A new study by the Energy Research Policy Foundation, Inc. (EPRINC) further debunks the popular talking point of USDA Secretary Tom Vilsack and the Renewable Fuel Association (RFA) that ethanol reduced gasoline prices by $0.89/gal in 2010 and $1.09/gal in 2011.

As noted previously on this site (here and here), Vilsack and the RFA tout a study by Iowa State University’s Center for Agricultural Research and Development (CARD), which concluded that if ethanol production had remained at year 2000 levels, the U.S. motor fuel supply would have been billions of gallons smaller and, thus, significantly pricier in 2010 and 2011. Subsequent studies by FarmEcon, LLC and MIT/UC Davis spotlighted CARD’s unrealistic assumption that the refining industry would not have increased gasoline production to meet consumer demand in the absence of policies mandating and subsidizing the blending and sale of increasing quantities of ethanol as motor fuel.

The EPRINC study (Ethanol’s Lost Promise: An Assessment of the Economic Consequences of the Renewable Fuel Mandate) shows, in addition, that if ethanol output had remained constant at the year 2000 level, refiners could have made up for the shortfall without importing or even refining “a single additional barrel of crude oil.” The Renewable Fuel Standard (RFS) has increased ethanol production by about 400,000 barrels per day (bbl/d) since 2000. A “remarkably small operational adjustment” in refineries’ product mix – a 1.8% increase in gasoline production — could have covered an ethanol shortfall of 400,000 bbl/d in 2011.

Figure Explanation: The figure shows how much additional gasoline would be produced if yields were 1, 2 or 3 percentage points higher, given actual crude oil runs through U.S. refineries for the given year. The orange dotted line shows the increase in gasoline production if yields were raised by 2.3 percentage points – this is the range in which gasoline yields moved during 2000 to 2011. Finally, the red and bluelines are the amount of ethanol that would be missing from the market if ethanol blending was capped at 400,000 bbl/d. The chart demonstrates that a 400,000 bbl/d ethanol shortfall could have been covered in 2011 had gasoline yields been just 1.8 percentage points higher, from 45% to 46.8%. A 46.8% gasoline yield is equal to or lower than the gasoline yield during 3 of the past 11 years. It is also well under the 2.3 percentage point range in which yields bounced during 2000 – 2011.

Back in May, I discussed a study conducted for the Renewable Fuel Association (RFA) by Iowa State University’s Center for Rural and Agricultural Development (CARD). The study 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 reduced average gasoline prices by a whopping $0.89 per gallon in 2010 and $1.09 per gallon in 2011. Ethanol boosters like the RFA and USDA Secretary Tom Vilsack tout this study as proof that federal biofuel policies benefit consumers and should be expanded.

The CARD researchers, Xiaodong Du and Dermot Hayes, attempt to determine the consumer benefit of ethanol by inferring what motor fuel prices would have been over the past decade had there been no increase in ethanol production. Ethanol now constitutes roughly 10% of the motor fuel used by U.S. passenger vehicles. Du and Hayes conclude that without ethanol, U.S. motor fuel supply would be significantly smaller and pain at the pump significantly greater.

This procedure, I argued, is ridiculous. First, it assumes that refiners are like deer caught in the headlights and do not respond to incentives. Even if motor fuel prices increase by up to $1.09/gal nationwide over a 10-year period, we’re supposed to believe refiners would not increase output and take advantage of this opportunity to sell more of their product at higher prices. But that’s exactly what refiners would do. In the process, supply would come back into balance with demand, pushing fuel prices down.

Second, the CARD study ignores the opportunity costs of ethanol policy. Capital is a finite resource. Dollars that refiners are mandated or bribed to invest in ethanol production are dollars they cannot invest in gasoline production. The CARD study implausibly assumes that all the refining capacity diverted by federal policy into ethanol production would have been left idle in a free market and not used to produce gasoline instead.

Admittedly, the CARD study is full of math I don’t understand. But two experts in the field – MIT energy economics professor Christopher Knittel and UC Davis agricultural economics professor Aaron Smith – have just produced a technical critique of the CARD study. Titled “Ethanol Production and Gasoline Prices: A Spurious Correlation,” the researchers make several telling points, some of which are funnier than the standard fare found in the ‘dismal science.’  

