Volkswagen (VW), the world’s best-selling automotive OEM, has been caught in a vehicle emissions scandal of unprecedented proportions. At least 11 million diesel-powered VW cars worldwide use a specially-coded piece of software to purposefully cheat during emissions testing. The result is that VW’s diesel cars appear sufficiently clean to government regulators – enough to be eligible for sale – but when consumers drive their cars in the real world, the vehicles’ software switches the engines’ behavior: In consumer hands, these VW diesel engines switch into a mode where they perform better (more power and more fuel efficient), but pollute up to 35 times more than during official testing.
The initial fallout for VW has been swift and brutal: Its stock plummeted 23% in value, its lowest in three years, wiping out almost $20 billion worth of market capitalization. It faces a revenue decline too, as the OEM has told dealers to stop selling new diesels. Consumers are starting to file class-action lawsuits, as their VWs will have lower resale values. Next will come the fines: In the U.S., it will face fines of up to $37,500 per vehicle from the Environmental Protection Agency (EPA), totaling $18 billion in the worst case. The final amounts may not be as high, but nonetheless VW is preparing for some high losses, setting aside $7.2 billion already to start handling the fallout. Besides the U.S. Environmental Protection Agency (EPA), VW faces other challenges too: South Korea has already announced it will investigate VW’s vehicles, as will Germany. Even the U.S. tax agency is looking into VW’s cheating, because the OEM benefited from $52 million in tax credits for its “clean diesels” that have now turned out to be dirty.
VW is not the first OEM to court disaster. Other high-profile fiascoes include General Motors’ faulty ignition key, Firestone’s tread separation on Ford Explorers, and Takata’s exploding airbags. All are bad in their own way, and these OEMs survived, just like VW will. The other fiascoes involved an inadvertent flaw in the design or manufacturing, which dishonest and incompetent managers later tried to cover up. The VW case is different: It appears that the OEM purposefully engineered the cheat into its cars from day one.
The audacity and sophistication of VW’s cheating software is stunning. Its engineers apparently programmed the cars to detect when a regulator like the U.S. EPA tested vehicles – doable because testing uses a stationary dynamometer, where some of the vehicle’s wheels spin, but others do not. For example, on a VW Jetta, the front wheels spin on a dynamometer because it is a front-wheel-drive car, but its rear wheels are stationary. In real-world driving all four wheels spin. VW engineers appear to have used sensors to distinguish between these two modes, programming the engine to behave in different ways depending on whether the car was being tested by the government or being driven in the real world by consumers. This cheat worked for years, until an independent study carried out by West Virginia University actually tested VW’s diesel emissions in the real world. It is flabbergasting that VW thought they wouldn’t be caught – the U.S. EPA had already fined diesel cheaters $1 billion in 1998, for deceptively programming their engines as well.
At its very root, VW’s misbehavior was driven by the push for cleaner cars. Automotive OEMs are under immense pressure from governments and consumers around the world to perform a fine balancing act: Make their cars emit less pollutants, keep power high and acceleration good, deliver better fuel mileage, and keep costs low. Diesel engines have had a hard time pulling all of these off. When OEMs optimize these types of engines to deliver good performance (snappy acceleration and fuel mileage), they become prone to emit poisonous, reactive gases known as nitrogen oxides (NOx). To deal with that NOx issue, OEMs like Mercedes-Benz and Toyota use an additive based on urea as part of a selective catalytic reduction (SCR) system, which is expensive. VW’s cars were unique in passing tests without a urea system, thus saving money on each vehicle. It turns out that their secret to doing so was a software cheat.
In the near-term, VW doesn’t have good options to fix the issue. If they reprogram the software to pollute less, then 11 million of their car owners will have poorer acceleration and worse fuel economy. If they re-engineer the cars to retrofit them with a urea system, it would likely come at a cost of tens of billions of dollars over recall, R&D, component costs, and ongoing urea refills. In the longer term, this will force VW to re-evaluate their strategy for clean cars. The OEM had staked a lot on its “clean diesel” strategy – for example, just a few months ago, VW’s marketing arm proudly announced that one of its diesel-engined cars had set a new Guinness World Record for lowest fuel consumption by a nonhybrid car. In the aftermath of the cheating scandal, VW will face an uphill battle to win back consumer trust and acceptance.
