EPA’s Regs for Rigs – Fuel Economy Fetish Goes Diesel

By Marlo Lewis -- November 5, 2010

Last week the U.S. Environmental Protection Agency (EPA) and the National Highway Traffic Safety Administration (NHTSA) issued a proposed rule to establish first-ever greenhouse gas (GHG) emission and fuel economy standards for “heavy duty” (HD) motor vehicles.

The proposed standards, which phase in during model-years 2014–2018, apply to three types of HD vehicles: (1) “combination tractors” (semi-trucks), (2) large pickups and vans, and (3) “vocational trucks” (a wide-ranging assortment of trucks and buses).  The agencies estimate that the technologies needed to comply with the proposed standards will cost $7.7 billion but that the rule will generate $27 billion or $41 billion in net benefits (depending on whether future benefits are discounted at 7% or 3%).

Here’s the curious thing that jumps out at you from the getgo. Although the ostensible objective of the rule is to reduce GHG emissions and oil imports, the overwhelming share of the claimed benefits (fuel savings for truckers) has nothing to do with either climate change or energy security. For example, based on the unverifiable assumption that each ton of carbon dioxide (CO2) emitted has a “social cost” of $22.00, the agencies attribute only $2.3 billion — about 6% — of the rule’s net benefits to its CO2 reductions and climate impact (p. 355). 

Six percent!

Sound familiar? Just as proponents of cap-and-trade tried to sell their stealth energy tax as a “green jobs” program when they couldn’t sell it as climate protection, so EPA and NHTSA now try to sell their save-the-planet-beyond-petroleum rule as a fuel-savings bonanza for owners and operators of big rigs, dump trucks, buses, vans, and pickups. 

Is Small Really Beautiful?

The agencies boast that the standards will reduce GHG emissions by 250 million metric tons (mmt) and save 500 million barrels of oil over the lives of vehicles manufactured during the program’s first five years (2014-2018). Such tiny changes can have no detectable effect on the alleged perils of either global warming or oil import dependence.

Let’s put those numbers in perspective. The agencies consider 10 years to be the “useful life” of medium- and heavy-truck engines (p. 58).  U.S. emissions topped 7,000 mmt in 2008, so cumulative U.S. emissions over a 10-year period are likely to be at least 70,000 mmt. Cutting HD vehicle emissions by 250 mmt would reduce total U.S. emissions by a mere 0.7%. The climate change “benefit,” if any, would exist only on paper. There would be no discernible evidence of it in the real world.

EPA’s calculations (p. 284)  implicitly confirm this. By 2100, the proposed GHG standards are estimated to reduce atmospheric CO2 concentration by 0.732 parts per million, which in turn is estimated to avert 0.002-0.004°C of global warming and 0.012-0.048 centimeters of sea-level rise. Such changes would be too small for scientists to distinguish from the “noise” of natural climate variability.  

NHTSA estimates (p. 357) that its fuel economy standards will reduce oil imports by 0.177 million barrels per day (bpd) in 2020 — about 65 million barrels lower than the baseline projection for that year.  The U.S. imported 4,267 million barrels in 2009, so the rule would avoid the equivalent of about 1.5% of current oil imports. Note that oil demand and imports may fluctuate by substantially more than that from year-to-year. For example, from 2008 to 2009, U.S. oil imports declined by 460 million barrels. Okay, let’s see a show of hands — who thinks this fluctuation materially weakens Al Qaeda, the Iranian mullahs, or the Taliban? 

Net oil imports account for about 54% of current U.S. petroleum consumption. The proposed rule will not get us even close to where things stood in 1973, when oil imports accounted for 35% of U.S. consumption (see Figure 2.2). A few simple questions: Was 1973 a good year for peace in the Middle East? Was it a time when OPEC was a shy and retiring actor on the world stage? Was it an innocent age that knew not hijackings, bombings, and the rise of international terror organizations? No, no, and no. The notion that EPA and NHTSA can make America safer by engineering a downtick in U.S. petroleum imports defies history and logic.

In terms of their stated rationales (mitigate climate change and enhance U.S. energy security), the proposed GHG/fuel economy standards are an empty suit.

Bureaucrats Are Smarter!

So what’s the point? The new standards will save truckers a bundle of money, EPA and NHTSA contend. According to their calculations, the rule will compel industry to invest $7.7 billion in fuel-saving technologies (p. 36), which will cut fuel consumption by 500 million barrels, which will save truckers $28 billion (assuming a 7% discount rate) or $42 billion (assuming a 3% discount rate). In the agencies’ words (p. 315), “the application of fuel-saving technologies in response to the proposed standards would, on average, yield private returns to truck owners of 140% to 420%.”

