May 14, 2008

Green Warranties:

As the price of traditional fuels soar, the alternatives are becoming more viable. And manufacturers are promoting the growing viability of electric and biofuel-powered vehicles through longer warranties. Government is also getting involved by mandating higher fuel efficiency, new fuel blends, lowered emissions levels, and longer warranties.

Environmental concerns are affecting the warranty industry in dozens of ways. Worries about global warming and problems with garbage disposal underpin many of the efforts, but good old-fashioned economics in the form of higher energy costs have also lately begun to add their weight.

In virtually every industry from air conditioning to aerospace, there are efforts under way to create products that use less energy and create less waste. Warranty is frequently a factor. With new technologies, long warranties are a sign of the manufacturer's commitment. With old technologies, warranty is part of the mechanism now being used to create alternatives to landfill.

Let's take a brief tour of some of these environmental efforts, one industry at a time. It's no surprise that the automotive sector, accounting for 40% of the claims and 45% of the reserves, is the one with the most going on. So this week, let's begin our green warranty tour with the automakers.

Global Warming & Fuel Inflation

While global warming remains a theory that most scientists believe in, high fuel prices are a reality that needs no scientific investigation to verify. And while cleaner air and better health remains a priority in most cities, the reality is that the alternatives to gasoline-powered cars and diesel-powered trucks may not reduce costs by much. One of the reasons the U.S. declined to ratify carbon emission treaties was the predicted cost of compliance. But the good news is that as the cost of traditional fuels soars, less polluting alternatives have become more viable through market forces alone.

Automakers are now adjusting their product lines and promotional efforts to deal with record high prices for gasoline and diesel. Smaller and more fuel-efficient vehicles are selling better, given the customer expectation that the cost of fuel per mile will continue to increase. Chrysler LLC, however, has found a novel way to attract U.S. buyers for its larger vehicles by guaranteeing the price of fuel for up to three years. Customers must use a designated credit card to get the $2.99 per gallon price, and can use that card to purchase 1,500 to 2,400 gallons of subsidized fuel per year, depending on the model (see the Let�s Refuel America Web site for details).

Is this a warranty? It would seem to be at least a price guarantee, which would need to be disclosed and accounted for at fair value under the same accounting rules that govern warranty expenses (FASB Interpretation No. 45). However, Chrysler LLC, as a private company, does not need to make any disclosures regarding the expected future cost of its guarantees. So we may never know how much either this fuel price promotion or its lifetime powertrain warranties really cost the company.

Raising Fuel Efficiency

Elsewhere, more effort is expended on reducing the need for fuel rather than on simply capping its price. The Corporate Average Fuel Economy (CAFE) standards for passenger cars and light trucks get the most attention, having a clear impact on both fuel input and emissions output. Administered by the National Highway Traffic Safety Administration, the CAFE standards set goals for both passenger cars and light trucks.

In the May 2 edition of the Federal Register (Volume 73, No. 86, Docket No. NHTSA-2008-0089, Pages 24351-24400), NHTSA outlined its proposal to increase average fuel economy and decrease emissions in the 2011 to 2015 model years.

For passenger cars:
2011: 31.2 mpg (285 g/mi of CO2)
2012: 32.8 mpg (271 g/mi of CO2)
2013: 34.0 mpg (261 g/mi of CO2)
2014: 34.8 mpg (255 g/mi of CO2)
2015: 35.7 mpg (249 g/mi of CO2)
For light trucks:
2011: 25.0 mpg (355 g/mi of CO2)
2012: 26.4 mpg (337 g/mi of CO2)
2013: 27.8 mpg (320 g/mi of CO2)
2014: 28.2 mpg (315 g/mi of CO2)
2015: 28.6 mpg (310 g/mi of CO2)

In that proposal, NHTSA estimated the value of the total benefits of the proposed increase to be $31 billion for passenger cars and $57 billion for light trucks. The total costs for manufacturers would be approximately $16 billion for passenger cars and $31 billion for light trucks, NHTSA estimated.

