HYDROGEN FUEL CELL VEHICLES

SHOULD THE UNITED STATES SUBSIDIZE FUEL CELL ADOPTION?

DANA LEONA ANDREESCU

RUSSELL GERMICK

BRET KADISON

JENNIFER POPPER

KREGG RADUCHA

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DANIEL WINTON

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TABLE OF CONTENTS

INTRODUCTIONEXECUTIVE SUMMARY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 01

PROBLEM STATEMENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 01

CURRENT OUTLOOKFOSSIL FUEL TRANSPORTATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XX

U.S. TRANSPORTATION NEEDS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXFUEL SUPPLY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXFUEL DEMAND. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XX

FUEL CELL VEHICLE (FCV) ALTERNATIVE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXHISTORY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXCOMPARISON WITH INTERNAL COMBUSTION VEHICLES (ICVs) . . . . . . . . . . . . . .…. XX

ECONOMIC ANALYSISGASOLINE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XX

CURRENT COSTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXEXTERNAL COSTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XX

FUEL CELL VEHICLE TECHNOLOGY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XX

HYDROGEN. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XXHYDROGEN PRODUCTION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXHYDROGEN INFRASTRUCTURE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XX

CURRENT FCV POLICIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXPUBLIC INVESTMENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XXPRIVATE INVESTMENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXFCV AND ICV COST TREND ANALYSIS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XX

POLICY ALTERNATIVESOPTIONS AND IMPACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... . . .XX

CAFE STANDARDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XXFULL PIGOVIAN TAX ON GASOLINE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XXPARTIAL PIGOVIAN TAX ON GASOLINE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XXR&D SUBSIDIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XX

CONCLUSION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XX

RECOMMENDATIONS FOR FURTHER STUDY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XX

APPENDIX

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INTRODUCTION

EXECUTIVE SUMMARY

The United States is heavily dependent on gasoline to fuel its vehicles. Recent price increases and geopolitical events have led the U.S. to question whether this dependence is a sustainable strategy. Recent technological innovations have led to the realization that hydrogen fuel cells could become a viable replacement for internal combustion vehicles (ICVs), and thereby diminish U.S. dependency on importers, especially those that might threaten national security.

Currently, artificially low gasoline prices distort consumption decisions and result in inefficient market equilibrium. These prices are low primarily because they don’t reflect the external costs of gasoline consumption – especially pollution and energy security. Since the cost of these externalities is not included in the price, consumers do not account for the true cost of gasoline when making purchasing choices and therefore consume an excessive amount.

The primary challenge in making the transition from ICVs to hydrogen fuel cell vehicles (FCVs) is their relative market competitiveness. Gasoline’s artificially low price also gives it a relative advantage over hydrogen fuel cells. The use of hydrogen fuel cells, however, eliminates the externalities under consideration and offers a competitive fuel supply if gasoline is priced efficiently. Nevertheless, the current and projected price differential between FCVs and ICVs will result in an inefficiently slow adoption of hydrogen fuel cells absent a change in policy.

To address the market’s failure to efficiently allocate fuel supplies, either a tax to recoup the externalities of gasoline or a subsidy that promotes adoption of fuel cell technology must be implemented. We recommend the United States both raise the federal tax on gasoline to account for specific externalities and continue to provide moderate levels of support for fuel cell vehicle research and development.

PROBLEM STATEMENT

Significant research and development has already begun on hydrogen fuel cells, much of it with support from the U.S. government. Although current costs of a FCV remain prohibitive, costs have fallen dramatically over the past few years and continue to approach competitive viability. Our paper analyzed fuel cell vehicle adoption and considered if it was occurring at an economically efficient pace. Looking forward, we addressed the following question: should the U.S. government subsidize fuel cell adoption?

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CURRENT OUTLOOK

FOSSIL FUEL TRANSPORTATION

U.S. Transportation Needs

The American economy is heavily dependent on its transportation infrastructure. In supporting the American lifestyle, transportation vehicles consume an enormous amount of fuel. Each day, more than 20 million barrels of crude oil provide ninety-nine percent of the fuel used in 200 million American vehicles traveling over seven billion combined miles, as reported by the Energy Information Agency (EIA)1. So closely is GDP growth correlated to a flourishing oil supply that recessions have followed shocks in its supply, such as those following the Arab oil embargo in 1973 and the Iran/Iraq war in 1980.2

Considering this transportation-dependent lifestyle, it is not surprising that radical price swings fail to sway Americans to curb their consumption. Emphasizing this dependency is the relative inelasticity of short-term demand for gasoline versus its price (-.26).3 Furthermore, Americans’ appetite for gasoline continues to grow. According to the EIA’s Annual Energy Outlook 2005 (AEO2005), U.S. consumption is estimated to increase by 1.5% per annum from 2003 – 2025.4 The U.S.’ rising consumption and low demand elasticity, unfortunately, sit in the context of growing uncertainty surrounding the future world oil markets.

Fuel Supply

U.S. domestic supply is expected to fall over the next 20 years while worldwide supply is becoming increasingly concentrated among countries with which the U.S. has tenuous relationships. As the world’s second largest crude oil producer, the U.S. met 38% of its 2003 demand using domestic supplies. The AEO2005 expects total U.S. petroleum supply to peak in 2009, largely due to additional discoveries in the Gulf of Mexico. In 2010, however, U.S. crude oil production is forecast to decline, falling to 82% of current domestic supply levels by 2025. In the context of low demand elasticity and expected consumption growth, total U.S. consumption will increase more rapidly than domestic supply. As a result, domestic sources will only meet 32% of the U.S.’ 2025 demand.

Meanwhile, other players in the world market face changes in their respective domestic needs as well as fluctuations in the production and discovery of crude oil. Table 1 outlines the quantity of oil the U.S. imports from its current top ten suppliers.5

Table 1: Top U.S. Oil SuppliersCountry Bbl/d Country Bbl/d Country Bbl/dU.S. 5.7M 4 Venezuela 1.2M 8 United Kingdom 0.4M

1 Saudi Arabia 1.7M 5 Nigeria 0.8M 9 Kuwait 0.2M2 Mexico 1.6M 6 Iraq 0.5M 10 Norway 0.2M3 Canada 1.5M 7 Angola 0.4M Total OPEC 5.2M

1 International Petroleum Monthly, July 2004, Energy Information Administration.2 U.S. Business Cycle Expansions and Contractions, National Bureau of Economic Research; Annual Energy Review 2003 Report No. DOE/EIA-0384 (2003), Energy Information Administration.3 Reducing Gasoline Consumption: Three Policy Options: Congressional Budget Office, November 20024 The AEO2005 uses its National Energy Modeling System (NEMS) to provide a 20 – 25 year outlook on energy-related activities, including transportation demand.5 EIA, AEO 2005

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The Organization of Petroleum Exporting Countries (OPEC)6 produces 39% of the world’s oil and holds almost 66% of its reserves. Since it was organized in 1960, OPEC has tried to keep world oil prices at a target level by setting an upper production limit on its members. OPEC has the potential to influence oil prices world- wide because its members possess such a great portion of the world’s oil supply.7 The AEO2005 projects that OPEC’s total oil production will increase by 80% by 2025. Over the same time period, non-OPEC oil production is expected to increase by only 41%. As a result, OPEC will meet an increasing amount of world petroleum demand as its production increases more rapidly than other producers.

Fuel Demand

Competition for imports is expected to continue to increase. World petroleum demand is expected to increase from 80 million barrels per day (bbl/d) in 2003 to more than 120M bbl/d in 2025. Top consumers and importers, as of 2003, are depicted in Table 2.8

Table 2: Top World Oil Consumers and ImportersTop World Oil Consumer, 2003 Top Net Oil Importer, 2003

Country Bbl/d Country Bbl/d1 United States 20.0M 1 United States 11.1M2 China 5.6M 2 Japan 5.3M3 Japan 5.4M 3 Germany 2.5M4 Germany 2.6M 4 South Korea 2.2M5 Russia 2.6M 5 China 2.0M6 India 2.2M 6 France 2.0M7 South Korea 2.2M 7 Italy 1.7M8 Canada 2.2M 8 Spain 1.5M9 Brazil 2.1M 9 India 1.4M10 France 2.1M11 Mexico 2.1M

*Table includes all countries that imported more than 1 M bbl/d in 2002.

