Electric Vehicle Economics

Erik Johnson:

When we think of the regions of the United States, of Canada that have faced the highest costs of trade and globalization, places like Southwestern Ontario, Quebec, certainly the Rust Belt in the Midwest, in the US, those are all places that really stand to benefit substantially from this transition, and reassuring of the supply chain related to electric vehicles. We're bringing new jobs, new investment, new opportunities to places that haven't seen nearly as much growth in those sectors for a long time.

Michael Torrance:

Welcome to Sustainability Leaders. I'm Michael Torrance, chief sustainability officer with BMO Financial Group. On this show, we will talk with leading sustainability practitioners from the corporate, investor, academic, and NGO communities to explore how this rapidly evolving field of sustainability is impacting global investment business practices and our world.

Disclosure:

The views expressed here are those of the participants and not those of Bank of Montreal, its affiliates, or subsidiaries.

Michael Torrance:

Today we're speaking to BMO economist Erik Johnson on the topic of electric vehicles. Erik's focus includes coverage of the auto sector and he's been tracking the evolution of the demand and supply side of the zero-emissions vehicle market. The growth of that market will be critical to a transition towards net zero and it's a big focus of our sustainability work at BMO. Erik, thanks for joining us today.

Erik Johnson:

Thank you so much for having me, Michael. It's a pleasure to be here.

Michael Torrance:

So let's start by telling the listeners a little bit about yourself and your work, the work of the economics department at BMO, and how that relates to sustainability.

Erik Johnson:

Absolutely. In the economics department, we do a mix of things. One of them is obviously the more traditional market coverage piece of any economic shop in capital markets, but a lot of the other work we do is more on the sector and industry longer-term outlook pieces as well as some risk, and I think that's really where our coverage of ESG-related topics really line up with our department's mandate. We spend a lot of time thinking about, certainly in the automotive space, but also in whether we're thinking of minings and minerals, whether we're thinking about utilities of how decarbonization of the economy and moving a little bit more to electrification is going to have implications in the long term prospects and even some of the short and medium-term investment opportunities in those sectors.

Michael Torrance:

Zero-emission vehicles is a really great example of that transformation that's maybe mitigating some risks. You've done some really interesting analysis of that trend. There is a demand-and-supply side to that question. One of the pieces that you wrote, and I've seen a lot about this topic recently, is around almost like a tipping point idea, that the demand uptake for zero-emissions vehicles, particularly electric vehicles, is growing. It still seems low, but I guess the trajectory of how it is growing and the level of uptake that it's reached could be indicative of the pace of future growth. Are you able to elaborate on that aspect of your analysis?

Erik Johnson:

Absolutely. That's a great point, Michael. I think if we think to right now where we are in the North American context, Canada so far this year is already pushing into the mid-7% range of EV sales as a component of total new vehicle sales. The US is a little bit behind us at just closing in on almost 6.5% this year. I think it shows you that we could really be seeing quite an acceleration of adoption.

Now, I think there's two components of that that you pointed out. One is on the consumer side, right? I think the biggest change certainly so far this year is that as gasoline prices pushed certainly close to $2 a liter in Canada, well above $4 a gallon in the US at different parts of this year, I think what it highlighted to consumers is this expectation that gasoline prices would remain relatively low in North America for the foreseeable future is a little bit more up in the air. I think there's going to continue to be a lot of volatility in energy markets and I think that's creating a little bit more interest in EVs than I think they'd traditionally gotten.

On the supply side, though, I think that's really what is the big hurdle. The biggest challenge to getting an EV today is being able to go out and find one at a dealership, or to be able to order one. I think that's changing to a degree. I think what you're seeing that really reflected in is this is something that automakers just really see as an immense business opportunity. I think there's one way you can think about it is for the past decade or so, a lot of automakers have essentially been selling unprofitable lower-cost cars mostly to meet fuel economy standards. What EVs kind of provide a lot of these automakers a chance is essentially to stop selling those and instead they're going to get to sell a product that on average is sometimes selling for as much as a 20 to 30% markup on a traditional kind of internal combustion engine vehicle, so I think both of those factors are really aligning to bring that adoption curve along irrespective of what country's ambitions are on decarbonization electrification.

Michael Torrance:

Still focusing on the demand side then, just anecdotally you could see that early adopters of EV vehicles maybe were doing so for value reasons or lifestyle reasons, and you point out that now we have this environment of higher gas prices where the economics of it even at a personal level are making more sense to people. How important is that factor, do you think, for there to be wide-scale adoption of EVs? Will the economics have to continue to make sense for this to broaden out? From a pure demand perspective, what's your take on the importance of the economics behind EVs?

