Biofuel Crossroads

Oil prices may have retreated from recent record highs, but that has not stalled a sudden consumer shift away from gas-guzzlers and toward smaller, more fuel-efficient vehicles.

The panic at the pump, along with growing alarm over the role vehicles play in global climate changes, has prompted major auto makers and government policy makers in 2006 to turn their mutual attention to a variety of alternatives to crude oil.

From pickup trucks in Thailand to SUVs in Australia to luxury cars in Europe, car companies and their army of suppliers are scrambling to provide greater fuel efficiency while politicians rush into place tax incentives and governments begin mandating new fuel formulations.

Automotive engineers worldwide are turning to varied solutions to serve regional needs. These include vehicles powered by hybrid-electric, biodiesel, hydrogen-internal-combustion, liquefied-petroleum and compressed-natural gas and bioethanol-fuel technologies.

Despite a growing consensus that hydrogen fuel cell-powered vehicles should be the global industry's ultimate goal — both to wean the world from its dependence on petroleum and to stave off further environmental damage to the planet — the loudest clamor in 2006 has been for flex-fuel vehicles (FFVs) that run on a combination of gasoline, or diesel, and ethanol made from corn, sugarcane and other natural plant materials.

China announced in August plans to build 90 new ethanol plants, with the first to come on line in October. The government is allocating $200 billion for biofuels production over the next four years, with a target of achieving 5% fuel self-sufficiency by 2010.

India plans to mandate a mix of 20% jatropha ethanol with diesel and gasoline by 2013. The government is investing $329 million for 988,400 acres (400,000 ha) of jatropha tree plantations to be developed within five years, and up to 27 million acres (11 million ha) by 2013. The oil derived from the nut of the small tree is used to produce the ethanol blend.

U.S. officials announced in October plans to replace 30% of the country's transportation fuels with biofuels by 2030. The Department of Energy will spend $250 million over the next five years to set up two bioenergy centers to develop new crops and processes for the next generation of ethanol fueled by biomass, such as switchgrass or wood chips.

The departments of Energy and Agriculture will spend an additional $4 million for bio-based fuels research that will accelerate the development of alternative fuels. The departments will issue a solicitation for proposals for new plant feedstock genomics research projects.

“It's possible to get this cellulosic ethanol industry within the next five years,” Department of Energy Under Secretary for Science Ray Orbach says.

Experts say biomass fuels offer the most attractive midterm solution for many global markets, including the U.S., primarily because they are an energy source that is readily accessible.

Biofuels typically can be used much the same way as conventional fossil fuels, minimizing the need to adapt end-use technologies and lessen the need for imported oil while increasing security of supply and reducing emissions, they say.

Plus, converting vehicles to run on biofuels is the cheapest way to begin to address alternative fuels. Most vehicles can run on a 15% ethanol/gasoline blend, while purpose-built FFVs adapt automatically to fuels ranging from pure gasoline or diesel to an E85 (85% ethanol) blend.

General Motors Corp. says the cost per vehicle to incorporate flex-fuel capability ranges from $100 to $300, not including engineering or emission-certification costs.

But there remains the problem of the chicken and the egg. As ethanol demand grows, experts say the volatility of oil prices and the cost of production makes it difficult to quantify the cost to society in achieving an adequate supply.

“There are a lot of uncertainties, a lot of risks,” says Gil Rogers, senior director of Global Insight's international forum on global climate change and head of the forecasting group's new study on biofuels that kicked off in October to examine these questions on a worldwide basis.

“The economic viability is so dependent on where gas and diesel prices go,” he says. “There's a lot of impetus right now to look at biofuels, but oil prices change and that affects interest.”

Commercial interest influences government subsidies, which make ethanol blends competitive at the pump. In turn, demand motivates farmers to grow the necessary crops and industry to build the infrastructure necessary to manufacture the fuels, he says.

Since 2000, worldwide production of ethanol reportedly has doubled and use of biodiesel has grown four times. Yet critics continue to argue it takes too much energy to create ethanol, and that it has markedly less energy content than gasoline. Additionally, they say accelerated production of both ethanol and biodiesel will impact food supplies.

