Energy security, environmental protection key factors in push for developing home-grown vehicles

China is transforming into a force to be reckoned with in several new energy and transportation industries. Chinese suppliers now control almost half the global wind turbine market and over 85 percent of the Chinese domestic market. A Chinese high-speed train recently broke the speed record for unmodified commercial-use trains by reaching 486 km/h during a test run on the new Beijing-Shanghai high-speed rail link.

At the nexus of new energy and transport lies the new energy auto sector. BYD Automotive, an offshoot of a major Chinese battery maker, is now mentioned in the same breath as Toyota and other new energy vehicle powerhouses worldwide.

Warren Buffett gave this Chinese company, otherwise known as Build Your Dreams, his stamp of approval by placing a bet to the tune of $232 million (176 million euros) for a 10 percent stake in 2008. The Chinese government recently placed a big bet of its own, announcing significant subsidies in 2010 for battery-powered vehicles but not for the more mature full hybrid electric vehicles. Some might wonder what is behind the government's big bet, and what role might China play in the evolving global new energy auto industry.

As for many nations, energy security is an increasingly crucial element on China's national security agenda. As of 2009, over half of China's oil was imported, much from political and security hot spots around the world. Automobile fuel consumption now makes up over one-third of total Chinese fuel consumption and will likely reach over 50 percent of total fuel consumption by 2020. Reducing automotive energy consumption is a key imperative for China's energy security.

More efficient

There are few energy sources with an energy density as high as hydrocarbon-based fuels (such as gasoline or diesel). However, the process of converting stored energy into driving mechanical energy using traditional internal combustion engines (ICEs) is not very efficient. Electricity battery storage and conversion to mechanical energy is much more efficient, requiring 25-40 percent less "well-to-wheel" energy per kilometer than for the equivalent gasoline engine-powered vehicles.

The Chinese government also aspires to provide a clean, pollution-free environment, which is one of the key pillars of President Hu Jintao's "Harmonious Society" theme. Among all the new energy automotive technologies, electric or hybrid electric vehicles currently present the best environmental option. "Well-to-wheel" greenhouse gas emissions required to operate an electric or hybrid electric vehicle can be around 25-60 percent lower than the equivalent gasoline engine-powered vehicle, depending on the mix of energy sources used to generate electricity. If certain renewable energy sources (such as wind or water power) were used, then greenhouse gas emissions through the entire energy chain would essentially be zero for pure electric vehicles.

It is clear that new energy vehicles can reduce energy consumption and greenhouse gas emissions. But of the many different technologies, which offer the best solution? For many years, Chinese government ministries tasked with devising an alternative energy automotive strategy took a conservative approach to allocating government funds. They spread limited funding across multiple technologies, fuel cells, electric hybrids and hydraulic hybrids to alternative fuels, such as natural gas, bio-fuels and methanol fuels derived from ample coal reserves.

In 2010, the Chinese government consolidated its focus and placed a real bet on one technology: Battery-powered electric and plug-in hybrid electric vehicles. A pilot program offered up to 60,000 yuan (6,900 euros) subsidies for these vehicles while traditional full hybrid electric vehicles would receive subsidies of only 3,000 yuan per vehicle, the same as for the most fuel-efficient gasoline engine-powered vehicles.

Why would the Chinese government bet so clearly on electric and plug-in hybrid electric vehicles, and so clearly not on the more mature and feasible traditional "full" hybrids? The simple answer may be that the government wanted to bolster the competitiveness of local automotive companies in technology areas in which they had the best chance of success globally. Chinese battery makers such as BYD and Tianjin Lishen already occupy top 10 positions in the global market. Electric motor production capability is also strong in China. In comparison, Toyota and other mature global players have an almost insurmountable technology advantage in traditional gasoline engines and full hybrid electric technologies.

