Why automakers are at a crossroads on diesel rescue

Checkpoints might become a familiar sight next year on the streets of Stuttgart, but police won't be looking for drugs or weapons. They will be searching for illegal Euro 5 diesels. As odd as it sounds, randomly stopping cars would likely be the only way without enacting a new law for authorities to determine if a vehicle's exhaust was clean enough to enter the city. This traffic-snarling scenario could become a reality for drivers should local authorities be ordered by courts to finally uphold a 7-year-old clean air target from the European Union.

The diesel engine is at the forefront of the debate about potential driving bans. A discussion that has caused sales of diesel-powered cars to drop sharply in Germany, where politicians are considering joining France and the UK in banning all combustion engines starting in 2040.

Diesels burn up to 25 percent less fuel than gasoline engines, so they are crucial to helping automakers reduce overall fleet carbon emissions to 95 grams per kilometer by 2021 from 118.1g/km now. "Diesel clearly is needed to reach the midterm climate and CO2 targets," BMW Group CEO Harald Krueger told reporters at last month's Frankfurt auto show.

For diesels, the main problem is that they produce more smog-causing pollutants collectively called nitrogen oxides (NOx) than gasoline engines. If the diesels are to survive, however, carmakers know they must produce engines that are cleaner during real driving and not just on the test bench. That is why Krueger pointed out at Frankfurt that independent tests show his latest BMW 520d can also deliver low NOx emissions in a real-world setting and why he said: "I don't hold any stock in driving bans, sales bans or bans in general."

Krueger's position on bans doesn't change the fact that BMW's home city of Munich isn't far behind Stuttgart in pollution, leaving diesel drivers facing a similar dilemma. Twenty-eight areas in Germany regularly breach EU clean air limits when it comes to hazardous nitrogen dioxide (NO2), a major emission of diesel passenger cars. Dozens more high-pollution cities are found across the UK, France, Italy and Spain including all the major metropolitan centers led by London.

Brussels has warned that Germany, the UK, France, Italy and Spain all face an impending infringement procedure for persistently failing to live up to clean air requirements in place since 2010. Roughly 70,000 premature deaths in the EU can be linked to ambient NO2, it argues – almost three times the number related to traffic accidents.

"The responses [from the five member states] are currently under assessment by the Commission to decide on the next steps," said a spokeswoman, adding the next step would be referring the matter to the European Court of Justice, where hefty fines could be imposed.

Too little, too late?

Manufacturers say they are taking steps to clean up their diesels. Daimler's Mercedes-Benz spent 3 billion euros to develop a new family of four- and six-cylinder diesels capable of drastically cutting on-road NO2 emissions. By the end of 2019, roughly 80 percent of all new diesels sold in Germany will be equipped with selective catalytic reduction (SCR) converters, which is the most expensive exhaust after-treatment system on the market. Acting now, however, may be too little, too late. The ground is already shifting beneath automakers' feet.

During the first six months, the penetration rate for diesels in Europe's car fleet dropped to 45.3 percent from 49.4 percent during the same period last year, according to JATO Dynamics. It was the lowest share and the fastest drop for diesel since 2009. That year, however, was bad for diesels primarily because government-backed incentives to lessen the blow of the global financial crisis favored sales of gasoline-powered small cars over larger, more expensive diesel models.

Adjusted for that effect, the 2017 numbers for diesels look historically bad, especially in Germany where new manufacturer incentives to purchase new Euro 6 diesels have so far fallen flat.

Sensitized to the risk ever since the Stuttgart debate grabbed headlines nationwide, customer demand for diesels fell once more in August, with the share dropping to 37.7 percent in August as sales slipped 14 percent. That was their lowest this year and down sharply from 45 percent in the previous one.

"I don't think we've reached the bottom of that yet," BorgWarner CEO James Verrier told Automotive News Europe. Referring to the EU's 95g/km CO2 target for 2021, he asked: "What do we do to avoid going backward on emissions and fuel economy levels?" Achieving this goal won't be easy. The European Commission is expected to propose a new CO2 industry target by the end of this year. "They have to assume how the diesel share will develop in the next decade amid this shifting landscape," said a BMW manager close to the talks. "I don't envy them."