Advocates say major advances in technology address these issues, including a new fuel called “butanol,” made from various biomass materials, and cellulosic ethanol, which is produced from a number of plant materials other than corn.

Butanol at 85% strength reportedly can be used in cars without any change to the engine or fueling system. It contains more energy than ethanol and almost as much as gasoline. It can be made from a variety of plants, pulp waste from paper mills and whey, a waste product from cheese.

Butonol reportedly was developed by David Ramey, whose Environmental Energy Inc. plant in Blacklick, OH, makes the fuel through a special fermentation process. Hydrogen also is produced as a byproduct of butanol and can be used to create electricity to power the production process.

The beauty of cellulosic ethanol is that it's a non-food source that can be made from plant materials as well as wood and forest residues. Corn stalks and other crop wastes also can be used. Even micro-algae is under review.

Experts say cellulosic ethanol, currently in the laboratory research stage, can be produced more cheaply than ethanol made from corn, because the source materials cost less.

Plus, it holds the potential for significant reductions in greenhouse gases — from 67% to 89%, according to a recent study by the U.S.-based Argonne National Laboratory — compared with a 10% blend of corn-based ethanol that reduces greenhouse emissions 1%, rising to 20% for E85.

A study by the National Academy of Sciences finds corn-derived ethanol yields 25% more energy than the fossil energy invested in its production — better than gasoline. Biodiesel yields 93% more energy than the fossil energy used to make it.

And if cellulosic ethanol becomes feasible, the result would be more dramatic, requiring 70% less energy to produce E85, the Argonne study finds.

Honda Motor Co. Ltd. and Japan's Institute of Innovative Technology for the Earth claim to have established a breakthrough technology to produce cellulosic ethanol from “soft biomass” such as leaves and stalks, including rice straw.

The process reduces the harmful influence of fermentation inhibitors, resulting in a significant increase in production of ethanol and expansion of biomass, which it says holds enormous potential as a major step toward an energy-sustainable society.

Against these changing dynamics, the green wave washed up on many foreign shores this year. In Europe, where member countries last year failed to achieve a mandated 2% ethanol substitution rate for gasoline and diesel fuels, the European Union now is raising the bar to 25% for the region by 2025.

France reportedly is aiming for biofuels to represent 5.75% of its transportation fuels by 2008 and 7% by 2010, as opposed to 1% this year and 3.5% in 2007. The country's E85 ethanol/gas mix is derived from sugarbeets or grain, and the government believes enough can be grown to satisfy the 7% target.

Currently, France's biofuels production is mainly biodiesel, largely made from rapeseed oil, a plant cultivated by growers and then blended with traditional diesel. Some 75% of French cars run on diesel. Germany, the European leader in the production of biodiesel, also uses rapeseed oil.

However, French Finance Minister Thierry Breton says in a media report five auto makers plan to supply ethanol FFVs to France by 2007, including PSA Peugeot Citroen, Renault SA, Ford Motor Co., Saab Automobile and Volvo Car Corp.

Biomass also can be fermented to produce methane, and Fiat Auto SpA has found its niche as the current leader in sales of methane-fueled cars, with more than 24,000 units delivered in 2005. Fiat recently unveiled its Multipla Multi-Eco and Panda concept cars in Paris that will join the Doblo and Punto in the Italian auto maker's stable of alternative-fuel vehicles.

But not every European auto maker is onboard the ethanol train.

Last month, German auto makers BMW AG, DaimlerChrysler AG, Ford of Europe, General Motors of Europe, Volkswagen AG and truck maker MAN Nutzfahrzeuge AG announced a pilot hydrogen fuel-cell vehicle project in anticipation of the technology's commercial application.

Many global auto makers insist new-generation “clean” diesels are the medium-term solution to improved fuel efficiency and cleaner air, despite admissions diesel sales appear to be peaking as new stringent emissions laws and exhaust-aftertreatment measures add to its premium price tag.

“The environment is a very complex issue,” says Phil Martens, former Ford chief of product creation and recently named to head the Light Vehicle Systems division at ArvinMeritor Inc. “I was on a taskforce at Ford, and it took us a year to comprehend the issue of sustainability,” he says.