Now, this should immediately raise a red flag. Trucking companies are in business to make money. The industry is competitive and fuel is a major operating expense. If every dollar invested to improve fuel economy yields returns of 140% to 420%, why aren’t truckers already making those investments? If the EPA/NHTSA-recommended package of fuel-saving technologies is such a great bargain, why do truckers need a regulation compelling them to buy it? 

The proposed rule implies that truckers are penny wise and pound foolish. Indeed, it suggests that truckers are too dim or lazy to make lots of easy money without a bureaucrat bending their ears and twisting their arms. Its core premise is the Nanny State notion that adults, like children, can’t be trusted to discern and pursue their best interest.

The agencies don’t put things that way, of course. They offer five “potential hypotheses” (pp. 316-323) drawn from economics literature to explain why trucking companies “under-invest” in fuel economy. None of these explanations provides solid evidence of “market failure.” In fact, some suggest that truckers are just behaving like prudent buyers. Let’s look at each in turn.

(1) Inadequate or Unreliable Information in the Original Sales Market. One possible reason for the supposed under-investment is that fuel-economy information available in the HD sales market is “inadequate or unreliable.” Quoting the National Academy of Sciences, EPA and NHTSA report that “Reliable, peer-reviewed data on fuel saving performance is available only for a few technologies in a few applications.” Okay, then how do EPA and NHTSA know that investing in fuel economy will yield returns of 140% to 420%? And if EPA and NHTSA know this despite the dearth of reliable, peer-reviewed data, how come the industry with a bottom-line interest in such information doesn’t know? The agencies do not address these obvious questions.

EPA boasts that its SmartWay program provides “information on fuel-efficient, low-carbon technologies and operational practices to help accelerate their deployment.” The program is a partnership between EPA and the freight goods industry, which includes “large, national trucking fleets.” One might suppose that with all the information EPA is providing them, semi-truck owners would exhibit the smallest gap between actual investment in fuel economy and what the agencies consider optimal. Yet that’s where the gap appears to be largest. EPA and NHTSA estimate that mandating fuel-economy improvements will save semi-truck owners 18 times as much as vocational truck owners and nearly 30 times as much as HD pickup and van owners (p. 337). Those with the most information are furthest away from the promised bonanza awaiting those who attain the proposed fuel-economy standards.

In short, the hypothesis fails to explain companies’ alleged under-investment in fuel economy. In fact, the agencies’ discussion inadvertently calls into question the notion that companies under-invest.

(2) Inadequate or Unreliable Information in the Secondary Resale Market. The agencies hypothesize that “the resale market may not reward the addition of fuel-saving technology to vehicles adequately to ensure their original purchase by new truck buyers,” the main reason, again, being a presumed lack of “reliable information about the fuel economy that potential purchasers of used trucks will experience.” This is odd. Would EPA and NHTSA say that the resale market does not reward the addition of technologies that enhance vehicle safety, performance, comfort, and amenities? That would be patently ridiculous, because people are willing to pay more for a better vehicle, whether it’s new or used.

Maybe fuel-saving technology doesn’t add much to the price of used vehicles because its money-saving potential is unproven or over-rated. Nah, that can’t possibly be why it’s not a big selling point in the secondary market. It’s got to be because fuel economy is different, special, not like other attributes buyers consider when purchasing a used vehicle. Here’s a simpler explanation. EPA and NHTSA make a fetish of fuel economy and most truckers do not. 

(3) Split Incentives in the Medium- and Heavy-Duty Truck Industry. According to this hypothesis, the trucking industry under-invests in fuel economy because truck owners and operators have different incentives. Fuel purchases are made by operators, who have “strong incentives to economize on its use.” In contrast, owners may place a higher priority on capital investment that “improves vehicles’ durability or reduces their maintenance costs.” Maybe so. But it does not necessarily follow that owners under-invest in fuel economy.

There are tradeoffs — opportunity costs — in every investment decision. Whether it is smart to invest more or less in fuel economy relative to vehicle durability or any other competing interest depends on each firm’s unique circumstances. EPA and NHTSA are in no position to divine an appropriate tradeoff for the industry as a whole, because the right tradeoff varies from firm to firm, and within each firm at different times.

Besides, just because truck operators make the actual fuel purchases does not mean that owners ignore fuel costs. An owner (or CEO of a publicly traded company) may delegate many purchasing decisions for many things to other people. He is nonetheless responsible for his firm’s bottom line. The tradeoffs he makes between fuel economy and other investments inevitably show up in the bottom line.

