The Fuse

A Hard Truth Revealed From Fuel Efficiency Upset: Government Can’t Predict Consumer Preferences

July 25, 2016

Guest Post by Sam Ori | @samori8

Sam Ori is Executive Director of the Energy Policy Institute at the University of Chicago.

This piece originally appeared in Forbes on July 22, 2016. For more of Sam’s perspective on fuel economy, click here to listen to Platts’ Capitol Crude Podcast on Oil, Cars and Gas Mileage.

The biggest news in energy policy circles this week was the release by federal regulators of a mid-term report on U.S. fuel-economy standards. As has been covered well here and here, the report delivered a bit of bad news: Instead of achieving the original, headline-grabbing efficiency target of 54.5 miles per gallon (mpg), the fleet of new vehicles sold in 2025 is likely to clock-in at more like 50 mpg. And even that target depends on fuel prices over the next decade—with oil prices needing to approach $100 per barrel by 2025 to keep efficiency above 50 mpg.

The shortfall came as a shock to many analysts and observers who had long operated under the assumption that U.S. vehicle efficiency targets were effectively written in stone. But those watching recent trends closely were not surprised. In fact, I explained why vehicles might not meet their targets in an earlier post, citing a nearly 30% gap between the levels of efficiency achieved and the target in 2016.

Rightly so, administration officials underscored this week that the projected 54.5 mpg was just that, a projection. As one official said, “54.5 isn’t a standard, never was a standard, and isn’t a standard now. 54.5 is what we predicted, in 2012, the fleet-wide average could get to, based on assumptions that were live back then about the mix of the fleet.”

“54.5 isn’t a standard, never was a standard, and isn’t a standard now. 54.5 is what we predicted, in 2012, the fleet-wide average could get to, based on assumptions that were live back then about the mix of the fleet.”

This underscores an important reason why the target won’t be met, and why achieving future emissions reductions in transportation could be exceedingly difficult: The standards are tied to consumer preferences. As preferences deviate from the forecasts, the target falls short. That’s what has happened over the last few years as consumers went out and bought more pick-ups and SUVs than predicted.

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Instead of representing 43 percent of the U.S. market, SUVs and pick-up trucks have accounted for nearly 60% of auto sales this model year. Meanwhile, sales of hybrid electric vehicles in the first half of this year hit their lowest levels in five years, implying that in addition to a shift toward trucks, consumers may be purchasing less efficient vehicles within each given class.

As a result of these factors, fuel economy performance is already trailing expectations by 1.3 mpg. This week’s report suggests that this gap may widen in the coming years.

A meaningful portion of this shift almost certainly has to do with low fuel prices, as the regulators noted. One recent analysis found that low gasoline prices shaved 0.3 mpg off of U.S. fuel economy performance between June 2014 and August 2015—a figure that happens to match the shortfall between projected and realized fuel-economy performance over roughly that period. Given the sustained drop in oil prices that occurred after August 2015, in addition to seasonal SUV buying patterns, it is a safe bet that low gasoline prices took a bigger bite out of fuel economy over the past year, which was not part of the analysis released this week. But the fact is that a range of additional factors probably affect consumer decisions—everything from economic conditions to style preferences.

As a result of these factors, fuel economy performance is already trailing expectations by 1.3 mpg. This week’s report suggests that this gap may widen in the coming years.

The essential truth revealed by all of this is that cutting emissions in transportation is going to be far more difficult than doing so in areas like the power sector. This is something that analysts have known for decades. That’s because there are only a few thousand large-scale power plants in the United States and really only a few hundred large coal plants. Replacing those with one of the numerous, increasingly competitive alternatives to coal—particularly natural gas—is low-hanging fruit for utilities that make investment decisions based strictly on rational assessments of long-run economics.

Transportation is a different story. Reducing emissions in this sector is directly tied to winning over consumers. And doing so is increasingly important, as the 260 million passenger vehicles on the roads account for nearly two-thirds of transportation sector emissions, and those emissions are surging. In fact, transportation eclipsed the power sector as the single largest source of U.S. carbon dioxide emissions in the 12 months through March of 2016.

To reduce those emissions, consumers will need to choose highly-efficient vehicles and new zero-emissions technologies. The current outlook doesn’t paint a pretty picture in this regard. More than 90 percent of the options available to consumers when they walk in a show room today run on a single fuel—petroleum—making it difficult to switch. And simply investing in the levels of efficiency projected by federal regulators requires consumers to accept a 5-year payback period.

Reducing emissions in this sector is directly tied to winning over consumers. And doing so is increasingly important, as the 260 million passenger vehicles on the roads account for nearly two-thirds of transportation sector emissions, and those emissions are surging.

Alternatives are beginning to appear, but they generally come with important drawbacks (lengthy charge times and reduced range), cost more to purchase than comparable gasoline models, and can take an even longer time to pencil out in terms of a return on investment than more efficient cars and trucks. While electric vehicle sales are growing, and Tesla continues to make important progress, no one has cracked the code on the mass market—yet.

In my next post, I’ll explain why this is the case—and put forward a framework for deep decarbonization in transportation. Stay tuned.

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