Knittel and Smith begin with a discussion of basic economics to “place loose bounds” on the potential effects of ethanol production on gasoline prices. They note that the largest component of the price of gasoline is the cost of crude oil.

A barrel of crude oil contains 42 gallons, so every dollar per barrel increase in oil prices raises wholesale gasoline prices by about 2.4 cents. Thus, when oil is $100 per barrel, roughly $2.40 of the price of gasoline will be the cost of crude.

Ethanol production can have only a “minimal impact” on crude oil prices. U.S. ethanol constitutes only 1% of world oil use. In addition, ethanol has one-third less energy content by volume than gasoline, so U.S. ethanol production replaces only 0.67% of world oil. Ethanol’s impact on the biggest factor affecting gasoline prices is likely very small.

Ethanol production could however affect gasoline prices by decreasing refiners’ profit margins. The CARD study concludes that the “crack spread” – the weighted average price of refined products minus the price of crude oil — would have been $0.89 higher if ethanol had been removed from the market in 2010 and $1.09 higher had it been removed in 2011. But, argue Knittel and Smith, crack spreads never stay that high for an entire year. Indeed, the “crack spread has not exeeded 60 cents for more than a few brief periods in the past 30 years.” The reason is that when “the crack spread is high, large profits encourage entry into the refining industry, which in turn puts downward pressure on the crack spread.” Or, as I put it above, refiners are not deer in the headlights; they respond to market signals (prices).

The CARD study implies that, but for ethanol production, the crack spread in May 2010 would have been $1.37 — “20 cents higher than the highest crack spread ever observed in the data.” Knittel and Smith comment: “For this to be a long-run effect — which is the implicit assumption in the RFA’s claims — we would have to expect that these historic high crack spreads would not increase capacity utilization,” even though refinery utilization averaged 86.4% in 2010, “lower than every year from 1992-2007.” In other words, we would have to assume that refiners don’t want to get rich.

For reasons of space, I won’t try to summarize Knittel and Smith’s detailed discussion of “issues related to model specification.” More newsworthy and certainly more entertaining is their discussion of “spurious correlation.” Using the CARD study’s models, they estimate the effects of ethanol production on natural gas prices and unemployment rates — “dependent variables” with no particular connection to ethanol. Here’s what they find.

Based on the CARD models, had no ethanol been produced in the U.S. in 2010, “natural gas prices would have increased by 65 percent.” Similarly, “eliminating ethanol in 2010 would have decreased U.S. unemployment by 65 percent.” (So much for RFA’s claim that ethanol creates jobs!)

The authors comment:

These empirical relationships are a classic example of spurious correlation. Ethanol production during this time period is increasing. Therefore, other variables that have a predominant trend, either upward in the case of unemployment or downward in the case of natural gas prices, are likely to correlate well with ethanol production.

To nail down the point, the researchers provide a “whimsical” example. Using CARD’s models, they find that every additional million barrels of ethanol produced increases the age of daughter Caiden Knittel by 26 days and that of daughter Hayley Smith by two months. Policy implication: Eliminating all ethanol in 2010 would ”cause Caiden to be a newborn (12 days old) and would cause Hayley’s age to be negative.”

Knittel and Smith conclude:

The results of Du and Hayes are at odds with the historical levels of either the crack spread or the crack ratio [the price of gasoline divided by the price of crude oil] and are inconsistent with an equilibrium [a long-term balance between supply and demand] in the oil refining industry. While an instantaneous surprise elimination of all ethanol sold in the U.S. might raise gasoline prices for a short period, one cannot assume these instantaneous effects would persist for more than a few weeks. This is precisely what Du, Hayes, the RFA, and Secretary Vilsack have done.

About a year ago on this blog, I offered some skeptical commentary about the gloomy testimony of Dr. Christopher Field of the Carnegie Institution for Science, who warned the House Energy & Commerce Committee that global warming would inflict major losses on U.S. corn crop production unless scientists develop varieties with improved heat resistence.

