Higher CAFE Standards: "There’s No Such Thing as a Free Lunch"

In July 2011, the Obama administration announced the new Corporate Average Fuel Economy (CAFE) standards that will begin taking effect in 2017. The standards for U.S. light-duty vehicle fleets (passenger vehicles and light-duty trucks) will be 54.5 miles per gallon (mpg) by 2025, and they piggyback on the 2009 mandate for a CAFE average of 35.5 mpg by 2016, up from 27.3 mpg in 2011. The 54.5 mpg target is the largest mandatory fuel economy increase in history, and officials claim that the plan will save Americans $1.7 trillion in fuel costs by 20251.  It is also expected to lower petroleum consumption by a total of 12 billion barrels and curtail the daily requirement by 2.2 million barrels a day (b/d) by 2025 (11% of current demand). Apparently, there is no downside to the new rules:

"These standards will help spur economic growth, protect the environment, and strengthen our national security by reducing America's dependence on foreign oil. Working together, we are setting the stage for a new generation of clean vehicles," Ray LaHood, U.S. Secretary of Transportation2

The U.S. energy system, however, contains great inertia, and several persistent trends will influence our energy economy well into the future. For oil, there is a lack of material substitutes that has both the International Energy Agency's World Energy Model and the U.S. Energy Information Administration's (EIA) National Energy Modeling System (NEMS) certifying the reality of petroleum's dominance for decades to come. The outlook for vehicles is central because gasoline is almost half of our oil demand. The present analysis details why the 54.5 mpg CAFE is not as desirable or beneficial as some say: 1) more dangerous vehicles, 2) higher costs, 3) efficiency paradox, 4) CAFE and gasoline taxes, and 5) multiple loopholes. Indeed, more domestic oil production will remain a non-negotiable pillar of U.S. energy security.

More Dangerous Vehicles

Higher CAFE standards push automakers to build dangerously smaller and lighter vehicles that can burn less fuel. According to the U.S. Department of Energy, the typical passenger vehicle is now around 3,560 pounds, compared to 4,060 pounds in 1975.3  When vehicles are lighter, extra material is removed, and the armor that protects motorists in the event of a crash is often discarded. The 54.5 mpg CAFE is set to begin in just five years time, and the automotive technology required does not yet exist. Given the long lead times for new technologies to be developed, tested, and incorporated into vehicle models, downsizing and downweighting will likely become an even more critical means of meeting CAFE. Unfortunately, a steady drumbeat of studies has demonstrated the fatal results of mileage regulations:

•    In 1989, the Harvard School of Public Health and the Brookings Institution found that a 500 pound weight reduction in the average vehicle increased annual highway deaths by 2,200-3,900 and serious injuries by 11,000-19,500.4

•    In 1999, USA Today estimated that 7,700 deaths occurred for every mpg gained in fuel economy standards.5  In the years since CAFE (1978-1999), "46,000 people have died in crashes they would have survived in bigger, heavier cars."

•    In 2002, the National Research Council reported that there were between 1,300-2,600 vehicle crash deaths in 1993 that would not have occurred if vehicles were as heavy as they were in 1976.6

•    In 2003, the National Highway Transportation and Safety Administration found that reducing a vehicle's weight by just 100 pounds increased the fatality rates by as much as 5.63% for light vehicles, 4.70% for heavier vehicles, and 3.06% for light trucks.7  This translated into additional traffic fatalities of 13,608 for light vehicles, 10,884 for heavier vehicles, and 14,705 for light trucks between 1996 and 1999.

Higher Costs

Although higher CAFE standards can save Americans money by lowering their gasoline requirement, there could also be numerous (unintended) adverse economic consequences. The ambitious 54.5 mpg standard will lead to higher vehicle prices because manufacturing costs are higher for advanced technology vehicles. The Chevrolet Volt, for instance, the first plug-in hybrid to hit the mass market, has a sticker price of $40,000, or just below the average annual per capita income of $43,000. Indeed, General Motors is now idling its Volt plant to match lagging demand. And since the automotive technology to achieve 54.5 mpg is not yet available, automakers will need to spend billions in research and development (R&D) to reach the new standards - an added cost that is often overlooked. Americans for Tax Reform reports that the wave of R&D required could add around $6,000 to the cost of every new vehicle by 2025.8  This rising price for new vehicles would necessarily be followed by higher prices for used vehicles, possibly squeezing low-end buyers right out of the automobile market altogether (Figure 1). In all, the Alliance of Automobile Manufacturers concludes that the new fuel economy standards will add $209 billion in costs by 2025.9