“The challenge is to level out the production of CO2 (carbon dioxide). It's a 25-30 year project. Unless the government mandates it, it won't happen on a voluntary basis.”

That is the case in Gent, Belgium, which now has five projects that will accommodate the production of biofuels. Total value of the investment exceeds $507 million.

Sweden also is taking a major role in promoting renewable fuels. Carl-Peter Forster, president-GM Europe, credits the growth of FFVs to the government, which is creating demand with tax exemptions and free residential parking for “clean” vehicles. Sweden's biofuels service stations are expected to grow to 2,400 by 2009.

The government's efforts have sent sales of clean cars soaring. Western auto makers, such as GM, are trying to capitalize on the movement to E85 as a way to compete with hybrid-electric vehicles from Japanese rivals Toyota Motor Corp. and Honda.

Sweden's new registration of clean cars reportedly jumped fivefold in July compared with year-ago, with 21,000 registered through September. Top-sellers include the Saab 9-5 BioPower, Ford Focus Flexi-Fuel, Volvo V50 Flexi-Fuel, Volvo V70 Bi-Fuel and Toyota Prius HEV.

While Sweden currently imports the bulk of its ethanol from Brazil, the world's largest producer, it reportedly is stepping up efforts to develop domestic production from forested parts of the country.

Brazil's vehicles have run on some form of subsidized ethanol for the last 30 years. The country's major meatpacking plants earlier this year began producing biodiesel from animal fat, as certain heavy-duty trucks can run on the fuel. It also is looking at making biodiesel from coffee beans.

McDonald's Corp. reportedly is joining a similar effort, collaborating with Brazilian researchers looking to power vehicles with recycled vegetable oil from its restaurants, a technology currently led by Germany.

Brazil's dedicated FFVs, capable of running on any mix of gasoline and/or ethanol, were launched in 2003, and sales continue to climb. The industry set a monthly record this July, with FFV sales spiking 71% to 121,001 units. Success is such that the government has cut its mandate of 25% ethanol content in regular gasoline to 20% in an effort to ease both demand for and the price of ethanol.

Global OEMs in Brazil have reaped the benefits of FFV technologies that now are being applied to their home markets. They include GM, Ford, DC, VW, Fiat, Renault, PSA and Toyota. GM and Ford are pushing to bring their Brazilian-inspired FFVs to the Australian market, as well. At Sydney's annual auto show recently, GM showed a Saab Aero X twin-turbocharged 2.8L V-6 adapted to run on 100% ethanol.

With the country's ethanol market currently too small to offer ethanol capability greater than E10, most Australians have turned to LPG as an alternative fuel. Demand has grown as a result of federal government grants for buyers of LPG cars or for owners wishing to retrofit their vehicles.

Ford in Australia recently announced plans to increase production of LPG-fueled cars and SUVs from 90 to 120 units per day beginning in January. Of 3,700 Falcons sold in August, 826 were LPG models.

Nevertheless, the Australian government is spending $42 million in production grants to offset the excise tax on ethanol production in order to help oil companies achieve a target of at least 92.4 million gallons (350 million L) in the next several years.

It also is providing $13.1 million over three years to retailers installing new pumps or converting existing pumps for biofuel blends.

Meanwhile, the National Party uses its federal conference in Canberra for a vote to call on its senior government-coalition partner, the Liberal Party, to remove or phase out the 10% cap on ethanol-blended fuels and promote the wider use of ethanol through motor sport events. It also wants to set up an independent fuel-testing agency.

Queensland National Party Sen. Barnaby Joyce says the big oil companies clearly are failing to meet their voluntary target.

“The Australian people want it, and if (oil refiners are) not going to come to the game with the voluntary target, we should be mandating it,” he says. “I don't know how much longer we have to play this game of herding the elephant with a feather. We have to actually get serious about it.”

The Australian Bureau of Agriculture and Resource Economics says in its 2006-2007 “Economic Overview” that 72 million tons (65 million t) of corn will be processed into bioethanol worldwide in the period.

The U.S. is the largest producer of corn-based ethanol, followed by China. Brazil ranks first in ethanol output overall, producing slightly less than half the world's total in 2004.

