Cheapest Gasoline Ever?

Last week the Energy Information Administration  (EIA) reported that the $2.43 per gallon average US retail price for regular gasoline in 2015 was the lowest since 2009. A quick look at the EIA's handy page for comparing nominal and real fuel prices over time shows that last year's average, when adjusted for inflation, was actually the cheapest since 2004. A recent article suggested that current prices are lower than those in the mid-1960s, in the heyday of the American love affair with driving. I've lost the link, but that factoid checks out, too. However, even this understates the bargain currently on offer at the gas pump.

The price of gasoline is still one of the most visible prices in the US, prominently displayed on gas station signage and roadside billboards across the country. However, it only captures one aspect of how much motorists really pay, just as measuring fuel economy in miles per gallon misses the economic impact of driving. A few years ago I ran across a metric that combines these factors into a simple gauge of driving cost: miles per dollar, or mp$.

The chart below incorporates EIA data on inflation-adjusted fuel cost and data from the National Highway Transportation Safety Agency (NHTSA) on actual fleet corporate average fuel economy (CAFE) performance for each model year of passenger cars--not SUVs or light trucks--to display average mp$ for the last four decades.

Taking last week's average price of $2.03 for unleaded regular and using 36.4 mpg for the 2013 model year (the latest on NHTSA's site), today's fuel cost of driving is cheaper than at any time since 1978--and maybe ever. The 18 miles per dollar I calculated just beats the previous peak of mp$ in the late 1990s, when fuel economy was around 28 mpg and gas prices averaged barely over $1, due to the effects of the Asian Economic Crisis. By comparison, the $0.31 per gallon that motorists paid in 1965 was downright expensive, after adjusting for inflation and factoring in the low-to-mid-teens fuel economy of cars of the day.

Miles per dollar is also handy for comparing driving cost on gasoline to the cost of operating vehicles that use other fuels or electricity. When I first looked at miles per dollar in 2008, electric vehicles were significantly cheaper, per mile driven, than cars running on gasoline or diesel, even hybrid cars like the Prius. That gap still exists, but it has narrowed. At an US average residential electricity price of $0.126/kilowatt-hour last year, a Nissan Leaf or Chevrolet Volt would get around 26 mp$. However, in New England and other parts of the country with significantly higher-than-average electricity prices, the miles of driving that an EV can deliver per dollar of energy used could be less than that for gasoline in some locations.

A few caveats are in order. Based on data from the Transportation Research Institute at the University of Michigan, new-car fuel economy has slipped 0.8 mpg since oil prices started falling in the summer of 2014. And in any case, new cars are typically more efficient than the entire US car fleet, which includes older vehicles and substantial numbers of SUVs and light trucks. The Consumer Price Index is also an imperfect tool for comparing prices over long periods of time, because the Bureau of Labor Statistics periodically changes the components of the "basket" of goods and services that go into calculating the CPI.

None of those issues seems big enough to alter the basic conclusion that the gasoline cost of driving is exceptionally, perhaps historically cheap at the moment. If oil prices stay "lower for longer", as some experts expect,  changing the make-up--and thus the emissions--of the US car fleet is likely to be an uphill battle.

How Much Will Low Oil Prices Stimulate Demand?

• Since weak oil demand growth is a major ingredient in the current oil price crash, higher demand stimulated by low prices could be a moderating factor.
• While US demand has risen since prices fell, there are several reasons why the global response may be slower to appear and less dramatic.

One of the main factors that will determine the depth and duration of the current slump in oil prices is the extent and timing of a resulting rebound in demand. It is likely to occur first in countries like the US, where fuel taxes are low and consumers see the results of lower oil prices at the  gas pump relatively quickly--a $1.65 per gallon drop already, since June. However, other factors besides taxes could impede faster demand growth elsewhere. 

From 2007 to 2009 the combination of high oil prices and a weak economy reduced US petroleum demand by almost 2 million barrels (bbl) per day, compared to its 2006 peak. The first volumes backed out of the market were imported refined products, which had grown rapidly from the mid-1990s until 2005. Low domestic demand and expanding US oil production then led US oil refiners to seek new markets, particularly in Latin America. US petroleum product exports have increased by around 1.7 million bbl/day since the recession began.

These refiners might reasonably expect their domestic and foreign markets to grow faster with oil prices dramatically lower. So far, it's hard to see more than hints of this in the lagged data from the US government or API, which reported December gasoline demand at a 7-year high. It's also hard to discern how much can be attributed to oil prices, rather than to US economic growth and a falling unemployment rate. The October update of vehicle miles traveled from the US Department of Transportation was still well below its 2008 peak but showed a modest upward trend, although that seems to have begun before oil prices fell.

Other indicators are also mixed. By the end of last year sales-weighted fuel economy of new vehicles sold in the US had declined by 0.7 miles per gallon from its August 2014 peak. That reflected US consumers buying larger vehicles, including more SUVs, fewer hybrids and only slightly more plug-in electric cars than in the prior year. Despite this retreat, full-year-average fuel economy tracked by the University of Michigan still showed a more than 5 mpg gain since 2007, equating to 20% better fuel efficiency. So the roughly 45 million cars and light trucks sold in the US in the last three years--nearly a fifth of today's light-duty fleet--will use less gasoline than the ones they replaced, even in the most robust response to low gas prices imaginable.

Globally, growth prospects seem equally mixed. Since last July the International Energy Agency has reduced its forecast of 2015 petroleum demand growth by a cumulative 500,000 bbl/day, to +0.9 million bbl/day, as the global economy weakened.  These conditions could combine with currency-related effects to dampen, or at least delay, a potential surge in global oil demand due to low prices. 

Because oil is traded in US dollars, the dollar's recent strength shrinks the oil savings experienced by other importing countries. While all of these countries are paying less for oil than they did last summer, exchange rates have eroded 10-30% of that benefit. The chart above displays this effect for the Euro and Japanese Yen. Closer to home, currencies like the Mexican and Colombian Pesos have depreciated by 12% and 29% since June, respectively.  That could prove significant, since Mexico's refined product imports from the US averaged over 500,000 bbl/day in 2014 (through October), along with over a million bbl/day to the rest of Latin America.

Since petroleum products are sold in local currency, after tax at the pump, consumers in many countries have seen a smaller drop to which they might respond, compared to US consumers. The average German gasoline price has fallen by just 19% since June and the average UK price by 20%, compared to 42% in the US. Meanwhile state-controlled gasoline prices in Brazil and Mexico have  gone up. That's unlikely to induce more driving.

So far the weekly figures  for US refinery throughput are up compared to last year, implying higher expected product sales. However, US inventories of gasoline and diesel fuel have also been growing for the last several months. If rising demand doesn't erode inventory gains soon, refiners may need to reduce processing rates, and that would feed back to oil prices. The next few months of energy statistics should tell a very interesting story.

 

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Virginia's Gas Tax: Ending A "Dinosaur Tax"

I don't know if the Speaker of Virginia's House of Delegates intended a double entendre when he referred to the state gasoline tax that Governor Bob McDonnell (R) just proposed eliminating as a "dinosaur tax".  He was certainly correct that this tax is rapidly becoming outmoded as its capacity to keep pace with necessary infrastructure investment fades with every EV, hybrid, or other efficient car that's sold.   In the Governor's remarks, he referred to the gas tax as a "stagnant revenue source." In a low-tax state like the Commonwealth, shifting the tax burden for transportation away from fuel taxes and toward registration fees and a higher general sales tax represents an innovative, though also controversial answer to a challenge that has concerned me for some time. 

