Blog Post

Research Questions for the Midterm CAFE Review: Credit Trading and Flexibility under the New Rules

This is the fourth and final blog post in a series by RFF’s transportation team that addresses some of the key research questions for the midterm CAFE review.

The first three blog posts in this series introduced the midterm review of the corporate average fuel economy (CAFE) standards and discussed important areas of research related to the fuel efficiency gap and the footprint-based standards. In this post, we focus on provisions in the rule that allow car companies to earn credits for reducing the fuel consumption and greenhouse gas (GHG) emissions rates of particular vehicle models below their targets. The new rules allow manufacturers to bank, borrow against, and trade those credits. Credit trading provides manufacturers with flexibility and can lower the costs of meeting these strict new standards, especially when the costs of complying vary across vehicle models. But will the manufacturers take advantage of this flexibility? And how much will the provisions lower costs?

First, how does crediting work under the new rules?  Each model produced by a manufacturer (including both light-duty cars and trucks) has a target level of fuel consumption (miles per gallon, or mpg) and a target level of GHG emissions (grams per mile) based on the footprint. (In the few cases where a model has versions with different footprints, the targets would vary for those versions.) The stringency of the targets is increasing each year between model years 2012 and 2025. However, manufacturers can earn credits when their fleetwide fuel consumption or GHG emissions rate exceeds the standards, and the rules provide several forms of flexibility. The standards apply to the average fuel consumption across a manufacturer’s cars and light trucks, for example; previously, manufacturers had to meet a separate standard for each category. Beyond that, manufacturers that exceed the standard in a particular year can bank those credits for use in future years. Finally, manufacturers can trade credits with one another.

The agencies introduced this flexibility to try to reduce the overall costs of meeting the standards. The rationale is that the cost of raising fuel economy differs across vehicle models in the market. For some models, it is cheaper (in terms of production costs) to add fuel-saving technology than for others. And consumers of some models may be willing to pay more for that technology than consumers of other models, which effectively reduces the cost to the manufacturer of adding the technology. Crediting allows manufacturers to increase fuel economy more for models for which the cost of doing so is lower, thereby reducing the overall cost of complying with the rules.

Is there evidence that manufacturers will take advantage of this crediting flexibility?  Indeed, some recent developments suggest that they will. In model-year 2012, most manufacturers exceeded the standards in their truck fleets and earned credits or at least had fewer deficits than in their car fleets. In addition, some manufacturers seem to be taking opportunities to bank credits for the future. Manufacturers were allowed to over-comply and accumulate credits before the new standards began, and a number of them did so. These manufacturers seem to be taking advantage of the flexibility to average credits across the car and light-duty truck fleets and over time.

The new rules allow manufacturers to trade with each other for the first time but, to date, only a handful of trades have taken place. A possible barrier to a competitive and robust trading market is the fact that three manufacturers accounted for close to 80 percent of the over-compliance credits in 2012. Even those manufacturers with large numbers of credits claim that they are reluctant to sell.

However, the fact that the US Environmental Protection Agency (EPA) compliance rules for the GHG standards are different from those of the National Highway Traffic Safety Administration (NHTSA) may encourage future cross-manufacturer trades. The CAFE rules under NHTSA allow manufacturers to pay a penalty if they do not comply, and a number of manufacturers have often done exactly that. Under the new rules, penalties for not complying with the GHG component under the Clean Air Act are so high that they are effectively not an option. The companies must comply. This creates a much greater need to trade credits across companies than if the manufacturers could pay the fees for GHG noncompliance.

The credit provisions make up a key part of the new CAFE rules, and their role and potential for cost savings will evolve over the next few years. A number of important research topics can provide key information for the midterm CAFE evaluation.

  1. Where are the biggest potential savings?  From intra- or inter-firm trading, across vehicle mix, or over time?
  2. What are the barriers to a robust inter-firm trading market?
  3. Can trading make it easier for manufacturers to simultaneously comply with the EPA and NHTSA requirements?