China began promoting ethanol in 2002 on a pilot basis in five cities in the Central and Northeastern regions. The trial was extended to nine provinces in 2004, with service stations in the pilot areas required to switch fully to E10 by the end of 2005.

In addition to plans to build 90 new ethanol plants, the Chinese government presently offers a number of incentives for biofuels production. It also covers losses incurred from the sale of E10 by service stations, as well as transport costs.

While most Chinese vehicles currently run on gasoline and diesel, Beijing's aggressive renewable-fuels plan comes as welcome news to many industry observers. Worldwide vehicle output is expected to grow 5% this year, with China contributing 3.6 million units, says OICA, the international auto makers' association.

In its recent global outlook report, PricewaterhouseCoopers predicts worldwide vehicle production will rise by more than 8.5 million vehicles in the next four years, for a 13.7% increase. More than half of all new capacity will be added in China, Russia, India and Brazil.

The report underlines the size of the problem governments face in their efforts to reduce CO2 emissions and global warming. But industry players say saving the world is only part of the pitch. Tax incentives are another.

“There's not much chance that customers are ready to pay more for a better environment,” says Remi Deconinck, vice-president-product planning at Renault. “Consumers are willing to pay more only because at the end there is an economic interest.”

Tim Manganello, president of BorgWarner Inc., agrees. “I think deep down most car companies are interested in the environment,” he says.

But “they have competitive pressures and economic pressures that cause them to make compromises. I think if you build the ultimate environmentally friendly vehicle, you may have a hard time selling it.”

Jim Muir, president of Mazda Europe, says geopolitical considerations also play a role, noting Europe is getting tough on CO2 because transportation energy is becoming important politically, as well as economically.

The political clout that can be wielded through the supply or denial of energy threatens to change the global balance of power, he says.

All the more reason for sustainable, renewable fuels, ethanol advocates say, emphasizing there is a pressing need for governments to link the taxation of vehicles and alternative fuels more vigorously to CO2 emissions.

But Muir warns there's a danger some international markets will put off such action in order to maximize profits, a move that could have ominous consequences.

“If we let CO2 emissions keep rising like they are, it's been calculated the worldwide temperature will increase 5°-6° C (41°-43° F) by 2100,” he says. “You and I certainly won't be around then, but our children will. They will cook.”
— with William Diem and Alisa Priddle in Paris, Eric Mayne in Belgium, Alan Harman in Australia, Sudhakar Shah in India and Sol Biderman in Brazil

THAILAND

Small Cars Find Favor as Thai Pickup Sales Slump

Thailand saw sales of its cash-cow 1-ton pickup slide this year, as the price of crude oil hovered at an all time high for much of the summer.

Light-truck sales initially rose 3.6% in the first three months to 108,752 units but slid 15.3% in June — bad news for major auto makers such as General Motors Corp. and Ford Motor Co., which have operations there.

Although oil prices retreated in August, overall sales in September fell 10.4% to 49,483 units, their lowest level of the year. The result left year-to-date sales down 3.2% to 48,450 units.

The previous government pushed natural-gas vehicles and planned to reduce the tax on E20 cars to 20% from 30%-50% in 2009, when locally produced ethanol is more plentiful. But industry players say a wider net must be cast to lessen the need for imported oil.

Ford Motor Co. of Thailand President Thomas Brewer said in June the government should explore B20 biodiesel, a 20/80 ratio of renewable biomass, such as vegetable oil, and fossil fuel. ‘“Don't forget, some 65% of the total vehicles used in the country are 1-ton pickup trucks that consume diesel,” he told the Bangkok Post.

But Honda Automobile Thailand Co. Ltd. President Hiroshi Toda is recommending support for an A-segment car that provides 47 mpg (5L/100 km) running on E20 ethanol, the same parameters set for the country's discontinued “Best Little EcoCar Project,” which now is being revived.

The issue temporarily was pushed aside with a late September military coup that ousted controversial Thai Prime Minister Thaksin Shinawatra.

Surayud Chulanont was sworn in by Thailand's King Bhumibol Adulyadej on Oct. 9 as the country's interim prime minister.

The new government plans to propose a project this month to promote the production of small cars without imposing specific engine or body size. Officials believe if the policy is implemented quickly, Thailand could meet its target to produce 2 million vehicles by 2010.

