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Feebates – Trends

DEVELOPMENT OF OPTIONS FOR A VEHICLE FEEBATE IN CANADA

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2. MARKET AND SECTOR TRENDS

2.1 SECTOR TRENDS

The automotive sector is Canada’s largest industrial trading sector, with a volume of over $160 billion in 2004. According to Statistics Canada, about 40,000 firms are involved with manufacturing, selling and repairing vehicles and the sector directly employs over 400,000 Canadians (not including aftermarket parts, repairs, or fuel stations), including:

• Vehicle manufacturing: 80,000
• Parts, accessories, body & trailer: 160,000
• Dealers, distribution and leasing: 180,000

Manufacturers produce 50 percent more vehicles in Canada than are sold here. Most of the vehicles produced in Canada are exported, and most of the vehicles purchased in Canada are imported. Overall, Canada’s vehicle production has stabilized at 2.7 million units, down from the peak of 3.1 million units in 1999. Overall vehicle sales in North America are now reaching 20 million per year, with Canadian sales of approximately 1.5 million. See Figures 2.1 and 2.2. The Canadian auto sector is currently facing a number of difficult challenges, including:

• Low Prices. Statistics Canada’s New Vehicle Price Index has been negative for the last five years; used vehicle prices are also falling, and the original equipment parts sector prices have been decreasing for most of the last decade. See Figure 2.3.
• Rising Costs. Some prices and costs affecting the industry have been rising, including material and labour costs, taxes and fees.
• Poor Profitability. Price deflation is affecting profitability for suppliers, vehicle manufacturers, and dealers. The market has been artificially inflated with incentives; the ability of manufacturers to maintain these incentives is questionable given the profit margins. Although a ‘soft’ landing is possible, significant price increases could have a significant negative impact on demand.
• Excess Supply. At the root of the problem is the excess supply of light-vehicle capacity in the global auto sector, especially in North America.

Given the political and socio-economic issues around reducing plant capacity, the problem of excess supply is likely to get worse before it gets better, and may not be resolved without significant restructuring. Lean pricing will be difficult to resolve in the short term and thus the profit outlook is very poor. That said, consumers benefit through continued low pricing. Although these problems affect all manufacturers, import name plates have responded more successfully and, as a result, have gained significant market share. These manufacturers also represent an increasing share of North American and Canadian manufacturing. Unfortunately, because import name plates use a smaller percentage of North American and Canadian parts, the overall impact is to reduce overall economic activity and employment. Figure 2.1: Total North American Vehicle Sales, 1960 – 2010F Source: DesRosiers Automotive Consultants, Ward's Automotive, CVMA, AIAMC Figure 2.2: Total Canadian Vehicle Sales, 1960 – 2010F Source: DesRosiers Automotive Consultants, Ward's Automotive, CVMA, AIAMC Figure 2.3: Canadian Nominal Price Changes – Purchasing & Leasing of New Vehicles Source: Statistics Canada

2.2 MARKET COMPARISONS AND TRENDS

The most relevant comparisons and trends that are relevant to this study are as follows.

• Ownership of vehicles is low and relatively stable. Canadian vehicle ownership is one third lower than in the US and has not changed substantially in over 30 years. As a result, the primary driver of growth in vehicle sales is population growth.
• Canadians purchase more environmentally-friendly vehicles than Americans. Although the distinction between vehicle segments is increasingly arbitrary, there are some significant observations to be made about Canadian preferences. (See Table 2.1.)Trucks as a percentage of new vehicle sales increased substantially until 1995 but have shown no growth over the last decade.
• The market is moving away from mid-sized family vehicles; the majority of consumers are moving downmarket although some are moving upmarket.
• Smaller vehicles are much more popular in Canada than in the US.
• Subcompact and compact light vehicles represent about 40 percent of the Canadian market but only 22 percent of the US market.Fleet buyers are a major source of demand for larger vehicles.
• Luxury vehicles and large/luxury/sport utility vehicles are much less popular in Canada.

