Financial Impact of H.R.6.
Until its signing into law in December of
2007, H.R.6. was known as the Renewable
Fuels, Consumer Protection and Energy
Efficiency Act of 2007. Perhaps lending more
clarity to the initial intentions of this
Democratic-sponsored bill in the United
States Senate, H.R.6. combined bills reported
out of the Energy and Natural Resources,
Environmental and Public Works, Foreign
Relations, Commerce, Science and
Transportation Committees which had broad
bipartisan support.
H.R.6. modifies various federally mandated energy programs, policies, and tax measures primarily in energy, agriculture and transportation. According to the Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT), H.R.6. will increase direct U.S. government spending by $582 million from 2008 to 2012, but will also increase U.S. government revenues by nearly $1.0 billion over the same period.
Of the 16 Titles of H.R.6. ENR, Title I and Title II provide the most opportunity for the automotive sector. Title I Provisions: Energy Security through Improved Vehicle Fuel Economy - mandates 35 miles per gallon (mpg) by 2020. Title II Provisions: Energy Security through Increasing Production of Biofuels to 36 billion gallons by 2022.
H.R.6. mandates an increase in vehicle fuel economy beginning with the 2011 model year, also known as 2010CY, and mandates that by 2020 passenger car and truck fleets reach a combined 35 mpg average. The 2006 light truck fuel efficiency standard serves as an excellent proxy for how this is likely to be achieved. The truck "size-based" system corrected the artificial imbalances created by the Corporate Average Fuel Economy (CAFE)-based system and leveled the playing field for all vehicle manufacturers. After 2006, light trucks were grouped into six different categories based on the vehicle's footprint - the area created under the wheels, calculated by track width multiplied by the wheelbase. Each category has its own unique fuel efficiency requirement. Light truck "average" fuel economy was subsequently increased to 22.5 mpg for 2008, 23.1 mpg for 2009 and 23.5 mpg for the 2010 model year. For light truck compliance, vehicle manufacturers are able to choose either the CAFE average or "size-based" system until 2010, when complete changeover to the "size-based" system is mandated.
H.R.6. allows for the creation of a "sizebased" fuel economy system for passenger cars and mandates that fuel economy standards be increased from 2011 to reach a combined passenger car and light truck fleet fuel economy of 35 mpg by 2020. However, there are several unanswered questions about the definition of 35 mpg. Is it the nationwide average of all vehicles sold in the United States, or each individual OEM fleet that must meet the standard?
Additionally, the law does not specify the passenger car standard, only that the Secretary of Transportation will prescribe a separate average fuel economy for passenger and non-passenger automobiles based on at least one vehicle attribute, and express the standard in a mathematical formula. The final ruling from the National Highway Traffic Safety Administration (NHTSA) is expected in 2009. Moreover, the legislation allows for the creation of a system where CAFE credits could be traded amongst OEMs to help each other meet the standard.
The primary risk for vehicle manufacturers
with the new "size-based" fuel economy
standard is that the U.S. government will
have the ability to arbitrarily increase requirements
in each category. Depending on the
vehicle "size" category, the increased standard
would need to be met either with powertrain-
based or weight-reducing technologies.
This poses a dilemma for OEMs not
heavily invested in fuel-saving technologies,
but presents a significant opportunity for
technology suppliers.
Initially, vehicle manufacturers will be incentivized to deploy bio-fuel capability as part of their early strategy to meet CAFE standards. Failure to meet CAFE standards can result in millions of dollars in fines annually. However, to incentivize bio-fuel capability in vehicles, for purposes of CAFE, the federal government allows vehicle fuel economy to be calculated on the oil content of the fuel. Where vehicles are E85 capable, the fuel economy is calculated on just the 15 percent gasoline content of E85. The net effect is a multi-fold increase in the fuel economy score of the vehicle. For CAFE the fuel economy calculation is determined by dividing a vehicle's fuel economy in equivalent miles per gallon of gasoline or diesel fuel by 0.15. Thus a 15 mpg alternative fueled vehicle would be rated as 100 mpg. However, the actual fuel economy increase allowed for the purposes of calculating fleet average from this method is capped at +1.2 mpg. The value equation for vehicle manufacturers is tremendous as technology required to equip a vehicle to meet the requirements for this calculation would be a fraction of the cost of adding other more expensive new powertrain technologies.
