The EU's Struggling ICE Market and the Rise of Hybrid Dominance: A Strategic Shift in Automotive Investment

The European Union's automotive sector is undergoing a seismic transformation. In the first half of 2025, internal combustion engine (ICE) vehicles—once the backbone of the industry—accounted for just 37.8% of new car registrations, down sharply from 48.2% in the same period of 2024. Meanwhile, hybrid-electric vehicles (HEVs) and plug-in hybrid electric vehicles (PHEVs) captured 34.8% of the market, with battery-electric vehicles (BEVs) claiming 15.6%. This shift is not merely a trend but a structural realignment driven by regulatory pressures, consumer behavior, and technological momentum. For investors, the question is no longer whether ICE automakers can survive, but how long they can cling to a shrinking niche—and who will dominate the next era of mobility.

The Decline of ICE: A Market in Retreat

The EU's ICE market is under siege. Petrol and diesel car registrations fell by 20.6% and 27.1%, respectively, in Q1 2025 compared to the prior year. Germany, the bloc's largest car market, saw a 13.8% drop in June 2025, while Italy's ICE sales plummeted 17.4%. These declines are not cyclical but structural, reflecting the EU's aggressive climate goals. The 2025–2027 CO₂ emission targets, coupled with the 2035 ICE ban, have forced automakers to pivot or face penalties.

For ICE automakers, the challenge is twofold: declining sales and thinning profit margins. While ICE vehicles still command high margins—especially in premium SUVs—their market share is eroding. Volkswagen, for instance, has adopted a “value over volume” strategy, prioritizing short-term profits from ICE models. But this approach is a temporary fix. UBS estimates that compliance with 2025 CO₂ targets could cut Volkswagen's profits by €2 billion. Ford, further from its targets, faces even steeper risks.

Hybrid Dominance: The Transitional Powerhouse

Hybrids have emerged as the bridge between ICE and full electrification. In H1 2025, HEV and PHEV registrations surged to 1.94 million and 469,410 units, respectively. Spain, Germany, and Italy led the charge, with PHEV growth rates exceeding 50%. Škoda Auto, a Volkswagen subsidiary, epitomizes this shift. The company's hybrid and electric vehicles accounted for 22.8% of European deliveries in H1 2025, up from 9.4% in 2024. Operating profit rose 12% to €1.3 billion, driven by strong demand for electrified models like the Enyaq and Elroq.

Hybrids' appeal lies in their pragmatism. They address range anxiety, charging infrastructure gaps, and upfront costs—key barriers to BEV adoption. For investors, this means hybrids are not a stopgap but a profitable segment. Škoda's 8.5% return on sales in H1 2025 underscores the financial potential of electrified vehicles. Other automakers, including Toyota and BMW, are similarly leveraging hybrid technology to meet regulatory targets while maintaining customer trust.

The Long Game: Electrification vs. ICE

While hybrids are thriving, the ultimate goal for the EU is full electrification. BEVs accounted for 15.6% of H1 2025 sales, up from 12.5% in 2024. However, their growth lags behind hybrids. This disparity is due to lingering consumer skepticism and infrastructure bottlenecks. For example, in Germany, 55.1% of PHEV registrations in H1 2025 were driven by policy incentives, not organic demand.

The regulatory tailwinds for electrification are undeniable. The EU's Vehicle Emissions Trading Scheme and the UK's CO₂ targets are pushing automakers to accelerate BEV production. Volkswagen's 2025 compliance strategy, which includes partnerships with Tesla and Volvo, highlights the urgency. Ford's reliance on BEVs for 71% of its CO₂ improvements underscores the scale of the transition.

Investment Implications: Where to Allocate Capital

For investors, the key is to distinguish between winners and losers. ICE automakers that fail to pivot will face declining market share and regulatory penalties. However, those that integrate electrification into their core strategies—like Škoda and Toyota—offer compelling long-term prospects. Hybrid manufacturers, in particular, are well-positioned to capitalize on the transitional phase.

1. Hybrid and Electrified Producers: Companies like Škoda, Toyota, and BMW are reaping the rewards of electrification. Their hybrid strategies provide immediate profitability while aligning with regulatory goals.
2. Battery and Supply Chain Players: As BEV adoption accelerates, demand for lithium, cobalt, and advanced battery technology will surge. Firms like Northvolt and CATL are critical to this ecosystem.
3. ICE Automakers with Compliant Strategies: Volkswagen and Ford, if they successfully pool with BEV leaders or launch affordable electric models, could mitigate their compliance gaps. However, this requires significant capital investment and strategic agility.

Conclusion: A New Era in Automotive Investment

The EU's automotive landscape is at an inflection point. ICE automakers are retreating, hybrids are dominating the transition, and BEVs are on the cusp of mainstream adoption. For investors, the lesson is clear: adapt or be left behind. Hybrid producers offer a bridge to the future, while BEV champions like Tesla represent the long-term horizon. ICE automakers that cling to legacy models will struggle to compete. The next decade will belong to those who embrace electrification—not as a trend, but as a revolution.