In the wake of high gasoline prices, the ethanol industry is making the rounds in Washington, and they want you to believe that the Renewable Fuel Standard has lowered gasoline prices by up to $.89 per gallon. This would be remarkable, if it were true. The ethanol industry relies on a study produced by the Center for Agricultural and Rural Development at the University of Iowa. Here is the abstract:

This report updates the findings in Du and Hayes 2009 by extending the data to December 2010 and concludes that over the sample period from January 2000 to December 2010, the growth in ethanol production reduced wholesale gasoline prices by $0.25 per gallon on average. The Midwest region experienced the biggest impact, with a $0.39/gallon reduction, while the East Coast had the smallest impact at $0.16/gallon. Based on the data of 2010 only, the marginal impacts on gasoline prices are found to be substantially higher given the much higher ethanol production and crude oil prices. The average effect increases to $0.89/gallon and the regional impact ranges from $0.58/gallon in the East Coast to $1.37/gallon in the Midwest. In addition, we report on a related analysis that asks what would happen to US gasoline prices if ethanol production came to an immediate halt. Under a very wide range of parameters, the estimated gasoline price increase would be of historic proportions, ranging from 41% to 92%.

If we go to E85prices.com, we see that as of March 29, 2012 the average nationwide price-spread between E85 and E10 is 14.7%, with E85 costing an average of $3.31/gallon and E10 costing an average of $3.89/gallon. Ethanol has less energy content than gasoline, so a direct price comparison is not appropriate. The generally accepted metric is that E85 must be priced about 28% lower than E10 in order to break even, meaning that the cost per mile driven is equal between E85 and E10.

Ethanol is blended into gasoline at refineries throughout the United States, and most gasoline that is sold in the United States is composed of 10% ethanol, 90% gasoline. If ethanol was really responsible for massively lowering the real cost (adjusted for energy content) of gasoline, we would expect E85 (a rough estimate of the actual cost of delivering ethanol to market) to cost much less than gasoline, below the break even point at least. As you can see, it doesn’t, and after adjusting for energy content ethanol is still more expensive than gasoline.

What the study does is it looks at refinery capacity throughout the United States. Refineries in the United States often run at close to max capacity, meaning if there were suddenly a very large increase in the demand for gasoline (suppose that every car driving American decides they want to take a road trip across the country, beginning tomorrow), refineries would be unable to immediately ramp up production, and gasoline prices would skyrocket. The same would happen, as the author notes in the abstract above, if ethanol production were to suddenly disappear overnight, as their refining capacity would drop precipitously.

The study holds refinery capacity constant over the past years, and models the effect that an absence of ethanol would have on gasoline prices. This is not a realistic assumption as there is no reason to believe that in the absence of ethanol, more refining capacity would have been built in the United States over the past decade.

I wrote about this same study in June of last year, and will quote the conclusion of analysis written by the Institute for Energy Research then:

The recent Iowa State study claiming that ethanol production has suppressed the growth in gasoline prices is very misleading. It takes for granted the current refinery capacity and other infrastructure that industry uses to deliver gasoline to motorists, without realizing that federal policies over the years have distorted the development of these markets. Ethanol only survives in the market place at its current levels because it is propped up by artificial mandates and preferential tax treatment.

The regression analysis of the Iowa study doesn’t accurately capture the timeline that would have occurred had the free market been allowed to operate. Of course a sudden disappearance of all ethanol would cause a bigger price spike in the Midwest than in the East Coast. That’s because the artificial federal support has displaced the development of oil-based gasoline delivery in the Midwest more than in other regions. The fact still remains that ethanol (at its current market share) is very inefficient. Taxpayers and consumers would be richer if the government dropped its support programs for it.

The final sentence is key. Despite generous subsidies for decades and a federal mandate, the real cost of ethanol is still higher than gasoline. Even the environmentalists are on our side on this issue, having realized that the environmental benefits of ethanol production are non-existent and the net effect (once you consider how much land globally has been converted to grow corn) is possibly worse than regular petroleum production.

