This article examines the economic and policy factors that have played a large role in the US motor fuels market, and quantifies future outcomes based on a range of possible economic and policy conditions. These include aggressive pursuit of biofuels programs, increases in Corporate Average Fuel Economy (CAFE) standards, dieselization of US motor fuels, and the pricing of carbon emissions.
Part 1 of this two-part series, last week (OGJ, Oct. 8, 2007, p. 66), developed a forecast for diesel and gasoline demand in the US based on economic factors. This week, the concluding article will examine the factors that influence US motor fuel demand to draw a picture of what is likely to happen over the next decade.
Our findings suggest there will be substantial effects on the gasoline market, but fairly small effects on the diesel market. The US administration’s program to decrease gasoline demand 20% in 10 years is unlikely to reach that goal, but pursuit of biofuels and higher CAFE standards still could substantially reduce historic gasoline demand growth. Continued economic growth should stimulate diesel demand, though constraints on carbon may temper its rate of growth.
Ordinarily, rising fuel demand would elicit additions to US refining capacity. Proposals, however, to control refined product prices and other measures to intervene in open fuel markets, or the imposition of special taxes on refiners, are likely to discourage such investment. Furthermore, efforts to mandate biofuels as a substitute for petroleum-based motor fuels create a new level of uncertainty in the downstream petroleum market.
Government policy is inherently unpredictable and current mandates may not be in place in the future. Some mandates are likely to have unintended consequences not yet fully understood. As a result, refiners face more rather than less risk in making decisions on how much capacity to add during the next 10 years.
We see a contradiction between the current market and recent policy proposals: market forces imply a need for more domestic refining capacity, while legislative and policy initiatives discourage it.
We chose a 10-year time span because beyond that the picture is less clear. Fuel prices, the state of technology, and policy all might be very different from today-projections beyond 10 years are highly uncertain. Still, a 10-year perspective can tell us a good deal about what the state of the world might look like by 2017.
Biofuels
President Bush’s plan to reduce US gasoline demand 20% by 2017 is based on two approaches:
- An aggressive effort to substitute biofuels for gasoline (15% reduction).
- A 4%/year increase in the fuel economy of new light vehicles sold in the US (5% reduction).
If the market otherwise would have grown 13% as projected by the US Energy Information Administration, to 158 billion gal/year (10.4 million b/d) in 2017 from 140 billion gal/year (9.1 million b/d) in 2006, biofuels would replace 24 billion gal and rising fuel economy standards would conserve another 8 billion.
How realistic is this? Most of the biofuel contribution would have to come from ethanol. Biodiesel will reduce diesel demand somewhat, but US biodiesel production is projected to increase to only 650 million gallons by 2015.1 If diesel demand grows 15-20% between now and then, this would be only a little over 1% of the total market.
Ethanol is currently made almost exclusively from corn and that is not likely to change dramatically in the next 10 years.
In the long term, ethanol from cellulose may make an important contribution to supply. The US Department of Energy has offered $385 million in grants to build plants capable of supplying ethanol from cellulosic sources. At least three technical hurdles must be overcome at production scale, however. The cellulosic portion of the feedstock must be isolated, the cellulose must be enzymatically degraded into sugars, and those sugars need to be fermented to turn them into ethanol.
Different cellulosic sources require somewhat different processes, further complicating the situation. DOE’s National Renewable Energy Laboratory has set a goal of cutting the cost of cellulosic ethanol by 50% over 5 years, which would make it competitive economically. The steps to do so, however, are likely to take longer than that and it appears unlikely that this technology will produce large quantities of fuel within 10 years.
In 2006, 23% of US corn production of somewhat less than 10 billion bushels was devoted to the fuels market, yielding about 5.3 billion gal. More acreage will be devoted to corn in 2007 and higher yields per acre may be possible.
The processing capacity exists or is under construction to produce as much as 12 billion gal/year of ethanol by 2009. This could consume 1/3 of the US corn crop, however, with consequent effects on food markets. Furthermore, because ethanol has only 67% of the energy content per gallon as gasoline, this is only 8 billion gal in gasoline equivalent. That is but 1/3 the 2017 goal.
Presumably, land that is now used for other crops could be replanted with corn to provide feedstock for the fuels market. That would reduce pressure on the corn market but would raise prices of other agricultural commodities. Also, some land now held in reserve might be released to increase aggregate corn production. But some of that land is unsuitable for corn and yield on other such acreage is likely to be low. Production devoted to the fuels market could yield 15 billion gal by 2017, but even this would replace only 10 billion gal of gasoline.
DOE’s Office of the Biomass Program projects 2017 ranges for corn-based and cellulosic ethanol of 12.5-15.0 billion gal/year and 2-5 billion gal/year, respectively. Combined, this is 14.5-20.0 billion gal/year. The lower end of this range, mainly from corn ethanol, seems more likely.
It is clear that US corn-based ethanol cannot replace 24 billion gal of gasoline by 2017.
