Testimony to the United States Senate Committee on Energy and Natural
Resources

**POLICIES TO INCREASE PASSENGER CAR**

**AND LIGHT TRUCK FUEL ECONOMY**

2:30 pm, Tuesday, January 30, 2007

Dirksen Senate Office Building, Room SD-366

by

Dr. David L. Greene

Corporate Fellow

Engineering Science and Technology Division

Oak Ridge National Laboratory

Good afternoon. Thank you for inviting me to discuss the need to
formulate effective policies to significantly increase motor vehicle
fuel economy. The views I express today will be entirely my own and do
not necessarily reflect the views of Oak Ridge National Laboratory or
the Department of Energy.

Our transportation system consumes more petroleum than any other country
in the world, on average 6,300 gallons of oil per second. It produces
more climate changing carbon dioxide emissions than any other country in
the world except China. There is good reason to be concerned about the
sustainability of conventional petroleum as a source of energy for the
world's transportation system. More than one fourth of all the petroleum
consumed in all of human history was consumed in the past ten years.
Both the International Energy Agency (IEA, 2006) and the ExxonMobil
Corporation have predicted that by 2010 conventional oil production
outside of OPEC nations will peak or reach a plateau. If we continue on
our present path, only OPEC or more carbon intensive unconventional
fossil energy sources will be able to supply the world's growing demand
for liquid fuels.

**Why do we need fuel economy policy?**

For too long we have ignored the urgent need to reduce our petroleum
dependence, protect the global climate and chart a course toward a
sustainable energy system. For the past twenty years we have spent the
technology that could have been used to raise fuel economy to instead
increase horsepower and vehicle mass. Since 1987 horsepower is up 85%
and mass over 25%. In part, this is because consumers value acceleration
and speed. But it is also because car buyers undervalue fuel economy.
Raising the fuel economy of passenger cars and light trucks will not by
itself solve our energy dependence, greenhouse gas emissions and
sustainable energy problems. But significantly increasing vehicle
efficiency is an essential component of any meaningful strategy to
address these important goals.

How do we know that consumers undervalue fuel economy? *Consumers say
so.* Consumers' responses to survey questions indicate a willingness to
pay for only about 2 years of fuel savings. Half of a random sample of
U.S. households was asked how much they were willing to pay for a fuel
economy improvement that would save them \$400 per year in fuel costs.
The other half was asked how much money they would have to save each
year in fuel costs to justify a \$1,200 increase in the price of a
vehicle. The average payback periods implied by consumers' answers to
these questions were roughly 2-2.5 years, regardless of which way the
question was posed. The published literature on consumer payback periods
for fuel economy improvements is almost non-existent. However, such
short payback periods are entirely consistent with the larger literature
on consumers' preferences for other energy-using durable goods.

![](media/image1.wmf){width="5.75in" height="3.9118055555555555in"}

Figure 1. Consumers' Inferred Payback Periods for Fuel Economy
Improvements

Source: Opinion Research Corporation, Caravan Survey for the U.S.
Department of Energy, May 20, 2004.

*Manufacturers say so.* Some say that consumers consider only the first
50,000 miles of fuel savings. Other manufacturers have told me they
believe payback periods of 2-4 years accurately reflect consumers'
willingness to pay. I have yet to find a manufacturer who believes that
consumers value the discounted present value of fuel savings over the
full lifetime of a vehicle. What manufacturers think consumers are
willing to pay is important because it is they who make the decisions
about vehicle design and the use of fuel economy technologies.

*Scientific research says so.* What little scientific research has been
done on the subject provides strong evidence that the simple model of an
economically optimizing consumer who compares the cost of improved fuel
economy to the discounted present value of fuel savings does not apply
to consumers' decisions about fuel economy. Detailed interviews of 57
vehicle-owning households in California covering the complete histories
of their car-buying decisions found not one that did any comparison of
the value of fuel savings versus its cost. The U.C. Davis researchers
concluded: "When consumers buy a vehicle, they have neither the
motivation nor the basic building blocks of knowledge to make a
calculated decision about fuel costs." (Turrentine and Kurani, 2004, p.
2)

It's not that consumers are irrational or uninformed. In fact, there is
relatively little net gain (or loss) for consumers from increased fuel
economy over a wide range of higher fuel economy levels. The National
Research Council (NRC, 2002) Committee's estimates of the cost of
increasing the fuel economy of an average passenger car, together with
the present value of future fuel savings are plotted in figures 2 and 3
for gasoline prices of \$1.50 and \$2.00 per gallon (constant 2000 \$).
The economically rational consumer is concerned with the net value of
the fuel economy improvement: the present value of fuel savings minus
the increased vehicle price. If the price of gasoline is \$2/gallon, as
shown in Figure 2, almost \$500 in net value can be gained by increasing
miles per gallon from 28 to 32. But there is very little difference in
net value between 32 and 41 mpg, about \$100 or so. Figure 3 shows the
same calculations at \$1.50 per gallon. There is perhaps a difference of
\$250 in net value between 28 and 40 miles per gallon. Of course, the
consumer doesn't know what the future price of gasoline will be any more
than I do.

