China’s quest to grow its electric vehicle market relies on heavy-handed policy intervention

March 29, 2017

China’s booming electric vehicle market is driven mainly by generous government subsidies

China is saying goodbye to double-digit growth in its domestic car market, but one segment stands out for its phenomenal growth. Electric Vehicles (EVs) and New Energy Vehicles (NEVs) have caught on in a big way in China, making it the largest EV market in the world with 37.7% of global sales in 2016.

The Chinese government is throwing its considerable weight behind the EV segment, a fact which was reaffirmed in Beijing’s 13th Five-Year Plan released in 2015. This important policy roadmap set a goal to have five million NEVs, including cars and buses, on the road by 2020. Beijing’s strong commitment to become a dominant player in this market is driven by two political risks: its over-dependence on oil imports and the severely polluted air in its cities.

Beijing’s commitment has manifested itself in very favorable policies for both NEV manufacturers and consumers. The central government provides subsidies to manufacturers that invest in NEV production and Chinese consumers purchasing an NEV can receive the equivalent of USD 6,740 in subsidies. The value of NEV subsidies for consumers provided by the central government in China reaches a similar level to those in other countries such as the UK, France and Japan. Many local governments also provide incentives on top of those from the central government, including cash subsidies, free parking spaces and free license plates (no small sum considering the fact that license plates can cost as much as USD 12,000 in cities like Shanghai).

The government has also ramped up its efforts to add more charging stations to overcome buyer “range anxiety”, an issue which has long plagued the adoption of NEV vehicles. At last count there were more than 85,000 public charging stations in China, up 65% from the end of 2015. Local governments have set an ambitious target in this area as well. For example, Beijing’s government has plans to install 400,000 charging points in its megalopolis by 2020.

So far, surveys show that satisfaction among NEV owners in China is high—the majority say they would purchase NEVs again and interest from Chinese consumers in NEVs has tripled since 2011. Although Chinese consumers have generally preferred foreign car brands over their Chinese counterparts, this does not seem not the case for the NEV market. This gives Chinese brands the opportunity to cement a strong position in the market as it further develops.

Government incentives have generated overcapacity

There is more to this growth story though, and not every aspect of China’s NEV market is as rosy as the figures make it out to be. China’s extensive financial support to the NEV market has undoubtedly created strong incentives for both consumers and suppliers, but the Chinese NEV market is not on track to reach government growth targets set out in the Five-Year Plan. Instead, downsides to China’s supportive policies are beginning to emerge in the form of overcapacity and imperfect competition.

More than 200 Chinese NEV manufacturers have entered this market to date, producing over 4,000 licensed NEV models. Some of these manufacturers only sell several hundred cars per year, far from the scale necessary to generate returns on investment in the automotive industry. To provide a glimpse of just how quickly this sector has expanded, there were only 140 manufacturers accounting for 1,300 licensed models in 2015.

Another hurdle to a mature market is that low-cost NEVs dominate—66% of market share belongs low-cost cars, which utilize basic technology and require lower R&D costs. Less than 20% of China’s NEV market share belongs to high-end NEVs backed by heavy investment in advanced technology and R&D. Time will tell if low-cost, low-quality NEVs produced by tiny outfits surviving on government largess will continue to account for such a large part of the market in China.

Battery shortage and protectionist policy crimp NEV production

The push for five million NEVs on China’s roads by 2020 is limited by scarce battery supply. And the scarcity of lithium-ion batteries is not just an issue in China. In fact, the price of lithium-ion batteries rose 300% from 2015 to 2016. If China’s NEV market grows as its current rate to an annual production volume of 2.2 million in 2020, the demand for batteries would reach 84.8 GWh,  far higher than the global output of 15.7 GWh produced in 2015. This scarcity has prompted a flood of investment in battery manufacturing operations in China. In fact, ninety percent of new lithium-ion battery manufacturing projects in the pipeline are expected to be located there, a big victory for government planners with designs to dominate the market for this critical technology. However, demand for batteries by Chinese NEV manufacturers will likely still far exceed supply.

China’s NEV manufacturers have long favored batteries from Korean and Japanese manufacturers due to their lower cost and better performance, especially in larger vehicles such as SUVs and buses. However in June 2016, the Ministry of Industry and Information Technology, China’s government agency responsible for NEV subsidy policies, left some prominent foreign companies off a list of battery manufacturers approved to receive government subsidies. Samsung and LG, two Korean industry giants which manufacture batteries for many of China’s NEV producers and have extensive operation in China itself, were left off. The upshot of the policy move is that producers of NEVs hoping to sell cars in China will think twice about using batteries from non-approved suppliers like LG & Samsung in cars. The announcement of this move encouraged at least one Chinese manufacturer to scale down production of one of its larger SUV models over concerns that its eligibility for subsidies may be at risk. Exclusion from the list means that from January 2018, manufacturers of electric vehicles using batteries made by manufacturers not included on the approved list will not be eligible for government subsidies.

Subsidy reduction could ruin the party

 Government subsidies in 2016 stood at 30 billion RMB (USD 4.5 billion). Not surprisingly, local governments and manufacturers have jumped at the opportunity to cash in, leading to the fragmentation and overcapacity we see in China’s NEV market today. In the period from January to October 2015, the sales volume of NEV was 174,000. However, the number of vehicle registration plates issued for NEVs was just 108,000. This means as many as 70,000 EV cars were produced but not sold to consumers. This unintended consequence of government interference in China’s NEV market is an open secret in the industry.

The central government reacted to the situation by enacting a new subsidy policy in August 2016. Under the new policy, only qualified manufacturers will be eligible to receive NEV subsidies moving forward. This is expected to leave out more than a third of Chinese manufacturers which fail to meet the policy’s qualification standards. Vice Minister of Finance Song Qiuling said that the government subsidy policy will be adjusted further in 2017. And while the subsidy amounts are not expected to be reduced significantly, today’s high levels are not sustainable, according to Song, because they will put pressure on government finances and continuing heavy-handed government intervention in the NEV market is also not seen as beneficial to the its long term competitiveness and development. This delicate balance between government support and market forces raises questions about the viability of NEVs in China over the long term. Without generous subsidies, Chinese consumers may no longer want to purchase NEVs. According to a recent survey, only 38% of consumers would be willing to buy NEVs without the government subsidy. China’s government planners have a remarkable record of meeting their stated targets, but the ambitious goal for NEV use requires a careful balance of policy support, fair competition and customer demand. So far, it is clear that China has work to do in all three areas to realize ambitions of its 13th Five-Year Plan.

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