At an RFF First Wednesday Seminar, The Evolving US Vehicle Fleet: Responding to New Federal Regulations, we gathered various experts to discuss key issues related to trends in the evidence regarding the efficiency and effectiveness of the new Corporate Average Fuel Economy (CAFE) standards. Several of these issues will be examined as part of this blog series, Evidence for the New CAFE Standards.
The new Corporate Average Fuel Economy (CAFE) requirements are a dramatic departure from past regulations of fuel economy, becoming more stringent over time and requiring both fuel consumption and greenhouse gas emissions to fall by roughly 50 percent of their 2012 levels by 2025. The regulating agencies—the Environmental Protection Agency (EPA) and the National Highway Traffic Safety Administration (NHTSA) —felt it was important to include new flexibilities to allow the auto manufacturers to meet the strict standards in a timely and cost-effective way.
An important component of this flexibility is the credits system, with new provisions that allow trading of credits between cars and trucks for a single manufacturer, and trading of credits between manufacturers. EPA and NHTSA report each year on the number of credits held by the auto manufacturers, and the EPA report includes the amount of trading between manufacturers (the most recent reports are for 2014 for EPA and for 2012 for NHTSA). What can we learn from this initial evidence about the credit trading programs?
The credits program should allow the manufacturers to lower the cost of complying with the CAFE standards, both across their fleets and over time. Companies were allowed to acquire credits by over-complying for several years prior to the start of the new rules in 2012, and those early credits could be banked and carried forward up to 5 years to meet the new standards (which became more stringent each year after 2012). Most companies opted into this early credits opportunity. In Figure 1, the left (blue) bar shows the early credits generated by the major auto companies for EPA’s greenhouse gas credits program.
The second (red) bar in the figure shows the total credits each company is carrying forward at the end of 2014 to the 2015 model year. Most companies have also over-complied in the first few years of the new rules (starting in 2012) adding to their credit holdings. Credit banking allows companies to over-comply early on when the costs of compliance are low, and not have to reduce as much later in the period when additional costs are higher. This strategy lowers costs over the entire regulatory period since the costs of compliance are likely to increase substantially over the period to 2025 as the regulations become increasingly more stringent. This was the same pattern that emerged under Phase 1 of the Acid Rain Program in the late 1990s.
It is important to note, however, that the total industry credit holdings for the EPA requirements amount to about 265 million megagrams (1 megagram is a million grams) of greenhouse gas emissions. This is roughly 10 percent of the total greenhouse gas emissions reductions that must be achieved by the industry as a whole, assuming the number of new gasoline-powered vehicles sold remains the same each year through the period of the regulations up to 2025.
Perhaps the most innovative aspect of the new credit provisions is the ability of manufacturers to buy and sell credits between themselves. This market for credits turns out to be two separate markets under the two rules: a market for fuel economy credits under the NHTSA provisions and a market for greenhouse gas credits regulated by EPA. Both of these markets have been slow to get started, with only limited amounts of trading. Only about 3 percent of total credits earned had been traded as of 2014. In our study of the credits markets, we identify reasons why there has been little activity in these markets. High transaction costs, overlapping regulations, and uncertainty about the path of future regulations may all be contributing to thin credit markets in the early years of the regulations.
There appear to be ways the regulating agencies can improve the efficiency of this market, if the goal is to attain the standards more cost-effectively. First, EPA’s greenhouse gas emissions regulations and NHTSA’s fuel economy regulations basically regulate the same thing—fuel economy and emissions are tightly linked for gasoline engines. Two separate markets for credits will not work well in this case. One regulation with a single credit market would be much more effective.
In addition, to have a well-functioning market for credits, potential participants must have information about the price of a credit. Currently, EPA reports only which companies bought and sold credits, but there is no information on the price at which credits were traded. NHTSA does not report any information on trading at all. Firms considering whether to trade have little information about what their credits are worth in a sale, or the possible purchase price for a buyer.
In spite of these issues and others, there have been some trades, and the number of credits traded has increased over time. Figure 2 shows total volumes traded between companies in the first few years of the program for EPA credits. As the regulations become more stringent, it is likely that more trades will become economic. In the meantime, the regulating agencies can look for ways to improve the efficiency of the markets.
Up next in the series: How Much Do Consumers Really Value Fuel Economy?
Read previous posts in this RFF blog series, Evidence for the New CAFE Standards:
- The New CAFE Rules and the Need for Evidence from the Field
- How Do Gas Prices Affect New Vehicle Sales?