Erik Johnson:

Yeah, absolutely. I think subsidies have certainly been a big part of the EV adoption story. If you take Norway as the example that people often lead with, I think what you have to remember is some of the degrees of subsidies we've seen talked about, or even the ones that made it into the inflation reduction act, they're certainly significant. I think what they really are about is the big difference between buying an EV today versus buying a conventional vehicle is often on that capital cost piece, right? Anything that goes towards that capital cost side is what really can pull people even more towards that equation. It's often the scale of those subsidies that can make a big difference.

In Norway, they have about a 25% value-added tax on new vehicles and for a long period of time since made some adjustments to those credits based on the actual purchase price, but they were exempting electric vehicles from that, right, so that's quite a sizeable subsidy, and it essentially changes the economics for consumers, right? If you were going to consider buying conventional vehicle, even if that was your preference, just from a pure cost point of view, it just made way more sense to transition to buy an e-vehicle in that setting, and so I think that's certainly what you're seeing in other parts of the global economy that have brought in some tax credits as well.

I think with the Inflation Reduction Act, right, most North American policy areas couldn't really afford that kind of a subsidy, at least on the surface of 25%, but the 75 or $100 potential credit for the IRA is roughly about 15% of the cost of a new vehicle in that space, and that really does bridge most of the difference in capital cost between those vehicles.

Michael Torrance:

You've mentioned that EVs are typically more expensive than internal combustion engines, and I've heard some chatter about some of these government subsidies that they introduce the subsidy, and then the prices go up. You still though think that government support for the purchase of zero-emission vehicles or electric vehicles is going to increase the uptake of that technology?

Erik Johnson:

I mean, I would say that historical evidence largely are supportive of the view that those subsidies do make a difference on the margin. Certainly, we did see Ontario take a little bit of a hit when they got rid of their subsidy a few years ago relative to where they were positioned between BC and Quebec before, so I do think on the margin it matters. I think what is changing a little bit, so right now probably if you're going to buy a new car today, the lifetime cost of buying an EV car today are more affordable than conventional vehicle. The challenge is most Canadians, most Americans actually don't drive cars, right? I would say three-quarters of all new vehicle purchases are what you'd qualify as trucks today, and so I think that's the challenge. The economics is a little bit more in favorable depending on exactly what gas prices you want to factor into ownership costs there of conventional trucks today.

I think what's going to change, though, is by 2030, I think irrespective of exactly what subsidy you have, the economics of buying EV truck are quickly going to turn over as well in favor of EVs. It's just a question of the pace of adoption you want, right, so what subsidies are going to do are pull a little bit more of that adoption forward in time, so it depends if you want to hit some of those interim targets. In some consumer surveys, there's still a lot of concern and question among households of exactly what are the economics and what are some of the costs associated with having EV. I think people are still quite concerned that the maintenance costs of having an EV might be more on par with what you'd expect with a traditional vehicle today and that's generally not the case. Most of the difference in cost is all in the purchase price as opposed to the operation.

Michael Torrance:

Yeah, that's one of the things that I find amazing about the EV product is that there are such lower maintenance costs, and that must be changing the whole business model of auto dealers. I think one of your papers noted that there was a few years ago, two models basically on the market of zero-emission vehicles, and now there's 62. How are auto dealers and manufacturers thinking about this market? What do you think is their rationale and their view on the economics from their perspective?

Erik Johnson:

Yeah, I mean, I think you can obviously speculate, but I think a big thing for them is just seeing some of the comments that people like the head of Ford, like Jim Farley have just said, right? I think they look at the differences of margins between more of the traditional automakers and Tesla. I think last year there were some comparisons where Tesla was basically having margins roughly five times what Ford had over the same period of time and so I think for them it's really this huge business case as a chance to hit reset a little bit.

I think what a lot of makers have seen over the past two years is that in a market where supply has been really challenged and unit prices have been very high, it's just a lot easier to manage your margins and exist in that space than it has been in the more traditional one where there's quite an oversupply of vehicles and you need to bring in a lot of incentives to clear out inventory from month to month.

I think a lot of automakers are also maybe seeing the opportunity to have a little bit more scale in the dealership network. GM is already committed to the idea that California's 2035 standard for fully phasing out conventional vehicles perfectly lines up with their business model 'cause I think what they're seeing, right, is that it makes a lot more sense to be producing vehicles that have higher margins, and you actually get to sell at a profit as opposed to what they have been doing for a long time, which is mostly selling trucks, which they make money on, and cars to meet their efficiency standards that they're constantly losing dollars on.

