Chart 1

Macro Risks To Light Vehicle Sales Make Production Discipline And Pricing Critical

Stronger-than-expected markets in Europe and North American might not last through 2023.  The gradual easing of supply side shortages since mid-2022 has reduced production constraints in 2023. While this supported steady year-over-year auto sales globally in the first quarter of 2023, S&P Global Ratings is concerned that the recent positive demand trend could falter, especially in North America and Europe. Geopolitical instability, sticky inflation, and the usual delayed impact of tightening monetary policy on consumers' purchasing power could dampen auto sales momentum in the second half of 2023. North America's and Europe's labor markets are still tight, though off their peaks. We expect a very shallow recession in the U.S., and stagnation in the eurozone, where we also see elevated risk of a mild recession down the road and a stickier inflation environment, compared to the U.S. Our global base-case scenario for light vehicle production and sales (see table 1) includes a very gradual recovery of light vehicle production and sales to near pre-pandemic levels by late 2025. That is largely unchanged from our previous forecast (see Industry Top Trend 2023: Autos, Jan. 23, 2023).

Faster-than-expected growth in the Chinese auto market could be a game-changer in our base-case scenario.   Our economists maintain a cautiously optimistic outlook for Asia-Pacific, largely driven by this year's organic recovery in China, led by consumption and services. We are, however, cautious about our 2023 outlook for China auto sales because we believe auto demand has been partially pulled forward to 2022 by stimulus policies. Taking into account the Chinese central government's restoration of the full purchase tax on internal combustion engine (ICE) vehicles, and its removal of the electric vehicle (EV) purchase subsidy from January 2023, we expect light vehicle sales growth (excluding exports) this year to be as much as 2%. Light vehicle sales in China are likely to decline by about 15% year-on-year in the first quarter, due to seasonality effects and the sidelining of consumers by price competition. Sequential improvement is likely from the second quarter, when original equipment manufacturers (OEMs) launch new models and conduct promotional activities, while different local governments continue to extend incentives on EV purchase.

We expect Chinese OEMs to further expand overseas in 2023, encouraged by their success in winning market share from global OEMs in their home market. China's auto exports grew substantially in the past two years, benefiting from a well-established supply chain that was less disrupted by the pandemic and by increasing product competitiveness. Exports remained strong in the first quarter, but may soften if demand weakens in key markets, including in Southeast Asia and Europe, or if trade tensions intensify.

Table 1

OEMs' prudent approach to production will lead to lower inventory rebuilding in 2023.   That cautious approach should also minimize the need to apply sales incentives in the event of a marked deceleration in demand. Stock rebuilding outperformed our expectations towards the end of 2022, so we have made slight downward revisions to our estimates for 2023 light vehicle production. We still expect an increase of 2%-3% over 2023 (from 3%-4% previously), and 3%-5% growth in 2024 and 2025 as volumes approach pre-pandemic globally.

From a regional perspective, the most important trend is the structural reduction of European volumes, which we do not see reverting to pre-pandemic levels any time soon. That reduction stems from a need to move production capacity out of Europe and closer to end-markets (typically China, for the Germans OEMS in particular) to mitigate the impact of geopolitical tensions and optimize variable costs. Carbon dioxide (Co2) regulation might have played a role to the extent it has accelerated the phasing out of legacy business and redirected strategies towards value and away from volume. The consequence of this shift is that Europe will cease to be a net exporter of light vehicles to the rest the world. But we don't believe that will jeopardize the industry's strategic role for Europe considering it remains central to the development of new technologies, new infrastructure, new value chains, and new mobility options. In the U.S., we expect most automakers with a heavier-truck mix to target around 50 to 60 days of total dealer inventory on a portfolio basis. That is down over 30% compared to pre-pandemic levels of 80-85 days (in mid-2019) for light-truck focused automakers.

Affordability challenges will add to modest pricing pressures to new vehicles, but demand for used autos will remain a wild card, especially in the U.S.  We have seen some signs of weakening new vehicles orders since the start of 2023 in Europe. At the same time, prices of second-hand vehicles continue to be high (up 10% in the EU in 2023) despite the normalization of supply chain tensions which had stretched time-to-delivery of new cars well beyond 12 months over the past two years. This could suggest that high new vehicle prices and tight financing conditions are diverting some pent-up demand towards the second-hand market. We anticipate a softening of sales to become more evident from the second half of 2023 and in 2024. That could be exacerbated if labor markets weaken.