 

• Large/luxury/sport market share is less than half the size in Canada.
• Canadian consumers are downsizing while US consumers are upsizing.Diesel sales, although a small percentage of the market, are much more significant in the Canadian market than in the US market.
• Hybrid share is a little lower in Canada, but is currently supply constrained and affected by higher diesel share.

Table 2.1: Light Vehicle Sales by Segment – 2004 Calendar Year

	UNITED STATES		CANADA
	Units	Share	Units	Share
Passenger Cars
Subcompact	255,671	1.5%	79,651	5.2%
Compact	1,932,530	11.5%	388,123	25.3%
Sport	385,503	2.3%	28,491	1.9%
Luxury	752,409	4.5%	54,933	3.6%
Intermediate	3,396,510	20.1%	240,317	15.7%
Luxury High	573,280	3.4%	20,380	1.3%
Luxury Sport	224,297	1.3%	8,204	0.5%
Total Passenger Car	7,520,200	44.6%	820,099	53.4%
Light Trucks
Compact Sport Utility	1,098,420	6.5%	115,337	7.5%
Intermediate Sport Utility	1,777,889	10.5%	87,781	5.7%
Large Sport Utility	1,059,539	6.3%	18,930	1.2%
Luxury Sport Utility	787,152	4.7%	39,832	2.6%
Small Pickup	555,524	3.3%	26,511	1.7%
Large Pickup	2,604,271	15.4%	212,805	13.9%
Small Van	1,110,817	6.6%	184,614	12.0%
Large Van	346,761	2.1%	28,506	1.9%
Total Light Truck	9,340,373	55.4%	714,316	46.6%

Source: DesRosiers Automotive Consultants, Ward's Automotive, CVMA, AIAMC • Both Canadians and Americans purchase less fuel-efficient vehicles than other countries. Table 2.2 lists the average light-duty vehicle fuel consumption for selected countries. Table 2.2: Comparison of Average Light-Duty Vehicle Fuel Consumption (2002)

Country/Region	Average Fuel Consumption (l/100km)
United States	9.8
Canada	9.2
Australia	8.1
China	8.0
European Union	6.3
Japan	5.1

Source: Pew Center on Global Climate Change

• There are significant regional differences in Canadian purchasing preferences. Some of the key differences are as follows.

 

• Consumers in Quebec and the Atlantic provinces tend to buy smaller and cheaper vehicles.
• Ontario has high family vehicle and large/luxury/sport segments.
• The Prairies have the largest commercial use penetration. Primarily pickup trucks
• Twice the national average in Saskatchewan and Alberta
• BC has a large high-end market and commercial-use market. Largest penetration of large/luxury/sport vehicles

Consumer demand is shifting towards the import name plates. Since 1997, the three largest manufacturers—GM, Ford and DCX—have seen their market share decline from 73.2 percent to 56.5 percent. See Figure 2.4. Figure 2.4: Manufacturer’s Share of Canadian Light-Duty Vehicle Market Source: DesRosiers Automotive Consultants Consumers expect and are getting vehicles with improved durability. Improved durability means longer ownership. As a result, today’s vehicles will last over 300,000 km versus 150,000 km in the 1960s. One of the consequences of this durability is that older and less environmentally friendly technology remains in the vehicle stock for a longer period, and that environmental performance has a longer time to degrade. Consumers shift readily between the new and used vehicle markets depending on pricing. In 2004, 60 percent of the 3.8 million vehicles purchased were used vehicles. Although most of these originated in Canada, consumers also have access to the extremely large US market. The import/export of used vehicles depends on price differentials which vary by segment and are exchange-sensitive. Consumer choice is driven primarily by purchase price, value, reliability and styling. Consumers consistently rank ‘price/cost to buy’ as the single most important reason for their choice of brand and ‘value for money’ near the top, by far outweighing all other market factors. (See Table 2.3.) When all purchase reasons are added together, reliability/dependability combined with styling rank at the top. In comparison, consumers rank ‘fuel economy’ and ‘safety features’ in the middle of the pack as reasons for purchasing their new vehicle, indicating they do not attach much value to fuel savings. Recent US studies also back this conclusion. Furthermore, consumers rank ‘environmentally friendly’ last of 21 factors in new-vehicle purchase. Table 2.3: Important Factors in Choice of New Vehicles – 2002

