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Commercializing an alternate vehicle fuel: lessons learned from natural gas for vehicles
Energy Policy 30 (2002) 613–619
Commercializing an alternate vehicle fuel: lessons learned from natural gas for vehicles Peter C. Flynn* Department of Mechanical Engineering,Poole Chair in Management for Engineers, University of Alberta, Edmonton, Alberta, Canada T6G 2G8
Abstract In the mid-1980s, unique conditions in Canada favored the adoption of a compressed natural gas as an alternate transportation fuel. This work focuses on the factors that limited acceptance of the fuel, and that ultimately held the rate of adoption below a critical level which would enable healthy suppliers to survive in a competitive market. The main barrier was a lack of infrastructure to support converted vehicles. Lack of refueling facilities was particularly critical; failure of existing refueling stations to achieve profitability stalled further investment, which in turn depressed sales of vehicle conversions. Other problems in the industry included excessive parts markup by conversion dealers, exaggerated claims for environmental and economic benefits, and poor design of promotional programs. Fundamental shifts in the relative values of oil and natural gas in the late 1980s removed momentum from sales of conversions. Major players, who had not achieved profitability, exited the market, and natural gas as a vehicle fuel has since remained on the fringe in Canada and the US. Today, new technologies and driving forces are creating conditions that favor different alternate transportation fuels, including electricity and hydrogen. Many of the issues regarding growth to commercial viability, in particular, the need to build a supporting infrastructure, will be the same as with natural gas. r 2002 Elsevier Science Ltd. All rights reserved.
1. Introduction In 1983, a unique set of conditions in Canada created a strong push for the use of natural gas as a vehicle fuel (NGV). A powerful corporate sponsor (Nova, a major Canadian gas transmission company) bought a 50% interest in an equipment supplier, CNG Fuel Systems (CNG-FS), and committed to itself significant product development. By 1984 (when the author became the president of CNG-FS), technically acceptable products were available for vehicle conversion and fuel dispensing. Oil price relative to natural gas price and favorable public policy programs created an economic incentive for high mileage vehicles to adopt NGV. There was interest (although a less favorable public policy and hence a less favorable economic incentive) in the United States. The growth rate of NGV was steep: conversion sales more than doubled in 1985 compared to 1984. However, sales growth ultimately was not large enough to achieve a critical and sustainable mass. Since equipment suppliers in the market needed a further quadrupling *Tel.: +1-780-492-6438; fax: +1-780-492-2200. E-mail address: peter.fl[email protected] (P.C. Flynn).
of sales to reach breakeven, the limited growth ultimately caused those suppliers to exit the market when startup funds were exhausted. This paper addresses these issues, since the lessons learned from attempts to build NGV usage to commercially sustainable levels are of relevance to future alternate transportation fuels, including hydrogen (which is increasingly cited as a fuel capable of reducing urban air pollution). In 1987, a dramatic drop in the price of oil changed the inherent economics of NGV, and sales of equipment in North America dropped sharply. Several major suppliers, including CNG-FS, exited the business. Hence, this paper will focus on barriers to growth in NGV during the period 1984–1986. Note that all costs in this work are cited in 1986 Canadian dollars. US costs were converted to Canadian currency at the then conversion rate of 1.33 Cdn$ per US$. One 1986 US$, adjusted for inflation, is equivalent to $1.43 2001 US $.
2. Background: NGV in 1984 In 1983 and 1984, several factors contributed to a favorable climate for the adoption of NGV:
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P.C. Flynn / Energy Policy 30 (2002) 613–619
Natural gas was seen as being available in abundance in North America, whereas oil was seen as being an import from politically unstable or hostile areas. Natural gas prices were still subject to some regulation, whereas domestic oil prices were increasingly tied to a fluctuating world market that was strongly influenced by political events. Alternate transportation fuels were seen as a mechanism for controlling urban air pollution, about which concern was growing. Governments in Canada had focused high on public policy and a willingness to engage in public spending. The climate of fiscal constraint and program contraction that characterized the 90s in both the US and Canada had not yet arrived. Hence, public support of alternate transportation fuels was an easier sell, especially in Canada.
One other country, New Zealand, had a highly active NGV industry, with remarkable results: 100,000 vehicles in New Zealand (10% of all the vehicles) used NGV. In all areas, NGV was an aftermarket conversion industry in 1984, since original equipment manufacturer (OEM) vehicles were not available except as the occasional demonstration vehicle. An aftermarket conversion costs $2400–$2900, and a large refueling station designed for installation in an existing service station and capable of servicing 200–300 vehicles costs $300,000.
25 cents/l eq between gasoline and NGV. Most of the price spread came from foregone taxes. Gas utilities in Canada were far more active than most in the US. NGV was seen as a means to expand and level load: a typical high mileage vehicle that converted to NGV would use as much natural gas as a home, but with an even (i.e. non-seasonal) load pattern. Individual utility programs varied, but included cash support for conversions (up to $900), investment in public refueling stations, and active promotion. Finally, there were technically competent national suppliers. Alternate transportation fuels have often been serviced by small local advocates (referred to as ‘‘blacksmith shops’’ by national suppliers), who often drew their income from other sources and did not expect a commercial return on their hobby of NGV. Commercialization of a fuel requires broader suppliers who can offer a full product line (including refueling equipment) and effectively ensure ongoing warranty and service. Dual Fuels (DF)of California (owned and supported by a gas utility) played this role in the US in the late 1970s, and CNG-FS played this role in Canada and the US in the mid-1980s. Other major suppliers manufactured related equipment, for example, Alcoa and Pressed Steel Tank each developed light weight fiberglass wound pressure tanks for NGV.
