Germany, Internal Combustion Engines and the Problem With Long-Term Investment Theses

Editors’ Note: MarketMinder doesn’t make individual security recommendations. The below merely represent a broader theme we wish to highlight. Also, MarketMinder favors no politician nor any political party, assessing developments solely for their potential market impact.

Two and a half years ago, California Governor Gavin Newsom issued an executive order directing regulators to ban gas-powered cars by 2035. As California goes, so goes the nation, said the zeitgeist. Europe, with its push for “net zero” carbon emissions by 2050, seemed sure to follow. A full-on rush for electric vehicles (EVs) ensued. Throughout 2020 and 2021, they were one of several next big things investors chased. It was all based on a simple thesis: that regulatory changes today would dictate innovation and consumer choices over the next decade and a half. There is some truth to this. But there is a risk in carrying it too far: Such thinking ignores the potential for all manner of unforeseen technological and political developments along the way, any one of which could buck the projected trend—a key reason why investors should focus on the next 3 – 30 months, not decades. Germany and Italy have just delivered the latest reminder.

For a while now, the EU has been working on its so-called Green Deal mandating how society pursues net zero. Everyone has long presumed it, too, would ban internal combustion engines by 2035, falling for the same flawed logic as California’s leadership. But the debate was far from settled, and not just because the bloc’s energy crisis exposed the risks in exponentially raising electricity demand without ramping up stable power generation capacity. Nope, there was also opposition from Germany and Italy, perhaps tied to two legendary sports car manufacturers with horses in their logos.

It isn’t just that petrolheads love engines with a loud vroom. Porsche and Ferrari have actually spent plenty of time and money on electric and hybrid offerings, and several automakers are banking on demand for electric muscle cars. But they have also spent resources on a problem confronting owners of older vintages: What happens if fossil fuel bans make it impossible to refine and sell gasoline? What happens to collectors in that world, not to mention the after-market value of older models? And if after-market value plunges, how will luxury sportscar makers be able to continue charging top dollar, pound and euro for cutting-edge, gas-powered models today? Logically, the prospect of increased scarcity would boost demand as an internal combustion engine ban approached, but that likely wouldn’t be enough to sustain high prices if the owners’ ability to drive the things became impaired.

Where there is a will, there is a way, and engineers believe they have found that way: e-fuels. As in, synthetic fuel. Not biofuel from algae, although that cool technology is also in the works in Japan. Not ethanol, which some complain burns too hot and harms engines. No, e-fuel is an elegant solution to a lot of problems. It is made by sucking hydrocarbon particulates from the air—cleaning prior pollution—and rehydrating them, creating a fuel that has basically the same chemical properties as refined petroleum. The goal is to power this process with renewable electricity—be it wind, solar, nuclear or something new—to make it “green” as can be. It wouldn’t require a reorganization of agricultural output, as mass ethanol adoption would. It wouldn’t require exponentially increasing power grid capacity, as 100% electric vehicle use would. And it wouldn’t require ramping up cobalt consumption and all of the ethical, human rights and environmental problems that accompany it. It simply requires there being an actual market.

A handful of startups are pursuing this technology and aiming to figure out how to produce it cheaply at scale now that they have cracked the formula and process. Government subsidies may have largely overlooked it, but Porsche and Ferrari have backed it financially. And so, those two raised their hands and asked their governments to convince Brussels to exempt e-fuels from its proposed internal combustion ban. After much negotiating, they won. On Monday, the EU announced internal combustion engines that run only on e-fuel will still be allowed from 2035 and beyond. That has shifted the American conversation markedly, with many suspecting California and the US will follow Europe’s lead as e-fuel renders prior policies moot.

In short, it took just one regulatory exemption to throw EVs’ eventual, long-term conquest into doubt, raising a question: What else could change to alter automobile production and consumption trends over the next decade? What is coming down the pike that investors can’t see now, and how could that change supply and demand for EV stocks—and automakers overall—over the next 5, 10 or more years? The short answer is no one knows, which we think makes it rather foolish to base any portfolio decisions on fuzzy expectations for climate policies. The trends today are unlikely to be the trends several years out.   

This isn’t the first time we have seen this. Remember when oil spiked in 2008 and everyone thought tiny cars were the future and big SUVs were history? The shale boom put that one to bed. Then EVs took the spotlight before crashing in 2022’s bear market, in part because the legacy automakers were able to subsidize their own cheaper EV models with bigger-margin gas guzzlers. Now e-fuel could extend interest in traditional and hybrid engines. And after that? Will the game changer be cobalt-free batteries? Mini-modular nuclear reactors re-shaping and re-energizing (pun intended) power grids? Something else?

The big fat who knows that answers all of these questions is why we don’t think it makes sense to look more than 30 months out when making investment decisions. Within the next 3 – 30 months, it is feasible to put probabilities on how supply and demand will evolve. Within that horizon, if you wish to wager that EV use will grow, fine. We know what general technologies are on the immediate horizon. We know what politicians are debating. But beyond that, there are too many unknowns on the supply and demand fronts. Markets move on probabilities, not possibilities—if you can’t assign probabilities to outcomes, how can you form rational expectations for which categories and companies will do best?

So rather than trying to guess at long-term winners and losers, we think it makes most sense to position for the foreseeable future. Determine whether stocks are likely to be in a bull market and then, if so, position yourself to maximize the likelihood of capturing those bull market returns. Let compound growth work its long-term magic.