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Several years ago, a study found that, between 2000 and 2010, the benefits of ethanol included reducing U.S. wholesale gasoline prices by nearly 28 cents per gallon nationwide.

May 29, 2012

7 Min Read

Several years ago, a study produced by Iowa State University’s Center for Agricultural and Rural Development found that, between 2000 and 2010, the benefits of ethanol included reducing U.S. wholesale gasoline prices by nearly 28 cents per gallon nationwide.

“That study wasn’t funded by anyone -- it was done because we were academically interested in the subject,” said professor Dermot Hayes, who authored the study with then-graduate student Xiaodong Du. “We sent it to a peer-reviewed journal, Energy Policy, and it was accepted and published.”

Du, said Hayes during a press call, “was interested in the whole crude oil market, in general, for his dissertation. He and I were trying to understand the link between corn prices and the energy value of corn. We were tracking those markets looking at historical data and had originally linked the price of corn to the price of crude oil via the relationship between gasoline and crude oil.”

(For more, see: Where would gas prices go if ethanol was removed?)

The pair noticed the historical relationship between gasoline and crude oil was “breaking down. Crude oil was strong but gas prices weren’t as strong. In particular, the price of diesel continued to track crude oil but the price of gasoline fell below its historic relationship.”

They decided to see what might explain observed patterns. “There are hundreds of issues that influence gasoline prices and the price of gasoline relative to crude oil. In our paper, we tried to control for all other forces such as hurricanes that might occur in a month and the stocks being held in the United States and elsewhere. … We took those out of the equation and what was left was the impact of ethanol on gasoline prices.

“We hypothesized that in areas of the country where ethanol penetration was greatest, the impact would be largest. We discovered that nationwide the impact of ethanol on gasoline was to reduce prices by about 28 cents per gallon. The impact in the Midwest was much greater – in excess of 40 cents.”

(For more, see: Don't pin gas prices on corn and ethanol)

Understandably, the study caught the eye of the Renewable Fuels Association (RFA) and the advocacy group funded an update to include 2011 data.

“Last year, we were careening toward $5 gasoline,” said Bob Dineen, RFA president and CEO. “Because of ethanol, because of the Renewable Fuel Standard requiring refiners to use renewable fuels, consumers were given some measure of relief.”

The RFA’s frustration, explained Hayes, “was that the original work was done for the period of 2000 to 2010. They knew the amount of ethanol had grown tremendously since then and they asked us to continue to update the work. We’ve done that for the last two years.”

Now, on a nationwide basis, the impact measured is greater by about 2 cents per gallon – 29 cents.

That figure, said Hayes “seems like a large number on a nationwide basis. What helped me understand why that number is so large is that we used to have big spikes in gasoline prices when the refining industry approached capacity…

“We haven’t seen such spikes in gasoline (lately) because we’ve found a new way to produce ‘gasoline.’ We don’t have a refinery capacity problem anymore because we’ve added 10 percent to that capacity. … In any market, if you increase supply, you’ll get a price reduction.”

What impact would more ethanol production – say, 12 billion to 14 billion gallons -- have on the nation? “In our update, we hypothesize that the impact of each billion gallons on the price of gasoline was linear. We took the … 29 cents and multiplied it by the proportion increase in ethanol. (That provided) the much larger numbers” in the updated report.

Those burgeoning numbers “forced” Hayes to three possibilities.

  • From net importer to net exporter.

“At the beginning of the (considered) period, the United States was a net importer of gasoline and now it’s a net exporter. Whenever a country moves from being an importer to an exporter, the domestic prices go from world price plus transportation costs to world price minus transportation costs.”

  • Refining capacity.

“Think about the world before ethanol occurred,” said Hayes. “Every time a gasoline refinery shut down, the price of gasoline would go up 10 or 20 cents. That was because the United States was at its refining capacity. Ethanol has, essentially, increased the U.S. refining capacity by about 10 percent.”

  • The magic bullet.

Lastly, “imagine that instead of producing gasoline, the refineries had found a magic bullet that could squeeze 10 percent more gasoline – not more diesel -- out of every barrel of crude oil. You’d expect a big effect on gasoline prices with no effect on diesel. That’s what we’ve observed historically. Back in the late 1990s, gasoline sold at a premium to diesel. Now, the opposite is true and that’s because we’ve found the magic bullet – we produce an amount of ethanol equal to about 10 percent of the gasoline we consume.”

Feed versus fuel

Hayes is not an ethanol cheerleader without hesitation. In the earlier report, the CARD economists considered what might happen to U.S. gasoline prices if ethanol suddenly went away. That issue was not included in the study update. Why not?

“We do now depend on ethanol to provide 10 percent of our gasoline supply,” said Hayes. “Ethanol is made with a product, corn, whose yields are determined by weather. There can be a year when we have bad corn harvests and, therefore, reduced ability of ethanol production. That’s a real issue.

“The big concern for me is that in 1995-1996, the United States literally ran out of corn and had to harvest new crop, wet corn to feed our animals. So, supply scarcity of corn can occur.

“If you look at the futures market, there are some people who are concerned that we could have a scarcity of corn this summer. Everyone assumes if there is a scarcity, we’ll shut down the biggest user of corn, which is ethanol.

“But the summer is when we drive most often. We simply can’t take 10 percent of the gasoline out of production by shutting down ethanol overnight. … It would be like shutting down 10 percent of the refineries. We’d have a big price spike in gasoline until we could start importing it again.

“It’s a concern and I tried to raise it. It didn’t go anywhere and nobody seemed to be too worried about it so I didn’t (include) it in this year’s report.”

What about ethanol impact on the U.S. livestock sector? Higher feed costs are often attributed to ethanol production but might that input cost be mitigated by lower fuel costs on the ranch?

Hayes and Du have not looked at that. “But what the whole industry has done is link the price of corn to its energy value,” said Hayes. “And energy values have increased, so corn prices have increased. Without that link, corn prices wouldn’t be as high. That’s pretty clear to me.

“The negative impact on the livestock industry has been more detrimental than the benefit those livestock farmers get by buying less expensive gasoline. Remember, they’re using gasoline for their personal cars. But tractors run on diesel and diesel, of course, hasn’t been impacted by the availability of ethanol.”

As for ethanol’s future, Hayes believes the country “has probably built the last ethanol plant. I don’t see continued expansion in the industry.

“I do expect corn yields to continue to grow. As corn yields grow, the impact of ethanol on the corn market will be less. Therefore, I wouldn’t expect continued increases in food prices resulting from the use of corn for ethanol.”

Dineen pointed out that the latest USDA figures project “a record corn crop based on what was planted so far this spring and what has emerged. We’re looking at a carryout close to 2 billion bushels.

“I think the American farmer has responded to the challenge and demonstrated he's up to that challenge. And he’ll certainly produce enough corn to meet the feed, food, fiber and fuel needs of the country.”

Dineen said the study would be provided to Congress and the public “to understand just how much a growing and evolving U.S. ethanol industry is benefitting their pocketbooks. Clearly, the 13.5 billion gallons of ethanol used last year had a tremendous impact on reducing gasoline costs and saving consumers at the pump.”

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