4. What limited growth of NGV: lessons learned 3. Support for NGV in 1984 The positive factors for NGV led to a widespread interest in NGV. In the United States, the American Gas Association (AGA) actively promoted the fuel through media-oriented events. Federal US support for NGV was minimal, and support by individual states (who levied taxes on retail fuels, i.e. the road tax, collected at ‘‘the pump’’) was spotty. In many states, fleets that converted to NGV did not have to pay road tax on fuel by neglect rather than by legislation. No US state supported an outright waiver on fuel tax. Gas utilities in the US gave verbal and promotional support to NGV, often promoting it in bill inserts, but few implemented fiscal support programs. In Canada, Federal and Provincial Governments were far more proactive in promoting the fuel. The Federal Government had been convinced by NGV promoters that NGV was an inherently economic fuel, and as a result designed a ‘‘kick start’’ support program that gave $500 grants per vehicle conversion and $50,000 grants per service station, but with an ultimate cap on the number of each. Both the Federal Government and the most Provincial Governments eliminated retail taxes on NGV, which coupled with the price spread between oil and natural gas created a retail fuel price spread of
In 1985 about 15,000 vehicles converted to NGV in North America, most of those in Canada where more active support and promotion programs improved economics and awareness. The growth rate of sales was over 100% per year. However, for commercial sustainability (suppliers who were profitable), at least 60,000 conversions per year were needed. What did we learn in trying, unsuccessfully, to reach this level? 4.1. Infrastructure profitability is the prime concern In a mature fuel, such as gasoline, the ‘‘invisible hand’’ of the marketplace regulates the profitability of the infrastructure. Competition prevents excess profits from damaging the market, and opportunity induces new investment because of the overwhelming demand for the fuel. This is not the case for a new fuel, and those who would promote the fuel need to resist the temptation to be absorbed by technological challenges and opportunities. Rather, they need to focus on and ensure that the infrastructure to support the new fuel emerges and is profitable, without excess profits at the expense of users of the new fuel, since infrastructure is far more important to existing and prospective customers than future improvements in technology. None of this is automatic, and for NGV these issues received
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P.C. Flynn / Energy Policy 30 (2002) 613–619
4.2. The alternate fuel must be available publicly to support conversion of individuals and small fleets NGV initially targeted commercial fleets, since fuel compression and dispensing have a large economy of scale and public dispensing of fuel was unavailable. The investment in compression and dispensing equipment per vehicle serviced was about $1000 per vehicle for large compressors servicing 300 vehicles, and $3300 per vehicle for smaller facilities servicing 30 vehicles. D F of California had focused on fleet customers for two reasons: public refueling in the US would attract road taxes, whereas private dispensing was often neglected by state authorities, and the capital cost of building a public refueling network was seen as prohibitive, especially in the absence of a guaranteed base of customers. However, very large fleets operating from a single location are rare and tend to be conservative buyers; so DF had focused on a 0.013 Nm3 s 1 (30 scfm) compressor capable of meeting the refueling requirements of 30 vehicles, despite the diseconomy of the scale noted above. CNG-FS discovered that the majority of sales were not to large fleets, which would hardly ever commit to a block purchase without an introductory trial. Leading purchasers of new fuels are by definition innovative purchasers, and CNG-FS found these in very small commercial fleets and single high mileage commuters. Over 90% of conversion sales in Canada were to such customers, who required refueling in public facilities. Thus, the first challenge in commercializing an alternate fuel was to create an infrastructure of public refueling. This was most often done through partnerships with existing fuel sellers (gasoline retailers) and sometimes with gas utilities. Public refueling through existing fuel sellers also requires that equipment maintenance be available. The typical fuel retail outlet is either a franchise or company owned; in either case, the owner or manager is not capable of doing maintenance on sophisticated new equipment (in the case of NGV, maintenance of a highpressure compressor and storage facility). Those promoting the new fuel must ensure that public retailers have easy access to an affordable source of equipment maintenance. Any new thermal alternate transportation fuel will face the same issues: small scale purchasers, who are often innovative early adopters and willing to try a new fuel, require public refueling because of the diseconomy of scale of small dedicated refueling equipment. Public
refueling stations will in turn require reliable third-party maintenance. Only electricity, which is already available in homes, can avoid this issue through affordable home repowering. 4.3. Fuel retailing must become profitable to sustain investment in additional stations The largest problem the NGV industry faced in Canada was a stalling in investment in public refueling facilities, which in turn retarded conversion sales. Investment in new refueling facilities stalled because existing stations did not build up sufficient load to make them profitable. Alternate fuels face a ‘‘chicken and egg’’ problem: without refueling facilities, no one invests in vehicles using the new fuel, and without sufficient customers for the fuel, no one invests in the refueling station. There were over 80 public refueling facilities in Canada in the mid-1980s; CNG-FS had an equity participation, usually co-ownership, in 34. The typical NGV refueling facility consisted of a compressor, storage and retail dispenser located at an existing gasoline station. Fig. 1 shows refueling volumes versus time in service for the stations for which CNG-FS was an equity partner. We viewed ‘‘stars’’ as stations that were on a path to reach capacity in 3 years or less, and dogs as stations that were not likely to reach capacity in 5 years. A station that did not reach nominal capacity in 5 years was below the threshold for acceptable return. Fig. 1 shows that for every star that showed early promise there was a dog, and this surplus of underutilized NGV refueling capacity eventually discouraged investment by fuel retailers. The failure to build profitability at existing stations in order to sustain investment in additional refueling facilities was, in hindsight, the most significant factor in limiting the growth of NGV. All suppliers were losing money at a market size of 15,000 conversions per year, and stayed in the business hoping for continued growth. Efforts to minimize losses meant marketing resources were scarce, and suppliers relied on gas utilities to help sell conversions. Efforts NGV Dispensed per Month, Litres Equivalent (000)
little attention quite late. As discussed in further detail below, one element of infrastructure, refueling, had insufficient return on investment and dried up, while another element, vehicle conversion, overcharged and made the introduction of the new fuel more difficult.
120
"Fully Loaded"
100
"Adequate Return"
80
"Cows"
60 "Dogs"
40 20 0 0
10
20
30
40
50
60
Months in Operation
Fig. 1. History of CNG Fuel Systems fuelling stations (June 1985).
