Is the US Producing Cars it Can't Sell?

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Macroeconomics, Supply & Demand

How many times have we seen the pendulum swing one way in the extreme only for it to swing back the other way just as excessively? Last year as fuel costs reached record levels on the back of an oil price nearing $150/barrel there was an almost (remember the 1970’s oil shock) unprecedented swing towards smaller more fuel efficient cars. The Prius became if not the car of choice then at least the dinner table topic of conversation. Major car producers such as Ford and GM idled production lines for their big SUV’s, pickups and so on while re-tooling to produce smaller and more fuel efficient cars. Thousands lost their jobs, communities around these plants were severely impacted as global car companies re-prioritized R&D and investments over months where previously they had worked in cycles of years.

Well the oil price has been down and come back up again in the meantime and the car companies’ travails are sufficiently well recorded elsewhere for me not to need to go over them again here. For the last six months the oil price has risen from $70/barrel to over $80 and is now back towards $70 again without any real pain being felt at the gas pumps. The car manufacturers meanwhile have moved mountains to refocus production on smaller cars in the anticipation of increased demand from this segment.

Automakers were responding to two dynamics when they shifted production to smaller cars. The first was a short term switch by buyers, started by the fuel prices and encouraged by the cash for clunkers program aimed at more fuel efficient cars, to buy smaller and more fuel efficient cars. This was short lived in nature. As the oil price dropped back, Americans were already beginning to ask whether they really wanted to drive compacts after decades of big Pickup’s and SUV’s. The second is the US DOT directive with regard to Corporate Average Fuel Economy (CAFE) for manufacturers to achieve minimum average fuel economy standards for a vehicle manufacturer’s entire fleet of passenger cars and light trucks. The directive has forced manufacturers to build a proportion of their fleet which must be capable of achieving sufficiently good economy figures to bring the entire range above a certain average standard. As a result, fears are developing that the US auto industry is building unsalable numbers of small cars that they cannot make money on according to Smaller vehicles are notoriously challenging to earn a good return. European and Asian manufacturers who have had more experience in this sector usually manage to make meager margins, but US manufacturers are generally behind the curve and doubts abound that new small fuel efficient vehicles like the Chevrolet Cruze will make any money for their manufacturers.

Demand has already stalled for small vehicles and without a ramp up in volumes it will be tough to cover costs on new models. It seems US drivers are more deeply wedded to their big cars than environmentalists had hoped a year or so back. No surprises there.

–Stuart Burns

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