The title of an op-ed published in The Wall Street Journal claims: “A Flex-Fuel Mandate Is Pro-Market.” The ethanol industry has made this argument time and time again, that somehow forcing private corporations to adjust their products in a way that will pad the wallets of certain energy sectors is somehow pro-market. Unsurprisingly, his argument relies on the notion that OPEC controls significant portions of oil output, so thus, the U.S. government ought to intervene to level the playing field:

The price of oil is set by a foreign cartel. The Organization of Petroleum Exporting Countries (OPEC) owns almost 80% of global oil reserves yet produces only 36% of daily global supply. This dominant position enables OPEC to raise or lower their production to maintain the global supply-demand relationship that suits their interest. If U.S. oil companies produce more, OPEC will produce less.

…

Let’s open our market to good old American competition. Friedrich Hayek and Milton Friedman stressed that the foremost economic duty of government is to eliminate cartel pricing. Bills are now pending in both houses of the Congress (HR 1687 and S1603) that seek to do exactly that by requiring car makers to enable fuel competition in their own product lines—adding flex-fuel, all electric, hybrid electric, or any other way auto makers choose to implement the law.

Again, cartel pricing implies that consumers are getting hosed because the cartel has an absolute monopoly over the provision of a good where there are no substitutes. This is a clear example of where this logic does not apply, because as the op-ed notes, there are plenty of alternatives to oil that vehicles can run on but they are not cost competitive.

Furthermore, a monopoly tends to imply that the price is set higher than it would be in a competitive marketplace. A higher price of oil makes the alternative fuels more competitive, so it can’t really be used as an argument to imply cost savings (or silly fears of sending money overseas) from new fuel sources, as they’re almost certainly still more expensive.

January marked the first month that the ethanol industry had to stand on its own feet was only supported by a massive taxpayer mandate for their product, rather than tax preferences, tariff protections, and a mandate.

Do not fret, as sales for E10 (10% ethanol 90% gasoline, commonly purchased at the pump) will hold remarkably steady, because this is the primary venue the rent-seekers use to dilute our nations gasoline supply with ethanol. I only slightly kid, as it makes sense to blend small percentages of ethanol into our fuel supply, though not in amounts exceeding 10 percent.

However, in the United States there are also niche markets for E-85, which is made up of 85% ethanol and 15% gasoline. E85 sales more accurately reflect what an actual competitor to gasoline would look like, as E10 blends only supplement regular fuel production. While there are a number of flex-fuel vehicles on the road (FFVs) capable of running on any blend of ethanol and gasoline, E85 sales have never taken off in the United States. This is because, after adjusting for the lower energy content in ethanol, it costs more money per mile traveled to fuel your vehicle with E85 than E10. It has always been this way and its unclear if it will ever change.

The lapse of the volumetric ethanol tax credit (VEETC) in January made this much worse, as E85 was receiving a tax credit worth just short of 40 cents per gallon, allowing the fuel to be sold more cheaply than it would absent the tax credit. Sales of E85 in Minnesota are about to discover this new reality:

The post-subsidy era also brings tough choices for owners of flexible-fuel vehicles, including the state of Minnesota, which has more than 3,000 vehicles capable of burning E85, and in 2010 used 963,000 gallons of it.

They must decide whether to support a fuel that is 85 percent home-grown ethanol even it it’s no longer competitively priced. Minnesota is the nation’s fourth-largest ethanol producer, and leads the nation with 364 retailers selling E85.

“We have our eyes open, and we are watching this,” said Tim Morse, director of Minnesota’s fleet. “We think it is too early to make any kind of decision right now.”

Morse said he wants to see if the full 38 cents of lost E85 subsidy gets added to the state’s fuel price. That could boost the state’s annual E85 bill by $366,000.

Last week in the Twin Cities, E85 was 16 cents to 40 cents lower than regular gasoline, which also rose in price. That’s as little as a 5 percent price difference. E85′s price advantage has sometimes been more than four times better and averaged 17 percent last year, according to the state Commerce Department.

The state of Minnesota has been purchasing E85 for state-owned flex fuel vehicles in the past. It isn’t clear if this saved them money, which is incredibly unlikely, or if they were doing it out of “statriotism.” Regardless, even now they feel the need to balance budget savings versus the very minute and possibly non-existent environmental benefits of corn ethanol.