#1 Most Important Reason For Choice
1	Price/Cost to Buy	4,131
2	Reliability/Dependability	2,879
3	Exterior Styling	2,840
4	Value For The Money	2,564
5	Interior Comfort	2,461
6	No Answer	2,324
7	Manufacturer's Reputation	1,731
8	Fun To Drive	1,525
9	Storage & Cargo Capacity	1,311
10	Quality of Workmanship	1,275
11	Fuel Economy	1,237
12	Engine Performance	1,056
13	Safety Features	1,010
14	Road-holding/Handling capabilities	955
15	Ride Quality On Highway	699
16	Durability/Long Lasting	594
17	Future Trade-In Or Resale Value	483
18	Rebate/Incentive	415
19	Length of Warranty	244
20	Discount/Value Package	183
21	Environmentally Friendly Vehicle	37
Unweighted Sample Total Count		29,954

Source: Maritz Canada Inc.

2.3 ON-ROAD FUEL CONSUMPTION AND GHG EMISSIONS

Figure 2.5 shows the improvement in car fuel consumption over the period 1979–2003. Since 1990, consumption has improved by approximately 5 percent but, as shown in the chart, it would have improved substantially more if not for offsetting changes in horsepower and weight, and for a shift from cars to trucks in the early 1990s. Figure 2.5: Performance of Light-Duty Vehicles Source: Natural Resources Canada, Office of Energy Efficiency As far as GHG emissions are concerned, the improvements in vehicle fuel efficiency have been negated by the increasing number of vehicles and longer distances travelled. According to NRCan, on-road emissions from the automotive sector represents almost 90 Mt, or more than 12 percent of Canada’s total GHG emissions. Further, these emissions have increased by more than 17 percent since 1990, led by an increase of more than 50 percent from light trucks. Figure 2.6 provides a breakdown of Transportation Sector Emissions while Figure 2.7 indicates the trajectory of emissions. Figure 2.6: Automotive Share of Transportation GHG Emissions Source: Canada's 2003 GHG Inventory Figure 2.7: GHG Emissions from Light-Duty Vehicles (Mt) Source: NRCan – Energy Use Data Handbook, June 2005

2.4 TECHNOLOGY OPPORTUNITIES

In the automotive sector, technology usually filters downwards through product lines, often starting with more expensive vehicles before becoming widely available on mass-production models. This can justify the production of low-volume, top-end models (with higher potential fuel consumption) which act as technological test beds for the industry. (An example is the Audi A8 and its use of aluminum spaceframe technology.) It can easily take seven to ten years for advanced technologies to become widely available across the new vehicle market, and some never become widely available. Thus, more elaborate/exotic fuel consumption reduction technologies such as gasoline direct injection, camless valve actuation, and full hybrid-electric systems may take many years to influence the fuel economy of the entire market. Table 2.4 provides a breakdown of the anticipated availability of key fuel consumption technologies. Table 2.4: Current and Future Fuel Economy Related Technology, Ranked by Availability

Currently Available	Limited Availability with Upside Potential	Low Availability, Cost Prohibitive
- Friction Reduction - 4Valve - Improved Accessories - 5W-20 Oil - Drag Reduction - Material Substitution - Improved Tires - Early Lock Up - Aggressive Shift Logic - Variable Valve Timing (VVT) - Electric Power Steering - Turbocharging - 6-Speed Automatic - Continuously Variable Transmission (CVT) - Mild Hybrid	- Cylinder Cut - VVT Dual - Variable Valve Lift (VVL) Continuous - Automated Manual - Direct Injection - Idle Cut	- VVL – Discrete - Camless Valve - 42V Electrical