The scope of the underlying problem should be uncontroversial: Like most states, Virginia's $0.175 per gallon gasoline tax is a holdover from an era in which fuel sales grew in tandem with road use, and both expanded steadily year after year.  I can personally vouch for Northern Virginia's traffic congestion, cited in this morning's Washington Post story on this issue. As in most states, Virginia's gasoline sales have been flat to declining since the recession that began in 2008, while the value of the fixed fuel tax has been further eroded by inflation.  These trends seem likely to continue for years, with recent new-car fuel economy improving sharply. The gas tax simply can't cover the cost of repairing and extending Virginia's highways without a large increase now, followed by periodic increases as future fuel sales fall. 

A key aspect of Governor McDonnell's proposal that appeals to me is that it doesn't rely on high-tech monitoring or low-tech inspections of actual miles driven, like many of the other solutions I've examined.  Instead of trying to fix the fuel-tied tax, he would eliminate it entirely and shift revenue generation to a combination of higher annual fees, especially for alternative fuel vehicles that currently pay little or no road tax, and an increase in the Commonwealth's 5% sales tax to 5.8%.  0.5% of the current sales tax is already dedicated to transportation.  The proposed shift exchanges one regressive tax for another, in a manner that recognizes that all Virginians stand to benefit from improved transportation networks, whether they personally use them or not. 

The current Virginia gas tax costs an average motorist around $100 per year, based on 12,000 miles of annual driving.  The rise in the sales tax would generate comparable revenue from $12,000 of annual spending subject to the sales tax.  That likely equates to little or no tax increase for low-income drivers, and an increase of up to a few hundred dollars a year for the better-off, while still leaving Virginia's sales tax slightly lower than those in Maryland and the District of Columbia. Motorists would continue to pay the federal gasoline tax, currently set at $0.184/gal.

I can envision various objections to the Governor's proposal, including concerns that cutting the gas tax might increase gasoline demand--and emissions--and reduce the incentives for higher fuel efficiency.  That seems unlikely in the current context for at least two reasons.  First, eliminating the Virginia gas tax involves a reduction in pump prices of less than 5% of last year's average price in the region, and more importantly represents less than a quarter of the total range of gas-price volatility we experienced in 2012. Moreover, fuel economy improvements are already mandated under the new federal Corporate Average Fuel Economy regulations that will increase fleet-average miles per gallon to 54.5 mpg by 2025.  Cars will continue to become more efficient, no matter what gasoline costs.

It will be interesting to watch how this proposal fares in Richmond.  The Governor's party may control the House of Delegates and effectively the Senate, by virtue of a tie-breaking Lieutenant Governor, but 2013 is an election year, and Mr. McDonnell is barred by term limits from seeking reelection. I wish him luck with this idea, even though its enactment would probably result in a small net tax increase for my household. I'm sure other states will be watching, too.

Does the Gas Tax Belong in the Fiscal Cliff Fix?

Recently I've seen several articles along the lines of this one from CNN, suggesting that an increase in the federal gasoline tax might be included in negotiations to avert the impending US "fiscal cliff".  While the gap between the gas tax, which was last raised in 1993, and highway repair costs grows each year, that's not just because past Congresses and administrations have been reluctant to hike it again.  As I've discussed in previous posts, gas tax revenue is declining for structural reasons related to curtailed driving, rising fuel economy and alternative fuel vehicles.  Simply adding another 10-15 ¢ per gallon to the current 18.4 ¢ tax wouldn't solve the long-term problem, although it would raise enough revenue to allow us to continue to ignore these growing challenges for a few years.  For that and other reasons, changing the gas tax deserves closer scrutiny than the waning hours of a preoccupied lame-duck Congress can provide.

Yesterday I attended another excellent event held by Resources for the Future in Washington, DC.  This one was devoted to "The Future of Fuel."  The panel discussion began with a presentation of the current energy forecast of the Energy Information Agency (EIA) highlighting the shifting energy mix the agency expects between now and 2035.  Although the slide deck didn't include the chart below, taken from EIA's 2012 Annual Energy Outlook, I couldn't help thinking of it in the context of both yesterday's meeting and the question of future fuel tax revenues. 

The EIA forecasts US gasoline demand to decline by about 8% from current levels by 2035 as cars meeting the new federal fuel economy standard enter the fleet, along with small but growing numbers of vehicles running on electricity and other non-petroleum fuels. An 8% drop in gasoline sales--and thus gas tax revenues--doesn't sound large until you realize that the current gas tax system was predicated on consistently rising gasoline sales as a means of expanding revenues. That's crucial, because highway construction and maintenance costs rise each year, too.  If gasoline sales were still growing at the 1% annual rate typical when the gas tax was last increased, gas tax revenues would be at least 37% higher by 2035 than the level the EIA would now project.

Stepping back from the details, the government faces a fundamental disconnect between its need to raise sufficient funds from the gas tax to cover the cost of maintaining the nation's road network and explicit federal policies aimed at reducing our consumption of the fuels being taxed.  Another one-time bump in the gas tax, whether of 5¢, 10¢ or 15¢ per gallon, will again be overtaken by the combined forces of inflation and declining volumes.  Fortunately, this problem is well-understood and a number of solutions are under consideration.  Inconveniently, many of them involve basic and controversial changes in how the road tax would be collected, such as shifting to a mileage-based tax assessed via annual inspections or real-time GPS monitoring. 

No one should expect or desire the 112th Congress to resolve these issues between now and the end of its term in January, particularly when the money at stake represents such a tiny fraction of either the fiscal cliff's package of tax increases and spending cuts or of the entire federal deficit.  I'm also not sure that reforming the gas tax belongs within the larger federal tax reform effort that should be undertaken next year, because the issues involved are so different from those associated with revamping the business, income, and payroll taxes.  Even a temporary fuel surtax would likely encounter strong opposition, due to its regressive nature and coincidence with gasoline prices that, despite recent declines, remain at or near seasonal record highs.  Unlike the rest of the fiscal cliff, this might just be one can that would benefit from being kicked down the road, at least past the current crisis.

Is North America the New Middle East for Oil?

With the President of the United States currently playing the role of pessimist-in-chief with regard to US energy independence, it's refreshing to see that goal raised as a serious possibility by someone whose experience and position give him deeper insights on the subject. A few years ago Ed Morse was running the oil trading operation for Hess, and now he's at Citigroup. His op-ed in today's Wall St. Journal offers an upbeat analysis of the ongoing resurgence in US and Canadian production and the potential for North America to move within striking distance of true oil independence. He doesn't appear to be predicting $2.50 per gallon gasoline any time soon, but he does remind us that permanently higher oil prices needn't be inevitable, although he is also very clear about the obstacles that could impede these developments.

How often have politicians and pundits reminded us that we can't drill our way to energy independence? I've said that myself numerous times in the eight years I've been blogging here. So before exploring the implications of producing significantly more oil than we do today, it's worth asking why some experts are starting to question what has been a bedrock assumption about the US energy situation since our conventional oil production peaked in 1970--not coincidentally just before the first oil crisis in 1973-74.

If the tired talking point about the US having just 2% of the world's oil reserves were truly reflective of reality, rather than a technicality based on the way the SEC requires oil companies to account for their chief assets, people like Ed Morse wouldn't give energy independence a moment's thought. The number to focus on is not the 21 billion barrels of proved reserves on companies' books, but the nearly 200 billion barrels of discovered and undiscovered "technically recoverable oil resources" onshore and offshore, in the lower-48 and Alaska. That figure represents more than 95 years of production at current rates.

