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Dudder: The Fuel Efficiency Follies

You can’t save your way out of petroleum dependency anymore than you can save your way into prosperity.

A firm believer that Ronald Reagan was correct when he stated that the most feared words a citizen can ever hear are: “I’m from the government and I’m here to help,” I know that raising vehicle efficiency via government fiat is terribly inefficient and full of unintended consequences. The first Corporate Average Fuel Economy standards created the split between cars and light trucks based on the fact that trucks were a much smaller percentage of the market and used predominately for business purposes. However, constant-dollar price declines combined with greater vehicle fuel efficiency reduced the real cost of gasoline, thus fueling the increase in vehicle miles traveled and the affordability of larger vehicles.
This accelerated when the recession of 1992-1993 ended, the problems associated with the savings and loan crisis abated, and the stock market rose on the triple booms of tighter Congressional fiscal responsibility, an appreciating currency, and tax restraint. Stir in the large growth in heavy truck traffic plying the nation’s highways, and many consumers made the rational decision to switch from their smaller cars to heavier and arguably safer light trucks. The recent rise in fuel prices—driven in large part by the drop in the value of the U.S. Dollar, and compounded by Hurricane Katrina’s attack on the bulk of the country’s remaining fuel refining capacity—has switched this equation enough to begin the shift in buyer demand away from SUVs and pickups and back toward cars.

But, just as the market is about to rectify the imbalance brought about, in part, by the CAFE standards of the 1970s, Congress rides in to snatch defeat from the jaws of victory by legislating greater efficiency from passenger vehicles. Genius! I leave it to others in the audience with a better command of mathematics to determine at what price per gallon the equation re-enters a state of equilibrium when mandated average fuel economy is 35 mpg, but I suspect the number is above $4/gallon (as measured in current, not constant, dollars). Though there will be an initial drop in both vehicle miles traveled and fuel use as the price of these new high-mileage vehicles rises in the coming years—possibly exacerbated by a recession, the only proven way for any government to reduce fuel consumption—these numbers will start to rise as incomes grow and both vehicle and fuel prices stabilize. As before, once these costs are amortized throughout the economy—not always an easy or painless process—the effective cost of fuel will decrease as greater vehicle efficiency makes it possible to drive farther on a given dollar amount.

What broader effect will this legislation have on the auto industry? If the current myopia continues—at both the corporate and government level—you can expect a replay of the past twenty years as automakers—those that survive—chase the most profitable segments at the expense of a balanced portfolio until the economics of the situation change. Though small cars are notoriously unprofitable in North America, or so the conventional wisdom claims, it is vital for automakers to have such vehicles in their portfolio, as well as plans for multitudinous derivatives in both the car and truck segments in order to be ready for this eventuality. Neglecting this segment—as the domestic automakers have done for many years driven, in part, by their inability to deliver compelling competitive vehicles on a sustainable basis—leads you back to the current situation where the vehicle mix is out-of-whack with reality and changing it is the work of years, not months. The same can be said of the government’s so-called energy policy. Benign neglect, hope, and fealty to the desires of agri-business in the case of ethanol subsidies has brought us to a point where panic rules with each significant rise in the price of crude. As stated before, most of this is due to the drop in the dollar and lack of refining capacity—there have been no new American refineries built in the last 30 years and large numbers have been decommissioned. However, if “energy independence” truly is a goal, or if we seek nothing more than to mitigate the price rises predicted as China’s and India’s economies continue to grow, increasing vehicle efficiency ultimately is worthless as no one has ever saved themselves to prosperity. 

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