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In the Tank: How Oil Prices Threaten Automakers' Profits and Jobs

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In the Tank: How Oil Prices Threaten Automakers' Profits and Jobs IN THE TANK How Oil Prices Threaten Automakers’ Profits and Jobs Principal Authors Dr. Walter S. McManus, Director, Office for the Study of Automotive Transportation, University of Michigan Transportation Research Institute Alan Baum, Director, Automotive Forecasting, The Planning Edge Roland Hwang, Vehicles Policy Director, NRDC Dr. Daniel D. Luria, Research Director, Michigan Manufacturing Technology Center Contributing Author Gautam Barua, Managing Director, Aclaria Partners Incorporated Office for the Study of Automotive Transportation University of Michigan Transportation Research Institute Natural Resources Defense Council July 2005 ABOUT NRDC The Natural Resources Defense Council is a national nonprofit environmental organization with more than 1.2 million members and online activists. Since 1970, our lawyers, scientists, and other environmental specialists have worked to protect the world’s natural resources, public health, and the environment. NRDC has offices in NewYork City, Washington, D.C., Los Angeles, and San Francisco. Visit us at www.nrdc.org. NRDC President: John Adams NRDC Executive Director: Frances Beinecke NRDC Director of Communications: Phil Gutis NRDC Reports Manager: Alexandra Kennaugh Production: Bonnie Greenfield CONTENTS Executive Summary iv Chapter 1: High Oil Prices are a Key Driver in the U.S. Vehicles Market 1 Detroit’s Big Three Are Hardest Hit by Slumping SUV Sales 1 Automakers Mask Drop in SUV Demand with Large Sales Incentives 4 Higher Oil Prices of $40 to $50 per Barrel Are Here to Stay 5 Prices Could Go as High as $80 a Barrel if Supplies Are Disrupted 6 Past Oil Shocks Led to Dramatic Declines in U.S. Automaker Market Share 7 Chapter 2: Methods and Assumptions of the Model 10 Chapter 3: Profits and Jobs at Detroit’s Big Three are Most Vulnerable 14 to High Oil Prices Detroit’s Big Three Will Absorb Nearly 75 Percent of Sales Volume Declines 14 Profits at Detroit’s Big Three Will Shrink by $7 Billion to $11 Billion 16 Sixteen Factories, Mostly in the Midwest, Are at Risk for Closure or Layoffs 18 At Least 297,000 Jobs Are on the Line, 37 Percent in Michigan, Ohio, and Indiana 19 Chapter 4: Automakers, Investors, and Lawmakers Should Act Now 21 Automakers Should Make Fuel Efficiency Job Number One 21 Lawmakers Should Provide Incentives and Standards to Raise Fuel Economy 22 Performance Investors Should Recognize the Role of Fuel Efficiency in Safeguarding 22 Shareholder Value Appendices 24 Appendix A: An In-Depth Look at What is Driving Oil Prices 24 Appendix B: Estimating Oil and Gasoline Prices in the Event of Supply 27 Disruption Appendix C: Discrete Consumer Choice (Nested Multinomial Logit Regression) 29 Appendix D: Detailed Planning Edge Sales, Revenue, and Variable Profit 32 Forecasts by Manufacturer by Segment, 2009 Appendix E: Detailed Planning Edge Production Forecast for U.S. and Three 36 Auto-Dependent States, 2009 Endnotes 38 EXECUTIVE SUMMARY ince the late 1990s, Detroit’s three big U.S. auto- FIGURE ES.1 Smakers—General Motors Corp., Ford Motor Com- U.S. Auto Plants Most at Risk from Higher Oil Prices pany, and DaimlerChrysler—have relied heavily on large, truck-based sport utility vehicles to drive com- pany profits. But with gasoline prices now at near- record highs, consumer demand for mid- and full-size SUVs is sinking fast. What if higher gas prices are here to stay and the trend away from gas-guzzling vehicles continues? To help automakers and policymakers eval- uate the consequences of high oil prices, we modeled potential effects of average gasoline prices at $2.86 a gallon ($80 a barrel) and $3.37 a gallon ($100 a barrel) against a baseline of $1.96 a gallon ($45 a barrel). This Fourteen U.S. factories, mostly in the Midwest states of Michigan, Ohio, and Indiana, are at risk for closure report says that sales, profits, and American jobs are and layoffs in the event of higher oil prices. at risk if Detroit automakers continue with their cur- GM Ford Arlington, TX St. Louis, MO rent business strategy in the face of higher oil prices Janesville, WI Sharonville, OH Moraine, OH Wayne, MI (Michigan Truck) and recommends actions that automakers, govern- Oklahoma City, OK Wixom, MI Romulus, MI DaimlerChrysler ment, and investors can take to mitigate the risks. Toledo, OH Detroit, MI (Mack Avenue) Ypsilanti, MI (Willow Run) Key findings include the following: Kokomo, IN Newark, DE Profits at Detroit’s Big Three will shrink by $7 billion to $11 billion. Reductions in vehicle sales, especially SUVs, will lead to an industry-wide decline in pretax profits auto-related employment in 2009 would drop by 9.8 to of $11.2 billion to $17.6 billion. Detroit’s Big Three 15.3 percent if gas prices rise to $2.86 or $3.37 a gallon. will absorb $7 billion to $11 billion