INSIGHT: Assessing the ‘VW impact’ on petrochemicals

By Mark Victory

LONDON (ICIS)–The saga of the Volkswagen (VW) emissions scandal continues to play out in the global media, leading many analysts to predict significant damage to the “Made in Germany” brand.

The long-term financial value of the German brand has fallen by 4% compared with 2014 in the wake of the scandal, according to brand valuation and strategy firm Brand Finance.

“German industry is lauded for its efficiency and reliability while Germans as a whole are seen as hard-working, honest and law abiding. That such an iconic German brand, the ‘people’s car’, could behave in this way is beginning to undo decades of accumulated goodwill and cast aspersions over the practices of German industry, making the Siemens bribery scandal appear less a one-off than evidence of a broader malaise” said Brand Finance’s CEO David Haigh.

The reputational damage, if metastasised, could lead to other auto brands taking share away from VW and wider German brands, which, in turn has the potential to reshape the petrochemical industry.

The biggest reputational risk for VW itself could be in the US where it is a dominant player in the diesel car sales industry, but has a much smaller position in overall US car sales, leading to greater exposure to brand damage due to a closer association with diesel cars in the region in the mind of the consumer. But there is also a risk of loss of share in Europe.

From the European Chemical Industry Council (Cefic), its deputy director general, Alistair Steel, said there are only speculative questions for now until more information is available, but he implied if other car manufacturers are to gain market share to be lost by Volkswagen, the chemical industry would be fairly safe.

“Our position is that any active deception to get around regulation or legal requirements is to be criticised and condemned. That’s got to be the case [in this case], but we can’t say anything else beyond that for now,” said Steel.

If any loss of share is taken by a European car brand, then the impact on the European petrochemical industry is likely to be negligible. If, however, lost share is taken up by US or Asian car manufacturers, this may cause a proportional shift away from the European petrochemical industry.

A major talking point during the 49th annual European Petrochemical Association (EPCA) meeting in Berlin from 3-7 October, the view from many petrochemical players is that the mid-to-long term reputational impact will be minimal once the scandal moves out of the news cycle.

It remains too early to see the extent of any brand damage, but there is some precedent for this view. Past major recalls and auto scandals have not led to long-term reputational damage, and there remains the question of how large a factor emissions are in consumer purchasing decisions.

Granted, other auto scandals have not had the same trust issues as raised by VWs wilful emissions test rigging, but this can be seen as analogous to scandals from other industries such as the British horsemeat scandal of 2013, where long-term brand damage was limited once the topic moved off the news agenda.

Nevertheless, food is a perishable and low-ticket item compared to the high-ticket cost and long-term asset value of a car. Fear of falling resale values for VW diesels – a previous strength of the VW brand – has the potential to drive consumer spending to other manufacturers.

As reported on CNBC, Kelley Blue Book’s auction data showed a 13% fall in used Volkswagon diesel prices in the US in the two weeks following the emissions scandal story breaking, compared with a 2% drop for petrol models. Whether this will recover will, again, come down to the news cycle and public perception, and as with VW shares, it remains too early to take the figures at face value before they’ve reached a level and settled position.

Of perhaps wider impact is the threat of changes to the legal and testing environment. As emissions come under scrutiny, the difference between real-world and test-environment readings is becoming more apparent. Coupled with the success of VW’s emissions cheat device in the US, it is likely that emissions testing will be overhauled as it has been shown as unfit for purpose.

The scandal has already led VW to delay the release of 2016 diesel models, and a change to test conditions would no doubt delay other brand launches.

This is of concern because auto demand is driven by new launches and delays will affect consumption, for Europe in particular where the diesel market is much larger than in the US. Diesel cars were just 3% of the US passenger vehicle fleet in 2013 versus 41% in Europe. As a major end-use for petrochemicals, lower auto demand means lower demand throughout the petchem complex.

Nevertheless, this could be of benefit to smaller petrochemical companies manufacturing parts on a cost rather than innovation basis as the continued production of older models may lead vehicle makers down a cost route for parts as contracts allow.

Tighter testing conditions are also likely to lead to higher cost for car companies, and the increasing scrutiny on diesel emissions may result in legislative action as it moves higher up the political agenda.

