By John Auers
Many words can and have been used to describe the first 100 days of the Trump Administration. This landmark period, which actually ends next Saturday, has been termed everything from frightening to glorious, tumultuous to confusing, failing to successful. The one adjective which hasn’t been used, though, is boring. Whether for good or bad, depending on your point of view, the first three plus months of the Trump Administration have certainly been interesting and impactful. Although policy developments in the energy arena haven’t had the front page prominence of other issues (healthcare debate, Gorsuch nomination, international conflicts, etc.), there certainly have been some important happenings. We’ve discussed some of these already in the blog this year – Pipeline Approvals (2/14 and 3/20), possible changes in the Renewal Fuel Standard (3/7) and a general overview of the Trump energy agenda (1/24). Today, we address another important issue to the petroleum industry which is being moved by the new Administration in a potentially very different direction than it was by the Obama team – Corporate Average Fuel Efficiency (CAFE) Standards. In one of its final actions, the Obama Administration made an effort to finalize regulations which would lead to a 54.5 miles per gallon (mpg) standard by 2025; however, in March, the new EPA Administrator, Scott Pruitt, announced that his agency would work together with the Department of Transportation’s (DOT) National Highway Traffic Safety Administration (NHTSA) to reconsider this decision. The Donald himself has expressed support for domestic automakers who are opposed to the standards for cost and marketability reasons. U.S. refiners would also benefit from less stringent mileage standards due to their impact on transportation fuels demand, primarily gasoline. In today’s blog, we explore the factors the EPA and NHTSA will consider in their review, and whether they will channel Head East to determine that there’s “Never Been Any Reason” to enact the stricter CAFE rules.
“You’ve Been Talking in Circles, Since I’ve Been Able to Cry”
The modern era for the CAFE program began in 2007 with the passage of the Energy Independence and Security Act (EISA). This legislation set a mileage target for Model Year (MY) 2020 vehicles of 35 mpg (compared to the then actual level of around 25 mpg). The first increase was to occur in the MY 2011 vehicles. These targets were adjusted in 2010 (for MYs 2012 through 2016) with the adoption of the National Program and then broadened substantially again in 2012.
While the focus of the EISA targets in the Bush Administration was on reducing the U.S. dependence on foreign oil imports, the establishment of the National Program during the Obama Administration realigned the initiative around environmental objectives of reducing greenhouse gas (GHG) production. The 2012 standards established the final targets for the MY 2017 through 2021 vehicles and set proposed targets for MYs 2022 through 2025. The 2025 target was to double the average vehicle fuel efficiency (compared to the existing MY 2012 average), cut GHG production in half and reduce oil consumption by 12 billion barrels over the lifetime of the 2012-2025 vehicles.
In addition to proposed targets for the MY 2022 through 2025 vehicles, the 2012 rules also require the EPA to conduct a Midterm Evaluation (MTE) to determine if these proposed targets are still appropriate given any new information which might have become available. This MTE is to be completed by April 1, 2018. The EPA, in coordination with the NHTSA and CARB, released a Draft Technical Assessment Report (TAR) as a first step in the MTE process in July 2016. The purpose of the TAR was to “examine a wide range of technical issues relevant to the GHG emissions and augural CAFE standards for MY 2022-2025, and share with the public the initial technical analyses of those issues.” The TAR further states, “This is a technical report, not a policy document. The information in this report, and in the comments we receive on it, will inform the agencies’ subsequent determination and rulemaking actions.” What follows then are over 1,200 pages of data, analysis and observations. The end result of the MTE will be the issuance the final targets for MY 2022 through 2025 vehicles.
The TAR points out that the automotive industry has been over-complying in the first years of the National Program. This occurred even as the industry was initially recovering from the Great Recession. In fact, automotive sales have increased for six consecutive years, reaching an all-time record in 2015 at 17.5 million vehicles.
“You Never Give Me No Answer, You Never Tell Me the Truth”
The TAR evaluated numerous aspects of the various technologies used in setting the proposed standards in 2012. These included the cost, effectiveness, implementation considerations and lead-time requirements as well as any new information on the introductions of the technologies to determine if the base assumptions should now be altered from the original views in 2012. These technologies include:
- More efficient engines and transmissions;
- Aerodynamics;
- Light-weighting;
- Improved accessories;
- Low-rolling resistance tires;
- Improved air-conditioning systems;
- Higher compression ratio engines;
- Naturally aspirated gasoline engines;
- Greater penetration of continuously variable transmissions; and
- 48-volt mild hybrid systems.
The TAR acknowledged that it did not evaluate new technologies such as electric-turbocharging, variable compression ratio engines, skip-fire cylinder deactivation and P2-configuration mild-hybridization.