I noted that long-term U.S. corn production was increasing, including in areas where average summer temperatures exceed 84°F, the threshold beyond which corn yields fall, according to Field.

Well, this just in, courtesy of the Renewable Fuels Association (RFA): USDA projects the U.S. corn crop for 2012 to reach 14.79 billion bushels, the biggest ever. RFA’s objective, of course, is not to debunk climate alarm, but to assure us that we can have our corn (ethanol) and eat it too. Nonetheless, the numbers are mighty impressive and indicate that, in this decade at least, U.S. corn farmers are more than a match for climate change. From RFA’s briefing memo:

At 14.79 billion bushels, the 2012 corn crop would:

• be a record crop by far, beating the 2009 crop of 13.09 billion bushels by 11%.
• be 65% larger than the crop from 10 years ago (8.97 billion bushels in 2002).
• be more than twice as large as the average-sized annual corn crop in the decade of the 1980s (7.15 billion bushels on average).

The 2012 projected yield of 166 bushels per acre would:

• be a record yield, beating out the 2009 average yield of 164.7 bushels per acre.
• be only the third time in history yields have topped 160 bu/acre, the others being 2009 (164.7) and 2004 (160.4).
• be 35% higher than the average yield from the 1990s and 12% higher than the average yield since 2000.

Writing in The Hill’s Congressional Blog, lobbyist in chief for the ethanol industry Bob Dineen waxes poetic about the historic nature of the ethanol industry voluntarily giving up losing one of its subsidies, the Volumetric Ethanol Excise Tax Credit (VEETC):

With growing concerns about gridlock in Washington and greed on Wall Street, Americans are wondering whether anyone with a stake in public policies is willing to sacrifice their short-term advantage for a greater good.

Well, someone just did.

Without any opposition from the biofuels sector, the tax credit for ethanol blenders (the Volumetric Ethanol Excise Tax Credit – VEETC) expired on January 1.

In fact, American ethanol may well be the first industry in history that willingly gave up a tax incentive. Facing up to the fiscal crisis in this country, industry advocates have engaged in discussions with the Administration, Congress and our own constituents in an effort to frame forward-looking policies that balance the needs for deficit reduction and the development of clean-burning, American-made motor fuels.

Incentives should help emerging industries to develop and grow, not to be forever subsidized by the nation’s taxpayers. The Volumetric Ethanol Excise Tax Credit — which actually accrued to biofuels blenders, not producers – has helped the renewal fuels industry to stand on its own two feet. So now it is time for this subsidy to be phased out.

As a colleague wrote in an e-mail regarding this work of fiction, “BWAHAHAHAHAHAHA!!!” The ethanol industry did not voluntarily give up this subsidy. Last year they fought to get it extended, but were only able to secure a 1 year extension due to stiff opposition by competing interests. Earlier this year, the industry — knowing that this subsidy was going away — attempted to terminate it halfway through the year and capture the remainder of the funds and use them to create ethanol pipelines (ethanol cannot be piped through the oil pipelines set up throughout the country).

Finally, this subsidy is small potatoes for the ethanol industry. The important subsidy is the Renewable Fuel Standard, which is still set in stone and getting more lucrative for the industry every year, as refiners are required to blend increasing amounts of ethanol into each and every gallon of gasoline purchased by Americans. This is conveniently left out of Mr. Dineen’s op-ed, as he hounds tax credits for fossil fuel industries (and we agree here, to the extent that some of these things are indeed subsidies, they should be ended. Unfortunately, he is assuredly referring to standard manufacturing tax breaks that hundreds of different industries take advantage of).

He also makes it clear that though this subsidy is gone, they would love help (read: money) to build out ethanol pipelines and blender pumps for higher blends of ethanol that consumers do not want.

H/T to Knowledge Problem.

The Washington Times today has an editorial chiding the U.S. Environmental Protection Agency for its decision to proceed with approval and support for higher blends of ethanol (E15) to be sold nationally. There are still a number of complications that seem likely to get in the way of (i.e., the lack of price competitiveness) of widespread use of E15, but recent decisions by the EPA are unfortunately steering the country down that path. However, the editorial makes one comment that doesn’t seem quite right:

This issue highlights the danger of allowing liberal zealots to set public policy. They are so obsessed with micromanaging the lives of others and fulfilling their environmental fantasies that they give no thought whatsoever to the real-world consequences of their schemes.

