In its ongoing quest for repeal of the Renewable Fuel Standard (RFS), the oil industry continues to spread misinformation about ethanol and other renewable fuels. In previous posts (here, here, and here), I addressed three popular myths employed by Big Oil and its PR firms to confuse and cloud the public discussion over the RFS and biofuels. Today’s post tackles another falsehood from the anti-ethanol crowd’s playbook; this one deals with the perpetual hot topic of gas prices.
MYTH #4: Adding ethanol to the fuel supply does not reduce gasoline prices for American drivers.
The average American household spent a record $2,912 on gasoline last year—nearly three times the amount spent just a decade earlier in 2002. Further, the share of the household budget spent on gasoline in 2012 reached its highest level since the early 1980s. Well, guess what? Without ethanol, it would have been worse…a lot worse.
Several analyses in recent years have estimated the impacts of increased ethanol blending on wholesale and/or retail gasoline prices. While the published estimates of ethanol’s impact on gasoline prices vary, they are directionally consistent and all of the studies indicate that using ethanol does in fact result in meaningful savings at the pump. Estimates of the reduction in gasoline prices due to increased ethanol use have ranged from $0.17 per gallon (adjusted for ethanol’s lower energy density) in 2008 to $1.09 per gallon in 2012.
The impact of ethanol and RFS on gas prices first came into focus in the summer of 2008, when Texas Gov. Rick Perry—under pressure (and with financial help) from donor Pilgrim’s Pride—asked EPA to waive the RFS. In June 2008, the U.S. Departments of Energy and Agriculture conducted an analysis that concluded, “We estimate that, if we had not been blending ethanol into gasoline, gasoline prices would be between 20 cents per gal. to 35 cents per gal. higher.” That same month, analysts at Merrill Lynch found, “On a global scale, biofuels are now the single largest contributor to world oil supply growth. We estimate that retail gasoline prices would be $21/bbl higher ($0.50/gal.), on average, without the incremental biofuel supply.” In the fall of 2008, McKinsey & Company released a detailed analysis it conducted for the National Renewable Energy Laboratory (NREL). The McKinsey study found, “Ethanol blending in the U.S. [at 2008 levels; ~6% of gasoline supply] is keeping U.S. retail gasoline prices about 17 cents per gallon lower than they would be with no ethanol…As mentioned above, this takes into account the lower mileage impact of ethanol. If available ethanol volumes can be increased economically, ethanol has the potential to lower gasoline prices even further: with economic blending to an average ethanol concentration of 20 percent nationwide, the per-gallon savings (mileage adjusted) could reach 18 to 63 cents.”
Du & Hayes of the Center for Agriculture and Rural Development (CARD) published a paper in Energy Policy in August 2009 that concluded, “…the growth in ethanol production has caused retail gasoline prices to be $0.29 to $0.40 per gallon lower than would otherwise have been the case.” Du & Hayes updated their analysis in April 2011, finding 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. 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…”
In February 2012, Marzoughi & Kennedy of Louisiana State University presented a paper finding that “…every billion gallons of increase in ethanol production decreases gasoline price as much as $0.06 cents. Adding ethanol to gasoline has the same impact on gasoline as a positive shock to gasoline supply.” They further concluded that, “Based on estimation results for the impact of ethanol production on gasoline price, [the amount of ethanol produced in 2011] can lower the gasoline price as much as $0.78 cents per gallon. …This low price means around $107 billion in annual savings for U.S. drivers as a whole.” Finally, Du & Hayes updated their analysis again in May 2012, finding that, “…over the period of January 2000 to December 2011, the growth in ethanol production reduced wholesale gasoline prices by $0.29 per gallon on average across all regions. Based on the data of 2011 only, the marginal impacts on gasoline prices are found to be substantially higher given the increasing ethanol production and higher crude oil prices. The average effect across all regions increases to $1.09/gallon…” [In the interest of full disclosure, the 2011 and 2012 papers by Du & Hayes were supported in part by the Renewable Fuels Foundation].
Despite the findings of these papers and others, ethanol’s impact on gasoline prices continues to be misrepresented by Big Oil (often through the use of a silly E85 energy equivalence calculation that is flawed for several reasons).
So, what are the factors behind ethanol’s ability to significantly reduce gas prices? There are at least three important dynamics to consider.
1. The effect of fuel supply extension on gasoline prices. Cumulatively, more than 67 billion gallons of ethanol were added to the gasoline supply from 2007-2012—an average of 11.2 billion gallons annually. Basic economic theory establishes that increasing the supply of substitutable-in-consumption goods will reduce the price for those goods, ceteris paribus. This effect can be understood by considering the analogous example of butter and margarine: prices for butter are forced downward when margarine (a cheaper substitute) is introduced to the marketplace and overall supply of these two substitute goods is enlarged. In the case of ethanol, according to Hayes, “It is as if the US oil refining industry had found a way to extract 10% more gasoline from a barrel of oil.” The magnitude of this effect will depend on the amount of the substitute good introduced to the market, the time period over which the good is introduced, the price elasticity of demand, and other factors.
2. The wholesale discount of ethanol to gasoline blendstock. Ethanol has consistently sold at a discount to gasoline blendstock at the wholesale level since 2007. Since 2010, ethanol prices have averaged approximately 83% the price of RBOB, or $0.47/gallon less (at times, the “spread” has been $1/gallon or wider). This means E10 has been an average of about $0.05/gallon cheaper than unblended gasoline based strictly on straightforward blending economics. The wholesale spread between ethanol and gasoline during this period has served as a strong economic incentive for gasoline blenders and refines to maximize their use of ethanol. Ethanol opponents often suggest ethanol’s discount to gasoline is offset by its lower energy content—this argument ignores the larger supply extension effects (discussed in point #1 above) and the actual role of ethanol in gasoline blends (discussed in point #3 below).
3. The price differential between ethanol and other oxygenates and octane sources. Ethanol is a high-octane fuel that is used ubiquitously by refiners and blenders to increase gasoline octane to the minimum levels required for sale (87 AKI in most states). Using ethanol in lieu of other octane enhancers has allowed refiners to reduce the use of energy-intensive alkylation and reforming units, significantly reducing gasoline production costs. Ethanol has consistently been priced far below other sources of octane over the past several years. In the absence of ethanol, refiners would be required to use much higher-priced octane sources (many of which, incidentally, are highly toxic in nature), which would necessarily increase gasoline prices at wholesale/retail. A recent analysis by the Department of Energy found that even if ethanol prices were 110% the price of CBOB gasoline (compared to 80-85% today), it would still be more economical for refiners to use ethanol for octane enhancement rather than producing octane from other petroleum processes in the refinery.
On its face, the myth that adding ethanol to gasoline does not reduce gas prices defies economic logic and suspends market realities. By focusing attention on ethanol’s lower energy density and using trumped up calculations, Big Oil is ignoring the larger economic effects at play. Without ethanol, gasoline supplies would be considerably smaller, and significantly more expensive octane sources would be needed. As a result, gas prices for American drivers would be far higher. Let’s hope the American public and Congress continue to see through Big Oil’s big myths regarding the impact of ethanol and the RFS on pump prices.