In two recent posts (here and here), I examined EPA’s and the National Highway Traffic Safety Administration’s (NHTSA’s) rationale for establishing first-ever fuel-economy standards for trucks. Today’s post provides additional evidence that what the agencies call the trucking industry’s “under-investment” in fuel-saving technology is an unintended (although not unforseen) consequence of EPA’s ever-tightening diesel-engine emission standards. The declining fuel economy of 18-wheelers is a case of government failure, not market failure. Conveniently, EPA’s role in holding back heavy-truck fuel economy is never discussed in the agencies’ proposed rule.
The trucking industry is highly competitive, profit-margins are thin, and fuel is the single biggest operating expense. Consequently, truckers, especially those who haul freight long distances in “combination tractors” (semis), have a strong incentive to purchase vehicles incorporating cost-effective improvements in fuel economy. Hence manufacturers also have a strong incentive to produce such vehicles. Yet the average fuel economy of semis declined by 1.2% annually over the past decade, according to the Department of Energy’s Transportation Energy Data Book (p. 5-2).
How can this be?
EPA and NHTSA present five “potential hypotheses” to explain why truckers “under-invest” in fuel-saving technology and why, supposedly, the agencies must compel the industry to act in its own best interest. The first of my earlier posts shows that none of the agencies’ explanations demonstrates a “market failure.” In fact, two of the hypotheses suggest that truckers are simply acting like prudent buyers. The agencies estimate that the technologies required to meet their proposed fuel-economy standards will increase the costs of a semi by $5,896 in model year 2014. [Draft Regulatory Impact Analysis, p. 7-3] Before incurring such an expense, truckers want real-world information on how the new technologies affect truck reliability and maintenance costs. They also want credible data on whether the fuel savings are as large as advertised.
The second post outlines an alternative hypothesis, albeit one that dovetails with the prudent buyer explanation. In a nutshell: EPA’s emission-control standards for diesel trucks caused the very problem — stagnant or even declining fuel economy — that the agencies now propose to solve with more rules.
What led me to this hypothesis was none other than EPA’s year 2000 Regulatory Impact Analysis of its diesel-truck emission-control program. The RIA estimated that:
The implications are obvious. Thanks to EPA’s emission standards, over a five-year period, 539 engineers and technicians would spend all or much of their time developing emission-control technology rather than fuel-saving technology. Engine manufacturers would have $385 million less to spend for R&D of fuel-saving technology. Truckers would have $7,000 less per vehicle to spend on rigs with better fuel economy. Slow or non-existent improvement in heavy-truck fuel economy would thus very likely be an opportunity cost of EPA’s PM and NOx regulations.
EPA’s year 2000 RIA forecast that the 1% fuel-efficiency decline due to the PM filter would be “more than offset” by fuel-efficiency gains from other emission-control technologies. However, this “don’t worry, be happy” assurance is not very reassuring. An RIA, after all, is a form of self-evaluation, a report card in which an agency grades itself. Grade inflation is the norm.
At the end of the second post, I made a request for information. How much did engine manufacturers actually spend to develop the technologies required to meet EPA’s emission standards — about $385 million, more, less? How much was that as a percentage of total engine manufacturer R&D — less than 10%, about 50%, more than 90%? How much extra did truckers have to spend per vehicle for trucks with the requisite emission controls — about $7,000, more, less? Finally, what was the net direct effect of the new emission-control technologies on heavy-truck fuel economy — positive, as EPA forecast, or negative?
I don’t have complete or definitive answers yet. However, reports by the Government Accountability Office (GAO) and NERA Economic Consulting suggest that EPA’s regulations, both directly and via their market impacts, held back heavy-truck fuel economy.
EPA Regulation of Diesel Truck Emissions: Case Study of Unintended Consequences
Despite its bland title, Air Pollution: EPA Could Take Additional Steps to Help Maximize the Benefits of the 2007 Diesel Emission Standards, GAO’s March 2004 report leaves little doubt that EPA regulations and enforcement actions hindered manufacturers from making and truckers from buying vehicles with better fuel efficiency.
EPA has been implementing progressively tougher diesel emission standards since 1984. Because of widespread concern that EPA-approved emission-control technologies impaired both fuel economy and engine reliability, engine manufacturers sold and installed devices that “bypass, defeat, or render inoperative” an engine’s emission control system. “These devices altered the engines’ fuel injection timing and, while this improved fuel economy, it also increased nitrogen oxide emissions by two to three times the existing regulatory limits,” GAO comments [p. 11].
Although illegal under the Clean Air Act, selling and installing “defeat devices” was a perversive practice. From 1987 to 1998, seven of the nation’s largest engine manufacturers, accounting for almost 90% of the U.S. heavy-duty diesel engine market, sold 1.3 million trucks equipped with defeat devices. [GAO, p. 1] To create such a big market for unlawful devices, the EPA-approved emission-control systems must have imposed a significant fuel-economy penalty on truckers.