That estimate is also mostly based on assessments from the 1980s done with technology that bears the same relationship to current exploration techniques as an old Ma Bell rotary phone does to an iPhone. It's technology that is shifting expectations about what is actually possible. Consider the Bakken shale formation in the Dakotas. The conventional Williston Basin oil fields were discovered in the early 1950s and mostly played out by the late 1980s. The billions of barrels of resources in the adjacent Bakken shale, which might produce a million barrels per day by the end of this decade, simply couldn't have been produced at commercially useful rates with the technology that was available until the last decade. The hot question now is where the next Bakkens will be found.

Then there's deepwater drilling, which suffered a big setback with the Deepwater Horizon accident and spill but is still contributing 1.2 million barrels per day and could reach 1.9 million next year. What moves Mr. Morse's speculation from wishfulness into the realm of practical possibility is the potential of applying technologies like those to exploit conventional and unconventional reservoirs to which industry has not had access since their development, if ever.

Another talking point that we've heard like a drumbeat over the last several months is that even if the US could produce more oil, it would make little difference to oil prices in a global market of 90 million barrels per day. We simply don't control the price of oil; OPEC does. That has been true for essentially the entire time I've worked in energy. But here's where it's handy to have the background in oil trading that I share with Mr. Morse. Traders have to think about how prices are really set, and they understand that it's the interaction of the last few million barrels per day of supply, demand and spare capacity that really count, along with inventories. An extra million or two barrels per day--a quantity of which North America is certainly capable--can make a huge difference in oil prices. We saw that in 2009, when a drop of about 3 million barrels per day of demand sent prices from $140 to $40 within a few months, and we saw something similar involving both supply and demand during the Asian Economic Crisis of 1997-98. (See chart below.)


Nor is OPEC monolithic; it's made up of a group of producers with very different levels of reserves and production, and differing domestic requirements for the revenue they earn from selling their oil. That means that, contrary to yet another talking point, OPEC does not have unlimited capacity to back down production, in order to keep prices high when others increase output. And even when it can maintain enough cohesion to tighten quotas and restrict its own output, the production in question merely shifts to "spare capacity", the expansion of which reduces oil market volatility. Imagine how different the market's response to the current confrontation over Iran's nuclear program might look if other producers had a multiple of Iran's exports in reserve.

Just because something is possible with a decade or so of determined effort doesn't make it inevitable. While I share Mr. Morse's optimism about the benefits of boosting North American oil production on a scale that would dwarf the modest recent upturn, which has received so much attention from politicians who had nothing to do with it, I'm also skeptical that it could proceed to quite that extent in today's climate. Aside from people who are genuinely concerned about the possible environmental impact of more oil development, there are also those who would regard such a turn of events as contrary to their own interests and their perception of the nation's. How would we convince consumers to pay the premium for new cars achieving an average of 54.5 mpg in 2025 if gasoline remained between $3 and $4 per gallon, instead of trending toward $6--let alone shifting them into electric vehicles that the government and carmakers have invested billions in developing? And how would we stimulate production of advanced biofuels if the future price of crude oil were seen as being capped at or below $100 per barrel, except during geopolitical crises?

I believe all such questions have answers that don't depend on us constraining access to our resources at the cost of remaining more vulnerable to overseas suppliers and weakening both our trade deficit and our currency. I'd rather have the extra domestic oil and then worry about how to spend some of the resulting windfall of federal and state taxes, bid bonuses and royalties on achieving our other policy objectives, such as promoting efficiency and reducing emissions. Nor is relying on OPEC to keep prices high the best or most effective way to encourage us to use oil more frugally.

I don't know if North America is the next Middle East, although it's worth recalling that we were the world's biggest oil supplier before the first well was drilled in Saudi Arabia, and DOE estimates suggest we have as much oil left as we've produced to date since 1859. However, I do know that I would much rather give OPEC's leaders sleepless nights worrying how they'll keep oil prices high in the face of a wave of new production from the US, Canada and possibly Mexico, in preference to giving US consumers sleepless nights about how they'll pay for the gasoline they need for their commutes and the fuel to heat their homes, if prices stay this high or higher from here on out.

How Helpless Are We in the Face of Rising Oil Prices?

Oil is rarely not political, and with gasoline prices hitting record levels early in a presidential election year, we shouldn't be surprised that both the President and his challengers have focused on energy policy. President Obama gave what was billed as a major speech on energy at the University of Miami in Florida yesterday. After urging more students to study engineering--a sentiment I would strongly second--he laid out his view of the situation and its solutions. He got a lot right, including the long-term nature of the problem and the value of improving the efficiency of our vehicle fleet. But unfortunately, he also missed the mark in many ways and generally reflected the exaggerated fatalism that his administration has consistently exhibited towards oil prices. Boosting domestic supply is not the only answer, but it could be far more effective in moderating high oil prices and their impact on the economy than the President admitted.

To see why requires a sense of how the oil market works, as well as the uses to which we put oil today, rather than a generation ago. For starters, although the President has worked hard to improve conditions for renewable energy sources like wind and solar power--sources that certainly have an important role to play in our long-term energy mix--these technologies, along with nuclear power, are out of place in a conversation about oil prices in 2012. That's because they produce electricity rather than liquid fuels, and less than 1% of US electricity is generated from oil today, compared to more than 10% in 1980. Electricity from renewable and nuclear power doesn't compete with imported oil or any other kind of oil; it competes with domestic energy sources like coal and natural gas, most of which now comes from conventional and unconventional gas fields, rather than as a byproduct of producing oil. So by all means lets have a conversation about renewables in the context of reducing greenhouse gas emissions today and displacing oil from transportation when there are tens of millions of electric vehicles on the road in the future, but in terms of oil prices now and in the near future, they are a rhetorical diversion.

Fuel efficiency and plain old conservation can play an important role in reducing both our exposure to higher oil prices and in contributing to lower prices, because both attack demand directly, and demand is a big factor in oil prices. The President is right to emphasize this. Americans have cut back on oil consumption to the tune of 1.8 million barrels per day since 2007, and this was a significant factor in the oil price collapse in late 2008 and the generally lower prices we've enjoyed since then. Unfortunately, that happened largely as a result of the recession and financial crisis, rather than a sudden spike in fuel efficiency. If Americans buy the new, more efficient cars that Detroit must make under the administration's stricter Corporate Average Fuel Economy standards, then over the next decades the efficiency of the US car fleet will improve significantly, and even after rebound effects our oil demand and need for imported oil should fall. But let's not delude ourselves that this can happen overnight. There are roughly 250 million cars, SUVs and light trucks on the road in the US today, and even at pre-recession sales levels it will take more than a decade to turn over enough of them to make a serious dent in oil consumption.

President Obama made only a passing reference to biofuels in his speech, and for good reason. At current production levels ethanol displaces up to 600,000 bbl/day of petroleum gasoline, after adjusting for its lower energy content. That's good, but we've essentially played that card already and can't play it again. Almost all the gasoline sold in the US today contains 10% ethanol, the maximum level that most cars can tolerate without damaging their fuel systems or voiding their warranties. There's little appetite among consumers for the 85% ethanol E85 blend that flexible fuel vehicles can use, and there's even less appetite among fuel distributors for the 15% ethanol blend that the EPA blessed in 2010. With ethanol maxed out for now, our focus must shift to biofuels that are much more compatible with gasoline and diesel fuel, and that rely on technologies that haven't yet been demonstrated at commercial scale or competitive cost.