Figure 1: Higher CAFE Standards Shrink the Low-Cost Vehicle Market

Note: For 2025, two average CAFE scenarios (45.8 mpg; 60.5 mpg) for new passenger vehicles and light-duty trucks are assumed
Source: U.S. Energy Information Administration, Annual Energy Outlook 2011 with Projections to 2035, p. 25, 26

The "price elasticity of demand" indicates that Americans buy fewer vehicles when new ones are more expensive, or worse, put off a new purchase while holding onto their "clunker." And fewer new vehicles mean more greenhouse gas emissions. In addition, the need to buy less fuel will cut revenues from gasoline taxes, and states could face the problem of subsidizing the infrastructure projects that those taxes were earmarked to fund. If the government then decides to compensate by hiking taxes, the savings that drivers accumulated with their fewer gallons bought could be wiped out. Increased CAFE standards can also reduce jobs because higher retail prices lower product demand, and the smaller vehicles that result trim the manufacturing process. Further, according to the Highway Loss Data Institute, the lightweight vehicles that are promoted by CAFE increase insurance costs because they are more prone to being involved in an accident.10

Efficiency Paradox

At best, higher efficiency standards only indirectly impact fuel demand: the EIA confirms that "the growth in vehicle-miles traveled has basically mirrored the increases in real disposable income."11  In contrast to a "low-hanging" panacea, energy efficiency is an intricate field of economics that is routinely oversimplified by those too easily swayed by the popular appeal of quick and easy energy solutions. Clearly, historical evidence invalidating the claim that energy efficiency improvements are sure to decrease consumption has not made its way from obscure economic journals to the general public. The counter-intuitive phenomenon that greater efficiency can actually lead to greater consumption is known as the "Jevons Paradox," named after the British economist who first articulated the peculiarity almost 150 years ago. "It is wholly a confusion of ideas to suppose that the economical use of fuel is equivalent to a diminished consumption," William Stanley Jevons noted in his 1865 book, The Coal Question, "The very contrary is the truth."12  Jevons observed that England's demand for coal at the time soared after Watt introduced his efficiency improvements to Newcomen's coal-fired steam engine. Efficiency gains have tended to increase consumption because they:

•    make the use of energy relatively cheaper, thereby encouraging greater usage
•    lead to economic growth for both the overall economy and the individual, causing total energy consumption to increase ("rebound effect")
•    multiply the use of the resource's "companion" technologies, products, and services that were previously restrained 

Indeed, CAFE increases have not yielded their desired and anticipated results. When CAFE first originated in 1975, the U.S. imported about a third of the 17 million barrels of oil it consumed each day, 15% of which came from the Persian Gulf. The 1973 Arab oil embargo abruptly exposed the security, political, and economic vulnerabilities of this dependency, and automakers were required to meet certain mpg efficiency targets for new vehicles starting in model year 1978. By 1983, this mandated standard had been elevated for passenger vehicles, from 18 mpg to 26 mpg, and for light-duty trucks (average for two- and four-wheel drive), from 16.5 mpg to 18.5 mpg.13  And from 1983 to 2007, the standards were increased respectively to 27.5 mpg and 22.2 mpg.

Over this 25-year period, however, national economic growth (+$7.2 trillion) and population expansion (+70 million people) persistently trumped these vehicle efficiency improvements (Figure 2). By the late-2000s, the U.S. was importing nearly 60% of its daily intake of 20 million barrels of oil. In 2004, The National Commission on Energy Policy determined that even if Congress mandated the passenger vehicle fleet extend its average fuel economy to 44 mpg, up from 27.5 mpg, domestic motor fuel consumption would still surge by 3.7 million b/d by 2025.14

 Figure 2: Higher CAFE Standards = More Driving, More Fuel, 1983-2007


Source: U.S. Energy Information Administration, http://www.eia.gov/petroleum/, 2012

