(Editor's Note: In this series of articles, we answer the pressing Questions That Matter on the uncertainties that will shape 2025—collected through our interactions with investors and other market participants. The series is aligned with the key themes we're watching in the coming year and is part of our Global Credit Outlook 2025.)

China has established, over the past twenty years, an unrivaled dominance in electric vehicle (EV) technologies and supply chains. Midway through this critical decade in the energy transition, the U.S. and Europe's lagging capabilities mean they face complex trade, cost, and affordability dilemmas that could affect their automotive original equipment manufacturers (OEMs).

How This Will Shape 2025

The automotive sector is one of the most visible parts of the energy transition.  About 90% of countries have set some form of greenhouse gas (GHG) emissions reduction target as part of their Paris Agreement commitments, according to the United Nations Environment Programme (UNEP), while a similar number have specific goals to increase their share of clean technologies, including electric vehicles. Though global emissions are expected to reach an all-time high in 2024, the road transport sector (mainly light vehicles) is showing signs of change, with investment in clean transportation technologies starting to reduce transport-related emissions and energy demand in major markets such as China, the U.S., and Europe.

China has accelerated away from the competition in clean tech.  In 2023 alone, the world's second-biggest economy added more solar power capacity than the total capacity of the U.S., and it launched more new EV models than any other market. China's manufacturing dominance in EVs relies on a combination of relatively simple technology, superior operating efficiency, and control of the supply chain. Despite a dip in local demand, China has resisted adjusting its domestic production capacity. The resulting domestic price war incentivizes the exporting of excess production, often at prices that some consider "dumping." That has prompted the U.S. and Europe to introduce trade tariffs on EVs and key EV components, aimed at protecting their OEMs' competitiveness.

Chart 1

China's dominance should be good news for climate targets, but piles pressure on legacy OEMs already facing wider challenges.  Demand for EVs outside of China has weakened and is likely to remain soft in 2025, with total cost of ownership (which includes the purchase price) a key factor. Non-Chinese players are under pressure to improve manufacturing efficiency (through restructuring and rightsizing of production capacity) and to speed up their time to market, while also maintaining strong investment capacity. They will continue to face unprecedented cost-reduction pressure in 2025, especially amid ongoing cost of living pressures. The EU, in particular, could see its ambition to decarbonize road transportation jeopardized by higher energy prices and insufficient government support for EV adoption, both of which discourage consumers from choosing cleaner mobility options. Additionally, the EU's carbon dioxide regulatory framework could leave some of its most important manufacturers with a share of as much as €15 billion in regulatory fines in 2025 (about 25% of the region's annual investment in R&D). This could divert much-needed capital away from investment and hurt the competitiveness of the domestic industry to the benefit of emerging Chinese competitors.

What We Think And Why

The introduction of tariffs on EVs from China looks untimely, given EU climate targets for the light-vehicle industry.  The European auto industry has so far managed to balance progress on electrification with the preservation of investment capacity and credit quality. Responding to Chinese manufacturing supremacy with traditional protective measures, such as tariffs, could prove ineffective, given the complexity of international trade flows, but also detrimental to EV adoption if they raise prices overall. The tariffs could also prove a headache for the very sector they are aimed at protecting. EU auto manufacturers are obliged to meet certain EV sales and fleet-averaged emission thresholds, which would be less earnings dilutive if companies could sell cost-competitive vehicles produced in China. From a credit perspective, 2025 could prove a particularly challenging year for manufacturers with sizable operations in Europe, which face both potential compliance-related costs and the need for continued restructuring to adjust to the post-pandemic demand decline. In the U.S., the Biden administration has already raised tariffs on Chinese EV imports to 100%, while postponing fuel efficiency targets to 2027-2032, which should buy time for the "Detroit Three" (General Motors, Ford Motor Co., and Stellantis) to reduce their EV production costs and ease pressure on their credit quality.

Chart 2

Chinese partnerships (outside China) could help close the gap in technology, research and development (R&D), and manufacturing efficiency.  EV uptake in China will likely be close to 50% in 2024 (compared to 15%-20% in the EU and 10% in the U.S.). Chinese expertise could benefit OEMs beyond China's borders. For example, Volvo, controlled by China's Geely, has a more advanced and competitive EV sales mix than its traditional/legacy brand peers due to the benefits of sharing technology and supply chain expertise with its Chinese parent. Lower cost bases would allow European and U.S. OEMs to offer mass-market products at lower prices without disrupting their profitability, potentially alleviating the main credit risk we see for the legacy automotive industry. Developing localized, competitive, and reliable clean-tech supply chains should boost security and create jobs, but it is likely to be a costly task that will last beyond 2025 and will ultimately contribute to higher EV premiums in the U.S. and Europe.

Affordability could be a game changer.  Chinese EVs' lower prices mean a potentially lower total cost of ownership that will appeal to price-sensitive consumers. At legacy automakers, EV prices typically remain higher than traditional vehicles, yet smaller and cheaper EV models will narrow that premium over 2025-2026. The end of the EV premium (as in China) will encourage consumer neutrality to powertrain options and support countries' energy transition goals. Whether that alone is enough to entice consumers remains unclear, especially amid high interest rates, high energy costs, and ongoing perceptions of limited public charging infrastructure.

What Could Change

Regulatory intervention is likely to play a significant role, one way or another.  With transport-related emissions representing about 25% of global energy-related emissions, many governments have introduced policies aimed at either increasing EVs' share of sales or limiting emissions on an average fleet sold basis. Some in the European autos sector are calling for potential emission regulation fines to be delayed, citing weak sales, higher-for-longer interest rates, and Chinese competition. A delay would lessen regulatory risks to OEMs' earnings and investment at the cost of potential emission reductions. In the short term, that could be credit positive, but structural issues would remain. The evolution of tariffs is also highly uncertain, and the protectionist policies deployed by different countries could affect trade and potentially increase volatility.

Political risks on the path to clean technology persist in the U.S.  The U.S.'s Inflation Reduction Act (IRA) and CHIPS Act have driven hundreds of billions of dollars of private-sector investment in clean energy and domestic manufacturing and created hundreds of thousands of jobs. Removing IRA support for the EV or semiconductor industries could prove a major blow to investment. The U.S. election results have created uncertainty regarding the future focus of these policies. A narrower focus on energy security and costs could reduce funding and tax breaks for some cleaner energy solutions, potentially affecting companies that have used this support and altering consumers' buying decisions.

Countries' priorities could have a big effect on emissions.  Progress on emissions reduction has so far fallen short of requirements to meet global warming targets. Countries are due to submit new climate goals next year, as per the Paris Agreement. Some may pursue more ambitious reductions, while others could opt to ease climate goals, particularly given competing pressures. The resulting policies could determine the future of EV adoption.

Read More

• How Could A Second Trump Term Affect U.S. Credit, Nov. 7, 2024
• Evolving Political Priorities Could Affect Energy Transition, Aug. 8, 2024
• China ahead in delivering affordable electric mobility, May, 29, 2024