![](media/image2.wmf){width="5.5in" height="3.8881944444444443in"}

Figure 2. Net Value of Fuel Economy Improvement to Car Buyer Using the
NRC 2002 Fuel Economy Cost Estimates and Assuming Gasoline Costs \$2.00
(Constant 2000 \$).

![](media/image3.wmf){width="5.625in" height="3.8291666666666666in"}

Figure 3. Net Value of Fuel Economy Improvement to Car Buyer Using the
NRC 2002 Fuel Economy Cost Estimates and Assuming Gasoline Costs \$1.50
(Constant 2000 \$).

In addition, it is rare that a consumer finds a clear trade-off between
fuel economy and cost. Higher fuel economy may come with a smaller
engine, a manual transmission, or a completely different model. It's up
to the consumer to infer what the price of higher fuel economy really
is. Finally there is substantial uncertainty about the actual fuel
economy a car will get on the road. Even if the EPA estimate is accurate
on average, any given motorist might get 7 mpg less or 7 mpg more in
actual use.

From the manufacturer's perspective, moving from a sales-weighted
average of 28 to 40 miles per gallon would require completely
redesigning all product lines, a project that would take 8-10 years and
billion of dollars for engineering and retooling; all for a fuel economy
increase about which individual car buyers are likely to be indifferent.

The NRC (2002) fuel economy study considered the undervaluing of fuel
economy in their cost-efficient fuel economy calculations. (A fuel
economy increase was considered cost-efficient if the marginal cost of
the increase was less than or equal to the marginal benefit in fuel
savings to the consumer). In estimating the cost-efficient levels of
fuel economy achievable by near-term technologies, the NRC report
considered two alternative ways consumers might value fuel economy. One
assumed that car buyers compare the discounted present value of fuel
savings over the full life of a vehicle to increased cost of fuel
economy technologies needed to achieve it. The other assumed car buyers
were willing to pay for technologies with a simple payback period of
three years or less. Using the full lifetime method and assuming
gasoline priced at \$1.50 (constant 2000 \$) per gallon, the NRC
Committee estimated that fuel economy improvements of 12% to 27% were
cost-efficient for passenger cars, and from 25% to 42% for light trucks;
the larger the vehicle, the larger the estimate percent fuel economy
improvement. However, using the simple 3-year payback rule, the
cost-efficient fuel economy changes ranged from -3% to +3% for cars and
2% to 15% for light trucks. Valuing fuel economy as both consumers and
manufacturers say they do, little or no improvement was justified.

In June of 2006, at the request of Senators Biden, Lugar and Obama, I
recalculated cost-efficient fuel economy levels using the NRC
Committee's spreadsheet model but assuming gasoline prices of \$2.50 and
\$3.05 (current \$) per gallon and accounting for the discounted present
value of fuel savings over the full lifetime of a vehicle. At these
prices, the overall cost-efficient fuel economy improvements for the
light-duty vehicle fleet were 41% and 50%, respectively.

Finally, the consumption of oil produces additional costs that are of
great significance to us as a nation but are generally not considered by
individuals in their car purchase decisions:

1.  Economic costs of oil dependence

2.  Military, strategic and foreign policy costs of oil dependence

3.  Climate change impacts of carbon dioxide emissions

4.  Other environmental impacts

By my estimates, the economic costs of oil dependence alone exceeded
\$300 billion last year. Military and foreign policy costs are extremely
difficult to measure in dollars but in my opinion they are at least as
great a problem for our nation. All of these additional costs of oil use
are what economists call public goods (or bads). In general, consumers
give them little or no weight in their individual purchase decisions.
Such problems must be addressed by public policy if they are to be
solved.

**What policies will work?**

While there are many policies that can reduce transportation petroleum
consumption and greenhouse gas emissions, I will focus on those that can
have the greatest impact on new vehicle fuel economy: fuel economy
regulation, fuel economy fees and rebates ("feebates"), the price of
gasoline, and research and development of new automotive technologies.

If the market for fuel economy were efficient, taxing gasoline would be
an efficient solution. Since the market for fuel economy is not
efficient, many governments have chosen to adopt fuel economy standards.
The European Union, Japan, China, Canada, Australia, South Korea and the
United States all have fuel economy standards for light-duty vehicles
(An and Sauer, 2004). Japan has also recently successfully implemented
fuel economy standards for heavy trucks. In many of these countries
gasoline prices exceeded \$4 and even \$5 per gallon last year (EIA,
2006, table 11.8). Yet fuel economy standards are still needed because
of the inefficiency of the market for fuel economy and because markets
are not concerned with the public goods, such as energy security and
preserving the global climate. Raising gasoline taxes is a less
effective way to increase fuel economy than standards or feebates.
Nevertheless, higher fuel taxes are an important complementary policy
because they send a consistent message to consumers that reducing fuel
consumption is important, they mitigate against the very small increase
in driving that fuel economy increases would otherwise produce, and they
can be used to offset the loss of revenues to maintain and improve
transportation infrastructure that would otherwise occur.