Source for Ranking: DesRosiers Automotive Consultants It should be noted that many cost-effective technologies have already been widely adopted to deliver fuel consumption benefits and that some of the most advanced technology on the horizon will be very expensive to implement and very difficult to service. Nevertheless, a range of lower-end technologies have good potential to deliver cost-effective improvements and some other technologies have the potential to become cost-effective with additional research and development (R&D). A study commissioned by Transport Canada and conducted by Energy and Environmental Analysis Inc. (EEA) using various published studies has developed a list of technologies available in the short to medium term, and associated fuel consumption improvements and costs, for each car segment and for domestic and import vehicles. Table 2.5 provides an example for domestic small cars. Table 2.5: Domestic Small Car Technology Cost Curve

Technology Type	Fuel Economy Improvement (%)	Cost (C$)	Cost Effectiveness (C$/FE%)
4 VALVE	0.0	0	S.O.
CYLINDER CUT	0.0	0	S.O.
6-SPD AUTO	0.0	0	S.O.
AUTOMATED MANUAL	2.0	3	1.6
EARLY LOCK UP	0.5	6	13.0
5W-20 OIL	1.0	16	15.6
AGG. SHIFT LOGIC	2.0	39	19.5
IMPROVED TIRES	2.0	52	26.0
CVT	3.9	110	28.2
ELEC POWER STRNG.	2.0	59	29,3
FRIC. REDUCTION I	1.5	46	30.3
VVT	2.0	65	32.5
VVL-DISCRETE	5.0	195	39.0
FRIC/ REDUCTION II	1.5	59	39.0
VVL CONTINUOUS	3.0	124	41.2
MATERIAL SUB.	3.3	137	41.4
DIRECT INJECTION	3.5	163	46.4
DRAG REDUCTION	1.7	85	49.7
VVT DUAL	1.0	65	65.0
IMPROVED ACCESSORIES	1.0	73	72.8
TURBO	7.5	585	78.0
CAMLESS VALVE	3.0	306	101.8
42V W/IDLE CUT	4.5	910	202.2
MILD HYBRID	3.0	650	216.7

Source: Energy and Environmental Analysis Inc. The opportunities to introduce new technologies will depend not only on the availability of the technology, but also on the timing of vehicle redesigns, and whether or not the market is large enough to justify the investment. Redesign of vehicle models is influenced by many external variables, including the market environment, political environment, and individual manufacturer direction, and is therefore subject to a lot of uncertainty. Notwithstanding this uncertainty, it is anticipated that 75 percent of vehicles will see a retrofit opportunity in the next 3 years, and that most remaining vehicles will see another opportunity within the next 10 years. Redesign thresholds depend on the type and cost of the technology and the value of the vehicle. Typically, manufacturers would not consider significant technology investments solely for the Canadian market. Instead, manufacturers would typically search other markets for replacement vehicles, recognizing that some models may not be suitable. (For example, Japan has vehicles that have unsuitable engines and right-side drive.) Nevertheless, if the Canadian demand was large enough, some investments might be considered. EEA has attempted to quantify the necessary sales demand for both domestic vehicles and imports that would trigger these new investments, and has proposed two sales thresholds: Imports - 2000 vehicles GM, Ford, DCX - 20,000 vehicles The lower threshold for imports reflects the potential availability of suitable vehicles in other markets that would only need minor redesign in order to be certified for the Canadian market. Beyond the conventional technologies listed in Table 2.4, two other technology options are important in terms of their impact on fuel consumption. Diesel Technology Diesel engines have to the potential to improve fuel economy by 25–30 percent. The technology is not new—there are currently more than 500,000 diesel light vehicles on the road in Canada—and has been proven to be profitable in Europe, but until recently the market penetration of diesels in Canada was limited by a number of barriers. These recent developments have improved the outlook for diesels: Improved clean-diesel technology has addressed the noise and odour issues traditionally associated with diesel. Diesel fuel availability has increased significantly across Canada. Government-mandated ultra-low sulphur diesel fuel will enter the market in January 2006, allowing vehicles to meet the stringent Tier 2 emission standards mandated by US and Canadian regulations. Although the ability to meet future emission standards and still be profitable is still somewhat uncertain, the penetration of diesel technology is expected to increase across all segments of the market. In the US, estimates of this penetration by 2012 range from 4–7 percent to 7.5 percent. , Market penetration in Canada could be even higher since it is already three times greater than in the US and diesel technology has traditionally been more attractive to Canadian consumers. Hybrid Technology Hybrid engines have the potential to improve fuel economy by 35–40 percent. There are currently approximately 5000 hybrid vehicles on the road in Canada. However, hybrids are rapidly becoming more widely available (for example, Toyota Prius and Highlander; Lexus RX400h; Honda Civic, Accord, and Insight; Ford Escape Hybrid) with more models coming soon. At present, the cost–benefit ratio still very uncertain for consumers; however, as economies of scale increase, the costs of hybrid technology will be reduced, making these models more accessible. In the US, estimates of hybrid market penetration by 2012 range from 3.5 percent to 10–15 percent. For manufacturers the future profitability of hybrids is still unclear. Availability of both hybrids and diesels has been an issue, but this constraint is likely to be overcome in the next few years as manufacturers invest heavily in new capacity.

