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Will CAFE Burn the Germans?

Moment of Zenlea

When President Obama announced new federal fuel economy standards in July 2011, he was surrounded by auto executives. The photo op demonstrated that the industry was onboard with the need to improve fuel economy to 54.5 mpg by 2025. A few German faces, however, were missing from the crowd.

"We are not in agreement -- that's a fact," says William Craven, senior manager of regulatory affairs for Daimler. Neither did Volkswagen Group endorse the new standards.

That's because German automakers face some particular challenges in meeting the new standards. No, it's not just because Americans don't like diesels. The standards have a curve for vehicle footprint -- bigger vehicles have lower targets -- but not for price segment. Mercedes and Volkswagen, along with BMW, rely heavily on the sales of luxury vehicles in the United States -- cars that tend to be more powerful and less efficient, aimed at customers less likely to make fuel economy a priority.

"They may be more challenged from their market position," says analyst Phil Gott, senior director of long-range planning for IHS Automotive.

The biggest issue may not be the standards themselves but the consequences. In the past, the Germans have paid millions of dollars in fines for missing fuel economy targets. It was the cost of doing business. "They used to just sell the cars and pay the fines," Gott says. But under the new rules they won't be able to sell cars if they miss the cut.

So, regardless of whether the German automakers agree with the standards, they plan to comply. Here's how they're going about it.

Mercedes-Benz: Plugging in

At the moment, Mercedes-Benz is treading water -- it has bought carbon credits via the new cap-and-trade system and might have to continue to do so.

Down the road, R&D chief Thomas Weber promises a "plug-in hybrid offensive" -- 10 of them between now and 2017 -- starting with the Mercedes-Benz S550 plug-in hybrid. We can also expect more compact, four-cylinder-powered Benzes like the CLA- and GLA-Class.

Will that be enough? Weber agrees when I point out that luxury plug-in hybrids don't tend to sell very well. For now, the automaker is unwilling to compel customers to buy plug-ins by pulling the plug on gas-engine models. For instance, Mercedes will still offer the V-8-powered S550 alongside the plug-in. The AMG brand, aside from the CLA45 AMG, promises to remain an eight-plus-cylinder brand. Longer term, Mercedes "will diminish combustion step-by-step," Weber says, but the automaker worries about moving too fast for luxury car buyers.

"We are willing to change, but we can't do it alone," Weber says.

Audi: To E-tron or not to E-tron?

Audi has plenty of ideas for improving fuel economy: First there was the R8-based E-tron, then it introduced a smaller, rear-wheel-drive E-tron followed by A1 E-tron, powered by a rotary engine and an electric motor. All promising projects, but, as European bureau chief Georg Kacher reported last year, little work was done on any of them.

In truth, Volkswagen Group's main green strategy has been to sell more Volkswagens -- 800,000 annually in the United States by 2018. That's actually not a bad plan, as a bunch of efficient Jettas and Passats would go a long way toward offsetting relatively thirsty A8s and Q7s. Alas, the execution has been lacking. Sales for the Volkswagen division have been slipping while Audi continues to grow, now accounting for nearly 30 percent of Volkswagen Group's sales in America. If VW hopes to continue meeting the fuel standards, Audi is going to have to carry much of the weight.

There are signs it's planning to do that. In July 2013, Audi replaced Wolfgang Dürheimer, who had killed the R8 E-tron, with Ulrich Hackenberg as technical development chief. Automotive News reports that Audi is developing several plug-in hybrids, starting with the A3 Sportback E-tron to premier in 2015. The Q5, Q3, and Q1 crossovers will also have plug-in variants, Kacher adds.

BMW—Betting big on Project i

BMW occupies the most interesting position. It's smaller than either Daimler or VW, yet it has been thinking seriously about improving efficiency for the longest time. It introduced the Mini in 2002 and has expanded it into a brand of relatively efficient compact vehicles. The automaker also poured resources into Project i, whose first fruits, the BMW i3 and BMW i8, have finally arrived. It's no coincidence that BMW endorsed the CAFE standards while its German peers did not.

Yet in some ways, the BMW strategy is the riskiest. Project i is enormously expensive, requiring development of a new platform, new powertrains, and a whole new supply chain for carbon fiber. For all that, it has no guarantee folks really want a $50,000-$140,000 electric car.

An opportunity for challengers

This challenge for German automakers could present an opportunity for brands that have long eaten their dust.

CAFE standards are weighted by sales for an automaker's entire fleet. For instance, Cadillac's emissions are counted as part of the overall number for General Motors. A rather small part, the Chevrolet Cruze alone, far outsells the entire Cadillac lineup. Lexus and Infiniti enjoy similarly large cushions courtesy of Toyota and Nissan.

It is thus no coincidence that these brands are all investing in high-performance cars - such as the V-8-powered Lexus RC F, the GT-R powered Infiniti Eau Rouge, and a new Cadillac V-8 coming late in the decade for the LTS flagship sedan. Mind you, none of these brands can afford to gleefully ignore fuel economy -- all of them offer hybrids and will likely introduce more -- but neither do they need orient their entire product strategy around meeting the standards.

They can do it

Before you shed too many tears for the German luxury brands, remember that they all have plenty of money and engineering resources to throw at this problem. They also collectively dominate the premium auto market and enjoy a deep reserve of goodwill with customers. If anyone can pioneer efficient new vehicles, it is BMW, Audi, and Mercedes-Benz.

"They can do it, obviously," Gott says. "The question is at what cost?"

With reporting from Georg Kacher.