Fuel economy and greenhouse gas emissions standards can take many forms.
Japan and China's fuel economy standards vary with vehicle weight. The
EU's greenhouse gas standards are a voluntary agreement on an
industry-wide target between the government and industry. The U.S.
Corporate Average Fuel Economy Standards require the sales weighted
harmonic mean fuel economy of a manufacturer's imported and domestic
passenger car fleets to meet a single fuel economy target. The target is
the same for all manufacturers regardless of the types of vehicles they
sell. The newly reformed light truck fuel economy standard assigns each
manufacturer a different target depending on the "footprint" (wheelbase
time track width) of the trucks it sells. The new reformed standard is
likely, in my opinion, to prove to be an important and valuable
innovation that could be extended to include the passenger car standards
in a unified system. Unfortunately, the NHTSA did not do a thorough
study of how vehicle designs might change under the new reformed
standards and what the consequences of such changes might be. This study
still needs to be done if we are to be confident that the new reformed
system will not have significant unintended consequences.

Feebates are a market-based policy that circumvents the market failure
of undervaluing fuel economy. A feebate system imposes fees on high fuel
consumption vehicles and gives rebates to low fuel consumption vehicles.
Fees increase in proportion to the gallons per mile by which a vehicle
exceeds a target value and rebates increase in proportion to the gallons
per mile by which a vehicle's fuel consumption is below the target
value. Because the market signal is given at the time of vehicle
purchase, feebates avoid the market failure that makes gasoline taxes
relatively ineffective in promoting fuel economy. Today we have a
partial feebate system in the form of gas-guzzler taxes that apply only
to passenger cars.

Feebates have certain advantages over fuel economy standards. Because a
fee avoided or a rebate gained is always valuable, there is a continuing
incentive for manufacturers to adopt the latest technologies and apply
them to improving fuel economy. Published studies show that feebates,
like fuel economy standards, will work almost entirely through the
adoption of fuel economy technology rather than by shifting the mix of
vehicles sold. Feebate systems can be designed to be revenue neutral,
revenue enhancing or a net cost to the government and net subsidy to
industry and consumers. An appropriately designed feebate system can
actually increase the sales revenues of vehicle manufacturers.

Feebates have the disadvantage that the quantity of fuel economy
improvement is not certain, as it is with a fuel economy standard. Also,
depending on how the feebate system is designed, some manufacturers will
be net receivers of rebates while others will be net payers of fees.
Such effects can be reduced by designing attribute based feebate
systems, in the same way that the current light-truck fuel economy
standards are adjusted according to the sizes of light trucks.

Future technological advances will expand the possibilities for
efficiency improvement and substitution of clean alternative energy
sources if industry, academia and government aggressively pursue
research and development. I will not dwell on the importance of research
and development of advanced automotive technologies but simply note that
continued technological progress is essential. The technologies
available today are amazing improvements over technologies available
three decades ago. Still, they are not up to the task of reducing
transportation's greenhouse gas emissions to acceptable levels nor of
achieving sustainable, secure energy for transportation in the 21^st^
century. To accomplish these goals we will need advanced vehicle and
fuel technologies, and the sooner the better.

**References**

1.  An, F. and A. Sauer, 2004. "Comparison of Passenger Vehicle Fuel
    Economy and Greenhouse Gas Emission Standards Around the World", Pew
    Center on Global Climate Change, Arlington, Virginia, December,
    2004.

2.  International Energy Agency (IEA), 2006. *World Energy Outlook
    2006*, OECD, Paris.

3.  National Research Council (NRC), 2002. *Effectiveness and Impact of
    Corporate Average Fuel Economy (CAFE) Standards*, National Academies
    Press, Washington, D.C.

4.  Turrentine, T. and K. Kurani, 2005. "Automotive fuel economy in the
    purchase and use decisions of households", presented at the 2005
    Annual Meeting of the Transportation Research Board, Washington,
    D.C., January, 2005.

5.  U.S. Department of Energy, Energy Information Administration, 2006.
    *Annual Energy Review 2005*, DOE/EIA-0384(205), Washington, D.C.

6.  U.S. Environmental Protection Agency (EPA), 2006. "Light-Duty
    Automotive Technology and Fuel Economy Trends: 1975 through 2006",
    EPA420-R-06-011, Office of Transportation and Air Quality, Ann
    Arbor, Michigan, July, 2006.