EXECUTIVE SUMMARY

I. BACKGROUND

Corporate Average Fuel Economy (CAFE)

In the wake of the Arab oil embargo and petroleum shortages in the 1970's, Congress enacted the Energy Policy and Conservation Act (EPCA) in 1975. This Act created the Corporate Average Fuel Economy (CAFE) program under which mandatory fuel economy standards are set for passenger car and light truck fleets.

Corporate average fuel economy is the average fuel economy, expressed in miles per gallon (mpg) of a manufacturer's fleet of either 1) passenger cars or 2) light trucks up to 8,500 lbs. gross vehicle weight rating (GVWR) produced in the U.S. over any particular model year. The values are determined by computing the weighted fuel economy average of the various model types of a manufacturer in a model year.

Fuel economy values are based on the results of tests required and conducted by the U.S. Environmental Protection Agency (EPA). Compliance is determined first by considering each manufacturer's actual average fuel economy achievement for the model year. If the manufacturer exceeds the standard for that year, the law permits the surplus to be used as "credits" to be carried forward or backward up to three years to help offset shortfalls in other years. However, if those credits are not sufficient to fully offset the shortfall, the manufacturer is subject to civil penalties.

Alternative Motor Fuels Act of 1988 (AMFA)

AMFA, Pub. L. 100-94, October 14, 1988, provides CAFE credit incentives for the manufacture of vehicles that use alcohol or natural gas fuels, either exclusively or as an alternate fuel in conjunction with gasoline or diesel fuel. The primary purpose of AMFA is to encourage the widespread use of these fuels and to promote the production of alternative fuel vehicles by manufacturers.

In enacting AMFA, Congress sought to provide incentives directly to the auto makers in order to put an end to the "cause and effect" paradigm, in which auto makers had consistently argued that they would manufacture and market alternative fuel vehicles, if only a supply and distribution infrastructure were available to support an alternative fuel vehicle fleet. The fuel industry, for their part, argued that it would develop such an infrastructure, if there were significant demand for alternative fuels in the marketplace that would justify the capital expense.

Congress sought to address this situation by allowing special treatment of CAFE calculations for "dedicated" and "dual-fuel" (also referred to as "flexible-fuel") vehicles. Through AMFA, Congress amended the automotive fuel efficiency provisions of Title V of the Motor Vehicle Information and Cost Savings Act by the addition of a new section that contains incentives for the manufacture of vehicles designed to operate either exclusively or flexibly on methanol, ethanol or natural gas. A manufacturer producing alternative fuel vehicles that meet specific energy efficiency and minimum driving range requirements is able, if the manufacturer chooses, to raise its overall fleet fuel economy average by manufacturing these vehicles.

The maximum CAFE benefit permitted from the addition of dual-fuel vehicles to a manufacturer's fleet is 1.2 mpg for model years 1993 through 2004. Most vehicles produced in response to AMFA have been flexible-fuel vehicles designed to operate on E85, a mixture of 85 percent ethanol and 15 percent gasoline. Vehicles powered by electricity, liquid petroleum gasoline (LPG), and bio-diesel are not covered by AMFA.

Reporting Requirements

AMFA directs the Secretary of Transportation, in consultation with the EPA Administrator and the Secretary of Energy, to conduct a study and submit a report by September 30, 2000, to the Commerce Committee of the U.S. House of Representatives and the U.S. Senate Committees on Commerce, Science, and Transportation and Governmental Affairs, evaluating the success of the policy decision to offer CAFE credit calculation incentives for dual-fuel and gaseous dual-fuel vehicles. Accordingly, this report focuses primarily on the impact of dual-fuel (flexible-fuel) vehicles, although it also presents some information on the larger group of alternative fuel vehicles, which includes dedicated vehicles.