CAFE and Gasoline Taxes

CAFE standards only partially and indirectly attack the negative externalities of motor fuel use (emissions, energy security, congestion, accidents). Thus, the cost of reducing fuel use via CAFE is higher than it would be through an increase in the more transparent federal gasoline tax, which applies to all vehicles, not just new ones. To understand why, the various ways consumers cut back on fuel use must be considered. In the short-term, Americans can buy an efficient hybrid instead of a gas-guzzling sport utility vehicle and/or curb discretionary driving. Over time, people can make other lifestyle changes, such as using public transportation, carpooling, finding a closer job, or working from home. Higher fuel prices directly impact all these choices by encouraging Americans to make the marginal adjustments best suited to their own personal circumstances. As stated by the National Research Council in 2002,

"There is a marked inconsistency between pressing automotive manufacturers for improved fuel economy from new vehicles on the one hand and insisting on low real gasoline prices on the other. Higher real prices for gasoline…..through increased gasoline taxes…..would create both a demand for fuel-efficient new vehicles and an incentive for owners of existing vehicles to drive them less." 15

Higher fuel prices, however, have a destructive ripple effect across the entire U.S. economy, and the increased overhead for businesses is ultimately paid for by consumers. Higher gasoline taxes, for instance, are wildly unpopular because they decrease the discretionary income available for other types of consumer spending, thereby nullifying the invaluable "multiplier effect," where an increase in spending sparks a chain reaction that generates more economic activity far greater than the original purchase. Affordable personal transportation provides Americans with an enlarged "opportunity circle," where they are more free to consume, pick a job, and socialize. As fuel prices rise, these choices begin to contract, and quality of life generally diminishes. Fuel taxes are regressive because they are a disproportionate expense for the less fortunate. Welfare to Work has shown that affordable personal mobility is the key for low-income Americans to find and keep the most rewarding jobs.16

Multiple Loopholes

According to Edmunds, the new 54.5 mpg CAFE has "plenty of loopholes, exemptions, and credits in the plan…..and their impact might result in a 'real' CAFE standard as low as 50 mpg."17  Among the features that could decrease the real fuel efficiency of new vehicles is a section that offers credits for the use of fuel-saving technologies, such as 1) energy efficient Light Emitting Diode headlights, 2) photovoltaic roofs than can use sunlight to generate power to help charge batteries or auxiliary equipment, 3) thermoelectric systems that use exhaust heat to generate power, and 4) automated grilles that close at high speeds to increase aerodynamics. In addition, if President Obama loses the 2012 election, the new president could simply rewrite CAFE rules based on the "reexamination" period. If President Obama is reelected, the increases will not begin until after his second term, leaving numerous chances to dilute, or even eliminate, the toughest aspects of the new CAFE requirements.

In fact, gaming CAFE is integral to Detroit's modus operandi. For example, many vehicles on the market today are rated as flex-fuel vehicles (FFVs), able to run on gasoline, E85 (85% ethyl alcohol and 15% gasoline), or some mixture in between. Regardless of what fuel combination drivers actually use, the automakers get credits on their CAFE requirements for every FFV they sell. The added cost to make a vehicle FFV-rated is only $100, so manufacturers have launched entire marketing campaigns around the tagline: "Fuel up with E85 or regular gasoline - whichever is more convenient."18  E85, however, is anything but convenient since only a few thousand of the 175,000 fill-up stations across the nation sell it. So, few FFVs are ever actually fueled with anything other than gasoline. In recent years, for instance, although the Suburban got less than 15 mpg, the credits General Motors earned against its CAFE ratings meant that, on paper, the Suburban delivered more than 29 mpg.19  From 2001-2008, U.S. News & World Report records that Americans used an extra 17 billion gallons of gasoline due to the FFV loophole.20

Conclusion

The effects of higher fuel efficiency standards are more complex than generally proclaimed. There is a lack of historical evidence to conclude that the 54.5 mpg CAFE will reduce oil demand in the absolute sense being assumed. Much more likely, oil and oil imports will stay an essential component of the energy portfolio for decades to come. Over the next 20 years, the EIA expects the U.S. to add more than two Japans to its Gross Domestic Product ($9.5 trillion) and expand its population by the size of France (65 million people).21  To that end, not even the widening focus on wind and solar power will alter our fundamental need for more crude because oil-based electricity accounts for only 3% of our total oil demand. Pre-recession growth trends are beginning to reemerge. In the International Energy Outlook 2011, the EIA's NEMS has domestic oil demand rising by as much as 21% by 2030.22  Considering that 80% of the world's proven oil reserves are controlled by a single cartel, OPEC, we need policies to enhance, not impede, the domestic suppliers of this irreplaceable liquid fuel. 

