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This staff memorandum was prepared by the Congressional Budget Office (CBO) in response to a request from Senator J. Bennett Johnston, Chairman of the Committee on Energy and Natural Resources, to analyze the economic impact of changes in the nation's corporate average fuel economy (CAFE) standards for light-duty vehicles. This memorandum analyzes the effects of changing CAFE incentives for the sale of vehicles that use alternative fuels. An earlier CBO analysis focused on the relative fuel savings from different proposals for higher CAFE standards.
The memorandum was prepared by Richard D. Farmer of CBO's Natural Resources and Commerce Division under the supervision of Roger Hitchner and Jan Acton.
INTRODUCTION AND SUMMARY
POLICY OPTIONS: CAFE INCENTIVES FOR ALTERNATIVE-FUEL VEHICLES
COST SCENARIOS: IDENTIFYING THE RANGE OF UNCERTAINTY
IMPORTANT CAVEATS TO STUDY FINDINGS
APPENDIX A: METHODS AND ASSUMPTIONS
APPENDIX B: REFERENCES
| TABLES | |
| 1. | Demand for Motor Gasoline Under Alternative Scenarios, 1990-2020 |
| 2. | Share of Alternative-Fuel Vehicles in New Sales of Passenger Cars Under Alternative Scenarios, 1990-2020 |
| 3. | Lowered CAFE Requirements for Gasoline-Powered Passenger Cars Under Alternative Scenarios, 1990-2020 |
| 4. | Demand for Motor Gasoline Under Alternative Scenarios and Assumptions About Gasoline Usage by Dual-Fuel Vehicles, 2020 |
| 5. | CAFE Incentive Options for Alternative-Fuel Vehicles |
| 6. | Current and Proposed CAFE Standards |
| 7. | Scenario Definitions |
| 8. | Gasoline Savings Under Alternative Scenarios, 1990-2020 |
| A-1. | Alternative-Fuel Vehicles Required by the Amendments to the Clean Air Act |
| A-2. | Cost, Fuel Economy, and Market Share Assumptions for Alternative-Fuel Vehicles |
| A-3. | Estimates of Incremental Costs for Alternative-Fuel Vehicles |
| A-4. | Assumed Statutory Fuel Economies for Alternative-Fuel Vehicles with Higher CAFE Standards, 2010 |
| FIGURES | |
| A-1. | Average Costs of Improving Vehicle Fuel Economy: Base-Case Assumptions Versus Point Estimates from Different Studies |
INTRODUCTION AND SUMMARY
The Energy Policy and Conservation Act of 1975 first laid out the federal government's corporate average fuel economy (CAFE) standards for new automobiles and light trucks. Fourteen years later, the Alternative Motor Fuels Act (AMFA) established incentives, to begin in 1993, for automakers to produce vehicles capable of using alcohol (including methanol and ethanol) or natural gas. The effect of these requirements was to create a relationship between the demand for gasoline and automakers' incentives for the sale of alternative-fuel vehicles. By artificially raising the fuel economy ratings of alcohol- and natural gas-powered vehicles, the AMFA could provide strong CAFE incentives to car and truck manufacturers to make and sell those vehicles.
Depending on how many alternative-fuel vehicles automakers sell, what level of fuel economy they achieve, and, for those dual-fuel vehicles that may also run on gasoline, how often they are fueled on gasoline, different CAFE incentive policies may cause total gasoline consumption to rise or fall. This analysis of policy options for increasing CAFE incentives for alternative-fuel vehicles demonstrates general conditions that would lead not only to increased sales of dual-fuel vehicles, but also to greater total gasoline consumption.
How the Sale of Alternative-Fuel Vehicles May Benefit Automakers
The design and the mix of vehicles sold affect calculations of average fuel economy. Automakers can raise the overall fuel economy of the vehicles they sell by altering engine and body design, vehicle size, or performance. Such changes would generally increase the cost of vehicles, with the cost per vehicle of improving fuel economy rising with higher standards for fuel economy. Optionally, automakers may save themselves the cost of some these changes if they can stimulate sales of their more efficient models. Automakers may also save themselves some costs of fuel economy improvements if they take advantage of the CAFE incentives of the AMFA.