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lagged, and some refueling stations became orphans. In hindsight, intense selling around every station (including direct telemarketing) to achieve profitability, or moving NGV fueling stations from sites that were not profitable (even if this meant buying back vehicle conversions from those who would have been orphaned) would have been a better strategy, since the loss of fuel retailer interest eventually destroyed the momentum in the business. Any new thermal alternate transportation fuel will need to be resolved wherever the fuel is sold. Including the new fuel in an existing fuel, retail outlet such as a gasoline station gives comfort to the customer and reduces the overhead cost for site and vehicle access. However, the fuel retailer will want to see profitability, and will tie future investment to initial success. 4.4. OEM equipment is needed in addition to aftermarket conversion NGV in the 1980s was an aftermarket product; it did not have the volume or the technology to justify OEM supply. Further, the main centers of NGV activity, New Zealand and Canada, did not have large indigenous auto industries and were by world standards small markets. Aftermarket products have lower credibility in the eye of the consumer than OEM product, and this was particularly true in the mid-1980s when NGV conversion equipment was the 1950s design based on pressureregulated carburetion rather than electronic fuel injection. There was always a concern that the conversion of a vehicle would void the warranty. Future alternate fuels will be best served by a mix of OEM supply and competent aftermarket conversions by large-scale suppliers who can address warranty and service. OEM is only likely to occur if certain countries, that are major auto design and manufacturing centers, support the alternate fuel through public policy. Aftermarket product is also needed because OEM sales are too low to build a profitable load on infrastructure, especially refueling. Aftermarket sales can target areas where refueling facilities are in place and build fuel demand quickly. 4.5. Aftermarket vehicle conversion and service cannot be on a dedicated facility basis When a large fleet that has its own in-house mechanics converts to an alternate fuel, the mechanics can be trained to install and service the new equipment. This is not practical for smaller fleets and individuals. CNG-FS originally created dedicated NGV conversion centers in four major metropolitan areas in Canada to install conversions and service vehicles. This was an economic disaster, since conversion sales were too erratic to keep the shop busy and many conversions
were too distant to be installed or serviced at the facility. The alternative was to develop a network of trained installation dealers using existing vehicle service centers, i.e. we approached auto dealers and other service facilities to add NGV conversion and service to the range of services they offered. This was a slow and expensive undertaking, but offered the potential for higher geographical coverage without dedicated and underutilized overhead. Any new alternate fuel that includes aftermarket product needs to face these issues: how does a customer who wants the new fuel get installation, and how does this customer get service if the vehicle is away from the original installing dealer. Local ‘‘blacksmith’’ suppliers cannot deal well with remote customers or vehicles that have a wide span of travel. 4.6. Aftermarket dealer parts markup needs to be controlled CNG-FS recruited new conversion dealers on the basis that they could charge the same parts markup and labor cost as existing service work on gasoline vehicles. This was a mistake, since the ratio of parts to labor for an NGV conversion is significantly different than for most service work and this distorts the economics of a conversion. On average, typical gasoline vehicle service charges are 50% labor and 50% parts. The owner of the service facility usually keeps half the labor charge and 20% of the parts charge (equivalent to a 25% parts markup) as contribution to overhead and profit. Thus, each service bay that was in use for 8 h in 1984 typically charged $400 for labor and $400 for parts; the owner of the service facility realized $280 per bay day of revenue, consisting of $200 from the labor charges and $80 of parts markup (Flynn, 2000). However, a typical vehicle conversion (which took 12 h) had the parts cost to the dealer of $1800 and at the 25% markup the dealer ended up making $450 of parts markup per conversion or $300 of parts markup per bay day. In effect, a dealer was making $450 of parts markup on a 12 h service job when any other work he would have done in the bay would have generated $120 of parts markup revenue in the same time period. The extra $330 came out of the pocket of the person buying the conversion. Since the customer’s cost of the conversion net of all rebates was often about $1500, the extra dealer revenue of $330 was a significant additional cost that reduced the attractiveness of a conversion to the end user. In effect, a careless initial policy by CNG-FS reverted to create a 20% premium in the cost of a conversion, which was a real deterrent to conversion sales. Once the dealer markup had been set, attempts to change it met stiff resistance. In hindsight, seeing the
P.C. Flynn / Energy Policy 30 (2002) 613–619
problem from the start and convincing the dealers that a lower percentage parts markup on vehicle conversions preserved their ‘‘bay day’’ revenue would have been a major help for sales of vehicle conversions. Any new alternate transportation fuel that includes aftermarket product installed through licensed dealers will need to address parts markup based on the specific relative mix of labor and parts in the conversion. 4.7. Exaggerated claims damage the market NGV was hailed as being economical and more environmentally friendly than gasoline; in 1984, neither claim was true and each claim came back to haunt the industry. NGV had the potential to be a cleaner burning fuel than gasoline, but was not so in practice because sophisticated fuel injection gasoline engines with stoichiometric control to enable emission systems to function properly were being replaced with carbureted natural gas aspiration systems that had poor stoichiometric control (see, for example, Gettel et al., 1985; Topaloglu and Elliott, 1986; Dhaliwal et al., 2000). Only NGV has the potential to improve urban air quality when it has fuel injection with stoichiometric control. The industry had the paradox that in California, where environmental issues were taken very seriously, most NGV conversions could not win approval even when ‘‘tweaked’’ just prior to testing. More serious were the claims that NGV was inherently economical compared to gasoline, since governments believed this claim. In the US, many governments saw no reason to even consider supporting NGV in order to realize an environmental benefit, since it was touted as already being economic, and in Canada governments put time or volume limits on subsidies of NGV conversions and refueling facility grants. The Canadian Government, for instance, viewed its conversion grant of $500 per vehicle as a market startup grant that would only apply to the first 35,000 conversions, and its $50,000 per refueling station grant was similarly capped at 125 stations. This presented the prospect of a ‘‘cliff’’ that would effectively destroy the economic attractiveness of an NGV conversion, since without the subsidies NGV was not economically attractive for most vehicles. As discussed elsewhere in more detail (Flynn, 2000), in the mid-1980s the long-term price of natural gas was set by competition with oil in the industrial fuel market in the US-midwest, i.e. natural gas at the burner tip of an industrial plant boiler would have the same value as fuel oil. Compression costs for NGV, about 14 cents/l eq (about 7 cents for operating and dispensing costs and 7 cents for recovery of the capital cost of the compressor) were virtually identical to the premium value of gasoline over industrial fuel oil. Hence, on a pre-tax
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basis, NGV and gasoline grew to have the same value by the mid-1980s. What created the impression that NGV was an economical fuel was differential taxation: retail taxes (often referred to as road taxes because in some jurisdictions they were dedicated to road construction and maintenance) were levied on gasoline, and either not levied or levied at a lower rate on NGV. (More recently, the widespread use of natural gas in North America to generate electrical power has decoupled the price of gas from oil and driven natural gas prices even higher relative to oil.) Proponents of NGV compounded the confusion by claiming that NGV was more efficient than gasoline on a net energy basis, and that this justified the claim that a lower amount of energy as NGV was equivalent to a liter of gasoline. These claims persisted despite ample evidence to the contrary: the perceived efficiency was due to lean tuning of the carburetion system, which also produced degraded performance from catalytic emission control systems. Any soundly designed NGV conversion would require stoichiometric air-to-fuel ratio, which would eliminate the apparent efficiency that was available from either gasoline or NGV in a lean burn mixture. Different ‘‘liter equivalency’’ standards had the effect of eroding confidence in the fuel. Natural gas is more costly to transport by pipeline than liquid fuels, and hence, in theory, one could create an economic incentive at the upstream end of a long gas pipeline. In practice, this difference was not large enough to justify the cost of an NGV conversion, and in any event the high population areas where alternate transportation fuels had the potential to find the largest markets and create the greatest environmental relief were at the downstream end of gas pipelines. One additional factor in a distorted sense of the economics of NGV was wild optimism in the early assessments of cost of conversions and refueling stations. Early promoters often believe that ‘‘prices just have to drop’’, and cited what turned out to be unachievable price levels. Those who relied on the early estimates had a sense of being abused. There was never a clear signal from any government that the environmental merit of NGV warranted a permanent deferral of collection of road taxes, and hence there was never a clear picture that the fuel price spread between NGV and gasoline that was created by foregone taxes and that was necessary to justify the high cost of converting the vehicle was permanent. In some US states, fuel tax due on NGV was ignored, but the industry was haunted with the prospect that once the fuel became widely used the foregone tax would be too substantial to ignore; in effect, success would kill the economic benefit of using NGV. A major factor deterring this assurance from governments was the exaggerated claims of the industry.