(4) Uncertainty About Future Cost Savings. Another possible reason companies don’t adopt fuel-saving technology as fast as EPA and NHTSA would like is “uncertainty about future fuel prices or truck maintenance costs.” The agencies explain:

When purchasers have less than perfect foresight about future operating expenses, they may implicitly discount future savings in those costs due to uncertainty about potential returns from investments that reduce future costs. In contrast, the immediate costs of the fuel-saving or maintenance-reducing technologies are certain and immediate, and thus not subject to discounting.

Exactly! The costs of investment in fuel-saving technology are certain and immediate. In contrast, the payoff depends on unknown quantities — the future price of gasoline and, perhaps more importantly, the “lifetime, expected use, and reliability of the vehicle” (p. 321). Companies are just being prudent when they invest less in fuel economy than they would if EPA and NHTSA were guaranteeing a 420% return! As the agencies acknowledge (p. 322), the proposed rule “requires purchasers to assume a greater level of risk than they would in its absence, even if the future fuel savings predicted by a risk-neutral calculation actually materialize.”

(5) Adjustment and Transactions Costs. The agencies opine that “truck owners and fleets may like to see how a new technology works in the field, when applied to their specific operations, before they adopt it.” No kidding! Companies want real — market-tested — information about alternative investments. They’ll listen to what EPA and NHTSA have to say, but very likely take the agencies’ assessments with a grain of salt. They look to the trial-and-error process of the marketplace to winnow out fact from hype. Nothing irrational or childish about that. It’s what prudent buyers do.

Contrary to the image they assiduously cultivate, EPA and NHTSA are not honest brokers. Each is a dog in the fight. Each has an organizational interest in exaggerating the benefits and understating the risks of fuel-economy mandates, because each agency’s control over the private sector grows each time it promulgates a new standard or tightens an existing one. There is also more than a dollop of green ideology in the now decades-old fuel-economy campaign, and ideology is not usually a sound basis for making business decisions (Duh!).

All of which is to say, the market is not failing when businesses choose to be guided by real-world results rather than by EPA and NHTSA’s self-serving, ideologically-charged proselytizing.   

To their credit, the agencies acknowledge that “there may be no market failure” in the risk-aversion induced by adjustment and transition costs, which, unlike the promised payoffs from fuel-economy investments, “are typically immediate and undiscounted.”

Future of the Fetish

EPA bases its authority to establish GHG standards for HD vehicles on its Endangerment Rule, the trigger and precedent for a cascade of GHG regulations via the Clean Air Act. In June, the Senate rejected, by 47-53, a resolution to overturn EPA’s Endangerment Rule, but all 41 Senate Republicans voted for it. With six new Rs joining the Senate, and with a GOP majority in the House, the 112th Congress may take another shot at the Endangerment Rule. Meanwhile, the Coalition for Responsible Regulation is attempting to overturn all of EPA’s GHG rules in the D.C. Circuit Court of Appeals. If either Congress or the Court overturns the Endangerment Rule, an enormous cloud of uncertainty will be lifted from the U.S. economy.

The trucking industry, however, would still have to bend to the will of the fuel-economy fetishists. NHTSA’s authority to set fuel-economy standards for HD vehicles comes from a separate statute, the mis-named Energy Independence and Security Act (EISA) of 2007. An HD vehicle program administered solely by NHTSA would be administratively simpler, but truckers would have to invest in the same technologies. As the agencies acknowledge, CO2 emissions represent 99% of all HD vehicle GHG emissions (p. 13), and the amount of CO2 emitted is “highly correlated” with amount of fuel consumed (p. 219). Hence, EPA’s CO2 standards and NHTSA’s fuel-efficiency standards are essentially interchangeable.

Congress could, of course, amend EISA. That’s more likely to happen if the trucking industry raises a rucus. So far it hasn’t. In fact, last week the American Trucking Association (ATA) commended the Obama Administration for its “focus on reducing carbon output and improving fuel efficiency from our sector,” stating that, “we look forward to working with both agencies throughout the rulemaking.” 

But that was then. A big change has just occurred in the composition and leadership of Congress. Maybe ATA will rethink their position. 

What should energy realists ask Congress to do? In addition to overturning the Endangerment Rule, the 112th Congress should make NHTSA’s HD fuel-economy standards voluntary. Let the agencies make their case that every dollar companies invest in fuel economy will generate returns of 140%-420%. But let markets decide whether EPA and NHTSA are peddling smart advice or hype.