the number of cars worldwide will grow from about 600 million in 2005 to nearly 2.9bn by 2050, by which time China alone may have almost as many cars as there are in the whole of the world today – surely a terrifying prospect even for newly car-mad Chinese.

According to some estimates, 90% of the car industry’s future growth will come from outside the traditional markets of America, Western Europe and Japan. The Volkswagen Group, which is poised to become the world’s second-biggest carmaker, already sells more vehicles in China, (where it is the market leader ahead of GM) than in its native Germany. China certainly matters more to embattled GM than Europe. GM recently sold its majority stake in Opel, its European arm, to Magna International and Sberbank, but it would not dream of letting anyone else into its joint venture in China with Shanghai Automotive Industry Corporation (SAIC), which is also one of VW’s two partners in China.

Paradoxically, although the car industry is undergoing one of the worst years in its history, its long-term future has never looked brighter. Despite all the damage they do, people love cars. The task for the industry and for governments all over the world is to find ways to reconcile that unquenchable passion with the needs of the planet and to realise they must do so urgently. Compared with that, rescuing GM seems of rather minor importance.

Matthew Symonds is The Economist’s industry editor

Electric Vehicles on the Horizon

Next year, Nissan will launch an electric powered version of its Cube hatchback in America. At first it will only be made available for fleet operators, but by 2011 retail buyers should be able to get their hands on one too. The Cube EV will have a range of about 160km, seat five passengers and cost about US$30,000 before the $7,500 tax credit for such cars. It is said to drive smoothly and quietly and has the strong initial acceleration typical of EVs (electric engines deliver maximum torque instantly). The battery can be fully recharged overnight using a household power point; 80% recharged in 30 minutes using a higher voltage power point – or it can be exchanged for a fresh pack in minutes at special battery swap stations.

In 2011, Renault, using the same lithium-ion battery pack and motor as the Cube, will launch the Fluence, a Laguna-based hatchback, in Israel. The country was chosen as a test bed by Project Better Place (a Silicon Valley start-up founded by software engineer Shai Agassi) and Renault because of the eagerness of its government to reduce its dependence on imported oil. Mr Agassi, whose firm is putting in the infrastructure, expects to have 150,000 charging points and 100 swap stations ready by 2011.

Another groundbreaking car that should be available by the end of next year is GM’s Chevrolet Volt (pictured above). Although it is propelled entirely by its electric motor, a small petrol engine works as an on-board generator when the battery is low on power. Most of the time, the Volt, which has a range of just under 65km on battery alone, will run as an EV and be plugged in each night for recharging. For longer journeys, close to 500km without refuelling should be possible. The attraction of the Volt is that it requires no supporting infrastructure and removes the problem of “range anxiety” that may deter potential EV owners.