Meanwhile, domestic auto makers are asking the new government to cut taxes on biofuels sooner to encourage the development of alternative-energy vehicles and promote the ethanol industry. The only Thai model currently able to run on E20 is the Ford Focus.
— Christie Schweinsberg with Alan Harman

INDIA

OEMs Push Expansion Plans for India

Honda Motor Co. Ltd. CEO Takeo Fukui predicts India will be more important than China for the future of the global automotive industry.

“The growth rate is coming close to China's, and one factor in favor of India is that it is a democracy,” he says in a published report. Fukui cites the more harmonious relationship Japan has with India than with China as another reason Honda is placing so much importance on India.

The Society of Indian Automobile Manufacturers announces an ambitious Automotive Mission Plan to raise automobile sales to $145 billion by 2016, requiring a $35 billion-$40 billion investment to achieve the goal, four times what has been invested over the last 16 years.

The majority of the investment is expected to come from the auto industry, Mahindra & Mahindra Ltd. Vice Chairman Anand Mahindra says.

Honda, along with fellow Japanese auto makers Nissan Motor Co. Ltd. and Suzuki Motor Corp., cranked up their commitment to the country this year, announcing expansion projects that are a nod to India's ever-growing importance as a center of automotive expertise.

Nissan and Suzuki announced a wide-ranging pact to provide each other with products in different markets. One tenet of the deal has Nissan using capacity at a plant owned by small-car maker Maruti Udyog Ltd., Suzuki's Indian subsidiary.

Separately, Suzuki will build an A-segment car for Nissan in India, to be sold primarily in Europe, beginning in 2008. Suzuki Chairman Osamu Suzuki says the auto maker and Maruti will invest in a new plant in Manesar, northern India, to supply 50,000 units annually of the small car to Nissan. The plant is set to commence production in late 2007.

Another Indian plant, with an investment from Nissan, also is in the works, he says, with an annual capacity of 250,000 units and requiring $551 million to build.

Honda is doubling capacity at its Honda Siel Cars India Ltd. subsidiary three years ahead of its previously announced timeline, to 100,000 units by the end of 2007. The auto maker last year increased capacity at the plant to 50,000 units. Honda also is investigating a new small car for India that will place below its 1.5L City ZX sedan.

The volume of small-car announcements is not a surprise, considering the impact of rising fuel prices on most auto markets in 2006. The need for vehicles with increased fuel economy, and also for alternative fuel sources, rose to the forefront in the year.

General Motors India Ltd. announced plans for a compressed natural gas version of the 1.6L Optra sedan, joining Mitsubishi Motors Corp. and Maruti by offering either CNG or liquefied petroleum gas-powered models.

Tata Motors Co. Ltd. also is readying CNG and LPG versions of its Indigo lineup.
— Christie Schweinsberg with Sudhakar Shah in India

CHINA

China Aims to Rein in Auto Exports

Following a flurry of export announcements by Chinese auto makers over the last two years, China in 2006 takes steps to stem the number of vehicles leaving the country.

The government says it will limit the number of export licenses available to domestic auto makers starting early next year. The goal is to prevent assemblers from shipping poorly made vehicles, thus sparing China embarrassment and harming chances of future auto exports.

The move no doubt was helped along by the European debut of the Landwind SUV from Jiangling Motors Co. Ltd., which was widely criticized by the European media for its lack of safety features and poor handling. German automobile club ADAC insisted it be banned from European roads.

Earlier this year, Geely Automobile Co. Chairman Shufu Li said he was well aware consumers have reservations about buying cars made in China.

“We still have a lot of work to do to improve our technology and quality, and that's what we're doing,” Li told Ward's in an interview at January's 2006 North American International Auto Show in Detroit. “We believe one day American consumers will accept us.”

The auto maker commissioned a study following its appearance at the show to gauge public reaction to media coverage of Geely. Results showed 25% of those surveyed were highly skeptical of the quality of Chinese products.

“It's probably a realization by the government, and the companies, that penetrating the (major) export markets in a meaningful way would require a lot more groundwork and would take a lot longer than they originally planned,” Global Insight Asian analyst Ashvin Chotai says of the Chinese government's reasoning for wanting to limit auto exports.