Developing nations currently have much smaller energy needs than the U.S.; China, India and South Korea collectively consume 10.0M bbl/d compared to the U.S.’ 20M bbl/d. These countries, however, are expected to increase consumption at a rate of 75% – 150%, or 17.4 – 25.2 million bbl/d combined, by 2025.9 This rate outstrips U.S. consumption growth, which is expected to increase by a relatively modest 40%, or 27.8 million bbl/d, over the same period. In addition to developing countries, many exporters are also facing increasing domestic demands. As a result, they have become increasingly unable to export crude oil. For example, Canadian supply has been a boon to rising demand in the U.S., supplying approximately 40% of consumption increases during 1986 – 2000. In 2003 Canada supplied a total of 6.6% of U.S. demand. Due to the country’s growing domestic needs and depleting supply, however, Canada’s National Energy Board reported it expects to decrease total exports by 2% per annum. Overall, the worldwide market is experiencing a tightening supply, an increased demand for imports and an increasingly influential OPEC. In combination, these factors combine to threaten the United States’ energy security. Among the most relevant benefits of energy security is the avoidance of

6 OPEC’s members are Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, UAE, and Venezuela.7 EIA, http://www.eia.doe.gov/neic/brochure/oil_gas/primer/primer.htm8 EIA, AEO 20059 International Energy Outlook 2004, Energy Information Administration.

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macroeconomic losses from higher oil prices when there are no political disruptions to supplies. Many analysts argue the U.S. would be less vulnerable to such disruptions if it used less oil.10

FUEL CELL VEHICLE ALTERNATIVE

History

The concept of fuel cells dates back to 1839 when Sir William Grove identified the potential to generate electricity through reversing the electrolysis of water. Based on this concept, his successors tried to develop energy cells that would convert fuel, such as air, coal, and carbon, into electricity and water. Two such scientists, Charles Langer and Ludwig Mond, coined the term “fuel cell.”11 A fuel cell is an electrochemical energy conversion device, which generates electricity by separating the fuel (usually hydrogen) into protons and electrons using a catalyst. While the protons from the fuel are then combined with oxygen to form water, the electrons flow from the anode to the cathode and create electricity. A diagram of this process can be found in the Appendix, Figure A1. While many electrochemical devices, such as batteries, are exhausted when their internal chemical fuel supplies are consumed, fuel cells generate electricity indefinitely provided a constant source of hydrogen and oxygen.

The push for the technology’s growth diminished after the fuel cell initially lost out to the internal combustion engine in the race to the market place as a commercially viable energy source. Focus on the technology renewed in the 1950s, when NASA started to fund advanced fuel cell development as a means of providing electricity during space missions. Over time, impressive gains have been made in cost, size, and energy density. Most recently, Toshiba unveiled a compact direct methanol fuel cell weighing 8.5 grams that generates 100 milliwatts of power and stated an intention to “. . . develop even more compact, more efficient [fuel cells].”12 Table 3 outlines characteristics of common fuel cell types today, of which the proton exchange membrane fuel cell is the most developed candidate for vehicular use.13

Table 3: Characteristics of Common Fuel Cell Types

Type Fuel (A – Anode, C-Cathode) Efficiency Notes

Proton Exchange Membrane

A – HydrogenC – Pure/ Atmospheric Oxygen

35–60%Recent advances have brought cost per kW <$3,000. Suited to vehicular power. Operating temperature ~75°C

Direct Methanol

A – Methanol Sol’n In Water C – Atmospheric Oxygen

35–40%Like proton exchange fuel cell, with methanol instead of hydrogen. Suited to vehicular power. Operating temperature ~75°C

AlkalineA – Hydrogen C – Oxygen

50–70%Limited use because its fuel process destroys costly catalyst Suited to space shuttles. Operating temperature ~<80°C

Phosphoric Acid

A – HydrogenC – Atmospheric Oxygen

35–50%In commercial use since 1992 due to reliability and efficiency. Suited to small stationary power generation. Operating temperature ~210°C

Molten Carbonate

A – Hydrogen, MethaneC – Atmospheric Oxygen

40–55%Highly efficient, but high operating temperature makes them suitable only for large stationary uses. Operating temperature ~650°C

Solid OxideA – Hydrogen, MethaneC – Atmospheric Oxygen

45–60%Suited to industrial applications requiring superheated steam. May be commercially competitive by 2007. Operating temperature ~800–1K°C

10 Reducing Gasoline Consumption: Three Policy Options: Congressional Budget Office, November 200211 http://www.sae.org/fuelcells/fuelcells-history.htm12 http://www.toshiba.co.jp/about/press/2005_02/pr2801.htm13 Rocky Mountain Institute

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Comparison with ICVs

FCV have many advantages over ICVs. Energy-wise, FCVs are nearly thrice as efficient so that, when fully developed, their ability to power transportation will be exponentially greater. FCVs generate direct current to power a range of electric devices without undergoing an inefficient energy conversion process. This represents a savings over the combustion system, which can only generate electricity from mechanical work powered by burning fuel. The effect fuel cell power has on vehicle design offers similar efficiencies. The FCV is predominantly controlled electronically and, as a result, has only 1/10 the moving parts of an ICV drastically reducing maintenance costs. A FCV ‘generator’ is merely a stack of individual fuel cells. To increase power, more fuel cells are simply added to the stack. Consequently, FCV assembly is highly scalable. This radically simplified production represents significant costs savings, which can be passed on to the consumer. FCVs also offer nearly soundless propulsion, reducing noise pollution near heavily traveled arteries.

Most significantly, fuel cell power offers an important and differentiating environmental factor. In bypassing combustion in the process of combining hydrogen and oxygen to generate electricity, fuel cells produce no pollution and instead generate a harmless byproduct – water. However, hydrogen does not replace gasoline as a source of fuel. Instead, it is actually a storage medium. Hydrogen consumes energy in its production and delivers it to the fuel cell and is not, in itself, a source of energy.

Consequently, if fossil fuels such as coal or natural gas are used to produce hydrogen from the electrolysis of water, the environmental benefits will be minimized or unrealized. Although problematic for environmental reasons, they at least offer an alternative to dependency on crude oil imports. However, energy sources ranging from nuclear to wind power can also be used which offer an equally diverse array of environmental impacts. This ability to use competitive sources creates an opportunity to diminish the influence on energy markets of bodies such as OPEC. Granted fuel sources like natural gas will require importation, but that can be from friendly and stable countries such as Canada or Russia. Furthermore, a greater number of sources will reduce the power of any one supplier. An adoption of renewable primary energy sources would lead to the greatest decrease in dependence on foreign energy supplies. In light of these considerations, hydrogen offers a noteworthy alternative to oil consumption. It can increase the balance of payment deficit, reduce the depletion of natural resources, and reduce the unwelcome dependence on imported oil.

However, hydrogen faces infrastructure issues: production, delivery, and storage – already overcome in the gasoline industry – which challenge its commercial practicality. In the near term, these issues hamper the viability of FCVs. FCV-ready hydrogen production is currently energy intensive and costly compared to motor gasoline production. No infrastructure exists specifically to reach FCV drivers and hydrogen suppliers in the well-established chemical and industrial markets cannot easily modify their distribution to meet this need. The result is that, considering production, distribution and consumption of fuel, FCVs require about 9000 BTU of energy per mile driven, compared to 7000 BTU/mile for ICVs14. Not the least of the problems is the current lack of a set of national standards for a hydrogen fuel use, inhibiting efficient engineering development. As a result, considerable innovation and infrastructure development is required to make the use of hydrogen-dependent fuel cells feasible.

