CAFE standards and the Law of Unintended Consequences.

Posted on 02 July 2009

“Commendable job on arranging those deck chairs, Mr. President.  The Titanic passengers will appreciate the more consistent look.”

Where did that story come from, anyway? Was there a survivor of the Titanic sinking in 1912 who later told about someone seen re-arranging the furniture? Was it before or after the impact with the iceberg? Was it someone who did not understand the gravity of the situation? Or someone who was trying to escape the reality of their situation by engaging in a distracting effort? How did the idea of arranging the furniture on the Titanic come to be such a well-recognized image of a futile effort?

It turns out the expression did not enter the common consciousness until the 1970s. Only starting in 1969, then in 1972 and 1976 did references to arranging the furniture on the Titanic first appear in public media. In any case, it so perfectly conveys a message of futile activity that we thought of it when we heard about the new proposed standards for auto mileage and greenhouse gas emissions from vehicles.  As we analyzed the situation, we discovered even more ways in which the Titanic analogy works in putting CAFÉ and GHG into perspective.

It is commendable to have a single Federal rule, rather than have California, followed by 13 other states who wanted to copy it, trying to implement its own separate standard.   It is also better to have the EPA and the DOT working together on standards for GHG emissions.  More miles per gallon are a good thing.  Less foreign oil imports are a good thing.  What’s not to like?

The iceberg, for starters.  Returning to our Titanic analogy, the proposed standards are akin to Captain Smith, hearing that there are icebergs in the vicinity, responding by modestly slowing the Titanic’s speed.  The ship is still on course to hit the iceberg, and it is still going to sink, but he has bought a little more time.  In our view, the proposed standards do not prevent the eventual combustion of gasoline, they simply stretch it out.  Climatologists are telling us that on our present course of carbon dioxide emissions, we will encounter catastrophic climate change.

What we really want the Titanic to do is slow down AND change course.  Here, changing course is an analogy for converting the world’s vehicle fleet from internal combustion engines to electric vehicles, supplying the electricity from clean energy sources (i.e. NOT conventional coal), and raising the price of all fossil fuels by putting a price on carbon.

Under the new proposed rule, the fleet average will rise from 27.7 mpg in 2008 to 35.5 mpg by 2016.  Passenger car mileage will improve from 29 mpg to 39 mpg while light trucks will move from 23 to 30 mpg.   Raising the mileage capacity of a car or light truck, per gallon of gas consumed, avoids gallons of gas consumed over the life of the vehicle.  The hypothetical 2008 passenger car that travels at a fleet average 27 mpg will consume 3,704 gallons of gas per 100,000 miles driven.  (100,000/27 = 3,704).

Under the new standard, a 2016 vintage vehicle with a 35.5 mpg fleet rating will consume 2,817 gallons of gas per 100,000 miles driven.  (100,000/35.5 = 2,817) The efficiency gain avoids an average of 887 gallons of gas per vehicle.  In aggregate, the Administration estimates that the United States reduces the amount oil imported for transportation by an estimated 1.8 billion barrels over the lifetime of the vehicles sold in the next five years.

The mistake we see is that without a corresponding tax or rise in the price of gasoline, the tightening of CAFÉ standards alone will prolong its use rather than force its substitution with electricity.

Consider that the Administration estimates that the accelerated fuel standard will cost an additional $600 per vehicle on top of $700 already in the pipeline to meet the original 2020 goals.  This President claims that this $1,300 cost on cars will be paid-back in three years with avoided gas savings.  Presumably, Obama is speaking about cost increases in comparable ICE models only.  Nor is it clear if $1,300 is an estimate using 2008 dollars.

What is clear will be a lower breakeven price of gasoline to the consumer.  For simplicity, on an undiscounted basis, at $1,300 of upfront cost, the breakeven price of a gallon of avoided gas is $1.47 per gallon ($1,300/887 g = $1.47).  Given that it is highly unlikely that gasoline will touch, let alone average, $1.47 over the period of ownership, the consumer is benefitting from the upfront investment in efficiency with lower effective energy prices.

The government assumes that because of this trade the 887 gallons of gas demand is permanently destroyed.   We argue that the avoided gallons are ultimately burned as the reduced price of mileage via efficiency encourages broader car usage than would’ve occurred without the cost improvement.  The classic example is the increase in coal usage after efficiency gains in steam locomotives. The contemporary example is the pending demand for Tata Nano’s across Asia after advances in small scale ICE technology.  Sales are already running 100,000 per month in India on a base of 1.5m annual car sales.  The phenomenon is known as Jevons Paradox, or the rebound effect (http://en.wikipedia.org/wiki/Jevons_paradox).