Geely, for example, failed to meet U.S. emissions and safety standards, delaying its entry until 2009, giving it time to develop a more sophisticated vehicle for the West than its current small, no-frills CK sedan.

The first Chinese auto maker to announce U.S. export plans, Chery Automobile Co. Ltd., also will not see its models on U.S. roads as early as first thought.

After pushing back the start of sales several times, U.S. entrepreneur Malcolm Bricklin, who formed Visionary Vehicles LLC to import Chery models, now is postponing the company's launch until late 2008 in order to meet top safety requirements in U.S. government crash tests.

Meanwhile, a Chinese truck maker may set up a plant in Brazil by 2010 if sales justify the move, says Mario Santos, technical director of the Tricos group of Portugal, which represents the Chana group of China.

The first lot of 300 imported units arrived in Brazil late this year, including five models: a minivan, van, pickup, small cargo truck, double cabin cargo truck and 5-seat pickup. Prices range from $13,000 to $15,900.

Chana plans to invest $5 million to set up the dealership network and create a car-part storage system and other technical structures. Officials say they want to win the confidence of consumers with quality services and products.

The Chinese government in August designated eight cities as regional auto-export zones, giving them undetermined assistance. These include Shanghai; Tianjin; Xiamen; Taizhou; Wuhan; Chongqing; Changchun; and Wuhu, where Chery is headquartered.

“Expanding the export of vehicles and spare parts, especially our own brands and those with our own intellectual property rights, is the only way to enhance our auto industry's international competitiveness,” Commerce Minister Bo Xilai tells the China Daily.

About 160 vehicle and spare parts manufacturers are listed as part of the first group of government-approved exporters.

China's auto makers and suppliers need not be in a hurry to rush into new markets, with the country's national vehicle association reporting car sales surged 40% in the first nine months through September.

General Motors Corp.'s joint-venture sales, led by GM Shanghai Automotive Co. Ltd., rose 36.7%, to 645,680 units in the first three quarters, helped by strong demand for newly introduced models such as the Buick LaCrosse and Chevrolet Lova and securing the auto maker's No.1 sales spot for the ninth straight month.

Ford Motor Co., relatively new to the hotly contested market, saw sales jump 105% in the period to 114,685, while Volkswagen AG sales rose 28.7% to 534,558. Newcomer Toyota Motor Corp. sold 203,000 vehicles through September, marking 164% growth over year-ago.
— Christie Schweinsberg with Sol Biderman in Brazil

AUSTRALIA

Australia's Small-Car Shift Takes Toll on OEMs

As Australia's domestic auto makers struggle to sell their bread-and-butter large rear-wheel-drive cars this year, General Motors Corp. helped boost the fortunes of its GM Holden Ltd. subsidiary by announcing plans to utilize the group's RWD expertise globally.

GM said in August it would build a production version of its Chevrolet Camaro concept for the U.S. based on its Global Rear Wheel Drive (formerly Zeta) Architecture, developed by GM Holden.

GM's Pontiac brand in the U.S. also may get a Zeta-based model, the Pontiac G8, and perhaps a GTO, as well as future generations of the Chevy Impala and Monte Carlo and the replacement for the Buick Park Avenue.

GM will use the platform to underpin vehicles in Europe and South Korea, as well, although in smaller volumes. The news helped soften the blow of declining retail sales at home for GM Holden, with vehicle deliveries down 18.2% through September, according to the Federal Chamber of Automotive Industries.

Record high prices at the pump have sent consumers scrambling for small, fuel-efficient cars, giving Toyota Motor Corp. Australia Ltd. the edge over top competitors Ford Motor Co. of Australia and Mitsubishi Motors Australia Ltd.

The major producers were counting on the launch of their restyled new large sedans this year to boost sales but instead saw demand in the sector slide 21.3% in the first nine months, while small car deliveries rose 20.1%.

Mitsubishi most notably has failed to revive the segment with its new 380 model, leading to reports parent Mitsubishi Motors Corp. may shutter its Adelaide plant.