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In hindsight, NGV would have had a more stable and sellable fuel if the proponents had been more honest: NGV had the potential to make a positive contribution to the environment, and realizing this potential would require permanent public subsidization. Exaggerated claims have damaged the credibility of alternate transportation fuels, and have retarded acceptance, especially by large commercial purchasers. It is particularly important that governments get clear messages about economics, so that stable public policy can be designed. 4.8. Promotional programs need to be designed for market effectiveness In Canada, vehicle conversions were promoted and sold by either equipment suppliers or gas utilities. All conversions were eligible for a $500 rebate from the Federal government, and in some areas additional support was available from a gas utility. Gas utility grants were typically administered through the dealer that converted the vehicle, but the Federal rebate was only available after the fact by application by the vehicle owner, which meant that the person converting the vehicle had to finance the $500 and wait about 6 weeks for the paperwork to be processed. Vehicle conversions were a high dollar item to commuters and small businesses, and in hindsight the Federal grant would have been far more effective had it been administered through registered dealers. After purchase, cash refunds are a less effective marketing promotion than a reduction in actual purchase price.
utilities would have better served their strategic interests by a broader strategic commitment to national suppliers who in turn had a commitment to technology development. Future alternate fuels will have either a utility or a major energy supplier as a potential ally; these allies need to screen their actions to ensure that they are in the strategic interest of the industry.
5. Conclusion There are powerful reasons to explore alternate transportation fuels, with urban air quality being the prime consideration. Public policy can be designed to support the adoption of an alternate fuel. However, if the fuel is to be sold to end-users rather than forced by mandate, the history suggests that a number of lessons can better ensure that a fuel becomes commercially viable, i.e. it sustains profitable suppliers. Key lessons are: *
*
*
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4.9. Utility support needs a strategic focus *
Gas utilities supported NGV since it represented increased load, but given that they were regulated it did not represent increased profit. For this reason, actual NGV programs within utilities were often administered by middle managers with little attention or guidance from senior management. To be successful, NGV required national technically competent suppliers, but often gas utilities became associated with local ‘‘one shop’’ converters (‘‘blacksmith shops’’) who sold a limited range of conversions and no refueling equipment. The result was that sales were fragmented and no national supplier achieved break even; the industry was characterized by a number of under-funded players. One common refrain from the industry in the 1980s was ‘‘98% of NGV equipment suppliers are losing money, and the other 2% are liars’’. Large national players had the backing and seed capital of major companies (a large gas utility and an aluminum company in the US, and a large gas transmission company in Canada), but eventually each of these backers gave up when sales failed to grow at a sufficient pace. In hindsight, gas
*
*
*
Once the alternate fuel is available to customers, infrastructure rather than technology is key to market acceptance and growth of sales. A thermal alternate fuel needs to be dispensed at publicly accessible outlets, in order to enable individual and small fleet conversions. These outlets will require reliable service. Conversion selling needs to be focused on ensuring the early profitability of refueling stations, in order to sustain investment in future stations. A combination of OEM and high quality aftermarket suppliers is the best way to develop the conversion market. A network of conversion dealers who have other service revenues is a better alternative than dedicated conversion facilities. However, parts markup at conversion dealers needs careful consideration. Exaggerated claims and optimistic projections are tempting in the early stages of promoting an alternate fuel, but damage industry credibility has the potential to seriously damage both policy support and market acceptance. Promotional programs, such as government programs aimed at realizing an environmental benefit, need to be designed for market effectiveness. Utilities or energy suppliers can be allies, but need to ensure that their actions are strategic in building the market.
Alternate transportation fuels have in the past failed to reach the critical point of commercial viability. Major suppliers left the market, exhausted by continuing losses. Careful attention to the factors that promote market growth can minimize the prospect of this for future alternate fuels.
P.C. Flynn / Energy Policy 30 (2002) 613–619
References Dhaliwal, B., Yi, N., Checkel, D., 2000. Vehicle emissions effects of alternative fuels in light duty and heavy duty vehicles. SAE Technical Paper Series 2000-01-0692, SAE International, Warrendale, PA. Flynn, P.C., 2000. Infrastructure profitability issues in NGV. SAE Technical Paper Series 2000-01-3081, SAE International, Warrendale, PA.
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Gettel, L.E., Perry, G.C., Smith, M.C., 1985. Performance evaluation of commercial CNG conversion kits. Symposium Papers, Nonpetroleum Vehicular Fuels V: CNG Fuel, Institute of Gas Technology, April, p. 139. Topaloglu, T., Elliott, D., 1986. Performance of first generation NGV kitsFengine and chassis dynamometer test results. Conference Papers, Gaseous Fuels for Transportation I, Institute of Gas Technology and BC Research, August 1986, p. 727.
