Ethanol Reduced Gas Prices by $1.09/gal. – Or Didn’t You Notice?

by Marlo Lewis on May 16, 2012

in Blog, Features

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Iowa State University’s Center for Agricultural and Rural Development (CARD) has just updated its 2009 and 2011 studies of ethanol’s impact on gasoline prices. CARD claims that from January 2000 to December 2011, “the growth in ethanol production reduced wholesale gasoline prices by $0.29 per gallon on average across all regions,” and that in 2011 ethanol lowered gasoline prices by a whopping $1.09 per gallon.

I’m no econometrician, but this study does not pass the laugh test. We’re supposed to believe that ethanol has conferred a giant boon on consumers even though gasoline prices have increased as ethanol production has increased, and even though gas prices hit their all-time high when ethanol production hit its all-time high. If that is success, what would failure look like?

CARD’s argument boils down to this. The gasoline sold at the pump today is E-10 — motor fuel blended with 10% ethanol. Ethanol thus makes up 10% of the motor fuel supply for passenger cars. If there were no ethanol, the motor fuel supply would be 10% smaller, and gas prices would be $1.09 per gallon higher (p. 6).

Well, sure, if we assume a drop in supply and no change in demand, prices will rise. But this scenario tells us nothing about what really matters — whether ethanol’s policy privileges, especially the Renewable Fuel Standard (RFS), a.k.a., the ethanol mandate, benefit or harm consumers.*

Note first that even in the absence of government support, billions of gallons of ethanol would be sold each year anyway as an octane booster. So a scenario in which 10% of the motor fuel supply simply disappears does not correspond to any policy choice Congress is actually debating or considering.

More importantly, CARD assumes that if the motor fuel supply were 10% smaller, refiners would not increase output to sell more of their product at higher prices. In other words, refiners would not engage in the economically-rational, profit-maximizing behavior that would bring supply back into balance with demand, thereby moderating the initial price increase.

Why wouldn’t they? There are only two possible explanations. One is that refiners don’t want to get rich, which is absurd. The other is that refiners operate like a cartel, colluding to restrict output in order to charge monopoly rents. CARD gives no sign of endorsing this view, and repeated investigations of the U.S. refining industry by the Federal Trade Commission repeatedly fail to find evidence of such anti-competitive scheming.

CARD’s analysis also ignores the opportunity costs of ethanol’s policy props. Capital is a finite resource. Every dollar refiners are forced or bribed to spend on ethanol is a dollar they cannot spend to produce gasoline. Government cannot rig the market in favor of ethanol without discouraging gasoline production. It is ridiculous to assume that all of the resources (e.g., refining capacity) commandeered by federal policy over the past decade to boost ethanol’s market share would have been left idle and not used to make gasoline in a free market.

In short, CARD’s analysis abstracts from the most basic economic realities we were all supposed to learn in Econ 101: resources are finite, choices have opportunity costs, and incentives (prices) matter.

I leave it to econometricians to quantify the repercussions, but this much is clear. In a free market, refiners would have blended less ethanol and produced more gasoline than they did in the market rigged by the RFS and other pro-ethanol policies. CARD — or, more precisely, CARD’s sponsors, the Renewable Fuel Association (RFA) — would have us believe that refiners would produce no more gasoline in a free market than they would in a market politicized by mandates and subsidies. That assumption is so unrealistic that any analysis based upon it is inappropriate and even fraudulent if used as a justification for maintaining or expanding government support for ethanol.

* Ethanol has about one-third less energy than an equal volume of gasoline. Consequently, even today, when the per-gallon price of ethanol is lower than gasoline, it still costs more to drive one mile on ethanol than it does on gasoline. But don’t take my word for it. According to the AAA’s Daily Fuel Gauge for May 16, 2012, the mile-adjusted price of E-85 (motor fuel blended with 85% ethanol) is $4.261 per gallon — pricier than regular gas ($3.728/g), premium ($4.026/g), and diesel ($4.032/g).

Or check out EPA and the Department of Energy’s joint Web site, www.fueleconomy.gov. The relevant information is not easy to find. Once you get to the landing page, click on Advanced Vehicles and Fuels, then on Flex-Fuel Vehicles, then on Fuel Economy Information for Flexible-Fueled Vehicles, and then again on Flex-Fuel Vehicles. For each of 25 models, EPA and DOE estimate how much the typical owner of a flex-fuel vehicle spends per year to fill up with either regular gasoline or E-85. The estimates fluctuate as gasoline and ethanol prices fluctuate. As of today (May 16, 2012), the average flex-fuel vehicle owner spends about $350 more per year to run the vehicle on E-85.

BobRGeologist May 17, 2012 at 1:30 am

I have never been a supporter of turning food grains into alcohol, which produces little benefit in reducing CO2 in our atmosphere and less miles per gallon than pure gasoline. Also is the fact that AGW is a figment of Enviro’s imagination. A study of ancient climates has shown that when atmospheric CO2 was 20 times greater than today, it did not produce dangerous to life levels of warming. With permanent ice in our polar regions today, we are far more likely to lapse into another major continental ice age than become too warm. Without a robust greenhouse gas to trap heat from our sometimes weak sun, that becomes a distinct possibility.

Paul May 17, 2012 at 10:40 am

That’s great. Now that ethanol is so competitive, I’m sure CARD will now advocate that we eliminate the ethanol mandate.

Dr. James H. Rust May 18, 2012 at 7:27 pm

ethanol from corn is so foolish you could write a book about it. Even environmentalists have given up on it because it adds to atmospheric carbon dioxide.

In 2011, five billion bushels of corn was converted to twelve billion gallons of ethanol which caused the wholesale price of corn to rise to $7 per bushel against $2.50 a few years earlier. Much research shows it requires more energy to make ethanol than is contained in the product. The situation will get worse in the future because of mandates from the 2007 Energy Independence and Security Act to use 35 billion gallons of ethanol as fuel by 2022. Wikipedia states a 2010 study by the U. S. Congressional Budget Office found the cost to taxpayers to replace one gallon of gasoline with ethanol was $1.78.

The whole country suffers because of food price inflation due to this program. Some policy experts speculated increased worldwide corn prices may have been the primary cause of the Arab Spring uprisings that started January 2011 due to starvation-level food prices.

Brain Valentine June 7, 2012 at 9:36 pm

ha ha ha this idiot assumes Ethanol is “free” in his cost “savings” hah hah hah

The junk is five bucks a gallon when you take away the Government artificial respiration this thing lives on

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