Focus
August 06, 2021 | 13:08
Autos: Trying to Put the Pandemic in the Rear-View Mirror
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Autos: Trying to Put the Pandemic in the Rear-View MirrorThe past 16 months have been a rollercoaster. But the second-half of the ride is proving to be more comfortable for the auto sector. Light vehicle sales in Canada and the U.S. will likely rise 15% (Chart 1) this year, nearly returning to pre-pandemic levels. The ability of households and dealers to adapt during the pandemic has been impressive. In the U.S., sales volumes are likely to reach 16.7 mln units this year. In Canada, we see vehicle purchases of roughly 1.9 mln units. Prior to a recent reversal, light vehicle sales were healthy in the U.S., with the level in the first seven months of 2021 only moderately below that of two years ago. Meanwhile, in Canada, purchases this year are still running more than 10% below 2019 levels. |
|
What explains the gap? Canada imposed more restrictions during the second and third COVID waves, which made it harder to make in-person purchases. Most U.S. states also reopened earlier than their Canadian counterparts, bringing more pent-up demand forward. Robust fiscal and monetary support have been key drivers of vehicle sales in both countries during the pandemic, but additional U.S. stimulus payments in January and March helped to accelerate demand. The auto sector has also benefited from the unusual pattern of consumer spending over the last 16 months. With many in-person services unavailable because of the pandemic, consumers channeled some of that forgone spending into other parts of the economy, namely durable goods. Those trends have started to reverse, particularly in the U.S., but not enough to supplant the strong consumer demand for new vehicles. We see sales recovering through the latter half of this year and returning to pre-pandemic levels in Canada and the U.S. in 2022. |
|
The biggest risk for sustaining strong demand is the Delta variant. Further restrictions on activity would slow the recovery, but with high rates of vaccination, we don’t anticipate broad restrictions being reimposed in Canada to contain future waves of COVID. In the U.S., with more geographic variance in vaccination rates there could be more of a fallout from Delta, particularly in the South, but the appetite for further restrictions is low in those regions. More economic activity is also generated in those states with higher vaccination rates. While the uncertainty around the future impact of COVID-19 remains high, the sudden turnaround of cases in some countries (e.g., U.K., Netherlands) suggests that broad health restrictions are unlikely to be needed to curb its spread. |
Recuperating SupplyAuto production has seen much volatility over the last 16 months. The shutdowns last spring brought production to a near halt. While North American production seemed poised to rebound last fall, shortages of microprocessors curbed the recovery. There isn’t a simple explanation for why the shortages became so acute. The U.S. imposed a 25% tariff on semiconductors from China back in 2018, shifting automaker supply chains away from China. The uncertainty around the timing of the rebound in consumer demand also led some producers to cancel their chip orders and delay their restart until late last year. These factors meant that there were major challenges in meeting chip orders, with fewer suppliers and more demand from other sectors (e.g., electronics, appliances). Additional waves of the virus also led to supply chain disruptions, while work-from-home boosted demand for new phones, computers and monitors. After production fell 19% across the USMCA countries in 2020, the pace in the first half of this year is running 27% above last year, but it’s still down 22% from 2019H1 (Chart 2). Supply chain issues have been particularly acute for Canadian producers as GM, Ford, and Stellantis have all had to limit or halt production of certain models this year. Canadian production through 2021H1 is tracking 40% below 2019 levels and is just barely ahead of 2020H1, which featured a month of zero production. Supply in the U.S. has held up better, as it’s down a lesser 16% from 2019H1 and well above 2020H1 levels. The supply shortages have started to impose speed limits on activity. Over the last few months, sales have struggled to keep pace with elevated consumer demand. U.S. auto inventories fell below their Great Recession lows to under 1.4 mln units in June (Chart 3). The implications can be seen most clearly in prices: the sticker price for new vehicles rose 5.3% y/y in June (Chart 4). With limited inventories of new vehicles pushing more consumers to the used market, prices have soared 45% y/y in June. Early indications are that wholesale prices for used vehicles have started to decline, suggesting relief is on the horizon. Over the near term, elevated prices could be a drag on sales, but with the excess savings accumulated over the pandemic, households are well-positioned to absorb some price increases. |
|
Another recent positive development for the sector comes from TSMC, a major supplier, saying that it expects the auto chip shortage to abate in 2021Q3. That might enable producers to raise production in the second half of the year and ease speed limits on sales. However, automakers have warned that the chip shortage may not ease for some time. It will be no small feat to close the auto supply gap; North American producers are short more than 1.6 mln vehicles compared to 2019, and filling that hole would require production to run nearly 20% above normal levels in the second half of the year. Broader shortages of semiconductors are likely to persist into 2022, which highlights the downside risks to production. The Future is ElectricThe last 16 months have reminded us how quickly things can change. The acceleration of the transition to zero-emission vehicles (ZEVs) certainly falls into the category. This year has featured new commitments by governments and producers in targeting 2035 as the likely date for new ICE vehicles to be phased out in most markets. President Biden just signed an executive order to target half of new vehicle sales in 2030 as ZEVs, and to set tougher auto emissions rules to reduce pollution. But charting the course to reach these goals is harder than announcing them. In 2020, ZEVs made up just 3.5% of new vehicle registrations in Canada. That’s a far cry from the pace required to hit 100% in 14 years. The largest barriers to adoption include higher upfront costs, a lack of charging stations, and consumer range anxiety. The economics of ZEVs are likely to improve, with larger scale manufacturing and declining battery costs predicted to bring the levelized cost of driving (LCOD, or the lifetime capital and operating costs) closer to parity with ICE vehicles by 2030. Policy interventions such as carbon taxes will also nudge the LCOD in favour of ZEVs. But matching the current gas station infrastructure with a similar charging station network will require major policy initiatives. Building up the necessary transmission lines to make that possible will also be a major endeavour in the years ahead. Factors can align quickly though, as ZEVs now represent the majority of new vehicle sales in Norway, which has set the most aggressive target for phasing out ICE vehicles. Another hurdle for ZEVs is the rising share of light trucks relative to passenger cars. Most ZEVs fall into the latter category. New models are quickly becoming available, but current regulations for corporate average fuel economy (CAFE) also lessen the incentives for replacing profitable ICE light trucks with electric ones. Since CAFE standards are based on a vehicle’s footprint, light trucks are given easier targets to hit than passenger cars, which is one of the reasons why the market has shifted toward larger vehicles in the last decade. One benefit to production, however, will be that increasing ZEV supply in North America may resolve a current issue arising under the USMCA around regional value content (RVC). Canada and Mexico believe that once core parts meet the 75% threshold for RVC, they should be rounded up to 100% in the overall calculation. The U.S. disagrees and that could see more vehicles facing the 2.5% tariff instead of qualifying under the USMCA. For models that rely on batteries made in the USMCA, the RVC will likely skew higher. Bottom Line: Supply shortages will continue to limit auto sales in the near term, but will likely abate through the latter half of 2021, allowing sales to attain pre-pandemic levels in Canada and the U.S. |