Although not directly concerned with investment, this article should be of interest to all long-term investors in the auto business, including Ford (F), General Motors (GM), Fiat-Chrysler (FCAU), Toyota Motor (TM), Renault (OTC:RNSDF), Peugeot (OTCPK:PEUGF) and Volkswagen (OTCPK:VWAGY), but especially those who are investing in electric car companies such as Tesla (TSLA) under the mistaken impression that they are somehow supporting sustainable transportation.

Governments have been promoting electric cars as a means of reducing greenhouse gas emissions and averting the global warming crisis. They are often referred to as “Zero Emission Vehicles,” or ZEVs, as if the electricity for charging those cars magically appears at the charging point with no regard for how it is generated. In fact, the term “zero emissions,” or ZEV, has come to be synonymous with the electric car when referring to greenhouse gases.

While it is true that electric cars have zero tailpipe emissions, they do increase emissions at the power plant, and the effect of a gram of carbon dioxide on global warming is the same whether it comes from the exhaust of a car or the stack of a power station.

Politicians may be able to influence the perception of electric cars as zero emission, but physics and chemistry determine what happens in real life.

Emissions from power stations

In the table below, I have calculated the greenhouse gas emissions from power stations. I have included the emissions from the mining and transportation of coal and gas (sourced from UK environmental reporting data) and the emissions from methane leakage (sourced from this paper). Methane gas is about 25 times as strong a greenhouse gas compared to carbon dioxide, on a 100-year cycle, so even though the amounts are small, the effect on greenhouse gases is significant.

For the purpose of simplifying the calculations, I have shown nuclear, wind, biomass and hydroelectric power as “clean” energy. Emissions from these sources are very low, but I have put in an average number to show that they are not zero.

Emissions from battery manufacture

In addition to emissions from the use of electrical power, BEVs create emissions from the manufacture of the large, heavy batteries over and above the emissions associated with manufacture of the rest of the car. Several attempts have been made to calculate those emissions with varying results, highly dependent on the power source at the manufacturing facility. I have used the estimate from this paper which averages several studies and provides a figure of 250,000 gCO 2 per Kwh of battery size. Using a 250,000 km. battery life results in 1 gCO2/km for every Kwh of battery capacity.

Emissions from ICE vehicles

The calculations for ICE car emissions are relatively simple. The table below includes the direct emissions from combustion and the indirect emissions per liter from extraction and processing for both gasoline and diesel fuels (the information comes from the UK government tables for calculation of GHG emissions).

Using the above information, it is a simple step to calculate the emissions per km for a car.

Comparison of electric versus ICE cars for various power sources

The charts below use published data based on the WLTP test procedure to determine km per Kwh for electric cars and Km/liter for ICE cars. Actual performance will be influenced by driving habits, so the real numbers are probably higher for both ICE and BEV cars.

The WLTP test is done at a starting temperature of 14oC and without the use of climate controls. ICE cars can draw waste heat from the engine to warm the car in winter, BEVs have to consume power for heating and batteries are less efficient when cold, and as a result, BEVs consume more power per km in winter and will therefore be responsible for higher emissions per km in cold weather.

I have used information from EV database to provide an estimate of cold weather greenhouse gas emissions for electric vehicles.

The table below shows results for small cars, I have used the Peugeot 208 in my example because the same car will be available in gasoline, diesel and electric versions in 2020. The Toyota Prius is included as an example of a similar hybrid vehicle, though the Prius is larger than the Peugeot 208.

In the second table, I have compared the Audi Q5 and the Audi E-tron. The Toyota RAV4 is included as an example of a conventional hybrid SUV of similar size.

Electric cars perform slightly better in the large car class - the regenerative braking component helps to overcome the extra energy consumption of the heavier vehicle.

From the charts, we can conclude:

Electric cars are effective in reducing greenhouse gas emissions, but only if they are charged using “clean” power. Electric cars charged from an efficient combined-cycle natural gas power station are better than conventional gasoline-powered cars but roughly the same as small diesels and hybrids. The advantage will disappear if the power station is a thermal station (i.e., a coal station converted to gas). Electric cars charged from coal-fired power stations have higher emissions than ICE cars. Compared to driving an electric car, driving a smaller car is a more effective way to reduce your carbon footprint.