Hydrogen storage presents another problem due to its low-energy density, which implies that large volumes of hydrogen are required to generate power. Consequently, researchers are developing hydrogen containers capable of withstanding the high pressure necessary to store

14 Well-to-Wheel Energy Use and Greenhouse Gas Emissions of Advanced Fuel/Vehicle Systems – North American Analysis-, General Motors Corporation, Argonne National Laboratory, BP, ExxonMobil, and Shell; (average of 650-860 g/mile range given for electrolysis)

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large quantities of hydrogen without the risk of leakage. For example, the holding tanks for FCV prototypes are constructed of carbon fiber composite, which is resistant to rupture even during high impact accidents; these tanks are designed to withstand impact 2.25 to 3.5 times their normal operating pressure.15 Hydrogen is highly flammable nature and its relatively low hydrogen-to-air concentration requirement for combustion has called into question its ability to be used safely. However, when handled properly, hydrogen proves to be as safe, if not safer, than traditional automobile fuels. Safety records from hydrogen producers over the past half-century support this claim. A recent study found that “the safety of a hydrogen fuel system proves to be potentially better than the demonstrated safety record of gasoline or propane, and equal to or better than that of natural gas.”16 These findings concluded that, in open spaces, the safety of hydrogen fuel cell vehicle collisions exceeds that of present gasoline, propane, or natural gas powered ICVs. Specifically, the study noted hydrogen’s buoyancy17, lower flammability limit, and lower detonation limit as major contributors to the forecasted safety of hydrogen as a fuel. Because of the greater efficiency of fuel cells, FCVs are forecast to carry less energy overall, reducing total damage potential from an explosion. Note that even the white elephant of hydrogen safety, the Hindenburg itself, was coated with cellulose acetate filled with aluminum powder, a good rocket fuel, which most likely was ignited by static electricity from lightening in the area at the time of the landing in Lakehurst, New Jersey.18

Moreover, hydrogen is not toxic and will not contaminate the environment like a propane, gasoline, or even a natural gas spill could. Hydrogen's safety record provides no evidence of an unusual safety risk. Liquid hydrogen trucks have carried on the nation's roadways an average 70 million gallons of liquid hydrogen per year without major incident.19 With proper handling, hydrogen should prove to be safe throughout the entirety of its lifecycle.

15 Direct Hydrogen Fueled PEM Fuel Cell System for Transportation Applications: Hydrogen Vehicle Safety Report,” prepared for the U.S. Department of Energy, Office of Transportation Technologies by the Ford Motor Company, Dearborn, Michigan, Report, May 199716 Direct Hydrogen Fueled PEM Fuel Cell System for Transportation Applications: Hydrogen Vehicle Safety Report,” prepared for the U.S. Department of Energy, Office of Transportation Technologies by the Ford Motor Company, Dearborn, Michigan, Report, May 199717 Hydrogen is only 7% as dense as air, so it will rise and dissipate when leakage occurs, rather than pool like gasoline.18 The Hype About Hydrogen, Joe Romm, former US Energy Department's Energy Office of Efficiency and Renewable Energy19 Direct Hydrogen Fueled PEM Fuel Cell System for Transportation Applications: Hydrogen Vehicle Safety Report,” prepared for the U.S. Department of Energy, Office of Transportation Technologies by the Ford Motor Company, Dearborn, Michigan, Report, May 1997

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ECONOMIC ANALYSIS

For our economic analysis, we analyze the current and future costs of FCVs and ICVs over the life of a vehicle. We start with an economic treatment of the total costs associated with gasoline, including its external costs. Afterwards we analyze the costs of production of FCVs, including future improvements based on technological maturity and scale and external economies. Next we analyze the costs of hydrogen production and distribution, including future gains in efficiency. We then summarize present policies in place regarding research and development of fuel cell technologies. We conclude with a cost model that predicts, within a confidence band, the time at which competitive convergence occurs between FCVs with ICVs. We base this model on the results of the preceding sections and correlate its output with observed real world behavior.

Following the present day convergence, we study various economic-based policy recommendations, using our model to estimate their impact on the competitive convergence points. Based on these results, we present our final recommendations.

GASOLINE

Current Costs

Predictions of the next move in gasoline prices garners numerous expert forecasts, which occur to varying degrees of accuracy. In reality, however, for the past 50 years U.S. gasoline prices have remained quite steady and, in fact, have declined modestly in real terms. Recently,

the price of gasoline in the U.S. appears to have reached new heights, but it is still far below the 1981 inflation-adjusted peak of $2.94. Generally, real prices in the U.S. fluctuate between $1 and $2 per gallon, with January 2005 prices averaging $1.83 / gallon. The time series to the left illustrates these trends through 2000.20 Graph A2 in the Appendix further corroborates this trend, showing downwardly trending real prices over the whole twentieth century.

Price fluctuations at the pump are largely accounted for by swings in the price of crude oil, which comprise over 50% of gasoline’s costs. As with many goods, however, gasoline’s price reflects factors other than its

20 Congressional Budget Office (see source below chart for details)

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marginal cost of production and distribution. The illustration to the right shows the major components of U.S. gasoline prices.21 Fundamentally the sum of the components depends on gasoline’s supply and demand conditions, but, in practice, these are affected by regional differences.

For example, distribution costs typically rise with distance from the Gulf of Mexico, and California requires a special reformulated blend that raises refining costs. Federal and state taxes currently comprise almost a quarter of the pump price of gasoline, averaging 44.0¢ per gallon total. In 1997, the 18.4¢ federal gasoline tax per gallon was allocated as follows: 15.44¢ to the Highway Account, 2.86¢ to the Mass Transit Account, and 0.1¢ to the Leaking Underground Storage Tank Trust Fund.22 These taxes compensate for some of the external costs of gasoline. For example, gasoline fueled cars damage roads, but gasoline taxes fund the corresponding necessary repair work. To the extent the Highway Account accurately keeps pace with needed road repairs, the cost of the damage is internalized into the price of gasoline. More pointedly, diesel fuel taxes average 6¢ per gallon higher than gasoline taxes23 in an effort to account for the increased damage to highways caused by the trucking industry. In either case, the cost of the repairs falls solely on the consumer; her/his fuel consumption reflects the amount s/he is willing to pay to maintain the road. The same economic argument applies to the Leaking Underground Storage Tank Trust Fund. The Mass Transit Account portion, economically, can be viewed as an attempt, small as it may be, to internalize the costs of congestion; i.e., to keep Americans from consuming too much personal transportation in lieu of mass transit options.

State and local taxes operate along the same economic rationale, attempting to internalize various costs upon society into the price of gasoline. These vary across regions of the United States. In 2004, state taxes averaged 25.6 ¢ per gallon, ranging from 8¢ in Alaska to 39.6¢ in New York.24 Table A3 in the Appendix outlines each state’s total gasoline tax burden.

Despite numerous competitive pressures in the worldwide crude oil market, the U.S. has maintained some of the lowest gasoline prices amongst the industrialized nations. Widely varying tax levies largely account for lumpy pricing across different nations; U.S. federal taxes of 18.4¢ per gallon compare to an average tax burden approximately 20 times higher in European countries. Table A4 in the Appendix compares these tax burdens.25

External Costs

As discussed earlier, the price of gasoline covers its marginal cost of production, a portion of oil company profits, a significant portion of highway maintenance26, and lesser support to other funds. While measures are in place to keep roads drivable, gasoline consumption during transportation is responsible for other costs, as well. These externalities include pollution from auto emissions, traffic congestion, accidents, vehicle and tire disposal, noise, and energy security

21 Energy Information Administration: http://tonto.eia.doe.gov/oog/info/gdu/gasdiesel.asp22 History of the Gasoline Tax: Dr. William Buechner, www.artba.org/economics_research/reports/gas_tax_history.htm. The Underground Storage Tank System (UST) covers tank systems having at least 10 % of their combined volume underground. The federal UST regulations apply only to systems storing either petroleum or certain hazardous substances (http://www.epa.gov/swerust1/faqs/ustdefn.htm).23 Nationwide and State-by-State Motor Fuel Taxes, November 2004, American Petroleum Institute24 API State Government Relations, “State Motor Fuel Tax Rates, November 1, 2004” www.api.org; the Federal Highway Administration, “Monthly Motor Fuel Reported by States”; the U.S. Energy Information Administration, “Petroleum Marketing Monthly,” and the AAA, “Daily Fuel Gauge Report.”25 Reducing Gasoline Consumption: Three Policy Options: Congressional Budget Office, November 200226 This discussion assumes the portion of the tax on gasoline diverted to the Highway Account covers the cost of road repairs, with any localized shortfalls covered by targeted toll collecting.

