Blog Post

A Look at New Markets for Credit Trading under US Standards for Automobile Emissions and Fuel Economy

In the United States, the Corporate Average Fuel Economy (CAFE) standards that require automakers to produce fuel-efficient vehicles have been in place since the late 1970s. But major changes have come about in recent years to both the rules themselves and how they are to be implemented. Perhaps the most significant change is that automakers must reduce not only oil consumption but also greenhouse gas (GHG) emissions from their vehicles. Specifically, the new rules require significant reductions in both fuel use and GHG emissions by 2025. The figure included here shows the reductions in fuel consumption under the CAFE rules since their inception, as regulated by the National Highway Traffic Safety Administration (NHTSA), as well as the reductions in both fuel consumption and GHG emissions that are forecast under the new rules up to model year 2025. GHG emissions are regulated separately, by the US Environmental Protection Agency (EPA), but the two agencies have attempted to harmonize the rules. The standards require each manufacturer’s fleet of vehicles to meet a minimum average miles per gallon (NHTSA rules) and a maximum GHG emissions rate (EPA rules). Cars and light trucks are subject to separate standards, and those for trucks are less stringent.

Because the new regulations become much stricter over time, requiring fuel consumption and GHG emissions to fall by roughly 50 percent, a number of new provisions were added to give automobile companies more flexibility to meet the standards. In a new RFF discussion paper, we examine these new flexibilities, which include the ability for manufacturers to trade fuel consumption and emissions credits between cars and trucks in their own fleets, and to trade credits with other manufacturers. We take a close look at this latter provision, which for the first time allows for the creation of a market for buying and selling emissions and fuel consumption credits. In addition, EPA’s rules allowed manufacturers to over-comply with target levels of GHG emissions before the rules went into effect and bank those credits for future compliance beginning in 2012. NHTSA has always allowed some banking of credits to meet the fuel economy standards.

Our results suggest that the potential for savings could be large because the regulations present uncertain and different costs to the various manufacturers, and large penalties in lieu of compliance under EPA rules. In addition, annual tightening of the standards until 2025, and perhaps beyond, presents particular obstacles when individual vehicle redesign schedules occur over multi-year periods.

In the paper we outline the differences and similarities between the NHTSA and EPA rules on credits and credit trading. Although the rules have similar provisions in many ways, there are some important differences in stringency. EPA’s rules allow for a longer banking period and NHTSA has some restrictions on trading between cars and trucks. Because the two rules effectively regulate the same thing—gasoline consumption and the associated GHG emissions—the stricter regulations will tend to dominate in the credit markets. And, differences between the two rules will tend to drive the credit price, and therefore the cost of compliance, up.

In general, the market for credit trading among firms is in its early stages, and whether an efficient market will develop is still not clear. Most automakers have been able to over-comply with the standards and accumulate credits, both in the early credit market and in recent years. The size of this credit pool is large, as companies have utilized the banking provisions of both regulations. In future years, the market is likely to become more active as the standards become stricter and the automakers gain more information and experience in buying and selling credits.  The agencies will also need to continue to try to make the rules more harmonized and flexible, and to facilitate a robust trading market.