Monday, October 29, 2007

The Battle of the Green Cars: Tax Credits, Price of Gasoline and Environmentalism

How costly is it for a "green" consumer to vote with her wallet? As this article reveals, the tax subsidy for buying a hybrid is being phased out for vehicles made by Toyota and Honda. Who will bear the incidence of this subsidy phaseout? In english, will the price of these vehicles fall? Will such vehicles be much less profitable? Were tax incentives really the reason that the Prius "took off"?

The article claims that the Prius "paysoff" in 18 years but this hinges on how many miles a household drives, their discount factor and the yearly price of gasoline. The article could have been more subtle about identifying different types of households; If I drive 20,000 miles per year and the interest rate is 0% and if the price of gasoline (inflation adjusted is $5 per gallon) and if the hybrid achieves 50 MPG and lives for 15 years, then over 15 years;

20000/50 = 400 gallons of gas per year if I own a Prius = $2000 a year in gas expenditure; the PDV of $2000 a year for 15 years = $30,000

In comparison , if the conventional vehicle I would have bought got 25 MPG, then
20000/25 = 800 gallons * 5 = $4,000 per year for 15 years = $60,000 gas bill

I realize that I'm ignoring the rebound effect here but I point is that the hybrid is a pretty good deal for this specific consumer in this price environment. How many consumers are like this guy? Note that he didn't need a tax incentive to buy the Prius. Note, that he wasn't an environmentalist! The guy was solving a cost minimization problem not a utility maximization problem. So, there are 2 types of hybrid buyers; the people who drive a lot and the environmentalists. This WSJ author hasn't thought enough about the heterogeneity here and how this aggregates to determine aggregate market shares for the "green" product.

Environment (A Special Report) --- The Economics of Hybrids: For most U.S. consumers, they're still a money-losing proposition
By Mike Spector
1706 words
29 October 2007
The Wall Street Journal
(Copyright (c) 2007, Dow Jones & Company, Inc.)

It's getting a lot easier to buy a hybrid -- but not necessarily cheaper.

Amid heightening concerns over America's proclaimed oil addiction, skyrocketing fuel prices and global climate change, auto companies are making more gasoline-electric hybrid cars and giving consumers more choices than ever before.

But marketplace dynamics in the U.S. -- including higher prices charged by the car companies, dwindling tax credits given to fuel-efficient cars and low gasoline taxes -- haven't yet allowed a hybrid or other more-efficient vehicle to become an economical choice for many consumers.

In Europe, by contrast, several countries offer significant tax breaks to people who buy more-efficient vehicles. And high fuel taxes also are propelling Europeans to invest in a more-efficient ride.

There are several hybrids on the market now, using different technologies. But basically, a hybrid consists of a traditional internal-combustion engine paired with an electric motor. The electric motor gets its power from a storage battery, which is replenished by a recharging system within the car's powertrain. Electric motors boost power to the gas engine, allowing manufacturers to install smaller -- and thus more-efficient -- motors in these cars. Most hybrids sport four-cylinder engines as opposed to the six- or eight-cylinder motors found in many vehicles.

There are essentially two types of hybrids on the mass market today, often dubbed "mild" or "full" hybrids, each with fuel-sipping and emission-curbing features. A mild hybrid shuts off the engine at a full stop; uses regenerative braking, which utilizes dissipated energy from braking to recharge the battery; and uses the electric motor to help power the gas engine.

A full hybrid does all of those things, but adds another big fuel-saving feature: electric-only driving, in which a vehicle runs on the electric engine alone at low speeds. That's why hybrids get better mileage in city driving than high-speed highway cruising. The laws of physics still apply, so you shouldn't expect a hybrid SUV to get incredible mileage. But it
will get better mileage than its gasoline counterpart.

Hybrids are currently the most popular green vehicle choice in the U.S. In the first seven months of this year, new hybrid-vehicle registrations nationwide rose 49% from the year-earlier period to 215,997, according to R.L. Polk & Co., an automotive-research firm in Southfield, Mich. Hybrids make up about 2% of the U.S. light-vehicle market.

Economics are still getting in the way of greater adoption, however. One reason is the tax system. Americans get a tax break for buying hybrids -- the starting amount varies by model -- but the more hybrids an auto maker sells, the smaller the tax break becomes on any hybrid models from that maker. After a manufacturer sells its 60,000th hybrid, the tax break starts to phase out. Buyers can claim the full credit during the calendar quarter after the quarter in which the manufacturer reaches the 60,000 limit. Then, the credit is sliced in half. It is reduced by half again after another six months. Six months after that, the credit disappears.

Toyota Motor Corp.'s popular Prius, for instance, once garnered a $3,150 credit. But Toyota sold its 60,000th hybrid in the second quarter of 2006. So starting Oct. 1 of last year, the credit dwindled, and today it's gone. That means consumers no longer get the tax break for buying a Prius, or hybrid versions of some of the Japanese auto maker's other models: the Camry, Lexus GS 450h, Lexus RX 400h SUV, Highlander SUV and the Lexus LS 600h L sedan.

