There’s been a lot of talk in the U.S. in the past year or two about the prospect of raising the requirements for average fuel economy. Current plans call for raising that average from 27.5 to 35.7 mpg by 2015, which has caused considerable alarm in some quarters. To make sense of all this, let’s talk about how the corporate average fuel economy rules work, where they came from, and what they’re designed to do. Also, your author weighs in on the merits of these regulations.
Author’s Note: This article was written in 2009 and is now out of date — it has not yet been updated to reflect subsequent regulatory changes. Reader beware!
BORN IN CRISIS
The current U.S. rules on corporate average fuel economy are a direct result of the 1973 oil crisis. In October 1973, during the Yom Kippur War, the Organization of Arab Petroleum Exporting Countries (many of the member states of OPEC, plus Syria and Egypt), declared an embargo on oil shipments to the U.S. and its allies to protest their military support of Israel. The embargo lasted until March 17, 1974, quadrupling the price of oil and leading to widespread shortages. In the U.S. (and some parts of Europe) there was a brief return to fuel rationing for the first time since 1945.
The first energy crisis was an economic disaster and it made clear how much damage even a temporary shortfall in oil supply could do. It provided the political will for America’s first serious effort at energy conservation. In December 1975, Congress passed the Energy Policy and Conservation Act (EPCA). The act empowered the National Highway Traffic Safety Administration (NHTSA) to set standards for the Corporate Average Fuel Economy (CAFE) of cars and trucks sold in the U.S., with the first standards taking effect for the 1978 model year.
The purpose of the CAFE rules was to browbeat the domestic manufacturers into building more fuel-efficient vehicles by penalizing them for producing too many gas-guzzlers. The NHTSA set “target minimums” for CAFE and levied substantial fines against any manufacturer whose fleet did not meet the target.
HOW CORPORATE AVERAGE FUEL ECONOMY IS CALCULATED
Corporate average fuel economy (CAFE) is the harmonic mean (weighted average) of the fuel economy ratings of all the cars or trucks a manufacturer produces. The fuel economy number used is calculated based on laboratory test results (similar to those performed by the EPA to generate the fuel economy estimates you find on the window sticker of a new car). The NHTSA uses a combined fuel economy figure, a weighted average of the city and highway figures. Those combined fuel economy numbers are weighted on the basis of total vehicle production; vehicles that are produced in large numbers count more, while those produced in smaller numbers count less.
Let’s say that a manufacturer produces 100,000 vehicles a year. 20,000 of these are a large car that gets 22 mpg (10.7 L/100 km) combined while the rest are a smaller car that’s rated at 30 mpg (7.8 L/100 km). The automaker’s CAFE is:
100,000 / ( (20,000/22) + (80,000/30) ) = 28 mpg (8.4 L/100 km)
If it sells an equal number of large cars and small cars, its corporate average fuel economy is:
100,000 / ( (50,000/22) + (50,000/30) ) = 25.4 mpg (9.3 L/100 km)
Since many automakers build at least some of their cars here and others overseas, each passenger-car fleet is divided into separate “domestic” and “import” fleets, each of which is supposed to meet CAFE requirements separately. “Domestic” is defined as a vehicle built with at least 75% U.S. or Canadian content, regardless of badge; a U.S.-market Honda Accord, built in Marysville, Ohio, is considered a domestic car. The distinction between the domestic and import fleets was created as a political concession to the United Autoworkers union (UAW), which was afraid that Detroit would try to meet the CAFE requirements by re-badging cars built overseas in nonunion factories.
PENALTIES AND CREDITS
If a manufacturer’s corporate average fuel economy doesn’t met the target minimum, the company has to pay a civil penalty. The current penalty is $5.50 for each tenth of a mpg the actual average falls below the target, times the manufacturer’s total production.
For example, the current target minimum is 27.5 mpg (8.6 L/100 km); if a manufacturer produces 500,000 cars for 2008, with a CAFE of 27.0 mpg (8.7 L/100 km), the manufacturer would be fined ($5.50 x (0.5/0.1) x 500,000) $13,750,000.
