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00:00

Brad

Welcome to the flip side. I'm Brad Rogoff, global head of research. And joining me today is Dan Levy, our US autos and mobility analyst. Thank you for being here Dan. 

00:10 

Dan

Great to be here Brad. Thanks for having me.  

00:12

Brad

Before we dive in, just a friendly reminder to everyone. Don't forget to hit subscribe so you never miss an episode of The Flip Side.

So Dan, you and I have been talking for a number of weeks, month or so even now and saying, okay, at some point, if this activity in the Middle East continues and we see higher prices and the effect on global consumers, we'd have to get together and do one of these. And now that time has come. So gas prices they’re higher, we're all feeling it.  

And even with oil prices coming down off the highs – and we'll see when you're listening to this, that can obviously change. US gas prices are still above $4, and that's a clear psychological threshold for a lot of consumers. So we couple that in with broader questions of affordability – and that’s been going on for a while for consumers – and the car market really becomes a key indicator of consumer health. 

So this feels like a classic stress test to me for US consumers. The question I keep coming back to is whether higher gas prices actually change how Americans by cars, or whether they just complain about it and carry on with their daily lives.  

01:12

Dan

Yeah, that's exactly the right question, because historically, the impact of higher gas prices on consumers is real.

Americans do complain about it, but preference is pretty much snap back once fuel prices stabilise. And just to put some context, fuel accounts for roughly 3% of average consumer spend.  

01:32

Brad  

Americans are good at complaining, I agree with that. Still, for consumers, that's not a trivial cost. And your 3% number is an average. That can be a lot larger for certain people.

01:41 

Dan

Yeah, just to put it in context of how that stacks up relative to what people spend on cars, it's roughly 15% of the average per mile cost for car owners. So I think really what you're getting at is this question of consumer behaviour, vehicle preferences in the US. And in the US, reality is we love our SUVs and pickups –these are the gas guzzlers.  

EVs, on the other hand, have just had a harder time seeing uptake and consumer preferences don't materially change just because of higher gas prices. 

02:09 

Brad

Guilty. I drive an SUV. And look, maybe this won't impact or change these preferences in the immediate term. And oil markets you know, still expecting a large degree of normalization by the end of the year. 

But we think there's a real possibility this war will add a significant longer-term premium to that market. So if that is the case, it feels like there could be some changes that actually eventually come to this industry. And if we look back historically, hasn't there been a pretty good inverse correlation between the mix of vehicles just and gas prices?

02:37 

Dan

Yeah, that's right. There has been an inverse correlation. We published on this a little over a month ago. And basically when you look at the past precedents, it does imply there is some risk to US vehicle mix. So if you just look at what happened in the last decade, in the earlier part of the decade, 2011 to 2014, when the average price of WTI oil was roughly $95 a barrel, we did see large pickups and large SUVs, what we'd refer to as these gas guzzlers as roughly 14% of new car sales.

But in the back half of the decade when WTI was in the 50s, so oil was much lower, mix of these vehicles increased a couple points. But I actually think that the much bigger impact was really felt in this sharp decline in the mix of sedans within new car sales – your Camry, Corolla, Honda Accord, which are generally viewed as the most fuel efficient vehicles. That mix basically was replaced by crossovers and SUVs. 

So just to put that in context, whereas prior to the oil price swing last decade, sedans were roughly 40% of new car purchases, by the end of the decade, it was down to nearly 20%. And that share basically all went to crossovers and SUVs. 

03:44 

Brad

I mean, it's a trend you notice when you're looking out on the road, but a 20 point swing is massive, and it's got to be evidence that consumers are swayed by gas prices. 

03:52

Dan

Yeah, to an extent. But for now, it's really a question of what you mentioned earlier in terms of how sustained these high fuel prices will be, because if it is sticky, yeah, it could eventually weigh on the mix of car sold. We don't want to be dismissive of that, especially for the larger vehicles. But I think it really is important to overlay this with these broader secular changes that we've seen in consumer preferences.

04:13 

Brad

All right. So we already established I'm not necessarily an anomaly driving an SUV. But one thing I do recognize, I've always recognized, that I am probably in the minority and not really caring about what exactly I drive, as long as it gets me from point A to point B.  

04:26

Dan

Yeah, I point out three things that most people apparently care about more than you.

First, the mix of large pickups within new car sales has more or less held in the last five years in the low to mid teens percent of new car purchases. Uptake of these vehicles is defined, if not more so, by their commercial benefits or their ability to get work done for their owners, and these owners are fiercely loyal to the segment. 

Second, on EVs, and I'm sure you'll want to address this further uptake has been defined by more than just affordability. 

And last, on those crossovers I mentioned, this is probably where we've seen the biggest secular change. The sedan segment in the US has effectively become a niche segment, and the average mass market cars today are your small and mid crossovers, which now count for, well more than half of vehicle purchases. 

05:11

Brad

Okay, so clearly there is some structural preference for larger vehicles. But I think what is more of a concern is where we are in affordability and whether this time is different. It seems like every week I see a data point in the media of vehicle prices consistently at all time highs. Or let's take monthly car payments, which have continued to climb higher, and the rise of interest rates the last few years certainly hasn't helped factor that in, with some data points of auto delinquencies at recent highs, and the vibes just don't feel that good.