Automakers calculate the fuel economy of vehicles using fuels other than gasoline on the basis of the gasoline-equivalent of the energy content of those fuels. Generally, in terms of British thermal units (Btus) consumed per mile, alternative-fuel vehicles are not more fuel-efficient than conventional vehicles. But the AMFA allows automakers to apply "fuel economy multipliers" for vehicles powered by alcohol and natural gas, enabling them to factor those vehicles into their corporate average fuel economy at nearly seven times their actual ratings. The higher the statutory fuel economy of alternative-fuel vehicles sold, the lower the fuel economy of gasoline-powered vehicles needed to meet any corporate average fuel economy standard.
The efficiency ratings of dual-fuel vehicles, capable of switching between gasoline and alcohol or between gasoline and natural gas, are further inflated because automakers are allowed to assume that those vehicles are operated half time on alcohol or natural gas. This statutory share probably understates the actual use of gasoline by these vehicles. (This analysis assumes dual-fuel vehicles on the road will use gasoline 75 percent of the time.) In part because of the resulting boost to their fuel economy multiplier, automakers are shown in this analysis to prefer dual-fuel vehicles to dedicated-fuel vehicles.
Taking into account this advantage in statutory fuel economy, the Alternative Motor Fuels Act limits the credit automakers can apply from the sale of dual-fuel vehicles towards the reduction of fuel economy of conventional, gasoline-powered cars. They cannot use dual-fuel vehicle sales to reduce the fuel economy of conventional vehicles by more than 1.2 miles per gallon (MPG) for model years 1993 to 2004 and 0.9 MPG for 2005 to 2008. (This analysis assumes the CAFE credits will continue after 2008.) Once these credit caps are reached, the preferential calculation of fuel economy for dual-fuel vehicles would presumably cease. Reductions in fuel economy from the sale of dedicated-fuel vehicles are not limited.
The Alternative Motor Fuels Act offers CAFE incentives only for the sale of vehicles powered by alcohol or natural gas. A separate Department of Energy rulemaking gives electric vehicles a boost in the calculation of fuel economy. For CAFE purposes, the fuel economy of electric vehicles can be based on the small amount of oil used in generating the electricity they consume. After accounting for losses of energy in electricity generation and transmission, the statutory fuel economy of electric vehicles is approximately double their actual fuel economy.
Vehicles propelled by other fuels (principally propane) receive no preferential treatment and so have a competitive handicap. Also, new companies that only manufacture alternative-fuel vehicles cannot realize these cost savings and may find it difficult to compete with multiproduct-line manufacturers.
Factors Affecting the Decision to Produce Alternative-Fuel Vehicles
The use of fuel economy multipliers may yield mileage figures on paper for individual vehicles that are much higher than the 1991 CAFE standard of 27.5 MPG for passenger cars and 20.5 MPG for light trucks. As long as the statutory fuel economy of alternative-fuel vehicles exceeds the standard for the corporate average, the more vehicles powered by alcohol and natural gas that automakers sell, the lower the required fuel economy of their conventional gasoline-powered fleet. And the lower the required fuel economy of gasoline vehicles, the less money automakers need spend on improvements for the sake of efficiency.
For automakers, the decision to produce alternative-fuel vehicles hinges on an economic trade-off. Is the cost of producing and marketing an additional alternative-fuel vehicle greater or less than the saving to be had from doing less to improve the fuel economy of conventional vehicles? The cost of alternative-fuel vehicles varies with fuel, engine technology, and class of vehicle. Precisely how much automakers may save will depend on the costs of redesigning conventional vehicles to improve fuel economy.
