Investment Thesis

Through a combination of emission regulations, growth in renewable energy initiatives, buyer incentives and pure economics, EV penetration in Europe is imminent. OEMs are planning ahead, no more so that Volkswagen (OTCPK:VWAGY) (OTCPK:VLKAF). Europe has correctly identified risks along the supply chain and the need for regional integration of the production process. VW has publicly stated its medium-term goal is to support lithium projects in Central and Southern Europe. There are very few economically viable projects in the region, leaving investors with a short list of listed equities to choose from.

Overview

The stringent new 2020 EU CO2 emission standards (95g per kilometre) are paving the way for the meteoric rise of electric vehicles (EVs) in the future. To meet the new standards, European OEMs will likely need to incorporate EV models in the form of full electric or hybrids. To incentivize this switch, many EU governments subsidize the purchase of energy efficient vehicles. News articles suggest that Germany is considering doubling subsidies for lower cost (EUR30,000 or less) EVs and raising subsidies for the balance (up to EUR60,000) to EUR2,500, up from EUR2,000. Potential fines for breaching the EU emission standards are severe, so much so that Fiat Chrysler (FCAU) plans to pool its fleet with Tesla (TSLA) to avoid fines as high as US$2.2bn in 2021 and 2022.

The transition to EV platforms isn’t cheap for OEMs, and whilst battery pack prices are falling, Bloomberg NEF suggests upfront price parity for large vehicles will only be reached in Europe around 2022. In anticipation of future consumer demand, OEMs are having to commit capital upfront to adjust to the changes in the supply chain and car assembly. Typical OEM new model redesign cycles are 4-6 years, sometimes longer, meaning the shift to EVs needs to be carefully planned. Mercedes-Benz is looking to make its entire fleet carbon neutral by 2039 and mentions this is less than 3 cycles away.

Outsourcing cathode/battery cell/battery pack production for EVs to 3rd parties has been the preferred OEM strategy to date given the low capital outlay associated with that route. However, those suppliers have limitations on their rate of expansion and, more importantly, on determining the availability of raw materials for feedstock in the future. In recognizing these risks, VW released a “manifesto” acknowledging lithium as the “irreplaceable element in the electric era”. In reaction to this acknowledgement, VW has signed an MOU for a 10-year offtake agreement with Ganfeng Lithium (1772 HK) for hydroxide. Additionally, VW has announced plans to partner with Northvolt to build a battery cell plant in Salzgitter, Germany. This will initially secure VW about 10% of its requirements and should it expand further, 20%. More OEMs are likely to recognize the merit in VW’s logic and will follow suit and hedge more of their supply chain risks in time. For now, they are locking in battery supply from external parties, mostly Asian battery manufacturers, an example is Volvo (OTCPK:VOLVY), which recently signed 10-year deals with CATL and LG Chemical (OTCPK:LGCLF). Ideally, battery manufacturers should be located close to OEM car plants as this cuts delivery times and reduces the cost of transporting heavy battery cells.

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