Similarly, in the U.S., demand for new vehicles is likely to be constrained by prices for the remainder of the year given tighter credit conditions due to the recent banking crisis. As a result, incentive activity increased slightly in March, and average transaction prices (ATPs, which are measured net of incentives) fell sequentially, according to data analytics group J.D. Power. Despite that fall, ATPs remain over $45,000, near all-time highs for the industry. We expect average new vehicle prices to fall about 5%-7% and more demand to shift away from new to used. However, used prices may remain roughly flat in 2023 as tougher financing conditions on the demand side are offset by a limited supply of used vehicles (especially for popular segments), and persistently high new vehicle prices. Steady used vehicle prices could also further limit declines in new vehicle prices. The average age of vehicles in the U.S. remains high, at over 12 years in 2022. This should boost replacement demand for some older vehicles given the supply constrained environment over the past two years.

In China, OEMs have offered price discounts (11%-13% for ICE and 7%-9% for EV over Jan.-March 2023) in a bid to win market share and clear older emission standard models, before new standards kick-in from July. While discounting may not intensify, given improving momentum from March, price pressures and an uncertain demand outlook will continue to weigh on local automakers' margins. This is especially the case for car makers that rely more on mass-market ICE sales, which could lose volume to EV producers.

Electrification Momentum Will Persist As Battery Suppliers Expand Capacity

The combination of lower year-on-year costs and, to a lesser extent, tax stimulus from provisions in the U.S.'s Inflation Reduction Act (IRA) should support a steady increase in global EV penetration through 2025.  Last year's all-time high lithium prices (of about $80,000/ton) were the primary concern for 2023 EV margins. The recent downward trend in lithium, nickel, and cobalt prices could relieve some of that pressure--particularly for larger automakers, which benefit from direct purchase agreements or pass-through pricing from miners and refiners). Pricing pressure could intensify in the EV segment, notably if disruptors seek to challenge traditional automakers whose electrification journey has begun at a cost disadvantage. We view the likelihood of a generalized price war as remote at this stage. But price pressure could be more pronounced in specific segments, including where disruptors are already well established, and where higher prices have attracted more competitors--larger/luxury sedans, large crossover utility vehicles (CUVs), and sports utilities vehicles (SUVs). In Europe, Chinese EVs are making inroads and could challenge traditional automakers. For example, by the end of 2023, China's BYD (not rated) will have launched five EV models in Europe in different segments (ranging from C to E) and at different price points.

We expect the margin for large global and Chinese EV producers could improve this year, given prices for EV critical raw materials and batteries are likely to fall further than those of EVs. However, EV start-up companies may continue to find it hard to break even given their small volume.

Chart 2

In Europe (Europe 10) EV sales were up just 5% over January and February 2023, compared to the same period in 2022, while sales of all passenger cars rose 10% over the same period.  EVs now represent approximately 20% of passenger car sales in the region, and we project that will rise to more than 30% in 2025 (see Table 2). This progress is regulation driven. From 2025, OEMs will have to deliver a 15% reduction in fleet wide Co2 in the EU, compared with 2021 average levels--equating to average emissions per vehicle of 80 grams of Co2 per kilometer (g Co2/km), down from 95g Co2/km. Failure to reach company specific targets would result in regulatory fines, though we do not expect that to be an issue given that all European OEMs are targeting EV sales of over 30% of total sales in the region by 2025.

The sales momentum of new energy vehicles (NEV) in China remains solid, albeit clearly down from its peak.  EV penetration in China exceeded 30%, well above the original government target of 20% set for 2025. At this level of adoption, incentives from local governments are no longer the most important factor supporting the growth of the EV market. With local producers upgrading product offerings and foreign OEMs trying to catch up in the EV race, competitive pressure is likely to intensify.

In the U.S., the combined market share of EV and plug-in hybrid electric vehicles hit 10% in February 2023 (on a last-twelve-months basis) up from high single digits last year.  This positive momentum, supported by IRA, appears consistent with our prior base case, which predicted an EV market share of 20% by 2025. Beyond 2025, increased EV affordability in the U.S. should be supported by lower battery costs, significant model launches, and regulatory proposals (announced on April 12, by the Environment Protection Agency) that could tighten emission standards each year between 2027 and 2032. Together these factors should help bridge the volume gap with Europe and China.

Table 2

Related Research

• Industry Top Trend 2023:Autos , Jan. 23, 2023