If a manufacturer’s CAFE exceeds the minimum, the manufacturer earns credits that can be applied to balance out their CAFE for previous or subsequent model years. For example, if the manufacturer who was penalized in the example above raised their CAFE to 28.5 mpg (8.3 L/100 km) the following year, they would earn a credit, which they could potentially apply to offset the penalty from 2008. This is called a “carry back.” Carry backs can only be applied within a three-year period, and only with NHTSA approval; you can’t get out of the fine by saying you’ll apply a credit at some arbitrary point in the distant future.
At that time these rules were written, the fuel economy of American cars was at an all-time low. The average fuel economy for the entire domestic industry in 1973 was 12.2 miles per gallon (19.3 L/100 km). Part of the reason for that thirst was the recent advent of pollution controls, which cut into engine efficiency, and of safety standards, which made cars heavier.
Even without those handicaps, the American automobile had been growing at an average rate of about an inch a year since the early 1950s. Full-sized cars, which still represented the majority of sales, were over 18 feet (5.5 meters) long and tipped the scales at around 5,000 pounds (2,268 kg). Ford, Chevrolet, and AMC had (somewhat reluctantly) introduced their first subcompact models in 1970 and 1971, but these represented only a small percentage of the market. Most Detroit executives were contemptuous of small cars, which they saw as appealing only to the poor and the lunatic fringe.
The oil embargo left the domestic automakers more open than they might otherwise have been to the prospect of higher fuel economy. Sales of big cars had plunged vertiginously during the oil crisis, although they began to recover once the crisis had completely passed. Still, Detroit was not at all keen on the idea of being required to improve their average fuel economy; they already felt unfairly burdened by safety and smog regulations. With everyone’s memories of the grim winter of 1973 still fresh, however, their lobbying efforts found little political traction.
The original CAFE legislation called for the target minimums for fuel economy to increase progressively, up to 27.5 mpg (8.6 L/100 km) for the 1985 model year. To meet the targets, domestic automakers had to “downsize” their large and intermediate cars, use smaller-displacement engines, and start paying more serious attention to aerodynamics. The biggest V8s disappeared, and automakers turned increasingly to six-cylinder and four-cylinder engines. The automotive press widely predicted that V8s would vanish completely by 1984, particularly after a second energy crisis in 1979, sparked by the Iranian revolution.
Instead, in the 1980s, oil prices began to fall, and the political support for the CAFE targets eroded. (The Carter administration also began deregulating oil prices and removing the windfall tax penalties on oil companies, a process the Reagan administration continued with enthusiasm.) Although the corporate average fuel economy target for 1985 was indeed 27.5 mpg, as stipulated by the original regulations, automakers successfully lobbied to have the target rolled back to 26 mpg (9 L/100 km) for the 1986-1988 model years, 26.5 mpg (8.9 L/100 km) for 1989. The target didn’t return to 27.5 mpg until 1990. Several subsequent attempts to increase it failed, so it has remained frozen at the 1990 level.
As improving technology boosted engine efficiency, it became possible to meet that target with larger and more powerful cars. The downsizing trend of the late seventies ended and cars began to get bigger once again. V8 engines, which had supposedly been on the verge of extinction, suddenly became all the rage for luxury cars, prompting even European and Japanese manufacturers to develop V8s, primarily for the American market.
TRUCKS AND SPORT UTILITY VEHICLES
What about trucks? The EPCA also gave the NHTSA the authority to set requirements for truck fuel economy, but defined the rules a little differently. A full-sized pickup truck, intended to carry heavy loads, couldn’t reasonably be expected to achieve the same fuel economy as a compact car. Rather than set specific targets for truck mileage as it did for cars, the regulation called for truck fuel economy to be set at the “maximum feasible level,” which the NHTSA determines for each model year. The first target, applied to the 1979 model year, was 17.2 mpg (13.7 L/100 km) for 2WD trucks, 15.8 mpg (14.9 L/100 km) for 4WD. (The separation between 2WD and 4WD was dropped in 1992.) By the late 1990s, it was up to 20.7 mpg (11.4 L/100 km).
Until 2008, the truck rules applied only to light-duty trucks, those with a GVWR (gross vehicle weight rating — weight with passengers and cargo) under 8,500 pounds. Really big trucks, like Ford’s late, unlamented Excursion, were exempt. Starting in the 2008 model year, “medium-duty” vans and SUVs with a GVWR of 8,500 to 10,000 pounds are now counted in a manufacturer’s truck CAFE. Open-bed pickup trucks are not, but they will be starting in the 2011 model year.