Another option is to relax import barriers to ethanol in order to induce greater supplies from around the world. To date, however, domestic producers have successfully opposed such relaxation and, in any case, such a program would merely replace one form of imported fuel with another.
In all likelihood, US-produced ethanol will slow growth in demand for gasoline but not prevent it. Even if that growth is no greater than DOE projects and 15 billion gal of ethanol are supplied by 2017 (equal to about 650,000 b/d of gasoline), ethanol will replace only a little more than half the projected growth amount (10 billion out of 18 billion gallons).
Tightened CAFE standards
Many studies have examined prospects for raising the average fuel economy of US vehicles. For example, the National Academy of Sciences in 2002 and Energy and Environmental Analysis Inc. in 2006 identified technologies already in commercial use that could increase fuel economy throughout the fleet. These include rolling resistance reduction, improved lube oils, weight reduction, engine friction reduction, and alternator improvements.
An analysis conducted at Oak Ridge National Laboratory found that at gasoline prices between $2/gal and $3/gal, increased light vehicle fuel economy of 30-50% will more than pay for itself.2
Other vehicle technologies also may contribute to increased fuel economy during the next 5-10 years. These include homogeneous charge compression ignition and hybrid electric vehicles, including plug-in hybrids with advanced batteries; but the contributions of these technologies will likely be limited during this time period.
Proposals have been made to raise US CAFE standards as a means to increase light vehicle fuel efficiency. For example, Senators Richard Lugar (R-Ind.) and Barack Obama (D-Ill.) have introduced the “National Fuel Initiative,” which would mesh light trucks with autos and increase the overall CAFE standard by 4%/year. For our analysis, we initially assume that during 2008-17, average annual mileage among the US light vehicle fleet will increase by that number.
Each year, new vehicles comprise about 7% of the vehicle fleet. The retirement rate is only about 4.5%; therefore, the vehicle fleet is expanding. Our first assumption is that 7% of the fleet turns over every year, with no net gain.
Currently, light vehicles average 21 mpg.3 In 2008, therefore, the 7% of new vehicles would average 1.04 x 21 or 21.8 mpg. The 2009 new vehicles would average 22.7 mpg, and so on. Because new light vehicles make up only 7% of the fleet, the average increase in mpg from the first year increment is only 0.07 x 0.04 = 0.0028 or 0.28%. In the second year, the percentage gain would be from a slightly higher mpg base. By the 10th year, new vehicles would average 21 x 1.0410 raised to the 10th power or about 31.1 mpg.
Given these assumptions, the 2017 fleet would consist of 10 years of vehicles averaging 26.2 mpg (assumed to be 70% of the fleet) and another 3 years averaging 21 (30%). Fleet average fuel economy would be 24.6 mpg, a gain of 17%. A vehicle traveling 13,000 miles/year, the average in the US, would consume 528 gal of gasoline rather than 619 gal, a savings of 15%. This arithmetic suggests that growth in gasoline demand would be significantly affected.
The actual gain in fuel economy, however, between 2008 and 2017 from increasing CAFE standards by 4%/year is likely to be considerably less. First, the 2008 and 2009 models already are past the design stage; a new program probably would not be implemented until the 2010 model year.
This would reduce the average mileage of new vehicles sold between 2008 and 2017 to 24.3 mpg, and the overall fleet average to 23.3 mpg. Of course, if CAFE standards continue to increase past 2017, the effects would continue to grow.
Automakers receive credit towards CAFE goals by marketing flexible fuel vehicles-vehicles that can use alternative fuels such as ethanol or methanol as well as gasoline. The credit allows each manufacturer to increase the calculated CAFE value of its fleet by up to 0.9 mpg. Almost all of today’s flexible fuel vehicles, however, use gasoline. Their production has little effect on demand.
If 0.9 is deducted from 24.3, new vehicles would average 23.4 mpg and the fleet average would be 22.7 mpg. A vehicle traveling 13,000 miles would consume 573 gal rather than 619 gal, a fuel economy gain of about 7.4%. Demand for gasoline would be reduced by about 775,000 b/d.
Other factors would reduce the effect of increased CAFE standards further. Better gas mileage means a lower cost of travel, which will induce people to drive more. This “rebound effect” is estimated to be about 20%. The average gain in fuel economy in new vehicles is effectively reduced by 0.5 mpg, to 22.9 mpg.
In reality, the light vehicle fleet will likely continue to expand by a few million vehicles every year. If this occurs mainly through old vehicles lasting longer-in contrast to extra new vehicles being sold-then new vehicles will comprise less than 70% of the total in 2017, and closer to 60%. In that case, raising CAFE standards by 4%/year for new light vehicles between 2010 and 2017 would result in fleet average fuel economy of about 22.1 mpg and a reduction in gasoline demand of about 550,000 b/d.
