Scottish Firms Impact Assessment

As stated in the ‘public Consultation’ section on page x, there was an extensive stakeholder engagement programme to understand better the views and opinions on the various design features, which included roundtables, official-led workshops (including a Scotland specific workshop) and bilateral meetings with a variety of organisations that included:

  • vehicle manufacturers
  • trade associations
  • chargepoint/infrastructure operators
  • energy providers and distributors
  • pro-electric vehicle organisations
  • fleet operators
  • engine/drivetrain manufacturers
  • non-governmental organisations
  • transport operators
  • insurance companies
  • delivery companies

Competition Assessment

These regulations will affect incumbent manufacturers as well as potential market entrants. It is therefore prudent to consider the potential effect on competition in the car and van markets.

The regulations will have some differential impact on firms of different sizes, as small volume manufacturers (SVMs) are proposed to be exempt from annual ZEV targets. SVMs are those with fewer than 2,500 car or van registrations per year and may be unable to fund investment in ZEV production, and/or incur disproportionate costs in administering the scheme. No derogations are proposed for manufacturers with annual registrations exceeding 2,499.

For non-exempt manufacturers (around 99.5% and 97.5% of sales, for cars and vans, respectively), these regulations are expected to apply similarly. This is because each manufacturer’s target is based on a proportion of their sales in a given year, so it inherently scales with their size relative to the rest of the market. In terms of their UK presence, then, the requirements of the scheme relative to the manufacturer’s size is likely to be broadly equal.

However, there are some costs associated with the scheme which are likely to be relatively fixed, most prominently the costs of setting up new business functions to monitor and ensure compliance. We expect these costs to be relatively small, given any new business functions will replace those that monitor and ensure compliance under existing EU regulations. Nevertheless, as these are not expected to vary closely with manufacturers’ sales, larger manufacturers may be at some advantage to smaller ones, as their costs could be spread over a greater number of sales.

Current analysis suggests that the costs of setting up this function, relative to current regulatory requirements, are likely to be less than £200k per manufacturer, on average. The effect on competition of these fixed costs is likely to be negligible.

As SVMs are not set binding targets, they may choose not to incur the fixed costs associated with monitoring and evidencing compliance. For this reason, these regulations will have a differential impact on SVMs versus non-SVMs. However, SVMs hold very small shares of the car and van markets; therefore, the effect of this differential impact on competition and market structure is expected to be minimal. In addition, some SVMs may choose to sell ZEVs and the allowances that they are allocated, though doing so would lead to administrative costs. This would reduce the average differential impact between SVMs and other manufacturers.

Smaller manufacturers above the SVM threshold could be perceived to be placed at a disadvantage compared to SVMs based on the proposed thresholds, however these regulations are broadly aligned with the thresholds in the regulations which they replace. The current retained EU CO₂ regulations provide derogations in the form of bespoke targets for SVMs which have between 1,000 – 10,000 and 1,000 – 22,000 registrations, for cars and vans respectively, across the whole EU market.

If these thresholds were to be applied proportionally to manufacturers’ domestic sales, the corresponding upper bounds would be circa 1,600 registrations for cars and circa 3,500 registrations for vans. The proposed threshold of 2,500 for both cars and vans is relatively closely aligned with these thresholds and is therefore not expected to have a significantly different impact on competition compared to the existing, baseline regulations.

In addition, a number of policy details are proposed, which intend to limit differential impacts which could affect competition in the automotive markets (as set out in Section 1). The rationale and methodologies under-pinning each of these policy details are explained in greater detail in the annexes.

Firstly, manufacturers will be permitted to trade allowances. This will help address uncertainty over sales volumes and proportions in individual years, and allow firms facing relatively high costs of decarbonisation to minimise costs by purchasing ZEVM and CO₂ allowances from firms with lower decarbonisation costs.

Secondly, banking and borrowing permits some level of under-/over-delivery in individual years; this is intended to allow individual manufacturers to align their longer-term production plans with annual targets and mitigate adverse impacts for manufacturers whose ZEV production is planned to ramp up later in the delivery period. Borrowing may also allow under-delivering manufacturers to reduce compliance costs if they expect to face lower decarbonisation costs in the future than the price of ZEVM and CO₂ allowances determined on the open market.

Thirdly, the compliance payment is also expected to mitigate any anti-competitive effects. The payment will be charged on a per-allowance of under-delivery basis, effectively functioning as a ‘price cap’ for ZEV allowances. This will prevent excessive costs of compliance for under-delivering firms by limiting the price which can be charged by over-performing firms.

Similarly, the Government may exercise discretion in the operation of an enforcement regime, should certain exigent criteria be met. This is intended to ensure that these regulations are reflective of - and consistent with - the geopolitical and industry-specific context. This could, for instance, be used to suspend payments for under-delivery should there be compelling evidence of supply chain issues which are outside the control of regulated vehicle manufacturers.

Taken together, then, the derogations offered to SVMs suggest that these regulations will impose no additional barriers to entry for car and van manufacturers. Manufacturers with annual sales exceeding 2,500 vehicles are proposed to receive no derogations, and those at the bottom of the distribution may face some disadvantage relative to larger manufacturers, who may be able to spread fixed costs over a greater number of sales. However, the marginal effect of these regulations on administrative costs is expected to be very small, therefore these costs are not expected to be disproportionate.