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costs related to dependence on foreign oil.27 These additional societal costs are not accounted for by the current U.S. tax structure and therefore not reflected in the price of gasoline. This creates inefficient market equilibrium with deleterious effects, such as a bias towards overproduction and over-consumption of ICV-based travel. The above inefficiency helps explain higher gasoline tax rates in other countries, which may better account for the cost of these externalities.

We focus on the costs associated with congestion, accidents, and pollution because most economic analyses conclude they are orders of magnitude more significant and meaningful than the other externalities. Additionally, this paper considers the security costs of foreign oil dependency, as it is specific to gasoline use and holds a powerful grip on the American psyche. It should be noted, however, that a review of several excellent economic studies quantifying the value of these externalities results in widely ranging estimates. Therefore, our analysis gives high and low endpoints to account for the uncertainty, but ultimately chooses best guess estimates with which to conduct further analyses.

Congestion Externality

Traffic congestion imposes an opportunity cost upon society of waiting in traffic, which reduces leisure time and causes drivers to be late to scheduled events. Because FCVs would provide no easing of congestion over ICVs, the aggregate cost to society is irrelevant if it is equally allocated to both vehicles. However, it is useful to approximate its cost to determine to what extent gasoline is under priced in the market today. Moreover, congestion is more closely correlated with total vehicle miles traveled (VMT) and a gasoline tax is not the preferred means by which to combat it. Because of the relatively inelastic nature of the demand for miles traveled verses price of gasoline, people respond to higher gasoline taxes by buying more fuel efficient cars, not by driving less.28

An ideal method for addressing congestion externalities would be through peak period rush hours taxes. The implementation costs of this method prove prohibitive in reality and an equivalent per gallon gasoline tax is more easily implemented, economic inaccuracy notwithstanding. Illustrating the sub-optimal nature of taxing consumption to address a VMT externality, more fuel efficient vehicles result in a higher required per gallon tax.

Studies of this cost yield a central value of 3.5¢ per mile for the marginal congestion cost averaged across the U.S., with a range of 1.5-9.0¢ per mile.29 Using the 2003 average fuel efficiency of 24 miles per gallon30 the conversion can be made to 84¢ per gallon of gasoline, with a range of 36-216¢ per gallon.

Accident Externality

Accident costs are external to the cost of transportation. This cost is somewhat internalized by higher insurance rates for bad drivers, albeit incompletely. An additional appropriate mechanism would be a direct tax on VMT, either collected by increased vehicle monitoring or more prolific toll roads. Similar to the external costs imposed by congestion, however, we convert these to a per gallon basis for ease of analysis.

Estimates of the marginal external cost of accidents caused by motor vehicles in the U.S. range between 1.3¢ and 9.8¢ per mile in year-2000 dollars31. Higher per mile costs are associated with lower volume vehicles, such that the weighted average cost per mile is approximately 2.3¢

27 Does Britain or The United States Have the Right Gasoline Tax?: Ian W.H. Parry, Resources for the Future and Kenneth A. Small, University of California, Irvine January 25, 200228 De Borger et al. (1997) and Mayeres (2000) simulate fuel taxes for Belgium.29 Ibid30 Edmunds.com31 Delucchi (1997) and the U.S. Federal Highway Administration

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per mile in year-2000 dollars.32 Again using an average fuel efficiency of 24 miles per gallon, these estimates result in a value of 55.2¢ per gallon, with a range of 31-235¢ per gallon.

Pollution Externality

Pollution is a textbook external cost, and internal combustion engines typify its effect. For our treatment we break down pollution into two components: greenhouse gas (GHG) emissions as covered by the Kyoto Protocol,33 which depend on fuel consumption and criteria pollutants, which depend on miles driven.34 In fact, regulations force emissions per mile to be uniform across most new vehicles.

Damage from criteria pollutants includes reduced crop yields from acid rain and building destruction, but both of these are dominated by health-related costs. Studies suggest the costs of local pollution from motor vehicles range between 1.4¢ - 16.2¢ per mile for automobiles typical of the 2000 model year. The authors of US FHWA (2000a) choose a middle value that comes to 1.9¢ per mile at year-2000 prices.35 This yields a value of 45.6¢ per gallon, with a range of 34-389¢ per gallon.

Because burning one gallon of gasoline releases 8.9 kilograms of carbon dioxide, ICV’s account for 20% of all U.S. carbon emissions36 and 17% of total U.S. greenhouse gas (GHG) emissions. GHG are linked to global warming and its associated costs, which are much more speculative than criteria pollutants due to the long time period involved, uncertainties about atmospheric dynamics, and inability to forecast adaptive technologies that may be in place a half-century or more from now. Given this evidence and the great uncertainty, we choose a central value of 6¢ per gallon, with range 0.2-24¢ per gallon.37

Geo-political Externality

Many believe that the U.S. spends a disproportionate amount of money on countries from which it imports crude oil, suggesting that the price of energy security is quite high. For example, Iraqi War commentators believe that its $150 billion cost to the U.S. should be accredited to the U.S.’s dependence on foreign oil.38 A review of the U.S. Department of State budget finds it reserved $860 million to provide foreign aid to our top oil suppliers in 2005.39 However, the extent to which energy security concerns impact these figures is uncertain and difficult to quantify. The vagaries of political justification of federal budgets and spending bills further confuse this issue, but execution of its analysis is central to assessing the real cost of gasoline consumption.

32 Does Britain or The United States Have the Right Gasoline Tax?: Ian W.H. Parry, Resources for the Future and Kenneth A. Small, University of California, Irvine January 25, 200233 The Kyoto Protocol recognized six greenhouse gasses (GHGs): Carbon dioxide (CO2), Methane (CH4), Nitrous oxide (N2O), Hydrofluorocarbons (HFCs), Perfluorocarbons (PFCs), and Sulphur hexafluoride (SF6). Carbon emissions make up 84 % of the United States’ total GHG emissions.34An Argonne study recognizes six criteria pollutants: volatile organic compounds, carbon monoxide, nitrogen oxides, particulate matter with diameters of 10 µm or less, and sulfur oxides.

35 Ibid36 Reducing Gasoline Consumption: Three Policy Options: Congressional Budget Office, November 200237 Does Britain or The United States Have the Right Gasoline Tax?: Ian W.H. Parry, Resources for the Future and Kenneth A. Small, University of California, Irvine January 25, 200238 U.S. Department of State, Foreign Press Center, Congressional Research Service39 Crude Oil and Total Petroleum Imports, Top 15 Countries, U.S. Department of Energy, Energy Information Administration; Country/Account Summaries (‘Spigots’) FY 2004, U.S. Department of State, International Affairs Budget FY 2004

13

Other than the expenditures on the operations of the Strategic Petroleum Reserve (SPR), the U.S. government does not specify how much spending is done in the name of energy security. In 2003, the U.S. spent $182 million on maintaining and adding to its stock, amounting to a trivial 0.1¢ per gallon of gasoline consumed.40 Extracting $935 million as the amount of foreign aid spent on the U.S.’ largest oil suppliers, then the cost of energy security rises to 0.7¢ per gallon.41 This expenditure excludes the $2.24 billion dedicated to the Iraq Relief and Reconstruction Fund (IRRF)Error: Reference source not found, which would add 2¢ per gallon on the high end, if it were perfectly correlated to gasoline consumption. Include another $62.37 billion that was allocated to the U.S. military operations in Iraq in a supplemental budget appropriation in 2003Error: Reference source not found, and the price of energy security rises to 43¢ per gallon.

