The European auto industry is bracing for impact as the EU races to reduce gas consumption and prevent power cuts and rationing this winter. We expect about half of typical Russian imports (140 billion cubic meters of piped gas last year; EU total consumption 450 bcm) to be covered by alternative supplies, such as LNG, leaving an about 70 bcm shortfall. Of this, a disproportionate amount may fall on European industry, including automakers and auto suppliers, given consumers in many countries enjoy strong protections against mandatory cuts in energy use.

In our scenario analysis, we assume that one-third of the EU's targeted 15% cut (approximately 23 bcm) would be borne by industry, although it could vary depending on national government allocations. Converted into megawatt hours (MWh), this totals about 186 terawatt hours (TWh)-187 TWh of net consumption after taking into account the conversion into electricity.

Our Two Scenarios Gauge Downside To Auto Production

Light vehicle production in Europe has already decreased significantly to about 13 million units in 2021 from 18 million-19 million in 2018 (see chart 1). This is due to relocation of production closer to end markets (China in particular), COVID-19 pandemic effects, and supply shortages linked to semiconductors. Despite a general decline in global production due to supply chain bottlenecks over the past two years, Europe ended up accounting for a mere 16.6% of total production in 2021, down from about 20% in 2018.

Chart 1

So far, the financial effect of lower volumes has been fairly muted. Automakers have mitigated the shortfall with solid pricing after post-pandemic demand strongly recovered, while auto suppliers have at least partly offset lower volumes with higher content per car. Automakers and suppliers started 2022 with the expectation of a robust recovery of light vehicle production from second-half 2022 and into 2023. This has failed to materialize, mainly owing to persisting supply shortages and additional disruption caused by the Russian-Ukraine conflict. The economic fallout of the war has also started weighing on the medium-term outlook for demand in Europe, although the immediate effect on automakers and suppliers is mitigated by record-high order books. These deliveries should carry the industry through the remainder of 2022 and into first-half 2023. However, the outlook could quickly deteriorate due to escalating geopolitical risks in Europe and declining consumer confidence.

The need to replace gas imports from Russia creates the short-term risk of an energy crisis this winter. Depending on how severe the winter is, energy restrictions could emerge from early 2023, and the level of gas storage Europe will target for the subsequent winter is an open question (see "Europe Braces for a Bleak Winter," published Aug. 29, 2022, on RatingsDirect). This analysis attempts to estimate a downside scenario where Russian gas supply is interrupted indefinitely and Europe needs to fully compensate via other sources and a 15% reduction in gas usage.

To do so, we have developed a high level and initial framework to assess the consequences of a possible cut in industrial energy consumption (whether through outright energy rationing or voluntary curbs) on European light vehicle production in 2023. Our scenario is not a base case but seeks to gauge the possible downside to light vehicle production in Europe. In practice, the actual production cut is likely to be less severe for the reasons discussed below.

Our Assumptions:

Table 1

• We use our own indicative estimates of energy consumption in Europe per light vehicle produced. This estimate represents an indication of the energy consumption along the European value chain that can be considered part of the auto industry, via automakers and suppliers, but excludes upstream industries such as steel production and raw material extraction.
• The starting point for our analysis is an estimate of energy consumption per vehicle at the automaker level. For the EU, data by industry association Acea suggest energy intensity of 2.8 MWh per vehicle--or about 3.5 MWh direct plus indirect energy consumption before conversion of gas to electricity, as per our estimates. This is broadly consistent with information extracted from automakers' sustainability reports.
• We combine data points from available studies and indications from suppliers' sustainability reports to gauge the relative energy intensity of the supplier network compared to automakers. This leads us to assume average (direct plus indirect) energy along the entire value chain of about 10 MWh per unit vehicle.
• We considered two scenarios for the European auto industry's expected share of the 23 bcm in total gas savings--10% and 5%. We regard the 5% scenario as more realistic because the 10% case would imply a higher sector contribution than its share of total industrial gas consumption.
• Given that the industry uses most gas for power generation, and few activities require gas directly, we assume high substitutability between gas and other forms of energy such as electricity. This allows us to refrain from making assumptions about fixed-input relationships of different energy sources in the production process.