As a fuel, ethanol is highly corrosive. The E15 gasoline blend reduces gas mileage by 6 percent compared to real gasoline. That adds up to about $150 a year for the average vehicle owner. This expense and the mechanical danger serve absolutely no purpose beyond filling the pockets of wealthy farming giants. Congress needs to repeal the ethanol mandate to protect American pocketbooks – and the car warranties of millions of motorists.

Assuming they are using ‘liberal’ in the liberal versus conservative sense,  ethanol has (both historically and to this day) been supported by both liberals and conservatives alike. Indeed, true market-oriented politicians oppose interventions in our energy markets. However, those politicians are few and far between as politicians from both sides rarely have issue with sacrificing their alleged principles in order to support local constituencies or interest groups.

If you look at current support for ethanol policies, you see a mish-mash of politicians from the Midwest, the Obama Administration, and the generally liberal environmentalists. However, to their credit the environmentalists have mostly abandoned support for corn ethanol while still unfortunately holding out hopes for cellulosic ethanol. Their are numerous conservative politicians who still actively support ethanol: Senator Grassley (R-IA), Mitch Daniels, Republican Presidential comic relief Newt Gingrich, former Republican Presidential candidate and Minnesota Governor Tim Pawlenty, and many more conservative and liberal politicians. President George Bush was a big ethanol supporter.

Ethanol is a costly boondoggle, but it is a bipartisan boondoggle, and turning this issue into yet another who to blame liberal versus conservative fight harms the bipartisan progress that has been made in limiting the use of government to expand ethanol. My colleague Marlo Lewis wrote about conservative support for ethanol earlier this year.

If you want to learn more about the historical bipartisan support for corn ethanol, I would recommend Ken Glozer’s book titled ‘Corn Ethanol: Who Pays? Who Benefits?’

A recently released report on the future of the biofuel industry, by the National Research Council concludes that the cellulosic ethanol targets are unlikely to be met and casts doubt on the utility of the renewable fuel standard. The report can be downloaded  (after a free registration) here, though the report itself exceeds 400 pages, so its not easy reading. Allow me to include a long quote from the conclusion:

A key barrier to achieving RFS2 is the high cost of producing biofuels compared to petroleum-based fuels and the large capital investments required to put billions of gallons of production capacity in place. As of 2010, biofuel production was contingent on subsidies, tax credits, the import tariff, loan guarantees, RFS2, and similar policies. These policies that provide financial support for biofuels will expire long before 2022 and cannot provide the support necessary for achieving the RFS2 mandate. Uncertainties in policies can affect investors’ confidence and discourage investment. In addition, if the cellulosic biofuels produced are mostly ethanol, investments in distribution infrastructure and flex-fuel vehicles would have to be made for such large quantities of ethanol to be consumed in the United States. Given the current blend limit of up to 15-percent ethanol in gasoline, a maximum of 19 billion gallons of ethanol can be consumed unless the number of flex-fuel vehicles increases substantially. However, consumers’ willingness to purchase flex-fuel vehicles and use E85 instead of lower blends of ethanol in their vehicles will likely depend on the price of ethanol and their attitude toward biofuels. Producing drop-in biofuels could improve the ability to integrate the mandated volumes of biofuels into U.S. transportation, but would not improve the cost-competitiveness of biofuels with petroleum based fuels.

This covers much of what CEI has concluded: cellulosic ethanol is too expensive to be widely produced, it is likely to remain so in the future, and blends exceeding 15% are tricky given the lack of cost competitiveness. This is why the Renewable Fuel Standard should not exist. Previous CEI work on cellulosic ethanol can be read here.

Naturally, the Renewable Fuels Association had an immediate press release condemning the study:

The results of a new National Academies of Sciences (NAS) study, entitled “Renewable Fuel Standard: Potential Economic and Environmental Effects of U.S. Biofuel Policy”, should be interpreted with extreme caution, the Renewable Fuels Association (RFA) warned today. Specifically, the NAS study released this morning and the executive summary reviewed by the RFA largely assesses ethanol and other biofuels in a vacuum and fails to appropriately compare the costs and benefits of renewable fuels to the impacts of the marginal petroleum sources they are displacing.

