Political Risk Brief
Winter 2017/2018

Collision Course: Environmentalism and the Industrial Midwest

Summary

Aggressive environmentalist policies that impose higher costs on the U.S. industrial sector – especially traditional auto manufacturing – create serious risks to the national competitiveness of the Democratic Party.

The remarkable success of President Donald J. Trump in forging a victorious Electoral College coalition that included historic, even if narrow, wins in Michigan, Pennsylvania, and Wisconsin reflects a serious tension between the rising anti-industrialism of the environmentalist Left and the national political fortunes of the Democratic Party.  Even as both major parties continue to underestimate the power of pro-industrial politics, intensified competition for voters in the industrial Midwest has the potential to reshape the debate regarding environmental regulation confronting the auto sector.

In particular, the looming battle regarding California’s Zero Emissions Vehicle (ZEV) program will test the ability of Democrats and Republicans to mitigate and exploit, respectively, the enhanced national political power of the industrial Midwest.  The outcome will signal the extent to which the result of the 2016 presidential campaign evolves from a political moment into an enduring movement capable of transforming the national electoral landscape.

Introduction

Unfolding political and policy factors promise to reshape the U.S. auto industry, with national consequences.

The public debate has explored many of these issues in detail, including: Corporate Average Fuel Economy (CAFE) standards; greenhouse gas (GHG) emissions standards; regulation of autonomous vehicle (AV) technology; and President Trump’s commitment to domestic manufacturing.  The national conversation largely has ignored, however, California’s ZEV program, which imposes a de facto national standard of growing significance.

The increasing requirements of California’s ZEV program – combined with relatively high electric vehicle (EV) prices, historically moderate gasoline prices, and associated consumer trends – threaten to collide with the ability of automakers to bear compliance costs in a complex competitive environment.

Moreover, much of the California-based environmental movement opposes significant reform of the ZEV program, creating the potential for a major confrontation between environmental ideals, industrial sector realities, and consumer preferences.

ZEV Program: Background

Under the Clean Air Act, EPA has the ability to grant California a waiver to adopt and enforce its own standards for vehicle emissions.1

Other states may adopt state-level emissions standards as long as those standards are identical to California’s.2  Nine “Section 177” states, representing about 30 percent of the United States new vehicle market, have adopted the ZEV program.3

The ZEV program, administered by the California Air Resources Board (CARB), operates through a credit-trading system.  Automakers operating in California must meet certain ZEV credit targets either by selling zero- or low-emissions vehicles, or purchasing the surplus credits earned by other automakers.

To this point, CARB has acknowledged that the ZEV program provides no net carbon or GHG benefit because of other strict fleet averages mandated by EPA and NHTSA regulations.4

The ZEV program functions in the near term as an EV sales mandate.  The result: increased prices of gasoline-powered vehicles to reduce the price of EVs, which disproportionately are luxury vehicles purchased by higher-income consumers.

Heightening Requirements Beginning in 2018

ZEV credit targets are set to increase markedly starting next year.

CARB finalized this increase in a “Midterm Review” released on January 18, 2017 and with the following changes compared to the pre-2017 period:5

Credits required: Credit requirements will increase nearly five-fold between 2018 and 2025;

Credits earned: Each sale of a ZEV will earn the automaker fewer credits per vehicle;

Vehicle types: Vehicles other than EVs, plugin hybrid-electric vehicles, and fuel-cell vehicles will no longer earn any credits; and

Credit travel: Credits will no longer be transferrable to meet requirements in other states.

Although automakers will continue to be able to meet ZEV targets through the purchase of excess credits from other automakers, the market price of those credits likely will increase in 2018 and subsequent years, further increasing the price of traditional combustion-powered vehicles.6  The higher market price of ZEV credits also will make it nearly impossible for EVs to diplace carbon cost effectively: already at current ZEV credit market values, an EV would have to be driven more than 1 million miles to displace enough carbon to equal the value of its ZEV credit subsidy, taking the Obama Administration’s estimate for the social cost of carbon of $37 per metric ton.7

Consumer Preference

For pickup trucks and SUVs 

In part thanks to relatively low gasoline prices, sales of pickup trucks and SUVs have surged in recent years.  Consumers increasingly are opting to purchase trucks over cars; as a result, the sales-weighted fuel economy of purchased new vehicles has plateaued for four years. According to the most recent data available, in only five states do trucks not account for a majority of light vehicle sales, and in most states, the most popular new vehicle is a full-size pickup truck.9  These trends are bipartisan: a 2016 survey found that four out of the five most popular vehicle models among Democrats are SUVs.10  At the same time, EV sales have lagged forecasts significantly.11  Consumers’ preference for trucks over electric vehicles raises questions about the viability of the current ZEV mandates: even in California, the market share of light trucks increased from 39 percent in 2014 to 50 percent in the first quarter of 2017.12