I guess what I'm saying is: I wonder, will hire gas prices be the straw that breaks the camel's back?  

05:48

Dan 

Yeah, Brad, I agree. And let's be honest, when you look at the pricing data, it's really hard not to ask questions about where we are on affordability and just to put some data around it, prices today are just much higher than they used to be. 

The average vehicle today in the US sells for roughly $46,000. Pre-COVID it was $34,000. Yes, there's been some inflation since Covid and car prices needed to increase for that, but that doesn't account for the magnitude of price increase we've seen. Automakers really have chosen to take price over volume and are emphasising more profitable, higher end vehicles, what we'd call richer mix, which is a shift from what they've historically done. 

And you can also translate that to higher monthly payments, right. Today, the average monthly new car loan payment in the US, roughly $770. That's up from $550 pre-COVID. And on top of the higher new car prices, as you mentioned, we've also seen interest rates pressure. So yeah, pricing is an issue. 

06:43 

Brad 

Well, you maybe under hyped it a little bit in terms of yes, there's definitely been inflation since Covid, but these numbers are in excess of that. 

And you know some of these moves because of that, inflation and everything, including wages, are sustainable for maybe your average buyer. But I guess what I'm asking here is whether that's sustainable for the market as a whole. 

07:02 

Dan

Okay. So the market today I think has re-sorted around buyers that can absorb these shocks without changing behaviour. And really this gets to what you know, many have described is this K shaped economy theme, which has just been very widely described. 

Higher income households today just account for a much higher portion of new car purchases. Pre-COVID, two thirds of retail new car purchases were from households with income of $100,000 or less. But last year, that mix declined to under 50%. 

You flip that around, households with $100,000 or more, the income rose. And when you look at households with $200,000 plus income, that mix increased by 10% - now it's just roughly 20% of total mix.  

So, even accounting for rising income levels, clearly there has been a shift in the mix of who is buying cars. And that's why we would argue some of the affordability concerns really aren't as bad as they appear. 

07:52 

Brad

All right. Well, I'll let one of our economists come on to debate how K shaped the economy actually is. But we'll stick to what you just talked about here. Because regardless of that, I do think there's only so many cars an upper income household actually needs. And again, back to the gas price stuff, you know, and the affordability issue just becoming more significant. I mean, how do you marry that with these auto loan delinquencies at highs already? 

08:16

Dan

Yeah that's right, the delinquencies have risen. And I can understand why this is getting a lot of attention. But again, I think you have to peel back the data, which to me really reinforces this K shaped economy. New car purchases are heavily skewed to prime, and super prime FICOs where there's generally more stability. And so in a way, the delinquencies are backward looking to when we saw more subprime mix from several years ago, but that's really changed. 

08:41 

Brad

So I said higher income consumers only need so many cars, but other consumers, they do need cars as well, right? And if we think about other consumers, they're probably getting priced out of the new car market to a degree. So don't those consumers need to go to a different car market? And if the used car market then is seeing consumers really come under pressure, that probably weighs on the health of the new car market, too, I would think? You know, and that leads to changes in residual values. Am I following that path correctly?  

09:10

Dan

Yeah, and maybe the way to look at it is if you look at the new car market, we've effectively substituted a million units of industry volume for these higher prices today. If you look at new car sales, it's roughly 16 million new vehicles are purchased annually in the US. Pre-COVID it was 17 million.

So what happened to that 1 million units of annual car sales? Basically, it's been spread throughout the used market, including in older cars, which are doing better. And actually just think about 200,000 mile cars – this used to be like the anomaly of anomalies. Today, it's actually, you know, fairly common.  

So back to the question of how gas prices are going to weigh on consumer choices. If the purchasing decisions are being made by consumers that are seemingly healthy, it seems to me that the secular preferences for larger, higher trim, more expensive vehicles – that can remain intact even if gas prices are up. 

10:02 

Brad

All right. Let's take a little bit of a different angle here. So you mentioned EVs electronic vehicles earlier and it's definitely something I want to get into as I'm surprised with higher gas prices its not driving more debate around electric vehicles.  

So I know the question of EVs has a lot of considerations, I don’t want to go off on every shoot that we can here. But let's look at what's happening in Europe and China, where uptake has been much higher than the US. And if part of that trend is due to higher gas prices, I wonder if this gas price issue will stoke more interest for EVs back here in the US, especially if the total cost of ownership equations now relatively more attractive?

10:39 

Dan

Yeah, I'll go back to my argument of secular preferences of consumers, because I think that that's weighing more on purchase decisions just than the affordability question. So you're right yeah, gas prices outside of the US are one of the reasons why consumer preferences for EVs have grown. 

Just to put some numbers on it. Whereas EVs in the US accounted for less than 10% of new car purchases last year, in Europe it was a quarter of purchases. China, it was over half. 

11:04 

Brad

All right. I'm going to put my economics degree to good work here. So such a huge gap. I'm guessing that can't all be on them demand side? 

