The People of America's Oil and Natural Gas Indusry

Ethanol – Academics and Reality

Mark Green

Mark Green
Posted May 16, 2012

Supporters of continuing ethanol subsidies are once again using a study out of Iowa State to bolster their case, and once again, it doesn’t.  This year’s study, “The Impact of Ethanol Production on U.S. and Regional Gasoline Markets: An Update to 2012,” is an update to their previous work. In reviewing that work, here’s what the Institute for Energy Research concluded:

"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."

The studies’ authors concede as much:

"Because these results are based on capacity, it would be wrong to extrapolate the results to today's markets."

And yet, ethanol’s supporters extrapolate away. Here’s more on why they shouldn’t.

Common Sense:  The Renewable Fuel Standard (RFS) mandates ethanol volume that must be consumed in the U.S., and motor gasoline fuel in the U.S. is nearly saturated with ethanol at current legal limits.  The U.S. is a net exporter of ethanol.  It doesn’t make sense that incremental ethanol production results in downward pressure on gasoline markets. 

Questionable Results:  The results for 2011, even to the report’s own authors, are questionable, and possibly invalid.  Specifically, the authors say: 

"The results for 2011 are very large. These results may be questionable because we multiply a mean coefficient that is estimated over the entire sample period against data that is specific to the end of the sample period. We can be much more confident in the statistical accuracy of the estimated average impact but this estimate is not relevant to the current debate because ethanol production has surged since the mid-point of the historic data."

They correctly identify that ethanol has a 2-3 percent decrease in range when compared to gasoline, and then go on to say that its energy value is about 9 cents per gallon. They then indicate that ethanol is blended with gasoline primarily for its additive properties, such as boosting octane and oxygen content.

First, seven years ago the oxygen mandate was removed when the Energy Policy Act of 2005 was signed into law, so oxygen content is not a property the refiners are seeking. Second, to meet the RFS, refiners are required to blend gasoline with as much ethanol as possible. Indeed, the amount that can be blended today that will work in all vehicles and small engines is a 10 percent ethanol blend.  The study does not consider the possibility that without the ethanol mandates, refiners might modify their manufacturing process to produce a fuel that does not require ethanol.  Yet, the authors say, none of this makes any difference to the overall conclusions.  How can that be?

Exaggerations Abound:  The benefits of small increases in ethanol manufacturing for 2011 are overly exaggerated, especially in the context of essentially unchanged ethanol consumption between 2010 and 2011 (EIA reports an increase from 12.86 billion gallons to 12.87 billion gallons, respectively).  The report is exaggerated because this small increase does not account for increased ethanol exports. We support the manufacturing of ethanol, but we must be realistic and recognize that increased production of ethanol that is above what can be used in the U.S. is not likely to have the ability to impact gasoline prices in the U.S.

A Bad Model:  This analysis is deeply flawed as it relies on an out-of-date model that doesn’t reflect current markets.  Beginning in January 2010, the U.S. became a net exporter of ethanol.  This is a critical structural change in the U.S. ethanol industry.  However, this aspect is not included in the report’s econometric model.  This is a serious omission and doesn’t accurately reflect ethanol’s impact.  The authors indicate that: “…U.S. prices are lower than EU prices by an amount equal to transportation costs.  In context a $1.09 per gallon marginal impact for 2011 seems reasonable.” However, transportation costs on gasoline have been typically only pennies per gallon, and stating that $1.09 is “reasonable” does not pass the red-face test. As Marlo Lewis notes:

“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?”

Inaccurate statements:  The report states that the surge in ethanol production has essentially added 10 percent volume to the fuel supply, and that to remove the ethanol fraction of gasoline would decrease supply, which in turn would raise gas prices when demand is held constant. More accurately, the RFS mandate to blend ethanol has displaced 10 percent of the petroleum portion of gasoline and replaced it with ethanol.  This reduced need for gasoline has contributed to such unintended consequences as reduced refinery runs and refinery shutdowns.  The report also ignores the fact that the current economic recession has further reduced gasoline demand.  The report states that as a result of ethanol, the U.S. has been able to reverse trade patterns and export gasoline. The study doesn’t appear to take into account gasoline blending components. The U.S. still remains a net importer of gasoline and blendstocks.  Here is the Energy Information Administration U.S. Gasoline Balance for 2011:

API supports a realistic and workable Renewable Fuel Standard.  But, the U.S. will soon hit the 10 percent ethanol “blend wall,” where the vehicle fleet will no longer be able to tolerate additional ethanol in the gasoline supply.  The negative economic impact of hitting the blend wall may be substantial and is not addressed in the report.  So what is this “blend wall?”  Autoblog.com explains:

“What's this blend wall term that's tossed around in the corn fields of this country? Basically, ethanol demand is maxed out at the current 10 percent blend rate and production has hit a ceiling. So, unless either gas demand increases or the blend rate goes up, there's just no need for any more ethanol at the pump.”

As we have seen, gasoline demand is not increasing in the United States, and with the new CAFE standards it is unlikely to increase, so ethanol producers are seeking to increase the blend rate. But rather than trying to expand their U.S. market by having the federal government force U.S. consumers to use their products, ethanol producers should pursue new markets –via exports–not new mandates.

ABOUT THE AUTHOR

Mark Green joined API after a career in newspaper journalism, including 16 years as national editorial writer for The Oklahoman in the paper’s Washington bureau. Mark also was a reporter, copy editor and sports editor. He earned his journalism degree from the University of Oklahoma and master’s in journalism and public affairs from American University. He and his wife Pamela live in Occoquan, Va., where they enjoy their four grandchildren.