As required by the statutory language, the evaluation is based on: (1) the availability to the public of alternative fuel automobiles and alternative fuels; (2) energy conservation and security; (3) environmental considerations; and (4) other relevant factors. The statutory language also requires that by December 31, 2001, the Department of Transportation either extend the incentive program for dual-fuel vehicles beyond MY 2004 for up to four more years with a maximum allowable increase in average fuel economy for a manufacturer of 0.9 miles per gallon; or issue a Federal Register notice that justifies termination of the incentive program.

II. METHODOLOGY

Multiple sources of data and information were used to support the analyses and conclusions in this report. Sources include the DOE Alternative Fuels Data Center (AFDC) and publications from the Energy Information Administration (DOE/EIA), the Center for Transportation Research at Argonne National Laboratory, and the Oak Ridge National Laboratory (ORNL). The AFDC was created to facilitate the directives of AMFA, to gather and analyze information on the fuel consumption, emissions, operation, and durability of alternative fuel vehicles, and to provide information on alternative fuel vehicles to government agencies, private industry, research institutions, and other related organizations. Other contributors and resources used for this study are EPA's National Vehicle and Fuel Emissions Laboratory, the California Energy Commission and the Government Accounting Office. Private sector sources include the American Petroleum Institute (API) and the American Methanol Institute (AMI). NHTSA data and analyses also were used.

In addition to these sources, NHTSA published a Federal Register notice soliciting responses to questions and issues related to automobile manufacturing, fuel production, distribution and retailing and topics of general public interest. (See 65 FR 26805; May 9, 2000--Docket No.: NHTSA 2000-7087.) The agency received comments on the published notice from eight organizations: three automotive manufacturers (General Motors Corporation, DaimlerChrysler Corporation, and Ford Motor Corporation), an automotive association (Alliance of Automobile Manufacturers), three alternate fuels coalitions (National Ethanol Vehicle Coalition, Clean Fuels Development Coalition, and Members of the Renewable Fuels Association), and a state government (Missouri Department of Natural Resources' Energy Center). No comments were received from environmental groups or the oil industry.

As well as responding to some of the questions presented in the Federal Register notice, all of the organizations that commented expressed support for extending the CAFE credit incentives for dual-fuel vehicles for the additional four years (through 2008). Subsequent to closing of the comment period, letters in support of extending the credit provision were received from several Senators and House Members. Also subsequent to closing of the comment period, a joint letter expressing opposition to extension of the provision was received from the Sierra Club, the American Council for an Energy-Efficient Economy, the Center for Auto Safety, and the U.S. Public Interest Research Group.

III. FINDINGS

Availability of Alternative Fuel Vehicles

The number of dual-fuel alternative fuel vehicles has increased to over 1.2 million vehicles. The vast majority of these vehicles are light trucks. Those vehicles using E85 as an alternative fuel include 115,000 passenger cars and 1,077,000 light trucks. Recent increases (MY 1998 through MY 2000) have been dramatic. In 1997, there were no dual-fuel light trucks. By 2000, close to 8 percent of all light trucks produced were dual-fueled vehicles. About 1.4 percent of passenger cars produced in MY 2000 were dual-fueled vehicles (compared to .025 percent in 1993).

Some manufacturers have used the CAFE credits for producing dual-fuel vehicles to help meet their CAFE requirements, notably Ford in its 1999 light truck fleet and DaimlerChrysler in its 1998 and 1999 light truck fleets. None of the automobile manufacturers have achieved the maximum benefit level of 1.2 mpg for their fleet. However, both Ford and DaimlerChrysler are approaching the 0.9 mpg maximum benefit level that would be allowed, if the dual-fuel vehicle CAFE credit provision were extended. In addition, GM has announced plans to significantly increase its production of dual-fuel vehicles.

