The Sad CAFE – What to Make of the Latest EPA Moves on Corporate Average Fuel Economy Standards (CAFE)

By Robert Auers and John Auers

While “The Sad Cafe” certainly wasn’t one of the Eagles biggest hits, it held the distinction of being the final track on what was to be their last album (“The Long Run”).  But that distinction went away in 1994, when the 70s super group reformed and released, “Hell Freezes Over”.   In a similar way, the announcement last week by EPA Administrator Scott Pruitt scrapping the 2022-2025 fuel economy standards  for light duty vehicles erases another CAFE from the books.  While that announcement wasn’t a complete surprise (and in fact anticipated ever since the new Administration took office), it certainly resulted in a barrage of alarmist commentary from many in the media of a drastic “rollback” in standards, a return to “gas guzzlers” and other breathless hyperbole.   Much of this commentary was made without a serious analysis of the Rube Golberg-esque details associated with CAFE or the real impacts on markets of the recent developments.   In today’s blog we will try to look behind the headlines to explain the CAFE program and discuss some of the aspects of the recent moves by the EPA which have not received sufficient coverage or analysis.

Explaining the Sad CAFE

CAFE standards for passenger vehicles were first introduced in the U.S. in 1978 at a time when the U.S. oil markets were in a completely different place than they are now.   In those days of increasing oil prices and declining domestic production, CAFE standards were tasked to combat fuel shortages and reduce dependence on imported oil.   Another important thing to note is that the testing procedures to determine CAFE fuel economy were set to match the EPA fuel economy testing standards of the 1970s.  Due to the fact that the EPA has since refined its testing standards to represent more real world conditions, the CAFE fuel economy of a car is ~1/3 higher, in terms of MPG, than the EPA-rated combined fuel economy shown on the window sticker.  Therefore, a car with an EPA rated combined fuel economy of 30 MPG will typically have a CAFE fuel economy rating of approximately 40 MPG.

The standard was initially set at 18 MPG for passenger cars in 1978, and standards for light trucks were introduced the next year at 17.2 and 15.8 MPG for 2WD and 4WD versions, respectively.    Beginning in 1982, car manufacturers were given the option to determine their mandated light truck fuel economy target by using the fraction of 2WD / 4WD vehicles sold, or by simply using a newly created combined number for all light trucks.  The individual 2WD / 4WD targets were then discontinued in 1992 in favor of the combined target for all light trucks.  Moreover, beginning for model year 2008, the EPA introduced new standards for light trucks based on vehicle footprint, which is equal to the wheelbase multiplied by the track width.  A higher, stricter standard was set for vehicles with a footprint less than 41 ft² and a less strict was set for vehicles with a footprint greater than 75 ft².  If a vehicle’s footprint was below or above these levels, the fuel economy requirement was equal to that at 41 or 75 ft², respectively (i.e., the requirement does not change as vehicles get smaller or larger outside of this range).  The requirement for vehicles with footprints between these two levels varies between the two extremes.  Beginning with Model year 2011, standards based on vehicle footprint were introduced for passenger cars as well, with the standard varying for vehicles with footprints between 41 and 55 ft².

The recent decision by the Pruitt-led EPA will relax the ever more stringent standards set for the 2022 to 2025 time period.  The standards set through model year 2021, on the other hand, will remain in place.  Therefore, 2021 model year vehicles, aside from large-footprint light trucks, will still be required to obtain a MPG rating about 12% greater than that for model year 2018 vehicles.  The requirement for trucks with a footprint greater than 71 ft² does not change between 2018 and 2021.

The charts below detail the historical and Obama-era proposed CAFE standards for cars and light trucks.  The first chart displays requirements utilizing the CAFE testing methodology and the second chart displays the same information, but shows the approximate required EPA window sticker fuel economy.  For the years where the fuel economy requirement is based on a vehicle footprint, we used the average of the highest and lowest requirements. 

Due to the way in which the CAFE fuel economy target is calculated, each manufacturer has a different target based off of the number of cars / light trucks that the manufacture sells and the footprint of each of those vehicles.  Furthermore, in calculating a company’s target, one must use the harmonic mean, not arithmetic mean, fuel economy of all vehicles sold.  For example, if a manufacturer sold one vehicle that achieved 10 mpg using the CAFE test method and another that achieved 50 MPG, the harmonic mean of the fuel economy of the two vehicles would be 16.7 MPG, not 30 MPG.  This is equivalent to saying that if each vehicle drove 100 miles, one would consume two gallons of gasoline and the other would consume 10 gallons of gasoline.  Two hundred miles divided by 12 gallons of gasoline equals 16.7 miles per gallon.  This calculation method makes compliance more difficult than one would likely believe at first glance.

There are also notable provisions (loopholes) that allow manufacturers to receive higher fuel economy rating for certain vehicles.  The most heavily exploited of these was that for flex-fuel vehicles, which can run on up to E85 gasoline; however, the EPA has since limited the maximum increase the fuel economy equivalent of flex-fuel vehicle to 1.2 MPG.  Additional credits exist for things such as high efficiency air conditioning systems, stop-start systems, high efficiency lights, solar roof panels and electric heat pumps.  Added together, taking advantage of these provisions can increase the CAFE fuel economy rating of a vehicle by about 3 MPG.  Lastly, manufacturers receive added credit for EVs, including plug-in hybrids (PHEVs).  First, these vehicles already achieve very high CAFE “fuel economy” ratings.  Second, in 2017, a Battery Electric Vehicle’s (BEV’s) fuel economy could be counted twice in your total vehicle sales. For instance, a manufacturer could count 1,000 BEV sales as 2,000 BEV sales when calculating its average sales-weighted fuel economy for the year.  This multiplier is set to decrease to 1.5 by 2021.  For PHEVs, the factor began at 1.6 and 2017 and decreases to 1.3 by 2021.

