After nearly fifteen years of remarkable growth, China’s auto industry began to transition in 2017 from its high growth phase to a maturity phase of development where growth is likely to be steady but much slower in percentage terms.

From 2002 to 2016, annual sales of trucks, buses and passenger cars in China grew at double digit annual growth rates in most of the fourteen years from approximately 2 million units to over 28 million units. In 2017, the industry grew at a much slower pace of three percent. Nonetheless the large scale of China’s auto industry meant that China’s auto industry increased by almost 900,000 vehicles, even at the lower growth rate.

Apart from the unit sales numbers, 2017 saw a number of newsworthy events. In September, China announced new rules with respect to New Energy Vehicles (“NEVs”) that essentially shift the burden of subsidizing NEV development from the government to the car companies. (NEV is a term that refers to all forms of alternative fuel vehicles, but where electric vehicles (“EVs”) represent the largest segment.) In addition, there were several important strategic transactions announced late in the year that provide some hints as to the industry’s future direction.

 

Unit Sales:

According to vehicle type, 2017 sales were comprised of passenger cars 24.7 million; trucks 3.7 million; and buses 527 thousand. Within the passenger car category, SUVs accounted for 42 percent of the total, growing by a healthy 13 percent. Every other category of passenger cars—sedans, crossovers and MPVs—- registered significant declines, though, the net effect of which was to reduce growth of total passenger car sales to only 1.4 percent.

The sale of heavy duty trucks was the big winner in 2017, growing by 52 percent to 1.1 million units. Stronger enforcement of over-loading regulations; prospective changes in emissions regulations and cyclical factors all contributed to the impressive performance of the heavy duty truck sector. The sale of buses declined by three percent, hurt by crackdowns on bus subsidy abuse at the beginning of the year.

With respect to NEVs, China continued its global leadership position. Sales of NEVs increased by 53 percent to 777,000, a figure which does not include the 1.3 million low speed electric vehicles that are increasingly popular in China’s Tier 2 and Tier 3 cities. By comparison, just under 200,000 NEVs were sold last year in the United States, the world’s second largest auto market.

 

China’s NEV Playbook:

Bernstein, a leading Wall Street research firm that follows the global and Chinese auto industries closely, has coined the term “China’s EV Playbook” to describe the country’s overall approach to promoting the development of NEVs.

In 2017, China’s EV Playbook changed and began shifting the burden of developing NEVs from the government to the assemblers. Currently, China’s Central Government provides subsidies of from 20,000 to 44,000 yuan ($3,030 to $6,666) per vehicle, depending upon range, with most local governments adding from 15 to 50 percent to that amount. For an EV with a range of 250 kilometers (150 miles) or greater, government subsidies can amount to 66,000 yuan, or $10,000 per vehicle. In addition, many cities provide favorable policies such as assured issuance of a vehicle license and increased access to HOV lanes.

In September, China’s Ministry of Industry and Information Technology, which oversees the auto industry, announced a Temporary Management Regulation for Corporate Average Fuel Consumption (“CAFC”) and New-Energy Vehicle Credits. The rule change was made in the context of China’s intention to phase out its subsidy program for NEVs by 2021. The combination of credits and dis-incentives in the new proposal are designed to improve the fuel efficiency of traditional-fuel vehicles, as well as to promote the deployment of NEVs in China. China’s proposal would require automakers to produce fleets with a Corporate Average Fuel Economy of 42 miles per gallon by 2020, and 54.5 mpg by 2025.

The new rules take effect in 2019 and require local and foreign auto makers that sell 30,000 cars or more annually in China to earn points equivalent to 10 percent of the vehicles they produce and import into the country, rising to 12 percent in 2020. According to Colin McKerracher, a London-based analyst at Bloomberg New Energy Finance, 12 percent in 2020 would translate to about 4 to 5 percent of a company’s actual vehicle sales.

Once battery prices decline to the point where the price of an EV is at parity with the price of an internal combustion engine (“ICE”) car, EV sales to individuals will increase.  Until that time, however, automakers in China will be forced to lower prices and sell EVs at whatever price consumers will be willing to pay in order to comply with Chinese regulations. Failure to reach Beijing’s NEV sales targets will result in mandatory production cuts in ICE vehicle sales to bring the automaker’s total fleet sales into compliance. China is now the most important—and most profitable—auto market for the local and global assemblers. As a result, no assembler will want its China sales to be hurt by production cuts mandated by the government.

 

Other Newsworthy Events:

China’s auto industry continued to develop qualitatively in 2017. Several noteworthy transactions and announcements illustrate the future direction of the industry—an increased penetration of markets outside China, and increased investment in NEVs by industry, as well as non-industry, players.

Late last year, Zhejiang Geely Holding Group Co., which made a very successful acquisition of Volvo cars in 2010, announced that it would  buy an 8.2 percent equity stake in Swedish truck-and-bus maker Volvo AB for $3.24 billion. The investment, which includes 15.6 percent voting rights in Volvo AB, will make Geely one of the largest shareholders in a leading commercial vehicle company, building upon its success in passenger cars.

At the Detroit Auto Show in January, Guangzhou Automobile Group (“GAG”), one of China’s strongest local assemblers, announced that it plans to start selling vehicles in the United States in late 2019, an initiative that the company has been studying for some time. While GAG is receiving some pushback from US lawmakers and the Trump Administration due to the discrepancy between the 2.5 percent duty on cars imported into the United States and the 25 percent tariff on cars imported to China, it’s only a matter of time until a Chinese manufacturer penetrates the U.S. market. As illustrated by its announcement, GAG may lead this trend.

Finally, 2017 saw major investments in two new NEV startups.  Led by Tencent, one of China’s largest internet companies, NIO raised more than $1 billion in its latest fundraising round at a valuation of approximately $5 billion. In January, Xiaopeng Motors, a Chinese EV startup, announced that Alibaba Group Holding and Foxconn Technology Group have co-led a 2.2 billion yuan ($348 million) funding round for the company, marking Alibaba’s first big investment in a car maker.