The most recent study of the National Defense Council Foundation may be the most encompassing analysis of the cost of energy security. It concludes that $49 billion per year is spent for the defense of oil42. In 2003, 46.9% of crude oil was refined into gasoline, which this paper assumes roughly correlates to the amount of that expenditure allocated in the interest of gasoline consumption43. This indicates that the cost of gasoline energy security in 2003 was approximately 15¢ per gallon, with a range of 0.1-43¢ per gallon.

Total Annual Cost of Gasoline Externalities

In sum, the midpoint value for these externalities is $2.06 per gallon of gasoline, with a range of $1.01-9.07 per gallon. It must be noted that the ideal manner in which to address these externalities would be through differing avenues appropriate to each specific source of the externality. Nonetheless, fully internalizing these external costs to society would necessitate a Pigovian tax of $2.06 per gallon of gasoline.

FUEL CELL VEHICLE TECHNOLOGY

The commercial attractiveness of any FCV is determined by several factors, chief of which is its final price. Its production cost must be comparable to that of the ICV. The production and distribution costs of hydrogen need to be considered against the respective components of gasoline. The potential availability of a hydrogen infrastructure must be considered, as well. Finally, a FCV’s performance must be comparable to that of an ICV in terms of refueling frequency.

As noted earlier, the most promising hydrogen fuel cell technology for vehicular use is the proton exchange membrane. Currently, GM and various government sources quote the current cost of manufacturing a FCV at $3,000 per kW of power generating capacity, or more44. This means, for example, GM’s latest FCV concept, the HydroGen3, a 60 kW system, costs about $198,000 to produce. 45 While the cost of FCVs remains extremely high, it declined tenfold in

40 (20 million barrels per day petroleum consumption) x (106% refinery volume gain) x (42 gallons/barrel) x (46.9% refinery gasoline yield) x (365 days/year), International Petroleum Monthly, July 2004, and Petroleum Supply Annual 2003, Energy Information Administration; White House Office of Management and Budget41 Crude Oil and Total Petroleum Imports, Top 15 Countries, U.S. Department of Energy, Energy Information Administration; Country/Account Summaries (‘Spigots’) FY 2003, U.S. Department of State, International Affairs Budget FY 200342 America’s Achilles Heel-The Hidden Costs of Imported Oil, National Defense Council Foundation, October 200343 Monthly Energy Review, March 2004, U.S. Department of Energy, Energy Information Administration44 Sedans generally require approximately 75kW, SUVs require about 100kW, and larger vehicles require 130 – 150kW.45 http://www.gm.com/company/gmability/adv_tech/600_tt/650_future/hydrogen3_050103.html

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just three years46 due to improvements such as a reduction in the amount of platinum required by a PEM fuel cell stack. The cost of FCVs is also sensitive to production volume and the scale economy potential is significant. This underlines the importance of ramping up demand for FCVs to become commercially viable; in the case of mass production, that cost is expected to decline tenfold to around $225 per kW47. In order for FCVs to be competitive with conventional vehicles, a consensus of estimates converges at prices around $30/kW.48 The durability of FCVs also needs to match that of ICVs, which average around a 5,000 hour lifespan (150,000 miles equivalent)49. Currently, the durability of fuel cells is uncertain. Government organizations, through policies, can play a significant role in increasing demand of FCVs or in providing incentives to automakers to allocate a higher R&D budget towards FCV research. Examples of such policies are environmental regulation similar to the Kyoto protocol or California's Zero Emission Vehicle mandate.

HYDROGEN

Hydrogen Production

Delivered hydrogen costs depend on the source used and scale of production. The sources that can be used to produce hydrogen are: steam reformation of natural gas, or steam methane reforming (SMR), gasification of coal or other hydrocarbons, gasification of biomass, and electrolysis of water using the present electricity grid. Table A5 in the Appendix50 compares potential costs of delivered hydrogen from different sources and produced at different scales (large, medium and small.)

The 50 million tons of H2 annually produced worldwide from these various sources is enough to power 206 million FCVs if expressly devoted to that purpose, according to GM Vice President of Research and Development, Dr. Larry Burns.51 To fully realize the zero-emission dream, hydrogen would ideally be produced from a clean source such as biomass gasification or electrolysis using wind or solar generated electricity. However, technologies for these methods are either in their infancy or are simply not viable on a large scale. As a result, other methods must be used during the next few decades during the transition to a hydrogen economy.

Presently, gasification of coal and other hydrocarbons yields the most cost-attractive option. However, this source results in heavy carbon monoxide (CO) impurities, rendering it incompatible with the PEM fuel cells used in FCVs.52 On the other hand, electrolysis using fossil fuel-based central sources is the most immediately viable option. Even so, per unit energy, it is apparent hydrogen produced electrically costs three times as much as petroleum based fuels on an equivalent per gallon basis. Furthermore, the bulk of electricity generation in the United States is through coal plants. As a result, with today’s energy infrastructure and technology, the production, distribution, and consumption of hydrogen by either coal gasification or water electrolysis will generate about 750 grams of GHG per mile (g/mile) driven in a FCV, compared to about 700 g/mile driven in a gasoline powered ICV.53 CO2 sequestration is possible when the

46 http://www.gm.com/company/gmability/adv_tech/400_fcv/fc_challenges.html47 Data provided by GM and it is consistent with other government estimates such as ones in NAS/NRC, 200448 http://www.eere.energy.gov/hydrogenandfuelcells/fuelcells/fc_challenges.html49 Ibid50 An integrated Hydrogen Vision for CA, white paper, Dr Timothy Lipman & others, July 200451 Dr. Lawrence Burns phone interview with the researchers of this paper, 08 February 200552 CO contaminates the platinum catalyst plates53 Well-to-Wheel Energy Use and Greenhouse Gas Emissions of Advanced Fuel/Vehicle Systems – North American Analysis-, General Motors Corporation, Argonne National Laboratory, BP, ExxonMobil, and Shell; (Ratio of WTT emissions for Electrolysis Station G.H2: U.S. mix and Central G.H2 NNA NG used

15

hydrogen is produced centrally which eliminates pollution but raises the cost of delivered hydrogen. CO2 sequestration costs are estimated to be $3054 per ton of CO2 (equivalent to 25¢ per gallon of gasoline).

As a result, we turn to another fairly cost-effective method, SMR. SMR utilizes a distribution system already in place; most homes have natural gas supplies and research has done preliminary research on home hydrogen generation systems (see graph A6 in the Appendix.) However, SMR is not without its drawbacks. In addition to the previously mentioned environmental concerns – albeit at lower levels than coal gasification – SMR may require the importation of natural gas.55 To capitalize on the greatest cost advantages, hydrogen generated by SMR is most efficiently produced gaseously in central plant and incurs a cost to be liquefied for distribution.56 Therefore, it is still a factor of 2-3 times as expensive as gasoline. Nonetheless, because of its relative cost and convenience advantage, it is viewed as the most viable option for the next decade. According to the challenged DOE estimates, even if we relied long term on natural gas to produce enough fuel for 150 million FCV’s -- virtually the entire U.S. fleet – we would only experience a 20 percent increase in today’s natural gas demand. We will have plenty of time to manage that increase in demand.57

Therefore, even if the manufacturing costs of fuel cells can be made competitive on a per kilowatt capacity basis with internal combustion engines, the high cost of hydrogen fuel would still leave FCVs more expensive than ICVs on a per kilowatt generated basis. In large-scale production, the total cost of fossil-based hydrogen can be as low as $2.0058 per kg. Costs are expected to decline to $1.50 – $1.60 per kg in the future for fossil-based hydrogen produced at a large scale, although additional liquefication costs are necessary.

