Back Story – Fall 2013

Virginia McConnell

One of the challenges in creating a greener planet earth is to carefully consider what policy initiatives will most effective for achieving sustainability goals. Virginia McConnell, a professor of economics and co-chair of UMBC’s Climate Change Task Force, is an expert on assessing the effects of policies to improve the environment. She talked with UMBC Magazine about her research on fuel regulations for motor vehicles — and the unintended consequences that often arise from well-intentioned initiatives.

UMBC Magazine: CAFE is an acronym that one often hears when we talk about fuel economy. What is it?

McConnell: CAFE stands for Corporate Average Fuel Economy standards – the federal regulations requiring automakers to achieve a target level of fuel economy measured in miles per gallon.  Each manufacturer must meet a standard that is a sales-weighted average across its whole product line.  There are separate standards for cars and for light-duty trucks.

CAFE standards were first passed by Congress in the late 1970s – the goals was to reduce oil use, and to promote energy security and energy conservation. These fuel economy standards were initially under the jurisdiction of the National Highway Transportation Safety Administration (NHTSA), which is part of the U.S. Department of Transportation.

Initially the CAFE standards were 19 miles per gallon for cars but rose quickly to about 27 mpg in 1984 and remained at that level for many years.  The standards were always lower for trucks, and did not rise as quickly in the early years.  They have been at about 20 mpg for trucks since 1986.  Most manufacturers have been able to meet the standards over the years, though they are allowed to pay a penalty if they cannot comply.  Many European manufacturers do not comply, and pay the fines instead.  But most domestic and Asian manufacturers have been able to comply in the past.  But, it is going to get a lot more difficult in the future as the new and much tighter standards kick in.

There is a general sense that some good things have come out of the CAFE standards in the past.  The standards have helped to spur technology improvements that have not only allowed for reduced fuel consumption, but also reduced tailpipe pollutants such as nitrogen oxides and hydrocarbons that contribute to smog and ozone levels at the same time.

UMBC Magazine: But there were some unintended consequences to CAFE, right? One big unintended consequence was a boost in popularity for sports utility vehicles (SUV) that had a lower miles per gallon standard.

McConnell: Yes, that was certainly the case.  Because the standards were lower for trucks, and also because there was a market for large vehicles in the U.S., we saw the advent of the mini-van and the SUV.  And, the station wagon, which was subject to the stricter car CAFE standards, virtually disappeared.

Gasoline prices have also played a role in influencing drivers’ decisions over car sizes and fuel economy. In the late 1970s, oil prices rose dramatically because of the oil embargo and other conditions in the world market. But in the early 80s, oil prices came down and continued to decline in real terms for many years.  And, lower prices increased the appeal of bigger cars with higher performance. So there was a dramatic shift in the automobile market toward light trucks and away from cars. Light trucks made up 53% of new vehicle sales by 2004, but they had been only 25% of that market in the mid 1980s.

UMBC Magazine: And under CAFE standards, SUVs counted as trucks?

McConnell: Right. And trucks have much lower fuel economy standards to meet.  So, with the big shift to trucks (vans and SUVs) we just discussed, you won’t have nearly the reduction in fuel use that people expected from the CAFE standards.  Estimates are that the regulations through the early years did reduce oil use overall, but those effects were mitigated by this shift toward larger vehicles. This was an unintended effect of CAFE design – the dual car – truck standards.

Another unintended effect of CAFE standards is that they lower the cost of driving.  The higher the fuel economy of the car you drive, the lower your cost of driving each mile. If it is less costly to drive, people will tend to drive more.  This is referred to as “the rebound effect” – the policy reduces the cost per mile of driving, and as a result there will be more total miles driven.  Like the shift to larger cars, this rebound effect also tends to offset the effectiveness of the CAFE standards.  Fuel use will not be reduced as much as it first appears if people are driving more.

One final point is that if the goal is to reduce fuel use, then a policy that directly targets fuel use will be the most effective.  CAFE standards target the type of new vehicles people can buy.  But a policy like a gasoline tax that targets fuel use has the capacity to affect not only the type of car people buy but the number of miles that drive (it makes driving more expensive, not less) and even where they might want to live (closer to work).   Gasoline taxes have been proposed as a either an alternative to CAFE standards or as a complementary policy, but as you know, they have proved to be very politically unpopular.  CAFE standards in contrast, even with the unintended consequences described above, have had a fairly high level of public acceptance.

