Fuel Economy Standards: Take the Time to Get It Right

Today the Senate held hearings for Scott Pruitt, President-elect Trump’s nominee to head the US Environmental Protection Agency (EPA). The hearings cover many important decisions that Pruitt would have to make, such as whether to provide a waiver to California to keep its Zero Emission Vehicle program. Very little was said about federal standards for new vehicle greenhouse gas emissions and fuel economy.

EPA and the US Department of Transportation (DOT) set standards for passenger vehicle emissions and fuel economy. In 2012, the agencies set standards that extend through 2025, which they projected would roughly double new vehicle fuel economy. When they set the standards, the agencies called for a midterm review, during which they would consider whether to change the standards based on new information. The agencies could also change other aspects of the standards, such as crediting for electric vehicles. The midterm review started last year and was to be completed by early 2018.

In a surprise move, EPA just completed its part of the review, ratifying the original plan for the standards through 2025. The agency asserted that this “administrative action” was not subject to congressional veto under the Congressional Review Act and other attempts to reverse “midnight regulations.”  Even if this view holds, DOT has not yet completed its review—and, in any case, the Trump administration, as stated by Mr. Pruitt today, will review the Obama administration’s decision last week on the 2025 standards. The point of the midterm review was to incorporate new information in setting the standards, and we hope the new administration’s review will consider several economic developments that affect costs and benefits:

1. Lower gasoline prices reduce consumer benefits of higher fuel economy. By raising vehicle fuel economy, the standards reduce gasoline consumption and fuel costs. The higher the price of fuel, the greater the value of the fuel savings. But since the standards were set in 2012, real fuel prices have dropped by about 30 percent. In a recent paper, we show that lower gas prices have several indirect effects on consumer choices about which vehicles they buy and how much they drive them. We show that the indirect effects on manufacturer costs and consumer benefits roughly cancel out, at least considering the vehicles sold in 2015. So the main effect of lower gasoline prices is lower consumer benefits, suggesting the standards should be weakened.
2. The social cost of carbon is higher than previously estimated, raising societal benefits. The standards are designed to reduce carbon dioxide emissions. Like any individual regulation, the fuel economy standards would have a small effect on global temperatures, (less than one degree Fahrenheit) but small is not the same as zero. One needs to account for lower emissions caused by any individual regulation—“ounces make pounds”, to borrow the rock climbing phrase. The government has estimated the social cost of carbon, which accounts for the costs of emissions on overall well-being. When the agencies set the standards in 2012, the government estimated that in the near term each ton of carbon dioxide emissions costs society about $26. Then, based on new information and better science, in 2013 the government updated the estimate to about $42 per ton. The National Academy of Sciences just issued a report that made a set of recommendations for further updating and improving the estimates. Until the government follows through, $42 is the best estimate, which is 60 percent higher than the estimates the agencies used when they set the standards, suggesting that the standards should be even tighter.
3. Energy security benefits are lower than previously estimated. The government’s cost-benefit analysis used to support a change in the standards also included an energy security benefit related to the resulting drop in oil consumption. This estimate was $8 per barrel of oil related to the unanticipated effect of an oil supply disruption on the US economy.  Advances in macroeconomic modeling and changes in the structure of the US economy, such as the vast increase in US oil production related to fracking, argues for new estimates of the energy security benefits. Research at RFF on this topic is ongoing, but preliminary estimates suggest that this benefit has fallen significantly, arguing for weaker standards.

With some arguments for tightening the standards (or at least keeping them on their prior schedule), and other arguments for relaxing the standards, we feel that a considered review is warranted. This review should also consider important issues such as further harmonizing the EPA and DOT programs, as well as the rules for banking fuel economy reductions.

Ed. Note: Learn more about the new NAS report on calculating estimates of the social cost of carbon, as well as the underlying economic principles that inform such calculations: New Guidance for Calculating Estimates of the Social Cost of Carbon