Rapidly increasing fuel costs are making gas burning Internal Combustion Engine ( ICE ) cars less and less affordable to drive. Can rapidly improving the fuel efficiency of cars keep them viable?
Let’s look at used car depreciation – using an average depreciation curve from 50 years of accumulated wisdom:
This chart shows an average depreciation curve for a $27,000 car ( $27,000 was the average cost of a new car this year ). The left axis is the price to buy the car used after each year it gets older. The right axis is the monthly payment to buy that used car with a 5 year car loan at 4%. The “traditional” depreciation has the car retain about half its value after 5 years and about 25% of its value after 10 years. This traditional depreciation curve shows the discounted value of the old car, based on the collective experience of the reliability and desirability of an old car.
An old car is a little more worn and creaky than a new car. It doesn’t have the newest features, but most importantly it has a much higher probability of failure, leaving you stranded or saddling you with an expensive repair.
The absolute dollar amounts aren’t important, just the curve. 100% on the scale is the total outlay at the most expensive point – brand new. The red is the cost of gasoline to operate the car, assuming that the car is typical of its time ( 22mpg, drives 12000 miles a year and gas starts at 1.15 a gallon and increases at 2% per year. )
The curve is very similar for most of the years from 1960 to 1990 except for short periods of high volatility.
The green line is the total amount you pay to own and operate that car, I call this the “historical total monthly expense”. It represents a reasonable constraint on what you are willing to pay for a an old car – note that in the first year the cost to fuel the car starts out at about 10% of the total and after 12 years the cost of fuel has risen to about 40% of the total because it has ticked slightly up while the value of the car has dropped.
This chart shows the original payment number in blue ( calculated from the historical depreciation curve ).
The red line is the cost of gasoline per month, assuming a 30mpg gallon car ( todays average new car ) with $3.60 per gallon gasoline, that is projected to increase at 6% per year more than inflation.
Gasoline has really been increasing at 8.5% per year for the last 10 years, but the government claims that inflation is only 2.5%, so gasoline is increasing at 6% per year more than inflation.
The green line is the total cost to own and operate the car.
The purple line is the “historical total monthly expense” of payment + operating cost.
This is today’s scenario, where the total cost to fuel the car starts out at about 18% and after 12 years would be 75% if traditional depreciation values held.
Notice that the green line and the purple line are very very different.
This chart shows what you should actually be willing to pay for such a car, if it conforms to the traditional value proposition for a used car. If you constrain yourself to not exceed the historical total monthly expense curve, then what you are willing to pay becomes = historical total monthly expense – monthly cost of gas. The operating cost has risen so much, that at 10 years, the car is essentially worthless.
Conforming to this curve is not any kind of economic law, its more of a quantification of the feeling “I am not going to pay anywhere near as much to drive an old car than a new car”
This chart shows the same scenario for a car in 2021, if that new car now made 35 mpg – but gasoline continues to rise at the same rate.
When you initially purchase the car, the cost of gasoline is already 32% of the cost to operate the car per month.
Its used value plummets quickly and becomes negative shortly after owning it for 6 years.
The standard value proposition of the used car is quickly destroyed. This is because the cost to fuel it is very significant the very first year, but very shortly it dominates the total cost to own the used car. The fact that the car manufacturers are going to have to dramatically improve the fuel efficiency of the cars very rapidly to make them affordable at all, will make older cars obsolete so fast they will have little value. This will happen so fast that even a 6 year old car will be worth very little.
But car manufacturers are going to raise efficiency even faster than 5mpg in 10 years to battle the rising cost of gasoline right?
Lets look at the scenario from the opposite point of view:
Its 2021, and you are trying to choose what car to buy. You evaluate a new car and used cars up to 10 years old.
This chart shows the average cost per month of gasoline for a new car on the left and a 10 year old car on the right. We assume that the cars are similar price but each year older car gets 1 less mpg – with a new car getting 40 mpg. ( This represents the cars improving at 1mpg per year between now and then. There are many ways to mprove the fuel efficiency of a car and only some increase the cost or decrease the size, you can change aerodynamics, weight, power, rolling resistance, engine technology. Probably multiple variables will need to change. )
This chart is my attempt at calculating a smooth curve of the relative value of these cars.
The green line is the traditional car value ( depreciated value + operating cost line ) as before.
The blue line is the new car value line ( depreciated value + operating cost )
The red line is the actual value of each car.
Notice that a 10 year old car instead of costing you about 38% of the new car to own and operate, is about 44%.
But the value of that 10 year old car is near zero.
In fact the value of the 5 year old car is under 25%, whereas in the past it was near 50%.
Is there a conclusion? Yes. Here is mine. The traditional value proposition of a car is that you pay for it with a 5 year loan and when the loan is over, you have something about half the value from what you started with. In 2021 if you buy a new ICE car you will be looking at something that is very likely to have insignificant value within 2 years of completing your loan term.
I think that by 2021 buying an ICE car will be an unattractive proposition for a great many reasons, and this is a very significant one. Nobody will want to invest such a huge amount of money into something that becomes worthless so fast.
Here is my wild prediction: by or before 2021, the sales of new ICE passenger vehicles in the U.S. will fall well below half of the per year peak ( which I believe was 17 million in the years 1999 to 2007 ) and the ICE age will be officially over.