On their own, the CAFE proposals would have no net effect on warranty duration, but some of those projected costs are likely to fall into each automaker's warranty claims bucket. Depending on how manufacturers meet the challenge, the use of new technologies and/or lighter materials could impact both the durability of the product and the frequency of repair. Even something as simple as fuel filter replacements and oil changes might need to become more frequent, because of what might be added to the gasoline or diesel fuel to make it burn cleaner.

However, notice that the new CAFE standards are denominated in miles per gallon. This assumes petroleum-based fuel, specifically gasoline, with some hopes expressed by NHTSA of an increased migration towards diesel. Biofuels made from plants and animal waste are positioned more as an additive than a replacement, and battery power is positioned as an assistive technology, as is the case with today's hybrid vehicles. In other words, CAFE is focused first on reducing the usage of gasoline and diesel, and only secondarily on replacing it. The internal combustion engine still has a long life ahead of it.

Cutting Emission Levels

The second piece of the puzzle is the inclusion of emissions standards within CAFE. The state of California was the early trendsetter in this area, setting both maximum emissions standards and minimum exhaust equipment warranty durations for vehicles registered in the state. These longer emissions warranties, sometimes called extended warranties or "super warranties," have also been adapted by the neighboring states of Oregon and Washington. However, the state of Arizona recently turned back an effort to do likewise.

According to a recent article in Aftermarket Business, the Arizona Department of Environmental Quality has announced that it will not include extended warranties in its new clean air rules, after a successful round of lobbying from an industry association. So while vehicles registered in the state will be required to pollute less, the equipment used to meet this goal will not need to be guaranteed for longer periods.

The California Air Resources Board (CARB), a unit of the state's Environmental Protection Agency, has for more than 40 years enforced an ever-widening array of air pollution laws. Its Biodiesel/Renewable Diesel Work Group meets every few months to discuss emissions tests, health effects, specifications, fuel production, blending, testing, and other topics. In the name of reducing air pollution, the agency has the power to require automakers to warrant not only their emissions manifolds for extended periods of time, but also to warrant items such as fuel injectors for up to ten years or 200,000 miles. CARB goes as far as to operate a Web page where citizens can anonymously report a smoking vehicle. One can even call in from a cell phone by dialing the number #SMOG.

Now that NHTSA is including emissions levels within CAFE, however, there may be less of a need for individual states to regulate so thoroughly. In fact, the potential future conflict between state and federal laws was one of the reasons that Arizona regulators chose not to include super warranties in their proposal. We note, however, that NHTSA's latest CAFE proposal made not one use of the word warranty in its 49 single-spaced pages. So we'll predict that bilaterally negotiated warranty extensions are unlikely to become a NHTSA enforcement mechanism for poor fuel efficiency or excess emissions (although the agency has become quite aggressive in recent years with its TREAD Act compliance and recall policies).

The U.S Environmental Protection Agency, meanwhile, sets emission rules for the heavy-duty diesel engines used in on-highway trucks and some farm and construction equipment. The Heavy-Duty Highway Diesel rule, also known as the 2007 Highway Rule, mandated a 97% reduction in the sulfur content of highway diesel fuel, from its old level of 500 parts per million to 15 ppm. Another rule, called the 2.5 gram NMHC+NOx emission standard, mandated the reduction of hydrocarbons and nitrogen oxides by heavy-duty truck engines.

These mandates caused a slight increase in diesel fuel cost and a slight dip in fuel efficiency, but caused a much wider disruption in truck buying patterns. In the run-up to the deadline, fleet operators rushed to buy up the remaining inventory, and were reluctant to buy the newer diesel engines for fear that they would be less fuel efficient and/or more costly to maintain.

Warranty to the Rescue

Cummins Inc. responded to the uncertainty by announcing an Uptime Guarantee program, which guaranteed that if any part on a customer's ISX or ISM engine fails and can't be repaired within a 24-hour period, Cummins not only will pay for the repairs, but also will provide a rental vehicle at no cost. It also introduced new extended warranty options for its EPA-compliant engines.