High EV prices

EVs are meaningfully more expensive than equivalent-sized gasoline-powered vehicles.  CARB has estimated that a 100-mile-range subcompact EV will cost $19,655 more than a similar internal-combustion engine vehicle.13  To make sales of ZEVs possible, manufacturers earn potentially more than $10,000 per EV sold in the form of ZEV credits that other automakers effectively are forced to purchase.14  This amount lowers the sale price that consumers see, entirely separate from the federal tax credit of as much as $7,500 that buyers receive and any applicable state and local subsidies.  The consumers who benefit tend to be significantly wealthier than average Americans.  A recent survey conducted by Tesla-focused blog Teslarati found that Tesla Model X owners had an average annual household income of $503,000, versus $267,000 for Tesla Model S owners.15

Financial pressure on the automotive industry

After strong auto sales in 2016, annual sales are expected to be lower from 2017 through 2020.  At the same time, the industry is under increasing pressure to invest in AV technology.  Unlike tech companies, several of which have become leaders in the AV industry, traditional automakers shoulder legacy costs associated with labor and environmental regulations at the same time as confronting high R&D and other upfront investments in AVs.

Growing political influence of auto-manufacturing states

The relevance of the auto industry to the concerns that propelled President Donald J. Trump to victory – including the state of domestic manufacturing, the wellbeing of the communities of the industrial Midwest, and the U.S. trade deficit – increases the likelihood of substantial reform to the benefit of automakers and autoworkers.  Yet industrial states key to President Trump’s victory are sponsors of a wealth transfer benefitting EV buyers concentrated in Democratic states.  For example, the 10 top auto manufacturing states accounted for only eight percent of national ZEV sales since 2011, while California alone accounted for 49 percent.16

Leading Indicators

Several statements by key actors signal that the above dynamics already are impacting the political landscape.

Californa Governor Jerry Brown has reportedly been pushing CARB chair Mary Nichols to act more forcefully, including emulating China’s plan to phase out internal combustion vehicle: “I’ve gotten messages from the governor asking, ‘Why haven’t we done something already?’ … The governor has certainly indicated an interest in why China can do this and not California.”17  Nichols indicated, however, that she was open to coming “to the table” to loosen near- and medium-term standards in exchange for more robust post-2025 standards given that the industry has “a whole laundry list of things they’ve asked for.”18  Such sentiments signal a shifting balance of political power in favor of the industrial sector.

Possible scenarios include the following: 

NHTSA could argue that the Energy Policy and Conservation Act of 1975, which established national fuel economy standards, preempts California’s authority to administer the ZEV program, which is closely tied to fuel economy.  Alternatively, EPA could revoke California’s waiver, essentially halting the ZEV program.  As occurred during the George W. Bush Administration, such actions almost certainly would result in litigation.  The Trump Administration might welcome such a legal battle with California as both a political statement and negotiating tactic.

To avoid the prospect of litigation, the Trump Administration could work with congressional Republicans to pressure auto-state Democrats to remove the prerogative of any individual state, including California, to regulate tailpipe emissions.  This can be done outside of a formal amendment of the Clean Air Act; for example, such a measure could be included in a spending bill.  Regardless of the outcome, the process could prove highly advantageous to Republicans in the 2018 midterm elections, in which

four Senate Democrats are seeking reelection in auto-manufacturing states won by President Trump in 2016, and three in other industrial states won or closely contested by President Trump.

Especially in light of efforts to reduce domestic federal spending, the Trump Administration, under the Congressional Budget and Impoundment Control Act of 1974, could exercise impoundment or rescission authority on projects in California.

Conclusion

Champions of pro-industrial policies appear to hold a stronger political position than commonly assumed.

Especially as right-of-center and other pro-industrial decision makers more fully recognize the cost-benefit ratio of the ZEV program, this dynamic likely will make a negotiated settlement more attractive to the environmentalist community than their current rhetoric suggests.  If the Democratic Party seeks to rebuild support in the industrial Midwest, then balancing environmentalist ideals with electoral considerations will produce policy consequences.

1 Clean Air Act, U.S. Code 42 (1990) § 7543(b). Note that California already had clean air standards in place when the federal government adopted the Clean Air Act.