A lot of uncertainty

Although Mercedes has sold more diesels in Europe on an absolute basis this year than last because of markets such as Italy, where demand for the powertrain is rising, executives are nonetheless worried customers are losing sight of the facts amid the heated public debate. "We have to watch it very closely," said Daimler board member and Mercedes sales chief Britta Seeger. "Do customers [in Germany] intellectually differentiate between CO2 and NOx emissions? Very many are simply uncertain because they don't comprehend the discussion," she said.

Given enough time, the auto industry can adapt to long-term exogenous developments such as currency movements – whether that's through cutting costs, increasing production abroad, buying financial hedges that secure exchange rates years into the future or all three.

Sudden changes, however, can do severe damage, and what appeared to be a slow, orderly decline of the diesel only a year ago is spinning out of control. "We have flexibility in our production," Seeger said. "The question is how abruptly these trends emerge."

After celebrating in late December of last year a record high in domestic new-car registrations of diesels despite Volkswagen Group's emissions-cheating scandal, Germany's powerful ADAC auto club told customers to shun the powertrain until it fulfilled the newest Euro 6d standard valid since last month. The ADAC, which has 20 million members, recently blasted both carmakers and politicians for failing to act sooner to prevent diesel bans and leaving drivers at risk of "paying the bill."

Days of splendor 'are over'

Reacting to the pressure, Volkswagen Group CEO Matthias Mueller preached last month about providing "more transparency and honesty with emissions and consumption figures" when he addressed hundreds of guests gathered at his company's hall on the eve of the Frankfurt auto show.

"The emotional debate about driving bans in cities, about the future of the diesel and electromobility, show the times that our industry celebrated itself here in Frankfurt, sunned itself in its own splendor, are over," said Mueller, whose company could be blamed for doing more to damage the diesel's reputation than any other.

The truth is, however, that even if VW had never used a defeat device to trick emissions tests around the world, it wouldn't have mattered. Until last month, there was no on-road element to the type approval test. As a result, manufacturers had plenty of legal EU loopholes to allow diesels to emit far more than the current 80 milligrams per kilometer threshold for NOx permitted on the rolling test bench.

The new Real Driving Emissions (RDE) legislation governed under Euro 6d now foresees measuring NOx outside of the laboratory environment as a second, complementary hurdle for type approval. The first cap of 2.1 CF (short for conformity factor) – equating to on-road emissions of no more than 168mg/km – won't take effect until September 2019 for all new cars sold. The second CF will apply in January 2021. At 1.5 times the legal lab limit, it still allows for 120mg/km of NOx to be produced when the car is on the road.

To "save this industry from itself," EU Internal Market Commissioner Elzbieta Bienkowska said last month she would propose by no later than spring 2018 a reduction of the second RDE conformity factor. "I expect more than window dressing," she told the EU Parliament in Strasbourg while car execs were gathering in Frankfurt. "This is all about the credibility and the reputation of industry. I fear that some still don’t seem to get it."

Should diesels be saved?

While the diesel could theoretically be saved if its on-road emissions are cleaned up, the more important question is: Should it? After all, the diesel rise is a relatively recent phenomenon. In 1990, its share of western European car sales was less than 14 percent. Following the signing of Kyoto climate accords, EU governments looked for a technology that could quickly reduce CO2 emissions in their vehicles. Diesel was the answer.

The problem is that an enormous amount of money has gone into perfecting the technology over the last few decades. It's not just potential writedowns on these investments that worry industry executives. Entire value chains are built around the technology.

"About 20 percent of the 800,000-automotive industry-related jobs in Germany depend on diesel. We will fight for them," Volkswagen’s labor boss, Karlheinz Blessing, said in a release last month.

As regulators crack down on combustion engine emissions in general, the diesel also suffers because it is a non-factor in key markets such as the U.S. and China. Factor in additional costs related to cleaning up diesels and the economics for the powertrain begin to break down rapidly.