Based on the automobile manufacturers' responses to the Federal Register notice, termination of the CAFE incentive program would significantly reduce the amount and types of alternative fuel vehicles available in the U.S. The manufacturers stated that the CAFE incentive program has been a major factor in developing and manufacturing alternative fuel vehicles in high volumes. They also stated that extension of the credit provision will be a major factor in their decision to continue offering dual-fuel vehicles in the volumes that are being produced today. A reduction in the production of these vehicles would likely result in a sharp decrease in interest in expanding the alternative fuel refueling infrastructure, and possibly result in a decrease in the number of alternative fuel refueling stations being operated.

Availability of Alternative Fuel

While there are an estimated 176,000 conventional fuel refueling stations nationwide, the National Renewable Energy Laboratory (NREL) reports that there are 5,236 alternative fuel refueling sites as of May, 2001, with alternative fuel refueling sites in all 50 states. In comparison, there were 4,676 alternative fuel refueling sites in the U.S. in 1995. Unfortunately, while ethanol is the alternative fuel that most of the dual-fuel vehicles that have been produced can operate on, less than three percent of the alternative fuel refueling sites offer ethanol. The vast majority of alternative refueling sites (3,270) are those that offer liquefied petroleum gas (LPG).

Ethanol: There are 121 ethanol (E85) refueling sites in the U.S., up from 37 in 1995. Ethanol refueling sites can be found predominantly in the Midwest, close to the major supplies of ethanol. Efforts by DOE are underway in Minnesota to help construct a number of ethanol refueling sites. As seen with CNG, fuel suppliers can rise to meet the demand by developing the necessary infrastructure. Although the trend in alternative fuels is in the direction of E85 use, the infrastructure has been slow to develop because these vehicles can use conventional fuel. Further, studies have shown that refueling stations need at least 200 steady customers for any single grade in order to make profitable use of the facilities. Though large numbers of flexible-fuel vehicles are being sold, they are spread out over the entire nation, and achieving a "critical mass" of 200 that use a single refueling station is still difficult to achieve. The small number of outlets available today points out the need to intensify the E85 refueling infrastructure. In addition, it is safe to say that many people who have purchased flexible-fuel vehicles do not know they could use E85. More public education in areas where E85 refueling stations exist is needed to inform people so that they are aware they can use E85.

Methanol: There are only two methanol (M85) refueling sites in the U.S., significantly down from 88 in 1995. Both of these sites can be found in California. The total number of methanol (M85) refueling stations has been dropping in the past few years, due to the lack of M85-capable flexible-fuel vehicles.

Natural Gas: There are currently 1,237 compressed natural gas (CNG) refueling sites and 44 liquified natural gas (LNG) refueling sites in the U.S., up from 1,065 CNG refueling sites in 1995. Natural gas refueling stations are usually located in urban areas near the major concentrations of natural gas vehicles, and are frequently constructed on a company's site to serve its fleet vehicles. Dedicated CNG vehicles, both heavy duty and industrial use, have been in the marketplace for some time, thus the larger number of refueling sites compared to E85 where the influx of vehicles using E85 in large numbers has just materialized in the past three years.

The cost to retrofit an existing refueling station's or retail outlet's gasoline/tank for E85 ranges from $5,000 to $30,000. For a new, underground tank and pump, the price ranges from $50,000 to $70,000. For LPG, the installation cost of a new outlet is $25,000 to $40,000. For CNG, the installation cost for an initial outlet is $250,000 to $500,000.

Since ethanol is the alternative fuel that most dual-fuel vehicles are capable of operating on, it is important to note the current water quality concerns regarding Methyl Tertiary-Butyl Ether (MTBE), an additive used to increase the oxygen content of gasoline. If MTBE is banned as a gasoline additive and fuel producers replace MTBE with ethanol, it is uncertain if there will be enough refinery capacity to both replace MTBE and to fuel flexible-fuel vehicles a substantial portion of the time with E85. Because of this situation, along with the small number of ethanol refueling stations nationwide coupled with the growing number of vehicles capable of using ethanol entering the marketplace, some special incentives to spur the development of an E85 refueling supply and distribution network might be warranted.

