Market Trends

Impact of Future CAFE Standards on Resale Values

December 5, 2011

by Mike Antich - Also by this author

In 2016, CAFE standards will increase to an average of 35.5 miles per gallon for passenger cars. It is estimated it will cost OEMs $52 billion cumulatively to be in compliance and will add an average of $1,000 to the cost of manufacturing a new vehicle. Starting in 2017, CAFE standards will increase again. Passenger cars will be required to increase fuel economy from 2017-2021 by 4.1 percent annually, while light-duty trucks will be required to have a 2.9-percent annual improvement.

The cost to design and build vehicles to meet the higher 2017-2021 fuelefficiency standards will average an additional $2,000 to $6,000 per vehicle. Proponents of the higher CAFE standards argue the higher acquisition costs will be offset by much greater fuel savings. However, is there a diminishing return on cost savings as fuel efficiency increases? Kelley Blue Book thinks so.

“All of these fuel-efficiency gains come at a cost,” said Eric Ibara, director, residual value consulting for Kelley Blue Book. “The higher CAFE standards are being sold to the public by saying, yes, your vehicle will cost more, but you are going to save money in the long run because you’re not spending as much for gasoline.”

The problem, according to Kelley Blue Book, is that, as vehicles get more fuel efficient, cost savings actually decrease. (See chart below.) “The annual savings from going from 40 mpg to 50 mpg is about $375 per year. At 40 mpg, you need 375 gallons a year to travel 15,000 miles. It is really hard to justify the higher acquisition expense when the fuel savings are only $375 per year or $1,125 over three years,” said Ibara. This assumption is based on gasoline costing $5 per gallon. If fuel is less expensive, then the annual cost savings will be even lower. “If the future cost of gasoline is $3 per gallon, then the cost savings is only $225 per year,” added Ibara.

Five-Year Forecast is for Flat Gasoline Prices

Kelley Blue Book does not foresee gasoline prices rising appreciably in the next five years. The forecast is for gasoline prices to oscillate between $3.50 and $4 per gallon over the next five years. According to Ibara, the OEMs will attempt to meet the higher CAFE standards by moving to smaller displacement gasoline-powered engines and to introduce more fuel-efficient compact and subcompact models into their new-vehicle portfolios.

“We believe future gasoline prices will remain constant relative to today’s prices,” said Ibara. “As more models are introduced in the compact and subcompact segments, we do not believe there will be a great demand by the American public to buy these types of vehicles. The American public has repeatedly shown that it prefers larger sedans and utility vehicles.

Therefore, the resale prices for compact and subcompact cars, along with hybrid passenger cars, are forecast to be soft due to this oversupply and weak consumer demand.”

The reason Ibara believes future resale values for hybrid passenger cars will be soft is that internal combustion engine technology is improving to a point that it is as fuel efficient as a hybrid, but at a lower acquisition cost.

“Nowadays, the non-hybrid version gets close to or even exceeds the fuel efficiency of the hybrid model,” said Ibara. “The resale value retention for hybrids is usually lower than the non-hybrid version of the same model when resale is stated as a percentage of list price.”

All of these forecasts, however, are contingent upon future fuel prices and the rate at which prices increase. Even if fuel prices rise beyond $4.50 per gallon, Ibara does not foresee consumers gravitating toward smaller vehicles, so long as the price rise is gradual. “I can’t say if $5 per gallon or $5.50 per gallon will trigger a change in buying sentiment,” said Ibara. “It depends on how we get there.”

If gasoline prices increase sharply within a short period of time, such as what we witnessed in 2008, consumer uncertainty as to how much higher prices will rise may drive buyers away from larger, less fuel-efficient vehicles to smaller models.

In terms of traditional fleet vehicles, Ibara does not foresee higher CAFE standards negatively impacting resale values of full-size trucks and intermediate sedans. “However, a ‘compression phenomenon’ can come into play, where the spread in resale values between vehicle segments might exert downward pressure on intermediates, especially if resale values for smaller vehicle segments decline,” said Ibara. “While this may occur with compacts, intermediates, and full-size sedans, I don’t expect it to spill over to trucks. But, there are times when the supply/demand equation becomes so imbalanced that these relationships break down, as we saw in 2008. If anything, I would expect full-size trucks may even go up in resale value if the housing market picks up and there isn’t an
adequate supply of new trucks to fulfill the need.”

In the absence of higher gasoline prices, Ibara believes that, in the future, there will be too many subcompact and compact models in the market relative to buyer demand. “Our concern is that when you legislate what people should be driving, you usually end up with a supply/demand imbalance,” said Ibara.

Every professional vehicle remarketer will tell you when supply exceeds demand, there is downward pressure on resale values. Let me know what you think.

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  1. 1. Dan [ December 06, 2011 @ 04:16PM ]

    We have reached the point of diminished returns with CAFE standards. We have a choice to buy these super fuel efficient vehicles and it may become in vogue to own an 'old car' with power and safety, as opposed to an underpowered, unsafe, government mandated econobox.
    It's time for the government to think outside the box. Here's a few ideas. 52 less visits to every address in America a year- end Saturday mail delivery. Increased postal profits, reduced US fuel consumption, reduced infrastructure impact and a full weekend for all postal workers to spend their hard earned pay. Intelligent roadway infrastructure. Lights that communicate with each other to keep packets of road volume moving and cue in alternate traffic. Highways that adjust speed limits to road volume keeping all traffic flowing at a constant speed. Tax breaks for companies that operate 4 day work weeks or allow employees to telecommute.

    These are the real changes that will reduce emissions, oil dependency, and as a bonus spur the economy.

  2. 2. Adam [ December 13, 2011 @ 10:23AM ]

    Dan's comments are spot-on. There are only so many firms who will embrace green vehicles before the real green premium is noted. Such vehicles are not mass-market vehicles. Who pays $8000 more for a Prius to save $400/yr in fuel? 17-20 year return on investment at 15k miles, 26 years at 10k miles. That doesn't include replacing the batteries that are only about 70% efficient after the first three years. We can't force auto companies to make stupid vehicles, but we need to fix the system that perpetuates stupid problems - the postal service being a great example. Every state should have annual auto inspections.

  3. 3. Jim [ December 16, 2011 @ 06:07AM ]

    How about letting the market system work? Prices send signals to consumers and producers alike; individual consumers make decisions based on needs, preference and price. Individual producers (entrepreneurs) make decisions based on consumer demand and profit potential. Both consumer and producer thrive in stable, predictable markets. Government mandates, restrictions, arbitrary laws and high taxes distort the market. We know now that the Green Movement has used fraudulent science to push cars like the Prius, the purchase of which can only be justified by these bogus, non-economic arguments. Fleet managers, more than any consumer, understand return on investment. We push the producers to deliver more efficient vehicles that will get the job done. With the new CAFÉ standards, getting the job done will likely be very expensive. And we will all be poorer as a result.

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