Consumer Discretionary / Industrials

Henry Kwon

Thematic (Sector/Industry)

United states Automobiles / Thematic (Sector/Industry)

The EPA has drafted a final determination of its views on light vehicle emissions standards for 2022-25 and submitted it to the Office of Management and Budget late last week.  The Agency has until April 1 to make an official determination.  According to press reports, the Agency has tentatively concluded that future standards should be lowered which is consistent with the Trump Administration's existing views and that of the auto industry, but stands at odds with California and 12 other states (about 40% of the U.S. light vehicle market).  A final determination by the EPA on April 1 will not immediately lead to changes in the existing federal emissions standards, but would involve a longer process rule change if the Agency determines that standards should be relaxed, or lead to a court battle with states that have adopted California's emissions standards.The EPA has also hinted at taking away California's waiver under the Clean Air Act which allows the state to set its own emissions standards so long as they are more stringent than the federal standards.  If the EPA acts on this hint, current mood in the states that have adopted California's LEV/ZEV standards seem likely to spur them on to challenge the EPA in court, which can potentially tie up the issue without resolution for longer than any equity investor's current investment horizon.  <div class="content-highlight">In our view, this is not a significant short term event catalyst for trading the auto sector, but it does have long term strategic implications (ie, 10+ years, or multiple development cycles) for global OEMs.  Unless there is a synchronized move by the EU and China to simultaneously relax and extend their emissions regulations, OEMs will continue to carry development cost burdens for making cleaner vehicles, whether they be on ZEVs or ICE platforms, and change in the regulatory stance by the EPA will not impact top line performance of auto OEMs in our view.</div>Because at the heart of every emission control regulations stand energy security concerns that equity markets tend to ignore but governments take seriously, we believe the pressure to burn less oil will not diminish in the long run, even if more immediate timelines are extended.  We believe that in many ways continuous and unrelenting focus on improving ICE fuel efficiency should be one of the key factors that investors should keep watch on OEMs as a gauge for long term success.

The EPA has drafted a final determination of its views on light vehicle emissions standards for 2022-25 and submitted it to the Office of Management and Budget late last week.  The Agency has until April 1 to make an official determination.  According to press reports, the Agency has tentatively concluded that future standards should be lowered which is consistent with the Trump Administration's existing views and that of the auto industry, but stands at odds with California and 12 other states (about 40% of the U.S. light vehicle market).  A final determination by the EPA on April 1 will not immediately lead to changes in the existing federal emissions standards, but would involve a longer process rule change if the Agency determines that standards should be relaxed, or lead to a court battle with states that have adopted California's emissions standards.The EPA has also hinted at taking away California's waiver under the Clean Air Act which allows the state to set its own emissions standards so long as they are more stringent than the federal standards.  If the EPA acts on this hint, current mood in the states that have adopted California's LEV/ZEV standards seem likely to spur them on to challenge the EPA in court, which can potentially tie up the issue without resolution for longer than any equity investor's current investment horizon.  In our view, this is not a significant short term event catalyst for trading the auto sector, but it does have long term strategic implications (ie, 10+ years, or multiple development cycles) for global OEMs.  Unless there is a synchronized move by the EU and China to simultaneously relax and extend their emissions regulations, OEMs will continue to carry development cost burdens for making cleaner vehicles, whether they be on ZEVs or ICE platforms, and change in the regulatory stance by the EPA will not impact top line performance of auto OEMs in our view.Because at the heart of every emission control regulations stand energy security concerns that equity markets tend to ignore but governments take seriously, we believe the pressure to burn less oil will not diminish in the long run, even if more immediate timelines are extended.  We believe that in many ways continuous and unrelenting focus on improving ICE fuel efficiency should be one of the key factors that investors should keep watch on OEMs as a gauge for long term success.

U.S. Autos: Impressions on the EPA's Draft Determination on Tailpipe Emissions Standards for 2025