INSIGHTS | China’s EV industry is in trouble

William Li, serial entrepreneur and founder of oft-touted Tesla-killer Nio, lost more than $1 billion in net worth this year. His company, the five-year-old poster child of China’s troubled electric vehicle (EV) industry, hasn’t gotten off so lightly.

Nio went public in the US to much fanfare last year. Hubris over the company’s future dominated the second half of 2018. It’s no surprise: Nio began pre-orders for its second SUV, the ES6, in December. It also delivered a record number of its flagship vehicle, the ES8, in the last quarter of the year.

But the honeymoon phase ended as quickly as it began. The company’s share price plummeted more than 75% between March and June of this year. The decline resulted from flagging sales, a slew of investor lawsuits, and a spate of battery defects.

At the heart of Nio’s story lies a narrative that is all too familiar in China. The government backs an industry that runs wild—and then promptly pulls back the reins. Hundreds of registered EV companies now face uncertainty as regulators attempt to control the tumult they had a hand in creating.

Bottom line: China’s EV industry is in trouble. A sudden boom as a result of the government-led drive to support the industry led to a startup explosion, in which new companies piled into the field to take advantage of preferential treatment, creating a regulatory bubble.

General overcapacity in the country’s stalling automotive sector and quality issues have led to the government slamming the brakes. Of the nearly 500 companies focusing on EVs, industry experts predict that just 10% will survive.

• Very few companies have significant experience making cars.
• Those that have entered production are struggling to sell their vehicles.
• Regulations are making investors nervous, adding to already existing financial woes among many EV makers.
• “Investors are losing their belief in the future of these [EV] startup companies. I don’t see any of them surviving as entities on their own; they will survive as part of state-owned companies,” the Financial Times cited Jochen Siebert, managing director of consultancy JSC Automotive, as saying.

The government won’t allow the market to fail, but an industry cull is coming, in which a few well-established players and state-owned automakers come out on top.

Rush to catch up: China was late in producing gas-driven cars, which put the country behind the US, Japan, and Germany. But the government now hopes that EVs can bridge the gap, catapulting China to the top spot in the global automotive supply chain. China created incentives for automakers to produce electric vehicles, with little thought to demand.

• In 2009, authorities introduced subsidies for prospective EV buyers in China to stimulate adoption of new energy vehicles (NEVs), which include electric cars and hybrids.
• The Chinese government has invested nearly $60 billion in its EV industry over the past ten years.
• The average subsidy was around RMB 70,000 (about $10,000) per vehicle, making these cars significantly cheaper for consumers.
• At the same time, China has increased research grants for electric vehicle technology.
• Support was extended to companies that make batteries, which are the most expensive component in an electric vehicle. Two of the world’s three biggest EV battery makers are now in China.
• To further pique interest in EVs, the government has also been giving away licenses for these cars, while still charging for their gas-driven counterparts.

These measures led to a fertile environment for a bubble. As the government put its might behind the industry, investors threw their money behind startups, causing the industry to blow up. During these types of booms, scammers inevitably wind up founding companies that collect investments or subsidies without ever making a serious effort to develop a product.

• In 2008, a little more than 2,000 NEVs were sold in China.
• That number increased to around 1.2 million in 2018, accounting for half of all deliveries worldwide.
• The country aims to produce around 2 million vehicles in 2020, according to a 2017 industry ministry plan.

Pulling subsidies: But things are changing—and fast. The Chinese government now believes that subsidies are doing more harm than good. Authorities say the allowances are stifling innovation, with companies relying on them to sell their vehicles rather than improving their technology. Since June, the government has made significant cuts, and there are plans to phase them out completely.

• Electric vehicles with a range of more than 400 kilometers have had their subsidies cut by half.
• Cars that are only able to travel 250 kilometers on a single charge no longer receive a subsidy.
• In addition, some municipalities have cut their EV allowances completely, instead diverting funds to focus on charging infrastructure.
• The scale of the cuts has taken the industry by surprise, with reductions totaling nearly 70% in some cases.
•  Already cash-strapped EV makers will face a tough decision: pass on the costs to consumers (by raising prices) or absorb them. Either way, these companies face trouble, particularly with their low sales volumes.

