With the recent developments in the auto industry and Federal government, it is clear the current administration would like to see Detroit automakers pursue building more fuel efficient vehicles. In fact, they are mandated to do so by Congress, and it is going to happen sooner, rather than later.  CAFE standards are set to increase to 35mpg by 2020. In addition, the 35mpg fuel economy standard will apply not only to cars, but to light trucks as well. Light trucks are currently exempt from the car standard, having to meet a lower fuel economy number.  Cars must actually meet a CAFE standard of 37.5mpg by 2015, only 5 model years hence. That is a rather large jump that Detroit is mandated to meet in the coming half decade.  The problem for automakers is that many Americans either don’t want to or can’t drive small, fuel efficient vehicles, unless they have no other choice.

Since the Federal government is now in an unprecedented position to control the kind of vehicles rolling off the assembly lines, and they have made it abundantly clear that they feel the future is in smaller, more fuel efficient vehicles, that means one thing. You are going to see smaller, more fuel efficient vehicles being produced buy U.S. automakers in the near future, and larger, more powerful, and safer vehicles (that Americans would really rather be driving) will gradually be phased out or dramatically reduced in availability.

The market conflict is this; the government is advocating the production of vehicles that many Americans don’t really want to drive, and only do so out of necessity. Witness the fact that sales of the Toyota Prius, the hybrid car that Toyota dealers could not keep in stock in the summer of 2008, has experienced a 50% drop in sales from the summer of 2008 to the spring of 2009. This is the case even though heavy government subsidies make it less expensive to buy than pure, consumer demand dictates. Some states have also enacted advance technology vehicle subsidies, substantially lowering the cost of such vehicles compared to others in the fleet.

This  all means that fuel prices in the U.S. are going to go back up again, no matter what other economic conditions dictate. Realistically, they have to. Expensive fuel is the only way to force American drivers to buy the smaller, more fuel efficient vehicles that the auto manufacturers will be building. The federal government has an ownership stake in these companies, and the only way for them to make sure the automakers (and the taxpayers) see a profit building the fuel sipping or electric vehicles is to ensure fuel prices are high. The Obama administration has also made it clear that they feel it is important, both economically and environmentally, for car manufacturers to produce hybrids, plug in hybrids and other technology de jour laden modes of transportation.

There will be many tools used to ensure that the prices you see at the pump will be higher in the coming years. Increased fuel taxes will happen, even though they are not politically popular. They will have to increase, because as fuel economy standards rise, the amount of tax revenue received by government for each mile traveled will decline. Since the government, federal or otherwise, is loathe to relinquish even a penny of revenue, they will have to increase the fuel tax rates to compensate.

Gasoline demand is relatively inelastic, so the the drop in consumption caused by a price increase will not be enough to reduce total revenue. It will still grow, because people and goods still have to use transportation. The fuel tax increases will also nudge fuel prices back upwards to the point where the new, smaller, more fuel efficient vehicles start to be attractive again. The administration will kill two birds with one stone; increase demand for the new cars produced by Detroit, and get people out of their cars, something environmental advocates have desired for quite some time.

For all the campaign promises about keeping the U.S. away from foreign oil dependency, it is becoming clear that the Obama administration would rather do that by reducing overall oil consumption, rather than increasing domestic supply. There are no signs significantly expanded domestic production is on the horizon anytime soon. In fact, quite the contrary. The administration has shown signs that they will keep it difficult to find and extract new sources of oil within our own borders.

Witness the extension of the comment period for new offshore oil and natural gas leases from 60 days to 6 months as was done a few months ago. This has the effect of delaying the time when these areas can be used for domestic energy production.  Another piece of legislation that will increase the price of fuel is the pending Waxman-Markey cap and trade proposal, of which the administration is a very strong supporter (President Obama met with congressional members on this yesterday to try and convince some holdouts to approve it). This will require that carbon emissions be capped at 2005 levels. The net effect is that and it will cost money to any industry who releases carbon. The goal of such legislation is to make carbon emissions more expensive so that people are incentivised to produce less atmospheric carbon.

Producing vehicles releases carbon, which will make the price of vehicles increase, but burning fossil fuel releases carbon too. That means that the price of fuel will increase as well, as is the desired effect of the Cap and Trade bill. Part of what president Obama proposed in his meeting yesterday was a short term increase of domestic proiduction in exchange for those holdouts approval of the cap and trade bill. He will then be able to claim he has allowed domestic production to increase. While this is true as a point of fact, the increase is very short term, only 2 – 3 years. Since it takes almost this long just to get production going, and far longer to drill new offshore wells,  the practical increase allowed will be very small from a domestic production standpoint. That means the effects of his short term increases will have very little effect on fuel prices, and will likely be overshadowed by other factors.

The U.S. Geological Survey recently estimated that the Bakken Formation in North Dakota and Montana may hold 3.65 billion barrels of oil. In addition, the outer continental shelf region will largely be left untouched, although it contains over 50 billion barrels of oil that could be extracted. At some time, domestic resources will have to be extracted (or exploited, depending on which side of the argument one sits). This will create jobs and reduce dependency on foreign oil. As the country’s population rises and the economy gains momentum, there will be a increase in the quantity of fuel demanded. We will have to get it from somewhere.

Even if we experience a large scale shift to plug in hybrids, it will be decades before enough of these are in service to reduce gasoline demand to the point where there is a significant reduction in our crude oil consumption. We can turn to green sources such as wind and solar, but collectively those two sources supply only about 2% of our domestic electricity production. The President has indicated that he will double these sources during his Presidency. George Bush did likewise, although he was eviscerated in the media and in progressive circles as being an environmental demon. It made little difference then, and another doubling will make little difference in the short term. A few more doublings, perhaps.

If the president does put 1 million plug in hybrids on the road by the end of his term it will definitely reduce the amount of gasoline burned. If the total number of automobiles on American streets did not increase for the first time in our history, here would be the net effect of those million new plug in hybrids: 1 million cars, driving 12,000 miles annually, would burn zero gasoline. On the inaccurate and  very generous assumption that only carbon free sources would generate the power for these new PIH vehicles, you would replace a like number of miles driven that would have burned 480 million gallons of gasoline, (assuming they were older cars that got only 25mpg, not the new CAFE figure of  35MPG new ones will be mandated to) with zero crude oil consumption.

According to Gibson Consulting, there are about 19.5 gallons of gasoline produced from each barrel of crude oil. That means we would eliminate the demand for 24.6 million barrels of oil annually by going to 1 million hybrid vehicles. That sounds like a huge number, and is more than a few drops. However, according to the U.S. Energy Information Adminsitration in 2007 the U.S. burned 390 million gallons of gasoline per day for motor fuel. That means that the 480 million gallons saved, while certainly a good start, (and we’ll have to start somewhere at some point) amounts to only about 0.34% of our annual gasoline consumption. That seems like quite a bit of hell to go through for American business and consumers to cur back on gasoline use by only 0.34%.

Increasing fuel prices will further hobble an economy that’s trying to improve, raise prices on heating oil and motor fuels for consumers that are already smarting from the struggling economy, cost jobs in the short term, and delay the economic recovery, no matter how much money the government keeps pumping in (when will it run out, anyway?)
Eventually the much touted “green jobs” producing advanced technologies for vehicles and other energy using consumer and manufacturing goods will increase to the point where they will overcome the jobs lost in the short term, but I’m not an economist, so I can not pinpoint when that will occur. The point of all this is that increasing fuel prices to drive us into the new, fuel efficient cars made by automakers because that is what the government wants, will be a painful experience. Will it be worth it?

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