VW prepares to fight latest diesel cheating allegations

(Bloomberg) -- Volkswagen Group's denial of new diesel-cheating allegations by the U.S. Environmental Protection Agency (EPA) sets up a new fight with U.S. regulators that could prolong a scandal that threatens to weigh it down for another year or more.

More than 10,000 Volkswagen Group vehicles in the U.S. including Audi and Porsche models have been found with illegal software that masked higher emissions than allowed by law, the U.S. Environmental Protection Agency (EPA) said in a statement on Monday.

Unlike the original Sept. 18 announcement involving small cars when VW admitted to rigging software to evade U.S. emissions limits, VW says that the EPA is wrong in implicating new models -- including, for the first time, the Porsche Cayenne.

"VW stresses that no software has been installed in the 3.0-liter V-6 diesel engines to change emission results in an inadmissible way," the company said in a statement. "Volkswagen will fully cooperate with the EPA to clarify the matter unreservedly."

The EPA said Monday its testing found some 2014-2016 VW, Audi and Porsche models with 3.0-liter engines have equipment to alter turn off emissions systems when they are being driven on actual roads and not in the testing lab.

"VW has once again failed in its obligation to comply with the law that protects clean air for all Americans," said Cynthia Giles, assistant administrator of EPA's Office of Enforcement and Compliance Assurance.

Porsche said it was "surprised" by the EPA announcement. "Until this notice, all of our information was that the Porsche Cayenne diesel is fully compliant," the division's U.S. unit said in a statement Monday.

The EPA and the California Air Resources Board (CARB) said on Sept. 18 that they were investigating VW after the carmaker admitted to rigging the emissions systems of diesel vehicles so they would pass pollution tests. That announcement affected almost 500,000 cars in the U.S., and 11 million worldwide.

More fines possible

The expanded probe adds only about 10,000 more cars now on the road, as well as an undetermined number of 2016 models, but draws in the prestigious Porsche brand that had been untouched by the scandal so far.

During stepped up testing of diesel models on the road, EPA, CARB and Transport Canada discovered software in VW, Audi and Porsche models with 3.0-liter diesel engines that turns pollution-control equipment on only when the cars are in "temperature conditioning" mode that mirrors federal test conditions, the regulators said.

In real-world driving, the controls are turned off, making the vehicles far more polluting than VW certified them to be.

The affected models are the 2014 VW Touareg, the 2015 Porsche Cayenne and the 2016 Audi A6 Quattro, A7 Quattro, A8, A8L and Q5. The vehicles’ emissions systems were rigged to turn off "one second" after government testing was complete, improving performance but causing nitrogen oxide emissions up to nine times the legal limit, Giles said.

VW "knew or should have known" that the vehicles had software installed that "bypasses, defeats or renders inoperative" emissions controls, the EPA said.

Under the Clean Air Act, VW may be liable for fines as high as $18 billion, based on maximum penalties per car involved, and it faces further costs from lawsuits filed in the U.S. and Europe.

1M more recalls?

The second EPA notice could trigger a recall of an additional 1 million cars, J.P. Morgan analyst Jose Asumendi said in a note to clients. "Worst case scenario, we estimate VW would have to top up the 6.7 billion euros provision by another 1 billion euros by year-end."

"All in all, this represents a limited negative impact on the current situation but does raise some questions whether we have seen the bottom of this investigation," Asumendi said.

Alexander Haissl, an analyst at Credit Suisse, said: "Expansions of sales sanctions on affected models is now likely to be increased, and the possibility of leniency from the EPA is now reduced."

Arndt Ellinghorst, an at Evercore ISI, said in a note that VW, not the EPA, should have uncovered the problem. "It seems extraordinary that this was not flagged within the company, investigated and declared in light of the challenges which the company has faced in the last 2 months."

The cheating scandal has shattered Europe’s largest automaker, leading to the resignation of its chief executive, Martin Winterkorn. VW set aside 6.7 billion euros ($7.4 billion) in the third quarter for recall repair costs and has already acknowledged this won’t be enough.

Mueller could be tainted

The conflict could also have implications for Matthias Mueller, VW's new CEO who was installed to help lead VW out of the emissions scandal. He will now have to contend with a spotlight for the first time on Porsche, the VW-owned nameplate he led before being appointed to his current post.

Mueller has professed no knowledge of the emissions cheating before it was uncovered by regulators.

Joe Phillippi, president of AutoTrends Consulting in Andover, New Jersey, said the inclusion of a Porsche model in Monday's allegations is problematic for Mueller, even if he isn’t directly implicated. If he didn’t know what his engineers were doing, that doesn’t look good for his management of the sports-car brand. For now, the first step is to try to dispel the accusations, he said.

"This just keeps getting uglier," Phillippi said. "If they are going to deny this, they will have to do a deep dive internally and figure out who did what. If the EPA is right, then Mueller could have to fall on his sword, too."

Mueller’s choice as CEO also signaled that the Porsche-Piech family that controls the carmaker wanted to rely on an internal candidate rather than somebody brought in from the outside. When Mueller took over, he vowed to leave “no stone unturned” in his quest to regain the public’s trust after the company admitted to cheating on emissions tests.

Inner circle

VW has hired law firms and external accountants to help shed light on the scandal but the main group of managers tasked with uncovering the probe is made up of the inner circle of the supervisory board, highlighting the company’s reluctance to look outside for assistance. The new chairman of the board, Hans Dieter Poetsch, was until recently the long-time CFO of the company.

If the company is guilty of cheating on these additional models, the extra 10,000 noncompliant cars in the U.S. will not do much more damage than VW has already sustained, said Maryann Keller, an independent auto-industry consultant in Stamford, Connecticut. The real trouble for Mueller comes if he or his management team knew what was going on before the U.S. government found the software cheat.

"If he knew," she said, “then they will have to find someone else."

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