2 Clean Air Act, U.S. Code 42 (1990), § 7507.

3 States adopting California’s ZEV program are colloquially referred to as Section 177 states for the relevant section of the CAA. Section 177 states include Connecticut, Massachusetts, Maryland, Maine, New Jersey, New York, Oregon, Rhode Island, and Vermont. Pennsylvania and Washington adopted other California vehicle standards but did not adopt the ZEV mandate.

4 “Staff Report: Initial Statement of Reasons for Rulemaking: Proposed 2014 Amendments to the Zero Emission Vehicle Regulation,” State of California Air Resources Board, September 2, 2014, 17, http:// www.arb.ca.gov/regact/2014/zev2014/zev14isor.pdf.

5 “California’s Advanced Clean Cars Midterm Review,” State of California Air Resources Board, January 18, 2017, https://www.arb.ca.gov/msprog/acc/mtr/acc_mtr_finalreport_full.pdf.

For further details on the ZEV program, please see: California Code of Regulations, Title 13, Sections 1962.1 and 1962.2.

6 Baron analysis of statements issued by CARB and Tesla reveals that the market price of ZEV credits has been between $2,400 and $3,900 per credit since 2014, in line with other researchers’ estimates. The market price for ZEV credits is likely to increase significantly because fewer ZEV credits will be disbursed beginning in 2018 (reduced supply) while ZEV targets will only increase (increased demand).

7 This assumes that an EV similar to a Tesla Model 3 earns three ZEV credits per vehicle sold, is rated at 100 mpge by EPA, and displaces a vehicle rated at 25 mpg by EPA. This estimate uses the Obama Administration’s estimate for the social cost of carbon of $37 per ton of CO2. See Howard Shelanski, “Refining Estimates of the Social Cost of Carbon,” The White House, November 1, 2013, https://www. whitehouse.gov/blog/2013/11/01/refining-estimates-social-cost-carbon.

8 “Monthly monitoring of vehicle fuel economy and emissions,” University of Michigan Transportation Research Institute, November 8, 2017, http://www.umich.edu/%7Eumtriswt/EDI_sales-weighted-mpg.html.

9 Baron analysis of state-level vehicle registration data from the Bureau of Transportation Statistics, monthly new vehicle sales data from The Wall Street Journal, state-level new vehicle sales data from the Alliance of Automobile Manufacturers (AAM), and IHS Automotive reports of most popular vehicles by states.

10 Mark Phelan, “Survey: Republicans prefer pickups, Democrats want SUVs,” Detroit Free Press, November 8, 2016, http://www.freep.com/story/money/cars/2016/11/08/survey-republicans-prefer-pickups-democrats-want-suvs/93464090/.

11 Vaclav Smil, “Electric Vehicles Aren’t Taking Over Our Roads as Fast as Hype Artists Claim,” IEEE Spectrum, December 2017, 24, http://ieeexplore.ieee.org/stamp/stamp.jsp?arnumber=8118478.

12 California Auto Outlook, May 2017 (Volume 13, Number 2), 5.

13 “Staff Report: Initial Statement of Reasons: 2012 Proposed Amendments to the California Zero Emission Vehicle Program Regulations,” California Environmental Protection Agency Air Resources Board, December 7, 2011, 60, http://www.arb.ca.gov/regact/2012/zev2012/zevisor.pdf.

14 These figures assume that ZEV credits are valued at $3,500 each, and that the maximum number of credits that can be earned per electric vehicle sold is four. Previously, electric vehicles could earn more credits, and credit values have been higher than $3,500, so the estimated subsidy presented here is far from the highest it has been.

15 Christian Prenzler, “New survey compares demographic of Tesla Model X vs. Model S buyer,” Teslarati, January 12, 2017, https://www.teslarati.com/survey-model-x-owners-income-double-model-s/.

16 Baron analysis of ZEV registration data from AAM and data on the contribution of the automotive industry to the economies of individual states from the Center for Automotive Research (CAR).

17 Ryan Beene and John Lippert, “California Considers Following China With Combustion-Engine Car Ban,” Bloomberg, September 26, 2017, https://www.bloomberg.com/news/articles/2017-09-26/ california-mulls-following-china-with-combustion-engine-car-ban.

18 John Lippert and Ryan Beene, “California Sets Demands for Auto-Emission Talks With Trump,” Bloomberg, September 22, 2017, https://www.bloomberg.com/news/articles/2017-09-22/california-sets-demands-for-talking-emissions-targets-with-trump.