Commercializing an alternate vehicle fuel: lessons learned from natural gas for vehicles Peter C. Flynn* Department of Mechanical Engineering,Poole Chair in Management for Engineers, University of Alberta, Edmonton, Alberta, Canada T6G 2G8
Abstract In the mid-1980s, unique conditions in Canada favored the adoption of a compressed natural gas as an alternate transportation fuel. This work focuses on the factors that limited acceptance of the fuel, and that ultimately held the rate of adoption below a critical level which would enable healthy suppliers to survive in a competitive market. The main barrier was a lack of infrastructure to support converted vehicles. Lack of refueling facilities was particularly critical; failure of existing refueling stations to achieve profitability stalled further investment, which in turn depressed sales of vehicle conversions. Other problems in the industry included excessive parts markup by conversion dealers, exaggerated claims for environmental and economic benefits, and poor design of promotional programs. Fundamental shifts in the relative values of oil and natural gas in the late 1980s removed momentum from sales of conversions. Major players, who had not achieved profitability, exited the market, and natural gas as a vehicle fuel has since remained on the fringe in Canada and the US. Today, new technologies and driving forces are creating conditions that favor different alternate transportation fuels, including electricity and hydrogen. Many of the issues regarding growth to commercial viability, in particular, the need to build a supporting infrastructure, will be the same as with natural gas. r 2002 Elsevier Science Ltd. All rights reserved.
1. Introduction In 1983, a unique set of conditions in Canada created a strong push for the use of natural gas as a vehicle fuel (NGV). A powerful corporate sponsor (Nova, a major Canadian gas transmission company) bought a 50% interest in an equipment supplier, CNG Fuel Systems (CNG-FS), and committed to itself significant product development. By 1984 (when the author became the president of CNG-FS), technically acceptable products were available for vehicle conversion and fuel dispensing. Oil price relative to natural gas price and favorable public policy programs created an economic incentive for high mileage vehicles to adopt NGV. There was interest (although a less favorable public policy and hence a less favorable economic incentive) in the United States. The growth rate of NGV was steep: conversion sales more than doubled in 1985 compared to 1984. However, sales growth ultimately was not large enough to achieve a critical and sustainable mass. Since equipment suppliers in the market needed a further quadrupling *Tel.: +1-780-492-6438; fax: +1-780-492-2200. E-mail address: peter.fl[email protected] (P.C. Flynn).
of sales to reach breakeven, the limited growth ultimately caused those suppliers to exit the market when startup funds were exhausted. This paper addresses these issues, since the lessons learned from attempts to build NGV usage to commercially sustainable levels are of relevance to future alternate transportation fuels, including hydrogen (which is increasingly cited as a fuel capable of reducing urban air pollution). In 1987, a dramatic drop in the price of oil changed the inherent economics of NGV, and sales of equipment in North America dropped sharply. Several major suppliers, including CNG-FS, exited the business. Hence, this paper will focus on barriers to growth in NGV during the period 1984–1986. Note that all costs in this work are cited in 1986 Canadian dollars. US costs were converted to Canadian currency at the then conversion rate of 1.33 Cdn$ per US$. One 1986 US$, adjusted for inflation, is equivalent to $1.43 2001 US $.
2. Background: NGV in 1984 In 1983 and 1984, several factors contributed to a favorable climate for the adoption of NGV:
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Natural gas was seen as being available in abundance in North America, whereas oil was seen as being an import from politically unstable or hostile areas. Natural gas prices were still subject to some regulation, whereas domestic oil prices were increasingly tied to a fluctuating world market that was strongly influenced by political events. Alternate transportation fuels were seen as a mechanism for controlling urban air pollution, about which concern was growing. Governments in Canada had focused high on public policy and a willingness to engage in public spending. The climate of fiscal constraint and program contraction that characterized the 90s in both the US and Canada had not yet arrived. Hence, public support of alternate transportation fuels was an easier sell, especially in Canada.
One other country, New Zealand, had a highly active NGV industry, with remarkable results: 100,000 vehicles in New Zealand (10% of all the vehicles) used NGV. In all areas, NGV was an aftermarket conversion industry in 1984, since original equipment manufacturer (OEM) vehicles were not available except as the occasional demonstration vehicle. An aftermarket conversion costs $2400–$2900, and a large refueling station designed for installation in an existing service station and capable of servicing 200–300 vehicles costs $300,000.
25 cents/l eq between gasoline and NGV. Most of the price spread came from foregone taxes. Gas utilities in Canada were far more active than most in the US. NGV was seen as a means to expand and level load: a typical high mileage vehicle that converted to NGV would use as much natural gas as a home, but with an even (i.e. non-seasonal) load pattern. Individual utility programs varied, but included cash support for conversions (up to $900), investment in public refueling stations, and active promotion. Finally, there were technically competent national suppliers. Alternate transportation fuels have often been serviced by small local advocates (referred to as ‘‘blacksmith shops’’ by national suppliers), who often drew their income from other sources and did not expect a commercial return on their hobby of NGV. Commercialization of a fuel requires broader suppliers who can offer a full product line (including refueling equipment) and effectively ensure ongoing warranty and service. Dual Fuels (DF)of California (owned and supported by a gas utility) played this role in the US in the late 1970s, and CNG-FS played this role in Canada and the US in the mid-1980s. Other major suppliers manufactured related equipment, for example, Alcoa and Pressed Steel Tank each developed light weight fiberglass wound pressure tanks for NGV.
