Unintended Disincentive?

A few weeks ago, I looked at the prospect for near-term oil savings and suggested that diesel cars, which have languished for years in this country, might be ready for prime time, thanks to some fuel and engine technology upgrades. Diesels could even beat hybrids, because they deliver the most valuable tranche of fuel efficiency at a much lower up-front cost premium. Unfortunately, that argument failed to consider that traditional price relationships between gasoline and diesel fuel might be shifting. If diesel remains as expensive relative to gasoline as it is today, carmakers' plans to sell hundreds of thousands of European-style diesel cars and diesel-powered SUVs may be frustrated, along with the efficiency gains they would have delivered.

Over the last five years, a gallon of diesel fuel has cost, on average, 5 cents more than a gallon of regular conventional gasoline--the grade sold everywhere except our most polluted metropolitan areas and California. In the last 12 months, however, diesel has averaged almost 17 cents higher than gas, and today that differential stands at +31 cents. Some of that current premium results from seasonal patterns associated with accumulating heating oil inventories for the winter, but much of the year-on-year increase can be attributed to the rollout of the new ultra-low-sulfur diesel. The new fuel contains no more than 15 parts per million of sulfur, in contrast to the previous standard, which allowed up to 500 ppm of sulfur.

The new sulfur standard was introduced to reduce emissions of particulates--a.k.a. soot--from existing diesel engines and to facilitate new diesel technology that could reduce diesel engine emissions to levels comparable to modern gasoline engines. However, if the price differential between diesel and gasoline remained at current levels, much of the economic incentive for motorists to switch to more efficient diesel vehicles would disappear. The average motorist driving 12,000 miles per year in a car getting 25 miles per gallon will spend $1,100 per year on gasoline, at current prices. A comparable diesel car would get 33 mpg, using 115 fewer gallons of fuel, but if diesel fuel cost 20 cents more than gas, the total annual savings would only amount to about $190. You'd never pay out your investment in a more expensive diesel engine at that rate.

The new Congress will have to decide how best to promote more efficient automobiles. Diesels represent an attractive option, but like hybrids, they may need a bit of help getting into the fleet in large enough numbers to reduce our overall oil consumption, both through their direct efficiency gains and by enabling the wider use of biodiesel blends. I've often cited the example of Europe, where diesels represent half of new car sales, but it's worth noting that many EU countries have nudged this transition along by taxing diesel fuel at a much lower rate than gasoline. The last time I rented a car in Germany, the savings worked out to almost $0.50/gal. As of 2004, it was $0.64/gal (large .pdf file) and about the same in France and Italy--though not in the UK, which appears to have the most expensive diesel fuel in the world.

With all the talk of raising gasoline taxes, it might be worth considering reducing diesel taxes to put diesel and gasoline closer to parity. That would at least neutralize the disincentive on sales of new diesel cars that was created by the government's policy choice on diesel fuel standards, at least until a more rational system based on relative greenhouse gas emissions could be introduced. The lost revenue could be made up by a modest hike in gasoline taxes, which would further reduce the diesel premium. While I've always been squeamish about such market tinkering, this represents a modest intervention, compared to what may be required as part of our larger response to climate change and energy security.