Fuel Economy Necessary to Mitigate Effects of Geopolitical Risk

May 23, 2018

Since they were first implemented in the mid-1970s, in the aftermath of the Arab Oil Embargo, fuel economy standards have served as a cornerstone of U.S. energy policy to reduce motorists’ vulnerability to petro-states’ actions and global oil market volatility. In the 2007 Energy Independence and Security Act, corporate Average Fuel Economy (CAFE) standards were increased and then further strengthened in 2012 to gradually rise to 54.5 miles per gallon by 2025. EPA and NHTSA are currently in the process of reviewing standards for 2022-25 under the Mid-Term Evaluation, and may loosen them. Given that geopolitical turmoil in numerous oil-producing countries and OPEC reducing output to manipulate the market are increasing gasoline pump prices for American consumers and affecting U.S. foreign policy, it is important that the administration uses the current review process to strengthen and modernize CAFE standards.

Fuel economy standards have served as a cornerstone of U.S. energy policy to reduce motorists’ vulnerability to petro-states’ actions and global oil market volatility.

A lot of commentary has focused on the rapid rise in shale growth as the main reason for reducing oil imports throughout this decade. While shale has significantly affected the U.S. oil market, the role of CAFE has also served as a key factor. Although vehicle miles traveled have soared in recent years, gasoline demand in the U.S. has increased modestly and is only slightly above previous records set in the mid-2000s. The gains from greater fuel economy are enormous. Dylan Yalbir and Amy Jaffe with the Council on Foreign Relations calculated that without the strengthening of standards that began in 2007, U.S. oil demand would be 2.6 million barrels per day (Mbd) higher by 2030. Moreover, the fact that roughly two-thirds of new vehicles currently purchased in the United States are light trucks or SUVs reinforces the need for robust standards to reduce dependence on petroleum and save drivers thousands of dollars over the lifespans of their automobiles.

Today’s oil market

With global oil markets now at $80 per barrel, U.S. consumers will experience pain at the pump this summer. Prices are expected to average the highest since 2014, and if they rise another 55 cents per gallon from the current average of about $3 per gallon, consumers will lose all their gains from last year’s tax cut.

Higher oil prices are not guaranteed, but more analysts see the possibility of $100 per barrel. That level is in sight because of a volatile mix we are now seeing—instability in oil-producing countries, OPEC and its non-OPEC allies cutting supply, demand rising sharply in emerging markets, and shale producers in Texas experiencing bottlenecks.

With global oil markets now at $80 per barrel, U.S. consumers will experience pain at the pump this summer.

Consider the long list of oil-producing countries contending with instability and conflict—Venezuela, Iran, Saudi Arabia, Nigeria, Libya, Yemen, and Syria. In Venezuela, where widespread poverty and hyperinflation have sent the economy into turmoil, oil production has fallen by a third since 2016, and could drop even further after ConocoPhillips won an arbitration suit against the country’s state-owned oil company PDVSA. The rigged presidential election results in favor of Nicolas Maduro this past weekend will exacerbate these challenges.

Iran is another wild card. Renewed international sanctions on the country’s oil exports are one of the clearest indicators of the intrinsic links between U.S. oil dependence and foreign policy. It is uncertain how much Iranian oil will come off the market because of re-imposed sanctions and whether OPEC (mainly Saudi Arabia) will increase supply to offset losses. Nonetheless, questions surrounding Iran will loom over oil markets for the rest of the year and have the potential to further increase prices, particularly since the entire Middle East is dealing with economic, cultural, and military shifts. Saudi Arabia and Iran are fighting proxy wars in both Syria and Yemen—both of which are oil producers but currently are pumping virtually zero barrels. The tension between Tehran and Riyadh, as Iran spreads its influence in the region and Saudi Arabia acts to counter it, has the potential to further destabilize the region and put more oil production at risk. Recently, for instance, Houthi militants in Yemen have attacked Saudi Arabia’s oil infrastructure numerous times.

There were 1,480 terrorism incidents against oil and gas facilities worldwide between 2011 and 2016, a 387 percent increase from twenty years ago. Nothing suggests these incidents will lessen in the coming years.

Outside of the Middle East, Libya and Nigeria are not producing at full capacity. Even though both have recovered recently, it is not guaranteed that they will be able to increase output in the near future. A key African supplier, Libya is contending with disruptions from violence, worker strikes, the lack of organization due to no central command, and warring factions vying for control of the country. Nigeria, which has seen its market influence dwindle due to shale’s rise, is also dealing with multiple issues constraining supply, including systemic corruption in its state-owned companies and militant attacks on pipelines and other oil infrastructure in the Niger Delta. Other countries such as Colombia, Brazil, Angola, and Iraq also have their own glitches that have affected their production.

All issues in these petro-states are ongoing and portend increased price volatility. This decade, with the uptick in global terrorist incidents overall, has easily been the most violent in oil market history. There were 1,480 terrorism incidents against oil and gas facilities worldwide between 2011 and 2016, a 387 percent increase from twenty years ago. There is nothing to suggest this situation will be less precarious in the coming years.

A way forward on fuel economy

Having to rely on unstable countries for oil supply makes demand-side solutions all the more imperative. Although the U.S. has become a big exporter of crude and refined products, net crude imports total 5-7 Mbd, and over the past decade, U.S. consumers have sent $1.41 trillion to OPEC producers, based on SAFE’s calculations.

Auto technology has changed significantly since the current rules were established in 2012. The EPA should work to sustain a rigorous, unified fuel economy standard, but also account for the innovation that has occurred in recent years. Existing advanced driver assistance technology, which smooths driving patterns and prevents crashes that result in congestion in fuel waste, combined with vehicle-to-vehicle and vehicle-to-infrastructure communications, could potentially bring about fleet-wide fuel economy savings of 18 to 25 percent. Moreover, the technology would improve vehicle safety, possibly reducing almost 10,000 deaths per year if is included in all vehicles, according to an analysis by Boston Consulting Group. In its final rule, EPA and NHTSA should also stimulate the use of alternative fuel technologies by preserving credit multipliers that apply to electric vehicles, and incorporate other advanced vehicle technologies.

U.S. consumers will ultimately have to continue to contend with oil price swings due to instability in oil-producing countries. But with new technologies available to reduce costs, accidents, and consumption, regulators have an opportunity to modernize CAFE standards and weaken petro-states’ influence over American motorists.