Rumble Seat: Frankfurt 2017: China, EVs, and Dieselgate -- WSJ

This article is being republished as part of our daily reproduction of articles that also appeared in the U.S. print edition of The Wall Street Journal (September 23, 2017).

Two weeks ago (Sept. 11), the night before the IAA Frankfurt International Motor Show opened to the press, I strolled through the doors of Daimler Mercedes-Benz' vast, lighter-than-air pavilion thinking I knew the story. I even had a headline: Daimler AG's Stuck Throttle.

The oldest of the German automaking giants, Daimler's recent financials have rocked. Group revenue was up 3% (153.3 billion euro) in 2016, with record profits (8.8 billion). Mercedes-Benz Cars in particular has come roaring back to retake the title of world's number-one premium luxury brand. Sales were up 9% in Q2 2017 alone. Product design is killing it.

Even the Formula One team is winning. Lounging on stage, an Amazonian creature in a windswept carbon-fiber negligee: the Mercedes-AMG Project ONE, a street-legal hypercar built around the +1,000-hp hybrid powertrain of a Formula One car. Each of 275 copies costs $2.7 million euros. The engine revs to over 11 grand. That should be lively.

But Daimler's solemn commitment to eternally high returns, what it calls a "sustainable" 10% net profit to shareholders, means it can't let off the throttle, ever. And it's heading for a wall. A Great Wall. In China.

See? I even had catchy phrases at the ready.

Two days before Daimler's pep rally, on Sept. 9, industry ministers in China confirmed that, like France, the U.K., Norway and the Netherlands, the world's largest vehicle market (24.4 million in 2016) would phase out fossil-fuel vehicle sales in favor of widespread, state-sponsored vehicle electrification.

Because of climate change? Sort of, sure. But with its cities shrouded with deadly tailpipe smog, China's air-quality concerns are more regional than global. The nation of 1.37 billion souls is also trying to kick the imported-oil habit. China has already outlined tough electrification mandates for automakers, with costly penalties behind them, that have left the German automakers crying for mercy. With German Chancellor Angela Merkel's help, they got the start date pushed back to 2019.

Though not unexpected, China's announcement brings two things to the EV battery industry it sorely needs: certainty of demand (albeit compulsory) and scale. Global battery production is expected to double in the next five years. As down-payment on its plan to lead the world in energy storage devices, China will add 120 gigawatt-hours of annual battery production capacity by 2021. That's three times the output of Tesla's Gigafactory. VW Group board member for research and development Ulrich Eichhorn told Automotive News the company will need more than 200 gigawatt-hours worth of batteries by 2025 to meet its goals.

Now sooner than later, China's mandates will push the market price of batteries below the $100/kWh threshold at which -- thereabouts, all things equal -- an EV design attains cost-parity with an internal-combustion vehicle. After that, Katy bar the door.

The other skunk at Daimler's picnic was Dieselgate. Two years after clean-air investigators discovered emissions-cheating software in VW Group products, affecting 11 million vehicles world-wide, the scandal and public ire has become general. In remarks from the stage, Daimler AG chairman Dr. Dieter Zetsche pushed back on growing sentiment in Europe to restrict diesel vehicles if not ban them altogether. "It's a fact that it's worthwhile to improve modern diesel engines rather than to ban them," Mr. Zetsche said. "That is why Daimler has invested 3 billion euros in the further development of our diesel engines."

With respect, that is a bit post-hoc: It's the 3 billion euros already spent that makes it worthwhile, not the other way around. Even the Project ONE raised an eyebrow.

In any event, Mr. Zetsche will have to take it up with the people and parliaments of Europe. In two years, diesel's market share has fallen by 8%. In the home court of Germany, sales fell 14% in August from 2016. Madrid, Paris, and Athens have announced diesel bans to combat urban concentrations of NOx and particulates, coming fully into force by 2025. Even Daimler's hometown of Stuttgart wants to brush the city's famous soot from its shoulders.

It's worse that it looks. In Western Europe the carmakers depend on the profits from large luxury vehicles, many with diesel engines, which produce less carbon per kilometer than gasoline equivalents. Without diesel's carbon offset, automakers have no hope of meeting the European Union's fleet-average standards (95 grams per kilometer by 2021) or avoiding hefty pollution fines, Brussels' bill for noncompliance.

The theme of Mercedes-Benz' media gala was #settingthemood; but everywhere I looked I saw #sunkcostfallacy, the human tendency to double-down on bad bets, for fear of losing what economists call sunk costs. But sunk costs are not recoverable in any case, thus the fallacy.

It's hard knowing when to walk away. But walk away. Diesel is politically doomed in Europe. China's electrification mandates represent a whole new industrial super-gravity. Given these events, and rising public sanction, Mr. Zetsche, how long can the German car industry afford to hang on to diesel? Long enough to recover sunk costs? Oh dear.

Anyway, even that wasn't the big story, the real story. Did you see those heels F1 driver Lewis Hamilton was wearing? G'wan, mate.

Corrections & Amplifications An incorrect version of this piece was initially published online. Madrid, Paris, and Athens have announced diesel bans to combat urban concentrations of NOx and particulates coming fully into force by 2025. An earlier version stated the year was 2015. Daim is the oldest of the German automaking giants; an earlier version said it was the oldest and biggest. Ulrich Eichhorn told Automotive News VW Group will need more than 200 gigawatt-hours worth of batteries by 2025 to meet its goals; an earlier version said it will need 200 gigawatt-hours. Clean-air investigators discovered emissions-cheating software in VW Group products, affecting 11 million vehicles world-wide; an earlier version said "more than" 11 million. Also, the Audi Aicon concept lacks a steering wheel, foot pedals or other basic cabin landmarks. A previous version of the slideshow included an image of the Audi Elaine concept, misidentified as the Audi Aicon. The image has been removed. (September 22).

(END) Dow Jones Newswires

September 23, 2017 02:47 ET (06:47 GMT)