Analytical Conclusions

• We estimate that for each bcm of gas rationing the European auto industry has to absorb, auto production would need to shrink about 0.8 million-0.9 million units in our main scenario of 10 MWh per vehicle.
• Based on these assumptions, we estimate production at risk of 7% in the 5% scenario and 15% in the 10% scenario, respectively (of 2021 light vehicles produced in Europe).
• We reiterate that this represents an extreme scenario and is highly dependent on our above numerical assumptions for the total shortfall, the share allocated to the auto industry, and energy use in the European auto supply chain. Furthermore, the effect on missed units produced could substantially vary due to different energy mixes in automaker/supplier production footprints.

Why The Impact Will Likely Be Smaller

Substitution with other energy sources is possible:   The above calculations assume that the necessary reduction in (direct plus indirect) energy consumption across all sources is equivalent to the gas savings required from the sector. However, we believe some of this gas usage can be substituted with alternative sources, such as oil-fired generation or other electricity production.

Energy savings, such as reduced heating and lighting in plants:   We believe these are feasible to some extent and would reduce the shortfall to be met by curbing light vehicle production.

Table 2

Reallocating part sourcing:   We believe relocating entire car assembly plants will be hard in the short term but buying individual parts from other regions that do not face energy rationing may be an option. In some cases, it may be possible to shift part sourcing to the same supplier's plants in another region. However, this may represent a risk for auto suppliers who cannot offer this possibility.

Political clout:   The European auto industry accounted for about 3% of EU industrial gas usage in 2020 (source: Eurostat), but about 7% of total employment (2019; latest available figure) and 11.5% of manufacturing jobs (2019), according to ACEA. This may give the sector bargaining power if it comes to a political allocation of mandatory energy savings.

In table 2 above, we also show the production at risk at different levels of energy efficiency, or substitution with alternative sources. For example, for our main scenario of 10 MWh per vehicle, 10% savings through energy efficiency, substitution, or sourcing of parts from outside Europe would reduce the production at risk about 80,000 units per bcm. That said, we note that certain factors could increase potential production risks, for example, if the industry suffers indirect effects in the form of additional electricity shortages as a result of reduced power production sector output. Moreover, we believe light vehicle production also involves a certain share of energy consumption that is independent of volume (such as basic factory lighting and heating), which is included in the basis of our per unit estimates and somewhat distorts the calculation. Furthermore, the advocated 15% reduction in gas usage for European industry might not be sufficient to avoid a gas shortfall in case of a cold winter.

Regional Footprints Within Europe May Matter

Gas dependency varies greatly between European countries (see chart 2).

Chart 2

German automakers appear at a disadvantage in comparison to peers like Stellantis and Renault. At this stage, however, we are unaware of specific automaker concerns on energy interruptions that could hit operations at their plants. We estimate energy costs of 1%-2% of revenue on average for automakers, which are pure assemblers. Energy efficiency and independence appear a medium-term goal. Mercedes-Benz and Renault have to date publicly communicated their intention to improve energy efficiency and independence in Europe.

Energy availability could be a higher risk for auto suppliers. When we compare energy intensity (measured as MWh per million euros of revenue) between automakers and suppliers, the order of magnitude is 1:3--based on global data for 2021 energy intensity as per issuers' sustainability reports--even excluding tiremakers Michelin and Pirelli, whose energy intensity far exceeds the auto supplier average in Europe (see chart 3). This observation spurred our assumption on average (direct plus indirect) energy use per car along the value chain of about 10 MWh per unit vehicle.

Chart 3

Reported energy intensity data from auto suppliers is global and we have no reason to assume that differences between regions are material. This is because global auto suppliers are aligning the operating and cost efficiency of their plants around the globe to improve their competitive positioning.

In our rated suppliers sample, the exposure to Europe is typically 40%-60%, whether measured in terms of revenue or noncurrent assets, with the only exception Autoliv at about 25%-30%.

Therefore, although not a direct concern for automakers, we believe the energy availability issues described in our scenario analysis could still represent a risk for European auto production via the supply chain.

Chart 4