Hydrogen Infrastructure

GM estimated the cost of building an infrastructure for hydrogen distribution. That study is based on the assumption that hydrogen fuel stations located in 100 U.S. cities and across major highways could cover 70% of the U.S. population. Serving the 100 cities would require 6,500 new or modified stations, which drivers would have to travel no more than two miles to reach any one. The 130,000 miles of national highway in the U.S. could be serviced with 5,200 stations (one station every 25 miles), totaling 11,700 stations altogether. With a fueling capacity of 100kg/day each station could serve a minimum of 22 fuel cell vehicles per day, or 154 FCV per week. This means that one million FCVs could be served by the 6,500 urban stations. GM estimates that each station would cost approximately $1 million including fully amortized capital, operation & maintenance, and variable costs for a 5-year period (assuming consistently increasing utilization rates from 10% to 100% over a 5-year period). At this per station cost, the total infrastructure investment would be approximately $11.7 billion.59

Generally speaking, the trend in annual expenditures are expected to rise for the first 15-20 years of fuel station expansion, but begin to stabilize and follow a downward trend after 20 years.

CURRENT FUEL CELL POLICIES

Given the stakes, there are considerable resources, at both public and private levels, allocated to fuel cells development in an effort to reduce fuel cell costs more immediately.

to estimate WTW emissions for Electrolysis Station G.H2: U.S. mix.)54 An integrated Hydrogen Vision for CA, white paper, Dr Timothy Lipman & others, July 200455 A Realistic Look at Hydrogen Price Projections, F. David Doty, PhD, Doty Scientific, Inc. Mar. 5, 200456 Ibid57 Department of Energy Posture Plan 200458 An integrated Hydrogen Vision for CA, white paper, Dr Timothy Lipman & others, July 200459 Alternative-Fuel vehicles star, but wide use is miles away, USA Today, January 21, 2005

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Public Investment

President Bush committed $1.2 billion in 2003 to support the Hydrogen Fuel Initiative and the Freedom Car Partnership for the first five years of a long-term effort to support the vision of a hydrogen-based economy.60 The Hydrogen Fuel Initiative is aimed athas the goal to reverse reducing America’s dependency on foreign oil by developing the technology needed for commercially viable hydrogen powered fuel cells. The U.S Department of Energy’s Office of Energy Efficiency and Renewable Energy (EERE) implemented the initiative through its Hydrogen, Fuel Cells & Infrastructure Technologies Program. The program is designed to accelerate the development of a hydrogen production and distribution infrastructure (includes hydrogen delivery, storage and usage). The table below outlines the program’s budget.61

2003 2004 2005 2006request

($K) ($K) ($K) ($K)Prod & Delivery 11,215 10,083 14,218 32,173 Storage 10,790 13,174 23,654 29,890 Infrastruct Validation 9,680 5,784 9,484 14,945 Safety, Codes & Standards 4,531 5,615 5,954 13,121 Education 1,897 2,417 - 1,881 Systems Analysis NA 1,372 3,404 5,203 Congressionally directed projects 42,000 37,300 Hydrogen Technology Total 38,113 80,445 94,014 97,213

Transportation Systems 6,160 7,317 7,495 7,600 Ditributed Energy Systems 7,268 7,249 6,902 7,500 Fuel Processing 23,489 14,442 9,721 9,900 Stack Components 14,803 24,551 32,541 34,000 Technical Validation 1,788 9,828 17,750 24,000 Tech and Program Support 398 395 535 600 Fuell Cell Technology Total 53,906 63,782 74,944 83,600

TOTAL 92,019 144,227 168,958 180,813 586,017

The DOE envisions that the Hydrogen, Fuel Cells & Infrastructure Technologies Program towill be a multiphase program62 and lastingwill be going through 2035-2040. Commercialization of FCVs is hoped to take place at some point during 2010 – 2015. The DOE foresees mass distribution of the fuel cell and hydrogen technology between 2025 and 2040.

Tax cuts will also increase demand for alternative energy.Another way to grow demand for alternative energy is through tax cuts. The Bush administration has proposed tax incentives totaling $4.1 billion through 2009 to encourage the use of clean, renewable energy and energy efficient technologies (i.e. FCVs, residential solar heating system, etc).

The FreedomCar Partnership, announced in 2002, is a cooperative research effort between DOE and USCAR.63 Its long-term goal is to develop automotive technologies that will enable mass production of affordable hydrogen FCVs to reduce pollution emissions and U.S. dependency on foreign oil. In the near-term, the partnership’s strategy is to develop hybrid cars.

Private Investment

60 Multi Year Research, Development and Demonstration Plan, June 200361 http://www.eere.energy.gov/hydrogenandfuelcells/budget.html62 Multi-Year Research, Development and Demonstration Plan, June 200363 A DaimlerChrysler, Ford, & GM partnership

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Auto companies are spending a large amount of money on fuel cell technology, in efforts to better meet increasingly stringent governmental environmental policies and spur growth in a troubled industry. For example, General Motors (GM) has devoted significant resources to fuel cell research, having spent more than $1 billion (includes FCV as well as stationary fuel cells) on collaborative research and development programs related to fuel cells.64 GM’s Mr. Burns believes FCVs can eventually be produced at a lower cost than ICVs. 65 With only 12% of the current world population owning a vehicle, this lower cost offers GM strong growth opportunities. A second order benefit that accrues to GM is freedom from the influences of price volatility and supply instability (related to oil supply) that affects demand for its core product. An aggressively stated company goal of GM is to make FCVs commercially viable by 2010.

However, mass production of a sufficient quantity to achieve scale economies is currently estimated around 250,000 units66, a tall order considering current Department of Energy forecasts. Table A8 in the Appendix breaks out forecasted demand for a range of alternative vehicles for around 8200 units by 2025. Furthermore, both Toyota and Honda estimate a longer horizon than GM. According to Toyota senior managing director Masatami Takimoto, "We have many issues to be solved. Car makers alone cannot solve them. It will take decades or longer" until the wider commercial use of fuel-cell cars becomes available.67

Furthermore, as evidenced by Table A8, hybrid sales dominate FCV sales for at least the foreseeable future. CSM Worldwide, an automotive research firm, reckons that at least 20 new hybrid models will appear in America by 2007.68 Besides the Ford Escape and Honda Accord hybrids, Toyota, DaimlerChrysler, Porsche, and GM plan toon includeadding hybrid sedans, trucks, and sport-utility vehicles (SUVs).) in their automobile lineup. A study by the Laboratory for Energy and the Environment at the Massachusetts Institute of Technology, which looked at energy use over the course of a vehicle's life and, predicteds that by 2020, diesel hybrids could achieve the same energy-efficiency and greenhouse-gas emissions as fuel-cell cars powered by hydrogen made from natural gas.69 The difference is that diesel-hybrid technology is available today. As Joseph Romm, director of the Centre for Energy & Climate Solutions, a non-profit organisationorganization based in Arlington, Virginia, explainsputs it, “hybrids are almost certainly the platform from which all future clean vehicles will evolve.”70

64 http://www.gm.com/company/gmability/sustainability/reports/04/400_products/423_alt_key.html65 Dr. Lawrence Burns phone interview with the researchers of this paper, 08 February 200566 Fuel Cells Hit The Road, The Economist, 22 April 199967 http://www.fuelcellsworks.com/Supppage285.html68 Why The Future is Hybrid, The Economist, 02 December 200469 Ibid70 Ibid

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FCV vs. ICV Cost Trend Analysis

