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.

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.

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.

Closing the SUV Loophole

We've had several reminders this year that, when it comes to energy and environmental policy, the executive and legislative branches of government aren't the only ones that matter. First it was the Supreme Court ruling that carbon dioxide could be regulated as a pollutant--defying a common-sense definition of the term--and now the 9th Circuit Court of Appeals is telling the administration that its 2006 update to fuel economy standards for SUVs and light trucks didn't adequately justify treating them differently from passenger cars--in which role most of them are actually used. Even though this ruling is bound to be appealed, it seems likely to influence Congressional thinking on the form that stricter CAFE standards ought to take. If it turns out to be illegal to treat cars and SUVs differently, then the debate over a new 35 mile per gallon standard could get even tougher.

Although the arguments with which the 9th Circuit justified its ruling seem a bit strained, the so-called SUV loophole should have been addressed years ago. It is a classic example of unintended consequences overwhelming the good intentions behind a regulation. While it may have initially benefited businesses that used such vehicles for truly commercial purposes, holding light trucks to a lower standard--even as sales of this class exploded--has increased total US gasoline consumption by approximately 440,000 barrels per day , or about 5% more than would have been the case, had the SUV fad never taken off. The cumulative fuel impact of the SUV loophole exceeds the entire contribution of our costly corn ethanol strategy over the same period.

Closing the SUV loophole might not be as dire as it sounds for auto makers, however, because the average fuel economy of new passenger cars in 2007 is running well ahead of its current target of 27.5 mpg, even though "light trucks", including SUVs, come in very close to their required minimum of 22.2. As of the latest posted report, the entire new car fleet was averaging 26.4 mpg. Achieving 27.5 for all vehicles would only require SUVs to improve by 1.8 mpg, or the sales mix to shift by 7 points of market share toward passenger cars averaging 31 mpg. And if they don't get there right away, the fines to which carmakers would be subject aren't severe.

Ratcheting the entire new vehicle fleet up to a uniform 35 mpg standard would be a very different proposition. Getting another 4 mpg out of passenger cars wouldn't be difficult, using a variety of affordable technologies. Boosting the average for SUVs by more than 50%, on the other hand, would require wide application of the best available technology, which still might not be sufficient. Compare the hybrid and non-hybrid versions of Ford's Escape small SUV, and you only get a 33% uplift. Closing the gap across the entire new vehicle fleet would thus require pushing passenger cars well beyond 35 mpg, boosting SUV efficiency as much as possible, and reducing SUVs' share of the sales mix significantly. In this light, the 40 and 50 mpg CAFE standards that some presidential candidates are espousing could legitimately be characterized as plans for the virtual elimination of SUVs, unless they are only counting the petroleum consumption per mile and banking on biofuels and plug-in hybrids. If so, that could create even more unintended consequences than the SUV loophole did.

The SUV Advantage

Thanks to some glitches in hotel broadband access, yesterday's intended posting became this morning's, and today's is now this afternoon's.

A colleague sent me a link to a story in the New Yorker advancing an interesting explanation of the apparent contradiction between Americans' support for improved fuel economy standards and our ongoing love affair with large, inefficient vehicles. It immediately resonated with something I had recently read in The Economist, on the topic of "ultimatum games." At the core of both of these ideas is the innate competitiveness of humans. Recognizing this might be the necessary first step towards diverting this competition onto a more generally beneficial path, at least in the way our vehicle choices affect national energy consumption.

The New Yorker looks at our desire for bigger and more powerful cars and concludes that it is a manifestation of the same underlying causes that led individual hockey players to eschew helmets until they became mandatory: the pursuit of a personal competitive edge. If you go back to the beginning of the SUV trend in the 1980s, it's easy to see how this could develop. The drivers of early SUVs were afforded a privileged position above the general sightline of traffic, and the resulting impressions of greater safety and dominance would be a natural, and probably self-reinforcing reaction. But as increasing numbers of SUVs entered the fleet, this advantage quickly eroded. If the car in front of you was an SUV, you were effectively back to where you had been in a sedan. The only solution would be a bigger, more powerful SUV.

Does this explain the size, weight and horsepower "arms race" that ensued over the next 15-20 years? Perhaps. It certainly wouldn't have been possible without improvements in the basic technology of the internal combustion engine, which, as I've noted before, were diverted into the horsepower necessary to deliver higher performance in increasingly heavy cars, rather than into fuel economy that looked unimportant with US retail gasoline prices averaging $1.20/gallon from 1990-2002.

And the results of the "ultimatum game", which The Economist describes as a preference for "relative rather than absolute prosperity" might help explain why, even after realizing that big car dominance had been largely nullified by the proliferation of ever bigger cars, new car buyers didn't quickly shift back to smaller, more efficient cars, when fuel prices started going up four years ago. Lags in future gas price expectations may have reinforced this reluctance.

But does knowing we are competitive make us less so? Or is our best option to try to alter the basis on which we compete? What would it take to elevate efficiency and low environmental impact above our perception that in cars, larger is automatically safer, and brisk acceleration is more reflective of the winners we aspire to be? Can we imagine a world in which we try to "out-green" each other, instead?

CAFE Reform

As I was reading the accounts yesterday of the Congressional meeting with the heads of Detroit's big three automakers on the subject of fuel economy, I was struck by Senator Dorgan's comment to Mr. Wagoner of GM, "I think this issue is over." While it's clear that he intended that as an admonition against more foot-dragging, I hope it isn't literally true. What we need is not just higher fuel economy standards, but a reform of the whole CAFE system, to make it more compatible with the other energy and environmental policies that will be forthcoming in the next few years. It's also important that we limit its potential for creating further unintended consequences.

