'It is clear that the business in the mature North American and certain European markets could be dragged down to lows we haven't seen since the recessionary days of the early '80s,' General Motors Europe president Carl-Peter Forster said.

 

'To put it bluntly, the rise in oil is having a profound and permanent impact on the fundamentals of our business -- and not just in North America,' Forster said on the GM web site.

 

'Adding insult to injury, while energy costs are draining the consumer side of our financial equation, the impact of skyrocketing commodity prices and the huge disparity between the euro and most other currencies are seriously dragging down the production side of things here in Europe,' Forster said.

Scope of the problem

Investment banker Credit Suisse said many investors have yet to come to terms with the scale of the imminent hit.

 

'Oil's impact on demand poses a greater threat than rising input costs, significantly increasing the risk of a 1970s-style shock to vehicle sales,' Credit Suisse autos analyst Stuart Pearson said in a report.

 

'We do not yet foresee a repeat of the 1973-74 oil crisis when car sales fell 12 percent, or the early 1990s recession when car sales fell 17 percent, but neither scenario can be ruled out,' the report said.

 

Meanwhile Credit Suisse still expects sales in Western Europe to fall just 3 percent in 2008 and continue to slide in 2009.

 

Western European car sales totaled 14.8 million in 2007, according to Global Insight.

 

Credit Suisse said record oil prices are forcing Europeans into significant lifestyle changes, with preferences turning to even smaller cars, as the average cost of fuel rises to about $1,100 a year. Some are even forsaking their cars for trains. This switch to smaller cars is costing manufacturers upwards of about $1.1 billion in annual profit, the investment bank said.

Raw material prices

In addition, the cost of raw materials like steel is also zooming.

 

'Our raw material model shows how an estimated $7.9 billion raw material headwind will hit the sector. We calculate a $280 per vehicle headwind for mass makers, potentially crippling in the context of average profitability of $790 per vehicle,' the bank said.

 

Another potential problem for the car manufacturers in Europe is new regulations seeking to drastically curb emissions of carbon dioxide (CO2) which are currently being negotiated by the European Union (E.U.). This might surprise Americans because European cars now, without direct pressure from governments, achieve an impressive average 35 miles per U.S. gallon, compared with about 25 mpg in the U.S. Washington has agreed legislation which will force American cars to match Europe's achievement today, by 2020.

 

The E.U. wants to raise average fuel economy to the equivalent of about 43 miles per U.S. gallon. Manufacturers that fail will be subject to huge fines. The original proposal was for this regime to start in 2012; now this is likely to be postponed until 2015.

 

Concern about fuel economy from car buyers, as well as pressure from regulators, is forcing car manufacturers to accelerate the development of piecemeal fuel saving technologies which will initially include turbo-charging, direct-fuel injection, mild hybrids and dual clutch automatic transmissions. Major changes like plug-hybrids will follow.

BMW, Mercedes best positioned

German premium manufacturer BMW, with its plan to sell all its current models with regenerative braking and stop-start fuel saving, is said to be ahead of the game.

 

In financial terms BMW and its compatriot Mercedes are the best positioned to withstand the pressure from falling sales, according to Credit Suisse, while Peugeot-Citroen of France and Italy's Fiat are the most vulnerable.

 

But not everybody is saying that a crisis is imminent.

 

Maria Bissinger, European Head of Automotive and Capital Goods Ratings at Standard & Poors, reckons that strong sales in Eastern and Central Europe will mitigate the impact from the poor performing West.

 

'We think that overall European new car registrations will remain on a stable level in 2008 and 2009. The profitability of European automakers, while on a modest absolute level, has actually improved recently as a result of the restructuring measures every player in the industry has undertaken. We believe, however, that the increase R&D spending to meet the proposed CO2 regulation, as well as high raw material costs, will add to the short and longer-term challenges the industry is facing,' Frankfurt, Germany based Bissinger said.

 

Weakening economic conditions

 

'So far, the record-high oil prices have not resulted in a drastic change in consumer buying patterns comparable to the U.S. because European fleets have been skewed toward cars and smaller segments for a long time. Nevertheless, weakening economic conditions in several main European countries are leading to reduced consumer confidence and delayed new-car purchasing decisions,' Bissinger said.

 

Some investment banks think even emerging markets might not be able to bail out the manufacturers.

 

Citigroup Global Markets pointed out that recent sales in Central and Eastern Europe, which had been rocketing ahead and promised to provide a safety net for the manufacturers, had turned negative. Scarily, even China, where the likes of VW/Audi, BMW, Mercedes and Porsche almost have licenses to print money, performed poorly in May.

 

European manufacturers also have been increasing production in lower-cost Eastern Europe, primarily small cars. If the contraction in the West does materialize, experts believe that this will lead to an increased shuttering of expensive plants there.

 

Deutsche Bank thinks the increasing cost of producing cars because of rising raw material prices might force takeovers and mergers on to the industry.

Consolidation might restore pricing power

The bank said that because competition in the car industry is so intense, no one company can force price increases on the public.

 

'This is in sharp contrast with the truck industry which has consolidated and is no longer suffering from raw material price increases. We are thus wondering if the auto industry will have to consolidate further to have more pricing power,' Deutsche Bank said.

 

Manchester University's Williams agreed that Fiat and Peugeot-Citroen are likely to be under the most intense pressure in the face of a severe downturn because of their heavy dependence on European sales, although Fiat is currently riding high on profits generated form its Brazilian subsidiary. Companies like Volkswagen of Germany, with its huge global portfolio, not to mention its Audi premium subsidiary, will be able to compensate for European weakness.

 

But nobody can hide from the impact of a steep downturn.

 

'This means distress for the car manufacturers because this is a volume business and you need to punch the stuff through the factories to make a profit. Below 70 percent (capacity use) can be very difficult to turn a profit,' Williams said.

Credit Suisse is relentlessly negative

'There are plenty of reasons to be pessimistic regarding the extent and duration of the current downturn in the European market. A potentially sharp deterioration in housing wealth together with a rising interest rate outlook adds to the pressure on demand that we expect from today's record oil price. Essentially, in a 'stagflation' economic scenario, we see little motivation for European consumers to buy new cars for which the cost of ownership is soaring with fuel prices,' the bank said.