UMBC Magazine: Despite the criticism of CAFE standards, Congress decided to use them again a few years ago. What are these new CAFÉ standards trying to accomplish? They’re trying to double the miles per gallon, the fuel efficiency element of it, by 2025, but they’ve also added a new element to it – regulating greenhouse gases.

McConnell: I think the political context for [using CAFE standards again] is interesting and changing a little bit now on the energy security side.

One major factor motivating the legislative effort to double CAFE standards for vehicle fuel economy several years ago was concern over energy security. This remains an issue for the U.S. and for other oil consuming countries around the world, but for the U.S. recent developments in techniques for extracting domestic oil and natural gas have increased domestic sources have reduced the urgency of this market.  There is even the possibility of the Unites States being a net exporter of oil as opposed to importing over half of what we consume.  Oil prices will still be determined in the global market, and disruptions in other parts of the world still result in price fluctuations, but the U.S. will be somewhat more insulated from such changes.

I think that the bigger motivation now for the new stricter CAFE standards is for the reduction in greenhouse gases.  In this new round of regulations, the Environmental Protection Agency (EPA) and NHTSA both have jurisdiction, and they have harmonized the rules to reduce both greenhouses gases and gasoline use.  The greenhouse gas piece of the regulations came about because of a Supreme Court ruling which allows the EPA to regulate greenhouse gases as a pollutant affecting public health. So, an important part of the way that EPA is trying to reduce greenhouse gas emissions is through the new CAFE standards.

It is a huge new effort for vehicle fuel use, the first major change in the CAFE rules since the late 1970s.

UMBC Magazine: Part of your own analysis of this new push is that the new CAFE standards may not be sturdy enough to accomplish both tasks.

McConnell:  An alternative policy would be to address the problem directly – to tax carbon emissions.  The higher price of products with higher carbon emissions would give people the incentive to change their behavior to reduce carbon emissions in a variety of ways – in transportation and electricity sources and others.  But again, politically, a tax on carbon has been difficult.  The new CAFE standards appear to be a way around the politics, at least in the transportation sector.

Also, the costs of the CAFE standards approach are not as clear to the public as a carbon tax, and that may also be why it is more politically acceptable.  For example, you don’t really see how much more you will pay for a car in 2017 than you would have paid in the absence of the regulations. You will pay more, but the amount is hidden in the cost of the car.

Another argument in favor of CAFE standards is that there may be what is called an “energy efficiency gap.” This is something that we see across the board with all energy-saving devices or products – from investing in solar heating to buying an energy-efficient refrigerator to buying a more fuel-efficient car.  You spend more money up front to buy these more efficient appliances or vehicles or whatever, and then you get energy cost savings over time. By the way, the higher the price of gasoline, the more those fuel savings will be over time.

So, what do we expect people to do?  The economically rational thing to do would be to think about the payoff over time in terms of the energy savings and ask: “Am I getting more over time compared to what I have to pay up front?” Then we would expect people to make that investment if the payoff is greater than what they have to pay up front.

UMBC Magazine:  Putting solar panels on your roof debate has a big upfront cost, but then your electric bill plummets.

McConnell: Yes, and how much in savings do you need to get in that electricity bill before it makes sense to put in the solar, and over how long a period of time?  There is some evidence that is difficult for people to make these choices in a consistent and economic way.  What appears to be true is that people have very short-time horizons for these energy savings – if the upfront costs of a more energy efficient product are not paid back very quickly, a potential buyer is not interested.

Automakers claim that they use a three-year rule. They assume the increased cost of a more fuel efficient vehicle must pay back in terms of saved gasoline costs over three years.   This is myopic behavior – people tend to hold onto new cars for much longer than that – about an average of 6 years.

If people do undervalue fuel savings over time, then they will tend to underinvest in fuel saving devices or vehicles.  This is one of the major arguments about why CAFE standards may be the best policy approach to promoting more fuel-efficient vehicles – CAFE will require people to make those investments even if they wouldn’t do it on their own.

But there are several problems with that approach. One is that it may be difficult to force people to do what they don’t want to do.  The car companies must sell vehicles to meet the standards, but if they can’t do that at current vehicle sizes and types, they may shift to trying to sell larger vehicles with lower standards as they did several decades ago.  This offsets some of the emissions reductions expected from the CAFE standards.

