Saving the Environment or Killing Detroit?

Jan. 27, 2009— -- Will cleaner air take the wind out of automakers' sails?

That's the question many are now asking after President Barack Obama took sweeping action Monday to reduce the amount of pollution that new American cars will be allowed to spew.

His move to curb auto emissions might be great for the environment, but several analysts said it's the last thing struggling automakers need.

"It's crippling in terms of its cost to the automakers," said Ron Harbour, a Detroit-based auto industry analyst with the consulting firm Oliver Wyman. "At this time, when all the automakers are gasping for air -- particularly the domestic ones -- it's a tough time to force that down their throat."

California, followed by 13 other states -- Arizona, Connecticut, Maine, Maryland, Massachusetts, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Vermont and Washington -- has sought to impose tougher tailpipe emission standards than the federal government had in place.

The Environmental Protection Agency, under former President George W. Bush's administration, blocked California from imposing the stricter standards.

Obama has now asked the EPA to reconsider that decision.

"At a time of such great challenge for America, no single issue is as fundamental to our future as energy. America's dependence on oil is one of the most serious threats that our nation has faced. It bankrolls dictators, pays for nuclear proliferation and funds both sides of our struggle against terrorism," Obama said. "It puts the American people at the mercy of shifting gas prices, stifles innovation, and sets back our ability to compete."

California's emissions rules would have cut vehicles' greenhouse gas emissions by 30 percent between 2009 and 2016. Since California is the largest car market in the country and it is cheaper to build one model of each car per nation, automakers would essentially have to change their entire lines to meet California's rules. Detroit resisted such a change, in part because of the cost associated with developing more-efficient vehicles.

"We hold no illusion about the task that lies ahead. I cannot promise a quick fix. No single technology or set of regulations will get the job done," Obama said. "But we will commit ourselves to steady, focused, pragmatic pursuit of an America that is freed from our energy dependence and empowered by a new energy economy that puts millions of our citizens to work."

California and the Environment

California Gov. Arnold Schwarzenegger, a Republican, Monday called the Democratic president "a strong ally" for California and the environment.

"Allowing California and other states to aggressively reduce their own harmful vehicle tailpipe emissions would be a historic win for clean air and for millions of Americans who want more fuel-efficient, environmentally-friendly cars," Schwarzenegger said in a statement.

The automakers were mostly silent on the issue, speaking through their trade group, the Alliance of Automobile Manufacturers, which called for "compliance clarity and one national standard."

"The Alliance supports a nationwide program that bridges state and federal concerns and moves all stakeholders forward, and we are ready to work with the administration on developing a national approach," Dave McCurdy, president and CEO of the group, said.

Regardless of whether this is a good or bad move, if California's regulations take effect, roughly 80 percent of the vehicles on the market today could not be sold in the state, according to Harbour.

"The people that live in those states would have their selection of vehicles, that they could buy from the dealer, dramatically reduced," he said.

The automakers would also have to pump billions of dollars -- dollars that they just don't have -- into research, development and new production facilities.

Harbour said a hybrid car today can cost $3,000 to $8,000 extra to produce. Most of that cost can't be passed on to the consumer.

"Fuel economy and emission are an important buying criteria but in this type of economy, people just want the best deal," Harbour said. "In the era of low-cost gas … people make a decision more on what vehicle they want in terms of size and comfort."

Cost of Fuel Efficient Cars

That might not necessarily be the most fuel-efficient car.

Craig Fitzgerald, an auto analyst at Plante & Moran PLLC, said this measure "adds a new layer of cost and complexity to a period when a lot of [manufacturers] are struggling to figure out how they're going to meet current standards."

Fitzgerald said estimates of the new costs are between $50 billion to $100 billion.

He added that these measures would either be "far too rigorous and expensive" or "difficult to logistically manage."

Stephen Spivey, a senior auto industry analyst with Frost & Sullivan, said the significant costs of this new measure should be subsidized.

"There are two questions that we're dealing with," Spivey said. "Can we actually make vehicles that are fuel-efficient and, if we made them, would people buy them?"

The demand for the more fuel-efficient cars has a direct relationship to gas prices, he added.

"Our assumption is that fuel prices are going up, and on that assumption, we believe people will buy the cars," Spivey said.

Fitzgerald said auto industries believe that larger vehicles generate more profit.

"If the vehicle grows in size, it doesn't necessarily grow proportionally in cost," Fitzgerald said. "A bigger vehicle adds more convenience and options that improve the profitability of the vehicle. Conversely, if you shrink the vehicle, you're taking options and profits out."

The new standards will require industries to move toward these smaller models, which Fitzgerald said will shrink both the market and profits.

"It will require massive changes in vehicles," Fitzgerald said. "It will take tens of billions of dollars that [automakers] don't have right now."