2.5 POLICY ISSUES

Manufacturing There is no explicit government automotive sector strategy for Canada. However, the Canadian Automotive Partnership Council (CAPC) involves governments in seeking to encourage investment. A key mandate of the CAPC is to maintain regulatory harmonization with the US. Both the federal and Ontario governments have sought to attract additional investment in vehicle manufacturing, and have offered financial incentives on a case-by-case basis. The attractiveness of Canada is also based on productivity of the workforce, public health care and a variety of other factors. Products Since most vehicles manufactured in Canada are exported (over 85 percent) and most vehicles sold in Canada are imported (over 75 percent), in theory the policy environment for vehicles should not affect manufacturing decisions. However, it is reasonable to assume that perceptions of market negativity could affect manufacturer investment decisions. Key policies affecting the design and sales of vehicles include: safety regulations, air emission standards, and the 2005 MOU between the Canadian Automotive Industry and the Government of Canada Respecting Automobile GHG Emissions. Because of its importance, the MOU is covered separately in Section 2.6. Safety. A variety of regulations exists for safety. In some cases regulations in Canada are different from regulations in the US. Air Emissions. Air emissions are governed by the On-Road Vehicle and Engine Emission Regulations. These regulations, which are aligned with the US Environmental Protection Agency (EPA) Tier 2 standards, came into force in 2003 and are being phased in over a number of years. The regulations will require reductions of approximately 90 percent in smog precursors (NOx, VOCs, particulates, and others). The same rules will apply to cars and trucks, as well as to gasoline and diesel vehicles. 2.6 MOU RESPECTING AUTOMOBILE GHG EMISSIONS The 2005 MOU between the Canadian automotive industry and the Government of Canada voluntarily commits the industry to achieving a 5.3 Mt reduction in GHG emissions from the light-duty vehicle sector in 2010 relative to the reference case. The reference is to be adjusted for changes in vehicle sales and sales mix, scrappage of vehicles, and annual kilometres traveled. The MOU targets are aggressive and there is a degree of uncertainty as to how the vehicle companies will achieve their commitments. The burden is alleviated somewhat by the potential to claim fuel consumption progress made beyond Company Average Fuel Consumption (CAFC) requirements since 2000. (Because of the cumulative nature of these gains, these will make a significant contribution.) The industry is expected to adopt a strategy that is approximately 75 percent based on technology and 25 percent based on shifts between market segments. Diesel, hybrid, and many ancillary technologies will probably be used in high-volume segments and additional vehicles from emissions-conscious overseas markets will be introduced—for example, Honda Fit. The industry is not relying on market shifts between companies, but there will likely be a move away from less fuel-efficient products designed for the traditionally less fuel-conscious US market and towards vehicles designed for more fuel-conscious global markets. Since the agreement is voluntary, the Government retains the right to regulate GHG emissions and the industry retains the right to terminate the MOU if regulations are implemented. In this context, regulation was primarily meant to refer to fuel consumption standards, but a feebate system would require a new set of regulations, and these could be interpreted by industry as a regulatory measure. The industry has not taken an official position on a feebate system relative to the MOU.