The challenges ahead

Unpredictable oil prices, more regulation and brutal competition loom for industry in next decade

Buckle up. We could be in for a heck of a ride over the next decade.

The last 10 years were turbulent enough, what with takeovers and corporate failures alike changing the map of the auto industry. To say nothing of having to deal with surging oil prices, disappearing profit margins, expensive new regulations and an onslaught of tough new competition from Japan, Korea and China.

Over the next decade, experts advise, be prepared to deal with – you guessed it – surging oil prices, disappearing profit margins, expensive new regulations and an onslaught of tough new competition from Japan, Korea and China.

To those factors, add the graying of populations in most developed nations, a trend that will impact both purchasing power (reduced) and the types of vehicles (mostly smaller) wanted by increasing numbers of buyers.

Volatile commodity

But it is oil, its price and availability, is the darkest cloud hanging over the auto industry. Oil is, analysts concur, the single-biggest issue facing the industry over the next 10 years and beyond.

Will prices continue to climb from current near-record levels of $60 to $65 (E50 to E55) a barrel? Is $100 a barrel inevitable, as some analysts project? How long will reserves last? Is there enough refinery capacity to handle projected increases in demand, both from developed markets and new ones, especially China and India?

Saudi Arabia’s oil minister, Ali Naimi, said earlier this month that the world has 2 million barrels a day “or less” of excess production capacity – not enough to offset a major output disruption. Such a slowdown, or shutdown, could come from another Hurricane Katrina or a punitive supply pullback by a major producing country such as Iran or Venezuela.

Global demand of 85 million barrels a day is projected to grow by 1.6 million barrels a day this year, according to the US Energy Department. That growth in demand will effectively eliminate the small production cushion cited by Naimi.

Shock therapy

Max Pemberton, a partner in Pemberton Associates, an automotive consultancy in Warwickshire, England, says the industry likely can cope with gradually increasing prices over the next decade. But a fast, steep price increase – a shock – would be “disastrous” for the industry, and society, he said.

“If [oil] edges up, the industry would have time to adjust,” he said. “But if there’s a sudden leap, and the price stays high, it would crucify the manufacturing base in Europe.”

Because higher energy prices increase the cost of both manufacturing and raw materials, a sustained higher price of oil would accelerate the migration of the industry to low-cost nations in Asia and eastern Europe, analysts point out. The business, social and political implications of that sort of shift would be profound.

“The impact would go way beyond the automotive industry,” says Nigel Griffiths, an analyst at Global Insight in London. “It would be multilayered. It would have implications on society in general and on government policies around the world.”

Sustained higher energy prices also would accelerate the industry’s shift toward alternative technologies, such as hybrids and hydrogen-fuel vehicles, or encourage the development of more small and minicars.

Other opinions

Not everyone sees steadily rising energy prices as inevitable. In an interview on Pages 32 and 33 of this issue, for example, former Valeo CEO Noel Goutard predicts that the melting of the ice in the Arctic due to global warming will open vast new reserves. Although credible, that possibility is years from becoming a reality.

A better reason for optimism is that rising energy prices tend to limit themselves through their effects on supply and demand.

On the demand side, businesses and consumers begin curbing consumption to adjust to the impact of higher prices on their budgets, which in turn takes pressure off prices. On the supply side, higher prices make marginal or high-cost reserves more economical to develop and exploit.

In Canada, for example, the sustained rise of world prices to well above $30 a barrel has made the development of the Alberta oil sands economically feasible, and they are coming into production. The reserves there that are considered to be retrievable with current technology are estimated at 280 billion to 300 billion barrels, the largest known accessible supply of oil in the world. Shell Canada estimates the total reserve there at more than 2 trillion barrels.

The reserves of Saudi Arabia, the world’s biggest producer, are estimated at 240 billion barrels.

More worries

Although energy prices are the most volatile item on the auto-industry’s agenda, other factors will be working to reshape the industry over the next 10 years as well.

1. Governments around the world, from Beijing to London to Berlin, are moving to curb traffic flows into and out of their cities. These bans have the potential to cut into sales as urban dwellers become

ever-more accustomed to not needing a car.

2. Regulatory demands for safety and environmental changes to vehicles have cost the industry billions of euros to implement over the past decade and show no signs of abating over the next 10 years. As our story on Pages 54 and 55 outlines, regulations have played as big a role in shaping the cars the industry builds as market forces.

3. The rising number of elderly in the developed countries along with mounting uncertainty over pension safety will influence the types of cars people want and the prices they are prepared to pay. According to a European Union study, the over-65 population in Europe will rise from 15.4 percent of the total in 1995 to 22.4 percent by 2025. The smartest companies already are tailoring their future-product plans to this shift.

Long-term vision

Not many automakers have the balance sheets to easily handle these and other developing challenges, analysts say. The

cost of meeting regulatory and market demands and the level of competition – over 30 main nameplates battling for

15 million European buyers – has drained many companies.

John Wormald, a director of the Autopolis consultancy and co-author of “Time for a Model Change,” says automakers need to adapt but can’t because of their “flawed” business model. To ensure long-term survival, he says, the industry needs to recognize that its traditional fuel – sales growth – has stalled.

For most of its first 100 years, he and co-author Graeme Maxton note, the industry experienced compound annual growth of 8 percent a year. Between 1973 and the mid-1990s, growth slowed to an average of 1 percent a year.

Between 1999 and 2003, it fell to zero.

“The industry plays an extremely important role in society, but it’s facing backwards,” Wormald insists. “Most people in the industry don’t see beyond the next product cycle. What is missing is long-term vision.”

If the industry discovers it, Automotive News Europe will be there over the next 10 years to report it.

– James R. Crate contributed

You can reach Richard Feast at autonews@crain.com.