Volvo Trucks North America Inc. took its new EPA-compliant engines on a "Drive the Future" road show, visiting 17 different truck stops on a fall 2002 tour and 20 more truck stops on a spring 2003 tour. Truck drivers were allowed to test out the trucks and to see for themselves that performance hadn't been compromised by the new technology.

Cummins said it had to rent only eight trucks to satisfy claims -- a rate under one in a thousand units, the company said. And Volvo was able to meet with drivers without any sales pressure to buy a new truck, convincing many that the EPA engines were not the disaster they were predicted to be. And while sales took a big dip at the end of 2002, a year later they were more or less back to normal.

Meanwhile, despite the federal focus on the traditionally fueled internal combustion engine, the automakers themselves seem to be on the verge of producing vehicles powered exclusively by biofuels or electricity, or ones that resort to gasoline/diesel power only after the alternative fuel has been exhausted. In these efforts, warranty is indeed a major factor -- a badge of commitment and of quality that helps to reassure the customer that their purchase will remain on the road.

In fact, one alternative fuel maker is warranting the fuel itself, in an effort to reassure customers that its usage won't destroy their engines. Blue Sun Biodiesel LLC is marketing its Blue Sun Fusion B20 fuel to service stations in the mountain states. B20 refers to the mix it uses, of 80% diesel and 20% biofuel. In its written guarantee, the company states that if its brand of biodiesel fuel, when sold by an authorized retailer, is proven to be the direct cause of damage to OEM-warranted fuel system materials, they will replace the damaged material at no cost to the driver.

Implied Warranty vs. Express Warranty

With gasoline and diesel fuel, there is usually no written guarantee or warranty given at the pump, although there is always an implied warranty of fitness for a particular purpose. In other words, if a service station pumps salt water instead of gasoline into your fuel tank, the damage is theirs to fix. However, such a breach of the implied warranty would usually be settled through a lengthy lawsuit rather than a simple warranty claim. And if the customer is entirely responsible for the error -- pumping gasoline into a diesel-powered car, for instance -- the damage is their own fault and their warranty is voided.

So here's another possible warranty-related ramification to consider: what if there really are warranty claims caused by contaminated biofuels? Will companies such as Blue Sun have to begin reserving for them? Or will the claims rates be so low that they can simply pay out of cash on hand? Or are these warranties mere marketing gimmicks, designed to reassure customers who would otherwise stick to fuels they know?

Notice also what the Blue Sun guarantee does not cover. While customers can rest assured that the fuel won't ruin their engine, customers may still worry whether its mere use will invalidate their vehicle's warranty. And that depends on the manufacturer. Some engine makers say the use of 20% or even 85% biofuel has no effect on the validity of the engine warranty, while others set higher or lower percentages. For instance, in Europe the Citroën Dispatch can be run on up to 30% biodiesel without any effect on its engine warranty.

In the U.S., Chrysler and Cummins have launched the Dodge Ram 2500 and 3500 optionally equipped with a 6.7-liter turbo diesel engine capable of running on a mix of up to 20% biofuel. And there are Jeep Liberty CRD and Jeep Grand Cherokee models capable of running on 5% biofuel. Plus, there are Jeep Grand Cherokee, Jeep Commander, Dodge Durango, Dodge Ram, Dodge Dakota, Dodge Caravan, Dodge Grand Caravan, Chrysler Sebring, Chrysler Town & Country, and Chrysler Aspen models capable of running on up to 85% ethanol (mixed with 15% gasoline). All of these "flex-fuel" engines are covered by Chrysler's lifetime powertrain warranty and three-year/36,000-mile bumper-to-bumper warranty.

A few engine makers set no limit at all, allowing 100% biofuel mixes, but this allowance is more common for construction or farm equipment than it is with passenger vehicles. There are numerous stories about resourceful drivers who collect cooking oil from fast food joints and use it to run their vehicles. However, widespread use of pure biofuel would require more frequent changes of engine lubricants and filters, not to mention more uniform standards for the purity and quality of the fuel. For instance, while ethanol made from corn or sugar cane are more or less interchangeable, biofuel advocates say soybeans make the best blend of biodiesel (use of other ingredients tend to solidify in cold weather, they say).

