How much should you pay for fuel economy?
In March, as fuel prices were just at the start of what was to become an incredible two-month 60% increase, interest in the question was high (and I blogged on it). Gasoline held at roughly $3.00 per gallon until a week before Labor Day. Are we re-examining the value of hybrids simply because the price of regular gasoline today is up 90% since 2002 instead of being up 100% since 2002? If so, that does not make much sense.
Why? Because even if we ignore nonpecuniary advantages of hybrids there is no direct connection between the current price of gasoline and the current value of hybrids. The current value of a hybrid vehicle over (or under) the current value of a conventional vehicle is not determined by the current price of gasoline.
Instead, the current (pecuniary) value of a hybrid vehicle over (or under) the current (pecuniary) value of a conventional vehicle is determined by the expected future price of gasoline. The typical car is driven more than 150,000 miles before it reaches its final destination (the junk yard) at age 14. That’s a long trip (from dealership to junk yard is equivalent to driving around the planet Earth at its equator six times; or driving around the (former) planet Pluto it its equator 33 times), and it’s all in the future.
To help car shoppers, I have estimated the value of fuel economy at various fuel economy levels and for a range of plausible future fuel prices and created today’s chart. It works as follows:
Suppose you are trading a car with 25 mpg and considering two cars with three different levels of (actual on-the-road average for your driving style) fuel economy: 35 mpg, and 45 mpg. How much more should you be willing to pay for the 45 mpg car than you are willing to pay for the 35 mpg car? The answer is that you should pay between $1,270 and $3,950.
Here’s how to compute it:
Average the top numbers for the cars ($489+$301)/2= $395. This is the most you should pay for one MPG, and since you would get 10 more with the 45 MPG car than with the 35 MPG car, you should pay no more than $3,950.
Average the bottom numbers for the cars ($157+$97)/2= $127. This is the least you should pay for one MPG, and since you would get 10 more with the 45 MPG car than with the 35 MPG car, you should at least $1,270.
I defined expectations about future prices of fuel in terms of the real price per gallon of regular gasoline half-way through the life of the vehicle: 7 years out. The extremes I chose were $1.50 and $6.50 per gallon. You should be willing to pay more, the higher your 7-year-out fuel price forecast.
Walter is the Director of the Automotive Analysis Division of the University of Michigan Transportation Research Institute (UMTRI). He studies the adoption by consumers and automakers of new powertrain (electric, hybrid, clean diesel, fuel cell, alternative fuels), safety, and telematics technologies. Walter worked for General Motors for 9 years in sales forecasting, product development, marketing, and manufacturing (1993 found him on the floor of one of GM’s component factories). Prior to joining the University, he was Executive Director of Forecasting and Analytics for J.D. Power and Associates. He earned his doctorate in Economics from UCLA in 1983.