1000 El Camino Real Menlo Park, CA Phone Fax An Economic Evaluation of the 2005 IEPR Michael C. Keeley, Ph.D. June 29, 2006

An Alternative Blueprint for California Transportation Fuel Policy June 2006 Page 2 Michael C. Keeley, Ph.D. My name is Michael Keeley. I’m a Senior Vice President of Cornerstone Research, a consulting firm specializing in the application of economics and finance to issues arising in business and complex commercial litigation. I have particular expertise in the oil and gas industries, and have provided economic expertise to the banking, electric utility, automotive, software, health care, semiconductor, chemical, pharmaceutical, and telecom industries among others. Prior to joining Cornerstone Research, I served as an officer of the Federal Reserve Bank of San Francisco and was an economist at Stanford Research Institute (SRI).

An Alternative Blueprint for California Transportation Fuel Policy June 2006 Page 3 An Economic Evaluation of the 2005 IEPR The California Chamber of Commerce asked me to evaluate the California Energy Commission (CEC) 2005 Integrated Economic Policy Report (IEPR) against Governor Schwarzenegger’s goals for California energy policy as stated in an August 23, 2005 letter to the state legislature: –“Adequate and reliable energy supplies… affordable energy… and advanced energy technologies that protect and improve economic and environmental conditions.” My study finds that the CEC’s recommendations are inconsistent with the governor’s goals and will hurt consumers in California. I recommend an alternative blueprint for California energy policy, based on market principles, that would better achieve the governor’s goals.

An Alternative Blueprint for California Transportation Fuel Policy June 2006 Page 4 The IEPR Recommendations The CEC supports an arbitrary, mandated reduction in petroleum fuel (gas and diesel) use to 35% below forecasted business-as-usual levels by 2025 (15% below the 2003 level). The CEC recommends these reductions be made by a mandated doubling of vehicle fuel economy (to 40 mpg) and mandating increased alternative fuel use.

An Alternative Blueprint for California Transportation Fuel Policy June 2006 Page 5 The IEPR Policies Are Flawed The CEC recommendations for petroleum fuel use reductions are unrealistic and unattainable. The CEC recommendations will not result in adequate, reliable and affordable transportation fuel supplies. The mandates would impose substantial costs on consumers and businesses in California while providing few benefits.

An Alternative Blueprint for California Transportation Fuel Policy June 2006 Page 6 The IEPR Policies Would Hurt California’s Consumers The mandates will have an impact on consumers’ driving equivalent to increasing gasoline prices to $5.14 per gallon. The mandates would cost consumers at least $8 billion and 90,000 jobs in the year Mandates for alternative fuels, which are more expensive than petroleum fuels, would increase fuel prices substantially. None of the IEPR’s transportation fuel policy options would contribute to increased fuel supplies, but instead would limit the quantity of fuel consumed.

An Alternative Blueprint for California Transportation Fuel Policy June 2006 Page 7 The IEPR Policies Offer Few Benefits The mandated reductions in petroleum fuel use could increase, not decrease, dependence on foreign crude oil. The policies would have no measurable effect on U.S. energy security. California already has the cleanest burning gasoline in the world. The IEPR policies would have a very small (almost negligible) effect on pollution. California’s citizens would be tackling global greenhouse gas emissions and would receive only a small fraction of any benefits. The policies could be self-defeating since they provide incentives for economic activity to move out of the state.

An Alternative Blueprint for California Transportation Fuel Policy June 2006 Page 8 Petroleum-Based Fuels Will Continue To Be Important The CEC agrees that petroleum–based fuels will be the primary transportation fuels for the foreseeable future.  Demand for transportation fuels will increase by at least 32% by  Recent growth in gasoline use in California (despite rising gasoline prices) implies that California would have to reduce its current level of consumption by almost 25% to meet the CEC target. Even larger reductions than forecast by the CEC will likely be required by Adequate, reliable and affordable supplies in California will require increased production and/or imports of transportation fuels.

An Alternative Blueprint for California Transportation Fuel Policy June 2006 Page 9 A Blueprint for California Transportation Fuel Policy Market forces tempered by environmental concerns will provide the right incentives for fuel efficiency improvements and the addition of alternative fuels to transportation fuel supplies. Regulatory roadblocks to conventional and alternative fuel infrastructure and use, such as a cumbersome permitting process, should be removed. The state should fund university research as a foundation for innovations in fuel efficiency and alternative fuel technologies. The state should educate consumers about fuel efficiency and alternative fuel options. The state should purchase fuel-efficient, alternative fuel, or flexible fuel vehicles for its fleets to the extent it is economic.