If the RFA disapproves, its probably a good study.

Bob Dineen, writing in Ethanol Producer Magazine:

This may seem a daunting task but the industry has no other choice than to do the hard work necessary to drive ethanol market expansion and accelerate this industry’s evolution.  As we have clearly seen, no one is going to do it for us.  The success of E15 and the future of this industry are firmly in our capable hands.

That about sums up their attitude. Wouldn’t it be easier if the government would do it for us? Because years of tax credits, foreign tariffs, loan guarantees, national mandates that require other companies to purchase your products, and state support have not been enough. No, they face the daunting task of actually having to convince consumers to buy more of their product than they’re already required to. Poor guys. After the EPA approved E15 for use in MY2001-present vehicles, the ethanol industry is charged with the difficult task of convincing gas stations to sell E15 (and for consumers to buy it) despite it providing lower fuel efficiency per dollar spent.

In announcing his intention to seek the GOP nomination in 2012, Tim Pawlenty visited Iowa yesterday to deliver so-called “hard truths” to the American people. Given that he was in Iowa, Pawlenty’s stance on ethanol is the perpetual elephant in the room. Most non-Iowan fiscal conservatives seemed happy with Pawlenty’s comments, though its not clear why. The WSJ, today, wrote a short op-ed praising the Pawlenty for his unprecedented, “amazing” steps in Iowa:

One of the immutable laws of modern American politics is that no candidate who wants to win the Iowa Presidential caucuses can afford to oppose subsidies for ethanol. So it’s notable—make that downright amazing—that former Minnesota Governor Tim Pawlenty launched his campaign for the Republican Presidential nomination Monday by including a challenge to King Corn.

I suppose its worth praising him for making a slight improvement to the Obama/Bush/Gingrich/*insert politician* doctrine, but it ends with slight. The “don’t pull the rug out from under them,” slowly-end the subsidy approach  isn’t a real stance, and its not an end to the subsidies.

What Pawlenty actually said:

The truth about federal energy subsidies, including federal subsidies for ethanol, is that they have to be phased out.  We need to do it gradually.  We need to do it fairly.  But we need to do it.

Now, I’m not some out-of-touch politician.  I served two terms as Governor of an ag state.  I fully understand and respect the critical role farming plays in our economy and our society.  I’ve strongly supported ethanol in various ways over the years, and I still believe in the promise of renewable fuels – both for our economy and our national security.

But even in Minnesota, when faced with fiscal challenges, we reduced ethanol subsidies.  That’s where we are now in Washington, but on a much, much larger scale.

It’s not only ethanol.  We need to change our approach to subsidies in all industries.

It can’t be done overnight.  The industry has made large investments, and it wouldn’t be fair to pull the rug out from under it immediately.

These are the same vague talking points that even Grassley is comfortable using these days. And indeed, the biggest ethanol jockey, the Renewable Fuels Association, is on board with the Pawlenty plan. Their support ($) is a good litmus test for confirming that the particular policy is horrible:

Governor Pawlenty’s remarks today appear to be in line with Senator Grassley’s approach for ethanol reform,” said Iowa Renewable Fuels Association President Walt Wendland in a statement after Pawlenty’s announcement speech. “The ethanol industry is united behind Senator Chuck Grassley’s legislation to phase down and reform the current ethanol incentive as part of the discussion on all energy programs.”

(The Environment & Energy Daily actually got it right, headlining their story: “Pawlenty echoes industry with call for gradual ethanol subsidy phaseout”)

When is ending a subsidy not ending a subsidy? When current preferential treatment is replaced with bigger, more damaging subsidies like infrastructure that sticks around for decades. When there is no talk of bringing the fuels market closer to an actual market by ending the mandates created by the Renewable Fuel Standard. Does anyone really think that 5 years from now the industry will go quietly into the night if the subsidies are once again “temporarily” extended? Of course not.