Last week, at ACT Expo 2014, I sat down with AB Volvo's (NASDAQOTH:VOLVY) Dennis Slagle, executive vice president of sales and marketing, trucks group, for the Americas. For those not in the know, Volvo is one of the largest makers of heavy trucks in the world, and also owns Mack trucks. Volvo recently pushed back the launch date of the natural gas version of its D13 engine, which will feature HPDI technology from Westport Innovations (NASDAQ:WPRT), to late 2015. Volvo currently offers the Cummins (NYSE:CMI)-based CWI ISX12 G natural gas engine in several of its trucks, but the delay of the D13 LNG leaves the heavy-truck market with a gap in the high power and performance segment.
Volvo is also releasing a version of the D13 that burns dimethyl ether, or DME, in late 2015. With this engine featuring exclusively Volvo technology, what are the potential implications for Cummins and Westport? On the surface, Volvo's development of an engine that uses DME seems to point to both companies getting left on the outside. Let's look at DME as a fuel, and talk about what it means for all three of these companies.
What is DME?
In short, it's a man-made compound that can be produced from natural gas. There are some inherent advantages to DME versus natural gas: It's a liquefied gas at room temperature with moderate pressure, so it behaves more like diesel and gasoline, meaning transport and storage is much simpler and cheaper than natural gas, which must be either super-cooled or highly pressurized. Simply put, DME is more like propane, but with the added benefit that it could support more demand since natural gas is more readily available.
On the other hand, it's not yet clear that DME can be cheaply produced on a large scale. Without disclosing specifics, Slagle told me that Volvo is working with a number of methanol producers to address this problem, describing the manufacturing process as not all that different from methanol production. The thing is, one of the primary driving factors behind natural gas for trucking is the significant cost advantage versus diesel. The jury is still out on where DME prices will fall.
Taking complexity out of trucks and refueling; putting complexity (and cost) into making DME
Volvo D13 DME prototype. Source: ACT Expo 2014.
Slagle talked about how current emissions standards have added significant complexity (and cost) to the modern Class 8 truck, including filtering and aftertreatment systems. He described DME as having the potential to take the manufacturing complexity "back to making a 1995 truck" in terms of simplifying the exhaust and emissions systems needed to meet today's standards. Obviously there's cost in developing an engine that can burn DME reliably and with the same power profile as diesel, but the engine itself would be simpler.
Additionally, the complex and expensive additional infrastructure needed to support CNG and LNG refueling might not be necessary. "One way to look at it," Slagle told me, "is you're moving the complexity out of the trucks and the refueling infrastructure (for CNG and LNG) and into production of the fuel." So it gets back to the cost to make DME. As Slagle said, "we just don't know where the price is going to land."
How does this affect Cummins and Westport?
Mack truck featuring Cummins Westport engine and LNG tanks. Source: Jason Hall.
Either way, Cummins loses out, because it has no "dog" in the fight anymore. Westport Innovations could also see some harm, because now you have its HPDI technology competing with Volvo's typical "go it alone," fully integrated products. So, again, on the surface, the appearance is that Volvo's efforts to advance DME as a fuel could negatively impact both Westport Innovations and Cummins. Simply put, in about 18 months, Volvo will be launching two new engines based on the company's D13 engine platform, which is the best-selling engine in the world larger than 10 liters, according to Volvo. There's little doubt that these engines, which will be more powerful than the current CWI ISX12 G, will take some market share in applications that need the extra power and capability.
Not so fast: DME won't succeed if Volvo is the only engine maker
Slagle made it very clear that Volvo cannot expect DME to be a success if it's the only company in DME:
We need more than Volvo in this thing. With any of these new ideas, unless we get alignment in the industry ... we get no special competitive advantage by spending the money and going it alone. But at this stage, it looks promising, and the same, by the way, with the 13 liter LNG engine. One (LNG engine) is right now, but this (DME) is a 10-year thing. The scope of this is not three years.
Final thoughts: Still massive opportunity for many years
The reality is, DME is years away from being a viable alternative to diesel. Meanwhile, natural gas is already in the market and significantly cheaper and cleaner burning, and hundreds of refueling stations are built and operating. The Cummins Westport engines are getting plenty of traction in trucking, and the market opportunity remains absolutely enormous. There will be more than 200,000 Class 8 trucks sold in 2014, and if 20,000 of them are natural gas, that will be a huge success.
I think the most likely scenario sees both natural gas and DME playing a role in displacing diesel, but it's unlikely that DME becomes a primary fuel and replaces natural gas completely, because of the cost advantage that natural gas will still maintain over DME. Cummins and Westport Innovations investors can rest easy: DME isn't likely to cause any problems in the short or long term.
Jason Hall owns shares of Westport Innovations. The Motley Fool recommends Cummins and Westport Innovations. The Motley Fool owns shares of Cummins and Westport Innovations. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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