MIT and UC Davis Scholars Agree: Ethanol Hasn’t Made Gasoline Cheaper

Back in May, we posted a critique of a Center for Agricultural and Rural Development (CARD) study that purported to show how ethanol mandates and subsidies had held down gasoline prices for American motorists. We pointed out that despite its fancy bells and regression analysis, the study—which was touted by the Renewable Fuels Association (RFA) and other pro-ethanol groups—was based on a simple mistake: It assumed that the conventional refining sector would be exactly the same, with or without government support of ethanol, and therefore “concluded” that there would be a lot less refined fuel for Americans if all of the ethanol suddenly disappeared.

If the government didn’t use tax preferences and mandates to artificially enlarge the role of ethanol in American fuel, then conventional petroleum refining would have grown faster than it actually did. Thus, the supply of fuel for motorists would not be any lower, and gasoline prices would not be higher, if the government had never supported ethanol. The pro-ethanol CARD study was doing the equivalent of someone saying that communism was necessary in North Korea, because clearly the free market wasn’t providing much food to those people. (I spelled out the evidence more comprehensively back in 2011 in response to an earlier version of the pro-ethanol study.)

Thanks to a tip from Marlo Lewis, we see that a new scholarly article [.pdf] (by economists from MIT and UC Davis) makes similar points to my earlier points. Here’s Lewis quoting and summarizing the study:

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 exceeded 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.”

Economics articles, especially when chock full of equations, can sometimes be used to reach absurd conclusions—in CARD’s case, the claim that government’s inefficient ethanol policies have made gasoline more than a dollar per gallon cheaper in 2011. In such cases, we can use our common sense to find the flaws. But, as the new paper by economists from MIT and UC Davis shows, we can also go through and illustrate the errors with a jargon-rich, mathematical paper too. When something is wrong, fancy math can’t salvage it.