Why We Believe the Auto Alliance Review of Fuel Economy Standards Misses the Mark
Last week, we published an analysis of how future fuel economy standardscould affect the auto industry and its suppliers. Federal agencies are now reviewing these standards (the Rule), and auto analysts like us are eager to see what the new standards, which stretch out to 2025, will be like.
Our analysis found that automakers can expect to remain profitable under the current National Program whether gas prices stay low or go higher. Under weaker fuel economy standards, however, we found that domestic automakers would be vulnerable to an oil price spike, as some consumers would buy from competitors that offer more fuel-efficient vehicles. This is similar to what happened during the mid- to late 2000s.
The same day we released our analysis, the Auto Alliance, the auto industry’s lead trade group in Washington, released its review of the standards. Although our analyses were designed differently, here are some key issues to consider.
Expected costs for technology
My colleagues and I relied on a National Research Council report and other sources which found that the costs for improving internal combustion engines are in fact consistent with, or less than, the costs projected by the original standards, or Rule. The Alliance’s review states that the Rule underestimates costs and overestimates applications rates (even though the industry agreed with the Rule’s assumptions in 2012). In fact, technologies such as weight reduction, stop/start, and advanced transmissions are more prevalent, and, in some cases cheaper, than what the Rule projected in 2012. Moreover, the Alliance uses outdated cost figures in some cases. For example, its estimates for added technology costs in hybrids are from 2010 and are specific to a particular type of hybridization that was the industry standard at that time.
As electrification expands, suppliers are making more and better batteries, and costs have been dropping significantly. Our study took a conservative approach, however, and did not assume continued battery cost reductions in the future, even though this is a reasonable assumption. Future costs could therefore be even less than what was projected by the original Rule.
The Alliance review lacks necessary rigor
Our analysis took a bottom-up approach, in which we carefully looked at various technology packages, their cost and fuel economy improvement impact, and used that to forecast each automaker’s projected future fleet. We think that’s an appropriate way of addressing the issue. By contrast, the Alliance’s review took a top-down approach, examining industry averages and only sometimes breaking things down by car and truck mixes, and occasionally by segment. In our view, that makes the Alliance’s review less useful, because it does not provide the necessary detail to predict how the industry (with each company having a different approach) will meet the fuel economy requirements.
Internal combustion engines, not hybrids, will drive compliance with the standards
Our analysis illustrates that improvements in internal combustion engines (ICE) will be by far the most important strategy for meeting the standards. In addition, vehicles sit on a spectrum of electrification, from gas engines that avoid idling with electric start / stop, to mild hybrids with regenerative braking, to full hybrids like the Prius, plug-in hybrids like the Volt, and to battery electric EVs like the Leaf and Tesla. When the Alliance compares fuel efficiency requirements to today’s “modern hybrids,” it conflates mild hybrids and full hybrids, which causes them to overestimate the role that electrification will have to play in meeting the standards, and conclude that 47 percent of 2025 vehicles would have to be hybrids. In fact, given that ICE improvements (which incorporate some forms of electrification) will be the primary means of meeting the standards, we find that full hybrids would constitute just nine percent of the fleet.
Consumers value fuel savings
The Alliance says that, “Hybrids can be viewed as a surrogate for consumer willingness to pay for the most fuel efficient technologies.” My colleagues and I respectfully disagree. Consumers have embraced a full spectrum of vehicles with fuel savings technologies. For example, the rate of turbochargers and direct injection engines has increased dramatically even at higher cost to consumers. The Alliance’s focus on sales of full hybrids is misguided. First, the degree to which automakers have effectively marketed hybrids to their customers is certainly debatable, and second, automakers have been methodically integrating fuel saving technologies into many more vehicles, from start/stop systems to advanced materials, and consumers have been willing to pay for those technologies.
The past fleet is not the future fleet
The Alliance review’s focus on the percentage of vehicles today that meet 2025 standards is irrelevant for at least three reasons: 1) the standards are calculated at the fleet level and are not dependent on the results of any individual vehicle, 2) the technologies applied are continuously being improved, and 3) Some vehicles have still not been subject to these technologies, but by 2025 certain improvements, including high speed transmissions,turbo charging, direct injection and lightweighting, will be standard. Furthermore, the Alliance’s comparison of actual improvement for the model years 2005 to 2014 with projected required improvement for the model years 2012 to 2025 is misguided. First, the latter time period is about 30 percent longer. Second, there were no new fuel economy standards driving progress on the books until 2011, so the relevance of model years that came before that is questionable.
Market effects of low fuel prices
Low fuel prices certainly affect the sales of alternative powertrains and the overall fleet mix between small cars and trucks and large cars. That’s something with which every analyst in this field would agree. However, the Alliance’s review doesn’t account for the benefits that automakers can accrue from low fuel prices. Our analysis shows that even under (unlikely) very low fuel prices of $1.80 per gallon, automakers would still be profitable because of a sales mix shift toward more profitable larger vehicles. Last year is a good example of how this works: low fuel prices led many consumers to choose larger vehicles that are more profitable for the auto companies. At the same time, we saw that car buyers were happy to opt for more fuel-efficient variants of popular models. Indeed, the same week that we released this analysis, Ford announced its millionth sale of the EcoBoost-powered F-150, noting that fuel efficiency is among the key reasons given by purchasers of America’s best-selling truck.
These issues are complex, and analysts will continue to disagree on key assumptions. But for the reasons outlined above, my colleagues and I hesitate to accept the arguments and subsequent conclusions in the Auto Alliance’s review. Naturally, we’re open to hearing more from the Alliance. Fuel economy standards have been a powerful force in reducing the amount of oil our vehicle fleet consumes, and this is an exciting time for vehicle technology.
About the Authors
Baum is Principal of Baum & Associates, an automotive forecasting and research consultancy. Prior to its launch, he was an analyst and forecaster with the State of Michigan, IRN, and The Planning Edge. Luria is an independent industry analyst whose career included eight years in the UAW Research Department and 28 as VP and Research Director at the Michigan Manufacturing Technology Center. Since 1990, Baum & Luria have collaborated on a respected quarterly forecast of North American vehicle, engine, and transmission sales and production. The forecast has been used in numerous studies for OEMs, suppliers, unions, financial institutions, and non-governmental organizations, including this study.