This could speed up the long term move away from diesel cars, with potential benefits for electrical and hybrid models, and may also speed up innovation for replacement technologies and lightweight materials such as carbon fibre to meet more stringent emissions regulation with the potential to make diesel an unviable alternative.

Already, the French government plans to boost incentives to lure drivers away from diesel cars, environment minister Segolene Royal said in a webcast television interview on Friday 9 October 2015. Diesel cars account for about 65% of cars on French roads.

Royal said that the government would expand a programme that grants premiums to drivers who give up their old diesel cars to buy electric or hybrid cars instead. 

Furthermore, she said that France would end diesel’s tax advantage over gasoline at the pump. 

The tax changes would be phased in over five years, so drivers “will have time to see it coming, and with oil prices currently low, it will be virtually painless,” she added.

However, diesel cars had been under fire before the VW scandal. Earlier this year, the city of Paris said that in order to improve air quality it was aiming to have diesel cars out of the city by 2020. 

A French refining industry official has said that less domestic demand for diesel and higher demand for gasoline should be a positive for French refiners who are finding it increasingly hard to export their surplus gasoline production against tough competition from refiners in Asia and the Middle East.

Industry analysts predict the Volkswagen emissions scandal will impact Europe’s diesel and gasoline landscape more than their US or Asian counterparts.

Gasoline could be the real winner if politicians pull the plug on diesel tax breaks, while the heavier fuel could turn bearish in the long term.

It will be good news for Europe’s refiners who are technically configured to produce more gasoline than the region needs, leaving it exposed to the whims of US consumers to balance the structural oversupply.

The automotive scandal has strengthened political campaigns against the energy-dense mid-distillate refined oil product.

Nevertheless, as Stefano Zehnder, an expert at ICIS Consulting, told industry participants in an informal presentation on the sidelines of EPCA, even if the manufacturing of diesel vehicles in Europe was to stop straight away, it would still take five or six years before there was a knock-on effect as diesel cars would still be a major part of the European fleet until then.

Any turning away from diesel in Europe would not create a mirror-image benefit for gasoline demand, because the long-term trend in vehicle design is toward hybrids and electric-powered cars, Zehnder said.   

Looking at the sources of oil demand growth to 2020, ICIS Consulting expects petrochemical feedstock demand to be the star performer, eclipsing diesel and gasoline. Refiners will increasingly focus on the petchem sector, Zehnder said.  

For VW itself, along with the reputational damage risk, the change in CEO and delays to its 2016 product line-up, there is also the risk of class-action law suits and regulatory fines.

The costs from penalties, lawsuits and car recalls may well exceed the estimated $70bn costs of BP’s Deepwater Horizon oil spill disaster in the US, said Christoph Bruns, manager at German investment firm Fondsgesellschaft LOYS, in an analysis he contributed to business daily Handelsblatt.

Bruns calculated that Volkswagen may face a cost of about €2,000 per car for recalling and fixing the 11m affected diesel vehicles, coming to €22bn. 

Furthermore, the company is facing huge penalties, estimated to come to $18bn in the US alone, he said.

Coupled with this, VW has a high amount of current debt (debt due to expire in the next 12 months) estimated by the Economist at €164bn. This could cause refinancing problems, especially as the damage to its share price – if sustained – will likely lead to higher borrowing costs.

There has been speculation from various commentators that this may lead to a need for VW to be bailed out, as with General Motors in the wake of the global recession, but at this stage that remains at the level of conjecture and contingent on a number of unknown factors playing out in very specific ways.

What seems more certain is that the financial burden may put strain on VWs growth strategy in the short-to-mid-term, and that there may well be further organisational change.

The automotive industry is a major global consumer of petrochemicals which contribute more than a third of the raw material costs of an average vehicle. ICIS tracks the movement of petrochemical raw material costs in auto production both globally and regionally with the weighted ICIS Basket of Automotive Petrochemicals (IBAP).

ICIS has launched a Global Automotive report covering the major automotive chemicals markets, and auto-industry and macroeconomic trends. For more information on the report and details on how to subscribe, please email automotive@icis.com

Additional reporting by Cuckoo James, Jonathan Lopez, and Stefan Baumgarten