Percentage peril: small print spells big problems for car makers

May 18, 2023 by

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UK-EU trade agreement looks set to cause headaches on both sides of the Channel in 2024

Beyond the reputations that ‘Handcrafted in England’, ‘Fabriqué en France’ and ‘Prodotto in Italia’ command, where something is built really matters as far as price is concerned.

Shipping costs aside, some countries and trading blocs provide more favourable import tariffs if things are made in specific other countries or trading blocs. For example, Canada, Mexico and the United States have a free-trade agreement that allows goods and services to be sold between those countries with no, or reduced, importation taxes. This brings down costs for citizens buying things produced within the trading bloc.

But while it’s easy to say that wine made from grapes grown and processed in California and contained in a bottle from Indiana is entirely made in the USA, cars are more complex. One individual vehicle might comprise 30,000 components from perhaps five or six different nations. If all those components come from places other than where a vehicle is assembled, can the car be said to originate from its place of manufacture from a trade perspective?

A good example of this is the crankshaft in a MINI’s engine, charted by the Guardian in 2017 as it crossed the English Channel three times, covering 2,000 miles in the process. The blank shaft was first sent by a French firm to England for milling, drilling and finishing, before being shipped to Munich where it was installed in a new engine, with that engine then ferried to England for fitment to a car at MINI’s Oxford factory.

What determines whether that MINI is British built or otherwise is a set of legislation known as Rules of Origin, or RoO. These rules currently specify that 55% of the value of the parts that make up a petrol or diesel car, and 40% of the parts that make up an electric car, must be ‘local’ content – meaning the parts come from the country in which the vehicle is built – in order for the vehicle to be considered to originate from that country.

So while the MINI’s engine might be made in Germany and cost, say, £2,000 to build, if the rest of the MINI’s parts cost £18,000 and a high enough proportion of them come from the UK, the MINI can be said to be built here as far as RoO are concerned. That means the 10% import tariff is not applied if the car is exported to the EU – a fate that awaits roughly half of all the cars that are manufactured here according to the European car trade body, the Automobile Manufacturers’ Association (ACEA).

It’s worth noting that this agreement is reciprocal, so a certain percentage value of the parts that make up a car built in the EU must come from EU countries, otherwise it is slapped with a 10% import tariff when it is exported to the UK. Given around 30% of all cars built in the EU are imported to the UK (source: ACEA), RoO are a big deal on both sides of the Channel.

Enter the electric car

All of this works pretty well for petrol and diesel cars, which can meet RoO regulations and avoid the 10% import tariff when traded between the EU and the UK, but electric cars represent a very different proposition for two reasons.

First, while an engine might cost £2,000 to build and therefore make up a relatively small proportion of the parts value of a car, EV batteries are much more expensive to make, and so represent a much higher parts-value percentage. The US Department of Energy estimates that the cost of an EV battery was $153 (£123) per kiloWatt hour (kWh) in 2022, meaning the 62kWh pack fitted to the UK-built Nissan Leaf costs an estimated £7,626 to manufacture.

Second, neither the EU nor the UK build EV batteries in any meaningful capacity, with around 92% of batteries coming from China, Japan and South Korea; an estimated 85% of all the cobalt used in EV batteries is refined in China, too.

In recognition of these issues there’s a specific annex to RoO for EVs. This currently allows up to 70% of the parts value of an EV battery to come from outside the EU or the UK and the battery to still be considered ‘local’ from a trade perspective, tipping the balance in favour of the car avoiding the 10% import tariff when exported between the two countries.

So what’s the problem?

The problem is that from 2024, as part of the deal agreed between the UK and the EU, Rules of Origin percentages for electric cars are changing. The percentage of local content an EV must be made from is increasing from 40% to 45%, while the percentage of the battery that must be local is rising from 30% to between 50 and 60%. These percentages increase to 55% for vehicles, and 65% for batteries from 2027, too.