By. Jude Clemente for Oilprice.com 

References

1  National Highway Traffic Safety Administration, July 29, 2011, "President Obama Announces Historic 54.5 mpg Fuel Efficiency Standard," U.S. Department of Transportation, available at: http://www.nhtsa.gov/About+NHTSA/Press+Releases/2011/President+Obama+Announces+Historic+54.5+mpg+Fuel+Efficiency+Standard.
2  Ibid.
3  U.S. Department of Energy, June 25, 2007, "Fact #475: Light Vehicle Weight on the Rise," available at: http://www1.eere.energy.gov/vehiclesandfuels/facts/2007_fcvt_fotw475.html.
4  Robert Crandall and John Graham, April 1989, "The Effect of Fuel Economy Standards on Automobile Safety," Journal of Law and Economics, Volume 32, Number 1, pp. 97-118.
5  U.S. Congress, July 15, 2000, Congressional Record - Senate, Washington, DC, p. 10950.
6  National Research Council, 2002, Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards, National Academy Press, Washington, DC, p. 27.
7  Institute for Energy Research, April 19, 2011, "Will Fuel Economy Mandates Increase Car Company Profits," available at: http://www.instituteforenergyresearch.org/2011/04/19/will-fuel-economy-mandates-increase-car-company-profits/.
8  Americans for Tax Reform, August 1, 2011, "Obama's Automotive Regs. Harm American Companies and People," available at: http://atr.org/obamas-automotive-regs-harm-american-companies-a6384.
9  Angela Greiling Keane, November 16, 2011, "U.S. 54.5 MPG Fuel-Economy Standard May Cost $157 Billion," Bloomberg, available at: http://www.bloomberg.com/news/2011-11-16/doubling-fuel-economy-may-cost-2-000-a-car-157-billion-u-s-draft-says.html.
10  Kevin Ransom, January 28, 2009, "Smaller cars can mean higher insurance rates," CNN, available at: http://articles.cnn.com/2009-01-28/living/aa.smaller.cars.higher.insurance_1_hybrid-small-cars-smaller-cars?_s=PM:LIVING.
11  Energy Information Administration, November 2005, "Household Vehicles Energy Use: Latest Trends & Data," U.S. Department of Energy, available at:
http://www.eia.doe.gov/emeu/rtecs/nhts_survey/2001/tablefiles/es0464(2005).pdf.
12  Jevons, William, 1865, The Coal Question (Chapter 7), Library of Economics and Liberty, April 4, 2009, available at: http://www.econlib.org/library/YPDBooks/Jevons/jvnCQ7.html.
13  National Highway Traffic Safety Administration, November 2004, "Automotive Fuel Economy Program Annual Update Calendar Year 2003," U.S. Department of Transportation, available at: http://www.nhtsa.dot.gov/cars/rules/cafe/FuelEconUpdates/2003/index.htm.
14  The National Commission on Energy Policy, December 2004, "Ending the Energy Stalemate: A Bipartisan Strategy to Meet America's Energy Challenges," available at: http://bipartisanpolicy.org/sites/default/files/endi_en_stlmate.pdf.
15  Ibid., p. 113.
16  Consumer Energy Alliance, September 15, 2008, "The Impact of High Energy Prices on Key Sectors of the U.S. Economy," available at: http://www.bipac.net/cea/impactpublication.pdf.
17  John O'Dell, July 28, 2011, "CAFE Players Settle On 54.5 MPG For 2025," Edmunds AutoObserver, available at: http://www.autoobserver.com/2011/07/cafe-players-settle-on-545-mpg-for-2025.html.
18  Ibid.

Biography

Jude Clemente is Principal at JTC Energy Research Associates, LLC and affiliated with the Department of Homeland Security at San Diego State University. He holds an MS in Homeland Security from SDSU and a MBA in Finance from Saint Francis University. Clemente's research specialization is oil and gas supply at the national and international levels. He is a frequent contributor to Oil & Gas Journal and Energy Pulse, and his most recent work has appeared in Oil & Gas Financial Journal, Journal of Energy Security, Pipeline & Gas Journal, The American Oil & Gas Reporter, Petróleo, and Public Utilities Fortnightly.