For our mathematical model, we assumed costs would need to be similar to enable full-scale competitive deployment and compared the lifetime cost of an ICV vs. a FCV. we compared the lifetime cost of an ICV vs. a FCV, assuming costs would need to be similar to enable full-scale competitive deployment. We projected into the future real costs of ownership of both vehicles, taking into account our best estimate predictions concerning FCV cost reductions. Where appropriate, we identified confidence bands for certain variables. We made two general assumptions of note:: 1) Ccars will be driven 100,000 miles over their useful life and, 2) ffor both FCVs and ICVs, insurance, maintenance, and tax costs roughly equal roughly half the variable fuels costs. In sum we use the simple formula:

CTOTAL = CPURCHASE + CFUEL + COTHER

For ICV cost projections, we started with the sales-weighted average net price of 2005 vehicles of $25,75071 with a slight (0.5%) annual cost increase consistent with the trend over the past few years. Starting with the current 2005 gasoline price of $1.83/gallon, we estimate a .1% annual decrease, consistent with long term pricing trends (Appendix, Graph A2.) Although seemingly inconsistent with our earlier discussion regarding contracting suppliers and increased demand from developing countries, we first note that, first, gasoline prices are already elevated over their long-term base-line trend. Although competitive market forces would tend to push the price upwards, oil cartels exert considerable influence over world prices, and they have historically increased output as prices rise. Finally, a late-term effect is that, as fuel cells increasingly penetrate the market, demand for oil in the United States will begin to decrease, counteracting rising demand elsewhere. We assume a slightly decreasing fuel economy for the next five years, (-0.4% annually), consistent with EPA findings over the past 20 years (Appendix, Table A7.) After 2010 we assume an increase in fuel economy, +0.5% annually, to reflect the increased mix of hybrids in the marketplace (Appendix, Table A8.)

Our FCV projections involve considerably more speculation. Using earlier consensus estimates that current FCVs cost around $3000/kW, and present sedans requirieng $50/kW72, we conclude the vehicles are 60X too expensive. Considering the engine is roughly half the cost of the vehicle, holding the cost of the other components constant, we start in 2005 with a FCV equal to 30X the purchase price of an ICV, or $772,500. Empirically, this is not inconsistent with current estimates from Mr. Takimoto’s current estimates of over $950,000.73

Going forward, according to Ms. Britta Gross, Manager of Hydrogen Infrastructure Development and Strategic Commercialization for GM Fuel Cell Activities, there are three phases of cost reductions in new technologies.74 First, the technological maturity phase typified by leaps in knowledge and rapid cost reductions. For our purposes we assume an annual cost reduction of 15% for the next ten years, 2005-2015, with high and low ranges of 12-18% to account for estimate variation. Next come economies of scale, where ramped up production volumes lead to additional cost reductions. We chose a 10X impact from economies of scale, consistent with 2001 data from A.D. Little (Appendix, Graph A9.) We also assumed these scale economies to occur over a period of 15 years, again consistent with DOE estimates of alternate fuel vehicle adoption, Appendix, Table A8, yielding an annualized cost reduction of 16% for years 2015-2030, again with high/low ranges of 11-21%. Here we chose a significantly larger confidence band to account for the varying predictions of FCV production ramp-up. Finally the

71 Edmunds.com, http://www.aiada.org/article.asp?id=2829872 Dr. Lawrence Burns phone interview with the researchers of this paper, 08 February 200573 http://www.fuelcellsworks.com/Supppage285.html, using a 17 March 2005 exchange rate of 1$=¥104.74 Ms. Britta Gross phone interview with the researchers of this paper, February 2005

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impact of dynamic increasing returns, or ‘learning curve effects’ impart our estimated ongoing 3% annual cost reduction from years 2030 onward. For this phase we used a high/low range of 3-5% annually.

Next, we looked at the cost of hydrogen production. Using natural gas for the above forementioned reasons, we arrived at a current cost of $7.80 / kg H2, comprised of $5.00 / kg H2 current cost of production75 plus $2.80 / kg H2 costs of carbon tax and liquefication.76 We also use Lipman’s long term projections of $1.60 / kg H2 which, when added to the carbon tax and liquefication costs, results in an estimate of $4.4 / kg H2 for an annual 3% decline. We convert these values to $ / gallon of gasoline for comparison77 and estimate first generation FCVs to have a mileage efficiency of 65 mpg78 with a slight (0.5%) annual increase. While recognizing that potentialthere are gains existto be made in the distribution of hydrogen, because hydrogen production is already a relatively mature industry, for simplicity we assumed no high/low band on hydrogen price decline and FCV efficiency.XXXXX I’m not really sure what is trying to be said here (above) XXXXX

Based on these assumptions, with status quo policies, we calculated that competitive convergence will occurs in 2025, as showneen by the graph below. Our high and low confidence bands for technological cost reduction results in outside convergence estimates ranging from 2021 to 2031.

0

100

200

300

400

500

600

700

800

900

20052006200720082009201020112012201320142015201620172018201920202021202220232024202520262027202820292030203120322033203420352036

Real 2005 dollars (000s)

ICV Ownership - Base Case FCV Ownership - Base Case FCV Ownership - Optimistic FCV Ownership - Pessimistic

75 An integrated Hydrogen Vision for CA, white paper, Dr Timothy Lipman & others, July 200476 A Realistic Look at Hydrogen Price Projections, F. David Doty, PhD, Doty Scientific, Inc. Mar. 5, 200477 1 kg = 2.2 lbs, 6.96 lbs gasoline = 1 gallon, and 1 kg H2 = 2.8 kg gasoline (energy equivalent content)78 THE HYDROGEN ECONOMY: OPPORTUNITIES, COSTS, BARRIERS, AND R&D NEEDS, Committee on Alternatives and Strategies for Future Hydrogen Production and Use, National Research Council, National Academy of Engineering.

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We next analyzed if this convergence calculation point was consistent with current activity in the marketplace. Certainly, this date is consistent with DOE vehicle projections and the opinions of others cited in this paper. With GM and other auto companies spending millions on fuel cell research, however, one mightwould conclude that they expected competitive convergence sooner than 2025; indeed, Mr. Burns has expressed a “target to have convincing and affordable fuel cell vehicles on the road by the end of the decade.”79

However, there are points to note in our model. First, we assumed competitive convergence to be when the costs of ownership between FCVs and ICVs are equal. FCVs will, of course, become affordable to affluent consumers sooner. If car companies predict consumers will pay a premium for FCVs, they would estimate a nearer rolloutsooner viability date. Second, because we started with a U.S. average gasoline price of $1.83, out estimates are not applicable to all regions. Due to regional differences in gasoline taxes, states such as California or New York may achieve convergence sooner. due to their higher local gas taxes. Urban areas will also benefit from cheaper and more accessible hydrogen earlier than most regions ofthe nation. as a whole. GM may also simply be placing a premium on the first-mover advantages. GM is to debuting a fuel cell vehicle and collecting the economic gains attributable to beating others to the market with such as product (i.e. extracting a premium on its first-mover advantage)it. Regardless, there are policies the U.S. government should consider to both affect impact this date and to address economic inefficiencies inherent in the current system. We will nextow analyze several options.

79 HydroGen3 Takes a Big Step toward the Production Line, http://www.gm.com/company/gmability/adv_tech/600_tt/650_future/hydrogen3_050103.html

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POLICY ALTERNATIVES

OPTIONS AND IMPACT

Several options exist for policy makers regarding transportation and oil consumption. Each options has specific features that impact oil consumption and, therefore, fuel cell adoption, in different ways. We consider raising CAFE standards, applying a full Pigovian tax to gasoline, applying a ‘partial’ Pigovian tax, providing additional funds for fuel cell R&D, and combinations of these policies. In analyzing these options, we adjust certain variables in our above model. Where appropriate, we show the affect of the policy on the quantity and price of oil, as well as its impact on FCV competitive convergence date.

CAFE Standards

CAFE standards are…

Full Pigovian Tax on Gasoline

The total cost of externalities associated with gasoline consumption and not yet internalized by current taxes, was found in this analysis to amount to $2.06 per gallon. The graph below shows the demand shift that would occur if a full Pigovian Tax were implemented, imposing an additional $2.06 cost per gallon of gasoline on consumers and assuming demand elasticity of –0.2.