Another argument on the other side of the myopia argument is that people are more rational than we think when they buy a vehicle.  When they purchase a more fuel-efficient vehicle they are giving up something else that they could have gotten – more torque or acceleration for instance.  We saw this throughout the late 80s and in the 90s, really. There were huge improvements in performance even as fuel economy standards stayed constant. The technology that was being developed during that time was being put toward performance and not toward fuel economy.  Presumably, that wasn’t because of any regulations.  That was because of what people wanted.

If people are being rational, and they are weighing off all the characteristics including fuel economy when they purchase a vehicle, then pricing policies such as a gasoline tax, or carbon tax will tend to work quite well.  Higher prices of fuel will induce people to value fuel economy more in the marketplace.  We have seen that recently as generally higher gasoline prices have meant that more people are more interested in the fuel economy of the vehicles they are buying.

UMBC Magazine:  Where do electric vehicles fit in? 

McConnell: We’re subsidizing electric vehicles pretty heavily.  For a full all-electric vehicle, you would get a $7,500 subsidy from the federal government as a credit on your taxes.  This is more of a subsidy for higher income people – in the extreme case where someone did not owe any income taxes, there would be no subsidy.

UMBC Magazine:  How much do electric vehicles cost?

McConnell: There are only a few all-electric cars, and the prices vary a lot.  The Tesla sells for $70,000 to $100,000. And, at the other end of the spectrum, the Nissan LEAF costs about $28,000. When you subtract the subsidy, you’re down to $20,000 or lower for the LEAF.  And there are state subsidies for these vehicles, too.

But one of the problems with CAFE rules – which are binding on manufacturers – is that the automakers will design cars to try to meet these standards.  And if you sell more electric cars, and those cars get better fuel economy under the standards, the automakers are going to be able sell more other vehicles that have lower fuel economy and balance that off.  No matter how many electric vehicles a manufacturer sells, they are still going to just meet the average CAFE standards. So, it’s not really changing the greenhouse gas or the energy use of the fleets as a whole.

UMBC Magazine:  Electric cars count as zero emissions under the new regulations, right?

McConnell:  Yes. Under CAFE, they count as zero.  In fact, under some circumstances, the automakers can count them double in their fleet.  So if you sell one electric vehicle, you can count it as two for emissions purposes.  That’s built into the 2017 and later CAFE standards.  The argument is that there will be early adopters, but what is really needed is much larger numbers of electric vehicles being sold.  How do you begin to convert a large share of the fleet to electrics?  There is one argument that there are important spillover effects from the early adopters.  Both manufacturers and consumers will learn from early adopters; interest in electrics will increase, and costs will come down. So, you need to provide incentives for them to allow this happen.  The problem is that there is no guarantee that these spillovers are large, and that costs of for batteries and vehicles will come down over time to be comparable to current gasoline vehicles.

Another reason the emissions effects for electric vehicles are counted as zero is that eventually the hope is that emissions from power plants that generate electricity will be from renewable sources and it will be close to zero.  But are these emissions currently zero?  The answer is “no.” Electricity production can create significant emissions, depending on how it is generated. But if the electricity used to power electric vehicles is generated from coal as it is in many parts of the country today, then that will have a high greenhouse gas emission, in some place resulting in GHG emissions that are almost as high as those from a conventional car.  The big growth in electricity production is now from natural gas.  There is controversy about methane leaks from natural gas extraction for electricity production, but overall it looks like the emissions from electricity from gas for electric vehicles may be about half of those from conventional vehicles.

UMBC Magazine:  So the emissions reductions from electric cars can vary a lot?

McConnell: Yes. And, I think the message here is that if you want to shift to any kind of alternative vehicle, you’ve got to think about the vehicle and the fuel to consider the effect on the environment.  That’s the bottom line. Just as we have gasoline-powered vehicles – we also now have all-electric vehicles (and hybrid electric), and we can’t ignore the fact of where and how the electricity to power them is generated.  There are various types of alternative fuel vehicles being suggested for the future in addition to electric plug-in vehicles (for example, fuel cells powered by hydrogen, diesel powered by biodiesel), but again, it’s the vehicle and the fuel together that matter for the effect on greenhouse gases and future climate impacts.  And policies toward both the vehicle and the fuel will be critical if we are to be serious about the goal of reducing greenhouse gas emissions.

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s