When the truck standards were written in 1975, legislators made two logical but incorrect assumptions: First, they assumed there was an easily definable difference between a passenger car and a truck. Second, they presumed that trucks were primarily working vehicles, purchased by businesses, building contractors, farmers, and other professionals. The idea that people would buy trucks in large numbers as substitutes for passenger cars apparently didn’t occur to anyone.
This was a curious lapse considering that car-based utility vehicles (notably, coupe-utilities like the Ford Ranchero or Chevrolet El Camino) had been blurring the lines between car and truck since the 1920s. At the same time, ‘real’ trucks had been growing progressively more civilized and livable. By the mid-1970s, the prospect of owning a truck as an ‘only car’ was far more palatable than it had once been. In the wake of Vietnam and Watergate, also, the cowboy image of trucks became increasingly appealing to a generation of disaffected Baby Boomers. In the late 1970s, the sales of trucks surpassed those of passenger cars and only some of those trucks were being sold to ranchers or businesses.
Automakers embraced the truck boom with relish. Since trucks didn’t have to meet the same safety, emissions, or fuel economy requirements as cars, they did not need to be nearly as mechanically sophisticated. The large production volume lowered manufacturing costs, and adding luxury features enabled posh trucks to be sold for premium prices, making them highly profitable. The profit margins became so enticing that other manufacturers got into the game. Automakers began to shortchange their passenger-car development to invest more in trucks.
The popularity of trucks — and the fact that they continue to be held to lower standards than cars — has brought the industry’s average fuel economy down quite a bit. For example, in 2007, light trucks accounted for 52.3% of the U.S. market, with total sales of 8,442,717 out of 16.1 million new vehicles. The CAFE target for trucks last year was 22.2 mpg (10.6 L/100 km) compared to 27.5 mpg (8.6 L/100 km) for cars. If we assume that all manufacturers exactly met the targets, the combined 2007 CAFE for the entire industry would be:
16,143,002 / ( (8,442,717 / 22.2 mpg) + (7,700,285 / 27.5 mpg)) = 24.4 mpg (9.6 L/100 km)
Let’s imagine that in the same period, only 10% of the market bought trucks and SUVs — the professional buyers the regulators assumed were buying trucks. In that case, the industry CAFE would be:
16,143,002 / ( (1,614,300 / 22.2 mpg) + (14,528,702 / 27.5 mpg)) = 26.9 mpg (8.7 L/100 km)
In short, the high percentage of truck sales has reduced the overall fuel economy of the domestic fleet by more than 10%.
(An important side note in all these calculations is that they really refer to gas mileage rather than fuel economy. To encourage automakers to develop alternative-fuel vehicles (i.e., cars and trucks that can run on ethanol, E85, compressed natural gas, hydrogen, et al), the NHTSA allows automakers to divide the actual fuel economy of their alternative-fuel vehicles by 0.15 when calculating CAFE. For example, a flex-fuel truck with a combined rating of 15 mpg (16.7 L/100 km), burning E85 or natural gas, counts as 100 mpg (2.4 L/100 km) for CAFE purposes. There’s a cap on the maximum amount that alternative-fuel vehicles can increase a manufacturer’s overall average — currently, 0.9 mpg (261.3 L/100 km). Even so, building modest numbers of flex-fuel vehicles is a cheap way for a manufacturer to bolster their averages.)
The corporate average fuel economy requirements have been controversial since they were first introduced and many pundits feel they are a mistake. Automakers hate the rules because they argue that CAFE standards force them to build cars that customers don’t necessarily want to buy and penalize manufacturers for offering the large, powerful vehicles that consumers prefer. Free-market conservatives feel that the market would do a better job of regulating fuel consumption than the NHTSA. They will no doubt point out that this year, thanks to the spike in fuel prices, truck sales are down more than 30%, which will raise 2008’s actual industry CAFE more than any legislation realistically could. Historians will also observe that GM’s move toward downsizing its big cars in the 1970s, which led the industry trend, was in the works before the EPCA passed — it was prompted by the oil embargo, not CAFE.