Michael Torrance:

There's also challenges that are pretty evident in terms of wide-scale adoption of EVs. A couple of things that come to mind, one would be EV-charging infrastructure, or if it's a hydrogen vehicle, having the infrastructure to refuel, the supply chain challenges. I mean, if you want to get an EV now, you're on a waiting list for a long time, 12 to 18 months sometimes. What are your thoughts about those challenges and how they could be overcome, what it means for the viability of the EV market?

Erik Johnson:

Yeah, I mean, I think, listen, there are some absolutely real challenges to adoption in this space. I think as we've talked before, I think consumer information, consumer knowledge is certainly one of those things, and I think that's something that will change a little bit as more and more people kind of get experience with EVs. A lot of people have actually never sat in an EV before and never seen one operate, and so I think as they enter the market more, a lot more people will develop a little bit more comfort with the product, so I think that's one piece of it.

I think on the charging infrastructures side, in Canada, we have roughly 7,000 electrical chargers spread across that country today. Only about 1300 of those would be so fast chargers, so to speak. If you compare that kind of our network of gas stations, right, we have 18,000 gas stations or so, and so I think what it says is we're still ways away from having the kind of infrastructure to right-size what that we want that market to look like five years down the road, 10 years down the road, 20 years down the road. I think that what that speaks to is if you want to have your light-duty vehicle fleet kind of meet your climate ambitions, you need to start planning today and you need to start making investments today.

There are some other challenges to adoptions from an emission-reduction point of view, right? I think what we often forget a little bit about is that we don't just have one electricity market in North America, or certainly in Canada, the United States, we have a whole bunch of them, and so in some markets if we really want to be focused on decarbonization, we need to start making not just investments on the, I would say the generation side, but a lot of transmission to change the way that we think about our energy grid today to bring a lot more clean energy to parts of the country that have a little bit more fossil-fuel-intensive grid 'cause I think at the end of the day, if you are shifting to EVs, you want to be shifting the primary energy to supply to more renewable sources as well, and so I think that is going to be another challenge.

Michael Torrance:

Yeah, I mean it's a fair criticism of the move to EVs if we are charging vehicles using unclean sources of electricity, so it's definitely going to have to be something that changes in tandem if the actual emissions challenges is going to be addressed. You've mentioned a couple of times some of the legislation that's been put forward and recently passed that relates to this market, one being the Inflation Reduction Act in the US. Can you unpack that a little bit?

Erik Johnson:

For a long time, I think there's been this huge back and forth in the US of whether we would ever see some of the climate change components of the original Build Back Better bill ever make it into legislation in the United States. I think the Inflation Reduction Act maintained a lot of those exciting aspects and I think in particular the ones that relate to electric vehicles as well. I think the biggest difference in the US context is you didn't really have kind of a federal credit that met the kind of ambition that the Biden administration had set forth to bring emissions down by 2030.

I think what was really exciting about this is that for one, they've taken off the cap of what it used to be is once you sold kind of 200,000 vehicles essentially as a fleet, then your cars were no longer eligible for the credit, so I think that's one of the exciting changes. That means at least some of the more lower-priced Tesla models will now once again be eligible for EV credits, which is certainly a huge piece of that adoption puzzle.

The big thing for a consumer is now if you buy an eligible vehicle, you're potentially going to get roughly $7500 back, and so the second piece of that is from the context of the North American supply chain and automotive sector in particular, that's going to drive just a dramatic amount of investment just in mining materials manufacturing because a lot of our supply chain isn't quite up to scale to meet maybe our 2035 and our 2030 electric vehicle production goals if we're going to hit those targets.

Now, I think there's lots of questions about exactly from an individual consumer point of view what is going to qualify because I think today certainly when we're thinking of things like cobalt, or a lot of other battery components, it's sometimes a little bit more opaque exactly where those are coming from, and so I think there is going to be a little bit of a learning process to think exactly what models are going to qualify. If you were at all leaning towards getting an electric vehicle today, I think this is really going to push you over the threshold of making a lot more feasible just from an economics point of view.

Michael Torrance:

What about the Canadian policy context? You mentioned the Canadian Emissions Reduction Plan and Act. There's provincial initiatives. What's the playing field for EVs in Canada and how does it relate to the US?

Erik Johnson:

We also had an update or an extension of our federal subsidy for EVs. Now, I will say it's still a little bit below where the Inflation Reduction Act hits, so I think it does suggest if Canada wants to meet that same ambition that the United States is laying forth here, we might want to rethink a little bit of the subsidies we're providing through that program. Some provinces, Ontario in particular, don't currently have an EV credit like other province, certainly BC, Quebec, and many others, and so I think that's one piece of it.

I think a lot of the discussion and potential investments on our critical mineral strategy really plays well with the inflation Reduction Act, friend-shoring, or this idea that a lot of the battery components, a lot of the critical material components are going to have to be sourced from trade-friendly partners for the United States, Canada really stands to benefit from that, so I think those provisions of our Missions Reduction Act really line up well, and set a lot of industries in Canada up for success if they want to be a part of this transition.

