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Is the Ethanol Mandate Pumping Up Gas Prices?

by Michael Levi
April 1, 2013


An esoteric fight of the Renewable Fuels Standard (RFS2), which mandates that the United States use an increasing volume of ethanol each year, has become a bit more prominent in recent weeks, with some accusing the mandate of contributing to rising gasoline prices in new and troubling ways. I remain perplexed as to what exactly is going on – more on that a bit further down – but I do find the defense from the Renewable Fuels Association, published last week in the form of a white paper commissioned from Informa Economics, hugely unpersuasive.

The basics of what’s happening are broadly agreed. There is controversy over whether large numbers of U.S. cars can safely use fuel that contains more than 10 percent ethanol. For all practical purposes, then, refiners and blenders don’t want to use more than 10 percent ethanol in the fuel they produce. Meanwhile, the RFS2 is mandating increasing use of ethanol – and, because of high gasoline prices and improving fuel economy, total U.S. fuel consumption is falling at the same time. This squeeze from both sides means that the United States has hit the “blend wall” – the point at which it can’t use any more ethanol without breaching the 10 percent threshold – far earlier than anyone expected. It is impossible to comply with the volume requirements of RFS2 and avoid the blend wall at the same time.

For the time being, though, there’s a way out. In years when ethanol producers make more ethanol than the mandate requires, they generate a surplus of something called Renewable Identification Numbers, or RINs. They can bank those for the next year. Before 2012, when ethanol subsidies stopped, producers built up a surplus of RINs; part of that surplus remains. Blenders and refiners can buy these RINs instead of actually blending ethanol into their fuel. That’s how they’re dealing with the current crunch: they’re buying RINs instead of blending the full mandated volume of ethanol. The problem is that there’s a limited supply of RINs, so prices for them have skyrocketed. It’s those super-high RIN prices that people are now blaming for higher prices at the pump.

The big question is this: How much are high RIN prices actually inflating fuel prices? And how might that impact evolve? The new industry association paper claims that the impact is tiny, and that, once you factor in the relatively low price of ethanol, RFS2 is still producing net benefits for consumers. But their analysis doesn’t hold up.

Let’s start with the biggest whopper. The white paper observes that wholesale gasoline (they measure this in Chicago) was $2.81/gallon on average this year, while wholesale ethanol cost $2.37/gallon. They thus claim that blending ethanol into gasoline lowers prices. Set aside for a moment some subtle issues about how prices are set; what’s amazing here is that they apparently don’t account for the fact that a gallon of gasoline has 50 percent more energy than a gallon of ethanol. Blending ethanol lowers the price of a gallon of fuel – but that gallon of fuel now gets you less mileage in your car. The net result is to increase the cost of driving. Claiming in this way that ethanol blending lowers fuel costs is like claiming that buying smaller boxes of cereal lowers the cost of getting yourself a nutritious breakfast.

Now for the more complicated part: the RINs. The industry white paper estimates the number of RINs that will need to be purchased in order to meet the RFS2 mandate and spreads their cost across the full U.S. fuel supply; they use that to estimate a price increase of between $0.004 and $0.02 due to RIN purchases. But prices aren’t set by average costs. What sets the price of fuel at the pump is the marginal cost, i.e. the cost of the most expensive gallon of fuel that’s sold. The big question, then, is what that marginal gallon is. The answer is either (a) a gallon of gasoline plus an appropriate volume of RINs, or (b) a gallon of fuel that’s a mix of gasoline and ethanol. (Perhaps it could be something in between too.) I can’t quite wrap my head around the answer –that might be the subject for another post or a real study (or someone will email along a good analysis) – but it certainly isn’t what the industry white paper claims. My instinct is that if the answer isn’t (a), things will eventually end up there, since the cost of ethanol is bounded above, while the price of RINs isn’t. And, if that’s right, we may see a big pump price run-up before too long.