Your author is among the minority that considers CAFE a fundamentally a good idea. Our reasoning goes like this:
- Reducing fuel consumption is important all the time, not just in the midst of a temporary crisis. Buyers may shift toward smaller, more efficient cars during recessions or fuel crises, but history demonstrates that customers and automakers go back to bigger, thirstier vehicles as soon as the economy improves or prices drop. If your goal is to reduce the use of oil, this is problematic.
- If automakers build more fuel-efficient vehicles only as a reaction to market pressures, they’ll always lag several years behind economic conditions. It typically takes at least three years for manufacturers to tool up for new models even if they involve no new technology or concepts. This is, for example, the dilemma General Motors faces right now; when they planned the 2008 models a few years ago, they bet heavily on big trucks. Now that people are looking for thriftier cars, the best GM can do is make grand promises about what’s coming in 2010-11. The conclusion is obvious: From a fuel-saving standpoint, waiting for cyclical market forces to dictate when it’s appropriate to launch fuel-efficient cars is a losing proposition.
- Most automakers have little to no inclination to offer small cars or fuel-efficient models without regulatory pressure. Automakers prefer to sell bigger, more powerful, thirstier cars because they’re more profitable. Manufacturers can charge a premium for the extra size and power that far exceeds the additional manufacturing costs. Smaller cars tend to have thinner profit margins and so manufacturers only offer them if they have to. There have been extended periods during which American buyers wouldn’t have been able to buy really frugal cars even if they’d wanted them, simply because no manufacturers offered any.
- High fuel prices do wonders to motivate buyers to want more fuel-efficient cars, but higher fuel prices aren’t particularly good for the rest of the economy. Sky-high fuel prices raise the costs of every other good, as anyone who’s shopped for groceries in the last six months can attest. Dramatically raising gasoline taxes would move buyers towards more frugal cars, but it would also have considerable economic consequences, especially for low-income people.
- Incremental improvements in fuel economy are worthwhile, even if they don’t seem significant to individual consumers. Let’s say there was a new technology or aerodynamic improvement that would increase combined fuel economy by 0.2 mpg. No buyer is going to be moved by a bump like that, but applied to all the cars sold in the U.S., it could save more than 30 million gallons of fuel a year. If fuel economy averages were dictated purely by market conditions, automakers would be unlikely to pursue such improvements. The CAFE rules encourage them to do so because even a 0.1 mpg bump can save them millions of dollars.
Opponents of CAFE insist that the rules restrict consumer choice and that raising the target minimums above their current levels would force customers to buy cars they don’t want. Without these rules, however, buyers who want more efficient vehicles would frequently be out of luck. Consumers do not design cars; if a buyer needs a car and is interested in fuel efficiency (or low CO2 emissions), his or her choice is to either pick the best of what’s available or wait until the next economic downturn to see if automakers bring out something better. Not much of a choice if you need a car now.
The purpose of the CAFE rules is to provide a leveling effect, to push manufacturers to offer fuel-efficient vehicles even when economic conditions are good and fuel prices are relatively low. It also gives automakers a financial incentive to raise the fuel economy of their most popular models — since the better a model sells, the more heavily its fuel economy is weighted for CAFE — and to try to make more-efficient cars that people actually want to buy.
In our view, the main problem with CAFE is that by current standards, the rules aren’t particularly stringent. The target fuel economy for passenger cars is still the one set in 1975 and has not been adjusted in 18 years. The standard for trucks — a term that has become so vague as to be useless — remains 22% lower than that of passenger cars. Nor are the penalties for failing to hit the target minimums particularly daunting. A $15 million NHTSA fine is less than manufacturers typically spend on wheel cover designs for a new model; it’s expensive, but not a major deterrent. That means manufacturers, particularly smaller ones, could simply ignore the CAFE requirements and pass the cost of the fines along to their customers.
Your author believes that CAFE is a valid tool for encouraging higher fuel efficiency — not a panacea, by any means, but a useful tool. For it to work, however, the bar needs to be raised, the penalties for noncompliance increased, and the loopholes (most particularly the disparity between car and truck standards) reduced.
Automakers and their supporters frequently complain that meeting higher CAFE requirements isn’t feasible. It’s important to remember, though, that they’ve been saying the same thing for more than 25 years, during which time the technology to build more fuel-efficient cars (even without resorting to hybrid technology or diesel) has only improved. What is lacking is not the means — only the will.