Why China’s electric vehicle market is at full throttle

After a dip in sales in 2019 and the impact of the pandemic in early 2020, the market for electric vehicles (EVs) in China is recovering strongly.

Among the factors driving this acceleration in sales is the combination of more attractive and cost competitive models. What’s more, new government directives have given strong support for China’s auto industry to electrify.

At the same time, valuations of many of these companies have been driven up to extreme levels.

How policy is helping to pave the way

The direction of travel was underlined at the United Nations last September, when the government has pledged to cut China’s carbon dioxide emissions to nearly zero by 2060. Low-emissions transport, including EVs, will be one of the strategic industries helping the country achieve its climate goals.

2020 also saw policy updates that will accelerate the adoption of EVs, even as vehicle price subsidies are phased out. Beginning this year, mandatory emission quotas for internal combustion engines (ICE) and EVs are being tightened to help EVs reach 20% of new car sales by 2025; this equates to around 6 million units a year, from 1.3 million in 2020.

By 2035, EVs are expected to account for 50% of all new car sales, according to the government’s ‘Energy-saving and New Energy Vehicle Technology Roadmap 2.0’. This sets out how China’s automotive industry will be transformed into a largely electric and hybrid industry. The State Council, China's cabinet, also set specific tasks for EV manufacturers to ensure they are fit for purpose by the time the ICE is phased out.

At present, most car manufacturers are not selling EVs at a profit, but China’s new policies do amount to a blueprint for the transformation of the automotive sector and are expected to boost sales of EVs after two stagnant years.

What else is driving the growth in EVs?

In addition to strong government policy support, three additional trends are increasing the attractiveness of EVs in China.

1. The price and driving range of EVs is improving

Chinese consumers have three main concerns about EVs: their high price, their limited driving range and the dearth of charging points.

Battery costs have fallen by more than 70% since 2014, narrowing the price gap between EVs and conventional gasoline cars. We estimate that as little as RMB30,000 (US$4,500) now separates the cost of the powertrain for a conventional ICE from its more expensive battery-powered cousin.

Powertrains are the most expensive part of any vehicle, electric or ICE. So if battery costs continue to decline at annual single digit rates, EVs could achieve price parity with ICEs in the next five years.

In parallel, the efficiency and range of electric batteries have improved to the point where top-selling EV brands now have a driving range of 300km-700km. This is similar to that of an ICE.

2. New models have been a game-changer

New EV models are being launched, including from traditional car manufacturers, increasing the competition between brands and also giving consumers more choice.

The bargaining power big car manufacturers have over their suppliers is expected to cut costs further and to provide more price-competitive products in the future. This should allow EVs to enter the mass market.

3. Vehicle smartisation

Chinese consumers are heavily influenced by the smart technology, or ‘vehicle smartisation’, that EVs offer. This trend could tilt the market decisively in favour of EVs, particularly once price parity with conventional cars is reached; expected within the next five years.

There is ongoing debate over when autonomous driving will become the norm, but this is a moot point. The role of the driver has already started to be diminished by technology, and this trend is set to continue. Smart driving systems are now a major feature. Meanwhile, the interior is increasingly seen as a “cabin”, with infotainment systems another differentiator.   

Why government support is changing, but remains crucial

While industry trends are encouraging, Chinese government policy support will remain crucial for the accelerated development of the EV sector. However, the nature of the support is changing.

Direct price subsidies are being phased out as the costs of batteries fall and their efficiency improves. Instead, the government’s New Energy Vehicle Development Plan (2021-2031) and Technology Roadmap 2.0 for energy saving and new energy vehicles, both published in October, aim to shift support to the construction of the charging infrastructure.

There are several groups involved in the charging infrastructure market, including the state-owned electric utility, State Grid Corp, third-party independent charger operators and leading EV makers, which are building their own fast-charging and battery switching networks.

Charging infrastructure companies are an increasingly important part of the EV ecosystem. There are currently about 600,000 EV charging points in China, equivalent to about one for every five vehicles. Government subsidies may promote faster construction.

EV growth aligns with broader climate goals

There are several factors underpinning Chinese government support for EVs: they reduce China’s dependence on imported oil; they lower air pollution in cities and help to reduce the country’s carbon emissions; and they are spearheading the creation of a world-class, technology-driven industrial ecosystem that supports jobs and exports.

With the country’s pledge to make China carbon neutral by 2060, EVs will become one of the strategic industries helping the country to achieve its climate goals. Which is why, despite of some of the current exaggerated hype and market valuations, we are confident that the outlook for the EV industry will remain strong for many years to come.

Is there still an opportunity for investors?

There is little doubt that EVs are going to become increasingly dominant as a share of overall vehicle sales over the next decade.

However, the number of EV manufactures has increased, while traditional, ICE manufacturers are having their sights firmly on gaining market share in the EV segment. This makes for a crowded, more competitive marketplace which will likely erode manufacturer profitability. It is worth noting that EVs have far fewer moving parts than traditional cars; barriers to entry are low.

The industry is likely to see some consolidation as a result. The winners will emerge, but predicting which companies is at this stage a difficult task. Where we have more conviction is for EV supply chain component companies, whether that be in electronics, parts or batteries production. In our view, these “pick and shovel” plays are most interesting for investors, albeit a focus on valuation remains key.