More broadly, this demonstrates why the ethanol mandate is non-sensical and needs to be abandoned. Cellulosic ethanol has hit its 4th or 5th straight year of still being “right around the corner” and even environmentalists are becoming skeptical of its touted environmental benefits, after seeing the realities of corn ethanol. Allowing increasing blends of ethanol beyond E10 into our fuel supply is a pointless handout to an industry friendly with the Obama Administration. It’s hurting our refining industries which already operate on very low margins, and consumers have demonstrated that they prefer the price savings to vague and questionable environmental benefits.

Something will have to give soon. Our fuels market is not ready to go beyond E10 (and absolutely not beyond E15 in its present form), and consumers are not going to purchase E85 or flex fueled vehicles unless it saves them money. If not abandoning the ethanol mandate completely, the EPA could start by capping it (or suggesting that Congress cap it) at its current level.

The ethanol compromise did not make it into any debt ceiling negotiations and its future is now looking bleaker than ever before. The Congressional ‘super-committee’ established by the debt ceiling negotiations will have to decide by November 23rd some manner to reduce the deficit by $1.5 trillion or face potentially unpopular automatic spending cuts to defense and discretionary spending (though USA Today writes that these “threats” have failed in the past). None of the rumored super-committee members seem to be from regions that would require their support of the ethanol industry

The ‘ethanol compromise’ had legs because it funneled money into the domestic ethanol industry while still maintaining a facade of deficit reduction. It would have collected $2 billion in revenue from the ending of the domestic tax credit as of July 21 and used a small amount less than that to spend on items near and dear to the ethanol industry (mainly ongoing support for cellulosic ethanol and money for the installation of blender pumps at fueling stations), hence their support.

The deficit reduction from the ethanol tax credit is no longer possible because the ethanol tax credit is again set to expire at the end of the year (as it was extended for one year at the end of 2010). This means that any potential deficit reduction is slowly being eroded as the tax credit continues on towards the end of the year, and renewal of support for the industry will add to the deficit rather than reduce it, making it much more difficult for conservative politicians to support it (though, obviously, they have been willing to forget their supposed free-market ideology when it suits them).

So it seems likely that the tax credit and tariff will expire at the end of 2011. It is possible (though it is harder to get subsidies back once they’ve been gone) that future support for the industry will get stuck into a larger energy bill, especially support for ‘next generation’ biofuels which remains popular among those who have given up on corn based ethanol. The Renewable Fuels Association has high hopes:

Bob Dinneen, president and CEO of the Renewable Fuels Association said that because the debt deal includes a call for a future budget framework, the opportunity to discuss comprehensive energy tax policy still exists. This could include infrastructure support, tax incentives for second-generation ethanol technologies and feedstocks and the repeal of petroleum subsidies. “With the debt ceiling crisis looking as though it has been averted for now, we hope Congress and the administration are now prepared to address the nation’s worsening energy crisis, as oil and gasoline prices continue to rise and the nation’s investment in homegrown renewable fuels languishes,” he stated.

The much bigger problem with ethanol is still the renewable fuel standard. This fight will manifest itself in future years as virtually every related industry outside of those who produce ethanol revolt against higher blends of ethanol entering the fuel supply (this assumes that ethanol does not become cost competitive with petroleum, if it does, the government would do best to get out of the way).

In an appearance on E&E TV, retired General Wesley Clark discusses the future of corn ethanol policy. Transcript here. Given that he is a member of Growth Energy, completely objectivity isn’t expected. However, he makes a number of incorrect statements and supports very poor economic analysis.

CLARK: And so we’re behind in cellulosic because we’ve been artificially constrained in the fuels market, first by the EPA blend wall at 10 percent, which meant there was no market for cellulosic. And then secondly then by the lack of infrastructure to be able to actually go out to the service agent and say, hey, I want to try 20 to 30 percent ethanol blend.

Cellulosic ethanol production is “behind” because its not economical, and investors are aware that the current market for cellulosic ethanol relies almost entirely on a government law that clearly isn’t guaranteed given how difficult it is to produce cellulosic ethanol at a price that is even close to something consumers would want.

