It was big news when the Obama Administration updated CAFE requirements in May to a new and higher national MPG standard of 42 mpg for cars (26 mpg for light trucks) by 2016. The higher standards will start increasing with 2011 model year vehicles. But what is CAFE? And how do these new numbers – before the raise, cars needed to average 27.5 mpg and trucks 24 mpg – change what will be available in dealerships in the coming decade?

Let's start with the official government wording. The National Highway Traffic Safety Administration (NHTSA) is in charge of establishing CAFE standards, so let's use their definition:

Corporate Average Fuel Economy (CAFE) is the sales weighted average fuel economy, expressed in miles per gallon (mpg), of a manufacturer's fleet of passenger cars or light trucks with a gross vehicle weight rating (GVWR) of 8,500 lbs. or less, manufactured for sale in the United States, for any given model year. Fuel economy is defined as the average mileage traveled by an automobile per gallon of gasoline (or equivalent amount of other fuel) consumed as measured in accordance with the testing and evaluation protocol set forth by the Environmental Protection Agency (EPA).

Clear as mud? We break it down after the jump.

[Image: Tim Boyle/Getty]

A super short History of CAFE

CAFE rules, officially called the "Energy Policy Conservation Act," became law in 1975 as a response to the 1973-74 Arab oil embargo. The stated goal was to double new car fuel economy by model year 1985. This did not happen. Starting with the initial average of 18 mpg (for cars) in 1978, the standard increased by about one or two mpg per year until 1985 when it reached 27.5. For 1986-1988, the number actually dropped to 26 mpg and then it sat quietly at 27.5 from 1989 until earlier this year.

Establishing a vehicle's MPG

CAFE is based on those little stickers that are plastered on every new car sold in the U.S. (an example label is pictured above) The miles per gallon numbers are, in turn, based on ratings calculated by the EPA and the DOE and available at Well, that's only 10 percent true. It's actually theautomakers themselves that conduct laboratory tests based on federal regulations and give the resulting mileage data to the EPA. The EPA then re-tests about ten percent of the models to confirm that what the manufacturer reported was accurate. Interestingly, the EPA doesn't directly measure the fuel that was burned; instead it measures the amount of carbon that came out of the vehicle's tailpipe during the test. The EPA claims that this method is more accurate than using a fuel gauge.

The tests are done on a dynamometer (pictured at right) by professional drivers using a standardized routines. As hypermilers and leadfoots can attest, the official rating doesn't always match a vehicle's performance on the road, but it does provide a baseline to compare different vehicles with one another – and all sorts of promotional opportunities – and gives the CAFE rules something to go on.

Establishing a fleet's MPG

Armed with the EPA's MPG numbers, automakers have to make sure that the vehicles that they make and sell (those under 8,500 lbs.) attain the CAFE limit for a particular year. So, for example, for model year 2011, the average for cars and trucks will be 27.3 mpg and that means that all of the vehicles that each automaker sells needs to average out to at least 27.3 mpg. Some vehicles can be less, obviously, but each company needs to make sure that it offers – and manages to sell – enough vehicles over 27.3 mpg to get the average up.

What about alternative fuels?

Here's where it gets a bit complicated, and somewhat dispiriting. Here's what NHTSA has to say about alt fuels:
The CAFE law provides for special treatment of vehicle fuel economy calculations for dedicated alternative fuel vehicles and dual-fuel vehicles. The fuel economy of a dedicated alternative fuel vehicle is determined by dividing its fuel economy in equivalent miles per gallon of gasoline or diesel fuel by 0.15. Thus a 15 mpg dedicated alternative fuel vehicle would be rated as 100 mpg. For dual-fuel vehicles (vehicles that can use the alternative fuel and gasoline or diesel interchangeably), the rating is the average of the fuel economy on gasoline or diesel and the fuel economy on the alternative fuel vehicle divided by .15. For example, this calculation procedure turns a dual fuel vehicle that averages 25 mpg on gasoline or diesel with the above 100 mpg alternative fuel to attain the 40 mpg value for CAFE purposes. Several limitations are established for CAFE credits for dual fuel vehicles.
Got that? What this means is that a "25 mpg" alternative fuel vehicle can be counted as a 40 mpg vehicle under CAFE. This is called the ethanol loophole, and is one reason why there are so many E85 vehicles on the road in America, even though most don't ever burn much, if any, ethanol. Car And Driver explained in 2006 how flex-fuel's big payoff works:

With fewer than 600 stations selling E85 fuel in 37 states, why have GM, Ford, and DaimlerChrysler been cranking out these flex-fuel vehicles by the millions?

The answer is the mandatory Corporate Average Fuel Economy (CAFE) standards. Federal law requires that the cars an automaker offers for sale average 27.5 mpg; light trucks must achieve 22.2 mpg. Failure to do so can result in substantial fines. However, relief is available to manufacturers that build E85 vehicles to encourage their production.

The irony here is that although E85 in fact gets poorer fuel economy than gasoline, for CAFE purposes, the government counts only the 15-percent gasoline content of E85. Not counting the ethanol, which is the other 85 percent, produces a seven-fold increase in E85 mpg. The official CAFE number for an E85 vehicle results from averaging the gas and the inflated E85 fuel-economy stats.

What happens when a company doesn't meet CAFE?

The short answer is that the automaker needs to pay a fine. This is calculated by taking the amount that an automaker missed the target by and multiplying each tenth of a MPG missed by $5.50 and then multiplying it again by the total number of vehicles the company manufactured for a given model year. Historically, European automakers have had to pay CAFE fines (often ranging from $1 million to $20 million per year) while Asian and big domestic automakers usually manage to conform to the standard. Since 1983, over $590 million in CAFE civil penalties have been paid.

Another option for non-compliant automakers is to use CAFE credits. If a company beat the CAFE standard in any of the previous three model years, the amount they went over can be used to offset the failure to meet a current year's standard. A final option is for the automaker to submit a "carry back plan" that explains how they will make up this year's loss by exceeding the standard in the coming three years. These credits can not be traded or sold between automaker or between the car and truck fleets within a company.

The future

CAFE looks to be a settled issue for now. Everyone – the federal government, California (which pushed for a long time to set its own standards), and the automakers – have agreed to the higher standards announced in May. How the car companies go about meeting them is another issue entirely.