No, Germany Did Not Just Ban The Internal Combustion Engine

by: Tristan R. Brown

Summary

A number of news articles are reporting that German legislators recently voted overwhelmingly to "ban" new internal combustion engines beginning in 2030.

The move has been portrayed as one step by policymakers to reduce greenhouse gas emissions and quickly transition to a renewable energy economy.

The supposed ban is actually a "suggestion" to the European Commission regarding steps that it can take to reduce the European Union's emissions.

If enacted, the ban will face a number of economic and technical hurdles that, if not overcome, will limit its impact on the financial markets and overall effectiveness.

Gizmodo ran the following eye-catching headline earlier this week: "German Lawmakers Vote to Ban the Internal Combustion Engine." It received quite a bit of attention and rightfully so: Germany has been and continues to be a major developer of internal combustion engine [ICE] technology. ICE history is so intertwined with the country that compression-ignition engines, a type of ICE, are more commonly known by the name of their inventor, German engineer Rudolf Diesel. For Germany to ban the ICE would be analogous to the U.S. banning the airplane or Russia banning vodka. This is the country of Porsche (OTCPK:POAHF), Audi (OTCPK:AUDVF), BMW (OTCPK:BMWYY), Mercedes-Benz (OTCPK:DDAIF), and Volkswagen (OTCPK:VLKAY), after all. Such a ban would be a very big deal indeed.

Proponents of policy to force fossil fuels to be left in the ground were quick to point to the article as evidence that major developed economies are taking steps to discourage, if not outright criminalize, fossil fuel consumption. Such measures represent a means for countries such as Germany that are not host to large fossil fuel reserves to contribute to the greenhouse gas [GHG] emission reductions targeted by the recently-ratified COP21, or Paris Climate Agreement. Indeed, Germany's Green Party was quick to characterize the successful vote in that context. There is just one problem: Germany did not actually ban the ICE.

Gizmodo's headline misleadingly characterizes as a "ban" a measure that was actually a non-binding legislative resolution. A German-speaking commenter on this Ars Technica article goes so far as to describe it more accurately as a "suggestion" for the E.U. Commission. These resolutions are effectively legislative wish lists, verbal statements of support that don't take any actual action. For example, in early 2015, the U.S. Senate voted by a 98-1 margin in favor of a resolution stating that "climate change is real and is not a hoax." (Apparently, one senator misread the thermometer.) Not that the Senate has taken many steps of late to combat climate change, however. And Germany's resolution is to ban new ICE vehicles by 2030. So Germany's legislature has made a non-binding suggestion to pass a specific law… in fourteen years.

The resolution is not entirely meaningless, of course. Germany is to the European Union as California is to the United States; as the entity's largest automobile market, any automotive regulations that it imposes are likely to eventually be adopted by its neighbors so as to maintain market access. It is also notable that the resolution passed with broad cross-country and cross-party support. As such, it serves two purposes: first, to let automakers know what today's policymakers envision in the future, and two, to send a signal to the rest of the E.U. as to what it wants to see from its neighbors. Viewed from that perspective, then, the resolution is a newsworthy event.

That being said, investors should refrain from exiting their positions in the aforementioned automakers for a few different reasons. The first reason is that Germany's policymakers are suggesting that the European Commission grab what it expects will be the low-hanging fruit in 2030. Falling battery prices and low electricity prices have made battery-electric vehicles [BEV] increasingly competitive with ICE vehicles running on petroleum fuels. In fact, were it not for 2014's petroleum price crash, BEVs would likely be cost-competitive with ICE vehicles on an unsubsidized basis in many parts of the U.S. today, let alone in 2030. If that point arrives then BEVs will become an example of a negative carbon abatement cost, or a carbon emission reduction strategy that saves money for the adopting party rather than costing it, similar to installing a smart thermometer in a new house or building natural gas-fired power plants instead of coal-fired power plants (to use an American example). Germany's automakers have already been investing heavily in vehicle electrification, and the legislators' hope is clearly that the market will have done the heavy lifting for it by 2030. In that case, a ban, if implemented at that time, will be a minimally-disruptive event akin to banning coal-fired furnaces in residential buildings today.

The second reason that investors should not read too much into the resolution's impact is that Germany's legislators have left their 2030 counterparts a well-lit exit route. Again, the resolution is a non-binding suggestion to implement a measure fourteen years from now. Let us assume for the sake of argument that BEVs don't actually become cost-competitive with ICE vehicles on an unsubsidized basis by then; perhaps battery costs stop declining or the marginal cost of petroleum extraction falls to $30/bbl. Germany's legislators in 2030 are under no obligation to adopt their predecessors' suggestion, especially if future conditions are different than those that are currently envisioned. Indeed, the E.U. as a whole has proven to be increasingly unwilling to take the hard steps necessary to prevent catastrophic climate change, let alone meaningfully reduce the region's carbon emissions. Its policymakers have repeatedly refused to take steps to increase its carbon price, currently about $6/metric ton, under the Emissions Trading Scheme [ETS]. France recently announced the unilateral creation of a carbon price floor of $30/metric ton, although it would be levied only on the country's very small number of coal-fired power plants and, in any case, will likely run afoul of E.U. rules. By comparison, researchers at Stanford University recently calculated that the optimal carbon price is over $220/metric ton, or nearly 37 times the current ETS price.

Finally, it is an open question as to whether or not the technology necessary for a ban will exist in 2030. Yes, BEVs are technically-feasible for light vehicles, but Germany is proposing to ban ICEs, not just gasoline-powered engines. Battery weight, let alone cost, will need to fall drastically from today's levels if electric motors are to replace diesel engines for the pulling of heavy loads over long distances, for example. The magnitude of the challenge becomes greater still if jet engines, which technically are a type of ICE, are included within the scope of the future ban.

Vehicle technology isn't the only constraint. Less than half of each barrel of petroleum is refined to gasoline (the specific percentage varies by type of crude and refinery, but the general fraction is correct). Add diesel fuel and you are still counting only 65% of total refined products by volume. One aspect of vehicle electrification that is often ignored is how electricity, which can replace gasoline and possibly diesel fuel but not other refined products like jet fuel, bunker fuel, petrochemicals, and asphalt, is incapable of replacing petroleum consumption. Furthermore, the various refined products are produced because of refining chemistry rather than demand: early refiners only cared about kerosene and actually disposed of the gasoline cut prior to the widespread commercialization of ICE vehicles. Until replacements for these other products are found, refiners will compensate for reduced gasoline demand by increasing the prices for the other products so as to remain profitable. Under such a scenario, widespread BEV adoption will result in lower expenditures from consumers on gasoline but higher expenditures on the other refined products that are critical components of modern life.

Europe has an advanced renewable chemicals sector compared to the rest of the world, it is true, but nothing that is capable of replacing petroleum products at scale yet. The modest displacement of gasoline in the U.S. from fuel efficiency and ethanol blending a decade ago were associated with surging propylene prices over the same period. Barring the rapid commercialization of renewable refined products, future German policymakers could ultimately decide that the economic distortions caused by the effective banning of gasoline consumption merit a different approach.

Some closing thoughts

Germany's decision to encourage the European Commission to ban new ICEs in 2030 is a notable step on the path to reduced greenhouse gas emissions. The media is making it out to be far more momentous than it actually is, however, and investors should keep in mind that it is really a non-binding suggestion to take action in fourteen years. There are a number of reasons to be skeptical as to the suggested ban's feasibility on political, economic, and technical grounds. This is not to say that it won't happen, of course, but Germany still has a vast distance to go before it bans the internal combustion engine.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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