Clark also complains about the 10% “blend wall” yet doesn’t acknowledge that the majority of ethanol sold is due to an “artificial” government mandate. I’d gladly end the EPA’s ability to determine what American’s can put in their gas tanks just as I’d gladly end the mandate requiring refiners to blend petroleum with ethanol.

Also, its obvious that a lack of infrastructure is due to a lack of demand for ethanol, not because of any artificial market constraints. E85 exists in almost all 50 states, yet sales are low because its still too expensive given the lower fuel economy. Why would anyone want to buy E20 or E30 if individuals with flex-fuel vehicles don’t purchase E85?

On fuel economy with higher blends:

CLARK: You know, our own personal research is that American cars that are flex-fuel cars, they work really great at 20 and 30 percent ethanol. And sometimes you get a falloff in mileage at 85 percent because the motor is not really tuned to use the ethanol. But at 20 and 30 percent, in some of these models, there’s no falloff and you’re saving.

I’m not sure what study he is referring to, perhaps an in-house, yet to be published, study. However, recent comprehensive studies show the exact opposite. As the percentage of ethanol increases as a percentage of the total fuel blend, fuel economy drops.

Here is a study by the National Renewable Energy Laboratory: “Effects of Intermediate Ethanol Blends on Legacy Vehicles and Small Non-Road Engines.” From the executive summary:

E.4.1 Fuel Economy
• All 16 vehicles exhibited a loss in fuel economy commensurate with the energy density of the
fuel.* With E20, the average reduction in fuel economy (i.e., the reduction in miles per
gallon) was 7.7% when compared to E0.
• Limited evaluations of fuel with as much as 30% ethanol were conducted, and the reduction
in miles per gallon continued as a linear trend with increasing ethanol content.

On importing foreign oil:

CLARK: They know, look, in the $14 to $15 trillion economy like the American economy, you cannot generate jobs if you are sending $400 billion a year, every year, abroad. It’s like a tax on the American people and that’s what our oil companies are — put a tiger in our tank and they look all-American, but they’re actually — they’re dollar extraction mechanisms. And the friendly service station operator there that some of them we’ve grown up with, they’re actually — it’s like a $1200 year tax on every man, woman, and child in America so we can import foreign oil.

The idea that importing goods from abroad is equivalent to a tax of $1200 is laughable, and I wish the host hadn’t been so easy on him. Perhaps Clark believes the world would be better off without any international trade.

Monica Trauzzi: Is corn ethanol being produced at the expense of other biofuels?

Wesley Clark: No, I don’t think it’s being produced at the expense of biofuels. This is market demand driven. Look, corn is a crop that people have learned to be increasingly innovative in growing. I mean the yield grows up — goes an average of maybe three, 4 percent per year, per annum. I mean year after year after year.

The demand for corn ethanol is not market driven. It’s government mandated.

2011 marks an important year for developments in ethanol policy. Building out infrastructure is just as big a waste of taxpayer dollars as is the current VEETC/mandate.

The ethanol industry has found a friend — the US Department of Agriculture. The industry will be less reliant on new legislation to encourage ethanol consumption, thanks to a new USDA announcement that the department will begin funding grants and loan guarantees for gas stations that choose to install new E-85 blender pumps. This was one of the primary legislative goals of the renewable fuels lobbyists.

The funding for the program will be provided by the 2008 farm bill which included funding that can be used to promote renewable energy development. The total fund amounts to $70 million in 2011 and another $70 million in 2012.

From the article:

Most gasoline sold in the U.S. is 10% ethanol, but a growing fleet of flexible-fuel vehicles can run on an 85%-ethanol blend, or E85. However, there are fewer pumps available to dispense it, Mr. Vilsack said.

In the U.S., only about 2,350 fueling stations out of more than 110,000 offer E85 pumps, according to the USDA.

It’s obvious why gasoline retailers are hesitant to install E-85 pumps, adjusting for energy content its not a better deal than gasoline.

When really pressed on why the USDA and the Obama administration continue to support corn based ethanol, they point to using it as helping support the fledgling cellulosic ethanol industry, which seems to always be just 5 years away from commercial viability.