A Coming Glut of Small Cars?

By J. Smith

12.10.2009

2011 Fiesta Red small

Ford reports that 1,000 people have reserved the Ford Fiesta that made its North American debut at the Los Angeles Auto show. Needless to say, this is very good news for the men and women that work in a certain modernist building in Dearborn, not to mention their North American dealer network and the good people at the Cuautitlán Assembly Plant in Mexico. It especially bodes well if, as Ford claims, it will make a profit on the car; traditionally, the Detroit Three small cars made in North America are for CAFE rather than profit-making purposes. But according to auto analysts interviewed by Reuters, dropping gas prices may mean a glut of small cars in our part of the world.

Currently, the subcompact class is served by the highly regarded Honda Fit, the not-so-highly-regarded Toyota Yaris, stalward Hyundai Accent and the all-but-forgotten Nissan Versa. Oh—and the Chevy Aveo, which many would like to forget. But with the coming of the Fiesta and, later still, the Fiat 500 and a small car from GM, there may be insufficient demand in this sector. The Chevy Volt, not necessarily subcompact, but certainly a fuel-sipper, will also add supply to this sector. Reuters includes the Chevy Cruze—oy, I hate that spelling—but that will be a compact, and a slightly larger one at that, so I’m not sure it should be included in the analysis.

Much of this new supply was spurred by the speculation-fueled gas price spike in 2008. Much is also fueled—no pun intended—by new CAFE standards of 35.5 MPG by 2016. But if gas prices remain low, consumers will continue to shift their demand towards larger “crossover” vehicles—i.e., glorified station wagons with a higher center of gravity and a few hundred pounds of extra flab.

And therein lays the conundrum of CAFE. The feds can mandate that automakers produce smaller, more fuel-efficient cars, but it can’t force people to buy them. And Americans only buy them in large numbers—that is, large enough numbers for them to be profitable—when gas prices are high. So, if gas prices remain low, automakers will be forced to slash prices, undercutting any profit, which may well lead to de-contenting the vehicles. Even then, according to the Reuters piece, domestic automakers may not be able to produce the vehicles profitably, at least not in North America.

As gas prices go up and down in the United States, if becomes difficult for producers to gauge their production needs. Gas prices go up—demand for small cars increases, shifting production and R&D. Then the price of gas plummets, and demand for small cars shrinks, and automakers are left with a plethora of small cars they cannot profitably sell. This is less of a problem for European and Asian makes because their home and international markets allow them to shift units to North America when demand arises. Domestic companies simply do not have that luxury. Although Ford and GM certainly have international models that seemingly could be imported, that undercuts the whole “domestic” moniker that, for some people, serves as a primary purchasing rationale.

It happened before. After the Iranian Revolution sent gas prices rocketing, automakers stressed Chevettes, Escorts and a plethora of other small cars. And then when prices declined, domestic automakers began producing larger vehicles. But CAFE limited their ability to produce large and powerful cars, so they exploited the lower CAFE standards for light trucks, birthing the SUV revolution of the 1990s. As an aside, large cars had also become, in the larger culture, “gas hogs” and “boats” only fit for the elderly or fleet duty. But, for whatever reason, SUVs and even full-size trucks were somehow seen as sporting. Go figure.

Gas Pump imageThe solution is simple: a hefty gasoline tax. In Europe and Asia, high gasoline taxes keep the price of gasoline relatively stable, insofar as it is always relatively expensive. I read something recently in Practical Classics that mentioned petrol being £1.05 per liter in the UK, which translates to about $6.00 per gallon. That’s pretty damned expensive, especially considering that the Great Recession is battering the UK. At any rate, that price will ensure that demand for small cars remains robust. At the same time, because there are no fleet-wide fuel economy standards*, anyone who wants to buy a car with, say, a large V-8 engine can do so, but they have to pay a lot more to keep it filled with petrol. That’s why VW can produce everything from city cars like the Fox to Bentleys and Bugattis.

And gas taxes could, say, help fund our embarrassingly poor transportation infrastructure. It makes sense, both from a public policy and an enthusiast’s perspective. One of the primary criticisms of increasing the gas tax is that it would fall disproportionately on low-income households. That effect could be limited with targeted tax credits or even better public transportation. Better yet, it could be set on a sliding scale, to create a price floor, which would decrease in order to prevent the price from reaching astronomical levels. This would allow both automakers and consumers and automakers to gauge their needs with a far greater degree of accuracy than can currently be accomplished—after all, both the guy who bought a Ford Excursion in 2002 and the schmuck who spent $6000 or so on a Geo Metro last summer have kicked themselves in the arse at some point in the past two years. But, given that tax increases of any size are anathema in the US, don’t hold your breath.

As a final point, the Reuters article may miss the mark in any case. The primary reason gas prices are low is because the Great Recession has depressed oil demand throughout the world, including in the US. As the economy improves, demand will increase, both at home and abroad. Given that the developing world is now getting into the habit of purchasing cars, notably India and China, demand may once again push gas prices to Sputnik levels.

*And, if the EU adopts a carbon emissions limit, it could amount to a de facto CAFE-like limit or even prohibit the production of large and performance-oriented cars.

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Autosavant published a previous article advocating an increase in the gas tax a few years ago; click here if you would like to read that piece.

Author: J.S. Smith

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4 Comments

  1. You’re right on the mark. With gas prices low, demand for excellent new small cars like the Ford Fiesta and Mazda 2 will be tepid at best.

    I’m in total agreement that we need a higher gas tax. The related increase in gas prices will cause short-minded consumers to give some thought to the fuel economy of the vehicles they are purchasing, and at the same time generate much-needed tax income for our bloated, inefficient government.

  2. Two reasons why we won’t see a gas tax increase: 1) no politician has the backbone to propose an increase, and 2) fuel economy standards are not really about reducing emissions or oil usage, it’s about controlling the marketplace. As stated above, companies in Europe offer everything from tiny fuel-sippers to large SUVs, and it’s up to the consumer to decide which vehicle is the correct choice. The direction we’re headed is the killing off of vehicles not deemed “acceptable” by politicians: trucks, SUVs, and large cars, and large engines. The decision of which vehicle to purchase should be left to the consumer.

  3. There is a correlation between fuel prices and small car sales for sure, but it’s not the only factor to consider. Some new car buyers, concerned with our uncertain economic times, have a more conservative approach to every major purchase. They simply want to spend less on a car. Bigger, more luxurious vehicles cost more. It’s possible to get a reliable, comfortable, safe small vehicle (with nice amenities) for under $16,000 dollars these days. I don’t know if higher gas tax is the answer either. Let’s face it, a lot of people are struggling to keep their heads above water, facing job loss and foreclosure. Raising the price of fuel would simply make their situation more desperate. I don’t think raising food prices to cut down on obesity is a good idea either. Some people would simple have to go hungry.

  4. I was just at L. A. Auto Show last night and was impressed with Fiesta. Not impressed enough to reserve one, but I am thinking about it. If the events described in this article do come to pass, that would actually give me more incentive to buy one now. I would rather buy the car now with the content is has, than risk getting one later that has been decontented to the point that I wouldn’t want it, no matter what the price was. Hmmm . . .

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