The Federal government, and specifically DOE, the General Services Administration and the U.S. Department of Agriculture (USDA) are involved with efforts to promote the use and expansion of alternative fuels and the alternative fuel infrastructure. A major focus of these efforts is the development of different feedstocks for ethanol and on partnerships that result in the expansion of the ethanol fueling infrastructure.

DOE runs the Clean Cities Program, which unites public-private partnerships that deploy AFVs and build supporting infrastructure, with the common goal of building the alternative fuels market. DOE also operates the Office of Fuels Development (OFD), whose primary focus is on working to reduce the cost of replacing imported oil with ethanol made from domestic resources such as corn fiber, bagasse and rice straw. OFD also includes a vital outreach and educational effort under its purview - the Regional Biomass Energy Program (RBEP). The specific goal of the RBEP is to increase the production and use of bioenergy resources, and help to advance the use of biomass feedstocks and technologies.

DOE and the General Services Administration (GSA) are jointly managing a program called the Federal AFV USER Program, whose goal is to support the expansion of an alternative fuel infrastructure by concentrating large quantities of Federal AFVs and substantially increasing the use of alternative fuels in Federal AFVs in six selected areas: Albuquerque, NM; Denver, CO; Melbourne/Titusville/Kennedy Space Center, FL; Minneapolis/St. Paul, MN; Salt Lake City, UT; and the San Francisco Bay area.

USDA agencies will use ethanol fuels in their fleet vehicles where practicable and reasonable in cost. USDA's E85 flex-fuel vehicles will use ethanol fuel where those vehicles operate in geographical areas that offer E85 fueling stations, and USDA agencies will purchase or lease alternative fuel vehicles, including E85 flex-fuel vehicles, for geographic areas that offer alternative fueling.

Use of Alternative Fuels

While alternative fuel use in alternative fuel vehicles in the U.S. has been rising over the past decade, it still represents a very small portion of total highway fuel use. In 1992, the Energy Information Administration estimated that a total of 230 million gasoline gallon equivalents of alternative fuel was used in alternative fuel vehicles. For 2001, that number was projected to rise to 366 million gasoline gallon equivalents, or an increase of roughly 6 percent per year. In comparison, the highway use of gasoline and diesel was about 133 billion gallons in 1992, and that number was projected to rise to about 164 billion gallons in 2001, or an increase of roughly 2 percent per year. Thus, alternative fuel use in alternative fuel vehicles has been rising at a rate three times faster than the total highway use of gasoline and diesel. Nonetheless, alternative fuel use only accounts for 0.22 percent of total highway fuel use.

Analysis of the Effects on Energy Conservation and the Environment

The current trend in alternative fuels seems to be in the direction of ethanol (E85), due to the relative transparency to the operator in using either ethanol or gasoline, and the relative ease and minimal cost associated with converting a gasoline-fueled vehicle to one that can accept either gasoline or ethanol. The CAFE incentives available to automobile manufacturers for selling vehicles capable of operating on alternative fuels have led to sales of more than one million ethanol flexible-fuel vehicles through the 2000 model year. Automobile manufacturers have responded to the incentives Congress provided in the Act. However, for several reasons, these flexible-fuel vehicles are operating almost exclusively on gasoline.

The CAFE credit incentive for dual-fuel vehicles can assist manufacturers in complying with the CAFE standards. Other than producing dual-fuel vehicles, manufacturers must either use other means (weight reductions, advanced technology, pricing, product mix shifting, and/or marketing) to meet the standards or pay civil penalties for not meeting the standard.

Conducting an assessment of the energy and environmental impacts of the CAFE credit incentive is complicated by behavioral uncertainty. While the use of alternative fuels can reduce petroleum consumption and greenhouse gas emissions, the energy consumption and environmental impacts cannot be determined with any reasonable amount of certainty because we cannot predict what manufacturers would have done in the absence of the credit incentive. If vehicle manufacturers took advantage of the incentive to relax the effect of the CAFE standard on the rest of their fleet, then the credit incentive has resulted in some slight increase in alternative fuel use (almost all E85), petroleum consumption (about one percent) and greenhouse gas emissions (well less than one percent).