And that brings us back to the potential for reducing our dependence on oil imports and moderating oil prices by producing more domestic oil. Now, it's certainly true that US oil production and consumption are only part of a much larger global oil market, where prices are actually set. The US couldn't control the global price of oil, as it once did, even if we imported virtually no oil from outside North America. However, it's simply not correct to gauge the potential impact of an extra million bbl/day of US production--a figure that is well within the range of what a more aggressive domestic drilling program could deliver--by comparing it to the entire global output of nearly 90 million bbl/day. As with other commodities like grain and coffee, the price of oil is determined by relatively small changes in supply, demand, inventories, and in the case of oil, spare capacity. What really counts is the last few million barrels per day that are traded, whether inventories are rising or falling, and how large global spare capacity is and who owns it. The last three times that oil prices collapsed, in the mid-1980s, late-1990s, and 2008, it happened as a result of net changes in these parameters amounting to less than about 3 million bbl/day.

Yesterday the President cited statistics indicating that US oil production has returned to levels we hadn't seen for several years. That's true, and it's equally true that this modest surge of about 14% is the result of factors over which his administration had no control: oil prices and federal policies in the previous administration and the application of improved drilling technologies in the deepwater Gulf of Mexico and onshore locations like North Dakota's Bakken formation and the Eagle Ford shale of Texas. Moreover, it's only technically accurate to state that he has "opened millions of acres for oil and gas exploration", when the lease sales in question were originally scheduled to have taken place earlier, and were to have encompassed much more acreage, including offshore acreage that has been off limits for decades, such as offshore Virginia. The Deepwater Horizon accident certainly changed the context for the President's previous drilling plans, but his administration's responsibility for the subsequent decline in offshore production, the slower pace of development and tighter geographic constraints on where the industry can look for oil since then must be acknowledged in this discussion.

Then there's that other shibboleth of oil prices, speculation, which was also mentioned yesterday. As I've discussed previously, there are times when speculation can increase some oil prices, at least for a brief period. However, it's worth recalling that for every trader buying futures contracts or options in hopes they will go even higher, some seller must take the position that current prices are high enough and likely to be lower, later. This adds a froth of sentiment to the market, but it can't sustain prices for long if fundamentals aren't supportive and if the physical market doesn't follow. So while politicians see a $10/bbl rise this month in the price of West Texas Intermediate on the futures market as a symptom of speculation, they tend to ignore data like the much larger recent increase in the spot price for Louisiana Light Sweet crude, for which someone must take physical delivery at St. James, Louisiana, rather than just offsetting against another "paper barrel". When you look at physical oil inventories, there's no evidence that speculators are taking delivery of large quantities of oil and storing it so refiners can't buy it.

The key factors driving the recent increase in oil prices are tensions with Iran and the fact that, with production off-line in places like Sudan and still not back to pre-revolution levels in Libya, OPEC's effective spare capacity is below 3 million bbl/day, not much above the level that contributed greatly to oil's near-$150 peak in mid-2008. So despite relatively weak demand growth, the market looks tight now, with the prospect of Iran cutting off sales--or being embargoed via sanctions from buyers--by a volume that would erode that cushion of spare capacity in Saudi Arabia and a few other Persian Gulf producers even further--capacity that mostly sits inside the Strait of Hormuz.

So what levers does this President--or any President--really have with which to try to moderate oil prices over the next few years? It's clearly not renewable energy policy at this point. It could include foreign policy, particularly if you agree with the view of Washington Post columnist David Ignatius that Iran has displayed a clear pattern of backing down in the face of "overwhelming force". Resolving the Iranian threat to Gulf shipping and setting the outlines of a solution to Iran's nuclear program could take $20/bbl off the price of oil in fairly short order, though I wouldn't suggest that looks easy. Yet even though a decision to expand access to US oil resources significantly, along the lines of the President's pre-Deepwater Horizon plan, would not deliver new production quickly, it's wrong to be dismissive about the impact of more drilling on prices or in mitigating the impact of those prices on the economy. And in the case of onshore opportunities for which infrastructure is already in place or in the works--and here I would include the Keystone XL pipeline--it need not take 10 years for the first barrels to reach market. Together with a strong, technology-neutral effort on fuel economy, a new, more expansive approach to exploiting domestic resources would affect the back end of the futures price curve, and that could start to nudge down nearer-term prices, as well. Even if I'm wrong about that, it's still the case that at current prices every additional 1,000 bbl/day we produce here would reduce our trade deficit and the drag on our economy by about $40 million--and there are a lot more thousands of barrels per day we could be producing.

At least one of the President's potential challengers has described a plan for getting gas prices back to $2.50 per gallon. Perhaps this had something to do with President Obama's choice of topic yesterday. I will devote a lot more time to analyzing such proposals once the Republicans have chosen their nominee. However, it's worth noting that as outlandish as $2.50/gal. sounds when the average price of unleaded regular has jumped to $3.59/gal. this week, it works out to an effective crude price of around $70/bbl, after subtracting state and federal taxes and refiner and dealer margins. That's roughly what oil cost in 2006 and 2007 and more than in 2009. It's also a higher price than most oil industry experts even imagined would be possible just a few years earlier.

I don't know if Mr. Gingrich's plan would work, and I suspect that the economics of at least some of the new production necessary to force OPEC to compete on price again, rather than managing the price to suit their own needs, might be challenging at $70/bbl. Yet I'd be much more inclined for us to work towards such a goal than to dismiss it as impossible or irrelevant and fatalistically accept the consequences of $100+ oil for another decade or more. The President should at least be as open to these possibilities as he is to the possibilities of renewable energy for reducing emissions.

The Next Big CAFE Loophole

The great pitfall of government policies, no matter how well-intended they might be, is their inevitable unintended consequences. When those are truly surprising, it's hard to attach much blame to the legislators or regulators involved. However, that degree of indulgence shouldn't apply when the unintended consequences are as obvious as the ones inherent in the new fuel economy regulations that were announced with such fanfare last week. After all, an earlier generation of CAFE standards gave rise to what might just be the classic unintended consequence of recent times: the "SUV loophole" that fed a 20-plus-year SUV fad and dug the nation's oil consumption hole much deeper than it needed to be, affecting oil prices, trade deficits and energy security. Now regulators are proposing the creation of a similar loophole for electric vehicles.

I'm not surprised that the coverage I have read on the latest CAFE debate didn't remind the public of the ongoing consequences of treating pick-up trucks and delivery vehicles differently than passenger cars when the first CAFE standards were established in the 1970s. (That loophole was mostly closed just a few years ago.) Who could have guessed that a provision intended to help small businesses would blow up, because an entire generation embraced deluxe versions of such vehicles as their primary transportation--by the tens of millions--undermining the purpose of the CAFE standards to reduce gasoline demand? When I looked at this several years ago, I estimated that SUVs had increased US gasoline consumption by over 400,000 barrels per day, or roughly 5% of total demand, equivalent to the energy contribution of around 10 billion gallons per year of ethanol.

In this case the problem starts with the evolution of Corporate Average Fuel Economy standards from a tool intended solely to improve US energy security by reducing the consumption of petroleum products in transportation, to one encompassing the greenhouse gas emissions implicated in climate change. Although there are important overlaps between these two goals--keeping a chorus of pundits employed touting them--they are not identical in operation or effect. Consider the specifics of the new CAFE proposal.

The "supplemental notice of intent" from the National Highway Traffic Safety Agency (NHTSA) of the Department of Energy, the body that along with the EPA designs and enforces the CAFE standard, spells out the special treatment accorded EVs in the rules that will be forthcoming. It states that EPA intends to give manufacturers multiple credit for each EV, plug-in hybrid (PHEV) and fuel cell vehicle they sell, starting at a multiplier of 2.0 for EVs and fuel cells and declining to 1.5 by 2021, as if these cars somehow canceled the emissions of more than one vehicle. They also intend to treat EVs and the electric portion of PHEVs as having zero emissions, regardless of how the power they use is generated. So in order to meet the tough greenhouse gas standards that accompany the 54.5 mpg CAFE standard, carmakers will have every incentive to produce as many EVs they can. Unfortunately, it's not obvious that this will reduce emissions in the real world, except in the rare instances when EVs recharge exclusively from renewable or nuclear power, which provide only 30% of our electricity mix today, up from 28% in 2005.