Rather than question the wisdom of its emission standards, EPA in 1998 launched what it called “the largest Clean Air Act enforcement action in history” against the manufacturers. The case was settled via consent decrees under which the seven manufacturers agreed to “(1) pay civil penalties of about $83 million, the largest civil penalty for an environmental violation as of that date; and (2) collectively invest $109.5 million towards research and development and other projects to lower nitrogen oxide emissions.” [GAO, pp. 11-12] The total tab may have been much bigger. According to GAO, “The manufacturers also agreed to collectively spend $850 million or more to produce significantly cleaner engines by October 1, 2002.” [GAO, p. 12].
In short, at EPA’s behest, industry may have spent nearly $1 billion in the early 2000s on penalties and R&D related to emission-control technology. How could that not crowd out significant investment in R&D of fuel-saving technology? How could it not divert significant engineering talent from fuel-economy innovation to emission-control innovation?
Lower fuel economy, a booming market for unlawful defeat devices, smaller-than-forecast emission reductions — such were the unintended consequences of EPA’s diesel-truck emission standards. EPA’s enforcement action had additional unintended consequences.
The consent decrees compelled the manufacturers “to accelerate by 15 months the schedule for meeting new, more stringent engine standards to October 2002 instead of the original mandatory date of 2004.” [GAO, p. 1] Truckers responded with a strategy known as “pre-buying” — purchasing new vehicles with older emission-control technology before the new emission standards kick in. Companies did this for three main reasons: (1) trucks equipped with older engines cost several thousand dollars less than trucks with the new emission-control technologies; (2) the new technologies had not been adequately road-tested to determine their effects on truck durability and maintenance; and, (3) the technologies were expected to reduce fuel economy.
The requirement to comply 15 months early with 2004 emission standards was the most disruptive aspect of EPA’s enforcement action. According to GAO, “Trucking companies maintain they need 18 to 24 months to road test an engine’s reliability in all weather and operating conditions and to develop their future purchasing plans.” [GAO, p. 6] The consent decrees did not allow time for adequate road-testing of the new technologies, and many truckers experienced engine problems:
For example, one company reported that roughly one-half of its 140 new heavy-duty engines experienced an engine valve failure prior to 50,000 miles. In addition, these officials noted that roughly 20 percent of their heavy-duty vehicles with the new engines are out of service at any given time due to maintenance concerns, compared to 5 percent for the remainder of their fleet. Several of these officials expressed a concern that some companies may have difficulty absorbing increased costs from such maintenance problems. [GAO, p. 20]
In the months preceding the October 2002 deadline, demand for new vehicles with older technology surged. Roughly 19,000 to 24,000 (20%-26%) of the 93,000 large semis (Class 8 trucks) produced during April to September 2002 were pre-buys. [GAO, p. 19] Before October 2002, “demand was so great, according to some engine manufacturers, they could not keep up with it, despite hiring hundreds of temporary employees and running production lines 24 hours a day, 7 days a week. According to all five of the engine manufacturers we contacted, the pre-buy could have been much larger, but the engine manufacturing industry did not have the capacity to fill the demand.” [GAO, p. 20]
After the deadline passed, however, demand for non-compliant vehicles collapsed, resulting in idle capacity, losses, and layoffs:
These truck-purchasing decisions in response to the consent decrees had a ripple effect on engine manufacturers, according to representatives of the five engine manufacturers subject to the consent decrees that we contacted. These representatives told us that, to meet the increased demand for old technology trucks before October 2002, their companies hired new workers and increased operations, concurrently increasing sales. But, after the deadline, engine orders dropped—at least until leveling off again by the end of fiscal year 2003—and the manufacturers let go many new hires and suspended operations at some plants. Such instability resulted in increased costs and a net loss of revenue for some manufacturers, according to their representatives. [GAO, p. 5]
Manufacturers that produced cleaner engines also took their lumps in the marketplace, because such engines “had inherent disadvantages relative to the existing engines that made them difficult to sell.” Makers of cleaner engines lost market share to manufacturers who marketed new trucks with older engines. [GAO, p. 22]
Just as EPA’s emission standards created a market for defeat devices that led to smaller emission reductions than EPA had forecast, so the requirement to comply 15 months early with 2004 emission standards created a pre-buy market that led to lower clean engine sales than EPA had forecast. Data for the first 13 of the 15 months “show that about 148,000 fully or partially compliant heavy-duty diesel engines are on the road, compared to EPA’s estimate of 233,000 such compliant engines for the entire 15-month time frame.” [GAO, p. 23]
Similarly, whereas EPA estimated that the consent decrees would require truckers to adjust the computers on 865,000 older trucks to reduce NOx emissions (a procedure known as “reflashing”), GAO found that, “As of September 2003, almost 60,000 trucks had been reflashed under the consent decrees’ mandatory program and another 43,000 under the voluntary incentive programs, about 12 percent of EPA’s projected total.” [GAO, p. 24]