It is also possible that manufacturers might have responded to strong consumer demand for performance and utility and produced the same vehicles without the provision as they did with it. In this case, manufacturers would have chosen to pay civil penalties rather than meet the CAFE standard. Under this scenario, the main effect of the program has been to greatly expand the population of vehicles that have the potential to use alternative fuels.

This report presents an analysis of the energy conservation and environmental effects to date, as well as projections through 2008, using an assumption that manufacturers used the incentive to relax the effect of the CAFE standard on the rest of their fleet. This assumption yields an "upper bound" estimate of the increase in petroleum consumption and greenhouse gas emissions. The analysis focuses on E85 flexible-fuel vehicles because they represent almost all of the vehicles that have been produced that are eligible for the credit. Note that because dual-fuel vehicles must meet Federal emission standards for criteria pollutants such as NO_x or volatile organic compounds, on both gasoline and the alternative fuel, the most significant environmental impacts are on greenhouse gas emissions. Therefore, the analysis of environmental impacts is focused on greenhouse gas emissions. In the case of petroleum consumption, 85 percent of E85 fuel used by flexible-fuel vehicles offsets the increase in gasoline use that results from the lower fuel economy associated with the credit, since 85 percent of E85 is ethanol and 15 percent is gasoline. In the case of greenhouse gas emissions, the offset is about 25 percent, since flexible-fuel vehicles burning E85 still generate some greenhouse gas emissions. The results of the analysis indicate that the incentive has resulted in an increase in alternative fuel use (almost all E85), and some slight increase (about one percent) in petroleum consumption and greenhouse gas emissions for 1996 through 2000. The effects beyond 2000 will depend almost entirely on the amount of E85 fuel used by FFVs. Unless actions are taken to significantly expand the availability and use of alternative fuels, the CAFE credit incentive program will not result in any reduced petroleum consumption or greenhouse gas emissions in the future.

It is important to note that the analysis assumes that, in the absence of the CAFE credit incentive, manufacturers would have chosen to take other actions to improve their average fleet fuel economy rather than pay CAFE penalties. We do not know with certainty that the manufacturers wouldn't have produced the same vehicles in the absence of the credit incentive. Therefore, the actual energy and environmental impacts are uncertain.

IV. CONCLUSIONS

Our evaluation of the AMFA CAFE credit incentive policy for dual-fuel vehicles indicates that the program has had mixed results. Key findings include:

The AMFA CAFE credit program has been successful in stimulating a significant increase in the availability of alternative fuel vehicles. Nearly all of these have been flexible-fuel vehicles that can operate on gasoline or E85 fuel (a mixture of 15 percent gasoline and 85 percent ethanol). There are currently about 1.2 million of these vehicles on the road. Because manufacturers had to overcome technological challenges, nearly the entire increase in the number of these vehicles has been in the past three years.

The auto manufacturers stated that the CAFE incentive program has been a major factor in developing and manufacturing alternative fuel vehicles in high volumes. They also stated that extension of the credit provision will be a major factor in their decision to continue offering dual-fuel vehicles in the volumes that are being produced today.

While the availability and use of alternative fuels has increased since the inception of the CAFE credit incentive provision, it has not nearly kept pace with the increase in the number of alternative fuel vehicles. Although there are 176,000 gasoline stations nationwide, there are only 5,236 alternative fuel refueling sites and just 121 of these offer E85. The Federal government, and specifically DOE, the General Services Administration and the U.S. Department of Agriculture (USDA) are involved with efforts to promote the use and expansion of alternative fuels and the alternative fuel infrastructure. A major focus of these efforts is the development of different feedstocks for ethanol and on partnerships that result in the expansion of the ethanol fueling infrastructure.

