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Valuing Cutting Oil Dependency: And the new auto standard deal

May 20th, 2009 · 2 Comments

The announced deal to strengthen auto mileage standards, aiming for a fleet average of 35.5 miles per gallon by 2016, has many implications. One of these is, quite clearly, reduced oil use. According to President Obama

we will save 1.8 billion barrels of oil over the lifetime of the vehicles sold in the next five years. Just to give you a sense of magnitude, that’s more oil than we imported last year from Saudi Arabia, Venezuela, Libya, and Nigeria combined. (Applause.) Here’s another way of looking at it: This is the projected equivalent of taking 58 million cars off the road for an entire year.

The Union of Concerned Scientists did an initial analysis translated this into other benefits.  “implementing the standard outlined in the plan would:

  • curb U.S. oil dependence by about 1.4 million barrels of oil per day by 2020, nearly as much as we currently import from Saudi Arabia.
  • cut heat-trapping emissions by 230 million metric tons of carbon dioxide in 2020, equivalent to taking 34 million of today’s cars and light trucks off the road that year.
  • deliver net savings to consumers of $30 billion in 2020, even after covering the cost of technology improvements, based on a gas price of $2.25 per gallon.
  • deliver $70 billion in net savings in 2020 if gas prices spike to $4 per gallon again.

Note this 1.4 million barrels per day. That would translate to some 500 million barrels of oil saved each year.

Now, the government and UCS look to the financial benefits of the program through the lens of saved gasoline costs for drivers through reduced fuel.  This cost savings is used to calculate payback times for purchasing fuel efficient vehicles.  This is a very limited way of thinking about ‘total system benefits’ in terms of this reduced oil (or liquid fuel) dependency.

In addition to the health care and global warming benefits, there is another, quite important, financial benefit that seems not to have been calculated.

Very simply, in the world of supply and demand, “demand destruction” (efficiency, conservation) has the exact same impact on increased production.   Achieving a reduction in US oil (actually, liquid fuel) use by 1.4 million barrels per day is the exact functional equivalent as having found a new oil source that, from 2012 on, would be gradually developed to then be producing 1.4 million barrels per day for the world market (and even more in the years to come).

Why does that matter? Well, to a tremendous extent, oil prices are an issue of supply/demand, with increased global demand bumping into the limits of Peak Oil and the difficulty (if not impossibility) of pushing global oil productiabove about 86 million barrels per day. (Let us assume that, probably unreasonably, current production levels are sustainable for the indefinite future.)  The deal President Obama spoke about yesterday will  start to impact US oil demand beginning slowly a few years from now and escalate to greater impact from there to the extent of representing a reduction in global demand against production capacity by about 1.6 percent.

So, why does this matter?

Just as with increased supply, decreased demand moderates prices (lowers what they might have been otherwise).  In 2008, oil prices went above $140.  The global recession drove down oil demand about 2.5 million barrels day (Mbd) and prices fell (not solely to demand destruction, but this was core) by $100 per barrel.

There are many (MANY) variables when looking forward to determine oil prices.   It is a straightforward proposition that reduced demand will foster lower oil prices, even if how much is uncertain.  (What will demand be of the rest of the world? What is marginal cost of oil in 2020? Etc …)

If that 2.4 Mbd dropped 2008 prices by $100, how much cost moderation will 1.4 Mbd drive? Will prices be $50 per barrel lower than they would be otherwise?  Higher? Lower? Let us take, for a moment, an assumption that the value is one-tenth that, or a $5 reduction of the price of oil in 2020.

  • This translates to about 12 cents per gallon less expensive gasoline. (Oddly, this savings actually works counter to the stove-piped calculation of the ROI of an efficient car for the direct purchaser.)
  • Assuming 15 million barrels per day of US usage (a 25% reduction from today), this would be $75 million per day of savings for US drivers and the US economy. This would translate to over $27 billion in annual savings for the US economy.

In fact, $5 calculation as to the lowered per gallon cost of liquid fuels in 2020 due to this deal seems to be an aburdly low figure.  But, using that “absurdly low” figure, it is quite evident that there is a huge societal benefit that has not been part of the overall discussion.

Now, the greater fuel efficiency will “pay for itself” through reduced fuel use. As per President Obama,

even as the price to build these cars and trucks goes up, the cost of driving these vehicles will go down, as drivers save money at the pump.  And this is a point I want to emphasize:  If you buy a car, your investment in a more fuel-efficient vehicle as a result of this standard will pay off in just three years.  In three years’ time you will have paid off the additional investment required.  So this is a winning proposition for folks looking to buy a car.  In fact, over the life of a vehicle, the typical driver would save about $2,800 by getting better gas mileage.

Lets go past this stovepiped calculation to the larger discussion. To understand the balance of total costs per year, the increased cost of a car in 2016 due to this deal will be about $600.

At 15 million vehicles sold per year (a possible figure), the total cost of this would be $9 billion per year.

Okay, so there would be a $9 billion per year total cost with at least a $27 billion per year societal benefit. (This, of course, is not looking at how much stronger the economy will be with lowering the trade deficit by $2.25 billion/month or the value of improved health due to reduced fossil fuel pollution.)

In any event, $9 billion per year in cost (cost that is paid back for directly via fuel cost savings) vs $27 billion in benefits.

A 3-to-1 payback …

This is starting to become an interesting calculation.

NOTE: Yes, only a small portion of the savings would accrue to the individual driver buying these cars. Let’s assume 300 gallons per year, the ‘simplistic’ (and absurdly low) 12 cents per gallon would translate to $36 per year for the car driver.   But, the drivers would benefit through a stronger economy.

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Tags: analysis · energy efficiency

2 responses so far ↓

  • 1 Understating the Value of New CAFE Standard Targets? // Sep 15, 2009 at 1:43 pm

    […] discussed this past May, when the deal was originally announced, in Valuing cutting oil dependency, valuing savings at “$3,000 in fuel costs” simply takes a straight line assessment of […]

  • 2 The Republican Agenda To Raise America’s Gas Prices // Mar 16, 2012 at 9:09 am

    […] not just for those driving the higher mpg vehicles but for everyone who goes to the pump).   This value stream has been, by the way, almost uniformly ignored when discussing the payoff from CAFE sta… – in fact, this ‘indirect’ savings might be three (or even more) times greater […]