Aggressive New CAFE Standards: The IC Empire Strikes Back

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Last Friday, President Obama and executives from 13 leading automakers gathered in Washington to announce a historic agreement to increase fleetwide fuel-economy standards for new cars and light trucks from 27.5 mpg for the 2011 model year to 54.5 mpg for the 2025 model year. While politicians frequently spin superlatives to describe mediocre results, I believe the president's claim that the accord "represents the single most important step we've ever taken as a nation to reduce our dependence on foreign oil" is a refreshing example of political understatement. After three decades of demagoguery, debate, dithering, and delay, meaningful policy change has finally arrived, and not a moment too soon.

The economic impact will be immense -- a staggering $1.7 trillion in fuel-cost savings that will flow directly to consumers. As those savings begin to work their way through the economy and kick-start secondary fiscal multiplier effects, the boost to GDP will be closer to $7 trillion. I believe Friday's agreement will ultimately be seen as the biggest economic stimulus event in human history.

(More information in the White House report "Driving Efficiency: Cutting Costs for Families at the Pump and Slashing Dependence on Oil.")

The most surprising aspect of this agreement isn't the aggressive goals; it's that the auto industry has helped forge the goals and plans to achieve them by implementing "affordable technologies that are on the road today." The new goals are not based on the electric dreams of a Tesla Motors. They're based on the automakers' hard-nosed evaluation of the cumulative gains that can realistically be achieved with existing internal-combustion-engine (ICE) technologies such as engine downsizing, stop-start idle elimination, turbocharging, optimized cooling, low friction, direct fuel injection, and variable valve timing.

Individually, the fuel-economy gains from advanced ICE technologies will be only baby steps toward energy independence. Collectively, they'll give American consumers passenger cars with lower well-to-wheels CO2 emissions than a 2012 Nissan Leaf plugged into the typical wall socket. They'll change the world without a budget-busting paradigm shift.

In early July, The Boston Consulting Group released a new report titled "Powering Autos to 2020; The Era of the Electric Car?" that evaluated the combined potential of baby-step fuel-efficiency technologies and considered their likely impact on wildly expensive and impractical proposals to convert the world's transportation infrastructure from liquid fuels to electricity. In the report, BCG concluded that:

  • Conventional technologies have significant emissions-reduction potential, but original equipment manufacturers will need to pull multiple levers simultaneously to meet emissions targets.
  • Advanced ICE technologies can reduce gasoline consumption by 40% at a cost to the consumer of $50 to $60 per percentage point of reduction -- roughly half what BCG predicted three years ago.
  • Advanced ICE technologies are likely to become standard equipment worldwide during the next decade.
  • Electric cars will face stiff competition from ICE and will not be the preferred option for most consumers.
  • Battery costs will probably fall to about $9,600 per vehicle but will become increasingly uneconomic as the potential fuel savings per kWh of battery capacity plummets.
  • In addition to dismal economics, plug-ins will face substantial go-to-market challenges, including battery-durability concerns and the absence of an adequate charging infrastructure.

In my view, the BCG report is a must-read for investors who want to profit from this fuel-efficiency megatrend and avoid heavy losses in vehicle-electrification schemes that will become increasingly uneconomic over time. The fundamental flaw is simple. Today an EV with a fully charged 24 kWh battery pack can save a consumer the equivalent of 3 gallons of gas. By 2025, the savings will be closer to 1.5 gallons of gas. Even with falling battery prices, the value proposition can only get more challenging with each passing year.

For the last few years, I've been cautioning investors that gee-whiz vehicle-electrification technologies are transitory, a flash in the pan, and the biggest business opportunities in energy storage involve cheap, simple, and effective baby-step technologies such as stop-start idle elimination that will slash fuel consumption by 5% to 15% for a few hundred dollars. The BCG report and the newly announced fuel-economy goals are yet further proof of that principle.

The future is all about getting more from less and has absolutely nothing to do with increasing consumption of one class of scarce natural resources in the name of conserving another.

Although I can't identify the component manufacturers that will thrive from the widespread implementation of advanced ICE technologies such as turbocharging, direct fuel injection, and variable valve timing, picking the winners in energy storage is easy. Johnson Controls (NYS: JCI) and Exide Technologies (NAS: XIDE) will be the first beneficiaries as automakers upgrade their electrical systems to withstand the strains of stop-start idle elimination. As stop-start systems become standard equipment worldwide and the inherent limits of current absorbed-glass-mat (AGM) battery technology become obvious, more powerful energy-storage solutions from emerging technology developers such as Maxwell Technologies (NAS: MXWL) and Axion Power International (OTC BB: AXPW.OB) will ascend to prominence, if not dominance.

The new fuel-efficiency standards are not an omen of doom for lithium-ion battery solutions from A123 Systems (NAS: AONE) , Ener1 (NAS: HEV) , and Valence Technologies (NAS: VLNC) , which will no doubt gain a toehold among the 6% to 13% of consumers who say they'd purchase an environmentally friendly car even if they had to pay a premium over the life of the vehicle. I'm just not certain how significant that toehold will be in light of the incontrovertible reality that less than 2% of consumers actually buy environmentally friendly cars.

On balance, I believe that survey-based uptake forecasts will be just another example of a painful lesson I learned in the biodiesel business -- that individual buying decisions speak louder than surveys and the green in a consumer's wallet always takes priority over the green in his or her cocktail-party conversation.

For several years the mainstream media, financial press, and sell-side analysts have been publishing irrationally optimistic stories and reports about the end of the ICE age and the dawn of a golden electric era. On Friday, the Obama administration and the automakers put the world on notice that the IC Empire is striking back and plans to bury the new generation of electric wannabes as it has all of their predecessors.

Disclosure: Author is a former director of Axion Power International and holds a substantial long position in its common stock.

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