As a couple of examples, let’s look at two cars – one petrol, one electric. These prices and their proportions are educated guesses, but the important ones to bear in mind are the engine cost, versus the battery cost, which bear some relation to reality.

Petrol car build cost and proportions

Total cost to build: £20,000

Value of components made in the UK: 60%

With a 55% threshold for local content, this petrol car is exempt from the dreaded 10% import tariff is exported to the EU.

Electric car build cost and proportions

Now let’s run a similar breakdown of an electric car; all the components of the petrol car that are built in the UK are also manufactured here for the EV, but we’re setting the build cost at £30,000 to reflect the fact EVs cost more to make. 

Total cost to build: £30,000

Value of components made in the UK: 40%

So 40% of this EV’s parts are made inside the UK, and that’s fine for now, but come 2024 when the requirement rises to 45%, the car would attract 10% import duties when shipped to the EU, with at least some of that cost being passed on to consumers in showrooms.

Is Brexit wholly at fault?

The instinct is to lay the blame for this potential 10% cost rise in electric cars entirely at the feet of Brexit, and it’s certainly true that we wouldn’t be agonising over RoO were it not for the UK’s decision to leave the European Union.

But the truth is that the legislation is intended to address Brexit just as much as it is a wider, cross-continental issue: the decision to allow only zero emission vehicles to be sold from new in the EU and UK from 2035, and the inability – at present – of the EU and UK to produce EV battery packs in meaningful numbers.

Increase the amount of an EV battery that’s required to come from the UK or EU in order to meet quotas, the theory goes, and you will boost local economies while simultaneously reducing dependence on trade with the current stalwarts of the battery-production scene.

Some of this is beginning to happen, in the EU, at least, with Tesla’s gigafactory in Germany beginning production in 2022 giving hope to the European Union.

Battery ‘gigafactories’ and rare-earth metal refineries take years to plan and build, and market dominances are hard to unseat. But while the EU has an advantage over the UK at this stage thanks to various initiatives, European nations face an uphill battle, regardless of their membership of any particular trading bloc.

So where does this leave car makers?

Not particularly happy, as things stand. Stellantis, owner of Vauxhall, Peugeot, Citroen and others, recently warned it might have to close its Ellesmere Port factory in Cheshire, where the EV Vauxhall Combo Electric, Citroën E-Berlingo and Peugeot e-Rifter are built, as a result of RoO percentages ramping up in 2024. The firm said: “Our request to government is to gain agreement with the EU to maintain the current Rules of Origin until 2027.”

Negotiation details aside, Stellantis is no outlier: Mike Hawes, chief executive of the Society of Motor Manufacturers and Traders, which represents the UK car industry, recently said RoO “pose a significant challenge to manufacturers on both sides of the Channel”, and that “we urgently need an industrial strategy that creates attractive investment conditions.”

A similar sentiment is held by the SMMT’s European counterpart, the ACEA, which said that while “there has been massive investment in European battery supply chains”, the organisation “has requested that the current phase-in period for battery rules is extended by three years.”

For what it’s worth, the UK had asked for more generous RoO percentages that would have allowed EVs to contain 10% more non-local content that the EU ultimately agreed on, so that might be a starting point for politicians on both sides to work from.

Here’s the kicker

If EU-made EVs can’t meet 2024’s tough new RoO percentages they’ll immediately become 10% more expensive in the UK. Same thing goes for car makers who build cars in the UK and export them to the EU.

Then there’s the small matter of China, which has been ramping up its presence in UK and EU automotive markets of late.

Chinese cars imported into the UK are currently subject to tariffs of 10% under World Trade Organisation rules. Given Chinese EVs are already extremely competitive on price, if EU-made cars shipped to the UK are soon to be slapped with a 10% tax bill for not meeting 2024’s RoO percentages, what will that do to the 30% of the European car market that is dependent on exports to the UK, and the 50% of cars built here that are sent to the Continent?