One needn't assume that EVs might be recharged using only coal-fired power to see that they aren't always a big improvement, emissions-wise, over non-plug-in Prius-type hybrids or clean diesels. Using the average US grid CO2 emissions of around 1.3 lb/kWh, a Nissan Leaf getting 3 miles per kWh is responsible for the emission of roughly 200 grams of CO2 per mile traveled. By comparison, a 2011 Prius with its 50 mpg EPA average emits around 196 g/mi. A more rigorous comparison would require a full well-to-wheels lifecycle assessment, but that is precisely what the new CAFE rules eschew in the interest of leaning on the scales to help today's preferred vehicle technology.

Subject to further refinement, this back-of-the-envelope analysis suggests that skewing the new CAFE regulations in favor of EVs isn't going to do much to reduce greenhouse gas emissions. Its main advantage is in reducing oil consumption, since less than 1% of our electricity is generated from oil. But if we only cared about oil and not emissions, producing gasoline from domestic coal--in the same manner as a sizeable fraction of South Africa's fuel supply--would be equally effective at backing out oil imports. Meanwhile, a gallon of gasoline saved by an advanced internal combustion engine with stop-start technology and other low-cost efficiency features would be worth exactly as much as a gallon saved by an EV, while costing dramatically less. That's especially true when you factor in the $7,500/car EV tax credit, which I can't help thinking will be a prime target when the joint Congressional committee on deficit reduction established by the debt limit bill passed by the House of Representatives last night and by the Senate just a few minutes ago sets up shop this fall.

The unintended consequence that is easily envisioned from this special treatment of EVs is a massive over-investment in a particular and still very expensive vehicle technology, at the expense of other, less costly and more cost-effective technologies. I certainly accept that EVs represent a major long-term trend in cars, but I don't believe that their development requires fiddling with the CAFE rules in this way. Nor is it obvious that US manufacturers enjoy any particular competitive advantage in producing EVs, which depend on ingredients such as rare earths for which we are even more import-dependent than for oil. If saving oil and emissions is what we really care about, then we are entitled to expect that new fuel economy regulations would focus squarely on those outcomes, without being diverted by the industrial policy fad of the moment. Perhaps this will be one of the topics taken up by the House Oversight and Government Reform Committee of the Congress as it investigates the new CAFE rules.

Grading Cars on the Curve

By now you may have seen some prototypes of the new-car fuel economy stickers on which the EPA is seeking public comment. The versions that prominently display letter grades for overall fuel economy performance are certainly eye-catching, rising above the potentially confusing mix of numbers and graphics in the body of the sticker. Yet although the current stickers are clearly inadequate to illuminate the choices and consequences associated with buying vehicles powered by an increasingly diverse array of fuels, devising a similarly simple summary page may be beyond the skills of even the cleverest engineers and graphic designers. And in the hyper-connected world in which we now live, the necessity of presenting all this information in one place deserves at least as much thought as the proposed new stickers themselves.


I don't envy the EPA its assigned task of coming up with a useful replacement for the venerable fuel economy stickers that adorn the windows of all new cars at every dealership in America. It should be obvious that the current stickers, displaying city, highway and assumed average fuel economy--a subject for discussion in itself--along with estimated annual fuel expenditures, are not up to the task of informing consumers faced with a choice of vehicles running on gasoline, diesel, natural gas, ethanol, electricity, or a mix of several of these. Whether you consider it necessary to attempt to do so probably depends as much on your personal philosophy as on the inherent complexity of the situation, so for the purposes of this posting, I will accept it as a given and focus on evaluating the range of sticker options furnished by the EPA.

Start with the prototype shown above, for a plug-in hybrid car (PHEV) capable of running on both gasoline and electricity. A larger image of this sticker is available on page 4 of the PDF file on EPA's site. The two features that stand out in this design are the letter grade, which compares the fuel economy of the stickered vehicle to all others on a scale running from A+ to D (further conveyed in a green to amber color range) and the estimated 5-year fuel cost savings compared to the average new car. I've seen comments elsewhere suggesting that the graded comparison should be based only on comparable vehicles, rather than all cars, and there's some merit to that. There might be a few folks out there looking to replace a Chevy Suburban with a Nissan Leaf, but I'll bet they're in the minority. At the same time, the goal of the program is to reduce fuel consumption and emissions, and people are generally smart enough to figure out that if the vehicles that meet their needs only range from B- to a D, the B- choice will probably cost less to run and be better for the environment.

Of course that raises questions about whether the letter-grade system dumbs-down the whole process and diverts attention from details that actually matter a great deal, including the assumptions underlying the system, many of which are displayed in the fine print. One of the biggest of those is that only emissions from the tailpipe count. That sounds like a technicality, but when the result is that vehicles powered directly by electricity are guaranteed to get most of the A's in the class, it has serious consequences. For example, it would skew the comparison between an only-moderately efficient PHEV and an extremely efficient conventional hybrid (non-plug-in.) The latter might produce fewer lifecycle GHG emissions than a plug-in running on the electricity mix of the applicable regional grid, but because its emissions mainly come out of the tailpipe, it would be at a disadvantage. This kind of comparison is only one aspect of the emerging transportation energy market for which any static, national-level representation such as a sticker plastered on a car window seems likely to be wrong more than right.

The new stickers also introduce several new concepts to motorists, including the MPGe, or mile per gallon equivalent--a worthy evolution of mpg. This provides a handy way to compare the energy content of different fuels, including electricity, to the standard energy content of a gallon of petroleum gasoline, approximately 115,000 BTUs. The problem is that in the case of electricity, the stated conversion rate of 33.7 kWh per gallon-equivalent ("eGallons in the stickers' parlance) grossly understates the energy required to produce most of the kWhs on the grid. It's only accurate for the 31% of our national electricity mix attributable to nuclear, hydro or other renewables. In the case of electricity from natural gas turbines, it can understate the fuel requirement by much more than half--and thus overstate electricity-based fuel efficiency by more than double. In other words, an accurate comparison of the equivalent fuel economy of an electric vehicle requires more information about the source of electricity for each consumer than any sticker could conceivably collect. I'd prefer to see a more conservative conversion rate for electricity, such as 14.4 kWh/gallon (based on a typical gas turbine heat rate), but at a minimum the CO2 grams per mile figure on all such stickers should be asterisked along the lines of, "Your emissions will vary depending on your local electricity source."

Another new concept incorporated in the sticker for PHEVs is the notion of "Blended Electric + Gas" fuel economy. Unfortunately, while it provides a basis of comparison among similar vehicles, its accuracy is limited to the precise combination of electric and non-electric miles that went into the EPA's calculation, accentuated by the kWh/eGallon problem described above. Drive mostly electric miles and just a few on gasoline, and you'll get a result like what I saw when I drove the Chevrolet Volt last winter. I much prefer the alternative sticker shown on page 12 of the PDF, in which consumers are given the fuel economy on gas only and electricity only and allowed to work out the likely result for their specific circumstances. I also like the range graphic on this PHEV sticker and the electric vehicle sticker on page 11, allowing an easy comparison between those two vehicle types.