Mandating Fuel Standards

Technical Committee 19 of the Comité Européen de Normalisation (CEN) has so far published two biodiesel standards: EN 14213:2003 (for heating) and EN 14214:2003 (for vehicles), in addition to older standards for diesel, liquefied natural gas and what the Europeans call petrol (gasoline). Chrysler has asked the National Biodiesel Board to take leadership of such standards developments in the U.S.

These standards merely specify the contents of the fuel. But it's still within the rights of the engine maker to specify the fuel type, and to make the validity of the warranty conditional on its use. If the engine is specified to be gasoline only or diesel only, so be it. Use of anything else (with allowances for mandated gasoline/ethanol blends in some high-pollution areas) would invalidate the engine warranty.

According to the National Biodiesel Board, any diesel engine can run blends up to 20 percent biodiesel without modification and without voiding manufacturer warranties. Then again, that's just their opinion, and they're not a party to the warranty claims that might result. However, various flex-fuel vehicles are warranted across a range of fuel mixes. Numerous gasoline engines can run on blends of up to 85% ethanol (E85). And then there are those diesel engines running on used cooking oil (hopefully after it's been strained and treated).

The warranty ramifications are varied. Municipal bus fleet operators say one of the biggest impediments to their experimentation with biodiesel mixtures is a fear that they'll somehow invalidate their engine warranties. However, state and local governments are passing laws that mandate a gradual switch to biofuels. In Minnesota, for instance, the governor recently signed into law a measure that will raise the current 2% biodiesel mandate to 5% on May 1, 2009, to 10% in 2012, and to 20% in 2015.

Local Production

However, when the governor first announced his intent to increase the biofuel mix, he also noted that biodiesel and ethanol production supports nearly 16,000 jobs in the state and generates close to $4 billion in total economic activity each year. The Minnesota Department of Agriculture reports that biofuel production has led to a 13 percent increase in demand for the state�s soybean crop. In other words, it's good for the environment but it's really good for local business. Governors in corn-growing states might back E85 for similar reasons.

Then again, why not look locally when searching for alternative power sources? Solar power makes perfect sense in the desert states where crops won't grow. In Brazil, ethanol is made from the plentiful sugar cane crop. Other countries can tap the power of the wind or the tides. Why shouldn't people in the farm belt look to locally grown crops such as soybeans and corn as a source of both fuel and jobs?

There is a problem, however. As petroleum prices increase, the attractiveness of crop-based fuels also increases. However, that also increases the scarcity of the crops and can itself lead to food price increases as stocks are diverted to fuel. It remains unknown how much of the current round of food price inflation is caused by increases in petroleum fuel costs (and the cost of running tractors, water pumps, and using fertilizer, etc.) and how much is caused by the increased demand for the crops themselves. Whichever it is, though, crop prices are rising, and some less developed areas of the world are perilously close to food shortages.

One alternative might be a purely electric car, but such a product has its own environmental cost. While the vehicle may not divert crops from food to fuel and may itself give off no harmful emissions, the electricity it stores in its battery needs to be produced somewhere. A hybrid vehicle can convert some of the braking force used to stop the vehicle into stored energy, but newer models will soon augment that with a 110-volt power cord. And of course, purely electric vehicles have to be recharged every so often as well.

The point is, the electrical power plant might burn diesel fuel, or perhaps coal. Those fuels create their own pollution. So while the vehicle might give off zero emissions, the power plant might not, unless it uses wind turbines or is hydropowered. In a future column we'll delve deeper into the equipment involved in power generation and the warranties provided. For now, let's just say that while electric cars may be clean, the power plants they will rely upon may not be.