Where the energy comes from is important

The energy source that should be used for calculating electric car emissions depends on where you live (or more accurately, where you charge your car). There is some controversy over whether we should use the average energy mix or the incremental energy source when calculating emissions.

The average energy mix assumes that cars are charged in some utopian realm where the wind blows constantly and the sun shines at night. The incremental energy is a more realistic choice, and since most electric cars are charged at night, the night-time incremental energy source will give us the closest approximation to real-world electric car emissions.

For example, suppose we have a power grid that has a demand of 40 Gw at night and is supplied by 20 Gw of fossil fuel and 20 Gw of wind. If we add demand from a million electric cars to that grid, we will increase demand by about 10 Gw. The wind won’t blow harder to fill that demand - the extra energy will have to come from fossil fuel.

In any electrical power grid that uses a mix of fossil fuel and “clean” energy sources, if the “clean” source is being utilized to its maximum capacity, then it follows that any load added to the system has to be supplied by burning fossil fuel.

So, electric cars can only claim to be “clean” if the electricity they use comes from a grid that has a surplus of “clean” energy at the time the car is being charged. Most electric cars are charged at night, and we want that to be the case because that is when demand is at its lowest and the grid has spare capacity. So, for an electric car to be “clean,” the power grid needs to have a surplus of “clean” power at night.

Our sources of electrical energy

The source of electrical energy depends on where you are, for example:

California

This is a chart of power use in California for Friday, November 8th. You can visit the CAISO website to look at other days.

(Source: CAISO)

As you can see from the chart, night-time power comes mostly from natural gas or from imports, which could be coal or gas. Even during the day, renewables are only providing about 40% of the total energy, and any incremental added load must be provided by non-renewable sources. These charts vary widely during the year, but you will not find any day on which renewables provide a power surplus in California.

With natural gas as a power source, the impact of electric cars on California’s greenhouse gas emissions is relatively minor, and if power is sometimes imported from coal-fired stations, the overall impact is probably close to zero.

USA, except California

Fossil fuels generate about 64% of the electricity in the USA, natural gas accounts for 35% and coal for about 28%. Any additional load used to charge electric cars would have to be supplied by one of those two sources, since “clean” energy sources are already running at capacity. Some of the natural gas generation is in high-efficiency combined cycle power stations, some is in lower-efficiency thermal power stations converted to gas burning from coal. Overall, the effect of adding the demand from electric cars to the US power grid is probably close to zero.

Germany

This a chart of German power supply for the week of November 3rd to 10th, from this site.

There is a small baseload of hydro, biomass and nuclear power (blue, green and red on the chart). Wind power (grey) varies wildly depending on wind conditions, then we have brown coal, hard coal and natural gas. Natural gas use is cranked up during the day to fill peak demand, but at night, hard coal is the source that is most often varied to match demand.

Since the clean energy sources (wind, hydro, nuclear and biomass) have limited capacity, it is the coal that would supply the extra power for the electric cars. If you look at the charts for all weeks, there are perhaps four or five nights in a year when the wind would have had spare capacity. Building more windmills would, of course, stretch that to a few more nights, but coal is still needed most of the time.

After the “diesel-gate” scandal, VW committed, as part of its settlement, to spend billions of dollars developing and building electric cars. How ironic that this will almost certainly lead to an increase in Germany’s overall greenhouse gas emissions.

United Kingdom

This is the UK graph from November 13th.

There is steady baseline of nuclear (grey) and biomass (dark brown). Wind (light blue) provides a small portion according to wind speed, and there are some imports from France and Ireland (pink). However, the bulk of the power is supplied by natural gas (orange). Coal burning is cranked up during the day to provide the peak load, and natural gas provides the incremental load at night. Natural gas from one of the UK's twenty-nine efficient, combined-cycle, gas-fired power stations would seem to be the appropriate energy source to use as a basis for calculating electric car emissions in the UK.

