Archive for October 27th, 2011

Efficiency Without Regulation

As many of you know, I’m completing a year’s sojourn here in Omaha, the midwestern town with a decidedly western sensibility. (Don’t believe me? Check out the River City Rodeo sometime.)

I’ve been doing web development for Werner Enterprises, one of the country’s larger trucking firms, but having dabbled in finance, I also always take a peek at the quarterly earnings reports. They almost always include a line like the following:

We continued to effectively manage the impact of higher fuel costs by improving our fuel miles per gallon… We are controlling truck idling; optimizing the speed, weight and specifications of our equipment; and implementing fuel enhancing equipment changes to our fleet.

How good are they at it? Turns out, they’re pretty good. Below is a graph of the national average diesel price vs. the company’s reported (or calculated) fuel cost per mile:

At first, you’ll see that the fuel cost grows faster than the fuel price. Some of this is a result of EPA emission regulations, which made the newer engines less fuel-efficient. As they newer engines were gradually introduced to the fleet, they affected overall operating costs. (In fact, at least one of the 10Qs from that era notes that Werner was able to command a premium when re-selling its older, hand-me-down tractors to other carriers.)

Over time, the company has managed to implement certain fuel-saving practices and patent aerodynamic designs that have cut fuel costs. The diesel price curve (courtesy of the US Energy Information Administration) look a lot like the curve leading up to 2008, but the cost per mile has dropped below it. For comparison, in Q3 2006 and Q3 2010, diesel was a little over $2.90/gallon, but Werner’s fuel cost per mile was 17% lower. That represents just under 4% of operating revenues, which is slightly enormous in this business.

They’ve done this even as the rise of intermodal has limited trip length:

Shorter trip lengths are associated with lower fuel efficiency; they involve more stops and starts, more idle time, and a higher percentage of time spent off of the interstates. So the cost containment has happened in spite of this.

It’s also happened despite the fact that class 8 trucks have no CAFE standards at all (although class 8 truckers probably have cafe standards of their own, mostly involving coffee & pie).

If anything, as we’ve seen, the government has made fuel efficiency more difficult by choosing emissions control over it. This choice may or may not be justified; that isn’t the point. The point is that, left to fend for themselves, with the government having made policy decisions that placed other priorities above fuel efficiency, trucking companies have been able to improve their own processes, and to demand better mileage from their suppliers.

More than that, it’s a little “I, Pencil” microcosm. These decisions are the result of a long chain of cost-benefit calculations stretching from engine manufacturer to trucker through customer to consumer. Each of these relationships has its own set of elasticities of supply and demand, which affect how much of the fuel cost can be pushed downstream. The amount that can’t be passed on to each customer provides the incentive for fuel economy.

It also provides the ceiling for how much each is willing to pay for it. Including the engine manufacturer. The government could probably demand higher fuel efficiency out of tractor engines, and the result would be greater inefficiency overall, because the cost of producing that engine would be greater than the system is currently willing to pay.

You could justify those expenses as externalities, say, the national security cost of keeping the Saudi pipeline safe and operating. But then you’re stuck arguing that the political & regulatory systems are as efficient in balancing interests as the economy is in balancing costs, which I think is, at best, an unproven assumption.

Note: Naturally, the opinions expressed here are entirely my own, and do not in any way represent Werner.

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