Electric Cars

In terms of hybrid electric/petrol or purely electric cars, most of the automakers either have something on the market now or will within a year or two. Typically, the vehicles use electric power at low speeds and gasoline power at high speeds, with the turn of the engine and/or the use of the brakes recharging the gigantic battery. The combination saves fuel, particularly on short trips within cities. Toyota, for instance, claims that owners of its Prius line of hybrid vehicles have already saved more than 400 million gallons of gasoline. The vehicle is sold in the U.S. with a three-year/36,000-mile bumper-to-bumper warranty, a five-year/60,000-mile powertrain warranty, and an eight-year/100,000-mile warranty for hybrid-related components.

Ford has two hybrid models for sale -- the Ford Escape Hybrid and Mercury Mariner Hybrid -- and more on the way. In most states, the vehicle is sold with a three-year/36,000-mile bumper-to-bumper warranty and an eight-year/100,000-mile warranty for hybrid-related components. But in California, New York, Maine, Massachusetts, and Vermont, the hybrid component warranty is lengthened to a statutory minimum of 10 years or 150,000 miles -- another facet of the so-called "super warranties."

The Chevrolet unit of General Motors sells the Tahoe Hybrid and Malibu Hybrid. Both feature the eight-year/100,000-mile warranty that has become the industry standard for hybrid-related components. GM also is developing the Chevrolet Volt, a purely electric car. The company announced that it expects the vehicle to have enough power to drive 640 miles between charges, and said it will be able to use standard 110-volt house current for those recharges. First shipments of the Volt are expected in 2010.

Ford is also working with VeraSun Energy Corp. to broaden the availability of E85 fuel, which is 85% ethanol and 15% gasoline, in the states of Illinois and Missouri. VeraSun is also working with car rental companies and convenience stores to encourage owners of flexible fuel vehicles to switch to E85.

Renault-Nissan teamed with NEC and Project Better Place, a Palo Alto-based start-up, to introduce all-electric vehicles and a network of charging stations in Israel and Denmark by 2011. Nissan also plans to launch a battery-powered car in the U.S. by 2010 and by 2012 the Renault-Nissan alliance will take the vehicle to other large markets.

Last week, Nissan CEO Carlos Ghosn said the vehicles will carry lifetime warranties, will cost about what gasoline cars cost to buy and run, and will accept a 70% charge in just a few minutes at quick-charge stations. Owners will subscribe to a battery-replacement and charging plan based on their anticipated annual mileage.

Converting the Prius to Plug-in

Even for hybrid vehicles, aftermarket conversion kits are appearing that can convert them into plug-in vehicles. This summer, the Hymotion subsidiary of A123 Systems Inc. will begin shipments of the L5 Plug-in Conversion Module for the Toyota Prius. The kit can allegedly allow the Prius to achieve fuel efficiencies of up to 100 miles per gallon over distances of 30 to 40 miles. But it's warranted for only three years -- well short of the Prius battery's warranty duration.

When hybrid vehicles were first introduced, there was a worry that some dealers either wouldn't or couldn't do the warranty work on the hybrid components, for fear of electrocuting their technicians. In recent years, that worry has dissipated, as the technicians have become better trained and the technology better understood. What remains, however, is an expectation that once these eight-year battery warranties begin to expire, out-of-warranty replacements will be extremely costly for the vehicle owner.

Environmentalism has also made its way into the realm of auto parts. A company called EverDrive LLC gives three-year warranties on its stock of used auto parts, which it encourages vehicle owners to purchase by highlighting the environmental benefits. The company's chairman said automobiles are the most recycled consumer product in the world. By reducing the mining and processing of natural resources and eliminating production of new parts, used parts sold by outlets such as such as O�Reilly�s, AutoZone and Pep Boys already help save an estimated 85 million barrels of oil annually, the company said in a recent press release.

The problem is, that savings is equal to only about four days of U.S. consumption. And while the U.S. produced nearly seven billion gallons of ethanol last year, it imported nearly 200 billion gallons of oil and consumed well over 300 billion gallons of oil. So maybe NHTSA is right: while there's plenty of room for improvement, the internal combustion engine powered by traditional gasoline or diesel fuel still has a long life ahead of it.

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