Cutting flab: The overall Chinese auto industry has an overcapacity problem. The country’s ability to make vehicles is far greater than demand for new cars, leaving production lines empty. Sales of vehicles fell by more than 10% during the first half of the year. The country reported its first annual decline in more than two decades last year.

Meanwhile, EV sales in the first quarter of 2019 more than doubled to reach nearly 225,000 vehicles, though this can’t necessarily be taken as a sign of the industry’s health.

• The drastic increase came before subsidy cuts and was mainly driven by well-established automakers including BYD—the world’s biggest EV producer.
• These cars made up less than 5% of China’s auto market in 2018.
• The slowdown could potentially spread to the EV market, especially once subsidies have been completely withdrawn.

The government is now taking measures to reduce capacity in the entire auto industry, but the move creates serious challenges for smaller EV makers. Restrictions have been placed on building new production plants. These facilities make it easier for an automaker to optimize costs, which is especially important during a market downturn. In order to set up a factory, a company must:

• Reach a capacity of 100,000 a year;
• Have produced 30,000 vehicles in the two years prior or reached RMB 3 billion in sales in the past two years.

Nio was blocked by the National Development and Reform Commission from building a production plant in Shanghai’s Jiading district after US EV maker Tesla broke ground on a factory in the same city at the beginning of the year. Nio’s backtracking led investors to file multiple class-action lawsuits following claims that they had been misled.

At the same time, the government is promoting a “joint manufacturing” model, in which new EV makers such as Nio and rival Xpeng, among others, partner with large, mostly state-owned automakers to produce their vehicles. Nio partnered with JAC to build its cars in Hefei, a city in eastern China. Xpeng’s vehicles are made by Haima in central China. But this model comes with its own set of issues.

• It’s expensive for the smaller companies: They’re typically required to pay the original equipment manufacturer for every vehicle produced and reimburse them for any losses as a result of slowing sales.
• It could lead to image problems: Smaller EV makers often pursue a luxury image. Their production partners are typically known for building low-cost vehicles. In some cases, the partner’s logo can be included on the car.

Quality issues: As with most industries that have grown on the back of heavy state support, the EV industry initially went underregulated. This has resulted in serious quality issues, and, in some cases, significant safety problems.

• More than 135,000 NEVs were recalled in 2018.
• Almost 30,000 NEVs have been recalled in 2019.
• Battery fires have become a significant issue. Around 40 electric vehicles self-ignited last year.
• In June, Nio recalled nearly 5,000 vehicles that posed a risk of catching fire.
• The recall followed a spate of fires that affected Nio, Tesla, and BYD in China.

The government is now taking action. Last month, the Ministry of Industry and Information Technology ordered automakers to conduct safety checks on all of their EVs, including those already sold. The ministry said that companies will be punished for hiding quality issues. The directive also requires companies to establish 24-hour emergency hotlines to deal with safety incidents.

The fallout: The EV industry is the latest victim of China’s tendency to promote and then regulate. Similar currents have been felt in other industries, most recently the peer-to-peer (P2P) lending sector.

The trajectory is often the same: The state relaxes regulation and encourages innovation, the market booms but puts consumers at risk, and then the state swoops in with tight regulations, driving smaller companies out and creating a downturn that only a few very large players can weather.

In the P2P lending industry, experts predict that up to 70% of firms may close this year. The situation is even more dire for the EV industry, which requires huge amounts of capital to keep it going.

• Investors are now turning their backs on the industry as the government crackdown takes its toll.
• Capital is becoming hard to come by, analysts have previously told TechNode.
• Carsten Breitfeld, co-founder of Chinese EV up-and-comer Byton, left the company to join a rival, reportedly as a result of funding issues.

The future: It’s clear that the government had not planned the current trajectory, though this scenario has appeared again and again across industries in China. For the EV market, consolidation is coming, with well-established automakers benefiting from manufacturing partnerships and technology gained through acquisitions.

Troubled Nio will most likely succeed, but only because the Chinese government won’t allow one of the darlings of its EV market to fail. It’s already made this abundantly clear—the company announced a RMB 10 billion bailout from a Beijing-based state-owned investment firm in May. The news came as Nio reported a 50% sequential drop in revenue and a significant slowdown in deliveries. It’s unlikely that the vast majority of companies in the industry will receive the same generous treatment.