The “clean” energy countries

Electric cars can provide significant reductions in GHG emissions, but only in those power grids that have a surplus of “clean” power at night.

Among the top ten BEV users, Norway (mostly hydro-electric power) and France (nuclear power) can claim to have “clean” power available for electric cars. Most of Canada (e.g., hydro in BC and Quebec, hydro and nuclear in Ontario) also has clean energy.

For example, a look at Ontario’s power supply mix (chart below) shows a mix of nuclear (brown), hydro-electric (light blue) and natural gas (dark blue), with some wind power (green) available at times and a small contribution from solar and biomass. However, at night, when demand is low, the natural gas plants are used only to provide grid stability, nuclear is held at a steady rate and there is surplus hydro-electric power available.

So, we have some countries where the energy source is clean enough for electric cars to make a difference, but in most countries, the burning of fossil fuels to generate electricity cancels out the emissions saving at the car's tail-pipe.

The net effect of electric cars on GHG emissions

I have made an estimate of the effect of electric cars on greenhouse gas emissions in the nine countries with the largest BEV sales.

The calculations are approximate because I have had to make assumptions about the annual mileage, the mix of cars and the power sources in each country. However, it does give us a rough indication of what is happening.

Outside of China, the impact of electric cars has been negligible. The extra emissions in the coal-burning countries roughly balance the savings in “clean” energy countries. However, China, which has by far the biggest number of electric cars and where coal is the primary power source, must have seen a significant increase in GHG emissions as a result of the move to electric cars.

China has at least avoided the use of the term “Zero Emissions” when referring to its New Energy Vehicles, and the mandatory fuel efficiency standards in China do give extra credit to small energy-efficient BEVs over large energy-guzzling BEVs. However, I think the subsidies they have handed out were intended to make sure the country established a foothold in a new industry rather than a reduction in GHG emissions.

How are we doing on that plan to reduce GHG emissions?

In 2018, greenhouse gas emissions worldwide rose at the fastest rate in the last seven years. Emissions from developing countries have been climbing steadily as a result of industrialization and rising living standards. Europe is holding steady - economic growth has probably offset any attempts to clean up the power grid.

The USA and China, the two countries with the most electric cars and the countries with major expansion in battery manufacture, have shown increases in GHG emissions in 2018, though there are many other factors in play and electric car and battery manufacturing emissions are only a small component of the total.

(Source: Carbon Brief – Clear on Climate)

Regulations are formulated to support the industry rather than reduce emissions

There is no denying that electric cars have a place in the future of personal transportation. They are ideal for some applications (e.g., as a commuter car in two-car families) and hopelessly inadequate in others (long-distance travel in cold weather).

The switch from ICE to BEV cars has been driven primarily by governments, using a combination of subsidies and regulations. However, the need to support the industry in the development of new energy vehicles plays a major role in decision making. As a result, both the subsidies and regulations are flawed and, in many cases, counter-productive with respect to the stated intent of reducing GHG emissions.

If you look back at the comparison charts for large and small vehicles earlier in this article, you will see that the biggest reduction in GHG emission comes not from choosing a BEV over an ICE, but from choosing a small car over a large car.

In California, the ZEV credit regulations encourage the sales of BEVs with longer-range and larger batteries, which will always have higher emissions than those with shorter range and smaller batteries. Small, fuel-efficient hybrids get one ZEV credit and large BEVs get four, even though the hybrid has lower life-cycle GHG emissions. It appears that the regulations were formulated not to reduce GHG emissions but to support an otherwise unsustainable automotive industry in California.

The European regulations date back to 2013 when the EU proposed emission targets and penalties based on the estimated GHG emissions from ICE cars. At that time, electric cars were not part of the equation, and manufacturers were aiming to meet the new regulations with smaller, more efficient engines and a move towards diesels. But the move to small diesel engines caused problems with local emissions of NOx and particulates in cities where traffic is heavy. This was highlighted by the VW diesel-gate scandal, which prompted a move away from diesel engines even though it had nothing to do with GHG emissions and even though the issues with NOx and particulate emissions have largely been corrected. The move away from diesels and a consumer trend towards larger cars and SUVs meant that auto manufacturers had no chance of meeting the regulations for 2020, the year when the penalties were coming into effect. As the chart below shows, average emissions continued to climb through 2018.