What about hybrids? Won’t a tighter CAFÉ bring increasing numbers into the mix, lowering gasoline demand?  Consider a 2009 Toyota Camry with a hybrid sticker premium over an internal combustion model of about $6,000. The hybrid to ICE comparison is 34 to 25 miles per gallon. Using the conventional 100,000 miles driven the hybrid uses 2,941 gallons of gasoline.  The ICE burns 4,000.  The hybrid avoids 1,059 gallons, so far so good.  But, the breakeven gasoline price of those good deeds is $5.67!  It is not surprising that, given the upfront cost for avoided gas, hybrids were only 2.4% of LDV’s sold in 2008 – a year when the entire year average gas price was a record high $3.25.

CAFÉ standards will not close the $6,000 premium gap for the Toyota Camry hybrid.   Yes, battery technology will improve and the gap will shrink, but a corresponding rise in gasoline prices will be necessary to fully make the cost of operating the hybrid an economic choice for the consumer and not just a fashion statement.

Finally, from the perspective of climate change, is this really the most cost effective way to reduce carbon emissions?  Obama estimates that the impact on climate change will be 900 million metric tons of reduced greenhouse gas emissions.  Consider that each gallon of gas burned in an ICE engine produces 19 lbs of carbon dioxide.  Going back to the 887 avoided gallons of gasoline that is 17,736 lbs or 8.9 tons of avoided carbon (1 short ton = 2,000 lbs).  At $1,300 of increased cost the consumer is paying $146 a ton in abatement.  A hefty price, given the spectrum of methods available to control CO2 emissions.   Not that buying a 2009 Camry hybrid makes that much sense either.  Abating 10 tons of carbon for $6,000 results in a whopping $600 per ton.

Even if we can reduce the ship’s speed, how much time have we bought?  On a base of 245 million light duty vehicles (LDV) in the United States, even robust sales rates seen in the previous few years means decades long fleet turnover (on average 14 years).  With GM’s revised US sales forecast of 10 million LDV’s for the next three years the turnover rate is now a staggering, although exaggerated, 24.5 years!   If the IPCC is correct, though, our window of influence of climate change is roughly the span of few auto fleets.  The choices we make with this generation of autos matters greatly.  With climate change, it is the absolute value of carbon that matters and not the efficiency by which we extend the period of its use.

What should be done? In our opinion, in order to stimulate a more rapid transition to an electrified transportation system, there needs to be a true price signal for gasoline in the form of a tax.   Demand for cheaper miles can ultimately be met with cheaper, clean KW/h rather than decreasingly efficient gallons of gas.  But this is hindered by “command” style attempts to dictate vehicle production.

While we don’t fault President Obama for the genuine effort to do something with respect to automobile and climate change we do continue to find the Titanic analogy instructive.

Regulations have a way of backfiring.  When the Titanic sailed from Southampton it should be noted that, with 16 lifeboats, it was in full compliance with the UK’s Board of Trade regulations that dictated the minimum number of boats based on the ship’s projected tonnage of over 10,000 tons.   More than twice that number was needed to accommodate the Titanic’s passengers.

Similarly, the original CAFÉ rules passed in 1975 were based on vehicles of less than 6,000 pounds gross vehicle weight, enough to capture the average station wagon.  Yet, Lee Iacocca drove his Dodge Caravan right through this loophole – the rest is history.  The loopholes for lifeboats and CAFÉ have both been closed since.  Might there be some unintended loopholes in the new proposed regulations?

The conventional wisdom today is that it is politically infeasible to implement a gasoline tax.  It is like pointing out the Captain of the Titanic could not have slowed the ship and changed course because the passenger would not have stood for it.  There were radio warnings about the presence of icebergs received by the ship’s radio room.  Because the radio room was staffed by employees of the Marconi Company and paid for by the passengers who received and sent messages, these messages were not passed along to the bridge.  The messages from the IPCC about climate change dangers come to mind.  If the Titanic passengers would not stand for a change in course, then the proper course would be to make the warnings from the radio room concerning icebergs more available and more understandable.

For those who want to access the proposed standards, the link is here:

http://www.nhtsa.dot.gov/CARS/rules/CAFE/overview.htm