In my blogging, I suspect I have seemed fairly negative about CAFE in general, because of the problems it has created, and because by itself it remains an incomplete mechanism for saving fuel or reducing emissions. The current system is a legacy of the first energy crisis, and while it has been updated somewhat, its main features were crafted in a world that worried much more about the gas going into a car's tank than the gases coming out of its tailpipe. Lets imagine that Congress could start with a blank piece of paper, rather than merely boosting what's already in place by 10 mpg or so. Here are some key attributes I believe a new CAFE system should have, in order to provide the maximum benefit for both energy security and climate change:

• SUV loophole phaseout - While the current system is morphing into a footprint-based scale, rather than two simple SUV and passenger car fuel economy targets, this is still a sop to Detroit's current advantage in big, heavy vehicles. By some date certain, say 2015, all vehicles intended for consumers should be treated equally under CAFE. Let's recognize that this will hit US carmakers disproportionally and give them some other benefit to offset it that doesn't just perpetuate this disparity.


• Shared penalty burden - Car companies have long argued that they can only make the cars that consumers will buy. In addition to penalties on manufacturers for missing their CAFE target, the gas guzzler tax on new vehicles should be increased and applied to all cars falling short of the CAFE for their class. Furthermore, this tax should be collected every time a vehicle is sold, not just on new cars. This would align consumers' and manufacturers' interests in cars that will meet the tougher standards.


• Fuel neutrality - If our goal is reducing energy consumption, it ought not matter what fuel a car uses. An SUV getting 15 mpg on E-85 may be achieve an effective 100 mpg on gasoline, but it is still guzzling ethanol that could displace gasoline in other cars. A "flexible fuel vehicle" uses the same amount of energy as the conventional model, and the time to close this wasteful loophole is now, before there are 50 million FFVs on the road. In the same way, the electricity consumption of plug-in hybrids, once available, should be counted along with their gasoline consumption. Electricity takes energy to generate, and 70% of the US supply produces greenhouse gas emissions. Ditto for hydrogen cars.


• Compatibility with CO2 targets - Even if CAFE does not eventually shift to tallying pounds of CO2/mile, rather than miles/gallon, it ought to incorporate a backup standard that addresses greenhouse gases directly, rather than indirectly through fuels with widely varying specific emissions.

I don't imagine for a moment that changing our fuel economy standards along these lines would be easy, politically, but considering the scale of the problems created by the old system, it's worth taking the time to design a new CAFE system properly, especially if it's going to be one of our primary tools for getting oil imports and greenhouse gas emissions under control. Building a new CAFE program along these lines will also send important signals to the market and to consumers, in advance of the enactment of pricing greenhouse gases, via cap-and-trade or a carbon tax.

Blaming the SUVs

SUVs and their owners get the blame for all sorts of ills, including higher traffic fatality rates and parking lot congestion. They are even lampooned in Dilbert. And with gas prices sky high, at least in nominal dollars, SUVs take the brunt of concerns about our growing dependence on imported oil. The data needed to assess the validity of this complaint are readily available. They demonstrate that SUVs have a sizeable impact on US oil consumption, and by extension, on fuel prices. While that result might not surprise anyone, the same data reveal another, even bigger culprit, posing a major challenge for efforts to reduce oil consumption.

The latest year for which all the necessary statistics are available is 2003. In that year, 87 million vehicles were classified as 'light trucks', including SUVs, pickup trucks, and all sorts of commercial vehicles. They drove 11,400 miles each, on average, and they averaged 21 miles per gallon, compared to 28 for passenger cars. The total number of light trucks in service in 1985, at the beginning of the SUV trend, seems like a reasonable proxy for all the non-SUV types of light truck today. If we assume that all the light trucks sold after 1985 were SUVs (or pickups used as SUVs,) that gives us a total of 50 million SUVs in 2003. With SUV sales running at half of all US car sales of 14.8 million per year, this seems like the right ballpark.

If the SUV fad had never happened, or if SUVs didn't fall under a special category of the Corporate Average Fuel Economy regulations allowing them to get considerably worse fuel economy than 'passenger cars', their owners would likely have bought cars getting about the same gas mileage as the average for the rest of the car fleet. Based on all these assumption, SUVs consume at least 440,000 barrels per day more fuel than if they were 'passenger cars'. That works out to 6.8 billion gallons per year, or about 5% of total gasoline demand.

What does that volume mean for prices? Well, this volume is about a quarter of the recent global demand increase that is generally held responsible for pushing oil prices from $30 to $50/barrel. In terms of gasoline, it's the difference between US refineries running at maximum capacity or at more comfortable levels. Or it's half of all the gasoline the US imports. No one can calculate the impact of this precisely, but when markets are as tight as they are now, that extra 5% of demand could easily account for 15-20 cents per gallon of today's prices.

Before we lay all the blame on SUV owners, though, it's worth considering another fact that emerges from the same data. Compared to 1985, Americans now drive 2,000 miles more per year, on average--passenger cars and SUVs alike. The impact of this change is more than twice as big as that of SUVs: 1 million barrels per day of extra fuel consumption at a fleet average of 25 miles per gallon. In other words, changes in our behavior have increased gasoline demand in the US by 1.5 million barrels per day, and 2/3 of that has nothing to do with the switch to SUVs.

Here's one last statistic to ponder: if the late 1980s had brought us a fad for cars getting 50 miles per gallon, instead of for SUVs getting 21, we would today use a million fewer barrels per day gasoline than we do. That would be just enough to make up for all of our increased driving. This illustrates the essence of today's fuel-economy debate: over time, the choices of millions of individual consumers--not just the kind of cars they buy, but how they use them--add up to big volumes of oil, with serious economic, environmental and security implications.