CAFE credits on their own may not provide sufficient incentives to automakers to produce alternative-fuel vehicles. Beginning in 19%, however, the Clean Air Act Amendments of 1990 will mandate sales of alternative-fuel vehicles in certain regions of the country. If automakers have to sell these vehicles to comply with the Clean Air Act, the incentives of the Alternative Motor Fuels Act may well influence their choices of alternative fuels and engine technologies and their selections of types of vehicles to convert.
How CAFE Incentives May Affect Gasoline Demand
The automakers' choice of alternative fuels and vehicle types will ultimately determine how CAFE credits affect the demand for gasoline. Because CAFE standards apply only to new vehicles sold each year, a change in the standards or in the use of credits by automakers could only affect the average fuel economy of the fleet slowly, as new vehicles come into service and older, less efficient ones go out.1 An increase in the average fuel economy of gasoline-powered vehicles combined with an increase in the use of alternative fuels would save gasoline. However, if the increased demand for alternative fuels came at the price of lower fuel economy for gasoline-powered vehicles, gasoline demand could increase instead.
Analysis of CAFE Incentives and Key Findings
Changing any of three key elements of the CAFE incentive program could affect market penetration by alternative-fuel vehicles, the fuel economy required for gasoline-powered vehicles, and, as a consequence, the demand for gasoline. Those three key elements are:
This analysis examines the impact on automakers' incentives to supply alternative-fuel vehicles and on the demand for gasoline of different policy options to change these elements. It does so under a range of assumptions about the costs of improvements in fuel economy and the costs of supplying alternative-fuel vehicles. In a "base-case" set of assumptions, the average cost of raising the fuel economy of passenger cars from 27.5 MPG to 37 MPG would be about $100 for each MPG of improvement, and dual-fuel methanol vehicles (as an example) would cost $500 more than comparably equipped gasoline vehicles. Dual-fuel vehicles are assumed to dominate the market for alternative-fuel vehicles. Accordingly, the analysis also considers the impact on gasoline demand of different levels of gasoline use by dual-fuel vehicles, from 50 percent to 100 percent.
The analysis indicates that policies that create CAFE incentives, including the current incentives program, would have little impact on sales of alternative-fuel vehicles or on the demand for gasoline as long as CAFE standards remain at their current level (see Tables 1 and 2). Only the minimum numbers needed to meet the requirements of the Clean Air Act Amendments would be sold. Even with higher CAFE standards, CAFE incentives would have no impact if the cost of supplying alternative-fuel vehicles were significantly higher than assumed in the base case.
With higher corporate average fuel economy standards and with base-case costs, market penetration by dual-fuel vehicles could be very significant. Sales of these vehicles would be even higher if the costs of fuel economy improvements were greater than assumed in the base case. However, the resulting drop in fuel economy of gasoline-powered cars would offset the gasoline savings from increased sales of dual-fuel vehicles (see Table 3). Policies that increase CAFE incentives for the sale of dual-fuel vehicles could result in still higher gasoline demand, since the analysis assumes dual-fuel vehicles run 75 percent of the time on gasoline and have on-road fuel economies inferior to gasoline-powered cars.
In general, the different policy options do not yield greatly differing levels of gasoline demand. Increased gasoline demand as a result of the lower fuel economy of gasoline-powered vehicles narrowly offsets the reduced gasoline demand resulting from higher use of alternative fuels (see Table 4). If dual-fuel vehicles used gasoline only 50 percent of the time, policies that increased the CAFE credits from the sale of dual-fuel vehicles would be almost precisely in balance, with no net change in gasoline demand. If gasoline use by dual-fuel vehicles were greater than 75 percent, however, the effect of lower fuel economy of gasoline-powered vehicles would dominate to a greater extent, and increased CAFE incentives would result in even higher gasoline demand.
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1. The turnover rate for the fleet, and the improvement in fleet efficiency, could slow if consumers reacted to changes in the design or cost of vehicles by buying fewer new cars. However, vehicle efficiency is probably more important in deciding which car to buy than in the basic decision to buy a car. Unless corporate average fuel economy standards become very costly, the level of new car sales and the turnover rate should not change much.