Longer term, Title I will potentially result in decreased vehicle size or increased technology content on a larger vehicle size. Initially, vehicle manufacturers will be legislated into building smaller vehicles as weight reduction, or vehicle downsizing, becomes the fastest way to fuel economy gains. Secondarily, the value of technology content on vehicles will increase dramatically in some size classes. Suppliers of technologies that improve vehicle efficiency such as: direct gasoline fuel injection, 6-, 7- and 8-speed automatic transmissions, continuous variable transmission, turbo and superchargers, variable valvetrain lift and duration mechanisms, cylinder deactivation, diesels, hybrids of all types, and further electrification of vehicle systems, could be deployed depending on cost versus fuel economy benefit. Thirdly, vehicles in the heaviest categories, such as category six light trucks, may get heavier and/or larger to enable them to move above the current regulatory size range. Potentially, it is a shortterm fix, as NHTSA will in the future also evaluate medium and heavy on-highway truck fuel economy standards.
Prior to H.R.6., fuel importers, blenders, refiners and distributors were required to purchase 5.4 billion gallons of bio fuel by 2008, increasing to 7.5 billion gallons by 2012. Title II now requires 9 billion gallons in 2008, 24 billion gallons by 2017, and 36 billion gallons by 2022. The act also establishes a goal of 180 million gallons of biodiesel this year, increasing to one billion gallons by 2012. The real net effect of Title II is a projected government net spending decrease of $1.2 billion over the next 10 years for farm programs and direct income support for agricultural producers. The assumption being that corn and soybean commodity prices will increase significantly in response to increased demand from enactment of the bio-fuels legislation. Thus, support of the agricultural sector shifts from government support to market support.
However, the larger question at hand is how the fuel will be consumed. Two scenarios exist which provide for the meeting of the 36 billion gallon per year by 2022 target.
First, the United States may adopt an E10 or E15 standard blend. This would preserve the existing liquid fuels infrastructure for refining and distribution, while simultaneously allowing the bio-fuels target to be met. Transportation of ethanol via the existing liquid fuels infrastructure, such as pipelines, fuel tankers, etc., is viewed as a limited option not only due to cost of overland transportation, but also because in high concentrations like E85, ethanol is highly corrosive and absorbs water and other impurities, which would ultimately degrade motor fuel quality. Higher ethanol blends would require significant new investments nationwide in dedicated pipelines and other infrastructure to allow for fuel blending at the regional terminal. The cost of which is just now being investigated.
Second, the United States may invest in more E85 capability in passenger vehicles and light trucks to increase usage. The current estimate to equip a vehicle for operation on ethanol blends up to E85 is approximately $100. This includes upgrades primarily to the fuel tank, pump, lines and other components of the fuel delivery system to counteract the corrosive effect of ethanol. Short term, this may be the most effective way to promote biofuels, as the energy bill already mandates unique labeling of vehicles which are E85 capable and vehicle manufacturers are incentivized under the aforementioned CAFE standards to implement E85 capability as a strategy to reduce compliance costs. However, due to cost, E85 capability/implementation on vehicles is expected to be capped at the point where maximum CAFE credits are achieved.
Contrary to popular belief involving national energy security, the primary incentive for the federal government to legislate increased use of biofuels is increased tax revenues. First, as commodity prices for corn, which is the main feedstock for ethanol, increase, agricultural subsidy payments to producers would decrease. Second, a provision of the American Jobs Creation Act of 2004 (P.L. 108-357) called the "Volumetric Ethanol Excise Tax Credit" (VEETC) provides for a $0.51 cents per gallon excise tax credit for fuel blenders to incentivize the creation of new markets for E10, E85, and biodiesel. The tax credit is payable on every gallon of blended ethanol fuel until the tax credit expires on December 31, 2010. Credits for biodiesel ended in 2006.
The third and largest benefit is due to the existing $ 0.184 cents per gallon tax which is collected on gasoline and gasoline-ethanol blends, such as E5, E10, and E85. Since ethanol contains less energy per gallon than gasoline, ethanol blends require more total gallons to be consumed thus increasing overall government tax revenues. The phaseout of per-gallon tax incentives when combined with increased total gallon usage of liquid fuels equates to approximately $ 0.06 cents per gallon tax revenue increase after 2011, or $1.1 billion between 2012 and 2017.
At first glance, H.R.6. ENR - Energy Independence and Security Act of 2007 appears to be a big win for proponents of increased national security through energy independence and also for environmental lobbyists concerned with CO2 issues. However, a closer examination reveals it is a mechanism for increased federal tax revenues, in part by increasing total gallons of liquid fuel consumption and utilizing the market to increase commodity prices, subsequently reducing agricultural sector subsidy payments. This is all enabled by mandating increased levels of bio-fuel usage. Additionally, Title I of H.R.6. ENR provides a framework for increased vehicle fuel economy, which would drive technological innovation into vehicles, but stops short of specifying the actual rules. Rather, the final ruling from NHTSA will not be handed down until 2009.
Eric Fedewa may be reached via Email at EricFedewa@csmauto.com.
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