The market and competition

Due to differences in manufacturers’ product cycles and decarbonisation strategies, the regulations may affect different manufacturers in different ways. Some manufacturers have already committed to phase-out dates for non-ZEVs and many have begun (or plan to begin) producing ZEVs, whereas some other firms may have intended to decarbonise their sales using non-zero emission technologies, during the transitional period, or to do so over a longer time horizon. In the simplest form of the ZEV mandate, with annual targets and no sources of flexibility, there could be undue differential impacts for these two groups of firms.

In addition, in absence of any exemptions and/or derogations, the regulations could cause barriers to entry and thereby limiting competition. This is because manufacturers would only be able to enter the market if they had already developed ZEV models which they would sell alongside any non-ZEV models.

Several policy features are proposed to mitigate these risks: flexibility achieved through the provision of banking, borrowing, trading, and non-compliance payments allow manufacturers to meet their obligations through delivering ZEVs in different time periods and/or purchasing allowances from Government or other manufacturers. This is expected to mitigate the potential differential impacts caused by the regulations.

To address barriers to entry, ZEV mandate allowances are offered to small volume manufacturers (SVMs). SVMs are not set binding targets, although they may sell ZEVs and trade the allowances they are allocated. This avoids creating barriers to entry, although taken in isolation there may be barriers to growth, as SVMs producing no ZEVs would be required to significantly alter their product mix once they cross the SVM registrations threshold.

Taken together, these measures are expected to preserve healthy competition by mitigating differential impacts based on manufacturers’ pre-determined strategies and their sizes, and support competition by avoiding barriers to entry and growth.

Supply constraints

The ZEV mandate is expected to lead to an increase in the supply of EVs to the GB market. At the same time, global demand for EVs and several other low-carbon industries is expected to rise, raising demand for similar input materials. The UK makes up a small proportion of demand for these inputs, and its share of production is much lower. For this reason, it is exposed to global shifts in supply and demand.

Demand for several key minerals such as lithium, nickel, cobalt, as well as other inputs like microchips/semiconductors is projected to increase significantly over the next decade. Supply of these inputs is also projected to increase, in response to long-term, widespread signalling of an increasing push towards electrification of industries which are currently largely dependent on fossil fuels.

For certain input resources (such as cobalt and lithium), the projected increase in supply and demand is expected to be broadly equal, although some small mismatches may occur. In addition, shortages of other inputs, such as semiconductors, are expected to alleviate by the beginning of the ZEV mandate trajectory, as investments expand productive capacity. In these cases, the likelihood of shortages and supply chain issues is likely to be fairly limited.

There are, however, some input markets which may be unable to increase supply at the same rate that demand is expected to increase (based on current technologies). There are also certain markets where production is very concentrated and geopolitical issues may pose a further risk to the supply of these resources. In these cases, it is possible that demand exceeds supply and there are difficulties meeting the requirements of the numerous sectors and nations competing for these resources.

However, there are market developments that will help mitigate supply side risks. Battery technology continues to develop, which is expected to lead to a diversification of the input materials required. For instance, the development of sodium-ion batteries is likely to mitigate strains on global lithium supplies; similarly, several car manufacturers have already begun producing ZEVs with cobalt-free batteries, and batteries free from both cobalt and nickel are also in widespread use.

Furthermore, widespread investment in battery recycling technology is expected in the medium to long-term, and the diversification of resource extraction will expand as the demand for earth minerals continues to rise. This is expected to increase supply of certain battery inputs – for instance, The Faraday Institute expects recycling of Cobalt to produce a significant amount of supply after 2030, and anecdotal evidence from Li-Cycle Corp suggesting that recycled cobalt, nickel and lithium could make up 10%-20% of global demand by the end of 2030. Such developments are expected both to alleviate supply issues in the ZEV supply chain as well as in other low-carbon technology supply chains, reducing competition for virgin, high-grade resources.

With regard to timing, the ZEV mandate will gradually raise the proportion of sales to be made up of ZEVs from 22% in 2024 to 80% in 2030 for cars. This increase will be incremental and has been clearly signalled in advance, meaning that supply chains have notice that demand will be increasing, and that the increase in demand will be gradual.

These technological developments offer several benefits: not only do they diversify the battery supply chain, reducing reliance on individual resources and nations, but they also, in cases, are expected to deliver performance benefits through increased energy density and reduced costs. This suggests that although the ramp-up in ZEV delivery may lead to some risks and costs, these effects are also likely to catalyse developments which will deliver social value in the long-run.

While we think it is unlikely that supply constraints will be binding, given the considerations set out above, there remains a risk of unforeseen circumstances impacting upon supply. As such, as stated in the ‘Consumer Behaviour’ section of this assessment, we have considered sensitivity analysis of constrained car sales. This found that even if ZEV sales are depressed by 10% between 2027 and 2029 (inclusive) this would only result in a relatively small impact of 2MTCO₂e in lost carbon savings from 2024-2050.

The proposals also include a recognition the Government may exercise discretion in the operation of an enforcement regime, should certain criteria be met. This is intended to ensure that the regulations are reflective of- and consistent with- the geopolitical and industry-specific context.