Yet while the EPA is clearly working hard to provide consumers with more information about the performance of vehicles that can use combinations of electricity and liquid fuels, I find it inexplicable that their proposed sticker (page 15) for flexible fuel vehicles (FFVs) would display the fuel economy only for gasoline, rather than for both gasoline and E85 ethanol, since the latter tends to be a quarter to a third less, based on the EPA's own results for actual FFVs.

The last issue I want to raise relates to the assumptions underlying the annual fuel costs and savings shown on all the stickers. When the first stickers were introduced in the 1970s, there was no easy way to convey to consumers up-to-date information on current and expected future fuel prices. That's certainly no longer true, and posting cost estimates relying on the assumption that we all pay the same price for gasoline and electricity and will do so for the life of a car makes little sense. Why not omit this information and replace it with a link to an interactive website that, with the input of just a zip code, could determine local fuel and electricity prices and calculate future savings based on those and the latest forecasts from the Department of Energy?

While I commend the EPA for its effort to make alternative fuel vehicle characteristics more understandable and for making these proposed stickers public now, I believe the agency is attempting to over-simplify a truly complex set of parameters and relationships, at the risk of inadvertently misleading a significant number of purchasers. Consumers would get more reliable value from stickers that provided them with just a few clear metrics, plus access to the information needed to work out how the vehicles among which they are choosing would be likely to perform in their circumstances of where and how they drive. And unless the basis of the letter grades can be expanded to include lifecycle emissions, rather than just those from the tailpipe, they should be jettisoned as fundamentally flawed. It will be very interesting to see what emerges from the next 60 days of public comment, and I encourage my readers to put in their two-cents worth.

Mustangs and CAFE Standards

Over the weekend a review of Ford's new 6-cylinder Mustang in the Wall St. Journal included an interesting perspective on the contribution of stricter Corporate Average Fuel Economy (CAFE) standards to the production of a car that provides both better fuel economy and more horsepower than the preceding model, in the absence of market incentives like higher fuel prices or taxes. While I have some quibbles with the reviewer's interpretation of the sequence of events involved, he does clarify the choice we've made in pursuing vehicle efficiency gains through a mainly regulatory, rather than a more market-based route. That choice implicitly trades off obvious costs at the gas pump for hidden ones in the sticker prices of new cars, while providing nearly unlimited scope for tampering to promote specific, favored technologies, as exemplified in the joint EPA and Department of Transportation CAFE and tailpipe emissions rules that were finalized last week.

The review in question concerned the 2011 Mustang equipped with a Duratec V-6 engine developing 305 horsepower but still managing a respectable 31 highway miles per gallon, a 29% improvement over the current V-6 model and a nearly 35% improvement over the current base V-8 with which the performance of the new, more powerful six might reasonably be compared. With its 19 mpg in city driving, the effective overall 24 mpg of the new model hardly puts it into competition with efficiency leaders like the Prius or Ford's own 39 mpg Fusion hybrid, but then I'm not sure how much time the typical Mustang buyer would spend looking at such cars, even if they achieved 100 mpg. More importantly, the most cost-effective fuel savings--and thus reductions in both oil imports and greenhouse gas emissions--will for some time come from improving the fuel economy of ordinary, non-hybrid cars. Consider that the new Mustang will save the average driver 130 gallons of gasoline a year compared to the old one. Buying a hybrid Fusion instead of the regular 4-cylinder Fusion saves only 40 more gallons per year than that, though at an extra cost of at least $3,295 on the sticker price.

It's debatable whether Ford would have produced a car like the 2011 V-6 Mustang without the tougher CAFE standards set by the US Congress in late 2007 and just finalized this April 1st. While the Wall St. Journal's new car reviewer sees clear cause-and-effect and wishes to "raise a cheer for government fuel economy regulations," I can't help wondering about the impact of gasoline price volatility during the product design cycle of this car. The last time I took a serious look at the subject, car companies spent three to four years creating a new model or major redesign of an existing model, tooling up to implement it, and then starting production. In 2007 US retail gasoline prices averaged $2.84/gallon and were coming off the first-ever summer in which monthly-average prices broke the $3.00 mark and on their way to $4.00 just a year later. I see as much causality in the arrival three years later of a 31 mpg Mustang as in the much less fortuitous arrival in 2007 and 2008 of various big SUVs and pickups that would have been designed in 2004-5, when gas prices averaged $1.89 and $2.31, respectively. Although I'm sure that the impending changes in CAFE standards influenced Ford's design department to develop products like the Fusion hybrid and the new Mustang, there's also good reason to suspect that Ford responded to changing fuel prices in much the same way that consumers did, albeit with an inherent lag of several years.

As long as it remains politically suicidal to take steps to increase fuel prices and provide consumers and carmakers with some certainty that they will remain high, we can't rely on a volatile fuel market to provide consistent signals favoring higher fuel economy. There are also solid arguments for holding down fuel taxes, unless their revenues are dedicated to improved highway maintenance or returned to taxpayers via rebates or breaks on other taxes. In the absence of higher gas taxes, however, the main policy levers available for reducing national fuel consumption are high taxes on gas guzzling cars, such as those levied on engine displacement in the UK and elsewhere in Europe, or the CAFE pathway the US has followed since the 1970s--and that unintentionally helped spawn the entire SUV fad through its infamous "SUV loophole."

In its latest incarnation CAFE treats SUVs less generously but still provides manufacturers with credits for producing flexible fuel vehicles capable of burning E85 that consumers don't seem to want, by letting carmakers count them as though they used E85 half the time--1% is more like it--and then only counting the 15% gasoline content of the E85 consumed for that half. The new CAFE also treats plug-in electric vehicles as though they consume no energy at all and somehow displace two non-electric cars each. While the latter distortion might not turn out as badly as the SUV loophole, these rules--along with hefty EV subsidies for consumers--are certainly going to push carmakers in the direction of making a smaller number of full EVs at the expense of a much larger number of non-plug-in hybrids, or even modestly improved cars such as the new Mustang, which must have required a considerable investment in technology and production retooling. Stacking the deck in that manner looks like a very expensive way to reduce greenhouse gas emissions, compared to other options. I'd much rather have seen a simpler set of rules--spelled out in many fewer than 837 pages--that established the required mpg and emissions outcomes by year and left it to carmakers and consumers to work out how to achieve them.

It's easy to forget how much the fuel economy of comparable cars has improved during my lifetime. The Mustang review caught my eye because my first car was a used '65, a quintessential baby boomer car that defined its entire category. Yet even when driven conservatively, the best I could eke out of mine was about 14 mpg, and 12 wasn't an unusual result. You can run two of this year's model on the quantity of fuel my '65 consumed, and in considerably greater comfort and with about 1% of the non-greenhouse emissions. How much of that improvement should be attributed to CAFE standards, the general advance of technology over the intervening years, or because fuel prices have finally surpassed the inflation-equivalent of the $0.60/gal. or so that I was paying when I bought my first car?

The Way We Drive Now

My posting of October 29th examined two of the ways we risk under-counting the greenhouse gas emissions (GHGs) from favored energy technologies such as biofuels and electric vehicles, with potentially serious consequences. Well, it turns out that the same joint proposal by the EPA and Department of Transportation establishing new fuel economy and vehicle emissions rules incorporates another, subtler distortion that could be even more significant over the next few years than treating electric vehicles (EVs) as if their external power sources emitted no GHGs. Consider the many ways in which personal transportation in the US has changed since the mid-1970s--longer commutes, heavier traffic, and new vehicle technologies--and then ask how it could possibly make sense to embed a vehicle-use statistic set by a 1970s' law at the heart of the new Corporate Average Fuel Economy system. Yet that is precisely what these new rules would do.