4. What limited growth of NGV: lessons learned 3. Support for NGV in 1984 The positive factors for NGV led to a widespread interest in NGV. In the United States, the American Gas Association (AGA) actively promoted the fuel through media-oriented events. Federal US support for NGV was minimal, and support by individual states (who levied taxes on retail fuels, i.e. the road tax, collected at ‘‘the pump’’) was spotty. In many states, fleets that converted to NGV did not have to pay road tax on fuel by neglect rather than by legislation. No US state supported an outright waiver on fuel tax. Gas utilities in the US gave verbal and promotional support to NGV, often promoting it in bill inserts, but few implemented fiscal support programs. In Canada, Federal and Provincial Governments were far more proactive in promoting the fuel. The Federal Government had been convinced by NGV promoters that NGV was an inherently economic fuel, and as a result designed a ‘‘kick start’’ support program that gave $500 grants per vehicle conversion and $50,000 grants per service station, but with an ultimate cap on the number of each. Both the Federal Government and the most Provincial Governments eliminated retail taxes on NGV, which coupled with the price spread between oil and natural gas created a retail fuel price spread of
In 1985 about 15,000 vehicles converted to NGV in North America, most of those in Canada where more active support and promotion programs improved economics and awareness. The growth rate of sales was over 100% per year. However, for commercial sustainability (suppliers who were profitable), at least 60,000 conversions per year were needed. What did we learn in trying, unsuccessfully, to reach this level? 4.1. Infrastructure profitability is the prime concern In a mature fuel, such as gasoline, the ‘‘invisible hand’’ of the marketplace regulates the profitability of the infrastructure. Competition prevents excess profits from damaging the market, and opportunity induces new investment because of the overwhelming demand for the fuel. This is not the case for a new fuel, and those who would promote the fuel need to resist the temptation to be absorbed by technological challenges and opportunities. Rather, they need to focus on and ensure that the infrastructure to support the new fuel emerges and is profitable, without excess profits at the expense of users of the new fuel, since infrastructure is far more important to existing and prospective customers than future improvements in technology. None of this is automatic, and for NGV these issues received
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4.2. The alternate fuel must be available publicly to support conversion of individuals and small fleets NGV initially targeted commercial fleets, since fuel compression and dispensing have a large economy of scale and public dispensing of fuel was unavailable. The investment in compression and dispensing equipment per vehicle serviced was about $1000 per vehicle for large compressors servicing 300 vehicles, and $3300 per vehicle for smaller facilities servicing 30 vehicles. D F of California had focused on fleet customers for two reasons: public refueling in the US would attract road taxes, whereas private dispensing was often neglected by state authorities, and the capital cost of building a public refueling network was seen as prohibitive, especially in the absence of a guaranteed base of customers. However, very large fleets operating from a single location are rare and tend to be conservative buyers; so DF had focused on a 0.013 Nm3 s 1 (30 scfm) compressor capable of meeting the refueling requirements of 30 vehicles, despite the diseconomy of the scale noted above. CNG-FS discovered that the majority of sales were not to large fleets, which would hardly ever commit to a block purchase without an introductory trial. Leading purchasers of new fuels are by definition innovative purchasers, and CNG-FS found these in very small commercial fleets and single high mileage commuters. Over 90% of conversion sales in Canada were to such customers, who required refueling in public facilities. Thus, the first challenge in commercializing an alternate fuel was to create an infrastructure of public refueling. This was most often done through partnerships with existing fuel sellers (gasoline retailers) and sometimes with gas utilities. Public refueling through existing fuel sellers also requires that equipment maintenance be available. The typical fuel retail outlet is either a franchise or company owned; in either case, the owner or manager is not capable of doing maintenance on sophisticated new equipment (in the case of NGV, maintenance of a highpressure compressor and storage facility). Those promoting the new fuel must ensure that public retailers have easy access to an affordable source of equipment maintenance. Any new thermal alternate transportation fuel will face the same issues: small scale purchasers, who are often innovative early adopters and willing to try a new fuel, require public refueling because of the diseconomy of scale of small dedicated refueling equipment. Public
refueling stations will in turn require reliable third-party maintenance. Only electricity, which is already available in homes, can avoid this issue through affordable home repowering. 4.3. Fuel retailing must become profitable to sustain investment in additional stations The largest problem the NGV industry faced in Canada was a stalling in investment in public refueling facilities, which in turn retarded conversion sales. Investment in new refueling facilities stalled because existing stations did not build up sufficient load to make them profitable. Alternate fuels face a ‘‘chicken and egg’’ problem: without refueling facilities, no one invests in vehicles using the new fuel, and without sufficient customers for the fuel, no one invests in the refueling station. There were over 80 public refueling facilities in Canada in the mid-1980s; CNG-FS had an equity participation, usually co-ownership, in 34. The typical NGV refueling facility consisted of a compressor, storage and retail dispenser located at an existing gasoline station. Fig. 1 shows refueling volumes versus time in service for the stations for which CNG-FS was an equity partner. We viewed ‘‘stars’’ as stations that were on a path to reach capacity in 3 years or less, and dogs as stations that were not likely to reach capacity in 5 years. A station that did not reach nominal capacity in 5 years was below the threshold for acceptable return. Fig. 1 shows that for every star that showed early promise there was a dog, and this surplus of underutilized NGV refueling capacity eventually discouraged investment by fuel retailers. The failure to build profitability at existing stations in order to sustain investment in additional refueling facilities was, in hindsight, the most significant factor in limiting the growth of NGV. All suppliers were losing money at a market size of 15,000 conversions per year, and stayed in the business hoping for continued growth. Efforts to minimize losses meant marketing resources were scarce, and suppliers relied on gas utilities to help sell conversions. Efforts NGV Dispensed per Month, Litres Equivalent (000)
little attention quite late. As discussed in further detail below, one element of infrastructure, refueling, had insufficient return on investment and dried up, while another element, vehicle conversion, overcharged and made the introduction of the new fuel more difficult.
120
"Fully Loaded"
100
"Adequate Return"
80
"Cows"
60 "Dogs"
40 20 0 0
10
20
30
40
50
60
Months in Operation
Fig. 1. History of CNG Fuel Systems fuelling stations (June 1985).