The new Holden Commodore has shown promise out the chute, with first full-month sales in September climbing 8.5% vs. like-2005. GM Holden also is benefiting from the import of small cars from GM Daewoo Auto & Technology Co. in South Korea.

Meanwhile, Ford plans to cut production at its Melbourne plant 20% in November, blaming falling profits resulting from the market shift to small cars. The auto maker also is considering other cost-cutting options, including worker layoffs.

Sales of the Ford Falcon large car and Territory cross/utility vehicle trailed prior-year by 19% and 18%, respectively, through September. To counter GM's cheaper South Korean models, Ford is emphasizing the European influence of its BF Falcon, which has been tuned to European standards.

Ford also will increase production of its liquiefied-petroleum-fueled vehicles, from 90 units to 120 per day, in January. Demand has grown due to federal grants for buyers of LPG cars or for owners who retrofit LPG systems to their cars. Ford sold 826 Falcons and 528 SUVs fueled by LPG in August.
— Christie Schweinsberg with Alan Harman

EUROPE

East to Eclipse West, Industry Trend Suggests

True to form, the sun is rising in the East and — industry insiders fear — setting in the West.

As the European market grows more crowded, led by Asian-based auto makers that enjoy lower labor costs, new manufacturing centers are emerging while old business models are vanishing into the dusk.

Eastern Europe's auto industry has on its horizon the pending investment of more than €3.4 billion ($4.3 billion) by Volkswagen AG, Suzuki Motor Corp., PSA Peugeot Citroen, Kia Motors Corp. and Renault SA.

Meanwhile, dark clouds are gathering over Western Europe in the form of downsizing and the resulting threat of labor strife.

“In the past, we used to see that there is a cycle,” says Marcello Malentacchi, general secretary of the International Metalworkers Federation, an umbrella organization for dominant auto industry labor unions such as IG Metall and Amicus.

“You would have slow times, but we could expect in one or two years to come back again,” he says. “This is not going to happen anymore. Unless we develop the market on some other continent.”

Malentacchi mentions Africa, Latin America and the Indian subcontinent. But he admits their economies are not developed sufficiently to support imports from Western Europe.

What remains, he tells Ward's, is “one of the worst” climates he has seen in the auto industry. “The situation with respect to the major companies is very tense. There is a lot of potential for conflict.”

At the center of the storm is Volkswagen. Its core-brand operations are the target of aggressive rollbacks championed by Wolfgang Bernhard, now entering his third year as CEO of the VW brand.

For the hard-line IG Metall union, the coming year will bring the aftermath of a deal negotiated by Bernhard. Using the promise of new production programs as a lever, the former Chrysler Group chief operating officer persuaded the union to accept an agreement that creates a flexible workweek of 25 to 33 hours at six German plants.

This comes on the heels of a similar accord reached last year guaranteeing the auto maker's Wolfsburg plant will build VW's all-new Tiguan cross/utility vehicle, scheduled to debut in 2008.

Yet analysts remain unappeased. “We viewed VW's recent labor agreement with IG Metall as slightly disappointing,” says an Oct. 18 research note published by JP Morgan. Expectations were talks would produce still greater productivity improvements.

The eastern half of the continent enjoys a compensation rate that is two-thirds less than levels paid in the West, according to the Federation of European Employers. For auto workers, that means €9.17 ($11.57) per hour vs. €27.50 ($34.70), and some auto makers are using every means possible to exploit this advantage.

“As far as a place for manufacturing is concerned, we are basically benefiting through our suppliers,” says Dieter Zetsche, chairman of DaimlerChrysler AG and head of its Mercedes-Benz Car Group.

Such opportunities are increasing almost daily. A partner of TRW Automotive Holding Corp. revealed in September the Tier 1 supplier has chosen a greenfield site in Slovakia for a 3-phase, €40.5 million ($51.1 million) complex that will launch production in first-half 2007.

The wage gap also is prompting competition within Western Europe. Belgium, whose auto industry expects to benefit from €453 million ($571 million) in 2007, restructured its payroll taxes to ensure auto workers are paid €1 ($1.26) less per hour than in Germany.

Tier 1 suppliers and OEMs are not the only industry players swept up by the winds of change. Lower-tier suppliers, such as electronics producer Jabil, have jumped on the Eastern Europe bandwagon.