The above graph illustrates that the full Pigovian levy would raise the total at-the-pump price of gasoline to $3.20, induce drivers to reduce gasoline consumption by 15%, and collect $251 billion in taxes annually. Ideally, the pollution components of such a tax would be scaled down as levels of emissions decline. Our model predicted competitive convergence in 2023, with a confidence band ranging from 2019 to 2029. The American public, however, is unlikely to accept such a radical impact on its consumption; opposition from political groups and various constituencies would lobby against this policy and, most likely, succeed in preventing its implementation. Furthermore, in fairness to ICVs, the congestion and accident portions of the above tax should be levied on FCVs as well – which impose identical external costs – and which could push out their acceptance. Because of these factors, we do not consider a full Pigovian

22

S

1.83

P gallon

340M 400M

1.14

3.20

Qgallons

Yields ~ $690M in daily taxes $251B in annual taxes

NOT realistically feasible

D = -0.2

gasoline tax, while theoretically efficient, to be a realistic policy recommendation. Rather, a more focused “partial” Pigovian tax on gasoline may be a better method of ‘leveling the playing field.’

Partial Pigovian Tax on Gasoline

A Pigovian tax on gasoline that considers externalities exclusively associated with gasoline consumption would incorporate the components relating to GHG and criteria pollutants and oil security. This narrowed focus reduces the proposed tax to $0.66 per gallon, again, requiring the scaling down of the pollution component as vehicle emissions are reduced. This partial Pigovian tax would rely on alternative means to address congestion and accident externalities, which are associated with any kind of vehicular use. In this way the playing field between hydrogen and gasoline powered vehicles would be leveled. The graph below illustrates the impact that such a tax would have on gasoline consumption.

This proposal would increase the price at the pump to $2.28 and generate $91 billion in tax revenues to the government. Although this is a deadweight loss to an efficient market, it is necessary, even preferable, to the alternate persistence of externalities. We feel such a modes tax could be politically palatable, especially if the additional tax revenues could substitute for more distorting taxes elsewhere in the economy. This action, by itself, would move the competitive convergence point to 2024, with a confidence range from 2021 to 2030.

R & D Subsidies

Raising the level of R&D expenditures on FCVs would also shorten the fuel cell competitive convergence window. Estimates on the impact of additional funding on technological improvement are varied. We estimated increased expenditures of 20% over current levels would result in annual cost reduction gain of a similar factor. Current spending of $240 million per year would increase to a budget of $288 million per year, continuing on for an additional total of $960 million over the next 20 years. This move would result in improvements during the FCV technological maturity stage (2005-2015) and the early parts of the scale economies stage (2015-2025), phasing out as FCVs approached full production. Alone, these subsidies would move the convergence point from 2025 to 2021.

23

S

1.83

P gallon

380M 400M

1.61

2.28

D = -0.2

Qgallons

Yields ~ $250M in daily taxes $91B in annual taxes

CONCLUSION

In light of the immediate and serious externalities associated with gasoline consumption that can be corrected with the use of an alternative fuel source, we recommend that the U.S. implement more extensive public policy to speed the adoption of FCVs. This should be done by way of ‘leveling the playing field’ by imposing an additional tax of $0.66 per gallon of gasoline, as reasoned by Pigovian tax ideals. This additional tax accounts for the pollution and national security market externalities not applicable to hydrogen consumption. Not only does this raise revenues for the governments, it also leaves the problematic externalities of congestion and accidents open for more efficient policy intervention. We believe such a tax, while controversial, is palatable if presented in the context of a national energy security policy.

We also recommend a $960 million increase in R&D funding for FCVs over the next 20 years (2005-2025) to speed the adoption of fuel cell technology for transportation purposes. This additional spending is easily funded by the new tax on gasoline. While we are justifiably concerned with the intervention of the government money in the free market of transportation, we feel well-directed subsidies can stimulate the move towards a hydrogen economy without unduly perturbing the equilibrium. Given the uncertainties in central versus distributed hydrogen production, we expect the market itself to manage the development of an infrastructure to best distribute hydrogen FCVs. But, the U.S. government should accelerate the creation of hydrogen industry standards to support these initiatives, with a 2010 target date for the creation of comprehensive standards. Finally, the government should continue to coordinate public education campaign’s to accelerate national awareness of a hydrogen-based economy. Our analysis suggests that such policies will result in a competitive convergence between FCV and ICV in 2021 as illustrated in the graph below, with a confidence band between 2019 and 2024.

0

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FCV Ownership - Base Case FCV Ownership - Optimistic ICV Ownership - Partial Pigovian FCV Ownership - Optimistic R&D

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RECOMMENDATIONS FOR FURTHER STUDY

Our study was limited by the accuracy of our model. The cost reductions based on technological advances variables exhibited a high degree of sensitivity but were also those for which we had the least data. To the extent possible, we recommend further study into predicted cost gains from future development of FCVs.

Further, our study of the external costs of gasoline was limited by difficult assumptions in the individual component costs. While no measure will ultimately prove accurate, we found the costs of pollution to be particularly problematic. Already hotly contested considering recent implementation of the Kyoto Protocol, a more accurate external cost of CO2 would result in a more accurate value for our proposed taxes.

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APPENDIX

Figure A1 – Fuel Cell Diagram

Graph A2 – Long-Term Gasoline Pump Prices

Source: EIA: http://www.eia.doe.gov/emeu/steo/pub/fsheets/PetroleumPrices.html

Table A3 – Total Gasoline Tax Rates by State

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source: API State Government Relations, “State Motor Fuel Tax Rates, November 1, 2004” www.api.org; the Federal Highway Administration, “Monthly Motor Fuel Reported by States”; the U.S. Energy Information Administration, “Petroleum Marketing Monthly,” and the AAA, “Daily Fuel Gauge Report.”

Table A4 – International Gas Tax Burden

Table A5 – Various H2 Production Costs

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Table A6 – GM Prototype Home Refueling Unit Data

Output: 3 kg per day

Input Power: 11 kW (13 kW peak)

Footprint: 0.5 x 1.5 meter

Fuel Cost: 8 € per kg (Europe)

cost equivalent to 8 liters of gasoline

Electrolyzer: Alkaline Type, Hydrogen Systems

Compressor: 700 bar, 5 kW, DK Enterprise

Storage Tank: 2 x 100 liter, 350 bar, Quantum

GM Hydrogen Home Refueling Unit

Technical Data

14 Cent/kWh

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AVERAGE U.S. VEHICLE CHARACTERISTICS: 1981 TO 2000 FIGURE 2

SOURCE: EPA

Table A7 – US Vehicle Characteristics

Table A8 – New Alternative Vehicle Car Sales 2001-2025

New Vehicles Sales - Car - Alternative (DOE AEO 2004)

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Fuel Cell Hydrogen

Fuel Cell Methanol

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LPG Bi-fuel

LPG ICE

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CNG ICE

Electric-Gasoline Hybrid

Electric-Diesel Hybrid

Electric Vehicle

Ethanol ICE

Ethanol-Flex Fuel ICE

Methanol ICE

Methanol-Flex Fuel ICE

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Figure A9 – Project FCV cost reduction

1990 2000 2015Year

20051995 2010

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200

3000

Cost in $/kW50kW system

Through 1990, PEM cost was dominated by platinum loading

(~20g/kW)

Today’s high volume estimate is $225/kW and is attributed to platinum

and membrane cost

Cost improved throughPlatinum reduction to

0.8 g/kW

Further platinum reduction to goal of 0.2g/kW, and

reduced membrane cost

1. High volume production defined as 500,000 units per year2. Cost estimated by A.D. Little (Sept. 2001) with enhanced hydroge n storage.

Cost goal of $30/kW approximates the cost of conventional engine

technology

Cost of a fuel cell prototype remains high (~$3,000/kW), but the high volume1 production cost of today’s technology has

been reduced to $225/kW

30