My scrutiny of the draft "Light-Duty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards" rulemaking was an outgrowth of a recent conversation with Jeff Breneman, Executive Director of the US Coalition for Advanced Diesel Cars. In addition to promoting to an American audience the benefits of the improved engine technologies that have enabled diesel passenger cars to capture over half of the new-car market in Europe, this group advocates an approach to emissions reduction and improved energy security that emphasizes outcomes, rather than "flavor of the month" pathways. That resonates with themes I've been expounding since I began this blog nearly seven years ago.

According to Mr. Breneman, achieving a level playing field for advanced vehicle types such as diesels, hybrids, plug-in hybrids and pure EVs depends on establishing metrics for judging them that reflect "real-world driving." In the case of the draft EPA/NHTSA rules, that means updating their assumption that the average American drives 55% in city traffic and 45% on the highway. That ratio was set by the Energy Policy and Conservation Act of 1975, when there were 100 million fewer cars on our roads, each driving on average about 2,000 fewer miles per year, and the only alternative fuel vehicle I was aware of burned propane. According to the EPA's own data from 2006, current average driving patterns exhibit a roughly 43% city, 57% highway split, even though its 2010 vehicle sticker program is still based on the old 55/45 ratio.

This divergence between current and historical driving patterns has become more significant as the array of available vehicle choices has broadened to encompass technologies such as hybrids that perform best in city driving, but offer little highway benefit, and others such as diesels that are at their best in sustained driving above 45 miles per hour (highway driving by definition in the EPA's split.) For example, the 2010 VW Jetta Diesel is rated at 30 mpg city/42 mpg highway, compared to 41/36 for the Ford Fusion Hybrid.

The two agencies involved indicate they intend to assess carmakers' fleets using the old split until at least 2017. That means that during this crucial transition to stricter fuel economy standards these rules will motivate manufacturers to invest more in vehicle technologies that perform best under the old assumptions--despite the resulting misalignment with how consumers really drive now--in order to meet their tougher corporate targets. The difference gives hybrids an extra edge vs. diesel, over and above any disparity in purchaser tax credits. It would likely limit the choices available to consumers, given the high costs of developing additional models with drastically different powertrains.

Prolonged reliance on the outdated 55/45 split could affect actual GHG emissions, as well. A study by the Energy Information Agency earlier this year indicated that the lifecycle emissions of diesel vehicles are typically 15% less than for comparable gasoline-powered vehicles. When fueled with blends containing 20% biodiesel they emit levels of CO2 per mile similar to gasoline hybrids or plug-in hybrids recharged using grid-average power in much of the US. That's a surprising result for a technology option that generally costs somewhat less than hybridization and many thousands of dollars less per car than a plug-in with its expensive batteries.

I don't know whether US consumers would ever warm up to diesels to the extent that Europeans have. But given their attractive fuel economy and emissions benefits, they shouldn't be impeded from trying, merely because of an accounting ratio that was set when I was driving my first car. Nor do I buy the argument that diesels are a dead end, compared to electric vehicles. Interpolating from the EIA data cited above, diesel cars running on advanced biofuel derived from sources that don't compete with food crops or result in deforestation appear no less sustainable than a plug-in hybrid backed by California's low-emission power grid. When the time comes for me to buy my next car, I hope to see a wider array of clean diesel options, including some from GM and Ford, which make wonderful diesel cars in Europe.

CAFE Convergence

I would be badly remiss if I didn't comment on yesterday's announcement by President Obama of a comprehensive framework for vehicle fuel economy and greenhouse gas emissions. While I'm not sure I'd go quite as far as one Congressman, who compared it to solving the "energy and economic policy equivalent of a Rubik's Cube", this represents an important step for reducing our oil imports and improving our energy security. At the same time, the corporate average fuel economy standard (CAFE) remains more of a goal and tracking system than a mandate with sharp teeth. By itself, a stricter CAFE won't force Americans to buy different cars, though it will doubtless alter the slate of choices available to them. It's also a little less clear that this measure is quite such a big win on climate policy, as I'll explain, though it does neatly finesse California's emissions-based request for a precedent-setting waiver to effectively set its own CAFE standard. Car companies may not be delighted to have to deliver an average of 35.5 miles per gallon by 2016, but they must be relieved to face one consistent set of rules in all 50 US states.

The most important question to ask about a change of this magnitude is whether it can be accomplished in the required timeframe. In this case, the answer appears straightforward: 35.5 mpg and the accompanying emissions standard of 250 grams of CO2 per mile in 2016 are very close to the 160 g/km average that the European car industry meets today. Of course, it does so with a very different mix of cars from that sold here, with very few trucks and large SUVs. Our new 39 mpg passenger car target equates to around 142 g/km--equal to the current performance of the most efficient European brands, Fiat and Peugeot/Citroen. Europe is also helped greatly by the fact that half the cars sold there are diesels, which get around 1/3 better fuel economy than conventional gasoline cars. As keen as I am on them, I have a hard time imagining that half our new cars will be diesels in seven years--or hybrids, for that matter, considering that hybrids made up less than 3% of our mix last year. Many other technologies can help boost fuel economy, including gasoline direct injection, more energy-efficient transmissions, and more extensive use of turbocharging, a strategy that was widely employed here the first time the CAFE standards started to bite, in the 1980s. All of this costs money, and the US car industry, which stood shoulder-to-shoulder with the President yesterday, estimated an extra $600 per car from this rule, on top of $700 per car from changes already in the works. It's those costs that lead to a more objective assessment of yesterday's announcement.

To gauge the change in CAFE standards as energy or environmental policy, we must know our starting point, the status quo ante. According to the NHTSA CAFE database, the 2008 model year US new car fleet averaged 27 mpg. Compared to that, the average car would save around 890 gallons of gas under the new 2016 standard over 100,000 miles of use. At $1300 per car that works out to $1.46 per avoided gallon on an undiscounted basis. That looks pretty good from a consumer perspective. When expressed in barrels, at $61 it is less of a bargain but still compares favorably with the $79/bbl at which oil futures for 2016 were trading yesterday, though I hasten to remind my readers that futures prices shouldn't be construed as a forecast. After factoring in the likelihood that many cars will last longer than 100,000 miles, the cost trade-off looks even better.

Unfortunately, the news isn't quite as good in emissions terms, because of the thermodynamics of engines and CO2, for which there is most definitely no free lunch. Each gallon of gasoline saved spares just under 20 lb. of CO2 emissions at the tailpipe. That means that our $1300 per vehicle premium versus the status quo is effectively purchasing 8.9 tons of CO2 reductions. That works out to $146/ton, or about ten times the price of emissions permits that the administration and Congress have told us to expect in the same timeframe. Even if you only count the $600 estimated to be directly attributable to yesterday's announcement, the resulting $67/ton of CO2 still makes this a pretty expensive way to reduce emissions.

There's an asterisk on this assessment, however, related to enforcement. I haven't seen any details of what is being proposed in that department, but unless the system of fines in the current CAFE standard is overhauled, too, the cost of missing the target would remain pretty small. When I looked at this last year, it worked out to around $55 per car for each mpg over the annual goal. That adds up when spread out over hundreds of thousands or millions of vehicles, but it could still be lost in the rounding for an industry that even in this depressed year will sell on the order of $250 billion worth of product.