Deja Vù All Over Again
GAO’s March 2004 report cautions that even larger market disruptions, pre-buying, and gaps between forecast and actual emission reductions could result from EPA’s “2007 Rule” — the rule EPA finalized in January 2001 that specifies diesel-truck emission standards through model year 2007:
In addition, because the technologies needed to meet the 2007 standards are much more advanced than those associated with prior upgrades, the trucking companies are concerned that the new engines will cost much more and decrease fuel efficiency much more than EPA predicted in 2000 when it was developing the standards. Consequently, according to representatives of 9 of the 10 trucking companies we contacted, companies most likely will once again decide to buy trucks before the deadline, but in larger numbers than they did in response to the consent decrees. This could again disrupt markets and postpone needed emissions reductions. [GAO, p. 7]
Once again, a key industry concern is the potentially adverse effect of tougher emission-control requirements on fuel economy:
Because the technology to meet the 2007 standard is more advanced than prior upgrades, some trucking companies are concerned that the new engines will cost more and decrease fuel efficiency more than EPA has predicted. Consequently, according to representatives of nine of the ten trucking companies we contacted, companies will likely once again pre-buy trucks, potentially disrupting markets and postponing needed emissions reductions. [GAO, p. 25]
Specifically, trucking industry representatives opined that the 2007 standards would reduce fuel efficiency by 3-5%. That’s a scary prospect for an industry where fuel is the single biggest operating expense and profit margins can be as low as 2 cents per dollar earned:
In addition, these officials are concerned that the 2007 trucks will experience another 3 to 5 percent loss in fuel economy—added to the 3 to 5 percent loss resulting from the consent decrees—that could increase their companies’ fuel costs by millions of dollars per year. Even minor increases in business costs can have adverse effects in the trucking industry, according to trucking industry officials we contacted, because these companies’ profit margins are very narrow—sometimes only 2 cents per dollar earned. The officials claim that the highly competitive nature of the trucking business precludes companies from passing such significant cost increases to their customers. [GAO, p. 33]
In short, industry representatives estimated the 2007 Rule combined with the consent decree could lower heavy-truck fuel economy by as much as 10%. And that’s just the potential direct effect of emission-control systems on the fuel efficiency of diesel engines.
If we also factor in the opportunity costs of EPA’s emission standards program — foregone investment in fuel-saving technology R&D, foregone purchases of more fuel-efficient trucks — it is entirely plausible that EPA’s regulatory and enforcement actions account for all of the 1.2% annual decline in heavy-truck fuel economy during 1998-2008. Were it not for truckers’ use of regulatory avoidance strategies — installing defeat devices in the 1990s and pre-buying older engines in the 2000s — heavy-truck fuel economy would likely have declined even faster.
NERA’s November 2008 report examines customer behavior in response to EPA’s 2007 Rule and the implications of EPA’s 2010 NOx standard. It confirms in spades that EPA’s diesel-emissions program imposes a significant opportunity cost on truckers. NERA found that EPA’s 2007 Rule increased the unit cost of a Class 8 truck by $7,000 between the 2006 and 2007 model years. [NERA, p. 13] That additional expense is money truckers could not spend to purchase vehicles with better fuel economy.
And there’s no relief in sight. NERA estimates that EPA’s 2010 NOx standard will increase the cost of a Class 8 truck by $7,000-$10,000. [NERA, p. 3]
In line with GAO’s expectations, NERA found that truckers engaged in massive pre-buying as the 2007 Rule phased in. In 2005-2006, truckers purchased about 120,000 more trucks with older engines than EPA had forecast, and in 2007-2008, they purchased about 183,000 fewer trucks with new engines than EPA had forecast. [NERA, p. 13] Consequently, the 2007 rule also produced smaller environmental benefits than EPA had forecast.
NERA expects that technological uncertainties and cost increases will similarly reduce the environmental benefits and cost-effectiveness of EPA’s 2010 NOx standard. NERA (writing in November 2008) recognized that the 2008-2009 recession could curb all vehicle sales, including pre-buys. [NERA, p. 17]
Don’t Expect Candor
Not once in EPA and NHTSA’s 300-page proposed rule to establish first-ever fuel-economy standards for heavy trucks do the agencies acknowledge the longstanding tension or trade-off between making diesel engines cleaner and making them more fuel efficient. They discuss five “potential hypotheses” to explain industry’s alleged “under-investment” in fuel-saving technology without ever wondering whether the regulatory environment in which truckers operate might have something to do with it.
EPA’s enforcement actions and regulations distorted the market for heavy trucks. If GAO and NERA know this, then EPA certainly does. EPA’s emission standards induced truckers to buy 120,000 more older engines than EPA forecast in 2005-2006, and 180,000 fewer new engines than EPA forecast in 2007-2008. Those standards also appear to have another massive unintended consequence, namely, hindering market-driven development and diffusion of fuel-saving technologies.
Maybe it would be unreasonable to expect EPA to stand up and take the blame for the very problem it now seeks more power over industry to solve. But is it also too much to ask EPA just to address the issue and at least make a case that its diesel-emission program did not undercut heavy-truck fuel economy? Apparently so.