For the technologies of which there has been some introduction since 2012, the TAR asserts that positive evaluations have exceeded negative evaluations. The agencies believe this indicates that these technologies can be fully implemented without significant hidden costs. The TAR states that consumer responses to the early standard improvements have been generally positive. The TAR also states that initial assessments indicate that the operating cost reductions associated with fuel-savings from the early gains far exceed the initial vehicle cost increases. As a result, the up-front price increases are not expected to negatively impact vehicle sales or affordability.
The logic of this conclusion may be flawed, however. It is likely the automotive industry has implemented the lowest cost improvements first. As a result, early consumer reactions would be expected to be positive. As efficiency standards rise, however, the cost of each improvement will rise progressively and could create significant consumer resistance in the form of declining vehicle sales. This same trend has been evident in other environment initiatives. Early sulfur reductions in gasoline did not incur significant expenses, but later reductions to 30 ppm and now to 10 ppm became progressively more expensive.
While the technology improvements have produced better-than-expected compliance results, the actual mileage gains have not followed. This is because the actual regulations are vehicle-specific. While each vehicle line has met its individual requirement, consumers are buying larger vehicles than was anticipated. This has skewed not only the gains since 2012, but also the expected improvements through 2025. Using the EIA’s Annual Energy Outlook 2015 (AEO 2015), the TAR has recomputed expected fleet efficiency for MY 2025. Because of the ongoing consumer preference to purchase larger trucks (SUVs), projected mileage efficiencies are now expected to be lower in 2025 than the 2012 forecast, while GHG production is expected to be higher. These results are shown in Table 1. The AEO 2015 has a reference case with a low gasoline price case and a high gasoline price case.
In 2012, the EPA estimated that 33% of the MY 2025 vehicles would be light trucks. The TAR now estimates that 48% of the MY 2025 vehicles will be light trucks. This has lowered the CAFE requirement from the 2012 estimate for MY 2025 of 48.7 mpg to a current forecast of 46.3 mpg. Similarly, GHG emissions will be higher, with a current estimate of 175 g/mi compared to the 2012 estimate of 163 g/mi.
The TAR also evaluated numerous other aspects of the National Program effects. Safety issues were noted and considerable data was provided which correlated the increase in deaths for lighter vehicles. This will likely be a key argument made by opponents of maintaining or even increasing the 2022 to 2025 standards. Potential impacts on employment will also be a point of contention. Although the TAR concluded that the total employment effects of the new standards are likely to be minimal, opponents could dispute this, arguing that the standards will put domestic automakers at a competitive advantage. One issue not addressed in the TAR (except in passing) was the potential need for higher octane gasoline to be able to meet the higher level mileage standards. This is a subject of intense interest to refiners and we will address it in a future blog.
“Save My Life I’m Going Down for the Last Time”
In the end, despite all the questions raised in the TAR about the costs and difficulties associated with implementing the aggressive 2022 to 2025 standards, the EPA issued a “final” verdict in the last days of Obama’s term which confirmed those standards. This verdict was issued more than a year before the statutory April 2018 deadline for the decision. Automakers cried foul and petitioned the incoming Trump Administration to reopen the review process. Among their many claims, Automakers say the standards are economically unachievable and will mandate the production of overly expensive cars which the public will not purchase, resulting in the loss of 1 million or more domestic auto jobs. Considering the Donald’s focus on jobs during the campaign and the decisive role the “Auto Belt” in the Midwest played in his victory, these pleas certainly fell on receptive ears and led to the announcement by the EPA last month that they would restart the evaluation. While most analysts believe this will ultimately result in the government throwing a lifeline to automakers by weakening the standards, the pro-CAFE lobbies, led by environmental groups, will not give up easily. Even if the standards are overturned in the decision which is to come by next April, major court challenges are probable. A key complication will be the potential conflict between California, which is on the path to maintaining higher CAFE standards and weaker federal guidelines. It should be noted that while refiners haven’t taken strong positions in the CAFE debate, they will be affected as well, due to the reduced domestic demand and increased octane requirements which would result from the very high mileage standards.
TM&C constantly monitors regulatory developments which impact all segments of the petroleum industry. Many of these are associated with transportation fuels, effecting not only demand but also production costs, compliance challenges, and other aspects of fuel production. We include our independent analyses of these impacts in our semiannual Crude and Refined Products Outlook (the latest version of which we released in February) and our various other studies. TM&C also assists clients involved in all aspects of transportation fuel production and blending activities, compliance-monitoring and planning. Please contact us for our views on the latest developments and their potential impacts, or if we can assist in any way or answer any questions regarding the petroleum industry, product demand, regulatory impacts, fuel compliance issues or any other issues associated with petroleum refining activities.