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lagged, and some refueling stations became orphans. In hindsight, intense selling around every station (including direct telemarketing) to achieve profitability, or moving NGV fueling stations from sites that were not profitable (even if this meant buying back vehicle conversions from those who would have been orphaned) would have been a better strategy, since the loss of fuel retailer interest eventually destroyed the momentum in the business. Any new thermal alternate transportation fuel will need to be resolved wherever the fuel is sold. Including the new fuel in an existing fuel, retail outlet such as a gasoline station gives comfort to the customer and reduces the overhead cost for site and vehicle access. However, the fuel retailer will want to see profitability, and will tie future investment to initial success. 4.4. OEM equipment is needed in addition to aftermarket conversion NGV in the 1980s was an aftermarket product; it did not have the volume or the technology to justify OEM supply. Further, the main centers of NGV activity, New Zealand and Canada, did not have large indigenous auto industries and were by world standards small markets. Aftermarket products have lower credibility in the eye of the consumer than OEM product, and this was particularly true in the mid-1980s when NGV conversion equipment was the 1950s design based on pressureregulated carburetion rather than electronic fuel injection. There was always a concern that the conversion of a vehicle would void the warranty. Future alternate fuels will be best served by a mix of OEM supply and competent aftermarket conversions by large-scale suppliers who can address warranty and service. OEM is only likely to occur if certain countries, that are major auto design and manufacturing centers, support the alternate fuel through public policy. Aftermarket product is also needed because OEM sales are too low to build a profitable load on infrastructure, especially refueling. Aftermarket sales can target areas where refueling facilities are in place and build fuel demand quickly. 4.5. Aftermarket vehicle conversion and service cannot be on a dedicated facility basis When a large fleet that has its own in-house mechanics converts to an alternate fuel, the mechanics can be trained to install and service the new equipment. This is not practical for smaller fleets and individuals. CNG-FS originally created dedicated NGV conversion centers in four major metropolitan areas in Canada to install conversions and service vehicles. This was an economic disaster, since conversion sales were too erratic to keep the shop busy and many conversions
were too distant to be installed or serviced at the facility. The alternative was to develop a network of trained installation dealers using existing vehicle service centers, i.e. we approached auto dealers and other service facilities to add NGV conversion and service to the range of services they offered. This was a slow and expensive undertaking, but offered the potential for higher geographical coverage without dedicated and underutilized overhead. Any new alternate fuel that includes aftermarket product needs to face these issues: how does a customer who wants the new fuel get installation, and how does this customer get service if the vehicle is away from the original installing dealer. Local ‘‘blacksmith’’ suppliers cannot deal well with remote customers or vehicles that have a wide span of travel. 4.6. Aftermarket dealer parts markup needs to be controlled CNG-FS recruited new conversion dealers on the basis that they could charge the same parts markup and labor cost as existing service work on gasoline vehicles. This was a mistake, since the ratio of parts to labor for an NGV conversion is significantly different than for most service work and this distorts the economics of a conversion. On average, typical gasoline vehicle service charges are 50% labor and 50% parts. The owner of the service facility usually keeps half the labor charge and 20% of the parts charge (equivalent to a 25% parts markup) as contribution to overhead and profit. Thus, each service bay that was in use for 8 h in 1984 typically charged $400 for labor and $400 for parts; the owner of the service facility realized $280 per bay day of revenue, consisting of $200 from the labor charges and $80 of parts markup (Flynn, 2000). However, a typical vehicle conversion (which took 12 h) had the parts cost to the dealer of $1800 and at the 25% markup the dealer ended up making $450 of parts markup per conversion or $300 of parts markup per bay day. In effect, a dealer was making $450 of parts markup on a 12 h service job when any other work he would have done in the bay would have generated $120 of parts markup revenue in the same time period. The extra $330 came out of the pocket of the person buying the conversion. Since the customer’s cost of the conversion net of all rebates was often about $1500, the extra dealer revenue of $330 was a significant additional cost that reduced the attractiveness of a conversion to the end user. In effect, a careless initial policy by CNG-FS reverted to create a 20% premium in the cost of a conversion, which was a real deterrent to conversion sales. Once the dealer markup had been set, attempts to change it met stiff resistance. In hindsight, seeing the
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problem from the start and convincing the dealers that a lower percentage parts markup on vehicle conversions preserved their ‘‘bay day’’ revenue would have been a major help for sales of vehicle conversions. Any new alternate transportation fuel that includes aftermarket product installed through licensed dealers will need to address parts markup based on the specific relative mix of labor and parts in the conversion. 4.7. Exaggerated claims damage the market NGV was hailed as being economical and more environmentally friendly than gasoline; in 1984, neither claim was true and each claim came back to haunt the industry. NGV had the potential to be a cleaner burning fuel than gasoline, but was not so in practice because sophisticated fuel injection gasoline engines with stoichiometric control to enable emission systems to function properly were being replaced with carbureted natural gas aspiration systems that had poor stoichiometric control (see, for example, Gettel et al., 1985; Topaloglu and Elliott, 1986; Dhaliwal et al., 2000). Only NGV has the potential to improve urban air quality when it has fuel injection with stoichiometric control. The industry had the paradox that in California, where environmental issues were taken very seriously, most NGV conversions could not win approval even when ‘‘tweaked’’ just prior to testing. More serious were the claims that NGV was inherently economical compared to gasoline, since governments believed this claim. In the US, many governments saw no reason to even consider supporting NGV in order to realize an environmental benefit, since it was touted as already being economic, and in Canada governments put time or volume limits on subsidies of NGV conversions and refueling facility grants. The Canadian Government, for instance, viewed its conversion grant of $500 per vehicle as a market startup grant that would only apply to the first 35,000 conversions, and its $50,000 per refueling station grant was similarly capped at 125 stations. This presented the prospect of a ‘‘cliff’’ that would effectively destroy the economic attractiveness of an NGV conversion, since without the subsidies NGV was not economically attractive for most vehicles. As discussed elsewhere in more detail (Flynn, 2000), in the mid-1980s the long-term price of natural gas was set by competition with oil in the industrial fuel market in the US-midwest, i.e. natural gas at the burner tip of an industrial plant boiler would have the same value as fuel oil. Compression costs for NGV, about 14 cents/l eq (about 7 cents for operating and dispensing costs and 7 cents for recovery of the capital cost of the compressor) were virtually identical to the premium value of gasoline over industrial fuel oil. Hence, on a pre-tax
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basis, NGV and gasoline grew to have the same value by the mid-1980s. What created the impression that NGV was an economical fuel was differential taxation: retail taxes (often referred to as road taxes because in some jurisdictions they were dedicated to road construction and maintenance) were levied on gasoline, and either not levied or levied at a lower rate on NGV. (More recently, the widespread use of natural gas in North America to generate electrical power has decoupled the price of gas from oil and driven natural gas prices even higher relative to oil.) Proponents of NGV compounded the confusion by claiming that NGV was more efficient than gasoline on a net energy basis, and that this justified the claim that a lower amount of energy as NGV was equivalent to a liter of gasoline. These claims persisted despite ample evidence to the contrary: the perceived efficiency was due to lean tuning of the carburetion system, which also produced degraded performance from catalytic emission control systems. Any soundly designed NGV conversion would require stoichiometric air-to-fuel ratio, which would eliminate the apparent efficiency that was available from either gasoline or NGV in a lean burn mixture. Different ‘‘liter equivalency’’ standards had the effect of eroding confidence in the fuel. Natural gas is more costly to transport by pipeline than liquid fuels, and hence, in theory, one could create an economic incentive at the upstream end of a long gas pipeline. In practice, this difference was not large enough to justify the cost of an NGV conversion, and in any event the high population areas where alternate transportation fuels had the potential to find the largest markets and create the greatest environmental relief were at the downstream end of gas pipelines. One additional factor in a distorted sense of the economics of NGV was wild optimism in the early assessments of cost of conversions and refueling stations. Early promoters often believe that ‘‘prices just have to drop’’, and cited what turned out to be unachievable price levels. Those who relied on the early estimates had a sense of being abused. There was never a clear signal from any government that the environmental merit of NGV warranted a permanent deferral of collection of road taxes, and hence there was never a clear picture that the fuel price spread between NGV and gasoline that was created by foregone taxes and that was necessary to justify the high cost of converting the vehicle was permanent. In some US states, fuel tax due on NGV was ignored, but the industry was haunted with the prospect that once the fuel became widely used the foregone tax would be too substantial to ignore; in effect, success would kill the economic benefit of using NGV. A major factor deterring this assurance from governments was the exaggerated claims of the industry.