Honda Motor Co.'s credits also will decline soon as the Japanese auto maker has just recently exceeded the sales cap. Other hybrids from General Motors Corp. and Ford Motor Co. should retain their full credits for some time amid lower sales volumes.

In Europe, by contrast, several countries offer significant tax breaks. In Belgium, for example, drivers get 15% of a car's price back -- maxing out at 3,280 euros ($4,640) -- if the vehicle emits less than 105 grams of carbon dioxide per kilometer, according to the European Automobile Manufacturers Association. Cars that emit between 105 grams and 115 grams get a 3% break; vehicles emitting more than 115 grams don't get anything.

Europeans also face high fuel taxes, encouraging them to buy more-efficient cars. And diesel is specifically taxed at a lower rate -- diesel engines are about 30% more efficient than their gasoline-powered counterparts because of the higher energy content in diesel fuel and the more-efficient combustion process in the engine. Diesel autos make up about half of the European market, compared with about 1% in the U.S.

Even taking a tax credit into account, U.S. consumers have to pay more when buying a hybrid because the vehicles use a lot of expensive technology. Between large battery packs and complex transmissions that join gasoline engines with electric motors, hybrids can cost anywhere from $2,000 to $7,000 more than comparable nonhybrid cars.

Take GM's Saturn VUE Greenline sport-utility vehicle, which sells for $1,300 more than its gasoline-engine only counterpart after factoring in a tax credit, according to, an auto-research firm. (This and other specific comparisons are for 2007 models.) It would take nearly five years to recoup that premium in savings at the pump with gas around $2.79 a gallon, according to Edmunds, assuming you drove about 15,000 miles a year. If higher taxes increased gas prices to about $6 a gallon -- roughly the price in Europe -- it would take about two years.

The VUE Greenline gets about 27 miles per gallon in combined city and highway driving, a
good uptick from the four-cylinder, front-wheel drive gasoline-engine version, which gets about 23 mpg.

Toyota's Prius, which gets a leading 46 mpg combined but no longer qualifies for the tax credit, costs over $7,000 more than the auto maker's compact Corolla. It would take nearly 18 years to recoup the premium, or more than twice the time you might expect to own it. Even with a more favorable comparison to the less-efficient Camry sedan -- which costs about $4,200 more -- Prius owners would still need about 6.5 years to get their money back in fuel savings.

That means the Prius isn't necessarily an economical buy despite its superior mileage. "If you want to save money on fuel, just buy a car with better gas mileage," says Jeremy Anwyl, chief executive of Edmunds.

Some hybrids are geared more toward performance than efficiency. The prime example is the Lexus LS 600h L sedan, which has a V8 engine in its hybrid drivetrain. The car, priced at more than $100,000, marks Lexus' attempt to market a super-luxury car with added hybrid cachet for wealthy consumers who have a green streak. The sedan gets just 21 mpg in combined city/highway driving, better than a comparable BMW model but a bit worse than the less-expensive Lexus GS 450h.

Auto dealers say consumers had unrealistic expectations about the economics of hybrids two years or so ago, but have adjusted and now tend to buy the vehicles to make a statement.

Earl Hesterberg, chief executive of Houston-based Group 1 Automotive Inc., a large nationwide dealership chain, says a typical reaction from hybrid buyers used to be: "Hey, this thing really does still use fuel." But now consumers are more educated, he says. "The majority of people just want to feel better about themselves and that they're trying to make some effort to be more green, be more socially responsible, reduce their carbon footprint."
One long-term consideration when buying a hybrid is the relatively untested maintenance history of battery packs. If a hybrid battery fails, it will be quite expensive to replace -- likely at least $5,000 and perhaps as high as $10,000 depending on the drivetrain's complexity, says Jack Nerad, editorial director of auto research firm Kelley Blue Book.

Fortunately, hybrids have experienced few, if any, major repair problems over the past few years. And while consumers may consider these vehicles new, they've actually been in production for a while, giving manufacturers time to refine them. The first Prius hit the road in 1997 in Japan and came to the U.S. in 2000.

Most hybrids come with long warranties on their powertrain technologies -- eight years or 100,000 miles for the Prius -- that cover potential foul-ups. Still, after the warranties end, it's unclear what problems might crop up in an expensive battery pack. There's no experience with this since few, if any, people have owned a Prius for more than eight years.

A spokesman for Toyota says the company placed extended warranties on the Prius to address just such uncertainty but adds that issues with the vehicles' batteries have been "virtually nonexistent." He says the company actually expects Prius batteries to live well beyond the eight-year warranty.

Auto makers are gradually pushing toward electric plug-in hybrids, which will allow drivers to recharge a battery with a traditional outlet and go much further on electric power alone.

Such cars could be a "game changer" that eventually displaces conventional hybrids, says Mike Jackson, chief executive of AutoNation Inc., of Fort Lauderdale, Fla., a nationwide dealership chain.

Another fuel-saver on the horizon: diesel.

Many Americans think of diesel engines as noisy and dirty, but the introduction of cleaner diesel fuel in the U.S. that can meet tough emissions standards promises less pollution and wider use. Auto makers are ramping up plans to put diesels in light-duty pickup trucks and passenger cars. And auto companies eventually may employ diesel-hybrids to really boost fuel economy.