Michael Torrance:

Some might say that EVs are luxury goods that they've historically been quite expensive, that's changing over time. There's more supply, as we've discussed. But what's your take on how these kind of government initiatives and the push towards zero-emission vehicles is consistent with the different needs of society from lower-income to higher-income segments?

Erik Johnson:

The distributional aspect of this question is a really important one. I think what has changed quite dramatically in the past two years is new vehicle prices have just continued to ramp up, where for a lot of households, the price point has just put them out of reach, so to speak, of being able to participate in the market, so I think for one aspect, making sure that we have some means testing for these things makes a lot of sense 'cause again, it seems a little bit unfair for someone to go buy a hundred or $150,000 electric vehicle and then have the taxpayer partially subsidize that purchase when if someone's purchasing a vehicle of that price, then they have the means to do so on their own.

I think the second piece of it is just providing more incentives for automakers to make more mass-market lower price point. If this is going to be a strategy that's going to both be a good business opportunity for everyone, but also to have a meaningful step in reducing our carbon emissions, then these vehicles have to be available and affordable for everyone.

Michael Torrance:

What do you think this means for the North American economy? US and Canada, car manufacturing is obviously a big part of our economy, but it strikes me that there's a whole supply chain and ecosystem around the manufacturing of EVs that we also could be supporting. What do you think this will mean for economic development?

Erik Johnson:

I think in the automotive space, in the minerals and mining space, I think in the utility space as well, just from a CapEx point of view, these industries are going to see way more inflows than they've seen in the past several decades of just more funds and more growth coming from these sectors that have struggled certainly over the past two decades as globalization has certainly pushed a lot of activity abroad as opposed to onshoring it, and so I think that's certainly an exciting piece on the macro side.

Then I think more from an equity and a social point of view, when we think of the regions of the United States of Canada that have faced the highest costs of trade and globalization, places like Southwestern Ontario, Quebec, certainly the Rust Belt in the Midwest, in the US, those are all places that really stand to benefit substantially from this transition and reimagining and reassuring of the supply chain related to electric vehicles. We're bringing new jobs, new investment, new opportunities to places that haven't seen as nearly as much growth in those sectors for a long time.

Michael Torrance:

Just as a final thought for the audience, if you were speaking to a room of CEOs and investors, what would be your key takeaways on things to watch related to the growth of the zero-emission vehicle market?

Erik Johnson:

Yeah, so I mean I think it really comes back down to the supply chain piece of it, right? If we want to make this dream a reality, then it means that we have to start investing today, being able to have those mineral capacities to produce vehicles at scale. I think that's one sector that I think is really worth watching, but just from a business opportunity point of view, whether you operate in the utility space, whether you're operating in mining, whether you're operating in manufacturing, I think what this speaks to is there's going to be a lot of opportunity for finance opportunities to these industries, but also partnering with governments a little bit more to kind of de-risk a lot of the innovation that's going to be required in these sectors. I think what I would be focused on is just making sure I have a pulse on where a lot of these sectors are going.

I think another big piece of it is also just going to be in recycling. I think as we transition our supply chain to produce a lot of these minerals in a more sustainable, environmentally-friendly way, I think it's going to certainly benefit a lot of North American businesses as well if they're able to find ways to use materials more efficiently, recycle battery materials. I think everyone should be focused on if they want to take part of the advantages of this potential growth.

Michael Torrance:

Well, thanks very much, Erik, for your time. It was a very interesting conversation.

Erik Johnson:

Thank you so much for having me, Michael.

Michael Torrance:

Thanks for listening to Sustainability Leaders. This podcast is presented by BMO Financial Group. To access all the resources we discussed in today's episode and to see our other podcasts, visit us at bmo.com/sustainabilityleaders. You can listen and subscribe free to our show on Apple Podcasts or your favorite podcast provider and will greatly appreciate a rating and review and any feedback that you might have. Our show and resources are produced with support from BMO's marketing team and Puddle Creative. Until next time, I'm Michael Torrance. Have a great week.

Disclosure:

The views expressed here are those of the participants and not those at Bank of Montreal, its affiliates, or subsidiaries. This is not intended to serve as a complete analysis of every material fact regarding any company, industry, strategy, or security. This presentation may contain forward-looking statements. Investors are caution not to place undue reliance on such statements as actual results could vary. This presentation is for general information purposes only and does not constitute investment, legal, or tax advice, and is not intended as an endorsement of any specific investment, product, or service. Individual investors should consult with an investment tax and/or legal professional about their personal situation. Past performance is not indicative of future results.