How Many Cars Meet Future Regulations Today?

The short answer is the most vehicles, aside from EVs and hybrids, struggle to meet the 2018 requirements, much less the 2021 requirement.  The 2025 requirements, would of course be even stricter and could not come close to being met with any current technology aside from hybrids and EVs.  Turner, Mason & Company (TM&C) took some time to compile a list of current vehicles and how they stack up against the CAFE requirements.  We then grouped these vehicles into categories and compared them against the CAFE standards that need to be met.  Our list is far from exhaustive, and we did not assign any weight to the data based on sales for specific vehicles (i.e., we simply used simple averages for each category), but we still believe they at least provide some insight as to where car manufacturers stand relative to the requirement laid out in the regulation.

Note that our simple, nonexhaustive, and nonscientific analysis shows that only today’s hybrids (and EVs, which are not represented in the chart) are the only class of vehicles currently capable of achieving 2021 CAFE standards.  Furthermore, economy cars are likely the only segment, aside from hybrids and EVs, achieving compliance in 2018.

One interesting item to note is that, due to the footprint method of determining fuel economy requirements, the most fuel efficient nonhybrid vehicles still often struggle to meet CAFE requirements; for instance, the 2018 Toyota Yaris iA, a super-compact sedan (41.3 ft² footprint) with CAFE fuel economy of approximately 46 MPG, has more trouble meeting the CAFE standards than a 2018 Toyota Camry 2.5 L (44 MPG), a mid-sized sedan with a 48.5 ft² footprint.  This is due to the fact that a Yaris iA has 2018 and 2021 fuel economy targets of approximately 45, and 51 MPG, respectively, while the Camry has 2018 and 2021 fuel economy targets of approximately 39 and 44 MPG, respectively.  As a result, CAFE does not always encourage consumers to buy smaller vehicles, since the requirements for fuel economy are based on vehicle footprint.

Compliance Enforcement

Compliance with CAFE is not mandatory, and civil penalties (fines) are enacted against manufacturers that do not comply.

Many manufacturers do not currently comply with CAFE, but it is difficult to obtain data to determine exact compliance.  There are a few reasons for this.  First, information regarding CAFE fines levied against individual manufacturers is only currently available through 2014.  Second, the 2009 revisions of the law created a system of credits that can be stored for use in future years and/or traded between companies to bring a company into compliance.  For the 2012-2014 period, the only manufacturers that actually paid CAFE related fines were Jaguar Land Rover and Volvo, and the total fines paid over these three years only amounted to ~$40 million.  Still, we suspect that many other manufacturers (especially those that focus on the luxury segment) failed to comply on their own, and complied by buying credits from other manufacturers.  Furthermore, the compliance of many manufacturers was likely assisted by the use of credit from previous years, when the standards were less strict.

News that was perhaps more important, but less covered, than the revision of the 2022-2025 standards announced two weeks ago, was the NHTSA’s proposal in late March to not increase CAFE compliance penalties going forward.  The current penalty for noncompliance is $55 per MPG over the standard per vehicle sold.  The fine was set at $50 in 1983, increased to $55 in 1997, and has not increased again.  Do to the fact that this fine has shrunk considerably in terms of real dollars over the years, the fine was set to increase to $140 beginning with MY 2015 vehicles.  Implementation, however, was delayed until 2019.  Then, on March 28 of this year, the NHTSA proposed not implementing the increase to $140 beginning in 2019, and to instead slightly increase the $55 dollar penalty each year to keep up with inflation, as well as impose a hard cap at $100.  This change was proposed due to the fact that NHTSA states that the increase to $140 may cost up to $1 billion per year.  Additionally, the change may significantly affect automobile manufacturers’ plans with regard to CAFE going forward.  A luxury or sports car that fails to comply with the regulation by 20 MPG would see the fine associated with its sale decrease from $2,800 to $1,100.  Furthermore, when is purchasing a new $50,000 sports or luxury car, for instance, a $1,100 penalty is not all that significant.  For an economy car that lags the standard by 5 MPG, the penalty (at $55/MPG) would only be a modest $275.  Lastly, due to the favorable treatment that EVs and PHEVs are given by CAFE, this change may alter manufacturers’ stance with regards to EV plans going forward; given that it may now be less expensive to simply pay fines instead of comply.

TM&C constantly monitors changes and projected changes in pricing and supply and demand across the globe for all petroleum products.  Our projections take into account changing rules and regulations, technological advancements, production and transportation costs, demographics, changes in consumer behavior, and other factors impacting supply and demand.  We include our independent analyses of these impacts in our semiannual Crude and Refined Products Outlook and our various other studies. More information on these publications and our other work involving oil industry developments and dynamics can be obtained by contacting us, visiting our website at turnermason.com or calling Cindy Parker at 214-754-0898.