Looking forward, clients should expect that:
1. Regulators will try to smarten up, but will need better equipment: It’s striking that the U.S. EPA, with its $8 billion budget and workforce of 15,000 staff, couldn’t catch VW, but a small team of researchers from West Virginia University could. Regulators should revise their testing protocols to test real-world performance when the vehicles are in motion in real traffic, rather than on a stationary dynamometer. With the miniaturization of sensors and better analytical software, making this change is easier than ever before. Indeed, testing authorities have known about discrepancies between real-world performance and testing for a long time, and more efforts like the upcoming Worldwide Harmonized Light Vehicles Test Procedure are needed.
2. VW will reconsider its clean vehicle portfolio strategy: VW was slowly moving beyond conventional gasoline and diesel engines anyway. Earlier this month, before the diesel scandal started, VW’s CEO discussed the OEM’s plan to put out 20 plug-in vehicles by 2020, like an Audi EV (client registration required) with a 500 km driving range. They have also invested (client registration required) in next-generation batteries, including lithium-sulfur and solid-state. VW is actually in a strong position to innovate their way out of this mess. They have been spending most on the R&D of any OEM (about $11 billion in 2013), and they are the largest automaker by volume. Arguably, no major OEM is better positioned than they are to decisively accelerate the push towards plug-in hybrids and electric vehicles, putting the shine back on their tarnished image. However, they probably lack the vision, leadership, and ambition to do it, so they will most likely carry on as usual after some apologies.
3. Automotive software will come under pressure to open up: In the U.S., it is illegal to prevent independent repair shops from fixing cars, under a policy called “right to repair”. However, OEMs successfully lobbied regulators to use the Digital Millennium Copyright Act (DMCA) to keep their software locked up and proprietary, and off-limits to diagnostic and repair companies the OEM does not like. That has led to legal squabbles, with GM arguing that while consumers may own their cars, the OEM owns the software; similarly, Ford sued a company called Autel, which was developing some independent repair software. Indeed, even VW itself sued some security researchers that pointed out a flaw in the way its key-fobs worked. Ironically, the U.S. EPA itself sided with OEMs, fearing that if the software is open-access then consumers would modify it at the expense of emissions. VW misused the protection of the DCMA to hide their crime – precisely the kind of scenario that open source software advocates have argued makes closed systems a bad idea. Forget consumers – OEMs’ actions show that they need watching too. The DMCA exception for automotive software should be struck down, and replaced with a policy in line with right to repair.
4. Diesel passenger vehicle sales in the U.S. will drop drastically: Due to strict NOx emission standards in the U.S. diesel passenger vehicles have failed to make any significant market penetration, representing less than 1% of passenger vehicles and only 3% of all vehicles on the road. In part, slow adoption was due to the requirement of installing the urea-containing SCR unit to control NOx emissions in diesel engines, which is expensive. When Lux Research compared OEM engine options – the cheapest engine option within a model range versus the diesel-engine option – we found on average the diesels cost $6,000 or more. VW’s “clean diesel” was positioned to revolutionize passenger diesel vehicles without the need of an SCR unit, saving costs. With the EPA setting new emission standards in early 2014, close to California’s much stricter regulations, this is not a good sign for diesel. Consumers will now consider other vehicle options likely to the charging of the U.S. EPA, which had plans to aggressively grow (client registration required) the biodiesel market over the next three years.
5. AdBlue systems and renewable diesel will infiltrate Europe’s existing diesel passenger vehicle market: The Euro 5 NOx emission standard that is applicable to vehicles prior to 2015 is nearly six times more lenient than that in the U.S. (180 mg/km compared to 31 mg/km). This has resulted in diesel powertrains present in approximately 35% of passenger vehicles and 53% of all vehicles and biodiesel making up 62% of Europe’s biofuels market (see the report “Biofuels Outlook 2018: Highlighting Emerging Producers and Next-generation Biofuels” [client registration required]). With Euro 6 approved and increased attention to NOx emissions (80 mg/km), and implementation of AdBlue systems in diesel passenger vehicles, it’s truly inevitable to achieve “clean diesel”. While biodiesel has carbon emission benefits that’s been the primary focus of Europe’s biofuel mandates, it actually has higher NOx emissions – up to 10% depending on blend percentage. Biodiesel will soon lose its luster as a viable solution. With the push for nonfood biofuels and new focus on NOx emissions, Europe offers potential for renewable diesel growth. By no means is renewable diesel the holy grail, but it has been shown through third-party testing to emit up to 9% less NOx compared to conventional diesel, and the region will see nearly 300 million gallons per year (MGY) of capacity come online by 2018, nearly doubling what it is today, according to our Alternative Fuels Tracker (client registration required).