Loophole Whiplash

The Corporate Average Fuel Economy (CAFE) standard is back in the news. One of the main results of the Energy Independence and Security Act of 2007 (EISA) was to increase the overall US new car fleet CAFE target to 35 miles per gallon by 2020. Now the National Highway Traffic Safety Administration, which administers the CAFE program, must establish the milestones for stimulating and measuring progress toward that goal. Today's Wall St. Journal reports that auto manufacturers that had previously embraced last year's CAFE compromise are now objecting to a 2015 interim standard of 31.6 mpg. As obtuse as this may seem, in light of consumers' recent and dramatic shift toward more efficient cars, it is a consequence of two past regulatory failures associated with CAFE: the well-known "SUV Loophole" and the much more obscure rules promoting the manufacture of "Flexible Fuel Vehicles" (FFVs.) Carmakers haven't just been slammed by high fuel prices; they also have a bad case of loophole whiplash.

To the surprise of many observers, last year's energy legislation finally closed the much-debated SUV Loophole, which had subjected "light trucks" to a different, lower fuel economy standard, compared to "passenger cars." This was a classic case of good regulatory intentions gone wrong. When the CAFE standard was originally established in 1975, Congress and the Ford administration recognized that the pickup trucks and delivery vans used by businesses could not attain the same fuel economy as personal cars using the technology of the day. Forcing them to do so would have made a bad US economy worse. Without rehashing how this sensible policy morphed into the SUV fad, the result is that 33 years later, the 2008 model (scroll down to March 2008 report) passenger car fleet came within 0.2 mpg of meeting the proposed 2015 target, while new SUVs and pickups still averaged only 23.4 mpg. So not only have SUVs become albatrosses on cardealers' lots, thanks to $4 gasoline, but the same federal program that promoted them in the first place has now turned them into a huge regulatory liability.

A less-publicized aspect of the 2007 energy bill has a bearing on this problem, as well. Previously, FFVs were treated as an even more privileged category under CAFE, and an FFV SUV was a precious commodity. As NHTSA's CAFE FAQ page explains, a model getting 13 mpg on E85 and 16 mpg on gasoline would be counted towards a carmaker's CAFE quota as though it were a sort of 50 mpg hybrid on paper. An automaker could meet up to 1.2 mpg of its overall fleet target this way, in another example of US alternative fuel policy gone awry. Under EISA 2007, this benefit will be phased out between 2014 and 2019. The result only amplifies the SUV pain for US carmakers.

Although the timing of all this could not have been worse for Detroit, it was never going to be otherwise. Only another energy crisis could produce the political coalition necessary to close these loopholes, guaranteeing that this would coincide with market conditions that would punish US carmakers for the past success they enjoyed by taking advantage of them in the first place. There is no doubt that GM and Ford, at least, can field entire new car fleets capable of meeting the 35 mpg standard. The technology exists today, and their 2006 European models already delivered the equivalent of the ultimate US target. In the EU they will be required to beat 40 mpg by 2012. The question is whether they can retool quickly enough to pull off the same trick, here, with a sales mix reflecting the expectations of US car-buyers--expectations that are currently in flux but still differ markedly from those of consumers in the UK or Germany.