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Industry And Environmentalists Can Both Win On Fuel Economy. Here's How

Cars in long row on highway in traffic jam

Cars in long row on highway in traffic jam. Via iStock

Earlier this month, at an automotive testing facility just outside Detroit, President Trump announced that his administration will re-open an eleventh hour final determination by the Obama Administration that would have cemented light-duty fuel economy standards for the years 2022 to 2025. Those rules represented the final phase of a broader National Program on fuel economy that federal regulators originally projected would save nearly 12 billion barrels of oil over their lifetime by doubling the efficiency of cars sold in 2025 compared to those sold in 2010.

The announcement was cheered by automakers, who are hoping to avoid being held to the rules’ most onerous targets at a time when demand for highly fuel-efficient models is low and demand for trucks is at record highs. But it was met with widespread criticism from environmental advocates, who argue that any weakening of the standards represents a setback on efforts to curb greenhouse gas emissions.

But environmentalists are picking the wrong fight. There is a deal to be made on fuel economy that reduces costs for the auto industry and still cuts massive amounts of oil consumption both in the near and long term. The re-opened review provides the launching point.

First, consider this fact. According to the EPA’s own estimates, the overwhelming majority—nearly 90%—of originally projected fuel savings under the current policy will have been locked into place by 2021. This might seem confusing given that the real headline-grabbing numbers don’t come into play until 2025. But because they regulate efficiency instead of consumption, the current standards run into some simple math: there are declining marginal benefits of increasing fuel efficiency. The fuel savings of going from 10 to 20 miles per gallon (mpg) are far greater than going from 40 to 50 mpg. In other words, the biggest benefits are captured at the beginning.

The 2021 fuel economy targets were originally expected to produce a fleet of new vehicles that averaged 42 mpg in 2021, up from 28.7 mpg in 2012. Over a 200,000 mile lifetime, that is a savings of more than 2,200 gallons in fuel per vehicle. But by pushing the fleet average to the originally projected 46.2 mpg in 2025, the rules achieve only an additional 430 gallons in savings per vehicle. The bottom line is that if the Trump Administration simply extends the 2021 fuel economy targets forward through 2025, the final rules would forgo just 1 billion barrels of fuel savings out of the originally-targeted 12 billion.

Some environmentalists might view this as a painful concession. And conservatives skeptical of EPA’s authority to regulate greenhouse gas emissions might prefer steeper rollbacks, say by applying a newly weakened social cost of carbon to the EPA rules beginning immediately. But both of those perspectives will ultimately trigger California to set its own standards and result in a lengthy and uncertain court battle that poses real risks to the American auto industry.

The cumulative projected lifetime fuel reductions from the MY 2012-2025 rules

EPA NHTSA. Source: Analysis based on EPA and NHTSA (2012)

Instead, the key parties in this negotiation—the administration, the industry, and the state of California—should strike this deal, declare victory and move on. Extending the standards at the 2021 level will provide the auto industry with the relief it wants and keep significant savings piling up through 2025, when the current policy comes to an end.

The real question is what to do next. California and the environmental community almost certainly do not believe that an adequate policy is to stay at 2021 fuel efficiency standards indefinitely. But the industry will be reluctant to agree to anything that reverts to the previous targets and system, which they argue became unsustainably costly in an era of low fuel prices. To their credit, a growing body of research shows that fuel economy standards achieve fuel savings at an incredibly high cost.

How to move forward?

Last week, my University of Chicago colleague Michael Greenstone, Harvard professor Cass Sunstein and I released a proposal for an entirely new approach to achieving cost-effective reductions in fuel consumption in the transportation sector. The core of our idea is to replace the current approach to regulating vehicle efficiency with a system that more directly targets expected lifetime vehicle fuel consumption. A company would be required to hold permits for the expected lifetime fuel consumption of all the vehicles it sells. There would be a cap on the number of permits available that could be adjusted upward or downward based on national policy goals, and auto companies would be able to trade compliance credits in liquid markets.

Such an approach has numerous advantages over the current system that should appeal both to the environmentalists and the industry. First, decades of research and experience shows that a system like ours would dramatically reduce costs. Rather than invest in efficiency upgrades that might be outside of their core competency, firms with high costs could instead buy credits from other firms that excel at cost-effectively manufacturing efficient cars. The gains from trade would make everyone better off.

Second, our approach is considerably more straightforward. We would eliminate loopholes like separate, weaker standards for trucks that have accelerated America’s SUV boom, and we would end bonus credits that too often save little fuel and weaken program effectiveness. Political and distributional concerns—say, for companies who currently produce a lot of SUVS—could be resolved during the permit allocation process at no cost to program fuel savings.

Finally, our approach would substantially increase the certainty of fuel savings. Today, a crash in oil prices and the predictable shift to more inefficient vehicles can undermine the amount of fuel saved in a given period, something I have written about before. Under our program, the cap would be a binding limit on the expected lifetime fuel consumption of all vehicles sold in a given year.

The re-opening of the 2022-2025 standards is being painted in combative, zero-sum terms. But the truth is that there is ample ground for compromise on the near term objective of achieving the goals of the National Program while providing automakers with flexibility. More importantly, there is a rare opportunity to establish an efficient long-term policy that benefits both industry and the environment.

By Sam Ori, Contributor

Follow me at @samori8 and share your thoughts.

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