The Fuse

Is the IEA Too Optimistic About U.S. Fuel Efficiency?

by Leslie Hayward | March 04, 2016

Even though the IEA does not see prices rising above $80 per barrel before 2020, the Agency perceives that the continued low price environment will fail to stimulate demand growth.

The latest Medium Term Oil Market Report (MTOMR), published last week by the International Energy Agency (IEA), contains the agency’s outlook for oil market supply and demand balances for the period through 2020. The report’s authors were key to emphasize the extreme uncertainties accounted for in this year’s report, noting that the oil market is undergoing a “fundamental shift” in structure, as OPEC has taken a step back in its management of global supply, and the low oil price environment strangles upstream spending and pushes oil companies to the brink.

It’s often said that the solution to low oil prices is low oil prices, not just because of how cheap oil impacts producers, but also because of the impact on demand. Even though the MTOMR does not see prices rising above $80 per barrel before 2020, the Agency perceives that the continued low price environment will fail to stimulate demand growth, and global oil demand will slow to 1.2 mbd—a significant decline from the 1.7 mbd observed since 2009.

According to the IEA, there are two reasons for this slowdown. One is structural changes underway in the Chinese economy, and the other is “relatively high underlying vehicle efficiency assumptions,” particularly in the United States and Asia.

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Reason for skepticism on efficiency improvements

But how well can we rely on these assumptions of high vehicle efficiency? IEA’s optimism is undermined by what has already been observed in transportation oil demand here in the United States.

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It’s true that impressive fuel economy improvements are underway. Under this framework, IEA says that the fuel economy of new American cars will improve by about 40 percent, while the total light-duty vehicle fleet will improve by just under 20 percent. But these improvements hinge on political decisions, as well as consumer choices.

In order to meet fuel economy goals for 2025, automakers will have to almost triple the rate at which they have improved the fuel efficiency of their fleets.

In June of this year, the Environmental Protection Agency (EPA) will undergo a technical review of the current fuel economy requirements, and a decision will be finalized in 2017 on whether to maintain or adjust these rules. For supporters of efficient vehicles, the timing of the oil price collapse couldn’t be worse, and automakers have the regulations in their sights. In January, Bloomberg reported on a series of private meetings between regulators and automakers near the end of 2015, in which car companies emphasized, “Improvements to gasoline engines, including direct-injection and turbocharging, clearly won’t be enough to reach the target in nine years. It will require more gas-electric hybrids, and therefore, cost more than originally estimated. Consumers, meanwhile, haven’t embraced hybrids and other green technologies nearly as fast as the government predicted.”

Their arguments are supported by the data. Over the past year, sales of efficient vehicles have begun to decline, very sharply. The University of Michigan tracks sales-weighted fuel economy standards, which have begun to collapse following years of impressive increases.

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Meanwhile, sales of light trucks are surging, reaching historic highs last year. With the United States as the world’s largest oil consuming country, such sales figures have global implications. The IEA writes, “In 2015 therefore, we saw a 6.9 percent increase in [global] oil intensity as dramatically lower oil prices spurred additional oil purchases and sales of less efficient vehicles boomed in the United States as part of a general increase in oil demand world-wide.”

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Additionally, in order to meet fuel economy goals for 2025, automakers will have to almost triple the rate at which they have improved the fuel efficiency of their fleets.

2 8 times faster

The fact that automakers still have so far to go doesn’t necessarily bode well for the 2017. The review was agreed to by President Barack Obama, when he augmented the fuel standards put into place during the Bush administration in 2007, and established the more aggressive 54.5 mpg target. The Environmental Protection Agency, National Highway Traffic Safety Administration, and the California Air Resources Board will publish a technology assessment this summer.

In other words, IEA appears to be taking fuel economy standards at face value, and not recognizing the either the issues on the consumer side, or the scrutiny that the 2025 rules are currently under. The group acknowledges the fact that improvements in American fuel efficiency stalled in 2015, but write, “Starting in 2016, we expect underlying efficiency gains to return to more normal levels, averaging approximately 4 percent per annum in the period to 2021.” While this is certainly possible, it’s not clear why the trends of the past 18 months would reverse over the course of this year.

Another example of the group’s perception of American policy on oil demand is a reference to the $10/barrel oil tax recently proposed by the Obama administration. On page 19, IEA writes, “Potential tax hikes, such as the USD 10/bbl oil import tax proposed by the Obama Administration in February, further add to the downside.” This proposal has been widely lambasted and was considered dead on arrival the day it was announced. Additionally, no serious initiatives to increase retail gasoline taxes in the United States are underway.

Of course, this is only in the United States. IEA expects a general increase around the world of fresh vehicle efficiency standards. The Agency writes, “On this assumption [of dramatic efficiency gains] gasoline deliveries in the Unites States fall to a projected 8.6 mbd by 2021, down to the level seen in 2001. Similar annual efficiency gains of 2 percent are assumed across the global vehicle fleet underpinned by rapid technological advances, tightening government regulations and, prior to 2015, higher oil prices encouraging prudent oil use via the purchase of more efficient vehicles. […] According to the IEA’s 2015 edition of the World Energy Outlook fuel efficiency standards covered 34 percent of all road vehicles, as of 2014, up from 30 percent in 2005, and their coverage will continue to rise through 2021 as nearly 70 percent of new passenger car sales are subject to fuel efficiency standards.” IEA is more ready to acknowledge that low fuel prices are derailing efforts to increase the efficiency of heavy duty trucks, writing, “Fuel economy standards for heavy-duty vehicles are less widespread and, with the current low fuel price environment, the business case for as rapid efficiency gains across the freight sector is diminished.”

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Furthermore, it’s not just efficient vehicles, but also alternative fuel vehicles have also been hit by cheap fuel. Electric vehicle sales have exhibited similar trends as efficient vehicle sales. When it comes to alternative fuel vehicles, IEA recognizes that while low oil prices are dampening demand for now, “Over the longer-term oil is facing increased competition in the transport sector from hybrid, electric and natural gas-powered vehicles,” but add, “This fuel-on-fuel competition will play out only at the margin in the medium term. “ In the period through 2021, all of these vehicles combined will trigger a net loss of .5 mbd of transportation oil demand on the road.

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