Blog Post

Why All the Talk about Gas Prices and Fuel Economy Standards?

Aug 27, 2018 | Justine Huetteman, Joshua Linn, Virginia McConnell

The Trump administration cites low gas prices as one of the main reasons for its proposal to freeze (that is, weaken) the federal fuel economy and greenhouse gas (GHG) standards. Much of the recent media coverage of the proposal has echoed the administration’s argument. We find that although gas prices affect benefits and costs of the standards, low gas prices provide only modest support for freezing the standards. Further, radically changing standards in response to fluctuating gas prices raises the costs of meeting the objectives of reducing fuel use and greenhouse gas emissions.

We discuss three ways that low gas prices affect the benefits and costs of fuel economy standards.

First, the value of the fuel savings to consumers that come from tighter standards is proportional to the price of gasoline, and low gas prices imply a low value of fuel savings. Lower gas prices, then, will lower the benefits to consumers, and lower benefits would be an argument for weakening the standards.

We note, however, that the price of gasoline has been low since 2014, and the current standards implemented under the Obama administration were established in 2012 and then reassessed in 2016 when gas prices were already low. Figure 1 shows recent prices as well as changes in price projections in the Annual Energy Outlook (AEO) made by the Energy Information Administration (EIA). The Trump administration’s proposal uses similar gas price projections to what the Obama administration used in 2016. As Figure 1 shows, EIA’s newest 2018 projection of gasoline prices is on average 7 percent higher than its 2017 projection, which is the projection the Trump administration used. Using the newer price projections raises the forgone fuel cost savings from $133 to $143 billion. In other words, using the most recent price projections raises the benefits of tighter standards and weakens the argument for freezing them.

Figure 1. Historical Gas Prices and EIA’s AEO Projections 1978–2040

A second way that low gasoline prices affect benefits and costs of fuel economy standards has to do with how many miles consumers travel. For a given level of fuel economy, low gas prices reduce the cost of driving, causing people to drive somewhat more. Although the economics literature hasn’t pinpointed a number, a reasonable estimate appears to be that a 10 percent decrease in gas prices raises miles traveled by 1–2 percent. If the stringency of the standards is reduced, low gas prices will cause an increase in the amount that people drive. The increase in driving raises fuel consumption and emissions, undermining some of the benefits of the standards.

Accounting for this effect is important and actually weakens the argument for freezing standards. If one ignores this effect and estimates benefits of tighter standards, the decrease in gas prices between the 2012 and 2015 projections reduce the value of fuel savings by 25 percent. But accounting for the higher miles traveled cuts that number from 25 to 20 percent. Under the proposed flattening of the standards, the agencies don’t account for this effect—they do not account for the recent gas price decrease when they estimate miles traveled.

The third way that low gas prices affect the standards is by raising costs to manufacturers of achieving the standards. This can happen because low gas prices may cause consumers to shift from small to large vehicles, or from cars to light trucks. For example, according to the agencies’ analysis, it is more expensive to meet the fuel economy requirements for light trucks than for cars. Consequently, a shift to light trucks could raise overall costs of meeting the standards. Or, if consumers shift toward larger vehicles, say from a mid-size car to a large car, this may not have much effect on the costs of the standards because larger vehicles are subject to lower fuel economy requirements. However, costs of the standards would be higher for manufacturers if consumers shift within a size category, say by buying a mid-size car with a 6-cylinder engine rather than one with a 4-cylinder engine (larger engines usually mean lower fuel economy).

Both of these possibilities (shifting within and across classes) depend on how consumer vehicle choices respond to gas prices. The greater the consumer response, the lower the benefits and higher the costs of the standards. We’ve found that the responses to gas prices in the short term, within a year, tend to be fairly small. It is possible that longer term responses could be larger.

Overall, low gasoline prices strengthen the argument for making the standards less stringent. However, the agencies already accounted for many of these arguments when they analyzed the standards in 2016, and developments since then have had only small effects on benefits and costs.

Further, what Figure 1 makes clear is that gas prices have been volatile in the past and are likely to continue to be so, making future gas prices highly uncertain. And changing or freezing standards in response to changing gas prices has happened in the past. Figure 2 shows fuel economy standards over time, plotting the fuel consumption rates of cars and light trucks. The fuel consumption rate, in gallons per mile, is inversely related to fuel economy, or miles per gallon. After a period of increasingly strict standards in the late 1970s that coincided with steeply rising oil prices, the standards remained essentially unchanged during the period of low oil prices from the mid1980s to about 2004. Rising gasoline prices and concern over energy security and greenhouse gas emissions caused standards to start to tighten since 2005. Now with gasoline prices falling in recent years, we are again contemplating freezing fuel economy and GHG standards. But such inconsistency in the regulations raises the long-run costs of developing new fuel economy technologies because firms will start, stop, and resume their programs for research, development, and commercializing new technologies. Efficient policy for setting standards in the long run might involve some accounting for gasoline price variation, but would involve steady, predictable progress toward established fuel economy and GHG goals.

Figure 2. Fuel Consumption Rate 1978–2030

The views expressed in RFF blog posts are those of the authors and should not be attributed to Resources for the Future.