(Source: SMMT)

In fact, if the mix of cars in 2020 is like 2018, the penalties would amount to more than $40 billion in total for all manufacturers selling cars in Europe. Investors have been bombarded with scare articles like this one from Bloomberg, giving the impression that emission penalties will eat up all of the European automaker's profits in 2020.

Bloomberg’s article seems to be a strong warning for investors to stay away from the ICE car makers for the foreseeable future, especially companies that sell a significant portion of their product into the EU.

However, faced with a choice between distorting the regulations or destroying their automotive industry and their economy, EU regulators have taken the easy way out - they have given the automakers an opening by which they can meet the standards with very little impact on profitability,

Electric cars are rated at zero emissions, completely ignoring the extra load on fossil fuel power stations.

Automakers can count each electric car as two cars in 2020, 1.67 cars in 2021 and 1.33 cars in 2022 when calculating average emissions.

5% of all cars can be excluded from the calculations in 2020.

Norway (the country with the highest proportion of EV sales, but not an EU country) is included in the EU calculations from 2019 inwards.

Manufacturers can continue to sell large luxury cars and SUVs without incurring penalties, provided they have a small percentage of electric cars in the mix. Those electric cars can also be large energy supping vehicles charged from coal fired power, it doesn’t matter because they are all rated “zero emissions.” Those cars will qualify for direct subsidies and very low tax rates on company cars in most EU countries, along with other perks such as free parking, access to carpool and bus lanes and free access to zones where ICE cars have to pay congestion charges.

The EU regulators can pretend that auto manufacturers are meeting their emissions targets, and everybody will be happy. It is much easier to tell voters that you will give them some money to buy an electric car than it is to tell them you intend to build a nuclear power station down the road, so politics has trumped common sense once again.

I love this quote from a recent article about the winter performance of electric cars:

“Perhaps the car industry and politicians should first remember to calculate physically and chemically correctly instead of acting politically correctly.”

The takeaway for investors

Investors should ignore the hype. Although automakers are spending billions of dollars to transition part of their production to electric cars, that expenditure is going towards the development of new models, investments in the battery supply chain and modernization of factories. Those are expenditures that will strengthen their competitive position in the future.

The major short-term risk is an imbalance between supply and demand for BEVs and PHEVs, but the EU penalties on ICE cars provide the automakers with a method of adjusting prices to make sure all of those electric vehicles can be sold.

The average ICE car sold in Europe in 2020 will incur an emissions penalty of about $3,000, but the sale of one BEV could reduce the penalty by $20,000. The risk to VW and the other major automakers is that they will have to sell a portion of their products below cost to balance the BEV/ICE market in Europe. However, they will probably be able to increase the price of ICE cars to compensate, since all automakers will be in the same position.

I like Volkswagen's approach - it is covering the high end of the market with the Porsche Taycan which will appeal to wealthy car enthusiasts. Porsche will undoubtedly sell all of its Taycan production at whatever gross margin it chooses. The Audi E-tron has already had an impact on the middle range of the luxury market, and the new ID3 platform looks like it will be a surefire winner in the mass market where Europeans favor smaller SUV style cars.

Tesla, on the other hand, is entering 2020 with two old luxury models whose sales appear to be in decline and one two-year-old mass-market car that is priced well above the competition. Add in the lack of service and sales outlets and the steadily disappearing supercharger moat, and Tesla's chances of competing in Europe next year without re-pricing the Model 3 seem to be slim indeed.

Perhaps the one thing that Tesla has going for it next year is that the European automakers will be focused on meeting the EU quotas, and they will be left alone for a year or two to continue their dominance of the US BEV market.

Disclosure: I am/we are short TSLA. 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.

Additional disclosure: Very small position in long-term puts.