in total reductions Approximately 110,000 of the jobs at risk are in only because of their dependence on SUV and pickup sales. three states: Michigan, Ohio, and Indiana. Detroit’s Big Three will absorb nearly 75 percent of the decline in total sales volume. Without deeper discounts, sales volumes in the North American car HIGH OIL PRICES ARE A KEY DRIVER IN THE and light truck market will shrink between 9 and 14 U.S. VEHICLES MARKET percent, or 1.9 to 3.0 million vehicles, because of the In just the first five months of 2005, sales of the overall effect of higher oil prices on the economy. Chevrolet Suburban fell by 31 percent, the GMC Detroit’s Big Three automakers absorb nearly 75 per- Yukon by 28 percent, and the Ford Expedition by cent of the sales decreases. 22 percent. GM cited falling U.S. SUV sales as the main culprit in its $1.1 billion first-quarter loss; its Fourteen U.S. factories, mostly in the Midwest, and shares are trading at 12-year lows. Falling sales also two Canadian factories, are at risk for closure and contributed to a 38 percent first-quarter profit plunge layoffs. Especially vulnerable are GM, Ford, and at Ford, which has seen its U.S. market share decline DaimlerChrysler plants in Arlington, TX, Jamesville, for 25 consecutive months. WI, Oklahoma City, OK, and Wayne, MI, that build In a bid to prevent sales from decreasing, U.S. mid- and full-size SUVs, large cars, 8-cylinder engines, automakers have offered steep consumer incentives. and rear-wheel drive transmissions . In fact, research shows that U.S. automaker incentives At least 297,000 jobs are on the line, 37 percent of between 2001 and 2004 correlate almost exactly to them in Michigan, Ohio, and Indiana. North American increases in fuel operating costs during the same time. iv Natural Resources Defense Council In the Tank Although incentives help move inventories of unsold nant of automaker competitiveness in the near future. cars and trucks, they also eat into profits, weaken Betting on low oil prices might have been a good brands, and mask a deeper sales slump. Without these strategy a decade ago, but today it’s a gamble that large incentives, both Ford and GM will likely con- places companies, workers, investors, and commu- tinue to suffer sales declines and lose market share to nities at grave risk. Without a product mix that meets foreign rivals. changing consumer demand in response to high oil Oil prices have more than doubled since 2001 and prices, Detroit will pay a heavy toll. have risen to more than $60 by early June 2005. In fact, Investors should recognize fuel efficiency’s role in with almost no spare oil production capacity, it would protecting shareholder value. Investors can identify, take only one major event to disrupt world oil sup- quantify, and, therefore, better manage their risk plies, sending prices to $80 per barrel or more. And exposure in the vehicles market if they have more in- with geopolitical tensions remaining high in critical formation about fuel efficiency. As with recent investor- oil-producing regions, a supply disruption is a grow- led actions on climate change concerns, investors should ing possibility. require greater transparency from U.S. automakers and demand analyses that consider fuel economy. AUTOMAKERS, INVESTORS, AND LAWMAKERS Lawmakers should raise fuel economy through SHOULD ACT NOW incentives and standards. Making our economy less Fortunately, several policy measures could stem these vulnerable to high oil prices by reducing oil dependency future job losses and declining sales. Automakers, is a national priority, and it merits public investment government, and the investment community should and commitment. Financial incentives to retool fac- come together to address the negative effects of sus- tories to build more fuel-efficient vehicles would tained higher oil prices on U.S. automakers in the help raise fuel efficiency levels and increase U.S. following ways: automaker competitiveness. It is crucial that the states most vulnerable to factory closings and job Automakers should make fuel efficiency job number loss—Michigan, Ohio and Indiana—lead efforts to one. Fuel efficiency will increasingly be a key determi- retool the U.S. auto industry. v CHAPTER 1 HIGH OIL PRICES ARE A KEY DRIVER IN THE U.S. VEHICLES MARKET surge in oil prices, from $10 a barrel in 1998 to more truck-based SUVs, consumers are purchasing more Athan $60 in July 2005, has prompted talk of a new fuel-efficient vehicles, including crossover utility era of sustained higher prices. Many analysts believe that vehicles (CUVs), minivans, and cars. Similar in look the combination of tightening global oil supply, limited to SUVs, most CUVs are front- or four-wheel-drive production capacity, and increasing global oil demand vehicle models built on car platforms that do not have will keep gasoline prices high by historical standards for heavy, rear-drive axles or frames like traditional SUVs.
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