CAFE Standards Protect Innovation From Low Oil Prices

Should the government require automakers to improve the fuel economy of new vehicles each year? If so, at what pace should such improvements proceed? Responding to those questions, this week Michael Levi and I released a peer-reviewed discussion paper urging the next administration to maintain President Obama’s planned Corporate Average Fuel Economy (CAFE) standards. We argue:

“The recent fall in oil prices could undercut the rationale for stringent standards because when gasoline is cheaper, consumers do not save as much on fuel costs when they buy more fuel-efficient vehicles. Ahead of a mandatory federal review of the policies, we modeled the costs and benefits of CAFE standards under lower oil prices than Barack Obama’s administration assumed when, in 2011, it enacted rising standards through 2025.

We find that the stringency of the standards, as currently planned, can maximize net benefits to society even under lower oil prices, assuming that U.S. government estimates of the costs of efficient technologies are correct. Moreover, we identify three benefits that federal agencies did not previously consider that make stringent CAFE standards attractive under low oil prices. We also find that climate change risks are more significant in justifying strong CAFE standards than they were in 2011."

Writing in Vox, Brad Plumer provides a terrific overview of our paper and adds detail on why automakers are likely to push the next administration to relax the standards when federal agencies review them in 2017:

“That review could prove contentious. So far, automakers have coped with the rules just fine, technology-wise. They’ve reduced the weight of the vehicles by using lighter materials like aluminum, and they’ve deployed technologies like gasoline direct injection and cylinder deactivation to improve the efficiency of their engines. Yet some companies are insisting that meeting the post-2020 standards could prove far more arduous.”

Automakers may be right that continuing to design even more efficient vehicles will be more expensive than anticipated, perhaps because they have already harvested the low-hanging fruit of technology enhancements. And they may conclude that as oil prices have fallen, so has consumer demand for higher mileage vehicles, eroding the justification for designing efficient but expensive models.

But relaxing CAFE standards when oil prices are low would doubly damage U.S. efforts to reduce oil consumption and curb greenhouse gas emissions. First, major automakers would fail to invest in efficient technologies for conventional gas-powered vehicles. And second, in the absence of fuel economy standards that induce innovation that is transferable across vehicle designs, low oil prices will chill investment in alternative transportation options, including electric and hydrogen vehicles.

CAFE Standards Direct Innovation Toward Efficiency Gains

Historically, automakers avoided investing in efficiency even while oil prices rose for the better part of the 1990s and 2000s. That is not to say that they did not innovate—on the contrary, automakers invested heavily in boosting the performance of new vehicles, increasing torque and horsepower to sate consumer demand for more powerful cars. But fuel economy languished as CAFE standards stagnated (see figure 1 from our paper, below).

Now that oil prices have plunged, automakers would be even less likely to market an efficient fleet of vehicles. This is because current pump prices heavily influence consumer buying decisions. As a result, the recent plunge in oil prices has led to national sales of less efficient light trucks—including SUVs and minivan—overtaking sales of more efficient passenger cars. If not for federal mandates, automakers would likely tailor their new vehicle offerings to satisfy customer demand for less efficient vehicles.

Innovation Helps Alternative Vehicles Even More Than Conventionals

Some argue that fuel economy standards, rather than a more comprehensive carbon price policy, actually hurt alternative vehicle technologies rather than help them. For example, David Livingston at the Carnegie Endowment contends:

“Even when successful, vehicle standards are incomplete solutions. As they become more stringent over time, they make traditional internal combustion engines more competitive by using new materials and technologies to increase fuel mileage, in the process rendering new alternatives such as hybrids or electric vehicles less desirable on the margin.”

Although I think fear of such technological lock-in is justified in some cases, fuel economy standards probably do more to help than hurt the competitiveness of alternative vehicle technologies. First, CAFE standards offer attractive bonus credits for automakers who sell alternative designs, including electric vehicles. Second, almost every technological advance that improves the efficiency of a conventional vehicle will also improve the efficiency of hybrid vehicles,  at present the most competitive alternative to fully gasoline powered vehicles.

Finally, efficiency improvements that carry over to electric vehicles (e.g., lighter construction materials) benefit their competiveness far more than that of gasoline powered vehicles. This is because lighter and more aerodynamic electric vehicles require smaller batteries, making the car even more lightweight, efficient, and cost-competitive.

These improvements can be crucial to advance alternative vehicle designs that otherwise would struggle to compete for investment when oil prices are low. Earlier this year, Michael and I convened a diverse group of academics, policymakers, and private sector experts  to investigate the effects of low oil prices on clean energy investment. Within the transportation sector, we learned that current low oil prices matter substantially. Advanced biofuels companies are struggling, and consumer demand for alternative vehicle technologies has fallen, denting the investment rationale in non-gasoline powered vehicles. In a market that does not value greenhouse gas externalities, a lack of a policy buffer could leave clean technologies at the mercy of an unforgiving oil market.

Although low oil prices can provide windfall savings in the near term for consumers, they can jeopardize the long-term investments that the United States must make to reduce reliance on oil. In our discussion paper, we have shown that upholding President Obama’s CAFE standards is justified because their economic benefits outweigh compliance costs more so than any more lenient standard. But in addition, CAFE standards play an important and more difficult to quantify role as a source of policy certainty shielding clean innovation from oil market uncertainty.