Govt rider

The announced subsidies came with another rider - to receive government subsidies, the Chinese automaker must own the intellectual property rights to at least one of the three core technologies of electric battery powered vehicles (batteries, electric motors or electronic controls).

The message that comes through in A.T. Kearney's meetings and interviews with government officials and industry bodies is loud and clear: If foreign players wish to participate in the potentially large and growing Chinese new energy automotive market, they must be willing to sacrifice by giving up rights to technology.

Although Chinese auto companies have picked up manufacturing and management expertise from their foreign joint venture partners, they have been less successful at building product development capability. Although building this capability is high on the government's agenda, Chinese firms don't always follow up with investment due to a practical mindset. Of the 100 automotive industry executives A.T. Kearney surveyed in 2010, more than two-thirds stated their belief that, for Chinese auto companies, buying technology was clearly easier than developing it from scratch themselves. The government subsidy policy will likely help at least one Chinese automotive company to acquire the technology to become a global player in new energy vehicles over the next decade, even if only at the lower end of the market spectrum.

China will also serve as a major raw material supplier for new energy vehicle technology - specifically electric motors and batteries. China currently supplies about 93 percent of the world's rare earth element minerals. These are key constituents of the permanent magnets in high-torque electric motors used in many new energy vehicles. Each Toyota Prius, for example, uses almost 1 kg of rare earth material. China's known reserves of lithium, used in lithium ion batteries, are the fourth-largest in the world. Aside from supplying its own domestic needs China could become a lithium exporter as well.

We know that China will contribute as a global new energy automotive technology and raw material supplier. But as the largest automotive market today, it is clear that China will also represent one of the leading new energy automotive markets in the world. Many analysts project that new energy vehicle penetration of the auto market will achieve 3-5 percent by 2020 but predictions vary from 1 percent to over 40 percent. As the adage goes - it's hard to make predictions, especially about the future.

When we think about how large the market for new energy vehicles will be by 2020 we must ask the question - "Why would anyone buy a new energy car?" Based on consumer surveys the primary mainstream motivation to buy a new energy car is to save money. New energy vehicles are cheaper to operate than traditional vehicles but purchase costs are much higher. New energy cars will only become cheaper to own and operate in the long run if oil prices increase. Based on A.T. Kearney market modeling, there will likely be a "tipping point" from traditional to new energy vehicles when the oil price approaches $200 per barrel. With many analysts projecting $100 oil prices by 2020, we wouldn't expect a dramatic shift for new energy vehicles by that time.

Driving range

Aside from favorable economics and image, car buyers also want performance, reliability, safety, and convenience. Dynamic performance is actually a less-known advantage of electric cars. Because they have very good low speed torque performance, electric motors can accelerate cars faster and smoothly than internal combustion engine-powered ones.

The key barrier to consumers buying a battery-powered vehicle is driving range - otherwise known as "range anxiety". A.T. Kearney market surveys indicate that the development of a sufficiently dense charging infrastructure network is critical to overcome this key purchase barrier. Half of the car owners in southern China drive less than 50 km per day and 90 percent drive less than 100 km per day. Plug-in hybrid electric vehicles (otherwise known as "range-extended electric vehicles), which use an on-board gasoline engine to charge the battery, address these concerns to a certain extent. Regardless of these options, electric cars may not become the first choice for a car in the near term. They may be better suited as a second household car that meets the needs of most urban commuting and short trips.

New energy automobiles represent a revolutionary new variant of the global automotive industry. These vehicles may prove disruptive to the traditional industry value chain, but only as oil prices increase and battery technology improves. As with other major global industries, China is set to play a significant role in this market. There will likely be at least one major Chinese player in the global new energy vehicle and components market. China's vast natural resources will ensure it a role as a key electric motor and battery raw material supplier. And as the largest automotive market today, China will certainly continue to be one of the most attractive regions for domestic and global firms to promote their new energy automobiles.

You can bet on it.

The author is vice-president of management consultant A.T. Kearney, Shanghai.