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Is The U.S. Missing Out On Diesel Fuel Economy Benefits?

 May 15, 2012 12:37 AM

(By Manikandan) Automakers may have to rely increasingly on diesel technology given the fuel economy benefits and upcoming tougher Corporate Average Fuel Economy (CAFE) standards, which will be effective from 2017.

However, the Detroit 3 are currently disadvantaged compared to their European counterparts with respect to diesel. Consumer demand, CAFE benefits, and stronger financial positions mean D3 should invest in diesel, which is a key piece of the changing powertrain landscape.

"We could see a diesel engine supply push (especially from European automakers) over the next 5 years. This makes sense based on diesel fuel economy benefits (30-35%) in an effort to meet tougher CAFE standards," RBC Capital Markets analyst Joseph Spak wrote in a note to clients.

A change to U.S. fuel tax policy would meaningfully aid diesel penetration, while automakers are expected to lobby for a return of clean-diesel tax credits.

Meanwhile, a meaningful diesel adoption in the U.S. largely depends on a change in emission standards, a change to the current gas/diesel tax structure, or a return of clean diesel tax credits. The first two options are a larger battle and unlikely, but automakers/consumers could lobby for tax credits.

"This would make sense from a fuel economy perspective but this could inherently disadvantage Ford, GM, and Chrsyler versus their European counterparts who would be able to leverage their current diesel investments," Spak said.

Still, the market has seen this before with prior hybrid credits which primarily aided Toyota (NYSE:TM). If diesel demand were to increase, Detroit 3 could enter engine alliances as General Motors Co. (NYSE:GM) has already started the trend by signing a deal with Italy's PSA.

U.S. light vehicle diesel penetration is low at 3 percent versus Europe's 50 percent, due to higher taxes and U.S. emissions standards that require greater emissions content. Compared to other countries, U.S. diesel taxes are higher than gas.

"In our view, if U.S. fuel taxes move closer to global averages, we would see a meaningful pickup in diesel penetration," the analyst added.

With a change in fuel tax policy unlikely in the near term, a return of the diesel tax credits that expired in 2012 could make sense. Even without credits, diesel has a quicker payback than hybrids, plug-in hybrids, and electric vehicles, the latter two of which still have subsidies.

In addition, tougher CAFE standards likely means increased diesel penetration anyway as U.S. diesel penetration could increase to 4–5 percent from 3 percent over the next five years. Spak noted this could prove conservative as some industry experts predict 10 percent penetration by 2015. As a reminder, light vehicles need to hit 35.5 miles per gallon (MPG) CAFE standard by 2016 and 54.5 MPG by 2025.

The new CAFE standards would be a welcome change for consumers, who are spending about $4 a gallon gas and accounts for a significant share of their monthly budget.

Currently, the average U.S. household buys more than 1,100 gallons of gas per year. At $4 per gallon, that means the average household spends $4,400 per year just on gasoline, according to Natural Resources Defense Council (NRDC). NRDC says that by 2025, the new 54.5 mpg fuel standard will save consumers $4,400 over the lifetime of their vehicle, and the nation could save $200 billion by 2030.
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