Among its 16 European plants are four in Eastern Europe, including a 1.3-million-sq.-ft. (121,000-sq.-m.) site in Hungary. But the drive eastward doesn't necessarily stop there.

“As people migrate to these low-cost countries, there's always the next low-cost country,” says Terry Bishop, regional director in Jabil's automotive group. “People are talking about Bulgaria and even further east. We're actively looking at acquisitions there.”

Ford of Europe is looking beyond, as well, as Eastern Europe's buying power improves with the auto industry's expansion. Demand for the Ford Focus has forced the auto maker to increase capacity at its plant in St. Petersburg, Russia.

“We've sold about 65,000 (Focuses) this year in Russia, alone,” Stephen Odell, vice president-sales, service and marketing, says. That is 5,000 units more than all the Ford vehicles sold in Russia last year, and the company expects to sell 120,000 vehicles this year. “It's a bit like the Wild West,” Odell says, adding the Russian market is slowly maturing.

Analysts forecast Europe will enjoy a solid economy in 2007. “Strong employment growth, combined with an expected slight increase in wage growth, is likely to keep consumer spending growing at stable, if unexciting, rates,” says a Merrill Lynch report. “Business investment spending, meanwhile, is only at the beginning of a cyclical upswing.”

This bodes well for auto makers that are rolling out a plethora of key products next year, such as the Renault Twingo, Nissan Qashqai and Volvo C30. But none will be watched more closely than the return of the storied Fiat Cinquecento, which debuts next September.
— Eric Mayne

MALAYSIA

Proton Struggles as Industry Loses Ground

It was a tale of two companies in Malaysia this year, as one national auto maker experienced growth and the other sunk further into the abyss.

Perusahaan Otomobil Nasional Sdn Bhd (Proton) lost its lead over rival Perusahaan Otomobile Kedua Sdn Bhd (Perodua) for the first time ever when Perodua overtook Proton in sales for the year's first half.

Perodua credits much of its success to its Daihatsu Motor Co. Ltd. joint venture. The Japanese small-car maker, owned by Toyota Motor Corp., provided access to product development and manufacturing expertise.

Proton's lack of fresh models has seen its market share shrink to 24.2% so far this year, a stark contrast to 1993, when the auto maker dominated with 57% of the Malaysian market.

Proton in June reported fiscal-year earnings of 47.02 million ringgit ($12.7 million), down from MR442.44 ($119.5 million) the previous year and one of the company's lowest profits in its 20-year history.

Struggling with a dearth of new product and a major management shakeup, Proton's search for a global partner has been protracted. Talks failed with Volkswagen AG earlier in the year, as the Malaysian government repeatedly rebuffed VW's takeover attempts. VW was troubled that anything less meant it would have to utilize Proton's uncompetitive local supplier network.

Proton inked a less significant pact with Japan's Mitsubishi Motors Corp. to build a vehicle co-developed by the two, but badged a Proton, for the domestic market by early 2007.

Proton also signed a memorandum of understanding with PSA Peugeot Citroen of France in September to study a limited alliance in the areas of vehicle development, production and distribution and supplier development.

Despite such efforts, analysts remain skeptical such linkups will solve Proton's overall problems or increase its exposure to regional export markets.

“I'm not convinced whether Peugeot has enough experience in that region” to help Proton recover its market-share lead, says Ashvin Chotai, director-Asian automotive industry research for Global Insight Inc.

Peugeot's sales in Europe are weakening. And while it is a player in the explosive Chinese market, it remains a minor one. Proton's main roadblock is the strength of the Japanese auto makers throughout Asia.

“Without protectionism, we expect the Japanese to make great inroads (in Malaysia),” Chotai says. “In a true market, all the odds are stacked in favor of the Japanese in that part of the world.”

Although Perodua performed well in 2006, Malaysia's total auto sales are expected to fall from an earlier forecast of 560,000 units to 520,000, a 6% decline, leading to calls from the auto industry to relax financing and establish a used-car scrap policy to spur sales.
— Christie Schweinsberg with Mack Chrysler in Japan and William Diem in Paris