Due to the lagging development of the alternative fuel infrastructure and the fact that E85 fuel is typically more expensive on a gasoline-equivalent basis, the vast majority of dual-fuel vehicles rarely operate on alternative fuel. Even under these circumstances, use of E85 increased from 694,000 gasoline gallon equivalents in1996, to more than 3.3 million gasoline gallon equivalents in 2000. It is also important to note that even if relatively few of these vehicles are actually being operated on E85, it is still valuable to be increasing that capability throughout the fleet because it could potentially contribute to the future transition away from petroleum, could spur an increase in the number of E85 refueling sites, and provide consumers an alternative if there are gas shortages or gas prices increase significantly.

Conducting an assessment of the energy and environmental impacts of the dual-fuel vehicle credit incentive is complicated by uncertainty regarding automobile manufacturers' behavior. While the use of alternative fuels can reduce petroleum consumption and greenhouse gas emissions, the energy consumption and environmental impacts cannot be assessed with any reasonable amount of certainty because we cannot determine what manufacturers would have done in the absence of the credit incentive.

If it is assumed that vehicle manufacturers took advantage of the incentive to relax the effect of the CAFE standard on the rest of their fleet, then the credit incentive has resulted in an increase in alternative fuel use (almost all E85), and some slight increase in petroleum consumption (about one percent) and greenhouse gas emissions (well less than one percent). Unless the availability and use of alternative fuels is significantly expanded, the CAFE credit incentive program will not result in any reduced petroleum consumption or greenhouse gas emissions in the future.

It is also possible that manufacturers might have responded to strong consumer demand for performance and utility and produced the same vehicles without the provision as they did with it. In this case, manufacturers would have chosen to pay civil penalties rather than meet the CAFE standard. Under this scenario, the main effect of the program has been to greatly expand the population of vehicles that have the potential to use alternative fuels.

In the past year, three significant initiatives have addressed issues related to the dual-fuel vehicle CAFE credit incentive. The National Energy Policy Development Group, in its May 17, 2001, report on the National Energy Policy states that, "ethanol vehicles offer tremendous potential if ethanol production can be expanded." Additionally, the report states that, "a considerable enlargement of ethanol production and distribution capacity would be required to expand beyond their current base in the Midwest in order to increase use of ethanol-blended fuels." In July 2001, the National Academy of Sciences' report on CAFE recommended that credits for dual-fuel vehicles should be eliminated, with the provision that enough lead-time be given to limit adverse impacts on the automotive industry." Finally, on August 2, 2001, the U.S. House of Representatives passed H.R. 4, which is entitled the Securing America's Future Energy (SAFE) Act of 2001. This bill, which has been placed on the Senate legislative calendar, includes a provision that would extend the dual-fuel vehicle CAFE credit incentive program through model year 2008.

Based on the results of this study, our preliminary conclusion is that continuation of the program should consider other actions that could improve the program and its chances for success. Specific actions by Congress or others might include any or all of the following:

(1) Examine alternatives to the current dual-fuel vehicle CAFE credit program structure, such as linking the CAFE credit to actual alternative fuel used;

(2) Develop, implement, and evaluate policies, regulations, or programs to promote the actual use of alternative fuels by consumers; and

(3) Develop, implement, and evaluate policies and programs that facilitate more rapid expansion and use of the alternative fuel infrastructure. Such policies and programs should be evaluated, taking into account the availability of alternative fuel and other potential transportation uses for each fuel.

In view of the nation's energy security interests, it is important to increase alternative fuel capability throughout the fleet. Given the mixed results of the program to date, it would be prudent for Federal agencies, Congress, industry, and other interested stakeholders to identify additional programs and authorities that could contribute to achieving greater use of alternative fuels in dual-fuel vehicles that receive the CAFE credit.

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