Increase fuel prices to increase the number of alternative fuel vehicles on the road

By Jessica

During our class on EVs, we spent some time talking about ways to increase the number of alternative fuel vehicles on the road. One thing that wasn’t discussed but has a significant impact on consumers’ vehicle choice is the price of gasoline.

Let’s cover the facts first—a number of studies have shown that people buy more fuel-efficient cars when gas prices increase:

– “A $1 increase in the gasoline price leads to a 21.1 percent increase in the market share of the highest fuel economy quartile of cars and a 27.1 percent decrease in the market share of the lowest fuel economy quartile of cars.” (See Source 1)

– In the last year, we’ve seen the inverse to be true: as gas prices go back down, sales of EVs and hybrids are going down as well (See Sources 2 and 3)

Anecdotally, I can also think about some of my experience living in Europe, where gas prices have been higher on a sustained basis for decades. Europeans absolutely make different car purchase decisions because of this high price—most Europeans don’t drive automatic cars because they consume more gas, and diesel cars have proliferated because, though more expensive up front, they reap significant savings over time through fuel efficiency.

Finally, we can look at the consistency of this information with other types of energy we’ve studied: people like cheap energy and we don’t see expensive energy catching on until it is put on par with other forms. Examples include subsidies and incentives for solar to put it closer to par with traditional electricity generation and the popularity of coal throughout the world due to its low cost relative to just about every other form of energy (at least in the short term).

Short-termism is certainly a big issue when dealing with the costs of energy: the upfront cost may feel too large for consumers even if the investment will pay off in the future. Something has to offset that large upfront investment, and high gas prices seem to help even though they are a long-term benefit. My hypothesis is that, though the high gas prices provide more of a long-term benefit than a short-term one, people can already feel the pain of high gas prices. This is in contrast to installing solar energy where most people are not aware of how much they pay to heat or cool their homes. At the pump, you stare at the price going up and are generally aware of what you pay. Think back to 2008—you can probably remember your friends saying, “It cost $60 to fill up!”

Now, a number of studies have shown that changes in gas prices do not create swings in gas consumption of similar magnitudes (e.g. a 10% increase in gas prices does not decrease gas consumption 10%), and that makes sense—America has a pretty car-dependent society where public transportation in most places cannot substitute for a car, and most Americans use cars to get to work each day, so we cannot just choose to stop getting to work. However, we can change what type of vehicle we use to get there. This would certainly have to be a longer-term commitment as individuals don’t buy a new car each year, but a sustained higher tax on gasoline would very likely lead to higher uptake of alternative fuel vehicles.

Sources:

1. http://ei.haas.berkeley.edu/pdf/working_papers/wp201.pdf

2. http://time.com/money/3529146/cheap-gas-prices-hybrid-electric-car/

3. http://www.npr.org/2014/10/17/356949485/as-gas-prices-drop-hybrid-sales-shift-into-low-gear

4. http://insight.kellogg.northwestern.edu/article/consumers_cars_and_common_sense/

5. http://www.outsidethebeltway.com/study-rising-gas-prices-dont-impact-consumption/

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About macomberjohnd

HBS Finance faculty interested in sustainability in the built environment including devices, structures, townships, and cities.

2 Responses to “Increase fuel prices to increase the number of alternative fuel vehicles on the road”

  1. Thanks for the post. I completely agree with your premise that increases in fuel price will increase the demand for alternative fuels on the road. The question is when will that happen? New technologies in oil & gas have drastically changed the outlook of fossil fuel prices. We all talk at length about the gas glut that followed the “shale revolution”, but hydraulic fracturing technology has also unlocked very large reserves/production in oil. While the impact is not as pronounced as it has been on gas, oil prices are now also becoming oversupplied and is beginning to cause a steady downward trend in oil prices. Case in point: oil prices are currently $80/bbl and lowering in an economy that is generally growing. This is primarily due to the huge increases in US oil production from tight oil plays. We have not even started to tap the tight oil reserves in the areas with large existing conventional reserves, such as the middle-east. Goldman Sachs is predicting oil prices will fall below $70/bbl in 2015: http://www.cbc.ca/news/business/oil-price-will-fall-to-70-a-barrel-in-2015-goldman-sachs-says-1.2814041.

    In the 1970’s everyone was talking about peak oil, and then in the 80’s prices plummeted. In the early 2000’s everyone was talking again about peak oil. In 2008 we all thought it was really happening and all analysts thought it was going to climb well beyond $150/bbl, and never return down. Today we are oversupplied and facing $70/bbl. The fundamental assumption that as fossil fuel prices rise it will drive alternative energy for transportation is difficult to argue, but the better question is how long will that be?

  2. Some great thoughts and numbers. So why hasn’t America increased gasoline prices? As you alluded to – in Europe, and most of the world, gas prices are much higher. That’s due to massive oil subsidies from the U.S. government to keep gas cheap (same that is done for coal and other fossil fuels). I’ve long thought that the U.S. government should end these subsidies, which would significantly increase the price of gasoline. Further, in the environmental world there has been much conversation about the need for a climate tax on gasoline. Most of the taxes on gasoline established to go to environmental causes no longer go to those causes, but go to the general U.S. budget.

    One of the biggest hurdles to raising gas prices in the U.S. is how it would hurt the poor. And outside of major cities, public transportation is severely limited. Another challenge is that high oil prices can cause stagflation — because the economy is so dependent on oil, high gas prices could significantly hurt growth can cause the economy to essentially stagnate. Ultimately, we’re subsidizing gas currently (1) because of the powerful oil lobby, (2) because high gas prices are damaging to the economy, and (3) because if we didn’t, it would cripple the poor. We do need to end the oil subsidies, let prices increase, but this must be coupled with some kind of safety net for the poor and the proper investments to minimize the economic damage.

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