It’s critical that we think through this now. At some point in the not-too-distant future, unless U.S. fuel demand rebounds, the surplus of RINs will presumably be exhausted. At that point all bets are off when it comes to the market impacts. Best to figure this out now, and come up with good policy adjustments if those are needed, rather than deal with this when things are much worse.

Post a Comment 5 Comments

  • Posted by Larry Johnson

    Mr Levi’s most correct statement is that we should think this through now but his other conculsions are flawed. Blending ethanol at 15% is not a mandate but an option; one that the oil industry is doing all it can to prevent.

    The reason refiners don’t want to blend additional ethanol is because it is not their product and they cannot control it. Ethanol has been proven to be safe by extensive EPA testing and the rules have been written for its commercial sale.

    Blending ethanol absolutely does lower the cost per gallon but the cost saving is not passed on to consumers, it is added to oil company profits. The amount that ethanol lowers mileage is variable with the blend and the specific vehicle but the reduction averages less than the reduced energy content, due to its more complete combustion.

    Yes, the RIN issue is more complicated but refiners currently hold 2.5 billion RINs enough to last into 2015. Only about 300 million may be needed this year to comply with the RFS requirements. Therefore the price impact today only affects the gallons that are short of the required blending amount; about 300 million gallons. Even if RINs cost a dollar, when spread over all gasoline sold, the cost passed on to consumers should not exceed $0.0022/gallon, ($300 million ÷ 135 billion gallons of gasoline used).

    The RFS and RINs are working as envisioned by Congress when they passed it in 2007. As world market conditions change let’s react to facts and reality, not hysteric lobbying tactics and sensationalist media.

  • Posted by Aaron

    Thanks for an informative post, Michael. You’ve answered your own question, however. Since we are past the blend wall, the marginal gallon is set by RINS and not by ethanol.

  • Posted by Chad

    The EPA tested E15, sure. However, the average age of a vehicle in the US is 11 years old – so for every brand new vehicle (like those tested by the EPA) there is one about 20 years old. Do we really think the effect will be the same on a 2012 model as a 1992 model?
    Second, refiners really don’t give a flip about whether they are selling petroleum or soy based products. They want to sell the best product they can at the highest price. As consumers we want to buy the best product we can at the lowest price. If a perverse mandate requires that the refiners introduce products that break the fuel injection in 30% of vehicles, what do you think will happen to the refiners? Class action lawsuit anyone?
    “These evil oil companies blended in too much ethanol in order to avoid buying RINs and destroyed my beloved Ford Fiesta”

    Before you jump to replacing the old vehicles think about who it would affect? Who exactly owns 1982 Hondas? It is certainly not the wealthy. So if we want to mandate that everyone purchase an E85 vehicle we are placing the greatest burden on the poorest people. If we say “tax the evil oil companies to pay for it” – who do you think will suffer the greatest from the higer gasoline prices inflicted from higher taxes?

  • Posted by Louis

    The ethanol problem on the street is the fact that older vehicles are exposed to mechanical issues that could arise from alcohol. Retrofitting the fuel delivery systems of older vehicles is a solution. This is not particle physics here, basic science. In one broad stroke the federal gov could help the nation of thrifty motorists with car aid……perhaps it’s not completely win win but it would otherwise be a small boon for all the thousands of auto shops around the country, they really deserve and need this just as the Midwestern farmers who are now swimming in ethanol cash. Then the country once and for all could move forward on this. Another fact that rarely is discussed is the simple fact that raising the cylinder compression of an alcohol engine highly improves the energy output thus nearly leveling ethanol with standard gasoline. Car manufactures know this but are rather mum on the subject. We need to conserve on oil period and this agricultural substitute has opened the scientific door in America for all the rich kids to embrace, which fortunately they are doing. It will be the next gen who rights the ship so I guess patience is what we should really be fermenting.

  • Posted by Charlie Peters

    Fuel ethanol stinks.

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