Market Alert: California Leads US in Ambitious ZEV Targets

At Best, EVs to Account for 50 Percent of CA Auto Stock in 2035

California has set aggressive zero tailpipe emission vehicle (ZEV) targets through 2035, thereby leading the US in reducing GHG emissions in the transport sector and mirroring European efforts to ban ICE cars. The “Advanced Clean Cars II” regulation targets a ZEV share of 35 percent of new light vehicle sales in 2026, rising to 100 percent by 2035. CARB's approval on August 25 sets a timeline for Governor Newsom’s executive order, issued in 2020, which called for a phase out of new gasoline-powered cars and light trucks.

How realistic is the 2026 target? EV sales in California have been rising quickly over the last two years. According to California’s New Car Dealers Association, BEV sales reached 16 percent of all sales during the second quarter of 2022 while PHEVs added another 3 percent for a combined 19 percent. A year ago, the combined EV share was 11 percent. The momentum is similar to trends seen in Europe and China, where EV subsidies and emission standards on new vehicles have helped accelerate EV sales. Given the recent momentum, reaching a target of 35 percent by 2026 (an increase of 4 percent per year for the next 4 years) appears feasible if California were to follow the example of countries such as Denmark, Sweden, or the Netherlands.

But jumping from 35 to 100 percent between 2026 and 2035 requires an aggressive upward trend. That said, there is some flexibility within the regulation, meaning that the annual targets may not be met as is. The regulation is based on a credit system, with the ability to pool across participating states and use banked credits during the initial years. The mandate also allows plug-in hybrids (PHEVs) to account for 20 percent of the target; these cars effectively have “dual fuel” capability.

These flexibilities will be important, as the hurdles to achieving the targets are numerous. First, will the purchase price of EVs be cost competitive? For context, the price of a new EV in the US averaged $51,000 in 2021 compared to $42,000 for a new light vehicle. While EV prices are expected to decline because of advances in battery technology, the cost of battery raw materials has surged this year and will be a challenge over the medium term. This raises the question of whether car drivers can afford to buy EVs without hefty subsidies.

Second, will the charging infrastructure keep pace? California currently has 80,000 chargers, or about 10 EVs per charger. Even if this ratio were 15, it would require 600,000 chargers by 2030 if the EV stock were to reach 9 million units by then. This would mean adding 60,000 chargers per year.

Last, can California’s clean power grid keep pace? The existing grid is currently under strain. A multi-year drought has affected hydropower generation, reducing its share to 8 percent of California’s power generation. At the same time, California hopes to phase out nuclear power, which accounts for another 8 percent. The electricity crunch has led the government to keep its last nuclear plant running for an additional five years instead of turning it off in 2025. Longer term, California has ambitious electricity sector goals to transition from fossil fuels toward renewables, zero-carbon electricity, and energy storage. The goal is for clean electricity to make up 100 percent of retail electricity sales by 2045. These goals parallel the ZEV efforts and are necessary to make EVs truly “zero emission”, but it adds up to a lot of moving parts in over just two decades. ESAI Energy believes this may force a reconsideration of nuclear power.

How will the ZEV targets impact the oil sector? The slow turnover of the vehicle stock means that California will continue to need gasoline demand for at least the next 20 years. Out of the 30 million light vehicles currently on California’s roads, EVs represented 3 percent at the end of 2021. This loosely equates to 25,000 b/d of gasoline demand being displaced by EVs (the state consumes 900,000 b/d in gasoline). By 2035, EVs could reach 50 percent of the light vehicle stock, but only if the annual targets are fully met by EV sales. The range of outcomes is wide, as much will depend on overcoming the EV hurdles - and to what extent drivers will buy used vehicles that are not ZEVs from outside of California.

That brings us to the rest of the US. Other states can elect to adopt California’s vehicle standards, and 15 have done so in the past. These states, which represent over a third of US light vehicle sales, will likely adopt California’s extended ZEV targets. Automakers thus face a fragmented US market, with primarily the West Coast and Northeast accelerating their shift to zero-tailpipe emission vehicles. This has implications for the speed at which gasoline demand declines in each PADD, with a decline in PADD 5 followed by PADD 1 and then PADDs 2 and 3. Federal EV subsidies will eventually help push the rest of the US toward EVs, but only after the US battery industry shores up domestic processing (which will take years) so as to qualify for these incentives under the recent Inflation Reduction Act.

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