11:10

Dan

Yeah of course, right. That's  correct. And it's not surprising that there is a wider set of low cost EVs in Europe and China, which really is at the core of that larger mix of EV. And by the way, these smaller vehicles, they're consistent with lower mileage ranges needs in those markets. 

But in the US, on the flip side, not only have we not really seen truly affordable EVs, but because of the preference for larger vehicles in the US, it's really more difficult to electrify those vehicles. And with Americans generally driving longer distances, this is really challenged the viability for low range options.  

I think that there are some significant policy differences between the US versus Europe and China on the side as well. 

11:51 

Brad

Well, I'm not going to argue with the Americans driving longer distances after the amount of a youth sports driving I did this weekend. But one thing I would say, you know, for those of us who aren't sitting in this industry every day, it would seem US policy has moved away from being more supportive of EVs.  

12:06

Dan 

Yeah, that's definitely the case. But again, that's not the full story. What's interesting is that in the US last year, even with some really attractive leasing deals we saw in EVs, we never got the full inflection on EV mix that we would have expected.

Just to put some context on this, there were points last year you could lease a Tesla model three or a Chevy Blazer EV for a monthly lease price in the roughly $250 a month range. These are really good deals, especially when you compare them to the lease prices for base gas powered models. So that tells you that EV purchasing decisions are about more than just headline affordability and things like charging, availability range, model options, consumer education, all of these things play a role as well. 

12:48

Brad 

All right. So I think honestly, I have to conclude for right now, it's fair to say that EVs aren't benefiting meaningfully from higher gas prices in the US, even though on paper they clearly should be. 

12:58 

Dan

Yeah, I think that's fair. If I were, gas prices were enough on their own, we'd have seen a clear inflection by now. But the fact that we haven't tells you that the constraints are still binding. 

13:08

Brad

All right, let's go to one last area. And that's been on my mind as well. And that is autonomous driving. And maybe it'll make me seem incorrect in my comments earlier about consumers all needing cars, right. So fuel prices probably don't matter as much on the autonomous driving front, but it does kind of bring up the spirit of the fuel price question. 

So how sensitive are consumer consumption choices to shifting costs? Just broadly, when I go to cities like San Francisco or LA, where I'll be shortly, I now see driverless Waymo cars on many blocks. It's not just a curiosity anymore, and it's a real commercial service and a rideshare option for consumers.  

And so right now, I think it's just a substitute for ride hailing, but it's hard not to imagine at some point, with more scale and tech improvements, and the cost of all electric autonomous fleets will come down dramatically. And with that, the consumer will be offered lower prices. And if gas prices stay too high. I could imagine some consumers might choose to substitute vehicle ownership instead of rely on autonomous ride hailing?

14:10  

Dan

Okay, Brad, the point you're bringing up. This was once a dream. This is very real now, and I think people need to appreciate that, especially if you haven't been to these cities and seeing these vehicles. 

As our colleague Ross Sandler can attest, Waymo is aggressively scaling its operations throughout the US. They're operating or testing in roughly 25 cities in the US. Tesla also ramping on robotaxi operations. Yes, they've only pulled the driver in a few Texas cities, but their testing a handful of other cities, they want to aggressively ramp. And so I think the question you're getting at that, if the cost comes down from the factors you mention, is there a path for convergence with the cost of vehicle ownership?

Right now, the cost per mile is in line with rideshare, which is in that call it $3 to $5 per mile range. But conversely, the average cost per mile of vehicle ownership is roughly $0.80. So that's a big gap.  

15:00

Brad

All right. So I love your enthusiasm clearly for the the these type of vehicles. But I mean the math you just did –rideshare and car ownership aren't exactly substitutes at these price points. 

15:12 

Dan

No they're not. But to your point, it's widely expected that over time scaling, tech costs, these are going to drive down that autonomous cost per mile. The tipping point we hear a lot about is this cost per mile going down to $1 per mile. And at that level it's pretty close to vehicle ownership. 

So you will see some people at that level sacrifice personal vehicle ownership, instead opt for retail. I think where it's more likely to happen is around the second car in the household, the car that just takes you to or from the train station. But back to the points I said earlier on consumer preference. It's about more than just affordability.

This equation has to be balanced against the desire for consumers to own their vehicles, the segment preferences, and exactly what job that vehicle serves. You were talking about getting from point A to point B, that is a job. There are other jobs for cars as well.  

15:58 

Brad

Well, I thought my car originally was just a train car. And then you have your second kid and it isn't necessarily the case.

So look, in summary, I think what this tells me is fuel prices are powerful, but they're competing with a lot of other forces that are shaping mobility decisions. That’s why you’re an autos and mobility analyst, right? 

And so it may explain why all shocks struggle to fully reset how Americans by cars. But there's a lot there for all of us to think about next time we're thinking about buying a car.

So thank you for joining me today, Dan.  

To learn more, clients of the Investment Bank can read more of Dan's views on our Barclays Live Equity page. 

Thanks for listening and don't forget to subscribe so you never miss an episode. See you again on The Flip Side.