Fig. 1 shows the effects on gasoline demand if a biofuels program yielding 15 billion gal in 2017 is combined with a program to increase CAFE 4%/year for the light vehicle fleet. Assuming a base case growth rate of 15% between 2007 and 2017, to 10.7 million b/d from 9.3 million b/d, biofuels would reduce demand by 650,000 b/d and CAFE standards by another 550,000 b/d. The two together would reduce demand by around 1.2 million b/d, to about 9.5 million b/d.
President Bush’s goal of a 20% reduction in gasoline demand would be only partly met, but the combined programs nevertheless would have a significant effect on gasoline demand.
Dieselization
Another way to reduce US motor fuel consumption would be a massive transformation of the light duty vehicle fleet from gasoline to diesel. Fewer gallons would be needed to propel vehicles because diesel has about 14% more energy per volume and because it combusts more efficiently than gasoline.
The two effects combined result in a vehicle of given size and weight going about 30% farther on a gallon of diesel than on a gallon of gasoline. For given aggregate vehicle miles traveled, therefore, about 23% less fuel is needed.
The net reduction in petroleum use would be less, however, because more oil is required to make diesel fuel than gasoline. Adjustment for this factor would reduce the net fuel efficiency advantage of diesel over gasoline by about 20%.
To help achieve greenhouse gas reduction goals, European nations have encouraged such a vehicle transformation through differential taxation of diesel and gasoline. The policy appears to be working. Despite diesel vehicles being more expensive (approximately $3,000 more for a comparable light vehicle), 50% of new cars sold in Europe in 2005 were fueled by diesel.
The current situation favors the US in one important respect. European refineries are producing more gasoline than Europe is consuming, and are exporting about 800,000 b/d to the world market.
Concurrently, the US is importing more than 1 million b/d of gasoline and gasoline components from world refining centers. Gasoline prices in the US would be higher if European refineries were not overproducing relative to European demand. To some extent in Europe, gasoline has now become an unwanted by-product of rising throughput to meet diesel demand.
A new policy to encourage diesel use in the US would require US refineries to substantially change their processing configuration. Currently, the product mix is heavily oriented towards gasoline, which makes up more than 50% of production. Only a little more than 20% is diesel.
A large-scale switch from gasoline to diesel would render past capital investments in catalytic cracking less valuable and would require large new investments in hydrotreating and hydrocracking. In the short run, such a policy would put pressure on the diesel market. In the longer run, increased US diesel production capacity would relieve that pressure, but several years would be required and cost recovery would be necessary.
US policy makers are indicating a preference for biofuels and fuel economy measures as the core strategy to reduce motor fuel consumption. Although diesel offers considerable potential for fuel savings, it appears unlikely that this alternative will be given serious consideration currently.
Carbon Tax
Increased motor fuels taxes are sometimes discussed by policy analysts, but rarely by policy makers, who would have to deal with voters’ wrath over a widely unpopular measure. Such taxes would likely slow economic growth as well as reduce the efficiency of distribution of goods. Furthermore, these imposts would be unpopular with motorists, whose real incomes would be cut and their mobility curbed.
Other unresolved questions include what would be done with potentially large revenues, and how these monies would be recycled within the economy.
Although higher motor fuels taxes are unlikely in the near future, constraints on aggregate US carbon emissions are being aggressively advocated. A quantitative limitation on carbon emissions coupled with an allowance trading system is most often discussed. Such a limitation would have many of the properties of a carbon tax, although it would not be entirely equivalent.
Without knowing the specifics of what might be done, it is difficult to precisely predict the future price of prospective carbon allowances, but there is experience within the EU of carbon allowance trading and the price ranges that emerge.
For analytic purposes, we assume an allowance price of $30/ton of CO2, which roughly equates to 30¢/gal of motor fuels. We also assumed the price is set in 2008 and remains constant in real terms through 2017. A base price of $2.60/gal for both fuels is also assumed.
We assume too that gasoline demand would rise 1.4%/year or 15% over 10 years if there were no carbon constraint; diesel demand would rise 1.8%/year or 20% over 10 years. The final assumption is that elasticity of demand increases in even increments towards intermediate term values of -0.5 for gasoline and -0.2 for diesel (for example, elasticity of demand for gasoline is assumed -0.05 in 2008, -0.1 in 2009, etc.).
Fig. 2 shows the effect of the carbon constraint on motor fuel demand.
We calculated that, by 2017, gasoline demand is 600,000 b/d less than what it otherwise would have been. But it still is more than 725,000 b/d more than 2007 demand. Diesel demand in 2017 grows by more than 400,000 b/d; it is only about 70,000 b/d below what it otherwise would have been. Together, the $30/ton implicit tax on carbon reduces demand for motor fuels by about 670,000 b/d in 2017.
References
- National Biodiesel Board, “Biodiesel Backgrounder,” www.biodiesel.org.
- Greene, David L., “The President’s State of the Union Fuel Economy Plan: How I know it will work,” Presentation at 11th Annual Washington Energy Policy Conference, April 20, 2007.
- US EPA, “Light Duty Automotive Technology and Fuel Economy Trends: 1975 Through 2006,” July 2006.