Meanwhile, gasoline engines are closing the gap in terms of consumption. VW is introducing a new 1.5-liter TSI engine that uses a leaner combustion cycle and can deactivate two cylinders when they are not needed or even all four in a further developed form of coasting called "sailing." On the Golf model, the new gasoline engine delivers the same 150 hp and emits the same 114g/km of CO2 as a 2.0-liter diesel, but costs 2,750 euros less in Germany.

Zero-emissions push

More importantly, the European Commission plans to push zero-emissions cars to fulfill the EU's Paris climate commitments. Full-electric vehicles also have the benefit that they lend themselves perfectly to highly and fully autonomous vehicles, which require complex electrical architectures already found on EVs but not necessarily on cars with combustion engines. Automakers have already responded, placing the bulk of their r&d budget in zero-emissions vehicles.

At the Frankfurt show, manufacturers fought an arms race over which would promise the most electrified vehicles for 2020 and beyond, despite EVs currently comprising roughly 1 percent of the European market.

BMW's Krueger, whose company saw its diesel share in Europe drop by 5 percentage points to 69 percent, this year, said rolling out new electric versions of popular models such as the BMW X3 has the "utmost priority" for the group. "There will be a change in mobility and I am behind it personally, because it's fun to drive an electric car," he said in Frankfurt.

VW Group boss Mueller envisions electrifying every model in every market by 2030. He now refers to all combustion engines as a "bridge to an emissions-free era," a polite way of saying the clock is running out on them. As part of his Roadmap E, the VW brand alone is investing 6 billion euros in electric drivetrains in the coming five years, almost twice the 3.5 billion euros it will pour into optimizing gasoline, diesel and natural gas combustion engines combined.

Going forward, it will be more a matter of managing a controlled and orderly decline of the diesel, for manufacturers, suppliers and dealers. Porsche, for example, decided against axing the technology because some of its retail partners depend entirely on models such as the diesel-powered Cayenne SUV.

Dealers are under even more acute pressure because used-car sales are crucial to their success. Registrations of 1-year-old Euro 6 diesels in Germany are performing even worse than their new cousins, according to market researcher Dataforce. Domestic dealer association ZDK estimated roughly 300,000 Euro 5 diesels are collecting dust on their lots, equivalent to an overall economic exposure of roughly 4.5 billion euros that could be impaired. "These vehicles can only be sold with great difficulty," ZDK Vice President Thomas Peckruhn said.

Making matters worse, more than 80 percent of people surveyed viewed leasing returns as an "existential risk," since a peculiarity of Germany is that residual value exposures stay on a dealer's balance sheet rather than a manufacturer's. A VW manager who closely follows used-car prices had some frank advice for all those with Euro 5 diesel vehicles, which were sold until September 2015: "Either drive it until it's scrap, or take it to the Ukraine and leave the keys in the ignition."

To deflect from the problem, executives have tried to explain away the scale of the pollution in Stuttgart. Measure the air only 100 meters away from Stuttgart's Neckartor station, the smoggiest place in Germany, and the level is not critical, they say. Meanwhile, Germany's Daimler, Volkswagen Group and BMW all agreed to offer a quick and affordable solution to reduce real-life NO2 emissions in German cities at a hastily arranged national summit in Berlin in August.

The three estimate ambient concentrations of the acrid gas could be cut by as much as 14 percent by 2019 if they offered car buyers incentives to trade in their Euro 4 and older diesels, while updating emissions control software on 2.8 million newer ones already on the road at no cost to the customer. This would be more than what a ban might achieve, they argue.

"That may suffice for other cities, but for Stuttgart, that's nowhere near enough," shot back an official from the state's transport ministry.

Unfortunately, there is no way to compel customers to act anyway, as they are under no obligation. Beyond the hassle involved, suspicions remain as to whether software updates might harm the car’s fuel consumption or performance, and there's no guarantee the ban may not come anyway.

So now the three automakers plan to pay into a new 1-billion-euro mobility fund to improve public transportation, financed in part by the German taxpayer and designed to prevent the kind of checkpoints that threaten Stuttgart. Speaking on behalf of his fellow mayors, Frankfurt's Peter Feldmann told industry executives at the show his city hosted last month: "I can tell you now, it won't suffice."

Douglas A. Bolduc contributed to this report