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In hindsight, NGV would have had a more stable and sellable fuel if the proponents had been more honest: NGV had the potential to make a positive contribution to the environment, and realizing this potential would require permanent public subsidization. Exaggerated claims have damaged the credibility of alternate transportation fuels, and have retarded acceptance, especially by large commercial purchasers. It is particularly important that governments get clear messages about economics, so that stable public policy can be designed. 4.8. Promotional programs need to be designed for market effectiveness In Canada, vehicle conversions were promoted and sold by either equipment suppliers or gas utilities. All conversions were eligible for a $500 rebate from the Federal government, and in some areas additional support was available from a gas utility. Gas utility grants were typically administered through the dealer that converted the vehicle, but the Federal rebate was only available after the fact by application by the vehicle owner, which meant that the person converting the vehicle had to finance the $500 and wait about 6 weeks for the paperwork to be processed. Vehicle conversions were a high dollar item to commuters and small businesses, and in hindsight the Federal grant would have been far more effective had it been administered through registered dealers. After purchase, cash refunds are a less effective marketing promotion than a reduction in actual purchase price.
utilities would have better served their strategic interests by a broader strategic commitment to national suppliers who in turn had a commitment to technology development. Future alternate fuels will have either a utility or a major energy supplier as a potential ally; these allies need to screen their actions to ensure that they are in the strategic interest of the industry.
5. Conclusion There are powerful reasons to explore alternate transportation fuels, with urban air quality being the prime consideration. Public policy can be designed to support the adoption of an alternate fuel. However, if the fuel is to be sold to end-users rather than forced by mandate, the history suggests that a number of lessons can better ensure that a fuel becomes commercially viable, i.e. it sustains profitable suppliers. Key lessons are: *
*
*
*
4.9. Utility support needs a strategic focus *
Gas utilities supported NGV since it represented increased load, but given that they were regulated it did not represent increased profit. For this reason, actual NGV programs within utilities were often administered by middle managers with little attention or guidance from senior management. To be successful, NGV required national technically competent suppliers, but often gas utilities became associated with local ‘‘one shop’’ converters (‘‘blacksmith shops’’) who sold a limited range of conversions and no refueling equipment. The result was that sales were fragmented and no national supplier achieved break even; the industry was characterized by a number of under-funded players. One common refrain from the industry in the 1980s was ‘‘98% of NGV equipment suppliers are losing money, and the other 2% are liars’’. Large national players had the backing and seed capital of major companies (a large gas utility and an aluminum company in the US, and a large gas transmission company in Canada), but eventually each of these backers gave up when sales failed to grow at a sufficient pace. In hindsight, gas
*
*
*
Once the alternate fuel is available to customers, infrastructure rather than technology is key to market acceptance and growth of sales. A thermal alternate fuel needs to be dispensed at publicly accessible outlets, in order to enable individual and small fleet conversions. These outlets will require reliable service. Conversion selling needs to be focused on ensuring the early profitability of refueling stations, in order to sustain investment in future stations. A combination of OEM and high quality aftermarket suppliers is the best way to develop the conversion market. A network of conversion dealers who have other service revenues is a better alternative than dedicated conversion facilities. However, parts markup at conversion dealers needs careful consideration. Exaggerated claims and optimistic projections are tempting in the early stages of promoting an alternate fuel, but damage industry credibility has the potential to seriously damage both policy support and market acceptance. Promotional programs, such as government programs aimed at realizing an environmental benefit, need to be designed for market effectiveness. Utilities or energy suppliers can be allies, but need to ensure that their actions are strategic in building the market.
Alternate transportation fuels have in the past failed to reach the critical point of commercial viability. Major suppliers left the market, exhausted by continuing losses. Careful attention to the factors that promote market growth can minimize the prospect of this for future alternate fuels.
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References Dhaliwal, B., Yi, N., Checkel, D., 2000. Vehicle emissions effects of alternative fuels in light duty and heavy duty vehicles. SAE Technical Paper Series 2000-01-0692, SAE International, Warrendale, PA. Flynn, P.C., 2000. Infrastructure profitability issues in NGV. SAE Technical Paper Series 2000-01-3081, SAE International, Warrendale, PA.
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Gettel, L.E., Perry, G.C., Smith, M.C., 1985. Performance evaluation of commercial CNG conversion kits. Symposium Papers, Nonpetroleum Vehicular Fuels V: CNG Fuel, Institute of Gas Technology, April, p. 139. Topaloglu, T., Elliott, D., 1986. Performance of first generation NGV kitsFengine and chassis dynamometer test results. Conference Papers, Gaseous Fuels for Transportation I, Institute of Gas Technology and BC Research, August 1986, p. 727.