All in all, I regard the new CAFE standard as a positive development, although it doesn't stand on its own. The specifics of how it will be enforced will ultimately determine its success in altering the car-buying habits of Americans. At the same time, it's worth noting that future increments of fuel economy beyond 35.5 mpg will cost much more and save many fewer actual gallons, because of diminishing returns. The same European car industry that has demonstrated that our new standard can be met has estimated that the cost of going from their present level of 160 g/km to the EU's 120 g/km standard--equivalent to 46 mpg--would likely increase vehicle sticker prices by approximately $4,900 per car. When translated into dollars per barrel of oil saved or per ton of CO2 avoided, that looks prohibitively high. The implication is that yesterday's move on CAFE should be our last tweak to fuel economy standards until technology has changed dramatically.

Demand Rebound

For a long time, it appeared as though US gasoline consumption was impervious to increasing prices. Last year we learned again that the price elasticity of gasoline demand, while low, is not zero, as the combination of $4 prices and a weakening economy triggered a change in America's driving habits, turning the vehicle miles traveled and fuel use trends negative for the first time in years. However, price elasticity works in both directions. Gas prices are now not only lower than their average for all of 2008; despite recent increases this week's average pump price of $1.96 per gallon remains cheaper than the same-month comparisons for 2006 and 2007, as well. This was bound to have an effect on demand, and the API statistics for January reflect the first year-on-year increase in monthly gasoline consumption since 2007. Even if this reversal is ultimately overwhelmed by the contraction of the economy, it provides one piece of evidence that structural demand might not have changed as much as some might like to believe. That has implications for future oil demand and prices, once the hoped-for economic recovery begins, and for what consumers should be factoring into their decisions.

Other than for gasoline, the API stats contained few surprises. Total petroleum product demand was down 3.1% from last January, on the back of big declines in diesel, heating oil, and jet fuel consumption--sure signs of the weakness of the economy. US oil production ticked up slightly, reflecting the lagged benefits of all the investment that has gone into the sector since prices started rising. Nor should the gasoline figures have startled anyone, since the Department of Energy's weekly estimates have been pointing in this direction for some time, as noted recently in the excellent R-Squared Energy Blog. Surprising or not, January's demand blip should put an end to wishful thinking about permanently altered lifestyles and consumption patterns.

What does this mean for government policy and for consumers? It points to a return to higher oil prices within a relatively short time after the economy resumes growing, and everything that goes with them, including high gas prices that will strain household budgets, just as they would be getting back into balance, and a bigger oil-import bill for the country, putting pressure on the trade deficit, the dollar, and our ability to finance the vast debt we are accumulating to combat the recession and financial crisis. Nor can we rely on big improvements in vehicle fuel economy to keep demand low. New cars built to meet higher corporate average fuel economy standards will feed into our fleet of 245 million cars and light trucks slowly, at best, particularly if Chrysler's pessimistic forecast of sales at the 10 million car/year level for the next four years proves correct.

That doesn't mean we should wait passively for the next oil price spike. If we want to keep oil imports as low as they are now, we'll need to produce more of it ourselves, because until there are millions of plug-in cars on the road, all those renewable energy projects that the stimulus bill should help advance will have no effect on our oil use. That means offshore drilling, like it or not. On a personal level, if you're buying a car, factor in the likelihood that gas won't remain at $2/gal. for more than a year or two. If you're taking advantage of the slump in housing prices to buy a home, minimize its distance from your workplace, rather than trading more miles for more square feet, as many Americans did for the last decade--and remember that every extra square foot will cost more to heat and cool in the future, too. In short, enjoy the near-term benefit of today's low prices, but act on the assumption they will go back up, again.

Tell California No

One of the most eagerly-awaited environmental decisions of the year is currently in the hands of the new Administrator of the Environmental Protection Agency. California has requested a waiver under the Clean Air Act to regulate CO2 as a pollutant from cars, based on the Supreme Court decision in Massachusetts v. EPA that confirmed that the EPA had the authority to regulate greenhouse gases. When I examined this issue in late 2007, I expected California to prevail in its request, and I still do. That doesn't mean, however, that there are not compelling reasons why it shouldn't. I can't think of a better signal the Obama Administration could send concerning the new federal direction on climate change than telling California, "Thanks for keeping the torch burning, but we'll take it from here."

There are two good reasons to turn down California's request to regulate tailpipe emissions, which would result in a de facto standard for Corporate Average Fuel Economy (CAFE) much more aggressive than the federal standard enacted by the Energy Independence and Security Act of 2007. The first reason is unlikely to gain traction, because frankly this boat has already sailed. I mention it only because I still believe it has merit. Simply put, based on engineering principles, the Supreme Court was wrong to designate CO2 as a pollutant, and any extension of the Clean Air Act (CAA) to cover it is based on a misunderstanding of the origins of this greenhouse gas.

Although it's widely accepted that CO2 emissions are a primary cause of climate change, that doesn't make CO2 a pollutant. Too much CO2 is bad, but then so is too much water, if you are drowning or standing downstream of an approaching flood. That doesn't make water a pollutant. CO2 emissions are not the result of a fuel impurity or a byproduct of combustion in engines and boilers, like the smog-forming pollutants the CAA was designed to regulate. It is a fundamental, inescapable consequence of all combustion and many natural processes, and the vast majority of it is recycled into plants and rocks, or dissolved in the oceans. The steady accumulation of the small remaining excess in the atmosphere creates the central problem in global warming. Unfortunately, we can't eliminate CO2 from car exhaust with filters, catalytic converters, additives, or more intensive fuel refining, but only by changing the way cars use energy, and by changing the way we use cars. That goes well beyond any reasonable interpretation of the intent of the CAA, though I suspect this point is no longer of any concern to policy makers.

What ought to be of great concern to policy makers is another, more pragmatic reason to turn down California's request, and by extension that of the thirteen states that wish to opt in to the California standard. Climate change is a global problem, and the science of predicting its local consequences is still in its infancy. Managing our greenhouse gas emissions must ultimately be addressed globally. Until that happens, they need to be tackled at the largest level of aggregation available, because the consequences of climate change will affect us all, directly or indirectly, and because the industries and consumption patterns involved in reducing emissions are so fundamental to the economy. Changing them will require resources and innovation on a national scale. I know that California is larger than many countries--I used to trot this point out regularly when I lived there--but that does not alter the nature of its connection to and interdependence with the rest of the country. In particular, while California has a few bits and pieces of the US car industry, in the form of an assembly plant or two, some parts suppliers, and design centers, the primary impact of its regulation of CO2 would be felt not in the Golden State, but in states such as Michigan, Ohio, Kentucky, Alabama and North Carolina. The effect on interstate commerce and the absence of overridingly unique local impacts should put regulation of CO2 explicitly within the purview of the federal government, not the various states.

A little more than a year ago I reluctantly conceded that California's desire to regulate CO2 from cars was justified by application of the notion of "lead, follow, or get out of the way," in the absence of any immediate prospect of the federal government's taking that lead with respect to climate change. The election has drastically altered those circumstances. It is inconceivable that the Obama Administration, with strong majorities in the Congress, will fail to enact sweeping federal measures to address climate change urgently and aggressively. It looks very likely that we'll have cap & trade within the next year or two, and if tighter CAFE standards are part of the solution--though I remain skeptical of their efficacy without a strong price signal to drive consumer behavior--they should cover the whole country, not just a few states. If we want Detroit to invest in emissions-reducing technologies, then it must have a national market for them. It ought to be instructive that Europe has done precisely that with a tailpipe emissions standard for the whole EU, not member by member.

Administrator Jackson has promised an "impartial review" of California's request, complete with public hearings. Her decision should follow the public comment period that will apparently end April 6. I hope that her finding will signal the end of a long period in which states were forced to blaze the trail on climate change, but can now yield leadership back to the federal government that must speak with one voice in the negotiations toward a global climate agreement in Copenhagen, this December.