By Andreas Cremer
BERLIN (Reuters) - Volkswagen Chief Executive Martin Winterkorn faced a reckoning with his board on Wednesday, summoned to explain the falsification of U.S. emissions tests in the biggest scandal in the 78-year history of the world's largest carmaker.
A source close to the company said a five-member executive committee was grilling Winterkorn at the company's headquarters in Wolfsburg, Germany, and was likely to make a recommendation on his future ahead of a full board meeting on Friday.
Volkswagen is under huge pressure to act, with its shares down more than a third in value since the crisis broke, and the bad news still coming.
German prosecutors said on Wednesday they were conducting a preliminary investigation into the manipulation of vehicle emission test results at Volkswagen, while French Energy Minister Segolene Royal said her country would be "extremely severe" if its investigation into the firm found any wrongdoing.
U.S. authorities are planning criminal investigations after discovering that Volkswagen programmed computers in its cars to detect when they were being tested and alter the running of their diesel engines to conceal their true emissions.
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German Chancellor Angela Merkel has urged Volkswagen to move "as quickly as possible" to restore confidence in a company held up for generations as a paragon of German engineering prowess.
But the board is in a tricky situation, with the 68-year-old CEO showing no sign of resigning after a hitherto highly successful eight year reign that saw the company double sales and almost triple profits. Volkswagen passed Toyota in the first half of this year to become the world's top selling carmaker.
"VW needs a fresh start and in our view a new CEO," said Evercore ISI analyst Arndt Ellinghorst.
A story in the Tagesspiegel newspaper, denied by Volkswagen, said the board would replace him with Matthias Mueller, head of the automaker's Porsche sports car business.
Winterkorn, who was due to have his contract extended at Friday's board meeting, did not mention his future in a video message posted on the company's website on Tuesday, in which he repeated his apology for a scandal which has wiped out tens of billions of dollars from the company's value.
SHOCKWAVES
The U.S. Environmental Protection Agency (EPA) said on Friday Volkswagen could face penalties of up to $18 billion for cheating emissions tests on some of its diesel cars.
The story has sent shockwaves through the car market, with dealers in the United States reporting people holding back from buying diesel cars and "#dieselgate" trending on Twitter.
Diesel engines account for less than 3 percent of new cars sold in the United States but around half of cars in Europe, where governments have encouraged their use to meet fuel efficiency and greenhouse gas targets.
Their biggest selling point is their fuel economy and low carbon emissions compared to standard gasoline engines. But they also emit far more nitrogen dioxide, a toxic gas blamed for health problems. The suggestion that their emissions in real world conditions are worse than reported in tests could harm the whole sector and alter the future of the car industry worldwide.
"The Volkswagen issue is another blackeye for the diesel engine overall," Mike Jackson, the chief executive of the AutoNation, the largest U.S. car retailer, told CNBC, adding the "brand position" of Volkswagen was at risk in the U.S. market.
Volkswagen said on Tuesday it was setting aside 6.5 billion euros ($7.3 billion) to help cover the costs of the crisis.
Analysts doubt that will be enough, with the company disclosing that 11 million of its cars were fitted with Type EA 189 engines that had shown a "noticeable deviation" in emission levels between testing and road use.
Commerzbank analyst Sascha Gommel said if these cars had to be recalled and modified, the cost of that alone could top 6 billion euros.
And the company could still face the potential cost of regulatory fines, lawsuits, criminal investigations and a possible hit to sales from a damaged reputation.
The U.S. Justice Department has launched a criminal probe, a source familiar with the matter said.
New York and other state attorneys general are also forming a group to investigate, New York Attorney General Eric Schneiderman said, while other countries in Europe and Asia say they will investigate Volkswagens and other vehicles as well.
Richard Leedham, a partner at London law firm Mishcon de Reya, said there was little prospect of Volkswagen clawing back costs from its insurers.
"Given their apparent internal knowledge, it seems unlikely that VW will be able to claim any insurance for product recall or for product liability cover, so they won't be able to pass on their losses," he said.
"INVESTOR'S NIGHTMARE"
Environmentalists have long complained that carmakers game the testing regime to exaggerate the fuel-efficiency and emissions readings of their vehicles. European politicians on Wednesday voted to speed up rules to tighten compliance with pollution limits on cars.
European car association ACEA said that so far there was "no evidence that this is an industry-wide issue".
But Societe Generale analysts said that while the uncertainty prevailed, the whole autos sector was likely to be "dead money" for a while.
As for Volkswagen, Deutsche Bank called the scandal an "investor's nightmare" and cut its recommendation to "hold" from "buy", predicting rising costs for making diesel cars would wipe out the company's cost-cutting programme.
Nevertheless, the precipitous two-day collapse in the company's share price reversed on Wednesday morning. At 1345 GMT, Volkswagen shares were up 7.7 percent at 114.5 euros, after earlier touching a four year low of 95.51 euros.
Traders say the plunge has stoked speculation that Volkswagen could become a takeover target, with Fiat Chrysler openly looking for a partner, though there is no sign Volkswagen's controlling Piech-Porsche clan is looking to sell.
Volkswagen was challenged by authorities as far back as 2014 over tests showing emissions exceeded California state and U.S. federal limits, but didn't admit wrongdoing until regulators threatened to withhold certification for its 2016 diesel models.
Winterkorn, known for a hands-on management style, is likely to come under pressure from the board over the time it took the company to respond to criticism.
In April, the CEO saw off a challenge to his leadership when the board ousted long-time chairman Ferdinand Piech.
There was no sign emissions testing was part of Piech's criticism of Winterkorn, but insiders say Piech was unhappy with Volkswagen's underperformance in the United States, where sales of VW-brand cars fell 10 percent last year to less than half of their 2018 target of 800,000 deliveries.
Volkswagen is strong in the small U.S. diesel sector and has spent millions on television ads promoting its "clean" diesel cars, central to its strategy to revive its business there.
($1 = 0.8959 euros)
(Additional reporting by European, American and Asian bureaus; Writing by Mark Potter; Editing by Peter Graff)