Catch-22: If Diesel Sales Boom, Will Their Cost Advantage Bust?

To a very small, select group of enthusiasts, diesel cars or utility vehicles have a lot of allure, with their strong, fuel-efficient engines and, for the most part, a great reputation for long-haul durability.

Yet for the rest of us who don’t delight in ‘b5’ biodiesel pumps or pine for compression ignition, whether or not it makes sense to buy a diesel is mostly a question of economics.

Motorists who cover more than the typical number of miles per year, and tend to do most of it on the highway, could see some reasonably strong cost advantages from driving a diesel car or utility vehicle, versus a gasoline version of the same. Their fuel savings alone, in many cases, could make up their somewhat higher sticker prices in just a few years.

But fuel costs are just part of the picture; the other reason why going with the diesel model keeps your costs lowest is that diesels—currently, and for years now—have had far superior resale value. In fact, if you're the type to trade every few years, they're commanding premiums that quickly negate—in some cases, before even figuring in the fuel savings—any premium you'll pay when new.

For instance, according to Kelley Blue Book, assuming typical miles for both, a 2010 Volkswagen Jetta TDI is now commanding close to $19,900 ($22,830 MSRP when new), while an SEL sedan ($23,455 when new) is now worth about $16,500.

Diesel owners enjoying very low depreciation

According to recent data from ALG—one of the foremost authorities for residual values (predicted resale values)—used diesels are holding their value far better than used hybrids. The typical compact car, like the Chevrolet Cruze, retains about 53 percent of its original MSRP after 36 months. Compact hybrids, including the Toyota Prius, will retain 55 percent on average, estimates ALG, while diesel models will still be worth 63 percent of their original value.

With the introduction this year of the 2014 Jeep Grand Cherokee EcoDiesel, 2014 Chevrolet Cruze Clean Turbo Diesel, and Mazda 6 Diesel, the field of diesel models has grown in a way that should please diesel owners and new-car shoppers.

Meanwhile, sales of new diesels are already on the rise. Year-over-year, ALG notes that the overall diesel market share in 2012 rose from 1.5 percent up to 1.7 percent. Hybrids gained in 2012, too, and they remain about double that of diesels in overall U.S. market share, however.

Market gaining fast, but still small

Looking at 2012, year-over-year, Volkswagen more than doubled its passenger-car diesel sales (due in part to the mid-size Passat), while its sales of diesel light trucks were up 88 percent. Mercedes-Benz diesel sales are just a fraction of that, but this past year in the M-Class, (ML 350 Bluetec especially) it more than quadrupled its diesel light-truck sales.

Oddly, the factor that right now makes diesels so fiscally attractive—their trade-in value—might not do as well if the market has too many new diesels.

ALG, in a recent statement, confirmed that diesels' strong residuals have been in part due to their scarcity on the used-car market; so that as their supply increases, residuals could come down.

That, in turn, could erase the financial benefits of choosing a new diesel model in the first place—or possibly make leases prohibitively expensive if automakers put more diesels out than the market's ready for.

According to ALG analyst Eric Lyman, whether diesels keep the momentum they're gaining in the market depends on two things: public perception and pure economics.

As for public perception, diesel is at last seen by American new-vehicle shoppers as a premium technology, Lyman recently confirmed to us. “We’re really starting to see a shift in consumer behavior the past couple of years, in American consumers valuing the technology,” he said. “So some of the long-held beliefs about 'dirty diesel,' or concerns from decades ago, are finally starting to fade as consumers get more exposure to the technology.”

Supply is short and demand is strong

In economic terms, just like with most kinds of vehicles, it's a matter of supply and demand. And today, with Volkswagen being the only mainstream automaker to offer diesel options, demand far outweighs supply on the late-model used market—which is why values are so inflated.

“We’re going to see more and more automakers introducing that technology, which should help awareness, but it also has an impact on supply relative to those numbers we see today,” said Lyman.

Chevrolet has already priced the 2013 Cruze Clean Turbo Diesel at $25,695, including destination—a price that’s somewhat higher than that of the Volkswagen Jetta TDI. With the Mazda model anticipated to roll in at about the same price, possibly even less, we may see them cutting into VW’s sales, and its inflated late-model used values.

ALG won't yet say whether it’s predicting that Mazda's diesels will do as well as Volkswagen's diesels in residual values, but Lyman says it's a good fit for the brand. “One of the things that Mazda has been doing well is the fuel-efficiency improvements in some of their recent redesigns, and the diesels fit squarely within that strategy,” said Lyman.

That said, success of the Mazda and Chevrolet diesels depends on those same familiar economics: initial pricing, and how long it takes to pay the sticker-price premium back with savings at the pump. Complicating that is that, in the U.S., diesel prices have stubbornly been significantly higher than those of regular-grade gasoline.

Will break-even economics slow diesels down?

“So you get the added fuel efficiency, but you have to pay extra on the front end for the technology, and you have to pay more at the pump—so it just really pushes forward the break-even point on your investment,” summed Lyman.

Automakers don't haveas much wiggle room on diesels' sticker price either, as the technology costs hundreds, perhaps thousands more in manufacturing costs (and related expenses like emissions certification) than a gasoline model

“Ultimately there's a factor at play that's beyond automakers' control, which is the price of diesel versus gas,” Lyman noted.

How does the diesel market expand without that softening on the used-car side, negating one of its key advantages? One scenario Lyman can think of is if gas prices rose up to the five- or six-dollar level for a sustained period. That’s because diesel has been at a lower cost premium in recent years, and as the per-gallon price of gasoline rises, the percentage premium for diesel usually lessens—making these vehicles more attractive, for people who keep a tally of their driving costs.

Diesel component supplier Bosch is, of course, bullish. It recently predicted than ten percent of the U.S. light-vehicle market by 2018 will be diesel-powered; and it counts a total of 42 diesel-powered product introductions just this year—most of them trucks, admittedly.

Will diesels make the jump from niche appeal to mass-market sensibility? Over decades, diesel technology in passenger cars has had a lot of false starts in the U.S. If recent, pleasing-to-drive products from Volkswagen, Audi, Mercedes-Benz, BMW, and now Jeep are any indication, the next couple of years are going to be interesting.

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